FTSE and European Insurers - Economic Capital and Solvency II trends - money pit filled?

Interim Results season - without question, the most exciting time of the summer for me (although to qualify that, I do live on the Isle of Man and blog in my spare time). As good an opportunity as any to peer review where the big boys are at in the UK and Europe, both on Solvency II preparations/costs and economic captial positions.

Solvency II project costs - on the wane?

As I had mentioned in an earlier post, the FTSE-listed insurers have gone noticeably quiet on both Solvency II and, in the UK's case, the havoc it was inevitably going to wreak in its 2012 form - while the 2013 silence "speaks volumes" as to the priority of the dossier, it is a smart idea to see what impact the threat of a 2014 start has had to EC positions of major insurers over the last 12 months (i.e. after last year's whingeing, did any of them actually do substantive capital-related activity!)

A few notes for each below;

Aviva

• Solvency II project costs of £44m - well down on £77m in 2012 year-to-June
• "...there is still significant uncertainty over the detailed requirements [of Solvency II]"
• Pro-forma economic capital surplus of 175%, up from 172% in December
• IGD coverage 1.8 times, up from 1.7 times in December

Axa

• Nothing on Solvency II at all or project costs
• Solvency ratio down to 218% (from 233%) since December - interest rated attributed
• Economic solvency ratio (calibrated to 1-in-200 VaR) down to 204% (from 206%) since December - dividend and market risk elements attributed

Allianz

• Nothing on project costs
• Solvency ratio (based on FCD) of 177%, down from 197% this time last year - change in accounting standards attributed
• "...Allianz continues to be exposed to two external forces that adversely affect our risk profile and would not normally be associated with our core operating activities: the European sovereign debt crisis and regulatory developments – especially the European solvency directive, Solvency II"
• No reference to economic capital or modelling

Legal and General

• "Investment projects and expenses" (which covered Solvency II last year) were £20m - £23m in 2012 year-to-June
• "...remains uncertainty both to the implementation timescales of Solvency II and the final calibrations that will be used for long term business"
• IGD surplus unchanged at £4.1bn, coverage ratio down to 226%

Old Mutual

• No mention of Solvency II project costs, same as last year
• EC coverage of "over 160%", calibrated to VaR 99.93%
• FGD surplus of 160%
• Dividend outweighed operational cash flows in the 6 month period, though this was due to the special dividend paid last year after a massive disposal

Resolution

• Solvency II project costs of £10m for the half year - well down on the £48m for 2012 comparable!
• "Proposals for Solvency II continue to be the subject of debate"
• EC Coverage of 192% - (194% in Dec - quantum increased by £200m though)
• IGCA coverage of 221% (222% in Dec) - sold a business unit, which helped cover dividend

Prudential

• £13m Solvency II project costs for the half year - £27m in 2012 year-to-June
• "...deferral until 1 January 2016 or beyond appears likely"
• "...we now know that it will not be implemented before 1 January 2016" - my emphasis
• "[potential for] optimising the Group’s domicile as a possible response to an adverse outcome on Solvency II" remains on the table, a copy/paste threat left in from last year.
• IGD coverage of 230% - quantum lower by over a billion since Dec, due to a change in requirements in their US business

Standard Life

• £36m Solvency II "and other programmes" costs for the half year - £42m in 2012 year-to-June
• Solvency II project "...continues to respond to changes in requirements"
• IGD down £500m since half year after accounting for a special dividend, and surplus generation down year-on-year (attributed to new business strain)
• IGD surplus of 185%, down from over 200% at YE2012, but up 11% from this time last year
• Not a single reference to "economic capital" in the document

Generali

• No mention of Solvency II
• Solvency I coverage at 139% - up from 130% this time last year
• Economic capital coverage of 167% - up from 159% this time last year

RSA

• Solvency II project costs down to £10m (was £16m  in 2012 year-to-June)
• "There remains continued uncertainty as delays in agreeing the rules have caused the planned implementation date of 2014 to be delayed."
• IGD covered 1.7 times - down from 1.9 times since December - dividends again cited in explaining the dip.
• Economic capital (calibrated to 1-in-200 VaR) £1.3bn, up from £1.2bn in December.

So a trend of steady Solvency I ratios, and no sign of any war chests being created by holding excess cash back - quite the opposite in some cases, with dividends (special or otherwise) on the high side. With project costs diminishing and barely a passing comment on the Omnibus II impasse, it looks very much like Solvency II is yesterday's news in the boardrooms of major insurers. 

That said, in just those insurers covered above there has been over £100m confirmed spend in the last 6 months on Solvency II preparations, during which time the implementation date has (informally) moved at least two years, IMAP has been elongated, and the LTGA panacea has turned out to be anything but. That's hardly chickenfeed, and the rest of this year can only get busier for the UK with ICAS+ and EIOPA Interim Guidelines to contend with.

I hope Finance Directors don't get too excited by the dwindling project spend though - we haven't started Pillar 3 yet, apparently!

PwC and CSFI's 2013 Insurance Banana Skins survey - "Conduct Risk" firmly a la mode

Following on from the 2011 version, PwC and the Centre for the Study of Financial Innovation have pumped out another version of their Insurance Banana Skins survey, identifying how well the insurance industry feels it is prepared to handle a list of pre-identified risks. The average response on a scale of 1 to 5 was 2.97, which rather unrevealingly suggests the industry is averagely prepared to manage its collective risk profile.

EU Legislative process - not for vegans

This survey was conducted during March/April 2013, and elicited 662 responses from 54 countries, with two-thirds of respondents coming the insurance industry (the rest consultants/brokers etc). Almost half were European, so no surprises that the risks emerging from the regulatory environment were top of the pops for the second survey in a row. Solvency II gets a particularly flavoursome mention, with reference to its struggles to get through the "Brussels Sausage Machine"...

Bearing in mind the exquisite pressures being applied by the EU machinery to quantify risk, this publication is a welcome return to horizon scanning, qualitative assessment and emerging risk, all of which is handy for the ORSA posse, who according to recent surveys, should be all over this during 2013.

Some very interesting snippets emerge from the report, in particular;

• "Conduct Risk" - if ORSA was the new boy in 2012, then its 2013 counterpart is surely Conduct Risk, which I suspect didn't warrant a category of its own in many risk managers thinking until the return of twin peaks regulation in the UK. Conduct Risk has shot up the charts in its significance for insurers, now sitting 4th (from 18th last year)! Specifically, the suggestion that insurers are now "...looking beyond conduct risk as simply a compliance exercise" makes you wonder what some firms through were acceptable products in the last 10 years!
• "Guaranteed Products" - was not listed last time around, now jumps to number 6
• Actuarial Assumptions (which can easily mask the emergence of a number of the risks listed) unchanged at 12th
• Capital availability down from 2nd last time to 16th this year - interim period been spent squirrelling capital away, or happy that the onerous elements of Solvency II are (thanks to Germany) in the distant future?
• Reputational risk still in mid-table, at 14th

And sectoral/country specific;

• Surprisingly, the Life sector doesn't have actuarial assumptions in its top ten concerns
• Equally surprisingly, the non-life sector doesn't have regulation in its top ten concerns - clearly happy with their proposed Solvency II lot!
• That reputation doesn't feature in reinsurer's top ten - with customers likely to be eager yet more discerning  under Solvency II, one would think this is an area for enhancement in order to stand out from the similarly-rated crowd
• The quality of risk management appears to have spiked as a concern largely due to the emergence of emerging market firms into the space playing catch-up (on paper at least), as well as concerns that some firms are playing at risk management without making necessary adaptations to the prevailing risk culture.

Moody's survey on Solvency II compliance preparedness - the chilly third pillar

So from what I can gather it has been a terrible week for the Girondins, with a freak hailstorm wreaking havoc in a thin strip along the vineyards of Bordeaux's Entre-deux-Mers appellation - my in-laws were seemingly spared further down the river, noting that it was merely "un peux froid".

On Ice - Solvency II programmes
and this year's white Bordeaux?

And speaking of a great deal of hard work getting aimlessly destroyed by an unpredictable European storm, Solvency II (do you see what I did there?) appears to have at least enough juice in the tank to have encouraged Moodys to survey practitioners on the preparedness of the industry to achieve compliance before the deadlines currently on everyone's lips (i.e. 2014-2015 for EIOPA Guidelines, 2016 for "go-live").

That survey is available here (short sign-up required, but worth it), with a very short summary here. The media have touched on the survey (here), but only seem to have read the summary, so I've picked through the whole shooting match to see what else was worth knowing.

The sample is small at 45 contributors, but they have all been interviewed one-on-one in Q4 2012/Q1 2013, so the responses are not too dated, particularly as many Solvency II programmes have been running on meagre rations since January of this year. Coverage of 12 EU countries is included in the 45 people, with a decent split of size and insurance type. Majority of respondents were CRO/equivalent, with a few accountants, actuaries and programme managers thrown in for good measure, and just over half are on Standard Formula.

Talking points for me were;

• That 22% have frozen Pillar 3 activity, while 11% have frozen all Solvency II activity
• Half are using Standard Formula to curb costs!
• In addition to that, 20% say that the Use Test is a barrier to using models!
• 27% are approaching Pillar 1 and Pillar 3 with a tick-box mentality (i.e. happy to use multiple manual processes/excel-based tactical solutions to deliver the balance sheet and reporting template elements), while 44% have worked exclusively on Pillar 1 at the expense of Pillar 3
• Solvency II project investment levels are "considerably more" in the UK and France compared to Germany - makes you wonder why they have such a long face!
• 67% have increased their control function staffing by 10% or more - 31% have increased by 50% or more.
• Only 7% note "capital reduction" as a perceived benefit of Solvency II, with 33% selecting improved capital planning (regardless of quantum) as a benefit.
• Only 6.7% say they are receiving "high" levels of support from their national supervisory authority.

Seemingly the stats are a hostage to the sample - I'm sure the PRA would be apoplectic if this was the position of Insurers of Britain plc, but for me the big story is the indiscriminate swelling of Risk/control functions in smaller organisations that evidently are only ticking boxes. Feels a tad disingenuous to pump the staff numbers up to demonstrate compliance, but I suppose it's not me they need to satisfy!

Insurance Europe on EIOPA's place in the European System of Financial Supervision

As a response to the European Commission's consultation on the new European System of Financial Supervision (ESFS) - you know, the one that gave birth to EIOPA and the other two ESAs - Insurance Europe have laid some home truths down in this questionnaire document regarding the performance of EIOPA to date, as well as problems they see on the horizon once Omnibus II gets through.

Due to the lack of transparency in much of the work performed by EIOPA to date (a by-product of their remit being squirrelled away in the Omnibus II dossier?), I found some of this comment very revealing from a body which I expected would be relatively pally with them. Specifically, I noted the following opinions;

• That ESAs should not issue Guidelines that circumvent legislative powers - these generate blurred lines between technical matters (where their input is welcome) and strategic/political matters (where it is not). Precisely here that would leave EIOPA's Solvency II Interim Guidelines in their ideal world is another thing I guess, though they go on to say that the "...level of detail on the Solvency II implementing measures is alarming", and indeed were pretty vocal in their public response to them.

  

  EIOPA Guidelines - back door regulation?

• That there is an absence of clear definition in EIOPA's materials around where Regulatory Technical Standards (RTS), Implementing Technical Standards (ITS) and Guidelines differ - going on to suggest that there is an element of "regulation by the back door" in the Guidelines issued to date.
• Concern regarding the level of power left in EIOPA's gift to adopt RTS, citing as an example that EIOPA have brought back (as part of L3 consulations) a proposal to make external auditors review SFCRs - this proposal having already been jettisoned by the Parliament at L1!
• Suggest that the Commission should have a vote in contentious decisions within EIOPA (the Commission attend in a non-voting capacity currently) 
• A diva-esque rant (p12) about the quality of EIOPA's processes and outputs during consultations (lack of feedback, poor quality documentation), as well as suggesting that consultation participant quantums are overweight in academics at the expense of the industry.
• That some of the membership of Insurance Europe would welcome qualified majority voting in the ESAs weighted by size (let me guess who!).

So without having been handed their full schmorgasbord of powers, EIOPA are already being lambasted for their use of them - tough break!

Germany, BaFin and Solvency II - Tchüss wisely...

With the British Lions rugby team having had such a marvellous summer, it's nice to see that the spirit of "getting one's retaliation in first" has been brought back to Europe with them. The Executive Director of insurance at BaFin, the German regulator, came out swinging late last week (while the rest of Europe was lotioning up), and delivered his two'penneth worth on, amongst other matters, the Long Term Guarantees situation currently holding up Omnibus II.

Omnibus II trilogue - work to do

This is the same man who has recently been quoted as saying that delays are not a problem, as "Solvency II was not designed for today". Which is true - strictly speaking, it was designed for about 8 months ago!

The German contingent have been labelled in a number of articles (here, here, here and here) as a major source of legislative delay (presumably ever since they twigged that the proposed design of the extrapolation element was massively unfavourable to their industry), and the lobbying angles pursued here are not really new news, but to emphasise;

• Concerned about the increase in interest rates at Central Bank level - "should be carried out gradually", though rather disingenuously saying that they would have no influence in that - BaFin may not, but Chancellor Merkel and the overflowing pot of export surplus certainly does!
• Solvency II go-live of Jan 2016 "absolutely realistic" provided the trilogues are finished this year - I've noted in earlier posts that the official schedules of the co-legislators are looking shoddy in this respect, so I'm more inclined to side with S&P (and indeed the president of BaFin!)on 2016 being on shakier ground than a Hippo's decking..
• That transitional periods should be determined individually in accordance with a firms existing maturity profile - they want to avoid an insurer "falling over" just to meet the new regulation. Worrying that after 10 years of efforts, Solvency II compliance still carries such a credible threat of business closure! 
• As they have so many insurance contracts (90m cited), they would simply "say goodbye" in a worst-case scenario if they don't get their way on transitional periods.

So the likelihood of the German industry "taking one for the team" here is pretty small, and with Hrs Balz and Giegold having made it pretty clear that the LTGA result will not elicit a swift conclusion to trilogue negotiations, it looks like there's still plenty of talking to be done...

Deloitte's 8th Global Risk Management Survey - cause for concern?

A survey from Deloitte has recently hit the news stands, namely the 8th edition of their Global Risk Management Survey - I thought I'd postpone my August holidays to pick through the bones of it (?).

The data was gleaned from an online survey they sent out to CRO/equivalents back in Sept-Dec 2012, so is a bit dusty, and there were 86 respondents, so a half-decent sample. It isn't dominated by a particular sector or continent (p7), but there are more conglomerate/bank-heavy respondents than pure insurers.

There is an infographic for those of a short attention span with a few headline numbers, but having sifted through the larger doc, I found the following elements worthy of note;

Boards, Committees and Risk Management

• 80% of Boards are reviewing and approving Risk Management Policies/ERM Frameworks and Risk Appetite Statements. Bearing in mind the types of organisation in the sample, that is disappointingly low.
• 25% don't review individual risk policies
• 23% don't review strategy against risk profile
• Almost half don't invite CRO to EXCOM meetings
• Almost two-thirds delegate risk oversight to satellite committees (and two-thirds of those delegate to a Risk Committee)
• Only half have their Risk Committee chaired by an INED.
• Use of specific management risk committees for individual risk types tends to cluster around the 40-60% bracket (for example, 60% have an ERM committee, while 44% have an Op Risk Committee). Heavily weighted by organisation size i.e. larger ones tend to have them! 
• Emerging risk reporting not supplied to 30% of Boards
• Model validation results not supplied to 70% of Boards!
• 66% (of insurance respondents) have their Boards responsible for reviewing economic capital results

CRO and Risk Management Function

• 97% of large respondents have a CRO, 81% of smaller firms 
• 88% using "3 Lines of Defence" (almost all of the larger respondents do)
• 62% have an "ERM Programme"
• 58% increasing risk management budgets (still!)
• In the list of tasks currently performed by CROs, the fact that only 63% are involved in the approval of new business lines/products is pretty telling, and not in a good way.

Other control functions

• Almost half of respondents said that Internal Audit and the ERM Framework do not use common risk categories and language.
• 33% do not have a independent model validation 'function' (remember, the banks are in these stats as well!) - most of those who have made provision park it in the Risk Management function.

Risk management techniques

• 90% using some form of stress testing in the business, with most saying the outputs are used in business planning, strategy setting and identifying risk tolerance. More than half however don't use the outputs in the allocation of capital to lines of business.
• 74% have some type of Stress Testing policy
• Over 20% either do not have a Risk Appetite Statement, or only have a quantitative one
• Almost 70% still use regulatory capital as one of their quantitative measures in their Risk Appetite Statements
• Risk limits tending to be set at enterprise level, as opposed to business or desk/subsidiary level - stats are a little murky due to the emphasis towards banking sector.
• Model risk and Liquidity risk seem to be the risk types least factored in to companies ERM programmes

Management of Key Risks

• Full list on p24, with the percentage shown representing the number of respondents who thought their management of each risk was "extremely" or "very" effective - stand outs were that perceptions of the effectiveness of the management of Operational, Model, Outsourcing and Data risks appear to be much lower than one would hope, with Lapse risk management ranked unusually high.
• Op Risk KRIs and Loss data only collected in 60% of respondents
• Just over half are modelling Op Risk in some way - varying degrees of complexity experienced
• Most are using stress testing and/or reserving to assess Insurance risk - over 40% not currently using EC, and over 50% not using VaR.

Risk and Reward

• Almost 60% of remuneration schemes have no clawback provisions
• Almost 70% of schemes do not align incentive payouts with the term exposure of the underlying risks

Solvency II-specific

• 92% (of relevant responders) will focus resource on ORSA in next 12 months
• 77% will focus resource on Data Quality in next 12 months
• 69% will focus resource on Documentation and Reporting in next 12 months
• Less than 25% rate their processes and systems for Data Governance extremely/very effective.
• Declining trend of insurers who will be modelling economic capital (p19)
• Only 80% actually calculate Economic Capital
• Some very grim stats on p21 covering which risk types are modelled for EC purposes (underwriting risks seemingly very low on the list)

There are a number of areas touched on here which fall short of pending (or indeed actual) national/international regulations and codes, never mind "best practice". Perhaps we can account for the innate conservatism of CROs in their responses, and assume things aren't quite as bad as they have self-assessed here?

FTSE and European Interim Reporting - Solvency II off radar

So it's Interim Reporting time again for Europe's beleaguered insurers and as far as internal models go, another one has apparently bitten the dust - Old Mutual formally withdrew from the PRA's Internal Model Application Process in early 2013 "...as a result of delays in Solvency II implementation" (p14), joining Resolution on the sidelines.

Solvency II - 'Time of your life'?

This time around there appears to be a conspicuous absence of comment on Solvency II and indeed Omnibus II, unlike this time last year, when every firm had an opinion about Solvency II's legislative progress and its financial cost.

This is not so unusual for the mainland Europeans such as Allianz, Axa and Munich Re (all of whom had nothing new to say at the half year), but the UK firms have normally used the Interim Report as an opportunity to sound off. With Old Mutual (above) and  Legal and General so far only offering minor comments on "delays" and "uncertainty", have both the industry and the legislators given up forecasting the end game, and put the Solvency II "baby in the corner"?

Hopefully the remaining big hitters such as Pru, Aviva and Standard Life will have something to say over the next couple of weeks.

Central Bank of Ireland - Corporate Governance Code refresh

The Irish approach to corporate governance in financial services, at least up until the onset of the financial crisis in 2006/07, resembled something of an all-you-can-grasp buffet for a select number of executive golf club pals and octogenarian ex-politico Non-Executive Directors (NEDs), having their voting arms operated a la Weekend at Bernies.

Ireland pre-2007 - Waking NED?

The new FSA-flavoured approach brought in by Matthew Elderfield in 2009 (elaborated on here) fortified by the findings of a devastating 2011 report summarising the truly horrid governance practices in the Irish banking industry, has led to a change of regulatory tack at the Central Bank of Ireland that represents the biggest volte-face in Europe since the Macarena.

Alongside PRISM, a piece of revolutionary work in the assessment of financial institutions by supervisory bodies, the CBoI also made substantial changes in areas such as Annual Compliance Statements, Fitness and Probity of directors, Risk Appetite Statements.

All of this ran off the back of Mr Elderfield's first major gig in 2010, a full revamp of the Corporate Governance Code, which could hitch a ride off the back of the work of the FSA and CEIOPS (at the time!) and deliver a more substantial suite of obligations to a cabal of directors who, after feasting on carrots for years, desperately needed the stick.

This makes the release of yesterday's consultation on the Corporate Governance code a touch baffling, as the ink is barely dry on 2010's effort - it perhaps reflects that the regulator has reached optimum staffing levels if they can review it so regularly! Having said that, the level of divergence from accepted CG practices in the UK was flagged by Grant Thornton back in 2011 as being substantial, so a point-in-time revamp should not be so unwelcome, regardless of the proximity to the last one, and of course, all of this activity was too late to prevent Quinn Insurance from going down.

They emphasise that this review takes into account developments in the Solvency II space, as well as on-the-ground experience and publications from other parties of interest. Of particular note was their emphasis that, where national regulations are not as stringent as relevant EU or international one (or indeed vice versa?), the most onerous one should be complied with. In a number of instances around corporate governance, this will mean the CBoI outranking Solvency II as the more onerous of the two!

While these are proposals rather than stitched-on changes at this point, the CBoI doesn't have a great track record for backtracking these days. Highlights for me were;

Risk Committees

• Require a majority of NEDs on Risk Committees, and must be chaired by a NED

Committees in general

• Require the Risk Committee and Audit Committee chairs to sit on each other's committees
• Require the Remuneration Committee chair to sit on the Risk Committee
• In High Impact firms, the Risk Committee and Audit Committee Chair may not be the same person
• Must be at least 3 members of Risk Committees and Audit Committees

Chief Risk Officers

• They note that it is "Generally accepted best practice" to have a CRO who, amongst other tasks, is charged with "...facilitating risk appetite setting by the Board". In addition;
• All "High Impact" firms will be required to appoint a specialist CRO
• Firms with a lower PRISM rating may have a CRO who is shared with another control function, "...provided that there is no conflict of interest between the two roles". Can't help but feel that this might rule out CRO/Chief Actuary dual roles, but allows for CRO/Head of Compliance and CRO/Head of Internal Audit, which would be to the chagrin of the Society of Actuaries in Ireland!
• CRO to have direct access to the Chairman of the Board

Board Meeting frequency

• Seem to acknowledge that the compulsory 11 meetings per year for High Impact firms may be a touch much, so are looking for comments
• Also acknowledge that compulsory 1 meeting per calendar quarter is a bit constrictive for the smaller firms, so may relieve this to be pragmatic

Chairman and CEO

• Some of the restrictions around number of roles held at any one time to be relieved for smaller firms, but seemingly only to populate inter-Group roles.

Board Diversity

• Acknowledges that, while the debate in the EU is gender-centric, that diversity of all types is a worthy target for Boards, but falls short of compelling firms to do anything at national level, choosing to seek comments and wait for the supra-national activity to drive any compulsion. This seems to fit with the thinking of Irish directors published back in 2011 i.e. no "Golden Skirt" quotas.

Random

• "...appropriate Risk Culture" makes its way in (6.3), perhaps cognisant of the FSB's proposals
• Built in a piece which allows for video-conferencing rather than physical attendance at meetings (7.5)
• Board responsibilities updated (13.1)
• Compulsory Board skills matrix (14.9)