Concurrent Sessions by Track

This session will provide case studies from CROs of leading-edge insurance companies who have implemented an Economic Capital framework into their financial modeling, business decision-making, and risk-adjusted pricing and performance management framework. The companies will provide both cross-sector and multinational perspectives.

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Use of Capital Models in Guiding Management Decisions

The use of economic capital models by insurers is rapidly moving beyond simply assessing capital adequacy, with more emphasis on using the results of these models to guide management decisions. This session will examine alternative approaches to economic capital modeling and discuss how to use these models effectively to guide risk management decisions, including how to judge which approaches are appropriate for which types of decisions.

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Proactive Applications of ERM

This session will begin with an overview of considerations related to designing an integrated risk program that facilitates decision-making, followed by a panel discussion among CRO's and senior risk practitioners. The panelists will discuss how elements of the risk program impact decision making. This is expected to include a broad range of activities, such as pricing, product and market development, assessment of alternative uses of capital, and the use of models in all of these.

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Strategic Pricing for Risk in Financial Services and Manufacturing

Pricing is one risk management activity common to different industries. ERM advancements in financial services are allowing more granular and detailed reflection of the true "cost of risk" by product--the contribution to the overall portfolio. This is also true in manufacturing, especially with respect to extended warranties and long term service agreements.

Reliability engineers are employing actuarial techniques to drive cost of risk into probabilistic design decisions, product pricing, and warranty pricing and valuation. In this session, experts will discuss recent advances in financial services and reliability engineering, showing how companies leverage ERM to price for risk more effectively, bringing greater transparency to risk decisions.

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Research Paper Session 3: Industry Perspective of ERM

This session will feature presentations by authors of three papers:

What About Underevaluating Operational Value at Risk in the Banking Sector by Georges Dionne and Hela Dahen
Abstract: The objective of this article is to develop a precise and rigorous measurement of a bank’s operational VaR. We compare our model to the standard model frequently used in practice. This standard model is constructed based on lognormal and Poisson distributions which do not take into account any data which fall below the truncature threshold and undervalue banks’ exposure to risk. Our risk measurement also brings into account external operational losses that have been scaled to the studied bank. This, in effect, allows us to account for certain possible extreme losses which have not yet occurred. The GB2 proves to be a good candidate for consideration when determining the severity distribution of operational losses. As the GB2 has already been applied recently in several financial domains, this article argues in favor of the relevance of its application in modeling operational risk. For the tails of the distributions, we have chosen the Pareto distribution. We have also shown that the Poisson model, unlike the negative-binomial model, is retained in none of the cases for frequencies. Finally, we show that the operational VaR is largely underestimated when the calculations are based solely on internal data.

ERM and Other Considerations Related to a Principles-Based Approach by John J. Doodian, John Knott, and James E. Rech
Abstract: This white paper is intended to educate and inform its audience regarding important considerations related to the transition from a rules-based to a principles-based approach, in line with changes in regulations and internal business requirements. The paper focuses on the role of actuaries and use of a centralized enterprise risk management platform in facilitating this transition, as well as other organizational considerations necessary to ensure that objectives are met.

ERM for Strategic Management – Status Report by Gary Venter
Abstract: Much of the push for ERM has come from regulators and rating agencies, but it is being applied in internal company decision-making as well. This paper reviews the progress made and the needs still outstanding in two key areas of application: optimal capital level for an insurer and risk-adjusted profitability of business units. The basic conclusion is that progress has been made in these areas, but more is needed. Building models is not emphasized – it will be assumed that a state-of-the art model is available. The emphasis is on using such models in decision-making.

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Risk Identification Track

Terrorism Risk

The risk of terrorism conjures up a host of complex issues for organizations potentially affecting their human capital, their clients, their competitors, their jurisdictions, their investments, their profits, etc. Despite the unknown description of this monster, companies should begin by examining various terrorism event scenarios and planning responses, which may include establishing protective measures to mitigate the impact of an event. In that vein, this session explores the implications of a hypothetical terrorist attack, including how various organizations may be directly and indirectly impacted. In addition, terrorism insurance protection currently available in various geographic areas throughout the world will be discussed including interpretations of event triggers and coverage definitions.

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Research Paper Session 1: Aggregation of Risks

This session will feature presentations by authors of three papers:

Interaction of Market and Credit Risk: An Analysis of Inter-Risk Correlation and Risk Aggregation by Klaus Bocker and Martin Hillebrand
Abstract: In this paper we investigate the interaction between a credit portfolio and another risk type, which can be thought of as market risk. Combining Merton-like factor models for credit risk with linear factor models for market risk, we analytically calculate their inter-risk correlation and show how inter-risk correlation bounds can be derived. Moreover, we elaborate how our model naturally leads to a Gaussian copula approach for describing dependence between both risk types. In particular, we suggest estimators for the correlation parameter of the Gaussian copula that can be used for general credit portfolios. Finally, we use our findings to calculate aggregated risk capital of a sample portfolio both by numerical and analytical techniques.

A Practical Concept of Tail Correlation by B. John Manistre
Abstract: This paper shows how the results of copula based capital aggregation models can always be locally approximated by relatively simple formulas. The paper defines the concepts of diversification factor and tail correlation matrix and describes methods for estimating these quantities from simulated data. We show how these ideas can be put into practice as both computational short cuts and presentation tools. Some examples are then developed which suggest that, when copula based models are used to aggregate capital, two new phenomena emerge a) diversification benefits are reduced because of additional tail dependence in the copula and b) diversification benefits are increased when aggregating risks that have finite variance and the model does not have too much symmetry. Since few of the risks held by a life insurer are so heavy tailed that they have infinite variance, the paper concludes by arguing that simple, correlation matrix based, capital aggregation formulas are more defensible than previously thought.

Multivariate Dependence Modeling using Pair-Copulas by Doris Schirmacher and Ernesto Schirmacher
Abstract: In the copula literature there are many bivariate distribution families but very few higher dimensional ones. Moreover, most of these are difficult to work with. Some of the bivariate families can be extended to more dimensions but in general the construction of distribution functions with more than two variables is a difficult problem. We introduce a construction method that is straightforward to implement and can produce multivariate distribution functions of any dimension. In essence the method takes an arbitrary multivariate density function and decomposes it into a product of bivariate copulas and marginal density functions. Each of these bivariate copulas can be from any of the available families. We also highlight the power of a graphical display known as a chi-plot to help us understand the dependence between pairs of variables. One illustration, based on changes in the exchange rate of three currencies, shows how we can specify the pair-copulas and estimate their parameters. In another illustration we simulate data that exhibits complex dependencies as would be found, for example, in enterprise risk management or dynamic financial analysis.

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In the Pursuit of Return, Have we Lost sight of Risk?

As a follow-up to the General Session “In the Pursuit of Return, Have We Lost Sight of Risk?” the panelists will reconvene for a more intimate roundtable discussion during this concurrent session. Session speakers will highlight their market concerns for 2008 and assess how an effective ERM program will help firms address these concerns. Attendees will have an opportunity for interaction with the panelists as we invite you to join the discussion of the question: Are we learning from past mistakes or simply repeating them?

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Elegance Undone- Unanticipated Forces That Can Kill the Model

One element often missing from a firm’s ERM process is a rigorous assessment of the firm’s human talent and associated risks. For example, does the firm have the right management team to assure its success? What are the risks of sudden changes in key positions due to job change, incapacity, or death? These can be difficult and sensitive questions for a Board and senior managers to ask, but they must be asked and answered to complete the ERM process. This session will discuss how best to handle this critical assessment and outline the advantages and pitfalls that could result from this process. Learn why examining your human talent risks is critical to your firm’s success in the first part of this session.

The second part of the session will address the measurement of large operational risks confronting financial institutions. While these events might be rare, when they happen, they result in severe liquidity problems. The risk measurement techniques used in other disciplines, when applied in these situations, have been found to be inadequate; therefore, a fresh look at this problem is necessary. This session will present a paper that describes experiments using a variety of empirical operational loss event data. The presenter will show how scenario analysis output can be exploited to better measure appropriate levels of operational risk. Successful integration of the results from the scenario analysis with internal loss event experience can be a challenging task. However, the techniques discussed will help financial services institutions to drive business value through their operational risk framework.

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Capturing the Complexity for Emerging Risk Identification and Management

Strategic risks are not simple events but rather a complex set of interconnected perceptions. We present a methodology that maps this complexity in a way that allows key 'at risk' areas of the business to be identified and quantified. This methodology has been trialed in two major insurers and lessons learnt will be highlighted. Finally, we outline a process that will allow future complexity mapping to be automated from real-time data.

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Quantification Techniques/Modeling

Economic and Mortality Scenario Generation

Economic Capital quantification techniques require the use of stochastic generators to derive the distribution of events faced by organizations. The development and parameterization of these stochastic events pose a challenge and an opportunity. This session will focus on the two risk categories, economic and mortality, facing many insurance organizations.

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Parameterization and Calibration of Actuarial Models

ERM has evolved to allow insurers (and other risk-based enterprises) to use economic models of risk and capital to make decisions about tail events. These models require assumptions that are calibrated using limited data history, perhaps with biases, and potentially the wrong underlying distribution. The presenters will look into the impact parameter uncertainty can have on the results of actuarial models and the decisions made with them. The presenters will discuss traditional and evolving techniques used to measure the parameter uncertainty.

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Aggregation and Correlation of Risks

This session will explore current industry trends in the aggregation of risks. In particular, panelists will discuss correlation between risks and the techniques employed to address the challenges faced by practitioners.

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Insight into Solvency II Quantitative Impact Studies

Since late 2005, European Insurance regulators have been involving the insurance industry in a consultation process to test the impact of the proposed new risk-based solvency regulations (Solvency II). As a result of these Quantitative Impact Studies, the regulators’ thinking has progressed significantly and companies have become more aware of their state of preparedness for full implementation of the framework by 2012. This session will include insight into the Solvency II consultation process, the key elements of the quantitative framework, where European companies are in terms of preparation, and the next steps for the regulators in Europe.

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The Challenges and Benefits of Using Replicating Portfolios

Insurance companies are turning to the use of replicating portfolios to generate the market value of their liabilities to gain efficiency in the stochastic modeling process. This session will discuss the current optimization methods being used to determine a universe of assets that replicate the cash flows for insurance liabilities. The presenters will discuss the benefits and challenges of using replicating portfolios to support their economic capital framework.

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Regulatory/Rating Agency

Roundtable on Global Regulatory Developments

With today's highly competitive business environment and the challenges of compliance with increasing global regulations, companies are reexamining their risk management strategies. The panelists in this session will discuss the ability of global enterprises to utilize the "chopped salad" of disparate accounting and reporting regimes in light of Basel II, Solvency II, and other initiatives throughout the globe.

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In Search of Excellence

Based on current Enterprise Risk Management (ERM) rating schemes, an "Excellent" ERM program demonstrates an advanced process has been implemented effectively throughout an organization capturing an overall view of risk which emphasizes making and measuring risk/reward trade-offs among the risks, and incorporates a process for anticipating emerging risks. In the short period since its formal incorporation into financial service industry published ratings, a select few organizations' ERM programs have been awarded the designation of "Excellent". During this session, a panel of leaders from this select group of ERM "Excellent" designees will share with the audience an overview of their ERM Programs. Discussion will also include insight on how they prepared for and presented their ERM programs to the Rating Agency during their review. Speakers will include representatives from the insurance, reinsurance, and banking industries.

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Economic Capital & Safety and Soundness

This session will examine the incorporation of economic capital modeling into the assessment of bank and insurer capital adequacy. Panelists will discuss how risk-based capital requirements for banks and insurers can better support public policy goals such as solvency and safety and soundness.

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A Consumer Perspective: External Ratings in the ERM Process Post Subprime

All levels of risk management, from enterprise down to transactional, requires the ability to accurately measure risk. Historically, the ratings community has provided benchmarks to understand expected losses and make judgments about obligors. The session will address questions such as:

How has the subprime crisis called this role into question?
Can internal ratings supplement external ratings?
What changes should be made in external ratings methods, especially regarding illiquid assets?

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State Regulation and ERM

State Regulators have begun to incorporate ERM requirements within their Examination Rating process. Representatives from 3 states will discuss the schemes currently used or under consideration in their jurisdictions and potential impacts of the use of ERM in state regulation of financial institutions.

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Board Issues

Poor Risk Disclosure: The Most Overlooked Risk

One of the key promises of ERM is providing shareholders with a better understanding of the risks of their investment. However, most companies' ERM programs have not yet delivered on that promise, which may represent a key risk in itself. Learn what some companies are doing to address this and what may be required in the future.

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Risk Governance Panel

A key to a successful ERM program is establishing a risk governance organizational and functional structure that is appropriate for the organization. Hear panelists from diverse perspectives address challenging issues on what constitutes appropriate risk governance, including such topics as: how to define risk appetite; who to include in various levels of ERM decision-making; what are the keys to a successful CRO role; what are appropriate external risk disclosures; which information to report to the Board and how frequently; and many others.

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Practical Implementation Issues

As a firm begins to implement an ERM program, how can it prevent the firm’s internal inertia from killing the program in the cradle? Representatives from two different firms will describe their experiences developing an ERM program and facing these challenges. Topics to be discussed include implementing ERM on a limited budget, unique challenges for an insurance subsidiary of a financial firm, and integrating ERM into the company’s organization and management structure.

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Research Paper Session 2: Impact of ERM

This session will feature presentations by authors of three papers:

Evolution of Loss Reserve Risk by Thomas Conway and Mark McCluskey
Abstract: Property/Casualty insurers face risks from many key areas such as operations, natural catastrophes and underwriting. Among the key underwriting risks are the potential financial impacts of adverse loss reserves development. This paper illustrates a model of loss reserve risk that will incorporate how risk evolves over time at annual time horizons. The paper will illustrate how to build and parameterize the model using multiple years of financial statement data. The model produces results for a sample line of business for time horizons from one to 10 years.

An Empirical Investigation of the Characteristics of Firms Adopting Enterprise Risk Management by Donald Pagach and Richard Warr
Abstract: We use a hazard model to examine the factors that influence firm level adoption of enterprise risk management (ERM). We find that firms that are more levered, have more volatile earnings and have exhibited poorer stock market performance are more likely to initiate an ERM program. When the value of the CEO’s option and stock portfolio is increasing in stock volatility, the firm is also more likely to adopt ERM. Our results suggest that ERM is being used for reasons beyond basic risk management. These other reasons include offsetting CEO risk taking incentives and seeking improved operating performance.

The Value of Enterprise Risk Management: Evidence from the U.S. Insurance Industry by Robert E. Hoyt and Andre P. Liebenberg
Abstract: Enterprise risk management (ERM) has been the topic of increased media attention in recent years. Many organizations have implemented ERM programs, consulting firms have established specialized ERM units, and universities have developed ERM-related courses and research centers. Despite the heightened interest in ERM by academics and practitioners, there is an absence of empirical evidence regarding the impact of such programs on firm value. The objective of this study is to measure the extent to which specific firms have implemented ERM programs and, then, to assess the value implications of these programs. We focus our attention in this study on U.S. insurers in order to control for differences that might arise from regulatory and market differences across industries. We use a maximum-likelihood treatment effects framework to simultaneously model the determinants of ERM and the effect of ERM on firm value. In our ERM-choice regression we find ERM usage to be positively related to firm size and institutional ownership, and negatively related to reinsurance use and leverage. By focusing on publicly-traded insurers we are able to estimate the effect of ERM on Tobin’s Q, a standard proxy for firm value. We find a positive relation between firm value and the use of ERM. The ERM premium is statistically and economically significant and approximately 17% of firm value.

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ERM in Mexico

This session will cover ERM regulatory and practical issues and compares the main differences between Banks and Insurance Companies in Mexico.

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Research Track

The 2008 ERM Symposium seeks to offer a diversity of views, and the research track will present research from the academic community. Authors will present their research, and an industry discussant will remark on how the research may be applied in practice. Questions and comments from the audience will be encouraged to stimulate the discussion.

The PRMIA Institute and ERM Institute International are jointly serving as scientific organizers of the research track.

The PRMIA Institute is a non-profit educational institution formed to promote the scientific, educational, and charitable work of the Professional Risk Managers' International Association (PRMIA). Through partnerships with leading universities and faculty, the PRMIA Institute provides educational resources from the cradle to the pinnacle of your risk management career. The PRMIA Institute is setting a higher standard in risk education.

The ERM Institute International, Ltd (ERM-II) is a non-profit educational and research organization, initiated by an international group of universities and professional organizations with a focus on education, research, and training within an ERM conceptual framework, quantitative methods and tools, and best practices.

“Tranching and Rating”

Wednesday, April 16, 9:35 - 10:50 a.m.

In this paper we analyze the gains to an investment banker who is able to market debt securities at yields that reflect the ratings of bond ratings agencies which depend on either the probabilities of default or the expected default losses of the securities issued rather than on the true risks. We derive some general results and characterize the gains for numerical examples based on the CAPM and the Merton (1974) debt pricing model.

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“Insurance company capital, improving skewness, and default risk”

Property/casualty insurers are continually challenged to assure the optimal deployment of capital. This is a universal and timeless quest that transcends legal ownership structure, individual constituents and national borders. Enterprise Capital Return and Risk Management provides a framework to evaluate capital allocation alternatives among different insurance products and investments, simultaneously, to achieve the maximum expected returns constrained by established solvency margins.

The results we present in this paper incorporate some previously developed technologies at the core of financial risk management. These include mean-variance optimization and ruin probability calculations. In this paper we will discuss the broadening of these tools to accommodate the asymmetric behaviour of insurance product margins and asset returns and the combined impact upon capital allocation and solvency estimation.

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“A Dynamic Competing Risk Model for Pricing Subprime Securities”