1. ERM Value Creation and the International Insurer
Wayne Fisher
Executive Director, ERMII

2. Why emphasize “international”
ERM creates value for all insurers
The risks and opportunities are greater for international insurers:
Multiple regulators
Diversification complexities/liquidity/F/X
Far-flung operations and cultures
Emerging risks
Aggregation and correlation complexities
Data consistency

3. Demands and Risks are greater
Solvency II, SST, ICA
SOX
S&P risk analysis
ART products/ new competition for risk transfer
Awareness of long term guarantees
Competitors are more global
Risks are more global/unforeseen aggregations and correlations
All resulting in increased Board awareness (Regulators, too)
And with a “show me” attitude

4. CEOs respond to the challenge
““…a global financial services company of our size must manage its risks comprehensively… in the end, we must arrive at an integrated view. This point is shared by rating agencies and regulators, two important partners in the risk dialogue. Our response to these challenges consists in a further strengthening of our risk management function and in developing an enterprise-wide framework.”
James Schiro, April 20, 2006 at Zurich Financial Services‘ AGM

5. ERM benefits impact all stakeholders….
View of future earnings and sustainability is impacted by perception of risk and its management.
=  SHV
Want well managed insurers who can manage the risks that they face.
=  Customer Value
Customers
Shareholders
Management
Employees
Regulator
Ratings
Capital regimes mean that risk management is having an impact on the level of capital required.
=  Regulatory Capital
Rating Agencies now looking at ERM. Risk management therefore impacting the price of capital. =  Cost of Capital

6. Regulators have the same views…
=  Regulatory Capital
When introducing the new capital rules in 2002 the FSA said:
"The main benefits of this proposed framework are that it meets our overall aim of reducing the probability of prudential failure, in a cost efficient way that creates greater transparency in the arrangements for setting regulatory capital levels, while at the same time promoting a strong culture of risk management."
In the Financial Risk Outlook 2006 they indicate further work is required:
“General insurers have also been subject to our new ICAS regime since January Although firms’ risk-management frameworks generally appear to be improving, their depth of analysis and use of quantitative techniques in determining their individual capital assessment have varied widely, largely reflecting the diverse nature of the general-insurance industry.”
The FSA’s new ARROW Framework indicates a lighter touch for good risk managers:
“By taking a more overtly risk-based approach to our assessment of whether firms are operating in line with these principles we can create incentives for firms to do the right thing in return for a regulatory dividend – that is less regulatory intervention.” (Draft document at present)

7. Meeting Regulators expectations will provide benefits in less required capital…
=  Regulatory Capital
Regulators throughout Europe are moving to more “risk based” solvency requirements
New risk areas include concentration risk, interdependencies and accumulation risk, loss potential in extreme stress scenarios, operational and ALM risk
With an aim to implement capital requirements that are specific to an insurer’s risk profile, and that:
Reflect all relevant risks
Encourage, reward and build on internal risk management
Encourage development and use of internal risk models
Reflect economic realities…fair value valuations
Are principles based
And the better the “story”...identification, assessment and quantification of risk…the lower the required capital
Follows Basel II. Enabled by more sophisticated tools to assess and mitigate risk; and new risks from financial instruments
Also necessary for level playing field with banks under Basel II
Multiple approaches being taken. Not surprising; this is Europe where can’t agree on an EU Constitution, free exchange of services, etc. Imagine agreeing on pros and cons of VaR and Tail VaR.
Switzerland is ahead of the EU. Not surprising; easier to build a concensus; UK too, good professional staff and moved independently
Regulatory arbitrage; between jurisdictions and banks and insurers
Complicated with Freedom of Services; Zurich and use of Ireland and branches

8. And favourable financial strength ratings lower capital costs…
=  Cost of Capital
“Standard & Poor's Ratings Services has always strongly emphasized an insurer's risks and how they are managed when forming an opinion of that insurer's financial strength or creditworthiness. Beginning in October 2005, we strengthened our emphasis further when we added a formal evaluation of insurer enterprise risk management (ERM) capabilities to the rating process.”
“Strong ERM insurers have exceeded the Adequate criteria for risk control and have a vision of their overall risk profile, an overall risk tolerance, a process for developing the risk limits from the overall risk tolerance that is tied to the risk-adjusted returns for the various alternatives, and a goal of optimizing risk-adjusted returns. In addition, Strong programs have robust processes to identify and prepare for emerging risks. Standard & Poor's expects ERM to be a competitive advantage for these insurers over time.”

9. Investors benefit from both the reduction in statutory capital and less operating losses…
=  Regulatory Capital
More consistent earnings through optimizing diversification and hedging peak risks
Higher growth through more favorable pricing due to less required capital
Lower cost of capital with more favorable financial strength ratings…and lower required statutory capital
Quality of earnings enhanced through more effective risk capital allocations
Board confidence for acquisitions and similar initiatives through confidence in risk framework
Incentive for management to influence operational risk exposures and lower operational risk required capital
Clear benefit with Solvency II/ SST/ ICA

10. Diversification is a key to value
ERMII Research Workshop in Lyon, FR
Constraints key to optimizing economic capital allocation
Liquidity key to regulatory acceptance
Correlations usually underestimated for tail or extreme scenarios
Actuaries/economists and causality models
Lower capital requirements may result in more competitive pricing

11. ERM Value Drivers Cost of Risk = Expected loss + Cost of Capital
Expected loss – risk limits and monitoring, aggregation and correlation modeling, identification and hedging of peak exposures
Cost of capital – diversification, correlation, liquidity, agreed risk tolerance, comprehensiveness and sophistication of ERM

12. Capturing diversification value isn’t easy
Diversification value requires understanding dependencies; “causal” modeling versus “loss modeling”
“Trapped” capital reduces group diversification benefit; requires credible analysis and modeling
Intra-group transactions provide leverage
Higher societal costs from requiring excess capital; rationale for accepting diversification
Explore cost of alternatives for “second event” capital replacement options

13. Future “ERM Value Add” ERMII research initiatives
Discussed at the Lyon research workshop
How to harmonize the treatment of risks of different time horizons in a market consistent manner
Benchmarks for correlation models
Diversification effect from regulatory constraints on liquidity and capital flows; related impact on pricing and competitiveness

14. Employees benefit, too… Employees Benefit, too
Employees want to feel comfortable that their employer will be around to pay their salary and pension
Most people want to work for a company that takes risk seriously especially with regard to incident management, security and Health and Safety
In some domains employee forums are taking an interest in the risk management and assurance activities of the company
Also has a potential impact on recruitment via the same drivers as customers

15. As do Customers… Improved customer service quality.
=  Customer Value
Improved customer service quality.
For an insurer, one example would be better control over the setting of terms and conditions, which can minimize disputes in claims paying. A knock-on effect of improved customer service quality would be increased customer retention.
Another customer benefit would be more confidence in the insurer due to increased financial stability and operational control.
Potentially more favorable pricing due to lower capital requirements
Greater financial strength, with capital linked to risk

16. ToDo’s to realizing ERM Value
“Walk the Talk” with embedding ERM into the corporate DNA
Credible risk reporting and limit adherence with monitoring at all levels
Realistic risk modeling with emphasis on data, aggregation and correlation modeling in stress scenarios
Explore alternative approaches for second or third event incidents, versus cost of additional capital
Leverage societal costs of excessive capital