Captives and Solvency II reporting: a market unprepared

A great deal has been written about Solvency II over the long years since the new capital regulations for the European Union insurance sector were mooted more than a decade ago. Much of the commentary – and indeed the actual, enormous effort and investment made by risk carriers – has related to the first and second pillars of the Solvency II framework.

Pillar I comprises the quantitative requirements, setting out formulae and methodologies for arriving at actual risk-based capital levels. Pillar II covers governance and risk management. For some regulated entities, demands under these pillars have been significant. Pillar III focuses on public and regulatory reporting. Its purposes are to improve transparency, which regulators expect will foster market discipline, and to generate the source material which underpins regulators’ risk-based supervision. Reporting requirements are implemented on a member-state level, and may vary in some detail from country to country.

One of the UK’s dual insurance supervisors, the Financial Conduct Authority (FCA), states that “the new requirements constitute a significant change to the current reporting regime, both in terms of content and frequency”. For many risk carriers in the market, Pillar III has been left as the last component of the process to addressed. It is no small task. “We expect that producing the necessary information will pose a significant challenge for all insurers,” accountancy PricewaterhouseCoopers has predicted. “The significant increase in the breadth and depth of reported information may stretch what is already a pressurised timetable for many firms.”

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The new reporting regime requires that regulated firms regularly file two distinct reports:the public Solvency and Financial Condition Report (SFCR), to be published by the insurer, and; the private Regular Supervisory Report (RSR), to be submitted to the relevant regulator.

The FCA and other national regulators will collect these reports in electronic documents employing eXtensible Business Reporting Language (XBRL) standards and formats, typically to be submitted to the relevant regulator through a dedicated portal. The reports follow prescribed standards, including Quantitative Reporting Templates (QRTs) common to all national supervisors, and National Specific Templates (NSTs), which cover additional requirements imposed by specific local supervisors.

Both narrative and data reports are required to cover various topics, on an annual or quarterly basis, or both. The level of detail required in some areas is greater than that compiled under International Financial Reporting Standards.

A further requirement is for ‘Own Risk and Solvency Assessments’ (ORSAs), which represent an ongoing analysis of the risks assumed by a carrier, relative to the capital they hold. The process for compiling OSRAs may involve standard formulae prescribed under Solvency II, or the use of internal models which must be approved by the relevant regulator. The process of approving internal models has been extremely slow.

MCRs and SCRs Quantitative Reporting Templates (QRTs), due quarterly, cover areas including:

• market-consistent balance sheet
• premium, claims, and expenses
• changes in available capital (own funds)
• the current Minimum Capital Requirement (MCR)
• assets (valued according to a prescribed formula)
• changes to technical provisions
• group reporting, including intra-group transactions.
• For firms that have not applied for and received an exemption from the first reporting deadline, it is set as the first financial quarter ending after January 1 2016.
• Annual reporting under the Solvency Financial Condition Reports (SFCRs), which is extended to narrative reporting and the Regular Supervisory Report (RSR), additionally require details of:
• variation analysis
• the current Solvency Capital Requirement (SCR)
• changes to reinsurance
• enhanced group reporting
• business and performance analysis
• an outline of the system of governance
• a detailed risk profile
• valuation of assets and liabilities for solvency purposes
• an explanation of capital management activities.

In a presentation to insurance companies in October 2015, the UK’s second supervisor, the Prudential Regulation Authority, said: “In most cases the information required is already produced and used by firms for other purposes. Where it is not, the PRA has designed the NSTs in order to ensure that any costs associated with submission of the information are likely to be minimal.”

In some cases, however, this has not proved to be the case. Some captives had not previously generated the required data, and find reporting requirements onerous.

For many risk carriers, the data required to complete SFCRs, RSRs, and ORSAs is much more detailed and complex than may currently be compiled for reporting or internal use. Systems upgrades have been seen as essential to deliver the data in an efficient manner.

Accountancy Ernst & Young has advised: “Insurers need to design reporting systems that maximise input and output flexibility if they are to grasp the opportunity to align national and regulatory reporting processes. System development life cycles and IT change processes and protocols in each insurance group will dictate the pace of change.” The firm identified Pillar III reporting challenges which fall into eight categories.

These are:

• the breadth and depth of data required
• business and legal entity issues
• identification of data gaps
• uncertainty around requirements and changes
• availability of resources
• external audit requirements
• more frequent reporting
• systems solutions.

Regarding the last point, Ernst & Young said: “Organisations should consider whether current reporting systems are adequate or fit to meet the requirements. If insurers use outsourced IT services, particular challenges may exist around the auditability of that data in order to demonstrate data validation and integrity to the regulators.”

Special Challenges for Captive Insurers

ECIROA, the European Captive Insurance and Reinsurance Owners’ Association, defines a captive as a “re/insurance company which is an affiliate created or owned by industrial, commercial, or financial groups [or sometimes government bodies], the purpose of which is to re/insure all or part of the risks of the group it belongs to”. Because of this unique role, captive re/insurance companies face a set of challenges arising under Solvency II which differs from those faced by many other risk carriers.

The trade body has said: “The need to provide reports to supervisors is accepted and agreed by captive owners. The scope and nature of the information needed and the frequency of reporting should reflect the nature, scale and complexity of the captive. Most captives are very straightforward entities, and it is important to consider how much information is necessary to get a full picture of the risks of the company in question. For smaller, simpler companies the supervisory body will very easily have access to more information, and there will be more transparency than it would ever be possible to obtain for a complex undertaking.”

The comment reflects a concern that the reporting requirements for captives are onerous, and may not always be necessary to present clearly the real risks they carry.

New research by Noria

New research by Noria shows that many captives domiciled in the European Union, despite extensive preparations over the past several years, are not yet ready to commence Pillar III reporting. More are unprepared even than the quarter predicted by Grant Thornton. Early in 2016, some were still implementing reporting tools. The effort has been enormous. “I have personally spent at least 20% of my time on Solvency II issues over the past five years, and over the same period our organisation has paid various consultants several hundreds of thousands of dollars,” the manager of a c. €9.2 million municipal captive reported. “We will definitely spend more money on achieving full compliance with the rules.”

Noria commissioned an independent survey of EU captive managers and parent companies with annual premiums ranging from €6.3 million €138 million. It was conducted in February 2016 by Haggie Partners. The highlights of the survey findings are as follows:

• exactly one third of responding captives do not feel ‘fully prepare d’ for Solvency II Pillar 3 reporting requirements
• half of captives have not conducted a cost-benefit analysis to help them determine the need for a robust Pillar III reporting solution
• 40% have not conducted a dry run of Quarterly Reporting Templates to check if the technology in place is sufficient
• half found the cost and time required for Solvency II implementation to be somewhat or greatly in excess of expectations
• one third do not believe that Solvency II reporting will be of value to their operations
• none think it will be ‘useful’ to their sponsors
• only slightly more than 10% believe Pillar III reporting will be straightforward and 78% believe it is too complicated
• only 22% have a Solvency II reporting system which is integrated with other administrative systems.

Companies feeling unprepared are continuing to work on methodology and software configuration. Few found the exercise likely to offer value beyond fulfilling reporting requirements. One respondent commented that the framework’s ‘approach to risk is questionable, as no strategic aspects are considered’. Another complained that the ‘implementation timeline in Europe differs by country’. Despite the possibility of different national requirements for captive insurers, one respondent argued that the SII framework offers ‘too little appreciation of different types, sizes, and scopes of companies within the industry’.

Pillar III ‘pain points’ for captives

Due to their nature as subsidiaries of their insureds, captives typically practise less stringent reporting than conventional insurers. In particular, public reporting rarely comprises more than a sentence or two in parents’ annual reports. That has made preparations to meet.

Solvency II reporting requirements more onerous for captives, since many will require a dramatic increase in the level of data they accumulate, process, analyse, and deliver to third parties.

Under Pillar III, further challenges have arrived hand-in-hand with the execution of the necessary enhancements of the complexity and comprehensiveness of reporting. The need for cost efficiency is one. Captives tend to be managed with minimal administrative support, and many will have little scope to increase this resource (and thus their overhead costs) by adding compliance personnel – especially if capital increases are required under Pillars I and II.

Further, the predictability of operational costs is critical within organisations designed solely to increase the cost efficiency of captive owners’ risk transfer programmes.

One great benefit delivered by many captives is the risk insight they possess. By being closely aligned with sponsors’ internal risk management teams, captive managers tend to have a greater insight into the internal risks of their insureds than is possible through open-market re/insurance arrangements, especially when intermediated by third parties.

However, Solvency II’s Pillar III requirements call for a new kind of risk management insight, which may be outside the current practice of many captive operations. This includes the complex modelling of individual risks against capital allocations, for example.

A further challenge is the lack of information management systems which have been developed specifically for use by captive re/insurers. While the market is flooded with various software ‘solutions’ for insurers, many target much larger organisations, or are far more complex than might be demanded by the typically limited risks carried by a captive.

One result is that it is not uncommon for captives to manage all of their IT processes on an inhouse platform based on simple spreadsheet software. However, the rigorous demands of Pillar III reporting will render such systems inadequate for the purposes of even the least complex captive re/insurers, as they will for many adapted commercial solutions.

Solvency II reporting as part of a packaged solution

For many captives, particularly smaller enterprises, a simple Excel spreadsheet has proved to be an adequate policy administration tool. However, European captives now require a more complex solution, to meet the Solvency II Pillar III reporting requirements. They need a tool which draws reporting data from the information routinely processed in the normal course of business.

Packaged software solutions designed to the needs of captives, such the ability to manage multiple entities, low cost, simple implementation, and minimal maintenance, have matured. They can now support multiple business function, as well as regulatory reporting, and therefore make operational and financial sense.

* Noria’s Policy and Reinsurance System (PARIS) is a commercial insurance application for the property, casualty, and employee benefits insurance markets. (www.noria.no)