New York - Insurers are taking enterprise risk management (ERM) seriously, but many companies have begun ERM programs without taking the necessary step of getting management consensus on risk appetite.

That’s one conclusion reported in a recent quarterly outlook by the the New York-based Insurance and Actuarial Advisory Services (IAAS) practice of Ernst & Young LLP in a recent quarterly outlook.

Ernst & Young suggests insurers develop a formal risk appetite, which it defines as the level of aggregate risk a company can undertake and manage over an extended period of time, as well as the level of risk and expected returns that will allow the company to meet its mission and financial goals.

The risk appetite must be meaningful--focused on risk and return, creating value, and protecting value, the company says. Companies should use it to define and calibrate the risk limits used to manage the business. It can also become part of the business strategy dialogue, the company says. At the same time, insurers should redefine risk appetite as the business strategy evolves.

By working with management to draft and validate the appetite, circulating it for comment and obtaining buy-in from the board of directors, insurers can formalize their risk appetite so that it can serve as a cornerstone for making strategic and tactical business decisions around risk.

“As companies feel pressure to put ERM in place, many get ahead of themselves,” say Chris Karow, Partner, Ernst & Young LLP. “It isn’t too late to build a risk appetite even for companies already on the ERM journey.”

Developing a risk appetite can get everyone on the same page, creating the links between business
strategy, value creation and risk management, Karow says, adding that the process can help improve ERM.

In other findings described in the quarterly report, the company says regulations surrounding
principles-based reserves for life products are continuing to evolve. Although the effective date of
the broad-based requirements remains several years away, the company says, the time to prepare is now.

Integrating ERM with the valuation process is a cornerstone of the principles-based reserves and
capital regime, the company says.  Insurers that adopt a reserve framework can match reserve levels with risk levels.

“Companies that investigate and address this interplay early will find themselves ahead of the curve when the regulations change and will be able to take better advantage of the ERM processes they already have in place,” says Tara Hansen, senior actuarial advisor, Ernst & Young IAAS. 

In another section of the outlook, the company maintains that the 2004 and 2005 hurricane seasons
revealed weaknesses in commonly used catastrophe risk modeling techniques.  The quality of exposure data, especially for commercial lines of business, was insufficient, the company says.  While 2006 was a quiet year, the memory of Katrina has not faded and a key imperative for 2007 is enhanced data collection, it continues.

As insurers plan improvements, they need to understand issues surrounding data quality that affect exposure to other naturally occurring catastrophes, such as earthquakes, the company says.  The right approaches to reconstruction can offer competitive advantages on pricing and risk selection as well as reinsurance pricing and capacity.

Ernst & Young suggests the following steps for improving data quality:

· Define a data governance process addressing who owns data and data quality

· Communicate the impacts of data quality on risk measurement, management and reinsurance pricing

· Determine which exposure data elements are important and how they can be obtained

· Evaluate the effectiveness and potential improvement of using third-party tools and databases

· Design a data collection process and warehouse architecture that positions companies for success now and in the future

· Initiate a review protocol to periodically assess the processes and controls surrounding data

“Smart companies will recognize that the current lull offers an opportunity to implement necessary changes addressing the way they collect, store and use data,” says Tom Stone, manager, Ernst & Young IAAS.

Those who invest today will realize significant benefits in the future, Stone says. “It is only a
matter of time before the winds blow again, and the industry has to answer the recurrent question of how its risk management practices performed against the latest hurricane.” 

Source: Actuarial Advisory Services (IAAS) practice of Ernst & Young LLP

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