Increased Economic Risks Highlight Importance of ERM Programs

Growth in economic risks, the increased severity and frequency of weather events, and the growing impact of social inflation underscore the need for enterprise risk management (ERM) processes to evolve with insurance companies' risk profiles, according to A.M. Best.

In a Best's Commentary, Rising Economic Risks Highlight Importance of Enterprise Risk Management, the rating agency said its analysis shows that a strong majority of insurance companies understand the importance of enterprise risk management. More than 90 percent of Best-rated insurers had ERM frameworks considered appropriate or better, Best said.

Best noted that ERM is one of the main pillars of its insurance rating process, along with balance sheet strength, operating performance, and business profile. The rating agency said its ERM analysis is based on an understanding of an insurer's risk management framework and its risk management capability relative to its risk profile.

According to the new Best report, despite the existence of appropriate or very strong ERM assessment for a significant majority of A.M. Best-rated insurers, many lack robust stress testing and reverse stress testing processes. Best said that approximately 30 percent of those insurers' stress testing assessments fell in the bottom three categories: evolving, nascent, or unrecognizable.

"These companies often lack the capability to manage concentration risk effectively," Jason Hopper, associate director, industry research and analytics at A.M. Best, said in a statement. "In recent years, companies' operating results have deteriorated due mainly to weather-related events and an increase in fire losses. Strengthening these ERM frameworks can further enhance understanding and management of risks."

Best said that along with stress testing, components of ERM programs include governance and risk culture, risk management and controls, risk identification and reporting, and nonmodeled risks and risk appetite and risk tolerance.

"A weak or nonexistent ERM framework can contribute to failures that can occur when insurers do not understand their key risks, which can lead to a failure to maintain adequate protection against stresses and shocks," the Best statement said.

"The failures of Silicon Valley Bank [SVB] and crypto firm FTX are two recent examples of insufficient risk management," Sridhar Manyem, senior director, industry research and analytics at A.M. Best, said in the statement. Insurers may not be susceptible to a run-on-the-bank scenario, but SVB's failure provides lessons pertaining to liquidity management and asset-liability risks. Strength and depth of management teams are also essential for an insurance company to execute its strategy, and at FTX, a lack of accountability of executives and board oversight led to poor management decision-making."

Copyright © 2023 A.M. Best Company, Inc. and/or its affiliates. ALL RIGHTS RESERVED.