Insurers rue Solvency II's loss of momentum

Leaving aside the further setbacks to the timetable for Solvency II implementation, participants in the recent InsuranceERM/QlikView roundtable also expressed concern over the attitude of regulators to internal models and the likelihood that the industry would see no capital benefits from complying with the directive. Most participants are resigned to ICAS+ and getting on with running their businesses

Coping with the further delay

Field: What are the challenges created by the latest delay of Solvency II implementation to at least 2016?

Borrett: Should you capitalise on where you are, put in your submission and deal with new regulations, new requirements or changes post-haste, or you hold back and try to incorporate them the first time. But if that means delay, how is that perceived by the regulator?

Yardley: The big flaw of Solvency II is that you find yourself having to deal with a regulator that doesn't own its rulebook. A big unknown is whether the PRA [the Prudential Regulation Authority, one half of the UK's new regulatory structure] is going to be as enthusiastic as the FSA about internal models. The recent proposals on early warning indicators imply that there are people there who don't trust internal models at all.

Pierre-Andre Camps: "Bermuda, the US, a lot of people will have their systems before us. We will have to be equivalent to them!"

Scott: We are 98% there. When the further delays became apparent, we thought why not get to 100% and finish the job? We all know how difficult it is to put something down and pick it up six months later.

ICA-Plus regime

Field: How will you implement it though?

Scott: We are implementing our Solvency II internal model through our individual capital assessment (ICA) and using it throughout the business.

Hilder: Will you use model with an existing balance sheet, rather than the Solvency II balance sheet?

Scott: We are transitioning towards a Solvency II balance sheet. The main exception is we are not currently holding the risk margin, which is very material for long-term business, and we are using an estimate of the counter-cyclical premium that partially offsets the transition to risk-free yields. Overall the result is fairly similar to our previous ICA.

Yardley: That would make sense. In our meetings with the FSA, the message we are getting is there is no immediate plan for them to move away from an ICA balance sheet.

Borrett: The sense we have had is that the emphasis for the ICAS+ regime has been more around pillar 2.

Lloyd's attitude

Field: How has Lloyd's reacted to the new delay?

Hilder: There is really nothing to change as far as our relationship and requirements to report to Lloyd's goes. Largely, their reporting to the FSA will be as it was going to be.
The one thing that will probably be delayed is the pillar 3 reporting requirements, but I think to a more material extent the thing will be largely unchanged.

For this year, capitalising for 2013, our capital is already established on an ICAS+ basis.

Lloyd's is benchmarking based on ICA; the SCR plus technical provisions is expected to be very similar to the GAAP reserves plus ICA. The total resources are largely unchanged in any case, so we are just restating the division effectively between the reserves and capital.

Field: Was there any point in this whole exercise, then?

Hilder: In terms of the capital calculation itself, I do not think it changes things very much, but a lot of the risk management, reporting and internal processes have moved on enormously as a result of Solvency II.

Field: At a previous round table, a number of people thought that we would not see a situation where the FSA would allow the industry to take a large amount of capital out.

Yardley: I think now the Bank of England is taking over, it's even more the case.

Borrett: Yes, when we embarked on an internal model, part of the rationale was that we believed that it could give a capital release. I think some of us with grey hairs were wise enough to add the caveat that it would not come for some considerable time.

Scott: Maybe you avoid a capital increase, which is kind of the same thing?

Borrett: I think it is managing whether this gives an impetus to potential removal of certain add-ons.

 Pillars 2 and 3 to come in first?

Field: What do you think of Eiopa, BaFin and the Dutch all saying that elements of pillars 2 and 3 might be introduced in advance of full Solvency II implementation?

Yardley: Provided it stays non-prescriptive, I think we can easily live with that. We are less keen about the French suggestion that some elements of pillar 3 should come in at the end of 2013.

Kevin: I agree with Rupert. I think the evolution of the ICA report into an ORSA report can be viewed as logical and with an increasing emphasis on risk principles alongside capital and solvency quantification. The challenge for insurers is making sure what other aspects of Solvency II are captured under a potential ICAS+ regime.

Kevin Borrett: "When we embarked on an internal model, part of the rationale was that we believed that it could give a capital release. Some of us with grey hairs were wise enough to add the caveat that it would not come for some considerable time."

Solvency II by 2016 or not?

Field: Does anybody want to make a bet on when Solvency II might finally be implemented?

Yardley: I don't think there's any chance it will be in before 2016 and even that date is extremely doubtful.

Field: Are you still concerned about some outstanding issues or are you just thinking that, actually, there is no point in worrying about them until something becomes clearer?

Hickman: If it does come in at some point, we are ready to go. If it never comes in, we are not going to be wasting any more money on it. We have spent enough already. It has done some good things, improved some areas.

Relationship with the regulator

Field: Which areas have improved?

Hickman: I think most people have much better models now, much better data, much better governance and process. They have come a long way in a short time but spent a lot of money doing it, because it has not been a straightforward, clear process.

We've been going round and round in circles for a few years wondering what's going to happen, spending a lot of energy trying to read where things are going.

Bernie Hickman: "One of the challenges is making sure we are not distracted by Solvency II any more. Part of the reason Solvency II has come to a grinding halt is a growing recognition that it would be damaging to growth and it imposes a bureaucratic burden that is not in keeping with a competitive market."

I think the FSA is being much more realistic and sensible now. It was not that long ago that they were saying it is all going to happen in 2014, whereas now they are not making a big deal about 1 January 2016 or any particular date. I think they have been much more constructive in dealing with ICAS+, which is a welcome movement.

Yardley: We now are getting back the relationship with the regulator. In our IMAP discussions, the regulators sometimes seemed more concerned about making sure that they did not fall foul of Eiopa for not implementing correctly, rather than being guided by the ultimate objective of making sure that insurance companies do not get into financial difficulties.

Hickman: The FSA did not operate effectively as an implementation outpost of EIOPA. It is difficult for them when you have Eiopa and the Commission setting one-size-fits-all, detailed, prescriptive rules, which cannot possibly work for everyone given the differences in social models, tax rates and history.

Solvency 1 reborn?

Field: So there are no issues that worry you much now, because Solvenvy II has been put off for so long?

Hickman: We are getting back a regulator who is saying, 'Let us focus on good risk management, on doing sensible things via proportionate approaches, going back to a principle-based regulation.' It seems quite ironic that, with the early warning indicators, we appear to be going full circle, heading towards a risk-based regime with a formulaic-based floor. That is a bit like Solvency I, is it not?

We are very much more focused on turning all of the money we have spent to good use now in terms of running everything with better models, better data and better governance that focuses on using the capability we have built and not worrying about how we are going to evidence compliance with a detailed, prescriptive set of rules that do not really work.

Shades of the millennium bug

Field: Any other thoughts about the ultimate deadline?

Golding: It is a bit like the "millennium bug" twelve years ago. There were inherent benefits gained from updating systems and software that were only realised after the more obvious benefits were found to be redundant. Just as with Solvency II, the benefits of pillar 2, i.e. risk management development, remain with or without the internal model. However, further regulatory change may inadvertently undo some of these benefits.

Value for money?

Field: So do you think the money you have spent has been worthwhile?

Golding: I wonder, if the market always knew there was a 2016 deadline, would it have cost more or less money than working towards the deadlines previously considered? It's impossible to tell at this point. If you have not implemented what you have developed so far, you won't have realised the benefits nor gone through the process of promoting the benefit or demonstrating it to the board and all the other stakeholders.

Field: Could you see the delay changing your decision about implementing the internal model, trying to embed it more in the business?

Golding: The company has repositioned the Solvency II programme to focus on the development of the calculation kernel and validation for the purpose of embedding its use. Validation of ancillary components, not directly relating to the calculation kernel, is being delayed until timescales for application have been confirmed by Eiopa and the FSA. Across the industry, this has made our roles more challenging as the big stick that we could rely on to influence the business has essentially been replaced with a chopstick.

Field: Is that a general view?

Scott: We learned more about the risks that we take on, but what may have suffered a little bit is our bread and butter work. Our raison d'être is providing services to our clients and helping them provide innovative products to the retail market and maybe we have been distracted from that.

On some of the things which are more compliance-orientated, like validation, I think it was a bit more valuable than we thought it would be, but still probably not worth the effort.

UK vs continental approaches

Field: Do you think the UK is now at a disadvantage to other parts of Europe by trying to keep to the original Solvency II plan?

Borrett: It is thought of as a British directive, is it not, among the member states?

Camps: Plenty of guys in Europe have a model, but will not go the route of asking for approval. A model is always better and gives you a competitive edge compared to your peers. I have been able to see and compare the two approaches a little bit across the channel. The UK approach can be very heavy, very expensive and time-consuming but ultimately very positive. We are much better than we were.

If it had been 2016 rather than 2014, probably you would have done things a little bit differently and it could have cost you less money but with a five- or six-year target, it is so difficult to maintain the sort of pressure on people for that length of time.

Who's going to be equivalent to whom?

Field: Presumably, this also makes the issue of equivalence under Solvency II less urgent especially in the US?

Yardley: I think the Canadians scuppered it when they said that they were not going to bother trying for equivalence.

Camps: Bermuda, the US, a lot of people will have their systems before us. We will have to be equivalent to them! 

Yardley: I think it is all going to be overtaken by ComFrame, which is going to genuinely try to harmonise the issues people really do agree on. I think that is a more fruitful way forward.

Field: Will the Americans see problems with that?

Camps: I received a request from our sister company in the US for our ORSA material. We consider it of great importance. I think pillar 2 is going to be quite well accepted worldwide.

Outstanding issues

Field: Are there any outstanding issues then, apart from the fact no-one is quite sure what is happening?

Hickman: I think one of the challenges is making sure we are not distracted by Solvency II any more. It seemed a great innovation. But I think part of the reason why Solvency II has come to a grinding halt is a growing recognition that it would be damaging to growth and it imposes a bureaucratic burden that is not in keeping with a competitive market.

Daniel Golding: "[Delays to the timescales for Solvency II application have] made our roles more challenging as the big stick that we could rely on to influence the business has essentially been replaced with a chopstick."

Hilder: I think we still have to remain vigilant that we do not end up with higher capital requirements, which I think has been our worry all along.

Kirby: Do you think you are in a better position now as a result of all the work you have done on Solvency II and risk management?

Hilder: Some things have been a waste of time and some have not. Now we can actually concentrate on the ones we think are genuinely valuable.

Kirby: Have you seen this initiative push the recognition, acceptance and understanding of risk within the business function down to lower areas of the business at all?

Borrett: On a day-to-day basis, one of the enduring benefits of Solvency II is it has raised the consciousness of risk and the importance of capital allocated to risk in general.

Scott: Pillar 2 is really what business managers should already be doing on the front line - it's mainly common sense.

Golding: Culturally, it has forced a lot of businesses to look at risk from an enterprise-wide perspective, which had not happened before. We are in a good position resulting from the work undertaken as part of the Solvency II preparedness; however, managing risk at an enterprise-wide level requires people to consider risk in a slightly different context. Change management, particularly where the change involves people's behaviour and attitude is not something that can be achieved overnight.

Camps: I think, on a long-term basis, this investment is going to be very beneficial. I can easily imagine that we can get a return through the various risks we will avoid. I think ultimately we'll decide not to be exposed to a lot of risks, whereas before we had an actuarial team telling us the capital was under review. It is not that you will definitely get a profit, but you will avoid a massive loss, I think.