Standard & Poor s ERM Benchmark Review

Transcription

1 Standard & Poor s ERM Benchmark Review Farooq Omer, Senior Director and Analytical Manager Sridhar Manyem, Director Standard & Poor s Ratings Services September 29, 2014 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor s. Copyright 2014 by Standard & Poor s Financial Services LLC. All rights reserved.

2 Agenda Introduction S&P s ERM Framework Survey Highlights Conclusions and Questions 2

3 Introduction

4 S&P s ERM Framework Strategic Risk Management Risk Controls Emerging Risks Mgmt. Risk & Economic Capital Models Risk Management Culture S&P s assessment of ERM examines whether insurers execute risk management practices in a systematic, consistent, and strategic manner across the enterprise that effectively limits future losses within the insurers' optimal risk/reward framework All else being equal, an insurer with a stronger ERM score is less likely to experience losses outside its predetermined risk tolerances under our criteria 4

5 ERM Acting As A Modifier Business Risk Profile Financial Risk Profile Anchor Score ERM-M&G Modifier Indicative SACP/GCP ERM analysis is tailored to each insurer's risk profile and focuses on five main areas: risk management culture, risk controls, emerging risk management, risk models, and strategic risk management An insurer's ERM is scored as "very strong", "strong", "adequate with strong risk control", "adequate", or "weak", based on the assessments of the five sub-factors, which we classify as "positive", "neutral", or "negative" ERM-Management & Governance combination can modify the anchor score up or down to arrive at indicative Stand Alone/Group Credit Profile

6 Survey Highlights

7 Survey Highlights Insurers with higher ERM scores are closest to meeting the deadline for submitting their self-assessments to NAIC regulators. Many insurers consider regulatory and legal changes some of the biggest risks they face, while threats to the integrity of their IT systems remain a concern. Although most insurers will benchmark business risks against capital, the definition of what constitutes that capital can vary widely. Comparing risk tolerances among insurers in some categories--such as for catastrophe coverage is complicated by the use of disparate models that can yield different results.

8 Avg. % of ORSA Report completed Insurers With Better ERM Scores Are More Prepared For ORSA Submissions Percent of ORSA Report Completed Average Percent of ORSA Report Completed Vs. S&P ERM Score 11% 12% 20% 33% 24% 0-30% 30-60% 60-90% 90%-100% Not Applicable 100% 90% 80% 70% 60% 50% 40% 30% 20% 0% 95% Very Strong 77% Strong 51% Adequate with strong risk control 47% 45% Adequate ERM Score of the Respondent Weak 53% of our rated universe in North America and Bermuda responded to the survey Survey responses received: 35% Life, 22% Health & Property/Casualty (PC), 15% Multiline, 6% Reinsurers 8 Source: Standard & Poor s Ratings Services

9 Risk Culture

10 Measuring Risk Tolerance Confidence Level For Risk Tolerance Capital Measure For Risk Tolerance 41% 27% 24% 1% 8% 5% 11% 31% 18% 5% 16% 2% 1 in 10 1 in 20 1 in in in 1000 Others None Economic capital Other Regulatory Capital GAAP Equity Rating Agency capital Statutory Capital 10 Our survey finds that insurance companies pre-dominantly choose a one year time horizon to measure their risk tolerances There is currently no widely accepted, or industry benchmark confidence level used in risk tolerance statements Consistent with our expectations, we found that a majority of companies used capital to benchmark risk- 96% use capital measures for setting tolerances However, definition of capital varies widely. Insurers have at least six different ways of measuring capital, and not more than 27% of the insurers use the same one Source: Standard & Poor s Ratings Services

11 Return on Equity Return on Assets Share Price Growth Combined Ratio Not Applicable Vesting Period of 1 year Vesting Period of 2 years Vesting Period of 3 years Restricted Shares Stock Options Bonus Bank Not Applicable Executive Compensation 60% 50% 40% 30% 20% 0% Metrics To Decide Top Executive Compensation 52% 47% 27% 24% 5% 6% 80% 70% 60% 50% 40% 30% 20% 0% Methods Used For Long-Term Incentives 75% 51% 31% 12% 8% In our survey, organizationally we found that of CROs reported to the board while 47% to the CEO Growth as an incentive metric appears to be balanced by other profitability metrics and longer vesting periods. Compensation as a risk governor is witnessed through mechanisms that include vesting periods, bonus banks, restricted shares, and stock options that discourage management from excessive risk taking in one year Source: Standard & Poor s Ratings Services 11

12 Risk Controls

13 1 in 10 1 in 20 1 in 50 1 in in in in in 1000 Not Applicable Risk Controls: Catastrophe Risk Confidence Level For Cat Risk Tolerance Basis For Catastrophe Risk Tolerance 60% 56% 50% 40% 30% 31% 3% 17% 13% 34% 20% 8% 6% 6% 3% 14% 3% 6% 20% 3% 0% Economic capital Not Applicable Rating Agency Capital Stat surplus GAAP Equity Other Regulatory Capital 56% of respondents used 1-in-250 level to manage cat risk consistent with our standards followed by 1-in-100 (31%) Catastrophe models differ and, therefore, can yield vastly disparate results. Even if all insurers used the same model, results would likely differ because an insurer can customize its model. This makes benchmarking tolerances difficult. 13 Source: Standard & Poor s Ratings Services

14 Risk Controls: Equity and Credit Risk Quantitative Techniques To Measure Equity Risk Exposure Others 25% Scenario-Based Evaluation 49% Partial Greeks 81% Full Greeks 19% Historical VaR 24% Simulation VaR 39% 0% 20% 30% 40% 50% 60% 70% 80% 90% Of the survey respondents, 46% use a value-at-risk (VaR) measure to quantify their credit risk. Many insurers used multiple quantitative methods to manage equity risk- we found that scenario-based evaluation, with an emphasis on stress-testing, appears popular. For insurers that take on equity risk through their liabilities, such as variable annuities with guaranteed returns, using various "Greeks," or hedge parameters tied to options, appears more common Source: Standard & Poor s Ratings Services 14

15 Risk Controls: Health Insurance Risk Health Insurance Risk Controls 100% 90% 80% 70% 60% 50% 40% 30% 20% 0% 4% 16% 24% 44% 12% 4% 8% 56% 40% 92% % of Revenue constitute % of premium from single by Govt. program state (medicare/medicaid) % of claim cost alligned with Risk share 0% - 25% 25% - 50% 50% - 75% 75% - 100% Health insurers can set risk limits in terms of revenues, claim costs, or premiums. Our survey respondents control the amount of regulatory/legislative risk they are exposed to by setting a tolerance for the percent of revenues derived from government programs 56% of insurers in our survey prefer to get 25% or less from Medicare and Medicaid, and 24% are satisfied with getting between 25% and 50% of revenues from those programs. Source: Standard & Poor s Ratings Services

16 Risk Controls: Operational Risk Top Five Operational Risks 100% 90% 80% 70% 60% 50% 40% 30% 20% 0% 16% 35% 16% 23% 17% 14% 13% 14% 37% 28% 8% 3% 7% 7% Information technology Regulation Compliance Business continuity processes Human resources Priority 1 Priority 2 Priority 3 16 Almost all of the insurers had a disaster recovery plan and business continuity process in place. The insurers we surveyed said IT is their major operational risk, followed by regulation and compliance. Insurers need IT systems that run seamlessly all the time to satisfy policyholders, suppliers, and investors. At the same time, those systems must be secure against an increasing tide of cybercrime. Regulation is also a major concern, with insurers increasingly uncertain about the impact of more mandates from both within and outside of their home nations Source: Standard & Poor s Ratings Services

17 Emerging Risk Management

18 Political/Economic Challenges Legal/Regulatory Challenges Competitor/Industry Landscape Cyber/Technology Risk Others Climate Change/Weather Volatility Emerging Risk Management Highlights Major Emerging Risks Faced By Insurers 25% 20% 21% 20% 20% 19% 15% 13% 5% 7% 0% 18 64% of insurers had formal committees to manage emerging risks. However, only of insurers quantified their emerging risks Insurers see political/economic issues and legal/regulatory issues as major emerging threats irrespective of their industry sector P/C and reinsurers were concerned about cyber-risk, climate change, and increasing competition from deeppocketed, nontraditional rivals. Life insurers worried about the impact of low interest rates, and health insurers' big concern was clearly the Affordable Care Act and other reform measures Source: Standard & Poor s Ratings Services

19 Risk Models

20 Internal Models Will Be A Key Focus In The Future Required Risk Capital Vs. Regulatory Capital Basis For Internal Capital Model 47% 11% 42% 28% 14% 11% 25% 22% Greater than regulatory capital Greater than twice the regulatory required capital Lesser than regulatory capital Cash flow model (Life/Health) DFA (relationship based on ESG) Factor Driven Individual risk towers aggregated through correlations Scenario based 20 Almost 73% of the respondents had some form of internal economic or risk capital model Given that regulatory capital acts as a minimum, it is not surprising that 89% of companies have internal targets greater than the regulatory capital. Internal models in our surveyed group are likely to range from a customized rating agency or regulatory model to a sophisticated dynamic financial analysis (DFA) model Source: Standard & Poor s Ratings Services

21 Strategic Risk Management

22 Capital Allocation and Strategic Risk Management Metrics Used To Compare Strategic Options Type Of Capital Allocated 100% 90% 80% 70% 60% 50% 40% 30% 20% 0% 88% 67% 34% Capital IRR Earning at Risk (EaR) 65% 37% 31% ROE RAROC Others 45% 40% 35% 30% 25% 20% 15% 5% 0% 36% GAAP Equity 37% Stat Surplus 39% Required Economic Capital 16% 42% Available Regulatory Economic Capital Capital 22% Rating Agency Capital IRR Internal Rate of Return, ROE Return on Equity, RAROC-Risk Adjusted Return on Capital 22 Metrics such as capital (89%) and ROE (72%) are popular among P/C insurers whereas life and health companies used capital (90%) and IRR (75%) to compare strategic risk options Companies used various types of capital to allocate to various risk but regulatory capital, Stat surplus, GAAP equity and required economic capital were more common Life and health companies tend to use regulatory capital in their strategic management decisions more than P/C companies. Source: Standard & Poor s Ratings Services

23 For more information about Standard & Poor s ERM Benchmark Review, visit Contact: Steven Cooke Senior Director Client Business Management T: [email protected] 23

24 Thank You Farooq Omer Senior Director and Analytical Manager T: Sridhar Manyem Director T: Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor s. Copyright 2014 by Standard & Poor s Financial Services LLC. All rights reserved.

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