The purpose of Enterprise Risk Management (ERM) is straightforward and unequivocal. It is intended to help (re)insurers determine how much capital is needed to support the risks they assume (subject to risk tolerance). Instead of segmenting portfolios and handling each peril on a standalone basis, ERM calls for a holistic approach to capital management. These frameworks are used to identify and monitor threats, develop action plans, and measure results. The result, of course, should be the optimal deployment of capital, ultimately leading to an increase in firm value. Unlike the traditional tools of the trade, ERM entails the assumption of risk based on its marginal impact to the company as a whole. While one risk, on its own, may seem tolerable, it could lead to disproportionate accumulation of linked risks. A portfolio may appear to be diversified, but one event would expose a costly underlying reality. This is exactly the problem that casualty writers experience in regard to casualty catastrophes. Insureds from several industries or countries could be affected by the same event, diluting the benefits of risk and geographic diversification. Separate risks do not reflect the integrated reality, masking a greater risk that typically goes unhedged.
Using ERM frameworks, casualty (re)insurers can ascertain the impacts of a new risk on their entire businesses. Within the casualty catastrophe context, this includes the risks resulting from the proliferation of risk along a supply chain or through other business relationships, such as joint ventures and partnerships. The implications of covering a new insured may be more profound than they appear at first.
The careful evaluation of each new risk added to a portfolio moves the firm toward a metrics-based approach to risk and capital management, facilitating governance and enhancing the deployment of capital. The only problem for casualty writers, however, has been the availability of data and models to determine the true effects of a new risk to the carrier’s entire portfolio. Even if a casualty carrier wanted to make the most of an ERM framework, it would be limited by data and technology. Fortunately, this situation is changing.
Innovation is catching up with the casualty catastrophe threat to (re)insurer capital. Access to rich data sets and the development of new technology now enables casualty writers to see how liability can radiate from one insured through an entire portfolio. The unknown, in effect, is becoming knowable.
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