Enterprise Risk Management and the Actuarial Profession 2004 CAS Annual Meeting November 14-16, 2004

1 Participants Moderator: Barry Franklin, FCAS, MAAA Managing Principal Aon Risk Consultants Panelists:Don Mango, FCAS, MAAA Director of Research & Development GE Insurance Solutions Mark Verheyen, FCAS, MAAA Vice President Carvill

2 Discussion Outline CAS ERM Efforts to Date, Practical Examples from Reinsurance – Mark ERM Leadership, The “New” Risk Profession and the Actuarial “Risk Franchise” – Don SOA Efforts to Date, Practical Examples from General Industry – Barry Q&A - All

3 Who Said It? “Is ERM a fad? Absolutely not – it is the science of a well-run company.” Don Mango, NYSE Magazine, October 1, 2004, “The Road to E.R.M.”

SOA ERM Activities

5 SOA Efforts to Date Established a Risk Management Task Force within the SOA Finance Practice Area in 2002 –to address the growing need for information on risk management –to make risk management a regular part of actuarial practice –to advance professional recognition and career opportunities for actuaries in the arena of risk management

6 Risk Management Task Force Implementing Task Force Goals –promotion of actuarial expertise in areas of risk management, –promotion of opportunities for actuaries in the arena of risk management, –sponsorship of seminars on risk management, and –development of new risk management educational materials.

7 Task Force Subgroups –Credit risk management –Economic capital calculation and allocation –Enterprise risk management –Equity modeling –Extreme value models –Health risk management –Policyholder behavior in the tail –Pricing for risk –Risk-based capital covariance –Risk management metrics

8 Risk Management Section The purposes of this Section are to further the education and research in the area of risk management and to establish leading risk management techniques. These efforts should be rigorous and based on sound principles such that resulting techniques are broadly transportable across disciplines and industries. These efforts should help to increase the profile of the actuarial profession as being leaders in the field of risk management. (emphasis added)

9 Other SOA Activities Co-sponsorship of ERM Symposium Course 8 offers an ERM extension Joint effort with CAS on public relations effort to raise awareness of the actuary as chief risk officer RFP for Internal Hedging Programs for Life Insurance Companies

ERM Consulting Projects

11 Operational Risk O1 Potential Impact on After-Tax Cash Flow (2,000) ( 1,000) - 1,000 2,000 3,000 4, Plan Year Cash Flow ($Millions) LRP Avg Event 1 SD 2 SD Operational Risk O1 Potential Impact on After-Tax Cash Flow (4,900) (4,400) (3,900) (3,400) (2,900) (2,400) (1,900) (1,400) (900) (400) Plan Year Deviation from LRP ($M) LRP Avg Event 1 SD 2 SD Operational Risk O1 Potential Impact on After-Tax EPS (8.00) (6.00) (4.00) (2.00) After-Tax EPS LRP Avg Event 1 SD 2 SD Operational Risk O1 Potential Impact on NPV 2008 Market Cap 12,626 25,251 37,877 19,548 16,290 13,032 9,774 6,516 33,126 27,605 22,084 16,563 11,042 31,564 18, ,000 10,000 15,000 20,000 25,000 30,000 35,000 40, NPV Loss ($Millions) Avg Event 1SD 2 SD Quantifying Critical Risks Assumed P/E Ratio

12 Assessing Critical Risks Relative to Risk Tolerance ABC Critical Risk Analysis Potential EPS Impact of Average Loss Event $- $0.20 $0.40 $0.60 $0.80 $1.00 $1.20 O1O2O5L1L2L3L4S1S2 Critical Risk Area After-Tax EPS Impact Avg Loss Event $0.03 per Share Supply Chain Disruption Manufacturing Disruption Location Concentration Changes in Regulation Third Party Liability Intellectual Property Environmental Contamination Product Launch Delay Outsourced Manufacturing

13 ABC Corporation Debt Coverage 75.0% 85.0% 95.0% 105.0% 115.0% 125.0% 135.0% 145.0% 155.0% 165.0% 0%20%40%60%80%100% Probability Debt Coverage Ratio Model Target Evaluating Impact of Critical Risks on Debt Ratings ABC’s debt ratings are based on a number of factors, the most prominent of which in the ratings analyses we have reviewed is Debt Service Coverage. Based on our understanding of the rating agency analyses we reviewed, ABC’s rating would likely be lowered if the Debt Service Coverage Ratio drops below 125%. Our simulation analysis suggests that the likelihood of the Debt Service Coverage Ratio dropping below 125%, as a result of the risk areas analyzed herein, is approximately 6.3%; that is to say ABC can be 93.7% confident that its rating will not be lowered due to contingencies associated with the risks analyzed. Reading the graph: The vertical axis represents the ABC’s Debt Service Coverage Ratio. The horizontal axis represents the probability of the ratio being at or below the indicated level. For example, the point indicated by the arrow suggests that in 80% of simulated years, the ratio is projected to be 155% or less.

14 Assessing Risk Finance Options Insurance Program Risk/Return Increase in 90th %tile Net Cost ($M) Expected Annual Savings vs. Current ($M) Current Alt I Alt II Alt III Alt IV