The Challenges of Implementing Solvency 2

Transcription

1 The Challenges of Implementing Solvency 2 Warsaw, June 10th, 2009

2 Introduction Solvency 2 is a new EU capital adequacy directive All insurers (GP>5mio/TP > 25Mio) must comply by 10/12 Many insurers have a plan, many don t ( S2 isn t ready yet ) The quantitative aspects will represent a challenge But the qualitative aspects should not be underestimated S2 should not be treated as a regulatory reporting/capital reduction exercise There are (really!) business benefits to be obtained This means looking at all the challenges in a enterprisewide context from the start of the project I will give a rapid overview of the components of an S2 project 2

3 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 3

4 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 4

5 S2: more transparency and consistency s: Solvency I Not risk sensitive No recognition of diversification Diverges from best practice capital assessment Not harmonised across jurisdictions Ignores risk process Solvency II SCR Better consumer protection Better alignment of risk- related processes with capital requirements Increased risk awareness and transparency of decision making Level playing field Better supervision Internal models Capital better aligned to risk profiles / strategies Risk-sensitive pricing Finer granularity of risk based decisions Market consistent valuation of assets/liabilities Consistent reporting of EV, S2, IFRS, Crisis: Strategy/appetite (eg AIG) Risk severity (ABS, equity, credit/counterparty, surrender, ) Systemic risk Stress testing 5

6 S2 based on economic balance sheet SCR Ladder of Intervention Solvency Capital Requirement (SCR) Desired capitalisation level shortfall triggers supervisory intervention 1Y, 99.5% VaR MCR Market consistent t TP value of assets Sub liabs Other non- ins liabs Minimum Capital Requirement (MCR) The point at which the superviser could take control and/or close books Basic Own Funds MV assets MV Liabilities + sub. liabilities Market consistent value of liabilities Market Consistent Value of Liabilities Best estimate of price of transfer to another party ( exit value ) Ladder of Intervention Supervisory measures to protect policy holders and creditors

7 Solvency II Risk Map Solvency II provides SCR as an Ecap starter kit : Modular predefined risk map 1Y, 99.5% VaR Economic Capital view Diversification benefit Loss absorption through PS Calibrated to typical insurer Incentive to use internal models Alignment with internal process Risk under/over stated Peer pressure BOTH SCR and IM capital required for up to 2Y 7

8 More than just capital adequacy Happy policy holder? SOLVENCY II Pillar 1 - Quantitative Requirements Eligible capital Technical provisions Required Capital Asset valuation Risks & methodology Pillar 2 - Supervisory Review ORSA Process GovernanceG Use test Add-ons? Intervention? Pillar 3- Market Discipline Disclosure Risks Policies Assumptions Well capitalised? Well run? Transparent? 8

9 No more wait and see Enough clarity to allow planning of a S2 project Pillar 1: QIS4 95% of final SCR, Internal model principles will not be made much clearer Pillar 2: current description i of ORSA and experience with B2- ICAAP enough to define scope Pillar 3: less clear but strong alignment with IFRS certain Lessons from Basel II many banks had difficulty completing on time in 2008 Silo-based lack of integration planning phase too light? Underestimation of governance aspects (Pillar 2 - ICAAP) = form filling Underestimation of level of detail interaction with regulator Banks start preparing Banks work on B2 Basel II start April 14th 2009 Solvency II start Banks finish Insurers work on B2 Insurers start preparing 9

10 Timeline for compliance 10

11 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 11

12 Market view of impact of S2 (after QIS4) Solvency I Solvency II SCR Solvency II Internal models Average Capital Ratio Impact (S1 to SII as defined in QIS4) 63% of participants consider a full or partial internal model, especially for: 200% 230% Underwriting risks 277% 193% Market risk (especially IRR) Operational risk 267% 230% Operational risk standard approach Solvency I Solvency II (average 5-10% of SCR) considered poorly designed by 53% - supervisors favour internal models. Very important to assess impact now 12

13 Where are the business benefits? Risk culture & governance Language, awareness, incentives Risk communication Regulator, shareholder, policyholder, creditor, counterparties,. Link with MCEV, IFRS Systems and data streamlining & quality Risk/return Underwriting & reinsurance Investment & hedging Tends to be first focus Capital allocation Capital Management Efficiency (how much?, what kind?) Risk Management (incl ALM) Proactive involvement in strategy, capital management, business lines 13

14 Planning in the benefits For most insurers the S2-pillar 1stream represents a very significant investment Compliance and lower capital requirements are unlikely to provide offsetting benefits Benefits will not materialise magically as a result of compliance they must be built in to the S2 project planning Business imperative ensure project involves all functions Identifies where S2 work can benefit them 14

15 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 15

16 Divide and conquer: S2 components Advice SteerCo Mandate QIS 5 Program Mgt Preliminary study: priorities, scope, resources, timing, quality Project Mgt Project Mgt Project Mgt Project Mgt Pillar I Ecap models Stress testing Valuation models Available capital Systems Data Pillar II Strategy/appetite Governance Policies & Procedures ORSA Model management Training Pillar III Regulatory disclosure Other external stakeholders Change Mgt Proactive internal communication Consultation with stakeholders 16

17 S2 RACI Matrix (eg from FSA) Key Messages Pillars 2 & 3- Pillar 1 - Internal Implications Governance & Reporting Capital Adequacy models for supervision Board and senior mgmt XXXXX XXXXX X X X Risk Management XXXXX XXXXX XX XXXX XXX Finances XXXXX XXXX XXXXX XXX XX Actuarial XXXXX XXXX XXXXX XXXXX XXX Internal Audit XX XX X X X XXXXX Accountable (ownership) XXXX Responsible (implement) XXX Responsible (day-to-day execution) XX Consulted X Informed 17

18 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 18

19 Data Challenges Often, risk management, actuarial function, finance etc have own process for data gathering, g processing and storage There is not necessarily a connection between these processes and those used for capital assessment S2 Principle: If its good for S2 its good for running the business S2 = Opportunity to save time spent doing piecemeal data processing across business Maximise standardisation/centralisation of data, meta-data and processes External sources market data, OpRisk, ratings, Basel 2 lesson: getting data right is more difficult than getting the calculations right! Data management must be tackled at start of project 19

20 Data Management Architecture Robust: Secure, well-(self)documented, auditable Standard definitions of measures and classification hierarchy Centralised input storage, limited set of output marts Single validation/reconciliation ili point per data type Quality Central definition of validation: completeness, accuracy, relevance Continuous assessment cycle Formal reporting on data quality Governance Formal responsibilities aligned with ownership of sources Clear procedures for producers, managers and consumers of data (SLAs) 20

21 Data architecture Mgt, Risk, BU Reporting Warehouse Analytics SCR IM EV IFRS BU marts Use Store Prepare Source Actuarial Financial Risk Data Warehouse Std Classification Policies Oprisk Data GL Assets Market ETL Controls Meta Data (D Dictiona ary) External Data Operational Sources 21

22 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 22

23 Analysis systems challenges Consistency/Re-use Same calculation, same system Re-use of systems for IFRS, MCEV, stress testing, Common data, common storage of outputs, robust interfaces (eg liability and asset systems) Transparency X Avoid black boxes adaptability to own risk profile/models Transparency/auditability of calculations crucial Reporting tools: cope wide range of internal /external reporting Performance Cope with high data volumes Cope with large numbers of calculations (eg Monte Carlo) Security and version control 23

24 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 24

25 Modeling challenges Standard parameters? (incl Prof fit sharing g) Man nagement actions Claims, biometrics, market data Historical data TP Reins. Exposures Assets OBS Link? Projections, BE, MVM replication, MTM Internal Calibration? Vols & Corrs Standard formula IM? Simulation Stress tests SCR Partial int ternal? 25

26 Benefits of internal models Reinsurance analysis, design and purchase Underwriting pricing to include risk margins Investment optimise investment w.r.t capital Product design optimise new products w.r.t capital Management information understanding risks in business plan, sensitivities to key assumptions, risk appetite and limits Strategy/planning impact on risk profile/capital of alternative strategies Corporate finance impact on risk profile/capital of potential mergers, acquisitions and disposals Finance function risk based performance: RoRaC, EVA 26 etc

27 The validation challenge Article 122 of Framework Directive Process: regular cycle cle of internal model validation Backtesting: performance versus experience, Relevance: Continuous review of appropriateness of model (demonstrate to supervisor) Calibration: must take into account past and projected risk factor behaviour Stability: are periodic changes explainable in terms of risk profile? Sensitivity: of the results to key underlying assumptions Data: accuracy, completeness and appropriateness p Weaknesses: blind spots, improvement plan 27

28 The documentation challenge Article 123 of Framework Directive: Insurance and reinsurance undertakings shall document the design and operational details of their internal model. The documentation shall provide a detailed outline of the theory, assumptions, and mathematical and empirical basis underlying the internal model. The documentation shall indicate any circumstances under which the internal model does not work effectively. Insurance and reinsurance undertakings shall document all major changes to their internal model Clear and well-managed (versioning, sign-off) documentation is the key Documentation is a process not an archive 28

29 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 29

30 What is Governance? Article 13 of proposed Directive: A governance function means an internal capacity to undertake practical tasks. The risk management function, compliance function, internal audit function and actuarial function are governance functions Article 41 That system shall at least include an adequate transparent organisational structure with a clear allocation and appropriate segregation of responsibilities and an effective system for ensuring the transmission of information Policies: i Written, enforced and regularly l reviewed steps to ensure continuity and regularity in the performance of their activities, including the development of contingency plans 30

31 Governance challenge: roles Top Management Risk appetite/strategy, direct implementation of governance Internal Control Policies & procedures: administrative and accounting, data management, incentives, reporting and compliance Risk Management Ownership and use of models to identify, measure, monitor and manage risks ik & advise di on risk ik strategy t Actuarial Function (Note: not necessarily actuaries) Ownership and use of models for TPs, testing vs. experience Advice on underwriting/reinsurance policy, risk modelling underlying capital calculations Internal Audit Independent evaluation of the adequacy and effectiveness of governance, reported to management 31

32 The Use test : process not numbers Demonstrate use of ORSA in decision process for: Business strategy pricing & product approval mergers and acquisitions capital management capital allocation investment reinsurance hedging dividend and share buy-back policy bonus setting Documented: Policies & procedures Roles and responsibilities Management information Risk-based decisions Etc 32

33 Agenda Overview of Solvency 2 Business benefits Components of a Solvency 2 project Challenges Data Analysis Systems Modelling, validation & documentation Governance, Processes and Organisation Own Risk Self Assessment (ORSA) 33

34 The ORSA challenge SCR calculation is not enough ORSA = Own Risk Self Assessment Definition of risk appetite ad tolerance Internal processes and procedures to identify, assess, monitor, manage, and report all present and future risks to ensure that the undertaking s overall solvency needs are met at all times Produce evidence of an internal assessment that t takes into account the specific risk profile of the firm, making use of internal data where possible Explain significant ifi differences to SCR figures Scope to include greater influence from business strategy and management actions within the ORSA capital compared to the SCR 34

35 Closing remarks 3 years is not long A Solvency 2 project must take into account much more than the capital calculation Pillar 2 (Governance, ORSA) not to be underestimated A preliminary study essential to Determine scope, quality, resourcing and timing issues Assess collateral benefits Close collaboration across departments important during project Clear and regular communiction with both external and internal stakeholders important 35

36 Finalyse can provide services in all the principle stages of an S2 project Solvency II requirements Impact study, workshops Feasibility study project Design project Implementation project Testing project Setting priorities and criterias Consistent Reporting of Risk Measures Processes & Procedures Models & Algorithms Data warehouses & Data Input Quality Systems & Tools Operatio onal risk co ontrol Effective risk management structure 36

37 Thank you! Please Visit our Website or contact our Professional Services Director, Brussels David Kemp our Finalyse Warsaw Country Director, Jerzy Markiewicz ic jerzy.markiewicz@finalyse.com