A Case Study: ERM Implementation
at Erie Insurance
Gene Connell, Senior Vice President – ActuarialErie Insurance Group
Casualty Actuarial Society Spring Meeting – June 2007
Chief Actuary’s perspective on ERM
• Background: Who is Erie Insurance?– Regional
• Independent Agents
– Reciprocal• 3.8 million policies• $3.8 billion net written premium• $4.3 billion in surplus• $10.0 billion in invested assets
– 22nd largest P/C insurer in US
ERM is a hot topic
• MS Office– Doesn’t recognize ERM– Does recognize “hooey”
• Google: – “ERM” has 10,700,000 hits– “Hooey” has 483,000 hits
ERM is not well defined
• General Counsel – compliance
• Internal Audit – controls
• Actuaries – DFA
• Risk Managers – path to becoming king of the world
ERM Goal: Increase the Mean and Reduce the Standard Deviation
Corporate Earnings
ERM Goal: Increase the Mean and Reduce the Standard Deviation
Ret
urn
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
11.00%
3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00% 11.00% 12.00% 13.00%
Ave
rage
Ret
urn
Risk Level
Efficient Frontier Analysis
ERM Identifies/Measures Risk Events
Corporate Earnings
Adver
se L
oss
Devel
opm
ent
Lack
lust
er N
ew B
usin
ess
Inte
rest
Rat
e Hike
s
Agenc
y Def
ectio
n
Maj
or C
atas
troph
e
Frau
d/Sca
ndal
ERM Identifies Strategies to Control Risk
Adver
se L
oss
Devel
opm
ent
Lack
lust
er N
ew B
usin
ess
Inte
rest
Rat
e Hike
s
Agenc
y Def
ectio
n
Maj
or C
atas
troph
e
Frau
d/Sca
ndal
Absorb, reinsurance
Rate reduction, technology
Hedge, reallocate
Compensation, technology
Reinsurance, reduce exposure
Audit
Corporate Earnings
ERM Optimizes Risk Management
Adver
se L
oss
Devel
opm
ent
Lack
lust
er N
ew B
usin
ess
Inte
rest
Rat
e Hike
s
Agenc
y Def
ectio
n
Maj
or C
atas
troph
e
Frau
d/Sca
ndal
Absorb, reinsurance
Rate reduction, technology
Hedge, reallocate
Compensation, technology
Reinsurance, reduce exposure
Audit
Corporate Earnings
Brief History of ERM at ERIE
• I was asked by CEO to “do ERM”– Board inquiries– Magazines and consultants: “hot topic”
• Created a “risk universe”• Did high level risk inventory
– Senior management and Board involved• Easy part
ERIE Risk Universe
Strategic
Governance
Investment
Financial
Technology
Relationships
Measurement
Product Development
Pricing
Catastrophe
Litigation
Communications
Competitor
Customer Wants
Political
Innovation
Infrastructure
Info Relevance
Info Integrity
Info Access
Product Distribution
Partnering
Outsourcing
Customer ServiceHuman Resource
Change Readiness
Knowledge Capital
Alignment
Leadership
Legal
Regulatory
ComplianceFiduciary
Contractual Obligations
Corporate Governance
Conflicts of Interest
Privacy
Industry
Budget/Planning
Financial Markets
Capital Adequacy/Availability
Credit
Liquidity
Reporting
Taxation
Accounting Info
Employee/Third Party Fraud
Illegal Acts
Performance Gap
Customer Satisfaction
Regulatory
Policy/Procedure
Internal Controls
Management Fraud
Business Interruption
Terrorism
Regulatory Reporting
Version 3: April 7, 2007
Insurance
Operations
Comparison of Top Ten ListsManagement
– Technology Innovation– Infrastructure– Change Readiness– Product Distribution– Performance Gap– Product Development– Measurement– Partnering– Competitor– Budget & Planning
Board– Catastrophic Loss– Technology Innovation– Infrastructure– Change Readiness– Business Interruption– Competitor– Leadership– Pricing– Performance Gap– Product Distribution
Organizing for ERM at ERIE
• Have CEO, Board support • ERM Steering Committee
– Executives: COO, CFO, and General Counsel– Internal auditor and Chief IT officer
• ERM Working Group– Representatives from investments,
underwriting, risk management, accounting, actuarial, planning, internal audit, IT
• Consultant to help keep things moving
ERM Governance StructureBoard ofDirectors
Board ofDirectors
ExecutiveMgt. Team
ExecutiveMgt. Team
ERMSteering
Committee
ERMSteering
Committee
DivisionalERM Reps.
DivisionalERM Reps.
ERMWorkingGroup
ERMWorkingGroup
SeniorMgt. Team
SeniorMgt. Team
ERM Facilitation & Support ERM Responsibility
ERM Working Group Deliverables
• Governance Structure• Policy Statement• Framework• Education, Tools and Metrics• Periodic Reporting
– Board Audit and Strategy Committees– Ad hoc depending on Board’s concerns over
risk areas or ERM Committee’s need for direction
Actuarial’s role in ERM at ERIE
• Chair the ERM Steering Committee• Pricing uncertainty (range of indications)• Loss reserve uncertainty (range of estimates)• Dynamic Financial Analysis• Reinsurance Evaluation and Decision Support• Economic capital concepts• ERM process and reports
Dynamic Financial Analysis (DFA)
Historical and Projected Ranges of Combined Ratios
70%
80%
90%
100%
110%
120%
130%
140%
150%
Historical 2002 2003 2004 2005 2006 2007 2008
Reinsurance Alternatives
55%
65%
75%
85%
95%
105%
Direct (Noreinsurance)
Layer A Layer B Layer C
Ne
t L
os
s R
ati
o
1 in 10 Chance of Exceeding 1 in 100 Chance of Exceeding1 in 500 Chance of Exceeding 1 in 50 Chance of Exceeding1 in 1000 Chance of Exceeding
Capital Adequacy of P/C Operations
2006
Q4
2007
Q1
2007
Q2
2007
Q3
2007
Q4
2008
Q1
2008
Q2
2008
Q3
2008
Q4
2009
Q1
2009
Q2
2009
Q3
2009
Q4
Po
lic
yh
old
er
Su
rplu
s (
in m
illi
on
s)
A+/A++ Benchmark Capital Company Action Level Risk Capital (1-in-400, 3.0 Yr)
Risk capital at 2006Q4 is $X.X billion, given risk tolerance of 0.25% and 3.0 year time horizon. Statutory Capital held is $Y.Y billion. This results in discounted excess capital of $Z.Z million
Pol
icyh
olde
r S
urpl
us in
mill
ions
Capital Adequacy after Terrorism
2006
Q3
2006
Q4
2007
Q1
2007
Q2
2007
Q3
2007
Q4
2008
Q1
2008
Q2
2008
Q3
2008
Q4
2009
Q1
2009
Q2
2009
Q3
Po
lic
yh
old
er
Su
rplu
s (
in m
illi
on
s)
A+/A++ Benchmark Capital Company Action Level Risk Capital (1-in-400, 3.0 Yr)
Risk capital at 2006Q3 is $X.X billion, given risk tolerance of 0.25% and 3.0 year time horizon. Statutory Capital held is $Y.Y billion. This results in discounted excess capital of $Z.Z million
Pol
icyh
olde
r S
urpl
us in
mill
ions
Capital Adequacy w/o Home
2006Q4 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 2009Q4
Po
licy
ho
lde
r S
urp
lus
(in
mill
ion
s)
A+/A++ Benchmark Capital Company Action Level Risk Capital (1-in-400, 3.0 Yr)
Risk capital at 2006Q4 is $X.X billion, given risk tolerance of 0.25% and 3.0 year time horizon. Statutory Capital held is $Y.Y billion. This results in discounted excess capital of $Z.Z million
Pol
icyh
olde
r S
urpl
us in
mill
ions
3 Year Time Horizon ending 2009Q4Box Represents Range of 99.5% of DFA Paths - Net FIT
LO
B 1
Non
Ca
t
LO
B 2
Non
cat
LO
B 3
Non
Ca
t
LO
B 4
Non
Ca
t
LO
B 5
Non
Ca
t
LO
B 6
LO
B 7
LO
B 8
Non
Ca
t
Ca
ts N
oR
ein
s
Ca
t N
et R
ein
s
Inve
stm
ent
(no
nad
j)
Oth
er
3 Y
ea
r P
roje
cte
d C
ha
ng
e in
PH
S (
mill
ion
s)
Source of Variation in Policyholder Surplus
3 Y
ear
Pro
ject
ed C
hang
e in
PH
S
ERM Process and Reports
• Huge potential impact on company– Improve decision making by incorporating
financial discipline
• Risk identification and measurement• Response prioritization and measurement• Clearing house of risks and responses
– Reduce redundancy– Sleep at night list for CEO, Board
My Opinion on ERM
• At this time:– ERM is overblown– Expectations are too high– Those of us who have to deliver ERM
find that no one has done it well yet– Easy to spend $$$ and resources– Easy for it to be a bureaucratic drag
My Opinion on ERM
• BIG plus: Getting company to consider the potential downside as well as upside of any initiative– ERM is potential antibiotic for “PowerPoint
disease”
– This alone has enough potential to pay for ERM headaches
Actuaries are well-positioned to be effective ERM officers
• Quantitative skills• Financial knowledge• Understanding of stochastic methods • Familiar with translating business needs into
models
• Actuaries particularly well suited for insurance industry ERM positions
Watch Out For:
• Overlooking the many, critical non-actuarial aspects
• Resource drains– It takes skilled staff; it is not trivial
• Reactions of rest of company– Another bureaucratic headache– Silos unwilling to give up their autonomy
• Unrealistic expectations
ERM is Today’s Reality
• ERM is a wave sweeping through the industry
• A big wave – it will not pass on by
• Ride it, don’t fight it