Fitch Ratings said in a Special Report today that Enterprise Risk Management ('ERM') represents a step forward in the evolution of risk management practices. From a qualitative standpoint, few changes in Fitch's criteria methodology are required as many facets of ERM are currently embedded in Fitch's review process. However, from a quantitative standpoint, Fitch's capital model 'Prism' provides a good measuring stick to gauge the success of ERM programs.
The recent spate of corporate bankruptcies has led to greater regulatory oversight and a push for enhanced corporate governance. However, ERM should not be considered as a brand new concept in the insurance industry. Insurance is the business of understanding, assuming and transferring risk. Thus, insurers need to be the pre-eminent risk managers and the ability to measure risk is paramount to their success. Although the sophistication and techniques can vary substantially between organisations, the principles of understanding relevant risks and managing them is universal. ERM is the next logical step in solid, fundamental financial management of business operations.
'Improvements in risk management have allowed insurers to better control their risks and has had an effect on the competitive landscape,' said Keith Buckley, Group Managing Director in Fitch's Insurance Group in Chicago. 'Insurers that are not up to date in their ERM techniques may be at a disadvantage in the market.'
ERM places an emphasis on risk evaluation at an enterprise level rather than in isolated business operations. Considering risks on an individual basis (the 'silo' approach) can ignore potential offsets and concentrations in risk across the various silos. The silo-approach can also lose sight of the overall objective - to protect and optimise the value of the enterprise. It is important for a risk department to view risks as profit opportunities that must be managed rather than as something to avoid at all costs.
Having identified the important risks, ERM also emphasises the importance of managing these risks in order to ensure that the desired objectives are achieved. Various risk mitigation tools are available to help an insurer to avoid risks that it is not adequately compensated for and the benefits of these actions can often be measured. An economic capital model can also help an insurer to optimise the use of scarce resources by helping to measure performance and acting as an aid to strategic decision-making. Fitch views measurement, especially of economic capital results, as an important component of ERM.
In June 2006, Fitch introduced its stochastic, economic capital model - Prism. An introductory period (expected to last until early 2007) provides insurers with access to the model via a survey and related results. Following the introductory period and a review of feedback and comments, Prism will become an important component of Fitch's ratings analysis.
Prism helps to assess ERM by measuring the effect of strategic actions carried out by management. The development of Prism assists in the understanding of in-house models, where the quantification of detailed risk mitigation exceeds the level provided by Prism.
Fitch's Special Report entitled 'Enterprise Risk Management for Insurers and Prism's Role' can be accessed from Fitch's website at www.fitchratings.com/prism. A teleconference will also be held at 15:00 BST (10:00 EDT) on Thursday 28 Sept. 2006.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
