Non-executive directors in Solvency II. 19 March 2015

Transcription

1 Non-executive directors in Solvency II 19 March 2015

2 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

3 Agenda Introduction Internal models System of governance/orsa Regulatory reporting Board understanding of Solvency II Paul Fisher Gareth Truran Giles Fairhead Giles Fairhead Ian Marshall

4 Introduction Paul Fisher Executive Director Insurance Division 19 March 2015

5 Internal models Gareth Truran Head of Department, London Markets 19 March 2015

6 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

7 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

8 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

9 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

10 Formal application phase Stocktakes in Q 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

11 Key questions for non-executives to ask (1) Model scope Key features of the model Use of the model 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? 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? 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

12 Key questions for non-executives to ask (2) Validation Ongoing review Other 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? 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? 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?

13 System of governance/orsa and nonexecutive directors Giles Fairhead Head of Department, Retail Life Division 19 March 2015

14 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

15 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

16 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?

17 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.

18 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?

19 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

20 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?

21 Board understanding of Solvency II Ian Marshall Senior Advisor and Chairman of a Board 19 March 2015

22 Four topics Board s role Validation Barriers to Board understanding ORSA and Risk Appetite

23 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

24 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

25 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

26 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