Global Survey Says Full Realization of ERM Will Require Major Effort

Greg Epperson

Stamford, Conn. — Insurers around the globe are finding it challenging to fully implement essential risk and capital management processes that would enable them to realize the full potential of enterprise risk management (ERM), according to Towers Perrin’s 2008 insurance industry ERM survey.

Conducted during May and June of 2008, prior to the global financial crisis, the global Web-based survey targeted 359 insurance and reinsurance executives. Respondents were split between North America (49%) and the rest of the world, with 29% from Europe, 19% from the Asia/Pacific region, 2% from Latin America, and 1% from Africa and the Middle East.

Incorporating Economic Capital

Towers Perrin notes that while insurance companies have made progress in integrating ERM into their business processes, more than half (55%) believe that substantial work is needed before they can use economic capital (EC) to guide risk-based decision making. The firm added that 60% of survey respondents noted that considerable strides must be made before they can link EC metrics to performance management. More than 40% remain focused on getting the basics right in their EC calculations.

Research from New York-based PricewaterhouseCoopers (PWC) in the second half of 2007 and first quarter of 2008 correlates with Towers Perrin's findings. Many of the 53 queried insurance companies felt their risk and data systems were insufficient.

According to PWC's survey, fewer than 40% of respondents believed their firm's risk data and systems are “good” or “excellent”.

As a result, many participants found it difficult to monitor and manage emerging risks. Similarly, fewer respondents appeared to be using their ERM knowledge to identify and capitalize on unfolding opportunities, rather than simply mitigating their exposures.

Despite the acknowledged need for improvement, Towers Perrin finds that ERM is influencing many important strategic decisions, according to the survey. More than 30% of survey respondents have made changes to their company’s risk strategy or appetite (36%), asset strategies (35%) and product pricing (31%) since the previous survey, conducted in 2006.

“The current crisis in the financial markets, the fragile state of the global economy and a North American hurricane season that has resulted in significant insured losses underscore the importance of having clearly defined risk strategies and tolerances in place,” says Tricia Guinn, managing director of Towers Perrin’s Risk & Financial Services segment. “Taking a holistic approach to risk management, one that connects a company’s risk tolerance to the decisions it makes and the capital it holds, while fostering a culture of prudent risk management and risk taking at every level of its organization, has never been more crucial.”

Who's Using EC?

However, insurers appear reluctant to link compensation to risk taking. Only 30% of respondents indicate that they incorporate risk measures of any kind into incentive compensation arrangements, and only 10% use EC for this purpose. Furthermore, 66% of insurers globally have no future plans to use EC in incentive compensation.

European insurers lead their North American counterparts in the implementation of EC and its use in decision-making. These capabilities, especially under Solvency II, are expected to lead to both lower capital requirements and a competitive advantage—in the short and long term—as illustrated in the survey findings. European insurers are giving greater short-term priority to the use of EC within their decision-making processes (56%), compared to their brethren in North America (40%) and in the Asia/Pacific region (38%).

Additionally, within the next two years, European insurers said they expect to use EC in most major decision processes (80% to 90%), compared to North American firms (60% to 75%) and those companies in the Asia/Pacific region (50% to 65%).

An Ernst & Young LLP, New York, survey of chief risk officers (CROs) released in June 2008 found that most respondents companies were developing, or had already implemented, EC at that point in time. Ernst & Young reported that insurers recognized EC's practical uses with respect to communicating exposures, setting tolerances and limits, managing tail exposure and making strategic decisions. The CROs expected EC to become integral to capital management and risk-adjusted performance measurement, and 90% expected that, within three to five years, EC would be a key element in performance measurement.

Risk Appetite

More than half (52%) of European firms have documented their risk appetite, says Towers Perrin, compared with only 40% of insurers in North America. Survey findings indicate that those same companies in Europe are also more apt to set risk limits for such day-to-day management issues as market risk (88%) than their counterparts in North America (61%).

“European insurers are implementing more sophisticated risk analyses that place them in a stronger position to demonstrate lower capital requirements,” says Steve Taylor-Gooby, managing director of Towers Perrin’s insurance consulting business. “Regulatory drivers are also raising awareness around risk mitigation, for example, hedging and reinsurance programs.”Conducted during May and June of 2008, prior to the global financial crisis, the global Web-based survey targeted 359 insurance and reinsurance executives. Respondents were split between North America (49%) and the rest of the world, with 29% from Europe, 19% from the Asia/Pacific region, 2% from Latin America, and 1% from Africa and the Middle East.

Sources: Business Wire, INN archives

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