© 2005 Towers Perrin

OCCA Presentation

Enterprise Risk Management

December 6, 2006

Pierre Laurin

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Not for use or disclosure outside Towers Perrin and its clients

There are four phases of ERM

Enterprise Risks

FinancialFinancialFinancialFinancial

HazardHazardHazardHazard

OperationalOperationalOperationalOperational

RegulatoryRegulatoryRegulatoryRegulatoryPoliticalPoliticalPoliticalPolitical

Human AssetsHuman AssetsHuman AssetsHuman Assets

MarketMarketMarketMarket

Legal Liability Legal Liability Legal Liability Legal Liability

Compliance and Governance

Diagnostics and Analytics

Solution Analysis and Review

Transaction Execution / Risk

Mitigation

ERM Framework and Processes

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ERM Value Framework

How much capital do I

need?

What type of capital do I

need?

Risk and Capital Management

Value Management

CapitalCosts

Returnon Risk

Risk Structure

Capital Structure

Capital AdequacyPortfolio of

Capital Resources

Portfolio of Enterprise

Risks

Economic Capital

Value Creation

Maximize value by relating a firm’s decisions on the risks it takes to decisions on the capital it uses to finance its business

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Specific Tasks under Enterprise Risk Management

Economic Capital

Reinsurance Optimization

Asset Allocation

Portfolio Optimization

Economic Capital Model Building/Parameterization Database

Operational Risk Management

ERM Governance/Function Design

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Why is Economic Capital economic?

Based on economic, rather than accounting, balance sheet Market value of assets Expected economic cost of liabilities

Also reflects distribution of economic, rather than accounting, profits (losses) Actual ultimate economic cost of liabilities

Set to maintain a selected defined level of policyholder security Economic cost of ruin

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What is Economic Capital?

Cumulative probability

Perc

en

t C

han

ge in

Econ

om

ic C

ap

ital

Policyholder/depositor security risk relates to insolvency and non-performance

Policyholder/depositor security risk relates to insolvency and non-performance

-100%

0%

Economic Capital covers the downside scenarios in all but the most extreme scenarios

Economic Capital covers the downside scenarios in all but the most extreme scenarios

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From a corporate finance perspective, reinsurance should be viewed as a form of capital

Tactical: Given the amount of paid up capital, how much contingent should I buy?

Tactical: Given the amount of paid up capital, how much contingent should I buy?

Strategic: Should I change the mix between paid up capital

and contingent capital?

Strategic: Should I change the mix between paid up capital

and contingent capital?

DebtDebt

EquityEquity

NetRisks

NetRisks

ReinsuranceReinsurance

GrossRisks

GrossRisks

ReinsuranceReinsurance

DebtDebt

EquityEquity

GrossRisks

GrossRisks

DebtDebt

EquityEquity

Conventional approach

Framework approach

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Reinsurance can also create value when the cost of reinsurance is offset by a reduction in the required rate of return

The ERM value framework can be used to evaluate reinsurance and other portfolio hedging strategies

RiskWith

reinsuranceWithout

reinsurance

Return

Expected cost of reinsurance

Market ConsistentRequired-Rate-of-Return

(Opportunity Cost of Capital)

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Summary

ERM: is an important process requires significant resources touches all aspects of the entreprise is an on-going process