Regulation and risk The strategic response to insurance regulatory developments Alex Thomson, May 2013!@#
Agenda 1. Strategic priorities and regulation 2. Global insurance regulatory developments 3. East African response 4. Core principles/focus areas 5. Deriving value from regulatory change 6. Closing 2
Strategic priorities and regulation 3
What are your strategic priorities as an insurer? Typical strategic priorities list: Distribution Claims Administration, systems, payments and servicing, digital Products and underwriting These are clearly important, but are they enough? What will be the factors driving market leadership in the next 5-10 years? 1. Finger on the pulse - Actuarial analysis and management information will be a key differentiator 2. Eye on the ball - Effective governance will allow you to stay focused on what s important, and to grow sustainably 4
How does regulation fit in? Recent experience suggests that many of the principles underlying the new regulations are aligned with good business practice Clear understanding of the business s value drivers and risks Effective integration of the functional responsibilities within the business (avoidance of silos) The theory may be good, but does this happen in practice? Businesses approach regulation reactively It s an extra burden and cost, and does not add value The approach to supervision is also critical 5
Global insurance supervisory developments 6
The new insurance world In March 2013, Dr Richard Ward, Lloyd's Chief Executive Officer, rebuked European regulators for further delays in Solvency II, highlighting that compliance with the rules had already cost Lloyd s about 300m to date, saying What planet are these guys on? Andrew Bailey, head of the UK s new Prudential Regulation Authority, said the mounting costs estimated to total at least 3bn for UK companies alone were frankly indefensible. 7
Global insurance supervisory developments Solvency II: Since 2004 the European Commission was working towards a target completion date of 2008 Level 1 directive was only eventually adopted in November 2009, providing for the regime to come into force from 1 November 2012 Owing to extensive economic impact debate and political challenges, implementation in 2015 seems unlikely, although various interim measures are being pursued by country regulators Insurance core principles (ICP s) and standards updated by the International Association of Insurance Supervisors (IAIS) in February 2011 Similar principles pursued in many regimes globally. Eg in South Africa: Solvency Assessment and Management (SAM) QIS1 and QIS2 completed Non-life insurance quantitative interim measures in force Governance interim measures and group supervision expected 1/1/2014, light parallel run in H2 2014, full parallel run in 2015, and full implementation 1/1/2016 8
Drivers of regulatory change in financial services Global Financial Crisis Insurance failures such as HIH, AIG, etc. Globalisation and the need for harmonisation of regulatory frameworks, reducing regulatory arbitrage Convergence between banking and insurance, and similar developments in the banking industry (Basel II/III) The International Association of Insurance Supervisors, supported by international development organisations (IMF, World Bank), has played a key role in driving regulatory change in the global insurance industry 9
East African response 10
East African response In light of Solvency II IAIS ICP s and standards Guidelines issued by Kenya s Insurance Regulatory Authority for observance by all insurers registered under the Insurance Act Cap 487 (all effective from 30 June 2013, except Reinsurance (1 April 2013)) : GUIDELINES ON ACTUARIAL FUNCTION GUIDELINES ON RISK MANAGEMENT AND INTERNAL CONTROLS Global developments (eg SAM) GUIDELINES ON EXTERNAL AUDITORS GUIDELINES ON REINSURANCE 11
ACTUARIAL FUNCTION (including FCR) RISK MANAGEMENT AND INTERNAL CONTROLS REINSURANCE EXTERNAL AUDITORS East African response (2) Solvency II/SAM Pillar 1: Risk-based restatement of balance sheet, and insurer specific capital requirement Pillar 2: Explicit requirements and principles on risk management and governance Pillar 3: Increased reporting on risk profile and financials (public) and strategies (to regulator) Own Risk and Solvency Assessment: Board and management s own views of risks and the appropriateness of capital requirements, strategies and risk appetite Kenyan guidelines 12
ACTUARIAL FUNCTION (including FCR) RISK MANAGEMENT AND INTERNAL CONTROLS REINSURANCE EXTERNAL AUDITORS East African response (2) Pillar 1: Risk-based restatement of balance sheet, and insurer specific capital requirement Pillar 2: Explicit requirements and principles on risk management and governance Pillar 3: Increased reporting on risk profile and financials (public) and strategies (to regulator) Own Risk and Solvency Assessment: Board and management s own views of risks and the appropriateness of capital requirements, strategies and risk appetite 13
Core principles/focus areas 14
Core principles/focus areas 1. Risk-based capital and risk-based management 2. Risk-based supervision 3. Governance models and the role of the board 4. Changing role of Risk and Actuarial 5. Principles based regimes, and proportionality 6. Data * 2012 Ernst & Young European Solvency II survey 15
Risk-based capital and risk-based management Requirements Company specific capital requirement, reflecting all risks associated with insurance activities, investments and financial decisions, and all operational activities Management s ownership through the ORSA, and requirements for use of ORSA and embedding ORSA into decision making Objectives and strategic impact Better understanding (and quantification) of risks will improve decision making and increase policyholder protection and stability of financial system Competitive advantages associated with risk selection, pricing and better informed strategies Lessons learnt and next steps Change does not happen overnight engage stakeholders early Get buy-in from top, especially in the way the performance of the business will be assessed in the new world (including KPI s) Structured and well-governed programmes ensure coordination, recognition of dependencies and responsibility for deliverables Recognise difference between project activities and BAU, but emphasise focus on overlaps and existing business calendar (strategy updates, budgeting etc) 16
Risk-based supervision Objectives A structured process aimed at identifying the most critical risks that face each company through a focused review by the supervisor to assess: The company s management of those risks The company s financial vulnerability to potential adverse experience. Lessons learnt Mutually beneficial to regulator and Board Requires firms to embrace regime and the true underlying principles Requires extensive regulators skills, and regulators to embrace principles based approach (as opposed to tick boxes) 17
Governance models and the role of the board Requirements General good governance across the organisation, with clear roles and responsibilities and mandates Explicit requirements for certain functions ( control functions ), including fit and proper Board responsible for policyholder protection and broader stakeholder interests Objectives and strategic impact Regulator passes significant responsibility back to Board Well defined and documented processes, especially risk management, reduce risk of extreme financial impact Avoidance of conflicts of interest reduces compromised decision making Lessons learnt and next steps Increased onus on board requires reconsideration of individuals appropriateness or their willingness to understand technical implications Operating model redesign often flows from governance gap analyses While documentation (very often absent of existing processes) is important, it should not be excessive/generic, but company specific Communication/Reporting to Board should not be excessive but should focus on key metrics and the impact of key risks 18
Changing role of Risk and Actuarial Requirements An effective risk-management system comprising strategies, processes and reporting procedures necessary to identify, measure, monitor, manage and report, on a continuous basis the risks, to which they are or could be exposed, and their interdependencies An actuarial function to give assurance on understanding of risks and the balance sheet Objectives and strategic impact Traditionally, risk management functions have been focused on operational risk, but will now be responsible for all risks in the standard formula as well as risks not covered by it The quantitative view of the risk position should form the basis for monitoring the risk appetite Lessons learnt and next steps A new paradigm for the Risk Function to understand and monitor all risk categories, and ultimately give assurance to the board on the risk position relative to the risk appetite Formulation of the risk appetite and translation into metrics and subsequently into limits and mandates Managing the first and second lines of defence roles, with risk being close enough to business to truly understand it, and actuarial adding business value to quantification and analysis of strategy, YET able to provide assurance 19
Principles based regimes, and proportionality Requirements The system of governance shall be proportionate to the nature, scale and complexity of the operations of the insurer Processes which are proportionate to the nature, scale and complexity of the risks inherent in its business and which enable it to properly identify and assess the risks it faces Objectives and strategic impact Reasonable costs Comply with Principles or Spirit as opposed to requirements Onus on organisation to demonstrate the methods used in the assessment Proportionality must be linked to materiality Lessons learnt and next steps Applies to the quantitative and qualitative aspects Size is not always a proxy for the degree of risk and appropriate point on the spectrum of proportionality In order to apply appropriate response, a comprehensive understanding of the requirements is critical Be proactive in performing assessment of requirements and communicating proposed response to regulator Evaluate comparable operating models, to explore potential efficiencies (such as combining control functions) 20
Data Requirements Internal processes and procedures in place to ensure the appropriateness, completeness and accuracy of the data used Suitable processes and procedures to ensure the reliability, sufficiency and adequacy of both the statistical and accounting data to be considered both in the underwriting and reserving processes Objectives and strategic impact Risk reporting will need to be more detailed and transparent the basis for this being robust data platforms Incentive for capital requirement to be lowered in case of adequate volume of credible historical data Need for detailed data to validate standard formula and adjust it to be appropriate for the organisation Necessary for regulatory purposes, but also critical as MI becomes a competitive advantage Lessons learnt and next steps The data used in the calculations must be capable of being traced from its sources through to the end results Quality data key in establishing industrialised calculation and reporting processes (as opposed to current manual), or at least more controlled and integrated calculations A significant component of many Solvency II/SAM programmes, with many of our clients spending more than a third of their total programme costs on data gap analyses, operating model redesign, systems acquisitions or systems upgrades/self-build. 21
Deriving value from regulatory change 22
Irrespective of regulatory timelines and scope the principles are sound, and the recognition of the strategic impact is what is driving change in industry leading insurers. Value-based management by large European insurers * 35% 30% 25% 20% 15% 10% 27% 24% 30% 5% 9% 10% 0% VBM concept exists, with ratios at company level. VBM-metrics used for a VB-compensation structure VBM-metrics used to manage at company or divisional level VBM-metrics used for operational management of portfolios & investments VBM-metrics used for operational management of new business * 2012 Ernst & Young European Solvency II survey * 2012 Ernst & Young European Solvency II survey 23
Irrespective of regulatory timelines and scope the principles are sound, and the recognition of the strategic impact is what is driving change in industry leading insurers. Expected return due to valuebased management * * 2012 Ernst & Young European Solvency II survey * 2012 Ernst & Young European Solvency II survey 24
Example: reinsurance structuring Moving towards a Solvency II world, insurers increased sophistication in quantifying and understanding risk is becoming the base for decision making The market is starting to prepare its commercial response as the acceptance, transfer or pooling of risks becomes critical Insurers are recognising that their existing reinsurance frameworks are yielding inefficient structures or overpriced purchase, or not effectively addressing or covering risks as per the risk appetite 25
Example: reinsurance structuring Redefining reinsurance objectives Business enabler Supporting commercial endeavours through capacity Risk Management Instrument Limiting exposure to individual large risks and concentration of risks; explicitly addressing components of the Risk Appetite such as Solvency or Earnings Volatility Efficient balance of different reinsurance objectives Capital management instrument A source of capital to underpin volume of business, and to reduce capital requirement as a result of certain exposures Risk taking vehicle A source of profit, through efficient structuring or increased risk retention at acceptable levels of risk/capital (including inwards RI) 26
Example: reinsurance structuring An example roll-out 27
Summary Actuarial Analytics Examples Technical Pricing Price Optimisation Value Based Management Reinsurance Investment Capital Management Enablers Data Tools Skills Actuarial, IT High quality admin systems Business Integration Understanding of Value Drivers Simplicity Scalability Minimise nasty surprises Reduce total cost of visible and invisible Risk Management Clear Stakeholder Management Regulatory Compliance Effective Governance Smart risk taking and risk management aligned with Risk Appetite Consistent approach to risk-based decision making Oversight of Risk Management Clear responsibilities and effective communication 28
Insurers that use regulatory change to facilitate enhancements to business analytics and governance will derive sustainable competitive advantage and market leadership 29
Ernst & Young Assurance Tax Transactions Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve potential. Contact: Alex Thomson - Director: Actuarial E: alex.thomson@za.ey.com C: +27 83 400 2380 For more information, please visit www.ey.com. 2013 Ernst & Young - all rights reserved. Proprietary and confidential. Do not distribute without written permission. 30