ORSA and Independent Review - Misunder-stud?

Independent review of ORSA
- banging the drum?

I listened in on a Solvency II readiness webcast a couple of weeks ago which pricked my ears like a low-budget high street beauty parlour. The specific theme was independent review of ORSA, and the broadcaster confidently included it in the list of "things we all need to do" in the Solvency II preparatory phase, both 2014 and 2015.

While most familiar with the topic would immediately cry "that got lobbied out in 2011", the speaker's argument was that, while EIOPA's Guidance no longer says firms should "independently" review its ORSA, it also doesn't not say it, therefore we must do it, and do it annually!

I would have chuckled and left it at that, but having read InsuranceERM's recent roundtable on preparations for Solvency II, the topic again reared its head, albeit in a more controlled manner, as a number of attendees explained how they have used Internal Audit (and dismissed the idea of using external firms) in reviewing their ORSA processes during the preparatory phase.

My problem is this - as an industry we were happy to, erm, relieve ourselves and moan when CEIOPS's first attempts at ORSA Guidance in 2010 included a guideline which compelled annual independent review of the ORSA Process (included in slide 32 of Mr Bernadino's pack here in Summer 2011, as I can't find the original CP anywhere).

This was lobbied-out by the time the re-badged EIOPA released their 2011 CP (here), and when their Final Report followed in June 2012, "independent review" was a distant memory.

Any compulsion to review the ORSA Process is now  covered only by EIOPA's System of Governance Guidelines (here), specifically Guideline 8 asking that a firm's SoG is regularly "internally reviewed on a regular basis" (5.11).

EIOPA continue in 5.11 that "...the review undertaken by the internal audit function on the system of governance as part of its responsibilities can provide input to this internal review" - i.e. this is not work considered to be performed automatically and exclusively by one's Internal Audit function.

In terms of frequency, EIOPA elaborate in section 4.26 of the Guidelines, namely that your AMSB, given your firm's nature, scale and complexity;

...determines the scope and frequency of the internal reviews of the system of governance

 So three things - no 'annual' requirement; AMSB's choice on frequency; and that this is internal review, not "independent", "external", or indeed any other word which gets me contracted past 2016!

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!

Governance flaws in UK financial institutions - complacency or one-offs?

Some very interesting bits released over the weekend which should prick the ears of the UK's banking and insurance entities like a corporate governance-driven piercing gun, hot off the back of last month's Co-operative Group scandal.

Governance structures
- unchallenged by Risk for too long?

Over at RSA, one of the UK's most venerable General Insurance, a house of horrors-style drama appears to be emerging. Starting with what looked like a serious, yet relatively modest, localised valuation issue over in Ireland has developed in short order into the straw which has broken the camel's back with regards to the tenure of the Chief Executive of the entire group - all off the back of a routine audit, according to one source, and perhaps not coincidentally breaking formally as a story one day after the announcement of enormous premium hikes in the country.

Astonishingly, one of the three men suspended at the Irish unit is also one of the biggest hitters in their national industry, being the current president of the Irish Insurance Federation. He was quoted in August thus (my emphasis);

I’m very optimistic about the future. The Irish Insurance Industry is robust, well capitalised, making a significant contribution to the economy and most importantly, delivering for customers.

While it is fair to say that the knives were already out for the Group CEO, who has presided over general bad news over the last year or so (this year's profit warnings one and two for example), to actually see a FTSE 100 insurer crippled to the point of fire sales to plug capital holes by such a matter is pretty remarkable, even if the geographical source of the pain is less surprising after Quinn went down actuary-less a couple of years back.

What's more, the interim CEO (who is pulling off the much-maligned Chairman/CEO double act for now, though was Non-Exec) has sanctioned a root and branch review of governance arrangements in the firm across all markets (cited here from an analyst call), quite an undertaking in itself bearing in mind its geographical spread.

It made me revisit the published feedback to EIOPA's preparatory guidance, where I had remembered that the feedback received from RSA was pretty caustic with regards to the appropriateness of EIOPA's guidance where it seemingly went above and beyond the Directive and Implementing Measures.

Pointedly in the context of this particular failure of their internal controls, they fed back extensively on the Fit and Proper requirements (p237), most of which centred around 'less is more', and emphasised the administrative burden such activity already causes. This is supplemented on p339 with a piece against the rotation of internal audit teams, both of which look discomforting in hindsight!

System of Governance - EIOPA's FINAL preparatory guidance for national supervisors

Based on feedback received since their initial consultation paper was released, EIOPA make the following generic clarifications/statements in the preamble of their guidance doc for System of Governance preparations;

• That proportionality will not be defined or presented as examples in the guideline text (p5-6)
• That NCAs are "expected to...review and evaluate the quality of the information provided to them" - bad news for the PRA, who were clinically uninterested in reviewing Solvency II reporting attempts according to one blogger (p6)
• The emergence of a new ORSA acronym, "FLAOR", which looks more like something an amused teenager would write on Facebook (p6)
• The expectation that 2015 will see submissions of (2014) ORSAs to NCAs (p7)
• While there is no generic take on what enforcement action should take place in this interim period, firms are expected to (a) Discuss any negative findings from their ORSA/Governance systems with their supervisor, and (b) To produce SCRs using information of appropriate quality. Enforcement action in the absence of this WILL NOT consist of capital add-ons, apparently (p7)
• That the submission date calendar for all of the information expected will be reviewed at the end of this year, so that EIOPA can take Omnibus II progress into account (p8)
• That the explanatory text in each set of guidance is NOT part of "Comply or Explain" (p9)
• That the reasons behind a negative "Comply or Explain" decision from any country will be kept secret as standard (p10, and disgraceful, frankly).

They then go on to focus on some of the larger bones of contention within the 52 guidelines provided. The following generic points stand out for me as a practitioner;

1. There is almost no discernible movement in EIOPA's position, even after a volumous lobbying effort;
2. That explanations for the inclusion of contentious content are generally forthcoming, though on a number of occasions, flimsy;
3. That planning for 2014 full-year mothballing of Solvency II programmes is not an option, particularly for ICAS+ candidates - some may get away with a few months of inertia, depending on the quality of their paperwork (strategies, policies, process guides/maps, terms of reference, charters etc).

The following supporting arguments for EIOPA's final view were, in my mind at least, poorly formulated, regardless of whether the end result is still agreeable;

3.48 (Guideline 6)

- Refused to add more definition around what constitutes a "significant decision", which is poor form.

3.58 (All of Chapter III)

- That the expectations of Risk Management in insurers  "...comprise risk management standards which are considered to be matter-of-course and wide spread activities" - extraordinarily loose, considering the lack of a majority-accepted global, or indeed pan-European standard on the subject (IRM/ISO/COSO/FERMA/FSB's efforts notwithstanding)

3.65 (Guideline 19)

- That, while it is "not an easy task", Operational Risks should be quantifiable, and therefore subject to tolerance limits - I don't think it would have hurt to suggest (or even compel the use of) a method if it is that difficult.

3.68 (Guideline 25)

- That firms should maintain Investment Risk-related KRIs outside of what might be provided by normal parties (for example, ratings agencies), which would help "...increase overall risk management" - not entirely convinced that a generic "increase" is any kind of worthy ambition. 

3.74 (Guideline 31)

- That a capital management policy and capital management plan is both necessary (though for not entirely convincing reasons when tying back to the Directive)

3.78 (Chapter VI [Internal Control])

- That there is already plenty of clarification on what the Compliance function is charged with. I would agree in principle, but have heard evidence to the contrary in practice.

3.81 (Chapter VII [Internal Audit])

- That they neither wish to mandate or discourage rotation of Internal Audit staff or whistleblowing direct to NCAs - in which case, why mention it!

3.110
- A bizarre comment in response to a suggestion that a public statement should be released by the AMSB annually regarding the discharge of responsibilities around the system of governance that the Directive "...only deals with internal governance, not corporate governance" - think I know what they are fishing at, but terribly worded.

3.144
- Justify their decision not to define risk appetite and risk tolerance in the context of these guidelines

They have however provided some more defendable clarifications, for example;

3.51 (Guideline 11)

- Clarified that the gold-plated "Fit and Proper" requirements apply to AMSB/Control Function staff only, as well as specify what is expected from Outsourcers.

3.57 (Chapter III [Risk Management])

- That in the context of separating the duties of the Risk and Actuarial functions, the Directive is abundantly clear and that undertakings "...cannot deviate from [the Directive's] distribution of tasks"

3.62 (All "Policy"-related guidelines)

- That efforts should be targeted towards drafting the required documents during the preparatory phase. I would imagine this would be "re-working" in the UK, where such activity is most probably long done.

3.67 (Guideline 19)

- That there is no compulsion for firms to operate an electronic database to store operational risk events

3.85 (Chapter VIII [Actuarial])

- That, regardless of the absence of a valuation framework for TPs, the processes behind their co-ordination and calculation justify early activity, rather than "wait and see" on Pillar 1.

3.124
- Regarding Op Risk, activity will have to include "...identifying all operational risks that have crystallised and their near misses" (my emphasis)

Relatively easy in summary then - if it was a gap/issue in your system of governance in March, it probably still is, so go and fix it!

Chartered Institute of Internal Auditors - final guidance on Effective Internal Audit for financial services

The Chartered Institute of Internal Auditors have followed up on their consultation earlier this year on Effective Internal Audit in the Financial Sector with this final set of recommendations.

Doesn't appear to have been any seismic changes as a result of the consultation, though the "need for proportionality" has been recognised, and clarification has been added that the content itself has not been mandated by the profession as best practice.

Interestingly, huge emphasis has been put on clarifying the primary role of Internal Audit as being the "protection" of a firms's assets, reputation and sustainability - does the profession feel well resourced and equipped to handle reputational defence? - while a few other elements sprung out at me;

• A focus remains on IA challenging the "tone at the top", as if the expression now carries so much weight and definition that professional guidance can be hung from it.
• "Risk Appetite" is again not defined, however IA are on the hook for assessing that it has been established and reviewed by senior management
• Emphatically declares that "...the assurance map cannot be carved up between the Risk, Compliance and Internal Audit functions", stressing that IA will be expected to include the challenge of the work of other control functions in their audit plans
• Built in some leeway around their earlier suggestion of compulsory attendance of IA function heads at Executive Committee meetings (ostensibly in order to understand strategy) - for insurers, one could anticipate that the advent of ORSA may take care of that knowledge gap 

Certainly the PRA/FCA have been fast to come out with support for the final version, so I guess all control functions had better make their peace with the content and prepare appropriately.

EIOPA Preparatory Guidelines - System of Governance

Consultation on System of Governance preparatory guidance (plus explanatory text)

For a topic which has felt like a given for a number of years (certainly in UK and Ireland where we already ask a lot in this area), the System of Governance preparatory guidance is still 40 pages, comprising of 57 guidelines, accompanied by 60 pages of explanatory text.

A couple of things immediately grabbed at me when going through the guidance (again anticipating a conservative approach of the supervisors rolling over and applying all content as is)

• That the Risk Management Policy (regardless of how one structures the component elements) is expected to contain procedure-level information about the management of each major risk category - this sounds hopelessly disproportionate, and almost impossible for supervisors to reasonably get through;
• That it is "expected" that large or complex firms separate their four key control functions, and that others at the small/medium end may ultimately find it easier to do so than consider the range of controls/maintenance of independence required to have combined functions;
• That an expectation that insurers' systems of governance require regular independent review, with the AMSB only retaining the ability to choose the performer;
• That insurers will be expected to formally identify/analyse/report on Operational Risk Events
• That EIOPA bottled out of defining Risk Appetite and Risk Tolerance, leaving national supervisors and insurers to fight it out amongst themselves.

Ultimately, the document reads like a checklist which practitioners or full-timers can run through against the suite of documentation no doubt already in existence which, if based on CEIOPS/EIOPA final advice and/or the Commission's Draft Level 2 measures, won't be miles away as it stands. On that premise, I've only listed elements which jump out for me.

GENERAL GOVERNANCE REQUIREMENTS

Guideline 3

• Evidence should be collected of the AMSB "proactively" seeking information from committees/key functions

Guideline 5

• No more detail than an expectation that the AMSB "appropriately implements" their key functions - in the explanatory text, it goes on to say that larger companies will be "expected" to fully separate Risk/Actuarial/Compliance/IA, with a series of measures expected to preserve functional independence if smaller companies choose to combine some.

Guideline 7

• Expectation that both AMSB decisions, and how information generated from the Risk Management System (RMS) influences them, is "appropriately documented" - compulsion for Board Decision Logs?

Guideline 8

• Regular System of Governance reviews appear to be expected, which are documented and reported back to the AMSB - the AMSB retains the right to choose who performs it 

Guideline 9 - All policies must include:

• Goal of policy
• Tasks to be performed and by whom (person or role, unlike for validation, where person/s was specified)
• Associated processes and reporting procedures
• Obligations of affected operational teams to inform control functions of "relevant facts" at all times

Guideline 10

• Contingency plans are expected for areas which are "especially vulnerable" - this pushes outside of what one would consider a conventional contingency plan for operational emergencies.

FIT AND PROPER

Guideline 11

• Must have a Fit and Proper persons policy
• It must be equally applicable to both hired staff and outsourced functions

RISK MANAGEMENT

Guideline 15 - AMSB is "ultimately responsible" for:

• RMS effectiveness
• Setting Risk Appetite and Risk Tolerance Limits
• Approving Risk Management strategies and policies

Guideline 16 - Risk Management Policy must cover at least

• Risk categories used and measurement methods
• How each category/grouping of risks is managed
• Risk tolerance limits for all categories in line with Risk Appetite
• Linkage of both SCR and ORSA to risk tolerance limits
• Frequency and content of regular stress tests, and circumstances for additional testing

In addition, the associated guidelines touch on the risk categories within one's Risk Management Policy. There is an expectation for pretty much every category that procedure-level information is included in the policy documents themselves, as well as hard limits, which is unlikely to be the case as it stands.

Guideline 18 - Insurance Risk Policy

• Expected to cover types of acceptable insurance risks, how premiums will cover claims/expenses, as well as how product design accounts for investment restrictions and formal risk mitigation techniques

Guideline 19 - Op Risk Policy

• Expectation that Operation Risk Events will be formally identified/analysed/reported in insurers, and that a system for collecting and monitoring them should be in place.
• Operational Risk Scenarios should be developed and used, based on failures of key persons/processes/systems and external events

Guideline 23 - Investment Risk Policy

• Buzzphrase introduced of managing the level of "security, quality, liquidity, profitability and availability" of one's asset portfolio

OWN FUND REQUIREMENTS AND THE SYSTEM OF GOVERNANCE

Guideline 32

• Concept of a "medium term capital management plan" introduced which covers; planned capital issuances, maturities and distribution policies - not sure how that works for mutuals, but I can see what they're fishing for

INTERNAL CONTROLS

Guideline 33

• "All personnel [should be] aware of their role in the Internal Control system
• The Internal Control system should be "commensurate to the risks arising from the activities and processed to be controlled" - this line should hopefully avoid overkill

INTERNAL AUDIT FUNCTION

Guideline 36

• The Internal Audit policy should include the procedure for informing supervisors [of whistleblowing-level wrongdoing I guess]

ACTUARIAL FUNCTION

Guideline 44

• "Material"deviations of Best Estimate Liabilities should be back-tested for by the Actuarial function, reported on, and remedial changes proposed

Guideline 46

• The Actuarial function is expected to "contribute to" specifying the risk coverage in the internal model, as well as the dependency structure - this feels like areas where, even in larger insurers, the function probably already leads, so will they be asked to take a step back?

Munich Re on Solvency II Control Functions - an actuary for all seasons...

Munich Re have continued their infrequent-yet-valuable Solvency Knowledge Series with a piece on Key functions within the system of governance of insurers under Solvency II.

Of course to the grizzled old set of risk practitioners who have done the rounds for the last few years, the fundamentals of the directive's requirements on the four control functions are as basic as the ingredients list for a frozen lasagne. It naturally draws attention to the likelihood that there will be "some overlap" between the activities of Risk, Actuarial, Compliance and Internal Audit, as well as touching on outsourcing as "...an attractive way of meeting the wide range of requirements" for those

However I detected more than a whiff of controversy around the content of this particular publication (which I hasten to add is a smart read nevertheless), were one to take it at face value. In particular;

• Their use of the three lines of defence model in the publication - while perceived to be good practice for segregating operations from risk advisory from risk assurance, it is certainly not cited in any existing materials at Level 1, 2 or 3, and the structure may be disproportionate at the small end of the insurer spectrum. On top of that is the Actuarial function's acknowledged dwelling over a grey area between the first and second lines, in particular if they haven't catered separately for the reporting lines of reserving, pricing and capital management actuaries (p8).
• The comment that "The risk management function will no doubt have to include people with a professional scientific and mathematical background, ideally backed up by appropriate qualifications (eg actuaries)". Whilst, internal model or not, the Actuarial function will clearly have to provide "considerable support" to the Risk function, I don't see any reason at the small-to-medium level for the Risk function to include actuaries unless through choice, using the lever of proportionality.
• That the Risk function "...shares responsibility for the risk strategy" - I think the implication is that it shares responsibility with the Board, but the statement doesn't help identify a) who authors and authorizes it and b) who gets fired for its poor deployment! I am more inclined to think the Risk function owns the risk management system and is responsible for monitoring and reporting on the implementation of the risk strategy which sits within it. The FSA define their requirements on this page in any case.
• That the Risk function "...identify potential risks and recommend appropriate countermeasures to the Board" - as far as emerging risk/top-down risk assessment goes, I certainly expect the function to facilitate the emerging risk/scenario analysis/reverse stress test activities in this regard, but it is most certainly not a solo job.
• That "The compliance function...will have to include staff with a legal background" - appreciating what the wording of Article 46 implies in particular, this is more a proportionality/outsourcing issue for me than anything. Having said that, I'm sure any existing compliance professionals out their who didn't take the Bar might feel slighted by this! 
• That "all four functions have a direct reporting line to the Board" - not certain that this is so in the vast majority of cases. Certainly via Board committees the Risk and Internal Audit functions will be well catered for (and the FSB recommended even better than that for the Risk function last week), but I suspect an executive reporting line is as good as it gets for the other two functions in most firms.

Certainly plenty to engage the grey matt with regardless of your country of origin, even around control function crossover areas (which I presented on at the end of last year), so dig in.

Chartered Institute of Internal Auditors - recommendations for UK financial services

The Chartered Institute of Internal Auditors recently created a sub-committee to provide professional guidance "...designed to be a benchmark for effective internal audit in financial services in the UK", and they have just reported back with this feast of fun, which is a vital read for anyone working in control functions within financial services. The opinions they have used to create this guidance have been purloined not only from the profession itself, but also from other professions, regulatory bodies and executive/non-executive directors

They note in summary that there is "strong support for an unrestricted scope for internal audit", while drawing attention to disparity of opinion around matters such as: IA directly challenging strategy; IA reporting to Risk Committees (rather than audit committees) in certain instances; compulsory attendance of Chief Internal Auditors at Executive Committees; and the direction of managerial reporting lines.

The proposed guidance reads very much like the Corporate Governance Code, and is relatively light. It is broken into the following sections, where I have noted anything I found new or controversial alongside (my focus being predominantly scope creep into the Risk function's activity):

1. Role and Mandate of IA - increased focus on risk assessment and risk coverage adequacy
2. Scope and Priorities of IA - unrestricted scope ultimately advised; expected to "independently determine" key risks, and assess "the setting of, and adherence to, risk appetite"; assess the "risk and control culture"; allows for potential involvement of IA on "real time basis" in key corporate events (mergers, disposals, new lines of business etc)
3. Reporting results - factors in reporting obligations to both Risk and Audit Committees where appropriate, and builds in an expectation of an annual independent assessment of governance (which covers off one of the FSB's recommendations covered yesterday!)
4. Interaction with Risk, Compliance and Finance functions - nothing new
5. Independence and Authority - Chief Internal Auditor expected to be executive committee-equivalent, have the right to attend Excom, access to all MI, and report directly to either the Chairman of the Board, Audit Committee or at a push, Risk Committee. A secondary line to an executive director should only go to CEO
6. Resources - all resourcing decisions effectively divorced from the business, to reside with the Chief Internal Auditor and the Audit Committee
7. Quality assessment - external assessment of the function recommended periodically.
8. Relationships with regulators - nothing new
9. Wider considerations - expectation that the "tone at the top" of a firm should be what fosters acceptance of IA

Any controversy? Perhaps around the seniority of the Chief Internal Auditor, and their assessment of the setting of and adherence to Risk Appetite. I think my main concern as a risk practitioner would be the potential for differences of opinion around what constitutes "adequate" risk management, given the Internal Audit predeliction for COSO on all things risk-related, against the IRM or ISO31000. 

Let battle commence?

Governance Matters at ILAG - Co-operation between control functions under Solvency II

Been a bit quiet on the Blog front - not because my country and I are licking our wounds after being opened up by HMRC like a Manx kipper, but because I had been asked to chip in with my two cents at an event hosted by the Investments and Life Assurance Group in London. It was an exceptionally well run event, with some interesting takes on the participation of Risk, Actuarial and Internal Audit functions in meeting not only the Directive requirements, but also the expectations of wider stakeholders and indeed policyholders.

My particular focus was on Control Function interaction, the inevitable areas of crossover and emerging skill gaps, and I also touched on some benchmarking papers as well.

My transcript is below and, conveniently enough, reads like a Blog Post. If you would like the slides with the script/hyperlinks embedded, either register with ILAG or drop me a line at allan@governance-matters.co.uk and I will send them on for the bargain price of...free!

________________________________________________________________________________

So back in my former life of BAU busy-ness, my interests in Control Function optimisation were generally led by budget (or lack of it), in particular;

•     Professional standards – were there enough bodies, and were they sufficiently skilled or motivated, to perform the fundamentals required (bearing in mind corporate governance code reforms both in the UK (2010 changes BTW, not 2012’s!) and Ireland meant that some system of governance work had to jump the Solvency II queue regardless)

•     Proportionality – would the lack of definition around the proportionality principle (Lloyds take a stab on p2) lead to companies being woefully underprepared once the national regulators inevitably bared their teeth post-2009. The impact of misinterpreting Article 41.2 genuinely put the fear in me!

•     Multiple roles per person/outsourcing – Whilst some common sense calls were made at the smaller end by merging Risk and Compliance functions, the more operationally substantial calls around merging risk and actuarial functions, outsourcing internal audit/compliance advisory services and recently the march towards outsourcing independent model validation and data quality assessments all posed questions.

Of course, having now worked with one of the biggest, my natural curiosities are not piqued by the unavailability of resource and budget, more by the complexity of wading through the reams of opinion and material that large budgets generate! In particular, I have been monitoring;

•     The ability to get bang for buck out of programme spend, with most Tier 1 firms having comfortable broken 3 figures despite, from a Pillar 2 perspective at least, having something akin to “textbook” governance systems at outset

•     Whether the “Consultant writes/BAU implements” will be proven to be a successful method of preparing for Solvency II, or whether the plethora of Pillar 2 material outputs will, once unsupported by its transient authors, die a little death

•     Control functions in Groups, and perceptions of which countries’ governance is considered superior/inferior in the world of supervisory colleges

But you lucky guys in the UK already have a decent amount of written word around what your control functions are up to, with GENPRU, INSPRU, SYSC, SUP and the Corporate Governance Code all building cases for functional remits and appropriate governance structures

•     So we know our friendly actuarial function will be knocking out the sums which end up in our pricing and reserving worlds, produce the EV and capital calcs that (hopefully) keep the wolf from the door, thus quantifying any risks which lend themselves to being quantified, and all the while self-policing the suite of models, methodologies and assumptions that aid them in doing so…

•     We know our compliance function will be focused on monitoring and assessing the effectiveness of an entity to comply with prevailing laws and regulations, at a micro and macro level…

•     We know our beloved IA function will be assessing the effectiveness of risk management, internal controls and governance processes…

However, the one rather raggedy looking function out of the existing set up is my one, the humble Risk function! While SYSC21 has beefed up the significance of Risk in the prevailing regs, the other SYSC tasks attributed make it feel a bit powder puff functionally by comparison.

In fact, both Risk and Compliance don’t especially feel enormously catered for in the prevailing set up as opposed to Actuarial and IA – not sure whether this is due to the consistency of their development as professions dwelling in the more certain lines either side of the second or not, but it’s certainly my feel as an outsider looking in…

…but thanks to Sol II (or at least the veiled threat of its implementation before I retire), we are now looking at control functions in reasonably neat packages complete with instructions!

One of the biggest problems that I’m sure all present have easily surmounted over the last couple of years is the ambiguities in the language of the Directive and Implementing Measures.

As a man who is married to a wonderful French woman, I am used to following instructions, but of course we are frequently confronted with flowery language such as “covers”, “advises”, “provides an opinion”, “liaises”, which is a consultant’s dream come true, but doesn’t help BAU demarcate and co-operate with any great certainty.

That said, the long and short of it ends with;

Risk

Risk come out with a pretty wide-ranging remit which mostly sits in the FSA’s Dream Function world of advisory, co-ordination, challenge and monitoring, though its ability to monitor “the general risk profile” is clearly reliant on the Actuarial function. Not assuming all present are part of IMAP, but the big ownership piece comes of course with the Risk function taking on responsibility for compliance with the internal model requirements on its design, implementation, testing, validation, documentation and weakness and limitation reporting. Clearly a massive undertaking and, certainly at the small/medium end, not one that can be naturally chalked off with an existing compliment of staff.

Actuarial

Actuarial function requirements include requiring knowledge of actuarial and financial maths but leaving an “other standards” clause in to help out the less well-policed countries! They do also however get some wriggle room on responsibility where it would otherwise be assumed (at least by me!), and so ”co-ordinate” TP calcs, “express opinions” on reinsurance arrangements and the underwriting policy, or “contribute to” implementation of the risk management system.

Compliance

Compliance are not burdened with a laundry list of tasks as such, however to advise the AMSB on compliance with Solvency II is a pretty unenviable one (particularly now!). Perhaps the biggest challenge looking at the remit impartially is the depth and breadth of coverage that the function will need to provide, not just on Level 1, 2 and 3 and SOLPRU, but also be able to challenge the adequacy of the vastly expanded internal policy suite

Internal Audit

IA get the unimaginable luxury of having a relatively unchanged remit, particularly in this neck of the woods where risk-based internal auditing and planning is de rigeur.

Outsourcing

The aggression in the wording around the Outsourcing requirements suggests that the days of outsourcing control functions being a “write a cheque, then dusting-of-the-hands” job are at an end!

Now the legislative ambiguities just mentioned leave ample room for control function bun-fighting due to the inevitable crossovers of skillsets for certain tasks and, perhaps most pointedly, who takes precedence in such instances.

ORSA

Probably the biggest area of convergence and potential toe-stepping-on is of course the ORSA space (covered here on the blog) which in the crossover context it is more about who performs which sub-processes, under whose authority, and who “holds the pen” when collating the record of the ORSA performance.

More by process of elimination than by legislative direction, ORSA oversight seems to sit at the door of Risk, a concession even made by the SAI over in Dublin whilst simultaneously illustrating how little they are required in the ORSA Process! Is this therefore real or nominal oversight, or even worse, a PMO-type record collection role.

One other crossover area comes from the removal of the requirement (after pre-consultation) of an independent assessment of the ORSA Process – whilst losing the compulsion should be welcomed on principle, is there a danger that the IA function, through risk-based planning, may under or over-Audit the ORSA space? Just a thought...

Risk IMMMR/Advisory/Challenge

The world of risk identification/measurement/management/monitoring/reporting also becomes one with potential for friction, through the merger of the worlds of the Risk function’s qualitative risk register-type approach and the actuarial function’s established risk quantification methods, into what ultimately comprises the “general risk profile” as per the Directive text – one of the Big 4 suggested that the P&L Attribution is, for actuaries, “the real risk profile” for example, and perhaps some of you concur!

Regardless, the twin horrors of agreeing with Actuarial quantification methodologies for hard-to-quantify risks, while fostering a dependence on them for measurement, monitoring and reporting facilities around financial and insurance risks suggests more of a one-sided dependence rather than “close co-operation” between the functions.

Compliance risk

This works similarly for the world of compliance risk identification/assessment, nominally in the remit of the Compliance function - are they being dragged somewhere nearer the first line if they are producing this work for the Risk function? Just feels a bit blurry…

Emerging Risk

For emerging risks, my main concern is the robustness of the top-down/emerging risk identification process filtering its way into some quantified element within the ORSA and/or internal model – Risk is chalked down for identifying and assessing emerging risks, but their ultimate measurement isn’t catered for.

For internal Modellers

And into the internal model space, the “close co-operation” between the Risk and Actuarial functions, at firms big and small, has the potential to cause all manner of difficulties, in pure process efficiency terms as well as the cost implications of IMAP failure,. One CRO referred to this as having to “solve the risk management team/actuarial team conflict” in a recent presentation on model governance! Clearly though there is quite a gap to bridge between how this governance worked under ICA and the demands of Solvency II.

Establishing an “independent” team for regular validation, regardless of headcount seems to be something of a holy grail, with a growing trend towards “bringing someone in”, if only for the comfort of benchmarking against one’s neighbours. This also helps a company stay in line with Mr Cardoni from the FSA’s call that “individuals performing the validation must possess the necessary skills, knowledge, expertise and experience”, but does little for self-sufficiency, as well as leaving the Risk function with the job of relationship manager during validation exercises.

The approaches available for the Risk function to discharge its other responsibilities around the internal model requirements, in particular around model design and implementation, of course crossover into terra firma for the actuarial function – would be interesting to know how any modelers in the room have approached this, as a cursory sign-off from Risk on a suite of model development and implementation paperwork doesn’t feel in keeping with the spirit of the regs, though an IRM survey from March suggested at least 11 IMAP applicants were doing something along these lines!

So even if Sol II doesn’t directly ask for enhanced skill sets, we in all functions can all see the iceberg coming if we don’t fix up and look sharp. As ever, the most fascinating movements are in the actuarial space as they meander over towards the risk in what is lined up to be the biggest land grab since Enclosure!

There is certainly plenty of encouragement, in a profession which one of its own was happy to recently decry is “trained to deal principally in numbers and statistics”, to branch out into Risk, with the CERA qualification – “the most comprehensive and rigorous demonstration of ERM expertise available” – perhaps leading the way. While the profession is quick enough to highlight the weaknesses and limitations of an Actuarial CRO, does this additional qualification do enough to bridge the gap?

Certainly the GCAE suggest in their work that professional education may need further enhancement “especially in relation to risk management”. Over in Ireland however, the SAI are taking it one step further in their Strategic Plan for the profession, going as far as looking to partner up with a university to develop a risk programme for anyone “who wants to skill up quickly in the area”. Can’t say I’m sure what the rush is, other than opportunity knocking!

On the Risk front, the IRM were very quick to respond to the FSA’s Dream Function presentation back in April 11 with a vigorous defence of the appropriateness of non-Actuarial heads-of-risk, noting that the two professions were “extremely complimentary while different”, whilst mockingly emphasizing that the very concept of CERA highlighted that “Core [actuarial] qualifications do not give sufficiently broad training”.

That said, while the IRM have focused attention on some big ticket items such as Risk Appetite and Risk Culture  over the last 18 months, is it fair to say that training or certification touching on capital measurement and management, modeling, financial and insurance risks and their strategic application would have been a welcome addition to the qualification roster (notwithstanding what is available elsewhere through GARP’s FRM designation)? I rather embarrassingly had to answer a question from a colleague the other day about “how did you get qualified for Solvency II” – I won’t tell you how I answered!

For IA, there is a brave new world for anyone with the chops to upskill or expand their horizons. While the ever-moving implementation date maybe postpones any programme assurance work that IA could have picked up on the run-in to go-live, there is clearly an expectation at the FSA that they will contribute to activity such as internal model validation and data quality assessments, though I’m not seeing anything in the world of training to aid them in doing this (hence the consultancies are doing so well out of it I suspect!).

Deloitte do present a nice picture of some of the additional skills that IA may fall short on, in particular a natural aversion to covering non-Operational risks, despite their relatively higher contribution to the risk profile of insurers. One other thing I had in mind, knowing the IA profession’s predeliction for COSO was changes in the world of Insurer ERM since the last refreshes of COSO’s ERM work, particularly COSO’s latest take on risk assessment – instinctively feels like there may be some catch-up work to do in the IA field, but may be wrong.

For the compliance guys, is it fair to say that you already have your work cut out swallowing Level 1, 2 and 3 paperwork as well as any handbook changes which will emerge at the end of the PRA/FCA divorce. Interested to know if anyone getting roped into other activities!

The last thing I was going to mention was that, in the absence of rapid upskilling, and the wind-down/mothballing of organisation’s Solvency II Programmes, has anyone worked out whose BAU budgets any outsourcing will come out of for the next couple of years?

Moving on to how people are doing on the functional operation and indeed co-operation front, there is a reasonable amount of intel and ideas out there, which you may have clocked on its way through, but maybe makes a bit more sense in aggregate.

Risk function effectiveness

As far as Risk function effectiveness goes, the IRM straw-polled their Solvency II SIG this year, and identified some worrying trends from a Sol II readiness perspective, in particular;

Only half have their CRO communicating directly with the Board on risk matters – breathes some life into the quote from Axa’s Life CRO that “risk management is too important to leave to the risk management department”…

•     Nearly half said risk papers are "noted with a short discussion" at Boards

•     A number of risks were not covered by the respondees' risk functions – ALM and strategic risk in particular

•     Over half felt they had overlap with either Actuarial or Compliance, and a quarter with IA

•     As mentioned before, a decent number of risk functions are not directly delivering documentation, testing and validation of the internal model.

•     Half said the process of implementing Solvency II affects their ability to become relevant to the Board

The IRM also very recently performed a survey (with a reduced quantum due to the subject) on Internal Model Governance trends, which highlighted that;

•     Risk is “responsible” for IM governance (with no exceptions in the survey), but Actuarial are “involved”, but with no further details

•     And many respondents feel “real decisions” continue to be made outside of IM Governance framework, in particular around stress testing, back testing, model change and expert judgement – makes one wonder if an Actuarial CRO could counter that governance leakage?

Risk appetite design and application

There was a paper released by our hosts this year which emphasized the differences in design and implementation of Risk Appetite Frameworks between Risk and Actuarial functions, noting that a quant heavy actuarial approach gets more traction and quicker! This doesn’t augur well for the new ORSA world of “everything must be quantified”, as it is the qualitative risks that need the most attention.

Reporting lines

The world of reporting lines remains a pretty hot topic, with KPMG putting out a decent paper which recommended, amongst other things, that the Actuarial function should consider a formal demarcation between risk taking and risk assessing/measuring actuaries, which would negate the trend of shoehorning capital actuaries through the Head of Risk, keeping them all reporting through the AFH. They also added that at least half of the respondees were not yet at their desired end-state regarding the basic new Actuarial function requirements around underwriting and reinsurance adequacy opinion provision.

IM Validation

In the model validation space, as early as the end of last year we saw KPMG reporting that half of the IM production staff were also involved in the validation process, emphasizing the practical difficulties in functional separation whilst in Programme mode – would love to see how those numbers have moved since. 

Having seen the FSA’s feedback in May on what had been observed at that point in time (in particular that independence from model development and being “sufficiently competent” went hand in hand), one can imagine that IA’s role in the activity will be marginalized in future at the ongoing expense of bringing in the Big Guns every year.

Things a Risk function could be doing

And finally, while I have touched repeatedly on activities which a Risk function may find cannibalized by their ravenous Actuarial counterparts, as well as responsibilities bestowed upon it that it may not be equipped to discharge, I have seen a few pieces around activities that the Risk function would probably love to be doing more of, given half a chance.

A recent piece by Accenture got my engine running, around the future of data analytics – I definitely feel that, with the appropriate informational power at their hands, the risk function can provide a massively enhanced IMMMR and advisory services at little additional cost (the main cost of course already being sunk into data  quality and data warehousing projects independent of the function)

One lovely piece, pitched in the context of why Equitable failed, reads like a list of things a CRO should be focused on, such as NED ambivalence and underperformance, or executive hubris, while a Towers Watson presentation on prepping for the future draws out the most practical big ticket activities such as superior understanding of model weaknesses and limitations and tail risk, rather than a more general clutch at the full bag of responsibilities bestowed on the function by Sol II.

A research piece from the CII (sadly no longer free!) compliments that, suggesting that a “balance between modeling and judgement” must be struck by Risk departments in order to breath relevance into a function that the author was outspokenly critical of in his research.