February 8, 2005 by Canadian Underwriter
Insurers are making progress in their efforts to implement enterprise risk management (ERM), but their success depends to some extent on their ability to link ERM to economic capital, says a new report by Tillinghast.
While insurers say they want to use ERM to build shareholder value, many remain focused on fundamentals, the report notes. Insurers surveyed are using ERM to improve internal risk reporting (67%), improve risk measurement (66%) and improve risk identification and prioritization (63%). However, “only about 40% are incorporating economic capital considerations and risk management into regular decision-making, and less than 10% are incorporating risk considerations into incentive compensation”, the report notes.
The increasing importance of ERM to insurers is evidenced by the rise of risk managers. Now 39% of insurers have a chief risk officer (CRO) position, compared to 19% in 2002. And 40% of CROs now report to the CEO, compared to just 26% in 2002.
“Senior management has become more involved in the risk management process in recent years due to corporate governance regulations, questions from rating agencies and demands for more financial transparency,” says Prakash Shimpi, practice leader for ERM at Tillinghast.
Insurers also note that better risk and capital management has allowed them to change business decisions in key areas including investment strategies, product pricing, business planning, reinsurance buying and strategic planning.
“More companies have chosen to move away from this ‘risk silo’ approach in order to improve understanding and communication on risk management throughout their organizations,” adds Ian Farr, principal at Tillinghast. He notes Canada, Europe and Asia lead the way, with 70% or more saying they have set up risk committees to respond to this new approach, while less than half of U.S. respondents have done so.
And despite the lack of integration with economic capital concepts, insurers recognize the need to make this connection, and 87% say they intend to improve economic capital calculations and methodology. This includes improved modeling and measurement, improved applications and extending the risks covered. The biggest challenge they foresee in improving the use of economic capital are lack of resources and modeling/measurement concerns.
Another area of concern is operational risk, with only 30% of respondents saying clear roles and responsibilities for measuring these risks are in place, while most feel confident in the areas of insurance and market risk.