English Appendix
One of the very important developments is the new framework for prudential regulation of insurance in the E.U. Solvency II
BRUNO PORRO
President of CRO Networks
The Geneva Association
IN RETROSPECT
When you asked insurance managers in
the mid eighties of the past century, how they
described the risk management function in
their company, the most likely response was
that they had some engineers looking at the
quality of the risks they took on their books
and proposed to the insured actions to reduce
loss frequency and severity.This
interpretation should not be interpreted as an
absence of any other risk management
function. But what was true is the
concentration of risk management actions to
silos of activity: asset management by the
financial function and liability management
by the actuaries and underwriters.
Since then, the environment in which
the insurance industry is working has
changed substantially. Let us just mention
some of them to illustrate the development:
- Accounting. High flexibility with local «generally accepted accounting principles», with a lot of liberty to value assets and liabilities and therefore to influence the bottom line over the insurance cycle and as an means of tax and dividend policy.
- Regulation. In many countries, there were still supervisory authorities that hat to licence product and prices, often with substantial margins allowing inefficient allocation of resources and the survival of marginal players.
- Governance. Transparency and separation of production and control activities was not considered to be an important issue.
- It was primarily a support tool for the administration of the portfolio, much less a instrument to analyse data and shape strategy.
- Rating agencies and Analysts. They had a much smaller impact on the allocation decisions of an investor and concentrated mainly on giving an opinion on the financial stability of a firm
- Products were less complex than today, and much less substitute products of other financial providers available.
- Management of internationally working companies focused on the valuation of the financial performance of the individual entities and otherwise dealt within the framework of the corresponding country.nacional.
THE CHALLENGES
It is not too difficult to track the many changes that the insurance industry went through over the past two decades.The main drivers of change in today’s business environment are manifold, but top priority is probably given to the following ones:
- Value creation. To measure value creation (avoid value destruction), an economic assessment of balance sheet and Profit and Loss items is a must. Economic valuation is based on estimated future cash flows (in and out) and taking into consideration the time value of money (discounting future cash flows using a risk free interest rate curve).
- Many stakeholders challenging the strategy and operation of an enterprise (Private Equity, NGOs, pension funds,…).
- The value of reputation and its vulnerability in a single brand approach, often affected by operational risks
- Reporting frequency and extent, transparency, consistency and expectations
- Risk mitigation, by traditional reinsurance/retrocession, but also using the capital market (securitisation).
- Developing a consistent framework of risk assessment in a multicultural environment.
The International Association for the Study of
Insurance Economics, or by its short name “The
Geneva Association”, is a unique world organisation
formed by a maximum of 80 chief executive
officers (CEOs) from the most important insurance
companies in the world. Its main goal is
to research the growing importance of worldwide
insurance activities in all sectors of the economy.
www.genevaassociation.org
One of the very important developments consists in the European Regulation for insurance and reinsurance carriers, Solvency II. If the draft directive survives the political process without being changed significantly, then we are very close to an economically founded and risk based supervision. Many large companies have realised that a specialised function has to take care of the various aspects related to Enterprise Risk Management (ERM). In addition to risk assessments related to a single risk as mentioned at the beginning of this article, ERM has a much wider scope by looking at risks that potentially can affect significantly the result of the company, stemming from all operational units. During the past few years rating agencies no longer limit their work to financial strength, but have developed frameworks or even economic models to quantify as many of the risks as possible, and ERM has become one of the criteria entering the rating process.
THE EVOLUTION OF THE RISK MANAGEMENT FUNCTION
Due to the developments sketched above, many companies have introduced a risk management function, that culminates in the nomination of a Chief Risk Officer (CRO), usually reporting directly to the CRO and sometimes with a escalation right to the Board of Directors or one of its committees.What are the tasks allocated to this function?
- Analyse the risk landscape of the company and the risk factors present in it’s activities. This includes observing «emerging risks» like climate change and effects on insurance, the issue of terrorism, pandemics etc.
- Create awareness and a common understanding of the notion of risk within the company/group.With the blurring of underwriting and financial management a clear separation between risk and capital management is no longer possible.
- Analyse products with regard to their effects on the risk landscape. An example is the evaluation of risk in life policies that grant the insured embedded options and guarantees that can change the risk content of a policy considerably.
- Making proposals to the Board of Directors and the Executive Management with regard to the risk appetite the company can digest, given a capital base and the probability of default within a given period of time.
- Regular reporting on the economic capital required to sustain the business on the books.
- Propose risk mitigation tools in different business situations (for instance hedging)
- Participation in risk management associations like the CRO Forum which acts as the technical discussion partner in the Solvency II process.
- Provide information to the Executive Management for a risk adjusted capital allocation for risk adjusted performance measures.
- Find new areas of activity to improve risk diversification.
- Represent the company in discussions with supervisors and rating agencies as far as risk issues are at stake.
The risk management function is still in an evolutionary process. But it is clear that with the enhanced focus on risk based management of the industry, the role is getting more prominent in the future.
Bruno Porro was member of the Executive Board Committee and the first CRO of Swiss Re until his retirement in 2005. Since then, he is part time consultant to The Geneva Association and acts as advisor in two companies specialising on risk management consulting and securitisation.