How to replace qualitative guessing with a capital view A look into quantitative based ERM programs February 14, 2017
Agenda 1. Who is Highmark Health? 2. Highmark Health Risk Management & Capital Allocation, how is our ERM program different? 3. Understanding a capital view of risk (education in risk quantification) 4. Capital Risk Example: Manufacturing 5. Capital Risk Example: Education 6. How a capital risk perspective can impact insurance purchase decisions 2
Who is Highmark Health?... … We are a diverse health & wellness company. Critical Statistics • ~$17 Billion in Revenue • ~$5.4 Billion in Surplus • ~5.3 MM Health Lives • 3 States (PA, WV, & DE) • ~30 MM Diversified Business Lives • 8 Provider Facilities • Over 1,000 physicians & clinical practitioners • ~37,000 employees Product Lines – – Health Vision Retail Insurance – Medicaid – Stop Loss – Patient Care – Workers Comp (Inpatient & Outpatient) – Dental – Insurance Insurer Platform & Solutions – Vision Insurance All remaining data within this presentation is fictitious and for example purposes only. 3
Highmark Health Risk Management Structure Chief Audit & Compliance Chief Financial Officer Chief Legal Officer Officer Chief Risk Officer Corporate Legal Counsel Corporate Audit Function Corporate Legal Function Risk Management Function Government Internal Audit Compliance Enterprise Litigation Capital Risk Privacy Risk Management Management Management Provider Integrity & Fraud & Compliance Investigations Business Corporate Business Insurance Continuity & Governance Management Services Resiliency Enterprise Business Activities and Processes 4
Critical Skill Sets & Education • Accounting & Auditing • Insurance Purchasing • Legal (Litigation, contracting, claim management) • Team Member Skill Sets Investment Management • Financial Forecasting • Business Planning • Actuarial Science • Certified Public Accountant (CPA) • IIA Certified Internal Auditor (CIA) • ISACA Certified Information Systems Auditor (CISA) • Education & Certifications RISM Certified Risk Management Professional (CRMP) • Associate in Risk Management (ARM) • Chartered Enterprise Risk Analyst (CERA) Traditional Skills & Education Emerging Skills & Education 5
Tools and weapons of a quantitative ERM program and culture The Tool How it helps Enterprise Risk Appetite Statement Drives a perspective that risks must be (with quantitative metrics & limits) measured and monitored at the Executive Leadership Level. Economic Capital Discipline Provides a clearer view of how much impact the Enterprise can absorb. Capital & Risk Executive Committee Creates a control point where risk and capital (with approval authority for investment & strategy) impact must be discussed before moving forward with any investment & strategy. Risk Deep Dives with the Board Extends the risk discipline and oversight to (or Delegate Committee) the Board of Directors. 6
Traditional qualitative view of risk (likelihood and impact) 7
Hurricanes do not care about your heat map Credit: Kevin Rudy (the Minitab Blog), Based on US hurricanes from 1950 to 2012, N=92, Normalized Damage is in $B, Katrina and Audrey excluded 8
Risk events actually occur across a distribution Financial Expected Potential Segment Volatility Statement Line Result Deviation Product Revenue $ % $ Example Risk Curve Product 1 Product Expense $ % $ Admin Expense $ % $ Balance Sheet $ % $ Product Revenue $ % $ Product 2 Product Expense $ % $ Admin Expense $ % $ Balance Sheet $ % $ Product Revenue $ % $ Product 3 Product Expense $ % $ Admin Expense $ % $ Solvency Level Business Earnings Balance Sheet $ % $ (REC) Plan at Risk 1-in-200 (50% prob.) (EaR) Diversification (not everything goes good or bad at once) (0.5% prob.) 1-in-10 (10% prob.) 9
What is our enterprise capacity for risk taking? Example Enterprise Capital Measures Shown in $ billions Difficult to Access Assets Risk Measures Calculation What is it for? (i.e. Goodwill, PP&E, & Restricted Assets) Capital Buffer AEC – REC What is our remaining capacity Expressed in $ for risk taking? $1.5 B Capital buffer Return on Risk Earnings / REC What is the return Adjusted Capital for the risk we are (RAROC) Expressed as % taking? Available assets $8.50 $8.00 Economic Value Net Operating Profit What accretive $6.50 Added (EVA) – (Hurdle Rate X REC) value will the investment Expressed in $ contribute to the enterprise? GAAP Equity Available Economic Required Economic Capital (AEC) Capital (REC) The capital we have The potential variation available to invest in in our earnings and the business and balance sheet based absorb risk. on the current business plan. 10
Example manufacturing: Ford Motor Company Choice A – Refine a core product How risk measures can bring Questions insight? Invest in the Ford Focus Line • Compare the RAROC% for Which investment improves the overall each option. Consolidate Ford Focus production in the Flat Rock & Hermosillo return of our business • Examine EVA for each plants into the new San Luis Potosi plant for $1.6B in capital 1 [and portfolio? option. maintain vehicle production.] • Compare capital buffer after How much investment • Long running small car brand – 6% of 2016 sales 2 capacity is left for other each option. • Sharp year-over-year decline from 2015 – ~16% 2 initiatives? • Compare capital • Potential savings from plant consolidation and investment diversification effect of each option. • Compare EaR of each option If things go bad, how Choice B – Invest in a future product bad will they be? (bad). • Compare REC of each option (really really bad). Invest in Autonomous & Electric Vehicles • How much risk capital is If we make a bet on a new car type, how big needed for other initiatives? Consolidate Ford Focus Flat Rock plant into Hermosillo [and should that bet be? reduce vehicle production]. Invest $700M in capital in Flat Rock • What level of earnings plant to add autonomous hybrid and electric SUV line. 1 deviation can the plan absorb? • US Electric Vehicle usage projected at 1.2M by 2020 (101K in 2015) 3 • High volatility likely for financial projections 1- https://www.bloomberg.com/news/articles/2017-01-03/ford-cancels-1-6-billion-mexico-plant-after-trump-s-criticism 2- Ford Motor Company December 2016 Sales Release 11 3- https://www.iea.org/publications/freepublications/publication/Global_EV_Outlook_2016.pdf
Example Education: Financing College Education Universities are looking to leverage capital to finance student education through Income- Share Agreement’s (ISA). Expected Invested Questions our ECap Model Segment Sub Segment Volatility RAROC EVA REC Result Capital can answer Mechanical $ $ % 5% $100 $ Engineering Programs • How much of our available capital Electrical $ $ % 7% $200 $ is left to support students? Chemical $ $ % 10% $50 $ • How can we grow deficit programs Computer $ $ % 9% $25 $ that support our mission? Accounting $ $ % 6% $400 $ Business Programs • Where do we need to improve our education programs to produce Marketing $ $ % 2% $10 $ better graduates? Business $ $ % 8% $50 $ • How will tuition increases affect our Logistics graduates’ futures? Actuarial $ $ % 9% $15 $ • What capital funding is required to Science increase financing of a degree Social Science Social Work $ $ % -5% $-150 $ program? Programs Psychology $ $ % -10% $-50 $ • Is our ISA program likely to be Education $ $ % 1% $100 $ stable in the future? Anthropology $ $ % -10% $-25 $ • Is our ISA program generating internal capital to sustain and grow Diversification (not everything goes good or bad at once) itself? Overall Portfolio $ $ % 3% $200 $3,000 The Chronical of Higher Education: Why a Novel Way to Pay for College Appeals to Conservatives 12
Questions a corporate insurance management team may be hearing How much D&O How do we deal with coverage should we the risk of cyber have (from a Board events? We cannot Member)? buy enough coverage! We need to reduce administrative costs, how can we cut insurance premiums? What should we include in our budget for expected losses this year? Is there a better way than benchmarking to make sure our exposures are covered? 13
Traditional benchmarking does not answer these questions Total Limits and Retention Benchmark $160 M $1,200,000 $140 M $1,000,000 $120 M $800,000 Limit of Liability $100 M Retention $80 M $600,000 $60 M $400,000 $40 M $200,000 $20 M $0 M $0 3rd Minimum 1st Quartile Median Average Maxiumum Company X Quartile Limits 5 20 30 38 40 140 40 Retention 10000 150000 200000 250000 275000 1000000 200000 14
A better view of making insurance program decisions Program Comparison Chart (at 99% confidence) $14 M $12 M $1.0 M $1.5 M $2.0 M $10 M CCoR in Millions $8 M $8.0 M $5.0 M $7.0 M $6.0 M $6 M $4 M $3.5 M $1.0 M $1.5 M $2 M $4.0 M $3.0 M $2.5 M $2.0 M $0 M No Insurance Policy A Policy B Policy C Expected Retained Losses Estimated Premiums Cost of Volatility "Value" Comparative Cost of Risk example is derived from Willis Towers Watson output from PRISM model. 15
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