Enterprise risk management (ERM)
Enterprise risk management (ERM) continues to be a hot management topic
for many industries. However, the early implementers remain primarily in the
financial services industry. The main reason for this is that financial risks
more naturally lend themselves to the quantification that is a central part of
the ERM process. As a result, banks and now insurance companies are
farther along in implementing ERM than most other sectors.
However, most insurance executives are now concerned about their ERM
programs. What are these programs doing to actually change the way
decisions are being made throughout the organization? These concerns have
recently been underscored by the attention that ratings agencies are giving
to ERM efforts.
S&P now has a separate rating just for ERM. A large part of S&P’s ERM focus
is going to be on the extent to which insurers have successfully embedded
ERM into their business decision-making process. Other rating agencies are
likely to follow suit.
One of the reasons that insurers are not quite there yet, is that most ERM
approaches lack the quantitative rigor and metrics to support decision-
making. Most banks and insurance companies have a capital-centric focus
when it comes to ERM metrics. While this can be very useful, it cannot fully
support decision-making. To connect ERM to decision-making, companies
need to go one step further. That next step is value-based ERM.
Value-based ERM is a concept that has been around for a while. The
approach is designed to solve one of the key shortcomings of ERM, i.e. the
lack of connection between enterprise risk management and value-based
management. This approach makes the quantification of value central to all
aspects of the ERM process. This enables companies to easily integrate ERM
into their business decision-making processes—from strategic planning to
tactical decision-making to pricing.”
Using a value-based approach allows companies to express risk in terms of
the current and potential impact on the value of the enterprise. This is the
alignment with decision-making. It takes the ERM approach and simplifies it
in terms of a key metric—value. Now you’ve got something that everyone in
the company understands and that everyone must care about—enterprise
The value-based ERM approach
Identification of key risks—The company must pre-qualify those risks critical
to the enterprise.
Develop risk scenarios—Due to the nature of the risks, this is done separately
for financial risks and operational risks.