As we approach the end of June, Solvency II is finally becoming a regulatory reality – only six months to go before we reach the ‘end of the tunnel’. Many firms still have important work to do to meet the deadline.
The core Solvency II regulations are now taking shape at national level and this is a good development, but insurers should not be complacent. With the Prudential Regulation Authority (PRA) publishing a number of supervisory statements and giving feedback around the Own Risk and Solvency Assessment (ORSA) in June, there is no excuse for insurers implementing key Pillar 1 and 2 requirements below the expected standard.
A coherent ORSA framework
ORSA is a perennial area for regulatory concern – or specifically, elements of ORSA that insurers tend to overlook. As a result, firms fail to demonstrate full compliance with the key principles of the ORSA requirements. The PRA’s June 2015 ORSA feedback is useful in this respect, providing good guidance for enhancing the elements of ORSA covering:
- level of board engagement;
- business strategy;
- material risk;
- capital and solvency;
- stress testing;group issues.
All these ORSA areas are interlinked. But the central theme is that firms need to develop an ORSA framework that coherently and conclusively links the risk-taking activity of the insurer on a forward basis (at least on a three-year basis) to the capital and solvency position under an effective system of governance and control across the firm. It’s also very important for firms to demonstrate in the ORSA why the risk profile of their business fits their selected regulatory model status, namely the standard formula or an internal model. This is also subtly and succinctly mentioned in the PRA’s June 2015 ORSA feedback
Time to commit
None of this is new or should be surprising to UK insurers, yet the PRA feedback on the weaknesses in these ORSA elements reflects our own experience in reviewing clients’ assessments. This suggests that senior management in certain firms still have some reservations about the benefits of Solvency II and are failing to commit to the necessary investment. Some may still view Solvency II as a minimum compliance task. This is a concern: we think the PRA’s early feedback is an indicator of more to come in terms of higher expected standards. So there really is no excuse if firms get caught out, for example, in PRA attestations exercises, which a number of our clients are currently facing.
Defined benefit pension schemes
Another area of concern, which some insurers and in particular smaller firms had not envisaged, relates to material defined benefit pension schemes and how these should be considered in the Solvency Capital Requirement (SCR) calculations and the ORSA. It’s interesting to note that the PRA’s Solvency II smaller firms survey (June 2015) specifically asks whether the firm has considered any defined benefits pension scheme (DBPS) in its SCR or ORSA. PRA Supervisory Statement SS5/15 issued back in March provides some good guidance on this and, given the ORSA feedback, it’s important to identify and review if DBPS liability is on the balance sheet. Firms should consider what stress and scenario tests and/or quantitative asset risk modelling needs to be carried out to adequately assess this risk and any additional capital requirement.
Category four and five firms: be prepared
In addition to enhancing the ORSA for business use we also expect PRA category four and five firms in the next two quarters to be focused on preparing for Pillar III, as they were not part of the 2015 PRA dry-run process. Many will need to gain a better understanding of the disclosure requirements detailed in the PRA’s SS11/15 (Solvency II: regulatory reporting and exemptions). Category four and five firms (and the groups to which they belong) can apply for exemptions to quarterly reporting (applications should be submitted by 1 September). But the PRA expects firms to have a contingency plan in place in case their application is rejected or their exemption expires without being extended. Note that even when a quarterly reporting exemption is granted, firms will still have to supply certain information, including minimum capital requirement quarterly reports and second quarter reporting of own funds and balance sheet templates.