Erm1 3

DEPARTMENT NAME
Enterprise Risk Management
Enterprise Risk Management at

Nationwide
September 18, 2008 Al Schulman, Vice President-Enterprise Risk Management
The Nationwide View
Nationwide Vision Requirements
• Risk classification
Significant Risks… • Identification and assessment
• Risk appetite / limits
• Metrics
…are clearly understood,… • Reporting
• Training and communications
• Clear roles and authority

…proactively managed… • Tools
• Controls / transfer / financing
• Standard language
…and consistently monitored by
• Reporting
Nationwide….
• Independent assurance and oversight
… in the context of achieving our • Link to strategy / planning

business objectives and strategy… • Risk-adjusted performance metrics
September 11, 2008 Page 2

Nationwide ERM Framework
– Risk Governance
– Planning
– Execution
– Evaluation
– Infrastructure, Communication & External
Environment

GOVERNANCE
• Risk Governance & Culture
Framework • Risk Policies Feedback
• Roles & Authorities
Legal, Regulatory, & Compliance

PLAN Insurance EVALUATE
• Strategic Planning Operational • Risk Adjusted Performance
• Capital Allocation Strategic • Capital Adequacy
• Risk Capacity, Appetite & • Risk Modeling
Market
Limits
Credit
Identify Measure Analyze Manage Monitor
EXECUTE
Objectives Aggregation
Infrastructure Communication External Environment
• ERM Tools • Internal Risk Management • Rating Agencies & Regulators

• Common Language Partnerships • Competitors & Best Practices
• Risk Classification Framework • Training & Communications • Customers
• Counterparties

Risk Governance Guiding Principles
 Business areas retain accountability for managing their own risks
 Enterprise perspective
 Proactive rather than reactive
 Independent assurance (e.g., Independent Audit)
 Clearly assigned responsible / accountable parties
 Transparency of accountability, communication, decision making,

and information flows
 Regular re-evaluation to ensure appropriate evolution

GOVERNANCE

Market
Limits
Credit
EXECUTE

• Counterparties

Core Framework Components
The three components of the framework are Risk Capacity, Appetite, and Limits, all of which are logically
aligned to achieve a common long-term goal: maximization of economic value subject to risk tolerances.
• Capacity represents the maximum amount of risk that can be supported by the company,
expressed as an aggregate capital dollar amount
Capacity
• Risk Capacity is determined considering the following:
– Available capital
– Ability to raise capital (access to capital markets)
– Earnings strength and stability, including planned growth in capital over time
• Amount of risk that management and the Board are willing to take, given available risk
capacity, our risk preferences, and our strategic business objectives
Appetite
• Risk Appetite serves as an overall guide to resource and capital allocation
• Business strategy should be aligned with risk appetite
• Allocation of Appetite to individual risk types, business units, and additional dimensionality
(or combinations thereof) based upon capital requirements relative to potential returns and
Limits
risk concentrations
• Serve to effectively control our significant risks within the context of our overall risk appetite
• Should be expressed in specific metrics appropriate for a given risk
• Should reflect enterprise Risk Preferences and align to support strategic plans and capital
allocation
• Should be set at a level which may be periodically tested (i.e., limits should be established at
levels that may be exceeded at times)

Risk Capacity, Appetite, and Limits Framework:
Conceptual Model
Nationwide’s risk Capacity, Appetite, and Limits framework expresses tolerance for losses:
• for three different loss magnitudes (severity)
• considering likelihood over both a one and three year horizon (probability)
• reflecting both rating agency and economic measures of risk and capital
Capital Volatility Severe Downgrade Insolvency
“Gradually leaking hull” “Hole in the side of the ship” “Ship sinks”
What is the …having capital adequacy …dropping below a minimum …becoming insolvent in a
acceptable decline over three years? acceptable rating level in a single year?
probability of… single year?
Examples of • High inflation environment • Large catastrophe • Large catastrophe

risk events: (multi-year)
• Severe equity market • Severe operational /
• High trade combined ratio + decline continuity event
high growth environment
Severity Severity Severity
- Loss Magnitude +

Appetite Quantification and Dashboard
A dashboard is utilized to reflect a chosen risk appetite and exposure levels relative to the
chosen appetite. The example below is illustrative.
Capital Volatility Severe Downgrade Insolvency
Model Economic Rating Agency Rating Agency Economic Rating Agency
Horizon Multi-year Multi-year Single year Single year Static
Loss Severity Required loss severity ($) periodically calculated for each dimension considering capital and risk profile.
Capital Required
Tolerance <X% X-Y% >Y% <X% X-Y% >Y% X%
for Ratings Targets
Modeled
Probability
Z% Z% Z% ≤X% AA- AA3 A+
Within Tolerance
Warning Level
Appetite Violation

CAL Risk Modeling Tools
Nationwide’s CAL framework calculations use two principal risk modeling tools:
Enterprise Required Economic Capital Dynamic Financial Analysis (DFA)

(REC) model model
• Tool for measuring economic capital • Statutory, GAAP, and economic views
adequacy
• Multi-year view of risk
• 1 year view of risk
• More centrally focused
• “Extreme Tail” focused
• Robust stochastic economic simulation
• REC used in determining Risk capabilities
Adjusted Return on Capital (RAROC)
• Enables more “complete” view of risk (central vs. tail, 1 year vs. 4, Economic
vs. Statutory vs. GAAP, etc.)
• Periodic calibration exercises to test models, assumptions, sensitivity, etc.

GOVERNANCE

Market
Limits
Credit
EXECUTE

• Counterparties

Nationwide Risk Management Cycle
There are five elements of best practice risk management execution
What do we want to do Did the management

What risks exist? How much is at risk? Do something about it
with the risk? strategy work?
• Identify potential risk • Measure direct • Compare to risk • Implement • Ensure actions took
events exposure preferences recommended actions place
• Investigate emerging • Consult experts • Look at aggregate • Execute projects • Compare current results
risks • Benchmark industry measures • Improve / add internal with previous results
• Classify risk events performance • Prioritize against other controls • Compare current results
• Gather actual loss data • Run potential loss risks • Change policies and with expected results
• Document Contributing models • Create strategies and procedures • Generate and distribute
Factors, Controls and • Measure actual impact recommendations for • Make investments reports
Key Risk Indicators • Perform scenario risk management • Sell assets • Etc.
• Consider possible analysis actions (terminate, • Acquire hedges
impacts • Gather anecdotal facts treat, tolerate, transfer) • Acquire reinsurance
• Uncover possible gaps regarding risk exposure • Get feedback and • Do nothing
• Etc. • Etc. appropriate approvals • Etc.
from risk owners and
oversight committees
• Etc.
Data Information Action

GOVERNANCE

Market
Limits
Credit
EXECUTE

• Counterparties

Risk Diversification
Credit Market Product Strategic Legal & Reg. Operational
1. Characterize
the risk
distributions
2. Combine Correlations, Dependencies

distributions
EL Solvency
3. Measure Standard
required
capital
4. Attribute
capital to
products and
business units
Economic Capital

RAROC Overview
• Risk Adjusted Return on Capital - Economic view of capital adequacy and
risk adjusted returns
Total Return
RAROC =
Required Economic Capital (REC)
How much capital is needed

How much are we earning on
to protect us to a given
the capital that we have
solvency standard (AA)?
committed to our businesses?
CAPITAL PRODUCTIVITY CAPITAL ADEQUACY
Compare RAROC with Compare Required Economic Capital

Hurdle Rate (Cost of Capital) with Available Economic Capital

Enterprise Capital and RAROC Applications
• Applications
– Capital adequacy
• Including future Rating Agency capital adequacy
determination
– Performance measurement & Incentive compensation
– Strategic planning & Capital allocation
– Product Structure & Pricing
– Risk Transfer
– Expense Allocation

GOVERNANCE

Market
Limits
Credit
EXECUTE

• Counterparties

ERM Tool – Ops Risk Information Architecture
ERM Common Information Architecture

 Common Dimensional Hierarchies
Compliance (Classification and Aggregation)
 Common Metrics Definitions
HR  Common Reporting
 Common Workflow
Privacy  Shared Risk and Control Data
 Shared Mitigation Activity Data
Internal Audits  Shared Internal and External Loss Data
IT Security / Continuity
Management

GOVERNANCE

Market
Limits
Credit
EXECUTE

• Counterparties

Strategic Asset Allocation Process
ALM Modeling Investment Policy

· Liability Valuation
· Liability Cash Flow
Liability Policy Portfolio

Simulation Portfolio Targets Benchmark
Target
Analysis
DFA
Economic & Optimization Client
Capital Market & & Risk
Simulation Assessment
Risk
VaR Appetite
· Inflation · Portfolio Objectives Risk Limit

· Interest Rates and Constraints Sensitivity
· Asset class Asset · Portfolio Efficient Analysis
returns Simulation Frontiers Risk Limits
· Value at Risk &
Analysis Budget
· Investment Appreciation
· Investment Cash Flow

Total P&C Efficient Frontier
Economic Value Efficient Frontier - Base Case

End of 2010
500
J
Change in Economic Value ($millions)
400
I
H
Same Risk Portfolio 300
G
200
Same Rew ard Portfolio E F

100
D
0
-650 -550 -450 C -350 -250 -150 -50 50 150 250 350 450 550
-100
Current Portfolio
B
-200
-300
-400
A
-500
Increase/Decrease to Economic Risk ($millions)
(Relative to standard deviation under Current Portfolio)

Total P&C Efficient Frontier
Current
Same Risk A D E F G K
Asset Allocation (%): Portfolio
Taxable Bonds 65% 39% 57% 48% 44% 39% 35% 28%
Tax-Exempt Bonds 16% 40% 40% 40% 40% 40% 40% 40%
Equity 16% 12% 0% 3% 7% 12% 16% 25%
Alternative Assets 3% 9% 3% 9% 9% 9% 9% 7%
Fixed Income Duration 3.5 5.0 1.7 4.3 4.7 4.9 5.2 6.8
Change in Economic Value - % 0.0% 1.1% -3.1% 0.1% 0.6% 1.0% 1.4% 2.8%
Increase / Decrease in Risk - % 0.0% 0.0% -19.3% -7.2% -3.8% -0.2% 3.5% 17.6%
Change in Economic Value - $ - 171.1 (492.2) 19.1 97.6 166.7 230.8 441.6
Increase / Decrease in Risk - $ - 0.0 (601.1) (224.9) (118.0) (6.6) 108.2 545.3

Asset/Liability Interaction
• Think of liabilities as negative assets

– Expected duration based on historical payout patterns
– Actual duration includes systematic and idiosyncratic volatility
• Inflation sensitivity
• Residual volatility
– Claims practices
– Mix of coverages/perils
– Litigation practices
• Impact on efficient frontier driven by several characteristics

– Inflation sensitivity and responsiveness
– Payout pattern (expected duration)
– Volatility of duration

Inflation and Economic Value
Avail. Econ. Capital (end year 4) $35bn
$30bn
$25bn
$20bn
$15bn
$10bn Average inflation (years 1-4)

-2% 0 +2% +4% +6% +8% +10% +12% +14%
In low inflation environments erosion of Nationwide is able to increase Nationwide not able to reset premia significantly
AEC is driven by catastrophe risk premia to keep up with inflation enough to protect AEC in high inflation or
changes inflation changing regimes

Asset/Liability Management – Inflation Modeling
• Investment portfolio optimization requires a defined view of inflation

sensitivity and responsiveness with respect to reserves and new
business
• Generally, losses have a low correlation with inflation, but a high
sensitivity to inflation
• Key questions:
– Inflation Modeling
• What is expected inflation over the model horizon?
• What is inflation volatility over the model horizon?
– Liability modeling
• How sensitive are your reserves to inflation? New losses? If less than fully
sensitive, why?
• How does expected inflation change when actual inflation occurs?
• How quickly does pricing react to a change in expected inflation?

US Inflation History
US CPI and CORE CPI inflation

% y-o-y
16
Inflation: low and stable Inflation: high and persistent Fed inflation fighting, core inflation falling
14
12
10
8 CPI avg: 6.6%
4 CPI avg: 3.1%

CPI avg: 1.4%
2
-2
52 55 58 61 64 67 70 73 76 79 82 85 88 91 94 97 00 03 06
CPI CORE CPI
2
Enterprise Risk Management – Role of Actuaries
• ERM provides actuaries with an opportunity to use their

understanding of the business and its risks to increase their
strategic role within the organization
– Data provider
• Limited – Reserves, ultimate losses
• Expanded – Payout patterns, volatility assumptions, correlations
– Subject matter expert
– Risk model developer/owner
– Risk management partner
• If the actuarial profession doesn’t step up to the challenge of
ERM, others will. Who understands the business better than
you?

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DEPARTMENT NAME

Enterprise Risk Management

Enterprise Risk Management at

• Clear roles and authority

… in the context of achieving our • Link to strategy / planning

September 11, 2008 Page 2

September 11, 2008 Page 3

Legal, Regulatory, & Compliance

Identify Measure Analyze Manage Monitor

Infrastructure Communication External Environment

• ERM Tools • Internal Risk Management • Rating Agencies & Regulators

September 11, 2008 Page 4

 Business areas retain accountability for managing their own risks

 Proactive rather than reactive

 Independent assurance (e.g., Independent Audit)

 Clearly assigned responsible / accountable parties

 Transparency of accountability, communication, decision making,

 Regular re-evaluation to ensure appropriate evolution

September 11, 2008 Page 5

Legal, Regulatory, & Compliance

Identify Measure Analyze Manage Monitor

Infrastructure Communication External Environment

• ERM Tools • Internal Risk Management • Rating Agencies & Regulators

September 11, 2008 Page 6

September 11, 2008 Page 7

Capital Volatility Severe Downgrade Insolvency

Examples of • High inflation environment • Large catastrophe • Large catastrophe

Severity Severity Severity

September 11, 2008 Page 8

Capital Volatility Severe Downgrade Insolvency

Model Economic Rating Agency Rating Agency Economic Rating Agency

Horizon Multi-year Multi-year Single year Single year Static

September 11, 2008 Page 9

Enterprise Required Economic Capital Dynamic Financial Analysis (DFA)

September 11, 2008 Page 10

Legal, Regulatory, & Compliance

Identify Measure Analyze Manage Monitor

Infrastructure Communication External Environment

• ERM Tools • Internal Risk Management • Rating Agencies & Regulators

September 11, 2008 Page 11

Identify Measure Analyze Manage Monitor

What do we want to do Did the management

Data Information Action

Legal, Regulatory, & Compliance

Identify Measure Analyze Manage Monitor

Infrastructure Communication External Environment

• ERM Tools • Internal Risk Management • Rating Agencies & Regulators

September 11, 2008 Page 13

Credit Market Product Strategic Legal & Reg. Operational

2. Combine Correlations, Dependencies

September 11, 2008 Page 14

How much capital is needed

CAPITAL PRODUCTIVITY CAPITAL ADEQUACY

Compare RAROC with Compare Required Economic Capital

September 11, 2008 Page 15

September 11, 2008 Page 16

Legal, Regulatory, & Compliance

Identify Measure Analyze Manage Monitor

Infrastructure Communication External Environment

• ERM Tools • Internal Risk Management • Rating Agencies & Regulators

September 11, 2008 Page 17

ERM Common Information Architecture

September 11, 2008 Page 18