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Enterprise Risk Management Challenges for Insurers. Donald Mango, FCAS, MAAA Director of Research and Development, GE ERC. GE ERC Worldwide provide of Reinsurance in P&C and Life and Health 2003 NWP ~US$9.8B Also major US primary insurance carrier 2003 NWP ~US$2.1B

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enterprise risk management challenges for insurers
Enterprise Risk Management Challenges for Insurers

Donald Mango, FCAS, MAAADirector of Research and Development, GE ERC

my role at ge erc
GE ERC

Worldwide provide of Reinsurance in P&C and Life and Health

2003 NWP ~US$9.8B

Also major US primary insurance carrier

2003 NWP ~US$2.1B

Subsidiary of General Electric

Unwavering parental commitment to risk management

Director of R&D

Risk and Pricing Models and Tools

Methods, thought process, software tools

Capacity Management

Techniques, risk modeling

Intellectual Property and thought leadership

Co-report to Chief Actuary and Chief Risk & Underwriting Officer

My Role at GE ERC
four major issues
Four Major Issues
  • Control versus Coordination
  • Point-of-Sale Risk Management
  • Product Cost Forecasts
  • Time Dimension
four major issues1
Four Major Issues
  • Control versus Coordination
  • Point-of-Sale Risk Management
  • Product Cost Forecasts
  • Time Dimension
1 control versus coordination
Control

Checks and balances are part of sound corporate governance

Inherent conflict of interest in the underwriting role (sales versus profit)

Coordination

Too many controls lead to paralysis

More eyes may lead to different but not necessarily better decisions

Local market presence is undermined by excessive referrals

#1: Control versus Coordination
1 control versus coordination proposal
#1: Control versus CoordinationProposal
  • Mandate the decision processes
    • Key decision variable suite, information requirements, pricing models, etc.
  • Distribute decision making authority
    • Acceptable concession to responsiveness, empowerment
    • Staff the positions appropriately, don’t legislate around weaknesses
  • Audit with Authority
    • Trust but verify
    • No self-marked portfolios
    • Accountability for violations
four major issues2
Four Major Issues
  • Control versus Coordination
  • Point-of-Sale Risk Management
  • Product Cost Forecasts
  • Time Dimension
2 point of sale risk management
Much of the risk management activity is reactive and forensic

Record of executed transactions

We end up with after-the-fact, lagging indicators

Portfolio information takes so long to compile that it often cannot inform real-time decisions

Not well matched to the inherent structural risks of insurers

Commitment to make future payments

Leveraged pool of contingent claims

History of failed companies over-committing

#2: Point-of-Sale Risk Management
2 point of sale risk management proposal
#2: Point-of-Sale Risk ManagementProposal
  • Risk Budgets = linear, additive constraints that reflect product risk characteristics, portfolio situation
    • Complexity must be distilled out  key challenge facing the quants and actuaries
  • For each opportunity under consideration, give front-line people: the marginal benefit (return) and marginal budget usage, along with cumulative usage-to-date and departmental target
  • Competent people can “improve” a portfolio under these conditions
four major issues3
Four Major Issues
  • Control versus Coordination
  • Point-of-Sale Risk Management
  • Product Cost Forecasts
  • Time Dimension
3 product cost forecasts
Accepted industry practice for loss ratio planning involves using one’s own history, modified for trends

These are somewhat incestuous, internally-based forecasts

Driving by looking in the rear view mirror

Fails to anticipate or even react to changes

Economic Invisible Hands move money in and out of various financial products

Periodic product cost shocks, followed by gradual restoration of balance

May be enough pattern and predictability to eliminate a material portion of the systematic risk

#3: Product Cost Forecasts
3 product cost forecasts proposal
#3: Product Cost ForecastsProposal
  • Independent forecast models for product costs and price levels
    • Need to have cyclical components (e.g., mean reversion)
    • Movements of the invisible hands
    • Factoring in major economic drivers
  • Would also be greatly facilitated by public domain synthetic indices, along with tradable options and futures on those indices
  • Would allow us to begin spreading systematic risk across a wide base
four major issues4
Four Major Issues
  • Control versus Coordination
  • Point-of-Sale Risk Management
  • Product Cost Forecasts
  • Time Dimension
4 time dimension
Project evaluation models are still largely static

Our capital usage is dynamic and flowing

Capital commitment to an insurance entity is ongoing

Yet, paradoxically, the capital is not meant to be “used”

Capital allocation and ROE models do factor in one aspect of time – discounting

But what about the dynamics and flow?

Can we reflect the time dimension in our decision processes?

#4: Time Dimension
4 time dimension capital usage
#4: Time DimensionCapital Usage
  • Capital Allocation may be the wrong asset usage analogue
    • Allocation can mean either earmarking or transfer
    • Typical models are based on a capital usage model of transfer to the segment, which then returns it over time
  • This may have theoretical appeal, by facilitating parallels to “project evaluation” from corporate finance
  • But it is unrealistic and unnecessary, and reinforces the static mindset
4 time dimension the capital hotel
#4: Time DimensionThe Capital Hotel
  • An alternative asset usage analogue is rental or occupation
  • “THE CAPITAL HOTEL™”
  • Underwriting of business occupies space (capacity) for a length of time
    • Reserves require supporting capital
  • Occupation of that space excludes it from other uses
  • It should therefore pay an opportunity cost
4 time dimension the capital hotel1
#4: Time DimensionThe Capital Hotel
  • Simple change that clarifies the time dimension
  • Focus on capital as a shared resource simultaneously exposed to depletion by multiple segments
  • Puts the past squarely in the present
    • Business that hangs around on the books uses up capacity
  • Focus moves to how long business occupies how much capacity (space)
    • Charged for usage per unit of time