IMMEDIATE IMPACT BY RATING AGENCIES

Rough Notes, Aug 2006 by Moody, Michael J

S&P's assessment of insurers' ERM programs should provide implementation impetus

Enterprise risk management (ERM) continues to make significant strides in corporate America. Organizations of all types are now beginning to establish formal ERM programs and early adopters continue to report positive results from ERM implementation. In the June issue (page 28), we provided an overview of how rating agency Standard & Poor's (S&P) was structuring its ERM assessment program for insurers. We provided details regarding the various components to their assessment and speculated on just how great an impact this would be in advancing an ERM agenda.

We did not have to wait long to see the impact of S&P's decision to incorporate an ERM segment into its overall rating process. Recently, the Insurance and Actuarial Advisory Services practice of Ernst & Young (E&Y) issued its quarterly insurance outlook and covered the S&P decision to include an assessment for ERM. As E&Y noted in its report, this new external influence is already having a significant impact on the insurance industry.

The financial services industry has been one of the strongest supporters of ERM for quite some time. While banks have been on the leading edge of ERM adoption, insurance companies have also been moving ahead with it. However, in an attempt to truly gauge the level of involvement with ERM, E&Y completed an in-depth survey with 30 of the largest insurers in North America. Shortly after the completion of the survey, E&Y brought the participants together for some additional insight into their responses via roundtable discussions. At this meeting, S&P was allowed to review its new ERM assessment framework. Results from the roundtable discussions provided further insight into how the insurance industry was going to view ERM.

ERM comes of age

E&Y completed its comprehensive survey of large North American insurers late last fall. The survey, titled "ERM Comes of Age," provides a great deal of hard data about how insurers currently view ERM in their organizations. While the survey addresses a number of specific issues, one fact that comes through loud and clear is the escalating interest of the participants in strengthening their organization's corporate governance. This view is most easily seen through a commitment to formalized ERM committees. The survey found that 67% of participating companies had formal ERM committees; further, over half of these committees have been formed within the last three years. Additionally, another 24% said they are considering establishing an ERM committee within the next 12 months.

This clearly illustrates the importance of risk governance and the reason why it has been identified as one of the three pillars of a solid ERM foundation. The remaining two foundation pillars, risk measurement and risk management, make up the approach that most insurers are using to implement ERM. Risk measurement is considered as those methodologies and metrics that are used to qualify risks and, for the most part, it remains a challenge for the industry according to most of the survey participants. One issue that appears to have been settled is the unit of measurement that will be used by the industry-most participants agreed that it will be economic capital.

Another encouraging finding to come out of the survey was how insurers are incorporating ERM into their business plans. Participants indicated that product development has been most impacted by ERM. They generally felt that new products were being exposed to more extensive risk reviews; that frequently limited or at least slowed product line growth. Some also mentioned both pricing and acquisitions as other areas affected by ERM policies. An additional finding dealt with the day-to-day involvement with ERM that occurs when information and reports are being aggressively embedded into various aspects of the daily business processes. Further, they noted that ERM is also now beginning to be integrated into all aspects of strategic planning.

Watershed for ERM

Shortly after obtaining the results of the "ERM Comes of Age" survey, E&Y decided to call together the participants for formal roundtable discussions to glean additional insights into the specifics of the insurers' ERM programs. Additionally, the roundtable also provided an opportunity for S&P to give a presentation regarding its new ERM rating criteria. The S&P presentation not only included specifics regarding the criteria and the expected timelines, but also explained how the ERM analysis would impact a carrier's rating. It was noted that while ERM is only one of eight rating criteria, it will quickly be incorporated into the regular rating process and receive the same attention as the other seven criteria.

Another aspect of the original survey was what the participants believed were the drivers of ERM. Among the most noted drivers were: It makes good business sense and it sharpens competitive advantages. Additionally, they also mentioned it improves shareholder value and it's the right thing to do. While several also mentioned the impact of rating agencies and regulators, these were considered by most as minor drivers. That was until they heard the S&P presentation. After hearing that, most agreed that the attention from the rating agencies would serve as a watershed for ERM.