This two part feature examines the effects of Solvency II on the Board. Part one looks at how directors and non-executive directors are handling their new obligations and how this is affecting the composition of the Board.
(Not) so close, yet (not) so far away
The Board, according to the Institute of Directors, “Must simultaneously be entrepreneurial and drive the business forward while keeping it under prudent control.” These obligations create a tension which challenges each Board member every time he or she sits down at a long mahogany table and studies the agenda for the next Board meeting.
Solvency II aims to enhance the risk management and governance of the firm. In so doing, it will require the Board to have a better understanding of the business and the environment in which it operates. The Directive makes it clear that the Board will not be able to delegate its responsibilities, and individual board members must be able to explain the company’s decisions to the regulator.
Expanding Directors’ skillset
The obligations of the Board set out by Solvency II will mean that individual board members, and in particular non-executive directors, will have to gain new skills and understanding of functions relating to the risk and capital management of the firm.
Kevin Borrett, UK Head of Risk at Unum, said that in response to growing demands from both executive and non-executive directors, Unum have introduced a number of training schemes for their board. “We have structured training sessions once a year which discuss changes to directors’ duties and legislation,” Mr Borrett said. “We also bring in a senior investment manager to talk about asset management and its implications for the company.”
The company also had requests from non-executive directors to add to their skillset, and for the past two years has been running training session to address specific skills areas such as ALM and actuarial methodologies.
Legal requirements raising questions
In addition to improving their technical skills, board members need to be fully aware of the legal obligation that Solvency II places on them, both individually and collectively.
Jeremy Irving, Partner at the legal firm Eversheds LLP, explained that from a legal perspective there is no difference between the responsibilities of executive and non-executive directors, but he cautions that Solvency II introduces specific demands which should be noted.
“Solvency II presents substantial challenges for boards and individual directors, and a number of articles in the Directive address specific areas of responsibility,” Mr Irving told Solvency II Wire. “For the Board as a whole, Article 40 of the Solvency II Directive emphasises the ‘ultimate responsibility’ of boards for ‘compliance’ with the requirements of Solvency II.”
In relation to the legal responsibilities of individual directors, Mr Irving explained, “Article 42 (Fit and proper) requires individual directors to be ‘fit and proper’ with requisite ‘qualifications, knowledge and experience’. Directors must also be ‘of good repute and integrity’.”
The Directive makes specific reference to decision making in respect of risk management. “Article 44 (Risk Management) requires the ‘decision making processes of … the persons who effectively run the undertaking’ to comprise, on a ‘well integrated’ basis, a ‘risk management system … to identify, measure, monitor and report … risks’. Such system must operate on ‘a continuous basis’.”
These explicit requirements are prompting some to examine their current position. “Insurers and individual directors are already starting to reassess how they will meet Solvency II’s requirements. Initial concerns have focused on board members being able to grapple with the actuarial elements of capital adequacy modelling,” Mr Irving said.
Solvency II: changing the composition of the Board
The legal and technical implications for board members could affect enthusiasm for taking up the role, especially for non-executive directors. It could also drive substantial changes in the composition of the Board.
The extent to which this could happen is unclear, but some anecdotal evidence is emerging about the discomfort non-executive directors might be feeling. David Simmons, Managing Director, Analytics at Willis Re, told Solvency II Wire, “I have heard that a number of non-executive directors are thinking of resigning their non-executive directorship because of the demands and responsibilities put on them by Solvency II.”
In the UK, the application of the “fit and proper” requirements for individual directors has been anticipated by the FSA’s work on approved persons. According to Mr Irving, “This work with its emphasis on due diligence by firms in their recruitment of senior personnel, is starting to affect the decisions, by firms and individuals, as to the offer or acceptance of a board appointment.”
Some firms are starting to reappraise the role of non-executive director, according to Mr Irving. “Whereas an appointment might once have been made in order, say, to capitalise on the market contacts, and thereby the promotional or ‘sales’ capability, of an individual, that individual will now need to have a broader range of skills and know-how in order to discharge the director function.”
Mr Borrett added, “Insurers will look for directors with strong business experience based on actuarial, technical analytical financial skills. The days of making solely sales and marketing appointments to the Board because of strong connections, or individuals not prepared to actively participate in capital management have passed.”
The growing demand for non-executives with relevant technical skills in capital management and particularly actuarial skills may pose another problem. According to Mr Simmons, “The makeup of the Board might well need to change with at least one person with financial and peril modelling experience. Such senior people are in short supply and I doubt there are too many of them around in the UK, let alone other parts of Europe where financial modelling within the insurance industry is less developed and the number of suitably qualified senior actuarial staff is lower.”
Stronger, better, and too close?
Solvency II is driving changes in the behaviour and composition of boards of insurance companies. It is fostering greater awareness and engagement with technical aspects of the firm, especially for non-executive directors. But these demands, combined with more stringent legal obligations are making some reconsider their position on the Board.
When the Board sits down round the table, the combined skills and knowledge of all its members must lead it to make decisions that are both entrepreneurial and prudent. The concerns raised by some is that while the changes wrought by Solvency II will increase the skillset and involvement of the Board, a narrowing of the scope of board membership could detract from its function.
Part two discusses the effect of Solvency II on the work of the Board as a whole and examines how it will affect its operations.