Agenda

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Agenda

• Issues and trends in emerging risk management
  practices
• Best practices and implementation challenges

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Competing Pressures on Management

• Management must reconcile differences of views
  among key constituents
• Differences in focus and perspective can lead to
  conflicting actions

Rating Agencies and Regulators Investors
Risk Default on Obligations Loss of Value
Capital Amount of Net Assets Value of Investment
Performance Accounting Returns Return on Investment
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Risk Management Continuum Market Trends
Stakeholder Value
Sophistication
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What are Companies doing?

• Building a bridge across risk silos
• Realigning management responsibilities to
  facilitate integrated discussions of risk across
  the enterprise
• Aggregating risk through common issues and
  exposures
• Aggregating risk through capital measurement
• Strengthening the management of non-financial
  risks
• Putting accountability for these risks back in
  the business
• Implementing operational risk management
  frameworks
• Developing internal control assessment methods,
  tools and processes supporting compliance with
  Sarbanes-Oxley controls certification

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Steady Movement Toward Integrated Risk Management
Integrated Risk Policy Framework

• Market Risk
• Market risk policy and limits
• Valuation and risk measurement methods
• Market data and forward curve modeling
• Stress and scenario testing
• FAS 133 issues and considerations

• Economic Capital
• Measurement methodology
• Risk Integration
• Capital Allocation

• Credit Risk
• Credit risk policy and limits
• Counterparty hierarchy definition
• Internal ratings methodology
• Exposure and default probability measures
• Stand alone and portfolio credit risk

• Proactive Portfolio Management
• Risk adjusted performance measurement
• Risk based pricing
• Risk management strategies

• Operational/Business Risk
• Risk control policy and framework
• Business risk definition and risk assessment
• Measurement methodology and assumptions

• Insurance Risk
• Underwriting and pricing policies
• Actuarial and financial modeling
• Loss/Reserve valuation methods
• Stat/Gaap/economic earnings reconciliation

Risk Management Technology Infrastructure
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Capital Management, Performance Measurement
Alternatives
Best suited for
Best suited for

• Determining capital adequacy
• Supporting risk-adjusted return measurement
• Evaluating customer, product and business risks,
  capital consumption and profitability
• Supporting marginal pricing

• Assessing adequacy of business returns
• Business planning and financial forecasting
• Evaluating strategic investments
• Linking to reward framework

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Trends in Risk Measurement and Performance
Reporting

• Greater interest in more aggressively managing
  capital and returns due to stakeholder pressures
• Availability of company-specific economic capital
  measures of growing importance in rating agency
  discussions
• Move toward common performance measures, cutting
  across an enterprise and allowing all businesses
  and managers to be evaluated on a consistent
  basis
• Numerous alternative performance measures are in
  use
• Clear trend toward economic measures, away from
  accounting measures
• Consensus emerging around Risk Adjusted Return
  on Capital

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Emerging Best Practices in Methodology

• Market value measurements increasingly viewed as
  the best conceptual framework, despite practical
  and management challenges
• Recognition of limitations of regulatory/rating
  agency risk measures as drivers of business
  change
• Excess regulatory/rating agency capital viewed as
  a cost of doing business
• Risk and capital measures more commonly based on
  earnings volatility, rather than insolvency
  considerations
• Growing interest in separation of investment and
  business activities for capital allocation and
  performance measurement
• Trend toward use of hurdle rates specific to each
  business units earnings risk profile

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Emerging Best Practices in Management Processes

• Banks have been doing it longer, offering both
  good and bad experiences
• Many insurers are designing and implementing
  RAPM, but far fewer have been successful
• Rapid integration into management processes is
  crucial, including
• Quarterly performance reporting
• Business planning
• Incentive compensation programs
• Rating agency discussions
• Pricing methodologies

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Implementation Challenges

• Data, Systems, Resources and Processes
• Relevant data for a rapidly growing
  business/enterprise
• Financial modeling expertise, adequacy of
  resources
• Dealing with dependencies on other management
  processes, e.g., planning, reporting
• Institutionalizing an efficient process
• Change Management
• Getting real buy-in
• Integrating into decision making processes,
  incentive compensation programs
• Communicating with stakeholders, e.g. rating
  agencies and analysts

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Implementation Challenges

• Methodology
• Selecting among measurement alternatives to
  compare heterogeneous businesses
• Reconciling to GAAP results
• Knowing when to stop drilling down
• Many complex technical issues