Moderator Robert F. Wolf, FCAS, MAAA Principal, William M. Mercer, Incorporated/MMC Enterprise Risk Consulting Panelists: Moderator Robert F. Wolf, FCAS, MAAA Principal, William M. Mercer, Incorporated/MMC Enterprise Risk Consulting Panelists: Scott M. Sanderson, Senior Vice President Marsh, Inc./Marsh Advanced Risk Solutions Benedetto Conti, Chief Actuary Winterthur Insurance Group FIN-13:The Evolving Role of Enterprise Risk Management Considerations in Ratemaking 2002 CAS Ratemaking Seminar March 7-8, 2002

Agenda n Introduction n What is ERM? n ERM Platforms –Insurance Customers –Insurance Companies n Wrap-up n Q&A Copies of Presentations Downloadable at

What is ERM? n To me, Enterprise Risk Management is a process for identifying and prioritizing critical risks facing an organization, quantifying their impact on financial and strategic objectives, and implementing financial and organizational solutions to address them. n To others, it varies but the essence is the same –“ERM assesses and manages all risks while looking for upsides in identifying risks.” –“Enterprise Risk Management is about information and capital management.” –“The ultimate goal of Enterprise Risk Management is preservation of shareholder value.” –“The job of Enterprise Risk Management is figuring out where the edge of the cliff is, and making sure the risk takers know where it is.”

No Consensus on Best Risk Measure A =Variance Principal= Squared Dev from Mean B= VaR (Pr Ruin) Principle EPD Principal D TVaR Principal= C+D A B C

Why the Evolution of ERM n New/Larger Risk –E-Commerce, Market/Book Values n New Risk Products –Merger of Insurance and Financial Institutions n Realization that Silo-Based Approaches are Flawed –Ignores inherent hedges and correlation n Increased Management Accountability –New Regulations requiring corporate governance

Why the Evolution of ERM n In short, because Society Demands it n Computer and Information Age –We couldn’t do what we are doing today if we needed to use slide-rules or abacus. n Focus Optimize Shareholder Value

First-Step: Two Inquiries? n How much capacity does a corporation have to bear risk? –= F(size and financial Structure, Attitude Towards Where the Edge of the Cliff Lies) n Within the above capacity, how desirable is it to retain/bear additional risk? –Businesses are not in business to merely survive, but to thrive.

Two Questions n Does the benefit of reduced costs given additional risk enhance or destroy a corporation’s shareholder value? n “How will the additional risk influence the total risk of retained portfolio of risks with regard to the marginal rewards in retaining the additional risk?”

Risk Retention: A Pseudo-Investment Decision Goal of this Project is to Go Northwest NW Return = Cost Savings

…Subject to Market Constraints Market Efficient Frontier Getting the Best Deal in this area. …however, the market is going southeast

Goal Accomplished Market Efficient Frontier This point signifies the best of all alternatives.

Cost Overruns Accounting irregularities Manage- ment ineffective- ness Supply Chain Issues Competitive Pressure M&A Integration Problems Mis- aligned Products Customer Pricing Pressure Loss of Key Customer Supplier Problems R&D Delays Customer Demand Shortfall % of top 100 Regulatory Problems StrategicOperationalFinancialHazard Foreign Macro- Economic Issues Interest Rate Fluct- uation High Input Comm- odity Price Law- suits Natural Disasters Primary Cause of Stock Drop (# of Companies) Source: Compustat, Mercer Management Consulting analysis - Period Examined was June 1993 to May 1998 Note: There were also 5 stock drops for which the primary cause could not reliably be determined. These 5 stock drops are not depicted. Fortune 1000 Group Analysis 10% of the Fortune 1000 companies suffered a loss of over 25% of shareholder value within one month How Does Risk Manifest Itself?

Two Ways to Interpret Graph n Hazard and Financial Risk is Not Important n Hazard and Financial Risk has been and continues to be managed well –Testimonial for risk managers, actuaries, brokers, and financial analysts. –We need to continue the process n …The opportunity now is to work on the left side of the graph.

“….We don’t do things because they are easy. We do them because they are hard.” ….John F. Kennedy …….Significant Challenges and Opportunities for Actuaries.

Thank You

Q&A