In the same spirit, The National Association of Insurance Commissioners' (NAIC) Solvency Modernization Initiative has placed heavy focus on reviewing key solvency areas, such as insurance valuation, reinsurance, and capital requirements.
In August, the NAIC released for commentary a draft guidance manual called "Own Risk and Solvency Assessments" (ORSA). It appears the risk assessments are being touted to become an annual expectation of U.S. insurers. These assessments are to be evaluated against the Insurance Association of Insurance Supervisor's Insurance Core Principles 16 Enterprise Risk Management, also known as, IAIS ICP 16 ERM. ORSA is to provide regulators a view of insurers' enterprise risk management practices.
So what is an "Own Risk and Solvency Assessment" anyway? Fundamentally, it is a simulated attempt at "breaking your bank." In many ways, it reminds me of my civil engineering days when we would design and cast concrete beams, load them up until the beams crumbled before our eyes.
Some have suggested that "Own Risk and Solvency Assessments'' seem redundant. Firms may look to their regulated formula for capital adequacy and their internal model and the economic capital, and deem their firm has sufficient solvency margin. But an ORSA transfers the burden of determining adequacy of capital from the regulator to management. Management and boards, through ORSA's, must now assert that the firm has adequate capital for its own risks and management systems. It is a move away from prescribed and possibly deficient capital adequacy formulas.
Insurers have had a tendency to look backwards to determine if they have enough capital for their future risks. A key objective of an ORSA is to shift evaluations from the past to the future. It is referred to a "Prospective Solvency Assessment." It tries to forecast whether the insurer is well-capitalized to withstand risk exposure in normal and stressed environments. The question that still remains is what is considered normal?
As such, we are hearing outcries claiming the guideline requires broader interpretation and needs to maintain flexibility. The guideline suggests that insurers have "procedures in place for material and relevant risks." In theory that is fair but without setting a standard set of stress conditions, it is very hard for examiners to fairly measure or compare what is "material or relevant."
Post-financial crisis, it seems few are arguing that is the most appropriate role of a regulator to use ORSA's to gain assurance that the company has well-established risk management practices and controls. But developing truly meaningful and well thought out stress tests and methodologies first is pivotal to offering true assurance that insurers are safe and well-capitalized. Otherwise, once again, our attempts at gaining comfort can quickly become illusory.
JOANNA MAKOMASKI is a specialist in innovative enterprise risk management methods and implementation techniques.
November 1, 2011
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