Challenging times for CROs

Risk is the business of insurance companies, but risk management in the sector is not nearly as developed as it is in the banking industry. Now, a new crop of chief risk officers will be trying to change all that. Rob Dwyer speaks to three CROs about the challenges they face

The challenges facing the insurance industry at the moment are substantial – a hardening market, reduced capacity, loss of regulatory capital, and new attention from international regulators – might make the job of chief risk officer (CRO) seem to be a rather high-stress role. It is.

And recent events, such as the collapse of US-based energy trading firm Enron, have highlighted the need for firms to have a much more integrated view of risk across their organisations. “Enron was a wake-up call in terms of what could go wrong,” says Wayne Fisher, executive vice-president and chief risk officer of Zurich North America. “Fortunately we had very little Enron exposure, but it showed what could have happened.” For example, an insurance company could have had exposure to surety bonds, a captive with credit risk, and directors and officers (D&O) policies, among other things.

Putting an integrated view in place will take a lot of time, money, technology, and data – commodities that the insurance companies do not have nearly enough of at the moment. Fisher explains that most insurance companies view their different business lines as ‘silos’, and don’t have a risk information platform across those businesses. “Previously, we had a silo-orientated approach to risk management which was addressed by hiring experienced people, giving them a short list of things they couldn’t do, then relying on their judgment,” he says. But as the risks being underwritten began to have greater correlation across insurance policies, as well as investments being bought by the company, the department-by-department approach became antiquated.

Creating an integrated approach is not just a question of ordering up some fancy new technology – a more strategic approach is needed to solve this problem. “We created the CRO function to develop a fully integrated risk management system,” says Fisher. The same is true at reinsurer Swiss Re, according to Bruno Porro, CRO and head of its reinsurance and risk division, and member of the company’s executive board committee. “I am in charge of combining all risk exposures to Swiss Re, then assessing where we might be overexposed in a single name, or class of business,”

Porro says. Identification and analysis of correlated risk is the priority. “This can only be done at an aggregated level by a CRO because independent business units only see their own part of the business.”

Scott Belden, managing director of risk and reinsurance for Hartford, Connecticut-based Travelers Property Casualty, says his responsibility for overall risk assessment and risk monitoring functions evolved from his position as chief reinsurance officer. For Belden, the two roles are very similar in nature – both require a company-wide assessment of risk. As head of reinsurance decisions, Belden was required to buy reinsurance when Travelers became overexposed to one category of risk. “I think the CRO role in a P&C [property and casualty insurer] is more important than it is for a bank, and certainly more important for, say, a manufacturing company,” says Belden. “Our underwriters view themselves as risk managers because they are making a risk-reward bet with each piece of business they write. The CRO provides analysis at the portfolio level – we set strategy in conjunction with the business heads of each individual line.”

Evolving role
The trend of appointing CROs at insurers and reinsurers is relatively new. As with the development of CROs in other industries, there is no established career path for a CRO candidate. At the moment, an actuarial background seems to dominate – Fisher and Belden have actuarial backgrounds, for example. “I think an actuarial background is essential,” says Fisher. “You also have to have an underwriting background and a solid financial background – those three are complementary and all-important.” Fisher also says the CRO has to incorporate these three areas of experience into a positive business attitude. “Within the company, a CRO must be seen as a problem solver, not somebody who says ‘you can’t do that’. You have to be an enabler.”

Belden started his career with Travelers in 1979 as an actuary. He says a large part of his job is to justify the largely intuitive underwriting process is financially sound. “A lot of our good underwriters make decisions on gut feelings,” says Belden. “My actuarial background gives me the ability to explain the mathematical logic behind the business instinct. And I find our best underwriters have it absolutely right, even if they can’t give you the calculations.”

Porro agrees that a CRO has to have actuarial experience, but argues that experience can be hired into the department. For Porro, who has a background in civil engineering and economics, industry experience is the most important attribute for a CRO at a reinsurer. “I have a lot of actuaries around me,” Porro says. “A CRO needs to be an experienced person who has been through a lot of critical stages in this industry. A lot of a CRO’s role is to recognise when an issue looks familiar and to ask when something like it has happened before. That comes from accumulated experience.”

All three CROs agree that the way the position is structured within the organisation is extremely important.

The creation of an integrated, corporate-wide risk manager will be purely cosmetic unless it is supported by the chief executive officer and completely independent from the chief financial officer (CFO) within the corporate infrastructure. “One of the biggest success factors for a CRO is having the whole-hearted support of the chief executive officer – they have to believe it is a valuable function,” Fisher says. “If the CRO reports to the CFO, the CRO isn’t independent in terms of watching and reporting in a candid fashion.” Porro agrees: “I report to the chief executive officer. I think a CRO reporting to the chief financial officer is totally wrong.” Porro says a reinsurer should make a clear distinction between the CFO’s responsibility to provide capital to the firm and the CRO’s responsibility for risk measurement and management. Belden reports to the chief operating officer and has a direct reporting line to the CFO. However, Travelers’ corporate infrastructure is being reviewed. Citigroup owns 80% of Travelers and is planning to sell its stake by the end of 2002. Belden says the company is having a lot of discussion about how the company’s departments should be structured when it goes fully public. According to Belden, the demands of a wider shareholder base may well necessitate a change in the reporting procedure.

Challenging environment
All the CROs agree the market is hardening, and will continue to tighten into 2003. Beyond that, the projections become more speculative and less confident. No-one expresses the view that the industry is likely to escape its extremely cyclical nature. “The industry needs money to rebuild its strength,” Porro says. “I am convinced that in 2003, despite the increase in capital coming into the industry, the market will continue to harden. The market in 2004 will depend on whether people have a long memory, or a short one.”

Fisher denies insurers are raising premiums too high, too quickly. “Our premium volume grew 40% last year and almost 40% for the first quarter of this year. But rates have dropped overall by 40% since 1995, so they have to go up 150% just to get back to the levels they were five years ago.”

Fisher’s focus during these years of rising premiums is to analyse the quality of the company’s portfolio. As premiums rise, customers are retaining more and more of the risk. While some core insurance risk cannot be retained, customers can alter the level of deductibles, limits and even the contractual scope of some contracts. The worry for Fisher is that when a client changes the mix of coverage, the risk that is transferred to Zurich is the poorer quality business. “We have to be very concerned that we might be losing the better business and retaining the poorer business as the risk retention of our clients alters the mix of our portfolio,” says Fisher. “The standard practices we use to address profitability don’t address this issue directly, so we have developed new tools to track the quality of our book as it changes.” Fisher says the basis of these new tools is a comparative analysis of business lines using historical actuarial trends.

Belden also says a lot of his time is being spent developing new models to understand Travelers’ exposure to catastrophic risk. As CRO, he has been responsible for identifying the company’s risk to catastrophic events, such as earthquakes and windstorms. However, he says these models have traditionally analysed the company’s property and casualty exposures to these exposures. Since the attacks on the World Trade Center he has been expanding catastrophic risk analysis to other business lines, especially workers’ compensation insurance. “The P&C world has the most developed models for assessing correlated risk,” says Belden. “Now we are expanding this approach and tracking other types of risk exposure. At the moment this process is a little less formal because the models are ‘back of the napkin’ models at this point.”

The role of CRO is becoming increasingly important for insurers and reinsurers. For companies that have risk as their underlying business currency, the CRO is a demanding job. At least in today’s hard market, with the return of underwriting discipline as a central business philosophy, there is a greater appreciation in most companies about the need to understand the business risk. But when the market softens, the CRO will have the responsibility to make sure the business remains adequately priced. All three CROs agree, the true value of a CRO will not be determined amid rising prices, but will be shown over an entire business cycle.

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