Tag Archives: ORSA

Recovery plans: A natural extension of the ORSA

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).

ORSA requirements
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.

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Issues in brief spring 2016: UK life insurance

The Spring 2016 edition of Milliman’s Issues in Brief features articles about the dynamic reporting of management information (MI), valuing lifetime mortgages, the Own Risk and Solvency Assessment (ORSA) process, and embedded value reporting.

Milliman Risk Talks: ERM implications; third NAIC ORSA pilot

In this episode of Milliman Risk Talks, Mark Stephens and Vikas Shah highlight new insights from the third Own Risk and Solvency Assessment (ORSA) feedback pilot project conducted by the National Association of Insurance Commissioners (NAIC). They also draw on their experiences to show how these observations apply outside of the insurance industry.

To watch our Milliman Risk Talks series, click here.

To learn more about the Milliman Risk Institute, click here.

Stepping stones to ORSA: Looking beyond the preparatory phase of Solvency II

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.

Assessing the appropriateness of the Standard Formula

Under the Central Bank of Ireland’s Guidelines on Preparing for Solvency II, all insurance and reinsurance undertakings are required to prepare a Forward-Looking Assessment of Own Risks (FLAOR) in 2014 and 2015. Those companies rated as high or medium-high impact under the Central Bank’s Probability Risk and and Impact SysteM (PRISM) rating system, which are not in either the preapplication or application process for an internal model, are required from 2015 onward to perform an assessment of whether their risk profiles significantly deviate from the assumptions underlying the standard formula Solvency Capital Requirement (SCR). This requirement will apply to all companies from 2016 onward.

Milliman’s Andrew Kay and I conducted a survey analysis of 27 companies in Ireland to gain perspective on the appropriateness of the standard formula for the risk profile of these companies in their 2015 FLAORs. To read the entire analysis, click here.

Establishing ORSA processes with Solvency II on the horizon

Insurers are finalizing Own Risk and Solvency Assessment (ORSA) trials as they prepare for Solvency II to take effect in January 2016. Assessing and documenting the uncertainties that affect business goals can help firms maintain risk profiles that align with their risk appetites. Milliman consultant Neil Cantle’s article entitled “The final countdown” provides insurers perspective on what they need to consider when running an ORSA exercise.

Here is an excerpt:

The focus on risks that produce financial uncertainty, and specifically those which might be absorbed with capital, has arguably led to a rather indirect way of thinking about risk in insurance. Most firms equate ‘risk’ with the capital needed to absorb it and often avoid the issue of understanding the actual risk itself, which can have consequences beyond immediate financial losses. This has led to wide-spread use of statistical approaches based on loss data and expert estimates which, by design, do not provide any rigorous linkage to other (non-capital) outcomes or directly back to risk management efforts. Scenario-based approaches are slightly more helpful but arguably leave firms open to the criticism that they have missed important scenarios, so the process for choosing them needs to be pretty robust. Developments in causal modelling have enabled firms to tackle this problem and show how the underlying dynamics of risks can simultaneously lead to a range of outcomes.

The regulator has expressed some concern that the types of scenarios and stresses being considered are too focused on regulatory capital (rather than the amount of capital you think you need), concentrated too much on the risks covered by the SCR, and have been rather too simple. Scenario and stress testing methodologies have advanced considerably over the past few years, and a key theme is the need to consider multivariate conditions (as real life tends to combine events).

In most cases, the shortcoming in the methodology is in developing the scenarios in the first place – the models are quite capable of producing the results once you know what the scenario is. The draft guidance is clear that the assessment of risk includes deciding the extent to which non-capital mitigation techniques are used and consideration of the effectiveness of the system of governance in different circumstances. While it is useful to have capital model outputs help you decide whether a scenario is extreme or not, take care not to create a circular argument centered on the model – it is better to decide the right scenarios and then explore their dynamics including, but not limited to, capital consequences.