Nearing the Finish Line

• Lori Chordas
• September 2012
• 

As the deadline inches closer to the highly anticipated Solvency II implementation date, carriers are turning their focus to data and IT.

That's because implementing systems and building models are a big part of gearing up for the new regulation that, as the Financial Services Authority describes, is a ''fundamental review of the capital adequacy regime of the European insurance industry.''

While many carriers have been preparing for those changes and readying their systems over the past several years, many others still haven't made decisions about technology or addressed elements of the new regulation framework, noted Nicolas Michellod, a senior analyst in Celent's insurance business.

Carriers, Michellod said in Celent's Solvency II IT Vendor Spectrum: 2012 Edition report, need to figure out what systems are missing within their existing IT landscape and identify how to fill the gaps.

However, many have ''underevaluated the massive work and investment needed,'' he said. That's opening the floodgates for vendors to step in and help. Chartis Research expects the Solvency II technology market will grow to $1.67 billion in 2013, up 8% from this year.

How are carriers gearing up for the looming deadline?

Most are now getting their ''respective reporting ready for submission during mid-2013 to ensure a smooth reporting cycle in 2014,'' said S. Ramakrishnan, group vice president and general manager at Oracle Financial Services Analytical Applications.

''While the regulatory pressure is there, most carriers want this to be the last delay,'' because delays bring added costs, he said. ''Further, business would like to see improvement in the risk management practices within the organization, and this requires a complete overhaul of the technology landscape in addition to the ultimate Own Risk and Solvency Assessment submission.''

Gearing Up

About five years ago, carriers began assembling task forces to understand whether their capital levels were sufficient within the new regulation, Michellod said.

''The big challenge in that, however, was being sure they could meet the regulatory requirements, especially around various risks that need to be included to satisfy calculation of the minimal capital and solvency capital requirements,'' he said.

Insurers also are tasked with demonstrating that they have an efficient risk management framework in place to monitor risk levels and ensure decisions to mitigate risk are well thought out, Michellod added. ''That means they need to apply specific processes and demonstrate that they have tools in place to run different scenarios and simulations.''

But carriers are falling behind, he said, ''and they need to get back to work to ensure that this overall enterprise risk management framework is in place and works well.''

Insurers now are focusing on what Michellod calls the ''third pillar.'' Over the past year, carriers have concentrated on reporting and implementing different tools based on qualitative reporting templates. ''However, regulators still need to clarify how often those reports should be done and what kinds of modifications need to be provided.''

He said it's important that vendors collaborate with regulators to understand ''how to adapt products for carriers so they meet the reporting requirements.''

Because many carriers have underestimated the investment needed to gear up for the new European regulatory regime, ''they have to evaluate what they already have in place around reporting and whether they can reuse tools to support reporting requirements,'' Michellod said.

''Some insurers have decided just to invest in new tools,'' he added. ''They thought changing the requirements of existing reporting tools was too much, similar to what banks faced when implementing Basel II,'' the international business standard that requires financial institutions to maintain enough cash reserves to cover risks incurred by operations.

While insurers can follow banks' lead, Michellod said, ''Solvency II is more complex than Basel II. Banking is more focused on the asset side of the balance sheet; insurance also has the liability side, which makes risk management more difficult.''

Rob Schimek, president and CEO of Europe, Middle East and Africa for Chartis, said the Financial Services Authority will only ''approve an internal model for the calculation of the Solvency II capital requirements if it is satisfied with the systems for identifying, measuring, monitoring, managing and reporting risks.''

That means carriers will have to ensure the ongoing appropriateness of the internal model so it continues to meet standards and reflects a firm's risk profile, he said.

''We have this day-one hurdle of getting across the finish line to implement the model,'' Schimek said. ''But we have an ongoing challenge to make sure that it has an appropriate reflection of our risk profile as we move forward. That brings vigorous requirements around ongoing maintenance of systems that have to be put in place.''

On the Journey

Some key technology challenges carriers face pre-Solvency II include lack of reporting and risk monitoring processes and systems; shortage of timely and quality data; the silo nature of existing IT systems that prevents an enterprisewide view of risk and performance; and ''black boxes'' and an inflexible nature of risk systems, Ramakrishnan said.

Added Andreas Schoenherr, head of global finance solutions at Zurich Insurance Group: ''The biggest technology and data challenges we face are triggered by comprehensive reporting requirements to regulators in the quantitative reporting templates. Here regulators are asking for detailed information for single products, investments or geographical splits, which we do not need for steering our business and therefore also do not have available in a common groupwide data warehouse.''

After meeting those requirements, he added, there are various technological challenges, beginning with ''the data availability in the right granularity and quality, as well as timeliness of this data in source systems like policy systems or claims systems.'' Other challenges, Schoenherr said, include developing a common, accepted definition of that data across systems; making transformation and submission processes auditable and reliable; establishing a single point of trust for the data; and transforming reporting and data to regulators into eXtensible Business Reporting Language.

Chartis' journey to Solvency II includes about 30 different data work streams covering 25 countries, Schimek said. ''And we're ensuring we put the correct quality of data into the model initially and build a sustainable, repeatable process for that data after we cross the day-one implementation.''

For Zurich, initial preparations began with reusing as much in-house technology and data as possible, Schoenherr said. ''That's already proven effective and efficient in the Swiss Solvency Test Production for Pillar One.''

Zurich also has developed an extensive catalogue that encompasses data required across all three pillars for internal models, the standard formula and various regulatory and internal reporting requirements, he said. Requirements were scored by central and local units and, early on, a gap analysis was built to enable transparency and support the planning of closing the gaps in time, Schoenherr added.

According to Celent's report, it's important that carriers evaluate how they can leverage existing IT infrastructures and tools, and find the right balance between internal IT resources and applications and specific technology offerings from expert system providers.

And, the report adds, component software should be implemented on commodity hardware to leverage extra hardware capabilities like grid computing.

Ongoing Process

''This is a journey, not a destination,'' Schimek noted.

''It is an ongoing process to ensure that we have the right models and that we update the model,'' he said. ''I view this as an evolutionary cycle that will continue to make the model more efficient and effective.

''One of the most important things we are working on today is that we have begun to think outside the model and ensure that we meet the 'use test','' Schimek said.

Under that FSA provision, companies will need to demonstrate that they have a robust model and use it in daily decision-making and operations.

Schoenherr said Zurich's next steps include doing as many ''dry runs'' as possible in various areas, along with end-to-end testing to ensure ''we can iron out remaining issues that only come up when the whole production process is being tested before the real go-live happens.

''At the same time, we're also preparing the organization for 'business as usual' around the new technology in defining relevant change cycles and system and process ownership to prepare ourselves for future regulatory changes and new requirements,'' he said.

Added Ramakrishnan, data quality should be high on carriers' agendas, and ''they should be busy preparing their data for calculations, such as SCR and MCR, and for any regulatory reporting.''

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Overcoming Challenges

The ''single biggest challenge'' insurers face in gearing up for Solvency II is around the data itself, said Rob Schimek, president and CEO of Europe, Middle East and Africa for Chartis.

''Companies are building robust models that will be capable of doing everything the Financial Services Authority expects, like identifying, monitoring and measuring risks,'' he said. ''But the model will only be as good as the data going into it. That data is coming from many parts of an organization, in many different formats and with many different levels of data quality. So we have to get the data ready to go into new robust models that we've built.''

The cost of implementing the new changes also is something carriers can't ignore, said Schimek. ''Those expenses are significant, and the timelines require us to ensure we have no risk of failure to meet the deadlines. That only adds to the cost of implementation.''

However, costs can't cloud carriers' minds about Solvency II, he said. ''In the end, it's intended to make sure they have a healthy, stable and well-capitalized insurance industry.''

David Gill, product manager for SunGard's iWorks Prophet, said uncertainty over the legislation itself also presents some hurdles for carriers. ''It's not yet final, and it's hard to agree on a solution that's acceptable to everyone. There have been numerous delays along the way and will likely be more to come. Companies are starting to speak out against regulators on this issue.''

There's also some uncertainty around internal direction, he said.

''A recent Deloitte survey found 51% of U.K. insurers changed their planning strategy over the last year between the standard formula, partial internal model and full internal model approaches.''

Nicolas Michellod, a senior analyst in Celent's insurance business, foresees a ''transitional implementation'' in which carriers will have some time to demonstrate compliance with the new regulation.

''It's kind of an evolution,'' he said. ''Insurers that have not yet correctly tackled the regulation need to work harder. It's important to hire a consulting firm to understand what solutions mean. For the most part, big players are well prepared, especially in Continental Europe, France, Germany and the U.K. Those insurers have a good view of what they need to do to comply and how to partner with IT vendors who can inform them about any late changes to the regulation and necessary changes to their systems.''

By Lori Chordas, senior associate editor, Best's Review: Lori.Chordas@ambest.com