Compliance and Risk Management,
The deadline for Solvency II, the set of new European Union wide rules bringing into force new capital adequacy and risk management requirements for insurers, is fast approaching and the insurance industry faces a major task in preparing for these rule changes. Many insurers remain blissfully unaware of the scale of the task ahead.
The new rules will hit every insurer and reinsurer with operations in Europe and gross premium income exceeding â¬5 million. Despite initial protests from the industry, EU regulators are convinced that the new risk management requirements will considerably reduce the likelihood of an insurer failing and thus triggering another financial crisis. Regulators are determined to push ahead with the rule changes and are preparing for a fifth and final test run of the rules, known as a Quantitative Impact Study, later this year.
These tests will highlight whether any last-minute amendments are needed before the rules are finalised. However, it seems that the requirements are largely agreed and insurers should begin preparing for the changes now if they are to meet the deadline set for the end of 2012.
Under the new rules insurers will need to comply with three central elements, known as pillars, to:
a) demonstrate that the capital they hold covers the liabilities on their risk books under Pillar 1 of the requirements
b) demonstrate that their risk management and prospective risk identification systems are effective under Pillar 2, and
c) be able to meet the required level of public and regulatory disclosures under Pillar 3
The bulk of the work for insurers will be ensuring that they have the right data available to them so that they can accurately calculate their capital and liabilities and identify the changes they need to introduce to their risk management systems before making disclosures.
One of the major challenges facing many insurers is their current inability to compare âapples to applesâ. Insurers offer a vast number of different policies and hold their policy data across a range of software systems, which makes it very difficult for them to collate all of the information correctly. For example, risk managers may think that collating data relating to their life insurance policies will produce accurate figures on their liabilities. However, the reality is that many of these policies may have varying characteristics with some including costs and others excluding them, facts which are not always made clear in insurersâ existing systems. When these inaccuracies are repeated across the entire organisation, it is easy to see how a considerable gulf could develop between what the data says and what the true levels of capital and liabilities on an insurerâs books actually are..
This problem has arisen partly because senior managers and risk managers have gradually ceded their powers to the IT department. While the IT department has an essential role to play in facilitating the transfer of data it cannot be expected to hold the skills needed to read or analyse the information. The first step insurers need to take will be to take the reins back from their IT department and urgently re-establish ownership and responsibility for data management.
This will then allow insurers to look closely at the systems and data flows they currently have in place before considering the adaptive software solutions they need to implement to ensure that their data is transparent and traceable going forward.
Understandably, those responsible for preparing for Solvency II, generally those working within the actuarial or risk department, often have very little understanding and experience of ICT. This has led them to fall into the trap of believing that the data stored in their policy administration systems is correct. Many are not aware that the policy administration system is simply a production system and that in order to process this data in the required models and reports it first needs to be extracted from that production system towards a data warehouse. It is here that data from different production systems can be safely manipulated into the same format without impacting on the insurerâs day-to-day operations. It is also essential that this step is completed before the data can be aggregated and put through risk management models.
This is undoubtedly a mammoth task as millions upon millions of data records will need to be processed in this way. However, clear data management is essential in ensuring that insurers have an accurate overview of their business, allowing them to assess risk at a moment in time and to mitigate and prevent risks from arising in future.
The benefits this will bring to insurers go beyond simply enabling them to comply with their new regulatory requirements. As well as helping to avoid the threat of operational failure, the new rules may also play a role in informing insurersâ business strategies and how to execute them effectively.
Accurate data will help insurers to identify missed opportunities, find solutions to problems and contribute to the long-term success of the business. There are many examples of how banks have improved their business performance after using clearer information accessed through compliance with the Basel II rules governing their capital requirements and risk management standards.
Ensuring that their data is processed correctly will give insurers a 37,000 foot view of their business without losing any of the detail of individual policies. This will allow them to access efficiency savings that will free up time for them to focus on driving their business forward, as well as helping them to identify any potential threats facing their business and meeting their regulatory requirements.
Failure to get these initial steps right may not only compromise insurersâ ability to meet the new regulatory requirements but may also prevent them from reaping the benefits the Solvency II will bring â the same benefits that their competitors are surely seeking to capitalise on.