Finance 590 Enterprise Risk Management Steve D’Arcy Department of Finance Lecture 6 Integrated ERM Risk Metrics and Industry Examples April 26, 2005

Reference Material ERM Symposium 2005 Presentations Chapters – in Enterprise Risk Management by James Lam CAS ERM Task Force

Overview Integrated ERM Metrics ERM in: –Financial Institutions –Energy Firms –Nonfinancial Corporations –Nonprofit Organizations

ERM Risk Metrics Risk categories with standard metrics –Market –Credit –Liquidity –Hazard (Insurance) Risk categories without standard metrics –Operational –Legal and regulatory –Strategic

Unified Risk Measure Robert Mark, May 2004 ERM Symposium “CROs have benefitted from significant progress made in measuring market and credit risk and are now attacking operational risk, but have not yet found a generally accepted unified risk measure. The market has reliable risk measures for individual portfolios, but no highly reliable measure for total risk across the trading book and banking book.”

Financial Institutions Monitoring default and counterparty risk Managing market risks –On balance sheet –Off balance sheet Incorporating leverage and liquidity Attributing economic capital Systemic risk –Chain reaction –Loss of confidence –Linkages between institutions

CIBC acquisition of Wood Gundy Canadian regulation ERM objective –Top five financial institutions for managing risk Hired Dr. Robert Mark in 1994 –CRO in 2000 Risk management structure –Board of Directors –Management committees –Risk management division 1998 market crisis –Cut limits –Most losses had been identified at top 10 risks

Energy Firms Price and volume risks Event risks Risk sharing Optionality Basis risk Price transparency

Enron Recognized leader in managing risk Failed on operational risk –Off balance sheet trades –Marking to “hypothetical” market –Employee incentives Lasting image - Lessons learned –Keep you eye on the cash –Manage all your risks –Get auditors back to basics

Nonfinancial Firms Risk management requirements –Credit risks –Market risks –Stock price risk –Investment risks –Hedging risks –Secondary risks –Operational and insurable risks –Catastrophic failures –Business risk –Cultural risks –Reputational risks

Best Practices Risk identification and assessment Quantification and reporting –Pro forma ananlysis –Regression analysis –Simulation Management and control

Microsoft Risk inventory Risk maps Risk grid Information technology Intranet

Non-profit Organizations Subject to same types of risks as other organizations –Hazard –Financial –Operational –Strategic

Casualty Actuarial Society ERM Task Force Charge This Task Force is charged with recommending a process under which the CAS could become an example of ERM best practices within the non-profit arena. The Task Force is expected to conduct an ERM audit of the CAS, generate recommendations for dealing with the significant risks, and establish an ongoing ERM process for the CAS. Scope Hazard risks, including both direct and indirect losses due to terrorism Financial risks relating to both assets and liabilities, including pension exposure Operating risks, including the credentialing process Strategic risks, including the effect of competing organizations both within the actuarial profession and in the broader area of risk analysis

Conclusion ERM is continuing to evolve Started as hazard risk management Financial risk management developed Failures brought increased attention Technology and risk management experience led to new approaches Regulation is pushing organizations to improve Modeling risks is key component No standard approach has yet emerged Challenging and attractive area