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ERM 57 Review. Mike Elliott, CPCU, AIAF, MBA Rich Berthelsen, JD, CPCU, AIC, ARM, AU, ARe , MBA RIMS – April 2014. Exam Basics – What to Expect Test-Taking Tips Review of Sections Students Find the Most Challenging. Overview. What to Expect on the Exam. Educational Objectives

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Erm 57 review

ERM 57 Review

Mike Elliott, CPCU, AIAF, MBA

Rich Berthelsen, JD, CPCU, AIC, ARM, AU, ARe, MBA

RIMS – April 2014


Overview

Exam Basics – What to Expect

Test-Taking Tips

Review of Sections Students Find the Most Challenging

Overview


What to expect on the exam
What to Expect on the Exam

  • Educational Objectives

  • Balanced Exam

  • Pretest Items


Test taking tips
Test-Taking Tips

  • Get the easy ones

  • Don’t get bogged down early

  • Use the “mark for later review” feature

  • Eliminate the obviously wrong answers

  • Use your scratch paper to keep track


Assignment 1
Assignment 1

  • Introduction to Enterprise Risk Management


Erm definition
ERM Definition

  • RIMSA strategic business discipline that supports the achievement of an organization’s objectives by addressing the full spectrum of its risks and managing the combined impact of those risks as an interrelated risk portfolio.







Assignment 2
Assignment classifications focus on specific characteristics of the risk itself, risk quadrants focus on2

  • Enterprise Risk Management

  • in an Organization


Purpose and types of maturity models
Purpose and Types of Maturity Models classifications focus on specific characteristics of the risk itself, risk quadrants focus on

  • The purpose of a maturity model is to evaluate or improve a business process.

  • Two types of particular interest are:

  • Capability Maturity Model

  • RIMS Risk Maturity Model


Capability maturity model cmm and capability maturity model integration
Capability Maturity Model (CMM) and Capability Maturity Model Integration

  • Has five levels:

  • Ad hoc

  • Initial

  • Defined

  • Managed

  • Optimizing



Rims risk maturity model
RIMS Risk Maturity Model Carnegie Mellon, an organization that has basic risk management processes with no attempt at enterprise-wide risk management is at which one of the maturity levels?

  • Uses 5 maturity levels based on CMM applied to 7 attributes:

  • Adoption of ERM-based approach

  • ERM process management

  • Risk appetite management

  • Root cause discipline

  • Uncovering risks

  • Performance management

  • Business resiliency and sustainability


  • A risk maturity model that uses five maturity levels based on the Capability Maturity Model, determining the maturity level for each of seven attributes by evaluating the degree to which key drivers are present, is known as the

  • A: Capability Maturity Model

  • B: Standard and Poor’s (S&P) Risk Maturity Model

  • C: RIMS Risk Maturity Model

  • D: Aon Risk Maturity Index


Organizational functions related to erm
Organizational Functions Related to ERM on the Capability Maturity Model, determining the maturity level for each of seven attributes by evaluating the degree to which key drivers are present, is known as the


Assignment 3
Assignment 3 on the Capability Maturity Model, determining the maturity level for each of seven attributes by evaluating the degree to which key drivers are present, is known as the

  • Enterprise Risk Management Framework and Process


Framework and process
Framework and Process on the Capability Maturity Model, determining the maturity level for each of seven attributes by evaluating the degree to which key drivers are present, is known as the


Iso 31000 framework and process
ISO 31000 Framework and Process on the Capability Maturity Model, determining the maturity level for each of seven attributes by evaluating the degree to which key drivers are present, is known as the

Source: ISO 31000:2009


Coso erm
COSO ERM on the Capability Maturity Model, determining the maturity level for each of seven attributes by evaluating the degree to which key drivers are present, is known as the

Source: COSO – Enterprise Risk Management – Integrated Framework


Applying risk management framework
Applying Risk Management Framework on the Capability Maturity Model, determining the maturity level for each of seven attributes by evaluating the degree to which key drivers are present, is known as the

  • The main purpose of the framework is to integrate risk management throughout the organization. The framework has 4 components

  • Lead and establish creditability

  • Align and integrate

  • Allocate resources

  • Communicate and report


Assignment 4
Assignment on the Capability Maturity Model, determining the maturity level for each of seven attributes by evaluating the degree to which key drivers are present, is known as the 4

  • Risk Oversight


  • The European Corporate Law Directive on Auditing has produced a recommended framework that defines the corporate governance roles. Under this framework, which one of the following is responsible for converting strategy into operational objectives?

  • A: Board of directors

  • B: Chief executive officer

  • C: Operational management

  • D: Senior management


  • Which statement describes produced a recommended framework that defines the corporate governance roles. Under this framework, which one of the following is responsible for converting strategy into operational objectives?one of the responsibilities of an executive-level risk committee?

  • A: Assist the board in establishing risk appetite and risk tolerance levels

  • B: Monitor the organization’s compliance with established risk limits

  • C: Approve the organization’s risk management strategies, including their design and implementation

  • D: Oversee exposures of the organization’s critical risks and advise the board on risk strategy


Assignment 5
Assignment produced a recommended framework that defines the corporate governance roles. Under this framework, which one of the following is responsible for converting strategy into operational objectives?5

  • Strategic Planning and Enterprise

  • Risk Management


Strategy implementation
Strategy Implementation produced a recommended framework that defines the corporate governance roles. Under this framework, which one of the following is responsible for converting strategy into operational objectives?

  • Some organizations apply a balanced scorecard approach to implement strategy and to provide a foundation for strategy evaluation. The balanced scorecard approach translates an organization’s strategy into specific goals and actions assigned to each department within the organization.


Swot analysis table
SWOT Analysis Table produced a recommended framework that defines the corporate governance roles. Under this framework, which one of the following is responsible for converting strategy into operational objectives?


Organizational levels
Organizational Levels produced a recommended framework that defines the corporate governance roles. Under this framework, which one of the following is responsible for converting strategy into operational objectives?



Assignment 6
Assignment individual departments within an organization direct their activities? 6

  • Risk-Based Performance and Process Management


Key performance indicators
Key Performance Indicators individual departments within an organization direct their activities?

  • A key performance indicator (KPI) measures progress toward an organization’s goals, provides an attainable standard for a specific activity, and gives the focus or direction the activity is to take.


  • Successful organizations have goals and objectives. A financial or nonfinancial measurement that defines how successfully an organization is progressing toward its long-term goals is referred to as

  • A: an operating standard (OS).

  • B: a critical success factor (CSF).

  • C: a key performance indicator (KPI).

  • D: an objective gauge (OG).


Purpose of key risk indicators kris
Purpose of Key Risk Indicators (KRIs) financial or nonfinancial measurement that defines how successfully an organization is progressing toward its long-term goals is referred to as

  • Effective KRIs provide objective, quantifiable information about emerging risks and trends in existing risks that can affect an organization’s success. A KRI can reveal an upward trend in the level of a risk that, if it continues, will exceed the designated risk threshold for that risk.



Assignment 7
Assignment 7 risk indicator (KRI) that a manufacturer might monitor?

  • Internal Audit and Control


Internal control and risk management
Internal Control and Risk Management risk indicator (KRI) that a manufacturer might monitor?

  • Internal control – a system or process that an organization uses to achieve its operational goals, internal and external financial reporting goals, or legal and regulatory compliance goals.


Coso internal control framework
COSO Internal Control Framework risk indicator (KRI) that a manufacturer might monitor?

Source: COSO Internal Control – Integrated Framework


Three lines of defense model
Three Lines of Defense Model risk indicator (KRI) that a manufacturer might monitor?

Source: FERMA/ECIIA



Evolution of internal audit
Evolution of Internal Audit audit’s role in risk assessment techniques is to

Transaction Approvals

Assurance of Internal Controls

Risk-based Approach


Risk based auditing
Risk-Based Auditing audit’s role in risk assessment techniques is to

  • Aligns audit resources with the areas that pose the greatest organizational risk.



Assignment 8
Assignment 8 traditional approach by focusing on

  • Regulation and Compliance


Regulation
Regulation traditional approach by focusing on

Rules-Based

Principles-Based

More flexible and focuses on outcomes

Responds more quickly in a changing environment

Requires more communication between the regulator and the regulated

  • More certainty and predictability

  • Less responsive to change

  • Inflexible

  • Often circumvented


Naic orsa
NAIC ORSA traditional approach by focusing on

  • Principles-based (guidelines)

  • Applies ERM to insurance companies



Assignment 9
Assignment 9 represents a change from past NAIC directives because it is

  • Risk Assessment and Treatment


Risk identification tools
Risk Identification Tools represents a change from past NAIC directives because it is

  • Facilitated workshops

  • Delphi technique

  • Scenario analysis

  • HAZOP

  • SWOT



Risk treatment techniques
Risk Treatment Techniques identification involves a select group of experts in question-and-response cycles until a consensus is achieved?


Assignment 10
Assignment 10 identification involves a select group of experts in question-and-response cycles until a consensus is achieved?

  • Risk Modeling


Influence diagrams and probabilities
Influence Diagrams and Probabilities identification involves a select group of experts in question-and-response cycles until a consensus is achieved?

  • GEV Industries hires inexperienced and experienced workers to operate simple and complex machines. Accident rates vary by worker experience and complexity of machine.

  • GEV would like to estimate accident rates if it (a) assigns workers randomly to machines or (b) assigns workers to machines based on experience.


Influence diagram
Influence Diagram identification involves a select group of experts in question-and-response cycles until a consensus is achieved?

Worker assignment to machines

?

Machine Complexity

Worker Experience

AccidentRate

Cost of

Risk


Machine and Worker Data identification involves a select group of experts in question-and-response cycles until a consensus is achieved?

Random Worker Assignments Probabilities

Accident Conditional Probability


Random Worker Assignments Probabilities identification involves a select group of experts in question-and-response cycles until a consensus is achieved?

Accident Conditional Probability

Accident Probability

Total accident probability = 15.5%


Worker Assignments by Experience identification involves a select group of experts in question-and-response cycles until a consensus is achieved?

Accident Conditional Probability

Accident Probability

Total accident probability = 12%


  • Twenty percent of PDQ Transport’s trucks have advanced safety equipment and 80% do not. Thirty of PDQ’s drivers are inexperienced and 90 are experienced. Assuming drivers are assigned randomly to trucks, what is the probability that an inexperienced driver is assigned to a truck without advanced safety equipment?

  • A: 18%

  • B: 20%

  • C: 24%

  • D: 60%


Correlation
Correlation safety equipment and 80% do not. Thirty of PDQ’s drivers are inexperienced and 90 are experienced. Assuming drivers are assigned randomly to trucks, what is the probability that an inexperienced driver is assigned to a truck without advanced safety equipment?

  • Relationship between two variables

  • Number between +1 and -1

  • 0 means no correlation



Value at risk var
Value at Risk (VaR) the variables increases, the other will


  • A $500,000, 2 percent the variables increases, the other willVaR means losses are expected to be

  • A: $10,000.

  • B: less than $500,000 2 percent of the time.

  • C: $490,000.

  • D: greater than $500,000 2 percent of the time.


Assignment 11
Assignment 11 the variables increases, the other will

  • Risk-Based Capital Allocation


Cost of equity
Cost of Equity the variables increases, the other will

  • KE = rf + ß (rm – rf )

  • Where:

  • ß = Beta of security

  • rm = Expected return on the market

  • rf = Risk-free rate


Cost of debt equation
Cost of Debt Equation the variables increases, the other will

  • Cost of debt KD = (risk free rate of return rf + risk premium) × (1 – tax rate)


Polytech company
Polytech the variables increases, the other will Company

69


Polytech company1
Polytech the variables increases, the other will Company

  • Estimate the cost of debt

  • Estimate the cost of equity

  • Optimal capital structure = weighted average of the cost of debt and the cost of equity


Polytech company cost of debt
Polytech Company – Cost of Debt the variables increases, the other will

(Risk-free rate of return + credit spread) X (1 – tax rate)

(4% + 2.10%) X (1-.40)

3.66%

71


Polytech company cost of equity
Polytech Company – Cost of Equity the variables increases, the other will

Risk-free rate of return + Beta X (Market rate of return – risk-free rate of return)

4% + 1.20 (10% - 4%)

11.20%

72


Polytech company weighted average cost of capital
Polytech Company – Weighted Average Cost of Capital the variables increases, the other will

$10 mil. debt divided by $110 mil. (debt + equity) = .091

.091 weight of debt; .909 weight of equity

(3.66% X .091) + (11.20% X .909)

.333% + 10.181%

10.514%


Market value surplus mvs
Market Value Surplus (MVS) the variables increases, the other will


Economic capital
Economic Capital the variables increases, the other will


Market value surplus example
Market Value Surplus Example the variables increases, the other will

  • Autumn Assurance Group has assets at fair value of $100 million. The present value of Autumn’s liabilities is $85 million. The market value margin is $5 million. Using probability models, Autumn determines that its VaR is $8 million because it expects to incur an $8 million or greater loss of capital at a .5 percent probability over a one-year period.

  • What is Autumn’s MVS?

  • What is Autumn’s economic capital?

  • Does Autumn have excess capital or a deficiency in capital?


Questions? the variables increases, the other will


Evolution of risk management
Evolution of Risk Management the variables increases, the other will

Insurance Management

Risk Management

Enterprise Risk Management


Erm value proposition
ERM Value Proposition the variables increases, the other will

  • Identify key risks

  • Employ risk-based decision making

  • Improve internal control

  • Improve risk governance

  • Comply with legal and regulatory requirements


Solvency i and ii insurance cos
Solvency I and II (Insurance Cos) the variables increases, the other will

Solvency I

Solvency II

3 pillars

1 – Risk-based capital

2 – Risk management and governance

3 – Transparent reporting

Includes an own risk and solvency assessment (ORSA)

  • Early 1970s

  • Focused on capital adequacy


Basel ii and iii banks
Basel II and III (Banks) the variables increases, the other will

Basel II

Basel III

Response to the Great Recession

Operational risk added

Risk management framework

Board of directors role (approve framework, risk appetite, governance)

  • Issued in 2004

  • Minimum capital requirements using weights for different types of credit risk


Erm process model
ERM Process Model the variables increases, the other will


Risk identification tools risk register
Risk Identification Tools – Risk Register the variables increases, the other will

Public University

1

2

3


Risk idenficationtools risk map
Risk the variables increases, the other willIdenficationTools - Risk Map

Public University

3

1

Loss of a personal computer

2

Damage to reputation

2

3

Loss of state funding

1


Inherent and residual risk
Inherent and Residual Risk the variables increases, the other will



Decision tree
Decision Tree residual risk indicates that the


Erm tools modern portfolio theory
ERM Tools - Modern Portfolio Theory residual risk indicates that the

X

X

X

Expected Value of the Return

Risk Appetite

X

Risk – standard deviation (variability)



Earnings at risk
Earnings at Risk residual risk indicates that the



Assignment 12
Assignment 12 projected to be

  • Risk Management Environment and Culture


Risk centers and owners
Risk Centers and Owners projected to be

  • Risk center – unit within an organization at which level a risk (or risks) is most effectively managed

  • Risk owner – individual accountable for identification, assessment, treatment, and monitoring of risks in a specific environment


Advantages of risk centers
Advantages of Risk Centers projected to be

  • Reduces the scope of risk analysis

  • Allows for the involvement of operational managers

  • Helps focus on the organization’s strategic goals and operational objectives

  • Ensures that risks are managed at the most appropriate level in the organization


Risk attitude
Risk Attitude projected to be

Risk Optimizing


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