Solvency II : more than mere risk modeling
An optimal implementation of the Solvency II directive starts by understanding its global framework in order to be able to identify its full operational, financial and organizational impact.
Solvency II implies that insurance companies model their risks so they can determine their capital requirements to cover these risks. But contrary to what is generally believed, this is not enough to meet the Solvency II standards.
Indeed, the impact of this directive goes beyond the mere modeling of risks. It includes at least :
· the ability to centralize the data,
· the integrated management of assets and liabilities,
· the modification of the business logic,
· the adaptation of the acceptance and governance rules.
Ability to centralize the data
The implementation of the Solvency II requires actuarial expertise and adequate modeling tools.
But there is more to it. To provide reliable results, the modeling system must rely on data that are complete, consistent and sufficiently detailed. Incomplete or poor quality data will deliver incorrect results which will lead to wrong decisions, or as the saying goes « garbage in, garbage out ».
In addition to its actuarial expertise and modeling tools, each insurance company will have to acquire a high-performance datawarehouse, to which all in-house systems can be connected. This step, which consists in obtaining a comprehensive and correct representation of the whole company, represents an important investment both in terms of financial and human resources.
Integrated management of assets and liabilities
On the basis of complete, consisting and detailed data, the modeling tool will indicate the capital adequacy the insurer will theoretically need to meet its contractual engagements.
The level of required capital highly depends on the nature of the engagements (the liabilities) and on the way the assets are organized/invested.
To be able to determine the actions to be undertaken and to optimize the business strategy regarding the Solvency II directive, the insurer must have a more integrated management of assets and liabilities allowing the analysis tools to detect rapidly the potential risks.
Modification of the business logic
In a first step, the modeling tools will supply the adequate level of capital that an insurance company needs to meet its engagements.
This information is only interesting if it can be translated into concrete actions within the insurer’s core business, which consists in defining insurance products and managing its distribution network. In most of the cases, the risk modeling tool concludes that the company’s capital is not sufficient to meet its engagements or trends show that a deterioration could occur if no action will be undertaken.
In both these cases, corrective measures must be taken. An increase of the capital level is rarely applicable; a reduction of the risk level however is most of the time possible. In practice, this can be done by stopping the selling of a certain type of product which is considered too risky, or by modifying the remuneration of the intermediaries. The « incentives » will also have to be adapted in order to give rewards not only for meeting the sales targets, but also for respecting the decisions aiming the optimization of the insurer’s risk and capital levels.
To ensure the Solvency II compliancy at any moment, insurance companies must be able to take rapidly corrective measure. In order to guarantee maximum reactivity, the insurer has to set up optimized processes. The processes for product creation and adaptation (« time to market »), including the adaptation of the bonus schemes must be short and efficient.
Solvency II compliancy implies the modification of the insurer’s business logic. The sales strategy consisting in maximizing the turnover has to go along with risk optimization. The underlying processes such as incentives, time to market, … must evolve at the same time.
Adaptation of the acceptance and governance rules
The risk modeling and the defining of the corrective actions are pre-conditional steps but are not enough to meet the Solvency II directive.
Indeed, insurance companies also have to make sure that the assumptions used in the modeling tools are correctly applied within its network. To ensure visibility and control, the acceptance and governance rules must be adapted.
By way of example, let’s take for instance a product that has been sold until recently with a rate of return of 5% but for which the HQ has reduced the rate of return to 3% in order to meet the Solvency II requirements. So when an intermediary tries to sell this product with a rate of return of 5%, the acceptance and governance rules will see to it that the insurer’s policy management system will automatically reject this request or at least let it pass through an acceptance logic.
To work properly, the acceptance and governance processes must be automated as much as possible. The insurer’s management systems must include within their workflow a mandatory validation step. Moreover, the use of “online” management tools will speed up these acceptance and governance processes or even make them instantaneous.
As a conclusion
As this article has clearly demonstrated, the Solvency II compliancy requires much more than mere risk modeling abilities. It concerns the complete reengineering of the insurer’s organization and processes which includes a minimum of data centralization, a more integrated management of assets and liabilities, a modification of the business logic and an adaptation of the acceptance and governance rules.
Insurance companies should also acquire IT tools to optimize the compliancy. This requires a high-performance risk modeling tool and a comprehensive datawarehouse. As for the policy management system, it must be easy to interface with other asset management tools, reflect business processes, include a mandatory validation step and allow the automatic management of the acceptance rules. And last but not least, an insurer using these tools “online” will be better prepared to successfully implement the Solvency II compliancy standards.
Didier Lambert – Consultant Assurance (actuaire) BSB
Erika Bourguet – Marketing Manager BSB
