Manuela Zweimueller, head of regulations, EIOPA on the potential for misinterpreting dialogue with the regulator as ‘soft’ in the Solvency II insurance regulation framework and a call to include more behavioural scientists in drafting regulation.
Good and effective governance is the basis for informed and timely decision-making and clearly assigning responsibilities in firms and organisations.
EIOPA is in the first year of implementing Solvency II, a major reform to the regulation and supervision of the European insurance industry. Governance plays a central part in Solvency II as historical evidence shows that insurance failures are closely linked to an ongoing failure of governance, which precedes them.
In insurance, governance failings can range from poorly designed insurance products (to the detriment of consumers), insufficient monitoring of the sales force or under-pricing insurance policies to boost sales (underwriting risk) to aggressive company expansion through M&A activity.
While Solvency II also introduces new requirements relating to capital management and disclosure, we view governance and risk management as the lynchpin at the centre of the framework.
The Own Risk and Solvency Assessment (ORSA) places the responsibility of good governance with the firm’s board, demanding a set and enforced risk culture that consistently drives the business strategy and thereby supports the embedding of its risk management framework and processes.
Common challenges of evaluating governance
Of the themes that emerged in the discussion, four stand out as being especially important for enabling good governance: effectiveness of the governance structure; hiring the right staff; balancing enforcement and sanctions; and evaluating boards.
Good governance relies on a well thought out governance structure. Evaluating the effectiveness of it requires judgement and a sense of reality rather than overly focusing on processes or a tick-box-like compliance exercise.
[pullquote]Finding the right mix of staff is essential, both for the regulator and the regulated entities.[/pullquote]In practice, this requires a closer look at what topics were approved by the board and what the outcomes of these decisions were. For example, was the decision taken at the right level, is the outcome of the decision more or less always the same, and how stringently are these decisions implemented?
Participants from across different sectors shared the view that evaluating the effectiveness of the governance structure was a challenge and it emerged that they often use similar questions in their evaluation.
Finding the right people
As evaluating governance requires judgment, finding the right mix of staff is essential, both for the regulator and the regulated entities.
Participants acknowledged this difficulty and noted that diverse teams with different backgrounds and experience would help avoid professional bias, which may exist if the collective experience of the board was based on the same or similar background.
A call for behavioural sciences in regulation
The emphasis on governance has also led to some reflection on the traditional roles of those involved in regulation.
Compliance functions are usually staffed with lawyers whereas risk management functions are often staffed with actuaries. As behavioural economics plays an ever more important role in today’s decision-making environment, sociologists and psychologists, for example, would be needed to complement the assessment teams and to enrich them with their perspective and methodological approach.
Some sector supervisors said that sanctions no longer delivered the desired effect and that despite rising penalty payments, they have become part of many firms’ business model, in a way that they are already factored into the cost of business calculations. This was leading the regulator to consider stronger emphasis of and reliance on governance in the quest for an appropriate alternative.
A serious “hard” and “soft” dialogue
The discussion also addressed the difficulties in finding the right balance as a supervisor, between a reasonable “soft” approach, based on dialogue and cooperation and a stricter, “harder” approach primarily based on enforcement measures and sanctions.
Placing more emphasis on governance in regulation means an emphasis on the former, which can lead to misunderstanding. There seems to be a risk that the dialogue approach that is currently promoted by insurance supervisors with the new Solvency II regulatory regime may be perceived as less “serious” and less respected than a strict control and rules based procedure.
Understanding needs to be created that a dialogue is challenging and tough on content as any other approach, but “soft” regarding the form of the interaction, emphasising mutual respect.
Boards have a special role to play in effective governance as they set the tone from the top and enable the right culture (and risk culture); therefore evaluating their activity plays a key part in good governance.
[pullquote class=”left”]Good governance is a key success factor for organisations and companies and will no doubt remain at the top of the agenda in the coming years.[/pullquote]In other sectors than insurance, the evaluation of boards seems to be more advanced already and was discussed with a critical view.
Supervisors started to use surveys to evaluate board effectiveness. But the time and effort put into establishing comprehensive questionnaires and assessing the responses, not to mention the time invested by board members to provide them, may not yet result in acceptable outcomes and conclusions to be drawn from the evaluations. This method is still in its early stages and may need more experience to be further refined to focus on practical outcomes.
Governance and dialogue
Good governance is a key success factor for organisations and companies. The topic will no doubt remain at the top of the agenda in the coming years.
Sharing experience and information between supervisors across sectors and beyond the financial market is a valuable exercise, as development stages differ and lessons learnt can help to refine evaluation of the effectiveness of governance systems and shape both regulatory and supervisory responses.
The views expressed in this article are the author’s own and not necessarily shared by Solvency II Wire.
The event was held in London on 03 March 2016 and hosted by DWF LLP.
To receive the next article in the series directly to your inbox and subscribe to the Solvency II Wire mailing list for free, click here.