Something To Spark LTC

By Jim Connolly

New York

What do you get when you put “plain old risk management on steroids”?

Enterprise risk management, quipped James Kallman, president of Kallman Consulting Services, Lakeway, Texas, who then proceeded to explain how the new approach, which takes a more holistic approach to managing risk, is a cutting-edge way for insurers to manage risks effectively. Risk management includes operational, financial and strategic risks, he said.

Kallman and a panel of insurance experts discussed the new approach during KPMG LLPs 16th annual insurance industry conference here.

Effective risk management programs were discussed against a backdrop of concern during the conference over Section 404 requirements for the Sarbanes-Oxley Act of 2002. That section requires management to attest to the soundness of a companys internal financial reporting program. In fact, in an instant poll taken of 125 respondents at the KPMG conference, an overwhelming 83.2% said the Sarbanes-Oxley Act of 2002 would be the piece of legislation to most impact the industry, a dramatic increase over last years 58% response.

The compliance checks being put in place to comply with SOX will complement the work being done to ensure effective enterprise risk management, said Don Watson, vice president of enterprise risk management with ACE, Hamilton, Bermuda.

Two good reasons to implement ERM, according to Watson, are the identification of risk and establishment of acceptable risk appetite.

For instance, Watson cited claims management and the potential risk that an adverse legal decision for a disputed claim could have on an insurer, both monetarily and, more importantly, to the companys reputation.

“We are selling our promise to pay,” he said. “The minute that is called into question, then it raises questions about the viability of a company.”

Rating agencies, Watson said, are paying attention to ERM because it is a “holistic, comprehensive way of assessing risk.” This involves thinking about risk in a deeper way, he said. For instance, if a company is asked why it includes real estate in its investment portfolio, a general response might focus on opportunities in that market. However, a more useful answer, Watson said, would address why the company could accept that level of risk and how that risk relates to a range of investment risks.

Gideon Pell, a senior vice president and chief risk officer with New York Life Insurance Company, said rating agencies are taking more of an interest in ERM. There is a growing focus on new risk management techniques such as stochastic testing rather than more formulaic approaches, he added. Stochastic testing relies on a series of scenarios rather than formulas.

ERM is becoming more important because risks are growing more complex, Pell continued. For instance, he said New York Life is operating in Asia and Central and South America and that globalization changes the risk components it manages, which adds another type of risk to traditional ones such as interest rate and equity risks.

When considering risk, an ERM approach looks at a portfolio of risks rather than individual ones, he said. ERM assists companies in understanding the dependencies among these individual risks in order to manage risk in the aggregate, he added.

And, in order for it to be successful, management has to make clear that it is a priority as New York Life has done, Pell added.

Robert Semke, a vice president with MetLife, said efforts to better assess risk involve both understanding the broad exposure of a company and developing a system to report and track risk. But developing such an ERM system takes a dedication of resources, he added. For example, Semke said that in 2003, MetLife spent 60,000 person hours in implementing SOX compliance. This year, 100,000 person hours have been budgeted, he continued.

Julie Burke, a managing director with Fitch Ratings, Chicago, said the concept takes a top-down approach of looking at how all risks affect a company rather than the individual risks of various businesses of an insurer. ERM looks at how risks act together, she added. Banks have been more active in adopting this practice than insurance companies, Burke noted.

ERM is a factor that is examined and is becoming a bigger part of the process, said Mark Puccia, managing director of the insurance group of Standard & Poors Corp., New York. The approach moves from a more static approach to a more dynamic way of measuring risks, he said.

The practical implication for companies that deploy an effective ERM program, Puccia said, is that S&P could view them as not needing as much capital when their ratings are being reviewed.

Puccia said he is seeing a real commitment and investment by company management in ERM. Two years ago, if you asked management about ERM, it would have said it is a great idea that is ahead of its time, he said. But two years from now, if you ask the same question, companies will have their own models, he added.

Currently, Puccia said, companies have components of an ERM program, but in most cases, full programs are not in place. Once they are, it is important to make sure the modeling has consistency and validity.


Reproduced from National Underwriter Edition, October 14, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.