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Economic Capital Modeling Now Becoming Part of ERM Process and is Influencing Important Strategic Decisions, CAS is Told

12/23/2008 —

SEATTLE, WA – Insurers are making increased use of economic capital modeling in the Enterprise Risk Management (ERM) process and it is starting to influence their strategic decisions, actuaries were told at the Casualty Actuarial Society’s 2008 Annual Meeting.

Moderator Stephen Lowe, managing director, Towers Perrin, noted that companies continue to make progress integrating ERM into their business processes. “Despite some challenges, ERM is influencing some important strategic decisions,” he said.

Citing data from the 2008 ERM survey by Towers Perrin, Lowe said that about one-third of survey respondents indicated they had made changes to their companies’ risk strategy or appetites, asset strategy, and/or product/pricing since the previous ERM survey in 2006.

European insurers are leading the progress. “Within the next two years, the overwhelming majority of European insurers said they expect to use economic capital modeling in most major decision processes, compared to only about half of North American firms.”

Use of economic capital modeling is poised to expand around the world, according to Lowe. “The survey results indicate strongly that as companies gain confidence in their economic capital models they expect to expand their current use from applications that relate to overall capital adequacy, broad investment strategy and reinsurance program evaluation, to applications that involve business and product strategy,” he said.

Lowe predicted that insurers eventually would also expand usage to performance measurement – linking capital to economic value creation.

Eberhard Mueller, chief risk officer, Hannover Re, noted that ERM is an integral part of the business process at Hannover Re, with all parts of the organization participating in the ERM process.

“You have to make sure there are not silos. Through all levels of the organization you have to have active communication,” he said.

Mueller went on to describe the lessons learned in ERM through the current credit crisis and other loss events of 2008. “We have had a busy year with Hurricane Ike, Hurricane Gustav and the credit crunch in one year.”

Despite the fact that the hurricanes and the credit crisis occurred independently of each other, Mueller said there is a perception among some that models have failed. “You have to explain again and again that no remark of [Federal Reserve Chairman] Bernanke can create a natural catastrophe.”

This has led to increased interest among executives for additional safety margins to be built into models. “We have to emphasize the purpose of models. They are the decision aid, not the decision maker,” he said.

The 2008 CAS Annual Meeting was held November 16-19. The Casualty Actuarial Society fulfills its mission to advance actuarial science through a focus on research and education. Among its 4,900 members are experts in property-casualty insurance, reinsurance, finance, risk management, and enterprise risk management.

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