New study looks at “best practices” for insurer risk management

Insurers are increasingly focused on their own risk management practices in response to market turmoil as well as incoming regulatory changes. In a new study, Ernst & Young looks at best practices for insurers to evaluate, control and account for their risk exposures.E&Y postulates insurers need to look at building a “risk-adjusted performance measurement” (RAPM) framework. This involves consideration of major risks including insurance, asset and liability mismatch, credit, operational and business risks. Leading-edge frameworks are evaluated on a “market-consistent” basis, the report notes, which means using the market prices of assets and a proxy for liabilities such as fair value or economic value. Risk capital is calculated as total net assets needed to pay liabilities over time, added to which is “stranded capital”, or the extra capital which may be required by regulators.Such risk assessment also gives the impetus for changing products, customer selection, capital deployment and investments.A major theme is the impact of operational risks, with the ability to assess their impact on the necessary risk capital providing the potential to reduce capital requirements under upcoming solvency regulations.These new regulations include International Accounting Standards (applying to European and Australian insurers in 2005), European Union Solvency II and even Sarbanes-Oxley. Risk assessment is also being turned to the issue of increasing specialization in the insurance industry. “Specialization enables higher concentration on customer needs, lower costs, and more efficient control and risk management,” the report notes. “The major question, though, is whether the benefits offset the risks associated with specialization: irrational competition, product obsolescence, regulatory pressures, and market saturation.