Embedding ERM: 2008 Global Insurance Sector Survey Results
Originally Published: October 27, 2008
In a global survey of more than 350 Chief Financial Officers, Chief Actuaries and Chief Risk Officers, Towers Perrin found that insurers are still having difficulty fully embedding ERM into decision-making processes. The survey included respondents from North America (49%), Europe (29%), Asia and the Pacific (19%), Latin America (2%), and Africa and the Middle East (1%).
Using Economic Capital to Measure Risk
Economic capital methodology is moving towards a one-year value at risk approach, with 56% of respondents using a market-consistent terminal balance sheet. The survey found that a significant percentage of insurers are still focused on calculating economic capital, while only 10% of respondents indicated that they have the ability to fully utilize economic capital to make risk-based decisions. Among larger insurers, 40% use economic capital in product design and pricing decisions with another 42% planning to do so within two years.
Eighty-four percent of large insurers calculate economic capital, compared to 69% of medium-size insurers and 37% of small organizations. In larger firms, 44% use economic capital in strategic planning and capital allocation compared to 19% for small firms. Seventeen percent of small firms use economic capital in products design and pricing as compared to 40% of large firms. The study found that larger insurers are more advanced in the calculation and use of economic capital in decision-making, and placed a higher priority on improving the implementation of risk-based decision-making in the future.
European Insurers Have Better ERM Implementation
European insurers are leading North American firms in key areas like economic capital implementation and its use in decision-making. Under Solvency II, these ERM capabilities are expected to lead to lower capital requirements and competitive advantage for those European firms that successfully embed ERM. A higher proportion of European insurers have documented their risk appetite and set risk limits for day-to-day management than those in North America. Seventy-eight percent of European firms calculate economic capital, compared to 45% in North America and 59% in Asia and the Pacific. Within two years, 80% to 90% of European insurers expect to be using economic capital in most major decision-making processes, and 74% anticipate using economic capital in performance measurement.
The study found that operational risk lags behind other risks in terms of setting risk limits and economic capital calculation methodology. Only 7% percent of respondents felt they had appropriate operational risk management capabilities in place. Insurers expressed more confidence in their measures of insurance, credit, and market risks. Of those companies that have set limits to govern risk-taking, over 70% have limits for market, credit, and insurance risk while only 26% have limits for operational risk.
Incentive management and performance management are two areas identified by the study where economic capital could be used to improve risk-based decision-making. The use of economic capital in decision-making over the next year was identified as a priority by 44% of respondents. Competitive advantage seems to drive ERM activities in larger organizations. Towers Perrin foresees market consolidation as larger insurers purchase smaller, less sophisticated firms that are unable to implement ERM to remain competitive.