Regardless of industry, people's understanding of enterprise risk management (ERM) varies. Traditional risk management centers on the identification, assessment and mitigation of risk. How does adding the word "enterprise" change things?
As the title suggests, ERM covers the whole organization and includes all sources of risk. However, it only very subtly hints that ERM can be strategic. ERM is more than just minimizing the downside—it is a way for organizations to seize opportunities to protect and even create value.
With that in mind, what are some of the benefits effective ERM can provide in the short-term?
Rating-agency scrutiny of insurers' ERM capabilities has already started. A favorable report—or at the bare minimum, the avoidance of a downgrade—is desirable. That said, the extent to which insurers leverage the work they perform for rating agencies for their longer-term benefit is open to question. In an economy in which systemic risk is in the headlines, we believe that proactively identifying and responding to risk—and, more importantly, developing a risk-focused culture—as well as communicating positive outcomes to stakeholders can only benefit an organization.
In addition, regulators soon will require many insurers to produce additional risk and solvency reporting through, for example, an Own Risk and Solvency Assessment (ORSA) or Commercial Insurer's Solvency Self Assessment (CISSA). To date, the requirements appear flexible and principle-based by design, and it seems likely that insurers will be able to report on risk and solvency in a way that is meaningful to their specific businesses. The starting point for producing assessments may be as simple as collecting and repurposing the information the board, risk committees and senior management already receive. This is an opportunity for insurers that proactively manage and report on risk to shine; on the flip side, for the companies that struggle with the seemingly rational demands, it may raise questions about how critical decisions are made.
And what about longer-term benefits?
Insurance is the acceptance of risk in return for premium. Policyholders benefit from the diversification benefit and access to capital that insurers are able to offer from pooling risks. That said, many insurers admit there is more they can and want to do to quantify and understand their diversified capital base; accordingly, capital-allocation strategies and risk-based metrics are of vital importance to them. Both of these technical challenges fall within the domain of ERM.
The current investment return environment has highlighted some weak underwriting results and has forced some companies to refocus on underwriting and core competencies. However, insurers that have invested prudently in ERM lead the pack in innovative product design, effective underwriting guidelines and differentiated rating structures—all of which contribute to a healthy bottom line.
But can investment in risk appetite and risk limits also enhance business planning? Effective ERM can help organizations identify opportunities. With a detailed understanding of its current and evolving risk profile, a company can develop metrics and scenarios that model outcomes under various conditions. In turn, these can help management know when an opportunity has arrived, how they can take advantage of it, and how to manage the changing business to its stated risk appetite. All of this can considerably improve speed-to-market and result in a competitive edge.
We believe it also is worth highlighting the "softer" benefits of strong ERM. A culture of robust governance and transparent channels of communication and disclosure can help an organization and its employees perform their roles more effectively. Many people may feel that risk processes and procedures are burdensome and restrictive, but appropriately designed frameworks—ones that are more about instilling risk consciousness than basic compliance—can elevate performance and help the entire organization move together toward shared goals.
Joseph Calandro, Paul Delbridge, and Henry Jupe contributed to this article.