Solvency II Updates and Corporate Governance in Financials - PRA "Back for Good"?

A few releases of note out of the UK regulator over the last working week or so means I had some catching up to do - sometimes it feels like "All I do each night is PRA"...

They started off with a Director's Letter just before the bank holiday weekend. A general unwillingness to crack whips was present throughout this doc, even at this late stage, with a few references to "inform your supervisor" as opposed to "just do it".

The letter states that the PRA were due to publish some of their findings from their balance sheet review work by the end of the month - not done as yet, hopefully turns out to be money well spent

Regarding Standard Formula appropriateness:

• They stress that firms must identify deviations from Standard Formula from their risk profiles, and include an assessment of the significance of that deviation in their ORSAs (emphasised in their October industry presentation from p6)- is the implication here that firms are not doing this at all at the moment, or just not reporting it in ORSA?
• Highlight that "supplementary information" used to explain such deviations will also be assessed by the PRA. Does this add significance to one's qualitative commentary around Standard Formula/Risk Profile deviations? Can a good explanation be the difference between having to IM/PIM at the earliest opportunity against being given a couple of years of capital add-on breathing room?
• The PRA note that, "...where a firm's conclusion on this question is not appropriate", it will intervene. It is not clear how a firm's conclusions about its deviation between SF and its Risk Profile could be considered "not appropriate", but I imagine that anything which attempts to dodge USPs/PIM/IM ONCE the divergence hits the limits in the Delegated Acts (276-287) would be frowned upon. There is certainly no appetite at the PRA for renewing capital add-ons in perpetuity (slide 13), which given the UK's familiarity with ICA and ICG, might be a desperado's first chance saloon.
• The PRA are planning "specific interventions" on this front (detailed here), but not necessarily in time to correct before 2016.

Regarding Internal Models

• Not happy with "wide variation in quality of IM Change policies. Sounds like firms are doing their best to avoid change criteria that results in frequent submissions for reapproval, which one would expect!



IMAP Submissions
- Everything Changes

• PRA seemingly expecting firms to have not only taken on board their feedback, but also had their IMs revalidated, before submitting their IM application. Given that validation will be chalked down as a 'once-a-year' job at the moment (despite the IRM's efforts), that seems highly unlikely. They give themselves a get-out-of-jail-free card though by stating that firms must be confident that any changes in their IMs both address PRA feedback and meet the tests and standards for model approval.
• They appear to advise against submitting applications if you have a material change in the pipeline.
• Heavily critical of Board involvement in validation. Here they look for evidence of Boards "overseeing and influencing" the validation process, whereas previous PRA presentation slides  did not have such expectations of Boards (slide 8 here), or indeed expected more (slide 9 here)!
• The expression "internal management loadings" appeared in my life for the first time, which sounds to a non-technical person like myself that firms are effectively "dumbing-up" the capital requirement currently delivered by their IM in order to plaster over mathematical or data weaknesses. PRA certainly not impressed by industry suggestions to date.
• Given the number of firms who must have dropped out of looking for Day 1 approval, they still shake the pineapple tree here in order to remind applicants that contingency plans should be ready in the case of application failures. "Many firms still have a considerable amount of work to do" sounds to me like some applicants are being pre-warned of their imminent failure!

The PRA also released a consultation paper entitled Corporate Governance: Board Responsibilities, which has the rather light ambition of identifying "key aspects of good board governance to which the PRA attaches particular importance in the conduct of its supervision".

A few straggler items in it;

• That failures in governance and/or risk management have been a key factor in "many" financial sector failures - as opposed to "all"
• That they consider the FRC's Corporate Governance Code, amongst others, a "comprehensive guide to good corporate governance" - given the firms experiencing the financial sector failures were most probably complying with it, not a great advert!
• "Culture is the collective responsibility of the Board" - a bit of a nowhere comment, but instinctively, I don't see how this can be right. They can be accountable to both supervisors and shareholders/members for cultural failings, but where could such a responsibility materialise into demonstrable actions? 
• "...the Board is responsible for the oversight of, but not for managing the business" - in relation to my comment directly above, can both statement be correct?
• "The Risk Control Framework should flow from the Board's Risk Appetite" - I'll work on the premise that this is missing the word "statement" at the end of the line
• Section 11 on remuneration expects that incentives are aligned with "prudent risk taking" - what if prudence is too conservative for one's risk appetite?

Into some of the expected themes;

• Strategy to be "owned by the Board as a whole"
• They wed Culture and Remuneration "...to encourage and enforce the kind of behaviours the Board wished to see"
• They want a "well articulated and measurable" Risk Appetite Statement which can also be "...readily understood by employees throughout the business". Doesn't seem feasible, given the metrics commonly used in risk appetite statements are not exactly Finance 101 (Solvency/Liquidity/Earnings-related),
• "It is the responsibility of the Board to ensure that the effectiveness of the Risk Control framework is kept actively under review" - has at least an air of COSO about it, don't think it was deliberate
• Big section (6) on responsibilities and accountabilities of exec and non-exec directors.
• Followed in 7.1 with "...non-executives should not simply delegate responsibility for major decisions to individuals among them who are considered specialist in the area" - this has internal models written all over it (p5-6)!

Happy to see this second document, though I don't know what it adds to firms' understanding about what is "good and bad".




PRA's Countdown to Solvency II Implementation Event - When I Need U(SPs)

PRA Implementation countdown
- "Feel like dancing" now?

So along with the entire UK Solvency II sticky-beak brigade, I had the unbridled pleasure of attending the PRA's 'Leo Sayer' on Friday, confidently titled Countdown to Implementation, despite going on to list a range of matters which have probably given both Internal Model and Standard Formula firms plenty of enthusiasm to try and turn the clock backwards rapidly!

Paul Fisher, Julian Adams' replacement as Executive Director of Insurance at the PRA, kicked off with a set of Solvency II vox-pops;

• Solvency II is the "main game in town"
• "The end is in sight"
• The PRA are "not gold-plating the Directive"

A nice bit of reassurance at kick-off time then - unfortunately, the clarity which was to follow from the technical specialists on a range of topics was probably not what everyone wanted to hear, given the tone of some of the audience questioning that followed! In particular (and with everything in full quotation marks below having been said by a PRA rep on the day);

• That the PRA will "have to prioritise" if everyone in the IMAP queue for 'from 2016' approval drops their applications in at the end of June, and that applicants should be "striving to submit" sooner. Suggests to me that the smaller firms in IMAP may get bumped to squeeze in the big boys.
• The reinforcement of Mark Carney's message from the other week that they will have no problem refusing permission to use models, though this was couched by Fisher in the more appropriate context of failure to meet any of the TSIMs simply "cannot be allowed".
• That, although over 90% of the UK industry was down for using Standard Formula, the PRA will be equally aggressive when challenging their preparedness as they will for IM firms.

I didn't hang around for the afternoon sessions as I had a hot date with BA, so pull whatever you can out of the Other Approvals and Regulatory Reporting slideshows. However, I would draw attention to the following from the earlier sessions:

Implementation and Policy overview

• The Old Lady of Threadneedle Street protested through multiple speakers about how they recognise that bank and insurance internal models are different, and how Insurance Supervision is now "embedded into the Bank" - I would assume to justify the credit crunch-influenced aggression now being taken by the PRA on assessing capital models (visible from Adams's speech around the time of BOE/FSA merger right through to Bailey's speech at Mansion House on Thursday night).
• An interesting slide 3 about how much more work Solvency II will generate for the PRA from go-live!
• Referred to FLAOR only once before switching to ORSA, suggesting that this disposable acronym is as much of a pain in the neck for the supervisor as it is for firms!
• Highlight what "Good" and "Bad" ORSAs have contained to-date. Clearly some firms are box-ticking, leaving an unusable report which is only skin-deep compliant as output. They were particularly scathing on Stress and Scenario Testing efforts, and implored that Reports should not be written for the PRA's benefit (though naturally must cover what the DAs and EIOPA have already set out).
• A nice piece was discussed around the expected depth of director-level knowledge of their internal models. Andrew Bulley made a useful distinction between "conceptual" and "technical" knowledge, where your dithering 80 year-old INED from the fishing industry might not be expected to understand correlation matrices, but should probably know their significance, and alternatives to them.
• For model applications to date, far too big ("encyclopedic" in cases), with too much process description, and not enough on assumptions and expert judgements.
• That it is a firm's responsibility to "ensure compliance" with the Delegated Acts, and given their lessening proximity to the legislators, the PRA flag in advance that they will not be able to give "concrete advice" to firms in future.

Standard Formula

A particularly good ground-setter, given the dearth of work published previously on Standard Formula firms and the PRA's expectations. Calendar included on the slide pack, which will be of massive use to your PM/PMO staff!

• PRA will review ALL firms ahead of 2016 for SF appropriateness - "priority" firms assessed by Q1 2015, everyone else by end of 2015.
• While SF SCR is apparently close to current ICG numbers for GENERAL insurers in the UK, it is noticeably larger in LIFE firms 
• PRA is "not promoting" SF ahead of internal models
• Vigorously directed all attendees to EIOPA's Underlying Assumptions of SF Paper - expectation that some firms won't read it, and just expect SF plus any add-ons?
• Very vocal on the "significance of the deviation" between SF SCR and one's own Risk Profile - as we know, the Delegated Acts quantify what 'significant' is in the context of capital add-ons
• An expectation that ORSAs will be used in the assessment of SF appropriateness - qualitative for sure, possibly quant elements as well?
• Range of examples of where significant divergences are being found, by Risk Category, and by Life vs General Insurer.
• A lot of emphasis on Capital Add-ons being used "only as a temporary measure", which will ultimately allow firms to PIM/IM or de-risk. They are however "patient and realistic" on how quickly that change can be done, so it sounds on the face of it like 2016 and 2017 will be targeted for Capital Add-on elimination.
• In the following session on models, a piece came up on Capital Add-ons, where the PRA confirmed that their process for handling these in future is "still developing", though they expect them to be "a lot, lot rarer" than the existing regime of ICG.

Internal Models

Calendar also provided for IM firms (slide 4), showing how tight their schedule is, and explaining why they threw the earlier curveball about all firms expecting to drop their applications in on 30th June 2015. They also touched on the following:

• Highlighting weak areas identified to-date such as over-optimistic (new?) business plans being used in capital calculations; ENIDs; omission of certain "Key Risks", and suspiciously low correlations
• That Use Test is "fundamentally important", and is an opportunity for firms to "put their money where their mouth is". They do not expect to see either end of the use spectrum i.e. no use, or blind use!
• Too much technical actuarial validation seen. Usefully suggested that validation questions may be better posed as "where might this model be inadequate", rather than "why is it OK".
• Confirmed that the PRA's SAT has now been replaced by EIOPA's CAT, which won't arrive until the back end of this year - surprisingly, no-one laughed when they said this "might create some work" for existing IMAP programmes!
• Importantly, they stressed that their powers are to Approve or Reject applications, with no "conditional" powers whatsoever. Attendees were therefore encouraged to delay applications which were thought to be unlikely to succeed, both now and in future.

Though they instinctively feel like they could have been supplied sooner, the clarifications provided in the presentations I witnesses will be hugely welcome by programme directors and PM's alike. I would venture a guess that they will be less welcome by executive committees, who may have hoped for more flexibility on the risk quantification front post-2016.

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.

PRA - Q&A from December's Industry Briefing

Following on from the PRA's Industry Briefing on Solvency II prior to Christmas, they have released a set of Questions and Answers, which appear to have prompted by questions asked on the day as opposed to being more generic. A useful document to push around your programmes in the UK in particular, even if you are not part of ICAS+/IMAP.

I was particularly interested to see if they had rowed back on any topics where they have previously expressed an opinion, as well as any new insights which aren't necessarily made public as a matter of course. The Q&A is broken out into topics, so I have grouped my thoughts accordingly.

Proportionality

• For ICAS+, the PRA are "...focusing in on those areas which move the dial the most", referring specifically to the ICA calculations.
• They will therefore apply "a relatively higher view" in some areas than others (later referred to in terms of their intensity of focus).
• They use their IMAP approach as an example of this, where they have grouped the 300+ requirements into 15 categories.
• My common-sense read of this is, to be proportionate in the above context, the first 7 consecutive categories on the IMAP template would receive less time and attention than the following 8, all of which have the potential to numerically "move the dial".
• They are already looking prospectively at firm's risk profiles during planning sessions, in advance of ORSA, so that they work and plan proportionally, but with the future in mind.
• They suggest that firms provide their own opinions on materiality if they wish for the favourable application of the proportionality principle (though they don't guarantee it!).

Documentation-specific proportionality

• Confirm that "...there is definitely a need for an improvement in the quality of documentation".
• Seem to specifically align the calibration requirements of Solvency II with the need for additional documentation, therefore a good area to be elaborate in your work.
• On expert judgement, they suggest that documenting why a judgement was made, and what were the alternatives will help firms currently falling short.
• "...no aspiration" to revisit documentation review work already conducted and concluded.

PRA's Supervisory Statement

• They confirm that letters confirming whether a firm is covered by the reporting guidelines will be sent this month. They suggest categories 1-3 (p20) will be the bulk of participants
• There are national-specific reporting templates to come, currently under consideration. While they are not certain on submission format for those, they reiterate that xBRL is required for QRT submission.
• QRTs can be submitted incomplete, but they reserve the right to intervene if you take too many liberties!
• Acknowledge that, due to most firms' ORSA Processes operating around year-end balance sheets, that they expect to receive a flood of ORSA Supervisory Reports, and that this will delay feedback (presumably worse in 2015 than this year?).
• A question regarding 'who is the ORSA for' was answered rather dismissively. However, bearing in mind the content of their "good and bad documentation" letter (which constantly refers to "the reader", which for me meant "the PRA"), it felt like a reasonable question. Clearly if the PRA do not like your style, it will add to your review time.
• They seem to indicate that the amount of time one's Board should spend on reviewing/using their ORSA is not subject to any periodic expectations. That means if you are planning for annual intensive interaction, or something more regular and fluid, you should get a fair hearing from the PRA.

Standard Formula

• Without much subtlety, they seem to be encouraging firms to look at the appropriateness of Standard Formula asap, encouraging further by stressing "...that internal models do not need to be overly complex". This feels like early positioning for their planned SF work with the industry, where no doubt they will find a few firms ripe for USPs/PIMs during the next 18 months. 

Early Warning Indicators (EWIs)

• Following on from a post in October, they are evidently still stuggling to calibrate them!
• They confirm that the purpose of automatic capital add-ons (in the event of a future EWI breach) is to freeze the modelled capital figure to prevent distribution

Trilogue

• Question 29 is a good example of the PRA showing where their hands are now tied, and where EIOPA will be the provider of guidance.
• Interesting confirmation that the Commission has apparently asked that as little as possible of the Draft Implementing Measures be changed. Those of us working on non-mathematical areas can perhaps take some comfort from that!

PRA on "good" and "bad" documentation for IMAP - restart or refresh?

As an welcome aside from the PRA's activity day on the 12th, they also delivered on a promise to provide examples of what constitutes "good" and "bad" documentation in the context of the internal model approval process (IMAP). Bearing in mind it has been quite some time since the PRA publicly pronounced on the matter - indeed, they were called something else the last time they did - the industry welcomed this in like a lottery-winning prodigal son.

Bad documentation
- reform or execute?

There have certainly been enough apocryphal tales spewed out by the industry over the last couple of years to suggest that the production of documentation to support participation in IMAP had transformed from a small cottage industry into something of a palatial Georgian Mansion house with a granny annex.

Whether or not this kind of advice is therefore timely enough to save the Solvency II Programmes of the UK from using documentation in their revitalised IMAP preparations that is neither good for man nor beast is another thing, bearing in mind there is three years worth of accumulated flotsam currently kicking around the servers of UK insurers which, given this message, will need to be revisited as a matter of urgency.

Regardless, as the UK still appear to hold the whip hand in EIOPA's model sub-committee, the PRA's views on model documentation are relevant to readers across the continent, so the document is well worth a read for anyone in pre-application.

I took the following from it;

• They have 3 principles of "good documentation" - accessibility, evidence and quality control
• "It is helpful to have a clear separation of policy, methodology and results"
• The document refers throughout to giving consideration to "the reader". Feels a little disingenuous if they mean "the PRA", and after reading their document a couple of times, I can't imagine who else they have in mind.
• Following on from that point, a reference to a bad example suggests that "...the author is not thinking carefully about the audience" - it is equally fair to suggest that the author may be assuming a level of technical/commercial knowledge at the PRA end which is lacking?
• The PRA are evidently not happy to have to "seek clarification" on matters, which suggests the time allocated to assessments is tightly planned, or indeed the level of technical knowledge held by the assessors is limited.
• Interested to know if these principles hold firm for Standard Formula firms if viewed conversely e.g. does paperwork for the justification to not use an internal model need to be of a similar standard?
• The reiteration that the PRA "...will rely, in large part, on the submitted documents" when assessing the model - just in case your friendly executive committee reckon they can talk their way in!
• A lofty aim to improve "accessibility" of documentation, by having levels covering; executive summaries; model reviewer/validator level info; and model user/operator level technical documentation. The PRA only want the first two levels as a matter of course, which would suggest that procedures and technical documentation should be used as supporting evidence only.
• Tabling up references to the Directive and Implementing Measures within documents is viewed favourably.
• Their "useful rule of thumb" feels instinctively unwieldy - they suggest better documents contain one-third 'what has been done' with the rest covering 'why and how'. That said, expert judgements are clearly not being evidenced anywhere near the level desired.
• A convoluted and potentially frightening reference to "self-validation" testing, which the PRA view favourably, but which seems to point towards a preference to see suites of documentary evidence for each assumption applied in the modelling process. 
• To conclude, readers are redirected to Julian Adams's letters from  mid- 2012 (here and here) - important to note that this guidance remains relevant, regardless of the passing of time.

I suspect that most model applicants will find they have re-work to do off the back of this, both with the pen and with the sickle. Expert judgement and assumptions documentation remain the unquenchable thirst though, so one's best endeavours would be well spent in that field in early 2014.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Moody's survey on Solvency II compliance preparedness - the chilly third pillar

So from what I can gather it has been a terrible week for the Girondins, with a freak hailstorm wreaking havoc in a thin strip along the vineyards of Bordeaux's Entre-deux-Mers appellation - my in-laws were seemingly spared further down the river, noting that it was merely "un peux froid".

On Ice - Solvency II programmes
and this year's white Bordeaux?

And speaking of a great deal of hard work getting aimlessly destroyed by an unpredictable European storm, Solvency II (do you see what I did there?) appears to have at least enough juice in the tank to have encouraged Moodys to survey practitioners on the preparedness of the industry to achieve compliance before the deadlines currently on everyone's lips (i.e. 2014-2015 for EIOPA Guidelines, 2016 for "go-live").

That survey is available here (short sign-up required, but worth it), with a very short summary here. The media have touched on the survey (here), but only seem to have read the summary, so I've picked through the whole shooting match to see what else was worth knowing.

The sample is small at 45 contributors, but they have all been interviewed one-on-one in Q4 2012/Q1 2013, so the responses are not too dated, particularly as many Solvency II programmes have been running on meagre rations since January of this year. Coverage of 12 EU countries is included in the 45 people, with a decent split of size and insurance type. Majority of respondents were CRO/equivalent, with a few accountants, actuaries and programme managers thrown in for good measure, and just over half are on Standard Formula.

Talking points for me were;

• That 22% have frozen Pillar 3 activity, while 11% have frozen all Solvency II activity
• Half are using Standard Formula to curb costs!
• In addition to that, 20% say that the Use Test is a barrier to using models!
• 27% are approaching Pillar 1 and Pillar 3 with a tick-box mentality (i.e. happy to use multiple manual processes/excel-based tactical solutions to deliver the balance sheet and reporting template elements), while 44% have worked exclusively on Pillar 1 at the expense of Pillar 3
• Solvency II project investment levels are "considerably more" in the UK and France compared to Germany - makes you wonder why they have such a long face!
• 67% have increased their control function staffing by 10% or more - 31% have increased by 50% or more.
• Only 7% note "capital reduction" as a perceived benefit of Solvency II, with 33% selecting improved capital planning (regardless of quantum) as a benefit.
• Only 6.7% say they are receiving "high" levels of support from their national supervisory authority.

Seemingly the stats are a hostage to the sample - I'm sure the PRA would be apoplectic if this was the position of Insurers of Britain plc, but for me the big story is the indiscriminate swelling of Risk/control functions in smaller organisations that evidently are only ticking boxes. Feels a tad disingenuous to pump the staff numbers up to demonstrate compliance, but I suppose it's not me they need to satisfy!

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

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

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

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

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

For me the headline points are:

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

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

Guideline 3

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

Guideline 6 - Documentation generated by ORSAs must include:

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

Guideline 7 - The ORSA Policy must include

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

As well as information on

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

Guideline 8 - ORSA Record

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

Guideline 9 - Internal ORSA Report

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

Guideline 10 - ORSA Supervisory Report

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

Guideline 11

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

Guideline 12

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

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

• Capital Management
• Business Planning
• Product Development

Guideline 18

• ORSA to be performed at least annually

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

Aon Benfield's CRO guide to Solvency II - in case you're not ready yet...

For all those CROs who are about to get left holding the Solvency II baby three years early by their over-enthusiastic executive colleagues, Aon Benfield pulled together a CRO guide to Solvency II which aims to take the journey "from complexity to best practice". 10 out of 10 for ambition...

It leans heavily towards General Insurers/Reinsurers (indeed it reads like a reinsurance sales brochure in many parts!), but nevertheless contains a suite of very useful content for anyone in the Risk space, as well as attempting to shatter a few myths. I took the following from it;

• Steady early bits on capital planning and common questions a CRO should be posing in that space
• On page 5, an excellent table comparing standard formula against internal modelling by risk driver, in particular emphasising why internal modelling may be more appropriate, rather than how much capital it could shave off. Being able to explain to the national regulator why one has neglected to apply the enhancements that internal modelling introduces to the accuracy of one's quantitative risk profile would be a smart thing for CROs to practice!
• The undo some of that noble work by suggesting part of any IM feasibility study should include estimating the capital benefits!
• Nice examples at the top of p6 of what mixes of business lend themselves to benefitting from an IM approach
• Highlighting that domicile of firm continues to dictate feasibility of IMs for smaller firms (i.e some countries can't staff it!).
• Recommend reviewing SF SCR factoring in the draft L2 asap. As was clear from the E&Y research I covered yesterday, many firms across the EU consider themselves to be advanced in the Pillar 1 space while disregarding draft L2. They highlight the Swiss experience as one where they struggled to authorise models for "Day 1" approval, and the Aon crowd propose some meaningful contingencies on p8
• Useful analysis of capital drivers and optimisation strategies (p9-10)
• Section on expert judgement validation (p15), touching on the Level 3 expectations, and in particular how a (non-Actuarial) CRO may struggle to adequately challenge certain judgement calls, such as selected data series or correlation matrices, without specialist advice. Very hard for smaller firms to obtain that, as most of their actuarial function will have probably contributed to the judgement!
• Note that one of the key challenges for documenting the IM is getting the best-placed people (who are normally swimming in BAU) to pick up a pen and write!
• Neat section on ORSA (p27-29), emphasising that SF firms with complex risk profiles may find they struggle to justify that approach when concluding the assessment. They go on to suggest that early experiences of ORSA Report/process documentation submissions have left CROs feeling that the regulatory approach is (Level 3?) tickbox as to content expectations.
• Key challenges for CRO in briefing and educating senior colleagues for Solvency II-readiness are all fair, in particular the gap that could emerge if a CRO is not also an executive member.
• The section on Risk Appetite is particularly useful for smaller non-IMAP firms, who may struggle to quantify their target measures - whether using Standard Deviations/volatility measures as suggested is a touch too simple depends on the business I guess.
• The Pillar 3 section hits on the same issues I (and the FSA!)have picked up on earlier, such as end-user computing, inability to transition to BAU, data ownership issues etc.

I did take exception to a couple of bits in here, where the industry or indeed common sense appears to suggest otherwise;

• The "fallacy" outlined on p5 that an IM enables a firm to hold less capital than an SF equivalent. The research I pointed to yesterday (p20) suggests across the EU that modellers are already "making it rain" with their capital savings
• That the IM alternative for Op Risk is based on ORIC and individual loss event info. I'd certainly seen Milliman suggest that this approach is as flimsy as the SF approach, recommending options such as Bayesian networks to generate IM inputs.
• Concerns that evidencing senior management model "use" could create a "value-destroying documentation burden". Is that what we call "minutes" these days!
• Comments around the documentation delivery for the Internal Model Application Process becoming detached from the underlying processes referenced in those docs influencing BAU value-adding activity are perfectly valid, but no real solution is proposed.
• The operation of the Model Change Policy features heavily (p19-21), as anyone in that space would expect. Again. little offered in the way of solutions, but I certainly would have expected more discussion on the "scope" of the model, which in my experience is a solid, liquid or gas depending on which control function you speak to, and I'm sure the FSA would agree!

PS All the best to you guys on the US East Coast, let's hope the worst has passed...

FTSE Insurers and IMAP - Resolution are out!

Shock news announced today (unless you actually listen to the grapevine I guess) that Resolution have dropped out of the FSA's internal model application process, citing the decreasing likelihood of go-live on Jan 1st 2014.

Unlike the other big-hitter candidates who appear, despite their concerns on go-live date, to hunger for approval at outset, Resolution seem happy to take their chances (at least in year 1) with a standard formula approach.

They note the following;

• "Looking forward, the Group believes there is heightened uncertainty around the future requirements of Solvency II both as regards its structure and timing of implementation. The implementation date for Solvency II has been delayed to 1 January 2014 and the Group expects that it will be delayed further" - p48
• "In line with this it has concluded that it is in the Group’s best interests to delay its internal model application to allow time for any further changes in the Solvency II implementation timetable and to help smooth the Group’s overall change agenda. Accordingly FLG has withdrawn from FSA’s internal model pre-application process and is now targeting obtaining internal model approval in January 2015" - p56
• "If the Directive is implemented in 2014, FLG will be ready to comply with its requirements through the use of the Standard Formula. Use of the Standard Formula, pending obtaining internal model approval is not expected to lead to any significant disadvantage in terms of capital requirements" - p56

I would hasten to add that this decision cannot reverse the whopping £48m of transformation costs for the 6 months booked predominantly to Solvency II (they were less than £60m for all of 2011!).

Whose next for dropping out...