Upfront: Rating Agencies Push for ERM

Rating-agency scrutiny has begun to influence the way companies develop their enterprise risk management (ERM) program. The Tillinghast business of Towers Perrin polled CFOs at North American life insurance companies. Not only are many of these organizations designing their ERM frameworks with agency oversight in mind (60 percent of respondents), but some are moving agency requirements to the top of their list of ERM objectives (27 percent).

"All major rating agencies have stepped up efforts to incorporate ERM into their overall assessment of companies' financial strength," says Prakash Shimpi, Tillinghast's practice leader with global responsibility for ERM in New York City. "This trend is likely to increase as rating agencies refine their demands for insurance companies and raise expectations for how companies manage risk."

Seventy-five percent of survey participants say that one objective for developing their ERM program is to improve risk decisions. They're also under the gun to use capital more effectively; nearly 60 percent of these CFOs use economic capital as an ERM metric today, and two years from now, that figure may be as high as 85 percent. Typically, respondents who calculate economic capital apply it to evaluating capital requirements (76 percent), pricing and designing products (69 percent) and managing catastrophic risk (64 percent). Although fewer than half of companies that currently calculate economic capital use it to make strategic or tactical decisions and to inform rating-agency discussions, that percentage is expected to rise to 94 percent for both uses by 2008.

"We expect life insurance companies to broaden their use of economic capital as regulators and rating agencies around the world begin to implement principles-based approaches to capital adequacy," says Hubert Mueller, Tillinghast principal and CFO survey leader in Hartford, Conn. "While multi-nationals and larger domestic companies have generally taken the lead in implementing [the] economic capital [measure for ERM] worldwide, midsize and smaller insurance companies are now increasingly facing peer pressure as well as increased scrutiny from regulators and rating agencies."

Mueller adds that companies that can prove they have sound, well-defined internal models for capital adequacy are starting to receive credit for these models in the form of reduced regulatory and rating-agency capital requirements.