Enterprise risk management

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Enterprise Risk Management: Operational Risk and COSO

Prepared and Presented by:Group 1

Link to Glossary

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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ERM INTEGRATED FRAMEWORKCOSO Framework for Operational Risk Management

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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COSO

• Acronym for Committee for Sponsoring Organizations

• Enterprise Risk Management- Integrated Framework by COSO: Aims to provide for the need for an enterprise risk management framework, providing key principles and concepts, a common language, and clear direction and guidance

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Operational Risk-COSO re-examined

• Written by Peyman Mestchian, Mikhail Makarov and Bahram Mirzai

• An analytical build-up as an answer to the criticisms given by Ali Samad-Khan (President, OpRisk Adisory) against the application of COSO framework to operational risk

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Criticisms offered by Ali Samad-Khan

• The definition of risk used by COSO is flawed• Likelihood-Impact Risk Assessment is flawed• Methods prescribed by COSO are highly

subjective, and only risk assessment based on historic losses is valid

• Risk assessment using COSO approach is too complex and resource intense

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Justifications or Counter-Criticisms!

• The criticism about Operational Risk’s definition (criticisms 1 and 2) is based on:

Risk=Likelihood x Impact• There is no reference in COSO for using this

formula to measure risk• COSO uses Value at Risk or Capital at Risk

concepts as measures of risk:Cost of Risk=Expected Loss + Cost of Capital

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Importance of Evaluated CoR

• Crucial to perform cost-benefit analysis within an integrated operational risk management framework

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Likelihood-Impact Based Risk Assessment• Introduced in MIL-STD-882A Military safety standard, by US Department of Defense

• According to this approach, for each risk the frequency of occurrence (likelihood) & the worst credible outcome(impact) are assessed & captured into a likelihood- impact matrix. Allows an entity to understand the extent to which potential events might impact objectives

• Integrating qualitative and quantitative approaches.

• E.g.- CRISIL Ratings provides the most reliable opinions on risk by combining its understanding of risk and the science of building risk frameworks, with a contextual understanding of business. It follows the Basel II guidelines to guard against the types of financial and operational risks banks face.

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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• Control It

• Share or• Transfer It

• Diversify or• Avoid It

• Risk• Management

• Process• Level

• Activity• Level

• Entity Level

• Risk• Monitoring

• Identification

• Measurement

• Prioritization

• Risk• Assessment

Risk Analysis

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Example: Call Center Risk Assessment

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Causes of Operational Risk

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Operational Risk Failures

• On February 6, 2002, Allied Irish Banks (read more) reported a fraud in its Baltimore-based subsidiary Allfirst. According to the report, around 1997 John Rusnak, one of their internal traders, lost a large amount of money. For five years, Mr. Rusnak covered his tracks by writing non-existent options and booking their equally non-existent profits as income. Compound interest being what it is, Mr. Rusnak’s problems and, hence, the bank’s, eventually grew to $700 million dollars. One Monday morning, Mr. Rusnak failed to show up for work and the entire fraud collapsed.

• Barings Bank (read more) had collapsed ten years previously and Allied Irish Bank was, at that time, Ireland’s second largest. The story of the Barings is one of a rogue trader that alone caused the bankruptcy of a supposed solid bank.

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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ERM AT ALLSTATE

Enterprise Risk Management: Managing Risk to better exploit risk opportunities

Case-Study

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Brief Company Profile

• Allstate was founded in 1931 as part of Sears, Roebuck & Co., and became a publicly traded company in 1993

• It is the nation’s largest publicly held personal lines insurer

• A Fortune 100 company, with $130 billion in total assets, Allstate sells 13 major lines of insurance, including auto, property, life and commercial

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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A Novel Approach in the Industry

• Allstate combined its scholastic modeling and operational governance to produce an ERM for the organization

• Over time, Allstate worked to align its analytics with corporate governance and decision making activities

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Allstate’s ERM Framework: Culture/Code of Ethics

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Allstate’s ERM Approach: Advantages

1. It allows the company to set a quantitatively based risk/reward threshold across its businesses

2. Management can evaluate how lines of business compare to each other vis-à-vis capital consumption

3. Provides solid new measurements to inform business decision making

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Allstate’s Successful ERM: Benefits• Helps managers take risk- and capital- related

decisions, such as reinsurance purchasing, asset/liability management, risk limit setting and monitoring, and capital allocation and pricing

• Starts small, focuses on key issues first and consistently build value

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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ERM Process

1. Identify top risks2. Build a consensus between risk “owners” and

management on the risk limit for the quantifiable risks

• Allstate uses its own metrics, rather than relying solely on rating agencies to determine overall capital needs as well as capital allocations and levels within the various businesses

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Growing with ERM

• Initially, ERM was used only for Allstate Protection, its property/casualty business

• Now implemented in Allstate Investment and others

• Allstate now operates a Risk Opportunity Forum-members analyze suggestions for greatest potential

• Repeats risk assessment every 2 years

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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References

• COSO Executive Summary: http://www.coso.org/Publications/ERM/COSO_ERM_ExecutiveSummary.pdf

• Basel Standards: http://www.bis.org/publ/bcbsca.htm

• Case Study: http://www.towersperrin.com/tp/getwebcachedoc?webc=TILL/USA/2006/200608/Allstate.pdf

• Allstate website: http://www.allstatenewsroom.com• CRISIL Rating: www.crisil.com• Other references: www.wikipedia.org

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Thank You!Questions?

08/04/2023 Group Members: Manu Prakaash, Rashi Saxena, Saurabh Saha, Urvi Gulati TERI University, New Delhi

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Glossary

1. Operational Risk: The risk of loss resulting from inadequate or failed business, people and systems or from external events (As defined by the

Basel Committee)

2. Risk Tolerance: A measure of the degree of uncertainty that an investor is willing to accept in respect of the negative changes to its business or assets