Aon Benfield's CRO guide to Solvency II - in case you're not ready yet...

For all those CROs who are about to get left holding the Solvency II baby three years early by their over-enthusiastic executive colleagues, Aon Benfield pulled together a CRO guide to Solvency II which aims to take the journey "from complexity to best practice". 10 out of 10 for ambition...

It leans heavily towards General Insurers/Reinsurers (indeed it reads like a reinsurance sales brochure in many parts!), but nevertheless contains a suite of very useful content for anyone in the Risk space, as well as attempting to shatter a few myths. I took the following from it;

• Steady early bits on capital planning and common questions a CRO should be posing in that space
• On page 5, an excellent table comparing standard formula against internal modelling by risk driver, in particular emphasising why internal modelling may be more appropriate, rather than how much capital it could shave off. Being able to explain to the national regulator why one has neglected to apply the enhancements that internal modelling introduces to the accuracy of one's quantitative risk profile would be a smart thing for CROs to practice!
• The undo some of that noble work by suggesting part of any IM feasibility study should include estimating the capital benefits!
• Nice examples at the top of p6 of what mixes of business lend themselves to benefitting from an IM approach
• Highlighting that domicile of firm continues to dictate feasibility of IMs for smaller firms (i.e some countries can't staff it!).
• Recommend reviewing SF SCR factoring in the draft L2 asap. As was clear from the E&Y research I covered yesterday, many firms across the EU consider themselves to be advanced in the Pillar 1 space while disregarding draft L2. They highlight the Swiss experience as one where they struggled to authorise models for "Day 1" approval, and the Aon crowd propose some meaningful contingencies on p8
• Useful analysis of capital drivers and optimisation strategies (p9-10)
• Section on expert judgement validation (p15), touching on the Level 3 expectations, and in particular how a (non-Actuarial) CRO may struggle to adequately challenge certain judgement calls, such as selected data series or correlation matrices, without specialist advice. Very hard for smaller firms to obtain that, as most of their actuarial function will have probably contributed to the judgement!
• Note that one of the key challenges for documenting the IM is getting the best-placed people (who are normally swimming in BAU) to pick up a pen and write!
• Neat section on ORSA (p27-29), emphasising that SF firms with complex risk profiles may find they struggle to justify that approach when concluding the assessment. They go on to suggest that early experiences of ORSA Report/process documentation submissions have left CROs feeling that the regulatory approach is (Level 3?) tickbox as to content expectations.
• Key challenges for CRO in briefing and educating senior colleagues for Solvency II-readiness are all fair, in particular the gap that could emerge if a CRO is not also an executive member.
• The section on Risk Appetite is particularly useful for smaller non-IMAP firms, who may struggle to quantify their target measures - whether using Standard Deviations/volatility measures as suggested is a touch too simple depends on the business I guess.
• The Pillar 3 section hits on the same issues I (and the FSA!)have picked up on earlier, such as end-user computing, inability to transition to BAU, data ownership issues etc.

I did take exception to a couple of bits in here, where the industry or indeed common sense appears to suggest otherwise;

• The "fallacy" outlined on p5 that an IM enables a firm to hold less capital than an SF equivalent. The research I pointed to yesterday (p20) suggests across the EU that modellers are already "making it rain" with their capital savings
• That the IM alternative for Op Risk is based on ORIC and individual loss event info. I'd certainly seen Milliman suggest that this approach is as flimsy as the SF approach, recommending options such as Bayesian networks to generate IM inputs.
• Concerns that evidencing senior management model "use" could create a "value-destroying documentation burden". Is that what we call "minutes" these days!
• Comments around the documentation delivery for the Internal Model Application Process becoming detached from the underlying processes referenced in those docs influencing BAU value-adding activity are perfectly valid, but no real solution is proposed.
• The operation of the Model Change Policy features heavily (p19-21), as anyone in that space would expect. Again. little offered in the way of solutions, but I certainly would have expected more discussion on the "scope" of the model, which in my experience is a solid, liquid or gas depending on which control function you speak to, and I'm sure the FSA would agree!

PS All the best to you guys on the US East Coast, let's hope the worst has passed...

Ernst and Young European Solvency II survey - the storm before the calm...

So Ernst and Young have decided to join the party with one of the more noble attempts to gather EU-wide industry opinion on progress towards Solvency II compliance, and kindly published those findings recently. Yes, I understand that this survey came out over a week ago, but I left my notes in the Isle of Man last Monday, and I'm not so enthusiastic that I fancied another turbo-prop into Ronaldsway Airport to 'go fetch'.

There was naturally plenty of media comment on its content (here, here and here for a start, but I'm sure you can do better), but bearing in mind it was released with a backdrop of 2015/2016 and the moveable feast that is UK IMAP, one could be forgiven for not caring less about the results that point to preparedness 'by 2014'. However, the E&Y guys obviously stayed up all night to do it, so I gave it the once-over and noted the following;

Sample - 160+ respondents from 19 countries, about as volumous as I have come across, though clearly weighted towards medium/large firms (€100m+ premium income per annum), and what we might call "old" Europe.

General

• 90% reckoned they could be compliant by 2015 (though E&Y say that is the date proposed by the EC, rather than to it)
• High level of confidence around Pillar 1 and Pillar 2 preparedness, though shockingly two-thirds of respondents did not use the draft L2 rules when producing their balance sheet, which makes you wonder what constitutes "ready" in some countries! 
• 80% not meeting Pillar 3 "requirements", with loose use of the expression "all requirements" for (as mentioned for Pillar 1, is this 'Level 1 plus draft Level 2', or 'Level 1 plus EIOPA advice'?). One of the worst affected areas is the development of a Disclosure Policy, which I find as understandable as I do sad.
• Almost 70% have only met some of the data quality requirements - I'm sure the national regulators, in particular the FSA, would wince at that, even factoring in an extension.
• Very interesting stat on the number of respondents developing Partial Internal Models (around half), with half of that number again looking for, what was at the time, "Day 1 approval". I wonder if the likely shift of "Day 1" to 2015 or 2016 allows these figures to flex, and if the national regulators are staffed to cope with it?
• "Range of capital optimisation strategies" will be applied by the majority of respondents in 2013 - curious to know why firms would not optimise their capital deployment as a matter of course!
• Larger organisations said to be tailing off expenditure during 2013 and have delivered compliance by mid-2014. Will an extension simply elongate existing expenditure plans or require fresh budget, and indeed how many times can one go 'back to the well' on this?
• ORSA is by some distance the biggest laggard in the Pillar 2 space, with only 30% "mostly" meeting requirements as they stand. Can only imagine the question was asked before EIOPA came back on the L3 public consultation in June, as EIOPA were pretty clear on what to do next.
• Some pretty flabby words on Data and IT readiness, but easy to get the general picture of "not very good" progress, particularly in the end-user computing space (three-quarters

E&Y angles

• Clearly lobbying for recalibrating long-duration debt (p5)
• Bit of scaremongering for smaller companies on their resource estimates (p6) - shake them down all you want, they just can't afford you!
• Strange bit of touting done around a lack of formal assessment around the effectiveness of one's Risk Management System (p12) - don't believe this is compulsory, only that your Risk Management System is effective.
• Also fishing hard for what was previously low hanging fruit around documentation, data governance and use test (p20).

Internal Model - specific

• Two thirds of French and half of German internal model applicants not fishing for "Day 1" approval - not sure if this is due to BAFIN and the ACP playing hardball (already seen an instance of a modeller fleeing Germany), but an extension to 2016 puts them back in the game for "Day 1" surely.
• Some expected discontent, though not in the majority, around the current SF risk calibrations (Op risk too low, underwriting and market too high). Even number found credit risk too high and too low, perhaps reflecting thought on long duration corporate debt and Eurozone government debt respectively.
• Nearly 80% of respondents expect the IM SCR to be at least 10% lower than SF SCR.

Worth adding as a footnote that 14% of UK respondents thought they'll be ready for implementation "in the course of 2012" - without Level 2 kiddies, are you sure!

FSA's Adams on Solvency II delay, IMAP and ICA - how long do you want lads?

It would appear that stabs in the dark on the Solvency II implementation date by senior insurance industry officials are like British buses - after the omerta-like silence of September, no fewer than three bigwigs have piped up in the last few days. First Sr. Bernadino decided to do his briefing via a Stateside publication, settling on 2016 as most probable, followed by Sr Montalvo who concurred (along with a great joke about his missus!).

While it didn't take a handsome Archaeology graduate to know that 2014 was ash, what the industry likes more than anything is cold, hard confirmation from their friendly national supervisor...

...which came today! Julian Adams gave a speech this morning ostensibly about the practical side of implementing the PRA's new approach after they get divorced from their FCA counterparts next year. Worth bulleting the big messages on IMAP;

• Current timetable "completely unrealistic" after Plenary postponement confirmed last week
• 2015 "...likely to prove very challenging"
• FSA will agree a revised landing slot with IMAP participants (presumably just those who have yet to submit?), UP TO A MAXIMUM OF END DECEMBER 2015.
• Will change this to match up with what comes out of Brussels if the two are divergent
• For ICAS, "we will have to live with the current regime for longer than any of us expected"
• The previously stated "aspiration" of potentially replacing ICA with internal model SCR will be formalised into a two step process. First, reconcile ICA with IM SCR (the easy bit!), then once the FSA are sufficiently happy, just produce IM SCR.
• Retain discretion to apply ICG throughout the interim period
• Benefits of this approach will therefore include much meatier pre-application evidence of use.

Hard to know where to go with this. Great news for anyone who remains on target for their original landing slots, as there is potentially some early-adopter capital benefits if they can abandon ICA. That said, the recent E&Y industry survey (which I will look at separately) suggested the Brits are mostly in a good spot for IMAP, so does extending the window negatively impact on the work already delivered? Certainly opens up a rather pricey Pandora's box around Validation activity which I'm sure many firms would have been delighted to have paid for one-time-only!

All in all, these public declarations will be welcomed by everyone who isn't writing a cheque for next year's IMAP activity...

Solvency II implementation delay - round up

"No news is good news" so goes the old motto, but in the case of this blog, "no news is new news"! After last week's sneaky peek at the options presented during trialogue discussions, the inevitable change of  EU Parliamentary Procedure file for Omnibus II was duly applied, and will now be discussed at the Plenary on March 28-31^st 2013 (honest).

That wouldn't have ruled out either of the options on the table of the Trialogue parties at the moment, but they might struggle to squeeze in an impact study on LTGs and publish the findings between now and March, particularly after it was made publicly clear by one regulator that EIOPA were not going to start that work as scheduled. The EIOPA lads did push out the tech specs for balance sheet valuation today though, which should at least get the frog out of the box.

 

It would have been a push to complete the study and leave enough digestion-time by March-end even without a late kick-off, so our friend Sr Bernadino has happily corroborated the "Big 4" speculators and faceless "sources" promoting 2016 as the new "go-live" date by giving his own counsel to the Wall Street Journal (cited in this non-paywall article). His preference for 2015 is qualified with the probability that 2016 will prevail.

 

While thumbing my nose at the Reuters article above, it does make the link between postponement and the Commission's desire to immediately spur longer-term investment in a stagnating, rioting, semi-employed Eurozone (which is much easier without Solvency II's heavy embrace, particularly the calibration of capital requirements for long duration debt instruments which the document referenced in this post covers all too well).

 

However, for DG Faull to effectively command a recalibration of that element now the going is a bit better makes you wonder how many more cherries we are going to pick - un deux trois, nous irons aux bois...

Society of Actuaries in Ireland on ORSA - a rock in a sea of turmoil

In these days of certainty around the Solvency II implementation timetable (i.e. certainly not 2014!), it’s nice to cling on to the consultant's comfort blanket of ORSA which, thanks to the IAIS and NAIC, isn’t disappearing in a hurry for global insurers. This item flagged on the SAI's newsletter last month, but dating back to April, would benefit anyone working in the ORSA space, being a "practical considerations" guide which is very accessible for non-actuaries, particularly for assessing or challenging options for the required ORSA processes.

 

The document takes care to reference the at-the-time EIOPA guidelines in each chapter (which would have been superseded by June's release of course, but didn't change seismically), and does an excellent job of focusing on required processes as opposed to ORSA Reporting, which these types of papers often do. Worth reading all but noting the following;

Overview

·     Proportionality - remember justification of approach is as important as executing the selected approach itself.

·     Documentation - "...Traditionally, this is not an area of strength for actuaries" - I'll drink to that!

ORSA Contributors

·     "It is likely" that Risk will co-ordinate the process. This logic follows on from the IRM’s survey findings (p2) which saw Risk as predominantly leading early process development, and there is nothing to suggest the other candidate functions are likely to be sufficiently staffed in the BAU world to both actively participate and co-ordinate.

·     Board as "owners” of the ORSA – this is an important point which, for practitioners, is awkwardly inferred by the Directive text, rather than spelled out. Indeed this document later goes on to say the Risk function "will likely be the owner of the overall ORSA process".

This gruesome melange of who owns what in the ORSA space (and indeed what 'ownership' confers), remains a little too common in thought papers like this, so be certain to define these elements in your ORSA Policy.

·     Capital Management function - "ORSA is the process where risk and capital management get together" - get a room you guys!

Policy and Process

·     Generally a very clean and useful section, particularly around "dynamic" and "static" processes and their outputs. Section on ORSA Report content is less useful, being based on the 2008 issues paper, and there are plenty of papers covering that topic (sift through yourself!).

·     Projection process - No suggestion of whether recommendations from balance sheet projection activity should be balled up in the ORSA Report or reported separately as part of conventional committee/Board reporting. I always found this element a nuisance to pin down, as one wouldn’t necessarily want to present material of such significance in a 20-200 page ORSA Report if it meant it didn’t get the appropriate table time at strategy days etc.

Economic Capital 

·     Practical obstacles - all seem to revolve around there being a shortage of actuarial time/resource. Well get off my land and go do some counting then!

EC and Risk Management

·     Document is a little unclear around risk appetite framework/risk management framework/risk management system terminology, which is a little unhelpful

·     Interesting comment regarding non-quantification of risk that "risks cannot be quantified" rather than "risks cannot be quantified easily" – this is an actuarial paper, you guys can quantify anything, surely!

·     Define reverse stress testing as "testing to destruction" - the UK definition is more discrete than this, and certainly more useful for stimulating debate in Board exercises

ORSA Projections

·     More industry consensus on what 'business planning period' constitutes, being 3-5 years. Barely seen anything to suggest firms venturing outside this window for projection purposes.

·     Nice simple explanation of the component parts of the economic balance sheet which should be projected as well as recommendations for projecting risk appetite metrics and the P&L.

·     Suggestion that, unless already stochastically projecting, firms will project deterministically, "unless the company is planning significant changes to its future business mix". Judging by the jostling for position around Long Term Guarantees right now, is that not likely to be quite a few!

·     Acknowledge that the approaches already used for Financial Condition Reporting should be leaned on for smaller or less complex entities.

Scenarios

·     Reverse stress testing has grown into a different beast from that reference earlier in the piece, incorporating "back-solving" (new one on me!), and looks for events that reduce own funds to zero - not sure I've heard RST defined like that before, and certainly not convinced that own funds of zero necessarily constitutes "destruction"

·     Good recommendation for selecting scenarios from emerging risk assessments as well as a firm’s existing quantum – best not to take the path of least resistance in this area of ORSA.

Omnibus II and the inevitable delay - why it's not so clear cut

Fantastic work over on the Solvency II Wire from Gideon on the meat and potatoes inside the eternally-baking Omnibus II pie, illustrating why the trialogue parties haven't just rolled over and declared 2015 as the new 2014.

While it would appear that the lobbying arms at Insurance Europe, AMICE, GCAE etc haven't piped up on industry preference yet, it looks like we have two deeply unpleasant alternatives to look forward to; hard launching a year late (i.e Omnibus II would only get signed off after the recently requested LTG consultation but 2015 would be the definitive "go-live"), or soft launching with 2 years parallel running (i.e. Omnibus II can go through before the LTG consult is finished, but with the sword of Damocles hanging over its contibution to the regulations until 2016).

My guess would be that there is little appetite in the firms for parallel running Solvency I/Solvency II to 2016 based on the administrative burdens this would currently place on the UK in particular through the current ICA process. A 'hard' 2015 and some more effective leadership in Brussels would be welcome relief to Solvency II Programmes from a planning perspective, though the knock-on effect on the model approval process and other scheduled supervisory work is yet to be seen.

Oddly, the EIOP-ians of the world pushed out the 2013 Work Programme this week which of course skips over any of the practicalities around such a delay - so having "already achieved a great deal" in Solvency II prep, they will "finalise the [53] standards and guidelines" currently required of them, set up an "internal model support expert unit", and "finalise the preparation of the [supervisory] Colleges" - and all of this while Rome burns!

It is a perverse situation when a subject as politically divisive as capital requirements for long term guarantees across the union is not as complex as trying to get three well-briefed parties around a table to agree on an implementation date. At a time when the Commission wants an inflation-busting funding rise (which Parliament have 'ole'd through) and EIOPA have grown in headcount and cost by 50% y-o-y, the alarming regularity with which national self-interest and horse-trading has derailed a project of such significance makes me long for the jingoistic certainty of the Corn Laws - I'm guessing that's not a good thing...

Deloitte with more on the US-of-ORSA

Billed as a "regulatory guidepost to the future", Deloitte in the States have published their thoughts on ORSA developments, following on from recent activity in the space, most notably the NAIC's adoption of the RMORSA Act a few weeks back.

Hard to tell whether Deloitte have borrowed much from their European counterparts, who ponied up with the EIOPA-compliant equivalent document last week, but both documents ultimately point at the same end goal, namely getting the ORSA Process and ORSA Report content right.

Confidently declaring the first regulatory filing of an ORSA Report to be precisely, errr, "Sometime in 2015", the stateside plans are anchored more to ERM and, I guess by association, ratings agency implications. The document does help identify a couple elements which, with the Solvency II hat on, are easy to forget;

• IAIS ICP 16 is bringing ORSA to the table of all signatories at some future juncture (which means I may get a job back home one day!)
• Existing techniques for monitoring solvency, even in a jurisdiction of this size, are seemingly past their sell-by-date in terms of both content and turnaround time (p2) - holds true for many of the Solvency II-covered countries as well (plenty on that topic in here).

The rest of the document draws out the preparatory work which firms should be undertaking, despite the relative lack of certainty at this point in time, such as increasing real-time data availability and changes in reporting, management and governance structures. It also touches on suggested content, process implementation (more like formalisation from experience), and a checklist of operational considerations, resourcing (or even briefing/coaching) being highest priority in my mind in 2012.

Good document for you statesiders to pass round your friendly non-executive directors anyway, as an early socialising of the concept in this format goes a long way when you have tiny windows to educate them on the topic over the next 3 years - looks like you will be filing ORSA Reports before we are!

Interesting footnote is that AIG have been labelled as a potential SIFI today - ORSA may be 5 years too late to have saved the behemoth it once was, but let's hope it can help its slimmed down current-day version.

FSA on ongoing appropriateness of internal models (which aren't appropriate yet...)

Ploughing on regardless like a John Deere with a lobotomised driver, the FSA continue to work on their plans for ongoing appropriateness of internal models after Solvency II goes live. Having put their initial ideas out for feedback in June, they have this week provided an update on responses received, which hinted at a few things;

• IMAP Participant apathy - 10 responses (attrition rate is potentially rising these days, but we must still have 60-odd with skin in the IMAP game, so that feels pretty lousy)
• That inappropriateness would only be to a firm's benefit, hence the supervisory response to its detection "in all but exceptional cases" will be a capital add-on (PS if 'inappropriateness' is a word, I'll mange my chapeau, but I'll stick with it for now).
• That the early warning indicators planned will form part of the FSA's BAU Supervisory Review Process alongside "in particular" model validation results - any danger the early warning indicators may therefore be used informally in the pre-application work? They do go on to stress in the letter that they "do not intend" to use early warning indicators in the initial approval process, but bearing in mind no-one showed up for round 2 of the three-way today, we're all eating at a pretty moveable feast right now!

The link between early warning indicators and validation results is probably the big message in here - could verging on breaching the % tolerance, plus a negative validation report, lead to a capital add-on in 2014/2015/20XX?