Holistic Approach to Setting Risk Limits: ERM for the Masses

Enterprise risk management and its holistic approach appear to have attained permanency as a best-in-class approach to risk management. Yet, we continue to see insurers utilizing risk limits that have been set in isolation and remain untested from an enterprise-wide perspective. Explanations range from “our conservative approach to setting individual risk limits renders the holistic approach unnecessary” to “we simply don’t have the resources to tackle this problem.”

This paper uses a hypothetical, medium-sized, multi-line, mutual insurer and the Public Access DFA Dynamo 4 Model (Dynamo 4) to holistically evaluate a company’s current risk limits. Historically, the company’s risk limits were set in isolation with an eye towards capital preservation. The risk limits reviewed include those pertaining to growth rates, retentions within the company’s reinsurance program, and investment policy statement limits. We also test some of the underlying risk assumptions used by Dynamo 4.

We utilized the Dynamo 4 model to test and suggest improvements to the current risk limits from an enterprise-wide capital preservation perspective. We concluded that certain risk limits that were set in isolation and originally appeared to mitigate risk were actually unnecessarily increasing the risks of violating the company’s long-term solvency goals.

Keywords. Risk Limits, Setting Risk Limits, ERM, Dynamo 4