“So Holmes, we’ve cracked the infamous Solvency II SCR case, what next ?”
“Elementary my dear Watson, it’s on to the ORSA !”.
OK, so it may not be the plot of the next Sherlock Holmes blockbuster; I doubt we could convince Robert Downey Jr. and Jude Law to be involved in an insurance regulatory plot, even though it’s an obvious cliff-hanger. But the questions remain; what is an ORSA, how does it differ from the SCR and what does an insurer need to do to produce an ORSA ?
What is the ORSA?
So let’s start at the very beginning “it’s a very good place to start…”, the ORSA stands for Own Risk and Solvency Assessment and is essentially an exercise whereby insurance companies calculate the size of the financial buffer required to protect themselves from unforeseen adverse events. This financial buffer represents an Own Risk Capital Requirement (ORCR). The ORCR needs to be based on the risks that the company could face at some time in the future and the size of this buffer ultimately depends on the level of protection the company wants to have and the appetite of the company for taking risks. And although the requirement to produce an ORSA is part of the Solvency II Directive, there are no hard and fast rules as to how an Insurer should complete the assessment.
How does the ORSA differ from the SCR?
All this seems very similar to the process for calculating the regulatory financial buffer the ‘Solvency Capital Requirement’ but there are differences and I’d like to explain them with a metaphor.
Picture two rooms side-by-side, each with one door in at the front and one door out at the back. The room on the left is our SCR room (our regulatory room) and the room on the right is our ORSA room. The instructions on the front of each room are the same “Upon exiting this room, you must be holding a document that defines the size of the financial buffer required to protect your business based on the risks facing your business”.
Upon entering the SCR Room, we are faced with detailed instructions pinned to the walls citing the minimum standards upon which the SCR should be calculated, the type of risks that it must consider as a minimum and the financial basis upon which the SCR should be based. In a nutshell, we have been told by the European Union, what we must do, how we must do it and the level of standards we must achieve. This of course sets the minimum standards that our insurance company must achieve.
Inside the ORSA room, we have a small booklet that just provides guidance as to the objective of an ORSA, the types of things it may incorporate and how we could undertake the assessment. There is an implication that we should follow these guidelines, but if we have good reason not to, then we can and should conduct the ORSA entirely in our own way. So we have been asked to provide an important deliverable once a year, and given the freedom to conduct and produce that deliverable in the way most appropriate to our business.
It’s worth noting that for some insurers, the values, approach and end deliverables for the SCR and ORSA will be exactly the same, but for those where the ORCR is lower than the SCR value, the company will be required to hold capital at the level of the SCR.
What does an insurer need to do to produce an ORSA?
We can think of the development of the Solvency II directive as the production of a standardised Risk and Solvency Assessment for the whole European insurance industry. An insurer’s Own Risk and Solvency Assessment will therefore produce a similar deliverable, but one designed for specifically for that company.
The processes, systems and models required to conduct the ORSA and produce the ORCR, will ideally be the same as those used to produce the SCR, but there are likely to be some differences. These may include:
- A system designed to help the insurer identify, document and manage the policies, risks, controls and governance activities – commonly known as Governance, Risk and Compliance systems.
- Models that value and calculate risks not included in the SCR calculation (e.g. Defined Benefit Pension schemes).
- Different configuration sets for the financial and actuarial models.
- Financial management systems that can help to document, reconcile and explain the differences between the different financial buffers (e.g. SCR and ORCR).
Insurers will be looking to streamline and align these systems, processes and models where possible to ensure that they conduct all the Solvency II activities as efficiently as possible.
Of course, Watson believes that the ORSA problem has been solved, but let’s be honest, he won’t be directly involved in putting in place the solutions required to produce these assessments on a regular basis. That’s where insurers need to take the opportunity to bring together people and companies with the knowledge, skills and experience to make these activities as painless as possible.