The Prudential Regulation Authority (PRA) recently carried out a sample review of Own Risk and Solvency Assessment (ORSA) reports for category 5 insurers and provided feedback in a Board of Director’s letter dated 15 November 2016.
Here we suggest practical approaches to meeting the feedback suggestions which category 5 insurers should consider when next reviewing their ORSA.
"It should be clear from the ORSA how a firm has made a profit in the past and how it intends to do so going forward."
Let’s start by stating the obvious; the ORSA is an insurers OWN assessment of their RISK and SOLVENCY. Therefore, one question to keep in mind when producing the ORSA is “Can someone new to our firm, read this document and understand the risks that we face and our solvency position; both now and in the near future?”
Regularly revisiting this question will help you to address many of the areas highlighted in the PRA’s sample review.
It should be clear from the ORSA how a firm has made a profit in the past and how it intends to do so going forward. This should be tied in with risk, by considering for example:
- How well the current business plan fits in with the risk appetite
- What risks could be potentially detrimental to the plan’s successful delivery and how these risks could be mitigated
- How likely is it that you will meet your planned targets?
Forward looking assesment
The ORSA needs to be a forward looking document. This means that the business strategy and capital should be projected for at least the next three years.
Producing capital projections can be very difficult. Demonstrating how the board have questioned/sense checked the projections can help to justify them. Asking questions such as:
- Do the projections make sense based on the business strategy (e.g. The business written will be doubling over the next three years so why is our capital requirement not also doubling?)
- Do the projections make sense based on the risk profile of the business being written over the next three years (e.g. if we are writing less risky business over the next three years then why is our capital requirement not reducing?)
- What are the key assumptions underlying the capital projections; do they make sense and how realistic are they?
Economic capital should also be considered in the ORSA (remember it is your OWN assessment of risk and solvency).
Standard formula appropriateness
It is very easy for a category 5 insurer to think “it is not proportionate for us to use anything else but the standard formula”.
Whilst this is likely to be true, it does not demonstrate that you have thought about this from a risk point of view. For example, if standard formula under-estimates your underwriting risk significantly then is it really suitable to use? This would not necessarily mean that you would need to use an internal model or even a partial internal model since there are other options.
The ORSA should demonstrate an evaluation of this.
"It is very easy for a category 5 insurer to think “it is not proportionate for us to use anything else but the standard formula”. "
Some category 5 insurers may believe that they are exposed to minimal risk. If this is the case then the ORSA should justify this. One approach could be for an insurer to identify its riskiest lines of business and then consider in detail the risks it faces from writing this business. This should include consideration of both current risks and potential future/emerging risks. Assigning probabilities to demonstrate the likelihood of a risk materialising can help put things in context for the reader.
However, the ORSA should go further than just listing risks which a firm faces. For example, consideration should be given to the management actions which could be used to mitigate certain risks.
Stress and scenario testing
The distinction between stress tests and scenario testing should be kept. Stress tests should show how movements in one factor could adversely affect the firm. Likewise, scenario tests should demonstrate how the firm is impacted when a number of factors change (or don’t change) together.
With the reverse stress test, it would be quite easy to think “our firm fails when we exhaust all our capital”. However, in reality if this did happen then it would indicate a potential governance issue; it is not unreasonable to expect management to take mitigating actions well in advance of all capital being exhausted.
Board ownership and embedding
The ORSA should be treated as a live document which is regularly referred to and updated as necessary. By treating the ORSA in this way, a board can refer to it when making decisions or explaining why a certain decision is being made which goes against the risk appetite for example.
The ORSA can also be a useful auditing tool; reference to it in board minutes can help to demonstrate both board ownership and embedding of the ORSA within the firm.
Many insurers may think that producing a thick document constitutes a good ORSA. However, in reality a concisely written ORSA which is proportional to the nature, scale and risks of an insurer will prove more useful in the long run (and that’s not just to the PRA!).
The ORSA should not be thought of as a regulatory requirement; rather it should be thought of as a document with multiple uses which should be useful to most if not all areas of the business.