Enterprise Risk Management – The Role of the Actuary James E. Rech, ACAS, ASA, MAAA, CFA, FRM, PRM, MBA May 16, 2005

2 Enterprise Risk Management Governance Issues Financial Entities –Metallgesellschaft AG (1993) –Orange County (1994) –Barings (1995) –Long Term Capital Management (LTCM) (1998) –Enron (2001) Insurance Entities –Superior National Insurance Company (1999) –Reliance Insurance Company (2000) –Equitable Life Insurance Company (UK) (2000) –HIH Insurance Group (Australia) (2001) Poor Enterprise Governance

3 Enterprise Risk Management More Vocal Stakeholders Regulators – State – Federal (e.g., SEC) Rating Agencies Financial Analysts Investors Management

4 Vision - The Future “In the next five or six years, the rules that govern insurers will increasingly resemble the regulatory capital regime for banks.” Alan McNee, The Next Generation of Insurance Regulation, August 2001, ERisk.com

5 Enterprise Risk Management Legislative Influences/Response USA –Legislation Gramm, Leach, Bliley Financial Modernization Act (1999) –Formal link between Banks & Insurers –“Privacy” Issues Sarbanes Oxley (2003) –Corporate Governance –Section 404

6 Enterprise Risk Management Regulatory Influences International Regulation Global Derivatives Study Group of the Group of 30 (1993) –“Derivatives: Practices and Principles” Basel II Capital Accord ( ) –First Pillar: Minimum capital requirements –Second Pillar: Supervisory review process –Third Pillar: Market discipline International Association of Insurance Supervisors (IAIS) –Seven (7) Principles Papers ( ) –Cornerstones Papers (2004) FSA Prudential Rules (UK) (2001) USA Regulation NAIC – Risk-Focused Surveillance Process Federal Reserve – GLB Financial Modernization Act

7 Enterprise Risk Management Market & Professional Influences Rating Agencies Standard & Poors Moody’s A.M. Best Professional and Academic Groups COSO Global Association of Risk Professionals (GARP) Professional Risk Managers International Assoc (PRMIA) CFA Institute ERM Institute International, Ltd. SOA & CAS – Risk Management Section Chicago Board of Trade (CBOT) – Derivative Markets American Strategic Management Institute (ASMI)

8 Enterprise Risk Management Actuarial Contributions Early Contributions –Risk Based Capital –Dynamic Financial Analysis –Asset Liability Management –Credit Risk: Actuarial Method Current Realms of Influence –SOA Risk Management Section (joint sponsors SOA & CAS) –ERM Symposium (SOA, CAS, PRMIA) –GARP Annual Meeting

9 Vision - The Future “The Actuarial profession is looked to as the most credible source for the analysis, modeling and management of financial risk.” Terri Vaughn, Iowa Insurance Commissioner, Contingencies article

10 Financial Actuaries Primary Area of Practice – Finance Financial AAA Actuaries (6/1/04)(12/23/03)Percent FSA/ASA , % FCAS/ACAS 27 2, % Combined , % Source:

11 Other FRM Organizations CFA Institute – 70,000 + Members Global Association of Risk Professionals (GARP) – 45,850 + members Professional Risk Managers International Association (PRMIA) – 24,350 + Members

12 CFA Institute Actuaries that hold CFA Charters CFA AAA CharterholdersActuaries (6/1/04)(12/23/03)Percent FSA/ASA , % FCAS/ACAS 18 2, % Combined , % Source:

13 PRMIA Started in ,000+ members/5,000+ PRMs 26 Primary Area of Practice is Insurance Professional Risk Manager (PRM) Designation – –Exam 1: Finance Theory, Financial Instruments and Markets (1.5 Hours) –Exam 2: Mathematical Foundations of Risk Measurement (2 Hours) –Exam III: Risk Management Practices (1.5 Hours) –Exam IV: PRMIA Standards of Best Practice, Conduct and Ethics (1 Hour)

14 What’s the Future? Vision Opportunities Created Strengths/Opportunities Threats/Challenges Strategic Initiatives

15 Vision - Opportunities Created in FRM Expansion consistent with our history –Value-added contributions in new areas –Development of new tools, applications and products Facilitate bridging the knowledge gap –Banking, Insurance, and Securities –Continuing education for members New growth areas for our members –Non-Traditional Roles

16 Vision - Strengths/Opportunities Our image and presence –Professionalism –Standards of Practice Insurance knowledge –Products –Hazard Risk management –Financial reporting –Operations

17 Vision - Threats/Challenges Our image and presence –Weak at best outside pricing and reserving –Many skills are not unique to the actuarial profession Banking and Securities knowledge gap –Products –Risk management -- Risk in Assets –Financial reporting –Operations

18 Strategic Initiatives Increase the awareness of actuaries in the area of Financial Risk Management Enhance our professional skills and standards Expand the scope of the profession