CRO Forum's Principles on Operational Risk Measurement - "Quant touch this"...

Hammer Time?
Current efforts in Op Risk quantification

Despite practitioners efforts over the last few years, Operational Risk continues to live on starvation rations when it comes to considered quantification. Never treated as an alpha-topic by executives inside insurance institutions, it has been treated with similar indifference by legislators, culminating in the  "totally inadequate" take-a-percentage methodology for calculating Operational Risk capital in the Standard Formula.

Internal Modellers on the whole are not likely to be shaming that technique with their efforts either (basic summary of their problems here, while InsuranceERM cover struggles as a whole with a roundtable here). A paucity of operational risk event (and near miss) data within firms may be good news for ORIC as a vendor, but from a parameter and data uncertainty perspective, it leaves internal model operators and validators in an invidious position, particularly due to the quantum of insurers' capital likely to be involved (10%, give or take?).

It's not that the actuarial world hasn't taken a stab at it before (here), aren't fully aware of the data holes (here), or haven't used the word "Bayesian" in a sentence (here). However an activity which was "in its infancy" in the UK as far back as 2005, is surely now old enough to be working in the mines...

I was therefore happy to see the unprolific-yet-important CRO Forum bring a white paper to the table, Principles of Operational Risk Management and Measurement. It is an update to a 2009 version which takes into account Solvency II demands, as well as developing practice within insurers over the period, the suggestion being that 2009's efforts were a little too Banking Industry-influenced.

While this document might feel at outset like an idiot's guide to "quanting" operational risk (and bearing in mind the number of prospective standard formula applicants - 9 out of 10 in UK - one may be needed soon!), the document touches on a number of noteworthy technical matters, in particular;

• The Definition section doesn't read well, but they have attempted to include outcomes other than monetary loss into the Op Risk definition, which from experience will improve discourse within firms. Are they attempting to squeeze strategic and reputational risks into this box though?
• Nice coverage of Boundary Events, and encouraging firms to consider them in their management of Op Risk.
• Very specific treatment of Risk Tolerance throughout, using it in preference to Risk Appetite. This is because it cannot be avoided, and so tolerance levels should be used to trigger "RAG"-type reporting up the chain. Nice work, and well justified, but I have certainly seen the expression "Zero Appetite" used for Op Risk, so no doubt this is not an industry standard perspective yet! (p5-6)
• No problems with their coverage of tried and tested techniques - "Top Down", RCSA's & Loss Event analysis (p9-10)
• Nice turn of phrase regarding emerging risks on p9 - "...assess the proximity of new risks to the organisation". It may need to include an attempt to quantify to be fully useful for ORSA purposes.
• Concept of residual risk arrives quite late in the day, but isn't omitted. Important, given how much qualitative, or spuriously quantitative, material is being promoted as aiding this measurement work (p10)
• Seem to accept at the bottom of p10 that Internal Modellers must do more than curve fit on internal Op Risk Event data - good news I guess.
• Internal Model validation pressures on current Op Risk quantification practices flagged directly (p16 in particular)
• Guidelines on embedding Op Risk monitoring processes highlight just how much work some practitioners are managing to cover (p11). Quite disheartening for those with smaller budgets.

Ther are a few points to make on section B around quantification:

• Pretty scathing on Standard Formula relevance. (p14)
• Scenario Analysis sold as something of a panacea to cure the ills of incomplete Op Risk Event data sets, but no mention of the biases which seem to permeate the creation of the scenarios, which is sadly a hostage to the invitee list. (p14)
• Expand more on scenario analysis, bringing the "severe but plausible" terminology to the table (p15)

As well as the following generic comments;

• Is risk measurement - "a tool for embedding risk culture in the organisation"? I would say so, particularly in the Op Risk arena, where decision makers will need to be involved at scenario-compilation time.
• That said, they then go on to reference "senior management sign-off" of scenario work, which is somewhat contradictory!
• Overweight in references to "culture" and "tone at the top", like most white papers these days (see the FRC's efforts from the other week). Playing with fire as a profession by shoehorning references to "culture" into everything.
• A couple of horror-show schematics used on pages 7 and 8 - the Forum must know how much time risk professionals lose walking non-experts through things like this. They serve no purpose, and detract from surrounding text.
• Attempt on p9 to solicit business for ORIC?

It was Professor Jagger who accurately prophesised "You can't always get what you Quant" - I'd say the Risk profession concurs, based on these very welcome principles.

KPMG on Pillar 3 and Public Disclosure - in or out?

Pillar 3 - rude awakening?

The operational reality of Solvency II Pillar 3 is seemingly about to deliver a ruder awakening than breakfast at Chubby Brown's. Whilst for example the UK's regulator has offered an element of flexibility in the content of the QRT reporting to be submitted during the Solvency II preparatory phase (Q21 here), Finance functions across the EU will be in an spreadsheet-fuelled scramble to deliver Solvency I, Solvency II and public reporting from now on in.

The lie of the land is not pretty as it stands. Evidently the PRA's crack team of Pillar 3 regulator and industry expets is tabling some sobering questions, given their recently revised Q&A, and both software solution providers (here) and asset data firms (here) continue to ebb and flow with their contributions to preparedness, depending on the pay-off. Some co-odination efforts have recently begun on asset data transference involving the larger EU players, but doesn't yet sound like the golden ticket for the teams charged with delivering Pillar 3 material.

Even EIOPA, the new custodians of the word ERRATA, are seemingly tied up with the less technologically developed EU members in an Excel-flavoured workaround to the xBRL question which, judging by the number of QRT template amendments already applied, has an air of inevitability about it.

It was therefore nice to see one of the Big 4 release results from this survey on how firms are preparing for Pillar 3 in the content of existing and future public disclosure requirements. Small sample (11 firms, all multinationals), and all evidently have existing plc-type disclosure requirements, but the topics and trends covered should inform anyone in the Pillar 3 space who has transitioning on their agendas.

Worthy of note:

• Pre-Solvency II disclosure of quantitative material not favoured - not much to be gained I suppose
• No-one planning to publish projected capital adequacy!
• Responders in IMAP seemingly working on the basis that "Plan B" won't be required
• Few likely to publish "internal views of capital" ( for this read "overall solvency needs" or "ORSA Capital") - analysts felt unlikely to be looking for it.
• Most common differences between Pillar 1 and OSN used were treatment of contract boundaries and the risk-free rate, with the list of distinctions going into double figures
• Some provisional plans for IFRS alignment on the balance sheet methodology front
• Embedded Value about to be jettisoned as a reporting metric - analysts are of course devastated!

Who said accountancy was boring?

Central Bank of Ireland and ORSA - fancy a bunch of FLAORs?

So the Central Bank of Ireland went and knocked together an ORSA Reporting tool for the less complex end of the Irish Insurance industry, specifically the "low" and "medium-low" rated insurers. And to think I have spent 4 years railing at the consultancy and supervisory industries for catering for the big boys, while ignoring the immaterial...


2014 FLAORs
- a serious affair

The tool was released back in July, and while it (intelligently?) copy-pastes EIOPA's guidance and dissects most of those words into a set of obvious questions, there are some aspects which are very revealing in respect of where supervisory expectations for 2014's ORSA reporting and process development efforts perhaps are at the less material end of the industry.

They have evidently taken the approach that most large programmes will have used over the last 3 years, namely to deconstruct paragraphs in Directive/Delegated Acts/EIOPA Guidelines in an Excel spreadsheet, and pose them as questions. Not every firm's budgets would have stretched to accommodate even that level of analysis though, so I'm sure the CBoI's efforts have been warmly received to date.

For example, the following elements are very shocking to me, given our proximity to go-live;

• No compulsion for ORSA Policy (and therefore process) to be documented and Board-approved in 2014 (2.3 and 2.4)
• No expectation that the 2014 version assesses one's ability to continue past the 1 year horizon (4.8)

These elements are perhaps revealing as to supervisory planning for 2015 and beyond;

• Asking when the Board approved the results and conclusions - likely to be hunting for evidence in minutes (2.2)
• Asking which personnel/units have been briefed as to the ORSA results - is there a feeling that outside of EXCOM and control functions, the reports won't see the light of day? (3.4)
• Highlight what they are really interested in, in the context of "overall solvency needs" quantification - risk measure, confidence level and time horizon, which feels proportionately light in focus given the detail in Article 262 of the Delegated Acts (4.1).

Some good elements include;

• Uses of ORSA in decision-making process listed in 1.1 - some are directly lifted from EIOPA, but couple of other examples may help focus the mind (I would add that setting "risk limits" feel sloppy, given the legislation uses "risk tolerance limits")
• Ask for a table to be populated with quantitative results for each risk category, but don't prescribe the category names, rather provide the legislative categories as examples - this is how it should be, especially for the smaller firms. (4.2)
• No expectation that the "medium or long-term" capital is calculated at this point - the column provided is marked *OPTIONAL* (4.2) 

Whilst the data gleaned from the template they have provided may be a bit cumbersome, fair to say that CBoI's efforts will be welcomed by both the qualifying firms (as a pro-forma) and the larger firms as an INED guide.

FRC on Risk Management and Internal Control disclosure - insurers way ahead?

Muddy Waters
- public disclosure on Risk

The UK's Financial Reporting Council have released guidance on Risk Management, Internal Control and related reporting, just in time to help muddy the waters for UK insurers, who have no doubt finally got their risk, actuarial and compliance functions writing non-conflicting words with Solvency II preparation in mind!

Anyone who has written, peer-reviewed or socially read these sections of public reports (i.e. me, and any other geeks), will know they are normally;

• Boiler-plate, and completely transferrable between industries, regardless of their disparate risk profiles
• Aligned to the Strategy sections with a few anchor words, but otherwise divorced
• Frequently unaligned with the ERM frameworks used internally - i.e. "this is what the City wants to read", not material on our actual risk profile!

Given that this is only guidance, and is further only directly relevant to LSE listed entities, readers may be inclined to take the content with a fistful of salt. There are a number of noteworthy aspects to this publication however which maybe show where the mindset of supervisory-types has got to in the eight or so years since the financial crisis commenced.

 I took the following general points from it;

• Very little for listed insurers to be concerned about, if they have prepared adequately for ORSA and supervisory reporting (SFCR, RSR) - indeed, their reporting teams will be delighted with the amount of content crossover! Check out the (still not finalised) Delegated Acts of Solvency II in order to see why listed Insurers won't need to stretch to meet these.
• Frequent references to "culture", as opposed to "risk culture". Checking the FSB's take on Risk Culture from April of this year, one can appreciate the FRC's desire to gemmy culture into these guidelines, if perhaps not the execution - one fears the "culture" words are likely to become a little weasely.
• Multiple crossovers into ORSA language, in particular re-emphasising the importance of the alignment of risk management with business strategy.
• Good work in section 4, bringing in the "IMMMR" concept from Solvency II, as well as assessment of current and emerging risks, and assessing exogenous and endogenous risks when doing so.
• Recommend that risk assessments are performed at inherent and residual level, and that control effectiveness is also considered when arriving at one's final assessment

On the technical front, the following elements caught my eye

• "Emerging principal risks" used as an expression - not sure if that stands up to scrutiny i.e. if something is emerging, can it be a "principal" anything? How would you measure it to gauge "principality"?
• Reference to "high profile failures in risk management" in recent years, which feels a little finger-pointy - we could deconstruct every corporate failure to one of risk management failure
• "Risk Appetite" put into inverted commas within the guidance, but not in the appendices - can't quite work out the aversion to definition given the FSB's work to date at the very least, but certainly EIOPA have similarly dodged it (p59), and looking at Appendix 1 of the Irish regulator's thought paper on Risk Appetite, one can see why!
• "It is the role of management to implement and take day-to-day responsibility for board policies on risk management and internal control" - really? responsibility for their implementation, sure, but policy content?

Solvency II Delegated Acts - whenever, wherever...

No sign of the Solvency II Delegated Acts sign-off as yet. The mighty ECON committee of the European Parliament have just about got their feet under the table after May's elections (and June, July and August's European summer holidays!), but despite meeting on the 3rd and 4th Sept, they don't appear to have discussed or even listed the matter as work in progress.

Wouldn't have felt such a big deal, given Gideon's summary on the topic back in early August, but the Mr Claffey and Co. at Milliman appear to have picked up on a potential sore point for the unit-linked boys, which might jack-up the Operational Risk SCR for anyone in standard formula world (which would cover a good number of pure unit-linked businesses I expect).

I've had a look around for the July version of the Delegated Acts, but they have yet to be leaked* as publicly as the January version - I would recommend anyone in the unit linked world gives this a once over, particularly if you still pay fat commission cheques!





* How about I shut my mouth - not only has the wonderful Petter Svensson (Sweden's foremost independent consultant) made it available on his own site, the Romanian Regulator has done similarly. Fill your boots...

ORSA - Institute of Risk Management special interest group

Of course while I spent the last couple of months topping up my tan in, errrrr, the Isle of Man, some of the guys in the UK and further afield have been building up an endeavour-flavoured sweat on some of the more malleable elements of Solvency II preparation.


Raining 'Mann' - Glorious Manx summer

The IRM as ever have kept the ball rolling, in particular hosting an ORSA session last month. While you can pick your way through the guest speaker presentations for ideas and comfort (one company specific, one consultant generic, and one which S&ST/RST fans might like as a sense check), I was much more interested in the attendee survey.

A whopping 34 replies came in, via which the attendees have delivered a reasonable ORSA landscape mock-up, which may help some of you get matters shuffled in your priority lists, given where your peers claim to be.

I noted in particular;

• ORSA Process overwhelmingly run by the Risk functions (over 90%)
• Just over half going for annual frequency, the rest (who responded) naturally more frequent - doesn't instinctively feel representative, but not all of the smaller firms would send someone down to this!
• Around two-thirds have their "Reports" at 50 pages or less - if we assume that by "report" we mean Supervisory as well as Internal, the PRA won't be too chuffed with that given their comments at the December industry seminar.
• Only a third have submitted draft ORSA Reports to the PRA and received feedback
• Coverage of emerging risk appears to be an area which not only do respondees think is lacking, but has received critical feedback from the PRA

That half have used external consultants in their ORSA work to-date is certainly no surprise. I'd be worried if that consultancy had more than a year's dust on it though, so think hard before you start submitting your 2014 gear!

FTSE Insurers and Solvency II costs - quick round up

So I'm back to work after a well earned pit stop back home. I'll start with a summary of all goings-on in the Solvency II world over the summer using the following complex schematic...

Solvency II implementation costs to insurers, having experienced feast and famine over the last 2 years, will be firmly back on the bean counters' agendas now the finish line is in sight. In the past I had mopped up the 2013 financial year end here, the 2013 interims here, and 2012's full year here, so there is plenty of numbers out there for those interested.

I've therefore taken a quick look at some of the UK interim reports out over the last couple of weeks, just to see what costs/lobbying elements are included. It has been pretty dry going, which may reflect analyst fatigue on the matter more than insurer ambivalence, but I'd flag the following;

Aviva
- Costs which are "mostly" Solvency II at £41m for the half year
- No substantive comments on current legislative position

RSA
- Costs of £14m for the half year, against £20m for all of last year
- Amusingly classify Solvency II expense as "One-off non-operating costs"!

Standard Life
- "...expect [their] capital position to remain strong following implementation"
- No reference to costs

Prudential
- Implementation costs (broken out into p10 of this IFRS supplement) of £11m for half year, versus £13m for the comparable half-year, and £29m for all of 2013
- "...preparations are well advanced"
- Backwards in coming forwards over the likelihood of model approval and valuation assumptions (p17)
- Domicile change still left dangling (p24)

Old Mutual
- "...well positioned" for Solvency II, though "...continue to experience a degree of uncertainty"
- Nothing on costs

Legal and General
- "...expect the final outcome on Solvency II to result in a lower Group Solevncy Capital ratio" than existing EC. They stress in their accompanying presentation and in Nigel Wilson's speech that their existing EC is not Solvency II capital!
- Indication on  p17 of the Analyst presentation notes where L&G and the ABI have potentially fallen out (hence their recent divorce)
- Nothing on costs

EIOPA's Implementing Technical Standards on Approval Processes - Cut and Paste?

EIOPA have at last commenced their work on "Level 2.5" regulation in the Solvency II world, and with it being something of a trip into the unknown (only their sister body ESMA world appear to have performed a similar exercise to-date), their consultation papers will no doubt be getting torn apart like a parking ticket by Insurers and NCAs alike.

Open until the end of June with a view to presenting this particular batch to the European Commission for endorsement by the end of October, the ITS cover how the following approvals should be applied for and administered, with definitions and rationale provided in this cover note.

• Use of Matching Adjustment
• Use of Internal Model, "Major" changes to that model, and changes to the Model Change Policy (phew!)
• Use of a Group Internal Model
• Use of Undertaking-Specific Parameters (USPs)
• Use of Ancilliary Own Funds for SCR
• Use of Special Purpose Vehicles for risk transference

For this post, I wanted to concentrate on the Internal Model-themed ITS (emboldened), specifically things which introduce something new to the table (i.e. not already in the thoughts of UK firms/regulators through the Directive, Delegated Acts, Preparatory Guidance or indeed the existing IMAP structure in the UK).

Therefore in the interests of recyclability, UK firms will be delighted by the requirements within this particular ITS - you will recognise the text as part of the Self-Assessment Template "tabs" which you would have been populating as part of IMAP over the last 2 years!

That text was of course co-opted from the Draft Implementing Measures from October 2011 (specifically Article 203 IM1 for the application requirements, IM2-IM8 for the model change and administrative process elements). These articles had disappeared from the latest version of the Delegated Acts, only to find its way into this ITS almost verbatim.

Elements which therefore show noteworthy change from that old text (other than semantics) include

• The addition of a requirement for a (year-end 2014?) P&L Attribution to be submitted as part of the application.
• Withdrawal of some of the ceremony around applying for a change to the Model Change Policy, which was a little more elaborate in the October '11 text (AMSB explanation and justification text, 6 month turnaround time for NCAs to make a ruling).
• The same for an application for a Model Change itself, now seemingly less formal
• Giving room for terms and conditions and transitional plans to be factored in to an NCA's decision on model approval
• That more detail should be published on the NCA's website regarding the approval (namely that the scope of the IM should be disclosed, as well as risk categories and business units covered, which feels a touch commercially sensitive to me!)

I'm guessing this isn't the only ITS which is going to use this approach (i.e. ripping text directly out of the Oct 2011 Draft Implementing Measures where it has been seemingly jettisoned), so a bit of cross checking might help you second guess what is going to appear in the rest of the ITS!

Now I'm off to have a look at the others...

EIOPA's "Common Application Package" for Internal Model Applications - UK back to the drawing board?

The release of an EIOPA Opinion today may very well raise the heckles of the UK Insurance Industry, regarding a move towards a "Common Application Package" to be used across Europe for assessing internal model applications. This appears on the face of it to be disjoined from the internal model-related ITS already scheduled in EIOPA's calendar (p12) over the next couple of months.

Their "package", to be published after consultation with the National Competent Authorities themselves, will comprise of;

•  Instructions 
•  A self-assessment 
•  Background Information 
•  An inventory of internal documentation 
•  An explanatory document 

Worth remembering at outset;

• This is an EIOPA Opinion. In their own words, "This opinion is aimed at proposing to NCAs the use of such common application package", so their proposal is non-binding (p10 here as well)!
• The UK has seemingly (and based on number of applicants, rightly) been in the box seat on this particular topic within EIOPA, so it is likely that their approach won't be far away from the UK's existing one! The suite of Internal Model Application (IMAP) materials in the UK is available here for example, and isn't far away from EIOPA list, in form at least.

That said, a combination of EIOPA's desire for convergence, and the recently released and revised Delegated Acts may have a particularly destructive effect on existing IMAP efforts within the Solvency II Programmes of UK insurers. I have therefore had a deeper trawl through the Delegated Acts in order find out what the practical implication of any changes in the redrafted Delegated Acts might be.

As anyone who has worked in the UK IMAP space will (un)happily tell you;

• The PRA's approach to assessing internal model applications (inherited from its predecessor) involves deconstructing Solvency II Directive and Delegated Act text into sentences, and in some cases sentence fragments. This created over 300 "requirements".
• Those are transferred into a spreadsheet list, within which firms are asked to list evidence of their ability to address each item (or why the requirement is not relevant).
• That spreadsheet list is housed on an Excel workbook known as the SAT Template, which contains various other worksheets, all of which require manual population of some kind.
• A fully populated SAT Template is required by the PRA for IMAP participants, along with some ancilliary documents (listed here), supplemented by any further documentation which the legislation or EIOPA deem is compulsory.

It's not a tick-box exercise though...

The recent versions of the Delegated Acts which have been creeping around are therefore of some significance to this work. Over the last couple of years, firms will have populated a SAT Template which contained deconstructed sentences from the Solvency II Directive pre-Omnibus II, and the Delegated Act text from November 2011, both of which have now been superseded (without being too presumptuous!).

How do the changes affect the contents of firm's existing IMAP templates, and indeed does it matter? Well, it goes without saying that the SAT Template will need to be amended and reissued by the PRA, regardless of what EIOPA produce. The question for UK firms, having spent considerable money and resource on populating the template in 2011/2012, is whether or not to start from scratch, now that time is something of a luxury, and the end-game is more definitive.

With 2013 being something of a write-off for both Solvency II programmes and the PRA's IMAP campaign (although the costs suggest otherwise!), it is likely that existing SAT templates, crammed with bespoke explanatory text and document references, have either gathered dust for a month or twelve, or received only minimal maintenance.

To see exactly how much of those early efforts will be salvageable, I have taken a look at the Delegated Act articles from January 2014* regarding the Tests and Standards for Internal Model Approval (or 'TSIM', after the acronym allocated to these articles by the draughtsmen), and compared it against the November 2011 version of the same text, and found some significant changes in form and substance, which may render some of your earlier SAT population efforts chocolate-fireguard useful.

The 24 original TSIMs, once deconstructed, respresent over 200 (almost two-thirds) of the "requirements" listed within the SAT template, so any changes in them could massively impact the recyclability of existing content.

IMAP Changes - has EIOPA gone Gaga?

I found, of those 24;

• 6 are unchanged verbatim
• 2 have minor definitional tweaks, but are otherwise unchanged
• 2 have been merged
• 2 'new' articles have been introduced into the section, though neither are labelled "TSIM" at this point.
• All others have been changed in at least form, and in the majority of cases, substance

IMAP candidate firms have therefore been left to contend with more awkward changes than a Lady Gaga concert in a broom cupboard...

Those which have received the most aggressive reworking include;

• Article 225 TSIM 15 - Management Actions
• Article 229 TSIM 18 - Model Validation Process
• Article 230 TSIM 19 - Validation Tools
• Article 232 TSIM 21 - Minimum content of the documentation

It is fair to say therefore that UK-centred internal model applicants may struggle to recycle their existing IMAP drafting efforts without re-engaging Business-As-Usual staff in a substantial way, and that is before we even get to what EIOPA may propose in the "common application package". It also remains to be seen how the other European countries react to the likely Anglicisation of internal model assessment.

If you need help with this on your Solvency II Programme, don't be afraid to get in touch at allan@governance-matters.co.uk


* Just for reassurance, the TSIM text doesn't change between the January 2014 and March 2014 versions, but unless someone published the March version online, you'll have to take my word for that!

Solvency II Delegated Acts available online (kind of...), plus EIOPA's plans for 2014/15

So let's start with something a bit unexpected - DRAFT DELEGATED ACTS! ONLINE!

I'm not sure who the leaky uploader is (appears to be a Spanish consultancy firm), but the document is very much online. Sadly, it is only the January 2014 version, which as you will see in the rest of the post, has just been superseded, but it definitely pairs up with the version currently doing the rounds, I promise!

I have managed to get a sneak preview of the latest version of this document (dated 14th March) which have seemingly managed to burst the banks of the tightly-knit circle of advisors, and are now no doubt winging their way to a Solvency II Programme Director near you! There are "tracked changes" on the March document now circulating, which only appears to cover changes since the emergence of the January document hyperlinked above.

Lord help anyone who wants to trace it back to the more familiar 2011 (unpublished) draft, you might as well draw a load of foxheads on sticks...

Insurance Europe were obviously part of the privileged few for the March revisions, hence they fired out this missive last week regarding all of the Pillar 1 technical areas which they feel (on behalf of the industry) remain deficient. There are no real surprises in their list - it is the same topics which have been on the whinge-list since EIOPA's LTGA last year, and indeed earlier in the case of the Currency Risk approach and Own Funds classification.

Following on from the draft Delegated Acts being made more widely available, there has been a reasonable amount of noise in the paid-for press (here, here and here for subscribers), as well as Insurance Europe's top man having a lobbying call published in the FT (here).

Being more of a Pillar 2 man myself, I thought I would check to see what, if anything, had been tweaked in my areas of interest. The impression given earlier this year was that little had changed outside of the Long-Term Guarantee elements, and that was certainly true if you compared the November 2011 and January 2014 documents.

However, having examined the amendments in the March 2014 version, I have found is that a few areas of governance (both SOG and Internal Model governance) which were previously untouched have actually received a fair bit of treatment, for example;

• Changes to the requirements for internal audit function holders not to cover multiple control functions (this constraint has been removed). This is presumably to pacify the smaller firms across Europe who have a Risk/Compliance/Internal Audit multi-tasker, so textbook "three lines of defence" have taken a bath in the interests of proportionality.
• The devil remains in the detail though, as the amended text allows someone to "carry out" more than the IA function, but seems to stop shy of them "taking responsibility" for other functions. Not sure how that will work in practice.
• Changes in the IM Validation space, in particular the removal of the requirement for a "Validation Policy". Fair to say most firms in IMAP would have produced one of these at least a year ago now (plenty of industry references here, here, here (p8) and here for example!), and while still a document of merit, does a "validation policy" now constitute gold-plating?
• Changes in the required Internal Model Documentation, targeting a much slimmer set of compulsory documents. This includes replacing a number of "policies" with "descriptions of...", which will no doubt be well received by those supervisors with multiple internal models to assess over the next 18 months!
• The tiered timescales for submitting QRTs, SFCRs and RSRs have now moved into the Directive, via Omnibus II text (as opposed to haveing been deleted, which is what it looks like at first glance!)
• A few of the other TSIM articles (Tests and Standards for Internal Model Approval) have been enhanced. "At least quarterly..." assessment of the IMs coverage of material risks is now specified, for example. Quite how the hard-coding of the regularity cramps your actuaries' style is another thing! 

I strongly suggest you all get back to work and check for yourselves!

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?

Myners briefing on Governance at the Co-op - working class barred from the Board?

Wolf - step away from the door...

A corporate governance story that will echo in the eternity of MBA classes for years to come, the unravelling of the UK's Co-operative Group from the benign grocer-cum-divvy machine into a ying and yang shotgun conglomerate of opposites is proving to be a watershed moment for UK plc, with stakeholders attempting to balance myriad legal, political and ideological considerations in order to both keep the wolf from the door, and preserve the principle of mutuality for its membership.

There are no surprises that the crux of the Group's issues lies in its banking arm, nor that being acquisitive during the financial crisis (here, here and here) has proven to be poor strategy. Keeping the wolf from the door has therefore largely been delivered through the tried and tested combination of begging and borrowing, which the recently departed CEO appears to have delivered with some aplomb.

Governance structures
- choices choices...

However, the Group's hiring of Paul Myners back in December, a man with an extensive collection of t-shirts and hats, to independently review its governance arrangements, seems likely to deliver to the membership a menu of choices as unpalatable as a Sunday skip-dip.

Lord Myners has hurriedly delivered a briefing on his findings to-date, as well as performed some mainstream media duties (here and here), following the Group CEO's resignation last week. This early sighter was seemingly unscheduled, but the manner of the CEO's departure ("a tragedy" in Myners' words) meant that his findings to-date could not wait until May for its full publication date.

Myners has therefore naturally delivered a ruthless and scathing take-down of the governance structure and processes within the Co-operative, while calling out the Board member who are clearly well schooled in how to game the system, as well as the playground tactics/rabbit-in-a-hat tricks that turn "one-man-one-vote" into "one hundred men-all votes"!

Killer quotes

• The group endures a significant "democratic deficit"
• The future of my recommendations lies in the hands of around 100 elected individuals on the current Group and Regional boards, few of whom have any serious business experience and many of whom are drawing material financial benefits from their positions
• There is a phrase frequently used in Co-operative Group circles that the Executive should be "on tap but not on top"
• ...the Group Board has spent far too much time on transactions such as Somerfield and Britannia which have been breathtakingly value-destructive

Observations

• The "exceptional skill and tireless efforts" of the Executive team are cited as the reason for the Group's survival in its current form
• The current governance framework is variously referred to as "flawed", suffering from "acute systemic weaknesses" and having "consistently produced governors without the necessary qualifications and experience to provide effective Board leadership". Ouch...
• That the Groups social goals are not aligned with its strategic and commercial objectives. This is of course less of a worry for its financial services competitors.
• The the Group's "massive scale and complexity" means that a man-off-the-street approach to electing Board members, which may be sufficient for a farmer/grocer co-op, is not suitable.
• Shatters the "myth" that the Group has always been run by lay members, as opposed to those with commercial experience.
• The thought of creating a board of INEDs and lay members is disregarded due to the potential for creating "second-class citizenship"
• Highlights that Co-op's core business of groceries is savagely competitive at the moment (just look at Morrison's and Sainsbury's), so continued ineffective governance could be devastating
• Notes that there have been previously (disregarded) reviews of its governance architecture, which is "long known for its labyrinthine complexity and its disfunctionality"
• Stresses that, due to the current voting structure, acceptance of  his recommendations "...potentially lie[s] in the hands of fewer than 50 elected members". It sounds like they haven't been shy to remind him of that either!

Recommendations

• Halve the size of the Group Board, which will be subject to annual re-election
• Independent Chair, with no previous association with Co-op
• 6-7 INEDs and 2 Executive Directors
• All with qualifications of a similar ilk to its (listed) competitors
• Create a National Membership Council (NMC), with a 12-person executive committee to effectively represent the membership and co-operative principles and values
• The Board to be subject to scrutiny by the NMC, who have the right to be consulted on "key strategic and operational intiatives"
• "Arrangements" to be made to safeguard the confidentiality of information shared between the Board and the NMC (certainly not the case with current arrangements!)

The entire document feels drenched in class warfare and spectrum politics. That rather hideous take from the existing Board on their executive team ("on tap, but not on top") feels like the inspiration of Myners' recommendation for a professionalised, appointed Board, rather than the beer and sandwich brigade which currently exists.

That said, there is thought on the left-wing (here and here) who feel that mutuality and co-operation should remain unsullied by the commercial world, who remain unable to affect much in the way of democratic change in Boardrooms even after the raft of FRC-sponsored guidance released over the last couple of years (though PIRC are trying!). Is one failed attempt to democratise stakeholders best replaced by cherry-picking from a similarly deficient model?

On the basis that I have banged the drum for background diversity in Boardrooms (not just gender or race), and the existing Co-op Board is "diverse" in that respect, I'm left to wonder if I've been barking up the wrong tree. The Board delivered by their existing process is neither fit nor proper, and are able to outmanouevre their executive compatriots armed with little more than a working knowledge of provincial politics and a polyester suit.

Should we therefore use the grey-area of "fit and proper" regulation to ban the contract plasterers, nurses and retired publishers of the world from financial service provider Boardrooms on the basis that they don't have an MBA, and count with their fingers? Or can one make a valid contribution to a financial services Board of directors regardless of the colour of their collar?

PRA on General Insurer Technical Provisions under Solvency II - Taking the "TPs"?

Allow me to take a quantum leap outside of my comfort zone while I pick my way through the PRA's latest Insurance Industry aide memoire, via a consultation paper on the calculation of technical provisions in General Insurers.

This looks specifically at TP calculations with Solvency II in mind, and is aimed specifically at GI firms currently in IMAP. That said, the tone and technical matter covered is an excellent heads-up to Actuarial, Risk and model validation personnel currently active in this space about how the PRA approach to assessing Solvency II compliance is developing.

The document itself reads very much like their last consultation paper release on Deferred Tax Assets, insofar as it is a laundry list of "what not to do" - look at how many times the expression "should not" appears! They have leaned on their findings from both thematic reviews of TP calculations (Life and GI-specific Questionnaires were sent out a year ago) as well as from IMAP and ICAS, so their finding will be well supported by most recent practices in the UK.

The consultation window is pretty short as well, with a mid-April shut-down scheduled, so if you don't like the cut of their jib, you'd better speak soon.

Stand-out points for me included;

Generic


ENID - TP accommodation required

• Expectations of Delegated Acts content are cited throughout, but in terms of the exact date of their public provision, they can only go with "Q3 2014". From what I have seen, there is nothing cited which isn't in the November 2011 draft.
• The abandonment of the term "binary events", replacing it with "Events not in data" or "ENID" - the fait accompli of "binary" (that events which are not in a data set must therefore be extreme and/or rare) is confirmed as unacceptable.  The PRA don't appear to be wedded to the old term in any case, and while the actuarial profession used it liberally in the past (here and here for example), they began a transition away from it late last year (p45 of this).
• "Any data that can have an impact on the outputs of the internal model should be considered to be 'used for the internal model'" (3.19) - important IMAP message across sectors I think!
• There is evidently some concern that firms are thinking of relying on the work of external model providers to meet Solvency II standards, with the PRA confirming that firms may not rely on "...generic validation performed by the model vendor" (3.25). This means that the model validation relationship between IMAP candidates and their third-party providers needs to be much more invasive and aggressive, and needs to start pretty soon!

Technical Provision-Specific

• A large number of points made in the paper relate to over-simplifications, which should help anyone who is struggling with the concepts of materiality and proportionality. These include methods relating to ENID, Risk Margin calculations, Approximations and  the emergence of risk over one year
• Similarly a few tricks of the trade appear to have been scuppered, such as using optimistic business plans for setting provisions, "actuary in a box" methods and assuming improved underwriting performance
• Some substantial focus around the quality and quantity of challenge applied to External Models (focused on third party Catastrophe models in this instance), in particular the challenge of  assumptions used by the provider (3.16-17 and 3.26-28)
• The concept of "cumulative materiality" is introduced in the context of multiple approximations, a concept which I suspect many firms are still struggling with in the context of Internal Model change (2.9)
• An interesting take on the justification of assumptions, with the PRA taking umbridge with firms using "industry standard" or "established good practice" as a supporting argument, rather than using their own risk profile as the basis for support (3.15)
• A section which seems to advocate conservatism, if not prudency, in the setting of sensitive parameters (3.10), as well as advocating the use of stress and scenario testing to make up for ENID when setting parameters (3.2)

Certainly lessons for both Life and GI internal model applicants in here, and the PRA should be congratulated for getting this paper out in good time. I'm not necessarily convinced though that third-party providers of internal model inputs will happily acquiesce with the demands which the industry are being asked to make of them here.

FTSE Insurer results for YE 2013 - Solvency II costs and capital commentary

Don't you just love financial year-end? Accountants and Actuaries piddling and moaning about turning numbers around while the Risk profession change some colours around in some spreadsheets? Ah, the good old days...

Figures - ropey

It wouldn't be fair to say the full year results releases for UK plc's insurers has sneaked in under my radar during a fortnight of incessant Omnibus II crowing - they all announced relatively close last year, so I have been waiting patiently for them to arrive en masse - but it's been a week since the first ones reared their heads, so I figured I would post what I have now and update it later.

We know that to-date, Solvency II preparation has been a pricey job - Deloitte and a couple of blokes who should know better have already thrown around more ropey figures than Thursday night at Zumba - so it's always nice to do a bit of regional backtesting (which you will find below), which totals almost £700m pounds just for the four who have definitively broken their Solvency II costs out!

Standard Life - AR&A

Generic Solvency II

• We continue to closely monitor the development of Solvency 2 and our business is well placed to implement the necessary changes expected to be required before 2016. (p10)
• We welcome the positive steps in the development of the Solvency 2 regime during 2013 and expect our capital position to remain strong following implementation. (p16)

 Cost-specific

• Total restructuring costs incurred during the year were £75m (2012: £114m) which includes £11m related to the acquisition of the private client division of Newton Management Limited...The remaining costs relate to a number of business unit restructuring programmes and Solvency 2. (p145)
• For info, the last broken-out cost Solvency II cost was £59m in 2011

Standard Life - Executive transcript

• "In ICA+ we are the pilot firm" (p23)

Legal and General - preliminaries

Generic Solvency II (nothing on costs yet)

• During the second half of 2013 there was encouraging progress on the development of the proposed Solvency II regulatory regime. We now believe that the worst case scenarios have been avoided to the benefit of customers and the wider economy. While full clarity on Solvency II capital will not emerge for at least another 18 months, we currently anticipate that our Solvency II capital surplus will be no lower than our Solvency I IGD capital surplus. (p5)
• We will provide dividend guidance for subsequent years when Solvency II clarity has emerged. (p5)
• Solvency II is targeted for implementation in early 2016. Revised capital calibrations for long term business provide sufficient flexibility to address many of the adverse capital impacts for UK insurance firms. Challenges remain, however, in ensuring that final implementation is proportionate and cost effective for the insurance sector. (p19)

Legal and General presentation

• We believe that the worst case Solvency II scenarios have been avoided. (p5)

Aviva - preliminaries

Economic capital and costs

• Strengthening our financial position has been a focus in 2013. Our economic capital surplus has increased to £8.3 billion, which represents a 182% coverage ratio and includes our defined benefit pension on a more conservative fully-funded basis. We welcome the progress made by our regulators on Solvency II and the level playing field that this is likely to create. (p5)
• Solvency II implementation costs reduced to £79 million (FY12: £117 million). (p18)

Aviva presentation slides

• Confirms last 3 year's worth of Solvency II costs as £89m, £117m and £79m (p10) 

Prudential - preliminaries

Generic Solvency II 

• We do not expect to submit our Solvency II internal model to the Prudential Regulation Authority for approval until 2015 (p6)
• With greater visibility on the potential outcome of Solvency II, we are reporting an economic capital surplus of £11.3 billion (2012: £8.8 billion), which is equivalent to an economic solvency ratio of 257 per cent (2012: ratio of 215 per cent). This result is based on an assumption of US equivalence, with no restrictions being placed on the economic value of overseas surplus, and using our internal model, which has not yet been reviewed or approved by the Prudential Regulation Authority. (p12)
• We regularly review our range of options to maximise the strategic flexibility of the Group. This includes consideration of optimising our domicile as a possible response to an adverse outcome on Solvency II. (p30)
• Over the coming months we will remain in regular contact with the Prudential Regulation Authority as we continue to engage in the 'pre-application' stage of the approval process for the internal model. In addition, we are engaged in the Prudential Regulation Authority’s 'Individual Capital Adequacy Standards Plus (ICAS+)' regime, which is enabling our UK insurance entities to leverage the developments made in relation to the Solvency II internal model for the purpose of meeting the existing ICAS regime. (p30)

Cost-specific

• £29m Solvency II costs versus £48m last year (and £55m in 2011)

RSA - preliminaries

Generic Solvency II and economic capital

• ...across the various ratings, internal and regulatory measures, we simply do not have enough tangible equity to properly support our business. This is partly due to 2013 setbacks and partly to rising regulatory standards. (p4)
• The Group is actively involved in shaping the outcome [of Solvency II]...The directors are confident that the Group will continue to meet all future regulatory capital requirements. (p35)
• The economic capital surplus was £0.7bn (31 December 2012: £0.7bn) (on a 1 in 1,250 year calibration) giving coverage over the economic capital requirement of 1.3 times (p9)

Cost-specific

• £20m, versus £32m in 2012 (and £30m in 2011)

Resolution - preliminaries

Generic Solvency II

• We are currently discussing our approach to implementation of Solvency II with the PRA (i.e. standard formula or internal model) and expect to enter the process for PRA approval of our internal model (“IMAP”) such that approval is granted before the end of 2016.

Although the final guidelines for calibration of the standard formula approach have not yet been released, our current expectation is that this would not give the most appropriate assessment of our solvency position. We do not currently expect to gain any capital benefit from IMAP, but continue to monitor this closely as further guidance emerges and our discussions with the PRA continue. (p19)

• "Increased non-recurring costs reflecting increase in Solvency II spend" is down as a negative on Free Surplus performance (p9)
• There remains considerable further work to transition the Group across to a Solvency II basis…In the absence of final regulation, we will continue to adapt our plans as specific requirements are confirmed. Nonetheless, as we transition, there will be an impact in terms of the way in which the Group needs to hold capital against a Solvency II balance sheet and we will consider how best to do this in the manner that best serves our customers and shareholders. (p54)

Cost-specific

• Finance transformation costs of £49 million largely relating to Solvency II (p24). This stands up alongside £76m for 2012, and £56m for 2011, remembering that they dropped out of IMAP during 2012, but appear to have been told to get back in!

 



 

Corporate Governance and the Co-op - Never too much?

Another day another maelstrom for the UK's Co-operative Group, with their Chief Executive having his resignation accepted by the Board of Directors, this following on from a truly extraordinary story from late last year, where the Chair of its banking arm was caught in a drugs and prostitutes 'sting', which in itself followed an earlier uncovering of a £1.5bn capital hole in the banking operation!

The Group CEO, Euan Sutherland, said in a statement that without "professional and commercial governance" it would be "impossible" for him to execute the changes he had planned. A 55 page rulebook, for a Group that has six million members, doesn't feel like too much on the face of it for a man with his CV, so I was interested to see what the story behind the story was.

"Professional and commercial governance"
- Say it twice, say it thrice...

The boiling point appears to have been the leaking of details around the CEO's proposed pay packet over the weekend, which materialised publicly in a stroppy posting by him on the Co-op Employee Facebook page, pointing fingers at colleagues trying to "undermine me personally". His only-recently-active Twitter went quiet after a bout of February activity, so perhaps his attentions have been on this matter a little earlier...

The Co-op has been as leaky as a porcupine's waterbed recently, with this snippet regarding outcomes of their "top secret" self-commissioned Board review, supplementing other sensitive leaks over the last year reported here and here, so clearly there are plenty of disgruntled paper-handlers in this unique organisation.

Regardless of the well-connected source though, a quick glance across the numbers leaked to the Guardian would be enough to sponsor a sharp intake of breath for anyone in financial services (a £2m pay-off for a HR head leaving after a year? Will Hutton breaks it out in this post, and the mind boggles!). That said, take a look at these terms of reference for the Co-op Remuneration Committee and tell me where you have seen self-perpetuating pay-puffer terminologies before: every other financial services provider perhaps?

The knives were out from early on with regards to the financial arrangements of Sutherland's new team though, with the spectacularly generous relocation package for one of his lieutenants drawn out by the press soon after his hiring. Perhaps he put some noses out of joint with his remarkable show of sartorial disdain on his first day - "...I came in, walked into this brand-new building, and I was not wearing a tie" - but he did say a few other things in that early-days Telegraph interview which appear to have turned around and bitten his kitten, such as;

• “It’s very valuable to have customers in the boardroom. And for the first time I think the group board felt they were involved in strategy.”
• “There have been some very big issues that we’ve worked through [with the board.] Not bank issues, other issues”

The thread that appears to be emerging for this Group is that its uniquely assembled Board is ill-equipped to deal with such manners in a technically professional and rigorous format, whether that be rolling over for the previous leadership while they made a string of horrendous strategic decisions, or the huffy, juvenile leaking of sensitive data when the new team has come in.

This is not to say that using mutual-style democracy to elect a functional Board of Directors can't work, but perhaps it doesn't work in financial services, where the stakes are higher, the jargon is less penetrable, and failure is catastrophic. I could certainly pick through the list of values and principles and find a number of institutionally-appropriate excuses for leaking confidential paperwork

From a pure decision making perspective though, should the shop-floor proles be allowed to mix with the MBA-laden executive class of the 21st Century corporate world in a way that affords this particular entity the luxury of competing against their more cut-throat rivals, while sticking to those core values and principles while paying off their massive debts?

If Lord Myners pulls a solution out of the bag for a quid (and he doesn't sound like he's shrinking to the task), they'll surely have to promote him to Marquis!