A.M. Best Issues Risk Management Methodology

Business Wire, Jan 25, 2008

OLDWICK, N.J. -- A.M. Best Co. is issuing "Risk Management and the Rating Process for Insurance Companies", a rating methodology which outlines how risk management is incorporated into the overall rating process for insurers and reinsurers, and explores the key risk-management trends in the insurance industry.

Risk management is the process by which companies systematically identify, measure and manage the various types of risk inherent within their operations. The fundamental objectives of a sound risk-management program are to manage the organization's exposure to potential earnings and capital volatility, and to maximize value to the organization's various stakeholders. However, A.M. Best believes it is important to note that the objective of risk management is not to eliminate risk and volatility, but to understand it and manage it.

Risk-management tools and practices across the insurance industry have advanced significantly in recent years--and it's a good thing they have. The industry has experienced a number of events and trends since the turn of the millennium that have exposed, and will continue to expose, insurers to increased levels of risk and uncertainty.

Enterprise risk management (ERM) has been one of the most significant and widespread additions to the insurance industry's vocabulary in recent memory. While many may see ERM as a completely new process, A.M. Best considers ERM as a natural extension of an insurer's fundamental risk-management and capital-management practices, with the foundation still rooted in sound traditional controls and policies encompassing the five key categories of risk: credit, market, underwriting, operational and strategic.

A.M. Best believes ERM encompasses three key areas.

* Culture--the establishment of an environment throughout an organization, from the board level to senior management to business line management to the employee, that embeds risk awareness and accountability in daily operations.

* Identification and Management--the ability to consistently identify key risks across the entire organization, and to establish uniform controls and procedures to effectively manage and mitigate the impact of those risks to the organization.

* Measurement--the use of sophisticated tools and data collection to quantify risks, including the impact of risk correlations within and among the five categories of risk, considering the impact of general economic conditions, industry-specific events and extreme events, and report these risk assessments to senior management on a regular basis.

A.M. Best believes that assessing an insurer's risk-management capabilities--within the context of determining an insurer's financial strength--should be viewed in light of a company's scope of operations and the complexity of its business. For insurance enterprises to remain competitive in today's dynamic environment, build sustainable earnings and capital accumulation, and ultimately maintain high ratings, complex organizations - such as insurers participating in the global reinsurance and retirement savings markets - must develop and constantly refine an ERM framework, including the development of internal economic capital modeling.

For organizations with a more limited operating scope focusing on more stable, traditional lines of business, the ERM process may be less comprehensive or complex at this time. However, the pending implementation of Solvency II in Europe and the significant efforts of sophisticated insurer's to raise the bar on the risk-management front, will ultimately become a competitive issue driving continued improvement and integration of ERM concepts for all insurers regardless of size.

Given the insurance industry's evolving risk profile and the significant recent advancements made in the risk management tools and practices, A.M. Best recognizes that a more economic, prospective view of capital can be another valuable supplement to the rating process. As a result, A.M. Best is exploring ways to incorporate stochastic modeling in the development of risk factors within its proprietary capital model, and to more directly tie probability of default to the determination of capital required to support individual rating levels. A.M. Best will also be expanding the use of company-provided capital models in our development of capital requirements within the rating evaluation process.

Whether utilizing a formalized ERM framework integrating selected elements of ERM into an insurer's operating practices, or relying solely on a traditional risk-management process, A.M. Best perceives risk management as paramount to an insurer's long-term success. As such, within the rating process, each company--regardless of its size or complexity--is expected to explain how it identifies, measures, monitors and manages risk. Insurer's that can demonstrate strong risk-management practices that are integrated into its core operating processes, its corporate "DNA", and effectively execute its strategy, will maintain favorable ratings in an increasingly dynamic operating environment.