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Regulation and risk The strategic response to insurance regulatory developments
Alex Thomson, May 2013
2 Financial Services Strategic Forum
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
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Strategic priorities and regulation
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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
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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
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Global insurance supervisory developments
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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”.
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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
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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
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East African response
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East African response
Solvency II
IAIS ICP’s and standards
Global developments (eg
SAM)
In light of
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
GUIDELINES ON EXTERNAL AUDITORS
GUIDELINES ON REINSURANCE
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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 A
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Pillar 3: Increased
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Solvency II/SAM
Kenyan guidelines
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East African response (2)
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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
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Core principles/focus areas
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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
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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)
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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)
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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
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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
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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)
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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.
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Deriving value from regulatory change
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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.
27%
9%
24%
10%
30%
0%
5%
10%
15%
20%
25%
30%
35%
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
Value-based management by large European insurers *
* 2012 Ernst & Young European Solvency II survey * 2012 Ernst & Young European Solvency II survey
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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 value-
based management *
* 2012 Ernst & Young European Solvency II survey * 2012 Ernst & Young European Solvency II survey
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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
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Example: reinsurance structuring Redefining reinsurance objectives
Risk Management
Instrument
Capital management
instrument
Business enabler Risk taking
vehicle
Limiting exposure to individual
large risks and concentration of
risks; explicitly addressing
components of the Risk Appetite
such as Solvency or Earnings
Volatility
A source of capital to underpin
volume of business, and to
reduce capital requirement as a
result of certain exposures
Supporting commercial
endeavours through capacity A source of profit, through
efficient structuring or
increased risk retention at
acceptable levels of risk/capital
(including inwards RI)
Efficient balance
of different
reinsurance
objectives
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Example: reinsurance structuring An example roll-out
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Regulatory Compliance
►Business Integration
►Understanding of Value Drivers
►Simplicity
►Scalability
►Minimise nasty surprises
►Reduce total cost of visible and invisible Risk
Management
►Clear Stakeholder Management
Summary
►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
Effective Governance
►Examples
►Technical Pricing
►Price Optimisation
►Value Based Management
►Reinsurance
►Investment
►Capital Management
►Enablers
►Data
►Tools
►Skills – Actuarial, IT
►High quality admin systems
Actuarial Analytics
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Insurers that use regulatory change to facilitate enhancements
to business analytics and governance will derive sustainable
competitive advantage and market leadership
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Ernst & Young
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© 2013 Ernst & Young - all rights reserved.
Proprietary and confidential. Do not distribute
without written permission.
Contact: ► Alex Thomson - Director: Actuarial E: [email protected] C: +27 83 400 2380