Posted tagged ‘ERM’

Updating your Risk Register

January 26, 2017

It is quite easy for an ERM program to become irrelevant.  All it takes is for it to stay the same for several years.  After just a few years, you will find that you risk management processes are focused upon the issues of several years ago.  You may be missing new wrinkles to your risks and also repeating mitigation exercises that are no longer effective or needed.

That is because the risk environment is constantly changing.  Some risks are become more dangerous while for others the danger is receding.  No firm anywhere has an unlimited budget for risk management.  So to remain effective, you need to constantly reshuffle priorities.

One place where that reshuffling is very much needed is in the risk register.  That is a hard message to sell.  Risk Identification is seen by most as the first baby step in initiating and ERM program.  How could a well developed, sophisticated ERM program need to go back to the first baby step.

But we do need to go back and somehow get people to seriously re-evaluate the Risks on the Risk Register.  That is because risk management is fundamentally a cycle rather than a a one way development process.  We are all brainwashed that constant growth and steady improvement is the fundamental nature of human enterprise.  For risk management to really work, we need that cycle model where we go back and do all of the same steps as last year all over again.

One way to freshen up the process of reviewing the risk register is to bring in outside information.  The link below provides some good outside information that you can use to stimulate your own review.

Willis Re took the top 15 risks from a dozen insurer risk registers and combined them to get 50+ unique risks.  Then over 100 insurer executives and risk management staff helped to rank those 50 risks.

2017’s most dangerous risks for insurers

We took a list of over 50 risks commonly found on insurer risk registers, and asked, “Which risks present the most danger to your firm in 2017?”

Take a look.  How does the resulting ranking look compared to your risk register?  Do any of the top 10 risks show up as middling priority in your program?  Are any of the bottom ten risks near the top of your priority ranking?  So your review can focus on a discussion of the most significant deviations between your ranking and the ranking from the link above. You need to convince yourself that you have good reasons for different priorities or change your priorities.

Risk Trajectory – Do you know which way your risk is headed?

July 25, 2016


Which direction are you planning on taking?

  • Are you expecting your risk to grow faster than your capacity to bare risk?
  • Are you expecting your risk capacity to grow faster than your risk?
  • Or are you planning to keep growth of your risk and your capacity in balance?

If risk is your business, then the answer to this question is one of just a few statements that make up a basic risk strategy.

RISKVIEWS calls this the Risk Trajectory.  Risk Trajectory is not a permanent aspect of a businesses risk strategy.  Trajectory will change unpredictably and usually not each year.

There are four factors that have the most influence on Risk Trajectory:

  1. Your Risk Profile – often stated in terms of the potential losses from all risks at a particular likelihood (i.e. 1 in 200 years)
  2. Your capacity to bare risk – often stated in terms of capital
  3. Your preferred level of security (may be factored directly into the return period used for Risk Profile or stated as a buffer above Risk Profile)
  4. The likely rewards for accepting the risks in your Risk Profile

If you have a comfortable margin between your Risk Profile and your preferred level of security, then you might accept a risk trajectory of Risk Growing Faster than Capacity.

Or if the Likely Rewards seem very good, you might be willing to accept a little less security for the higher reward.

All four of the factors that influence Risk Trajectory are constantly moving.  Over time, anything other than carefully coordinated movements will result in occasional need to change trajectory.  In some cases, the need to change trajectory comes from an unexpected large loss that results in an abrupt change in your capacity.

For the balanced risk and capacity trajectory, you would need to maintain a level of profit as a percentage of the Risk Profile that is on the average over time equal to the growth in Risk Profile.

For Capacity to grow faster than Risk, the profit as a percentage of the Risk Profile would be greater than the growth in Risk Profile.

For Risk to grow faster than Capacity, Risk profile growth rate would be greater than the profit as a percentage of the Risk Profile.

RISKVIEWS would guess that all this is just as easy to do as juggling four balls that are a different and somewhat unpredictably different size, shape and weight when they come down compared to when you tossed them up.


Knowing the results from Stress Tests in Advance

July 13, 2015

Insurers and regulators need to adopt the idea of characterizing stress tests scenario frequency as:


Normal Volatility

Realistic Disaster

Worst Case


Or something equivalent.


With the idea that it is reasonable for an insurer to prepare for a Realistic Disaster Scenario, but not practical to be prepared for all Worst Case scenarios. Not practical because the insurance would cost too much and less insurance would be sold.


With such a common language about frequency relating to stress tests, the results of the stress testing and the response to those results can make much more sense.


The outcomes of stress testing then fall into a pattern as well.


  • An insurer should be able to withstand normal volatility without any lasting reduction to capital.


  • An insurer should be able to withstand a Realistic Disaster for most of their risks without a game changing impairment of capital, i.e. it would be realistic for them to plan to earn their way back to their desired level of capital. For the most significant one or two risks, a Realistic Disaster may result in Capital impairment that requires special actions to repair. Special actions may include a major change to company strategy.


  • An insurer can usually withstand a Worst Case scenario for most of their risks with the likelihood that for some, there will be an impairment to capital that requires special actions to repair. For the largest one or two risks, the insurer is unlikely to be able to withstand the Worst Case scenario.


Those three statements are in fact a requirement for an insurer to be said to be effectively managing their risks.

So the ORSA and any other stress testing process should result in the development of the story of what sorts of stresses require special management actions and what types result in failure of the insurer.  And for an insurer with a risk management program that is working well, those answers should be known for all but one or two of their risks.  Those would the second and third largest risks.  An insurer with a perfect risk management program will not have very much daylight between their first, second and third largest risks and therefore may well be able to survive some worst case scenarios for even their largest risks.

Hierarchy Principle of Risk Management

September 8, 2014

The purpose of ERM is NOT to try to elevate all risk decisions to the highest possible level, but to master discerning the best level for making each risk decision and for getting the right information to the right person in time to make a good risk decision.

This is the Hierarchy Principle as it applies to ERM.  It is one of the two or three most important principles of ERM.  Why then, might you ask, haven’t we ever heard about it before, even from RISKVIEWS.

But most insurers follow the hierarchy principle for managing their Underwriting process for risk acceptance of their most important risks.  

You could argue that many of the most spectacular losses made by banks have been in situations where they did not follow the hierarchy principle.  

  • Nick Leeson at Barings Bank was taking risks at a size that should have been decided (and rejected) by the board.
  • Jerome Kerviel at Soc Gen was doing the same.
  • The London Whale at JP Morgan is also said to have done that.  

On the other hand, Jon Corzine was taking outsized risks that eventually sank MF Global with the full knowledge and approval of the board.  Many people suggest that the CRO should have stopped that.  But RISKVIEWS believes that the Hierarchy Principle was satisfied.  

ERM is not and cannot be held responsible for bad decisions that are made at the very top of the firm, unless the risk function was providing flawed information that supported those decisions.  If, as happened at MF Global, the board and top management were making risk decisions with their eyes fully open and informed by the risk function, then ERM worked as it should.  

ERM does not prevent mistakes or bad judgment.

What ERM does that is new is that

  1. it works to systematically determine the significance of all risk decisions, 
  2. it ranks the significance and uses that information, along with other information such as risk velocity and uncertainty, to determine a recommendation of the best level to make decisions about each risk,
  3. it assesses the ability of the firm to absorb losses and the potential for losses within the risks that are being held by the firm at any point in time,
  4. it works with management and the board to craft a risk appetite statement that links the loss absorbing capacity of the firm with the preferences of management and the board for absorbing losses.

ERM does not manage the firm.  ERM helps management to manage the risks of the firm mainly by providing information about the risks.  

So why have we not heard about this Hierarchy Principle before?  

For many years, ERM have been fighting to get any traction, to have a voice.  The Hierarchy Principle complicates the message, so was left out by many early CROs and other pioneers.  A few were pushing for the risk function to be itself elevated as high as possible and they did not want to limit the risk message, deeming everything about risk to be of highest importance. But RISKVIEWS believes that it was mostly because the Hierarchy Principle is pretty fundamental to business management and is usually not explicitly stated anywhere else, even though it is applied almost always.

ERM now receives a major push from regulators, to a large extent from the ORSA.  In writing, the regulators do not require that ERM elevate all risk decisions.  But in practice, they are seeing some insurers who have been elevating everything and the regulators are adopting those examples as their standard for best in class.  

Just one more way that the regulatory support for ERM will speed its demise.  If regulators advocate for consistent violation of the Hierarchy principle, then ERM will be seen mainly as a wasteful burden.  


Insurers need to adapt COSO/ISO Risk Management to achieve ERM

July 29, 2014

Both the COSO and ISO risk management frameworks describe many excellent practices.  However, in practice, insurers need to make two major changes from the typical COSO/ISO risk management process to achieve real ERM.

  1. RISK MEASUREMENT – Both COSO and ISO emphasize what RISKVIEWS calls the Risk Impressions approach to risk measurement.  That means asking people what their impression is of the frequency and severity of each risk.  Sometimes they get real fancy and also ask for an impression of Risk Velocity.  RISKVIEWS sees two problems with this for insurers.  First, impressions of risk are notoriously inaccurate.  People are just not very good at making subjective judgments about risk.  Second, the frequency/severity pair idea does not actually represent reality.  The idea properly applies to very specific incidents, not to risks, which are broad classes of incidents.  Each possible incident that makes up the class that we call a risk has a different frequency severity pair.   There is no single pair that represents the class.  Insurers risks are in one major way different from the risks of non-financial firms.  Insurers almost always buy and sell the risks that make up 80% or more of their risk profile.  That means that to make those transactions they should be making an estimate of the expected value of ALL of those frequency and severity pairs.  No insurance company that expects to survive for more than a year would consider setting its prices based upon something as lacking in reality testing as a single frequency and severity pair.  So an insurer should apply the same discipline to measuring its risks as it does to setting its prices.  After all, risk is the business that it is in.
  2. HIERARCHICAL RISK FOCUS – Neither COSO nor ISO demand that the risk manager run to their board or senior management and proudly expect them to sit still while the risk manager expounds upon the 200 risks in their risk register.  But a highly depressingly large number of COSO/ISO shops do exactly that.  Then they wonder why they never get a second chance in front of top management and the board.  However, neither COSO nor ISO provide strong enough guidance regarding the Hierarchical principal that is one of the key ideas of real ERM.    COSO and ISO both start with a bottoms up process for identifying risks.  That means that many people at various levels in the company get to make input into the risk identification process.  This is the fundamental way that COSO/ISO risk management ends up with risk registers of 200 risks.  COSO and ISO do not, however, offer much if any guidance regarding how to make that into something that can be used by top management and the board.  In RISKVIEWS experience, the 200 item list needs to be sorted into no more than 25 broad categories.  Then those categories need to be considered the Risks of the firm and the list of 200 items considered the Riskettes.  Top management should have a say in the development of that list.  It should be their chooses of names for the 25 Risks. The 25 Risks then need to be divided into three groups.  The top 5 to 7 Risks are the first rank risks that are the focus of discussions with the Board.    Those should be the Risks that are most likely to cause a financial or other major disruption to the firm.   Besides focusing on those first rank risks, the board should make sure that management is attending to all of the 25 risks.  The remaining 18 to 20 Risks then can be divided into two ranks.  The Top management should then focus on the first and second rank risks.  And they should make sure that the risk owners are attending to the third rank risks.  Top management, usually through a risk committee, needs to regularly look at these risk assignments and promote and demote risks as the company’s exposure and the risk environment changes.  Now, if you are a risk manager who has recently spent a year or more constructing the list of the 200 Riskettes, you are doubtless wondering what use would be made of all that hard work.  Under the Hierarchical principle of ERM, the process described above is repeated down the org chart.  The risk committee will appoint a risk owner for each of the 25 Risks and that risk owner will work with their list of Riskettes.  If their Riskette list is longer than 10, they might want to create a priority structure, ranking the risks as is done for the board and top management.  But if the initial risk register was done properly, then the Riskettes will be separate because there is something about them that requires something different in their monitoring or their risk treatment.  So the risk register and Riskettes will be an valuable and actionable way to organize their responsibilities as risk owner.  Even if it is never again shown to the Top management and the board.

These two ideas do not contradict the main thrust of COSO and ISO but they do represent a major adjustment in approach for insurance company risk managers who have been going to COSO or ISO for guidance.  It would be best if those risk managers knew in advance about these two differences from the COSO/ISO approach that is applied in non-financial firms.

Key Ideas of ERM

July 24, 2014

For a set of activities to be called ERM, they must satisfy ALL of these Key Ideas…

  1. Transition from Evolved Risk Management to planned ERM
  2. Comprehensive – includes ALL risks
  3. Measurement – on a consistent basis allows ranking and…
  4. Aggregation – adding up the risks to know total
  5. Capital – comparing sum of risks to capital – can apply security standard to judge
  6. Hierarchy – decisions about risks are made at the appropriate level in the organization – which means information must be readily available

Risk management activities that do not satisfy ALL Key Ideas may well be good and useful things that must be done, but they are not, by themselves ERM.

Many activities that seek to be called ERM do not really satisfy ALL Key Ideas.  The most common “fail” is item 2, Comprehensive.  When risks are left out of consideration, that is the same as a measurement of zero.  So no matter how difficult to measure, it is extremely important to really, really be Comprehensive.

But it is quite possible to “fail” on any of the other Key Ideas.

The Transition idea usually “fails” when the longest standing traditional risk management practices are not challenged to come up to ERM standards that are being applied to other risks and risk management activities.

Measurement “fails” when the tails of the risk model are not of the correct “fatness“.  Risks are significantly undervalued.

Aggregation “fails” when too much independence of risks is assumed.  Most often ignored is interdependence caused by common counter parties.

Capital “fails” when the security standard is based upon a very partial risk model and not on a completely comprehensive risk model.

Hierarchy “fails” when top management and/or the board do not personally take responsibility for ERM.  The CRO should not be an independent advocate for risk management, the CRO should be the agent of the power structure of the firm.

In fact Hierarchy Failure is the other most common reason for ERM to fail.

Who should do ERM?

February 25, 2014

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