Enterprise Risk Management

1. Enterprise Risk Management September, 2008 Michael E. Angelina, ACAS, MAAA Endurance Specialty Holdings Ltd

2. Initial Thoughts • Enterprise Risk Management • New fad or a step into a new frontier • ERM due to its name is thought to be defensive • Manage risks to protect downside • ERM is strategic weapon (even within reserving) • Process of understanding the drivers of risk and the impact to underwriting decisions can make you a strategic partner in your organization. • Think portfolio theory and risk levels • Avoid too much focus on individual cells at the ERM level • Technology is our friend • Analytical insights can takes us to the next level

3. Economic Capital Modeling ERM Objectives/Principles • Optimally manage the company’s capital • Required return on capital • Eliminate risks that threaten solvency/viability • Target maximum aggregate level of risk given range of opportunities • Manage volatility – Expected Value Curve • Understand, manage, mitigate • Shape business by taking risk we can quantify • Risk mix, diversification, hedging • Create behaviors that reinforce ERM culture • Internally and externally

4. ProcessSilos and Integrated Approach • ERM – Initial Phase • Silo approach – focus on broad categories • Identification, Measurement, Management • Communication by individual risk owners • ERM – Second Phase • Bringing it all together – Integrated Approach • Holistic approach / Connecting the silos • Dashboards can be helpful - Stress test different scenarios • ERM Process – Third phase • Correlation Analyses • Need to reflect interactions with other stakeholders (eg Enron effect) • Examples • Catastrophe events on property coverages, investments in cat bonds, mortgage backed securities • Pricing errors and impacts on loss reserves • Adding value by understanding other parts of business • Understanding and communicating - this is cultural

5. Execution Risk Categories - Identification • Separate Risks into General Categories • Primary • Five broad categories • Consequential (downward spiral) • Based on primary risk or event • Liquidity, Reputation (client/investor), Rating agency / Regulatory, etc • Overall Risk Tolerances derived at organizational level • Percent of equity limits, Rating agency trigger – capital adequacy levels, Liquidity • Additional tolerances should be established for all primary risk categories • Levels of investments, peak exposure zones, casualty premium, etc • Controls • Processes, guidelines, models & data, external reviews, risk assessment process, internal audits, Sarbanes-Oxley process, disaster recovery planning & testing, succession planning

6. Execution Measurement of Risk Categories • Select risk owners / gatekeepers of the broad risk categories • Identify the various types of events/risks associated with each of the primary categories • Change in asset value, movement in interest rates, large property/casualty event (hurricane, earthquake, Enron), adverse claims trends, etc • Measure financial and operational impact to organization • Balance sheet, liquidity, capital requirements • Contingency planning • Define tolerances for such events/risks • Percent of capital, cash-flow, change in rating agency capital • Establish controls to monitor risk exposure within established tolerance levels and to enhance risk profile • Manage business around such thresholds • Optimally at the point of sale

7. Economic Capital ModelRisk Assessment –Pricing Example • Developed a model that assesses pricing risk • Produces a set of risk-capital metrics • Monitors level of capital deployed in the business units across group. • Allows for better measurement of the marginal return on capital • Real-time basis, for each contract in our portfolio • Manages unique interaction of each contract with others in portfolio • Based on the geographic distribution of exposures for property. • Results in a significantly more efficient portfolio • In terms of the capital required to support it • Relative to typical industry position • Supports a broad array of risk and capital management issues

8. Economic Capital ModelingImplementation Issues/Challenges • Lack of full transparency • Black box stigma attached • Much noise when revisions were made that changed results • Willingness for many to embrace technology • Resistance to models and ability to forecast (predictive value) • Used to differentiate like risks • Full commitment from executive level • Non-traditional way of thinking • People are generally open to change ?! • Real time examples made this easy to grasp • Too focused on defensive uses initially • Desire to seek opportunistic risks • Understand outcomes outside the norm • Returns too good to be true, probably are

9. Other Thoughts Communication • Consider the Audiences • Management • Executive team, Reserve committee, Risk committee • Board of Directors (Audit or Underwriting Committee) • Sarbanes Oxley, put risk in context with other risks • External (The Street, Rating Agencies, Regulators) • Caution on how the message is perceived • Consider the Message • Move away from the point estimate • Embrace the range, communicate the volatility • Don’t be Pollyanna • Communication of drivers allows management to make better decisions • Consider risks in the reserves when making investment decisions

10. Other ThoughtsStrategic Planning • Three approaches • Contingency planning • What we will do if/when this happens • Need to model both • Sensitivity analysis • Focus on cause and effect – the drivers • Impact and immediacy • Scenario analysis • More than simulation • Present different paths under different assumptions • Look at the external factors as well as internal • Non-modeled events, undervaluation, demand surge, point in cycle • Portfolio Theory • Remember this is one part of the entire group of risks in portfolio