2001 Casualty Loss Reserve Seminar Fairmont Hotel New Orleans, La September 9-11, 2001 Robert F. Wolf FCAS, MAAA Principal William M. Mercer/MMC Enterprise Risk Consulting. The Evolving Role in Enterprise Risk Management. Agenda. Introduction ERM/Actuarial Evolution Trends - What’s Going On?
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2001 Casualty Loss Reserve Seminar Fairmont HotelNew Orleans, LaSeptember 9-11, 2001Robert F. Wolf FCAS, MAAAPrincipalWilliam M. Mercer/MMC Enterprise Risk Consulting
The Evolving Role in Enterprise Risk Management
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B= VaR (Pr Ruin)
A =Variance Principal=
Squared Dev from Mean
Exogenous Contingent Events
Loss Forecasting/Reserving Models
Dynamic Financial Modeling
Discounted Cash-Flow Models
Goal is to optimize shareholder value
(See Presentation By Barry Franklin)
Case Study Framework
ERM Insurance Company
2.0 Billion of Premiums
$700 Million Surplus
Mulli-line Company - Primarily Personal Lines
The Company Manages its silos well
50% Premium Volume is rate sticky states
25% growth rate in recent years
Less Pressure on Rate Adequacy to Achieve Corporate Goals
How much capital is Enough?
Supporting Future Growth
Should we give back to Shareholders?
What if a beneficial acquisition arises?
Should we increase our Shareholder dividend?
Is debt financing appropriate?
Is our investment strategy providing a good risk/reward
How efficient is our reinsurance Structure?
Should we be self insuring/insuring our operations risks?
Capital Truly Held includes
Capital embedded in UEPR,
Discount in Loss Reserves,
Capital Tied up in NAIC RBC/
Economic Capital is all that matters.
The above reflects a timing constraint as
to how much capital to hold if >Economic
Capital. Must reflect this timing cost.
Considerations - Credit Risk
Asset/ Liability Management
Change in Equity = Change is Assets - Change in Liability
If the asset duration exceeds the liability duration, then an upward shift in interest rates decrease equity.
If the asset duration exceeds the liability duration, then an downward shift in interest rates increase equity.
Interest rate shift
Needs to Consider Cash Flows of New/Renewal Business
Effects of Duration Mismatch
And in many cases the LiabilityDuration is actually NEGATIVE
….so we May Need to consider inflation hedged securities or assets that tend to move with inflation such as stocks (long-term) and real estate
Interest rate shift
Handled Similarly to Barry’s Approach to Corporate Client
Also Includes Seasoning of Business - Renewals Get Better
Let K = Policyholder Supplied Funds (PHSF)
Let S = Shareholder Supplied Funds (SHSF)
RA = Return on Investments Using both policyholders
and shareholder supplied $s
RL = Cost of Debt (Borrowing PHSF)
RC = Cost of Capital (Using SHSF)
on K+S funds
Balanced Levered Trust
(K+S)RA = KRL + SRC
at rate of RC
K Costs at a rate of
RL is the reserve discount rate,
RL = RA - (S/K)(RC- RA)
RU = - K RL/Premium
Insurance Company Earns Positive Economic Returns on Underwriting if RA > RL (Ru> - (K/Premium) RA )
RC = (1 + K/S)RA + (Prem/S)RU
Market Value of Firm = S(ROE)/(1+RC)+ S(ROE)(1+G)/(1+RC)2 + S(ROE)(1+G)2/(1+RC)3 +……..
Book Value of Firm = S
Market/Book Ratio = ROE/(Rc-G)
S = Statutory Surplus
G= Long-Term Growth
Rc = Discount Rate@
Cost of Capital
Let P = Return and C = Capital. Then the insurer is better off by adding a line/policy if:
Marginal return on new business >
return on existing business.
Fortune 1000 Group Analysis10% of the Fortune 1000 companies suffered a loss of over 25% of shareholder value within one month
% of top 100
Primary Cause of Stock Drop (# of Companies)
Loss of Key Customer
Foreign Macro-Economic Issues
High Input Comm-odity Price
Interest Rate Fluct-uation
Customer Demand Shortfall
Customer Pricing Pressure
M&A Integration Problems
Supply Chain Issues
Source: Compustat, Mercer Management Consulting analysis - Period Examined was June 1993 to May 1998
Note: There were also 5 stock drops for which the primary cause could not reliably be determined. These 5 stock drops are not depicted.
…….Significant Opportunities for Us.
“….We don’t do things because they are easy.
We do them because they are hard.”
….John F. Kennedy