property of tillinghast - towers perrin enterprise risk management papers presentation at cas 2001...
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Property of Tillinghast - Towers Perrin
Enterprise Risk Management Papers
Presentation at CAS 2001 Seminar on Understanding the Enterprise Risk Management Process
Jerry Miccolis, FCAS, MAAA, Tillinghast - Towers PerrinSamir Shah, FSA, MAAA, Tillinghast - Towers Perrin
April 2-3, 2001
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We will be addressing two ERM papers today
“Enterprise Risk Management: An Analytic Approach” by Jerry Miccolis and Samir Shah, Tillinghast - Towers Perrin Monograph, January 2000
“Creating Value through Enterprise Risk Management — A Practical Approach for the Insurance Industry” by Jerry Miccolis and Samir Shah, Tillinghast - Towers Perrin Monograph, April 2001
We will focus primarily on the second paper It represents our most current thinking It illustrates how to practically apply the concepts of the
first paper (within a specific industry) Applications to other industries should be clear
Property of Tillinghast - Towers Perrin
Creating Value through Enterprise Risk Management
A Practical Approach for the Insurance Industry
Value
Gro
wth
Retu
rn
Con
sis
ten
cy
Capital
This document is incomplete without the accompanying discussion; it is confidential and intended solely for the information and benefit of the immediate recipient thereof.
Jerry Miccolis, FCAS, MAAASamir Shah, FSA, MAAA
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Here are some key findings from our recent ERM survey of insurance executives
Executives believe ERM is critical to helping them deal with their key business issues
They are not satisfied with current tools, techniques and processes to implement ERM — especially for dealing with operational risks
They want a more robust conceptual and methodological framework that: Encompasses all relevant risks — both financial and
operational Integrates both financial and operational strategies to
manage those risks
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In our client work, insurers are increasingly asking important risk-related questions
How much capital do we need? And how do we convince the rating agencies?
How should our capital be deployed to business segments?
How can we maximize our return on capital, given our risk appetite?
How do we best invest our assets, given our liability mix?
Can we get a handle on our operational risks?
How can we optimize our distribution channel strategy?
How much, and on what terms, should we reinsure/hedge?
How do we encourage the right risk management behavior?
Are we prepared against our most critical down-side risks?
How can we minimize economic and accounting volatility?
We believe these questions need to be answered within the context of a comprehensive and coherent risk management framework...
We believe these questions need to be answered within the context of a comprehensive and coherent risk management framework...
The RiskValueInsights Framework
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Product andDistribution
Product mix Distribution
strategy Pricing Customer
service
Investments Asset/liability
management Liquidity Market risk
tolerance Tax profile
Organization Hiring/training HR policies Pay and
benefits Communication
Companies are managing a number of separate, but related, activities...
CapitalStructure Equity vs. debt Managing
excess capital Reinsurance Securitization
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…with the overall objective of increasing enterprise value
Increasing returnIncreasing return
Improving consistencyImproving
consistency
Providing appropriate level, structure and allocation of capital
Providing appropriate level, structure and allocation of capital
Enhancing growthEnhancing growth
More on…using Embedded Value as the value measure
More on… the link between consistency and enterprise value
Increase valueIncrease value
by
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The best way to effectively drive value is to understand the full risk environment in which you operate...
Financial
Asset
Liability
Risk
Operational
Event
Business
InternalEnvironment
Expansion/diversification
Culture
Distribution
Risk appetite
People
Processes
Technology
ExternalEnvironme
nt
Economic conditions
Social/legal trends
Political/regulatory climate
Natural catastrophes
Customer behavior
Competition
Investor expectations
Reputation/rating agency
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…and the complete set of strategies available to you…
Risk
Financial
Asset
Liability
Operational
Event
Business
Operational Strategies
Hiring/training
Customer service
Market strategy
Distribution
M&A
Technology
Internal controls
Incentive programs
Financial Strategies
Capital structure
Investment strategy
Pricing
Product mix
Dynamic hedging
Reinsurance
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…and to use this knowledge in a holistic risk management framework
Holisticallymanage
financial and operational
risks
Holisticallymanage
financial and operational
risks
Exploit natural hedges
and portfolio effects
Exploit natural hedges
and portfolio effects
Understand both
internal and
external environment
s
Investigate both
financial and
operational strategies
Increase return
Increase return
Improve consistenc
y
Improve consistenc
y
Establish capitalEstablish capital
Enhance growth
Enhance growth
Increase valueIncrease value
The RiskValueInsights Process
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A continual management process is needed to “operationalize” the framework
Develop Best
Strategies
Develop Best
Strategies
Implement
Strategies
Implement
Strategies
MonitorPerformance and
Environment
MonitorPerformance and
Environment
Operating Margin
0% 2% 4% 6% 8%
1999
Target
2000
8%
7%
6%
8%
7%6.80%
6.50% 6.60%
3.20%
2.50%
1.90%
3.10%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
1997 1998 1999 2000 YTD
yields-new invmts portfolio yields GNP deflator
0
2
4
6
8
10
12
14
16
1997 1998 1999 2000 YTD
# catastrophes # bad faith lawsuits
Set theagenda
Establishbusiness
performancerequirements
Assess organization capabilities
Build the changestrategy
Align & deliver
Leadership
Measurement
Involvement
CommunicationChange
Enablers
Articulate
Strategies
Assess
Risks
Evaluate Strategies: Policyholde
rs’ Perspective
Evaluate Strategies: Owners’ Perspectiv
e
Refine Strategies
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Develop
Developing best strategies involves a five-step exercise
Click on appropriate chevron above to see details of that step
Attribute capital to business segment
Attribute capital to business segment
Establish economic capital
requirement
Establish economic capital
requirement
Link to key performance
indicator(s) via financial model
Link to key performance
indicator(s) via financial model
Identify & overlay financial & operational strategies
Identify & overlay financial & operational strategies
KPI distributio
n
Articulate Strategie
s
Assess Risks
Evaluate Strategies:
Policyholders’ Perspective
Evaluate Strategies:
Owners’ Perspective
Refine Strategies
Decompose risk into root causesDecompose risk into root causes
Isolate impact of each strategy
Isolate impact of each strategy
Set objectives & constraints
Set objectives & constraints
Establish risk & value metrics
for growth, return &
consistency
Establish risk & value metrics
for growth, return &
consistency
Optimize strategies &
sensitivity-test
Optimize strategies &
sensitivity-test
Identify financial & operationa
l risk factors
Identify financial & operationa
l risk factors
Classify & prioritize
risk factors
Classify & prioritize
risk factors
Risk factor distribution
s
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Successfully implementing certain strategies requires a change management process
Implement
Develop Change Capability
Energize and Engage for Broader
Impact
Mobilize First Wave and Secure Early Wins
Focus and Sequence Effort
Articulate the Ambition
Align & DeliverBuild the Change Strategy
Assess Organization Capabilities
Establish Business Performance Requirements
Set the Agenda
DeliverDesign
Leadership
Measurement
Involvement
CommunicationChange Enablers
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Strategy performance and risk environment must be monitored to adjust strategies as necessary
MarketingMarketing
New business sold Retention of old
business Mix of business: new
and renewal Market share
New business sold Retention of old
business Mix of business: new
and renewal Market share
UnderwritingUnderwriting
Price achieved vs. target price
Exposure mix Quotes
accepted/declined Variance analysis
Price achieved vs. target price
Exposure mix Quotes
accepted/declined Variance analysis
ClaimsClaims
Frequency and severity of claims
Claims productivity
Frequency and severity of claims
Claims productivity
FinancialFinancial
Revenue Underwriting profit Investment profit Pre-tax operating income Net income Return on equity and total capital
Revenue Underwriting profit Investment profit Pre-tax operating income Net income Return on equity and total capital
InvestmentsInvestments
Cash flow Yield on new investments Yield on portfolio by class and
duration Convexity of assets Duration of assets Investment mix: new and
portfolio Credit default Total return
Cash flow Yield on new investments Yield on portfolio by class and
duration Convexity of assets Duration of assets Investment mix: new and
portfolio Credit default Total return
Human ResourcesHuman Resources
Agency composition (number, age, service)
Total employment by department Number and percentage
leaving the company Vacancy rates Average salary increase
vs. plan
Agency composition (number, age, service)
Total employment by department Number and percentage
leaving the company Vacancy rates Average salary increase
vs. plan
OtherOther
Audit compliance Inflation rates Interest rates GNP Exposure data (number of
cars, payroll, etc.) Competitor pricing
Audit compliance Inflation rates Interest rates GNP Exposure data (number of
cars, payroll, etc.) Competitor pricing
Monitor
Click here…to see these measures combined as a dashboard for performance management
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Insurance and banking approaches to ERM are -- and should be -- different
Asset risk and liability risk
Liability characteristics: Certainty Liquidity Duration Demand payments
Risk metrics/models: VaR and ECOR/EPD Coherence
Operational risks Business risks and event risks Regulatory pressure Modeling approaches
Summary
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The framework is holistic...
Holisticallymanageall risks
Holisticallymanageall risks
Financial Risk
Operational Risk
Exploit natural hedges
and portfolio effects
Exploit natural hedges
and portfolio effects
Investigate both financial
and operational strategiesCapital
structure
Investment strategy
Pricing
Product mix
Dynamic hedging
Reinsurance
Hiring/training
Customer service
Market strategy
Distribution
M&A
Technology
Internal controls
Incentive programs
Understand both internal and external
environmentsEconomic conditions
Social/legal trends
Political/regulatory climate
Natural catastrophes
Customer behavior
Competition
Investorexpectations
Expansion/diversification
Culture
Distribution
Risk appetite
People
Processes
Technology
Reputation/rating agency
Increase
return
Increase
return
Improve consisten
cy
Improve consisten
cy
Establish capitalEstablish capital
Enhance
growth
Enhance
growth
Increase valueIncrease value
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...The process is complete...
Develop Best
Strategies
Develop Best
Strategies
Implement
Strategies
Implement
Strategies
MonitorPerformance and
Environment
MonitorPerformance and
Environment
Operating Margin
0% 2% 4% 6% 8%
1999
Target
2000
8%
7%
6%
8%
7%6.80%
6.50% 6.60%
3.20%
2.50%
1.90%
3.10%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
1997 1998 1999 2000 YTD
yields-new invmts portfolio yields GNP deflator
0
2
4
6
8
10
12
14
16
1997 1998 1999 2000 YTD
# catastrophes # bad faith lawsuits
Set theagenda
Establishbusiness
performancerequirements
Assess organization capabilities
Build the changestrategy
Align & deliver
Leadership
Measurement
Involvement
CommunicationChange
Enablers
Articulate
Strategies
Assess
Risks
Evaluate Strategies: Policyholde
rs’ Perspective
Evaluate Strategies: Owners’ Perspectiv
e
Refine Strategies
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…And the approach can provide great value
Enables you to determine your appropriate capital level, redeploy unneeded capital and improve return on capital
Permits the proper attribution of capital to business segments and supports performance tracking of each segment
Helps you evaluate alternative capital structures that leverage returns
Provides a method for ensuring that enterprise owners receive proper compensation for risks assumed
Allows you to stabilize earnings and thereby increase enterprise value
Supports the development of an optimal risk financing strategy and program
Provides better information about your company, which increases negotiating leverage with: Reinsurers Rating agencies Capital markets Industry analysts M&A targets