Life Insurance International
March 7, 2007
CORPORATE GOVERNANCE: Risk management takes front of stage 

SECTION: Pg. 10
LENGTH: 954 words 

Spurred on by regulatory and other external pressures, enterprise risk management is becoming an integral part of business processes of insurers throughout the world. However, ratings agencies and self- assessments show that most insurers' models are far from the point of excellence
Though managing risk is the name of the game for insurers, it is only in recent years that the concept of managing overall business risks - from investment market risk to the risk of a systems failure - have come to the fore in the form of enterprise risk management (ERM).
There are many definitions of ERM but one of the most apt is perhaps the US Casualty Actuarial Society's (CAS): "ERM is the discipline by which an organisation assesses, controls, exploits, finances and monitors risks from all sources for the purpose of increasing the organisation's short- and long-term value to its stakeholders."
Though ERM is rapidly gaining acceptance, it is not yet universally applied. According to a survey by research firm Tillinghast of 200 insurers and reinsurers throughout the world, 60 percent of respondents explicitly factor risk management considerations into their decision- making. A similar survey by professional services firm PricewaterhouseCoopers found that two-thirds of those questioned had basic ERM principles in place.
Of note in Tillinghast's survey, conducted in the latter part of 2006, was that two-thirds of insurers globally now use economic capital (EC) as a risk quantification tool in their ERM strategies. EC differs from regulatory minimum capital requirements and for life insurers the US Society of Actuaries (SOA) defines it as "sufficient surplus capital to cover potential losses at a given risk tolerance level and over a specified time horizon".
SOA members believe six key elements must be included in an EC estimate: interest rate risk, product pricing risk, credit risk, equity market risk, liquidity risk and operational risk.
Tillinghast said current use of EC represents a significant increase compared with its findings in 2004 when only half of the respondents were using EC. In addition, another 19 percent of the participants in the 2006 survey indicated they were considering adopting EC measurement. This implies that EC may soon be a universal risk management tool, observed Tillinghast.
The adoption of EC is at its highest in the UK, where it is used by 99 percent of respondents. In part, this is a result of the Financial Services Authority's requirement that all insurers perform an individual capital assessment, explained Tillinghast.
Globally, two external factors - rating agencies and Solvency II regulations - are adding pressure on insurers to adopt or enhance ERM. Tillinghast said rating agency considerations are a very big factor for North Americans (72 per-cent), while looming Solvency II regulations are a major driver for European Union (EU) insurers.
"EU insurers generally agree that the Solvency II regime will require significant improvements to their risk man-agement capabilities, including enhancements to risk quantification capabilities and enhancements to actuarial and ac-counting tools," said Tillinghast.
Significantly, a survey by professional services firm Ernst & Young found that only 20 percent of EU insurers be-lieve their capital models will comply with Solvency II. However, on a positive note, Niek de Jager, a member of E&Y's Solvency II task force, said: "Solvency II appears to be driving a welcome need for improved risk management and an integrated view of risk across the whole organisation."
In general, Tillinghast found respondents worldwide were dissatisfied with their capabilities in many ERM areas and were significantly dissatisfied with their abilities to quantify operational risks and to reflect risk in performance measures. "Most respondents (77 percent) are highly focused on improving risk measurement and quantification proc-esses to enhance their overall ERM efforts," it said.
Prakash Shimpi, Tillinghast practice leader with global responsibility for ERM, said: "Insurers now recognise the potential impact a single event like a security breach or systems failure can have on their operations, as well as on their financial position." He added that as operational risks can be complicated and difficult to quantify, many insurers are turning to scenario analysis to achieve meaningful results.
Indicative of the increasing importance of ERM, Shimpi said 43 percent of respondents reported having a chief risk officer with primary responsibility for risk management. This was up from 39 percent in 2004 and only 19 percent in 2002.
However, many challenges remain and, E&Y noted, 64 percent of respondents to its survey of EU insurers said there was a need to upgrade the skills of actuaries and risk managers. 
The role of actuaries in ERM was highlighted recently by Thomas Hettinger, managing director of actuarial con-sulting firm EMB America. Speaking at a CAS meeting he stressed: "Actuaries have the tools to help develop the ERM process, but it requires actuaries to perform as risk managers, looking forward to all the risks that could be encountered in the future."
Providing an example, he continued: "One of the key components [of ERM] is to develop an understanding of eco-nomic capital - understanding the difference between minimum capital and different thresholds of extra capital."  
Past attempts by actuaries at ERM failed, in part, because of a reliance on overly sophisticated models, explained Hettinger. The result, he said, was that the process lived within actuarial circles and was not incorporated into daily practice. "To succeed, actuaries need to be able to demonstrate the value of what they talk about," he concluded.

LOAD-DATE: March 9, 2007

PUBLICATION-TYPE: Newsletter