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Rating Agencies Assess Carriers' Use of ERM

Bob Mueller November 2006

Insurance has always been about risk, and insurance companies, armed with actuarial tables and reinsurance, have generally handled it well. But there are risks that go beyond the ordinary-storms that wipe out a city's worth of houses and businesses and create enormous correlative exposure; lawsuits that result in liability where none existed before, or threaten to remove exclusions. These sorts of risks can drain capital reserves and put the entire company in jeopardy.

To protect themselves, insurance companies increasingly step back and take a holistic, enterprisewide view of risk, and align their reserves to meet not just everyday actuarial and financial risk, but risks that cross organizational silos.

Enterprise risk management (ERM) is nothing new, says Prakash Shimpi, practice leader for ERM at Tillinghast, Towers Perrin in New York. His company has been using the term for about a decade, and Shimpi, along with colleagues at a former employer, wrote a book on the subject seven years ago. But lately, he says, interest in ERM has swelled from a trickle to a flood, especially among banks and insurance companies.

Why the interest? A.M. Best vice president Daniel Ryan sees ERM as a natural, evolutionary stage in the development of risk management. "It's really just a natural extension of what we've been doing-just the evolution of risk management," Ryan says. He notes that the 2004 and 2005 hurricane seasons may have nudged forward the evolution.

Adding further impetus is the recent tendency of rating agencies to check for ERM practices when they grade insurers. Some, such as Oldwick, N.J.-based A.M. Best and Fitch Ratings, New York, consider ERM an element of the overall quality of corporate governance and capital management. Others, notably New York-based Standard & Poor's, have specific ratings for ERM.

"At the end of the day," says Shimpi, "if we hear them correctly, what they're really saying is, 'We want to make sure ERM is not just something companies put in and do some calculations and walk away from.' We want to make sure that this becomes embedded as a management philosophy-that a culture of managing risk is embedded in the organization."

NOT APPROPRIATE FOR ALL

Although A.M. Best has issued a statement in support of ERM, Ryan notes that the presence of an ERM framework isn't something the company rates separately. "Unlike some of our counterparts, we do not have a separate rating category for it, nor is ERM a prerequisite," he says.

In fact, Ryan adds, a comprehensive ERM program isn't even appropriate for all companies. "You could have a small, single-state, single-line company that has been doing, say, inland marine for the past 75 years, and they may not need a comprehensive framework that gathers all their silos. Maybe there are only two silos, and they measure and manage that business very well and they have a track record that proves it."

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