Thursday, 18 October 2012

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The document takes care to reference the at-the-time EIOPA guidelines in each chapter (which would have been superseded by June's release of course, but didn't change seismically), and does an excellent job of focusing on required processes as opposed to ORSA Reporting, which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

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