By B.G. YOVOVICH, a business writer who lives in Chicago
Look for enterprise risk management to get a lot more C-suite attention this fall.
The big boost to top-management interest in ERM is driven by a powerful bottom-line reality: New ERM evaluations by ratings agencies are poised to have an impact on companies' credit scores, and thereby, on companies' cost-of-capital--a key management concern.
More specifically, Standard & Poor's announced in May that it will expand its use of ERM as a factor for all nonfinancial businesses whose creditworthiness it evaluates.
Previously, S&P's use of ERM criteria had been limited to insurance companies and other financial services firms.
In connection with its ERM rollout, S&P announced that:
--In the third quarter of 2008, it will begin to incorporate ERM into its discussions with management at all companies that it rates.
--In the fourth quarter, it will add ERM commentary in its reports.
--During 2009, it will implement formal ERM scoring of companies that will be used to determine company credit ratings.
For top management at nonfinancial firms, the new set of ERM discussions with credit analysts will underscore that their ERM programs now can have a very clear, bottom-line impact.
And, for insurance companies and other financial firms, the increasingly detailed and extensive ERM discussions also are likely to prompt additional attention from top management.
As the legions of corporate credit analysts fan out to begin to engage companies in new ERM conversations, here's a set of quick introductions to the executives who are leading these efforts at the ratings agencies and who will be guiding and monitoring the ERM discussions.
THE CHANGE AGENT
At S&P, managing director of corporate ratings Steven J. Dreyer jokes, "Since I started here at S&P in 1990, I have been known as someone who will do the crazy stuff and risk getting canned--and for 18 years I have been able to avoid losing my job."
Although he now oversees S&P's ERM initiatives, Dreyer's involvement in groundbreaking efforts at the firm began nearly 20 years ago when he was hired to help develop a new service that would significantly branch out from S&P's traditional ratings of insurance companies.
Until that time, credit ratings that were available for insurance companies were based on information that was gathered from detailed and in-depth discussions with the firms that were being evaluated.
With the new "Qualified Solvency Ratings" service that Dreyer helped to develop, S&P branched out to address a much broader swath of insurance companies and to provide measures of creditworthiness that were based entirely on publicly available information--and without the companies' consent or cooperation.
"Back in 1991, that was a pretty revolutionary idea," recalls Dreyer.
These days, Dreyer is in the forefront of another new S&P initiative: The effort to begin to weave ERM considerations into the evaluation of a company's creditworthiness.
The methodology used by S&P bases its ERM evaluation on how the company rates in specific facets of risk management: risk management culture, risk controls, emerging risk management, risk and economic capital models, and strategic risk management.
According to Dreyer, the push for the ERM criteria has come from the companies that S&P has been rating.
"A growing number of companies have been telling us that they were structuring their businesses in ways that can create less risk than another company that does not structure its business," says Dreyer.
"A company would say, for example, 'Look at how these mortgage assets are connected to the liabilities on the other side of our balance sheet, and, if one goes up, the other goes up accordingly ... you can't have them both move in the wrong direction.' The companies wanted to have that reflected in ways that could help their credit ratings," he says.
AT THE NEXUS
A Wharton graduate, Mark Puccia did an early tour of duty as a senior management analyst with Connecticut General (now Cigna), then spent several years at Chase Manhattan as a lending officer. Then a recruiter called him about a position at S&P.
"I had been in a planning position in the insurance industry at Connecticut General, and I had picked up credit skills at Chase's insurance group," says Puccia. "This was an opportunity to work at the intersection of those, which I found intriguing."
Twenty-three years later, Puccia is S&P's chief criteria officer of insurance ratings worldwide and is responsible for establishing insurance rating criteria and overseeing ratings quality for property/casualty insurance, reinsurance, life/health insurance and various international insurance company ratings.
In that role, Puccia was at the nexus of S&P's decision to introduce ERM considerations into its credit ratings in the insurance industry.
"In 2004, under my initiative, we made the call that we really wanted to invest a lot more resources and effort into developing an ERM capability at S&P," says Puccia.
Two key factors contributed to that decision in 2004.
"I am always looking for ways to improve ratings, and one of the real attractions of ERM was that we recognized that it had the potential to be a much more prospective element of our analysis," says Puccia. "We have been talking for a decade about ERM and its predecessors."
The timing of the decision in 2004 stemmed from evidence that "the industry was starting to put in place mechanisms to talk about and act on ERM," says Puccia.
One clear sign was that Puccia could see the ratio of practitioners to consultants at ERM conferences was going up.
The opportunity to address issues at the intersection of risk, credit and strategy continues to appeal to Puccia.
"The reason this job is so attractive is that I am talking to the brightest and most powerful people in the industry, and I am in a position to compare and contrast the strategies of leaders in our industry," says Puccia. "That's what makes the job fun."
THE ENTHUSIASTIC PIONEER
At A.M. Best, Edward Easop is energized by the opportunity to work at the leading edge of a rapidly evolving discipline.
"What I love about my job is that it's so dynamic," says Easop, who is A.M. Best's vice president, ratings criteria and ratings relations. "Everyone is trying to figure out things that no one has tackled before. I can come in on any day, and my to-do list can be completely different based on what is going on in the industry."
Easop also encounters this energy and excitement when he goes out on the speaking circuit.
"It is incredibly gratifying to speak about capital models and ERM at conferences," says Easop.
"The Q&A discussions are fantastic, with a lot of very interesting questions, and the conversations after the sessions are very insightful," he says.
"Insurance companies are trying to look at risk in a completely different way, and there are dozens of different issues that companies are trying to address for the first time. The input we get from companies helps our methodology keep evolving, and the information that my group downloads to our analysts is changing almost every day," he adds.
Prior to joining A.M. Best, Easop spent more than 10 years in various roles at Prudential, and he also did an early stint with the Peat Marwick accounting and consulting firm, which "gave me a pretty good appreciation of the roles of things like internal controls and strategic management."
Easop says that this previous experience has helped him appreciate that ERM is not just about financial reporting and internal control.
"You also are looking to set up a business strategy that protects against the downside, at the same time that it also takes advantage of opportunities in the market," he says.
He also sees timeliness as a key ERM factor.
"Some companies have sophisticated risk management models that they run once a year, but that do not really fit with their daily decision-making," says Easop. "The companies that are successful are the ones that can recognize the trends early and make the adjustments."
ANALYST TO ERM EXPERT
The path to ERM has been an evolutionary process for Matt Mosher, who joined A.M. Best in 1995.
"I started as the actuary for the property/casualty department, and it was the first time that they had an actuary in over 10 years," says Mosher, who now is the group vice president of global Property/Casualty ratings.
"They had brought me in for specific actuarial skills having to do with reserving and capital models, but they did not allow me to just be the actuary. They said, 'We also want you to analyze companies so that you get a better perspective of what an analyst goes through.' "
As time passed, "I got drawn more into ratings and when I was given responsibility for property/casualty ratings in 2001, I got more involved in overall criteria issues," he says.
This involvement with ratings criteria has led to Mosher's role in helping shape the new set of ERM tools for A.M. Best, where the approach has been to include ERM considerations as part of its ratings process, though not as a separate ratings factor.
In addition, A.M. Best has aimed to develop an approach to evaluating ERM that is appropriate for small and midsize companies, as well as to large enterprises.
The overarching objective of using ERM considerations, says Mosher, is to take "another step--and important step--in the evolution of the overall analysis" of credit-worthiness. ERM provides tools that helps an analyst "to get behind the numbers and to learn more about why a company might be doing very well, versus not very well."
"ERM is that missing piece that helps you understand if a company's results are just very lucky, or if they are good in that they are managing risks and have a good understanding of the volatility of the results," says Mosher.
"That is what draws me in, and why ERM is so important."
Given the relatively short history of ERM, the decade-long involvement of Fitch Rating's Jeff Mohrenweiser with the discipline ranks him as a seasoned, long-time veteran.
An actuary by training, Mohrenweiser had worked on asset liability issues in the life insurance arena for 15 years before he moved to the Mercer subsidiary of Marsh & McLennan Cos. in 1999 to head its effort to develop an ERM practice.
However, even though companies expressed interest in ERM in the late 1990s, it turned out that Mercer launched its initiative just a bit too early to get traction, and Mohrenweiser eventually returned to working in the insurance sector.
When ERM activity kicked into a higher gear in 2004, "I was hired to build Fitch's economic capital model and spearhead our ERM," says Mohrenweiser, who is senior director and global Prism project manager at Fitch.
Fitch's Prism proprietary capital model was unveiled in mid-2006, and Fitch now significantly relies on it to assess insurers' capital adequacy and creditworthiness, but the agency says that it also looks for companies to establish an ERM framework that makes use of the information generated by the capital model.
During the four years that Mohrenweiser has been involved with Fitch's ERM efforts in the insurance sector, he has witnessed striking changes in industry practices.
"One of the advantages of working with a ratings agency is that you get to sit down with many of the senior leaders of insurance companies," says Mohrenweiser. "Not long ago, the finance guys would come in and talk to the ratings agency, then the marketing guys would come in, and then the actuaries would come in. It was very silo-oriented."
"More recently, we are seeing a maturation of senior management perspectives on ERM," says Mohrenweiser. "It is not the case at all companies, but we definitely have begun to see them singing from the same hymnal, and, increasingly, they are all are sitting around at the table and speaking the same language."
And, although Fitch has not yet formally applied the Prism model and ERM criteria outside of the insurance sector, Mohrenweiser says, "We have had discussions about applying it to banking and other financial institutions, as well as to utilities and other regulated entities."
September 15, 2008
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