NU Online News Service, Oct. 2, 12:50 p.m.EDT

While models and mathematical analysis are important inmonitoring risk, there's nothing like digging beneath the surfaceto truly understand exposures, according to a new report on "TheFinancial Crisis and Lessons for Insurers."

The paper--authored by Shaun Wang, Ph.D., and sponsored by theSociety of Actuaries--looks at the subprime mortgage problem andsubsequent financial crises, as well as the role of enterprise riskmanagement in addressing future events.

Mr. Wang--a professor at Georgia State University who has workedin the reinsurance industry, and as a researcher andconsultant--said two important takeaways of the study are thatinsurers need to see the "macro picture," and that they need to owntheir own risks.

For example, looking at the subprime crisis--which he comparedto the underwriting cycle--Mr. Wang said organizations were notconcerned about the true quality of the underlying mortgages theywere risking their capital on.

What they needed to do was "look behind the risk structure," hesaid, pointing out that while charts of housing prices continued toclimb, a look at the underlying data would have shown householddebt levels and income information. "They need to get into thesubstance," he added. "Based on research, people are still stayingat the appearance level."

"This is uncharted water," he said, adding that business models"need to change to survive."

Mr. Wang observed that the property and casualty industry hasthree major risks to consider:

o Macro economic risk

o Systemic risks with the underwriting cycle

o Natural catastrophes

"If there is another major event--this is already a fragileeconomy--it would trigger a chain of events," he said, noting thatcompanies need to observe the reality and study the inter-reactionsthat could result.

While leadership and culture are a given in establishing asuccessful ERM plan, he noted that ERM must go beyond anorganization's culture, to the development of tangible intelligenceamong facets of the organization.

"This can make ERM more relevant," he said. Actuaries,underwriters and others in the organization need to "work togetherto make ERM more useful."

He also noted that in identifying systemic risk, companies mustcompare themselves to their peers, but also go outside of theirindustry.

Companies investing in many aspects of the economy, for example,need to check out other firms' investment performance and analyzepotential impact, he said.

According to the paper, there are ERM strategies and principlesthat financial firms and insurers should focus on for anenterprise-wide approach:

o A strong risk management culture must start at the top.

o Using risk management is most effective when used to preventrather than manage crises.

o The financial system is interconnected, so businesses need tolook at what others are doing in the industry, not just their ownrisks and processes.

The study suggested that companies also need to:

o Establish a robust liquidity management system.

o Develop a counterparty risk management system and limits.

o Keep watch on high-profit areas, as these are the areas wherethe greatest risks emanate.

o Refine tools to systematically aggregate exposures.

o Understand the limitations of models and the relatedassumptions.

o Incorporate a wide variety of economic scenarios for stresstests.

Companies can use these guidelines in helping to apply anenterprise-wide approach to risk management, the Society ofActuaries said. Both inside and outside of the insurance industry,it is essential to look at ways not only to mitigate risk but alsomaximize opportunities for businesses in today's difficult economicclimate, according to the group.

In examining the mortgage and financial crises, the paper alsoaddresses the related issues of liquidity and diversification, andtheir roles in the downturn.

Diversification, for example, was widely thought to be a solelyrisk mitigation and profit-building strategy. The paper advises theC-suite--CEOs, COOs, CFOs and chief risk officers--to understandthat diversification brings its own risks that need to beconsidered in an evaluation.

In conjunction with the release of this research, the AmericanAcademy of Actuaries provided recommendations for regulatoryimprovements. Specifically, these include:

o Developing a systemic risk regulatory structure for thefinancial services sector.

o Determining appropriate constraints and capital requirementson investments.

o Establishing new regulatory transparency requirements forrating agencies and third party advisors.

The research conducted to complete the paper, and the regulatoryrecommendations developed as a result, are part of actuaries'ongoing efforts to help businesses navigate past the financialcrisis and prepare for emerging challenges on the horizon, theSociety of Actuaries said.

For a copy of "The Financial Crisis and Lessons for Insurers,"visit www.soa.org.