Enterprise Risk Management Topics



ERM-1:ERM Committee Priorities, Progress, and Findings
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In December 2001, the CAS Executive Council approved the numerous and ambitious recommendations of the Advisory Committee on Enterprise Risk Management with regard to the CAS ERM research and education priorities. One of those recommendations was to form a standing ERM Committee (ERMC) to take on those research priorities. In this session, ERMC members will discuss their progress to date and future plans in several key areas, including:
  • Developing intellectual capital to educate the membership on ERM and its components, including a summary of an original ERMC research paper
  • Discussing the correlation, concentration, and integration of financial, hazard, strategic, and operational risks within a property/casualty insurer, including summaries of four new Call Papers
  • Quantifying the value of ERM within an organization, including summaries of a funded research project, an original ERMC research paper, and summarizing plans to tackle the other identified ERM research priorities.

Moderator/Panelist:
Jerry A. Miccolis, Principal, Tillinghast-Towers Perrin
Panelists:
Kevin G. Dickson, Senior Actuary, Allstate Insurance Company
Barry A. Franklin, Managing Director and Actuary, Aon Risk Consultants, Inc.



ERM-2: Enterprise Risk Management Post 9/11—A Benefit or a Fad?
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Although appealing and gaining acceptance, there are some perceptions in the industry that purported benefits of ERM are concretely elusive. In this session a proactive panel and audience discussion will explore what ERM is and isn't, and how to measure ERM's success or failure. The chief notion of ERM is the concept of risk integration. How can insurers who operate with department budgets that drive their behavior think in integrated results? This constraint is one that has driven the "fad" naysayers.

Panelists will share their perspectives on and debate the practical benefits of ERM and offer viewpoints and counter-points on the state of ERM for insurers today and in the future.

Moderator:
Claus S. Metzner, Principal and Consulting Actuary, EPIC Actuaries, LLC
Panelist:
Scott M. Sanderson, Marsh Mclennen Advanced Risk Solutions



ERM-3: Sarbanes-Oxley Section 404—Assessment and Audit of Internal Controls
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Effective this year, Section 404 of the recently enacted Sarbanes-Oxley Act requires management to assess internal controls over financial reporting, report on the assessment, and subject the assessment to an independent audit. Primary focus of the controls will be on those risk areas in which lack of a control can result in a misstatement in the financials.

For property/casualty companies, the risk of reserve misstatements implies that developing controls in this area is critical. This will require a multidisciplinary team from the underwriting and claims operations, actuarial, financial, and legal departments. The team will need to pay particular attention to the control of the data, analysis, and management review underlying financial statement entries.

The panel members will discuss implementing the assessment process, and the role of company actuaries, along with independent auditors and actuaries, in auditing management's assessments.

Panelist:
Edward J. Chanda, Partner, KPMG LLP
G. Christopher Nyce, Senior Manager, KPMG LLP
Brian P. Reilly, Chief Internal Auditor, Travelers Property Casualty Corporation



ERM-4: Risk Integration, Aggregation, and Correlation
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A number of capital adequacy models reflect the offsetting effects of covariance when evaluating an enterprise's aggregate risk. Focusing on the flip side of the issue, this session will address how a "domino effect" can be missed if an underlying correlation of risks is not adequately considered.

For example, a catastrophic event impairs liquidity, in turn forcing an untimely and costly disposition of assets, which triggers issues with the company's lenders, further impairing the enterprise's ability to compete. This session will focus on how such correlations interacted to accelerate the recent demise of several companies, in the process leaving regulators, rating agencies, and the industry insufficient time to seek more palatable alternatives than seizure of the companies' assets.

Panelists:
Matthew C. Mosher, Group Vice President, A.M. Best Company
Eric Simpson, Senior Vice President and Chief Financial Officer, American Re Insurance Company
Chester J. Szczepanski, Chief Actuary, Pennsylvania Insurance Department

Dynamic Financial Analysis Topics


DFA-5: Asset/Liability Management
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The CAS Valuation, Finance, and Investments Committee (VFIC) has continued its research into asset/liability management and duration (mis)matching. Results published last year focused on analysis using a DFA model with risk and return metrics defined in terms of statutory and GAAP accounting results. The committee's current work extends this analysis in two ways. First, results on a mark-to-market, or "economic" accounting basis are being studied. Also, new metrics are being tested that combine risk and return so that diverse strategies can be ranked on a risk-adjusted basis. These extensions have provided new insights into the question of whether asset/liability management makes sense, and if so, whether a targeted duration (mis)match adds economic value.

Panelist:
Christopher M. Suchar, Principal, DFA Capital Management, Inc.



DFA-6: Important Considerations in the Use of DFA
Panelists will share their experiences making decisions when considering the use of DFA. This will include their thoughts on how they intend to apply models in their decision making and what they look for in deciding whether to purchase or build their own model.

Panelists:
Shawna S. Ackerman, Principal & Consulting Actuary, Pinnacle Actuarial Resources, Inc.
Thomas P. Conway, Partner, Earnst & Young LLP



DFA-7: Reinsurance and DFA
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Reinsurance can affect many facets of an insurance company's operations: cash flows, income, and capital requirements. In addition, products are now being sold with even more complicated features such as embedded equity market participation and contingent capital protection. As a result, it is becoming increasingly difficult for companies to analyze the difference between alternative structures using traditional approaches.

Session presenters will show how DFA models can be used to help simplify this process and will discuss potential pitfalls that need to be avoided. The session will also address how reinsurance purchasers can use reinsurance DFA analysis to tie their reinsurance program design into their larger strategic objectives, whether it be increased earning, surplus stability, capital management, or the like.

Panelists:
Raju Bohra, Vice President, American Re-Insurance
Daniel B. Isaac, Vice President, Conning Asset Management



DFA-8: International Perspectives on DFA
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The actuarial profession in the United States has been actively discussing and developing DFA models for a number of years now. But what is the status of DFA outside the U.S.? How is it viewed? Are regulators encouraging its use? Do companies view it as an important management tool? In this session, representatives from Canada, Europe, and Asia will discuss how DFA models are being discussed and used in their respective parts of the world.

Moderator/Panelist:
Jacqueline Frank Friedland, Consultant, KPMG LLP
Panelists:
Jean-Pierre Berliet, Ernst & Young LLP
ChangSoo Lee, SoongSil University



DFA-9: Implementation of DFA Models
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Current DFA users will discuss implementing models in their companies. Included in the discussion will be:
  • What area of the company controls the model?
  • Who supplies input to the model?
  • Who runs the model?
  • Who has access to the model?
  • How are changes made to the model?
  • What are the uses of the model?
  • How is output of the model shared?
  • What has been the company's acceptance of the model?

Moderator:
Peter G. Wick, Consulting Actuary, Milliman USA
Panelists:
Jennifer R. Ehrenfeld, Vice President, American Re-Insurance Company
Emily C. Gilde, Senior Actuary, Nationwide Insurance Company
Michael Bond, Allstate Insurance Company



DFA-10: Practical Modeling Challenges and Solutions
When creating and implementing a DFA model there will inevitably be a road block that must be overcome. The panelists will share their experiences and practical solutions to take control of these obstacles.

Panelists:
Charles C. Emma, Principal, Pinnacle Actuarial Resources, Inc.
Christopher G. Gross, Assistant Vice President, The St. Paul Companies



DFA-11: An Application of DFA in an Economic Value-Added Framework
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This session combines a DFA approach to capital requirements with a return on capital pricing model and an economic value-added (EVA) performance measurement system. The panelists will review concepts that are widely used in other industries and apply them to the specific setting of property/casualty insurance pricing.

Moderator/Panelist:
Sholom Feldblum, Vice President, Liberty Mutual Group
Panelist:
Neeza Thandi, Actuary, Liberty Mutual Group



DFA-12: Modeling Terrorism Risk
Since September 11, 2001, terrorism has become an important issue for insurance companies. Catastrophe modeling has emerged as a tool to help companies understand their exposures. This session will feature representatives from major catastrophe modeling firms who will speak about their models.

Moderator:
Krista Lienau, Guy Carpenter & Company, Inc.
Panelists:
David A. Lalonde, Senior Vice President, Applied Insurance Research
Thomas I. Larson, Group Manager, EQECAT, Inc.
Peter Urlich, Managing Director, Risk Management Solutions

Capital Management Topics


CM-14: Utilizing a Marginal Cost of Capital Approach to Product Pricing
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Panelists will discuss their recent paper, which addresses an apparent discrepancy between modern financial theory and the practical use of allocated capital in pricing products. While much attention has been paid to allocating the cost of capital to products, financial theory tells us that it is the marginal cost of capital that matters, not the average cost of capital. The authors will discuss a new approach to determining the cost of capital that can be applied to the pricing of a property/casualty insurance product.

Panelists:
Nathan J. Babcock, Senior ALM Analyst, Conning Asset Management
Daniel B. Isaac, Vice President, Conning Asset Management



CM-15: Managing Investments—The Role of the Asset Manager and the Actuary
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Through the exam process, many casualty actuaries are familiar with fundamental asset management concepts, yet relatively few have the opportunity to become actively involved in the process. In the first part of this session, a member of an asset management firm will give an overview of some of the basic tools and approaches that are commonly used to manage the investments of insurance companies. Topics will include:
  • Allocating among asset classes;
  • Balancing investments with the underwriting operation; and
  • Developing fixed income strategies.

The second part of the session will focus on the specific role that actuaries currently play inside an asset management operation, and how that role may evolve in the future.

Panelist:
Stephen W. Philbrick, Vice President, Conning Asset Management



CM-16: An Overview of Capital Management for Property/Casualty Insurers
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A considerable amount of financial theory surrounds the topic of capital management. This session will provide a primer for those interested in understanding the underpinnings of capital management. What determines the optimal capital structure for a firm? How much capital is needed to run the business? What special issues do property/casualty insurers face? This session is for those seeking to deepen their knowledge in this fundamental area of management.

Panelist:
Richard W. Gorvett, Consulting Actuary



CM-17: Capital Allocation
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Capital allocation has been, and continues to be, a hotly debated topic. From Chuck McClenahan's statement, "Every dollar of capital stands behind each and every risk," one can argue that capital is unallocable. Can it and should it be done at all?

From Glenn Meyers' statement, "Since capital is a scarce resource, one can make an `economics 101' argument to its allocation," it seems that one should allocate capital as economic theory dictates the best way to allocate any scarce resource.

In this session, we will explore the financial underpinnings of why capital allocation is important to firms and discuss several approaches to accomplishing this seemingly controversial task.


Moderator/Panelist:
Donald F. Mango, Chief Risk Officer, American Re-Insurance Company
Panelist:
Russell Bingham, The Hartford



CM-18: Communicating With Wall Street
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Property/casualty insurance companies face considerable challenges in securing the confidence of investors and Wall Street analysts. Granted, the business's complexity complicates dialogue, but Wall Street's insistence on more reliable information represents a crucial need to better serve investors. In this regard, some accuse the industry of financial reporting that is either misleading or incomplete, particularly in the area of loss reserves. To some, the industry manipulates reserves and uses "gimmicks" such as finite reinsurance to manage results and mislead investors. Skepticism is affecting the image of the actuarial profession itself, with some suggesting the only reliable measurement of performance has become cash flow. Disclosure challenges abound including pricing for terrorism coverage, and how companies describe motivations for reserve strengthening. The panel will focus on how communications must improve as companies fall under increasing scrutiny after Sarbanes-Oxley.

Panelists:
Maria Olivo, Executive Vice President of Investor Relations and Corporate Development, The Travelers Insurance Companies
Alice Schroeder, Managing Director, Morgan Stanley



CM-19: Risk-Based Regulation in Insurance
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The International Actuarial Association Solvency Capital Working Party has completed its draft report describing a global framework for developing solvency regulation. The report is written assuming an audience of insurance regulators and supervisors. This session is intended to describe the proposed framework and outstanding issues, and allow the audience to provide feedback and commentary. The audience will have the opportunity to review a copy of this draft report prior to the seminar.

Panelist:
Glenn G. Meyers, Chief of Actuarial Research and Assistant Vice President, ISO
Les Peter Rehbeli, Mercer Risk Finance & Insurance Consulting



CM-20: Cost of Capital
The financial economics approach to measuring the cost of capital is typically derived from asset pricing models such as the Capital Asset Pricing Model (CAPM). However, recent research has expanded our understanding of the cost of capital and it is now fairly well accepted that the CAPM does not fully capture all the risks that get priced in determining the market value of a firm. The panelists in this session will discuss two issues in particular:

  • Recent models of how the external capital markets price risk and estimates from these new models on the cost of equity capital for insurers by line of insurance, and
  • New theories which suggest that risk is not only priced in the capital market but can also cause frictional costs within firms such that it is important to consider both internal risk factors as well as the external risk costs.

Professor Phillips will present evidence on the external cost of equity capital for the property & liability insurance industry. He will begin by reviewing the dominant asset pricing models from finance including the CAPM as well as the Fama-French three-factor cost of capital model, which is generally regarded as an improvement over the traditional CAPM. He will then discuss the recently developed full-information industry beta methodology which can be used to decompose the cost of capital for conglomerate firms, in general, or by line of insurance for insurers. The analysis suggests estimates of the cost of capital for insurers using the Fama-French model are significantly higher than estimates based upon the CAPM. In addition, he will present evidence that there are significant differences in the cost of equity capital across lines indicating that the use of a single company-wide cost of capital is generally not appropriate.

Professor Doherty will discuss how the development of ERM has given rise to the insight that risk is not only priced in the capital market but can cause frictional costs within the firms (costs of distress, agency problems, etc). This insight has given rise to a number of papers that incorporate both internal and external risk costs. The ideas from these papers can be distinguished by two approaches.

The basic model (Doherty 1985, 1990; Froot and Stein 1996) considers a firm with multiple activities in which the risk of the enterprise causes frictional costs that should be deducted from income before it is accessible to the creditors and shareholders of the firm. Thus, the overall cost of capital will reflect both total risk (as a proxy for frictional costs) and the systematic risk as priced in the capital market (of which Professor Phillips will discuss).

The alternative approach, which captures the same idea of dual risk, focuses not on the firm divisions, but on the multiple sources of capital (Doherty 1985, Shimpi 2000). The basic idea can be seen simply by formulating the cost of capital as the weighted average of the cost of debt, the cost of external equity capital and the cost of risk capital (which could for example be insurance or derivatives). Linkages between this latter model, which been labeled by Shimpi as the "insurative" model, the first modeling approach will be shown.

Panelists:
Richard D. Phillips, Bruce A Palmer Professor of Risk Management and Insurance, Georgia State University
Neil Doherty, Ronald A. Rosenfeld Professor of Insurance and Risk Management, The Wharton School

Research Topic


RE-21: Research Working Party Kickoff
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Be prepared for an informative and interactive session introducing research working parties. Working parties are like "collective call paper task forces." A group of interested volunteers, with guidance and oversight from members of research committees, will select a topic to research jointly over the coming year, with the goal of producing a single document for presentation at next year's seminar. In this session, we will field your questions and comments, brainstorm, select our first topic (or topics), and even draft any interested members! These pilot working parties will present their work at the 2004 RCM Seminar. Your participation is essential, so come join us.

Moderator/ Panelist:
Donald F. Mango, Chief Risk Officer, American Re-Insurance Company
Panelist:
Mark R. Shapland, Consulting Actuary, EPIC Actuaries, LLC

Call Paper Program



The CAS Committees on Enterprise Risk Management (ERMC) and Dynamic Risk Modeling (DRMC) have solicited responses to a call for papers on the topic of "Risk Correlation, Integration, Dependency, and Concentration."

Recent events have forced companies to consider, model, and manage against contingencies previously thought impossible, if thought of at all. The World Trade Center disaster highlighted the need to consider the reality of extreme events. This loss, the collapse of Enron, and the significant downfall of the capital markets forced companies to consider correlations between different risk factors. Experts in modeling contingent financial events, actuaries, and others are called upon to provide insight into these various risk factors, the correlations between them, and their resultant financial implications in gauging and managing enterprise risk. Papers related to any of the following topics were sought:

Correlation/Dependency: Propose data sources and empirical methods for measuring correlations/dependencies between variables within any risk type (hazard, financial, operational, or strategic) or between risk types.

Integration: Given correlation estimates, discuss methodology for integrating or aggregating correlated risk distributions.

Dependency/Causal Models: As an alternative to variance-covariance-based models, model risk factors with causal, or dependency, models. This class of models includes, but is not limited to, DFA models.

Concentration: Discuss issues related to the concentration of exposures within a risk class or between risk classes. This area could include the identification, measurement, and modeling of exposure concentration and extreme events.

Four authors of accepted papers are being invited to present their work.


CP-22 Advanced Modeling for the New Risk Landscape
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The paper addresses what the authors believe is an enormous opportunity for the actuarial community. For decades, scientists have been developing mathematical and technological tools for the purpose of modeling and interpreting some of the most complex phenomena of the sensory world. From relativity theory and quantum mechanics to string theory, complexity and chaos theory, tools have emerged which can complement traditional actuarial approaches.

Extreme events, cascading risks, multiple correlations, globalism, connectivity and derivative products have all contributed to a need for mathematical structures which reach beyond those which were developed for different times. Actuarial events, like those occuring in the subatomic world arise under a cloud of uncertainty. By incorporating developments which have arisen to model the multidimensional, fuzzy, holistic, dynamic, emergent, probabilistic, virtual behavior of the fundamental constituents of physical reality, actuaries can propel themselves into the twenty first century on a wave of unprecedented energy.

Presented by:
Lee M. Smith, Consultant, Paradigm Shift


CP-23 ERM and DFA using Active Knowledge Structures
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The requirement for integration of historical and hypothetical risk is part of a trend to increase the dynamic response of analytic systems within an organization subject to change. The paper presents a general formalism whose textual representation is immediately familiar, but which uses elements in a structure rather than a stream of instructions in its operation. The structure is uncommitted it allows information to flow in any direction and is closer to the use of knowledge than other techniques. There are many benefits it is easy to combine structures, the structures can be self-modifying, and elements within the structure can learn from its activation, eliminating the need for tens of thousands of simulations which do not accurately mirror the response of the organization to its environment.

Presented by:
James Brander, Director, Interactive Engineering Pty Ltd


CP-24 The Aggregation and Correlation of Insurance Exposure

This paper begins with a description of how to calculate the aggregate loss distribution for an insurer. The model underlying this calculation reflects dependencies between the various lines of insurance. We reflect two kinds of dependencies:

  • Dependencies generated by random changes in the underlying parameters of the model. Using data from several insurers, we show how to quantify these dependencies.

  • Dependencies generated by geographic proximity that are quantified by a catastrophe model.

Next we show how this aggregate loss distribution can be used to allocate the cost of capital and evaluate various reinsurance strategies. We demonstrate the use of this methodology on two illustrative insurers. We believe this methodology can be used in practice by most insurers.

Presented by:
Frederick L. Klinker, Actuarial Manager, ISO
David A. Lalonde, Senior Vice President, Applied Insurance Research
Glenn G. Meyers, Chief of Actuarial Research and Assistant Vice President, ISO