Solvency II - Cost V opportunity: A cost worth paying

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After complaints over the amount of management time needed to comply with Solvency II and the costs associated with this, Rachel Gordon asks if the grumbles are justified.

It would seem Groupama's managing director hit a nerve when he wrote in Post recently about the inordinate amount of time being taken up within his company by Solvency II-related work.

While there were consultants and IT providers aplenty only too willing to say they were the panacea to Solvency II woes, therewere some surprisingly big names within insurers that were too scared to say on the record if they supported Laurent Matras' view. So, would this suggest that perhaps they have not been making the ‘Herculean' efforts referred to by the Groupama managing director and indeed may incur the regulator's displeasure come 2013? Or were they simply too busy? Who knows, but among those contacted that had nothing to say were RSA, Travelers, Zurich, Markel and Aviva.

Mr Matras had complained in his article that he felt there was an enormous opportunity cost to be paid with Solvency II. While he supports its intentions, that having more than 60 hours of meetings linked to the requirement-as occurred in quarter one of this year - was damaging, since there are other business priorities.

One fact is clear, however, there is no hiding place. No matter which regulatory organisation is in charge at the time of enforcement it will have to audit all insurers and indeed, may impose sanctions if they do not achieve compliance. Mr Matras is only too aware of this - as he pointed out, the Financial Services Authority is currently taking on some 450 additional employees to inspect insurers-and this alone more than is half the size of Groupama's UK workforce.

A tough job
Perhaps surprisingly, given it has a tough job in hand, Lloyd's takes a refreshing open approach to the challenges of Solvency II - and given its unique structure has one of the most daunting challenges. It has said each of its syndicates will have an internal model -and each of these will be a component and integral part of the Lloyd's internal model.

Nonetheless, from chief executive officer Richard Ward downwards, Lloyd's has taken a transparent approach to its work, including emphasising the support it is providing to managing agents and holding dry run exercises with each of these, along with working closely with the FSA. Finance director Luke Savage is first to admit that Solvency II has created a massive amount of work-and cost.

"We have a team of around 90 people and their primary work is around Solvency II and -if we're looking at current expenditure- then for Lloyd's it has probably been around £60m to £70m."

Lloyd's is arguably one of the UK's strongest brands, not least with BP now in freefall. It is also known for its high regulatory standards and getting Solvency II right is clearly a critical mission. However, Mr Savage is prepared to be open that it is not an easy task and that he can see flaws. "I am quietly confident that we've been doing enough, although would never be complacent.

"Yes, of course, I believe that the underlying principles are sound and that it is going to improve risk management, but I am not sure it is going to increase our competitiveness -and it is going to cost us a huge amount to implement - across the industry, it is going to run into billions. You need a big team for a complex task - but we have rebuilt what is now a really strong brand and we must show we can meet the highest standards."

Lloyd's has introduced new technology as part of its Solvency II work and also made numerous recruits - and it plans more. As Mr Savage says: "One thing this has brought home is the shortage of actuaries in the UK. Right now, we are looking to bring over some actuaries from Australia to work with us for a couple of years. They have some good people who have similar qualifications to the UK but it's a long way to go."

In terms of hours spent, Lloyd's - and consultants it has engaged - are also working closely with European regulator Committee of European Insurance and Occupational Pensions Supervisors, in addition to the FSA, and providing a lot of support, in particular to smaller managing agents, which need most assistance. This is in areas like improving data, educating people in why the internal model is right over the standard model and creating validation policies.

"The internal model may mean more work, but we see the standard model as being badly calibrated, so we will provide as much support as is needed."

There is no doubt that insurers with a presence across Europe-as with Groupama -will be working even harder to co-ordinate their Solvency II efforts. However, Allianz's UK finance director George Stratford comments: "The real question insurers should be asking themselves is the cost of not doing Solvency II. The signs are the solvency capital requirement is going to be significantly higher than the capital required via an internal model, therefore, the cost will be the return on the additional capital for insurers that go down the SCR route."

Using resources
He continues: "Solvency II is certainly taking up a lot of resource, which is increasing as we approach implementation. At Allianz our modelling and risks teams are separate from the pricing and reserving work, which is proceeding as normal. The cost really comes from the essential business involvement plus the cost of the team we have built up. There is certainly a lot of senior management time being invested but for us the return will come if we develop a superior capital model and risk management framework compared to our competitors. Given the market crisis the requirement for improved risk management is not going to go away."

Outwardly, it would seem that insurers without legacy issues would have an easier ride with Solvency II. Barbican Insurance Group is a young company, established at Lloyd's in 2007. It is known for its disciplined underwriting approach and has grown steadily - achieving a stamp capacity of £75m in year one, which grew to £130m in 2009-and currently stands at £180m.

Director of risk and governance at Barbican, David Russell, says while he would certainly have plenty to keep him occupied elsewhere within the business, that Solvency II is his key project. "It should make Solvency II easier if you are a new company, but working on our internal model is a stringent test for all insurers-but beyond this, I can understand what Mr Matras is saying because there is also a huge amount of bureaucracy. We have a full time project manager who has to do an enormous amount of administration - we fully agree there is a lot of good stuff going to come of Solvency II, but it is unfortunate that so much process has overtaken the principles at the heart of it."

Given the ongoing mess that has resulted from troubles at Quinn Insurance, higher standards are clearly required - and there are those who emphasise that Solvency II is in line with a growing demand for reduced risk taking and consumer protection.

CUNA Mutual Europe specialises in providing financial services for credit unions and co-operatives and currently provides life and creditor cover from its bases in the UK and Ireland. Chief executive officer Paul Walsh comments: "If you look at what underlies Solvency II, the concepts are straightforward - understanding the risks that affect your business, better governance and transparency and having sufficient capital to cope - it is about having seamless integration of your capital levels and governance models and it's right this should be measured."

He notes while a "cottage industry" has been spawned around Solvency II in terms of external consultants and others, that some are raising fears unnecessarily. "Companies should only be scared if they are not coming up to the mark. The opportunity cost is not as great as some are saying - yes, change costs, but this is going to be change for good. Insurers need to communicate with the regulator and equally importantly, their customers."

CUNA Mutual has opted for the standard model, which pundits say results in higher capitalisation being required. However, Mr Walsh stresses: "It is less complicated and that is what we are about. Solvency II is about the way your business is run-of course, I realise if you have a large company it is more work, but overall, my message would be that we should be embracing this and making it happen."

While the consultants are cashing in, Mike Wilkinson, who heads EMB's risk consulting team and focuses on Solvency II, says his message to insurers is: "Use consultants wisely. You cannot pass responsibility on. We can do as much as required to help with technical aspects, but enterprise risk management is what underlies the three Solvency II pillars - and that needs to be addressed and fully understood by the insurer."

As such, EMB has been involved in board education and Mr Wilkinson says coming from a non-technical background, is no excuse for lack of understanding. "In the amount of time being spent on this, some will say there is an opportunity cost, but I think they should also focus on the tangible benefits and the ways the business can be improved, rather than just seeing this as a massive project in isolation."

Along with consultants, IT providers have also been enjoying a Solvency II bonanza, given the requirements for improved data and processes. Michael Graham, director with Lloyd's software specialist Sequel, says insurers should stop their moaning. "Solvency II is big. It is a rulebook for everyone. And, you can see it as a necessary evil or an opportunity. There do seem to be some who are being swallowed up by the work, but they may well have problems with data held in different places. They need to structure their businesses better and get their houses in order. People have been talking about the benefits of high quality management information and a joined-up system for years - now the regulator is involved - some may not like it, but no one can deny we won't have a stronger industry as a result."

And, Norman Black, industry principal at SAP, says: "Being part of the debate is positive - clearly some see it as a case of obligation versus opportunity. But, if you just look at the recent situation with the Iceland volcano, we can see how a major event can create enormous disruption. We need the strongest insurers to manage and respond to risk. Solvency II has now become urgent - it is not just about meeting a precise set of regulations."

Mr Black also believes insurers must view Solvency II as the catalyst to improve their enterprise risk management. "Going through the motions and ticking boxes is not going to produce the long-term benefits - getting it right is a means to an end."

Accountants too should be having a field day. Neil Coulson, partner with Littlejohn, says Mr Matras is certainly not alone in his views. "Boards are having to deal with reams of information. They cannot leave work to actuaries, consultants and accountants. In fact, it would not surprise me if the work and costs involved do not prompt some smaller insurers to merge-the burden will be too much."

Evident rewards
Again, he agrees that it is far better to be in the ‘glass half full' camp though. "The rewards are there - and everyone knew that there was going to be additional work, even if, it can appear over the top. Those who have not properly worked out their capital requirement should be concerned - and now is the time to work hard on that."

He points out that it is not just about paying fees for external specialists. "Insurers also need an internal audit function and that is positive. Senior management needs to be more involved now - in all aspects - ultimately, they have to make it all fit together." Feeling the strain-and not being afraid to talk about it-would suggest that Groupama has taken the responsibilities of Solvency II on board and so this must be applauded.

Consultants Deloitte last month said a third of UK insurers were not confident that the industry is ready for Solvency II, that some 38% of boards were not fully briefed and engaged on the requirements and 11% believed they may have to relocate as a result of the regulatory requirements. Considering 2013 is only just around the corner and a beefed-up FSA is gearing up should it be included in regulation, this has to be alarming news. Certainly it would seem those insurers putting in the hours now - even if they are feeling the pain - would indicate this is a cost worth paying.

Is Solvency II too laborious? Join the debate.

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