16.1 ERA 1.1 Historical Context

Two similar quantitative initiatives from the past

• Dynamic Financial Analysis

  • RBC (from 1990s) was the precursor to scenario testing and Dynamic Financial Analysis (DFA) but DFA didn’t pan out

  • DFA requires support from many functions and was not widely used due to lack of natural champion

• Cat Model

  • Primitive in 1980s

  • Faced external and internal pressure to use cat models after HU Andrew

  • Nowadays it would be considered mismanagement for a company not to use cat models

There is a spectrum of acceptance for both internal and external, and ERM is somewhere between the 2 examples above

External Pressure on ERM as of 2007:

• International Association of Insurance Supervision (IAIS) began development of an approach of rating insurer based on Basel II

  See 2004 IAA document

• Canada (Dynamic Capital Adequacy Test) and Australia (Internaal Model Based Method) developed and implemented regulatory requirements regarding the construction and use of internal risk models

• UK (Financial Service Authority) implemented Individual Capital Adequacy Standards (ICAS) in 2004:

  “A firm is required to undertake regular assessments of the amount and quality of capital which in their view is adequate for the size and nature of their business…”

• NAIC is moving towards a new audit paradigm:

  Capital adequacy, Asset quality, Reserves, Reinsurance, Management, Earnings and Liquidity (CARRMEL)

• 2005 S&P stated that a firm’s EMR program will become a critical component in its rating methodology

Internal Champion

• ERM needs an internal champion (e.g. CRO) with:

  • Quantitative skills

  • Operational experience

  • Political skills (executive rank) to work across organizational silos