Published by Scott Eason on
However, it is not necessary to have a named person responsible for the investments of a firm. Given the importance of investment performance to the profitability of firms and the fact that market risk has been the largest risk at industry level disclosed during all the QIS exercises, is this correct? Certainly, many large firms do now have a CIO as part of their structure as a matter of choice; so is this good practice also for smaller and medium firms?
One of the challenges is that a CIO often needs to wear two hats; often they have a first line objective to achieve return and a second line objective to manage the level of risk. It could be argued that a CIO is looking to maximise a risk-adjusted return but, in reality, conflicts between the two will exist. The proposed Controlled Function regime requires all other individuals to be subject to the oversight of one of the named Controlled Function holders – however, it is not clear whether this should be the CFO or the CRO if they are different people.
Historical evidence shows that the greatest driver of investment performance is asset allocation over stock-picking. From the first line perspective therefore, the key capability of the CIO is to continually monitor and assess the appropriateness of asset allocations. They may well get advice from their investment manager but ultimately the insurer is responsible. To satisfy this, a CIO will often have a markets or economics background or will seek external support.
Some CIOs will go a step further and also carry out a shadow fund manager role, monitoring and challenging individual asset choices. Whilst this clearly has value, we feel that it is reasonable to delegate this activity to the investment manager, as long as strong risk and performance guidelines and monitoring are in place. This is where we feel a large number of firms are still currently below best practice.
Whilst performance responsibility is clearly important, Solvency II regulations and guidelines focus heavily on ensuring strong risk governance and explicitly require detailed written risk policies on:
So the CIO needs also to have a clear understanding of the liability and capital side, and hence an actuarial background is also common for a CIO. The largest firms often recognise the need for both skill-sets and will have a Head of ALM as well as a CIO. But what about small and medium firms where this is clearly not cost-efficient?
The core base for any successful structure is to have clarity in what you are trying to achieve through strategy and risk appetite statements. A robust and understood governance framework can then be created to deal with the monitoring and management of the risks and we would suggest that this could be managed within the risk function as long as they are provided with sufficiently timely and accurate information on both the asset and liability side.
The biggest challenge will be in respect of new ideas, strategies or approaches. These are not usually frequent occurrences and it may be most efficient to seek external support when such issues arise.
So, to come back to the original question – should companies appoint a CIO? Given the importance of investment returns and the size of investment risks, we feel it is sensible for a Board to have a named individual to whom they have delegated responsibility for the investments of the firm. Individuals that can carry out the economics and actuarial parts of the role are rare and we would recommend that firms ensure that they provide appropriate support to enable the named individual to fulfil the role successfully.