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.

Reporting/Submission of information to NCAs - EIOPA's FINAL preparatory guidance for national supervisors

And last, but not least, EIOPA have produced their final preparatory guidance to NCAs regarding the submission of information by firms to their supervisors, covering both quantitative reporting templates (QRTs) and narrative reporting. The consultation paper (summarised here by the PRA) caused quite a stir due to the volume of requirements during what is purported to be the 'preparatory phase', and even EIOPA's own Insuarnce and Reinsurance Stakeholders Group (IRSG) put the boot in on a number of elements.

It was of course natural that a combination of parallel running, legacy system horror-shows and potential ambivalence from third party information vendors was going to make this consultation the most controversial, but that said, the outcome appears to be pretty fair insofar as concessions have been made by EIOPA while still keeping the pressure on over-reluctant firms to construct the required processes in a timely manner.

One attempt at quarterly reporting is therefore retained (set for Q3 2015) as well as one run at completing annual templates, based on YE 2014.

The preamble borrows from the other preparatory guidance documents without anything new, so ignoring that, the following items jumped out at me thematically;

Concessions
3.54 Despite the gibberish in paragraph a), this effectively allows for some simplification in the quarterly reporting during the preparatory phase
3.55 Captives are excused for the quarterly run in Q3 2015

Parallel run costs/strains
3.58 As with other papers, EIOPA don't care!

Template changes
3.62 A change log covering amendments between the original template release and those now available has been included to help firms level any work already done in this space. A surprisingly large number of changes made, magnifying the difficulties faced by firms, NCAs and ultimately EIOPA.

Legal entities which are below the threshold
3.72 If a legal entity is below the reporting threshold in isolation, but forms part of a group which is above it, the LE will still have work to do

Annual reporting
3.76 An extra two weeks added to the submission deadline (now 22 weeks for solos, 28 for groups)

Quarterly reporting
3.81 As above, the requirement to report on Q4 2015 has been removed, a practical attempt to manage the myriad other reports expected from firms in early 2016.

XBRL
3.83 Up to each NCA as to whether they demand firms use XBRL in submissions - I think some of the supervisors may already favour it or have indirect experience of handling it (UK, Ireland, France)
3.84 EIOPA will provide a tool to aid firms in doing this, should they want/need to

Internal Model applicants obliged to complete Standard Formula templates
3.94 Confirms that IM applicants will need to complete both, though their SF template work will be governed by the pre-application for internal model guidance (due to the different timescales applicable to that work)

Narrative reporting
3.102 Not negotiable - get it done!

Balance Sheet
3.106 Statutory accounts figures must be included

Assets
3.111 Unit-linked assets will not be exempted - also a clumsy reference to "contagious risk", one of many which betray mother-tongue related drafting problems

Particularly telling is that while the IRSG were obliged on some of their issues, they were not able to drive home all of their agenda - they had asked for and additional 4 weeks for completion of all templates for example.

Unquestionably a great deal of work to do for both firms and NCAs on this matter, and with existing reporting teams no doubt working to tight schedules, the sooner 2014 programmes factor in this disruption the better.

ORSA/Forward Looking Assessment of Risk - EIOPA's FINAL preparatory guidance for national supervisors

EIOPA reuse the preamble from the System of Governance guidance in their ORSA/FLAOR guidance, save for confirming that an assessment of overall solvency needs will be expected in 2014 and 2015 (more on that later). I will use ORSA rather than EIOPA's shiny new acronym for my own convenience throughout this post!

It ultimately reads in parts as a circuitous and convoluted piece due to the way that EIOPA have had to splice the ORSA requirements into three component parts, as per Article 45.1 of the Directive, to accommodate the postponement of some elements until 2015. An horrific example of this is point 3.112, which to paraphrase Chris Morris, reads like the ramblings of a drugged horse.

That said, they have clearly had to contend with a mountain of feedback since the initial consultation paper was released, and have done a better job of explaining why most comments were, in EIOPA's view at least, misguided.

Again from the practitioner's perspective I would highlight in general that;

1. There is almost no discernible movement in EIOPA's position, even after lobbying;
2. That explanations for the inclusion of contentious content are generally forthcoming, though for this subject are more forthright and pragmatic (perhaps naturally due to the lack of L1 and L2 substance);
3. That 2014 ORSA is a genuine piece of work which will require the attention of the most senior staff in insurance firms - it would be a brave company that play-acts at any elements of the documentation, processes and outputs of the assessment.

Supporting arguments for EIOPA's final views are listed below, along with any relevant commentary from my practitioner's angle; 

Clarification re Omnibus II
3.49 - If go-live in 2016 does not happen due to further Omnibus II delays, "...undertakings will still be expected to perform the [overall solvency needs] assessment from 2014 onwards"

Clarification re continuous compliance with SCR and Technical Provisions calculations requirements, and the deviation from SF SCR assumptions assessment
3.50 - Confirm that these elements are postponed until 2015, and that technical specifications will be forthcoming from EIOPA by year-end to aid in the conduct of some of this activity.

Parallel running Sol I/Sol II concerns
3.53 - basically, not EIOPA's problem!

Compulsion for model applicants to also use SF in the assessment
3.54 - clarify that this in NOT about benchmarking models, rather "taking into account contingencies" should a firm's model not get through IMAP. A thoroughly negative and unsympathetic approach from EIOPA on this one I'm afraid

Timing
3.58 - "EIOPA considers it necessary that all undertakings perform the assessment of overall solvency needs at least two times during the preparatory phase, once in 2014 and once in 2015...[and] at any time during 2014"
3.60 - Stress that "...it is for the undertaking to decide on the appropriate reference date for its FLAOR", though couched in an expectation that financial year-end is most likely.

Guideline 5 - Delegation of activity by the AMSB
3.73 - "not acceptable" to delegate full responsibility for ORSA to sub-committees of the AMSB

Guideline 7 - ORSA Policy
3.62 - "...it is necessary to develop a full policy during the preparatory phase"
3.63 - "...[The ORSA Policy] may be part of the policy on Risk Management", though must be clearly identifiable

Guideline 8 - Record of the ORSA
3.64 - Rather bizarrely suggest that the ORSA Record is "...no less, but maybe even more important during preparation that after the start of Solvency II", but either way the message is clear - maintain the records carefully

Guideline 9 - Sharing information internally
3.77 - "It is for the AMSB to decide which parts of the information will be distributed to whom" - clearly some panic amongst respondents that they may have to start telling the 'proles' about their future employemnt prospects!

Guideline 10 - Supervisory Report
3.66 - EIOPA "...does however not expect that the first report will necessarily already be perfect"
3.69 - AMSB sign-off, accepting the results of the ORSA is the trigger for the 2 week window in which to submit the Supervisory Report
3.70 and 3.71 - Some rather confused paragraphs which seem to indicate that, if there is enough resistance to the results internally, that extra time may be afforded to the firm

Guideline 11 - Valuation bases
3.79 - EIOPA scrutiny postponed until 2015, but justifications on bases used expected

Guideline 12 - Overall Solvency Needs assessment
3.83 - EIOPA expect "...it will take several years" before this assessment is good enough, hence they expect the preparatory phase to include practice!

Guideline 14/15 - Continuous compliance with SCR requirements and Technical Provisions calculation rules
3.85 - Postponed until 2015, and again justify activity prior to Solvency II going live by using a practice makes perfect mantra, noting that attempting to do this will "...intensify the learning experience"! I wonder if anyone ever used that phrase in their budgeting requests...

Guideline 16 - Deviation of one's Risk Profile from SF SCR assumptions 
3.89 - Postponed until 2015, and also note that quantifying one's deviation from the SF assumptions will not be necessary "...if there is no indication that the deviation is significant". I guess modellers will have to wind their necks in around Credit Risk assumptions in particular on this matter, bearing in mind the diversity of methods currently on display.

Ultimately, little opportunity for shortcuts then, but perhaps enough time to review what's already in place before resource planning your 2014 activities.

EIOPA and PRA - model appropriateness, expanding remits and early warnings

Another short flurry of activity recently on the Solvency II front ahead of the day (well, 'month') of reckoning for the Long Term Guarantees assessment. The industry media is certainly very chipper around the prospects of a deal being done off the back of the LTGA (here and here), highlighting that some German products may be the beneficiaries of this new found camaraderie (here).

German products - carved out from 

LTG requirements?

EIOPA themselves have been vocal on power extension this week, with Sr Bernadino making a few waves in his submission to a public hearing on Financial Supervision in the EU. Apart from his Partridge-esque diatribe about 'evolution, not revolution', he also highlighted what he considers enhancements to the existing supervisory structure in the EU, namely:

1. Strengthening EIOPA's operational independence - effectively through a change in its funding arrangements, going as far a potentially levying the industry direct, and also by having more money in any case (referred to cheekily as 'budgetary flexibility'!).
2. Reinforcing its existing 'independent challenge' role - by securing access to national supervisors' QRT data and allowing EIOPA to conduct EU-wide investigations of conduct-related issues (effectively an FCA for Europe!)
3. Enhancing both its mandate and powers - perhaps most controversially, fishing for centralised oversight of internal models, as well as powers to ban or restrict activities in member states.

One might say to EIOPA 'don't walk before you can toddle', but I guess if we are serious about operating a single market, the UK's consumers shouldn't need to rely on generally being in the vanguard on these matters (both producing nefarious financial products, then banning them and recouping the profits for compensation!)

Back to the UK's national regulator, the PRA dropped a few pearls of administrative agony for the insurance industry this week, with a couple of 'dear CEO' letters which were part-briefing and part-data request, ultimately driven by the UK's aggressive take on assessing internal model adequacy (i.e the same activity which EIOPA wishes to expropriate from national hands!). 

The purpose of the letters is nicely summarised by Chris Finney here, so I only need to highlight a couple of elements for my own interest;

Solvency II update letter

• "Unlikely to be any certainty" on timetable before autumn
• "Just under half" of IMAP candidates have applied to participate in ICAS+
• They are hoping to share learnings from ICAS+, "particularly developments used by firms in their modelling techniques" - danger here of the early birds determining what's hot and what's not in the world of assumptions/calibration/expert judgement/documentation for those not participating in ICAS+?
• Highlight pension risk as one area where the standard formula is potentially not suitable
• Next industry briefing forecast for late November (post-Omnibus II ratification?) - that's what I call 'scaling back' on costs!

Early Warning Indicators letter - remember here that the PRA's plans are potentially at odds with EIOPA's, to the extent that the PRA are already braced for some kind of legal challenge

• EWI's aim to test calibrations of internal models as well as "monitor any downward drift in capital" - presumably just quantity for the latter?
• Ratios being monitored are of pre-corridor MCRs (as illustrated in firm's LTGA submissions earlier this year) against current Individual Capital Guidance - once we go live, this is likely to be replaced by modelled SCR
• Special treatment for With-profits business to account for the fineries of that sector (cost of guarantees, level of free assets and the proportion of non-profits written in the book)
• Ratios are deliberately set so that 10% of affected firms will fall below
• Information required to conduct this work is covered by the data collection exercise below

Data collection exercise letter

• Fishing for data from all internal model applicants using YE2012 balance sheets (unless you can excuse using earlier data) which covers standard formula SCR, Internal Model SCR and ICAS by end of July.
• Also asking Life firms for key percentiles from distributions for 'risk variables' - one assumes this means each one of the risk drivers in one's SCR calculation.
• Conducting what seems to be peer review work around credit stresses and stochastic simulation files (for anyone using them).

With EIOPA and the PRA both seemingly interested in being top dog in the world of assessing model appropriateness, it looks like we might need a walk-off...

Judging model appropriateness - EIOPA or PRA?

Solvency II "Where are we now" - summaries from Milliman and PwC

Some useful "where are we now" materials have emerged over the last couple of weeks which you may find helpful, if only to validate your own interpretations of the current state of play:

PwC Ireland preparing for solvency II

Predominantly covers summaries of EIOPA's preparatory guidance, with some nice touches around;

• Differences between Irish Corporate Governance code and L3 system of governance demands (p15)
• Insisting that "an automated solution is required" for the reporting to NCAs, no doubt in the hope of drumming up some work out of such projects now that Pillar 2 work is largely done (p27)
• Comprehensive Use Test schematic (p39)
• General problems encountered meeting data requirements (p47)

In addition, PwC appear to be facilitating the set-up of a CRO Network over in Ireland, which will allow "all the different professional skills that feed into risk management" a place to swap Solvency II risk function-related war stories. First meeting at the end of the summer, can't wait to hear the outcomes.

Milliman - Solvency II Where are we now?

This very detailed slide package was released last week, and like the item above, covers all of the timeline-related activity around EIOPAs L3 work. It goes into updating readers on the latest position on;

• Economic Balance Sheet - noting similarities and differences in IFRS Phase II/Solvency II approaches to valuation, and a large amount of detail around technical provisions
• Data Management - retreads some of the FSA's findings from last year
• SCR - Covers latest standard formula position, as well as partial internal models and generic IMAP issues (again, retreading FSA letter content from last year). Particularly nice IM schematic on slide 21
• System of Governance - Basics on general requirements, function requirements and risk categories (which they have as 'risk management areas'). ORSA piece is fairly generic, but the schematic on Risk Appetite Frameworks (p35) is quite handy.
• Supervisory review - covers circumstances around capital add-ons and how they see the PRA identifying and assessing such instances.
• Supervisory disclosure - SFCR, RSR and QRT content and timetables for submission. Particularly useful to have this summarised, bearing in mind EIOPA's expectations for the interim period are for a subset of the full QRT suite previously published
• Insurance Groups and Equivalence are also covered at the end

Plenty of substance between the two (around 100 slides), so if you have an hour to kill, sers toi tout seul!

EIOPA Preparatory Guidance - ORSA (or 'forward looking assessment of risks')

Forward-looking assessment of the undertakings own risks (based on ORSA principles) (plus explanatory text)

The ORSA preparatory guidelines* are not a massive burden for anyone busy rolling eggs down hills at the moment, coming in at 34 pages containing 25 guidelines, as well as 29 pages of explanatory text. In this instance, it is probably disappointing to any underprepared supervisors and insurers in that they may have preferred more!

More pointedly, the materials add little to what was already in existence from EIOPA in July 2012, and certainly will required little in the way of adaption in the UK's instance, who are already in a similar headspace and have been advising accordingly.

Of course the world and her husband have piped up with their opinion on what ORSA should cover and how it should be administered and documented (this post has a decent sweep at capturing most of them), so opinion on this matter is something we are not short on.

For me the headline points are:

• ORSAs (well, 'overall solvency needs assessments', but let's be serious!) expected from 2014
• Internal Models should be used by anyone in pre-application
• Likely that most standard formula firms will have to qualitatively assess deviations between SF and their own Risk Profile at this time
• Expectation of an internal ORSA report and a ORSA supervisory report
• Records of the assessment expected to be documented and kept which must be "appropriate" - no prescription of what that means
• ORSAs to be performed at least annually

The following points are either new, or worthy of reiteration for anyone whose preparations on this front are less than certain - for ease of reference I have used 'ORSA' where EIOPA use 'forward looking assessment of risk', and as with the other preparatory guidance papers I have looked at, I will assume there will be blanket application as written, with no dissent from industry or NCAs:

Guideline 3

• Overall Solvency Needs assessments will be expected from 2014 (i.e compliance with Article 45.1)
• Minimum of 80% of the market must also assess whether they would comply with the Articles 45 (b) and (c) from 2014 - regardless of any Pillar 1 uncertainty.
• Internal Models expected to be used in ORSAs if a company is in model approval pre-application
• IF the standard formula is 'provided' by 2014, expectation that SF firms will assess deviation between the SF assumptions and their own Risk Profile - this excludes anyone outside of the magic 80% catchment figure mentioned above.

Guideline 6 - Documentation generated by ORSAs must include:

• An ORSA Policy
• An ORSA Record
• An Internal ORSA Report
• AN ORSA Supervisory Report

Guideline 7 - The ORSA Policy must include

• Description of component ORSA processes and procedures
• Consideration of the linkages between Risk Profile, Risk Tolerances and Overall Solvency Needs (OSN)

As well as information on

• frequency on stress tests, scenario analyses and reverse stress tests; 
• data quality standards; and 
• the frequency of the assessment, justified in relation to Risk Profile, volatility of OSN relative to capital position, timing (from calendar perspective I guess) and circumstances for ad-hoc assessments

Guideline 8 - ORSA Record

• Firms expected to "appropriately evidence" the assessment - no prescription as to what that means (logs, working papers, meeting minutes, e-mails)

Guideline 9 - Internal ORSA Report

• AMSB must communicate results to "all relevant staff" post-approval, which includes the ORSA results and conclusions

Guideline 10 - ORSA Supervisory Report

• 2 weeks after concluding ORSA, ORSA supervisory report must be submitted, which must include;
• Quantitative and qualitative results, and conclusions drawn
• Methods and main assumptions
• Comparison between Own Funds, SCR and OSN

Guideline 11

• Must quantitatively estimate the impact of different valuation bases (if used) when assessing OSN

Guideline 12

• OSN must be quantified, supplemented by a qualitative description of all material risks
• Expectation that these items are all stress/scenario tested

Guideline 17 - ORSA output to be used at least for;

• Capital Management
• Business Planning
• Product Development

Guideline 18

• ORSA to be performed at least annually

* So let's end with something fundamental, EIOPA - it is NOT useful to replace 'ORSA', as an acronym or indeed in full, with the expression "Forward-looking assessment of risk (based on ORSA principles)" 5 years down the road - I'm sure there is a rationale, just as sure as I am not going to like it (even the GCAE agree with me, going with 'ORSA-like')!

KPMG's Solvency II Readiness Survey for CEE - the flaw in EIOPA's plan?

So KPMG released this little gem in the same time period as Solvency II preparedness became something of a moot point!

Drawing in responses from 84 people, with around three-quarters EU-based and 70% under £100m in GWP, the questions were posed in Q2 2012, so with Omnibus II missing the last plenary before summer holidays, the writing was already on the wall - despite that, KPMG reckon most respondees would have been working to a 2014 go-live date. It expands on their 2010 work in this area, where 44% or respondents hadn't got started on their Solvency II projects, so progress on that front would be considered a good start!

I gleaned the following from it;

• 31% not expecting to be "Solvency II compliant" before 2014 - one problem that's gone away then!
• Almost half do not have a risk management function in line with the Directive, with smaller companies the main culprits
• Only 19% (down from 40% in 2010) will be using IM or PIM for SCR calculation. Attributed to the realities of building them as well as Groups rethinking their IMAP strategies over the last few years.
• 62% of companies not even planning an ORSA dry run until 2013 at the earliest, with 14% not planning for one at all as it stands.
• Only 14% electing to use more than 3 years as their "business planning period" for ORSA - two thirds settling for 3 years - supports the anecdotal trend of 3-5 years as par for the course
• 20% reported that their internal models allow for multiple year calculations to project for the ORSA - not sure if that is stochastic or deterministic though, didn't think any of the kernel technologies out there could do multi-year projections
• Half of companies have 50% or less of the data required to populate their QRTs
• Extraordinary perceptions on staffing requirements for both project and BAU, which even KPMG are drawn into calling "excessively pessimistic and indeed unrealistic" - it may be led in some respects by subsidiaries using shared Group services, but is still shocking in its naivety.
• Three quarters would like "more interpretation" from their regulator on Level 1 and 2 texts - not sure what there is to "interpret", so maybe its the Pillar 2 and 3 elements that they are struggling with (the other stats here would certainly lend weight to that).
• More than half of model applicants strugglinbg with Validation, highlights assumption setting and expert judgement as problem areas (no surprises there)
• 70% looking to define "new roles and responsibilities" around Data Governance - as referenced in my earlier post, not convinced that will end happily. Over a quarter don't plan to compile their data dictionaries until mid-2013.
• Only a third looking to do full SCR calculations quarterly, and over 50% look like they will struggle to generate the SCR calculation faster than 8 weeks.
• 20% have a dedicated Solvency II team - explaining a lot of the shortfalls in preparedness relative to Western Europe, but given the delays and uncertainty, a financially astute move.

What should worry EIOPA is the results around control function preparedness, or lack of it. If Sr Bernadino thinks that the low hanging fruit of Pillar 2 is ripe for picking before 2016, a quick review of those stats would suggest that a decent number of the 27 countries are in no such state.

Legal and General - Counting the cost of Solvency II

Spotted by his Lordship John Walton this morning, L&G  appear to have broken the mould by dropping some substantive Solvency II comment into their Q3 IMS, notably that they have booked £129m of costs in project spend.

They also go on to plead unhappiness on the inability of the rules as they stand to encourage the provision of long-term capital to the wider economy, echoing DG Faull's rollocking letter to Sr Bernadino the other week on longer-duration debt instrument capital costs, though are clearly only interested in UK investment opportunities as opposed to loading up on fruity Eurozone government debt (good on you!).

Of course the Solvency II preparation costs of most of the big-boys have been covered on this blog before, and £129m feels suitably light for a UK-focused business in comparison to some of its more complicated competitors. That said, with the FSA offering some hope of a transition to "ICA+" rather than dual running ICA and IM SCR for the next x years, how much leverage does this sort of investment buy a firm down at Canary Wharf when it comes to meeting the transitional criteria?

Look forward to seeing a bit more of these disclosures over the next week or so now we are in IMS season, but not counting on it!

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...

Deloitte on "How to conduct the ORSA" - facts and apocrypha

While our pals at the FSA, EIOPA, the CRO Forum, 3 of the Big 4 (here, here and here), the Little 3 (here, here and here), the IRM,  the Irish SoA, and even the guys in the stars and stripes have deemed to recommend to all and sundry what ingredients will make a good ORSA, Deloitte have chipped in this week with a 50-page whopper that tells us everyone else was wrong and they are right...

...well OK, not quite! Deloitte's release about this "important yet enigmatic" area, which seems to have a mainland Europe-flavour to it, works its way through EIOPA's reformulated opinion on L3 ORSA guidance released in July, summarising what changed between the Nov 2011 and July 2012 versions. I of course managed this feat two months ago, but I couldn't quite pad it to 50 pages! They then embellish a section-by-section analysis of the two documents with some charming apocryphal tales of what "many companies" or "the industry" are struggling with currently (i.e. their clients' problems!).

As with most things generated by the behemoths, it is a really useful piece of material despite on the face of it not adding anything new to the knowledge pool, so from an ORSA consultant's perspective, I've made the following notes;

• Emphasises that supervisory intervention will come from lax ORSA processes, as opposed to ORSA Report content (which will drive the US approach)
• Notes that, given the opportunity for the ORSA and the SCR calculations to to be conducted on different reference dates, that this may allow organisations to keep any existing strategic planning processes where they already are in the calendar, rather than unnecessarily shift them to, say, follow financial year-ends. The proviso of "no material change in the risk profile" may of course discourage that, if only due to the need to define "material"!
• Some rather controversial free text around risk appetite ("intuitively simple" as a concept) and risk appetite frameworks ("very much a work in progress" at insurers) - appreciating progress is somewhat inconsistent across industries and the inter-body squabbling on the matter, I can imagine many practitioners would argue the opposite of both points - it's complex, but we're well on the way!
• Highlights difficulties with performing obligatory entity-level ORSAs if risk appetite is expressed in regions/products/funds, which seem perfectly reasonable anchors for risk appetite statements on the face of it.
• "Most organisations" defining AMSB as parent company Boards, plus entities if applicable - no evidence provided though.
• "Many firms" struggling with the "cultural challenge" of getting Boards to drive ORSAs - this I found odd, as many ORSA processes will already be in place to a greater or lesser extent, and most would feature in their individual crystallised reporting form in a BAU board pack. They go on to suggest that getting AMSB input into stress and scenario testing is one way of evidencing ORSA "driving".
• Comment that "In general, the ORSA guidelines were seen as too prescriptive" [my emphasis] - I generally recall the clamour from the industry over the last 3 years being that there isn't enough!
• Common (unevidenced) theme identified that ORSA policies have tended to be signed off by Risk Committees, which may not satisfy the AMSB sign-off requirement
• "Some organisations" electing to split out record of the ORSA Process from the ORSA Report to trim the document size - makes perfect sense, as there's no danger of the co-ordinating function not retaining those records for repeatability purposes.

Plenty of other clutter in there on risk quantification and capital management, but nothing controversial, just nice to read. Bon appetit...

Operational Risk - Scenario analysis and best practice

Short and sweet - couple of interesting papers in the Op Risk space which should help anyone working on operational risk scenarios or indeed brushing up on best practices.

Milliman start off with this scene setter on approaches being adopted in order to bypass the rather broad brush (and I suspect in some cases, financially onerous) standard formula approach to calculating the Op Risk SCR element. They of course touch on the old-but-legitimate complaint around imput data quality if one wants to model their capital requirement rather than sketch it on the back of EIOPA's fag packet.

While they take the opportunity to applaud the efforts of those creating a database of scenarios, or indeed using the ORIC database, they ultimately come down on the Bayesian side of the debate, which I suspect is a touch too rich for most people's blood, but those of us with deep pockets (and large Op Risk SCR totals!) may give that a stab.

The second piece came from Corven around best Op Risk practices from other industries, and how they could be adopted by the Financial Services industry. Not much of the research is actually published yet (and the main meat of their published findings is hidden behind FT's paywall), but I found it particularly interesting to see which industries were cited as areas where Financial Services could learn from.

Some good interim stats (full report to follow in October), including;

• All respondents to date trying to tie in op risk performance with compensation
• Regulatory hounding appears to have inspired 64% of respondents to inprove Op Risk management
• Full root cause analysis only conducted by 38% of respondents upon a "major risk failure" - woolly words aside, that is not impressive at all.
• Responses to major risk incidents overwhelmingly look to amend processes and systems, not the people and capabilities that inevitably led to them!

The example of air crews being compelled to point out senior staff members' inadequacies is a particularly powerful example of bottom-up op risk mitigation, though I struggle to see its application in financial services. However, it was also strange to see the Oil industry also cited as a best practitioner - the major risk events in that industry surely draw parallels with financial services at their most grasping over recent years.

EIOPA's response on the ORSA consultation - get on with it!

In a week so full of heavy reading (EIOPA's response to the Reporting Package consultation and the FSA's second tome on creating their SOLPRU handbook), I was hoping to get to something a bit lighter towards the end of the week (heard great things about 50 Shades of Grey on the grapevine...).

Then appears EIOPA's response to the ORSA consultation paper feedback, which is affixed to the document in a whopping 200 page annex. While I have blogged on the consultation paper itself back in November, the real meat and spuds of the response is condensed into the front 15 pages, from which I would flag the (non-exhaustive) following lobbyists points, along with EIOPA's responses;

• Lobbyists were still asking for more prescription/examples in areas of the guidelines, regardless of this being Level 3
• Specific concerns around the "deviation from risk profile" guideline, which may force insurers to adopt internal models
• Continued concerns around proportionality and materiality definitions
• Still seeking "ORSA Report" examples
• Concerns around projecting overall solvency needs over the planning period, so looking for simplifications in that area
• Range of concerns around Group ORSAs (diversification, Colleges of Supervisors, Third Countries, ORSA scope)

EIOPA's highlights in response are;

• Re: proportionality and materiality - stop whining and get on with it (p8)!
• Re: "Record of the ORSA" - a specific document containing all records of ORSA-related activity is NOT required, where existing documentation/records contribute to the assessment as they stand (in such cases "a reference to the relevant data is sufficient") (p9)
• To supplement this, they note "A record of an individual ORSA will in most cases contain more information than is contained either in the internal ORSA Report or the ORSA Supervisory Report" (p10)
• No specific approach for captives (so another 'get on with it'!) (p10)
• All risks are expected to be quantified, regardless of the difficulty (p10)
• Lobbying on forward looking perspective has clearly paid off, as the requirement to quantify overall solvency needs for each year of the projection period has been dropped (p10)
• Onus on companies to justify conclusions around the severity of deviations of risk profile (which may lead a Standard Formula firm to start modelling) - a result of sorts for the industry I guess (p11)
• Confirms that ORSA and SCR calculations cannot be completely divorced, but would allow an ORSA to be performed using an older SCR calculation, providing the risk profile hasn't materially changed in the interim

No reason to think they would radically divert from their proposal (indeed, they didn't on the reporting package as well, so at least the industry is getting the certainty it craves, if not the actual legislation!)

Lloyds of London on Solvency II - Annual Report content

Hot on the heels of their delay in submitting their IMAP pack to the FSA, Lloyds of London pushed out their annual report today - as ever, a riveting read in general (and emphasises the scale of Nat Cat activity last year), but I concentrated more on the Solvency II side. They noted;

• "… we have made excellent progress to ensure that, whatever its final implementation date, the Lloyd’s market will be operating to the standards required of Solvency II by January 2013" (p8) - no mention of the IMAP delay, although this could of course work in their favour when looking to achieve this target.
• "Lloyd’s preparations for Solvency II advanced well in 2011, both within the Corporation and the market, and the entire programme across all relevant parts of the business is on track" (p22) - again, odd when IMAP activity has been postponed 3 months!
• "...Solvency II may have a positive impact on the reinsurance sector by increasing demand for reinsurance products" (p49) - same message put out by Swiss Re.

They also note good progress on the ORSA process and reporting front;

• "Lloyd’s has also further developed its approach to the Own Risk and Solvency Assessment (ORSA) – which aligns all of the activities Lloyd’s uses to manage risks and ensure the right level and type of capital. This alignment improves the quality of management information and the resulting decisions. In 2011, we produced a series of pilot reports to enable senior management to review the ORSA’s proposed structure and content. A live report was finalised and approved by the Franchise Board during the first quarter of 2012. In future, the report will be produced at least annually." (p30)

And finally a nice piece of disclosure on economic capital;

• "The capital provided by every member is assessed according to the Lloyd’s Individual Capital Assessment (ICA) capital setting framework. When agreed, each ICA is then ‘uplifted’ (by 35% for 2011) to provide an extra buffer to support Lloyd’s rating and financial strength. This uplifted ICA, which is the Economic Capital Assessment (ECA), is used to determine members’ capital requirements subject to prescribed minimum levels. The FSA oversees the annual review of syndicate ICAs by the Corporation, which reviews the historical performance, business plans and risk appetite of that syndicate in assessing the adequacy of the capital level proposed." (p69).

Whether all of this is good enough to allow them to achieve their objective of avoiding parallel running ICA and the internal model in 2013 is anyone's guess, but let's wish them good luck.  

FTSE results and spare capital - Aviva

Just when you thought, after first AEGON and then the Pru, the EU exodus was about to start at the thought of Solvency II compliance costs, up front the lads at Aviva with their results today, accompanied by their UK CEO stating they were committed to being part of UK plc 'hook line and sinker'.

Regardless of whether such an EU-centric company has anywhere else to go is another matter, but it is refreshing that such regulatory arbitrage is not near the top of everyone's agenda (at least not publicly!).

The view also seems somewhat perverse when you look at the numbers - IGD surplus is down seismically y-o-y (although the sneaky pro-forma IGD estimate for end of Feb highlights how much of that was due to grumpy markets), but of more interest from an overall solvency needs perspective, their economic capital coverage is also well down, sitting at around 125% at year end. Again, they have thrown a quick-and-dirty pro-forma in to show the number at 145-150% at end of February.

As they are calibrated to AA rated (p8), this is ample for SCR coverage I guess, but the cynic in me suspects that capital efficiency must be putting HQ moves on everyone's agenda, particlarly when you look at the £96m bill for their Solvency II preparations last year (p 31)!

Axa results and economic capital measures - indication of things to come?

So results season kicked off today with Axa putting the basic full year out (got to love European efficiency on these matters!). This was followed by the EEV Report and Analyst Presentation.

Of particular interest is of course the Solvency I vs Economic Capital measures which most insurers are now kind enough to table up, and the figures were pretty stark. On the Solvency I measure they were a touch up year-on-year, while their Economic Capital measure was massively down (numbers on first page, rationale on third).

Detail on their Economic Capital (and indeed their entire Capital Management Strategy) was fired out in 2010 as part of an investor day. They appear to be using the 1-in-200 stress as their EC measure, which would suggest that (model approval notwithstanding) they have received a 'beasting' on their SCR coverage over 2011.

I blogged in August last year about an FT article which opined on how companies may approach economic capital targets under Solvency II (125-150% of SCR in UK, and perhaps 170% in mainland Europe was their conclusion, for what its worth). While that would have put Generali fractionally out at the time, most of the other big boys were comfortably covered using that yardstick...until now!

The rationale for the drop presented goes to adverse experience on interest rates and spreads "net of changes to the liquidity premium". A smarter man that me will probably be able to read between the lines on that one to find where they are exposed in a way that leads to such a swing in EC, but if one of the major lobbyists is experiencing this volatility, what chance the rest of us?

NB - Generali punted this round today in order to contextualise the recent downgrading activity of insurers by the ratings agencies - surprising to see a company lump all of their competitors onto a press release from their own offices, but I guess there is safety in numbers! Few comments on Solvency on it, but mostly seems to be about negative outlooks on Eurozone default possibilities, new business and economic conditions etc

ABI, Lloyds & the FSA - behind closed doors...

Flagged elsewhere on Friday, I read through the FSA committee minutes which noted that “contingency” may be required (p3) if Solvency II is not implemented by 2013 – no mention of what that will consist of, though it sounds ominous and probably ends with the words “-million pounds”.

Also reported on Friday, the ABI and Lloyds are looking to lobby for a 2013 go-live date, regardless of the content of Omnibus II, so that Lloyds’ existing ICA process can be jettisoned and replaced by Internal Model SCR (thus restricting the dual ICA/SCR obligations to one year). I suspect they will have plenty of people who would ride on their coat-tails if they can squeeze this one through!

FSA "quantitative tools" for IMAP candidates - Life firms

The FSA have pushed out their "quantitative techniques and tools" for (Tier 2) internal model pre-application candidates to help assist discussions with everyone in the application queue. Primary objective of this is "to identify and prioritise areas for review".

First they are asking for ICA, Internal Model SCR and Standard Model SCR figures as at end of 2010. A questionnaire wil be out in the next couple of weeks, to be returned by end of September, and analysed by the FSA over Q4.

They are also asking for risk dependency and aggregation structures, also in a questionnaire format, along the same timescales (however, as there is an EU-wide aspect to this, the timescale is looser).