A (personal) view. Philip Whittingham, European Chief Enterprise Risk Officer. 22 March 2010

Transcription

1 The role of the risk profession in a Solvency II world A (personal) view Philip Whittingham, European Chief Enterprise Risk Officer XL Group plc 22 March 2010

2 Session Aims Successful Solvency II implementation hinges on embedding risk management practices across an insurance organisation and demonstrating that risk and solvency information is used in making key decisions. But what is the unique selling point (USP) of risk professionals and how can ERM make a real different to the credit rating of insurers?

3 Agenda Outline of Solvency II scope and timeline Links between Solvency II and Rating Agency Expectations ERM at the core of successful implementation Drill down on the Use Test Expectations ti for Risk Manager in Solvency II

4 Background to Solvency II Insurance legislation over the last 30 years: The business driver to be compliant with SII is about Cost and Risk avoidance. Could lead to loss of insurance licenses in the EU, reputational risk, rating declines. Solvency I established in the 1970 s but had inadequate capital allocation Inconsistency across Europe - territories introduced their own regulation e.g. ICAS in the UK that resulted in a patchwork of regulation Single EU market in early 1990 s led EU regulators to draft the Level I Solvency II Directive in 2002 The Insurance market was weak in the following areas before Solvency II: Lack of transparency of risk and volatility Lack of transparency on economic volatility of balance sheets Solvency I CURRENT in Europe Uneven playing field in Europe One size fits all rather than risk based approach to solvency capital requirements Individual Capital Adequacy (ICA) CURRENT in UK Principles based not rules based Risk based capital assessment Must meet individual capital guidance provided by the FSA Private, no disclosure required on nature of model (i.e. set formula) or output Solvency II FUTURE in Europe Replaces Solvency I across Europe and ICA in the UK, promising a (more) level playing field Is risk based, encouraging and rewarding evidenced integrated risk management Uses market consistent valuation methods for all insurers with set risk parameters calibrated with industry experience Firms subject to standard formula unless able to demonstrate suitability of internal model Greater attention on Own Risk Solvency Assessment (ORSA) which is more onerous than ICA (in the UK) Requirement for risk management, governance, actuarial and internal audit embedded in the business Requires annual report on solvency and condition financial report (SFCR), Report to Supervisor (RTS) and quarterly reporting (QRT) Approach extended to both assets and liabilities, defining quality and market benchmarks required as part of capital

5 3 Pillars of Solvency II Internal models Big challenge Solvency II is based on 3 guiding principles which cut across market, credit, liquidity, operational and insurance risk The new system is intended to offer firms incentives of lower capital requirements to encourage better measurement and management of risk The new system includes both quantative and qualitative aspects of risk, each pillar focusing on different regulatory component ORSA pulls together all the Pillar II elements of SII Pillar I Pillar II Pillar III Quantative Requirements Regulations on minimal capital requirement Solvency Capital Requirement (SCR) Technical provisions Qualitative Requirements & Supervision Supervision regulation ORSA Capability and powers of regulators Supervisory Reporting and Public Disclosure Transparency Disclosure Requirements Competition related elements Investment rules Quantification Governance Disclosure Requirements to report on specific basis within short timeframes

6 Impact on risk management standards within the industry Current State: Many components parts exist already driven by local regulation (e.g. UK), rating agency expectations or firm s own good practice. Solvency II state: t More industrialised risk framework, with more demonstrable independent oversight of all risk types Specific new functional expectations (e.g. risk) Driving use of the model within the business for a single version of the truth (use test) Some component parts need developing or enhancing Firms typically developing enhanced approaches around: Risk appetite Risk governance Model integration Risk reporting Stress tests (Multi year and reverse) ORSA risk and capital management A traditional risk framework? Operational risk Risk policy

7 Structure of the SCR

8 Solvency II project progress Dry runs of Internal Models. QIS5 to calibrate technical provisions. Est. risk appetite and changes to governance Regulatory discussions IMAP Pre-application (if req.) Group supervision discussions (if req.) Validation By October 2011 Run internal model on 2012 plan. ORSA & industrialisation of risk processes Drafting waiver application Waiver application Use test embedded Systems build, incl. production of QRTs Ongoing g operation By October 2012 Compliant with S II

9 Outline of Solvency II scope and timeline Links between Solvency II and Rating Agency Expectations ERM at the core of successful implementation Drill down on the Use Test Expectations ti for Risk Manager in Solvency II

10 Rating Agency Views on Solvency II London, 23 November, The impending implementation of Solvency II and the increasing expectations among rating agencies are driving insurers to continue to bolster their enterprise risk management (ERM) programmes, according to a recent survey conducted by global professional services company Towers Watson Also included in the regulations is the requirement for a use test before companies can use their internal models for Solvency II purposes. We believe that our definitions of Strong and Excellent Strategic Risk Management (one of the five components of our ERM criteria) are closely aligned to the potential use test. If this is a guide then only around 14% of European insurers today would be candidates for internal model recognition by supervisors. Source: S&P on Solvency II Experts Group

11 Outline of Solvency II scope and timeline Links between Solvency II and Rating Agency Expectations ERM at the core of successful implementation Drill down on the Use Test Expectations ti for Risk Manager in Solvency II Vision of Solvency II Risk Manager

12 Scope of model Principal 1. Senior management and the administrative, management or supervisory body, shall be able to demonstrate understanding of the internal model Firms need to define the scope and purpose of the internal model and the risks covered by the internal model, as well as those not covered.

13 Scope of model?

14 Model approval key areas Scope of Model Use test Internal Model Governance Statistical Quality Standards Calibration standards Profit and Loss Attribution Validation Documentation External Models and data

15 Outline of Solvency II scope and timeline Links between Solvency II and Rating Agency Expectations ERM at the core of successful implementation Drill down on the Use Test Expectations ti for Risk Manager in Solvency II

16 Use Test A fundamental requirement for an undertaking to qualify for an internal model approach is that it demonstrates that there is sufficient discipline in its internal model development and application such that it is widely y used and plays an important t role in the ecouseo course of conducting its regular business, particularly in risk management. From a regulatory perspective, the Use test philosophy boils down to the following: if an undertaking does not trust its model sufficiently to use it, why should the supervisory authority?

17 Use Test framework assumptions Insurance and reinsurance undertakings must have only one modelling framework The internal model is more than the calculation kernel ( actuarial model ), but may have different tools. The integration into the risk-management system shall be on a consistent t basis for all uses. Any outputs t from different parts of the modelling framework with their decision-making processes need to be reconciled.

18 Requirement for Use Test Article 120 Use Test (extract) insurance and reinsurance undertakings shall demonstrate that the internal model is widely used in and plays an important role in their system of governance, in particular: Their risk-management system and their decision making processes Their economic and solvency capital assessment and allocation processes

19 Use Test caveat CEIOPS does not expect that an undertaking will make decisions based solely on the output of the internal model..but that decision-making will: take account of the output of the internal model, [demonstrate] understanding the shortcomings of the internal model.

20 Use Test and Internal Model approval process Please provide details of how you will develop your system of governance to make sure that.the internal model is widely used in your risk management and decision-making i processes, including your economic and solvency capital assessment and allocation processes. (FSA)

21 Survey of 30 London Market respondents Capital Allocation and management (96.4%) Catastrophe Risk assessment and aggregates (82.1%) Reinsurance purchase (78.6%) Business strategy setting (75%) Investment management (67.9%) Product development / pricing (67.9%) (Source: Institute of Risk Management )

22 Possible uses for the model Adequate pricing Asset liability management Business planning / strategy Capital management Developing and monitoring risk appetite Developing risk strategy t Efficient use of capital Exposure management and limit setting External risk reporting Incentive and target setting Financial reporting (IFRS) Investment decisions (e.g. strategic, tactical and operational) M&A Measurement of material risks ORSA Other risk mitigation Portfolio transfer pricing Producing MI Product development / pricing Reconciliation between internal model outputs and internal/external financial reporting Reconciliation between internal model and technical implementation of management actions Reconciliation between internal model and technical provisions Regulatory capital Reinsurance decisions (e.g. strategic) Reinsurance programme design Reinsurance strategy and development of reinsurance programme * Reporting on business performance Reporting on performance including return on capital Risk balancing (efficient use of capital) Risk mitigation Setting profit targets t Setting return on capital targets and remuneration Underwriting policies

23 Genesis of the Risk Manager and Risk Management in Insurance Outline of Solvency II scope and timeline Links between Solvency II and Rating Agency Expectations ERM at the core of successful implementation Drill down on the Use Test Expectations for Risk Manager in Solvency II

24 Genesis of Risk Management In Insurance (UK example) Solvency II State? Risk Function ority of Role Seni Compliance based risk management Silo risk management e.g. cat man Risk manager Ad hoc risk management Technical Sophistication

25 Required Duties of the Risk Function The undertaking shall embed the risk management function.a manner which ensures that the function is objective and free from influence from other functions.. The tasks of the risk management function shall include: a).the effective operation of the risk management system, in particular..performing specialist analysis and performing quality reviews; b) Monitoring the risk management system; c) Maintaining an organisation-wide and aggregated view on the risk profile of the undertaking; and d) Reporting details on risk exposures and advising the administrative, management or supervisory body with regard to risk management matters in relation to strategic affairs like corporate strategy, mergers and acquisitions and major projects and investments; and e) Identifying and assessing emerging risks.

26 Required Duties of the Risk function relating to Internal Model The risk management function is required to: Design and implement the internal model Test and validate the internal model and any changes to it; Analyse and report on the performance of the model; Monitor compliance with the on-going requirements for internal model approval; and Suggest areas for improvement to the internal model to the Board.

27 Skill Set for the Solvency II Risk Manager? Able to influence at Board level Able to understand ALL risk types Able to engage with actuaries Able to engage with the business Able to engage with regulators Able to drill down on risk areas and undertake specialist reviews Able to understand capital planning Able to understand business and risk strategy Able to understand actuarial and other modelling techniques

28 Conclusions Solvency II is absolutely about risk management There are clearly defined roles for risk managers within Solvency II Good risk managers will be in heavy demand d under Solvency II

29 Tel: +44(0) Fax: +44(0) The views expressed in this presentation are those of the speaker and do not necessarily represent those of XL Group plc or any of its subsidiaries.