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The Actuary The magazine of the Institute & Faculty of Actuaries

Solvency II: Keys to Success

Solvency II comes to us in the form of a three-pillar concept similar to that used for the banking industry under the new Basel II rules. These three pillars provide an all encompassing set of regulations that will provide new and interesting challenges for the insurance industry.

Firms have developed their compliance methodologies and are now starting to focus on, and tackle, key topical areas. Below are some of the areas that firms need to consider, or are in the throes of planning to address in the near-term.

Modelling and model development
As per the QIS 4 results a sizeable portion of insurance firms in the UK will adopt an internal, or at least a partially internal, model. Currently firms are at varying stages of development or planning their model development and model implementation methodologies. This is a crucial area and a lot of focus and discussions have been held as to how to approach this subject. Various risk-type models (credit, operational, market, etc) have been developed and are being used for internal capital (economic capital) purposes and a lot of consideration is being given to adapting these models for regulatory capital purposes.

While this seems to be in-hand at most of the larger firms, one area that is causing a lot of concern is the aggregation of these risk types to produce the regulatory capital number. A successful (approved by the regulator) aggregation methodology that accurately reflects the risk profile of the firm is something that is key to the success of an internal model development programme.

Data and data management
It is comforting to see that most of the larger firms have started to consider the state of their data, and of the infrastructure and architecture that houses it. Many firms have taken deliberate steps to include data quality assessment initiatives as part of their data and infrastructure compliance programmes. Data as a single factor has the greatest impact on the compliance of the firm and the regulatory capital number it produces.

We have seen time and time again how poor data management and data quality have led to negative results in supervisory reviews, and in the results that the models have produced. Data underpins the entire Solvency II initiative and this can be clearly demonstrated by the fact that the regulator has gone to great pains to highlight this in as many areas of the proposed legislation as possible.

Controls and processes
Firms have stepped up their efforts to enhance and develop their internal audit functions. In addition, they have started to identify weak areas of the business, where controls and processes are inadequate or in some cases do not exist, and they are beginning to address these gaps. Most have approached their process engineering programmes using risk-types as the drivers to their initiatives, emphasizing the level of the threat to the organisation as a way to identify critical path issues.

Firms have had established and functioning governance frameworks in place for some time. However Solvency II has placed pressure on firms to transform them into more risk-focused/risk-aware frameworks. This includes enhanced, or in some cases newly convened, risk committees as well as enhancing the information reported to these committees. Some of these firms are also considering an enhanced role for the governing body, with increasingly active participation in risk and capital management. An increase in accountability and awareness will lead to a number of new roles being created, as well as new internal reporting regimes being introduced.

Outsourcer reviews
This is an area that requires more attention from insurance firms. One of the key requirements of the firm is to ensure the outsourcer meets with the stringent Solvency II requirements stipulated on this subject. Outsourcing is usually a key aspect of an insurance firm, with a majority of the larger firms outsourcing a substantial portion of their business operations to external parties. Solvency II has considered this and placed new rules on how that relationship will evolve. This includes the firm being liable for a failure on the outsourcer’s behalf. Firms need to conduct a stringent review of their outsourcer and specifically ensure that the outsourcer’s infrastructure is fully compliant with the new rules.

To sum up, there is, for many insurance companies, a considerable programme of work that needs to be undertaken in order to become compliant with Solvency II by 31st October 2012. We should not however lose sight of the fact that the purpose of refocusing how insurance companies report and manage their business is to provide stronger and less risky entities that provide a level of transparency from which investors and customers will benefit.

Andy McQuade is vice president and head of Insurance at Capgemini Financial Services