Risk Management in the Insurance Industry and Solvency II

8/9/2019 Risk Management in the Insurance Industry and Solvency II

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Risk Management in theInsurance Industry andSolvency II

European Survey 2006

Financial Services the way we see it


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Contents

Preface 3

1 Management Summary 4

2 About the Survey 6

3 Solvency II: The New Regulatory Capital Framework 8

3.1 Solvency I 83.2 Solvency II 9

3.3 Improved Risk Management 11

3.4 Solvency IIs Impact on Insurance Marketing Policies 11

4 Solvency II and IAS/IFRS 13

4.1 Solvency II and IAS/IFRS Phase 2: 14

the guidelines and the timing of both projects are crucial

4.2 Examples of current differences in the financial statements 14

of European insurance companies

5 2006-2007: The Time To Approach Solvency II 15

6 Survey results 17

6.1 Importance and Development of Risk Management 17

6.2 Risk Management Organisation and Processes 22

6.3 Internal Reporting 25

6.4 Legal Framework 27

6.5 Methods of Risk Management 28

7 Key Findings and Conclusions 33

Appendix 1: Sample Insurance Company Participants 34

Appendix 2: Economic Capital as an Implementation Framework 35

Appendix 3: Literature 38

About The Survey

This survey and report was produced

by Capgeminis Compliance and Risk

Management Centre of Excellence.

Author

Sjaak Bouma

Contributors

Luca DOnofrio

Augusto FranconiGiuseppina Aprile

Vincenza Tarallo

Marco Folpmers

Sponsor

Harmen Meijnen, Global Lead,

Compliance & Risk Management

Centre of Excellence

Survey Coordination

Jan van Rompay, Council of Europe

Compliance & Risk Management

Local Survey Coordination

Norway

Jon Qvigstad

Peer Timo Andersen

Germany

Ulrich von Zanthier

Andreas Duldinger

Netherlands

Marien van Riessen

Garnt van Logtestijn

Belgium

Dermot Redmond

France

Antoine Pailhes

Portugal

Ana Cerqueira

Spain

Lucia Gonzalez

Italy

Luca DOnofrio

Claudio Trecate


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Preface

Insurance is a form of risk management that parties use to protect themselves

against a loss. Ideally, it involves the equitable transfer of the risk of loss from

one entity to another, over a set period of time, in exchange for a reasonable fee.

Third, the increased use of risk

vehicles could result in risk being

transferred to sectors in which capital

requirements are lowest. This type

of reallocation is possible because

capital regulations are not the sameacross the financial services industry.

The inconsistency means financial

services companies can potentially

reduce regulatory capital without

reducing riskespecially at financial

conglomerates, which operate both

banking and insurance businesses.

In November 2005, European Central

Bank president Jean-Claude Trichet

addressed a CEIOPS (Committee of

European Insurance and Occupational

Pensions Supervisors) conference1

and warned of how the growing link

between banking and insurance

could weaken the insurance industry,

and the financial system as a whole.

He specifically noted how financial

conglomerates face larger capital

requirements in banking than they

do in insurance. By transferring risk

from their banking divisions to their

insurance divisions, conglomerates

can therefore benefit from capital

relief without actually reducing theamount of risk exposure for the

conglomerate as a whole. Such risk

transfer could potentially weaken

conglomerates, he said.

For insurance companies, risk is more

integral to business than it is in perhaps

any other industry, so why do European

regulators want to introduce new

requirements for solvency and risk

management in the form of Solvency II?The answer, in short, is that regulators

want to protect the stability of the

financial system. However, there are

three different underlying drivers of

change to consider.

First is the economic development

of the insurance segment itself. The

insurance sector has grown significantly

in recent decades, making it the

second-largest within the European

financial services industry. Due to

this growth, any negative disturbanceswithin the industry will potentially

affect the entire financial system.

Second, companies and markets are

becoming increasingly complex,

creating new types of risk, such as

operational risk. Insurers may not be

able to manage these new risks as

well as they manage those that are

core to their business, such as the

insurance technical risks. To preserve

systemic stability, regulations must

therefore tackle a broader range of

risks. Concomitantly, technological

developments are creating advanced

risk management possibilities, and

insurance companies must learn to

use these technology-enabled tools

in order to manage both existing and

new risks properly.


1 Source: Jean-Claude Trichet, Developing the Work and Tools of CEIOPS: the views of the ECB, Keynote speech at the Committee of European Insurance and

Occupational Pensions Supervisors (CEIOPS) conference, Frankfurt, November 2005

These changing market conditions are

the reason the European Commission

(EC) is trying to develop a

state-of-the-art solvency framework

Solvency II to ensure proper

protection for policyholders.

In light of the pending revolution,

Capgemini conducted a survey

entitled Risk Management in the

Insurance Industry and Solvency II

to gauge how European insurance

companies are positioned to tackle

the risk-management challenge

created by Solvency II. This report

presents our findings, and offers

additional context and detail on the

new solvency framework.

Since Solvency II represents significant

challenges for the Insurance industry,

The European Financial Management

and Marketing Association (EFMA)

welcomes the opportunity to bring

these latest findings, market research

and insights to its members as part of

their value-added services. Capgemini

welcomes this collaborative effort to

bring industry leading research to the

EFMA community.


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Times have changed. Insurance

companies and their operating

environment have been radically

altered by growing complexity in

markets and products, evolving

technology standards, globalisationand conglomeration. As a result,

says the European Commission (EC),

existing solvency requirements fail

to provide the necessary level of

policyholder protection. In developing

Solvency II, the EC hopes to make

solvency requirements more relevant.

Solvency II envisages enterprise-wide

risk management as the basis for capital

requirements. It also seeks to create a

harmonised set of requirements across

Europe, providing a level playing fieldin the financial services industry.

Solvency II seeks to incorporate IFRS

(International Financial Reporting

Standards) on valuation, but it will be

complex to develop, as it is seeks to

assure consistent guidelines.

Solvency II is built on a three-pillar

framework like the Basel II approach

developed for the banking industry,

and it similarly aims to align capital

requirements more closely with actualrisks. The framework also provides

incentives for insurance companies

to disclose their entire risk profile to

both supervisors and the market a

provision the EC hopes will encourage

insurance companies to develop their

risk management function proactively.

For insurance companies, then,

Solvency II presents a looming

compliance challenge. Lessons

learned from Basel II reveal two

key imperatives.

The first involves implementation,and the need to influence the entire

insurance organisation. Solvency II

will require well-planned change

programmes, whose impact will

reach from the front office to the

board of directors and from risk

management to IT. These programmes

will span several years, but must start

promptly to ensure compliance in

2010, when Solvency II is currently

expected to take effect. The demands

on personnel in the organisation will

be significant throughout the

implementation years.

The second major challenge will be

managing the strategic consequences.

Solvency II should offer competitive

advantage to companies with a

low risk profile and superior risk

management as it will lower their

capital requirements. Risk-savvy

insurers can also use insights from

their sophisticated internal risk

models to develop risk-based

marketing, and employ risk-based

performance management, helping

to optimise their balance sheet.

Insurance companies that move

quickly to execute such risk-based

activities are likely to become

winners in the insurance industry.

1 Management Summary

4


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Risk profiles and capabilities differ

among business segments. Companies

with both life and non-life businesses

are less sophisticated in areas where

risks are to be integrated under

Solvency II, and on enterprise-widerisks, such as operational risk. In

addition, less then half of participating

insurance companies currently employ

integrated risk management as is

advocated by the new framework.

Current risk-management practices

suggest many European insurers

may face a significant capability gap

when it comes to Solvency IIs

risk-based approach:

- Insurers may be familiar with

risk-management methods suchas stress-testing, scenario analysis

and actuarial approaches, but not

with specific risk dimensions, such

as the probability of economic ruin

and value at risk, which are likely

to be integral to the Solvency II

approach.

- Almost half of the participating

insurance companies already have

access to their own internal risk

models, which are an option for

calculating solvency ratios under

the new framework.

Insurance companies already

comprehend the gravity of risk, and

expect risk to become even more

important in the future. Significantly,

though, improvements in risk

management are being driven first

by compliance and only secondarily

by the business case, even though

insurers across Europe see the

potential commercial benefits of

improved risk management.

As of this point, though, where does

the European insurance industry

stand in terms of risk management?

A survey conducted by Capgemini

across 8 European countries

and 63 insurance companies revealsthe following five insights about the

European insurance industry:

The development of the risk

management function typically

reflects the importance of the

underlying risk. As such, policies,

procedures, frameworks and strategies

are most often in place for the more

important risk types and are less

developed for less important risks.

There is also a difference between

the risk profile of life and non-life

companies, and thus their capabilities.

Since Solvency II requires disclosure

on specific risk types, it is likely that

most insurance companies will need

to fortify their risk management

function in certain areas.

Most insurance companies use

similar risk management processes,

procedures, frameworks and strategies,

but there are some tangible differences

across peer groups. Overall, for

example, large insurance companies

are more advanced in their risk

management approach than small and

medium-sized insurance companies.

That disparity justifies the existence

of a standard capital formula for

smaller insurance companies in the

Solvency II framework.

Risk Management in the European Insurance Industry and Solvency II 5

In summary, Capgeminis insurance

and risk management experts are

convinced that Solvency II needs to

be high on the agenda of European

insurance companies. The risk

management function in insuranceis well-developed, but shows some

tangible gaps with respect to current

Solvency II blueprints.

Among insurers, the current state

of the risk management function, and

thus the roadmap towards compliance,

depends on the companys size, region

and business segment. To develop

a company-specific roadmap and to

prepare for Solvency II, Capgemini

recommends that insurance companies

conduct three key initiatives:(1) compliance scans (2) development of

(quantitive) advanced risk management

skill sets (3) pre-emptive data

management and data gathering.

In the next couple of years, the strategic

impact of Solvency II is likely to start

producing industry-wide changes for

insurance. Now is the time for insurers

to ready themselves for Solvency II,

and prepare to leverage the potential

benefits of the changes that are to come.



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The survey Risk Management in the

Insurance Industry and Solvency II was

developed and conducted in light of the

new regulatory capital requirements

being prepared by the EC. The results

provide valuable insight into the statusof the risk management function

across European insurance companies

in relation to the new Solvency II

framework, and the data highlight

potential compliance gaps. The survey

results should help to increase awareness

at insurance companies across Europe.

For participants, the findings offer insight

into their position relative to all insurance

companies and to others in their peer

groups and should, therefore, help

these companies to identify potential

development areas on the road toSolvency II compliance.

QuestionnaireThe survey questions cover five topics:

1. Key areas of risk. Questions relate

to the current and future importance

of risks, as well as to the processes

and procedures set to managethese risks.

2. The risk management organisation

and processes, including the presence

of a framework, risk strategies and

responsibilities, and the integration

of risk management.

3. Internal risk reporting, including

processes and the distribution of

risk reports.

4. Legal framework.

5. Available risk management methods.

Some of the questions relate to the

importance, quality or existence of risks,

processes and procedures and require a

self-assessment. The results assume the

respondent was capable of answering

the question and of answering honestly

and objectively. The development of risk

management and the existence of certain

risks may vary anyway, depending on

the insurers size or business segment.

2 About the Survey

6


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ParticipantsCapgemini used its international network

of offices to conduct the survey in

local markets. In total, the survey

covers 63 insurance companies across

8 European countries Norway,Germany, The Netherlands, Belgium,

France, Italy, Spain and Portugal.

Appendix 1 names some of the

participating companies. Note that

five questions reflect answers from

only 7 countries, due to certain

national differences in the survey.

Peer Groupsand Insurance TypesTwo peer groups are defined. The first

comprises small and medium-sized

insurance companies with total annualpremium revenue of< 1.5 billion.

The second comprises large companies

with total annual premium revenue

of 1.5 billion.

ResultsIn general, th e survey analysis

presented in chapter 6 reflects

the consolidated results from

all participants, but we also offer

comparisons of peer groups orinsurance business types when

those data breakdowns are of

particular interest.

Table 2.1 Distribution of participants

Total number of participants 63

Peer groups

Small and medium-sized insurance companies 32

Large insurance companies 31

Insurance type

Life insurance business 20

Non-life insurance business 16

Life and non-life business 27


For the purposes of this survey,

participants are characterised as

one of the following:

1. Life insurance business

2. Non-life insurance business,

including health insuranceand credit insurance

3. Life and non-life business

The distribution of participants across

peer groups and insurance categories

is outlined in Table 2.1.

Country ComparisonsSolvency II is not just a state-of-the-art

solvency framework; it will further

harmonise the existing European

insurance market. As Europe movestoward unifying legislation and a single

market, national differences should

play a far reduced role, so the findings

are presented from a single European

market perspective, and there is generally

no comparison of regions or countries.


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The insurance market has been subject

to significant change in recent years. The

industry has had to cope with major

destabilising forces, from technology to

terrorism and financial market instability.

The insurance market has also grownin size and complexity, making it

second in size only to banking among

European financial services. From

a regulatory standpoint, then, the

importance of solvency has increased

dramatically, since any failure in the

insurance market potentially creates

systemic risk risk that threatens entire

financial markets and systems, not

just individual market participants.

The threat of systemic risk has also

become more acute with the growthof financial conglomerates, which

combine banking and insurance

activities. Jean Claude-Trichet, president

of the ECB, said in 20052 that there

are several ways in which insurance

companies can potentially affect banks

and disrupt financial stability. Perhaps

most striking is the danger created by

the fact that insurance and banking are

subject to different capital regulations.

As a result, a bancassurance group could

transfer risk from its banking businessto its insurance companies and capture

capital relief without actually reducing

risk for the group.

All in all, then, the EC believes existing

solvency regulations are not adequate to

protect policyholders and beneficiaries.

The EC started to develop Solvency II as

a way to provide the proper protection.

The new framework also aims to create

a level playing field for all participants,

harmonise supervision across EC

member states, improve capital

allocation, and increase competition

in the European insurance industry.

3.1 Solvency ITo frame the discussion of Solvency II,it is important to look first at existing

regulations. Solvency I comprises a

core set of regulations plus various

amendments. The non-life and life

directives of 1973 and 1979, respectively,

form the core of the framework.

Additional regulations adopted for

both businesses in 2002 aimed to

improve the calculation of solvency

margin requirements. For the life

business, the solvency requirement

is based on a percentage of themathematical provisions plus a

percentage of the remaining positive

capital at risk. In non-life, the required

solvency margin is based on a

percentage of gross written premiums,

a percentage of average claims over a

time period, or the carried-forward

amount of preceding years. The

solvency requirement can be reduced

by reinsurance. For both businesses

there is a minimum guarantee fund

that provides a safety net.

Current regulations do provide a certain

level of protection to the policyholder,

but there are limitations. A UK Treasury

report provides examples of where the

regulatory capital based on the current

framework diverges from an individual

companys economic capital3. Another

limitation of Solvency I is that non-life

solvency margins are based on the

volume of contracts rather than the

3 Solvency II: The New Regulatory

Capital Framework

8

2 See footnote 1

3 Source: HM Treasury, Solvency II: a new framework for prudential regulation of insurance in the EU, a

discussion paper, London, February 2006



The EC has similar aspirations forinsurance, and is employing a three-

pillar approach for Solvency II, though

the scope of each pillar will obviously

be tailored to insurance. In the proposed

framework being used in consultations

with the industry, the EC has defined

some general conditions4, including

the following:

The framework should provide

supervisors the ability to assess the

overall solvency of individual life

insurance, non-life insurance andreinsurance institutions.

This assessment of overall solvency

should be based on a risk-oriented

approach.

The framework should contain

incentives for insurance companies to

measure and properly manage risks.

Solo supervision should remain a

national supervisors task. However,

it should be a goal to harmonise

supervision across member states.

actual risks embedded in specificcontracts. Other examples of short-

comings relate to the inadequate

determination of technical provisions

and the lack of comprehensive

guidelines on how to benefit from

diversification and pooling effects.

These examples illustrate just a few

of the solvency provisions that are

inadequate for todays environment.

3.2 Solvency II

The ECs new regulatory frameworkfor insurance follows closely on the

heels of Basel II capital regulations

developed for the banking industry.

Presented in July 2004, Basel II adopts

a new approach to the management

of risk and the calculation of capital

requirements. Its three-pillar framework

deals specifically with credit, market

and operational risk and offers banks

the option of using their own internal

risk models to estimate risk and

calculate risk-weighted assets.


4 Source: European Commission, Amended framework for consultation on Solvency II, April 2006

Solvency II should be compatible

with valuation standards and thus with

the accounting standards of the

International Accounting Standards

Board (IASB).

The framework should encouragea level playing field in the financial

industry by being consistent and

compatible with banking regulations.

Small insurance concerns should

be able to comply with Solvency II

without having to incur

disproportionate costs.

In developing the framework, the

EC is using the so-called Lamfalussy

method, which takes a phased

approach to legislative and regulatorychanges to ensure that EC-wide,

national and industry issues are

addressed separately but consistently.

In the case of Solvency II, Level 1

focused on developing the framework

and should, based on current timelines,

be adopted by July 2007. In the

next levels, technical details will be

worked out (until 2009) followed by

implementation across the countries

involved. According to current timelines,

Solvency II should take full effect in

2010 (see Figure 3.1).

Within the Lamfalussy approach,

the CEIOPS has an important

advisory role on Solvency II. The

EC initiated three waves of calls

for advice from the CEIOPS. The

consultations yielded responses in June

and November 2005 and May 2006,

which together provide the first

indications of what the three-pillar

framework requires.

Figure 3.1 Solvency II Roadmap

CEIOPSAnswers To Calls

For Advice

QIS1 QIS2

Adoption ofEuropean Commission

SuggestionsEffective Date

Solvency II

FormalAdoption ofFramework

fromCommission

(July 2007)

Definition ofRealisation

Dates

EuropeanCommission Draft

of Directive(Oct. 2006)

2004 2005 2006 2007 2008 2009 2010

Source: Capgemini 2006


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The Solvency II framework (see

Figure 3.2) mirrors the concept of

its Basel II forerunner. Pillar I deals

with the quantitative determination of

capital requirements, and Pillar II with

the supervisory review process. Pillar III

tackles disclosure, sets requirements

with respect to market transparency

and completes the framework.

Pillar I contains four items of note.

First, it stipulates how technical

provisions should be calculated. The

CEIOPS adviceand thus potentially

the frameworkadvocates a policy-by-

policy valuation (rather than a portfolio

approach) and a calculation of the riskmargin per business line. Second, the

pillar stipulates Minimum Capital

Requirements (MCR), which CEIOPS

explains as follows5: The MCR reflects

a level of capital below which an

insurance undertakings operations

present an unacceptable risk to

policyholders. If an undertakings

available capital falls below the MCR,

ultimate supervisory action should be

triggered. Third, Pillar I contains

Solvency Capital Requirements (SCR),and states that the SCR level of capital

should be enough to allow an insurer

to absorb unforeseen losses and should

assure the desired level of policyholder

protection. Insurers have the option of

calculating the SCR, which must take

into account all material and quantifiable

risks, using a standard formula or using

(partly or wholly) an internal model.

Smaller insurance companies are likely

to use the standard formula, allowing

them to comply without incurring

disproportionate costs. By using internalmodels, though, insurance companies

can tailor capital requirements to their

specific risk profile. Fourth, Pillar I

deals with investment management

rules. The call for advice focuses onasset eligibility and high level

requirements for Asset and Liability

Management (ALM), investment and

concentration limits, and the balance

between these items and financial

resources calculated under the

technical provisions, SCR and MCR.

Pillar II pertains to corporate governance,

ALM and investment management rules

and the supervisory review process

(SRP). Corporate governance in the

Solvency II framework focuses on risk

management processes and the internal

control function. The involvement of

the board of directors and that of senior

management are frequently stated

requirements. Other requirements relateto fit and proper personnel, risk

strategies, risk reporting, responsibilities,

independence of functions, and risk

management policies and procedures.

An important feature of Pillar II is

the power of the supervisor to require

additional capital, resulting in a

so-called adjusted SCR, and to take

measures to reduce risks. Pillar III

completes the framework with a set

of disclosure requirements. Unlike

Basel II, which only demands market

disclosures, Solvency II establishes rules

for supervisory and public disclosure.

5 Source: CEIOPS, Answers to the European Commission on the second wave of Calls for Advice in the framework of the Solvency II project, October 2005.

Figure 3.2 Solvency II Three Pillar Framework

Subjects

Risks

Pillar IIIMarket Discipline

Pillar IISupervisory Review Process

Pillar IQuantitative Requirements

Public Disclosure

Supervisory Disclosure

Supervisory Review ProcessSupervisory Powers

Corporate Governance &Internal Control

Safety MeasuresSolvency Control Levels

Risk Management FunctionAsset & Liability Management

MCR

SCR; Standard Formula,Internal Models

Risk DependenciesRisk Mitigation

Technical Provisions

Material, Quantifiable Risks

Underwriting Risks

Market RiskCredit RiskOperational RiskLiquidity RiskALM RiskOther

All Risks



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3.4 Solvency IIs Impact onInsurance Marketing PoliciesThe Solvency II model will require

insurance groups to allocate capital

based on insurance, financial and

operational risks. It is therefore likely

that levels of solvency capital will vary

between insurance companies with

different risk profiles. This disparity

will create strategic opportunities.

We strongly believe insurance

companies will be presented with

four avenues through which they

can gain a competitive edge as a

result of Solvency II:

I. Competitive Advantage in

Capital Requirements

Specific types of insurance companies

will benefit from lower capital

requirements than their competitors,

due to differing company profiles.

Large insurers are expected to benefit

from risk diversification, both

geographically and across portfolios.

Niche players are another group

of potential winners. Some of those

insurance companies will have

relatively simple and low-risk

portfolios that will have relatively

lower capital requirements.

3.3 Improved Risk ManagementSolvency II reflects the ECs desire to link

solvency capital more directly to the

actual risks faced by an individual

insurance company, and it contains

specific incentives to encourage

insurance companies to improve their

risk management function. In short,

insurers will be able to directly influence

their solvency capital requirements in

a number of ways under Solvency II.

First, each insurance company has

three options for calculating SCR,and the more advanced the chosen

approach, the lower the SCR will

be, all else being equal.

Second, the formula used to calculate

the SCR is likely to be based on Tail

Value at Risk (TailVaR; see Appendix

2). TailVaR, unlike Value at Risk

(VaR), takes account of losses in the

tail of a distribution. By reducing the

magnitude of losses in the tail, an

insurance company can reduce

solvency capital. The third incentive for insurers is in

Pillar III, which demands that insurers

report risks to market parties, such

as investors and rating agencies.

Insurers that demonstrate superior

risk-management capabilities should

enjoy higher company ratings (and

potentially share prices) than those

companies that prove to be less

sophisticated in risk management.


Indeed, the Standard & Poors

credit-rating agency has said leaders

in adopting Solvency II principles may

benefit from significant competitive

advantages, while laggards risk having

to give up their independence or even

quit the market.6

II. Risk-Based Marketing

Until now, insurance companies have

defined the price of new products

based almost solely on technical

insurance indicators. When Solvency

II takes effect, the product price must

also take account of financial and

operational risk indicators. Insurance

companies should also be able togarner superior portfolio insights from

the historical data and risk modelling

required for Solvency II.

By leveraging risk insights in commercial

activities, insurers can develop a risk-

based marketing approach, characterised

by risk-based pricing, targeted portfolios,

more relevant product development,

improved cross-selling, and the buying

and selling of portfolios based on the

underlying risk profile.

In short, we expect the first adopters

of new capital-allocation criteria will

have a competitive edge, making better

strategic choices as they align product

development with the best profitability

on risk ratios.

III. Performance Management

New profitability indicators required to

manage risk will also offer a competitive

advantage to some insurance companies.The valuation of profitability will no

longer be based on absolute returns

on equity ratios. Rather, profitability

will be based on returns on equity

adjusted for risk capital consumption.

The RORAC (return on risk-adjusted

capital) ratio, which will replace EVA

(economic value added), is considered

to be a better indicator of the risk

capital allocation.


Risk

Management

Systems

Capital Allocated

in Line with

Actual Risks

Returnon Invested

Capital


6 Standard & Poors, Industry Report Card: European Insurance, January 2005


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Pioneers of Solvency IIs risk-based

principles will gain a competitive

advantage by proactively and promptly

identifying and pursuing profitable

lines of business and abandoning less

profitable ones.

Capgemini advocates the use of

an economic capital approach in

implementing Solvency II (see

Appendix 2 for details). Economic

capital, a recognised risk-based

performance management tool, provides

an approach for steering business based

on the optimal mix of profit and risk.

As such, it provides a performance

management solution that aligns well

with the new Solvency II requirements.

IV.External Rating

Pillar III includes requirements

not only on supervisory disclosure,

but on market disclosure. Insurance

companies will be required to report

on risks and the management of riskin their annual reports. For investors

and rating agencies, such information is

useful in determining creditworthiness.

In the future, then, the share prices and

credit ratings of insurance companies

will be more dependent on risk profile

than ever beforeand it will be in the

best interest of insurance companies to

demonstrate sound risk management.

12



IFRS 4 (International Financial

Reporting Standard 4) on accounting

for insurance contracts already took

effect in Europe in January 2005, but

IFRS 4 represented only the first phase

of the IASBs project to develop acomprehensive accounting framework

for insurance companies. In Phase 2,

the IASB will issue a Discussion Paper

detailing new and complete IAS/IFRS

principles on insurance contracts. The

paper is due out by December 31st 2006

(see Figure 4.1).

Then the IASB will deliver definitive

IAS/IFRS principles, currently expected

by September 30th, 2008. The last step

will be to implement an insurance

liabilities evaluation and measurementmodel based on fair value. It is due to

take full effect by 2010.

The insurance market faces radical

change due to Solvency II. Indeed, the

French Society of Financial Analysts

(SFAF) has called the new framework

a Revolution in value measurement

and strategy for the insurance sector.

7

To fulfil the solvency requirements,

insurance companies must review

both the business processes and the

profitability of their business lines.

Certainly, Solvency II is revolutionary

in that it provides:

A better and more detailed

measurement of risks

The evaluation of company assets at

market value according to IAS/IFRS

accounting principles

A global focus on enterprise riskmanagement (not only technical

risks but also financial, operational

and other risks)

4 Solvency II and IAS/IFRS

7 Source: Solvency II, une rvolution pour la valorisation et la strategie Analyse Financiere n20 July,

August, September 2006 from the Dossier Avenir radieux pour lassurance (Translation: Solvency II,

a revolution in value measurement and strategy from the Dossier Great perspectives for insurers)

Figure 4.1 IAS and Solvency II Roadmaps

CEIOPSAnswers To Calls

For Advice

QIS1 QIS2

Adoption ofEuropean Commission

SuggestionsEffective Date

Solvency II

FormalAdoption of

Frameworkfrom

Commission(July 2007)

Definition ofRealisation

Dates

EuropeanCommission Draft

of Directive(Oct. 2006)

2004 2005 2006 2007 2008 2009 2010

Discussion PaperPhase 2 (31-Dec)

Exposure DraftPhase 2 (30-Jun)

Final IFRS(30-Sep)

IAS Phase 2Balance Sheet

IFRS 4

Local& Intl.

Acct.Principles

Year 1: IASBalance Sheet

International Accounting Principles




14/40

Meanwhile, the EC is expected to finalise

the draft directive of Solvency IIs 3-pillar

framework by October 20068, with

formal EU adoption due by July 2007.

European countries are due to adopt

the Directive in 2008, and insurancecompanies are expected to be compliant

by 2010.9 This timeline remains subject

to change, however.

4.1 Solvency II and IAS/IFRSPhase 2: the guidelines andthe timing of both projectsare crucialThe IAS/IFRS accounting principles

and the Solvency II capital standards

both hinge on the evaluation of

insurance contracts. It is essential to

calculate company liabilities accuratelyin order to determine appropriate

solvency ratios and capital requirements.

Insurance contracts are the main

component of an insurance companys

liabilities, and the adoption of IAS/IFRS

accounting rules will create an important

tool for evaluating those contracts.

Phase 2 of the IAS/IFRS project is

expected to deliver the key reference

guidelines on solvency issues. The IASB

aims to create one set of accountingprinciples for both financial and

regulatory reporting a set that also

matches the demands of Solvency II.

Currently, however, inconsistencies seem

inevitable. For example, Solvency II

demands that insurers estimate all risks,

including catastrophic and equalisation

risks. IAS/IFRS Phase1 does not include

provisions for catastrophic risks, though

IAS/IFRS Phase 2 seems to consider the

possibility of making provisions foridentifiable catastrophic risks, such as

earthquakes, in calculating risk margins.

IAS/IFRS Phase 2 insurance principles

are still in the draft stage, and any hold-

up in the definitive version might delay

the implementation of Solvency II.

On the other hand, if Solvency II took

effect before IAS/IFRS Phase 2, it would

reduce accounting transparency, since

standards would not be harmonised.

Ideally, then, Solvency II regulatorswill take IAS/IFRS Phase 2 drafts as

a benchmark, rather than using the

interim Phase 1 rules, in order to

prevent conflicts in the application

of the related disposals and controls.

Certainly, the alignment of Solvency II

and IAS/IFRS Phase 2 principles could

help insurance companies to avoid

the additional expense of updating

information systems and reengineering

business processes to get the datarequired for one initiative and

then another.

14

8 Source: European Commission, Solvency II Roadmap Towards a Framework Directive, July 2005

9 Source: CEIOPS Expected Project Time Schedule

4.2 Examples of currentdifferences in the financialstatements of Europeaninsurance companiesAccording to IFRS 4, an insurance

company must fulfil the local generallyaccepted accounting principles (GAAP)

in calculating liabilities until the

definitive IAS/IFRS accounting

principles on insurance contracts

based on fair value are adopted.

As a result, the following issues can

arise currently:

The different evaluation of assets

(at fair value - IAS 39) and liabilities

(local GAAP) means a companys

results can be highly volatile, and

vary significantly from one reporting

period to the next. It can also create

an accounting mismatch. The

mismatch can be mitigated by

short-term investments, but these

may produce an economic loss.

It can be difficult to compare insurance

companies in different countries,

because GAAP differs by location.

IAS principles demand that insurers

distinguish life-insurance contracts

from financial contracts. However,

they do not provide any quantitative

rules for evaluating those contracts,

so GAAP prevails. In Italy, for example,

insurers distinguish life contracts on

the basis of the size of the riskand

that risk is significant, ranging in 2005

from 5% to 10% of the total value of

the contract.


15/40

To fulfil Solvency II and IAS/IFRS

Phase II requirements, European

insurance companies must accomplish

an in-depth review of their business

processes, information systems and

organisational structures. In short,they should spend coming months

defining their Solvency II business

and operating plans.

We advocate an integrated vision,

using a structured project plan that

addresses the following themes:

1. Design of future risk management

model. A first design of the

Integrated Model for financial,

technical and operational risk.

2. Strategy to manage requiredorganisational and commercial

changes.

3. Future state design of risk data

management and reporting function.

The next step is to ingrain the new

business model into the organisation,

so it can drive business decisions

optimally. The change process will

entail multi-year programmes, involving

people, processes and technology

throughout the organisation, and it

is critical that the process be iterative.

The new regulatory framework is

revolutionary for the insurance industry.

With Solvency II, regulation will move

away from rules-based supervision

and give companies the lead in

assessing risks and calculating capitalrequirements. Based on current work by

the EC, and lessons learned in banking

from Basel II, a few realities are becoming

clear, including the following:

Solvency II regulations will

radically change the business

of insurance groups.

The business scenario is being made

more complex by the concomitant

development of the Solvency II and

IAS/IFRS Phase 2 projects; the timeline

to implement and fulfil theserequirements is extremely tight.

The sooner insurance groups can

adopt an integrated vision and a

structured project approach to

accomplish the changes required

for Solvency II, the better business

opportunities they can get, and the

more likely it is they can beat

the competition and become

market leaders.

Dealing with these realities will create

numerous difficulties for insurance

companies, but the overall challenge

is essentially two-fold. First insurers

must ensure robust implementation

of Solvency II. Second, and more

importantly, they must decide how

to recognise and utilise the strategic

opportunities of the new framework

(as discussed in section 3.4).


5 2006-2007: The Time

To Approach Solvency II



16/40

Accordingly, insurers should make

sure to assess resource availability

in the preparation phase and act

on the outcome. They should,

for example, make sure theyhave adequate quantitative risk

management expertise for risk

modellinga resource that many

banks have found to be in short

supply in preparing for Basel II.

Pre-Emptive Data Management

and Data Gathering

With Solvency II taking effect

around 2010, it is critical for

insurance companies to start

capturing and manage the rightrisk data in the right way as soon

as possiblein order to avoid

costly manual risk data gathering

and recovery later. First, capital

calculations require enterprise data,

so data from all business units or

sub-divisions must be unified and

stored. Second, adequate data history

must be developed for model

validation purposes.

16

Figure 5.1 Project Scope for Adopting a New Enterprise Business Model

Corporate Governance Model

Processes andProcedures

Structure

Internal ControlSystem

RiskManagement

System

Information System


To develop a company-specific roadmap

to prepare for Solvency II, Capgemini

strongly recommends that insurance

companies conduct three key initiatives:

Compliance Scan

Compliance scans are a useful tool

in identifying weak spots in the risk

management domain. Insurance

companies can develop a checklist

of likely needs, based on available

Solvency II guidelines, and use that

list as a framework for assessing

people, processes, procedures and

existing methodologies. The outcome

of the compliance scan provides

valuable context for crafting theSolvency II change programme.

Development of (Quantitative)

Advanced Risk Management

Skill Sets

One lesson learned from Basel II is

that the implementation of such a

framework demands both knowledge

and resources in various areas.



6 Survey results

Figure 6.1 Present Level of Importance Per Risk Area

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Importance

1(noimportance)to4(hig

himportance)

Insurance Market Credit

Risk Area

Operational Liquidity

All insurance companiesLifeNon-LifeBoth Life and Non-Life

Source: Capgemini Analysis, 2006

6.1 Importance andDevelopment ofRisk ManagementThe risk management function will

change significantly in coming years

amid the move to a more risk-basedsolvency approach. The new supervisory

regime will force insurance companies

to be proactive in moving to Solvency II

compliance. In preparing for Solvency II,

it is vital for insurance companies to

understand the importance of the

five types of risk that are central to

the framework and to assess where

they stand in their ability to manage

those risks.


What Levels of Importance

Do the Following Areas of Risk

Have In Your Company at the

Present Moment?

The five risks defined by the IAA are

insurance technical risk, market risk,credit risk, operational risk and liquidity

risk. Survey responses show market risk

and insurance technical risk are the most

important types of risk for insurance

companies (see Figure 6.1). Each risk

scored a 3.7 on a scale from 1 (low

importance) to 4 (high importance),

followed by credit risk and operational

risk (both scoring 3.0). Liquidity risk

is the least important (2.3).


18/4018

This assessment differs little between

large insurance companies and small

and medium-sized companies, though

large companies generally assign

slightly more weight to most risk

types. For technical risk, though, large

companies actually assigned slightly

less importance (0.1) to the risk than

did the smaller companies.

Considering different insurance

businesses, technical risk is more

important for non-life insurance (4.0)

then for the other segments (life, 3.5,

combined life and non-life, 3.6). Not

surprisingly, market risk is paramount

in the life business (4.0), where horizonsare long, and there is a big difference

between the maturities of premiums

and claims. The gravity of market risk

is slightly lower for non-life companies

(3.6) and those operating in both

segments (3.7).

Figure 6.2 Increase of Importance Per Risk Area

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

%I

ncrease


Risk Area


3.4%

2.1%

6.8%

12.3%

11.7%

All insurance companies


What Level of Importance Do You

Think the Different Areas of Risk

Will Have in the Future?

The importance of these five risk typeschanges little in the future. Again,

insurance technical risk and market

risk are deemed most important (both

3.8), followed by operational risk (3.3)

and credit risk (3.2). Liquidity risk is

still least important, with a score of

2.6. As is the case in the current state,

the importance of a specific risk type

varies most between countries for

credit risk and liquidity risk, though

the divergence is slightly larger in the

future assessment.

Survey respondents expect all types of

risk to become more important in the

future, with the gravity of individual

risk types rising as much as 12.3% (for

operational risk - see Figure 6.2). The

increased focus on operational risk

no d oubt reflects a real increase in

such risks, but it is probably also a

manifestation of the increased attention

that operational risk has received in

recent compliance initiatives, from

Basel II to Sarbanes-Oxley.

Again, large insurance companies tend

to assign a greater importance to all risk

types than do small and medium-sized

insurers. Only for market risk is the

same score assigned (3.8). The largest

gap in perceived importance lies in

credit risk, where large insurers assigned

a 3.4 score, compared with 3.0 among

smaller ones. Again, certain risks areexpected to remain more important

to some segments than others in

the future, though the size of those

differences between businesses

tends to decrease in the future.


19/40

For the Following Areas of Risk,

Have You Established a Risk

Management Procedure?

Managing risk is not just a matter ofdeveloping tools and models. It is

equally important that the tools and

models be used properly. Pillar II of

the Solvency II directive will contain

requirements related to processes and

procedures for identifying, measuring,

monitoring and managing risks. These

strategies, policies and procedures

should assure adequate day-to-day

execution of risk management activities.

Processes and procedures should be in

place for each risk type, and should be

updated on a regular basis. It is likelythat all insurance companiesregardless

of size or segmenthave procedures

for the defined risk types, but the

level of detail and quality will vary

among companies.



The survey shows the existence of

risk management procedures for a

specific risk type largely depends

on the importance of the risk type.

Procedures are established for

insurance technical risk and market

risk at 77.8% of all survey participants.

For operational risk and liquidity risk,

such procedures are in place for only

47.6% and 46.8%, respectively. (We

assume that respondents who say

procedures are not in place mean

those procedures are not properly

established, as opposed

to being non-existent.)

In fact, the presence of risk managementprocedures is exactly in line with the

stated importance of those risks when

we consider the number of insurance

companies that have established or

recently started risk management

Figure 6.3 Presence of Risk Management Procedures Per Risk Area

0%

20%

40%

60%

80%

100% All insurance companiesLifeNon-LifeBoth Life and Non-Life

%o

fCompan

ies

withProce

dure

Es

tablis

he

dor

Recen

tlyStarte

d


Risk Area



procedures. In other words, there are

relatively more companies with risk

management processes for the more

important risk types. In the case of

operational risk, the majority (47.6%)

have procedures in place and many

(30.2%) have recently started to employ

such processes.

Procedures for managing market,

credit and operational risk are equally

prevalent across business segments

(see Figure 6.3). However, 100% of

non-life companies have well- or

recently established procedures for

managing insurance technical risk,

though only 28.6% have processesfor handling liquidity risk. That is far

less than the 84.6% of life insurance

companies and 55.6% of companies

operating in both life and non-life that

have liquidity-risk processes in place.


20/40

How Important are the

Various Areas of Risk

Relative to Your Companys

Aggregated Risk Exposure?10

Solvency II aims to create a level playing

field across the financial sector in

Europe. As a result, there are definite

similarities between Basel II and

Solvency II. Nevertheless, fundamental

differences between the industries also

require the two frameworks to diverge.

In particular, Basel II focuses on the

asset side of bank balance sheets, while

Solvency II targets the liabilities side

for insurers. Also, Basel II reflects the

paramount importance of credit risk to

banking, while Solvency II must reflectthe relative importance of different

risk types to insurance companies.

Our survey shows market risk is the

most important risk type for European

insurance companies, accounting for

38% of aggregate risk exposure (see

Figure 6.4). Insurance technical risk

is second, accounting for 31% of total

risk. Credit risk (13%) and operational

risk (14%) are next, and about equally

important, while liquidity risk accountsfor only 6% of total risk. Respondents

were also asked to identify any other

important risks they face. Several cited

business risk, but the results offer no

insight into the degree of exposure to

that type of risk.

Since Solvency II is a pan-European

initiative, we generally did not dissect

the survey results by country or region.

However, we thought it would be

interesting to look for any country

divergence in risk exposure, since such

differences might pose a challenge for

the EC as it seeks to unify solvency

regulations. Significantly, the survey

confirms insurance companies in

northwest European countries have

a different risk profile from those

operating in southern European

countries.

20

How Would You Assess Your Risk

Management Processes Within

These Different Areas of Risk?

Insurance companies are more confidentin their ability to manage market and

technical insurance risk than other

types of risk. On average, market risk

management processes scored 3.3 on

a scale from 1 (bad) to 4 (very good).

Technical-risk activities scored a 3.0,

while the marks were lower for credit

risk (2.8), and liquidity risk (2.4).

Participants were least confident in

operational risk management processes,

which received a grade of 2.3.

Among individual countries, assessmentsdiffered most widely on credit and

liquidity risk. Large insurance companies

generally believe their processes to be

of a slightly higher quality than do

smaller companies. (The difference in

scores ranged from 0.1 for liquidity

risk to 0.4 for credit risk.)

Life insurance companies are less

confident in their capabilities than

non-life businesses, except in the

case of managing liquidity risk, whichlife insurers scored at 2.7, compared

with the non-life score of 1.5. According

to th e assessments by survey

participants, non-life insurance

companies have the best processes

for insurance technical, market and

operational risk management, while

insurance companies operating in

both life and non-life segments are

best at handling credit risk.

10 Methodology: participants are asked for an assessment of their risk profile by dividing total (100%) risk over

the five risk types. Guidance was given by dividing the whole spectrum in five categories. But more specific

answers were also given and used. To assure total risk of 100% per respondent, some of the answers were

calibrated by the survey team.


21/40

In southern Europe, market risk

represents a smaller share of total

risk than it does in the northwest or

in Europe as a whole, while operational

risk plays a larger role (see Figure 6.4).

Liquidity and credit risk are also more

important than in the northwest or the

continent as a whole. For insurance

companies in northwest Europe, market

risk accounts for 44% of aggregate

exposure, significantly more than in

southern Europe, and more than the

continents average, while operational and

liquidity risk are relatively less important.

The survey does not offer a rationale

for these divergences. It is possiblethat companies in different regions

simply define risk categories differently,

or that the sampling itself has skewed

the results. CEIOPS quantitative

impact studies may provide more

insight into the risk definitions and

insurer risk profiles.

Risk profiles do not seem to differ

much with company size. Market,

operational and credit risk make up

much the same proportion of risk forlarge and small and medium-sized

insurance companies. Insurance

technical risk accounts for a greater

portion of total risk at smaller companies

(35% vs. 27% at larger companies),

while credit risk accounts for less

(11% vs. 16%).

Risk profiles do differ among insurance

businesses, though (see Figure 6.5).

Market risk accounts for the largest

share of aggregate risk exposure for

life insurance companies (45%), whileinsurance technical risk looms largest for

non-life businesses (47%). Interestingly,

companies involved in both life and

non-life are exposed to more operational

risk (16% of total risk) than companies

dedicated to one business or the other,

but their exposure to other types of

risks generally lies somewhere between

the two.



Figure 6.4 Relative Risk Exposure Among Insurers, by Region

Insurance31%

Market38%

Credit13%

Liquidity6%

Operational14%

Insurance31%

Market25%

Credit15%

Liquidity10%

Operational19%

Insurance32%

Market44%

Credit12%

Liquidity3%Operational

11%

All Insurance Companies Region North-West Region South


Figure 6.5 Relative Risk Exposure Among Insurers, by Business

Insurance22%

Market45%

Credit16%

Liquidity8%

Operational13%

Insurance29%

Market35%

Credit13%

Liquidity7%

Operational16%

Insurance47%

Market

32%

Credit9%

Liquidity2%

Operational11%

Life Insurance Companies Non-Life Insurance Companies Both Life and Non-LifeInsurance Companies



22/4022

Business logic, however, is the second

most powerful force (3.3). Losses

incurred by others provide the least

impetus for improving risk management

(2.1), and few companies are driven

by aspirations to be risk-management

pioneers (2.2).

Losses incurred by own company

seem to be more influential in cases

where the loss has been considerable.

The distribution of survey responses

on this driver was widespread, and

suggests a company that experienced

major losses over an extended period

is more likely to be driven by that loss

to improve risk management than acompany that has suffered only a mild,

short-term loss. Generally, though,

insurance companies do not seem

to be image-driven when it comes

to improving their risk-management

function, though reputational risk is

always an issue.

In short, the survey results show

insurance companies know they need

to comply with new regulations, and

many believe enhanced risk management

could improve their business and

revenues. Few, however, see enough

benefits to want to pioneer risk

management advances.

6.2 Risk ManagementOrganisation and ProcessesDoes Your Company Have a Risk

Strategy Related to Risk Classes

and Overall Risk Exposure?

The economic capital framework

presented in Appendix 2 starts by

defining the risk appetite and scopefor economic capital management

two aspects of corporate risk strategy.

Solvency II will require insurance

companies to develop risk strategies,

and the board of directors will need to

be involved in the process, and informed

about these strategies at all t imes.

Day-to-day risk management activities

should reflect the strategies defined.

Most European insurance companies

have such strategies for the mostimportant risk typesinsurance

technical risk and market risk (see

Figure 6.7). Credit risk comes third,

with slightly more than half of the

insurance companies having a strategy

fully in place (52.4%). For operational

risk, most companies are in the

decision-making or implementation

stage. For liquidity risk and overall

risk, about one-third have neither set

a strategy nor decided on one.

As is the case with the presence of risk

frameworks, strategies are more common

for large insurance companies, where

processes are in place or partly in place

for between 63.0% (liquidity risk) and

93.5% (market risk) of all companies,

depending on the risk type. For small

and medium insurance companies

these percentages range from 37.5%

(overall risk) to 78.1% (market risk).

Less than 40% of the companies in

this group have any type of liquidity-

risk strategies in place. There is littlesignificant difference between strategy

positions among business segments,

Figure 6.6 Level of Influence on the Development and Improvement in Risk

Management Processes

Comply withmarket requirements

Businessdriven logic

Losses inown company

Losses madeby others

Be a pioneer inrisk management

1 = No Influence4 = High Influence

Image drivenComply with

the requirementsof the owner

Comply withregulatory requirements

1.5

2.0

2.5

3.0

3.5

4.0


Which Factors Will Influence

Your Fu ture Development

and Improvement of Risk

Management Processes?

The EC hopes Solvency II will encourage

insurance companies to become more

sophisticated risk managers. Indeed, the

framework offers capital incentives to

those that move past mere compliance

and adopt a risk-based approach. But

are insurance companies also looking at

Solvency II as a business opportunity?

And what is really driving any plans to

develop their risk management function?

The survey shows regulatory

compliance is still the main driverbehind improvements in risk

management processes (see Figure 6.6).

Regulatory compliance scored an

average 3.8, on a scale from 1 (no

influence) to 4 (high influence). Other

facets of compliance are also quite

important, including the requirements

of the company owner (3.2) or the

market (3.0).




with results per business type fluctuating

around the average of all companies,

with an absolute maximum deviation

of 14.4%.

Does Your Company Have

a Department With Overall

Responsibility for the Companys

Risk Exposure? Do You Account

for Dependencies Between Risks?

If You Have Established / Plan to

Establish Such a Unit, Where in the

Organisation Does / Will It Reside?

Solvency II contains requirements for

overall risk and risk interdependencies.

The survey shows 55.6% of European

insurance companies already have adepartment with overall responsibility

for risk. An additional 17.5% have

such responsibilities partly in place.

The remaining 27.0% have not assigned

overall responsibility for risk to any

specific department(s).

Among small and medium-sized

insurance companies, overall

responsibility is in place for 53.1%,

partly in place for 15.6% and not

in place for 31.3%. Among largeinsurance companies, 58.1% have

assigned overall responsibility for risk,

19.4% have partly assigned it, and

22.6% have no overall governance.

Companies with both life and non-life

insurance businesses are less likely

than life or non-life companies to have

assigned (wholly or partly) overall

responsibility for risk. Admittedly, the

organisational structure of life/non-life

companies is generally more complex,

perhaps making it more difficult to

assign overall responsibility. The survey

shows 63% of companies involved in

both businesses have defined overall

responsibility for risk, a much smaller

proportion than life insurance (80.0%)

or non-life insurance companies (81.3%).

The department (or departments) to

which overall responsibility is assigned

varies by company. Most common is

a risk-controlling or risk-management

unit in the insurance organisation(see Table 6.1). For companies with

a department responsible for overall risk,

Table 6.1 Department with Overall Responsibility for Risk

Departments % of companies that assigned overall

responsibility to this department

1. Project team in the IC 2.3%

2. Controlling unit in the IC 23.3%

3. Risk controlling/risk management 51.2%

4. Other staff division in the IC 4.7%

5. Board of directors of the IC 25.6%

6. Corporate level 23.3%

7. Others 9.3%

Total (multiple answers possible) 139.5%

Figure 6.7 Presence of Risk Strategy Per Risk Type

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Insurance Market Credit Operational L iquidity Overall Risk

57.1%

22.2%

11.1%

6.3%

3.2%

52.4%

22.2%

11.1%

11.1%

3.2%

38.1%

22.2%

20.6%

9.5%

9.5%

37.1%

17.7%

12.9%

14.5%

17.7%

44.4%

8.9%

13.3%

15.6%

17.8%

69.8%

15.9%

6.3%4.8%

3.2%

In PlacePartly In PlacePlannedDecision Not TakenNo



24/40

51.2% embed it in a risk controlling/

management unit. Other popular

overseers are the controlling unit, the

board of directors and the corporate

level (e.g., corporate risk controlling).

Solvency II will contain more

complex requirements than Basel II

with respect to risk dependencies.

Basel II includes a general function

to calculate diversification effects,

but Solvency II will have a set of

requirements more tailored to specific

circumstances. The survey shows 34.9%

of European insurance companies

already take risk interdependencies

into account, and the process is partlyin place for another 27.9%. Those

averages also hold largely true for

small and medium-sized insurance

companies, where 57.1% already have

processes wholly or partly in place

to account for interdependencies,

compared with 68.2% of large

companies and 62.8% of all companies.

Is Your Risk Management Integrated?

What Importance Do You Consider

Integrated Risk Management to Have?

Integrated risk management takes

account of the active influence of

all aspects of all kinds of risks at the

same time, considering the correlation

between the risks in order to control

the potential loss by selectively using

control measures. The survey shows

all European insurance companies

regardless of size or segmentbelieve

integrated risk management is very

important, with a score of 3.7 on

a scale from 1(low importance) to

4 (high importance).

24

Figure 6.9 Presence of Internal Risk Reporting Processes Per Risk Type

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Insurance Market Credit Operational Liquid ity Overall Risk

17.5%

61.9%

9.5%3.2%

7.9%

58.7%

11.1%

12.7%

11.1%

6.3%

23.8%

39.7%

17.5%

12.7%

6.3%

37.1%

21.0%

9.7%

16.1%

16.1%

47.8%

8.7%

8.7%

17.4%

17.4%

6.3%

77.8%

4.8%

4.8%

6.3%



Figure 6.8 Presence of Integrated Risk Management

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

All InsuranceCompanies

Small and MediumInsurance Companies

Large InsuranceCompanies

43.8%

22.9%

12.5%

12.5%

8.3%

41.7%

16.7%

8.3%

20.8%

12.5%

45.8%

29.2%

16.7%

4.2%

4.2%





Of all participating insurance companies,

43.8% already have integrated risk

management in place (see Figure 6.8),

while 22.9% are in a transition phase.

Similarly, 41.7% of small and medium-

sized insurers have integrated risk

management in place, while 16.7% are

in transition, compared with 45.8% and

29.2%, respectively, of large insurers.

However, a large number of the smaller

companies have not yet decided to

adopt integrated risk management.

6.3 Internal ReportingDoes Your Company Have a Reporting

Process That Takes Into Account Both

Individual Categories of Risk and theInterdependencies Between Them?

Adequate management and control over

risks requires high-calibre reporting

processes that form an institutionalised

procedure in which flows, roles and

responsibilities are regulated. Risk

reports provide vital information

and should be available in a timely


manner and appropriate form to risk

management, senior management

and the board of directors, depending

on their information needs. The

complexity of Solvency II, and in

particular the interaction between

risks, will require even more

sophisticated internal reporting.

Again, capabilities are strongest

in the area of market risk. Of all

participating companies, 77.8% have

processes in place for market risk

reporting (see Figure 6.9), followed by

insurance technical risk (61.9%) and

credit risk (58.7%). The implementation

of risk reporting processes foroperational risk is only complete at

39.7% of companies. However,

insurance companies are progressing,

as evidenced by the fact that 23.8%

have reporting processes for operational

risk partly in place and 17.5% are

planning to adopt such processes.

Again, small and medium-sized

insurance companies are less

advanced than large companies.

The number of small and medium

insurance companies with reporting

processes in place or partly in place

ranges from 42.1% for liquidity risk to

78.1% for insurance technical risk.

For large insurance companies, the

range is from 64.3% for liquidity risk

to 93.5% for market risk.

Across business types the number of

insurance companies that have reporting

processes in place is relatively low

among companies with both life and

non-life business (see Figure 6.10). Forfour of the six risk types, this group

scores lower than the groups comprising

companies active in only the life or

non-life segments. Remarkable are

operational risk and overall risk, where

the number of companies with reporting

processes in place or partly in place is,

in absolute figures, between 10% and

37% lower than for the two other groups.

Figure 6.10 Presence of Internal Risk Reporting Processes Per Risk Type, by Business

0%

20%

40%

60%

80%

100%

%o

fCompaniesw

ithProcess

InPlaceorPart

lyInPlace

Insurance Market

Risk Area

Credit Operational Liquid ity Overall Risk

All insurance companiesLifeNon-LifeBoth Life and Non-Life



26/4026

Does Your Company Issue an Internal

Report on Each Risk Type and On

Risk Interdependencies? If So, Who

Receives Which Reports?

The risk report most commonly

available in the desired form relates

to market risk (see Table 6.2). About

90% of companies create internal

reports on market risk, and more than

83% of companies create insurance

technical risk and credit risk reports.

Least prevalent are liquidity r isk

reports, which are available at about

60% of participating insurance

companiesalthough that number is

perhaps higher than expected, given

that insurance companies assign arelatively low importance to liquidity

risk. In fact, though, a similar number

of companies also have available

operational-risk and risk-

interdependency reports.

It is not surprising that internal reports

are so readily available for the more

common risk types, since these are

typically required by regulation. But

it is worth noting that the absence of

a report does not necessarily equateto an omission. Some reports are not

required (in the case of small companies,

for example), and some information

may be relayed in a form the survey

respondents do not class as a report.

When a company has a report for a

specific risk type it goes, on average, to

four divisions or division heads in the

organisation. In other words, a single

report is typically sent to four different

departments in that insurance company.

The board of directors receives 81.3%

of all risk reports (see Figure 6.11). Risk

management or risk controlling receives

56.2%, followed by internal audit

(51.5%). Solvency II requires tangible

involvement in risk by the board and

senior management a term that has

not yet been clearly defined but is likely

to include local division/department

heads, who now receive 42.6% of

available reports.

Table 6.2 Availability of Reports Per Risk Type

Report Availability in %

Insurance Technical Risk 83.6%

Market Risk 90.7%

Credit Risk 83.3%

Operational Risk 69.8%

Liquidity Risk 60.5%

Dependencies Between Risk 66.0%

Figure 6.11 Distribution of Reports

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Local Division/Department Heads

Head Risk Controlling/Risk Management

Head Finance

Head Accounting

Head Other Staff Division

Board of Directors

Division at Group Level

Internal Audit

External Accountant

Other Division

Head Controlling





Table 6.3 Department Responsible for Solvency II

Not Defined 11.1%

Department % of Companies That Assigned

Responsibility for Solvency IIto this Department

Project Team in IC 25.4%

Central Controlling Unit in the IC 17.5%

Central Risk-Controlling Unit/

Risk-Management Unit in the IC

42.9%

Other Staff Department in the IC 15.9%

Direct Responsibility of theBoard of Directors of the IC

17.5%

Group (e.g. Group Risk Controlling) 12.7%

Others 9.5%

Total (Multiple Answers Possible) 152.4%

6.4 Legal FrameworkSolvency II: How Would You Assess

Your Company With Regard to the

Following Aspects?

Lessons learned from Basel II suggest

insurance companies will have to work

hard on Solvency II in the coming

years. The road to timely compliance

will be paved with new experiences,

cultural change and potential pitfalls.

Prerequisites include proper information,

free capacity and know-how for

implementation. The survey shows most

European insurance companies

regardless of size or segmentbelieve

they are only partly armed for the

challenge (see Figure 6.12). SinceSolvency II offers different approaches,

it makes sense that the size of the

company does not affect its perceived

readiness for the new framework.

With respect to risks, 55.8% of insurance

companies have an open mind toward

the dynamics and transparent handling

of risk. Also positive is their openness

to changean attitude that exists among

59.6% of the participating European

insurance companies. In fact, nocompany said it would not reconsider

its risk management approaches.

Which Department(s ) Within Your

Company Is (Are) Responsible For

Solvency II?

Of survey participants, 11.1%

have not assigned responsibility for

Solvency II to any department (see

Table 6.3). Of those that have assigned

the responsibilityto one or more

departments42.9% said responsibilityresides with the central risk controlling

or central risk management unit, and

25.4% put a project team in charge

to ensure sound implementation. The

board of d irectors is widely expected

to sponsor Solvency II efforts, but is

held directly responsible at only

17.5% of companies.

Figure 6.12 Assessment per Solvency II Relevant Aspect

0%

10%

20%

30%

40%

50%

60%

70%

%o

fTo

tal

Level ofInformation o f

Employees on SII

Free Capacityfor SII

Implementation

Risk Area

Know-Howfor SII

Implementation

Open AttitudeTowards Risk

Open to Changes

Existent

Partly ExistentNon Existent



28/4028

6.5 Methods of Risk ManagementWhich Methods and Dimensions

Do You Use in the Risk Management

Process for the Various Risk Types?

Which of Them Do You Plan to Use?

For each risk type, there are several

common methods used in the risk-

management process. None is the

obviously preferred method (see

Figures 6.13AD), with the exception

of actuarial methods to manage

insurance technical risk, CEIOPS

documentation refers often to stress

tests, scenario analysis and simulation

techniquesmethods that will be

required where they can help assure

robustness and validation of models.Actuarial methods are also relevant.

Taking the average use per risk type,

simulation techniques are the least

used method with 23.3% (average of

as is percentages for insurance, market,

ALM and loss/solvency/credit risk),

followed by actuarial methods (30.5%),

scenario analysis (37.7%) and stress

testing (39.1%). Where most methods

are more or less used equally across

risk classes, actuarial methods aretypically reserved for insurance risk.

Taking into account that insurance

companies have methods partly in

place (as is / to be) or are planning

to implement a method (to be), stress

testing and scenario analysis are likely

to be used most in the future, while

actuarial methods remain favoured

for managing insurance risk. Only a

few participants plan to use actuarial

approaches for other risk types.

Figure 6.13A Usage of Stress Testing Per Risk Type

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Insurance Market ALM Loss/Solvency/Credit

43.6%

10.9%

25.5%

34.5%

14.5%

18.2%

30.9%

9.1%

18.2%

47.3%

18.2%

12.7%

As IsAs Is/To BeTo Be


Figure 6.13B Usage of Scenario Analysis Per Risk Type

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%


34.5%

9.1%

20.0%

40.0%

23.6%

12.7%

30.9%

10.9%

18.2%

45.5%

16.4%

16.4%






Figure 6.13C Usage of Simulation Techniques Per Risk Type

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%


29.6%

9.3%

27.8%

27.3%

16.4%

21.8%

12.7%

3.6%

27.3%

23.6%

7.3%

25.5%



Figure 6.13D Usage of Actuarial Methods Per Risk Type

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%


52.7%

25.5%

Risk Management in the Insurance Industry and Solvency II

Documents