EC: A Key Tool For ERM

Enterprise Risk Management (ERM) continues to gain momentum as an important issue among U.S. life insurance company senior management, and economic capital (EC) software may be the key to successful ERM.In its Life Insurance CFO Survey in 2006, the Tillinghast division of Towers Perrin, New York, focused on how life insurers approach ERM in general terms, their risk management objectives and how they define their ERM framework. The survey also analyzed companies' approaches to establishing EC-the minimum amount of capital that the firm needs to bear its risks-including planned improvements to their existing EC framework.

The survey points to internal and external pressures as reasons many companies extend their solutions beyond regulatory compliance and control to include value from risk-taking. As a result, corporate strategy and shareholder value initiatives require ERM tools and techniques that deliver a more complete business solution.

According to Tony Dardis, practice leader, Tillinghast Software Solutions Americas, companies need to measure the risk structure of their firm using EC, which is calculated using financial modeling software applications that simulate the financials of the firm over a range of possible futures. "The software should be capable of running sophisticated stochastic financial models and be open, flexible and auditable to satisfy the company's needs as their business changes over time," he says.

These EC software applications are designed to help managers evaluate different combinations of capital resources, such as equity, preferred stock, debt, insurance and hedging.

"Using these tools within a unifying framework, managers can include more risks in their planning and arrive at a more comprehensive economic analysis of their businesses," says Dardis.

The survey also suggests that ERM and EC are used more widely to improve risk-based decisions and capital management, and companies have come far in their uses of ERM and EC but recognize they still have room for improvement.

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