The CRO perspective on ERM and Solvency II

The InsuranceERM/QlikView risk survey polled 13 chief risk officers and three heads of solvency from 16 insurers with UK operations. The goal: to gain an insight into what the risk management professionals think about the challenges they face on issues such as data, regulation and investment risk as they prepare for Solvency II

Solvency II

Interviewees were asked a series of questions to gauge attitudes and approaches to Solvency II.

Respondents were nearly all critical of the workload pressures that have evolved from the European regulation over the past couple of years, as what started off as an exercise in creating better risk management has turned into a chore.

Comments included Solvency II had 'gone over the top,' it was 'too detailed and not too well formulated' and was 'burdening already-stretched resources.'

Do you see Solvency II compliance as a necessary chore or an opportunity for your business?

75% of respondents to the survey stated that Solvency II had become a chore for their business.

"Conceptually it's a good idea and has driven positive things like investment in risk management," says Brett McWilliam, CRO at Sterling Insurance Group. "I struggle with something though that is principles-based but now has such a volume of prescriptive rules. Any sense of proportion has been lost. Many of the efforts we are putting in to be compliant will not have proportionate benefits in return."

The change in attitude to the rules is a relatively recent thing. Insurers said that they still felt the principles behind Solvency II were likely to benefit the industry. Indeed some of the items which were initially viewed as a chore - examples cited include data requirements and validation - have added "unexpected value."

The issue is not that the principles have changed but that Solvency regulators have become over-prescriptive and lost focus in the complicated discussions over the last year or so.

"I support the original intentions and general principles of Solvency II," says Andrew Buchanan, CRO for UK, Australia and South Africa, at Munich Re. "Some of the details have become increasingly disappointing as the framework has deviated from its original principles."

Do you think that the current implementation date for Solvency II of January 2014 will be extended further?

Only one insurer thought that Solvency II still had a chance of being implemented by its original date of 2014.

Uncertainty over the deadline has crystallised over the last year as setbacks and delays marred the drafting process. Several insurers mentioned that the delays had had a negative impact on their business.

"The deadline has been a very disappointing aspect of this," says McWilliam. "There's a lot of pressure from the FSA [Financial Services Authority] to ensure firms meet the deadline, but then the date moves."

Bernie Hickman, MD Solvency II at Legal & General, believes that the drafting of a stable and realistic timetable for Solvency II implementation would be the biggest benefit to the company's risk management work this year.

"With insurance organisations having to focus so much time and money on Solvency II, there must have been an industry-wide reduction in exploring growth opportunities," he says. "Imagine how much more growth and innovation there would have been if the money spent by the industry complying with Solvency II had instead been invested in growth opportunities for the benefit of customers, shareholders and the economy."

Despite the overall delay, many insurers felt that the UK would seek to implement Solvency II by the 2014 deadline anyway, and most appeared to be well set up to meet this.

"I don't see any extension affecting anything in the UK or Bermuda," says the head of group risk at a large UK non-life insurer. "People have got their own timelines and this shouldn't impact things outside the UK."

Is your firm in the IMAP?

Ten of the survey participants said they had entered the FSA's internal model approval process (IMAP), of which two are following via the Lloyd's of London programme. Respondents were split in their experience of the IMAP to date.

A CRO, who asked to remain anonymous, said that the IMAP had run according to timetable with no slippages adding, "it's been so smooth that I wonder if I am missing something."

However not everyone had such a positive experience. One life insurer said it had dropped out of the IMAP process because of the burdensome FSA work:

"We didn't feel the benefits of the engagement with the FSA were equal to the burdens of meeting their timescale. Our engagement with the FSA was minimal because we are small but we still had to meet their deadlines."

Do you expect to have to hold more capital after Solvency II implementation than now?

Most respondents (46%) said they would have to hold more capital than now. However answers to this question were equivocal, with insurers adopting a wait-and-see approach due to the uncertainty surrounding the final form of the rules.

"The final numbers will depend on final rules and IMAP outcome," says the CRO of one midsized life insurer. "There are a lot of moving parts so a like-with-like comparison is difficult to provide. Also a lot of the increase comes from the risk margin rather than the capital requirements per se."

Increases and decreases are generally estimated to be minor - between 10% to 20%.

However there are a couple of issues which could impact the market in the final shake up.

One of the key factors over capital is the adoption of the matching adjustment in the final rules. "We expect capital requirements to eventually decrease," says Kevin Borrett, CRO of Unum. "But there are a number of technical decisions which could impact the capital requirement, most notably matching premium. Similarly the removal of historic individual capital adequacy (ICA) add-ons is an important concern."

Since you started preparing for Solvency II, have you changed your approach from one based on an internal model to the standard formula, or vice versa?

The majority of respondents (43%) said they had decided to prepare for an internal model from the beginning. Only one had moved from a partial to full model whereas, perhaps more surprisingly, 19% said they had decided to move from a full internal to a partial model or standard formula.

Reasons given included the cost of implementing the internal model, reorganisation in strategy due to a takeover and the limited business benefits of adopting the full internal model. The latter remains generally anomalous with one respondent stating that it was "illogical" to adopt a partial model.

Data

Gathering and making use of data remains a challenge for all insurers. Every participant in the survey said they felt they could improve on their data use.

For some the strains of adapting for Solvency II had taken away focus from implementing better data systems.

What is the value of data?

"Data is critical," says Borrett, "especially with the internal model you need an authoritative single source of data-at the end of the day your results from the model depend on appropriate data.  Solvency II has presented resourcing challenges and the need to prioritise. If we could buy back some of the time spent on Solvency II then it might have allowed us to carry out a more granular analysis of our risk profile, something now occurring as part of own risk and solvency assessment (ORSA)."

There was no single answer to which areas of data required most improvement. Respondents mentioned insurance liability data, investment data-relating to bond performance for example-or property cat modelling data, as benefiting from closer analysis.

How could you get more out of your data to help the business?

Most CROs said that continual practical use of data in the decision-making process would help improve its quality and consistency.

"To improve data you have to use it all the time and for real decisions," says Andrew Hitchcox, CRO at Kiln. "Using it this way forces you to make improvements. We think we are doing roughly the right amount at the right speed - the number one thing is to just keep using it."

One CRO warned, however, that with already large data resources, there is an equal risk that increasing the volume of data could obscure the picture for risk managers. Another respondent agreed stating that streamlining data derived from various sources of business into one channel would greatly help the decision-making process.

Approaches to ERM

Getting better appreciation and communication of enterprise risk management (ERM) throughout the business was cited as the being the second most important factor which would help insurance businesses.

31% of respondents stated that risk management was still viewed as a subsidiary concern to the main business of underwriting.

"There's a danger you don't get involved in things early enough," says Unum's Borrett. "So risk management becomes almost an audit or validation activity, rather than being able to challenge management early on and strengthen the decision making process."

Does the board accept the value of ERM and understand all the risks the business faces?

All of the respondents answered yes. The larger insurers were particularly vocal in promoting the expertise on their boards.

"The board have actively pushed the ERM agenda over the last two years," says one CRO who preferred to remain anonymous. "The risk management information we produce for the board allows them to see, question and challenge all of the risks faced by us as a business. It also allows them to understand how we rank each risk and oversee delivery of action plans designed to improve controls."

Smaller-company CROs still had a few challenges in putting risk management onto an equal footing with underwriting. While the board may have an "intuitive understanding" of risk this "isn't always formalised," said one.

Another small-company CRO felt that there was a dichotomy between underwriters and actuaries. "Underwriters tended to be more traditional and have not bought into the concept of ERM while actuaries, also with underwriting skills, are more forward thinking in terms of the risk strategy."

How do you assemble and present the information you need to give your CEO and the board? How often is this done?

All of the companies responding had a formal risk or capital management committee which deals with high-level risk decisions.

56% of CROs and senior Solvency managers surveyed said they met on a quarterly basis, though they also had monthly meetings to supplement the quarterly reviews. For the remainder, risk reporting is done monthly as well as on an ad hoc basis and can be a daily occurrence depending on issues in the market.

"We have strong suite of management information (MI) within the business and operational functions," says Mark McCausland, CRO at ACE European Group.

"These are aligned to our risk appetite and tolerances and are one of the tools used by the risk function to prepare focused risks reports for the board. Our executive committee regularly receives a pack of MI that can be used to assess the key risks and potential interrelationships."

How long does it take to prepare the regular risk reports? 

The diversity of risk reporting meant that there was no consistent answer to how long it takes to compile reports. This could be anywhere from a few hours to a couple of person days to a week.

As regards who has access to the data - most said they disseminated data openly as and when it was required. Others said reports were targeted according to seniority or job function.

Challenges

Respondents were asked to name the biggest challenges to carrying out the job of risk management in the current environment. The majority (56%) said that regulatory demands were the biggest issue they faced (See Question 1).

Apart from Solvency II, UK insurers have also had to face up to other regulatory demands-including the retail distribution review, pensions reform and the foreign account tax compliance act.

Several respondents replied that harmonisation of domestic and overseas regulations would benefit the industry and their business.

How will you maintain overall profitability in the face of all the challenges?

Regulatory Cost

Regulatory changes have increased overheads and costs for most in the industry. Respondents said they were trying to make sure that they were not just doing things for compliance purposes but were focused on regulatory changes as real ways of improving the business.

Smarter asset liability management, price and better operational control are some of the ways that regulatory cost could be mitigated, according to replies to the survey.

Certainly the cost of meeting the Solvency II challenge has meant a much more disciplined approach to writing insurance:

"Regulatory changes bring with them increased costs," says one anonymous participant.  "We are placing emphasis on ensuring the volume of business we write is commensurate with the cost base we are trying to support.  The most obvious action is always to cut costs.  But we are trying to consider other options, such as reducing risk (hence reducing costs of capital) and achieving economies of scale."

However, despite the cost, the challenge of regulatory change is something the whole industry is having to face up to and, says Hitchcox of Kiln, should not skew individual competitiveness: "Solvency II is a burden and it does cost extra money," he says. "But this is pressure which is hopefully impacting everyone else similarly. So the effect on us is no different to that on competitors."

Investment risk

Investment challenges remain a major focus for UK insurers. Around 70% of respondents said this was an issue for them as volatile financial markets have clearly hit insurer portfolios.

Julian Cusak, CRO at Aspen, says the challenges on investment were being met by taking a shorter-duration approach: "The challenges we face are from low bond yields coinciding with low casualty insurance prices. In these circumstances it makes sense to look at shorter tail business where we can make more margin. In the long term we think bond yields will rise, so are maintaining short durations."

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