Post on 08-May-2018
Copyright © 2000 Enterprise Risk Solutions
N960-01-019
February 2, 2000
Enterprise Risk Management
James C. LamPresident, Enterprise Risk Solutions
Copyright © 2000 eRisks.com 1N960-01-019
Oliver, Wyman & Company is a leadingfinancial services consulting firm
• Founded in 1984
• Strategy consulting firm with a dedicated risk practice
• Rated #1 consulting firm in “Risk and FinancialManagement” in latest NYU independent survey
• 200 professionals, including 35 Directors
• Headquartered in New York, with office in London,Frankfurt, Toronto, Madrid, Paris, Singapore
Copyright © 2000 eRisks.com 2N960-01-019
Enterprise Risk Solutions
• ManagementConsulting
• TransactionAdvisory
• Risk Portal
• Vertical ASP
• B2B Exchange
Copyright © 2000 eRisks.com 3N960-01-019
Discussion outline
• Lessons learned from the headlines
• Establishing an overall risk management framework
• Key challenges facing management
• The role of a chief risk officer
Copyright © 2000 eRisks.com 4N960-01-019
Wheel of Misfortune
BANKS
ASSET MGMT
INSUR-ANCE
ENERGY COs
CORPs
LTCM
MorganGrenfell
ConfedLife
Lloyd’s
MG
PCA
Phar-Mor
Bausch& Lomb
CendantKidder
BankersTrust
Barings
Questionabletrades
Rescuefund
required
Tradinglosses
Lawsuits$350MM
$300MM
$42MM
$350MM
$236MM
$1BN
£3.2BN
$1.3BN
$3.5BN
$1BN
$737MM
False profitsAccounting
fraud
Misreportedrevenue
Charge-off
Claims
Tradinglosses
SettlementReal EstateLosses
$300MM
Copyright © 2000 eRisks.com 5N960-01-019
Lesson #1 Know Your Business
Lesson #2 Establish Checks and Balances
Lesson #3 Set Limits and Boundaries
Lesson #4 Keep Your Eye on the Cash
Lesson #5 Use the Right Yardstick
Lesson #6 Pay for the Performance You Want
Lesson #7 Balance the Yin and the Yang
Key lessons learned
Copyright © 2000 eRisks.com 6N960-01-019
Yin and yang of risk management
• Risk Oversight Committees
• Policies & Procedures
• Risk Assessments
• Measures and Reporting
• Risk Limits
• Audit Processes
• Systems
Hard side (yang)
• Risk Awareness
• People
• Skills
• Integrity
• Incentives
• Culture and Values
• Trust and Communication
Soft side (yin)
Copyright © 2000 eRisks.com 7N960-01-019
Redesign reengineering
Process
FOCUS
ReengineeringThe
Corporation
ReengineeringThe
Corporation
FOCUS
Process People
ReengineeringThe
Corporation ReengineeringManagement
Copyright © 2000 eRisks.com 8N960-01-019
Discussion outline
• Lessons learned from the headlines
• Establishing an overall risk management framework
• Key challenges facing management
• The role of a chief risk officer
Copyright © 2000 eRisks.com 9N960-01-019
ListApples
Butter
Carrots
Eggs
Grapes
Hair Brush
Milk
Oranges
Potatoes
Shampoo
Shaving Cream
Sour Cream
Going Shopping
Going Shopping
Shopping list
Copyright © 2000 eRisks.com 10N960-01-019
Structured shopping list
Going Shopping
Going Shopping
DairyProducts
Fruits
Vegetables
Toiletries
• Butter• Eggs• Milk• Sour Cream
• Hair Brush• Shampoo• Shaving Cream
• Apples• Grapes• Oranges
• Carrots• Potatoes
Copyright © 2000 eRisks.com 11N960-01-019
ERM Framework
2. Line ManagementBusiness strategy
alignment
3. PortfolioManagement
Think and act like a“fund manager”
4. Risk TransferTransfer out
concentrated orinefficient risks
5. Risk AnalyticsDevelop advanced
analytical tools
6. Data and TechnologyResources
Integrate data andsystem capabilities
7. Stakeholders ManagementImprove risk transparency for key stakeholders
1. Corporate GovernanceEstablish top-down risk management
Copyright © 2000 eRisks.com 12N960-01-019
Key questions
R is for ReturnAre we achieving an appropriate return for
the risks we take?
I is for ImmunizationDo we have the
controls in place tominimize risk
losses?
K is for KnowledgeDo we have the rightpeople, skills, culture
and values foreffective risk
management?
S is for SystemsDo we have the
systems to measureand manage risk?
Copyright © 2000 eRisks.com 13N960-01-019
Risk-adjusted pricing
RequiredNet
Income
Capitalat
Risk
Costof
Capital= X
Required + Tax + Expense + Risk = Required Net Losses Net Income Revenue
Copyright © 2000 eRisks.com 14N960-01-019
Calculate ROE
Volume $100 mm
Margin 2.50%
Revenue $2.5 mm
Risk Losses <0.5 mm>
Expense <1.0 mm>
Pre-Tax Net Income $1.0 mm
Tax <0.4 mm>
Net Income $0.6 mm
Economic Capital $2.0 mm
Risk-Adjusted ROE 30%
Calculate Pricing
$100 mm
2.20%
$2.2 mm
<0.5 mm>
<1.0 mm>
0.7 mm
<0.3 mm>
$0.4 mm
$2.0 mm
20%
Risk-adjusted pricing (cont’d)
Copyright © 2000 eRisks.com 15N960-01-019
Risk/return analysis
Organizational Unit
Credit Risk
Market Risk
Operational Risk Other Total
Business Unit A
Business Unit B
Business Unit N
TOTAL
EconomicCapital
ROE
$ $ $
$ $ $ $ $
% % % %
%%%%%
$
•••
Copyright © 2000 eRisks.com 16N960-01-019
Uncertainty drives risk
Risk Expected Best
Market 0% or Bid/Ask Price%
Credit Average Loss% 0 Loss%
Operational Average Error% 0 Error%
Worst
Price%
Unexpected Loss%
Unexpected Error%
SET LIMITS
ProbabilityDistribution
Worst Expected Best
Copyright © 2000 eRisks.com 17N960-01-019
Effectiveness of statistical approaches
Overall Effectiveness
MarketRisk
CreditRisk
OperationalRisk
Exposure
Volatility
Timing
Correlation
Drivers OfUnexpected
LossMarket Credit
Operat-ional
Measurement Quality
Copyright © 2000 eRisks.com 18N960-01-019
Risk Incidents
Reporting of riskincidents, exposures,
and near misses
1.__________________________________________________________________________________________
2.
3.
4.
Managementdiscussion of majorrisk issues (“what
keeps me up atnight”)
Gross Losses Current YTD
Operational Losses
Credit Losses
Market Losses
Other Losses
Sub-Total:
Loss/Revenue Ratio:
ManagementAssessment
Accounting foractual losses
incurred
1993 1994 1995 1996
Losses
1992 Q1 97
Incident Exposure Response
1.
2.
3.
4.
Monthly risk report
Copyright © 2000 eRisks.com 19N960-01-019
Core Risk Measures
Period
VAR Analysis
VARLimit
Value-at-Risk
Mark-to-Market P&L
Period
LossLimit
+
-
Period
Trading ErrorsLimit
Key Risk Trends
Improving Trends
Period
Other Trouble Indicators
Period
Operational Performance
Period
Goal
MAP
Monthly risk report (cont’d)
Copyright © 2000 eRisks.com 20N960-01-019
Discussion outline
• Lessons learned from the headlines
• Establishing an overall risk management framework
• Key challenges facing management
• The role of a chief risk officer
Copyright © 2000 eRisks.com 21N960-01-019
Credit
Market
1980s
FinancialRisk Management
Credit
Market
Operations
Business
Organizational
1990s
EnterpriseRisk Management
Evolution of industry practices
Credit
1970s
CreditRisk Management
Copyright © 2000 eRisks.com 22N960-01-019
Trend #1 Control functions integration
Trend #2 Risk products integration
Trend #3 Business integration
Trend #4 Internet revolution
ERM trends
Copyright © 2000 eRisks.com 23N960-01-019
RiskManagement
Audit
Legal/Compliance
Finance/Insurance
Security
Integrated Risk Assessment
Integrated Risk Strategies
Global RiskManagement Committee
Integrated Risk Reporting
• Audit
• Risk•
Executive Summary• • •
….
Control functions integration
Copyright © 2000 eRisks.com 24N960-01-019
Swaps,OptionsFutures
ExchangeProducts
Securitization
Financial Products Insurance Products
Errors andOmissions
PropertyLoss
WorkersCompensation
LegalLiability
Risk products integration
Target Risk Profile
Risk Profile Optimization
Low HighRisk
Current Risk Profile
Low
Return
High
Self Insurance[Net Premium]
– Losses
+ Gains
Financial EngineeringInsurance [Options]
Policy Limit[OTM Strike]
Deductible[Strike]
+ Gains
Copyright © 2000 eRisks.com 25N960-01-019
Risk/Return Analysis
Executive Committee
• Product/relationship management
• New product/business development
• Business strategy and planning
• Mergers and acquisitions
• Compensation strategy
• Resources allocation
Business integration
Organizational Unit
Credit Risk
Market Risk
Operational Risk
Other Total
Business Unit A
Business Unit B
Business Unit N
TOTAL
EconomicCapital
ROE
$ $ $
$ $ $ $ $
% % % %
%%%%%
$
•••
Copyright © 2000 eRisks.com 26N960-01-019
Net impact on risk management
Internet/Intranet
Develop aCommunity
EstablishCommonStandards
ImproveAnalytics
IntroduceB2B
Exchanges
EnhanceEducation
Copyright © 2000 eRisks.com 27N960-01-019
Discussion outline
• Lessons learned from the headlines
• Establishing an overall risk management framework
• Key challenges facing management
• The role of a chief risk officer
Copyright © 2000 eRisks.com 28N960-01-019
DecentralizedRisk Monitoring
and RiskManagement
Centralized RiskMonitoring;
Decentralized RiskManagement
Centralized RiskMonitoring and
Risk Management
Corp.
BU BU
P C D P C D
BU BU
P C D P C D
Corp.
Organizational approaches
• Policies• Limits• Measures/Reporting• Exceptions• Escalation
Corp.
BU BU
P C D P C D
MIS
MIS
MIS
MIS MIS MIS MIS MIS MIS
MIS :
Copyright © 2000 eRisks.com 29N960-01-019
Role of a CRO
• Evangelist !!!! Motivate
• Leader !!!! Change
• Steward !!!! Control
• Consultant !!!! Help
• Technician !!!! Teach
Must have!
Nice to have
Copyright © 2000 eRisks.com 30N960-01-019
Case study : Heller Financial
• $15 billioncommercialfinance company
• IPO onMay 1, 1998
• “Best in class”vision
Background 3-Month ERM Project
• Conducted Risk Survey
• Reclassified credit losses
• Developed ERM framework
• Implemented operational riskmethodology
• Integrated risk functions undernew CRO
Copyright © 2000 eRisks.com 31N960-01-019
Case study : Fidelity Investments
• $1 trillion of assetsundermanagement
• Private company
• Decentralizedbusiness culture
Background 3-Year ERM Project• Organized Global Risk Forum
• Implemented annual Global RiskReview
• Automated loss accounting
• Developed ERM framework
• Implemented intranet-basedGlobal Risk MIS
• Conducted multiple consultingprojects
• Experienced significantreduction in loss ratio
Copyright © 2000 eRisks.com 32N960-01-019
Business case for ERM
• History demonstrates the pitfalls of disconnected riskmanagement
• Risk interdependencies require integrated risk approach
• Trends in globalization, financial products, and technologyadvances
• Service providers are offering integrated risk managementsolutions
• Financial institutions and corporations are integrating riskpractices
Bottom Line : ERM can improve management effectiveness,reduce losses, and increase shareholder value
Copyright © 2000 eRisks.com 33N960-01-019
Thank you
James Lamjlam@erisks.com
212-541-8100