Insurers Get Serious About Enterprise Risk Management, Tillinghast Reports

Driven in part by increased demands from regulatory and rating agencies, enterprise risk management (ERM) has become integral to insurers’ business processes around the world. Sixty percent of survey respondents explicitly factor risk management considerations into their decision-making, according to a survey of risk and capital management practices among insurers worldwide by the Tillinghast business of Towers Perrin.

The same study found that external pressures are raising the bar for risk management globally. While most companies globally (78 percent) cite “good business practice” as the principal driver for their current risk management efforts, rating agency considerations are a significant factor for North Americans (72 percent) whereas changes in insurance solvency regulations are a major driver for European Union insurers.

The 2006 study focuses on a number of issues including risk measurement, quantification competencies, how companies calculate and use economic capital (EC), risk reporting and areas where the global insurance community is seeking to improve their risk management capabilities. In addition, a special section has been included that focuses on the impact of Solvency II on the European community.

Other key findings from the study:

• Two-thirds of the insurance industry globally uses EC as a risk quantification tool. This is a significant increase over 2004 where only half of the respondents indicated they were using EC. A further 19 percent of the participants indicated they are considering the use of EC.

• Insurers are using a diverse set of risk metrics. Insurers assess the impact of risk on their capital, value and earnings in a variety of ways, with 63 percent using at least three differing measures. The most common are statutory or regulatory capital and surplus (56 percent), economic value (42 percent) and GAAP or IAS measures (38 percent).

“Companies are clearly more disciplined in their use of ERM today than ever before, as catastrophic events, capital efficiencies and competitive pressures have driven companies to adopt less of a ‘seat-of-the-pants’ approach to risk issues,” said Managing Director Tricia Guinn, who oversees both the Tillinghast and reinsurance businesses of Towers Perrin.

Risk Management Raises Its Profile
“As risk issues have gained importance, so has the role of the chief risk officer,” said Prakash Shimpi, practice leader with global responsibility for ERM. “Insurers are not only examining risk more closely, but they are also holding executives more accountable for the results.”

Almost half of the respondents (43 percent) report having a chief risk officer (CRO) with primary responsibility for risk management, up from 39 percent in 2004 and only 19 percent in 2002.

The study also indicates that risk management is gaining importance in board rooms, with nearly all respondents (92 percent) reporting on risk to their board of directors at least annually, up from 84 percent in the 2004 survey. Also, 53 pefcent of all respondents report at least quarterly to their board. Risk reports to senior management have become a common practice, with 39 percent reporting monthly and another 35 percent reporting quarterly.

Risk reporting varies regionally:
• Bermudian (89 percent) and Canadian (82 percent) insurers are more likely than U.S. or Asia/Pacific companies (53 percent respectively) to report quarterly on risk to their boards.

• European life insurers (65 percent) and p/c insurers (60 percent) are twice as likely to report to senior management monthly as their North American counterparts (31 percent respectively).

Room for Improvement
While ERM has made significant progress in recent years, the study finds that there are still growing pains:

• Most respondents (77 percent) are highly focused on improving risk measurement and quantification processes to enhance their overall ERM efforts, particularly in the U.K. (97 percent) and Japan (95 percent).

• Respondents are generally not satisfied with their current capabilities in many of the risk management areas they see as important. They are significantly dissatisfied with their ability to quantify operational risks and their ability to reflect risk in performance measures.

“Insurers now recognize the potential impact a single event like a security breach or systems failure can have on their operations, as well as on their financials. Operational risks can be complicated and difficult to quantify, so many are turning to scenario analysis to achieve meaningful results,” said Shimpi. “We expect operational risk modeling and management practices to steadily improve over the next few years.”

Economic Capital as a Key ERM Tool
The survey also found that many insurers are moving toward the use of economic capital (EC) as a risk management tool. As stated previously, nearly two-thirds (65 percent) of all respondents calculate EC and an additional 19 percent said they are considering calculating EC, implying that it may soon be a universal tool.

“U.S. insurers tend to use regulatory or statutory capital benchmarks more than EC,” said Stephen Lowe, managing director and leader of the Towers Perrin P/C Insurance Practice. “However, EC measures have some inherent advantages that, over time, will drive broader use in the U.S.”

About the Study
The report details findings from a Web-based survey, conducted in the summer of 2006, of chief risk officers, chief financial officers, chief actuaries and other senior executives from more than 200 insurance and reinsurance companies around the world. Eighty percent of the participants were almost evenly split between North America and Europe, with another 16 percent representing the Asia-Pacific region and 4 percent from Latin America.

Source: Towers Perrin and Tillinghast