In Solvency II, supervisors will not just be asking insurance companies operating in the European Union to submit new figures for the SCR (Solvency Capital Requirement). Instead, regulators are likely to pose probing questions that allow for the interrogation of report data. For instance, supervisors will be keen on knowing whether the SCR was based on unbiased risk estimates.

Another key concern will be on the reliability of the data. They will also probably want to know which department within the insurance firm has oversight or control of the actuarial model used. How independent and objective is the risk management process? What documents support the processes, models and assertions used to generate regulatory reports?

SCR calculation will compel bigger insurers to take up an internal risk model. The standardised approach is inherently conservative and will give firms that use it, an edge over the competition. In addition, insurance firms that adopt internal risk models first will reap the most benefit from a better capacity to harness risk-sensitive pricing and optimal price-volume balance.

What insurance companies can learn from banks and Basel II/III

But insurance companies would do well to study the lessons many banks painfully learnt in the process of complying with their Solvency-equivalent regulation – Basel II and Basel III. The first was an underestimation of the time required to comply. The problem with regional frameworks such as Basel II, Basel III and Solvency II is the staggered implementation timetable that often spans several years.

Underestimation of Timelines

For instance, Basel III requires that banks comply by latest 2019. Basel II too had a similarly long timetable. While the objective of such a long timeline is to give affected institutions enough time to put up the requisite infrastructure, processes and controls necessary to align with the new rules, many banks get sidetracked leaving compliance questions to the last minute. By doing that, not only do they risk regulator censure but they are also likely to spend more on implementation as well as be at higher risk of making serious errors.

Scarcity of Skilled Personnel

A second consideration is the availability of skilled personnel. The general principles around which frameworks such as Basel and Solvency II are built on is not too difficult to understand. However, the detailed requirements and how their map onto the unique dynamics of each insurance firm is something that only a trained and experienced expert can decipher. Given the high stakes compliance with regulation such as Solvency II comes with, few insurance companies would be willing to risk entrusting such a complex implementation to untested hands.

In fact, the project teams that will be tasked with seeing through Solvency II compliance are going to draw from several specialist skill sets with the most important competencies being actuarial modelling, risk management, project management and data warehouse management. A number of bankers that were involved in Basel II implementation also intimated that if they had to do the implementation all over again, they would seek out individuals that Some skills will be available in house while others will have to be sourced externally e.g. via consultants.

Just getting the right skills would be challenging enough. Matters are however further compounded by the fact that virtually all insurance companies will be racing toward Solvency II compliance at the same time. The result of the high demand for such a small niche of expert skills is a chronic shortage, expensive hiring/consultancy costs and, ultimately, delays in implementation.

Breakdown of Costs

A third valuable lesson from Basel II comes from analysing the breakdown of the various costs of implementation. On average, banks spent between 10 and 20 per cent of the Basel II budget on changing front and back office processes. Another 10 to 15 per cent went to reorganising the risk governance functions. The bulk of implementation funds – 60 to 85 per cent - were channelled toward data integration, data models and the data warehouse. This cost breakdown, including the dominance of data-related issues in the implementation budget, is unlikely to be any different for insurance companies as they embark on Solvency II compliance.

For instance, the calculation of SCR is based on the market value of the firm’s liabilities and will require a different set of data from that used in computing statutory reserves. Such data will be drawn from several sources which will pose a challenge to the high level of data integrity the new framework requires. The insurance company’s internal model must take into consideration outlier factors and be sensitive to unusual events.

Developing data models in house versus outsourcing

Best practice in data warehouse management, data governance and business intelligence must be applied to Solvency II implementation projects. In particular, the use of a comprehensive, institution-wide data model that reflects current product types and business processes, is a crucial factor in successful compliance. Such data models can be built in house. However, the specialist skills required, the time taken to perfect the models and the competing responsibilities for staff seconded to the project, do not favour an in house approach.

Instead, it makes more business sense to tap into an expert third party whose experience makes them a treasure trove of industry efforts. In other words, a third party consultant that has worked on similar projects (e.g. Solvency II or Basel II/III) with other financial institutions, will bring with them not just a working model but also their experiences on what works and what does not. Compliance is likely to be achieved much faster as the insurer will not have to reinvent the wheel.

Whereas no two insurance companies are identical, there are numerous aspects that are common across the industry which means there is at least a rudimentary data model that can capture these commonalities. The insurer can then work with the consultant to incorporate or amend elements that are specific to their organization.

Author's Bio: 

Graz Sweden AB provides financial services players with the most cost-effective way to access, manage, and analyze their data. Using the flexible data management platform HINC, Graz’s data warehouse infrastructure helps manage tens of thousands of investment portfolios for several institutions including 9 insurance companies, 120 banks and the largest fund manager in Scandinavia. For more information, visit