Direct Contracting may offer ACOs a unique opportunity
The Direct Contracting model includes a unique feature allowing accountable care organizations the ability to contract with providers.
Enterprise risk management (ERM) projects often fail to achieve their potential value. In many cases, the full measure of that value is never even recognized. That is because most discussions of ERM tell only half of the story—the half that’s about preparing for and protecting against risks that can threaten the solvency of an enterprise. This is certainly a worthy goal. Companies that analyze and plan for "tail" risk are better able to preserve their value in the long term than those who don't. But focusing exclusively on value preservation misses an even more compelling opportunity—to use ERM to create operational and financial advantages by optimizing assets, balancing product lines, introducing risk-aware governance, and more.
Applied in this way, ERM becomes a tool for maximizing the ability of insurance companies (or any enterprise) to take on risk-bearing profit opportunities. Instead of solely quantifying the minimum level of required capital to prevent insolvency at certain confidence levels, ERM as value creator optimally allocates scarce resources (including capital) to enable companies to take advantage of the maximum number of business opportunities. At its best, ERM improves decision making, helps to increase the company's value, and balances risks in the most resource-efficient ways.
We start with a definition of ERM that includes its role in the creation of value: Enterprise risk management is a comprehensive, distributed framework for the risk-conscious deployment of capital in localized decision making.
In practice, this definition of ERM leads to a distinct approach with identifiable features. It is:
They must also be aligned with corporate culture to ensure observance and adherence.
The result is a way of doing ERM that goes beyond the remediation of risk exposures to enable the following:
Economic capital (EC) models are central to ERM. In keeping with our definition of ERM as a means to create value by distributing risk awareness and decision making throughout an enterprise, we define economic capital thus: Economic capital is the balance sheet power that ensures the long-range economic vitality of the enterprise and its ability to seize risk-bearing profit opportunities.
The first part of this definition is the one that is discussed most often. EC is characterized as a better, more sophisticated way to measure the resources necessary to ensure solvency in tail-risk situations. The second half is what distinguishes value-driven ERM from other approaches: ERM is a means to maximize opportunity and value in a risky world. Understanding resource needs under extreme conditions is part of the equation; understanding how risks are interrelated and can exacerbate or offset one another completes it.
Value-driven ERM asks EC to answer more sophisticated questions than "How much risk capital do we need to set aside?" As with ERM in general, EC should inform decision making at the level of individual projects and products on a daily basis. Two questions that permit EC this enlarged role are:
Discussions of ERM tend to become opaque rather quickly, and it is not our intention to cloud already murky waters. Our unique approach to ERM arises from experience in the field, watching companies implement ERM tools in ways that add to the burden of management without creating value for the organization beyond regulatory compliance. When ERM is implemented as an empirical, enterprise-wide, governance-conscious system, it can create an operational environment that allows a company to maximize opportunity, minimize misallocated capital, and help to ensure solvency in tail-risk scenarios.
The diagram on this page maps the movement of the ERM process through the organization. This diagram graphically represents the assertion that good ERM drives two types of initiatives: analytical (risk assessment) and operational (good governance). Analysis alone can help address balance sheet issues but cannot effect operational change, which is crucial for minimizing tail risk, enhancing returns, and demonstrating risk awareness to ratings agencies and the marketplace. Operational change in the absence of numeric analysis can create more risk than it ameliorates, especially in the financial and insurance industries, where risks and the relationships among them are complex and interrelated.
On the other hand, when operational and analytical ERM initiatives work together under the guiding principle of value creation, the results can be transformative. Integrated, distributed, profit-focused ERM can give companies real competitive advantages both immediately and in the long term. The key is to stop seeing ERM as compliance drudgery or a cost center and start seeing it for what it is: a tool for making better decisions.
Jay Glacy is a senior consultant in the Chicago office of Milliman. He focuses his efforts in the area of enterprise risk management, helping clients balance total risk exposures and optimize their deployment of risk capital. He has specific expertise in enterprise risk management, strategic asset allocation, strategic capital deployment, asset/liability management, and capital markets risk management.
Charting a course: How enterprise risk management can balance risks, improve operations, and create value
Enterprise risk management (ERM) projects often fail to achieve their potential value. In many cases, the full measure of that value is never even recognized. That is because most discussions of ERM tell only half of the story—the half that’s