Enterprise Risk Management in (Re)Insurance Saskia Goedhart CRO, Munich Re North America (Life)
Topics of Discussion • Enterprise Risk Management • Risk management structure and tasks in a global insurance company • Emerging risks and their importance for a Reinsurer • „A model is a model is a model is a model!“ • The future of risk management? Rainer Sachs – Risk Management – 28 January 2009 2
Enterprise Risk Management Requirements of Risk management are expanding – internally as well as externally Supervisors Rating Agencies Solvency II Disclosure Supervisory Transparency Quantitative review Measures to Rainer Sachs – Risk Management – 28 January 2009 Requirements process foster market discipline Source: S&P New Insurance Enterprise Risk Management Evaluation Criteria, October 19, 2005 2008 – 2009 Financial crisis made clear risk management needs strengthening Development of holistic approach � Enterprise Risk Management 3
Enterprise Risk Management ERM requires strict separation of roles and responsibilities Board of Management • Approves business strategy • Sets risk appetite and expected risk-adjusted returns • Resource and capital allocation Business Management / Risk Owners Independent Risk Management • Business Planning • Clear mandate by the Board to ensure that for all classes of risk appropriate limits, policies, • Identify and evaluate risks procedures and measures are in place within each • Take steps to manage / mitigate all risks Business Unit Rainer Sachs – Risk Management – 28 January 2009 associated with their business • Aggregate and monitor group-wide risks (e.g. risk • Manage and own risks of all approved transactions capital) and report to Board regardless of ultimate approval level • Develop risk mitigation strategies • Act as a risk consultant to Business Units Internal Audit Audit function independently verifies that effective controls are in place and functioning properly 4
Structure of Risk management Integrated Risk Management – Structure follows process Risk Strategy / Risk Identification Risk Analytics & Asset & Liability Business Enabler & Control Reporting Management � Identify and support new � Risk assessment / � Development and mainte- � Strategic Risk risk reporting nance of risk models Management Framework business opportunities � Enable operational units � Risk disclosure � Legal entity models � Strategic ALM to display the additional � Emerging risks � Risk capital calculations � Limits and Triggers value of reinsurance management System � Allocation of risk capital for Rainer Sachs – Risk Management – 28 January 2009 � Strengthen client � Operational risk � Risk Management VBM purposes relationship through management Governance � Scenario calibration advice and service � Accumulation control � Risk reviews and new product approval � Structure aligned with risk management process � Business liaison roles designed to “embed” risk management tools and processes in our daily business � IRM reports to the Group CRO, i.e. is independent from the risk taking process 5
The value of Risk Management Munich Re Example: Cost of capital substantially reduced Beta factor Munich Re and industry Investment risks 2.2 2.0 � Lowered equity gearing 1.8 1.6 � Reduced concentration risks 1.4 Munich Re � Moderate credit risk 1.2 significantly 1.0 below industry 0.8 0.6 Asset-liability management � State-of-the-art ALM Source: Bloomberg raw beta to DJ Stoxx 600, total return, daily basis, 1-year. Status 31 Dec. 2008. Rainer Sachs – Risk Management – 28 January 2009 � Strong risk management Munich Re CDS spreads in basis points 1 Insurance risks � Active cycle management � High diversification � Strong Group reserves 6 1 5-year CDS. Peers: Allianz, AXA, Berkshire, Generali, Hannover Re, ING, SCOR, Swiss Re, Zurich Insurance. Source: Bloomberg
Risk Identification – Emerging Risk Management Accumulation Control Rainer Sachs – Risk Management – 28 January 2009 7
Emerging Risks What are Emerging Risks? “Definition” Emerging risks comprise new and developing risks and their related business opportunities for the insurance industry. They result from changes in risk factors •with a high degree of uncertainty both in terms of occurrence probability and loss amounts, and •with a substantial potential impact on the company’s risk profile. Rainer Sachs – Risk Management – 28 January 2009 Key Characteristics � Driven by environmental, technological, social, economic or legal changes � Link between cause and effect not proven � Catastrophe potential across insurance lines and balance sheet � Difficult to quantify (frequency / severity) � Often long-term exposure 8
Emerging Risks Emerging Risks can be shock events as well as trends Spanish flu, Mortality rates from 900 1918/19 infectious diseases per 100,000 US Source: Preventing Emerging Infectious Diseases – 65 800 population 60 700 55 50 600 45 A Strategy for the 21st Century, CDC 40 500 AIDS 35 Rainer Sachs – Risk Management – 28 January 2009 30 400 25 1980 1982 1984 1986 1988 1990 1992 1994 300 200 100 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 9
Emerging Risks World Economic Forum identified “Core Global Risks” – most have direct impact for the insurance industry Rainer Sachs – Risk Management – 28 January 2009 10 Source: World Economic Forum, “Global Risk Report 2009”, January 2009
Example Asbestos – From occupational disease to product liability Rainer Sachs – Risk Management – 28 January 2009 11
Emerging Risks Scenario planning and analysis as fundamental risk management tool Rainer Sachs – Risk Management – 28 January 2009 Systematic approach to manage the “unknown Unknowns” 12
Example Shell – Prepared for the Oil Crisis Beginning of 1970’s 1973 oil crisis � Shell planning group focusing on factors/events influencing the oil price � Strategy development taking into account potential wild card … � Core strategy based on assumption of continuation of past oil price movements � Alternative strategy based on “wild card” significant oil price increase due to supply limitation Rainer Sachs – Risk Management – 28 January 2009 � Being prepared for wild card – definition of … � Required precautionary measures � Oil price quadrupled due to limited � Respective strategic options and supply following Yom Kippur war operative actions � Shell able to significantly strengthen market position within crisis due to fast implementation of measures predefined in scenarios Source: Munich Re, Corporate Development; Shell 13
Accumulation control U n p r e Breakdown of “WTC” loss Breakdown of “Katrina” loss (as of 7 Dec 05) c in % in % e Other (e.g. aviation, life, Aviation hull 1.5 Property WTC 1&2 commercial auto, watercraft) d 11.1 2 (US$ 1) Life 3.1 Residential property e Property other Personal auto 4 (US$ 2) homeowners Event cancellation 3.1 n 18.5 31 (US$ 17) Liability 6 (US$ 3) Workers’ comp. 5.8 t e Marine & energy Other liability d 11 (US$ 6) 12.3 Rainer Sachs – Risk Management – 28 January 2009 a c Commercial Aviation liability property c 10.8 29 (US$ 16) Business interruption Business interruption u 33.8 17 (US$ 9) m Source : Wharton Risk Centre with Data from Insurance Information Institute Source: Insurance Information Institute (III), Tillinghast – High Loss Estimates u l 9/11 triggered initial cross-line and cross-segment considerations of catastrophic losses � Katrina turned them into a prerequisite. a t 14 i
Accumulation control A c c u Interconnection of Risks Management Approach m Past: u l � Classic scenario analysis considered individual scenarios and accumulation risks independently from a each other. t � Complex accumulation risks feature conditional dependencies, e.g. supply chain business interruption i or pandemic accumulation risk o � Management requires a different approach: n Present / Future: Rainer Sachs – Risk Management – 28 January 2009 � Identification of dependencies within a holistic c approach to cover all possible and relevant o accumulation risks and its connections. � Recognition and quantification of tail dependencies in n risk model (e.g. copula). t � Allocation of risk capital to Lines of Business and therefore risk adjusted pricing. r � Definition of measures to mitigate so far unforeseen o accumulation risks l Source: World Economic Forum, “Global Risk Report 2009”, January 2009 n e 15
Accumulation control I n c r Nature of Loss e Illustrative a Creeping death Complex s Flu Asbes- pan- i demic tos Na n no Climate EMF g change WTC Big Bang Katrina Asbestos c Pollution o Rainer Sachs – Risk Management – 28 January 2009 NatCat Terror- “Ambiguous” m flood exclusion e.g. EQ, ism p hurricanes One-off hit l Time horizon e Short-term Long-term x i t y Big Bang-type of risks easily develop into more complex loss structures o 16
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