February 2nd, 2016

Addressing Own Risk and Solvency Assessment/Enterprise Risk Management and Insurance Capital Standard Globally

Posted at 1:00 AM ET

In accordance with the objectives of the National Association of Insurance Commissioners (NAIC) and European Insurance and Occupational Pension Authority (EIOPA), Own Risk and Solvency Assessment (ORSA) is “people and risk-centric,” primarily employing a principles-based approach, as opposed to a rules-based approach. This means that decisions on matters related to risks are largely based on the judgment of individuals relying on underlying facts, as opposed to decisions being made mostly by following intricate sets of rules. This is similar to the principles-based approach taken by International Financial Reporting Standards (IFRS). Although the calculation of the Solvency Capital Requirements (SCR) under Solvency II is rules based, like Insurance Capital Standard (ICS), Solvency II can be a “one size fits all” rules-based approach to capital, especially if the standard formula is used. (Re)insurers will need to find a way to incorporate ICS into their ORSA processes and the vehicle to accomplish this may be through the internal model.

The calculation of the ICS will most likely be very complicated but it is too soon to determine if the calculation of the capital measure under ICS will be too dissimilar from the calculation kernel under Solvency II or even the economic capital requirements under the NAIC’s ORSA. With any luck, the calculation of the capital requirements will be similar to that which groups are already doing and using either because it is similar to the main regulatory calculation or is similar to the (re)insurer’s own internal model and the calculation of the capital requirements in the calculation kernel. Time will tell just how complicated the ICS will be and whether it will be similar to the standard formula in Solvency II

Internal Model

What is an internal model? The EIOPA does not give a formal definition of what an internal model is. However, in Article 112, General Provisions for the Approval of Full and Partial Models in the Solvency II Directive, it merely states that “Member States shall ensure that insurance or reinsurance undertakings may calculate the Solvency Capital Requirements using a full or partial internal model as approved by the supervisory authorities.”

Much like EIOPA, the NAIC stated that quantitative risk measurement should incorporate a “range of outcomes” and that a (re)insurer should use “risk measurement techniques that are fit for purpose and that are proportional to the (re)insurer’s risk profile and size.” However, unlike European regulators that are required to approve a (re)insurer’s internal model, the NAIC is not currently requiring pre-approval of the (re)insurer’s internal model prior to its use.

What will be interesting to see is how the different proposed insurance capital standard options may affect (re)insurers. Hopefully whichever option is selected, it will be a calculation that is not too dissimilar from the one done today or the one that will be done under Solvency II and NAIC ORSA.

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