IRM urges FSA to set apart risk managers and actuaries under Solvency II

In a consultation paper sent to the FSA on the role of the risk function and risk professionals under Solvency II, the IRM said that it has recently become aware of some of the thinking on the developing role of the risk and actuarial functions in the Solvency II ‘world’ and is worried about some of the assumptions apparently made. Specifically the FSA gave a presentation to the IRM’s Solvency II Special Interest Group, which has over 370 members from insurance companies, including captives, early last month. This persuaded the IRM to respond and try to clarify what it sees as some important distinctions between the actuarial and risk functions. In a letter signed by Alex Hindson, chairman of the IRM and risk manager for Amlin and Phil Whittingham, chairman of IRM’s Solvency II SIG and risk manager at XL, the IRM said that its members broadly support the Solvency II directive. This is because it recognises the importance of risk management as a discipline and the need for the function to have structure and independence within an organisation.hideBut the letter urged the FSA to provide clarity about the respective roles of the risk and actuarial functions and stressed that the distinction be maintained and not somehow blurred, possibly through the enforced appointment of some form of super risk manager expected to perform both roles. “The IRM believes that risk management and actuarial professionals have extremely complementary whilst different skill sets to bring to the analysis and management of risk. Likewise many other functions contribute to the overall management of risk, including finance, legal, compliance, human resources and information technology to name but a few,” stated the paper. “We believe that a robust risk management structure will include both roles and that both will be held by senior individuals in the organisation. Solvency II should be seen as an opportunity to build bridges between professions and encourage closer working,” continued the IRM. The paper said that it is quite possible that there are individuals who possess both sets of skills. But the IRM said that it would be folly for the directive and subsequent implementation rules to assume that is the case and that both functions should be carried out by one individual. The IRM explained that risk management is typically focused on both the qualitative and quantitative assessment of risk across all risk types, with a focus on forward looking assessment, as well as responses to business risk exposures. Actuarial analysis, on the other hand, is primarily focused on detailed technical examination of aspects of insurance and credit risk, stated the institute. The IRM told the FSA that it is ‘fair to say’ that actuaries, and equally accountants, have many skills relevant to the management of risk. It also said that there is a common theme across the industry whereby other risk specialists have expanded their skills to take on wider risk management roles such as catastrophe modellers, operational risk managers, credit analysts, internal auditors and the like. It also noted that many of these professions, including the actuarial profession, have recently extended their own educational programmes to include separate ERM examinations, which suggests to it that the core qualifications on offer do not give sufficiently broad training. But the IRM told the FSA that it would be wrong to mandate that risk managers must be qualified actuaries to carry out the role effectively. “There should not be a presumption that the chief risk officer of an insurance company should have a specific background or qualification, be it actuarial or otherwise. Indeed there is a trend in the market for companies to appoint business‐focused CROs with a strong understanding of the core business and excellent relationship management skills,” said the paper. Rather, management must demonstrate that any individual who holds such an important function has the appropriate skills, experience and personal attributes to provide insight and critically challenge at the most senior level, the IRM advised the regulator. It also advised that organisations should be allowed to work out the best system for their own operation rather than be forced to adopt a one-size-fits-all model dictated by the regulator. “Each organisation should remain free to determine how best to organise its resources across the risk management, capital modelling and actuarial disciplines. There should not be a presumption as to an ‘ideal’ organisation or reporting structure. Flexibility should remain as to how each management team determines how best to organise itself,” stated the consultation paper. The IRM said that recent confusion about distinct roles of risk managers and actuaries in the management of insurance company risk may well have been sparked by their roles in the internal model, the core tool that insurance companies will use to calculate their solvency capital requirements under Solvency II. “If we consider the calculation kernel as the internal model then the differentiation between the actuarial mandate and the risk management mandate is obvious: The risk function has a role to make sure the risk management framework is appropriate and that would include looking at the risk quantification tools in place. One of these tools would be the calculation kernel, but it would be set alongside the other risk management tools such as stress tests, risk registers and so on. “The actuarial function then, clearly, has a role in the development and execution of the internal model kernel, not least the development of the insurance risk calculation kernel. In most cases the two functions have found the need to cooperate on a range of challenges for example the development of an operational risk module for the internal model,” continued the paper. The IRM said that it believes that one aspect that is ‘insufficiently articulated’ in the directive is the risk function’s responsibility to provide the board with guidance on the design of the risk management framework and specifically the qualitative risk processes, in particular risk identification, assessment and control. The institute also advised the FSA that it feels ‘further emphasis’ could be placed on the role of the risk function as leader of the development of stress testing approaches that complement the calculation kernel. Another good reason for the separation of the duties of the actuarial and risk management functions is the need for independent assessment and oversight of technical provisions, according to the IRM. “These are a significant item on the balance sheet of an insurance company and the actuarial function has a key role, set out in the directive, around the calculation of these provisions. Following the Three Lines of Defence principles which the directive applies, there then needs to be some independent risk oversight of reserve risk and the actuarial function would appear to be conflicted in taking this independent role. This suggests the need for an independent risk function providing this oversight,” stated the IRM paper. And, the IRM told the FSA that there is also potential for conflict between the actuarial and risk management function around the annual opinion on the company reinsurance policy and urged it to provide more clarity here too. Each European Union insurance company needs a risk management policy as set out in Article 44 of the directive and for UK insurers CP33 that would include the use of reinsurance as a risk management tool to manage insurance risk. The IRM said that ‘clearly’ the risk function would be expected to comment on the operation of the risk management framework and added that it ‘seems wrong’ to separate the key risk mitigant tool for separate consideration. “We would expect the risk manager to call on the skills of the actuarial function in considering the appropriateness of the reinsurance, but would expect this to be contained within a wider role around ensuring the ongoing appropriateness of the risk management system. If the intention is to provide a view independent of the risk management function on the appropriateness of part of the risk management framework, then this should be stated more clearly,” the IRM advised the FSA. The IRM also said that it is aware that there have been suggestions that there is a lack of suitable qualifications for the risk management professionals and took the chance to set the record straight. It pointed out that there are a wide range of specialist risk management qualifications as well as broader enterprise‐wide risk management qualifications, not least its own Postgraduate International Diploma in Risk Management, that provides a professional designation of MIRM. It also offers an International Certificate in Risk Management, that provides a stepping stone to the Diploma, a designation of CIRM. And recently the IRM has also launched a specialist qualification in Risk Management in Financial Services. “The risk profession is maturing to the point where both qualifications and experience are required to be a credible and effective risk professional within a risk function. The skill set of risk professionals is broad and equips them well to work cross‐functionally with many specialist functions and professionals,” stated the IRM paper. On top of this the IRM believes that modern day risk managers within insurance companies need to fulfil a wide range of key roles and provide skills to support the board and wider management in an enterprise-wide manner. “This is a comprehensive set of skills which, when taken with the roles and responsibilities set out for the function in the Solvency II directive, would suggest a specialist full‐time role requiring access to and support from the board to be effective. Given the importance of this function within a Solvency II regulatory environment, IRM would encourage further guidance on what constitutes a fully effective risk function,” it stated.

IRM urges FSA to set apart risk managers and actuaries under Solvency II

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