A window to the heart of your business


Victoria Raffé

Pillar III is still largely relegated to the ‘also ran’ category in preparations for Solvency II. In this article, Victoria Raffé, Head of Insurance Policy at the FSA argues that Pillar III may yet be the decisive pillar in determining a firm’s success in a Solvency II world.

Imagine this. It’s five years from now, the principles of risk management and governance in Pillar II of Solvency II are embedded. Internally, this means that the firm understands its business model, the risks inherent in it, and it has a clear understanding of what data it needs to drive effective decision making.

From a regulatory perspective, the firm uses this to produce its regulatory returns, both public and private, which are consistent across Europe. The public element of the reporting will be both quantitative and qualitative. And the results of Europe-wide stress tests will almost certainly be made public on an individual firm basis.

In that sort of world we need to examine the implications of public disclosure more closely. Investors and policyholders will be able to use the results of Europe-wide stress tests on individual firms, and put that into context of what your firm tells them about the business. This could include (depending on the outcome on Level 2), how your balance sheet is made up, including the amount of free assets; your firm’s risk based capital requirement, by risk module or category; whether your firm has any regulatory imposed capital add-on, and if so how much and why; and whether your firm has breached its SCR or MCR during the course of the year. And there’s the qualitative disclosure too.

You could be disclosing how you have approached stress testing and what assumptions you used, as well as how the ORSA is performed and used in the business. It is a staggering amount of information, that will be available publicly.

Moreover, it will be comprehensive and consistent, so the world will be able to understand you, compare you with other insurers, and compare insurance with other industries. Now imagine if this regime was in place during the darkest moments of the 2008 financial crisis. What would your firm, and others, have been reporting if the Solvency II world already existed?

The history books, many already written, naturally focus almost exclusively on the deepening despair and panic in the banking sector. Insurers, by contrast, fared very much better. They were not the cause of the crisis but its victims. Nevertheless, it is certainly the case that the senior management in insurance firms became very concerned about the immediate and long term effects on their business, as was the FSA.

With all eyes on the banking sector, and in the absence of evidence to the contrary, most commentators assumed that insurers did not face issues. Nowadays, even insurers seem to have forgotten how tough it was and I frequently hear them talk about how they sailed through the crisis with no problem. But regulators have long memories … and we remember how important it was for the insurance sector as a whole that the markets and policyholders remained confident in insurers’ ability to pay up on their promises.

More disconcerting is the fact that we know that this market confidence was founded on a deeply imperfect set of information about the firms. The Solvency II Directive sets out the unambiguous objective of policyholder protection. Put another way, it must ensure that when insurers make promises to their customers to pay them a sum of money, possibly many years in the future, the insurer will still be around to make those payments. Expressed in these terms, the vision is all about the confidence of policyholders in the firms that they do business with.And in our current regime that confidence is based on what firms tell the market about their balance sheets. Which is another way of saying that it is based on very little that is transparent, consistent or comparable.

All this will change. And as a result, the industry itself will change in ways that right now are hard to imagine. Reporting in the future, unlike now, will be a window into the heart of your firm’s business.

In a Solvency II world there will be a premium on good management in individual firms. It will be much easier to see which firms do and don’t have good management. It will be obvious to everyone that having lots of capital will be no substitute for having good management. This is about the whole firm, and not just its immediate finances. Business models can be broken long before a firm runs out of capital. So now is the time to ask yourselves what it is that people will be seeing about your firm as a result of the new reporting regime. And what you will do to make sure they like what they see.

— The author is Head of Insurance Policy at the Financial Services Authority. The views expressed are the author’s own.

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