The Year-End 2016 Solvency II technical provision (TP) audits raise questions about whether some (re)insurers are doing enough to build the evaluation process into business as usual (BAU). For others, solid foundations for evaluation and audit preparation are already paying dividends.
The TPs are the building blocks of the Solvency II balance sheet and the solvency assessments, decision making and disclosure that stem from it.
Done well, the results offer valuable insights into the risks being run. With so much riding on the TPs, and the diminishing timeline for getting them ready, it is time for the evaluation process to be built into BAU.
The central challenge is how many moving parts and expert judgements are involved, with each having a knock-on impact further down the line. The valuation guidelines are peppered with words like “justification” and “rationale”, putting the onus on your business to show the workings as well as the results. Accordingly, assessing whether the underlying evaluation process was fit for purpose was one of the keys to providing an audit opinion on the material accuracy of the TPs.
We at PwC reviewed around 40 insurers and reinsurers in what was, for most, the first round of Solvency II TP audits, covering businesses of different sizes and product focus. This has given us a good idea of the state of play on TP evaluation now and (re)insurers’ readiness to deal with the tightening timelines. So what have we learned?
There’s a big spread in how effectively TPs are evaluated and built into BAU. The differences have little to do with the size of the organisation – some bigger groups recognise the importance of TPs to their business and its reputation, and have developed capabilities to match this; while others have been hampered by the challenges of applying a complex process to a large and varied organisation. Indeed, some of the businesses out in front are relatively small, suggesting that progress is more about attitude and approach than resources. The big demarcation is between organisations that see value in the TP evaluation and associated audit process, and have prepared accordingly on the one side, and counterparts that see this as just more red tape and have thus opted to do the bare minimum on the other.
The front-runners are finding that the more they put in, the more value they get out. This includes a better understanding of the economic dynamics of their enterprise and how to address the business opportunities and inefficiencies this reveals. Moreover, solid foundations for TP evaluation and preparation for audit also make the process a lot more straightforward. By contrast, the minimal approach can actually create more work in the long run. It also heightens the risk of error, regulatory sanction and resulting reputational damage.
So what marks out the front-runners and what does ‘fit for purpose’ look like?
A good understanding of what the regulations specifically require and how to apply this to the realities of the business is critical. Less effective approaches are often based on perception or instinct, which raised issues within the audits in a number of key areas including the calculation of the risk margin and changes in treatment of outwards reinsurance.
Close interaction between valuations of IFRS/GAAP and Solvency II TPs, rather than running them as completely separate processes, can help. Breaking down the silos that often close off interdependent activities, such as IFRS/GAAP and Solvency II calculations or finance and actuarial evaluations within Solvency II, makes it easier to deal with differences (e.g. treatment of reinsurance) and ensure that any adjustments in one component evaluation are fully reflected in other relevant areas.
A lot of thought has gone into the make-up, structure and required capabilities of the TP evaluation teams, which ensures that the people involved are clear about their role, their responsibilities and how they interact. This is supported by a systematic governance process. Such clarity is one of the keys to meeting timelines and ultimately building the process into BAU.
Models are not only set up to deal with the complexity of the process, but also flexible enough to respond quickly to changes and apply appropriate proportionality and materiality as required.
Solid documentation ensures that assumptions and requirements are well understood and communicated. This helps people coming into the team to get up and running quickly. It also aids engagement with regulators and auditors, reducing the number of questions arising.
Prior engagement with auditors helps the front-runners to gain a better understanding of focus areas and potential issues. They can then deal with any issues in advance, rather than ‘firefighting’ during the audit.
The approaches and capabilities that mark out the front-runners are proving useful now. As the timelines tighten, they are going to be vital. Less prepared businesses could struggle as inefficiencies become more significant and the need to address them in a hurry drains resources and heightens disruption. TPs are too important for bare minimum compliance.