December 21st, 2015

Integrating & Synthesizing New Emerging Risks – Within the ERM Framework

Posted at 1:00 AM ET

One purpose of enterprise risk management (ERM) is 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, a robust ERM methodology would use a holistic approach to risk and capital management where threats are identified and monitored, all action plans are developed and risks are measured.

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 (known and/or emerging) could expose a costly underlying reality. This is exactly the problem that casualty writers experience in regard to casualty catastrophes and emerging risks. 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 an ERM approach, casualty (re)insurers can ascertain the impacts of new and emerging risks 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, models and technology. Fortunately, this situation is changing.

Innovation is catching up with the casualty catastrophe and emerging threat to (re)insurer capital. Access to rich datasets and the development of new technology is beginning to enable (re)insurers to see how emerging and liability risks can radiate from one insured through an entire portfolio of risks. Although their development stage varies by peril and modeling approach, in an increasing number of scenarios, the unknown, in effect, are beginning to become knowable through the various models in development - and then can be integrated into an economic capital model framework.

Proper enterprise risk management assessment requires relative quantification of the various risks to the firm in addition to the absolute quantification of each of them. These risks encompass underwriting risk, reserve/payout pattern risk, reinsurance risk, traditional catastrophe risk as well as the various emerging and casualty cat risks previously discussed. Guy Carpenter’s MetaRisk® and BenchmaRQ® are standardized economic capital models empowering key decision makers with a deeper and more sophisticated view of complex risk drivers throughout their business. They also generate complete scenarios and the financial statements for each scenario contemplated. Built on the same foundation for each insurance company, these models can facilitate comparisons of a company’s risk profile to that of its peers and peer composites. 

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