Thursday, 20 March 2014

The PRA and Insurer Business Model Analysis - emerging risks into capital add-ons?

A rather revealing "topical article" was pushed out by our pals at the PRA this week, mouthwateringly titled "The role of business model analysis in the supervision of insurers".

I obviously threw my Woman's Weekly professional reading materials to one side in order to see how much juice there was in this particular fruit, and it is certainly worth a glance for anyone in the risk management game, if only for the idiot's guide to Life and General insurer business models it provides!

Ironically, in the Life Insurer case (where they have chosen 'non-standard annuities' as a paradigm-changing product offering), they weren't able to forecast yesterday's scuppering of the UK annuities market in its entirety in their business model analysis!

It actually reads as quite a good case study in how we should be conducting emerging risk assessment against one's prevailing strategy, walking through specific changes in the operating environments of Life and General Insurers driven by both exogenous and endogenous factors.

With the price comparison website example, it is a good example of how a strategic risk filters down into second order risks which require reconsideration. The annuity example shows how the impact of competitors can impact both existing new business streams and the risk profile of one's existing book.

There is evidently an enormous emphasis being paid in the regulator's BMA activity to those grim business school concepts no doubt already permeating your emerging risk assessment processes such as SWOT and PESTLE analysis, as well as what (in future) will be supplied under Solvency II, most notably Profit and Loss Attributions and ORSA supervisory reports. I'm sure we will see over the next couple of years how the PRA's demand for these very sensitive in-house outputs materialises into supervisory action!

What perhaps Risk and Capital Management functions should be particularly cautious of is the leitmotif of the PRA "responding pre-emptively" where they feel that profits are not aligned with the risks insurance firms are taking. The following quote is of particular concern, as I can't see how this and the ORSA supervisory report aren't sharing the same womb (my emphasis)!;
"...the results of a BMA exercise help to inform the PRA's expectations of a firm's financial and non-financial resources. For example, the PRA might raise capital requirements, or require a firm to improve its governance process, to address weaknesses identified by BMA"
Bearing in mind we are months away from the first glut of ORSA material being delivered to Moorgate's finest, is the industry about to fertilise an expensive new world of capital add-ons via supplementary business model disclosure?

I appreciate that it has been emphasised by the PRA (p8) that ORSAs, and their supervisory reports, simply cannot be used to set regulatory capital, but in the context of what is being stated by the BMA team here, would they really be ignored?

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