Conditions Favorable For ERM Initiatives

But industry participants emphasize that ERM is clearly gaining momentum in this country and in the p-c sector, triggered in part by rating agencies' actions and the heightened regulatory scrutiny into corporate management practices, as well as by the uncertain and changing economic landscape.

Ernst & Young's executive vice president Tom Conway, who runs an E&Y practice focusing on risk and capital management for insurers, said that while ERM is still fairly new in the p-c sector, "it is having a rapid growth in acceptability." Currently, he added, U.S. insurance companies are trailing other financial-service sectors, and "large European multinationals are leading the wave."

"Enterprise risk management is a lot more well-entrenched in Europe than it is in the United States, and it is more entrenched in the life industry than it is in the property-casualty industry," Mr. Conway said. If anything, he went on, the companies that are embracing it the most tend to be the Bermuda companies, particularly catastrophe reinsurers. These reinsurers are ahead of the game, he said, because they very much have to be up to speed on risk management. "All this," he said, "is pushing companies in the United States from a competitive position to get up the curve."

Interestingly, Mr. Conway observed that one reason behind many U.S. p-c insurers lack of ERM utilization in the past may be found in a common notion hes come across often: that p-c insurers, already in the risk business, dont need such additional risk management functions.

"That was the fallacy that many p-c insurance companies senior executives believed for a period of time," Mr. Conway said. He noted that in a number of conversations that he had going back more than a couple of years, the chief executives had basically told him, "Look, I am in the risk business. I understand risk, and I can manage risk."

But, Mr. Conway emphasized, "their focus was always on what I would call the underwriting risk, and not operational risks and not reputation risk. It was a very narrow focus and thats one reason why, to be honest, p-c companies are a little bit behind other financial service companies."

Mark Puccia, managing director of the Financial Services Ratings Group at Standard & Poors, agreed that despite the current progress, ERM is still very much in its early days in the p-c insurance sector.

"Any insurer would tell you there is plenty of work ahead still," he said. "But in some parts of Europe, they are in more advanced, middle stages. Thats because of the fact that in Europe, the regulatory community has encouraged it, as well as just the culture even," Mr. Puccia said.

"Its much more common in the European industry, and as companies look at their competitors, they realize that a robust risk management function is a viable thing to have. The U.S. companies are still learning that."

Mr. Puccia also pointed out that ERM in general has been around for well over a decade in the banking community. "There has clearly been a lot more work done with commercial banks, largely because of regulators who really pushed it. Banking regulators have really been focused on enterprise risk management to better manage banks for well over a decade," he said. The insurance community and insurance regulators, on the other hand, have definitely been slower to act on this, Mr. Puccia observed.

The fact, Mr. Puccia said, is that commercial banks now often have staffs of hundreds of people dedicated to their ERM functions. In contrast, its rare to see any insurer with as many as 10 people dedicated to ERM in the United States, he observed.

Ernst & Young's Mr. Conway noted also that its not easy to measure the insurance industrys progress in adopting ERM because there are still no industry-wide best practices, and companies often use different definitions of ERM, depending on their own needs and practices.

But Mr. Conway explained that generally, ERM for p-c insurers can be thought of as just another way of looking at their business operations. "ERM is kind of a cross-functional, cross-business-operation view that asks, Where are all the risk centers in the business? Where does risk get emanated? And then how do I look at those areas that emanate risks in a comprehensive global view?"

Ernst & Young's global director of insurance services, Peter Porrino, added that there are now also two distinct categories in ERM. One is risk management, which is a traditional ERM function. "It's measuring all the risks around the company, including not just insurance risk obviously and not just asset risk, but also operational risk, reputation risk, strategic risk, and all the other risks that you could think of," Mr. Porrino said.

"The companies that I have seen that really embrace ERM would have what I would call the ERM mandate," he said, "including all those risks that impact the company." Those companies would look at things like business continuity, catastrophe concentrations, asset and liability management, and all those would come under a broad mantle of ERM, Mr. Porrino said.

Following from that is another type of ERM function, which Mr. Porrino called "risk quantification"determining how much capital a company needs for all the risks that are embedded within the entire enterprise.

Mr. Porrino also noted that hes always found insurance companies to be silo-oriented, separated by product lines and functional areas. "And so another benefit of ERM is breaking down these walls, so that different parts of the company know what the other parts of the company are doing." In the long term, Mr. Porrino forecast, getting rid of such walls will be critical for the success of the insurance industry, as companies try and manage all the risks that they undertake.

The good news is that the current industry environment is highly favorable for adopting ERM. Mr. Conway from E&Y noted that ERM is now clearly on an upward trend and that various factors are driving a lot of focus around ERM.

"One of the drivers is the focus the Sarbanes-Oxley Act of 2002 has created around looking at business processes and improving financial reporting processes," Mr. Conway observed. He said there has also been general pressure from rating agencies that are driving some of the increased focus on ERM as well.

Larry Moews, vice president and corporate risk officer at Allstate Corporation, also agreed that the Sarbanes-Oxley Act is boosting ERM's acceptance in the United States. "Having senior management sign off that you have the proper internal controls and that the books reflect exactly the financial conditions of the companythats a driver in improving risk management," Mr. Moews said.

He also pointed out another factor boosting ERM's acceptance, a recent rule from the New York Stock Exchange, section 303A, which asks publicly held companies on the NYSE to have an audit committee that must be up to speed and examine risk-management practices of the company, which would include ERM.

Further, the National Association of Corporate Directors has guidelines on what the board audit committees should do in regard to risk management practices, Mr. Moews noted.

He also found that rating agenciesparticularly Moody's Investors Service, followed by Standard & Poors and A.M. Best Co.are paying more attention to ERM as well, with agencies announcing they will use this factor as part of their criteria in rating actions further down the road. "So these are all part of driving factors for ERM," Mr. Moews said.

Mr. Puccia from S&P noted another favorable condition for ERM: more regulators blending their banking and insurance regulatory functions. "Enterprise risk management in general has been around for well over a decade in the banking community because banking regulators have really been focused on ERM," he observed. "But now whats happening is that when you take a look around the globe, more and more regulators are starting to blend their banking and insurance regulatory functions."

For example, The Financial Services Authority in the U.K. now oversees both banks and insurance regulation, with a similar consolidation of regulatory functions also seen in Canada and Australia.

"So, you are getting these crossovers from bank regulation relative to ERM coming to the insurance world," Mr. Puccia said. "A number of insurers are starting to hire former bankers to become their chief risk officers. Sometimes they are hiring these former bankers as chief financial officers, so that these people can bring with them their ERM knowledge to the insurance sector."

Reproduced from National Underwriter Edition, December 10, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.