Non-executive directors in
Solvency II
19 March 2015
Speakers
Paul Fisher – ED Insurance Division
Gareth Truran – HoD, London Markets
Giles Fairhead – HoD, Retail Life Division
Ian Marshall – Senior Advisor and Chairman of a Board
Agenda
Introduction
Paul Fisher
Internal models
Gareth Truran
System of governance/ORSA
Giles Fairhead
Regulatory reporting
Giles Fairhead
Board understanding of Solvency II
Ian Marshall
Introduction
Paul Fisher – Executive Director
Insurance Division
19 March 2015
Internal models
Gareth Truran – Head of Department,
London Markets
19 March 2015
Topics
• PRA’s approach to internal models
• Lessons from the pre-application phase
– Modelling issues
– Supporting governance
• Formal application phase
• Key questions for non-executives to ask
PRA approach to internal models
•
No policy preference for firms to develop internal models
•
Linked to firms’ and PRA’s view on standard formula appropriateness
•
All models have limitations and need to be used with care
•
Solvency II sets a high bar for model approval and sets rigorous
standards for technical modelling and supporting governance
•
Boards of IM firms are responsible for ensuring that models are fit for
purpose, meet the tests and standards, and that the output is credible
for use in the business and for regulatory purposes
Lessons from the pre-application phase (1)
•
Modelling weaknesses:
– Key judgements and assumptions not always highlighted or justified
– Documentation insufficient to explain the approaches adopted
– Optimistic assumptions which do not match prior experience
– Use of data which excludes historical events
– Use of external models without consideration of appropriateness
– Models ignoring some key risks faced by firms
– Overly-optimistic assumptions on diversification in extreme scenarios
Lessons from the pre-application phase (2)
Supporting infrastructure and governance:
Use test
•
Important to demonstrate belief in the model – but not “blind faith”
Board understanding
•
•
Key assumptions, strengths, weaknesses, limitations, sensitivities
Not technical detail
Validation
•
•
•
Should be seen as a key tool to help give Boards insight into the model
Boards should be involved in directing validation onto key issues, not getting lost in the detail
Boards need to own the validation design, ensure its output is in a format they can engage
with, and track key issues raised
Formal application phase
•
Stocktakes in Q1 2015 of progress so far
•
Assess likelihood of firms being able to submit a credible application on intended timeline
•
Some firms have delayed applications to complete remaining work in a less-rushed manner
•
Boards need to own the plan and its delivery
•
Formal application phase = six months
•
PRA open for applications from April 2015
•
Limited opportunity to amend applications once submitted
•
Firms need to have contingency plans in case models are rejected
Key questions for non-executives to ask (1)
Model scope
• Why does the firm want internal
model approval?
• What is the scope of the firm’s
internal model - what
risks/entities does it cover/not
cover?
• Where risks are not captured in
the internal model, are they dealt
with adequately in the firm’s
ORSA?
Key features of the model
• What are the model’s key
strengths, weaknesses and
limitations?
• Where does the model work well /
work badly?
• What are the key assumptions that
underlie the model? How has the
Board been involved in assessing
these?
• How sensitive is the model output
to these key assumptions? (“What
moves the dial?”)
• Does the output of the model give
a credible answer?
Use of the model
• For what purposes does the firm
use (or plan to use) the internal
model? Possible examples
include:
• Capital planning (e.g. future
dividend capacity)
• Risk appetite setting and
monitoring
• Pricing
• Reinsurance decisions
• Mergers & acquisitions
Key questions for non-executives to ask (2)
Validation
• Has the Board been involved in agreeing the
design of the validation work?
• Who has independently reviewed the model
apart from the model developers?
• What were the key conclusions of the last
validation report?
• Does the validation report give the Board a
good summary understanding of the key
strengths / weaknesses / limitations of the
model and whether it meets S2 requirements?
• Is the Board tracking actively how key
validation issues are being addressed?
Ongoing review
• How will the Board review
ongoing model
appropriateness (e.g. as the
business changes, or as new
risks or data emerge)?
• How will the Board be
involved in decisions on major
changes to the internal
model?
Other
• What feedback has been
given previously given by the
PRA and how this has been
addressed by the firm?
• What contingency plans exist
if model approval is not
granted? Can the firm
survive on the Standard
Formula or would it need to
take other mitigating actions?
System of governance/ORSA and nonexecutive directors
Giles Fairhead –
Head of Department, Retail Life Division
19 March 2015
Own risk and solvency assessment
•
During the preparatory phase – the PRA will review at least one ORSA from all
Category 1-4 firms.
–
•
The PRA is intending to provide industry feedback in 2015-Q2
Key Messages:
–
A large number of reviews show a lack of evidence of significant involvement from the
Board and senior executives
–
The ORSA is not a compliance exercise resulting in a report for the PRA
–
It should not be a ‘good news’ report but should highlight key risks and allocate
mitigation to named people
–
The ORSA should be holistic, bringing together strategy, stress testing, risk
management and solvency into one cohesive framework
–
The key to a ‘good’ ORSA is linking these areas together successfully
PRA findings from ORSA reviews
Linking ORSA with current risk management
system
CRO increasingly responsible for ORSA
preparation (before Board input)
Material risks usually well documented
Current capital requirements well evidenced
Good engagement with supervisors
Proactive response to feedback provided
Lack of evidence of embedding and buy in
from senior management board
Delegation of ownership of the ORSA by
the Board to senior management
Business strategy absent from report
Lack of forward looking assessment
Stress and solvency test not well
evidenced
Lack of realistic management actions
Key questions for non-executives to ask
The ORSA
Is the ORSA embedded within all aspects of the organisation?
Is there evidence that the Board has actively challenged the ORSA report before approving
the content?
Has the ORSA been used as part of the strategic business planning and is it incorporated in
the use test (if an internal model firm)
Does the ORSA aide NEDs with decision making?
Does the ORSA link all the different aspects of the firm (strategy, risk, capital, solvency and
stress testing?
Is the ORSA forward thinking and cover the business planning period?
Does the ORSA clearly allocate future mitigation actions to named people in the firm?
Is there a top-down and bottom up approach to the ORSA?
System of Governance
• The EIOPA Guidelines are similar to PRA Rules and expectations.
• The notable exceptions are different are: prudent person principle:
actuarial function holder: and outsourcing.
• During 2015, the PRA will be asking Boards and executives
questions to gain comfort firms are working towards Solvency II
compliance.
• Where a firm has undertaken detailed work to implement the
system of governance requirements, the PRA may review to
assess progress.
Key questions for non-executives to ask
The system of governance
Challenge the executives to ensure they are reviewing the interim Guidelines and latest EIOPA
Guidelines to ensure they are going to be compliant?
Is work proportionate to the nature and complexity of the firm?
Does the firm have sufficient evidence to show they are complying with the EIOPA Guidelines?
Does the firm understand and meet the new prudent person principle requirements and is this
evident in the investment strategy?
Does the firm understand and meet the new outsourcing arrangements, and where work has
been outsourced is there a suitably knowledgeable person in the firm who can provide
adequate challenge to the outsource provider?
Regulatory reporting
• Category 1-3 firms need to provide their interim reporting for
year-end 2014 by the end of June 2015
• A recent PRA survey indicated that firms are: progressing well
with their work on reporting; have stable templates and
taxonomy; and are not expecting any serious issues in meeting
regulatory reporting preparatory Guideline requirements
• The more detailed Solvency II reporting requirements will mean
the PRA can undertake more detailed analysis than it does today
Key questions for non-executives to ask
Regulatory reporting
Have you seen any of the regulatory reporting data and has this been explained to you
by the executives?
Has your firm undertaken at least one dry-run to collect the data required?
Have you challenged the executive on their progress towards ensuring they are ontrack to complete interim reporting on time?
Is the information the firm is planning to submit to the PRA of a high quality?
Do you know your firm’s major issues for reporting?
Board understanding of Solvency II
Ian Marshall – Senior Advisor and Chairman
of a Board
19 March 2015
Four topics…
• Board’s role
• Validation
• Barriers to Board understanding
• ORSA and Risk Appetite
The Board’s role
• Well its your model!
• Its not the actuarial department’s model and not the PRA’s
• So we need to understand the key drivers of this model
• And we then need to validate those key drivers
• We also need to understand the limitations of the model
Questions to consider on regulatory reporting
•
What are the key drivers / assumptions – very few!
•
What are the key correlations?
•
Scenarios – play with the model
•
P&L attribution – very helpful and not ticking a box
•
Is the model useful?
•
What are the model’s limitations
•
Does it make sense !!!!!
•
PRA needs to see evidence of Board’s active engagement
Barriers – too much noise crowds out the big theme
•
It has gone on for a long time and the process confusing
•
Difficult to get the big picture
•
European legalistic approach compared with Anglo Saxon pragmatism
•
Board’s nervous of S2
•
PRA and firm’s actuaries carry on debate below the Board?
•
Models cumbersome and difficult to play with
•
Consultant’s approach to validation – bottom up not top down and MUCH TOO
MUCH included in validation exercise
ORSA and risk appetite
• To some extent the SCR limited
– One year model
– Emphasis on best estimate
• ORSA
– SCR provides a one year look, ORSA is forward looking
– Scenario analysis
• Risk appetite
– No longer an aspiration