Ernst & Young Quarterly Insurance Industry Outlook Identifies Opportunities for Maximizing and Leveraging Enterprise Risk Management
-- Key Trends and Issues Create Challenges but Offer Potential to Build Competitive Advantage --
NEW YORK -- The Insurance and Actuarial Advisory Services (IAAS) practice of Ernst & Young LLP today released its quarterly outlook addressing key trends and issues facing insurers, including the need for a formal risk appetite, the impact of principles-based reserves and the urgency for Property/Casualty companies to improve data quality to enhance catastrophe modeling.
Setting the ERM StageO Step One: Formal Risk Appetite
There is no question that insurance companies are taking enterprise risk management (ERM) more seriously, particularly as such external pressures as new rating agency criteria increase, but concerns remain around their approach. Unfortunately, many companies have begun implementing ERM programs without doing the necessary upfront legwork of gaining management consensus around the overall risk appetite of the organization.
Ernst & Young suggests all insurers develop a formal risk appetite, which it defines as the level of aggregate risk that a company can undertake and successfully 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.
It is crucial that the risk appetite be meaningful -- focused on value creation, risk and return, as well as value protection. It should be used to define and calibrate the actual risk limits used to manage the business and become a part of the overall business strategy dialogue. At the same time, an organization's risk appetite must be redefined 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 both strategic and tactical business decisions around risk.
"As companies feel pressure to put ERM in place, many get ahead of themselves," explains Chris Karow, Partner, Ernst & Young LLP. "It isn't too late to build a risk appetite even for companies already on the ERM journey. The process of developing a risk appetite can get everyone on the same page, creating the linkage between business strategy, value creation and risk management that can help drive the organization and its ERM programs to the next level.
Principles-Based ReservesO Regulatory Changes and New Opportunities Emerging
The regulations surrounding principles-based reserves for life products continue to evolve. Although the effective date of the broad-based requirements appears to be several years away, the writing is on the wall, and the time to prepare is now.
The integration of enterprise risk management with the valuation process is a cornerstone of the principles-based reserves and capital regime, and there are significant opportunities for insurers who act early. Those who implement the new reserve framework will be able to match reserve levels with risk levels, with potential reserve decreases resulting from effective risk management techniques.
"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," adds Tara Hansen, Senior Actuarial Advisor, Ernst & Young IAAS.
Raising the Bar on Data QualityO Leaping Ahead of the Competition
The 2004 and 2005 hurricane seasons revealed weaknesses in commonly used catastrophe risk modeling techniques. Among the major revelations, it was determined that the quality of exposure data, especially for commercial lines of business, was insufficient. While 2006 was a quiet year, the memory of Katrina has not faded, and a key imperative for 2007 is enhanced data collection.
As insurers begin to plan improvements, it is important to fully understand all of the issues surrounding data quality that equally impact exposure to other naturally occurring catastrophes such as earthquakes. In some cases a major reconstruction effort is necessary, and if done properly, it can offer significant competitive advantages with respect to 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
* Research 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 collection.
"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, as 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."
About Ernst & Young
Ernst & Young, a global leader in professional services, is committed to enhancing the public's trust in professional services firms and in the quality of financial reporting. Its 114,000 people in 140 countries pursue the highest levels of integrity, quality, and professionalism in providing a range of sophisticated services centered on our core competencies of auditing, accounting, tax, and transactions. Further information about Ernst & Young and its approach to a variety of business issues can be found at www.ey.com/perspectives. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited does not provide services to clients.
About Ernst & Young IAAS
The Insurance and Actuarial Advisory Services (IAAS) practice of Ernst & Young includes 150 professional staff with more than 90 credentialed actuaries throughout the United States and Canada. IAAS delivers actionable business advice to its clients in the life/health and property/casualty insurance industries. It also provides insurance, risk management and claims advisory services to a range of businesses and corporations. IAAS employs financial modeling and other quantitative analysis techniques and technologies to assist clients in making decisions that will improve performance and achieve competitive advantage.
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