The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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Current Solvency II developments are making all insurers take a good, deep look at their programmes. The capital cost of not having an approved internal model in its fullest sense - and therefore having to use the standard formula - will be significantly higher.

Early indications are that quantitative impact study five (QIS5) will mandate an increase in the region of 50-80 percent of the QIS4 requirements. Certain markets are facing an even bigger rise.

This means that one of the current priorities for insurers is to improve and develop a robust internal model that will satisfy the regulator while ensuring maximum value for their businesses. In summary, to create an internal model and get it right. And all the evidence suggests that the London market has already recognised the importance of doing this early and doing it well.

"The emphasis is shifting increasingly towards making a virtue out of compliance - not just making the best of regulatory requirements"

Since the Financial Services Authority (FSA) asked for indications from companies likely to seek approval to use internal models, nearly 100 have indicated they intend to apply under the FSA's internal model approval process. The large majority of these are general insurers.

Tightening up
However, Solvency II is not just about capital models and capital models are not just about technical actuarial calculations. Insurers will also need to address their corporate governance and tighten up business processes. One area companies are focusing on in the short-to-medium term is data, models and systems.

While UK insurance companies have been subject to individual capital assessments (ICA) for a number of years, full end-to-end data and model links will become an integral part of Solvency II. Wholesale system changes may not be as commonplace in the London market, but system enhancements are being undertaken.

Another one of the central aims of Solvency II is to embed risk management into the business, making it part of an insurer's DNA. Chief risk officers are becoming more prominent, detailed risk metrics are becoming more common and models are being used to make real business decisions instead of merely being seen as a regulatory burden.

As requirements have been increased the focus has begun to shift towards the areas of disclosure and transparency. Management are beginning to demand access to more granular information, allowing them to see rates and detailed loss and risk information broken down by line and region.

Transparent
As well as encouraging the creation of a well-diversified portfolio, this will allow management to identify and track individual risks. Investors will also require insurers to be transparent by making much of this information available to them, thus subjecting companies to informed market discipline. Outliers will find themselves being under more public scrutiny.

"Another one of the central aims of Solvency II is to embed risk management into the business: making it part of an insurer's DNA"

Given the unique nature of the Lloyd's market and the role of the Society in Solvency II, it has been on the front foot of incoming regulation. For example, all Lloyd's syndicates were required to submit a detailed implementation plan for Solvency II by 31 December 2009. The Society is keeping a close eye on progress within the managing agencies to ensure that the individual internal models will fit with Lloyd's plans for its own overall internal models.

But although the London market is in good shape overall, challenges remain. One of the biggest of these is the resource crunch that is widely expected to hit next year. To push through major change programmes like this with big technical components, insurers are going to need access to actuaries, risk managers, IT staff and programme managers. There is a limited pool of quality personnel and if everyone comes to address this issue in 2011, then some may find they are struggling to recruit. The market is already seeing a hike in salaries for key resources.

Global challenges
International insurers face the additional challenge of fitting the changes into wider systems of corporate governance and capital management. Some markets such as Switzerland and Bermuda have made clear their desire for seeking Solvency II equivalence. This would simplify matters for London market insurers with parents in these jurisdictions. A number of EU-based international insurers and reinsurers are running globally co-ordinated Solvency II-like programmes, with a large number looking to see what happens in 2010.

The emphasis is shifting increasingly towards making a virtue out of compliance - not just making the best of regulatory requirements, but making Solvency II work for a company. The ideal outcome would be to use the regulation to change to a new, fundamentally better, way of doing business. Already, some key players are looking to take advantage of the opportunities that have arisen from Solvency II.

Gurpreet Johal is a partner at Deloitte.