International Congress of Actuaries Cape Town

Transcription

1 ERM in the governance and supervision framework: Solvency 2 and actuarial role(s) International Congress of Actuaries Cape Town March

2 Background Despite a broad consensus supporting the evolution of governance and supervision paradigms in relation to risk management in the financial sector globally, these generally failed the test of the 2008 financial crisis. Why? Solvency 2 is often popularly l compared with Basel 2 and appears to share key features such as three pillars and use of internal models. Yet we say the crisis should mean pressing forward rather than pulling back. Why? Risk has become a new mantra for actuarial bodies if not for actuaries. Substantial investment is going into educational development and promotion internationally at an uncertain time for the sector. Why? 2

3 Experience Insurance and retail banking Actuarial and general management UK, Ireland etc. Conception of Solvency /02 UKAP ERM PEC; IAA E&FRC Privileged to lead for European actuaries as Solvency 2 stakeholder Director (non-executive) of several different insurers 3

4 October

5 Agenda Casualties and survivors - what went wrong (and what didn t) and why; Rainbow revolution why Solvency 2 is good for firms, investors, and policyholders; Opportunities and threats for actuaries; Take - aways 5

6 That was close! Financial systems were very close to total meltdown (Strauss-Khan, IMF). The financial crisis is probably the biggest in history (Charlie Bean) This is a once-in-a-century century crisis (Alan Greenspan). Major sectors of America s financial system are at risk of shutting down. Without immediate action by Congress, America could slip into a financial panic. (GW Bush) Le laisser-faire c est fini, et la fin d un monde (N Sarkozy).this largely under-regulated system is collapsing today. (P. Steinbruck). Greatest crisis in the history of financial capitalism (Lord Turner, Turner Report) 6 6

7 Myths about the crisis We were in the grip of impersonal global forces It was all the fault of America Basel II was the problem It was purely a banking crisis It was because of reliance on fancy mathematical models It was all about sub-prime We should never have used VaR It was all the fault of the accountants Etc. 7

8 Some truths about the crisis Governance at many firms was lacking or at best unbalanced Liquidity risk had been forgotten Authorities had become complacent Incentive structures had become dysfunctional in many cases 8

9 Governance failures One UK bank persisted with acquisition despite having legal means to withdraw Another UK bank persisted with reckless lending to corporates until weeks before the end Irish banks vied with one another to lend to property developers in UBS set out to build market share in mortgage-backed securities just as the market approached the turn AIG allowed a relatively insignificant business unit to run a highly geared hedge fund 9

10 and authorities / supervisors Lacked a big picture perspective Failed to conceive of severe liquidity stress and its consequences Lacked contingency plans Were naïve about enlightened self-interest Proved inconsistent in the approach they took to failing firms 10

11 Walker Review themes (UK) Structures and comply or explain governance code remain fit for purpose Pattern of lack of boardroom challenge to be addressed by renewed emphasis on diversity of composition and increased time commitment t Material increase in risk monitoring and in active discussion of appetite / tolerance. CRO with authority and direct reporting to board. Owning institutions should take their stewardship responsibilities seriously Board oversight of remuneration practices to be increased with emphasis on alignment to longer-term strategy 11

12 April

13 Impact upon on the insurance industry Escaped the crisis of confidence faced by banks However, still tackling Weakened investment returns Recovering share prices Low interest rates Subdued growth in premiums Capital shortage Cost cutting 13

14 There, but for fortune, go you and I 14

15 CEIOPS March 2009 Our main lesson of the current events is that Solvency II must be adopted. The crisis has highlighted needs for a further refinement of the existing Solvency II calibrations, both at module and sub-module levels. As in the financial sector at large, governance, risk management, and internal controls in the insurance sector need to be strengthened. Effective risk management requires a strong emphasis on own risk assessment, for example where the use of external ratings by Credit Rating Agencies is contemplated. We need to rethink the scope of regulation and supervision focusing more on consolidated entities rather than on solo entities only. We should take a similarly holistic approach to insurers' exposures to special purpose vehicles The aforementioned idea of consistency in the regulatory treatment should be extended as well to the treatment of Credit Default Swaps (CDS), The crisis has also raised the issue of procyclicality of regulatory regimes. 15

16 and from Creedon Without public confidence, no amount of capital can be definitely sufficient Short-term VaR is meaningless for insurance, but may serve a confidence-sustaining purpose Treat the markets neither as master nor as slave market inputs are relevant but not conclusive Any mechanistic approach is almost certainly doomed to fail Quality risk governance directed from the very top characterised those who best survived the crisis The illiquidity of (most) (life) insurer liabilities is valuable 16

17 Agenda Casualties and survivors - what went wrong (and what didn t) and why; Rainbow revolution why Solvency 2 is good for firms, investors, and policyholders; SWOT for actuaries; Take - aways 17

18 Insurer views of risk Enterprise steering has become increasingly complex & multi-dimensional Historical instruments no longer dependable with change in terrain Before the financial crisis After the financial crisis 18

19 Scope and Structure of Solvency 2 Unified prudential regulation of insurers and reinsurers Beyond quantitative measures Overall risk management Overhaul of European supervisory structure t Transparency and market discipline Increase policyholder protection and minimise regulatory burden Non-zero failure regime Three pillar structure, based on Basel II and CRD Link to IASB work on insurance contracts? Employs Lamfalussy arrangements 19

20 Solvency 2 timeline Draft Framework Directive published Jul 2007 CEIOPS reports on Groups and Proportionality May 2008 Level 2 implementation Framework Directive approved Apr/May2009 approved CEIOPS H provides final advice on implementation Jan 2010 Level of effort Solvency II in force Oct 2012 MILESTONES QIS 3 report Nov 2007 QIS 4 report Nov 2008 CEIOPS finalises Level 3 guidance H FSA TIMELINES QIS 4 QIS 5 Apr to Jul 2008 FSA notified of Sol II project lead Mar 2009 Firms to notify of intention to seek internal model approval Jun 2009 Aug to Nov 2010 Dry runs of models for approval Jun to Nov 2010 Formal submission to FSA for approval Oct 2011 Model approval effective 20

21 Solvency 2 Three-Pillar Approach Three-pillar approach recommended in KPMG study for EU (and reflecting Basel II approach) Pillar 1: Pillar 2: Pillar 3: Quantitative capital requirements Technical provisions Minimum capital requirement (MCR) Solvency Capital Requirement (SCR) Investment rules Qualitative supervisory review Principles for internal control and risk management Individual risk and capital assessment Supervisory review process Market discipline Transparency Disclosure Support of risk-based supervision through market mechanisms Market-consistent valuation Validation of internal models New focus for supervisors Maximum level of harmonisation Use test More pressure from capital markets More pressure from rating agencies 21

22 Insurance Companies strategy is driven by several forces Social Pressures (Reputation) Legal Demands Demands by (Current and Insurance policyholders and Future) Company stakeholders Strategic ambitions of management 22

23 Risks in insurance business Risk accumulation Policyholders behavior Re-insurers shortfall Risk Operational Risk Management Risk Legal Risks Changing Markets Risk Market Risk IT Risks Social changes Economic cycles Technological changes Risks in the insurance business Underwriting Risk Credit Risk Investment Risk Liquidity Risk ALM Mismatch Risk Expense Risk Policy Cancellation Risk Reserve Risk Inflation Risk Interest rate Risk Currency Risk... 23

24 ORSA Building Blocks The Eight Dimensions of Risk and Performance Management Treatment of Model Limitations Well understood risk and performance Governance and Control Environment indicators Integrated governance structure and control environment are crucial for the Use Test Reporting Integrated view on risk and performance Strategy Comprehensive strategy that leads to operational decisions Risk Performance Integrated with Business Processes Better fit of business processes and strategy Risk Appetite and Risk Tolerance Better aligned business decisions Risk and Performance Measurement Better informed management decisions Capital Allocation and Internal Competition for Capital More effective us of capital 24

25 ORSA Requirements Definition of ORSA CEIOPS Issues paper 27 May 2008 defines the ORSA 9. The entirety of the processes and procedures employed to identify, assess, monitor, manage, and report the short and long term risks a (re)insurance undertaking faces or may face and to determine the own funds necessary to ensure that t the undertaking s overall solvency needs are met at all times What is the ORSA? Risk management tool For assessing risks and own funds required to back them ORSA process versus ORSA outcome More than a just a calculation engine! Proportionality principle 25

26 CEIOPS guidance ORSA principles Principl e A Principl e B Principl e C Principl e D The ORSA is the responsibility of the undertaking and should be regularly reviewed and approved by the undertaking's administrative or management body. The ORSA should encompass all material risks that may have an impact on the undertaking's ability to meet its obligations under insurance contracts The ORSA should be based on adequate measurement and assessment processes and form an integral part of the management process and decision making framework of the undertaking The ORSA should be forward-looking, taking into account the undertaking's business plans and projections Principl e E The ORSA process and outcome should be appropriately evidenced and internally documented as well as independently assessed 26

27 March

28 Agenda Casualties and survivors - what went wrong (and what didn t) and why; Rainbow revolution why Solvency 2 is good for firms, investors, and policyholders; Opportunities and threats for actuaries; Take - aways 28

29 System of governance draft legislation Elements of the system of governance General governance requirements Principle of proportionality Risk management system Areas covered by the risk management system Internal control system Functions Risk management function Compliance function Internal audit function Actuarial function Fit and proper requirements Outsourcing Remuneration issues 29

30 Solvency 2 article 48 : the actuarial function 1) Insurance and reinsurance undertakings shall provide for an effective actuarial function to undertake the following: a) To coordinate the calculation of technical provisions; b) To ensure the appropriateness of the methodologies and underlying models used as well as the assumptions made in the calculation of technical provisions; c) To assess the sufficiency and quality of the data used in the calculation of technical provisions; d) To compare best estimates against experience; e) To inform the administrative or management body of the reliability and adequacy of the calculation of technical provisions; f) To oversee the calculation of technical provisions in the cases set out in Article 81; g) To express an opinion on the overall underwriting policy; h) To express an opinion on the adequacy of reinsurance arrangements; i) To contribute to the effective implementation of the risk management system referred to in Article 43, in particular with respect to the risk modelling underlying the calculation of the capital requirements set out in Chapter VI, Sections 4 and 5 and the assessment referred to in Article 44. 2) The actuarial function shall be carried out by persons who have knowledge of actuarial and financial mathematics, commensurate with the nature, scale and complexity of the risks inherent in the business of the insurance or reinsurance undertaking, and who are able to demonstrate their relevant experience with applicable professional and other standards. 30

31 Draft implementing measures -1 The actuarial function shall have unrestricted access to the relevant resources and information necessary for the discharge of its responsibilities. In coordinating the calculation of the technical provisions the actuarial function shall at a minimum: Apply methodologies and procedures to assess the sufficiency of technical provisions and to ensure that their calculation is consistent with the requirements set out in Articles (or Chapter VI, Section II) of the Framework Directive; Assess the uncertainty t associated with the estimates; t Ensure that problems related to the calculation of technical provisions arising from insufficient data quality are dealt with appropriately and that, where it is impracticable to apply common methods of calculating technical provisions because of insufficient data quality, the most appropriate p alternatives to common methods are found, taking into consideration the principle of proportionality; Ensure that homogeneous risk groups for an appropriate assessment of the underlying risks are identified; Consult relevant market information and ensure that it is integrated into the assessment of technical provisions; Compare and justify any material differences among the estimates of different years; and Ensure that an appropriate assessment of options and guarantees embedded in liabilities is provided. 31

32 Draft implementing measures -2 In order to ensure the appropriateness of the underlying methodologies and models used in the calculation of the technical provisions, the actuarial function not only has to assess the general suitability of the methodology or underlying model for the calculation of technical provisions as such, but also has to decide whether they are appropriate for the specific lines of business of the undertaking, for the way the business is managed and for the available data. While assessing the sufficiency i and quality of the data used in the calculation l of the technical provisions, the actuarial function shall have regard to the objectivity, reasonability and verifiability of management actions included in the calculation of technical provisions. It shall also assess whether information technology systems used sufficiently support the actuarial procedures. The comparison of the best estimates against experience requires the actuarial function to assess whether past best estimates have proved sufficient and to use the insights gained in this assessment to improve the quality of present best estimate calculations. This analysis shall also include comparisons between observed values and the assumptions used in the calculation of technical provisions in order to produce conclusions on the appropriateness of the data and assumptions used as well as on the methodologies applied on their estimation. 32

33 Draft implementing measures -3 Information addressed to the administrative, management or supervisory body on the calculation of the technical provisions shall at least include a reasoned opinion i on the reliability and adequacy of the calculation l and on the degree of uncertainty about the final obligations as well as on circumstances that might lead to significant deviations from the provisions made. The actuarial function shall clearly state and explain any concern it may have as to the sufficiency of technical provisions. The actuarial function shall oversee the calculation of technical provisions whenever, in specific circumstances, insurance and reinsurance undertakings have insufficient i data of appropriate quality to apply a reliable actuarial method and decide to follow case-by-case approaches in the calculation of the best estimate. In addition it has to produce judgement to establish assumptions and to safeguard the accuracy of the results. 33

34 Draft implementing measures -4 Regarding the overall underwriting policy, the opinion to be expressed by the actuarial function shall at least include the following issues: Sufficiency of the premiums to cover future losses, notably taking into consideration the underlying risks (including underwriting risks), the impact of expenses directly associated with future claims and of unallocated loss adjustment expenses and the impact of embedded options and guarantees on future liabilities; Considerations regarding inflation, legal risk, change in the composition of the undertaking's portfolio, anti-selection and adequacy of bonus-malus system(s) implemented in specific line(s) of business. Regarding the overall reinsurance arrangements, the opinion to be expressed by the actuarial function shall include an opinion on the adequacy of the significant reinsurance arrangements as well as the expected cover under stress scenarios in relation to the underwriting policy and the adequacy of the calculation of the technical provisions arising from reinsurance. When carrying out the tasks in accordance with this Regulation the actuarial function shall act objectively and independently from other functions or the administrative, management or supervisory body. The persons involved in the actuarial function must have a sufficient level of independency, the level of which may be further defined in guidelines referred to in paragraph 1. The actuarial function shall at least annually produce written reports to be submitted to the administrative, management or supervisory body. The reports shall document the tasks that have been undertaken, clearly state any shortcomings identified and give recommendations as to how the deficiencies could be remedied. 34

35 The tasks of the risk management function include: Assisting the administrative, management or supervisory body and other management in the effective operation of the risk management system, in particular by providing specialist analysis and performing quality reviews; Monitoring the risk management system; Maintaining an organisation-wide and aggregated view on the risk profile of the undertaking; Reporting details on risk exposures and advising the administrative, management or supervisory body with regard to risk management matters in relation to strategic affairs such as corporate strategy, mergers and acquisitions and major projects and investments; and Identifying and assessing emerging risks. In compliance with the requirements set out in Article 120 of Directive 2009/138/EC, the risk management function shall bear responsibility for the design, validation, application and monitoring of internal models and shall ensure the integrity of the models and of the modelling process. 35

36 August

37 Implications for actuaries Article 48 actuarial function To be effective, Solvency 2 depends on professionally competent scientific actuarial judgement transparently exercised and subject to appropriate testing by managements and supervisors Actuaries will have to learn to work in collaborative relationships with fellow-professionals at management and board levels Quality of reporting outside their own professional sphere likely to be key, including justification of assumptions by reference to data, communicating uncertainty and explanation of modelling / calculation tools Challenges may be greatest in non-life? 37

38 Grasping the opportunity Communication internally with management, colleagues Communication interacting with supervisors Explaining uncertainty Transparency of judgement Transparency of modelling Value-adding relationships with those responsible for underwriting, reassurance Professional approach to risk management while retaining objectivity / independence 38

39 September

40 Biggest Challenges Currently Face FS / Banking Executives Managing Risk Finding new srcs. of rev. growth Complying with regulations Raising Capital Restoring investor confidence Restoring business confidence Stabilizing the balance sheet 39% Restoring consumer confidence 39% Managing/cutting costs 28% Adjusting to changing customer demand 26% Right-sizing head count for the business 25% Marketing 18% 44% 44% 44% 40% 57% 70% Both technology (66%) and consumer (55%) said Finding New Sources of Revenue Growth 40

41 Six key findings 1. Embedding ERM is proving to be a significant challenge. While companies have made progress in integrating ERM into their business, challenges remain. Significant work is required to utilize economic capital (EC) in decision making (55%) and performance management (60%) 2. Size matters. Larger insurers are significantly more advanced in most aspects of ERM implementation and are increasingly looking to realize their competitive advantage. 40% of large companies are already using EC in product design and pricing decisions, with another 42% planning to do so within two years 41

42 Six key findings 3. European insurers are better positioned. North American insurers are trailing European counterparts in key aspects, such as EC implementation and its use in decision making. Under Solvency II, these capabilities are expected to lead to lower capital requirements and therefore competitive advantage 4. ERM is influencing decisions. In spite of the challenges of embedding ERM, significant numbers of respondents indicate their ERM program has resulted in key business changes, including risk strategy or appetite (36%), asset strategies (35%) and product pricing (31%) 42

43 Six key findings 5. Economic capital standards are emerging. EC methodology is moving toward a one-year VaR approach, with the majority (56%) using a marketconsistent terminal balance sheet 6. Operational risk remains a weak spot. Just 7% of participants believe they have an appropriate capability in place, and 37% indicate that significant work is required. Operational risk also lags behind other risks in terms of setting risk limits and EC calculation methodology 43

44 Some personal thoughts Risk management is a team sport Ati Active exchange of ft top-down and bottom-up risk views is essential The appropriate mix of (bottom-up) skills and experiences often depends on the context Directors (top-down) should address substance as well as process Things are never really as good or as bad as they are generally perceived It s ERM! 44

45 Thank You co uk 45