How Much Strategic ERM is Enough?

Strategic Risk Management is the name given by S&P to the enterprise level activities that seek to improve risk adjusted returns by a strategic capital allocation process.  It is also considered by S&P to the the “Use Test” for economic Capital models.  Strategic Risk Management includes

  • Capital Budgeting and Allocation
  • Strategic Trade-offs among insurance coverages AND investments
    • based on long term view of risk adjusted return
    • Recognizing significance of investment risk to total risk profile
    • Recognizing ceded reinsurance credit risk
  • Selecting which risks to write and which to retain over the long term
  • Strategic Asset Allocation
  • Risk Reward Optimization
Meanwhile Solvency II had created standards for its internal model Use Test.
The foundation principle of the Solvency II Use Test states that
internal model use should be sufficiently material to result in pressure to increase the quality of the model 
This strongly self referential idea is then supported by 9 Basic Principles.
Principle 1. Senior management and the administrative, management or supervisory body, shall be able to demonstrate understanding of the internal model
Principle 2. The internal model shall fit the business model
Principle 3. The internal model shall be used to support and verify decision-making in the undertaking
Principle 4. The internal model shall cover sufficient risks to make it useful for risk management and decision-making
Principle 5. Undertakings shall design the internal model in such a way that it facilitates analysis of business decisions.
Principle 6. The internal model shall be widely integrated with the risk-management system
Principle 7. The internal model shall be used to improve the undertaking’s risk-management system.
Principle 8. The integration into the risk-management system shall be on a consistent basis for all uses
Principle 9. The Solvency Capital Requirement shall be calculated at least annually from a full run of the internal model
From these two descriptions of a Use Test, one should be forgiven for picturing a group of priests in long robes prowling the halls of an insurer in procession carrying a two foot thick book of the internal model.  Their primary religious duty is to make sure that no one at the insurer ever have an independent thought without first thinking about the great internal model.  Every year, the internal model book is reprinted and the priests restart their procession.  
But take heart.  A quick look at the website of the European CRO Forum reveals that those firms do not revere their internal models quite so highly.  
The above chart suggests that in most groups the internal model is just one consideration for making most strategic decisions of the insurer.  
The excerpt below from the Tokio Marine Holdings puts these things into perspective.  

The Group carries out a relative evaluation of each business and prioritizes the allocation of management resources (business portfolio management).  It is achieved by using risk/return indicators for each business and applying a scoring indicator covering market growth potential and profitability, competitive advantages and expected effects of strategies.  Allocated management resources include funds, human resources and risk capital. By allocating these resources to business units and new businesses with even higher profitability and growth potential, we aim to improve the profitability and growth potential of our business portfolio.

You see from that statement that risk return is not the only input nor is capital the only factor under consideration.  Describing Strategic Risk Management as its own separate management process is incorrect.  
Strategic Risk Management is one set of inputs and outputs to/from the Strategic Decision Making Process.  
And if read carefully, that will satisfy both S&P as well as Solvency II Use Tests.
Explore posts in the same categories: Enterprise Risk Management, Solvency II

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