March 21st, 2017

Emerging Practices in Risk Tolerances: Part II

Posted at 1:00 AM ET

brian-fischer-2014-hs-sm1Brian C. Fischer, Managing Director, GC Analytics®

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As A.M. Best implements a new rating methodology with enterprise risk management (ERM) as a specific rating category, risk tolerances will play an increasingly important role with the potential to further differentiate risk profiles in Best’s evaluation of companies’ risk and capital needs. Risk tolerances will likely positively impact a company’s ERM evaluation when A.M. Best deems the company’s risk tolerances as adequate and appropriate.

Risk tolerance statements have four major components:

  1. metric, for example net income or surplus;
  2. value, for example five percent or USD 10 million;
  3. probability, for example “not greater than ten percent or 20 percent”; and
  4. element of time, for example one year or three months.

The probability component of risk tolerances and the need to understand potential capital outcomes prompt companies to use economic capital modeling. This process brings the company closer to its “Own View of Risk.”

We expect that eventually a specific company’s “standard” for risk tolerances will emerge. As more companies articulate their risk tolerances the industry will migrate to an accepted set of principles on which risk tolerance statements are built. Guy Carpenter believes that one of those principles may be “response policy,” which will dictate the value and probability used for a risk tolerance statement - at what value or number or probability will the company take action? What type of action will the company take? Will the action be far reaching or preventative? The response policy principle may provide guidance to companies in answering these difficult questions and ultimately help form the companies’ “Own View of Risk.”

Guy Carpenter is focused on the future and continues to invest in innovative resources and expertise to add client value. We help clients develop risk tolerance statements that align with their “Own View of Risk” and key stakeholder expectations, and are supported by a robust capital modeling platform. Our extensive experience with risk tolerance consultations and access to public data enables us to create custom benchmarks of industry practices. Guy Carpenter’s BenchmaRQ® and MetaRisk® are robust capital modeling solutions to help companies validate their risk tolerance statements and ensure alignment with key risk limits within their organizations.

Link to Part I>>

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