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?

Central Bank of Ireland - Prudential regulatory agenda for 2013

A pretty meaty speech was delivered last week by the CBoI's head of life insurance supervision, covering the prudential regulatory agenda in Ireland for 2013 and beyond. In essence it is a rather sobering take on the flipside of the Celtic Tiger's death and its impact on what was an effervescent, if still fledgling, cross-border insurance industry, noting that new business volumes recorded in Ireland have declined for the 5th year in a row, and currently aggregate out at a break-even APE/PVNBP margin.

I found there was actually a lot to take from this on the ORSA front, and would recommend any readers on the Emerald Isle pick the bones out of it, in particular that the regulator "expects to see";

• Strategies reflecting "current market realities" - highlighting excessive commission to brokers, swollen lapse/surrender rates and reduced margins from over-competition.
• Tight management of costs
• Increased efforts put in place to retain existing in-force business
• "Credible business plans"
• Viable alternatives to grow business through distribution or product range changes (online facilities highlighted specifically)

While much of this may read as common sense, one can reasonably assume that the CBoI is not seeing enough evidence of this in the Financial Condition Reports and strategic plans that currently cross their desks, and are expecting a much meatier ORSA-type approach to managing strategic risks over the business planning period in the immediate future.

FSA Business Plan for 2012/13 - probably a quiet year...

The FSA fired out their business plan for next year today. Of interest for the insurers amongst us is p30;

• We will extend our work with the largest firms to deepen our assessments of insurers’ business models and their resilience under a range of conditions.We will maintain our focus on understanding the financial impacts of stressed market conditions, including through use of standardised stress testing and reverse stress testing.
• As part of our supervisory work on Solvency II, we will continue our assessment of firms’ progress towards meeting the new standards, including through detailed reviews of insurers’ risk management arrangements and proposed internal models

Specifically on the Solvency II front (p32)

Continue to work with the Treasury, the European Commission and EIOPA on the negotiation of Omnibus II, Level 2 and Level 3 of the Solvency II directive;
Continue to work with the insurance industry to keep firms up to date with policy developments so they can effectively prepare for implementation;
Conduct our consultations to transpose Solvency II into UK rules and a new draft Handbook by 1 January 2013;
Develop and deliver the design and build of the processes required for implementation on 1 January 2014 and beyond, where policy developments allow us to do this;
Work with firms on the implications of the change from a paper based to an electronic reporting process;

Deliver the required training and support internally and externally.
Provide UK-specific regulatory reporting templates, with supporting systems and materials for firms and FSA staff to complement the EU-wide material; and

Finally, on page 51

• We will continue to reform our conduct regulations, where necessary, to implement the requirements of the Solvency II Directive while maintaining appropriate levels of consumer protection. The bulk of this work is expected to be in relation to our rules on permitted links (COBS 21) and on with-profits (COBS 20), with the revised rules intended to be included in the Handbook at the start of 2013. Some aspects are dependent on the completion of work currently being carried out by EIOPA.

Pretty quiet year ahead then all in all...