A.M. Best Special Report: A.M. Best Comments on Enterprise Risk Management and Capital Models.

OLDWICK, N.J. -- Risk management and capital modeling have evolved with the risk environment of the insurance industry. Enterprise risk management is the broad description of the further integration of risk management across an organization's operations-- incorporating the assessment and monitoring of investment, underwriting, operational and reputation risks--along with greater sophistication in the modeling of the organization's risk, according to A.M. Best Co.

Modeling tools, such as dynamic financial analysis (DFA) and many other risk-based stochastic capital modeling "tools," have been around the insurance industry for more than 10 years but until recently have not generated broad interest. Several stumbling blocks have been the amount of data required to effectively run the model; a fragmented or silo approach to risk management; difficulty in addressing the correlation of risk; and questions over what to do with the model output. Additionally, the focus of the insurance industry has been centered largely on the basics of cycle management, underwriting, claims management and asset management. However, more recently, interest in the topic of risk management and the use of more sophisticated capital modeling tools has been on the rise. Companies increasingly are asking the questions: What is our aggregate risk profile, what are our most significant individual risks, what are we doing to manage and/or mitigate these risks, and are we being compensated for the risks we are taking?

Significant events over the past few years have helped to underscore the importance of work related to these dynamic "black box" models that require so much data and so much effort. The impact of huge losses in the property/casualty sector related to terrorism, more severe and frequent hurricanes, and ongoing asbestos losses, as well as the increased volatility of the investment markets and corporate-governance failures, have raised the importance of risk management and placed a premium on gathering and evaluating the most critical information related to risk management at the enterprise level. Through this accumulation and management of information related to the risk, companies are able to utilize more sophisticated capital models that provide an aggregated view of the risk inherent in their operations.

A.M. Best expects the risk-management process and capital modeling tools to continue to evolve as more data are collected and additional information is obtained through the analysis of the collected data. The use of risk modeling itself provides additional information that will be used in future iterations of these models. At this point, most within the insurance industry have recognized the need to go beyond the underwriting fundamentals and investment management. Insurers must take a broader view of risk management and the volatility of earnings in competing with other industries for capital as they seek to provide risk-management solutions to customers and offer shareholders and policyholders the best returns on, and security of, their money.

A.M. Best recognizes that the risk environment and the tools used to monitor that risk are continuing to evolve. Through these changes, A.M. Best continues to address the challenge of utilizing the appropriate level of sophisticated model for each company A.M. Best rates to appropriately assess its risk, while at the same time ensuring consistency in the overall assessment of each company's financial strength.

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A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at www.ambest.com.