Monday, 18 August 2014

ORSA - Institute of Risk Management special interest group

Of course while I spent the last couple of months topping up my tan in, errrrr, the Isle of Man, some of the guys in the UK and further afield have been building up an endeavour-flavoured sweat on some of the more malleable elements of Solvency II preparation.

Raining 'Mann' - Glorious Manx summer
The IRM as ever have kept the ball rolling, in particular hosting an ORSA session last month. While you can pick your way through the guest speaker presentations for ideas and comfort (one company specific, one consultant generic, and one which S&ST/RST fans might like as a sense check), I was much more interested in the attendee survey.

A whopping 34 replies came in, via which the attendees have delivered a reasonable ORSA landscape mock-up, which may help some of you get matters shuffled in your priority lists, given where your peers claim to be.

I noted in particular;
  • ORSA Process overwhelmingly run by the Risk functions (over 90%)
  • Just over half going for annual frequency, the rest (who responded) naturally more frequent - doesn't instinctively feel representative, but not all of the smaller firms would send someone down to this!
  • Around two-thirds have their "Reports" at 50 pages or less - if we assume that by "report" we mean Supervisory as well as Internal, the PRA won't be too chuffed with that given their comments at the December industry seminar.
  • Only a third have submitted draft ORSA Reports to the PRA and received feedback
  • Coverage of emerging risk appears to be an area which not only do respondees think is lacking, but has received critical feedback from the PRA
That half have used external consultants in their ORSA work to-date is certainly no surprise. I'd be worried if that consultancy had more than a year's dust on it though, so think hard before you start submitting your 2014 gear!

FTSE Insurers and Solvency II costs - quick round up

So I'm back to work after a well earned pit stop back home. I'll start with a summary of all goings-on in the Solvency II world over the summer using the following complex schematic...


Solvency II implementation costs to insurers, having experienced feast and famine over the last 2 years, will be firmly back on the bean counters' agendas now the finish line is in sight. In the past I had mopped up the 2013 financial year end here, the 2013 interims here, and 2012's full year here, so there is plenty of numbers out there for those interested.

I've therefore taken a quick look at some of the UK interim reports out over the last couple of weeks, just to see what costs/lobbying elements are included. It has been pretty dry going, which may reflect analyst fatigue on the matter more than insurer ambivalence, but I'd flag the following;

Aviva
- Costs which are "mostly" Solvency II at £41m for the half year
- No substantive comments on current legislative position

RSA
- Costs of £14m for the half year, against £20m for all of last year
- Amusingly classify Solvency II expense as "One-off non-operating costs"!

Standard Life
- "...expect [their] capital position to remain strong following implementation"
- No reference to costs

Prudential
- Implementation costs (broken out into p10 of this IFRS supplement) of £11m for half year, versus £13m for the comparable half-year, and £29m for all of 2013
- "...preparations are well advanced"
- Backwards in coming forwards over the likelihood of model approval and valuation assumptions (p17)
- Domicile change still left dangling (p24)

Old Mutual
- "...well positioned" for Solvency II, though "...continue to experience a degree of uncertainty"
- Nothing on costs

Legal and General
- "...expect the final outcome on Solvency II to result in a lower Group Solevncy Capital ratio" than existing EC. They stress in their accompanying presentation and in Nigel Wilson's speech that their existing EC is not Solvency II capital!
- Indication on  p17 of the Analyst presentation notes where L&G and the ABI have potentially fallen out (hence their recent divorce)
- Nothing on costs

Wednesday, 2 April 2014

EIOPA's Implementing Technical Standards on Approval Processes - Cut and Paste?

EIOPA have at last commenced their work on "Level 2.5" regulation in the Solvency II world, and with it being something of a trip into the unknown (only their sister body ESMA world appear to have performed a similar exercise to-date), their consultation papers will no doubt be getting torn apart like a parking ticket by Insurers and NCAs alike.

Open until the end of June with a view to presenting this particular batch to the European Commission for endorsement by the end of October, the ITS cover how the following approvals should be applied for and administered, with definitions and rationale provided in this cover note.
  • Use of Matching Adjustment
  • Use of Internal Model, "Major" changes to that model, and changes to the Model Change Policy (phew!)
  • Use of a Group Internal Model
  • Use of Undertaking-Specific Parameters (USPs)
  • Use of Ancilliary Own Funds for SCR
  • Use of Special Purpose Vehicles for risk transference

For this post, I wanted to concentrate on the Internal Model-themed ITS (emboldened), specifically things which introduce something new to the table (i.e. not already in the thoughts of UK firms/regulators through the Directive, Delegated Acts, Preparatory Guidance or indeed the existing IMAP structure in the UK).

Therefore in the interests of recyclability, UK firms will be delighted by the requirements within this particular ITS - you will recognise the text as part of the Self-Assessment Template "tabs" which you would have been populating as part of IMAP over the last 2 years!

That text was of course co-opted from the Draft Implementing Measures from October 2011 (specifically Article 203 IM1 for the application requirements, IM2-IM8 for the model change and administrative process elements). These articles had disappeared from the latest version of the Delegated Acts, only to find its way into this ITS almost verbatim.

Elements which therefore show noteworthy change from that old text (other than semantics) include

  • The addition of a requirement for a (year-end 2014?) P&L Attribution to be submitted as part of the application.
  • Withdrawal of some of the ceremony around applying for a change to the Model Change Policy, which was a little more elaborate in the October '11 text (AMSB explanation and justification text, 6 month turnaround time for NCAs to make a ruling).
  • The same for an application for a Model Change itself, now seemingly less formal
  • Giving room for terms and conditions and transitional plans to be factored in to an NCA's decision on model approval
  • That more detail should be published on the NCA's website regarding the approval (namely that the scope of the IM should be disclosed, as well as risk categories and business units covered, which feels a touch commercially sensitive to me!)

I'm guessing this isn't the only ITS which is going to use this approach (i.e. ripping text directly out of the Oct 2011 Draft Implementing Measures where it has been seemingly jettisoned), so a bit of cross checking might help you second guess what is going to appear in the rest of the ITS!

Now I'm off to have a look at the others...


Monday, 31 March 2014

EIOPA's "Common Application Package" for Internal Model Applications - UK back to the drawing board?

The release of an EIOPA Opinion today may very well raise the heckles of the UK Insurance Industry, regarding a move towards a "Common Application Package" to be used across Europe for assessing internal model applications. This appears on the face of it to be disjoined from the internal model-related ITS already scheduled in EIOPA's calendar (p12) over the next couple of months.

Their "package", to be published after consultation with the National Competent Authorities themselves, will comprise of;

  •  Instructions 
  •  A self-assessment 
  •  Background Information 
  •  An inventory of internal documentation 
  •  An explanatory document 

Worth remembering at outset;


That said, a combination of EIOPA's desire for convergence, and the recently released and revised Delegated Acts may have a particularly destructive effect on existing IMAP efforts within the Solvency II Programmes of UK insurers. I have therefore had a deeper trawl through the Delegated Acts in order find out what the practical implication of any changes in the redrafted Delegated Acts might be.

As anyone who has worked in the UK IMAP space will (un)happily tell you;
  • The PRA's approach to assessing internal model applications (inherited from its predecessor) involves deconstructing Solvency II Directive and Delegated Act text into sentences, and in some cases sentence fragments. This created over 300 "requirements".
  • Those are transferred into a spreadsheet list, within which firms are asked to list evidence of their ability to address each item (or why the requirement is not relevant).
  • That spreadsheet list is housed on an Excel workbook known as the SAT Template, which contains various other worksheets, all of which require manual population of some kind.
  • A fully populated SAT Template is required by the PRA for IMAP participants, along with some ancilliary documents (listed here), supplemented by any further documentation which the legislation or EIOPA deem is compulsory.
It's not a tick-box exercise though...

The recent versions of the Delegated Acts which have been creeping around are therefore of some significance to this work. Over the last couple of years, firms will have populated a SAT Template which contained deconstructed sentences from the Solvency II Directive pre-Omnibus II, and the Delegated Act text from November 2011, both of which have now been superseded (without being too presumptuous!).

How do the changes affect the contents of firm's existing IMAP templates, and indeed does it matter? Well, it goes without saying that the SAT Template will need to be amended and reissued by the PRA, regardless of what EIOPA produce. The question for UK firms, having spent considerable money and resource on populating the template in 2011/2012, is whether or not to start from scratch, now that time is something of a luxury, and the end-game is more definitive.

With 2013 being something of a write-off for both Solvency II programmes and the PRA's IMAP campaign (although the costs suggest otherwise!), it is likely that existing SAT templates, crammed with bespoke explanatory text and document references, have either gathered dust for a month or twelve, or received only minimal maintenance.

To see exactly how much of those early efforts will be salvageable, I have taken a look at the Delegated Act articles from January 2014* regarding the Tests and Standards for Internal Model Approval (or 'TSIM', after the acronym allocated to these articles by the draughtsmen), and compared it against the November 2011 version of the same text, and found some significant changes in form and substance, which may render some of your earlier SAT population efforts chocolate-fireguard useful.

The 24 original TSIMs, once deconstructed, respresent over 200 (almost two-thirds) of the "requirements" listed within the SAT template, so any changes in them could massively impact the recyclability of existing content.

IMAP Changes - has EIOPA gone Gaga?
I found, of those 24;
  • 6 are unchanged verbatim
  • 2 have minor definitional tweaks, but are otherwise unchanged
  • 2 have been merged
  • 2 'new' articles have been introduced into the section, though neither are labelled "TSIM" at this point.
  • All others have been changed in at least form, and in the majority of cases, substance
IMAP candidate firms have therefore been left to contend with more awkward changes than a Lady Gaga concert in a broom cupboard...

Those which have received the most aggressive reworking include;
  • Article 225 TSIM 15 - Management Actions
  • Article 229 TSIM 18 - Model Validation Process
  • Article 230 TSIM 19 - Validation Tools
  • Article 232 TSIM 21 - Minimum content of the documentation
It is fair to say therefore that UK-centred internal model applicants may struggle to recycle their existing IMAP drafting efforts without re-engaging Business-As-Usual staff in a substantial way, and that is before we even get to what EIOPA may propose in the "common application package". It also remains to be seen how the other European countries react to the likely Anglicisation of internal model assessment.

If you need help with this on your Solvency II Programme, don't be afraid to get in touch at allan@governance-matters.co.uk


* Just for reassurance, the TSIM text doesn't change between the January 2014 and March 2014 versions, but unless someone published the March version online, you'll have to take my word for that!

Wednesday, 26 March 2014

Solvency II Delegated Acts available online (kind of...), plus EIOPA's plans for 2014/15

So let's start with something a bit unexpected - DRAFT DELEGATED ACTS! ONLINE!

I'm not sure who the leaky uploader is (appears to be a Spanish consultancy firm), but the document is very much online. Sadly, it is only the January 2014 version, which as you will see in the rest of the post, has just been superseded, but it definitely pairs up with the version currently doing the rounds, I promise!

I have managed to get a sneak preview of the latest version of this document (dated 14th March) which have seemingly managed to burst the banks of the tightly-knit circle of advisors, and are now no doubt winging their way to a Solvency II Programme Director near you! There are "tracked changes" on the March document now circulating, which only appears to cover changes since the emergence of the January document hyperlinked above.

Lord help anyone who wants to trace it back to the more familiar 2011 (unpublished) draft, you might as well draw a load of foxheads on sticks...

Insurance Europe were obviously part of the privileged few for the March revisions, hence they fired out this missive last week regarding all of the Pillar 1 technical areas which they feel (on behalf of the industry) remain deficient. There are no real surprises in their list - it is the same topics which have been on the whinge-list since EIOPA's LTGA last year, and indeed earlier in the case of the Currency Risk approach and Own Funds classification.

Following on from the draft Delegated Acts being made more widely available, there has been a reasonable amount of noise in the paid-for press (here, here and here for subscribers), as well as Insurance Europe's top man having a lobbying call published in the FT (here).

Being more of a Pillar 2 man myself, I thought I would check to see what, if anything, had been tweaked in my areas of interest. The impression given earlier this year was that little had changed outside of the Long-Term Guarantee elements, and that was certainly true if you compared the November 2011 and January 2014 documents.

However, having examined the amendments in the March 2014 version, I have found is that a few areas of governance (both SOG and Internal Model governance) which were previously untouched have actually received a fair bit of treatment, for example;
  • Changes to the requirements for internal audit function holders not to cover multiple control functions (this constraint has been removed). This is presumably to pacify the smaller firms across Europe who have a Risk/Compliance/Internal Audit multi-tasker, so textbook "three lines of defence" have taken a bath in the interests of proportionality.
  • The devil remains in the detail though, as the amended text allows someone to "carry out" more than the IA function, but seems to stop shy of them "taking responsibility" for other functions. Not sure how that will work in practice.
  • Changes in the IM Validation space, in particular the removal of the requirement for a "Validation Policy". Fair to say most firms in IMAP would have produced one of these at least a year ago now (plenty of industry references here, here, here (p8) and here for example!), and while still a document of merit, does a "validation policy" now constitute gold-plating?
  • Changes in the required Internal Model Documentation, targeting a much slimmer set of compulsory documents. This includes replacing a number of "policies" with "descriptions of...", which will no doubt be well received by those supervisors with multiple internal models to assess over the next 18 months!
  • The tiered timescales for submitting QRTs, SFCRs and RSRs have now moved into the Directive, via Omnibus II text (as opposed to haveing been deleted, which is what it looks like at first glance!)
  • A few of the other TSIM articles (Tests and Standards for Internal Model Approval) have been enhanced. "At least quarterly..." assessment of the IMs coverage of material risks is now specified, for example. Quite how the hard-coding of the regularity cramps your actuaries' style is another thing! 
I strongly suggest you all get back to work and check for yourselves!

Thursday, 20 March 2014

The PRA and Insurer Business Model Analysis - emerging risks into capital add-ons?

A rather revealing "topical article" was pushed out by our pals at the PRA this week, mouthwateringly titled "The role of business model analysis in the supervision of insurers".

I obviously threw my Woman's Weekly professional reading materials to one side in order to see how much juice there was in this particular fruit, and it is certainly worth a glance for anyone in the risk management game, if only for the idiot's guide to Life and General insurer business models it provides!

Ironically, in the Life Insurer case (where they have chosen 'non-standard annuities' as a paradigm-changing product offering), they weren't able to forecast yesterday's scuppering of the UK annuities market in its entirety in their business model analysis!

It actually reads as quite a good case study in how we should be conducting emerging risk assessment against one's prevailing strategy, walking through specific changes in the operating environments of Life and General Insurers driven by both exogenous and endogenous factors.

With the price comparison website example, it is a good example of how a strategic risk filters down into second order risks which require reconsideration. The annuity example shows how the impact of competitors can impact both existing new business streams and the risk profile of one's existing book.

There is evidently an enormous emphasis being paid in the regulator's BMA activity to those grim business school concepts no doubt already permeating your emerging risk assessment processes such as SWOT and PESTLE analysis, as well as what (in future) will be supplied under Solvency II, most notably Profit and Loss Attributions and ORSA supervisory reports. I'm sure we will see over the next couple of years how the PRA's demand for these very sensitive in-house outputs materialises into supervisory action!

What perhaps Risk and Capital Management functions should be particularly cautious of is the leitmotif of the PRA "responding pre-emptively" where they feel that profits are not aligned with the risks insurance firms are taking. The following quote is of particular concern, as I can't see how this and the ORSA supervisory report aren't sharing the same womb (my emphasis)!;
"...the results of a BMA exercise help to inform the PRA's expectations of a firm's financial and non-financial resources. For example, the PRA might raise capital requirements, or require a firm to improve its governance process, to address weaknesses identified by BMA"
Bearing in mind we are months away from the first glut of ORSA material being delivered to Moorgate's finest, is the industry about to fertilise an expensive new world of capital add-ons via supplementary business model disclosure?

I appreciate that it has been emphasised by the PRA (p8) that ORSAs, and their supervisory reports, simply cannot be used to set regulatory capital, but in the context of what is being stated by the BMA team here, would they really be ignored?

Wednesday, 19 March 2014

Myners briefing on Governance at the Co-op - working class barred from the Board?

Wolf - step away from the door...
A corporate governance story that will echo in the eternity of MBA classes for years to come, the unravelling of the UK's Co-operative Group from the benign grocer-cum-divvy machine into a ying and yang shotgun conglomerate of opposites is proving to be a watershed moment for UK plc, with stakeholders attempting to balance myriad legal, political and ideological considerations in order to both keep the wolf from the door, and preserve the principle of mutuality for its membership.

There are no surprises that the crux of the Group's issues lies in its banking arm, nor that being acquisitive during the financial crisis (here, here and here) has proven to be poor strategy. Keeping the wolf from the door has therefore largely been delivered through the tried and tested combination of begging and borrowing, which the recently departed CEO appears to have delivered with some aplomb.

Governance structures
- choices choices...
However, the Group's hiring of Paul Myners back in December, a man with an extensive collection of t-shirts and hats, to independently review its governance arrangements, seems likely to deliver to the membership a menu of choices as unpalatable as a Sunday skip-dip.

Lord Myners has hurriedly delivered a briefing on his findings to-date, as well as performed some mainstream media duties (here and here), following the Group CEO's resignation last week. This early sighter was seemingly unscheduled, but the manner of the CEO's departure ("a tragedy" in Myners' words) meant that his findings to-date could not wait until May for its full publication date.

Myners has therefore naturally delivered a ruthless and scathing take-down of the governance structure and processes within the Co-operative, while calling out the Board member who are clearly well schooled in how to game the system, as well as the playground tactics/rabbit-in-a-hat tricks that turn "one-man-one-vote" into "one hundred men-all votes"!

Killer quotes
  • The group endures a significant "democratic deficit"
  • The future of my recommendations lies in the hands of around 100 elected individuals on the current Group and Regional boards, few of whom have any serious business experience and many of whom are drawing material financial benefits from their positions
  • There is a phrase frequently used in Co-operative Group circles that the Executive should be "on tap but not on top"
  • ...the Group Board has spent far too much time on transactions such as Somerfield and Britannia which have been breathtakingly value-destructive
Observations
  • The "exceptional skill and tireless efforts" of the Executive team are cited as the reason for the Group's survival in its current form
  • The current governance framework is variously referred to as "flawed", suffering from "acute systemic weaknesses" and having "consistently produced governors without the necessary qualifications and experience to provide effective Board leadership". Ouch...
  • That the Groups social goals are not aligned with its strategic and commercial objectives. This is of course less of a worry for its financial services competitors.
  • The the Group's "massive scale and complexity" means that a man-off-the-street approach to electing Board members, which may be sufficient for a farmer/grocer co-op, is not suitable.
  • Shatters the "myth" that the Group has always been run by lay members, as opposed to those with commercial experience.
  • The thought of creating a board of INEDs and lay members is disregarded due to the potential for creating "second-class citizenship"
  • Highlights that Co-op's core business of groceries is savagely competitive at the moment (just look at Morrison's and Sainsbury's), so continued ineffective governance could be devastating
  • Notes that there have been previously (disregarded) reviews of its governance architecture, which is "long known for its labyrinthine complexity and its disfunctionality"
  • Stresses that, due to the current voting structure, acceptance of  his recommendations "...potentially lie[s] in the hands of fewer than 50 elected members". It sounds like they haven't been shy to remind him of that either!
Recommendations
  • Halve the size of the Group Board, which will be subject to annual re-election
  • Independent Chair, with no previous association with Co-op
  • 6-7 INEDs and 2 Executive Directors
  • All with qualifications of a similar ilk to its (listed) competitors
  • Create a National Membership Council (NMC), with a 12-person executive committee to effectively represent the membership and co-operative principles and values
  • The Board to be subject to scrutiny by the NMC, who have the right to be consulted on "key strategic and operational intiatives"
  • "Arrangements" to be made to safeguard the confidentiality of information shared between the Board and the NMC (certainly not the case with current arrangements!)
The entire document feels drenched in class warfare and spectrum politics. That rather hideous take from the existing Board on their executive team ("on tap, but not on top") feels like the inspiration of Myners' recommendation for a professionalised, appointed Board, rather than the beer and sandwich brigade which currently exists.

That said, there is thought on the left-wing (here and here) who feel that mutuality and co-operation should remain unsullied by the commercial world, who remain unable to affect much in the way of democratic change in Boardrooms even after the raft of FRC-sponsored guidance released over the last couple of years (though PIRC are trying!). Is one failed attempt to democratise stakeholders best replaced by cherry-picking from a similarly deficient model?

On the basis that I have banged the drum for background diversity in Boardrooms (not just gender or race), and the existing Co-op Board is "diverse" in that respect, I'm left to wonder if I've been barking up the wrong tree. The Board delivered by their existing process is neither fit nor proper, and are able to outmanouevre their executive compatriots armed with little more than a working knowledge of provincial politics and a polyester suit.

Should we therefore use the grey-area of "fit and proper" regulation to ban the contract plasterers, nurses and retired publishers of the world from financial service provider Boardrooms on the basis that they don't have an MBA, and count with their fingers? Or can one make a valid contribution to a financial services Board of directors regardless of the colour of their collar?

Tuesday, 18 March 2014

PRA on General Insurer Technical Provisions under Solvency II - Taking the "TPs"?

Allow me to take a quantum leap outside of my comfort zone while I pick my way through the PRA's latest Insurance Industry aide memoire, via a consultation paper on the calculation of technical provisions in General Insurers.

This looks specifically at TP calculations with Solvency II in mind, and is aimed specifically at GI firms currently in IMAP. That said, the tone and technical matter covered is an excellent heads-up to Actuarial, Risk and model validation personnel currently active in this space about how the PRA approach to assessing Solvency II compliance is developing.

The document itself reads very much like their last consultation paper release on Deferred Tax Assets, insofar as it is a laundry list of "what not to do" - look at how many times the expression "should not" appears! They have leaned on their findings from both thematic reviews of TP calculations (Life and GI-specific Questionnaires were sent out a year ago) as well as from IMAP and ICAS, so their finding will be well supported by most recent practices in the UK.

The consultation window is pretty short as well, with a mid-April shut-down scheduled, so if you don't like the cut of their jib, you'd better speak soon.

Stand-out points for me included;

Generic

ENID - TP accommodation required
  • Expectations of Delegated Acts content are cited throughout, but in terms of the exact date of their public provision, they can only go with "Q3 2014". From what I have seen, there is nothing cited which isn't in the November 2011 draft.
  • The abandonment of the term "binary events", replacing it with "Events not in data" or "ENID" - the fait accompli of "binary" (that events which are not in a data set must therefore be extreme and/or rare) is confirmed as unacceptable.  The PRA don't appear to be wedded to the old term in any case, and while the actuarial profession used it liberally in the past (here and here for example), they began a transition away from it late last year (p45 of this).
  • "Any data that can have an impact on the outputs of the internal model should be considered to be 'used for the internal model'" (3.19) - important IMAP message across sectors I think!
  • There is evidently some concern that firms are thinking of relying on the work of external model providers to meet Solvency II standards, with the PRA confirming that firms may not rely on "...generic validation performed by the model vendor" (3.25). This means that the model validation relationship between IMAP candidates and their third-party providers needs to be much more invasive and aggressive, and needs to start pretty soon!
Technical Provision-Specific
  • A large number of points made in the paper relate to over-simplifications, which should help anyone who is struggling with the concepts of materiality and proportionality. These include methods relating to ENID, Risk Margin calculations, Approximations and  the emergence of risk over one year
  • Similarly a few tricks of the trade appear to have been scuppered, such as using optimistic business plans for setting provisions, "actuary in a box" methods and assuming improved underwriting performance
  • Some substantial focus around the quality and quantity of challenge applied to External Models (focused on third party Catastrophe models in this instance), in particular the challenge of  assumptions used by the provider (3.16-17 and 3.26-28)
  • The concept of "cumulative materiality" is introduced in the context of multiple approximations, a concept which I suspect many firms are still struggling with in the context of Internal Model change (2.9)
  • An interesting take on the justification of assumptions, with the PRA taking umbridge with firms using "industry standard" or "established good practice" as a supporting argument, rather than using their own risk profile as the basis for support (3.15)
  • A section which seems to advocate conservatism, if not prudency, in the setting of sensitive parameters (3.10), as well as advocating the use of stress and scenario testing to make up for ENID when setting parameters (3.2)
Certainly lessons for both Life and GI internal model applicants in here, and the PRA should be congratulated for getting this paper out in good time. I'm not necessarily convinced though that third-party providers of internal model inputs will happily acquiesce with the demands which the industry are being asked to make of them here.