RCM-4: From Enterprise Risk Management to Ratemaking 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 Bottom Line Message (“Takeaway”) 1)Actuaries are already practicing ERM 2)Actuaries must learn about ERM 3)Actuaries must reframe our traditional roles as part of the larger ERM context 4)Actuaries must prepare to be part of the new Risk Profession (whatever it looks like)

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

5 / 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

6 / 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

7 / 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)

8 / 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

9 / 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

10 / 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

11 / GE / June 7, 2004 Next Steps Implied By This? 1)Actuaries are already practicing ERM 2)Actuaries must learn about ERM 3)Actuaries must reframe our traditional roles as part of the larger ERM context 4)Actuaries must prepare to be part of the new Risk Profession (whatever it looks like)

12 / GE / June 7, 2004 Operational Risk

13 / GE / June 7, 2004 Operational Risk – Defined Per Basel II, Operational Risk is what is left over in a bank when you have eliminated market and credit risk. Risk of loss due to failures of internal processes or controls, or external events Property-Casualty actuaries are experts in “insured operational risk” (at least in commercial insurance) Banks are looking for insurance to cover operational risk, so they can reduce their Basel II required capital

14 / GE / June 7, 2004 Operational Risk – Opportunity for CAS Leadership Article from January 2005 issue of Operational Risk magazine (see by THE thought leader in operational risk in financial services, Dr. Ali Samad-Khan. Presents a serious challenge to the COSO ERM framework (COSO = Committee of Sponsoring Organizations; see The COSO framework is the most highly visible ERM document in the public domain. COSO’s recommended operational risk assessment measure is “likelihood-impact” = product of likelihood and impact as the key determinant of “riskiness.”

15 / GE / June 7, 2004 Operational Risk – Opportunity for CAS Leadership Dr. Khan explains why this metric is so flawed, and why an actuarial approach is superior: he mentions evaluation of historical loss information by risk experts, development of frequency and severity distributions, and convolution to get an aggregate distribution. This article represents an unsolicited endorsement of the profession and its value in properly assessing operational risk. It highlights how actuaries, and casualty actuaries in particular, may actually be de facto professional leaders in the operational risk space, because of core franchise values: training, experience, and techniques.

Thank you for your attention Q&A