Why Does the Upside of Risk Management Matter for Insurers' S&P Ratings?

No. 55 , February 2015 Why Does the Upside of Risk Management Matter f or Insurers’ S&P Ratings? By Miroslav Petkov+ Standard & Poor's Ratings Services considers that the role of enterprise risk management (ERM) is not only about having a framework and process to assess and control the downside of insurers' risk exposure ; ERM is also about using the insights drawn from risk analyses to understand the upside of taking risks and managing exposure toward s the best -rewarded risks within risk appetite constraints and available financial resources. We consider this to be an important part of effective management for insurers and we incorporate it into our rating analysis. Insurers with the most effective processes to optim ise risk return should, over time, deliver higher risk -adjusted returns. The ability to outperform peers is a favourable factor in our rating analysis. How S&P analyses the upside of risk management Strategic risk management (SRM) forms a part of our ERM assessment, which is one of the factors determining ratings on insurers. While other aspects of our ERM analysis mainly focus on limiting the downside, SRM is also about the upside of risk management. It covers in surer's capabilities to optimise risk-adjusted returns and to priorit ise strategic options consistently. The analysis focuses on the risk/reward rationale underlying the insurer's chosen strategy. It incorporates evidence of where the insurer has made stra tegic decisions using economic risk/reward metrics that are consistent with its risk appetite , and considers how an insurer balances other concerns, including regulatory and accounting considerations. We assess SRM as positive, neutral or negative for all rated insurers. A positive SRM assessment is required (in addition to positive assessments in other key ERM factors) for a stron g or very strong ERM assessment—these are the highest ERM assessments under our ratings criteria. The SRM assessment is positiv e if the insurer executes consistent and effective risk /reward analysis in most of our key areas of analysis, including the company's strategic planning ; product pricing and repricing ; strategic asset allocation ; reinsurance strategy and net retained risk profile ; new risk -bearing initiatives (including mergers and acquisitions or entry into new markets) ; capital, or economic capital budgeting ; and optim isation of risk -adjusted returns. The score is positive only if an insurer demonstrates a history of succ essful execution of its strategic risk management program me, including, for example, better- than-peer risk -adjusted returns and a track record of successful mergers and acquisitions that is consistently accretive on a risk- adjusted basis. We assess SRM as a neutral factor when an insurer uses some risk/reward analysis in decision -making, but applies the metrics and processes inconsistently across the company. The score could also be neutral if an insurer has developed an economic capital model and uses mod el results in the strategic risk management process, but the economic capital model has limited history or credibility. + Miroslav Petkov is a Director in Standard & Poor’s Insurance Ratings Group , based in London; he is head of the Europe, the Middle East and Africa Enterpri se Risk Management (EMEA ERM) team.