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23rd May 2012

European insurers must move from risk measurement to real risk management to achieve a return on Solvency II investment says report

Insurance companies across Europe preparing for the implementation of Solvency II risk missing this one-off opportunity to achieve a return on the substantial investment made in complying with the regulations, according to a publication released by Towers Watson.
In 'Embedding the model and meeting the Use Test', Towers Watson states that a clear plan for moving from "risk measurement to real risk management" is needed if insurers are to achieve a payback on the multibillion investment in compliance costs. For example, the UK's Financial Services Authority (FSA) estimates the one-off cost of implementing Solvency II in the UK to be £1.9bn with an estimated average annual expenditure between 2008 and 2013 of £380m.
Naren Persad, a director in the Risk Consulting and Software division of Towers Watson, explained that firms have so far justifiably concentrated on the quantitative aspects of calculating the Solvency Capital Requirement (SCR) and the QIS exercises. He said "However, an improved actuarial model for calculating risk exposures is of limited value if the culture within an organisation does not facilitate understanding and use of the model to improve risk management. A more immediate concern is that it might mean that the organisation fails the Use Test and the model will not be approved."
According to Towers Watson, embedding and risk management is relevant to all European insurers and this is formalised through the ORSA (Own Risk Solvency Assessment) that every insurance company has to complete.
Towers Watson argues that the approach some firms have taken in preparing for Solvency II may not be conducive to bridging any cultural divides between the technical and non-technical functions in the organisation.
Persad added "Across Europe, companies have typically organised their Solvency II projects as ring-fenced programmes. Front-line managers can easily regard Solvency II as a compliance exercise mainly because the potential benefits for the business and for them as individuals have not been clearly communicated."
Patricia Mackenzie, a management consultant at Towers Watson noted " The tone has to be set from the top. Boards need to make use of the new available risk management information a priority and reinforce this change in working practices with education programmes so that expectations and standards are filtered throughout the organisation.
A key area for insurers operating internal models, according to Towers Watson, will be to prioritise applications that offer the most tangible business benefits out of the 37 possible model uses that were listed in the original EIOPA consultation paper. The company's research shows that many companies have ambitious plans for the uses that should be covered by the risk model, but these might not all be developed on the first attempt and realistically might take a few years until they are fully embedded.
Meeting the Use Test is not a one-off exercise, but an iterative process to ensure companies embed a wider risk framework that not only promotes an appropriate risk culture but provides the company with a competitive edge in the market."