Overview of ERM

This article was written by the CAS describing just about everything regarding ERM. The beginning of the article relates to what was on the first exam. They state that organizations have practiced ERM for a long time by prioritizing their risks. To counter their risks two common tools have been a transferred of risk or through financial tools.

With increasingly pure competition by means of globalization, ERM may become more important than ever before to companies. This may also contribute to companies facing more complicated risks that may be impossible to hedge against. Risks that are relatively new may not have enough people to insure to adequately pool their risks. Thus, the insurer would have to charge a percentile premium that could hurt the company if the insured incurred a catastrophic loss, since there are no past models to follow.

One of these new risks is exchange rate risk. This was one contributing factor to the failure of Enron and Barings Bank. The advancement in technology, accelerating pace of business, globalization, increasing financial sophistication and the uncertainty of irrational terrorist activity all contribute to the growing number and complexity of risks. These risks are anticipated to increase in the future.

With these increasing risks investors still want stable cash flows. To protect against such an event, a company could purchase some kind of earnings insurance that will make up the difference in expected income and actual income. If a company performs at a sub-par level, the insurance will make up for the difference in expected cash flows.

Links:http://www.ucop.edu/riskmgt/erm/documents/overview.pdf