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  • 1. Understanding The Enterprise Risk Management Process Casualty Actuarial Society Special Interest Seminar San Francisco, April 3, 2001 Through The Risk Managers Eyes

2. Presenters

  • Robert Wolf - Principal
    • William M. Mercer Inc./MMC Enterprise Risk - Chicago
  • Laurie Champion - Manager, Corporate Insurance
    • Ford Motor Company - Treasurers Office - Dearborn
  • Ken Zignorski - Managing Director
    • MMC Enterprise Risk - New York

3. Agenda

  • Introduction
  • ERM Trends - Whats Going On?
  • Integrated Risk Management Programs - What Does this Mean?
  • Risk Manager Response - Industry Examples
  • Risk Manager Response - Ford Motor
  • Q&A

4. Actuarial Perspective

  • ERM EvolutionActuarial Evolution
  • Traditional Roles
    • Evaluating Hazard/Financial Risk in a silo
    • Insurance Company
      • Determine what to charge in order to meet profits targets (Ratemaking)
      • What to set aside to meet future obligations of past events (Reserving)
    • Insurance Customers
      • What to budget in order to pay for self-insured obligations and premiums
      • What to set aside to meet future obligations of retained risk

5. Actuarial Perspective

  • Continuing EvolutionActuarial Evolution
  • Evolving Demands for Risk Integration
    • Insurance Company
      • Holistic Evaluation of Assets and Liabilities (Dynamic Financial Analysis (DFA))
        • Optimum Capital Structure
        • Realization of Business Plan
    • Insurance Customers
      • Optimum Risk Financing
        • What risks to retain/insure - captives, retros, large deductibles
    • ..but still only Hazard and Financial Risk

6. Actuarial Perspective

  • ERM EvolutionActuarial Evolution
    • All sectors of Corporate America
    • Not merely Insurance Companies and their Customers

7. Evolution of Risk Management

  • As the quantification/approach to measuring/handling risk evolves, so too does our job description.
  • Risk Manager
    • From Insurance Buyer to Integrated/Consolidated Risk Strategy
  • Actuary
    • Traditional: Evaluate Hazard/Financial Risk
    • Evolution: DFA (Insurance Companies)/ ERM

8. Why the Evolution of ERM

  • New/Larger Risk
    • E-Commerce, Market/Book Values
  • New Risk Products
    • Merger of Insurance and Financial Institutions
  • Realization that Silo-Based Approaches are Flawed
    • Ignores inherent hedges and correlation
  • Increased Management Accountability
    • New Regulations requiring corporate governance

9. Why the Evolution of ERM

  • In short,because Society Demands it
  • Computer and Information Age
    • We couldnt do what we are doing today if we needed to use slide-rules or abacus.
  • FocusOptimize Shareholder Value

10. How Does Risk Manifest Itself? Cost Overruns Accounting irregularities Manage- ment ineffective- ness Supply Chain Issues Competitive Pressure M&A Integration Problems Mis- aligned Products Customer Pricing Pressure Loss ofKeyCustomer Supplier Problems R&D Delays Customer Demand Shortfall % of top 100 Regulatory Problems Strategic Operational Financial Hazard ForeignMacro- EconomicIssues InterestRateFluct- uation HighInputComm- odityPrice Law- suits Natural Disasters Primary Cause of Stock Drop (# of Companies) Source: Compustat, Mercer Management Consulting analysis - Period Examined was June 1993 to May 1998 Note: There were also 5 stock drops for which the primary cause could not reliably be determined.These 5 stock drops are not depicted. Fortune 1000 Group Analysis 10% of the Fortune 1000 companies suffered a loss of over 25% of shareholder value within one month 11. Two Ways to Interpret Graph

  • Hazard and Financial Risk is Not Important
  • Hazard and Financial Risk has been and continues to be managed well
    • Testimonial for risk managers, actuaries, brokers, and financial analysts.
    • We need to continue the process
  • The opportunity now is to work on the left side of the graph.

12. Todays Risk Manager Is Seeing Many Things

  • EmergingERM Trends
  • Enhanced Financial Management & Sophisticated Analysis
  • Integrated Risk Management Thinking
  • Changing & Competing Risk Management Roles & Responsibilities
  • Evolving Risk Management Practices & Needs

13. Risk Managers and Senior Executives Are Hearing More and More About Risk Management 14. What is Enterprise Risk Management? - EIU Survey

  • ERM assesses and manages all risks while looking for upsides in identifying risks.
  • The goal of Enterprise Risk Management is to understand all of the risks on a quantitative and intuitive level and to manage them through a central risk area - to take advantage of the synergies of managing risk in one area.
  • Enterprise Risk Management is about information and capital management.
  • Good risk management is reflected in share price indirectly, but the market is not giving a premium for ERM yet, its still too new.
  • The ultimate goal of Enterprise Risk Management is preservation of shareholder value.
  • Managing risk enterprise wide means two things: bringing all the pieces of the enterprise together to add the exposures, and using the whole enterprise to manage risk - making sure at the corporate level that all the different oversight departments are working together.
  • The job of Enterprise Risk Management is figuring out where the edge of the cliff is, and making sure the risk takers know where it is.

Selected views of ERM by Senior Management: 15. Enterprise Risk Management Enterprise Risk Management is a process for identifying and prioritizing critical risks facing an organization, quantifying their impact on financial and strategic objectives, and implementing financial and organizational solutions to address them. 1.Risk management is a systematic,critical-risk focused activity 2.Risk is quantified to makeinformed business decisions 3.Risk management is an integral part ofstrategic planning and budgeting 4.Pricing,capital allocation, performancemeasures consider potential risk as well as returns 5.Risk is not automatically avoided, butweighed against opportunity to optimize risk versus return 6.Risk mitigation/financing focuses on events and volatilities that could compromise financialand strategic objectives 16. Economist Intelligence Unit ERM Study 17. Economist Intelligence Unit ERM Study Plan ToPlan To 18. Economist Intelligence Unit ERM Study 19. Economist Intelligence Unit ERM Study 20. Todays Risk Manager Is Seeing Many Things

  • EmergingERM Trends
  • Enhanced Financial Management & Sophisticated Analysis
  • Integrated Risk Management Thinking
  • Changing & Competing Risk Management Roles & Responsibilities
  • Evolving Risk Management Practices & Needs

21. Economist Intelligence Unit ERM Study 22. Economist Intelligence Unit ERM Study 23. Some Candidate Models -Random Walk & Mean Reverting 24. Comparison of Price Paths Random Walk vs. Mean Reverting Process RW: lnS t- lnS t-1= e t MR: lnS t- lnS t-1= .10 [ln100 - lnS t-1 ] + e t Comparison of Sample Price Paths Random Walk vs. Mean Reverting Process 0 50 100 150 200 250 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 Week Price Random Walk Mean Reverting Process 25. Volatility Around Annual Expected Cost

  • Diversification / covariance effect captured through integration of financial risks
  • Reduces capital required to manage volatility

AllRisks Currency $(43)M Currency $700m -$500m

  • $100m

D E V I A T I O N F R O M M E A N Mean $10m $500m - $10m - $100m -$700m Combined Total Effect of Integrating $764M Combined Risks (1 to8) Integrated Risks (1 to 8) Risk 4 Risk 3 Risk 5 Risk 2 Risk 6 Risk 7 99% 10% 90% 1% $132M $115M $332M $1M $173M Risk 1 Risk 8 Mean values Individual Risks $2.4B Summed Total $1.6B Separate Treatment $4B $433M $434M $4B $4B 26. Economist Intelligence Unit ERM Study 27.