Agents using ERM approach need to understand actuary's role
By Samuel Schiff
Actuary - An insurance professional who specializes in statistical information.
--Handbook for Reporters; 1993
Revised edition; 1995
Actuary - Architects of financial security.
--Robert Conger, FCAS
President, Casualty Actuarial Society, July 2002
Those one-line descriptions from the Handbook for Reporters, published by the Insurance Information Institute (III), and the Casualty Actuarial Society (CAS) describe the function of an actuary in a mere eight and four words, respectively. However, a decade after the first III definition was published, the role of a property/casualty insurance actuary has changed. That process is continuing, amid signs that in the future the actuarial function will play a more significant role not only in the insurance business but also in all sectors of the American and international business community.
The Casualty Actuarial Society (CAS) (originally called the Casualty Actuarial and Statistical Association of America) was organized in 1914. The initial roster consisted of 97 members with Dr. I.M. Rubinow, who was responsible for its formation, as the first president. Its present name was adopted in 1921. Initially the CAS members were concerned primarily with workers comp problems, but that gradually changed to involve all lines of property/casualty insurance--automobile, fire, homeowners, commercial multiple peril, medical malpractice, general liability and others.
As the disciplines grew in numbers, so did the membership--to its present size of more than 3,400 men and women in two grades of credentialed members: Fellows and Associates. Casualty actuaries are now found not only in insurance companies but educational institutions, rate-making organizations, state insurance departments, the federal government and independent consulting firms. The Society has 14 affiliated regional organizations in the United States as well as in Ontario, Bermuda, Taiwan, Hong Kong and Europe, which provides members with various publications, and sponsors year-round seminars and educational offerings.
The role of the casualty actuary is undergoing significant changes, according to Robert Conger, FCAS, president of the CAS and consultant and principal with Tillinghast-Towers Perrin. According to Conger, this is "thanks in part to a pair of emerging developments: the evolving role of enterprise risk management (ERM) which has been around for a number of years and the introduction of a new kind of executive at the corporate level--the chief risk officer (CRO). Each of these trends is going to impact all sectors of the property/casualty insurance industry, including agents and brokers and their commercial customers. "Accelerating these trends, the sudden and shocking terrorist attack on the United States on September 11 jolted many corporations into an expanded awareness of the magnitude of risks their businesses face.
"The September 11 attack was the first event that produced significant claims in virtually all segments of the insurance industry--including property and casualty, business interruption, aviation (hull and liability), event cancellation, life and health, workers compensation, and others," he says. Conger also notes that 9/11 showed that a disaster not only affects a company directly but produces almost a domino effect, touching the entire chain of an organization's operations--including its suppliers, customers and the transportation systems that connect them, as well as the company's financial investments.
"I think September 11 further helped highlight the importance of ERM--the holistic approach to risk management for the nation's businesses. The tragedy of 9/11 showed vividly that a corporate risk manager cannot look at managing risk simply by purchasing a series of insurance policies but must rather take a comprehensive approach, one that addresses all lines of insurance as well as business risks not traditionally covered by insurance."
Conger indicates that ERM is not a job for one person. "It now involves the entire organization and has become truly a team effort. ERM calls for the creation of a comprehensive way for a corporation to think about the risks it is facing, and to create a disciplined mechanism for managing those risks. Currently we are all in a learning process, seeking an understanding of how risk affects an entire organization. Through ERM we now have the tools for making better and more informed management decisions about the placement of insurance," he says.
The CAS should take a leadership role in the development of ERM as a modern management discipline, according its Advisory Committee on ERM, chaired by Jerry A. Miccolis, FCAS, principal with Tillinghast-Towers Perrin. In a report to the CAS Executive Council in December 2001, the committee concluded that ERM provides an opportunity to create a compelling business-relevant framework for virtually all the parts of the casualty actuarial discipline. It adds that, if they are properly integrated, these component strengths should make CAS members the prime candidates for chief risk officer positions. In addition, the actuarial knowledge base could come to be regarded as a valuable commodity in industries that go well beyond insurance and financial services, and all of these factors would aid in the recruitment of young professionals to careers as actuaries.
Agreeing with Conger on the scope and effects of 9/11, Miccolis says that in the years ahead, the insurance industry will have to consider five key elements in managing its own risks. He lists them as exposure management; extreme event risk planning; disaster response; capital management; and stakeholder communications (stakeholders that include shareholders, the general public, customers, regulators, legislators and rating agencies). "That act of terrorism," says Miccolis, "brought ERM home to the insurance industry in a dramatic and near-devastating way."
Is ERM just a passing fad? Robert F. Wolf, FCAS, principal with MMC Enterprise Risk Consulting, does not think so. He calls ERM "a process for identifying and prioritizing critical risks facing an organization, quantifying their impact and strategic objectives, and implementing financial and organizations' solutions to address them." He adds, "Two other aims of ERM are the preservation of shareholder value and figuring out where the edge of the cliff is and making sure the risk takers know where it is."
In addition, Wolf suggests: "Prudent ERM should also reflect the returns on retaining risk to guide corporate decision-making. If the edge of the cliff is closer than shareholders like, they either want to see strategies to move the cliff further away or they want to get a greater return for their investments on taking that risk. In other words, retaining risk is okay, as long as a corporation is getting rewarded for it (e.g., Return on Inherent Capital at Risk).
In looking at the evolution of ERM, Wolf cites four factors:
* the development of new and larger corporate risks, including
e-commerce, increased corporate pressures on earnings per share and market to book values, and as a result of 9/11 the risk of terrorism
* the creation of new risk products generated by mergers and acquisitions of insurance and financial institutions
* the growing realization within corporations that the silo-based approach to risk is flawed and that a corporation must take a holistic look at all the risk it faces
* and that we have entered a period of increased management accountability, spurred by the new regulations passed by Congress concerning corporate governance
Wolf concludes that ERM is a benefit to corporations but that it is coming along slowly, despite that fact that it is widely talked about and has a significant impact of shareholder value. "I think it is slow in being more readily accepted largely because of budgetary factors within a corporation," he says. "Each department--human resources, risk management, purchasing, etc.--is concerned primarily with its individual area and therefore has little incentive to look at the corporation's risks on an integrated basis. Good ERM must find a way to reward and punish all areas of business activity on an integrated basis (holistic view) and at the same time retain the entrepreneurial spirit (silo-based view). Once established and bought into, full-ERM will take off."
He stresses, "Many companies are 'ERM-lite,' but to really get into ERM and have a meaningful impact on the company, it must be a top-down decision, coming from either the chief executive officer or the chief financial officer. It can't be a bottom-up decision.
"Our recent studies show that stockholders place a significant value on stability and predictability of financial results," says Conger. "Furthermore, a stable company requires less capital for its operations. Through ERM, the actuary--together with other members and advisors of the management team--can identify and address internal and external factors that cause financial volatility; by doing so they increase the value of the company to its stockholders."
"Corporate audit committees are taking an increased interest in understanding risk and risk management," observes Conger. "In a property/casualty insurance company, for example, a best practices audit committee meets regularly with the CRO and with the board's independent actuary to receive comprehensive reports on the company's business risks--and how those risks are being addressed."
The growth of the CRO function should be an aid in the recruitment of young professionals to an actuarial career, according to Miccolis. However, the role of CRO will vary from company to company and so will the skills required. Miccolis says the person must be able to accumulate information from various sources within the company, such as legal, audit, finance, human resources, etc.; be conversant with the risks in those sectors; determine how the risks are inter-related; develop an aggregate risk profile of the organization; and be able to communicate those findings and practical risk management responses to senior management and the company's board of directors.
Respondents to a Tillinghast-Towers Perrin survey indicate that six skills are considered as most necessary: communications, managerial, accounting, finance, math/quantitative skills and risk management. Educational background for a CRO is also diverse--with half of current CROs having a bachelor's degree, 30% a master's and 20% a Ph.D.
The survey responses indicated three main reasons for the creation of a CRO/risk executive position within a company:
* the centralization and coordination of all risk management activities
* the introduction and development of an integrated risk management framework
* the improvement of risk communication to management, the board of directors and others.
When asked about the top five risks a CRO faces, respondents indicated: regulatory, property/liability, equities market, human capital and credit.
The survey concluded that the CRO concept is beginning to catch on, and while its true value is currently seen primarily in the insurance, financial services, utility and energy industries, others are starting to realize that a CRO can be a valuable addition to the senior management team. The CRO position began in the banking industry and is just a bit more than two years old in the insurance industry, says Miccolis. As its value to a corporation becomes more obvious, it will spread to more industries.
Another indication that the role of the CRO is becoming more important can be seen in the annual survey of CAS thought leaders for 2001. They were asked to select the top news articles for the past year. While it's no surprise that the September 11 terrorist attacks and the hardening of both price and terms in the insurance market ranked first and second in the opinion poll, the seventh rated story was the naming of CROs by various insurers and other corporations. This marketplace trend reflects the growing recognition of the importance of evaluating and managing holistically all dimensions of an organization's risk. Actuaries have an important role to play in understanding, evaluating, quantifying, and modeling the diverse set of risks and their interactions.
ERM will also be of significant benefit to agents and brokers, says Conger. "They will now be dealing with a more intelligent and knowledgeable buyer than before--one whose appetite for insurance products will change and who will be seeking more sophisticated insurance and risk management products for the company. The agent or broker will also become part of a management and professional team that thinks about ERM and how it can better serve the corporation.
"At the same time the agent or broker will be interacting with corporate officials who are higher up in the organization chart. The holistic approach to business risks can make the agent and broker more valuable than ever before. The challenge to agents and brokers is to meet the demands and be in a position to provide the company with a broader and more sophisticated array of products and services."
Miccolis points out that as agents and brokers evaluate the quality of the insurance companies they are dealing with, the existence of an ERM process will reflect more and more on the quality of insurance company management. In addition, they'll need to be aware of the various different corporate/client risks that the insurer is exposed to--including weather, prices of commodities, and currency fluctuations.
With the expansion of ERM into new areas and signs that the concept of the CRO is growing and being considered by more corporations outside the financial area, the role of the actuary in all phases of business will increase--and that's a good sign for the CAS. Another and most satisfying indication for the future for the CAS comes, once again, from the Jobs Rated Almanac (Sixth Edition, 2002), which rates "actuary" as the second best job in the United States, topped only by "biologist." The editors use data from 250 occupations, ranging from accountant to zoologist. Six key criteria for the basis of the rankings are environment, income, employment outlook, physical demands, security and stress. In prior editions of the Jobs Rated Almanac, actuary was number 1 in 1988 and 1995, second in 1992 and 1995 and fourth in 2000.
All this places a new face and responsibilities on the members of this nearly 90 year-old organization. It is highly unlikely that in the next 90+ years an actuary will be described as a specialist in statistical information. Rather, the public will recognize an actuary as an architect of financial security--in all phases of the American and international economy. *
The author
Samuel Schiff is a New York-based freelance writer.