A Portfolio Approach to Enterprise Risk Management

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A Portfolio Approach to Enterprise Risk Management

• Bruce B. Thomas
• November 11, 2002

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About Conning Research Consulting

• 90 year history of Insurance Industry Research
• Closely connected to industry thought leaders
  and practitioners
• Produces strategic studies, industry insights and
  industry commentary
• Industry standard models including
  Property-Casualty Insurance industry, Life
  insurance industry and Property-Casualty
  reserving
• Provides proprietary, confidential research and
  insights to institutional investors

Conning Research
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Redefining ERM

• ERM is a coordinated process for managing risk
• Throughout business units and departments
• Across organizational, operational, and financial
  dimensions
• Over time

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Rationale for ERM

• Identify risk issues early
• Mitigate threats and capture opportunities
• Coordinate risk management efforts
• Conserve resources (capital and operational
  efficiencies)
• Implement best practices
• For well-known risk issues

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Benefits of Risk and Management

• Risk is a byproduct of change and value
• Absent risk, we can not advance our interests
• Risk management is about preparing for change
• Minimizing bad outcomes
• Enhancing good outcomes

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Is Risk Increasing?
More value x more change more risk

• Value
• More people and property, better lifestyles,
  higher concentrations of people and goods
• External change
• Technology, demographics, preferences,
  competition, legal and regulatory, natural
  hazards, markets, relations with suppliers and
  distributors, etc.
• Internal change
• Management and employee turnover, strategic
  shifts, system implementations, organizational
  structures, crisis, product and service
  initiatives, etc.

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Top 10 Risk/Management Issues

• People think risk is bad
• Managers have different understandings of risk
• Managers disagree about how much they can
  influence risk
• Responsibility for risk management is unclear
• Functional approaches do not work for important
  issues
• Managers have different perceptions of value
• Incentives are inconsistent with risk management
  strategy
• Risk management is inconsistent with business
  objectives
• Lack of relevant and timely information
• Information is not shared

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A Portfolio Approach

• Involves creating a general understanding of
• A companys resources
• The business environments in which it operates
• How value is created and stored
• The key risk issues underlying its value
  propositions
• How its business models are alike and dissimilar
• Every important business dimension

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The Relationship Between Risk and Value
Value
Internal Environment
External Environment
Risk
The relationship between the internal and
external environments produces value, which in
turn gives rise to risk.
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Value

• Value is created via
• Relationships
• Knowledge, expertise, and technology
• Scale efficiencies
• Value is stored
• Tangibly in financial and physical assets
• Intangibly in relationships, knowledge,
  expertise, and technology

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Risk Identification
Value
External Environment
Internal Environment
Risk
Identification
Understanding these relationships permits us to
identify sources of potential risk.
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Risk Identification

• Experienced-based approach
• Is dependent on personal experience
• Search for bad outcomes and try to identify risk
  drivers
• Environmental approach
• Seeks to understand the business in the context
  of its environment
• What is changing and how will it affect the
  business?

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The Business Environment
External Indirect
POLITICS
LEGAL
External Direct
CUSTOMERS
CUSTOMER PREFERENCES
MARKETS
REGULATORS
Internal
THE ORGANIZATION
COMPETITORS
DEMOGRAPHICS
SUPPLIERS
DISTRIBUTORS
PHYSICAL ENVIRONMENT
TECHNOLOGY
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Risk Assessment and Monitoring
Value
Internal Environment
External Environment
Risk
Identification
Data Analysis
Assessment
Management
Monitoring
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Gathering and Analyzing Important Data
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Gathering and Analyzing Important Data
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Risk Management Initiatives
Value
External Environment
Internal Environment
Risk
Identification
Data Analysis
Assessment
Management
Monitoring
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Realigning the Internal Environment
Mission, Vision Values
Operational
Financial
Employees
Debt and Equity Holders
Employment Practices and Compensation Structure
Governance and Organizational Structure
Legal and Ownership Structure
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A Portfolio Approach
Value
Internal Environment
External Environment
Risk
Identification
Data Analysis
Assessment
Management
Monitoring
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Risk Management Cannot be Static

• Most companies are only prepared for risks that
  have already impacted firm value.
• Insurers must
• Augment their experienced-based approaches with
  environmental models.
• Change their focus from assets and liabilities to
  emerging issues that will create assets and
  liabilities
• Develop strategies to mitigate potential losses
• Identify new ways to create value