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<ul><li> 1. Understanding The Enterprise Risk Management Process Casualty Actuarial Society Special Interest Seminar San Francisco, April 3, 2001 Through The Risk Managers Eyes</li></ul><p> 2. Presenters </p> <ul><li>Robert Wolf - Principal </li></ul><ul><li><ul><li>William M. Mercer Inc./MMC Enterprise Risk - Chicago </li></ul></li></ul><ul><li>Laurie Champion - Manager, Corporate Insurance </li></ul><ul><li><ul><li>Ford Motor Company - Treasurers Office - Dearborn </li></ul></li></ul><ul><li>Ken Zignorski - Managing Director </li></ul><ul><li><ul><li>MMC Enterprise Risk - New York </li></ul></li></ul><p> 3. Agenda </p> <ul><li>Introduction </li></ul><ul><li>ERM Trends - Whats Going On? </li></ul><ul><li>Integrated Risk Management Programs - What Does this Mean? </li></ul><ul><li>Risk Manager Response - Industry Examples </li></ul><ul><li>Risk Manager Response - Ford Motor </li></ul><ul><li>Q&amp;A </li></ul><p> 4. Actuarial Perspective </p> <ul><li>ERM EvolutionActuarial Evolution </li></ul><ul><li>Traditional Roles </li></ul><ul><li><ul><li>Evaluating Hazard/Financial Risk in a silo </li></ul></li></ul><ul><li><ul><li>Insurance Company </li></ul></li></ul><ul><li><ul><li><ul><li>Determine what to charge in order to meet profits targets (Ratemaking) </li></ul></li></ul></li></ul><ul><li><ul><li><ul><li>What to set aside to meet future obligations of past events (Reserving) </li></ul></li></ul></li></ul><ul><li><ul><li>Insurance Customers </li></ul></li></ul><ul><li><ul><li><ul><li>What to budget in order to pay for self-insured obligations and premiums </li></ul></li></ul></li></ul><ul><li><ul><li><ul><li>What to set aside to meet future obligations of retained risk </li></ul></li></ul></li></ul><p> 5. Actuarial Perspective </p> <ul><li>Continuing EvolutionActuarial Evolution </li></ul><ul><li>Evolving Demands for Risk Integration </li></ul><ul><li><ul><li>Insurance Company </li></ul></li></ul><ul><li><ul><li><ul><li>Holistic Evaluation of Assets and Liabilities (Dynamic Financial Analysis (DFA)) </li></ul></li></ul></li></ul><ul><li><ul><li><ul><li><ul><li>Optimum Capital Structure </li></ul></li></ul></li></ul></li></ul><ul><li><ul><li><ul><li><ul><li>Realization of Business Plan </li></ul></li></ul></li></ul></li></ul><ul><li><ul><li>Insurance Customers </li></ul></li></ul><ul><li><ul><li><ul><li>Optimum Risk Financing </li></ul></li></ul></li></ul><ul><li><ul><li><ul><li><ul><li>What risks to retain/insure - captives, retros, large deductibles </li></ul></li></ul></li></ul></li></ul><ul><li><ul><li>..but still only Hazard and Financial Risk </li></ul></li></ul><p> 6. Actuarial Perspective </p> <ul><li>ERM EvolutionActuarial Evolution </li></ul><ul><li><ul><li>All sectors of Corporate America </li></ul></li></ul><ul><li><ul><li>Not merely Insurance Companies and their Customers </li></ul></li></ul><p> 7. Evolution of Risk Management </p> <ul><li>As the quantification/approach to measuring/handling risk evolves, so too does our job description. </li></ul><ul><li>Risk Manager </li></ul><ul><li><ul><li>From Insurance Buyer to Integrated/Consolidated Risk Strategy </li></ul></li></ul><ul><li>Actuary </li></ul><ul><li><ul><li>Traditional: Evaluate Hazard/Financial Risk </li></ul></li></ul><ul><li><ul><li>Evolution: DFA (Insurance Companies)/ ERM </li></ul></li></ul><p> 8. Why the Evolution of ERM </p> <ul><li>New/Larger Risk </li></ul><ul><li><ul><li>E-Commerce, Market/Book Values </li></ul></li></ul><ul><li>New Risk Products </li></ul><ul><li><ul><li>Merger of Insurance and Financial Institutions </li></ul></li></ul><ul><li>Realization that Silo-Based Approaches are Flawed </li></ul><ul><li><ul><li>Ignores inherent hedges and correlation </li></ul></li></ul><ul><li>Increased Management Accountability </li></ul><ul><li><ul><li>New Regulations requiring corporate governance </li></ul></li></ul><p> 9. Why the Evolution of ERM </p> <ul><li>In short,because Society Demands it </li></ul><ul><li>Computer and Information Age </li></ul><ul><li><ul><li>We couldnt do what we are doing today if we needed to use slide-rules or abacus. </li></ul></li></ul><ul><li>FocusOptimize Shareholder Value </li></ul><p> 10. How Does Risk Manifest Itself? Cost Overruns Accounting irregularities Manage- ment ineffective- ness Supply Chain Issues Competitive Pressure M&amp;A Integration Problems Mis- aligned Products Customer Pricing Pressure Loss ofKeyCustomer Supplier Problems R&amp;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 </p> <ul><li>Hazard and Financial Risk is Not Important </li></ul><ul><li>Hazard and Financial Risk has been and continues to be managed well </li></ul><ul><li><ul><li>Testimonial for risk managers, actuaries, brokers, and financial analysts. </li></ul></li></ul><ul><li><ul><li>We need to continue the process </li></ul></li></ul><ul><li>The opportunity now is to work on the left side of the graph. </li></ul><p> 12. Todays Risk Manager Is Seeing Many Things </p> <ul><li>EmergingERM Trends </li></ul><ul><li>Enhanced Financial Management &amp; Sophisticated Analysis </li></ul><ul><li>Integrated Risk Management Thinking </li></ul><ul><li>Changing &amp; Competing Risk Management Roles &amp; Responsibilities </li></ul><ul><li>Evolving Risk Management Practices &amp; Needs </li></ul><p> 13. Risk Managers and Senior Executives Are Hearing More and More About Risk Management 14. What is Enterprise Risk Management? - EIU Survey </p> <ul><li> ERM assesses and manages all risks while looking for upsides in identifying risks. </li></ul><ul><li> 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. </li></ul><ul><li> Enterprise Risk Management is about information and capital management. </li></ul><ul><li> Good risk management is reflected in share price indirectly, but the market is not giving a premium for ERM yet, its still too new. </li></ul><ul><li> The ultimate goal of Enterprise Risk Management is preservation of shareholder value. </li></ul><ul><li> 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.</li></ul><ul><li> 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. </li></ul><p>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 </p> <ul><li>EmergingERM Trends </li></ul><ul><li>Enhanced Financial Management &amp; Sophisticated Analysis </li></ul><ul><li>Integrated Risk Management Thinking </li></ul><ul><li>Changing &amp; Competing Risk Management Roles &amp; Responsibilities </li></ul><ul><li>Evolving Risk Management Practices &amp; Needs </li></ul><p> 21. Economist Intelligence Unit ERM Study 22. Economist Intelligence Unit ERM Study 23. Some Candidate Models -Random Walk &amp; 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 </p> <ul><li>Diversification / covariance effect captured through integration of financial risks </li></ul><ul><li>Reduces capital required to manage volatility </li></ul><p>AllRisks Currency $(43)M Currency $700m -$500m </p> <ul><li>$100m </li></ul><p>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. Many New Analytical Models </p> <ul><li>Value at Risk </li></ul><ul><li>Dynamic Financial Analysis </li></ul><ul><li>Monte Carlo Simulation </li></ul><ul><li>Time Series Analysis </li></ul><ul><li>Data Segregation and Analysis </li></ul><ul><li>GARCH Analysis </li></ul><p> 28. Todays Risk Manager Is Seeing Many Things </p> <ul><li>EmergingERM Trends </li></ul><ul><li>Enhanced Financial Management &amp; Sophisticated Analysis </li></ul><ul><li>Integrated Risk Management Thinking </li></ul><ul><li>Changing &amp; Competing Risk Management Roles &amp; Responsibilities </li></ul><ul><li>Evolving Risk Management Practices &amp; Needs </li></ul><p> 29. Financing Risks Via Silo Management </p> <ul><li>Over insurance/hedging of non-correlated and negatively correlated risks </li></ul><ul><li>Under insurance/hedging of positively correlated risks </li></ul><ul><li>Higher than understood exposure to event risk </li></ul><ul><li>Missed opportunities to place risks in different markets </li></ul><p>Often leads to a sub-optimal enterprise result: Risk N Risk 3 Risk 2 Risk 1 . . . DECISION RETAIN PREMIUM + Enterprise Total Risk Retained Risk unknown Premium unknown 30. Silo Risk Management as a Portfolio of Interrelated Decisions Risk N Risk 3 Risk 2 Risk 1 . . . Enterprise Total Risk DECISION RETAIN PREMIUM + Retained Risk known Premium known Some risks should stay in silos Some risks should be split out from silos in which they currently reside Some risks should be combined in larger portfolios And, Overlay decisions may be necessary to produce the desired result. 31. Managing Risk Financing Strategies on a Portfolio of Risk Basis Risk N Risk 3 Risk 2 Risk 1 . . . Enterprise Total Risk DECISION RETAIN PREMIUM + Retained Risk known Premium known 32. Understanding Current Risk Management Systems Decisions &amp; Responses Strategic/Tactical Operating Financial Results </p> <ul><li>Take Risk </li></ul><ul><li>Shed Risk </li></ul><ul><li>Avoid Risk </li></ul><ul><li>Prevention </li></ul><ul><li>Mitigation </li></ul><ul><li>Recovery </li></ul><ul><li>Capital Structure </li></ul><ul><li>Capital Budgeting </li></ul><ul><li>Pricing </li></ul><ul><li>Ins./Hedge/Retain </li></ul><p>What information and performance measures are used to make decisions? How are decisions made? Who manages what risk and how do they relate? 33. Todays Risk Manager Is Seeing Many Things </p> <ul><li>EmergingERM Trends </li></ul><ul><li>Enhanced Financial Management &amp; Sophisticated Analysis </li></ul><ul><li>Integrated Risk Management Thinking </li></ul><ul><li>Changing &amp; Competing Risk Management Roles &amp; Responsibilities </li></ul><ul><li>Evolving Risk Management Practices &amp; Needs </li></ul><p> 34. Economist Intelligence Unit ERM Study 35. Economist Intelligence Unit ERM Study 36. Economist Intelligence Unit ERM Study 37. Economist Intelligence Unit ERM Study 38. So What is The Result? </p> <ul><li>Evolving Risk Management Positions </li></ul><ul><li><ul><li>Chief Risk Officer, ERM Councils, Global Director of Risk Management </li></ul></li></ul><ul><li>Rise of, and Partnership with, Internal Audit </li></ul><ul><li><ul><li>Corporate governance issues and perspectives </li></ul></li></ul><ul><li>Rise of, and Partnership with, Treasury </li></ul><ul><li><ul><li>Financial Management perspectives and insights </li></ul></li></ul><ul><li>Rise of Board Audit Committees </li></ul><ul><li>Evolving Skill Base for Risk Managers </li></ul><p> 39. Enterprise Risk Management Can Mean All These ThingsCorporate Governance Never in all history have we harnessed such formidable technology.Every scientific advancement known to man has been incorporated into its design. The operational controls are sound and foolproof. Crisis Management Integrating Hazard and Financial Risks into a Single Contract Establishing a Chief Risk Officer E.J. Smith Captain, H.M.S. Titanic 40. Todays Risk Manager Is Seeing Many Things </p> <ul><li>EmergingERM Trends </li></ul><ul><li>Enhanced Financial Management &amp; Sophisticated Analysis </li></ul><ul><li>Integrated Risk Management Thinking </li></ul><ul><li>Changing &amp; Competing Risk Management Roles &amp; Responsibilities </li></ul><ul><li>Evolving Risk Management Practices &amp; Needs </li></ul><p> 41. Financial Services InstitutionCompany / Title ERM Perspectives, Roles &amp; Responsibilities Reporting Structure Mutual Fund Company Chief Risk Officer Source:EIU Study , 2000 CRO only responsible for financial and operational risks. Ensures that Companys financial risks are well integrated. CRO reports to CFO. Risk Group, consisting of risk, audit, compliance, &amp; security, meets regularly. CRO functions as advisor regarding business risks, with decision responsibility falling solely on business units. Market and credit risks are isolated in specific areas of the business, whereas operational risks are inherent in all business processes. Metrics used include VaR, cash flow volatility, claims exposures and notional exposure amounts; earnings-at-risk is not used due to high day-to-day volatility of amounts of exposure and earnings. CRO views risks broadly but is weary of trying to reduce them to too few metrics because you lose track of the numbers. All categories of risk are managed by senior line executives, supported by control specialists. Market and credit risk specialists are traditional risk managers with analytical expertise and industry expertise. Operational control team includes auditors, contingency planners, security specialists, compliance experts and traditional risk managers. Strategy is to make ERM even more nimble company has formed a horizontal, cross functional, rapid-response team to quickly evaluate risks of e- business initiatives across the units. CRO does not believe that risks should be run high up in the company.Also, past experience with one CFO resulted in too much focus on controller type risks. CRO has spent a lot of energy trying to defuse issues of clout, turf, etc. while trying to make risk management an automatic, not too complicated part of ongoing business practices. 42. Power &amp; Energy IndustryCompany / Title ERM Perspectives, Roles &amp; Responsibilities Reporting Structure Large company that markets energy services and products throughout North America. Business also includes a Gas and Electric Company that delivers natural gas and electricity service to one in every 20 Americans. Chief Financial Officer Risk Manager Source:EIU Study , 2000 CFO has enterprise risk management responsibility, and the Risk Manager reports to him. The firm takes a portfolio approach via profit at risk and they do analyze correlations across commodities, but they havent found correlations in other areas such as cash-flow volatility vs. other kinds of risks. They do much to offset or manage risks across business units (e.g., determining how to handle being long power and short gas without artificially limiting what the power and gas sides can do). The risks they manage include commodity, foreign exchange, interest rate and credit risk, and they believe that most of their risks are quantifiable They are also focused on bringing top management to a fundamental agreement on profit at risk. Then they will consider plans to take positions at holding company level to balance the risks in the business units. Risk Manager faces cultural hurdles, spending lots of time teaching managers who grew up in a regulated environment about risk. CFO is creating a broad conceptual framework to help traders think about risk, to evolve the company away from micro-management. CFO is ERM champion with support from Risk Manager, who reports directly. 43. Chemical/Agricultural Industry Company / Title ERM Perspectives, Roles &amp; Responsibilities Reporting Structure Companys ERM goal is to maximize shareholder value while minimizing capital outlays. Theyre not at the point of measuring correlations, domino effects etc. Large global producer &amp; marketer of agricultural products, operating in nearly 70 countries worldwide ERM Manager Source:EIU Study , 2000 ERM Manager reports to the CEO and is viewed as the equivalent of a CRO. ERM Manager thinks good risk...</p>