Regulatory and rating agency pressures are causing many insurers to turn to capital management strategies, including enterprise risk management, to manage their capital. They are making good progress in this area and experts think these new approaches ultimately will benefit the insurers.

Two of the prods toward development of capital management strategies by insurers are Solvency II and the National Association of Insurance Commissioners' Risk Management and Own Risk and Solvency Assessment Model Act.

Rating agencies are encouraging its use as well, experts say.

“Every rating agency has a required capital model that's typically risk-based to some extent,” said Don Mango, vice chairman and head of enterprise analytics for New York-based Guy Carpenter & Co. L.L.C.

Typically, insurers with good ratings from the rating agencies have “more than enough capital to satisfy the regulators,” he said.

“Insurers' capital modeling has been around the market for probably 15 years, but over that time the use has been growing,” partly because of regulatory pressure, said David Simmons, London-based managing director with Willis Group Holdings P.L.C.'s Willis Re unit and head of its strategic capital and results management operation.

A lot of capital management started in Europe, “primarily driven by Solvency II and the changing regulatory environment in Europe,” said Stephen M. Sonlin, head of risk and capital management solutions at Hartford, Conn.-based Conning & Co.

As a result, large European companies “have been at the forefront” in this development, “but it's being followed up pretty much across the globe,” Mr. Sonlin said. While it has been adopted more by larger, more complex companies, it is “moving down pretty rapidly” in terms of company size as it becomes more of a widespread requirement, he said.

Louis DiFranco, head of the insurance business at Pasadena, Calif.-based Western Asset Management Co., said enterprise risk management “goes way beyond capital risk lots of times” and can include factors such as underwriting, the competitive landscape and product development.

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Zurich North America's economic capital model encompasses multiple tools and techniques to quantify and aggregate risk from all sources, including insurance risk, which includes premium, reserving, mortality and natural or man-made catastrophe data; market risk, including investment and asset/liability matching; credit risk, including investments and reinsurance; and operational and business risks, said Barry Franklin, Schaumburg, Ill.-based senior vice president and chief risk officer for the insurer.

“We have a very well-developed economic capital model that really encompasses a 360-degree view of risk,” Mr. Franklin said. The insurer has “been able to weather the storm quite effectively when you look back to the most recent financial crisis. While we experienced some losses, just as anybody would, we did construct our asset portfolio with an eye towards managing risk, so we were able to avoid the degree of investment losses that some others experienced.”

“There's a lot more enterprise risk management and risk focus today” as insurers “look at their various businesses and what sort of capital they need to support that risk,” said James Auden, managing director of insurance for Fitch Ratings Inc. in Chicago. “I think companies have gotten better at managing their concentrations of exposure over time.”

“Most insurers at this point in time have adopted some element of enterprise risk management,” although “some of it more formally than others,” said Laurie Champion, Atlanta-based managing director of Aon Global Risk Consulting's enterprise risk management practice.

Insurers these days are “really looking at the breadth of their current risk management efforts” and “looking at all types of risk” on a broader ERM basis, she said.

Overall, the industry, which has been proactive in managing risk, “did pretty well during the financial crisis,” said Cliff Gallant, San Francisco-based managing director and senior analyst with Nomura Holdings Inc.

However, John Wicher of San Francisco-based Wicher & Associates, said many insurers “still are struggling with trying to understand where risks correlate.” An example, he said, would be the Sept. 11, 2001, terrorist attacks, when “no one really thought about” the aggregation of exposures for companies, which included business interruption, workers compensation and disability.

Carmi Margalit, director at rating agency Standard & Poor's Corp. in New York, said, “We cover several hundred insurers, and I think within that universe there's a wide spectrum of companies in terms of how far along they are in implementation of various (capital management) frameworks.”

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Mr. Wicher said he thinks intuitively that “larger companies have been thinking about this issue and some in a very elegant way for a number of years, certainly since 9/11.”

“Smaller companies have fewer resources” and “don't necessarily have the resources available internally” to develop these models, “particularly if you're looking at smaller, regional mutual companies,” Mr. Wicher said.

But Mr. Mango said that specialty midsize regional companies with big enough staffs may be further along in the process of developing capital models.

However, many of the global insurers also “have done really well — surprisingly well, given their size — at getting a model and having input from all the necessary parties and sharing the output with their boards on a regular basis,” Mr. Mango said.

He said one development he has seen are supporting models that are more flexible “in terms of being able to respond in short time frames for more strategic opportunities and decisions,” such as an acquisition, “where the larger model can't just sort of turn on a dime and be adopted quickly.”

“You sacrifice a little bit of accuracy,” but these secondary models can “give directional guidance in a timely manner, and that's really valuable,” Mr. Mango said.

Insurers will benefit from all of this, experts say. A lot of benefits have “come from the creation of processes to unify” all the disparate sources of risk information, Mr. Mango said.

“Capital management decision-making certainly will be enhanced because of these new sources of information,” although it will take time “to absorb and understand, so there's still a maturing that needs to happen,” said Maryellen J. Coggins, Boston-based managing director with PricewaterhouseCoopers L.L.P.'s insurance practice.

Mr. Sonlin agreed.

The move toward capital modeling “is going to create better profitability and greater opportunities for the companies” that have these processes in place, he said.