European Reinsurers Implementing ERM More Often
Move toward ERM could stabilize market, according to experts
by Stuart Collins
Europe's ultimate risk takers increasingly are using enterprise risk management techniques to reduce their own financial exposures.
Reinsurers across the continent employ economic capital models, price-tracking procedures, protocols to control risk accumulation, and other ERM techniques to get a firm grasp on the risks they face, experts say.
And as they are the organizations at the end of the risk-transfer process, reinsurers' drive to implement ERM is likely to have a stabilizing effect on the whole market, experts say.
Several insurers and reinsurers in Europe have embraced sophisticated risk management techniques for managing their exposures, said Simon Harris, team managing director for insurance in the Europe, Middle East and Africa region for Moody's Investor Service in London.
"Reinsurers were first and fastest to react to the recognition that risk management had to improve after the equity crisis of 2002, building dedicated teams of risk professionals and appointing chief risk officers," he said.
And the development of risk-based capital rules in the European Union under Solvency II, has created a stronger drive toward ERM in Europe, Mr. Harris said.
As a result, leading reinsurers have invested in technology and have recruited additional expertise in areas such as actuarial analysis, financial risk, and modeling, according to reinsurers and consultants.
And many reinsurers and insurers in Europe have developed internal economic capital models to analyze all the risks their organizations face. Regulators in the United Kingdom and Switzerland allow reinsurers and insurers to use the models to assess their regulatory capital requirements, and, under Solvency II, reinsurers and insurers in the rest of the European Union will be able to do so from 2012.
Internal models are sophisticated actuarial tools that help an insurer calculate the amount of capital it should hold in order to cover its risks, including insurance liabilities, market risk, credit risk or operational risk.
The development of an "all-risk" or enterprise-wide approach to risk management through the use of economic capital models has been a significant development for the reinsurance sector during the past decade, said Raj Singh, chief risk officer at Swiss Reinsurance Co. in Zurich, Switzerland. Reinsurers have begun to model all business risks-including investment and insurance risks-to deploy capital more effectively, he said.
"Enterprise risk management has gained a real foothold in the reinsurance industry, driven by business, but supported with rigor by regulators and rating agents," he added.
And reinsurers will benefit as regulators and rating agents increasingly adopt a common approach to solvency, Mr. Singh said. Reinsurers use the models to help determine their business strategies, but they also have to satisfy the different approaches of regulators, investors and rating agents, Mr. Singh said.
"A move by regulators worldwide towards risk-based and economic value-based solvency regimes would lead to full alignment of economic steering with solvency," Mr. Singh said.
Economic capital models are used by reinsurers in key management processes, such as deciding on levels of capital and its allocation, said Joachim Oechslin, chief risk officer, Munich Re Group in Munich, Germany.
In addition to economic capital models, reinsurers are working on internal controls and governance procedures and risk-reporting requirements, to establish risk appetite and limit their exposures to certain risks, Mr. Oechslin said.
A growing trend is reinsurers' use of risk management to manage risk aggregations, optimize their portfolios, and track technical pricing levels, said Richard Rodriguez, a partner at London-based actuarial and consulting firm EMB Consultancy L.L.P.
And their investment in risk management is starting to bear fruit, he said. "We are only seeing the beginnings of the benefits coming through for the market and while we will not be rid of the (pricing) cycle, we should see more stability on rates. There should be less severity of pricing movements and the boom-and-bust nature of reinsurance should be reduced over time."
Reinsurers are placing a lot more emphasis on capturing data at the time a risk is placed, such as premium rate movements, according to James Illingworth, group chief risk officer at London-based Amlin P.L.C.
"As risk management becomes more established, it should take out the extremes of the underwriting cycle, and there are already signs of this happening with the current cycle," Mr. Illingworth said.
In addition, reinsurers say they have better control of their exposures.
For example, reinsurers increasingly are imposing absolute limits on how much business they will underwrite in peak zones so as to protect their capital base, according to Conan Ward, chief executive officer of Validus Reinsurance Ltd. in Hamilton, Bermuda.
The history of carrier failures shows the risk of ruin is not so much in a single large loss, but much more in having to rectify, in a single year of account, an accumulation of several consecutive underwriting years of bad risk management in a given class of business coupled with an uncontrolled volume of writings, according to Victor Peignet, Paris-based chief executive officer of SCOR Global P&C S.E.
"One of the direct applications of ERM is in diversification between classes and self-limitation of volumes by class, being both driven by the capital available to the company and its appetite to put it at risk," he said.
As reinsurers better understand their exposures, they may become more selective of the risks they take on, and only underwrite in line with their risk appetite, according to Mr. Harris. "Some risks may be harder to place, or insurers may have to pay more, as reinsurers reduce their appetite for certain risks."
And reinsurers' product offerings likely will adapt to insurers' changing reinsurance needs, driven by their own improved understanding of catastrophe risks, according to Jon Tilman, practice leader for Towers Perrin's European property/casualty insurance business in London.
Quota share reinsurance and products that cap losses to certain catastrophe exposures are likely to become more sought after by primary insurers, he added.