A Case Study: ERM Implementation at Erie Insurance Gene Connell, Senior Vice President – Actuarial Erie Insurance Group Casualty Actuarial Society Spring Meeting – June 2007

Chief Actuary’s perspective on ERM Background: Who is Erie Insurance? –Regional Independent Agents –Reciprocal 3.8 million policies $3.8 billion net written premium $4.3 billion in surplus $10.0 billion in invested assets –22nd largest P/C insurer in US

ERM is a hot topic MS Office –Doesn’t recognize ERM –Does recognize “hooey” Google: –“ERM” has 10,700,000 hits –“Hooey” has 483,000 hits

ERM is not well defined General Counsel – compliance Internal Audit – controls Actuaries – DFA Risk Managers – path to becoming king of the world

ERM Goal: Increase the Mean and Reduce the Standard Deviation Corporate Earnings

ERM Goal: Increase the Mean and Reduce the Standard Deviation Return Risk Level Efficient Frontier Analysis

ERM Identifies/Measures Risk Events Corporate Earnings Adverse Loss Development Lackluster New Business Interest Rate Hikes Agency Defection Major Catastrophe Fraud/Scandal

ERM Identifies Strategies to Control Risk Adverse Loss Development Lackluster New Business Interest Rate Hikes Agency Defection Major Catastrophe Fraud/Scandal Absorb, reinsurance Rate reduction, technology Hedge, reallocate Compensation, technology Reinsurance, reduce exposure Audit Corporate Earnings

ERM Optimizes Risk Management Adverse Loss Development Lackluster New Business Interest Rate Hikes Agency Defection Major Catastrophe Fraud/Scandal Absorb, reinsurance Rate reduction, technology Hedge, reallocate Compensation, technology Reinsurance, reduce exposure Audit Corporate Earnings

Brief History of ERM at ERIE I was asked by CEO to “do ERM” –Board inquiries –Magazines and consultants: “hot topic” Created a “risk universe” Did high level risk inventory –Senior management and Board involved Easy part

Comparison of Top Ten Lists Management –Technology Innovation –Infrastructure –Change Readiness –Product Distribution –Performance Gap –Product Development –Measurement –Partnering –Competitor –Budget & Planning Board –Catastrophic Loss –Technology Innovation –Infrastructure –Change Readiness –Business Interruption –Competitor –Leadership –Pricing –Performance Gap –Product Distribution

Organizing for ERM at ERIE Have CEO, Board support ERM Steering Committee –Executives: COO, CFO, and General Counsel –Internal auditor and Chief IT officer ERM Working Group –Representatives from investments, underwriting, risk management, accounting, actuarial, planning, internal audit, IT Consultant to help keep things moving

ERM Governance Structure Board of Directors Board of Directors Executive Mgt. Team Executive Mgt. Team ERM Steering Committee ERM Steering Committee Divisional ERM Reps. Divisional ERM Reps. ERM Working Group ERM Working Group Senior Mgt. Team Senior Mgt. Team ERM Facilitation & Support ERM Responsibility

ERM Working Group Deliverables Governance Structure Policy Statement Framework Education, Tools and Metrics Periodic Reporting –Board Audit and Strategy Committees –Ad hoc depending on Board’s concerns over risk areas or ERM Committee’s need for direction

Actuarial’s role in ERM at ERIE Chair the ERM Steering Committee Pricing uncertainty (range of indications) Loss reserve uncertainty (range of estimates) Dynamic Financial Analysis Reinsurance Evaluation and Decision Support Economic capital concepts ERM process and reports

Dynamic Financial Analysis (DFA)

Reinsurance Alternatives

Capital Adequacy of P/C Operations Policyholder Surplus in millions

Capital Adequacy after Terrorism Policyholder Surplus in millions

Capital Adequacy w/o Home Policyholder Surplus in millions

Source of Variation in Policyholder Surplus 3 Year Projected Change in PHS

ERM Process and Reports Huge potential impact on company –Improve decision making by incorporating financial discipline Risk identification and measurement Response prioritization and measurement Clearing house of risks and responses –Reduce redundancy –Sleep at night list for CEO, Board

My Opinion on ERM At this time: –ERM is overblown –Expectations are too high –Those of us who have to deliver ERM find that no one has done it well yet –Easy to spend $$$ and resources –Easy for it to be a bureaucratic drag

My Opinion on ERM BIG plus: Getting company to consider the potential downside as well as upside of any initiative –ERM is potential antibiotic for “PowerPoint disease” –This alone has enough potential to pay for ERM headaches

Actuaries are well-positioned to be effective ERM officers Quantitative skills Financial knowledge Understanding of stochastic methods Familiar with translating business needs into models Actuaries particularly well suited for insurance industry ERM positions

Watch Out For: Overlooking the many, critical non-actuarial aspects Resource drains –It takes skilled staff; it is not trivial Reactions of rest of company –Another bureaucratic headache –Silos unwilling to give up their autonomy Unrealistic expectations

ERM is Today’s Reality ERM is a wave sweeping through the industry A big wave – it will not pass on by Ride it, don’t fight it