President, Enterprise Risk Solutions - Université Laval · Enterprise Risk Solutions •...

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


Enterprise Risk Solutions

• ManagementConsulting

• TransactionAdvisory

• Risk Portal

• Vertical ASP

• B2B Exchange


Discussion outline

• Lessons learned from the headlines

• Establishing an overall risk management framework

• Key challenges facing management

• The role of a chief risk officer


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


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


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)


Redesign reengineering

Process

FOCUS

ReengineeringThe

Corporation

ReengineeringThe

Corporation

FOCUS

Process People

ReengineeringThe

Corporation ReengineeringManagement


Discussion outline






ListApples

Butter

Carrots

Eggs

Grapes

Hair Brush

Milk

Oranges

Potatoes

Shampoo

Shaving Cream

Sour Cream

Going Shopping

Going Shopping

Shopping list


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


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


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?


Risk-adjusted pricing

RequiredNet

Income

Capitalat

Risk

Costof

Capital= X

Required + Tax + Expense + Risk = Required Net Losses Net Income Revenue


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)


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

$ $ $

$ $ $ $ $

% % % %

%%%%%

$

•••


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


Effectiveness of statistical approaches

Overall Effectiveness

MarketRisk

CreditRisk

OperationalRisk

Exposure

Volatility

Timing

Correlation

Drivers OfUnexpected

LossMarket Credit

Operat-ional

Measurement Quality


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


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)


Discussion outline






Credit

Market

1980s

FinancialRisk Management

Credit

Market

Operations

Business

Organizational

1990s

EnterpriseRisk Management

Evolution of industry practices

Credit

1970s

CreditRisk Management


Trend #1 Control functions integration

Trend #2 Risk products integration

Trend #3 Business integration

Trend #4 Internet revolution

ERM trends


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


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


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

$ $ $

$ $ $ $ $

% % % %

%%%%%

$

•••


Net impact on risk management

Internet/Intranet

Develop aCommunity

EstablishCommonStandards

ImproveAnalytics

IntroduceB2B

Exchanges

EnhanceEducation


Discussion outline






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 :


Role of a CRO

• Evangelist !!!! Motivate

• Leader !!!! Change

• Steward !!!! Control

• Consultant !!!! Help

• Technician !!!! Teach

Must have!

Nice to have


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


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


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


Thank you

James [email protected]

212-541-8100

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