More Detailed, More Frequent and More Transparent Reporting - Implementing the Pillar 3 Reporting Requirements of Solvency II

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1 29 April 2009 White Paper AUGUST 2011 Christophe Burckbuchler Senior Director Mark Irwin Associate Director Contact Us Americas Europe Asia (Excluding Japan) clientservices.asia@moodys.com Japan clientservices.japan@moodys.com Visit: solvency2@moodys.com About the Authors Christophe Burckbuchler is Senior Director at Moody s Analytics and is leading our Enterprise Risk Management Solutions for insurance teams. Christophe joined Moody s Analytics six years ago via Fermat where he occupied several positions in the Research & Development team across the Fermat product suite. Prior to joining Fermat, he spent five years at the Caisse Nationale de Prevoyance, a major French insurance company where he was in charge of several solutions related to insurance risk modeling and ALM for insurers. Christophe holds a degree in engineering from ESPCI in Paris, and his MBA from GGSB. Mark Irwin is Associate Director at Moody s Analytics managing product marketing for a range of regulatory solutions. Mark joined Moody s Analytics two years ago and has occupied several marketing positions at a range of financial services companies. Mark holds a First Class Honours degree in International Business from Edinburgh University. More Detailed, More Frequent and More Transparent Reporting - Implementing the Pillar 3 Reporting Requirements of Solvency II Highlights»» The Solvency II Directive is imposing huge demands on insurers in terms of the market and regulatory disclosures they need to make. Yet, for many insurers, meeting the reporting requirements has slipped down the agenda as managing the Directive s capital requirements and risk governance aspects have taken priority. Many of the reporting requirements are still to be finalized, but insurers should be assessing how they are developing their systems and processes to manage the heavy data flow from Pillar 1 capital requirement calculations to Pillar 3 reporting. This paper has been prepared for risk managers, actuaries, regulatory reporting leads, and Solvency II project and IT managers. It provides an overview of the current Pillar 3 requirements and discusses best practices that insurance companies should consider when implementing Pillar 3 requirements. It demonstrates that managing Pillar 3 in isolation is not recommended and that insurers should be taking a holistic approach to Pillar 3 implementation. By building a disclosure strategy that coordinates implementation of the reporting requirements with the Pillar 1 data management and capital requirements, insurers will be building an efficient, effective, and robust regulatory risk platform for stronger operational effectiveness and risk-based decision making.

2 Table of Contents Importance of Pillar 3 for Solvency II Compliance 3 Overview of Pillar 3 Reports 4 Group and Solo Reporting Requirements 6 Best Practices for Pillar 3 Implementation 7 Conclusions 10 About Moody s Analytics Solutions for Solvency II Compliance 11 2 More Detailed, More Frequent and More Transparent Reporting

3 Importance of Pillar 3 for Solvency II Compliance The Solvency II Directive promises full and transparent public and private disclosure under Pillar 3. The Directive introduces extensive quantitative and qualitative disclosure requirements for insurers and requires both annual and quarterly reporting to be relevant, reliable, and comprehensible (Art (c)). Many of the disclosure requirements are included in Articles 35 and 51 of the Solvency II Directive. Pillar I Pillar II Pillar III Quantitative Requirements Supervisory Review Disclosure Requirements Characteristics: Technical provisions Capital rules Results: Market consistent valuation Minimum Capital Requirement (MCR) Solvency Capital Requirement (SCR) Eligible capital definition Characteristics: Internal controls and sound management Insurer s internal view Results: Own Risk and Solvency Assessment (ORSA) New Supervisory Focus Characteristics: Transparent Forward-looking Frequent Results: Solvency and Financial Condition Report Regular Supervisor Report Quantitative Reporting Templates Many insurers have been heavily focused on managing the capital requirements and governance elements of Pillars 1 and 2. However, Pillar 3 because it acts as the external voice of the Directive represents a real challenge. Gathering the required information and embedding adequate systems that automate the process and strengthen the overall reporting and risk management framework are primary objectives and should be managed in parallel with Pillars 1 and 2. This will ensure that insurers do not encounter any unforeseen surprises that might cost additional time, money, and resources to fix at a later date. 3 More Detailed, More Frequent and More Transparent Reporting

4 Overview of Pillar 3 Reports The reporting requirements are set out in Pillar 3 of the Solvency II framework and comprise a mixture of quantitative and qualitative elements. These are divided into two main reports: the Solvency and Financial Condition Report (SFCR), Article 51 of the Solvency II Directive, which is publicly available; and the Regular Supervisory Return (RSR), Article 35(1), which is sent privately to supervisors. Quantitative Reporting Templates (QRTs), as defined in CEIOPS Consultation Paper 58 (CP58), will be required to underpin quantitative data in both reports. Solvency and Financial Condition Report (SFCR) Regular Supervisory Report (RSR) Reference Directive - Article 51 Directive - Article 35 (1) CEIOPS CP58. Quantitative Reporting Template (QRT) Audience Publically disclosed document Supervisor only All for supervisor; elements for public disclosure (TBD under level 3) Structure Qualitative and quantitative Qualitative and quantitative Quantitative Contents Business, external environment and performance Governance system Risk profile Valuation Capital Management Business, external environment and performance Governance system Risk profile Valuation Capital Management Format Electronically Electronically Electronically Group Requirement Solo Requirement Frequency Annually Full report every three years or when requested by supervisor Submission Date Within 14 weeks of an undertaking s financial year end. Groups: Up to additional 4 weeks Within 14 weeks of an undertaking s financial year end. Groups: Up to additional 4 weeks To be further defined under level 3 guidance but will include elements covering: MCR SCR Technical provisions Assets Own funds Quarterly (supervisor only) and annually Quarterly - 5 weeks after quarter end Annually 14 weeks after year end Source: Solvency II Directive and CEIOPS Level 2 Implementing Measures on Solvency II: Supervisory Reporting and Public Disclosure Requirements (former Consultation Paper 58) Much of the underlying analysis and information used in the SFCR and RSR will be drawn from a firm s Own Risk and Solvency Assessment (ORSA) and financial reports. ORSA is the mechanism by which the board satisfies itself that it has a process to manage the current risks to the business and the future risks arising from the business strategy. You must report the results of the ORSA to your supervisor as part of the supervisory reporting requirements. Any significant change in your risk profile will require you to undertake an ORSA. The Solvency and Financial Condition Report The SFCR is produced annually and will contain qualitative and quantitative information, which is supplemented, where appropriate, with quantitative templates. Groups can either produce an SFCR covering the group on its own, with each solo entity producing a separate SFCR, or it can submit a single return that includes not only the aggregate group position but also the information for each solo entity. 4 More Detailed, More Frequent and More Transparent Reporting

5 Regular Supervisory Report The RSR comprises a number of components that must be provided at regular intervals. It includes what is termed the narrative element, which contains qualitative information that represents the position of the firm as of the financial year-end. Each solo entity that is subject to Solvency II must submit a narrative RSR. A narrative RSR must also be submitted for a group. In addition, the RSR also requires insurers to submit quantitative reporting templates (QRTs) on a quarterly and annual basis (see the following section). Quantitative Reporting Templates The template information covers the minimum capital requirement, the solvency capital requirement, some information on technical provisions, and assets and own funds. The annual QRT contains this core information, plus more detail on various aspects, including technical provisions and reinsurance contracts. Annual data is likely to be subject to audit, at least in part, and elements of the annual QRT will be publicly disclosed, within the SFCR. Groups will also need to submit annual templates. Discussions are under way with the European Commission regarding group reporting that is more frequent than annually. The recent reporting pre-tests suggest that there will be 48 solo reports and 15 group reports with 63 in total. Q R T Variation Analysis Capital Requirements (SCR/MCR) & Own Funds Reinsurance Technical Provisions (Life & Non-life) Assets (incl. Detailed List) Balance Sheet For most firms, the current implementation date for Solvency II of 1 January 2013 proposed by the European Commission means that firms must provide the first annual reports (narrative RSR, annual QRT, and SFCR) as of 31 December The implementation dates are currently being revised under Omnibus II, and the new implementation date could be 1 January For insurers with a year-end of 31 December, the first quarterly QRT will be produced as of 31 March For non-31 December year-end firms, the first quarterly QRT is likely to be as of the end of the firm s first quarter (after the Solvency II commencement date), determined according to the financial year-end of the firm. Disclosure Content The precise requirements of Pillar 3, in terms of what must be included in the public and supervisor-only reports and audit requirements, have yet to be finalized. The European Commission and the European Insurance and Occupational Pensions Authority (EIOPA) are working on the detailed requirements, which might be watered down in their final form, although the key elements are embedded in the framework legislation. Concerns have been expressed about the required workload, particularly for smaller firms that might still be expected to follow an extended standard template for disclosure, much of which might not be relevant. EIOPA is considering whether the reporting requirements could be simplified for smaller insurers. It is also possible that the reporting requirements might be phased in over a number of years. The Omnibus II Directive published in January 2011 proposed transitional periods for the reporting requirements of as much as three years for the SFCR and five years for the RSR. It might not be clear until early 2012 whether transitional periods will be allowed and over what period. Despite these uncertainties, it is clear that the regulators will require more quantitative and qualitative information to be reported more frequently and in a shorter time frame than ever before. This will include more detailed information on individual assets, as well as the sensitivities of those assets to risk factors, the assumptions applied in risk calculations, and other aspects of the business. For most insurers, this will require a fundamental shift from annual or biannual reporting. 5 More Detailed, More Frequent and More Transparent Reporting

6 Group and Solo Reporting Requirements The group supervision framework of Solvency II is complex. The Directive sets out additional reporting requirements at the group level. Furthermore, the Directive demands that risk management and reporting procedures shall be implemented consistently across the group. Group supervision is applicable to an authorized European Economic Area (EEA) insurance company within a wider insurance group. The Directive requires groups to comply with significant components of the solo supervision regime, supplemented by group reporting where applicable for example, a group SFCR. The complexity increases when considering insurance groups whose ultimate parent is outside the EEA, such as the following. EEA insurer not part of a group Solvency II group requirements do not apply. EEA subsidiaries of EEA groups Each subsidiary must submit and justify stand-alone (solo) Solvency II requirements to the local supervisor. The group must submit a consolidated filing (group) to the head office supervisor. EEA Subsidiaries of non-eaa groups If the non-eea group is subject to equivalent supervision, the following apply. Solvency II does not apply to the worldwide group. Each subsidiary must submit and justify stand-alone (solo) Solvency II requirements to the local country supervisor. The group submits consolidated group reports to its national supervisor. If the non-eea group is not subject to equivalent supervision, the following applies. Solvency II applies to the worldwide group, and the process of supervision needs to be agreed with the group supervisor of the EEA. The complexity of group and solo reporting has enormous implications for insurers. On top of assessing their current group structures to manage the solo and group reporting challenge, insurers also need to consider the following. Do you have access to the level of data granularity that is required to report at the solo and group level? Do you know where the required data is stored across the enterprise to meet the increased quality and quantity of reporting? Is the data centralized for improved accuracy? Are the current reporting systems consistent across the group and subsidiaries? Do you have capabilities to manage multi-jurisdictional reporting, including local languages and reporting formats? 6 More Detailed, More Frequent and More Transparent Reporting

7 Best Practices for Pillar 3 Implementation What should insurers be doing now to ensure smooth and compliant disclosure? A good starting place for insurers is to develop appropriate policies, systems, and governance to ensure that accurate and reliable information can be presented to the regulator, rating agencies, investors, and wider public. It is also vital that insurers take an integrated approach to Solvency II, so that Pillar 3 requirements are considered in light of Pillar 1 and Pillar 2. For example, the design of the internal model and development of management information could have significant bearing on how the firm discloses information under Pillar 3. Many of the conversations we are having with insurers involve elements of the following six disclosure areas. We have mapped out the core challenges and best practices for each. 1. Integrated and Centralized Approach Taking an integrated and centralized approach to Pillar 3 reporting can add tremendous value. Breaking down the regulatory reporting process into four simple steps helps demonstrate this Collect Validate Collate Publish» Liabilities data» Assets data» Market data» Client behavior data» Macro economic data» Operational losses data» Data quality management tools» Built-in check and error capabilities» Four-eye technology» Collate and aggregate risk data: Life Non-life Health Operational Market Credit Strategic» XBRL, XML, MSExcel» Internal vs. external stakeholders» Level of detail and drill-down capabilities» Relevant, reliable and comprehensible First, insurers need to collect the required data. This data could be stored in multiple source systems across the organization and might not be easily accessible by those responsible for regulatory reporting. Second, as mentioned previously, the data needs to be validated and checked for manual errors and inconsistencies. Third, the data needs to be collated and summarized along many dimensions including group and solo entity and region. Finally, the data needs to be published according to the required national supervisor format (for example, Extensible Business Reporting Language [XBRL]). Making this process as integrated as possible and centralizing it by leveraging a risk Datamart, for example, could greatly improve the process in terms of accuracy, speed, and effectiveness. 2. Automation As already mentioned, the Directive requires insurers to deliver processes consistently across the group. In addition, the proposed quarterly QRT submission represents a significant increase in reporting requirements for EEA-based insurers, who will need to accurately and efficiently aggregate results for the different risk types and deliver QRTs in local formats and languages on a quarterly basis. Streamlining and automating as much of this process as possible should significantly reduce the burden and cost going forward. Automation also facilitates reduced operational risk. Additionally, regulations change and future versions of the Directive may increase the frequency to monthly or more. Having a system that is automated and fast will allow you to easily handle even more frequent reporting requirements that are bound to happen as regulations evolve. Whether you are looking for a reporting solution that compliments existing calculation engines or one that has built-in calculation and aggregation capabilities, openness and flexibility are primary characteristics to consider. A reporting solution that is open and can process and consolidate imported results from upstream source systems accurately and efficiently is very valuable, especially with the quantity and quality of reporting data that is required. Flexibility should also mean that you can accommodate changes in the regulation very rapidly, without needing to review all your architecture. 7 More Detailed, More Frequent and More Transparent Reporting

8 Data Quality Assessment 29 MOODY S April 2009 ANALYTICs 3. Data and Data Quality Considerations The level of granularity that is needed under Pillar 3 will require considerable changes to data management and financial reporting processes. Although the reporting requirements have yet to be finalized, insurers already have a good idea of what might be required by supervisors. Firms should be putting a platform in place that can deal with this level of granularity. Furthermore, the quality of the reports greatly depends of the quality and accessibility of the data. Both the SFCR and RSR will require information from across the organization. Understanding where this information is stored and who owns it, and mapping this out as you manage your Pillar 1 and 2 activities, will add tremendous value. Using a central risk Datamart that is focused on managing and storing the data required for Solvency II compliance will reduce the multiple sourcing challenges by providing a golden copy of your data. Data quality is a key component of Solvency II, and it is crucial that the data used is fit for disclosure. Insurers, therefore, need to have processes and controls in place to ensure that the data is complete, accurate, and appropriate. We propose a data quality management process consisting of four main steps, shown in the following figure. Data Definition Data Quality Monitoring Data Quality Management Problem Resolution First, you need to define your data based on appropriateness and completeness before validating it through the second step data quality assessment. The third step involves addressing the highlighted data quality issues, and the final step is monitoring the performance of IT systems going forward. For more information on data quality management for Solvency II, see Moody s Analytics separate white paper Meeting the Data Quality Management Challenges of Solvency II, which is listed in the Further Reading section. Setting automated rules that assess the quality of the data as well as implementing measures that assess the evolution of this quality is key to enhance your data management. Reports that regularly display the evolution of these measure will demonstrate your commitments to comply this regulatory demands in terms of data quality. Furthermore, audit and tracking tools facilitate stronger transparency in the Supervisor s eyes. 4. XBRL XBRL has been chosen as a reporting taxonomy for Solvency II compliance. It is not yet clear whether national supervisors will accept other formats alongside XBRL, including Extensible Markup Language (XML) and Microsoft Excel. Therefore, it is important for insurers to start building their XBRL knowledge and capabilities so that they possess the necessary experience and knowledge to leverage XBRL from Day 1. As and when regulators change reporting formats, it will be useful to ensure that your reporting solution is flexible enough to handle a range of reporting languages. The XBRL taxonomy should be facilitated by automated processes and should ideally be a software solution. This solution should be able to manage the technical specificities of XBRL and also should offer a complete and accessible reporting data model. 8 More Detailed, More Frequent and More Transparent Reporting

9 5. Board-Level Reporting Insurers are under pressure to increase the quantity and quality of board-level reporting. The board will require accurate, timely, and comprehensive analysis of the quantitative and qualitative aspects of the Directive. Boards should be asking themselves if they clearly understand the quantitative and qualitative descriptions of the company s risk and should consider whether the company has clear processes and systems to manage the risks going forward. Risk managers should be asking themselves if the information they are providing is clear, holistic, and dynamic, and should ensure that the relationships between risk types are evident. 6. Public Disclosure Early collaboration with any third-party suppliers of the information, such as asset managers, will be invaluable in achieving the disclosure requirements. A clear and well-prepared communication strategy is also an essential part of an insurer s reporting program. Firms need to understand how the company will appear under the Pillar 3 disclosures and ensure that senior management is comfortable with the results. As part of this process, companies need to consider stakeholders expectations and the interaction of the different reporting bases. In addition, any differences between the Solvency II disclosures and those of other statutory reports are likely to be challenged by analysts and investors. Insurers should consider what messages would improve their understanding of the company s performance. Some of the disclosures are highly complex and are open to different interpretations. The question of what data is public and what can remain private is also still a gray area. Leveraging a complete, flexible, and open data model that is dedicated to reporting enables insurers to report to their supervisors, investors, rating agencies, and other major stakeholders. 9 More Detailed, More Frequent and More Transparent Reporting

10 Conclusions Pillar 3 is one of the most challenging areas of the Solvency II regime, requiring fundamental changes for all insurers. More robust, more detailed, and more frequent regulatory and public reporting will place immense pressure on insurers internal processes, systems, and architectures. Insurers who view the three Pillars in a holistic manner and are integrating their disclosure requirements into their capital requirements and governance plans will be at a distinct advantage. The next 18 months will be crucial for firms in developing a robust response to the reporting requirements. It is vital that insurers do not lose sight of the challenges and opportunities that are presented by this aspect of the new regime. Pillar 3 will require significant systems and process change, and for some insurers will require major cultural change. Reporting will be more detailed, more transparent, and more frequent than ever before. The requirements have yet to be finalized, but enough detail is available for insurers to make preparations now. Insurers should be developing a strategy for disclosure, and they should be coordinating the implementation of the reporting requirements with the other elements of Solvency II. This includes the following. Designing the RSR and SFCR templates, in conjunction with the teams working on Pillar 1 and Pillar 2. Identifying the data requirements and addressing any gaps, as well as making sure that the data is fit for the purpose, with processes and controls implemented to ensure that the data is complete, accurate, and appropriate. Establishing whether the systems and processes can handle the disclosure requirements. The level of granularity will require considerable changes to data management and financial reporting processes. Insurers should consider automating their reporting processes to increase efficiency, accuracy and ability to audit. Developing a robust communication strategy. Insurers need to consider what messages would improve the understanding of the company s performance. Senior management should engage with the process early to understand what is being disclosed. Finally, insurers should consider the potential benefits of developing a single, integrated reporting model for Solvency II. This could result in significant synergies in terms of data management, modeling, and investor relations. 10 More Detailed, More Frequent and More Transparent Reporting

11 About Moody s Analytics Solutions for Solvency II Compliance Moody s Analytics offers an end-to-end solution to manage all aspects of Solvency II compliance, from data management and consolidation to SCR/MCR calculation and reporting. Leveraging more than 15 years of experience of regulatory projects, our solution: Includes, as standard, a very detailed model for assets, liabilities, and accounting data; built-in data management capabilities including quality checks, audit tracking, and general ledger reconciliation; and additional features to generate model points and compute triangles. With this thorough approach, the data that is passed to the calculation layer is of very good quality and expected granularity. Leverages a robust calculation engine to efficiently aggregate the relevant data. The regulatory configuration for existing bodies (for example, QIS5) is already embedded in the solution, and regulatory updates are managed going forward. Integrates comprehensive management and regulatory reporting that delivers the regulatory templates (for example, QRT) that are required to meet the Directive. Our reporting architecture is flexible and includes the ability to manage data that comes from our calculation engine with that of existing upstream calculation engines. Incorporates economic scenarios from Moody s Analytics leading Economic and Consumer Credit Analytics to stress test the robustness of a company s asset allocation process using severe global macroeconomic scenarios.. Risk Identification Risk Quantification Risk Response & Disclosure Input Data Manage Data Quality Calculate Aggregate Risk Types Report Refine Strategy Liabilities Assets Market Data Client Behaviours Macro Economic Data Operational Losses Other Data Accurate Appropriate Complete Cleansing Consolidation Reconciliation Cash flows Valuations Indicators Scenarios - Deterministic - Stochastic Life Non Life Health Operational Market Credit Strategic Regulatory Reporting Internal Reporting Key Risk Indicators Risk Based Decision Making Investment Strategy Hedging New Product Launches Risk Datamart Data Integration, Storage, Security and Audit Capabilities Beyond our regulatory capital management and reporting solutions, Moody s Analytics offers insurers comprehensive economic capital calculation capabilities through our award-winning solution RiskFrontier. Some of the world s leading insurers leverage this solution to determine MTM values, expected returns, and volatilities of their portfolios, as well as to facilitate the integration of credit risk and investment management through establishment of portfolio referent pricing systems. For more information on our range of solutions, visit or solvency2@moodys.com. 11 More Detailed, More Frequent and More Transparent Reporting

12 Further Reading For additional details, please read the following resources.»» Moody s Analytics Meeting the Data Quality Management Challenges of Solvency II white paper. Accessible for free at Supervisory-Reporting-and-Disclosure.pdf»» Group-solvency-assessment.pdf»» Intra-group-transactions-and-risk-concentration.pdf 12 More Detailed, More Frequent and More Transparent Reporting

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