Dynamic financial analysis is an essential part of successful ERM frameworks

Since the Casualty Actuarial Society (CAS) published its enterprise risk management (ERM) framework in 2003, the need for a holistic approach to identifying and managing all the risks a company faces has achieved the status of accepted doctrine in the industry.

Today, regulatory and rating agencies evaluate companies on the basis of their ERM programmes. The approach of Solvency II in 2012 has stimulated companies working in Europe to take ERM seriously.

In the USA and the EU, boards of directors are looking to senior management for sophisticated ERM programmes that not only identify risks but analyse, quantify, integrate, prioritise and help make decisions on avoidance, acceptance, and how to deal with various scenarios.

While increasingly being used to evaluate a company’s capital adequacy and corporate management, ERM is more than an exercise to satisfy regulatory and rating agencies. It is a critical tool used by senior management to prepare for the impact of unanticipated events and to decide the level of risk to take in relation to the company’s capital.

As defined by CAS, ERM is the “discipline by which an organisation in any industry assesses, controls, exploits, finances, and monitors risks from all sources for the purpose of increasing the organisation’s short- and long-term value to its stakeholders”.

Advanced risk modelling

Dynamic financial analysis, utilising the most advanced risk modelling technology, is an essential element of any effective ERM programme.

Subjective evaluation of risks by senior managers is not enough. The daunting list of risks confronting any insurer or reinsurer requires more than traditional risk assessment tools to know the range of outcomes produced by different scenarios.

At Ultimate Risk Solutions, our Risk Explorer™ software simulates hundreds of thousands of random scenarios for large corporate portfolios; evaluates reinsurance, investment, and underwriting strategies; helps manage catastrophe portfolios; analyses business strategy options; identifies key risk factors; and quantifies the cost of risk, among other uses.

It enables companies to analyse the effects of different scenarios on portfolio risk management, capital estimation and allocation, ceded reinsurance, management strategies, cash flow, financial statement modelling and projections.

Economic variables

One of the important concerns for an insurance company is market risk, which is the risk of a decrease in the value of a company’s assets. The market value of the assets depends heavily on the performance of the global economy. For example, the market value of bonds depends on the behaviour of interest rates, while the market value of a company’s stock portfolio depends on the behaviour of the major stock indices.

URS Real World™ provides stochastic scenarios for modelling economic variables, including growth of GDP, rate of inflation, interest rate yield curves, and stock market indices. Modelling these economic scenarios allows companies to evaluate their market risk properly as part of an ERM programme.

Risks cut across all aspects of a company’s business. Without ERM, the different risks cannot be singled out, compared to other company risks, and analysed in terms of their collective impact on the company.

This is the holistic approach that leads to good decisions, and any successful ERM programme depends on state-of-the-art, dynamic financial analysis.

Alex Bushel is chief executive officer of Ultimate Risk Solutions, LLC