Riskviews was once asked by an insurance sector equity analyst for 10 questions that they could ask company CEOs and CFOs about ERM. Riskviews gave them 10 but they were trick questions. Each one would take an hour to answer properly. Not really what the analyst wanted.
Here they are:
- What is the ﬁrm’s risk proﬁle?
- How much time does the board spend discussing risk with management each quarter?
- Who is responsible for risk management for the risk that has shown the largest percentage rise over the past year?
- What outside the box risks are of concern to management?
- What is driving the results that you are getting in the area with the highest risk adjusted returns?
- Describe a recent action taken to trim a risk position?
- How does management know that old risk management programs are still being followed?
- What were the largest positions held by company in excess of risk the limits in the last year?
- Where have your risk experts disagreed with your risk models in the past year?
- What are the areas where you see the ﬁrm being able to achieve better risk adjusted returns over the near term and long term?
They never come back and asked for the answer key. Here it is:
There are a number of issues relating to this question. First of all, does the insurer ever trim a risk position? Some insurers are pure buy and hold. They never think to trim a position, on either side of their balance sheet. But it is quite possible that the CEO might know that terminology, but the CFO should. And if the insurer actually has an ERM program then they should have considered trimming positions at some point in time. If not, then they may just have so much excess capital that they never have felt that they had too much risk.
Another issue is whether the CEO and CFO are aware of risk position trimming. If they are not, that might indicate that their system works well and there are never situations that need to get brought to their attention about excess risks. Again, that is not such a good sign. It either means that their staff never takes and significant risks that might need trimming or else there is not a good communication system as a part of their ERM system.
Risks might need trimming if either by accident or on purpose, someone directly entered into a transaction, on either side of the balance sheet, that moved the company past a risk limit. That would never happen if there were no limits, if there is no system to check on limits or if the limits are so far above the actual expected level of activity that they are not operationally effective limits.
In addition, risk positions might need trimming for several other reasons. A risk position that was within the limit might have changed because of a changing environment or a recalibration of a risk model. Firms that operate hedging or ALM programs could be taking trimming actions at any time. Firms that use cat models to assess their risk might find their positions in excess of limits when the cat models get re-calibrated as they were in the first half of 2011.
And risk positions may need to be trimmed if new opportunities come along that have better returns than existing positions on the same risk. A firm that is expecting to operate near its limits might want to trim existing positions so that the new opportunity can be fit within the limits.
SO a firm with a good ERM program might be telling any of those stories in answer to the question.