Recovery and resolution plans (RRPs) are receiving a lot of attention from regulators lately. In an InsuranceERM article, Milliman consultants Bridget MacDonnell, Eamonn Phelan, and Eoin King explore the Solvency II requirements related to RRPs for insurers and reinsurers.
The article is based on the authors’ paper “Recovery and Resolution Plans: Dealing with financial distress.”
Liquidity risk is one of those risks we often don’t pause to think that much about, but it’s one that can wreak havoc on a business if not kept constantly in check. It is also a risk that has become heightened in recent times, because of a combination of regulatory and macroeconomic developments. Companies can often grow complacent about liquidity risk, especially if they have tended to generate cash on a consistent basis through ongoing operating performance. However, certain activities, such as mergers and acquisitions (M&A), a new product launch, or perhaps regulatory development, can give rise to new exposures. It’s worth reminding ourselves of some of the key drivers of exposure to liquidity risk, and what we can do to manage and mitigate this risk.
In Europe, the ability to recognize negative best estimate liabilities on the solvency balance sheet, effectively capitalizing estimated future profits on books of in-force business, and considering these profits to be immediately available to absorb losses in the business, requires companies to be extra vigilant. In reality, such assets may be far from liquid, unless they can be repackaged through value-in-force (VIF) monetization, or used to secure reinsurance financing of some sort. The same may be said of the likes of deferred tax assets, except that these assets may be even less liquid, unless they can be sold on to other entities within a group structure.
Other aspects of the liability side of the balance sheet can also pose liquidity challenges. Take, for example, a company with a range of unit-linked funds operating on a t+1 basis (i.e., settlement occurs one day after the transaction date), with a further range of funds operating on a t+2 basis. Policyholder fund switches out of the t+2 funds and into the t+1 funds can leave companies needing to provide liquidity for transaction settlements upon purchase of the t+1 assets, before payment is received from the sale of the t+2 assets. Depending on the volume of transactions, which could be significant, firms may struggle to provide such financing on an ongoing basis. More severe examples of firms struggling to cope with fund switch activity have included suspension of redemptions from property funds, albeit more because of the underlying lack of liquidity of the assets than the nature of the pricing basis, though ultimately leading to similar problems. Funds that permit a mix of both individual and corporate investors may be particularly susceptible, as the latter potentially have the ability to move vast sums of money very quickly, and before redemptions are suspended, precipitating the lack of liquidity for individuals.
The Solvency II preparatory guidelines require undertakings to prepare a Forward Looking Assessment of Own Risk (FLAOR), which is based on the Own Risk and Solvency Assessment (ORSA) principles. While the FLAOR can be prepared on a “best efforts” basis, it is undoubtedly a useful first step toward full implementation of the ORSA. In this research report, Milliman’s Eamonn Phelan and Sinead Clarke explore the progress that undertakings have made toward meeting the preparatory guidelines in a number of different European countries. They also outline the feedback provided by various European supervisory authorities and discuss the steps that can be taken to build upon what has been achieved during the preparatory phase in order to meet the full requirements of the ORSA from 2016 onward.
Solvency II will change the way insurance and reinsurance undertakings determine their capital requirements as well as introducing new rules with regard to what forms of capital can be used to meet those requirements.
This paper by Eamonn Phelan, Scott Mitchell, and Sinead Clarke addresses some of the key issues, including the need for a robust decision-making framework, how investment strategy fits in, uses of reinsurance, and the new regulatory landscape. The paper also outlines Pillar 2 and Pillar 3 requirements.
The Own Risk and Solvency Assessment (ORSA) is quickly becoming a global regulatory requirement for insurance undertakings. It is one of the key elements of enterprise risk management (ERM). Numerous insurance regulators around the world are introducing ORSA requirements.
Many of the global developments stem from the International Association of Insurance Supervisors (IAIS), which requires an ORSA as part of Insurance Core Principle 16 (ICP16) on ERM, which was adopted in October 2010. The inclusion of an ORSA requirement within the ICPs has resulted in an effective worldwide requirement for an ORSA, albeit one that can vary in certain respects from country to country.
In this paper, Eamonn Phelan and Padraic O’Malley compare and contrast the IAIS requirements with the requirements applying in Europe (through Solvency II), in the United States, and in Australia. It also summarizes the ORSA requirements applying in a number of other territories, looks at a number of common challenges facing insurers when embedding an ORSA into their organization, and also covers potential solutions to some of these challenges.
Reinsurance undertakings will be required to prepare a “Forward Looking Assessment of Own Risk” during 2014. This will be a new requirement for all undertakings in advance of Solvency II’s full implementation. This paper outlines some of the key challenges to be overcome in producing such an assessment.