1. Enterprise Risk Management: Enterprise Risk Management: What’s the Fuss All About? Brian C. Schneider, CPA, CPCU - Director Casualty Loss Reserve Seminar September 11, 2006

2. www.fitchratings.com1 Takeaways Next Logical Step in Risk Management Measure What You Manage Enterprise “Reward” Management

3. www.fitchratings.com2 Premise #1: Next Logical Step in Risk Management

4. www.fitchratings.com3 “ERM is the discipline by which an organization in any industry assesses, controls, exploits, finances, and monitors risks from all sources for the purpose of increasing the organization’s short- and long- term value to its stakeholders.”

5. www.fitchratings.com4 ERM is nothing “new” – improves existing skills Insurance is the business of risk assumption (or risk trading) Insurers must be the pre-eminent risk managers Evolution of Three Letter Acronyms: ALM: Asset / liability management DFA: Dynamic financial analysis ERM: The latest trend Aided by vast improvements in technology and data management Greater regulatory oversight due to corporate malfeasance

6. www.fitchratings.com5 Risk Management Features Monitoring, Assessment, Reporting Risk Governanc e (people, process) Capital Modeling, Allocation Crisis Management (catastrophe, operational) What else? What if?

7. www.fitchratings.com6 Benefits of ERM – “squishy” Common “risk language” throughout organization Better risk and crisis management Earlier identification of problems Potential to eliminate inefficiencies Improved Board and statement disclosure Consistent strategic and financial decision- making

8. www.fitchratings.com7 What Goes Into Fitch’s Rating Analysis?

9. www.fitchratings.com8 Has Our Rating Methodology Changed? Since Risk Management is not new, no reason to create a new component to our rating methodology Not a new “pillar” Risk management is a fundamental component of rating analysis Analysis is updated to understand / utilize today's management techniques and related information output

10. www.fitchratings.com9 ERM Cuts Across All Aspects Industry Review Operational Review Organizational Review Financial Review Management Review ERMERM

11. www.fitchratings.com10 Overall Rating Analysis - Methodology ERM RATING OPINION

12. www.fitchratings.com11 Premise #2: Measure What You Manage

13. www.fitchratings.com12 Measure What You Manage Financial analysis “proves” the success of ERM process How successful were limits / reinsurance programs How successful were underwriting / pricing decisions Did management have crisis programs in place - liquidity backstops Number of “exceptions” Economic Capital is a Cornerstone Fuels growth opportunities Offers protection to stakeholders Maximizes value – not too much, not too little

14. www.fitchratings.com13 Considerable Time Spent on “the Numbers” ERM RATING OPINION 1.Earnings 2.Reserves 3.Capital 4.Investments 5.Asset / Liability Management 6.Liquidity 7.Financial flexibility

15. www.fitchratings.com14 Where does Prism come in? Earnings Reserves Capital Investments Asset / Liability Management Liquidity Financial flexibility Prism

16. www.fitchratings.com15 Capital Adequacy Requires Three Perspectives Regulatory Requirements Insurer’s Internal Capital Models Prism Official “scorekeeper” May be insufficient for today’s products / issues Independent, third-party review Consistency – universal model / work with the data provided Granular data / product analysis Moral hazard of opportunistic assumptions

17. www.fitchratings.com16 SimpleComplex Current regulatory models Insurer’s In- House Capital Model Stochastic platform with interactive surveys using consistent assumptions Optimal Spot for Fitch is Vertical Less than vertical is unresponsive >Arbitrary adjustments >Incomplete scope Past vertical is inefficient > Too much data > Too much time > Lack of comparability Prism’s Targeted Approach

18. www.fitchratings.com17 Prism Features Uses country-specific data for insurance risk parameterization Powered by a realistic, economically based stochastic engine Adaptable to more closely reflect an insurer's unique financial profile Integrates and analyzes risk on a fully aggregated basis A sophisticated, stochastic methodology A common platform from which to evaluate insurers globally

19. www.fitchratings.com18 Many papers available at www.fitchratings.com/prism

20. www.fitchratings.com19 Premise #3: Enterprise “Reward” Management

21. www.fitchratings.com20 ERM Pitfalls Model over-reliance Garbage In, Garbage Out Over-optimization Inappropriate diversification Must have fundamental skills Greatest asset: People A few can bring firm down SBU become risk-averse Pass up opportunities since business line hurt but firm benefits Resource issues Objectives Benefits Complexity Modeling / measurement issues Data / IT constraints Credibility of results

22. www.fitchratings.com21 Business 101 Adequate compensation for risks undertaken Cannot mitigate all risks – leaves no profit opportunity Firm’s appetite for risk Past performance is not always a good future predictor Equity markets Catastrophe events Knowing the unknown

23. www.fitchratings.com22 ERM Sample Questions Assess current regulatory, legal and accounting risks Describe ensuing competitive factors What crisis management plans do you have List top threats to franchise What risk reports are monitored by your Board Define your risk appetite List support agreements amongst entities Stress-test upstream dividend capabilities Show expected variability in future earnings What is your risk exposure What is economic capital threshold

24. www.fitchratings.com23 Enterprise “Reward” - Sample Questions What is your expected variability in future earnings projections - by business line and in aggregate? What is your estimated redundancy or deficiency in your liabilities – by business lines and in aggregate? How much capital is considered in place to support the current book of business on balance sheet versus expected new sales? What do you determine your capital needs to be related to operational risk? At what thresholds do you target for economic capital? How does your risk mitigation efforts – reinsurance, securitization, hedging – lower your required capital needs? How do hedging strategies influence your earnings profile? Do you consider potential liquidity charges in your various economic scenarios? If yes, what are they?

25. www.fitchratings.com24 Recap ERM: Next Logical Step in Risk Management Measure What You Manage Enterprise “Reward” Management

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