Solvency II Industry Forum in Ireland - Clint and Chocolate

Having treated the speech by EIOPA's Chair as the main course a few days ago, I'd better take a look at the hors d'ouevres and pudding. At the CBoI's industry event in late April, a couple of their biggest hitters delivered speeches of their own, with a similar tone to the PRA's effort in October (i.e. a considered yet firm rollicking).


Solvency II Marathon
- no Snickering...

Sylvia Cronin's speech, in which she referred to Solvency II as the "Marathon of Marathons", shone some light on how Ireland plc has dealt with ORSA during the preparatory phase. If you remember, the CBoI kindly provided ORSA templates for the entities lower down the PRISM spectrum, which I felt at the time was fully justifiable, and a tactic other NSAs should have adopted.

It wouldn't appear that the industry has performed exceptionally in their 2014 efforts, with Ms Cronin drawing attention to the following flaws in execution

• Variances in ORSA Report content between firms in similar sectors  "cause for concern" - a slightly worrying comment, given that some firms will be over-elaborating with content with the help of their friendly consultancy firm.
• Boards were aggressively called out on the "ownership" front. If your Boards have been ambivalent to-date with regards to participation in the ORSA process, they will seemingly get a hard time from now on.
• ORSA Process "...as important as the document itself" - music to my ears, and still a surprisingly difficult concept to convey
• The "so called use test" is referenced around ORSA, and not in the context of internal model applicants - no idea what that is about, so will assume it was a clumsy turn of phrase, rather than a new element of legislation
• Stress testing seen to be "too benign", with firms ignoring key risks and hard-to-quantify risks. Given that the UK firms received similar feedback on their 2014 ORSA stress testing efforts, it doesn't appear to be a country-specific failing.
• 'Local' (i.e. Irish) ORSAs which filter into wider Group ORSAs have not been adapted to fit the business model of the Irish entity. Good issue to pull firms up on, if they are relying Head Office to provide them with process and reports in template format 
• Business plan and forward looking time horizons not considered plausible, possibly a by-product of the lack of Board involvement in the ORSA Process

On the Pillar 3 front, she noted the following

• Pillar 3 is now a "cause for concern" - decisions by firms on architecture and expenditure "now overdue".
• Only half of High or Medium PRISM firms have participated in external user testing on Pillar 3. This still feels proportionally more than the PRA have tested out, though it is still viewed as a negative by the Bank.

"Problematic Applicant"?

Cyril Roux on the other hand wanted to reflect on "the good the bad and the ugly of Solvency II" in his address. While most executives paying for Solvency II programmes in EU insurance entities would suggest that "A Few Dollars More" is a more apt Clint Eastwood hook, he took a more macro view during which he;

• Patted the Irish regulator for its "good work" putting the house back in order after the laissez-faire approach at the start of this century. 
• Also reiterated that Pillar 3 preparations are light in the country, urging firms to "...devote the resources necessary"
• Dwelled heavily on the subjects of investment risk appetite and prudent person principle
• Pointed at "problematic applicants" who can now seek approvals to do business in the EU regardless of the supervisor's thoughts about their business models
• Called Solvency II's quantitative requirements "ill conceived" and "overboard" and "clearly too complex"
• Commented that SCR is "unlikely, unreliable tool to manage capital" - "...certainly the supervisor will not be using it for more than its worth".
• Gave short shrift to the abolition of prudential reserving under Solvency II, and indeed Bernadino referred glowingly to the Irish approach to reserving governance (presumably to counteract this grievance?) in his keynote speech.

A lot to be taken from these speeches if you have any dealings with Irish insurers, and with the clock ticking, I can't imagine there will be better steers than these during the preparatory phase.

Elderfield at the European Insurance Forum - one for the road...

So the European Insurance Forum is in full swing over in Dublin, which from what I have seen to date in the tweetosphere (thanks DIMA and Mike!), sounds more like Alan Partridge's sales conference for Ireland plc.

That aside, Matthew Elderfield, the outgoing Head of Financial Regulation at the Central Bank of Ireland, gave a rousing speech touching on risk-based supervision and the 'prospects' for Solvency II. As a member of EIOPA's management board and head of the second largest internal model assessment body in the EU, his words are very much worth heeding.

Given that he has already addressed this forum a couple of years ago on such matters, as well as being relatively outspoken  recently on the quality of components parts of Irish risk management systems, one might expect a few home truths on his way out of the door to an equally precarious task as Head of Compliance at Lloyds Banking Group.

EIF 2013 - More to Ireland 'dan dis'?

The headline acts for me was his revelation that diversification in internal models remains a bugbear, to the extent that he supports the kind of 'floor' arrangement being given airtime at the PRA. Given he had already made his distaste at the extent of the diversification benefits being sought clear in a speech last year, it is not surprise to see it on his agenda, more that it implies that the expert judgements of those involved in the calculation process may be overridden (due to regulatory prudence?), regardless of how well they are documented or supported. 

In addition, his angle on bridging the LTG issue makes interesting reading for anyone who doesn't receive briefings on EIOPA's inner workings.

Noteworthy points (my emphasis if emboldened) therefore included;

On Solvency II

• Drawn out process has "naturally resulted in a combination of fatigue and exasperation", with the "...high costs of preparation compounding concerns"
• Regardless, "it is unacceptable that the common regulatory framework for insurance in Europe in the 21st century is not risk-based"
• "Urgently need" the framework to reflect asset risks, riskiness of different lines of business, encourage better governance and risk management, and provide better disclosure.
• "Solvency II does indeed have its imperfections", but "...the benefits of moving ahead with Solvency II outweigh the costs..."
• Notes his "long-standing concern" around over-optimism in the calibration of internal models
• "...complexity has clearly gone too far in some areas - and makes implementation very difficult for smaller companies"

On Omnibus II and EIOPA's LTGA

• Omnibus II delay "...is a course of considerable concern to regulators and industry alike", and the "...entire framework is essentially stuck on one issue" which "...will require a political compromise"
• Personally supports a more generous approach to matched premium adjustments on certain lines of business, provided they are (a) only applied to the back-book, (b) companies provide Pillar 3 disclosures both with and without those adjustments, and (c) supervisors can apply capital charges if they are not happy.
• "With European elections looming next year, it is important that this process concludes in the autumn at the latest"

EIOPA - filling gaps
since 2013

On EIOPA's Interim Guidelines

• As justification for supporting them, "Much of the Solvency II framework is already clear", and emphasises that "we will adopt a proportionate approach"
• EIOPA is "helping 'fill the gap' created by the hiatus in the political negotiation"
• "The EIOPA initiative should be strongly welcomed by regulators and industry alike"
• Hopes the system of governance and ORSA interim guidance provide "manageable and useful transitional steps towards full Solvency II adoption"
• For Pillar 3, expecting "best efforts" especially from High Impact insurers, with the use of statutory powers held in reserve "as a last resort.
• For IMAP, can neither sanction an "early conclusion" nor a "hard stop", so will ultimately elongate the administrative burden, hopefully leaving less to do towards the end.

On Diversification benefits

• "...in common with a number of other [unnamed] supervisors", CBoI is concerned to ensure "prudent recognition of diversification effects"
• "Fundamentally, what is needed is a broad agreement on the outer bounds of acceptable levels of diversification in the model approval process", citing one jurisdiction (UK?) looking at hard SCR floors based on proportion of MCR.
• "...the Central Bank's message to Irish firms is to take a conservative approach to the recognition of diversification..."
• Points to the failure to add formal constraints on diversification benefits in the Directive text
• "Supervisory quants are at risk of being outgunned by industry quants in the minutiae of a correlation debate"
• Also has a stab at "overly generous approval" in other member states in the context of regulatory arbitrage - is it that hard to say "no" just because the home regulator says "yes"?

Of less consequence for those outside of Ireland, he goes on to cover the CBoI's bespoke work around VA-specific risks (in light of prolonged low interest rate environment), the failure of Quinn Insurance, and the bedding in of their PRISM risk-based supervisory framework, the latter eliciting the comment that "we are still some way from fully embedding our new approach".

From this, one might reasonably think that, should Mr Elderfield's successor continue in the same vein, that the correlation matrices of Ireland's 30-something IMAP candidates are likely to get a severe working over in the next couple of years. Let's hope the industry gets their documentation in order!

PRISM and Central Bank of Ireland - ORSA come early?

Towards the end of last week, Matthew Elderfield launched the Probability Risk and Impact SysteM (PRISM, summary here and detail here), which aims to usher in a new age of supervisory challenge to the Irish financial sector, well documented as having had an easy time of it before credit started to get crunchy.

One big challenge for the CBoI will be to get everything up and running before June 2012 (hopefully the recruitment drive wasas good for quality as it seemingly was for quantity!), so all the best to them for that. More pointedly, the acknowledgement that the ramping up of staff numbers will start to be felt in the industry levies asap, coupled with future income streams referenced in their planned aggresive enforcement and fining of non-compliant firms must have any of the stragglers still living in 2006 quaking in their boots.

Very interesting to see the take on Risk Appetite, Risk Tolerance, Risk Assessment Criteria etc applied by a regulator to its industry, rather than my normal vantage point of a risk consultant, either advising on or benchmarking the same facets of individual ERM frameworks within an insurance undertaking. I would have thought the way in which these things are described in Mr. Elderfield's speech should be good guidance for corporate governance code adherence over there (let's face it, it doesn't get better than from the horse's mouth!).

One thing that would make me very uncomfortable as an Insurance consultant is the extent of the crossover between ORSA, QRTs, SFCR and RSR and what is being proposed under PRISM. I would not be keen on, for example, defining 'Risk Profile' for my client in line with Solvency II definitions, only to be contradicted by the regulator's PRISM definition of 'Risk Profile', which is overall solvency needs by any other name.

If I get some spare time, I may run a cross-check between ORSA and PRISM obligations, and work out whether the CBoI is trying to tell the insurance industry how to do an ORSA via subliminal messages - for the life of me, I can't quite work out what this does for the industry that an ORSA run with "appropriate" frequency doesn't.

Elderfield speech to the MacGill Summer School - governance angle

Matthew Elderfield's speech this week to the MacGill Summer School was on the future of Irish banking, but has a heavy corporate governance flavour, so I picked out the pieces with cross-over relevance for Insurance;

• "We have learned from the banking crisis the importance of good corporate governance" - I actually thought we learned about the folie a deux of rancid corporate governance mixed with an intimidated and unskilled regulator, and the inquest seemed to support that. 
• New powers on fitness and probity (for all financial services) will come in later this year (prohibitions, suspensions and removals of execs and non-execs)
• Law containing new powers has been drafted in a way that "grandfathers in" existing board members - regulator however will retrospectively review all bailed-out bank board members if they haven't been replaced since the crisis
• Anticipating legal challenges from said executives!
• Invites said executives to "take up the Minister's (Michael Noonan's) request to act in the public interest" and jump before being pushed
• PRISM framework for a tiered supervisory approach will be rolled out towards the end of this year, and more fully next year - He is "sure it will take a while to bed down" - I'm not sure how much leeway that gives any non-conformists however!

Central Bank of Ireland - Consultation on Risk-based Impact Metrics

Having followed this subject from when the consultation first opened, I was fascinated to see what had materialised. The comment and response document and the individual responses are worth poring over if you are on that side of the pond. My take was as follows;

• Four impact categories confirmed (High/Medium High/Medium Low/Low)
• Surprisingly clear tone that supervision for 'Low' impact firms will be minimal, reactive, and that failure is not a problem. 'Medium Low' firms will however receive proactive supervision with some inspections.
• 'Vigorous Enforcement' will be used to discourage ineffective risk taking - evidence of this already in themed inspections and issued fines
• Best practice from Australia, Norway and Canada utilised (may look into the reasons behind this)
• Impact metrics are being road tested - will not be used for levy setting immediately
• "Primary consideration" for metric selection is measurement of the scale of the firm (as opposed to nature or complexity in Solvency II jargon)
• The PRISM system will be expected to identify business model and governance weaknesses
• Metrics for Life firms all seem reasonable, if pre-determined by common sense. 
• Sticking with the use of divisors to normalise the different metrics onto a common scale - I really like this idea, and advocate it for ERM risk profiling as well, so I'm glad they will "trial and error" it.

Of the comments, I looked specifically at what the IIF had to say, and whether their requirements were met by the outcome. I spotted;

• Alignment of levies with resource consumed was on their agenda
• They wanted weighted averages to be used for the divisors, and regular review of their appropriateness
• Premium income by business line and market share were on their list of possible metrics, but didn't make the cut (the former did, but only as APE).

All in all, the split of impact metrics and PRISM as two ways of determining allocation of resource seems like it has the potential to lead to internal dispute further down the line - hopefully I will get a chance to look in more detail at both aspects at a later date