Tag Archives: Solvency II

Central Bank of Ireland review of Solvency II life insurance pricing and reserving assumptions

In February 2017, the Central Bank of Ireland published letters on its website relating to its review of the consistency of Solvency II life insurance pricing and reserving assumptions. This briefing note by Milliman’s Aisling Barrett and Sinéad Clarke summarises the contents of these letters. The authors also reference the contents of the December 2016 industry letter on the standard formula Solvency Capital Requirement.

Recovery and resolution planning considerations

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.”

Spotlight on operational and reputational risk

macdonnell-bridgetOperational and reputational risks have become areas of greater focus in recent times. There have been so many high-profile operational risk events that it is clear how important operational risk management is for all companies—Anthem, Volkswagen, and UBS are just a few examples of companies that have suffered significant losses because of operational risk events. In addition, for every publicly reported incident there are sure to be a host of smaller cases, which have not been large enough to hit the headlines, and which, of course, can have a cumulative detrimental effect over time. There is also a somewhat invisible aspect to operational risk, given that the damage does not always affect physical assets. Information can be stolen through a cyber breach, agents can act in their own interests, fraudulent activity can happen, and all of these events can go undetected.

Operational risk can also contribute to other risks that undertakings face, particularly reputational risk—a risk we don’t always fully appreciate until the damage is done. There are many strategies and marketing campaigns aimed at ‘one brand’ and ‘one vision’ which show the value organisations place on their reputations. Yet reputational risk management is not always given the attention it deserves. It’s worth pausing for a moment to take a closer look at operational and reputational risk management.

Operational risk
The challenges of quantifying operational risk are numerous—they include the lack of data to properly calibrate models and there are also challenges in relation to the models themselves. For example, the major shortcomings of the Solvency II standard formula calculation of operational risk capital are highly topical at the moment. Under Solvency II, operational risk capital must be held as part of the company’s Pillar 1 capital requirements. Criticism of this factor-based calculation includes its failure to capture many relevant elements of a company’s risk profile, such as the operating model and the specific processes within the company.

Interestingly, the solvency regime in Switzerland (known as the ‘Swiss Solvency Test’) does not require operational risk capital to be held. Rather, operational risk is considered as part of the company’s risk management, therefore treating it as a Pillar 2, as opposed to a Pillar 1, issue. Earlier this year, the Basel Committee on Banking Supervision imposed an outright ban on operational risk internal models for banks, acknowledging the widely differing approaches and complex modelling of this risk within the industry. Whether or not such developments will flow over to the EU (re)insurance solvency regime remains to be seen, but regardless of where operational risk sits from a regulatory perspective it is nonetheless an area where there are increasingly sophisticated methods being used in companies’ own risk assessments, such as, for example, Bayesian Network modelling.

For those who may be unfamiliar with Bayesian Network modelling, it is a technique that is gaining more and more traction as companies continue to develop their understanding of their operational risk exposures. This technique aids the understanding of operational risk exposures through workshops with various experts within the business, in order to establish the key underlying drivers of operational exposure and the relationships between these drivers. They are often not obvious at first glance and tend to involve quite nonlinear relationships. Once these exposures are well understood, the company can focus its attention on managing and mitigating the risks.

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Overview of Solvency II external audit considerations

With Solvency II’s public disclosure requirement, European countries are considering a variety of policies for the external audit of insurer information. A significant number of member states have not yet decided on making external audit an official requirement or the supervisor is not in the position to make external audit an official requirement. In this article, Milliman consultants Luca Inserra and Glennfor Hellement highlight which countries require an external audit, and provide more details on the scope of and reasons behind the external audit policies for Europe.

Solvency II opening up outsourcing opportunities

European insurance companies should consider how outsourcing certain business functions can create value for their entire organizations under Solvency II. The latest edition of Milliman Impact entitled “Added value outsourcing” highlights some factors that make outsourcing advantageous and also explains how Solvency II requirements may ultimately impel insurers to outsource actuarial work.

Here’s an excerpt:

Outsourcing offers the function a wide range of benefits, says [Roy] O’Neil: flexibility to deal with variable workloads; access to leading practices; freedom for senior management to focus on other business priorities. For established players, outsourcing presents an avenue to carve out repeatable, non-core tasks; for new market entrants, it provides core actuarial back office support while the organisation grows ….

…Pressure on actuarial departments responsible for assumptions informing firms’ reserving models is particularly acute. Many—and perhaps especially the smaller organisations less prone to outsource such functions in the past—will struggle to meet the new requirements on their own, argues [Lars] Hoffmann.

“In Germany we have almost 100 insurance companies, and about 80 of them are pretty small. Of those it seems likely a large portion will move toward some sort of outsourcing,” he says.

“The additional work from Solvency II is considerable,” confirms Ulrich Starigk, senior counsel at Milliman. “It requires more people and training for staff on the new requirements. In many cases it’s going to be more efficient to buy these resources from outside.”

Life insurance risks: Observations on Solvency II and the modeling of capital needs

Many of the core ideas of Solvency II are drawn from the realms of finance and investing. These may or may not extend naturally to the domain of insurance risk. Tools are increasingly available that enhance our ability to develop forecasts and to critique these forecasts as part of the capital management, business planning, and decision-making process. There is an explosive growth in potential applications of data analytics, predictive algorithms, and behavioral modeling to challenges related to insurance risk. In this paper, Milliman’s Stephen Conwill describes several key areas that can serve as building blocks for a new analytical framework.