david biggin | board talk | 8 January 2016
This blog first appeared on Board Talk
The implementation of Solvency II on 1 January 2016 comes after 10 years of work from governments, regulators and insurers to introduce a modernised set of rules for the European insurance industry.
First envisaged in the early 2000s and fraught with multiple delays and policy negotiations, Solvency II introduces risk-sensitive capital requirements. These are designed to ensure that an insurance firm can withstand a one in 200 year shock event and transfer its liabilities to another insurer in the event of its failure. In addition to the capital framework, Solvency II also harmonises risk management, governance, and reporting and disclosure requirements across European insurers.
Implementation of Solvency II has already placed a burden on the Boards of insurers as they work to get to grips with the new regime. For those insurers who applied a bespoke approach to calculating their capital using an internal model, regulators have forced boards both individually and collectively to prove that they understand the calibration of the firm’s risks, that they understand and are in control of decisions being made on capital requirements and have a robust approach to checking or validating that their capital model remains correct and appropriate. For many board members, particularly those from a non-actuarial background, this has required a concerted effort to understand and challenge complex actuarial topics.
Now a number of challenges remain for the board of any insurer.
Finalising implementation: although the large majority of work to prepare for the new regime is complete and insurers looks well prepared to meet the capital and risk management requirements, there remains a large amount of work to meet the disclosure requirements. These require the identification, aggregation and reporting of large amounts of asset and liability information following quarter and year end. The window to report this information of eight weeks will reduce to five weeks following a transition period and this will place strain on the finance teams to complete an already convoluted process in even shorter timescales before the Board can sign off the information.
Reporting first quarter results and managing messages to the market: listed insurers will begin to report solvency ratios from January 2016. The CFO and the Board will need to understand and explain changes to solvency ratios, particularly where they decrease from those reported in 2015. They will need to provide more colour to analysts on how the transitional elements of Solvency II affect the capital requirements of the business.
Risk management shaping investment and product strategy: Solvency II requires insurers to invest their assets to ensure the security, quality, liquidity and profitability of their portfolio. As the capital requirements associated with assets vary according to the instrument and the riskiness of the asset, this may lead the Board to reconsider its investment strategy to reduce the associated capital requirement.
In turn this may lead the Board to reconsider products offered, in particular long term guaranteed products such as annuities. This “steering” of the Board and the corporate strategy through a risk management lens will mean the Board will need to engage with both the finance, risk and capital modelling teams alongside the sales and marketing part of the business to define a post-Solvency II implementation business strategy.
M&A: Solvency II is widely expected to increase merger and acquisition activity across Europe for two reasons. Firstly, a level playing field for capital requirements makes valuation of companies’ liabilities across different markets and geographies more comparable and transparent. Secondly, Solvency II rewards insurers who have a well-diversified risk profile with lower capital requirements, making mergers with complementary companies more attractive. The Boards of some European insurers may adopt a “hunt or be hunted” mind-set in the coming months and years.
Further individual accountability for the Board driven by the Senior Insurance Managers Regime: under Solvency II, specific roles including responsibility for internal audit, risk management, the actuarial function and compliance must be allocated to senior staff. The Senior Insurance Managers Regime coming into force in March 2016 further increases the amount of individual accountability taken on by individual executive board members and further increases the pressure to be felt by the Board.
The implementation of Solvency II has already required a heavy investment from insurer boardrooms and the transition to Solvency II will make the ride in 2016 no less exciting.
David Biggin is a financial services regulation expert at PA Consulting Group