Basel experience - good reason for EIOPA?

I couldn't help feel when I read this in the FT that the inexorable wait for EIOPA's Omnibus II powers to get final clearance is actually an event worth waiting for, when contrasted with the Basel implementation experience for EU territories.

To hear a man of Mr Barnier's authority struggling to convince that the draft EC legislation doesn't play favourites, when evidently the bancassurers will hold the whip hand is very sad, particularly when coupled with the fact that there is no pan-European regulator which will police consistent application in any case.

The Tier 1 capital argument is of course the same debate that the insurance industry (indeed probably the same countries!) are having via the CEA et al with EIOPA - I suspect there will be a more equitable application of the final rules on instrument types and the transition length knowing that EIOPA will carry a pretty big stick...

FSA Special Projects fees - additional info

Just a few bits of additional information from the FSA special project fees for Solvency II

• Focusing IMAP fees on confirmed model applicants only means small internal model applicant companies will obviously suffer the twin agony of losing the industry-wide "subsidy" for model application costs, as well as paying standard non-IMAP fees for 2011/12
• No refunds if anyone withdraws mid year!
• Straight line recovery based on premiums and liabilities
• Any late entrants who try to join the model approval process will be levied
• Difference in FSA costs between provisional and final budget is nearly £5m - is this vast difference due to the number of model application drop-outs (which must be around 20 companies)?
• Some sniping comments from industry in the consultation responses, saying the differences between budget and requirement showed the FSA "had not budgeted effectively", are spending too much, and should give a more detailed cost breakdown.

I guess all of these comments were gathered before the two-tier approach was revealed last month. I suspect some smaller companies would be happy for the FSA to spend some of this underrun and staff ongoing model validation during 2011, rather than go fishing for more consultants!

FSA Solvency II Levy - details on calibration

The FSA have just published a mammoth guide on their levy calibration for 2011/12 - the Solvency II-specific section starts at page 111.

On the face of it, good news, as they didn't spend enough of last year's levy, leaving a cheeky underrun. There's a piece of Friday good news!

Solvency II and Proportionality

For my own benefit I am posting my notes on the proportionality guidance issued by CEIOPS back in 2008 - feel free to use as you wish!

In particular, if the Internal Model levies are likely to be proportional to the nature scale and complexity of the undertaking, it is important to be able to argue the toss if one feels one is being overcharged!

Fundamentals

Level 1 – proportionality established as general principle, leaving details to L2

Article 28  - proportionality linked to “nature scale and complexity of the risks inherent in the business”

Nature criteria

•  Classes of business (short/long tail)
• Low frequency/high severity or vice versa
• Reinsurance/captives get bespoke treatment

Scale criteria

• Size criterion (assets. liabilities or risks)
• Governance processes via scale and cost benefit analysis

Complexity

• Cash flows of investments not interest-rate sensitive
• Homogeneity of portfolio
• Similar characteristics of policies mean valued using model points
• Product lines with increasing complexity (Life business with/without options and guarantees, Non-Life with/without renewal options)

Applies to all provisions, and therefore by proxy, all future implementing measures

Applies to both implementation of directive and conduct of supervision

“The individual risk profile should be the primary guide in assessing the need to apply the proportionality principle”

Pillar 1

“Justifies simpler and less burdensome requirements for low risk portfolios”

“In order to be considered proportionate a measure has to be, at least, suitable and necessary to achieve its objective as well as appropriate”

“Lack of resources can never be an excuse for not complying with supervisory standards”

Pillar 2

“function” denotes that a person/s must perform the task, not that they are precluded from doing other tasks.

“high risk undertakings may also be expected to introduce a code of conduct” – this followed by a piece on “complex risk profile” undertakings needing expertise in ‘the development of an internal model’. Not sure if the implication is high/complex risk means all internal model applicants.

“Insurers risk management function should be closely integrated with its capital management function, and its risk management policy should describe how this interaction takes place” very important!

“there will be very limited scope for proportionality with regard to the quantity and quality of its regulatory capital requirements”

“One aim of documentation is helping communication between the board of directors, management and personnel. The description should be intelligible and comprehensible also to a knowledgeable third party.” – benchmark for policy writing

“Not only can the compliance function be outsourced but it may also be performed by members of the management or administrative body”

Pillar 3

“CEIOPS places particular importance on the proportionality principle where supervisory reporting is concerned”

“CEIOPS believes that public disclosure as a principle is required in order to enhance market discipline and thus must apply to all undertakings”

Internal Model

“Proportionality should never be put forward to justify a failure of the use test, not meeting the statistical quality standards or not properly validating the internal model and its use.”

“Proper segregation of duties, as appropriate given the nature complexity and scale of the business, can be viewed as a mitigating factor” – for key person risk on Internal Model

“As regards the validation function, CEIOPS does not consider that each company must have this task fulfilled by independent staff” – followed with “it is also essential that the individuals performing the validation possess the necessary up to date skills, knowledge, expertise and experience”

FSA Special Levy for Internal Models - Just like the Irish...

New levies on the way it seems, with a FSA-led consultation kicking off this week - having seen the Irish go this way early in the week it should be no surprise, but I guess it begs the question "did we not already pay you for this?".

No doubt more to follow today and tomorrow on this one - in the meantime, UK followers may want to start taking notes on how the FSA approach them, because it looks like the levies will follow some kind of "proportionality" principle judging by the terminology used, and that could indicate future likelihood of proportionality reliefs in your Solvency II implementation.

Bernadino in the Telegraph - reiterates comments on Solvency II Deadline

Big shout out to Gideon Benari, whose excellent Solvency II Wire picked up on Gabriel Bernadino being interviewed by the Sunday Telegraph (I clearly don't check the mainstream press as vigorously as I ought to!).

Bernadino seems to reiterate his impressively terse outlook on deadlines, keeping his line on transitionals - strangely, they haven't managed to wheedle much more comment than that.

New features on the blog

Depending on how you like your news and comment, I have just plugged the blog feed into my Twitter account, and also dropped in a feed of my starred items from Google Reader - it is a maximum of 5 items, and I normally tag up 10 a day, but hopefully you can get some benefit out of it!

Reputational Risk in Germany - Nicht so gut...

A quite unbelieveable story on how to reward salespeople at a sub unit of Munich Re. If there is ever an incentive to inflate your figures (pun intended!) then this is it.

I am more interested to know if the remuneration committee had factored in any clawback provisions...

FSA update - Solvency II, Supervision Framework and death of ARROW

The FSA had a busy week, with a major conference in London on the future of the regulator in its new guise as the Prudential Regulatory Authority (PRA) .

Media commenced with an interview in which which Hector Sants discussed the obligations of the regulator to publish findings  such as those from their report into RBS (which has been taken out of the FSA's hands). Speeches given by Hector Sants and Andrew Bailey are available here and here respectively.

It is of course banking focused, but the new risk assessment framework (p9) shows much more agressive intent from the regulator, and it will be interesting to see any transference of experience between Solvency II preparations and changes on the Banking side when the PRA finally comes out to play

As a funny aside, Andrew Bailey confirmed in the speech that the ARROW supervision model was to be scrapped - having seen the number of site visits it generates dwindle as shown in these numbers, I am surprised it has taken so long to confirm it!

More excellent Solvency II materials

"Reassuring expensive" - not a bottle of Stella Artois, but subscription to InsuranceERM, who continue to produce cracking material to help validate your Solvency II approach on all three pillars. I picked out the following from last week (sign up for trial to view if you don't subscribe).

Dutch problems under Solvency II - Fitch ratings provide the research this time on Dutch preparedness for Solvency II. It highlights a couple of items; that AEGON and ING will be praying for the USA equivalence assessment to be successful (both of course have received state help on the capital front recently, so will be light on that front), and that secondly there would be a maximum of 12 Internal Model applicants, and potentially even less, due to resource scarcity.

CRO at Torus on his Solvency II approach - As a new company, he notes that the benefits of not having to incorporate legacy systems into the data warehouse is somewhat negated by the lack of historical data in producing the calculation kernel (relying on a deterministic approach in some areas). Very interested to see his approach to addressing the use test, which is by performing gap analysis between current and future state in 12 areas where model output could potentially be used.

Solvency II Balance Sheet volatility challenges - succinctly lists responses to the volatility expected when performing market consistent valuation as "raise capital, hedge, or change product lines". While UK already values in market consistent manner under IFRS, this will introduce SCR volatility across the continent. Makes a nice distinction between short and long term liabilities, and the ease of capitalising the former with reduced spread risk. Also suggests that asset-liability matching will become a more exact science across the board.

Corporate Governance - careful what you pay...

Noticed this from the ABI - alert to FTSE 350 boards to make sure they don't get too excited when catching up with executive pay after a couple of years of what one could call 'austerity' (tee hee!).

It isn't the only bit of hot topic in the UK governance world - the chairman at Prudential got a mild birching last week in protest at the failed AIG Asia bid (not unprecendented, but unpleasant I dare say). This follows a trend of dissent during the last few months (nicely collated here), and makes it that much easier to make the case for genuine debate, participation and use of the ORSA process under Solvency II.

Solvency II and the USA - start de-risking or close the door!

Very cute article citing Moody's research on how Solvency II is already driving asset selection (and even product viability) in the United States, a jurisdiction that still hasn't made too many steps towards jumping through the "equivalence" hoops!

It is of course a given that products with embedded options and guarantees are going to be pricey under the new regime, but to hear that it is already driving capital allocation away from a country which will no doubt get equivalence (thus avoiding extra capital charges) is quite something.

Solvency II Approach in Australia - APRA review

If all EU-based readers can wind their clocks back, I spotted this article on Australia's Solvency II cousin which seems to have all the hallmarks of the EU/IAIS experience.

I was very interested to read that capital requirements would be substantially higher - sadly I'm no expert on calibration, but this shows there is an intense lobbying effort ready to go. This may even mirror the history of the QIS exercises in Solvency II, where the calibrators have started on the conservative side and folded when necessary.

Matthew Elderfield speech to European Insurance Forum

The European Insurance Forum has been the poor relation in terms of big events in Dublin this last week (Queen's visit, Obama's visit, Cup Final etc), but the big presentations given are available off this link

I haven't been through all of those yet, but I rushed to go through Matthew Elderfield's keynote speech on the regulatory landscape. Some media comment here and here might help sift through the 20 pages of detail, but my take was as follows;

•  Take some comfort from his comment "rule book for banks should not be Xeroxed wholesale onto insurance"
• Attributed Irish problems to lack of regulatory resource (and an adequate assessment framework) and lack of effective standards for Fit & Proper assessment ("gaping hole")
• Having done the work on corporate governance standards at macro level, the Central bank will be looking at "internal governance standards" later this year - this is intriguing to say the least!
• Only 11 "major institutions" in Ireland according to his definition (significant policyholder detriment and reputational damage to Ireland)
• FAQ's will be publised on board participation requirements - truly staggering if this is correct, and flies in the face of the views of the IOD on skills adequacy just blogged on.
• "Corporate Governance standards were improved due to the input of industry comments" - I analysed these at the time, and they barely changed after feedback ("Major institutions" definition notwithstanding)!
• Fitness and probity standards under consultation compared to Approved Persons regime in UK
• Big section on Variable Annuity providers who have set up en masse in Dublin - they have responded by setting up a bespoke VA team.
• They will require all VA writers to produce an Internal Model for Sol II - no mention on whether, if a model fails the application test, it will be forced to move jurisdictions!
• "Invested in building up staff levels" for Solvency II - yet can still only produce their Solvency Matters document quarterly, with virtually no "new news" in it.
• General sympathy with deadline pressures at EIOPA/Commission level, noting that the intention is "to progress as much of the non-Omnibus II impacted work as possible"
• "Need to give consideration to the phasing of particular obligations on supervisors and insurance firms" - asking for transitionals?
• Emphasised the usual areas requiring change in the QIS calibrations (nothing new), EPIFP and Contract boundaries etc.
• Central Bank favours a "middle course" for recognition of EPIFP in tier 1 - CEA estimated the gap would be €100bn of capitalisation if it was excluded, against €3bn if fully included across the whol industry.
• Wants to "disabuse" the industry of the fear that a beneficial step change in capital requirements using an internal model will necessarily lead to model rejection - peer comparison will be used for reasonableness though.
• VERY IMPORTANT - highlights that diversification benefits derived from correlation matrices or copulas that include "a significant degree of subjective judgement" are not currently given enough regulatory attention, due to excessive focus on risk buckets - "...the marginal impact of these changes are dwarfed by the impact of judgement calls on correlation or dependency".
• VERY IMPORTANT - planning to introduce a special levy for internal models - unlucky Ireland!
• Refers to the trend of hub-and-spoke models rather than subsidiaries due to loss of Group Support section of Solvency II. He wants to "...make sure that the hub [in Ireland] is substantial and has sufficient critical mass to exercise effective control over its branch operations". Basically negating any regulatory arbitrage plays.
• As a hub supervisor, he will be "prepared to exercise effective direct oversight over branch operations",
• Notes that, in the absence of the IAIS ComFrame framework that Solvency II as become de facto binding international standard on solvency

Change of model scrutiny focus to correlation is a big call, and the special levy is sure to go down badly in a country which has just hit pension providers with a separate one-off levy.

Corporate Governance catch up - Ireland: Elderfield, Gender and Captives

Busy in the last week, so catch up exercise required!

Ireland has been awash with interesting developments on the Solvency II and Corporate Governance front, so I have bulleted them below;

Captive Insurer governance – Ireland’s pre-emptive strike for proportionality parameters have been released in the regulator's consultation paper - nicely summarised by Lexology here

Society of Actuaries feedback on "Fit and Proper" consultation - interesting to get the views of the actuarial world on Fit and Proper requirements, particularly due to the relatively vague nature of the function's responsibilities under Solvency II. Also interesting that Matthew Elderfield referred to the impending regime as being very similar to the FSA's prevailing regime (more on this later).

Themed Regulator Inspection - product failings - Good example of how thorough the investigative work is becoming on the enerald isle, as well as how scathingly the findings are portrayed. This will surely filter through under Solvency II into the capitalisation side should similar weaknesses be found in guaranteed products.

Board Diversity and Gender - Institute of Directors research - some very sobering research on board diversity and quality in Ireland, which shows there may be some distance left to run before governance quality improves in reality. How 80% of responsdents can think they have an appropriate mix of skills, yet only half have some kind of skills framework in place is beyond me (although I appreciate measuring and monitoring does not necessarily ensure application).

More intriguing is the 60% of female respondents in favour of an imposed quota to ensure representation of both sexes on boards (against less than 30% of men). Solvency II, in both the Level 2 and 3 papers provides a ticklist of required knowledge in the management body, but doesn't go as far as to demand quotas.

I dare say that direction will arrive via other means...

Captives - Does ERM mean higher costs under Solvency II?

Can't help but think I am missing something having read though A.M Best's special report on Captive Insurers under Solvency II.

The report has some bright spots (covers proportionality and reasons not to factor it in to project plans very nicely), some weak spots (recommends participating in QIS studies which are surely now finished), and some great definition on why so many companies may be caught out (narrowed definition, lower diversification benefits, perhaps had hoped that parent would absorb the impact).

What is not so pleasant is the implication that by tightening standards in the Pillar 2 and 3 areas there will be higher operating costs ("significant impact" in their words). I may be missing a business opportunity here, but this is surely a 'proportional' one-off cost, where they can even get leverage from their parent company's project work?

Operational RIsk data - ORIC and the future

Spotted this ORIC slideshow from May's Solvency II presentation for the IRM. Not too much to glean from the light content other than the last slide, which gives a glimpse into the future of ORIC's work (develop consensus for industry use, improve data standards, develop best practices, increase usage levels).

All very noble aims, and can only aid the move towards stochastic modelling of Op Risk for the internal model users amongst us.

Solvency II "Boom" - but some missing out?

Saw this incredible piece today in RM Professional citing some research by Kinsey Allen on risk professional demand at the moment. I wasn't startled by the trend, more that a number of the questions  regarding pay increases, team size increases etc did not elicit 100% responses!

Also shocked that only 85% thought Solvency II knowledge increased their value - I can only assume they haven't checked the market...

More reasonable was the 66% who thought there would be board-level promotions for Risk in the offing. I cannot imagine that, even in face of Solvency II, everyone will be clamouring to make another executive appointment.

More on IRM issues with Risk Function under Solvency II

The FSA presentation that appears to have caused the mild outrage with the IRM has actually already featured on this blog - at the time I didn't pick up any undercurrent of an attack on risk professionals in general, so I guess you had to be there.

Having reviewed the IRM's lobbying letter, it certainly has the tone of a rebuke ("recent debates have caused unnecessary confusion" being my favourite line). The presenter was a relatively big hitter at the FSA, so no reason to think this isn't the FSA party line.

What I noted from the rest of the letter was;

• Felt that the directive is being interpreted to assume a CRO must have risk and actuarial skills
• Rather harsh contention that the development of ERM-related actuarial qualifications shows that their profession does not provide "sufficiently broad training".
• "Trend in the market" for hiring business-focused CRO's. Not substantiated, but having looked at the CVs of a couple of the CRO membership it does stack up.
• Struggled to find an example where risk and actuarial have to collaborate at the moment, using Op Risk modelling as the easy case study.
• Suggests that actuarial could not perform independent oversight of reserve risk, when via chinese walls or basic separation of duties one would think they could
• "There have been suggestions that there are no suitable qualifications for risk management professionals" - this must have come verbally at the presentation, as I cannot establish this from the slides. If this was said or even insinuated it is pretty outrageous.
• Ticklist of risk function attributes under Solvency II matches up largely with the Level 2 and 3 guidance
• Strange comment that the IRM wants "further guidance" on what constitutes a fully effective risk function, presumably as the FSA and Solvency II views are perceived to have diverged.

I suspect there is a few miles left in this one...

Risk Managers vs Actuaries - place your bets

I couldn't have put it any better than this brilliant article on the spectacularly blurred lines between actuarial and risk functions under Solvency II.

The letter referenced  sounds like it was directly inspired by an FSA closed-door presentation (which I cannot find a copy of) on the subject of the risk function's future. The theme of that presentation must have been very certain in order to have generated such a swift and piqued response.


Being of a non-mathematical persuasion I would not say that I felt uncomfortable by the Level 2 & 3 covert (and in some places, overt) direction that the best person to run a risk function/be the CRO under Solvency II would be an actuary who knows a bit about risk - indeed, with the advent of the CERA, I suspect there ought to be a conveyor belt of suitably qualified people.

However, it would be incredibly disconcerting to find at UK national regulator level  that a professional who followed the strategy/soft skills path to risk management may not be considered able to gain enough understanding of actuarial concept in order to discharge their obligations with regard to ORSA, Model Design and Validation etc in the same way that a pure Capital Allocation actuary could do it the other way.

The work on gaining that knowledge must start now though if it hasn't already - start with the kernel, and work your way out risk-guys!

In the meantime, I'll look out for that presentation, as this dismissive approach to risk professionals in the Solvency II context was not one I had come across previously.