Enterprise Risk Management at Nationwide Emily Gilde Session: Implementing DFA 2003 CAS Risk and Capital Management Seminar

Key Forces driving ERM at Nationwide: Need for greater centralization Influence of banking industry

Nationwide: an increasingly complex and diverse institution in recent years 30 thousand employees, 60 thousand agents 21 separate P&C companies Financial services company Life Insurance company An international asset management company

DIVERSITY/COMPLEXITY Need for ERM Challenge to Implementing ERM

Banking PhilosophyComfort with ERM CEO, at NW since 2000, former executive VP at Bank One CFO, at NW since 2002, former CFO at Bank One Treasurer, at NW since 2001, former banking executive Office of Corporate Development “hands on” control of ERM tools former bankers sponsor ERM tools at Nationwide

Initial push for ERM: How much capital do we need to prevent insolvency with a very high degree of confidence? How are our lines of business performing on a risk adjusted basis? adoption of RAROC model

RAROC = Risk Adjusted Return on Capital Developed by banks in early 1990’s and in widespread use there today Differs from DFA –Uses a correlation matrix to aggregate risks –Risk measure = Value-At-Risk –Capital adequacy tied to specific bond rating benchmark; e.g. default probability for AA corporate bonds

Current Uses of RAROC at Nationwide: Assessment of capital adequacy Performance measurement Reinsurance optimization Evaluation of new strategic opportunities

Governance of RAROC Model Office of Corporate Development usually leads model development initiates model applications runs the model and publishes results Business Unit “Module” Owners responsible for updating models work with OCD to determine if model changes needed SVP Finance represents Business units – CPA – FCAS – Several Analysts – Investments – Actuarial – Reinsurance – Finance –supervisory role –Key participant in final decision on model changes

Recent Corporate Initiative: Asset- liability management of P&C business RAROC not an appropriate ERM tool for ALM –Relationship between assets and liabilities summarized in a correlation coefficient –Focuses on extreme tail events only ALM DFA

Asset - Liability Management Using DFA: A B C Current portfolio Efficient frontier Different asset portfolios Economic Value Standard deviation of EV Economic Value = MV assets – PV liabilities + PV future business cash flows

ALM: Maximize after-tax Economic Value Subject to: “Hard” constraints: various practical and legal constraints on asset allocations affect the position of the efficient frontier “Soft” constraints: for each asset portfolio on efficient frontier, examine the probability distribution of variables such as statutory surplus and GAAP equity

ALM Decisions: Optimal duration of bond portfolio % of portfolio to hold in market equity % tax exempts Whether or not to invest in “alternative” assets such as TIPS

ERM Implementation Issues: Consistency between models: RAROC & DFA Modeled output viewed as “law” that is either “right” or “wrong” Difficult to elicit unbiased assumptions –tendency to be conservative –on other hand, business plans may reflect “stretch” goals Decentralized organization  Decentralized data and potential inconsistencies

Conclusion ERM is here to stay Vehicle for building consensus and common vision within a complex, decentralized organization