Company Enterprise Risk Management & Stress Testing Case Study

moderated by Joe Petrelli Sr. President, Demotech, Inc. presented by Anya Kutsina Director, U.S. RE Analytics / Ultimate Risk Solutions

Implementing ERM and DFA Utilizing Risk Explorer

 The Importance of ERM for an Insurance Company Why this topic is relevant Evolution from RM to ERM Industry Challenges What is DFA? Analyzing DFA results Solvency Testing Structure of a DFA model URS DFA Application Suite Agenda

 Case Study: Lake George P&C Company Lines of Business Assets Reinsurance Structure Viewing Simulation Results Comparison of Reinsurance Programs Analysis of the Company’s Equity position under different scenarios. Cost / Benefit Analysis  Conclusion - Q&A Agenda (cont’d)

Why this topic is relevant  The source of origination for ERM, DFA concepts Risk Management process is the foundation for Enterprise Risk Management Static (deterministic) Financial Analysis is the foundation for Dynamic Financial Analysis  Evolution of both from original concepts Dynamic Financial Analysis

The definition of Risk Evolution of Risk Management  Any event that presents the possibility of loss or danger to organizations or people  Uncertainty – dealing with the unknown and uncertainty of outcomes

Risk Management: the original concept  Risk Management is a process for managing the uncertainty created from unexpected, unintended or accidental events  A process for making decisions that will minimize the impact of risk  The original focus was primarily on “Pure Risks” Evolution of Risk Management

Evolution from RM to ERM  Enron and other scandals prompted Congress to call for more financial controls  Calls for even greater corporate governance resulted in Sarbanes-Oxley Act of 2002  Government and regulatory authorities responded by creating the Committee of Sponsoring Organizations (COSO) of the Treadway Committee  Rating organizations such as AM Best include it in their analysis Evolution of Risk Management

ERM – Holistic Management of Risk  Enterprise risk management is driven by the concept that one cannot effectively protect the whole organization without analyzing all factors that influence financial outcomes.  Risk is viewed across the entire enterprise Evolution of Enterprise Risk Management

The Focus of ERM  It considers the impact of “speculative, economic or business risks” on entity as well as “pure risks”  ERM incorporates each of management’s decisions with respect to risk  Who is in charge of risk at your company? How is it managed?  Who has the role of Chief Risk Officer? ERM — General Concepts

 Regulatory Inquiries  I.e. Stress Testing  Reinsurance Optimization  Strategic Asset Allocation  Capital Allocation  Performance Measurement  Business Mix  Pricing Decisions  Mergers and Acquisitions Dynamic Financial Analysis DFA applications

Dynamic Financial Analysis ERM Tools  Scenario testing – projects business results under selected deterministic scenarios into the future. Results based on such scenario are valid only for this specific scenario.  Stochastic simulation (DFA) – thousands of different scenarios are generated stochastically allowing for the full probability distribution of important output variables, like surplus, written premium, loss ratios.

Setting the Time Horizon  The first step used to compare different strategies is to apply a fixed time horizon  In the Insurance industry a projection period of five to ten years seems to be a reasonable choice  simulate to determine the long term effects of a chosen strategy  simulated values are less reliable over a longer projection period ERM Tools - Dynamic Financial Analysis

Analyzing DFA Results  Return measure (e.g. expected surplus)  Risk measure (e.g. expected policyholder deficit) –  Efficient strategy – if there is no one with lower risk at the same level of return, or higher return at the same level of risk Dynamic Financial Analysis

Solvency Testing  Financial position of company is evaluated from the perspective of regulators, agents and insureds  Quantify in probabilistic terms whether the company will be able to meet its commitments in the future DFA provides a range of results regarding the anticipated Surplus of the company Dynamic Financial Analysis

What is ?  Portfolio risk management  Risk modeling  Reinsurance/retro-cession analysis  Risk-based capital calculation  Cash flow testing and financial planning (Statutory and GAAP) Dynamic Financial Analysis

FUNCTIONALITY

FUNCTIONALITY

Evaluating Ceded Reinsurance/ Retrocession Programs  Handle any complexity  Easy to design alternative programs  Analyse the impact on: Capital requirement Profit RAROC Reinsurance cost allocation Dynamic Financial Analysis

RBC and Capital Allocation  Compare Capital alternatives: Varying risk assumption Varying reinsurance or investment strategies  Measure ROE for any portfolio segmentation Dynamic Financial Analysis

Case Study

Conclusion - Basic ERM Components Dynamic Financial Analysis