ERM and the Actuarial Profession Don Mango, FCAS, MAAA Director of R&D, GE Insurance Solutions Vice President of R&D, CAS CAS Annual Meeting November 2004

2 / GE / June 7, 2004 GE Insurance Solutions protects people, property and reputations. With over $50bn in combined assets, the GE Insurance Solutions group of companies is one of the world’s leading providers of commercial insurance, reinsurance and risk management services. PROPRIETARY INFORMATION NOTICE The information contained in this document is the property of Employers Reinsurance Corporation, a member of the GE Insurance Solutions group of companies. It should not be reprinted, redistributed or disclosed to others without the express written consent of ERC.

3 / GE / June 7, 2004 About Me Fellow of the Casualty Actuarial Society (FCAS) Vice President of Research for the CAS (through 2005) Involved in ERM initiatives with PRMIA, RMA, Society of Actuaries, International Actuarial Association, Georgia State University, Wharton, RAND Co-report to Chief Actuary and Chief Risk Officer at GE Insurance Solutions Former CRO of American Re-Insurance (US subsidiary of Munich Re)

4 / GE / June 7, 2004 Bottom Line 1.Actuaries are the logical candidates for ERM leadership in insurance and pensions 2.Much of our “risk franchise” has already been co-opted 3.We need to stop thinking protectionist and embrace expansion fearlessly and confidently

5 / GE / June 7, 2004 Benchmarking ERM Practices in a Derivatives Firm

6 / GE / June 7, 2004 ERM Best practices from leading industries Resource: The Practice of Risk Management, Goldman Sachs (GS), Risk Books, 1996  Securities firm risk management market standard reference Insurers and reinsurers sell derivative-like products  Long-dated, illiquid, OTC derivatives on untraded underlyings Learn from GS how to manage risk of a derivatives portfolio Model Standards and Risk Management Not taking any position regarding the accounting treatment of insurance products and embedded options

7 / GE / June 7, 2004 GS: Structure and Skills of Centralized Risk Mgmt Group 1.Risk Monitoring and Analysis 2.Quantitative Analysis 3.Price Verification 4.Model Development 5.Systems Development and Integration

8 / GE / June 7, 2004 Derivatives Risk Management RoleResponsibilityIn Insurance and Pensions Risk Monitoring and Analysis Monitor position and price data Evaluate risk exposures Identify and monitor limit violations Analyze potential scenarios Summarize and report on risk exposures Reconcile with other areas Perform backtesting Monitor reserve and price data Evaluate risk exposures N/A (usually UW risk mgmt) Analyze potential scenarios Summarize and report on risk exposures Reconcile with other areas Perform backtesting (e.g., reserve run-off, actual versus expected)

9 / GE / June 7, 2004 RoleResponsibilityIn Insurance and Pensions Quantitative Analysis Determine modeling for new products Design new quantitative models Test new models Determine modeling for new products Design new quantitative models Test new models Price Verification Verify prices of complex derivatives Track changes in pricing models Verify prices of complex policies, treaties, or books of business Track changes in pricing models and rates Derivatives Risk Management

10 / GE / June 7, 2004 RoleResponsibilityIn Insurance and Pensions Model Development Develop new models for system Develop risk analysis tools Maintain historical return data Develop new models for system Develop risk analysis tools Maintain historical reserving and pricing data Systems Development and Integration Develop infrastructure to support processing Accept feeds from other systems Automate data scrubbing and translation Develop database to support risk data Develop infrastructure to support processing Accept feeds from other systems Automate data scrubbing and translation Develop database to support risk, pricing and reserving data Derivatives Risk Management

11 / GE / June 7, 2004 GS Risk Management Principles No Self-Marked Portfolios Self-marked (to market) = self-valued portfolios Where there may be conflict of interest, incentives to overstate profitability Sound corporate governance and controls Peer review from expert source increases credibility GS has Derivative Price Verification Group  Specialized pricing support to areas with difficult- to-value derivatives

12 / GE / June 7, 2004 Next Steps Implied By This? 1)Actuaries must learn about ERM 2)Actuaries must reframe our traditional roles as part of the larger ERM context 3)Actuaries must prepare to be part of the new Risk Profession (whatever it looks like)

13 / GE / June 7, 2004 Co-Opting the Risk Franchise

14 / GE / June 7, 2004 Actuarial Techniques in the Broader ERM World Credit Risk  One of the established methods is called the “actuarial method”  # of borrowers by rating category = exposure  Default rate by rating category = frequency  Defaults = claim count  Loss given default = severity Operational Risk  Basically an internal actuarial study of loss-generating events  State-of-the-art is basically re- created “Basics of Actuarial Analysis”  Dr. Ali Samad-Khan’s presentation from the 2004 ERM Symposium  04/handouts/samad-khan.pdf 04/handouts/samad-khan.pdf

15 / GE / June 7, 2004 The Actuarial Risk Franchise Is not…  Statistics  Simulation modeling  Risk forecasting Honest self assessment:  We are not world- leading experts in any of these fields Hybrid Professional  Depth and breadth  Scientific methods  Mathematical rigor We may be the prototype for the risk professional of the future But not necessarily the only risk professionals of the future

Thank you for your attention