the role of auditing in the erm process

The Role of Auditingin the ERM Process

Agenda

• Background

• Enterprise risk management

• Internal audit and ERM

• NAIC risk-focused surveillance framework

• Conclusion

An Initial ERM Comment

• You don’t become a famous writer by…– Reading a book– Reading about other authors– Watching someone else write

• Similarly, you don’t become an “Enterprise Risk Manager” by…– Reading a book– Taking a course– Listening to a presentation

Rather, ERM is…

A complex process…

… involving broad-based and in-depth knowledge and understanding,…

… requiring an appropriate corporate culture,…

… and creativity…

… born of a variety of experiences…

… and insatiable curiosity.

ERM Definition from IIA

From Position Statement, The Institute of Internal Auditors:

ERM “is a structured, consistent and continuous process across the whole organization for identifying, assessing, deciding on responses to and reporting on opportunities and threats that affect the achievements of its objectives.”

Steps in theRisk Management Process

• Determine the corporation’s objectives

• Identify the risk exposures

• Quantify the exposures

• Assess the impact

• Examine alternative risk management tools

• Select appropriate risk management approach

• Implement and monitor program

Enterprise Risk Management

• Or “Enterprise Risk and Assurance Management”

• What is ERM?– Concerned with a broad financial and operating

perspective– Recognizes interdependencies among corporate,

financial, and environmental factors– Strives to determine and implement an optimal

strategy to achieve the primary objectives: e.g., maximize the value of the firm

Evolution of ERM

• Historically: “risk silo” mentality• Mid-1990s:

– First “Chief Risk Officer”– First use of ERM terminology

• Late-1990s:– Risk-related regulatory requirements (e.g., Turnbull)– Earnings protection insurance debuts

• 2001:– September 11– Corporate scandals– Beginning of efforts to improve corporate governance (e.g.,

Sarbanes-Oxley)

A Paradigm Shift

Traditional• Risks managed in silos• Concentrates on

physical hazards and financial risks

• Insurance orientation• Ad hoc / one-off

projects

Emerging• Centralized mgt., with

exec-level coordination• Integrated consideration

of all risks, firm-wide• Opportunities for

hedging, diversification• Continuous and

embedded

Current State

• Findings from various surveys– An acknowledged need to improve risk

management– A recognition that a holistic approach is

appropriate and preferable– ERM can improve overall capital management and

thus enhance corporate value and competitiveness– A variety of approaches to improving risk

management– There are still problems to overcome

Types of Risks• Operational

– Hazard

– Physical

• Strategic– Capital / resource allocation

– Industry / competitors

• Technological– Databases

– Security

– Confidential information

• Stakeholder

• Legal– Compliance

– Regulatory

• Financial– Capital markets

– Credit risks

– Taxes

• Human capital– Retention

– Training

• Reputational

Issues in ERM Implementation

• Different corporate cultures require different ERM approaches

• Who is going to be the ERM champion within the company– Among senior executives

– Among departments / functions

• How to embed a risk management culture and responsibilities throughout the firm

Components of the ERM Process

• Determine corporate objectives

• Risk identification– Goal: comprehensiveness

– E.g., self-assessment

• Risk measurement– Volatility measures

– Value at Risk (VaR)

Impact

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Components of ERM (cont.)

• Assessing the impact– Stress or scenario testing

– Stochastic simulation

• Examine and select alternative risk management tools and techniques– Traditional risk transfer

– Natural hedging / diversification

– Integration of risks

E.g.,“dynamicfinancialanalysis”

Keys to Success in ERM

• Senior management commitment and sponsorship

• Embed a “risk management culture” in the corporation at the operational level

• Provide for accountability, both specific and widespread

• Clearly defined responsibilities for coordination and maintenance

• Adequate communication

Internal Audit and ERM

Overview

• Provide independent and objective assurance for Board on effectiveness of ERM– Identify/assess/manage key risks– Internal controls

• IA has assurance and consulting roles– Function of other resources– Relative time/effort between roles may vary

among firms and over time

Internal Audit and ERM

“The Role of Internal Auditing in Enterprise-wide Risk Management” - The Institute of Internal Auditors

Core Roles • Assurance regarding, and evaluation of, the risk

management process– Risk reporting, evaluation, management

• Assurance regarding handling of key risks

Internal Audit and ERM (cont.)

“The Role of Internal Auditing in Enterprise-wide Risk Management” - The Institute of Internal Auditors

NOT Roles • Establishment of “risk appetite”• Imposing / implementing risk responses /

management

Internal Audit and ERM (cont.)

“The Role of Internal Auditing in Enterprise-wide Risk Management” - The Institute of Internal Auditors

Possible Roles • Facilitating risk management

– Identification, evaluation, championing

• Coordinating ERM• “Developing risk management strategy for board

approval”

NAIC

“Risk-Focused Surveillance Framework”

Main Objectives

• Focus on areas posing greatest risk to solvency• Focus on “the assessment of governance structure,

corporate culture, and management processes in insurance companies to identify, assess and manage (where manage is defined as measurement, mitigation and monitoring) risk”

NAIC (cont.)

Risk Classifications • Credit

• Market

• Pricing and underwriting

• Reserving

• Liquidity

• Operational

• Legal

• Strategic

• Reputation

NAIC (cont.)

Conclusion

“The revolutionary idea that defines the

boundary between modern times and the past

is the mastery of risk”

- Peter Bernstein, Against the Gods