Solvency II - 7 year transitional periods, white noise and Omnibus II on the move

A particularly weird week for Solvency II, with more aimless racket than a drunken tennis player, yet only a slither of substance to it.

Ignoring if I may the robust line being taken by the UK Pensions Minister about occupational pension schemes falling under Solvency II and the Daily Mail's scare piece on annuities becoming potentially more expensive, the big story has of course been Burkhard Balz's alternative for life insurers (presumably on the trialogue table for longer than the last couple of days, but leaked this week to FT Deutschland for the scoop) to transition in the more onerous capital aspects of Solvency II over as many as 7 years.

Bearing in mind the rather blase attitude at the time towards extending the Omnibus II plenary vote to September ('all they are doing over the summer is technical drafting' was the party line), to have something so significant being kicked around the table at this late stage is a truly grim prospect, particularly if it is loaded with national, rather than pan-european considerations.

Of course, conjecture around knock on effects on the legislative timetable is only as good as its source - hence I have linked through to the Omnibus II procedure file, which has been updated to reflect a late October plenary vote (when it was previously Sept 2012, July 2012, April 2012, Jan 2012 and Dec 2011!).

I'll leave it to the experts to work out whether 2014 is realistic given the trialogue curveballs and the phantom plenary...

FSA Annual Report and Business Plan - Solvency II coverage

Our friends at the Wharf have had a busy week, throwing out a multitude of paperwork with some nuggets of gold deep within - this post covers their annual report and workplan. Pretty light on Solvency II-specific material to be fair

From the FSA 2012/13 business plan, I noted the following;

• Still talking about transposition from 1st Jan 2013 (p13) - typo, or just written before Solvency 1.5?
• From p32 Insurers should expect "detailed reviews" of their risk management arrangements and internal models; with-profits business reviews from a PRA and FCA angle; underwriting and reserving controls at GI firms; and use of "external tools" in challenging senior management (citing their use of section 166 of the FSMA as an example, but not certain what else they are suggesting).
• As well as standard Solvency II work on L2 and L3 etc, they will conclude their consultations on the FSA handbook transition.
• Special levy for Solvency II will be £25.9m for the next year (and they continue to use their £100-£150m parameters for their overall Solvency II spend, which is liberal at the top end given the £110m figure they mentioned in the SOLPRU document).
• Consultation paper around Solvency II expected out at the end of this month (table on p83)

From the annual report and appendices, the following;

• Reiterates the Jan 1st 2013 date for transposition (p39) - again, I though Solvency 1.5 effectively moved that date to July 1st?
• £23m of Solvency II income booked (p137)
• In their Diversity Report, it would appear that their profile is sadly similar to many firms, being top heavy with blokes and bottom heavy with female administrators (p2). Making some headway on the ethnicity mix though (p8), and getting a little older in aggregate (p14), perhaps a by-product of all of the young bucks leaving to work on Solvency II! Also touches on sexual orientation, religion  and disability, so I highly commend this genuine look at diversity, rather than allowing gender to dominate it.

While they still haven't got to grips with the staff turnover issue, the levels of turnover that most Solvency II projects will be experiencing will be no different, so I suspect throwing more money at the issue wouldn't do much good (which the chief exec effectively said at the Treasury Select Committee in November)- the benefit of this frugality is a lower than expected industry levy, so fair play to them on that.

What is perhaps less convincing is the £150m tag to split the regulator into the PRA and the FCA - that's one expensive axe Hector...

StoneRiver Financial Regulatory Survey - ERM and ORSA in the US

An interesting US perspective published today touching on the near term future of ERM and ORSA reporting in the States from the guys at StoneRiver (need to fill out a little form for the download).

They are of course attacking it from a "buy some reporting software" perspective so the questions are a touch loaded, but the findings from the survey (68 in the sample, majority of P&C insurers) are certainly sobering for the NAIC, namely;

• Only a quarter were confident enough to state that they had a formal process for ERM, including reporting
• 44% claim to have "in-house expertise" on ORSA, despite the requirements being in a state of flux (guess I'm not getting a green card anytime soon!)
• Only 40% were confident that their existing software will efficiently handle ORSA reporting requirements

Bearing in mind when I blogged on the draft NAIC ORSA manual in November the regulatory filing aspect was heavily emphasised, the combination of undocumented ERM processes and software fallability may be cooking up an administrative nightmare for the insurance industry over there - welcome to our world!

Lloyds of London on Validation - Workshop Output

For all of you working on one of the FSA's (and indeed I suspect other supervisors') pet peeves, Model Validation, the Lloyds guys published some slides from their recent workshop on the topic.

Anyone not in the IMAP space may still find their presentation of interest, particularly as they have already had to ask for 3 months leeway on their original application "landing window", perhaps hinting at the enormous complexity and expense of producing material to support a successful model application.

They start with a "Top 5" ways to improve existing validation practices, rather worryingly stressing coverage and ranking, which one would think would be par for the course rather than something which required additional emphasis. They go on to hint at, if not confirm;

• That both analysis of test results and subsequent escalation has been found to be lacking during their validation dry run
• That historical syndicate experience is "always necessary" in modelling, even if not sufficient on its won
• An over-reliance on sensitivity testing using pre-defined SCR ranges
• Their recommended materiality hierarchy of validation tests
• Their take on reserving risk (not my forte, but dig in if it's yours)
• Their take on correlations and the diversification matrix (interesting bit on diversification in the tail)
• That their model walkthrough exercises brought up material issues for "most" agents, and that clearly some syndicates have been asked to complete remedial action before the end of this month
• That they are waiting for L3 before reviewing their validation reporting formally.

Not sure whether this keeps the guys on track for their group application, but certainly not an unhealthy thing to be picking up such flaws at this stage - if it was that easy, everyone would be doing it!

ORSA guidance materials from CRO Forum and Lloyds - any help?

It is always nice to get a bit of friendly steer around ORSA when the powers that be stubbornly refuse to give us boxes to tick!

Released over the last week or so came two such documents, one from Lloyds of London and the other from the CRO Forum.

The Lloyds effort is of course tailored for their syndicates, but the areas they emphasise clearly have merit for any organisation which is embarking on the ORSA adventure, whether sponsored by Solvency II, IAIS ICPs, the NAIC, or indeed any other random acronym! In particular I liked;

• Clearly set out an explanation to cover difference between regulatory and economic capital measures
• That while the ORSA Report would be expected to set out the impact of shocks over the medium term, this does not imply that a multi-year model is required (anyone struggling to keep it stochastic after year 1 would be relieved to hear that!)
• Small set of simple questions which one might like to ask their Board after they review the report in order to establish use
• No specification on size!

The tables which make up the bulk of the document should be a useful reference point for anyone with an inferiority complex, as it highlights gaps which have been identified during their own QA work, as well as suggesting remediation. Appreciating ORSA is only required for IMAP from a use test evidence perspective (which they comment on in the Q&A in the appendix), any chance that these gaps contributed to the delay in their submission?

The CRO Forum paper on the other hand tries to cater for both the poachers and the gamekeepers by summarising observable best practices from regulatory-themed bodies (who I suppose will ultimately determine what's hot and what's not on the matter). From their doc, I noted the following;

• Potential divergence between what lobbyists said about ORSA supervisory report when feeding back on Level 3 (i.e shouldn't differ from that presented to the AMSB, otherwise what would supervisors be considering it against) and the CRO Forum (who expect it to be a "summary of the results of the ORSA assessment") - doesn't feel like semantics the more I read it, so worth highlighting
• Value of the ORSA Report for the AMSB is covered in a few paragraphs, which is always handy for board/senior management briefing
• Strange bit around internal approval of ORSA reports, stating that the AMSB should review but not approve the ORSA Report, and that this is as per Level 3 - worth some attention if you have structured your ORSA governance around Board sign-offs of the associated reporting
• An "illustrative purposes only" ORSA Report structure, which has no more or less merit than any others you may have seen, other than it is less granular than some which have emerged publicly from consultancies etc
• Tips the hat towards leveraging RSR and ORSA administrative efforts in order to reduce duplication.

Whether or not you gain something from reading these materials, it's always nice to know someone is having a go!

Elderfield speech to Insurance Day summit in Bermuda - equivalence, model approval and "hub and spoke"

Very informative speech delivered this week by Mr Elderfield from the Central Bank of Ireland to the Insurance Day summit held in his previous stomping ground of Bermuda (certainly a more welcoming climate that last month's summit in not-so-sunny London!).

He mainly covers equivalence, internal model applications and, as one might expect from the Emerald Isle, the potential for Hub and Spoke operations and the potential capital benefits of this technique (which has a sniff of Group Support about it in all but name). I noted the following;

General

• Suggests Solvency II provides "...an incentive for investment in risk management, including the use of internal models" - I would substitute "incentive" for "compulsion"!
• Singles out "small firms" as those which will "certainly" struggle to assimilate and implement Solvency II in its current guise
• Notes that "...the current target is that member state governments will domestically implement [Solvency II] by 30th June 2013" - I have emphasised the "current target", as the very wording suggests that there is an implication it is not the "final target"!

Model applications

• "...it is important that approval process doesn't get bogged down in detail such as endless documentation reviews" - cue some raised handbags down at Canary Wharf I suspect!
• Highlights expert judgements around correlation and diversification (as he has done this time last year) as being much more significant around challenging the solvency requirements calculated by the models, in particular the "swing" these elements have on the final numbers. On that premise, he puts these "...at the forefront of the regulatory approval process", as well as expecting them to generate the most challenge in the boardroom.
• Elaborates on the extent of Board challenge by commenting that "...boards should be expected to challenge vigorously the amount of diversification benefit being claimed in internal models, even if they don't know the internal plumbing of copulas or correlation matrices". Very telling comment, and clearly one to heed, bearing in mind he is on EIOPA's management board.

Hub and Spoke

• Seeing "considerable interest" in using Ireland for the "hub" of the "hub and spoke" business model - one may have said this was for regulatory arbitrage purposes 5 years ago, but I'm guessing corporation tax, falling wages and underemployment may have kept it in play even after the recent beefing up of the CBoI
• Comments that "...it will be interesting to see whether [the hub and spoke] model will grow as Solvency II gets closer to implementation - implies that not only does he think the existing corporate structures are not settled yet, but that Ireland is actively open for business in this regard.

Equivalence

• Not sure if he was just being polite to his hosts, but he commented "...Bermuda is very well placed for [the equivalence] assessment process" - again worth heeding in the context of his position at EIOPA, as well as Bermuda coming off worst of the 3 countries which have been assessed in wave 1.
• Suggests there should be some sort of early adopter's premium for Bermuda which makes it worth being ahead of those countries who may come in in wave 2 (no mention of one of their competitors Guernsey in this context, who continue to bang the IAIS ICP drum while stating categorically that they will not seek equivalence).

Good intelligence all in all - PS must try and swing an invite to one of these things when they go tropical!

Barnier speech to the Insurance Europe conference

Msr Barnier put a few words out for the great and good the other week at the Insurance Europe conference, which have finally been published for the proletariat on the EUROPA website this week. As well as touching on the conjoined matters of IORP and IMD, he wades into Solvency II in a pretty forthright manner (driven by the increasingly fractious and desparate attempts of the EU to jump-start economic growth, and what the Insurance industry can do to aid this), noting;

• Solvency II should not prevent or discourage investment in certain asset classes per se
• Insurers with long-term guarantees should therefore be rewarded (via a reduced capital burden) for investing in long-term assets, and that Omnibus II should mop up outstanding concerns from individual countries.
• That politically, the EU Parliament has had plenty of time to reflect on Omnibus II, and their tardiness has ultimately led to the need for Solvency 1.5

Interesting to see real world politics and probles interacting with the legislative timetable, and in particular how quick the Commission have been to point the finger at their Parliamentary pals when under duress!

Risk Appetite benchmarking study - Grant Thornton

Very neat release from Grant Thornton this week, trying to capture some of the juicy Risk Appetite space which corporate governance codes and indeed Solvency II is making particularly profitable.

The sample is reported on their website to be 43 CEO/Director-types from the London Market, hence the content isn't quite as picture perfect as a conventional life insurer may want, but the findings are very important for anyone who is in the thick of Risk Appetite Framework construction, refresh or replacement as we speak (which must be the majority of you, surely!).

Both ORSA and a general interest in understanding what one's neighbours were doing in the area of Risk Appetite Frameworks and Statements seems to have been the driver to participate, although strangely the corporate governance angle (whether it be UK code or indeed non-Solvency II EU activity) wasn't mentioned.

Elsewhere of note, I spotted;

• Average 12-18 months to get a Risk Appetite Framework (RAF) signed off - from a standing start, that seems fair, bearing in mind the educational aspect is one which, from my experience, is massively constrained by pre-existing committee agendas which simply cannot (or perhaps will not) yield some additional time for coaching.
• Wonderful split in perceptions between actuarial-led and risk-led RAFs. The actuaries are perceived to lend more weight to insurance and investment risk, use more quant in their synthesis, and as a result deploy the frameworks more effectively. The risk profession came off worse in this head-to-head, with a stringer focus on qualitative elements and operational risk. The actuarial approach was also observed to exert "more discipline, and in general demonstrated greater progress". Never mind, we'll win the war!
• Instances where Risk Appetite Statements have been flexed in order to accomodate business cases which have been successfully presented to the Board. I seem to remember flexed limits (off the back of successful lobbying/inept challenging) causing Lehmans a problem or two a few years back...
• Approaching the setting of limits in the Risk Appetite Statements from bottom up, using business plan content, appears to have been more successful than cascading down. Some debate about whether the tail should wag the dog here is also included.
• Approach to Credit and Operational Risk was observed to be application of fixed limits for losses, as these are seen to be necessary evils in order to be in business.
• Use of previous years results in setting some limits/tolerance levels seems to be common practice - not sure how that tallies with top-down/bottom-up approaches to rolling a framework out, but one might expect to see some element of projections in this activity.
• Sadly, insurers were observed to be afraid to fall behind or indeed trailblaze on the matter due to fears of additional regulatory scrutiny. I truly hope that is a misplaced fear, and not a by-product of the zealousness of the pre-Solvency II regulatory interface.

Thanks GT, looking forward to the next one, but with a wider sample and a few more stats ideally.