Recovery and resolution1 plans (RRPs) are becoming increasingly important for insurance and reinsurance companies. A requirement to develop RRPs already applies to global systemically important insurers (G-SIIs) and in some territories we are also seeing requirements coming into force which apply to smaller insurers that have not been classified as G-SIIs. In Europe, for example, the European Insurance and Occupational Pensions Authority (EIOPA) is looking at the area of recovery and resolution planning, with Gabriel Bernardino stating that ‘One of the lessons learned from the recent financial crisis is the need to have in place adequate recovery and resolution tools which will enable national authorities to intervene in failing institutions and resolve failures when these materialise in an effective and orderly manner.’2 This speech was followed by the release of an EIOPA discussion paper on the potential harmonisation of recovery and resolution frameworks for insurers.
This blog post offers a look at the link between RRPs and the Solvency II Own Risk and Solvency Assessment (ORSA).
One of the key aims of the ORSA is for insurers to identify and measure the risks that they face, with a view to either holding capital against these risks, or taking steps to manage or mitigate them. This process is called the insurer’s assessment of its overall solvency needs.
Guideline 7 of the Solvency II Level 3 Guidelines on the ORSA covers this assessment. It says that, “The undertaking should provide a quantification of the capital needs and a description of other means needed to address all material risks ….”
The explanatory text of this guideline expands on the factors to be considered by companies in deciding whether to cover risk with capital or to use risk mitigation techniques. These considerations include the following:
• If the risks are managed with risk mitigation or recovery techniques, the (re)insurer should explain the techniques used to manage each risk.
• The assessment needs to cover whether the company currently has sufficient financial resources and realistic plans for how to raise additional capital if and when required.
• The assessment of the overall solvency needs is expected to at least reflect the (re)insurer’s management practices, systems and controls, including the use of risk mitigation techniques.
• When assessing the overall solvency needs, the company should also take into account management actions that may be adopted in adverse circumstances. When relying on such actions, companies should assess the implications of taking these actions, including their financial effect, and take into consideration any preconditions that might affect the efficacy of the management actions as risk mitigators. The assessment also needs to address how any management actions would be enacted in times of financial stress.
Based on some of the ORSA reports that I have seen, companies are generally good at identifying possible risks and projecting their solvency positions allowing for the impact of these risks. Companies are also quite good at using the results of such analyses in determining capital buffers as part of the assessment of their overall solvency needs. Furthermore, as required by Solvency II, companies tend to have capital management plans in place, identifying possible shortfalls in own funds and how they might be addressed. However, some of these plans are often quite vague in terms of companies’ prospects of raising capital in the event of financial distress. In such cases, parents might not be willing or able to provide capital and the investment markets might also prove difficult to access.