ERM platforms help gather data across siloed risk management domains, presenting an enterprisewide view of risk.
Facing the unknown is perhaps the greatest challenge for risk managers. Fraught with peril and potential disaster, uncertainty is a major impediment to devising effective strategies and mitigating risk. When confronted with unfamiliar situations, risk managers should categorize what’s known and what’s unknown in order to assess risk, and use that information to better focus their risk management efforts.
In recent years, a set of new or evolving risks has emerged between known and unknown risks—emerging risks. Difficult to quantify, emerging risks can lead to massive losses because they are marked by a high degree of uncertainty, and are difficult to assess in terms of frequency and severity that might lead to better insight into exposure. In other words, there’s no historical data from which to take an actuarial point of view.
Enterprise risk management (ERM) can facilitate the management of emerging risks by providing a framework that facilitates the identification of new risks that heretofore had not been identified. Companies also can use ERM to help manage their exposure to emerging risks by providing a framework and process to assess the potential impact from these risks. One technique that could be used as part of an ERM program is scenario analysis. Using ERM to manage emerging risks will facilitate a company’s overall risk management program, help optimize capital allocation and reduce the risk of insolvency.
Over the last few decades, reinsurers have received significantly less regulatory attention than other industries such as banking. This is changing rapidly as evidenced by initiatives such as Solvency II, which is based on the Basel II accord designed for banks. The framework focuses on areas of regulatory compliance including risk management and disclosure. Additional focus is coming from local supervisory bodies, such as the Financial Services Authority in the United Kingdom, and the National Association of Insurance Commissioners in the United States. Both groups require insurers to mature their risk management programs.
The economy is another emerging risk, as it is creating a competitive environment previously unknown in the insurance industry. The barriers to entry are dropping, and the rising power of the consumer is changing the game as well. Customers are living longer and looking for lower prices, guarantees and living benefits that are now provided in the form of variable annuities. For insurers, competition and customer focus continue to shrink margins and highlight the criticality of retention.
The same degrees of uncertainty are manifest in the areas of climate change, nanotechnology, pandemics, terrorism and information technology. Traditional models based on historical patterns may not adequately address the assessment of these risks because of the paucity of data necessary to accurately model their potential impacts. All of these risks must be assessed, priced and managed within the context of the entire risk portfolio on any one insurer.
THE ROLE OF ERM
Emerging risks have created a new world order where, in many situations, quantification techniques using historical data can give a false sense of security. Few insurers have sufficient historical data to adequately model many kinds of emerging risks to which they have exposure. The variables have changed (and keep changing), so insurers need to take into account extreme scenarios in order to expand the spectrum of risk that should be considered.
Insurers must tackle the challenges of implementing ERM frameworks and methodologies for dealing with emerging risk, which will allow them to capitalize on new opportunities. A robust ERM framework coupled with the right technology can help insurers identify and manage the entire spectrum of risk.
An ERM technology platform can help gather data across siloed risk management domains and present an enterprisewide view of risk in relation to lines of business, core processes, products and regulatory issues. A single system of record for identifying and assessing risk can set the stage for efficient mitigation efforts, and issues management and root cause analysis to minimize surprises and decrease volatility. Companies with sophisticated ERM technologies can generate meaningful decision support to make business decisions and capital decisions with the proper insight into the risk-reward tradeoffs.
The pace of change will continue to accelerate, and the need for quick and sound decision making will be critical to the growth and survival of insurance companies. As best practices emerge and individual organizations’ capabilities improve, ERM adoption rates will increase, and the depth and breadth of ERM deployments will expand.
There is no turning back on the ERM journey. The increasingly complex world of finance and global economics, politics and socio-environmental concerns will ensure that risk management, and the associated technologies, continue to gain more importance as we move deeper into the 21st century.
Insurers that find a way to deploy ERM successfully will win market share, minimize disruptions and enhance shareholder value.
Jeff DeRose is senior risk management solutions specialist at OpenPages Inc. in Waltham, Mass.
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