1. Enterprise Risk Management: Benefit or Fad? CAS: Risk and Capital Management Seminar July 29, 2003 Washington, D.C Claus S. Metzner, FSA, FCAS, MAAA, Aktuar-SAV EPIC Actuaries, LLC

2. What is ERM? Is it a Tool? Is it a Theory? Is it a way of Managing? Is it a Benefit? Is it a Fad?

3. What is ERM? ERM is: Focusing on all risks  Financial risks  Operating risks Developing appropriate risk constraints  Including checks and balances Assessing risk/return trade-offs Assuring the enterprise is operating within the predetermined risk constraints

4. What is ERM? ERM is Not Modeling  Models can be very helpful in quantification of trade-offs  Models can be very helpful in developing a “base case” Bureaucratic Stifling

5. ERM: Some Key Concepts Extreme Events What are they Severity/frequency Maximum Possible Loss How defined Severity/frequency Price Adequacy Long term/short term

6. ERM: Some Key Concepts Balance Sheet “Honesty” Risk Appetite Level of assessment: Firm wide or subsets?  % of Earnings?  % of Revenue  % of Capital What fluctuation is “tolerable” What fluctuation is “unacceptable” RAROC Risk adjusted return on capital

7. ERM: Time Frame Is ERM prospective What is the relevant time frame? Does the time frame vary for different risks? Pricing risk Reserving risk Reputation risk Considerations When do we know something How long before we can take corrective actions

8. Key ERM Interrelationships Asset Risk Liability Risk (including future business) Capital Operating Risks/Constraints People and processes are important

9. ERM View Consider: ERM views the enterprise as a going concern What are the implications? Capital is not just balance sheet capital Capital includes the franchise value Balance sheet capital (and economic capital) are important since they serve as possible constraints (insolvency has consequences!)

10. ERM Open Issues Asset Risks Current models are tested, in existence Current models seem to work Current models can provide some operating metrics, e.g. Value at Risk Cautionary Notes  Remember the LTC debacle  Who anticipated the drop in equity prices?

11. ERM Open Issues Liability Risks Models exist to develop maximum possible loss (e.g. earthquake, hurricanes) and distribution of outcomes for a portfolio of risks Output of models is relevant only if appropriate risk control measures are in place (e.g. operational risk management must be in place and effective)

12. ERM Open Issues Liability Risks (continued) Models need to consider risks associated with realizing the value of good will  Reputation risk  Dynamic responses to pricing/underwriting initiatives  Responses by customers  Responses by competitors  Political responses

13. ERM Open Issues Operational Risk – People and Processes Internal perspective Underwriting Claims Pricing Marketing Auditing (general financial discipline) Etc, etc

14. ERM Open Issues Operational Risk – People and Processes External Perspective Response of market to internal initiatives  Customers  Competitors Response of rating agencies Response of shareholders (publicly traded companies) Response of regulators Response of Legislators

15. Enterprise Risk Management: Benefit or Fad? Answer depends on How well the liability risks and the operational risks are addressed  Consider – we may need to develop day to day operational metrics Quantification (modeling) comes after, not before, we understand the risks Holistic view of the risk management process (RAROC)  Many tools are available, but these appear to not yet be integrated into a cohesive risk management program

16. Enterprise Risk Management: Benefit or Fad? Considerations for Improvements Develop Operational Risk Assessment  Function of Management  Co-operative Effort across all disciplines Develop Operational Risk Management Tools  Some exist (e.g. underwriting guidelines, etc.) Develop an Actuarial Control Cycle  How do we know if experience is consistent with assumptions  When do we know  How do we bring information forward to foster adjustment to new reality

17. Enterprise Risk Management: Benefit or Fad? Let’s take a vote How many believe it is a benefit? How many believe it is a fad?