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The Enterprise in Enterprise Risk Management A Case Study

The Enterprise in Enterprise Risk Management A Case Study. CAS Special Interest Seminar Understanding the Enterprise Risk Management Process. Case Study - ABC Corporation.

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The Enterprise in Enterprise Risk Management A Case Study

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  1. The Enterprise in Enterprise Risk ManagementA Case Study CAS Special Interest Seminar Understanding the Enterprise Risk Management Process

  2. Case Study - ABC Corporation • Based on composite and rescaled individual data, industry information, recent press releases and some pure “guestimates” • Quantify risks individually and aggregate • Measure “untreated” earnings impact • Quantify the impact of the “portfolio effect” on aggregate risk

  3. ABC Corporation -Assumptions • Market Cap = $42.8 Billion • Net Income = $5.45 Billion (ttm) • EPS = $4.72 (ttm); Share Price = $38.12 • Effective Tax Rate = 35% • Protect against the “1 in 100 year event” • Exposures can be transferred at pretax nominal cost (expenses offset PV factor)

  4. Hazard/Legal Risks Property Business Interruption Cargo/Marine Workers’ Compensation Automobile Liability General Liability Product Liability Employment Practices Crime Boiler & Machinery Directors & Officers Intellectual Property Product Recall Foreign Liability E&O/Professional Liability ABC Corporation Risks - I

  5. Financial Risks Credit Residual Value ERISA/Fiduciary Foreign Exchange Commodity Prices Energy Prices Interest Rates Operational Risks Warranty Product Recall Contingent Business Interruption Political Intellectual Property E-Commerce Strike/Labor Relations ABC Corporation Risks - II

  6. Strategic Risks Model Selection Geographic Expansion Brand Image Product Pricing R&D Investments Acquisitions & Divestitures ABC Corporation Risks - III

  7. Property Business Interruption Warranty Residual Value Political Geographic Expansion Product Recall Product Liability Strike/Labor Relations Employment Practices Acquisitions & Divestitures Directors & Officers Examples of Correlated Risks

  8. Measurement “CORREL” function Rank Correlation Regression Analysis Judgement Implementation Causative/Formulaic Correlation Matrix Resort/Resampling Combinations Approaches to Correlation

  9. ABC Corporation Hazard Risk 6,000 5,000 4,000 3,000 2,000 1,000 0 99% 90% 80% 100% Case Study - Hazard Risk Avg. NI NI (Agg) $Loss (Sum) $Millions NI (Sum) $Loss (Agg) Avg. Loss 1% 0% 70% 60% 50% 40% 30% 20% 10% Probability of Exceedence

  10. Case Study - Hazard Risk

  11. ABC Corporation Financial Risk 8,000 6,000 4,000 2,000 0 -2,000 99% 90% 80% 70% 60% 50% 100% Case Study - Financial Risk Avg. NI NI (Agg) $Loss (Sum) $Millions NI (Sum) $Loss (Agg) Avg. Loss 1% 0% 40% 30% 20% 10% Probability of Exceedence

  12. Case Study - Financial Risk

  13. ABC Corporation Operational Risk 20,000 15,000 10,000 5,000 0 -5,000 99% 90% 80% 70% 60% 50% 100% Case Study - Operational Risk NI (Agg) Avg. NI $Loss (Sum) $ Millions NI (Sum) $Loss (Agg) Avg. Loss 1% 0% 40% 30% 20% 10% Probability of Exceedence

  14. Case Study - Operational Risk

  15. ABC Corporation Strategic Risk 8,000 6,000 4,000 2,000 0 -2,000 99% 90% 80% 70% 60% 50% 100% Case Study - Strategic Risk Avg. NI NI (Agg) $Loss (Sum) Loss ($Millions) $Millions NI (Sum) $Loss (Agg) Avg. Loss 1% 0% 40% 30% 20% 10% Probability of Exceedence

  16. Case Study - Strategic Risk

  17. ABC Corporation Composite Risk 20,000 15,000 10,000 5,000 0 -5,000 -10,000 Case Study - Composite Risk 30,000 25,000 Avg. NI NI (Agg) $Loss (Sum) $Millions NI (Sum) $Loss (Agg) Avg. Loss 1% 0% 99% 90% 80% 70% 60% 50% 40% 30% 20% 10% 100% Probability of Exceedence

  18. Case Study - Composite Risk

  19. ABC Corporation - Implications • To protect against earnings volatility at the “1 in 100 year” level on a pretax basis: • finance $11.2 B if risks treated individually; • finance $3.6 B if risks treated as a portfolio. • Risk finance cost difference of $76 Million. • $0.04 in after-tax EPS. • Almost $400 M in market capitalization at current P/E multiple.

  20. ABC Corporation - Caveats • Not all risks to Net Income are included. • WC, cargo, etc. due to lack of data; • general economic risks - interest rates, etc. • “Portfolio Effect” potentially overstated • not all correlations reflected (warranty, recall and product liability, for example); • companies may look at some risks in portfolios (integrated insurance programs, combined aggregate excess programs, etc.).

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