enterprise risk management rick gorvett, fcas, maaa, arm, frm, ph.d. director, actuarial science...
DESCRIPTION
“Who am I? Why am I here?” - Admiral James Stockdale, 1992 Currently –Director, Actuarial Science Program –Professor, Depts. of Mathematics and Finance –University of Illinois at Urbana-Champaign Prior –Senior Vice President –Director of Internal Audit & Risk Management Internal Audit Corporate Investigations Risk Management Enterprise Risk Management Business ContinuityTRANSCRIPT
Enterprise Risk Management
Rick Gorvett, FCAS, MAAA, ARM, FRM, Ph.D.Director, Actuarial Science Program
Department of MathematicsUniversity of Illinois at Urbana-Champaign
Finance 590 – UIUCSpring 2005
March 29, 2005
Agenda
• About me• A risky world• Broadening our perspective• Enterprise risk management (ERM)
– Evolution– Current state– Key considerations
• Conclusion
“Who am I? Why am I here?” - Admiral James Stockdale, 1992
• Currently– Director, Actuarial Science Program– Professor, Depts. of Mathematics and Finance– University of Illinois at Urbana-Champaign
• Prior– Senior Vice President– Director of Internal Audit & Risk Management
• Internal Audit• Corporate Investigations• Risk Management• Enterprise Risk Management• Business Continuity
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Let X = current academic salaryLet Y = proposed corporate salary
Let Y = 4X
Y > X (or, Y >>> X)
Hmmm....
Enron... Worldcom...Economy...Insurance industry...Gorvett’s Co. Announces$3.4B Loss
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.
A Risky WorldAnd it just seems to be getting riskier!
• What’s getting riskier about our world?• What isn’t ?
– Perhaps aspects of technology, medical care,…?• Evidence of riskiness
– Catastrophic events in a more crowded world with greater vulnerabilities
– Current events– Books – e.g., Safe Food: Eating Wisely in a Risky
World– Financial markets
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
The Bottom Line:It All Boils Down to Capital
• “Capital”– Assets less liabilities; owners’ equity; net worth– Support for (riskiness of) operations– Thus, supports profitability and solvency of firm
• “Capital Management”– Determine need for and adequacy of capital– Plans for increasing or releasing capital– Strategy for efficient use of capital
Why Do We Care About Managing Capital?
• Leads to solvency and profitability• Benefits of solidity and profitability
– Higher company value– Happy claimholders– Better ratings– Less unfavorable regulatory treatment– Ability to price products competitively– Customer loyalty– Potentially lower costs
The “Problem” With Capital
• A certain amount of capital is needed in order to promote solvency– Thus, we need to be able to raise capital
• But.... If there is too much capital, profitability
(as measured by return on equity) will suffer– Thus, we need to be able to efficiently deploy capital
What Does Capital Management Entail?
CapitalManagement
ProductPricing Financial
Risk Mgt.
SettingObjectives
RaisingCapital
StrategicPlanning
LiabilityValuationAsset
Allocation
RiskManagement
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 objective: maximize the value of the firm
Goals of ERM
• Ensure business continuity
• Enhance opportunities for the company to achieve its objectives
• Create and increase company value
• Make risk management more cost-efficient
• Stabilize earnings
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)
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
A Paradigm ShiftTraditional
• 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
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
Like
lihoo
d
Size of lossLi
kelih
ood
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
Conclusion
“The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk”
- Peter Bernstein, Against the Gods