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2012 ERM SymposiumRisk & Risk
Management
Tom Mount, Vice PresidentA.M. Best CompanyApril 20, 2012
Agenda
• Risk Management – Risk Management & Rating Process– Changes to rating process– Impact on rating– Example & Sample Text– Qualitative benchmarks– Observations from last year’s ERM SRQ
Risk Management
Risk Management is the common thread that links balance sheet strength, operating performance, and business profile.
Risk Management = (Identify + Understand + Measure + Manage) Risk
AMB is Looking for a Practical Approach to Risk Management
• Tailored to your business and risk profile – Process must fit your company, not the other way around– Pick the right tool for the job, not just the most expensive one– Risk management will be defined differently by each company
• Function over form– CRO’s and sophisticated models are not absolute pre-requisites
for strong risk management – For some insurers, strong risk management may be a more
traditional approach supplemented by an understanding of how risks correlate
• Flexible and adaptive to the changing business environment– Strong risk management is not a finitely defined set of tasks– Ongoing process…emerging risks…risk learning
Risk Management Spectrum • Wide spectrum of risk
management tools, techniques, and approaches
• Differences in geographic and product complexity/diversity, as well as management team skill sets and mind sets, must be considered – Approaches range from a
traditional “silo” mentality to an integrated ERM platform with ICM, with many hybrids in between
– Companies may migrate from one approach to another over time as their profile, skill set and the business environment changes
• Bottom line: a company’s process must fit its profile and provide a stable, sustainable operating platform in good times and bad
Risk Management and the Rating Process – A Practical Approach
• An open-ended and open-minded assessment of each company’s operating practices that does not pre-judge the effectiveness of a company’s approach to risk management based on a predetermined expectation
• AMB wants companies to “show me” how your risk and capital management process provides a stable, sustainable operating platform that can weather the storm year after year
Risk Management and the Rating Process…
• Top 5 Exposures and Critical Success Factors to Mitigating/Managing these Risks
• Lessons Learned through your Risk Management Development Process
• “Risk Management Questions You Should Address at Every Rating Meeting”
• Next Steps in Risk Management Development
AMB recognizes risk management is an ongoing process.
Demonstrating commitment and progress toward a goal is the key.
Questions You Should Address at Every Rating Meeting
• What is the Board’s and Senior Management’s role in your risk management framework?
• Has your organization established and communicated any risk management objectives to your employees, and other stakeholders?
• What is your risk appetite? How is it measured?• How does your organization encourage good risk-
based decision making? • What is your organization’s process for identifying
and cataloging key risks across your organization?
Questions You Should Address at Every Rating Meeting
• What tools does your organization use to determine required capital? Is it a static, dynamic, or hybrid approach?
• How do you factor in correlation/dependency of individual risks?
• How are liquidity, cash flows, and financial flexibility incorporated into your risk management framework?
• How do you incorporate operational risk and strategic risk in your evaluation of required capital?
• How are emerging risks identified and evaluated?
What Should You Share with AMB?
• Provide AMB whatever materials you feel will help us understand how your organization defines and strives for strong RM – Demonstrate how you identify, understand, measure and
manage risk
– Sample reports used by Board, senior management, etc.
– De-briefing on how risk tools were used to make a strategic or tactical decision…the USE TEST!
– Internal or external assessments of your overall process, or components of your process
Risk Management
• How has our process changed?– SRQ questions on ERM– Rating committee discussion on risk
management & impact on rating– Added a new Risk Management section in
the company reports• Risk management• Stress tests performed• Cat exposure and management• Investment risk management
Risk ManagementRating committee discussion:
What is the impact of a company’s Risk Management on the company’s rating?
Need to know two things:
Company’s risk management
capability
Company’s risk profile
Risk Management
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Risk ProfileRisk Management
Capability
A company’s risk management capability needs to meet its risk profile
Superior
Strong
Good
Weak
Risk Management
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Risk ProfileRisk Management
Capability
A company’s risk management capability needs to meet its risk profile
Superior
Strong
Good
Weak
Negative Rating Factor/Potentially
Higher Capital Requirements
Risk Management
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Risk ProfileRisk Management
Capability
A company’s risk management capability needs to meet its risk profile
Superior
Strong
Good
Weak
Positive Rating Factor/Potentially
Lower Capital Requirements
Risk Management
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Risk Profile
Characteristics for Low Risk Profile:
Low volatility in earnings and capital
Favorable regulatory/judicial environment
Low severity claims / low limit policies
Limited competition / stable pricing
Standardized/unchanging coverages
Low leverage measures
Strong reinsurance protection
Strong financial flexibility
High liquid / stable investments
Stable economic environment
Strong data capture/quality
Risk Management
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Risk Profile
Characteristics for High Risk Profile:
High volatility in earnings and capital
Unfavorable regulatory/judicial environments
High severity / low frequency claims
High policy limits / excess layers
Strong competition / inadequate pricing
New/changing/complex coverages & products
High leverage measures
Weak / no reinsurance protection
Weak / no financial flexibility
Illiquid / volatile / complex investments
Unstable / multiple economic environments
Weak data capture/quality
Risk Management
Risk Management Capability
Superior
Strong
Good
Weak
Characteristics of Good RM Capability:
Good traditional risk management (silos):• Market Risk• Credit Risk• UW Risk• Operational Risk• Strategic Risk
Good capital management:• Earnings• Debt market• Equity market• Good knowledge of BCAR
Good management and management info:• Good decision making• Traditional metrics• Reliable projections• Risk aware culture
Limited ERM Capabilities
Risk Management
Risk Management Capability
Superior
Strong
Good
Weak
Characteristics of Superior RM Capability:
• Superior traditional risk management
• Superior capital management
• Superior management and management info
• Superior ERM Capabilities:• Corporate wide risk aware culture• Experienced CRO / ERM committee• Well quantified risk appetite / risk tolerance• Superior risk identification/
quantification/mitigation/monitoring/ controls• Superior Knowledge of Correlations
• Across lines of business• Across risk categories • Superior Economic Capital Model• Decisions based on risk metrics• Compensation based on risk metrics• Frequent “what if” scenario testing
Risk Management
Company’s Risk Management
Capability
Therefore – A qualitative assessment of a company’s Risk Management capability requires reviewing its Traditional risk management capability and its Enterprise risk management
capability.
Superior
Strong
Good
Weak
Enterprise Risk Management
Capability
Superior
Strong
Good
Weak
Traditional Risk Management
Capability
Superior
Strong
Good
Weak
Risk ManagementLet’s do an example:LRP Company is a regional personal lines company with $200m of PHS that writes personal auto liability and physical damage in 5 states and has the following characteristics:
Low volatility in earnings – average ROE of 5% +/- 2pts over 10 yearsConsistent stable growth in PHS from UW profit and some investment incomeOnly operates in states with Favorable regulatory/judicial environmentMost policies have limits of 100K or lower, but some 300k and 500k
Some financial flexibility – publicly traded stock co. w/ debt = 10% of total capitalHighly liquid / stable investments – mostly US treasuries and AAA corpsStable economic environmentCompany has strong data capture/quality and long history of data
Company is in top 5 market share in each stateSome competition but competitors not overly aggressive so stable adeq pricingStandardized/unchanging personal auto coveragesLow leverage measures – (NPW/PHS = 0.6 :1) (Net reserves/PHS = 0.8:1)Strong reinsurance protection – losses over 100k per occ ceded to A+ reinsurer
Risk Management
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Risk ProfileRisk Management
Capability
A company’s risk management capability needs to meet its risk profile
Superior
Strong
Good
Weak
LRP Company
Risk ManagementQualitative review of LRP Company’s Traditional risk management
capability:Traditional Risk
Management Capability
Superior
Strong
Good
Weak
Strong traditional risk management (silos):Market Risk – manages to short durations, low volatility,
no concentrationsCredit Risk – manages to low credit risk - US Tbills, AAA corps, A+ reins, no overdue balUW Risk – manages different states well, monitors results
frequently, by agent, territory, etcOperational Risk – Low ee turnover, ee training, data secureStrategic Risk - extensive research before enter new states
Good capital management:Earnings – manages to good mix of UW profit vs interestDebt market – manages to low debt level (10% of capital)Equity market – has shelf registration approvedKnows BCAR score, but not how model works
Superior management and management info:Superior track record and extensive experience Traditional metrics – Combined, Operating, ROR, ROEReliable projections – consistently meets projections
Risk ManagementQualitative review of LRP Company’s Enterprise risk management
capability:Enterprise Risk Management
Capability
Superior
Strong
Good
Weak
Risk Culture:CEO meets individually with CFO, CUO, COONo CRO / No ERM committee/ No holistic viewNo risk based metrics presented to board
Risk Identification/Measurement/Monitoring:No formally quantified overall risk appetite/risk toleranceNo attempt to quantify correlations:
Across statesAcross linesAcross silos
No what if testing of:Inflation impacts on reserves, pricingBond defaultsNew competitors
Economic Capital Model – Does not have oneDecisions based on traditional metricsCompensation based on growth and Op ratio
Risk Management
LRP Company’s Risk Management
Capability
Superior
StrongOverall RM
Good
Weak
Enterprise Risk Management
Capability
Superior
Strong
Good
Weak
Traditional Risk Management
Capability
Superior
Strong
Good
Weak
Overall qualitative assessment of LRP Company’s Risk Management capability:
Risk Management
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Risk ProfileRisk Management
Capability
LRP company’s risk management capability needs to meet its risk profile:
Superior
Strong
Overall RM
Good
Weak
Positive Rating Factor/Potentially
Lower Capital Requirements
Risk Management
• Benefits to improved risk management– Potentially greater outside stakeholder
confidence• Policyholders/Investors• Creditors• Reinsurers• Regulators• Rating agencies
– Potentially lower capital requirements• After impacts observed in results over time
– Consistent or consistently within expectations
– Potentially more efficient capital allocation– Potential opportunities based on risk/reward
Risk Management and BCARRisk Management and BCAR – A.M. Best’s Traditional Approach
Exposure to Earnings and Capital Volatility
Strong Risk Management
BCAR Guidelines
Weak Risk Management
Risk Management
The company has a chief underwriter who is responsible for ensuring the company’s underwriting guidelines are being adhered to. Loss ratios and reserves are reviewed quarterly by the company’s actuaries to ensure pricing and reserve adequacy. Results are monitored at the agent and state levels. The company also monitors competitor’s rate filings on a monthly basis. Routine claim audits ensure consistent claims settlement practices across all claim offices. Results are presented quarterly to the board using traditional statutory and GAAP financials.
The company does not have a formally stated overall risk appetite/ tolerance and does not measure results on a risk adjusted basis.
The company does not have a formal ERM program to measure risk correlations but has identified what it believes are its 5 largest risks and has developed a risk mitigation plan for these risks & assigned a risk owner.
The company has a committee to research strategic opportunities.
Sample Text in Best’s Insurance Report:
Risk Management
HIGH RISKExcessLong tail liab (WC, Occ)Catastrophe Exposed
MODERATE RISKMedium tail liab (Prof, CM)Non-Cat prop (HO, CProp)
LOW RISKShort tail liab (Auto)Auto PhysSmall value property
Line of Business Correlation of Lines
Qualitative benchmarks for risk profile characteristics:
Volatility
HIGH RISKHigh volatility in:LRs, Combined, OpRatio, ROE, RORCapital, etc.
MODERATE RISKModerate volatility in:LRs, Combined, OpRatio, ROE, RORCapital, etc.
LOW RISKLow volatility in:LRs, Combined, OpRatio, ROE, RORCapital, etc.
HIGH RISKHighly correlatedmovement in losses, esp.esp. in tail
MODERATE RISKIndependent movementin losses
LOW RISKNegative correlationNatural hedges
Risk Management
HIGH RISKLow frequencyHigh severity
MODERATE RISKModerate frequencyModerate severity
LOW RISKHigh frequencyLow severity
Frequency and Severity of
Claims
Product/Coverage Changes
Qualitative benchmarks for risk profile characteristics:
Policy Limits
HIGH RISKHigh limits(over $1m)(over 10% of PHS)
MODERATE RISKModerate limits($100k to $1m)(1% to 10% of PHS)
LOW RISKLow limits(under $100k)(under 1% of PHS)
HIGH RISKFrequent changesMultiple coverage optionsManuscript policiesComplex, untested
MODERATE RISKOccasional changesFew coverages offeredStandardized policies
LOW RISKMinimal changesLimited coverage optionsStandardized legallyaccepted/proven policies
Risk Management
HIGH RISKAggressive competitor(s)and wide spread
MODERATE RISKSome competition on rate or localized competition
LOW RISKNo competition onrate anywhere
CompetitionJudicial
Environment
Qualitative benchmarks for risk profile characteristics:Legislative/Regulatory
Environment
HIGH RISKDifficult to get rate orpolicy changesSlow response
MODERATE RISKSmall rate changesapproved but largerrate change difficult
LOW RISKCooperative ins deptApprovals routineNo political obstacles
HIGH RISKFrequent adverse verdictsFrequent high awardsUnpredictable outcomes
MODERATE RISKOccasional adverse orvaries by jurisdiction
LOW RISKPredictable awardsConsistent outcomes
Risk Management
HIGH RISKLow rated fixed incomeConcentrations, illiquidHigh % in equitiesSpeculative derivatives
MODERATE RISKMostly highly ratedMostly liquidModerate % in equitiesMinimal speculation
LOW RISKHighly rated fixed incomeWell diversified, liquidLow % in equitiesHedging with derivatives
InvestmentsEconomic
Environment
Qualitative benchmarks for risk profile characteristics:
Financial FlexibilityHIGH RISK
No access to equity mktNo access to debt mktExisting high level of debtTight credit conditions
MODERATE RISKLimited access or onlyaccess to one mktSome existing debtCredit avail, but expensive
LOW RISKProven access to equity mktProven debt raising/payoffLow levels of existing debtLoose credit conditions
HIGH RISKVolatile interest rateUnstable/high inflationProlonged recessionHigh fraud
MODERATE RISKSmall int rate movementsSmall chgs in inflation rateEconomy unpredictableSome fraud
LOW RISKStable interest rateStable manageable inflationStable economic growthLow fraud
Risk Management
HIGH RISKHigh concentrationsLine, state, agent, etc.
MODERATE RISKSome concentrations inportions of operations
LOW RISKNo concentrations
Concentration Growth
Qualitative benchmarks for risk profile characteristics:
Data Quality
HIGH RISKPoor data qualityData outdatedInappropriate for decision
MODERATE RISKSome data missingSome data miscoded/bulk
LOW RISKHigh quality dataObtained quicklyAdequate for decisionRegular testing of data
HIGH RISKNew line, new state,New country, new agentsExcessive level of growthInadequate ratesInadequate expertise
MODERATE RISKNew product in existing linew/ current agentsManagement expertise ingrowth lines/jurisdictions
LOW RISKStable sustainable growthIn line with economic growthGrowth in existing line/areasFavorable rate environment
Risk Management
HIGH RISKUnratedB or belowNo collateral
MODERATE RISKB+, B++, A-Collateral on lower ratedonly
LOW RISKA or aboveCollateralized
Credit Quality of Reinsurance
Impact of Reins Program
Qualitative benchmarks for risk profile characteristics:
Ceded Leverage
HIGH RISKRecov/PHS > 100%
MODERATE RISK100% > Recov/PHS > 25%
LOW RISKRecov/PHS < 25%
HIGH RISKHigh Retained ExposureParametric basedNo reinstatesExposure to frequencyCaps, corridors, APs
MODERATE RISKModerate RetainedExposure
LOW RISKLow Retained ExposureIndemnity basedMultiple reinstatesNo caps, corridors, APs
Risk Management
Note:
Some of these qualitative factors vary by line of business or by location or both!
Some of these will change over time too!
The company’s risk profile is constantly changing and the appropriate level of risk management must move with it!
Therefore, risk management must be an on-going process!
ERM SRQ Observations
Although the industry is making progress in its efforts toimprove its ERM, it would appear that the industry has a long way to
go.
Risk ManagementAt what level do you define risk tolerance?
86%
45%
40%
32%
29%
22%
10%
0% 20% 40% 60% 80% 100%
Overall
Line of Business
Policy
Business Unity
Legal Entity
Account
Other
Percent of All Respondents
Risk Identification / Measurement / Monitoring
Risk ManagementWhat is management’s overall appetite/tolerance for
risk?
Inadequate Responses:
Highly conservative, Moderately conservative Generally conservative at most moderately conservativeLow, Very Low, Low to moderatePrimarily low, with some tolerance for mediumRisk averse, Very limitedMaintain 250 BCAR
At least 90% of the responses fell into the category of Inadequate Responses!
Adequate Responses:
Appetite-Minimum limits NSA writer in state x w/low volatility in avg return of y%; Medium size WC account manufacturing risks in all states w/retained limits of $x w/high volatility in avg return of y%; $1m+ Homes in hurricane exposed states but purchase reins so that…
Tolerance-No more than a 2% chance of losing 10% of PHS Annually; 0.5% risk of insolvency over x year period; UW loss no more than once every 15 years and not to exceed more than 10% of PHS
No Response
2%
Yes28%
No70%
EC Models - All Respondents
Risk ManagementDo you use an EC model to quantify your aggregate risk?
Commercial 54%Personal 46%
Commercial 60%Personal 40%
Large 23%Medium 35%Small 42%
Large 52%Medium 32%Small 16%
A++ & A+ 9%A & A- 68%B++ & B+ 18%Vulnerable 4%
A++ & A+ 21%A & A- 70%B++ & B+ 9%Vulnerable 1%
Risk Management
No Response
1%
No 6%
Yes 93%
Those Using EC Models
Do you use the EC model to make key business decisions?
Risk ManagementDo you use the EC model to determine any portion of
management compensation?
No Response
3%No 70%
Yes 27%
Those Using EC Models
Risk ManagementPlanned Mitigation Strategy for Inflation Stress Scenarios:
20%
20%
8%
0% 5% 10% 15% 20% 25%
Adjust Rates
Adjust Reserves
Change Claims Handling
Percent of All Respondents
Those Estimating Inflation Impacts
One Time Reserve
Charge, 44%
Subsequent Yr Adverse Develop,
56%
Reserve Strengthenings 2001-2009
Risk Management
Sch P Part 2 by company
Larger than Previous,
48%Smaller than
Previous, 52%
Reserve Strengthenings 2001-2009
Risk Management
For those companies that had a subsequent strengthening,
Subsequent strengthening was
Sch P Part 2 by company
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