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Driven by pressures from regulators and rating agenciesas well as recognition of the potential impact on their bottom linesinsurers and reinsurers have begun to firmly embrace enterprise risk management. Prakash Shimpi, enterprise risk management practice leader at Towers Perrin in New York, is well-versed on the subject of ERM, having previously served as president of Fraime L.L.C., an ERM consulting boutique; as president and chief executive officer of Swiss Re Financial Services Corp., where he was involved with products such as insurance-linked securities and credit and weather derivatives; and having written a book on the topic. Recently, he discussed ERM and its potential benefits.
Q. After years of discussion of the benefits of an enterprisewide approach to risk management, it seems like it's begun to take hold in many companies. Is this something that just took time or the right set of conditions to fully develop?
A. It was rather like the development of the catastrophe bond market. Things were percolating for several years and then this "magically happens overnight." It's one of those overnight successes that took many years to develop.
I think the good news is that it's been on the stove for a while, slowly stewing and percolating.
Q. It seems that at the heart of ERM are the notions of spreading the risk management culture throughout the organization, that of a coherent approach to risk and the ability to make informed risk-reward decisions. Are those concepts becoming more widely accepted?
A. When you undertake any business activity, like it or not you've got risk in that. So risk management is inherent in almost any business endeavor.
For example, a company looking to cut costs by outsourcing some activities, how far do they think ahead about, "And what really are the implications of this?" Have you actually diversified your risks or have you multiplied them? Or say you're adding branch offices overseas. You've added global reach, but you've also added foreign exchange risk, you've added people risk, you've possibly added political risk.
You have to think about, "If it doesn't go well, is it a small blip in our earnings or is it potentially firm destroying?"
Q. Is ERM really a new discipline? How does it differ from previous approaches to risk management?
A. It's been there all the while, but business managers have not been trained to look at it.
The value of risk management is in allowing shareholders to earn a levered return. What enterprise risk managers have done in the end game is better economics for the business. It's not an alarmist view. It's, "What is your ability on a day-to-day basis to manage the things that are affecting your firm?"
And you can't just look at the statistics and the number of risks. One of the things to recognize is you can have too much of a centralized risk management. The value is to understand the connections, not just to understand the total.