The forecast for actuaries could be gloomy, seeing them lose out to other risk professionals, if they fail to maintain a wider influence in managing risk under Solvency II. Scott Robinson reports
Since Solvency II arrived on our radar it has thrown up many areas of uncertainty, and continues to do so. Just as I started drafting this article, the European Union announced a further delay in the consideration of Omnibus II by the European Parliament until after the summer recess, with the likely result that there will be an even shorter timeframe for member countries to transpose the regulations into national law ahead of the implementation date in January 2014.
The art of interpretation - and perhaps a crystal ball in some circumstances - has become part and parcel of the tools required for those charged with making sure companies are ready for Solvency II.
Such tools do not necessarily fall within the comfort zone of all actuaries. After all, we have been trained to deal principally in numbers and statistics, even if we do have to be able to recognise trends and patterns in order to turn them into meaningful distributions and models.
But one aspect of Solvency II that is too close to home to ignore is the future of the actuarial function. The degree to which we understand the nuances that can be read into the Solvency II definitions and work through issues to demonstrate solutions could make all the difference in positioning actuaries as risk management strategists rather than regulatory compliance robots. So, let's consider some of these headline nuances.
The actuarial function is one of four elements of the system of governance defined in Solvency II, along with compliance, risk management and internal audit. Of these, only internal audit is required to be fully independent, meaning that, in theory, a single person may carry out more than one of the other three functions. Only operational independence is required. Moreover, companies are free to decide how to organise these functions.
What does this mean? First, the actuarial function is not considered an organisational unit, be it one person or a group of people. Instead, Solvency II defines it as a regulatory function. Although Article 42 states that the function must meet 'fit and proper' requirements, there is no explicit expectation that those fulfilling the actuarial function, including the actuarial function head (AFH), need actuarial qualifications.
Parking the issue of who is qualified to carry out the actuarial function in the first place, the key responsibilities of that function, as set out in Article 48, provide the majority of the grey areas. These comprise:
- Calculation of technical provisions
- Methods, assumptions and data
- Reporting requirements
- Risk management
The stated role of the actuarial function is to coordinate calculation of technical provisions. But what is meant by 'coordinate' and does this imply that the actuarial function is an operating or a controlling activity? Reading further into the draft Level 3 measures for governance, the firm needs appropriate controls around the calculation and establishment of technical provisions, but it is not clear whether such controls fall to the actuarial function. It is left to individual firms to manage potential conflicts of interest.
Methods, assumptions and data
The actuarial function needs to be able to challenge models and methods and understand the different drivers of risk that affect technical provisions. One area that needs to be resolved, for example, if there is to be a personal sign-off, is how much the AFH can be involved in the design of the technical provisions. How firms choose to interpret the coordinating role, and the extent to which actuaries are involved in this decision, may have a considerable influence on the scope and deliverables of the actuarial function, be they technical reports or certification and/or opinion.
Determining whether the main drivers of risk are reflected appropriately in models, and in the assumptions and methods used to derive technical provisions, is a responsibility that will be familiar to UK actuaries at least. One area where Solvency II is pretty clear is that the review of the sufficiency and quality of data, both internal and external, used in the calculation of the technical provisions lies with the actuarial function.
Solvency II does, however, place more emphasis than the current regime on interacting with other professionals, particularly with regards to audit and IT. So, in addition to core areas such as setting assumptions for expenses (including those that are not linked with servicing insurance obligations, such as pension scheme deficits), biometric risk factors and the future impact of management actions, the extent to which the actuarial function is involved in 'operating' or 'controlling' remains up for grabs. The question of proportionality, and how companies embed this core principle of Solvency II in their approach to data and risk assessment, is perhaps one key area where actuaries can make an important contribution.
The reporting requirements of Solvency II require firms to consider how they will demonstrate compliance with the concepts of 'reliability' and 'adequacy'. The AFH will need to give an opinion on the reliability and adequacy of technical provisions. Aside from customary checks on models and results, additional tools may be developed. One possible approach may be to use benchmarking, where lapse, mortality and expense assumptions, for example, and potentially absolute levels of technical provisions could be compared against market averages and/or specimen policy results.
In addition, as technical provisions include the risk margin, which itself is dependent on the Solvency Capital Requirement (SCR), does this mean that the AFH is expressing a view on the SCR? The regulations do not explicitly require the actuarial function to consider the SCR, but boards are likely to expect the AFH to have a detailed understanding of the SCR, and may therefore expect the actuarial report to cover views on it.
A lot of the uncertainty surrounding the requirements revolves around possible organisational reporting lines. There are numerous ways in which this could be approached but, whatever the reporting line is, there is a need for operational independence. Conjecture also extends into the structure of the actuarial function's report, since EIOPA has stated that it does not intend to stipulate specific requirements.
In addition to helping shape workable solutions, actuaries may also need to consider whether they need to upskill in order to meet the more material reporting requirements implied in Solvency II, particularly with regard to expressing opinions on the adequacy of underwriting policies and reinsurance arrangements.
While the Framework Directive does affirm the actuary's role in risk management, the draft Level 2 and 3 measures do not make the interaction of the actuarial and risk management functions any clearer. To all intents and purposes, it seems reasonable to project that the operational independence requirement in the directive is more of a mindset than a formalised structure.
Another way of looking at the distinctions and the need to avoid conflicts of interest might be to consider how and to what extent the actuarial function might contribute to the elements of the Own Risk and Solvency Assessment (ORSA) - risk appetite, identifying and assessing risk, risk measurement, monitoring and reporting, links to business strategy, and stress and scenario testing. A useful exercise could be to consider the responsibilities and interactions between the actuarial and risk functions.
Firms are also likely to consider the role of the actuarial function in the context of the 'three lines of defence' governance model that is widely used across financial services. This would help place specific areas of activity required for Solvency II as geared towards business as usual, oversight or independent assurance.
Straddling all these unresolved questions, the bigger question is whether actuaries are sufficiently engaged with these issues to make an impact on the decisions and structures that will ultimately be put in place by senior management. Or, are we typically too buried in the detail of the calculation of the technical provisions and the SCR?
Could it be that Solvency II is in danger of sucking actuaries into a vortex where some of the profession is in danger of becoming identified with a regulatory function rather than wider risk management within the business? The two roles are very different.
So, here are a few things for actuaries to contemplate in the coming months as Solvency II edges closer to reality:
- How involved are you in defining your firm's operating model for risk management?
- Who are you likely to report to under Solvency II?
- How involved are you getting in setting standards and organisational structures for your business?
- Are you championing the actuarial skillset in meeting organisational challenges?
- Have you considered the detailed requirements of the actuarial function and, where regulations are not so clear, what this means for you and your organisation?
- How comfortable do you feel about providing an opinion on overall underwriting and reinsurance policies?
Unlike much of what actuaries do, Solvency II compliance is an inexact science. Let's not allow that to put us off asserting our broader role in managing risk.
I totally relate to this article and I fear that the actuarial profession, in spite of its desire to expand into the risk field - with efforts like the new international CERA - will not attain its goals. Essentially, as a profession, we don' t have any kind of principles-based ERM to propose, where we could present our version of ERM instead of simply becoming the technicians of risk, who will implement what others have been thinking about like COSO or Solvency II. We need to work on that!
Michel Rochette, ERM Advisor, Researcher and Trainer at Enterprise Risk Advisor