Ch. 4 - Enterprise Risk Management

enterprise risk managament

strategic business discipline that supports the achievement of an organization’s business objectives by addressing the full spectrum of its risks and managing the combined impact of those risks as an integrated risk portfolio

ERM Process

Risk Identification

Risk Analysis

Selection of Risk Treatment Measures

Monitoring Program Changes

Chief Risk Officer (CRO)

responsible for the treatment of all the risks facing the organization, and for creating a program to successfully manage these risks.

hazard risk

risk associated with the organization’s property, liability, and personnel-related loss exposures.

financial risk

risk created by the changing value of financial assets, commodities, currencies, and interest rates

operational risk

risk arising out of an organization’s operations

how to identify operational risk

1. A number of groups of individuals are involved in a business organization, including employees, managers, contractors, and suppliers

2. process risk is the risk associated with deviations from an organization’s regular practices and procedures

3. “Systems” risk develops because of the use of technology by an organization

4. External events are events outside the control of the organization.

strategic risks

external risks to the organization

risk register

listing of the risks faced by an organization with pertinent information about each risk

risk map

a grid on which risks facing the organization are charted based on potential frequency and severity of loss to the organization.

risk appetite

the total exposure that an organization is willing to accept, given the risk and return trade-off for an individual risk or in aggregate for the portfolio of risks

risk tolerance

the amount of uncertainty that an organization is willing to accept

underwriting cycle

cyclical pattern in underwriting stringency, premium levels, and profitability

hard insurance market

Property and liability insurance markets fluctuate between periods of tight underwriting standards and high premiums

soft insurance market

periods of loose underwriting standards and low premiums

combined ratio

ratio of paid losses and loss adjustment expenses plus underwriting expenses to premiums

capacity

relative level of surplus

surplus

difference between insurer’s assets and its liabilities

clash loss

several lines of insurance simultaneously experience large losses

securitization of risk

insurable risk is transferred to the capital markets through creation of a financial instrument, such as a catastrophe bond, options contract, or other financial instrument

cash flow underwriting

If insurers expect favorable investment results, they can sell their insurance coverages at lower premium rates, hoping to offset underwriting losses with investment income.

catastrophe bonds

corporate bonds that permit the issuer to skip or reduce scheduled payments if a catastrophic loss occurs

insurance option

option that derives value from specific insurable losses or from an index of values

weather option

provides payment if a specified weather contingency (for example, temperature above a certain level or rainfall below a specified level) occurs

three (3) loss forecasting techniques

probability analysis

regression analysis

forecasting based on loss distributions

independent events

the occurrence does not affect the occurrence of another event

dependent events

the occurrence of one event affects the occurrence of the other

mutual exclusivity

the occurrence of one event precludes the occurrence of the second event

regression analysis

characterizes the relationship between two or more variables and then uses this characterization to predict values of a variable

loss distribution

probability distribution of losses that could occur.

time value of money

when valuing cash flows in different time periods, the interest-earning capacity of money must be taken into consideration

compounding

the operation through which a present value is converted to a future value when you are earning compound interest (aka interest on interest)

discounting

bringing a future value back to present value

capital budgeting

a method of determining which capital investment projects a company should undertake

net present value (npv)

the sum of the present values of the future net cash flows minus the cost of the project

internal rate of return (irr)

the average annual rate of return provided by investing in the project

risk management information system (rmis)

a computerized database that permits the risk manager to store, update, and analyze risk management data and to use such data to predict and attempt to control future loss levels.

intranet

a private network with search capabilities designed for a limited, internal audience

predictive analytics

the analysis of data to generate information that will help make more informed decisions.

value at risk (var) analysis

the worst probable loss likely to occur in a given time period under regular market conditions at some level of confidence

catastrophic modeling

a computer-assisted method of estimating losses that could occur as a result of a catastrophic event