Jim RozsypalPartner Risk Management Practice -Ernst & Young

ERM Symposiumfocus | support | accelerate

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Agenda

Issues and trends in emerging risk management practices

Best practices and implementation challenges

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Competing Pressures on Management

Management must reconcile differences of views among key constituents

Differences in focus and perspective can lead to conflicting actions

Rating Agencies and Regulators

Investors

Risk Default on Obligations

Loss of Value

Capital Amount of Net

Assets Value of Investment

Performance Accounting Returns Return on Investment

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Sophistication

Sta

keh

old

er

Valu

e

Insurance Legal

Treasury

ERM

Most companies are positioned here with

leading edge companies moving up the

continuum.

Banks are leading the pack ; and will continue to

improve as they rush to meet Basel by 2005/6

Risk quantification, capital measurement, KPI and KRI Measurement Alignment with balanced scorecard and broader organization

measures.

Enterprise-Wide Risk Assessment

RiskSpecialization

RiskManagementIntegration

Value / RiskOptimization

Credit

Risk Management Continuum Market Trends

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What are Companies doing?

Building a bridge across risk silos:

—Realigning management responsibilities to facilitate integrated discussions of risk across the enterprise

—Aggregating risk through common issues and exposures

—Aggregating risk through capital measurement

Strengthening the management of non-financial risks:

—Putting accountability for these risks back in the business

—Implementing operational risk management frameworks

—Developing internal control assessment methods, tools and processes supporting compliance with Sarbanes-Oxley controls certification

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Steady Movement Toward Integrated Risk Management

Credit Risk Credit risk policy and limits Counterparty hierarchy definition Internal ratings methodology Exposure and default probability

measures Stand alone and portfolio credit

risk Operational/Business Risk Risk control policy and framework Business risk definition and risk

assessment Measurement methodology and

assumptions

Market Risk Market risk policy and limits Valuation and risk measurement

methods Market data and forward curve

modeling Stress and scenario testing FAS 133 issues and

considerations

Economic Capital Measurement

methodology Risk Integration Capital Allocation

Proactive Portfolio Management

Risk adjusted performance measurement

Risk based pricing Risk management

strategies

Risk Management Technology Infrastructure

Integrated Risk Policy Framework

Insurance Risk Underwriting and pricing policies Actuarial and financial modeling Loss/Reserve valuation methods Stat/Gaap/economic earnings

reconciliation

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Capital Management, Performance Measurement Alternatives

Determining capital adequacy Supporting risk-adjusted return

measurement Evaluating customer, product

and business risks, capital consumption and profitability

Supporting marginal pricing

Assessing adequacy of business returns

Business planning and financial forecasting

Evaluating strategic investments

Linking to reward framework

Best suited for:

Accounting BasedMetrics

External Risk Capital

Requirements

Bottom-up

Top-down

Internal Economic Capital Process

Measures of Risk and Capital Adequacy

Single Period Multi Period

Measures of Return Adequacy

Economic Driven Metrics

Financial Performance Metrics

ROEROIROA

RegulatoryRating Agency

Volatility ofAsset/Liability Values

Earnings Volatility

Economic ProfitEmbedded Value

Shareholder Value AddedAppraisal Value

Best suited for:

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Trends in Risk Measurement and Performance Reporting

Greater interest in more aggressively managing capital and returns due to stakeholder pressures

Availability of company-specific economic capital measures of growing importance in rating agency discussions

Move toward common performance measures, cutting across an enterprise and allowing all businesses and managers to be evaluated on a consistent basis

Numerous alternative performance measures are in use:

—Clear trend toward “economic” measures, away from accounting measures

—Consensus emerging around “Risk Adjusted Return on Capital”

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Emerging Best Practices in Methodology

Market value measurements increasingly viewed as the best conceptual framework, despite practical and management challenges

Recognition of limitations of regulatory/rating agency risk measures as drivers of business change

—Excess regulatory/rating agency capital viewed as a cost of doing business

Risk and capital measures more commonly based on earnings volatility, rather than insolvency considerations

Growing interest in separation of investment and business activities for capital allocation and performance measurement

Trend toward use of hurdle rates specific to each business unit’s earnings risk profile

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Emerging Best Practices in Management Processes

Banks have been doing it longer, offering both good and bad experiences

Many insurers are designing and implementing RAPM, but far fewer have been successful

Rapid integration into management processes is crucial, including:

—Quarterly performance reporting

—Business planning

—Incentive compensation programs

—Rating agency discussions

—Pricing methodologies

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Implementation Challenges

Data, Systems, Resources and Processes

— Relevant data for a rapidly growing business/enterprise

— Financial modeling expertise, adequacy of resources

— Dealing with dependencies on other management processes, e.g., planning, reporting

— Institutionalizing an efficient process

Change Management

— Getting real buy-in

— Integrating into decision making processes, incentive compensation programs

— Communicating with stakeholders, e.g. rating agencies and analysts

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Implementation Challenges

Methodology

— Selecting among measurement alternatives to compare heterogeneous businesses

— Reconciling to GAAP results

— Knowing when to stop drilling down

— Many complex technical issues