CONTEMPORARY MANAGEMENT TECHNIQUES 5
EnterpriseRisk Management (ERM) is a risk management, organizational frameworkthat can be applied to mitigate the risks that are likely to affectthe organization’s financial ability or competitiveness (Blocher etal, 2013). Several factors account for organizational risks. Theserisks include fire and flood hazards, fluctuations of foreigncurrency value, product prices and interest rates. Organizations arealso faced with operating risks such as related to employees,products and customers and strategic risks that affect the decisionsmade by the top management in terms of policy formulation andimplementation (Kaplan, 1990). By focusing on American InternationalGroup (AIG) as the case for analysis, this paper intends todemonstrate the importance of ERM toward achieving the coreobjectives of a company.
AIGis an insurance company with its origin in the United States and hasbranches in 130 countries. The sole aim of the company is to help itsclients, individuals and corporations, to manage financial risks withconfidence. ERM serves an important function in the insuranceindustry. An insurance firm adds value in three major ways, that is,investment, underwriting and financing (Errath& Grünbichler, 2007).Insurance business offers leverage services, where it borrows moneyfrom the policy holders and stockholders. For the insurance torealize more value, the cost of capital should be lower than returnsgenerated from the capital so acquired. Insurance firms are facedwith both investment and insurance risks. The purpose of ERM is tomanage the volatility of the risks involved in insurance business.
ERMoffers proactive approaches that help the firm prepare for risks thatmay occur in future. In addition, a good ERM program can help thefirm to stabilize at the time of crisis and financial distress(Blocheret al, 2013).AIG is the main insurer in the US. Many times, several unexpectedrisks have occurred in the country, including the California forestfires and hurricane. Such unanticipated catastrophes and others, suchas earthquakes and portfolio loss scenarios can be managedeffectively through an efficient ERM program.
Duringthe outburst of the US housing bubble in 2006-2007 period, AIG faceda financial crisis before signing the short credit default swaps(CDS). The company faced financial pressure and failed to settletheir CDS until it was rescued by the government (Pathaket al, 2013).The major risk was not their issue, but the modeling of the CDS. Aneffective ERM program can help direct the company from landing intosuch financial crisis. A good ERM will help the company to evaluateits prospects from within as opposed to how the company is viewedfrom the outside. A well modeled ERM will help the company toeliminate the actual risks which can be revealed from its balancesheet and business plan.
AIGcan utilize ERM as a tool to assess the growth of the company. Thiscan be achieved through risk measurement of the use standarddeviation (Elsinger et al, 2006). Following its financial crisis, AIGfocused on returning to its position and the company targets furthergrowth within and outside the US. A smaller standard deviationimplies lower cash flow risks. Expected shortfall (ES) and Value atRisk (VaR) are important components of ERM and are useful forassessment of probable tail risks (Elsinger et al, 2006). VaR willhelp the company assess all the risks it faces and help consolidatefinancial and non-financial risks. VaR will help the company separatethe core from non-core business risks.
ERMis an effective management technique, especially on businesses thatface higher risks. AIG is a key player in the US insurance industryand the insurer to millions of individuals and thousands ofcorporations. According to Blocher et al (2013), the strategy of ERMfor the company is significant for the risk management function. ForAIG, ERM will help the company prepare for the many risks and avoidthe repeat of the historical financial failures. Use of VaR will helpthe company eliminate actual risks and will help the company tohandle the risks when they rock the company. Standard deviationmeasurement can help assess the trend of the company in its growth.
Blocher,E. J., Stout, D. E., Juras, P. E., & Cokins, G. (2013). Costmanagement: A strategic emphasis (6th ed.). NewYork, NY: McGraw-Hill/Irwin
Elsinger,H., Lehar, A., & Summer, M. (2006). Risk Assessment for BankingSystem. ManagementScience,52(9): 1301-1314.
Errath,W., & Grünbichler, A. (January 01, 2007). Enterprise riskmanagement: A view from the insurance industry. Lawand Economics of Risk in Finance: Second International Conference onLaw and Economics at the University of St. Gallen, June 29, 2007 St. Gallen, Switzerland.
Pathak,J., Karim, K. E., Carter, C., & Xie, Y. (January 01, 2013). Whydo enterprise risk management systems fail? Evidence from a casestudy of AIG. InternationalJournal of Applied Decision Sciences, 6 (4):345-371.
Kaplan,R. S. (1990). The Four Stage Model of Cost System Design. ManagementAccounting (February): 22-26.