Solvency II - what we’ve learned from the first round of standard formula audits

The first audits of standard formula solvency calculations presented a steep learning curve for all concerned. Looking across the market, what worked well, what might have been done better and what could help to make your audit run smoother when the timelines are cut in 2018?

The great news from the first standard formula audits is that everyone we worked with met the deadlines, though for some this was harder than others.

Whilst we have the benefit of being able to gain experience and insight from working across the market on many of these capital calculations, if you’re a standard formula firm you’ll probably only have ever made the calculation for your own organisation. We did have to report some minor misstatements over the audit season, although we’re confident this is a ‘first year effect’ that can be resolved rather than an ongoing concern.

So what marked out the companies whose capital evaluations were in good order and where the audit went without a hitch?

4 things we learnt from the first round of standard formula #solvencyII

1. Understanding how it all fits together

The best prepared companies had thought through how the overall process would work, not just how the calculation should be carried out. People from finance, actuarial and the IT team are all required. Giving them a clear understanding of their role, and who should be responsible for what, made a significant impact on the quality of the final output. Where this wasn’t the case, we often saw the process run aground until senior management stepped in and took direct responsibility.

2. Confidence through transparency and control

A clear differentiator was the calculation model being used. We saw a wide variety. The biggest difficulties tended to stem from instances where the company had bought a calculation tool without understanding how it worked and had often relied on it without sufficient consideration of the regulations. They were therefore unable to adequately articulate how their capital was calculated and how it aligned with the rules. We also saw instances where companies were trying to get by with ‘black box’ models, which made it difficult, sometimes impossible, to see how the calculation was being performed. As a result, it was hard to obtain enough evidence to signoff the audit without lengthy discussions with the model providers.

Looking ahead to 2018, it’s going to be even more important to ensure a clear understanding of your model and its workings, along with sufficient control to prevent accidental or inappropriate changes.

3. The right stuff

A surprising number of clients caused problems for themselves by not feeding the right information into their model. Sometimes the Solvency II balance sheet hadn’t been completed and checked prior to the capital being calculated. Any errors in the former lead to revisions in the latter. In some cases, information provided by the regulator hadn’t been updated to the latest available (e.g. yield curves). There were also a number of occasions when clients weren’t aware of important regulations, perhaps not surprising considering that the provision of the rules is fragmented across quite a few documents. A good example of this is the separately published regulations on applying reinsurance to catastrophe risk, which many weren’t aware of but which often had a significant impact on the work.

4. Ready to go

The more engagement we had with the company prior to the audit, the smoother the review went. As ever, documentation was also crucial. When a company was able to produce detailed documentation in time for our work, they’d earn the well-deserved reward of not having us ask so many questions! In many cases, however, documentation wasn’t up to the level required by the regulations. In particular, we found justifying simplifications, the application of reinsurance to non-life catastrophe risk and out of model calculations (e.g. how the four premium ‘buckets’ for non-life premium and reserve risk were derived) weren’t well documented.

Model confidence

Overall, UK insurers can give themselves a huge pat on the back for getting over a difficult first hurdle. But with timelines being squeezed, it would be useful to look at what marked out the best prepared companies. They not only benefit from more straightforward assurance, but they also gain greater confidence in the model outputs they use in their business and put out into market.

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Richard Williams

Actuarial, PwC United Kingdom

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