Enterprise Risk Management

Software that helps integrate risk analysis

Towers Perrin product designed for risk managers also can be useful for brokers

By Michael J. Moody, MBA, ARM

It’s clear that enterprise risk management (ERM) is gaining significant traction in corporate America. At first its use was limited primarily to financial institutions; however, today many non-financial organizations are also seeing the wisdom of using a holistic approach to risk management. Unfortunately, there remain a number of impediments to the implementation of ERM programs at many corporations. One of the primary roadblocks has been a common understanding of what ERM is, as well as what activities make up ERM.

One of the early approaches to ERM was advanced several years ago by COSO. It encompassed eight interrelated components, which provided a framework for ERM. And while there continues to be significant debate regarding the exact approach to ERM, most experts agree with the basic components as outlined in the COSO framework.

The framework notes that the first component is “internal environment,” which is essentially the tone of the organization. It basically sets out how risks are viewed and addressed by the organization. Central to this component is the development of a risk management philosophy and risk appetite. This dovetails with the second ERM component of the COSO framework, “objective setting” which must be in place before management can properly identify potential events affecting the organization. ERM ensures an organization that there is a process in place that aligns the corporate mission with its risk appetite.

Heretofore, it’s the determination of this enterprise-wide “risk appetite” that has created implementation problems, because in order to work properly, the risk appetite must be a high-level view of how much risk the organization’s management and board are willing to accept. Closely related and equally difficult to quantify on an enterprise basis is “risk tolerance,” or the acceptable level of variation around the objectives that are aligned with risk appetite. While organizations can determine these figures for a given exposure or line of insurance coverage, it becomes much more difficult on an industry-wide basis. Frankly, this enterprise view of risk appetite/risk tolerance has been a major impediment for many companies.

Technology advancement

Towers Perrin recently introduced new software that can assist an organization in determining its risk appetite and documenting its process for dealing with risk throughout the enterprise. According to Towers Perrin, the new software, called “Risk Diagnostics” (RD), is designed to achieve the following:

Now, if you are thinking that there are several current software products in the marketplace that can perform those tasks, you would be correct. So what’s the big deal with Towers Perrin’s product?

The major competitive advantage of RD is that it evaluates risk on an integrated basis. As a result, the RD dashboard can provide critical risk data in a timely fashion so as to help make better budgeting and forecasting decisions based on the combined risk for the entire organization.

The nitty gritty

The RD product makes it easy and cost effective to examine multiple risk factors by running state-of-the-art simulations that determine the optimal line between self-insuring and transferring risk to a third party. Fundamental to the flexibility of the new product is that it allows the user to decide what aspects and variables are to be included in the model.

Further, these variables can be modified at any time to better reflect changes in the risk environment. This ability to handle variables at a granular level allows the program to be applied easily to specific risk categories and lines of business, while allowing data to be pooled into a true enterprise-wide evaluation. It’s this consolidated aspect that has eluded many who wish to advance ERM within their organizations.

However, the software is much more than just an aggregator of risk data. Organizations can use RD to establish value-at-risk calculations, prioritize mitigation and transfer activities and evaluate the effectiveness of existing insurance programs. The program also can be used for a detailed comparison of various risk transfer alternatives, such as captives, self-insurance and high-deductible programs. It can also analyze the effectiveness of more advanced risk transfer methods such as finite risk programs and derivatives. The software delivers the tools than can help organizations better understand the unique risk variables in each part of the enterprise and then more confidently determine a better risk management strategy for the entire organization.

The software was designed to facilitate collaboration among numerous members of the ERM team. These would include critical members such as the risk manager, treasurer, CFO, auditors, as well as external resources like outside advisors or consultants, brokers and even prospective insurers. While the program performs extremely complex calculations, the software’s “plug-and-play” adaptability and graphical interface were created with non-actuarial users in mind. This feature should make risk management strategy discussions more productive at all levels.

Another feature intended to make usage of the program as easy as possible is that it is designed as an add-on to Microsoft Excel. This allows the program to be a desktop application, and thus requires minimal IT assistance.

Another use

Although Risk Diagnostics is designed to be used primarily by corporate risk managers, it can also prove useful for mid-sized agents and brokers. Today, many corporations are looking to their agents and brokers to provide more value-added services, and some of the middle market accounts are transferring more responsibility to their brokers. While some of the larger, international brokers can assist their clients in implementing an ERM program, few have the capabilities that can be provided by Towers Perrin’s new risk management product.

By offering their clients the service that can be obtained by the RD software, mid-sized agents and brokers can greatly add to the competitive advantages they are able to bring to the table. As time goes on, ERM will be the standard for risk management in all industries, and brokers who can assist customers in establishing holistic risk management programs should gain a significant competitive advantage.

There is little doubt that ERM will become the “best in class” approach to risk management in the near future now that the rating agencies have put their weight behind the concept. And while the rating agencies are currently confining their ERM analysis to financial organizations, particularly insurance companies, all of the rating firms have signaled that they will be applying ERM criteria to all industries soon. Towers Perrin’s introduction of their Risk Diagnostics should greatly increase the ability of organizations to establish, with a high degree of certainty what their risk appetite should be. Once this figure has been determined, full implementation of an ERM program should be accelerated.

This is good news for the risk management community, and for mid-sized agents and brokers as well. *