More Companies Using Enterprise Risk Management to Handle Risks

[DW Simpson]

forbes.com/prnewswire/feeds/prnewswire/2005/07/27/prnewswire200507271017PR_NEWS_B_MAT_NY_NYW091.html

PR Newswire
More Companies Using Enterprise Risk Management to Handle Risks
07.27.05, 10:19 AM ET

But New Report from The Conference Board Shows Most Companies Have a Long Way to Go NEW YORK, July 27 /PRNewswire/ -- An overwhelming majority of companies have started to use enterprise risk management as a strategic business tool to more effectively manage a variety of risks that can impact the firm's capital and earnings -- but most firms say they still have a long way to go, according to a report released today by The Conference Board.

The report, based on The Conference Board/Mercer Oliver Wyman survey of 271 risk management executives, found that more than 90% of executives say they are building or want to build enterprise risk management processes into their organizations but only 11% report they have completed their implementation.

Enterprise risk management (ERM) is a framework, instituted by a firm's board of directors and management, applied strategically and across the enterprise, designed to identify potential events that may impact the firm, manage risks within defined parameters and provide reasonable assurance regarding the achievement of the firm's business objectives.

The study includes executives based in a wide variety of industries throughout North America and Europe and insight gleaned from top executives at conferences held recently by The Conference Board. The study is sponsored by Mercer Oliver Wyman, a leading financial services and risk management consulting firm which also provided key data for the report.

Companies continue to face increasing pressures to implement ERM processes. Both industry and government regulatory bodies, as well as investors, are increasingly examining these policies and processes. Boards of directors in a rising number of industries are now required to review and report on the effectiveness of ERM frameworks in their companies.

"Most companies are in the process of adopting enterprise risk management to contribute to the value of the organization, to meet rising corporate governance challenges and regulatory actions particularly in the U.S., and to meet the challenges arising from external and internal risks," says Ellen Hexter, Senior Research Fellow and Program Director for The Conference Board's ERM conferences and author of the report with Stephen Gates, Principal Researcher at The Conference Board. "Enterprise risk management is clearly gaining ground."

Says Michael Chagares, Director, Corporate Risk Consulting at Mercer Oliver Wyman: "Corporations are seeking to build on this better understanding of critical risks to support the strategic and operational decisions that the company has to make and to enable them to evaluate business returns on a consistent basis."

The survey results indicate that more than two-thirds of both boards of directors and senior management staff consider risk management to be an increasingly important responsibility. At the financial/operational levels, especially among Chief Financial Officers, there is an even higher awareness of the importance of ERM. Behind this trend: pressures to reduce the unexpected volatility of earnings and a need to implement internal mandates

demanded by the Sarbanes-Oxley Act and other similar regulatory frameworks globally.

HOW ERM IS PAYING OFF

Companies that have already implemented ERM report a significantly higher level of value added than companies that have not yet fully implemented these measures. This level of value is true for all the benefits attributed to ERM, including the top three: better-informed decisions (86% of companies with fully-implemented ERM; 58% of all other companies); greater management consensus (83% of companies with fully-implemented ERM; 36% of all other companies); increased management accountability (79% of companies with ERM; 34% of all other companies).

The study finds that companies fully embracing ERM are better able to improve management practices, such as strategic planning, and have a greater ability to understand and weigh risk-reward equations in their decisions.

Better understanding of operational and strategic risks was cited as the second most important driver for implementing ERM. "There is clearly a heightened awareness of the need to manage risks more strategically in order to achieve expected shareholder value," says Chagares.

"Over the past five years, the 9/11 attack, two wars, corporate scandals and failures, it is not surprising that more than 60% of those we surveyed believe that there will still be at least a significant increase in external risk during the next five years," says Hexter. "Although it might not be possible for businesses to control external risks, understanding how such risks are interrelated can help companies anticipate major surprises."

Another important reason for pursuing an improved understanding of risk is the recognition that rating agencies and debt providers are also taking risk management into consideration.

THE DRIVE TO AVOID SURPRISES

ERM is also gaining ground as a framework for corporate business practices. When asked to rank their highest priority objectives for their ERM program, survey participants place the greatest emphasis on "ensuring risks are considered in decision making" and "avoiding surprises and predictable failures," reflecting companies' interest in their ability to discover and use critical risk information.

Despite the clear objectives cited for ERM, few companies have fully implemented the practices needed to achieve these aims. Particularly in the U.S., few companies say they have fully implemented even basic elements of ERM, such as establishing a business risk inventory.

Only 16% of respondents report that their companies have integrated ERM practices into corporate practices, such as strategic planning and the annual budget process. However, the fact that just under a third say their companies' ERM is integrated with internal audit illustrates that risk management efforts often begin within the internal audit area. But once the company has achieved a certain level of ERM sophistication, risk oversight is often moved to an independent status or another area, since there are inherent conflicts in having audit units establish ERM objectives and then use them to determine operating managers' performance.

Some techniques used to evaluate risks include key risk indicators, individual self-assessments, group assessments and industry benchmarks. More quantitative techniques involving statistical and scenario analyses are rapidly beginning to emerge to support the inclusion of risk in corporate decision making. The use of these ERM techniques varies depending on the industry and the stage of ERM implementation.

Source: From Risk Management to Risk Strategy Report #1363, The Conference Board About The Conference Board Non-partisan and not-for-profit, The Conference Board is one of the world's leading business membership and research organizations. The Conference Board produces The Consumer Confidence Index and the Leading Economic Indicators for the U.S. and other major nations. These barometers can have a major impact on the financial markets. The Conference Board also produces a wide range of authoritative reports on corporate governance and ethics, human resources and diversity, executive compensation and corporate citizenship. Our conference and council programs bring together more than 10,000 senior executives each year to share insights and learn from each other. Visit The Conference Board's award-winning website at www.conference-board.org.

About Mercer Oliver Wyman

Mercer Oliver Wyman is a leader in financial services and risk management consulting. The firm is comprised of two consulting groups. The Financial Services Consulting group includes practices focused on Corporate Strategy, Finance and Risk, Corporate and Institutional Banking, Retail and Business Banking and Insurance. The Corporate Risk Consulting group includes practices in Enterprise Risk, Actuarial and Strategic Finance. The firm was formed in April 2003 from a merger of Oliver, Wyman & Company (est. 1984) and the financial services strategy and actuarial consulting practices of Mercer Inc. The firm now employs more than 800 staff working out of 32 offices in 13 countries throughout North America, Europe and Asia. www.merceroliverwyman.com

SOURCE The Conference Board -0- 07/27/2005 /CONTACT: Frank Tortorici, +1-212-339-0231, or f.tortorici@conference-board.org; or Michael Gormley, +1-646-364-8355, or mgormley@mow.com / /Web site: http://www.conference-board.org http://www.merceroliverwyman.com / CO: The Conference Board; Mercer Oliver Wyman ST: New York IN: PUB FIN INS SU: ECO SVY LH -- NYW091 -- 9377 07/27/2005 10:17 EDT http://www.prnewswire.com

[mikeshinoda]

nice post

[DudeMan]

To me this stirrs a big question....should ERM be a department within corporations? Or should it be consultant work? Which would overall be more beneficial to our economy? With consulting, the benefit is a higher level of expertise in the ERM field. A unique ERM department within a corporation provides more company specific expertise.

[Danny Boy]

To me this stirrs a big question....should ERM be a department within corporations? Or should it be consultant work? Which would overall be more beneficial to our economy? With consulting, the benefit is a higher level of expertise in the ERM field. A unique ERM department within a corporation provides more company specific expertise.

One of the largest benefits of DFA & ERM is learning more about the business and internalizing views of risk. A good majority of my work is DFA/ERM consulting. The clients who have an internal team dedicated to this type of risk management are the ones who get the most out of our consulting.

With that said it's relatively rare to have actuaries on their risk management teams. Most are PhD's or graduates of top MBA programs (or both). The company actuaries provide the data, and some of the liability assumptions, but for the most part they're happy staying in their traditional pricing/reserving role.

[DudeMan]

One of the largest benefits of DFA & ERM is learning more about the business and internalizing views of risk. A good majority of my work is DFA/ERM consulting. The clients who have an internal team dedicated to this type of risk management are the ones who get the most out of our consulting.

With that said it's relatively rare to have actuaries on their risk management teams. Most are PhD's or graduates of top MBA programs (or both). The company actuaries provide the data, and some of the liability assumptions, but for the most part they're happy staying in their traditional pricing/reserving role.

ahh so the addition and presence of actuaries employed in internal ERM departments may bring the quantitative expertise that is presently sought out from the consultants?

[Danny Boy]

ahh so the addition and presence of actuaries employed in internal ERM departments may bring the quantitative expertise that is presently sought out from the consultants?

No, the PhD's and MBA's are plenty quantitative. Actuaries, in my opinion, are too wrapped up in 30 year old techniques. It gets a bit disheartening when you talk to an actuary about their view of inflation and how it affects the line of business they are responsible for. Too often they don't have a view and just rely on the historical inflation present in triangles. When you're trying to internalize risks and tail exposure to important factors such as inflation you have to think outside of what information the chain ladder spits out (which is not a typical actuarial strong point).

[DudeMan]

No, the PhD's and MBA's are plenty quantitative. Actuaries, in my opinion, are too wrapped up in 30 year old techniques. It gets a bit disheartening when you talk to an actuary about their view of inflation and how it affects the line of business they are responsible for. Too often they don't have a view and just rely on the historical inflation present in triangles. When you're trying to internalize risks and tail exposure to important factors such as inflation you have to think outside of what information the chain ladder spits out (which is not a typical actuarial strong point).

ok so let's see if i'm getting this right. Actuaries like to use historically reliable analytical methods to draw conclusions from data whereas these PhD ERM types seek to constantly develop new methods than can better reflect an unpredictable dynamic market? I can definately see where a PhD in economics is important to this field.

[Danny Boy]

ERM and DFA are often used to evaluate tail risks and how the company would fare under different stress scenarios. Actuaries typically don't function in that fashion (they're looking more at the mean of the distribution than the extreme tail). Actuaries also tend to rely on dated methods and not consider other factors. An example is in the P&C forum where someone is asking about regressing loss ratios. As expected a suggestion was thrown out there to not regress loss ratios but instead focus on frequency/severity trends. While this may be a valid method for what the original poster is trying to accomplish, why not focus on loss ratios? Why not try to factor in inflation sensitivity, underwriting cycles, etc.? These questions are just not asked by your typical actuary but need to be asked in an ERM department.

[WWSituation]

ok so let's see if i'm getting this right. Actuaries like to use historically reliable analytical methods to draw conclusions from data whereas these PhD ERM types seek to constantly develop new methods than can better reflect an unpredictable dynamic market? I can definately see where a PhD in economics is important to this field.

Do you really think that actuaries are better suited to model the market than a PhD in economics? Fundamentally, your typical actuary will not be quantitative enough for ERM - on the other hand, those that are will be even more valuable than the quants that are there.

[JMO]

With that said it's relatively rare to have actuaries on their risk management teams. Most are PhD's or graduates of top MBA programs (or both). The company actuaries provide the data, and some of the liability assumptions, but for the most part they're happy staying in their traditional pricing/reserving role.
That is really sad. Just sayin'

[Danny Boy]

That is really sad. Just sayin'

I agree. Perhaps it will change in the future although many managers tend to hire those they're comfortable with (MBA's will hire MBA's from similar schools, PhD's will hire similar quants, etc.). Since a good portion of ERM departments are offshoots from M&A departments (those are the ones with the modeling skills needed), a good portion are quants and bankers, not actuaries. I guess the truly sad part is how involved actuaries are with minutia and how detached they are with the big picture of how an insurance company works. (I'm making broad generalizations. Obviously there are actuaries who have all the skill sets needed.)

[JMO]

Well, Dan, it does occur to me that the companies who do have actuaries on the ERM team are less likely to need to call on you for consulting.

Still, your observations demonstrate that an actuarial image campaign alone is not enough, unless actuaries actually change to fit the new image. ;)

[campbell]

I rather imagine that the "traditional" attitude is going to go away, especially as principles-based capital and reserving ideas spread through insurance products.

It is sad that there may be people who decide that their learning ends with having finished all the exams. It's not like business is going to stand still -- one's skill set may lose pertinence over time. Maybe continuing ed. requirements for FSA is not a bad idea after all.