Enterprise Risk Management -- the CAS Perspective

1
Enterprise Risk Management-- the CAS Perspective

• John J. Kollar, ISO
• Jerry Miccolis, Tillinghast - Towers Perrin

2
Discussion Outline

• Recent History (1998-2000)
• CAS Board Task Force/Executive Council
• CAS ERM Advisory Committee (2000/1)
• ERM Definition and Framework
• CAS Research Priorities
• CAS Education Priorities
• CAS ERM Research Committee (2002-)
• Current Imperatives/Activities
• The CASs Future in ERM

3
CAS Task Force on Non-Traditional Practice Areas

• Board appointed in 1998
• How to better support members in non-traditional
  practice areas
• Recommendation -- Expand education and research
  in four areas
• ALM and investment policy
• Valuation of P/C insurance companies
• Enterprise risk management
• Securitization/risk financing

4
CAS Executive Council (2000)

• 4 Advisory Committees
• ERM highest priority
• Report to CAS President - Elect
• CAS VP on each Advisory Committee
• Letter to membership
• Announce committees
• Recruit members

5
Advisory Committee on ERM Charge

• Identify ERM research and education needs
• Recommend methods, priorities, timetables to
  satisfy needs
• Learn about and monitor efforts of existing
  committees
• Recommend additional efforts by existing or new
  committees
• Use broad definition of ERM in its work

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Goals

• Define ERM
• Develop conceptual framework
• Outline desired knowledge level
• Determine current knowledge level
• Specify learning objectives
• Identify research needs to close gaps
• Identify education needs to close gaps
• Recommend methods, priorities, timetable,
  industry focus

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Goals (contd)

• Compile initial ERM bibliography
• Identify implications of ERM on CAS policy and
  standards
• Recommend additional efforts of existing/new CAS
  committees to further CAS research and education
• Recommend efforts to increase CAS visibility on
  ERM

8
ERM Definition

• The discipline by which organizations in all
  industries assess, control, exploit, finance and
  monitor risk from all sources for the purpose of
  increasing the organizations short- and
  long-term value to its stakeholders
• Key elements
• Dual nature of risk
• Value creation
• CAS relevance beyond insurance industry

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ERM Conceptual Framework Two Dimensions
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Strategic Risks

• Competition
• Customer wants
• Demographic and social/cultural trends
• Technological innovation
• Capital availability
• Regulatory and political trends

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Operational Risks

• Business operations (product development,
  capacity, efficiency)
• Empowerment (leadership, change readiness)
• Information technology (relevance, availability)
• Integrity (management fraud, reputation)
• Information/business reporting (budgeting and
  planning, accounting information)

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Financial Risks

• Price (asset value, interest rate, foreign
  exchange, commodity)
• Liquidity (cash flow, call risk, opportunity
  cost)
• Credit (default, downgrade)
• Inflation/purchasing power
• Hedging/basis risk

13
Hazard Risks

• Liability claims
• Fire and other property damage
• Windstorm and other natural perils
• Theft and other crime
• Personal injury, disease, disability
• Business interruption

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Risk Management Process Steps

• Establish context
• External (environment, stakeholder relations)
• Internal (objectives, governance, performance
  criteria)
• Risk management (coverage, coordination)
• Identify risks
• Conditions/events
• Threats/opportunities
• Analyze/quantify risks
• Risk calibration
• Probability distributions

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Risk Management Process Steps (contd)

• Integrate risks
• Aggregate risk distributions, reflecting
  correlations
• Express results in terms of key performance
  criteria (aggregate risk profile)
• Assess/prioritize risks
• Marginal contribution to aggregate risk profile
• Treat/exploit risks
• Develop strategies
• Monitor and review
• Risk environment/strategy performance

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ERM Framework Grid
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Gap Analysis

• Identify the role of the actuary
• Determine the current level of ERM knowledge
• Determine the source of knowledge
• Determine the desired level of knowledge
• Where and to what degree is the shortfall?

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Gap Analysis
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Gap Analysis Approaches

• Review syllabus and committee plans
• Review continuing education and future plans
• Review other relevant surveys
• CAS non-traditional practice area
• CAS CEO
• Tillinghast ERM Benchmarking

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Gap Analysis Approaches (contd)

• Discussions with other professional organizations
• RIMS
• GARP
• IAFE
• SOA
• Advisory Committee discussions
• Membership survey -- April 2001
• 300 responses (10 response rate -- exceeded
  expectations)

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Gap Analysis -- Key Results

• Figures in the following table represent of
  survey respondents who believe it is important
  for all CAS members to know about, or be expert
  in, the various elements of the ERM framework by
  2005
• Highlighted figures represent areas of the
  greatest gap between this desired level and
  current level of knowledge

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Gap Analysis -- Key Results
54
51
44
54
41
46
51
53
69
61
72
79
81
64
73
89
91
75
85
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Recommendations -- Research

• Identified research topics (see next page)
• For each topic
• Priority by industry focus
• P/C Industry
• Other Financial Services
• Other
• Recommended research method
• Funded research
• Call Paper programs
• Compile existing research

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Recommendations -- Research (contd)

• Highest priority topics
• ERM overview
• Value creation through ERM
• Risk quantification (financial, operational,
  strategic)
• Risk correlation integration
• Remaining topics
• Risk tolerances, risk/reward metrics, portfolio
  optimization, monitoring, treatment, integrated
  products

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Recommendations -- Research (contd)

• Form standing ERM Research Committee
• Direct monitor research per above
• Expand, update, organize, maintain ERM
  bibliography
• Work with other CAS committees to coordinate ERM
  research and provide content for education
• Partner with other organizations
• Develop internal and external communications,
  designate spokespersons

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Recommendations -- Education

• Codified 2005 CAS ERM education needs
• For each element of ERM framework
• By degree of desired knowledge level
• By type of education vehicle
• (see next page)
• Developed detailed Learning Objectives for each
  element of ERM framework
• Publish ERM bibliography
• Accomplish through existing committees

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Recommendations -- Education (contd)

• For exam syllabus treatment (in varying degrees)
• ERM overview
• Analysis/quantification of all risk types
• Risk integration
• Establishing context
• Assessing/prioritizing/treating/exploiting hazard
  financial risks
• For continuing education treatment
• Topics above other elements of framework

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Recommendations -- CAS Visibility

• Develop and publish CAS position on ERM
• Publish ERM Advisory Committee report
• Invite non-CAS organizations to ERM seminars
• Proactively promote actuarys role in ERM through
  CAS/AAA Media Relations

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ERM Research Committee -- Current Imperatives

• ERM Overview document
• Associate-level exam material
• History/evolution of risk management
• Reasons/motivations for ERM
• ERM definition/framework
• Language/terminology/metrics/models/tools
• Applications/case studies
• Practical considerations in implementation
• Bibliography

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ERM Research Committee -- Current Imperatives
(contd)

• Financial risk quantification
• Literature review wealth of existing material
• Publish road map/reviews
• Value creation through ERM
• Literature review no useful material available
• Non-insurance industry
• Original research needed
• RFP to professionals, practitioners, academics
• Co-sponsors from other organizations
• Insurance industry
• Case study documentation

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ERM Research Committee -- Current Imperatives
(contd)

• Risk correlation/concentration/integration
• Literature review limited material available
• Call for papers
• Coordinate with other CAS committees
• ERM bibliography
• Abstracts
• Organization
• Maintenance

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ERM Research Committee -- Current Imperatives
(contd)

• Coordination with other CAS committees
• DFA joint meetings, joint call for papers
• VFIC joint research project
• Syllabus/Ed Policy/Continuing Ed/SIS/etc.
• RCMS
• Coordination with other professions
• GARP
• AIMR
• RIMS
• Academia
• etc.

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Concluding Thoughts

• ERM as a value creation tool
• ERM as a unifying framework
• ERM as a recruitment tool
• The membership wants to go there
• The leadership void
• Do we really have a choice?
• The CRO profile
• The CASs future in ERM

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ERM as Value Creation Tool

• Systematically identifies material threats/
  opportunities (re business objectives)
• Rigorously analyzes capital requirements
• Financial efficiency (shareholder view)
• Solvency protection (customer view)
• Optimizes strategies under uncertainty -- for
  improving growth and return
• Exploits natural hedges, portfolio effects
• Enhances stability

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ERM as Unifying Framework

• Actuarial subject areas
• Logical structure/integrated whole/
  business-relevant
• Cross-silo Chief Risk Officer training

• Pricing
• Reserving
• Risk modeling
• Accounting
• Financial performance measurement

• Capital management
• Asset/liability management
• Reinsurance
• Portfolio management

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ERM as Actuarial Recruitment Tool

• Strong business focus
• Re-engagement of CAS candidates and recent
  Fellows/Associates
• Coordination with AIMR (CFA), GARP (FRM), et al
• The membership wants to go there
• Advisory Committee oversubscribed
• ERM survey response
• 2001 ERM Seminar attendance/response

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Filling the Leadership Void

• Many interested professional organizations
• No leading organization
• CAS discipline spans many risk types
• Sophisticated risk modeling tools (e.g., DFA)
• Team approach with other professionals

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Do We Really Have a Choice?

• The world is moving to ERM
• Pricing/reserving for integrated products
• Multiple risk coverage through captives
• Rating agency ERM models
• CAS manifest destiny

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Where are Chief Risk Officers coming from?

• Source
• Tillinghast - Towers Perrin 1999/ 2000 survey of
  finance and actuarial officers in 66 life, health
  and P/C insurers and mutual funds

• Source
• IIA/Tillinghast - Towers Perrin 2000/ 2001 survey
  of finance and audit officers in 130 companies
  across various industries (including 11
  insurance industry, 11 other financial services)

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Where are CROs coming from internally?
Insurance Industry
All Industries
Internal
Other
Internal Audit
Treasury
Finance
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The CASs Future in ERM

• To paraphrase JFK (We choose to go to the Moon,
  1962)This profession does not intend to founder
  in the backwash of the coming age of enterprise
  risk management
• With its dedicated efforts to date, its ambitious
  priorities -- and its reaching out to other
  professions -- the CAS is purposefully stepping
  into the leadership void