December 23rd, 2009

2009 Top Stories: ERM and Capital Management

Posted at 12:30 AM ET

With 2009 coming to a close, this week we’re taking a look at the most popular stories of the year.

Update: Risk Profile, Appetite, and Tolerance: Fundamental Concepts in Risk Management and Reinsurance Effectiveness: In April 2009, Guy Carpenter’s Financial Intelligence Team published a briefing entitled Risk Profile, Appetite and Tolerance: Fundamental Concepts in Risk Management and Reinsurance Effectiveness. That briefing included definitions of Risk Profile, Appetite and Tolerance and how these concepts fit into an Enterprise Risk Management (ERM) framework. It also presented the results of our initial Risk Tolerance Benchmarking study, which summarized the information publicly disclosed in this area.

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(Based on the earlier briefing published April 30, 2009)

Risk Modeling Part IV: ERM: A misunderstanding of models and exposure data is not the primary cause of most modeling failures. Indeed, many companies that have suffered in recent catastrophes, both physical and financial, had substantial and sophisticated resources invested in risk analysis. What is often missing is the connection between analysis and management decisions, and this is the link that the rapidly evolving practice of enterprise risk management (ERM) is meant to create.

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Defining the Value of Risk Management: How do you put a price on risk management? In the early days of finance theory (1950’s), the value of risk management was questioned—unless, of course, it was costless. The nuances of a more complex business environment have rendered this position untenable, but we still struggle to quantify the benefits of risk management, especially in the (re)insurance industry. Thus, the fundamental activity of risk-bearers has not been measurable, leaving a cloud of ambiguity in the middle of every carrier’s operation.

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Five Ways to Allocate Capital: No single approach to capital allocation is objectively superior. Those that are more effective require an investment of time and resources, while the simpler methods sacrifice accuracy. A tradeoff is required based on a (re)insurer’s priorities and capabilities. Before you make a choice, however, be sure you’re aware of the alternatives.

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ERM Did Not Fail in 2008, Part I: A Year of Significant Loss: The profound financial damage that began last year has left the insurance industry looking for answers. Diligent underwriting and conservative investment strategies were not enough to prevent natural and financial catastrophes from bleeding balance sheets. Both firm leadership teams and key stakeholders have questioned the value of Enterprise Risk Management (ERM) frameworks, yet the conclusion that ERM failed may be hasty. After all, the insurance industry actually survived the events of 2008 reasonably well, with at least some of the credit going to their ERM efforts. Where risk management did fail, the underlying causes were deeper.

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