aamga / a.m. best / lloyd’s conference - london 25 september 2014 enterprise risk management...

AAMGA / A.M. Best / Lloyd’s Conference - London

25 September 2014

Enterprise Risk Management

Rating Analysis & Industry Best Practices

Stefan HolzbergerManaging Director, Analytics - EMEA

AAMGA / A.M. Best / Lloyd's Conference - London 2

Disclaimer

25 September 2014

© AM Best Company (AMB) and/or its licensors and affiliates. All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT AMB’s PRIOR WRITTEN CONSENT. All information contained herein is obtained by AMB from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. Under no circumstances shall AMB have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of AMB or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if AMB is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor does it address the suitability of any particular financial obligation for a specific purpose or purchaser. Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due. Credit ratings do not address any other risk, including but not limited to, liquidity risk, market value risk or price volatility of rated securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY AMB IN ANY FORM OR MANNER WHATSOEVER. Each credit rating or other opinion must be weighed solely as one factor in any investment or purchasing decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security or other financial obligation and of each issuer and guarantor of, and each provider of credit support for, each security or other financial obligation that it may consider purchasing, holding or selling.


AAMGA / A.M. Best / Lloyd's Conference - London 25 September 2014 3

Risk profile versus risk management capabilityHow Enterprise Risk Management can make a difference

Enterprise Risk Management in the rating process


ERM - A Hot Topic

25 September 2014

Insurance and reinsurance undertakings shall have in place an effective risk-management system comprising strategies, pro cesses and reporting procedures necessary to identify, measure, monitor, manage and report, on a continuous basis the risks, at an individual and at an aggregated level, to which they are or could be exposed, and their interdependencies.

Source: SII Directive - Article 44 - Risk Management

AAMGA / A.M. Best / Lloyd's Conference - London

Enterprise Risk ManagementRating Analysis & Industry Best Practices

Enterprise Risk Management in the Rating Process

25 September 2014 5


Rating Analysis Overview

25 September 2014 6

Balance SheetStrength

Operating Performance

Business Profile


+ Country Risk

Rating

Insurance Company Financial Strength


Strong Operating Performance Builds Balance Sheet Strength

Weak Operating Performance Erodes Balance Sheet Strength

Dateof lastbalance sheet

Present Future

Operating Performance and Business Profile

Leading Indicators of the Future Balance Sheet

Bal

ance

Sh

eet

Str

eng

th

- Time -

BCAR GuidelineBusiness Profile Drives Strong and Sustainable Operating Performance

Rating Analysis Overview


BCAR

Exposure to Earnings and Capital VolatilityLow High

ERM & Capital Requirements

Will consider allowing insurers to maintain lower BCAR levels relative to the guideline for its rating if they demonstrate:

Superior traditional risk management fundamentals Superior capital management and financial flexibility Strong ERM characteristics Strong EC modeling capabilities

Weak Risk ManagementWeak Risk Management

Strong Risk ManagementStrong Risk Management

BCAR GuidelinesBCAR Guidelines


ERM - Definition

25 September 2014 9

ERM is the process through which insurers identify, quantify and manage risk on an enterprise-wide, holistic basis; it takes into

consideration the individual risks at hand, as well as any correlations and inter-dependencies of risk across the organization.

Three key areas: culture ● identification and management ● measurement


ERM – A Practical Approach

25 September 2014 10

Risk management capability is viewed in light of the company’s risk profile

A.M. Best wants companies to show us how their risk and capital management process provides a stable, sustainable operating

platform that can weather challenging times

Risk management is not a box ticking exercise


Enterprise Risk ManagementRating Analysis & Industry Best Practices

Risk Profileversus

Risk Management Capability



ERM Capabilities


• Risk Culture• Risk Identification and Controls:

– Risk Dashboards– Scenario Testing

• Risk Measurement:– Correlations– Capital Modelling– Risk-Based Decisions

• Risk Appetite:– Well-Quantified Risk Tolerances

• Market Risk• Credit Risk• Underwriting Risks:

– Pricing (attritional loss ratio)– Cat losses (PMLs; cat loads)– Reserves

• Non-Financial Risks:– Strategic (business plan)– Operational– Off-Balance Sheet

Traditional Risk Management Enterprise Risk Management

Overall Risk Management Capability


A.M. Best’s Approach to Risk Management


What is the impact of a company’s Risk Managementon its rating? Need to know two things:

Company’srisk management

capability

Company’srisk

profile


Risk Profile Assessment


• Investments• Liquidity• Financial Flexibility• Volatility in Earnings and Capital• Concentrations• Data Quality• Credit Quality of Reinsurance • Ceded Leverage/Potential Disputes• Reinsurance Program• Management Philosophy

• Line of Business• Correlations• Policy Limits• Product / Coverage Changes• Competitive Environment• Legislative/Regulatory Environment• Judicial Environment• Economic Environment• Growth




SUPERIOR

Risk Management

Capability

RM Capability ExceedsRisk Profile

RM CapabilityShortfall Relative to Risk

Profile

LOW MODERATE HIGH

Risk Profile

WEAK

RM Adequate

For Risk Profile


HIGH RISK

MODERATE RISK

LOW RISK

MINIMAL RISK

RiskProfile


A company’s risk management capability needs to meet its risk profile

SUPERIOR

STRONG

GOOD

WEAK

Negative Rating Factor / Potentially Higher Capital

Requirements



HIGH RISK

MODERATE RISK

LOW RISK

MINIMAL RISK

RiskProfile


A company’s risk management capability needs to meet its risk profile

SUPERIOR

STRONG

GOOD

WEAK

Positive Rating Factor / Potentially Lower Capital

Requirements



RiskProfile


Low Risk Profile

HIGH RISK

MODERATE RISK

LOW RISK

MINIMAL RISK

Characteristics of a Low Risk Profile

Low volatility in earnings and capitalLow severity claims / low limit policiesLimited competition / stable pricingLow leverage measuresStrong reinsurance protectionStrong financial flexibilityHighly liquid / stable investmentsStable economic environmentStrong data capture / quality


RiskProfile


High Risk Profile

HIGH RISK

MODERATE RISK

LOW RISK

MINIMAL RISK

Characteristics of a High Risk Profile

High volatility in earnings and capitalHigh severity claimsHigh policy limits / excess layersStrong competition / inadequate pricingHigh leverage measuresWeak financial flexibilityIlliquid / volatile / complex investmentsUnstable economic environmentWeak data capture / data quality



E&S Market Exhibits Strong ERM

SUPERIOR

STRONG

GOOD

WEAK

Characteristics of Strong Risk Management Capability

Dynamic capital managementCorporate wide risk aware cultureWell quantified risk appetite & risk toleranceIdentify, quantify, monitor & control risksInternal economic capital modelIdentifying correlationsCompensation based on risk metricsFrequent deterministic scenario testing


ERM Questions: Risk Appetite


• What is your risk appetite?• How frequently is it revised?• What happens if it is

breached?• How is it cascaded to your

business units?• How does it relate to risk

tolerances and risk limits?

Risk Appetite


ERM Questions for E&S Insurers

• How is the credit risk of your MGAs or TPAs monitored?– Review of premium trust funds –

segregated accounts– Audited financial statements –

going concern opinion

• How are risks associated with delegated u/w authority handled?– Pricing, coverage, manuscript

endorsements, exclusions, data quality, fraud

– Underwriting audits, IT systems• How confident are you that your

MGA is sourcing quality business?– Ranking in MGA office– MGA compensation

arrangement: volume based or profit share


ERM Questions for E&S Insurers

• What is the data quality, timeliness and reliability for setting loss reserves & IBNR post event?– Track record of loss adjusters– Pre-arranged team of loss

adjusters for catastrophe response

• Are risks associated with outsourced claims handling identified?– Leakage, fraud, salvage &

subrogation, regulatory requirements

– Are you a key client for the TPA• What mechanism ensures proper

and timely premium collection?– Automated web portal– Real time data or monthly

bordereaux


Some of these threats are also opportunities for the industry.To provide governments, industry and individuals enhanced risk transfer

opportunities.

ERM can Protect Insurer Solvency

25 September 2014

1. Risk Management Shortfall – Loss Reserving and Pricing

2. Model Error

3. Emerging Underwriting Risks

3 Key Threats and How They are Managed Through ERM


1. Risk Management Shortfall

25 September 2014

a mismatch is created between risk appetite and risk management capability. This leads to excessive risk taking and sudden, unanticipated losses that impair the insurer

Threat

• More of a company-by-company issue today• But with capital model and risk metric

standardisation the potential exists for an industry-wide view on risk that fails to identify emerging threats to the balance sheet


Risk Management Shortfall


• Poor Risk Management leads to under reserving– Failure to identify loss trends– Providing unintended coverage

Reserving Snapshot

Vicious Cycle: Inadequate reserving leads to false sense of underwriting profit which leads to underpricing

• Uncertainty around financial strength– Lost business partners and

distributions sources– Rating triggers

• Rapid spiral toward insolvency

Reserve charges lead to loss of credibility




• Deficient loss reserves:– BCAR contemplates loss

reserving trends – Industry and company specific

trends contrasted– Capital factors well-developed– Discount applied conservatively

Reserving Snapshot A.M. Best’s Analysis

• Third-party and in-house actuarial reports

• Advanced pricing models– Multivariate pricing– Telematics

• More granular underwriting data

Reserving Snapshot




• Poor ERM leads to under pricing– Unaware of technical rate– Throwing in free coverage

• IT systems inadequate to price risks and monitor performance

• Underwriting controls weaken as business expands

Pricing Snapshot

Risk of under pricing reduced through improved risk management, data quality, policy wording and caps imposed on long-tail liability lines

• Movement of rates, exposures, terms & conditions

• Monitor accident year performance

• Peer analysis• Capital charge for excessive growth

A.M. Best’s Analysis


2. Model Error

25 September 2014

capital management is driven by risk modelling that underestimates extreme scenarios that can impair insurer balance sheets

Threat

Taking too much diversification creditGetting the PMLs wrong and blowing out of the top end of reinsurance protectionDanger that event scenarios in models are not rigorous enough (e.g. financial markets shock)


Model Error


What should insurers consider?

• Risk of placing too much reliance on economic capital models

• Be aware of un-modeled perils• Consider PMLs as a range and not

as the number• Don’t disregard more basic metrics

such as TIV, zonal aggregates and gross underwriting leverage

How are insurers handlingthese risks?

• Using multiple models– Challenging the models

• Developing their own risk models• Rigorous model validation process• Management and Board• Reverse stress testing /

deterministic scenarios (realistic disaster scenarios)

• Back-testing post event


3. Emerging Underwriting Risk


Source: The Geneva Association – Annual Report 2013/14

‘The Geneva Association has highlighted the changing nature

of liability insurance. [The Liability Project] was initiated in

2013 in recognition that unexpected liability loss

conditions were the leading causes of every industry crisis of

the past 30 years.’

Companies fail to detect emerging loss exposure before extensive business is underwritten leading to class action level claims emergence

Threat


Emerging Underwriting Risk


Cyber Risk

• Considered by many to be the underrated risk¹

• Opportunities abound– Cloud computing– Social media– On-line financial transactions– Electronic personal information

Cybercrime costs global economy estimated USD 575bn annually²

• Forms of attack– Theft– Fraud– Hacking– Sabotage

• Risk and opportunity as an insurance product

¹Source Aon Risk Solutions: Underrated Threats ² McAfee & Centre for Strategic International Studies




Source: The Geneva Association – Risk Management Newsletter No. 54 June 2014

Solar Storms

• What would a 1:200 year solar storm do to the power supply?

• Power failure estimates range from 16 days to 1 – 2 years

• Potential economic costs between USD 600bn to USD 2.6tr




Insurer Actions

• Better data quality & ERM– Early detection system

• Tightening of policy wording to reduce potential for unintended coverage

• Better communication between underwriters and claims adjustors

Soft Market Dangers

• Loosening terms and conditions– Free coverage thrown in

– E.g. cyber, terrorism – Exclusions and sublimits removed


.Thank You

25 September 2014

Q & A

AAMGA / A.M. Best / Lloyd’s Conference - London

25 September 2014


Rating Analysis & Industry Best Practices

Stefan HolzbergerManaging Director, Analytics - EMEA

aamga / a.m. best / lloyd’s conference - london 25 september 2014 enterprise risk management...

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