Assignment Writing Help on Market Discipline in Insurance and Reinsurance

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Solvency refers to the potential of a company or organization to meet its long-term fiscal obligations. It is important for companies to consider Solvency so as to stay in business. However, companies also require liquidity, which is the ability of meeting shot-term obligations for successful operations. Solvency II Directive refers to a European Union decree that seeks to codify and synchronize the Insurance regulations in the European Union Economy. This universal standard focuses on the realistic models for insurance companies’ management of all their risks. Insurance companies take part in diverse activities, not only operational, service-driven activities, but also other strategic level activities. The purpose of this paper is to establish the frameworks around Solvency II and its influence on the Insurance Companies among the European Union member countries.

Brief description of the contents of the Solvency II including factors such as its 3 Pillars risk based approach coupled with the fact that it will include enhanced risk management rules and capital requirements.

The most prominent strategic activities incorporated within the insurance company operations include evaluation of the external environment through conducting PESTLE Analysis, determination of Missions, Objectives and the Visions for the Insurance companies, and implementation of strategic plans and fiscal budgets to ensure that objectives are achieved. Organization of the company structures thus ensures consistency with the stipulated objectives and conducting continuous risk assessment and controls in every sector of the implementation plans. The Solvency II standard provides for real opportunities for the companies to improve on their risk management strategies in order to adjust their performance and operational efficiency, and thus enhance effective service and appreciation for the insurance industry and generate benefits for the entire EU Economy. Through the maximum synchronization of the Insurance companies, this directive will achieve its main objectives, which are to contribute towards the European Union Financial Action Plan by encouraging more understanding of the single insurance services that recommends all European Insurers operate with a single license throughout the member states (Scott, 35).

The framework comprises three main areas technically referred the Three Risk Pillars which stipulates guideline for the maximum amount of capital an insurer should be entitled to, requirements for the governance and risk management strategies within insurance companies, effective supervision of the insurers as well as declarations and transparency of the companies. The directive also initiates the Risk-Based Approach among member States, which enables a comprehensive coverage of actual risks within the operations of specific insurers. This approach takes into account both asset and liability oriented risks within the companies and establishes models for managing these risks (Scott, 35).

Under Pillar 1, quantifiable standards are mainly considered. These are mainly used to demonstrate adequate financial resources within the insurance companies. The valued requirements are established with the aim of ensuring that firms are sufficiently capitalised with risk oriented capitals. In this case, the solvency II embraces financial statements centred approach. Solvency Capital Requirement (SCR) as well as Minimum Capital Requirements (MCR) comprises the two major aspects of capitals constituting various degrees of supervisory intercession.  All the assessments in this pillar are to be done in a discreet and market dependable manner. Insurers may use either interior model approaches or the standard expression plans of attack. Through the use of the internal model, an insurer will be subjected to tighten standards and anterior supervisory to make it possible for the insurer to calculate its regulatory capital requirements. The SCR will cover all the quantifiable risks an insurer or reinsurer faces, risk mitigation techniques are also relevant factors in relation to SCR calculations thus making the MCR calculation a low requirement. If a violation of the MCR calculation is done then this will prompt an intervention of the ultimate withdrawal of authorisation (Pindyck & Rubinfeld, 169).

Pillar II enforces extreme rationales of risk management and governance in firms. It provides for supervisory powers challenging the corporations on risk management matters. It enhances own risk solvency in which these companies are required to conduct prospective self assessment of its risks, capital requirements that accompany these risks and adequacy of capital resources within the firms. In this pillar, organizations demonstrate effective governance systems. According to this framework, qualitative requirements are considered based on fundamental strategic issues including; overall responsibility of leadership on risk management, clearly defined risk management strategy in line with the business approaches and continuous management and control of the company risk bearing capacity (Pindyck & Rubinfeld, 170).

Pillar III incorporates the public disclosure and regulatory reporting requirements. It points towards achieving more outstanding degrees of transparencies to the companies’ executives as well as to the entire society. It focuses on declarations demands to ascertain that transparency of the authorities and that the business supervisors posses relevant information about adherence to the Solvency II Directive. From a practical perspective, the scope of tasks beneath the Pillar III unification encompasses activities surrounding definition and updates on company disclosure policies as well as technical demands, and the completion of certifications of Solvency II procedures and the implemented reporting cycle run (Scott, 39).

The governance requirements for insurers implies that firms should develop structures and functions each comprising specialized responsibilities and expertise to deal with the risk management issues at different levels. Solvency II is not meant o prevent the insurers’ own decisions on company administrative approaches (Cummins, James et al., 422) but to Harmonize the companies and regulation on investments among other insurer behaviours. In respect, most decisions will require collective contribution of various insurers, to mean that, no insurer is entitled to implementation of a sole decision. Certain drastic changes in operations such as reallocation of various investment rights and resources will majorly impact on the risk management decisions within these companies (Pindyck & Rubinfeld, 167).

Strategic decisions have the characteristic of looking into long term prospective, company level perspectives within which the company decisions are made as part of achieving the company mission and outward analysis of the external business environment to establish potential risks, competitive advantage and best practices in the company management. These decisions should always have supportive grounds for the organizations. Insurance companies should establish diverse strategic decisions coupled with diverse strategic initiatives to support these decisions. These decisions nonetheless could at times be flawed besides risk factors. Some of the potential risks include selection of incompatible initiatives, which could be inconsistent with the existing market situations, failure in the implementation of management strategies efficiently, loss of track in the selected management initiative with progressive time commonly referred to as the strategic drift, selection of strategies that would fail to deliver the required profits due to their excessive high-risk or low-risk nature and adverse reactions of the staff or other stakeholders concerning the selected strategy causing an imbalance on the decision making process (Barth 245). Ideally, through the Solvency II key industrial deductions straddling from product pricing and design to the investment strategies as well as marketplace communications are experienced. It indeed has potential of allowing for competitive advantage to the European Union Insurers by modifying models of penetration into each other’s areas as well as provision of inducements for ameliorated risk evaluation and management. Solvency II requires that the Insurance companies attain greater understanding of their projected and potential risks and develop models to update their capital to back up the risk features. In essence, solvency helps insurers to distinguish what products, features are relevant for Solvency positions, and which ones are not (Eling & Holzmüller, 45).

Introduction of capital requirements for investment risks will enhance companies’ concentration on less risk investments such as shares in equity and property within their investment portfolio and increase their share of higher rated fixed income securities to reduce capital requirements. Within the Solvency II framework, the entire risk alleviation tools, consisting of reinsurance, hedging, and securitizations, are treated in constant forms. For these to be accepted as risk mitigation instruments, Solvency II demands that insurers measure their literal share to the risk reduction approaches (Eling & Holzmüller, 45). Proficient stipulations are the largest points on the insurers’ balance sheets. Under Solvency II, the reserving risk, that is, the kind of risk that is above the ability of the Proficient provisions require sufficient capital charge backup (Klein, 397).

Solvency II Directive appears to be a realistic and smart approach of integrating risk management approaches among corporations hence possibly improves the performance of these companies.

Explore how this may influence the way strategic and risk decisions are being made within the company.

The Solvency II demand of a risk framework throughout the enterprise as well as the allied focus on product plans and risk management schemes also have the potentiality of influencing the market structures of these insurance companies. Within the setup, extensive formal strategies of to administration, arrangement, and decision-making processes that demands insurers to show that they have embedded the risk management approaches into every details of the companies are very crucial.

This idea also requires more complex and broad analyses, together with more systemic approaches to risk management; this is likely to enhance demand on statistical and risk management procedures. The insurance companies will also be compelled to take into account realistic models of coordinating the statistics, finance, risk management as well as the entire business strategies in detail. In particular, the data and the processing methods incorporated in the in the solvency arithmetic require a reflection of the strategic and management approach being adopted within the business, and vice versa. Sustainability of the market credibility, investor relation departments within these firms will require declarations on the financial and regulatory disclosures to confirm that they are attuned and to explore reasons for those that are not. Ultimately, as part of the “fit and proper” rules, boards will need to understand, endorse, and challenge what could be new and unfamiliar quantitative and qualitative information as part of their responsibilities as managers of the business and policyholders’ interests (Klein, 397).

The solvency II directive may also pose some weaknesses in the case that its implantation on rules and regulations may take time. In prioritization of activities, insurers ought to concentrate on implementing ideas that are geared towards the improvement of their business routine. The development of a risk-based capital framework is the foundation to Solvency II (Cummins, James et al., 422). To establish the structure, insurers require adequately accurate, opportune data from all categories of the enterprise. Therefore, the quality and availability of active enterprise statistics are key to any flourishing Solvency II execution. Most of this risk measurement information will come from the business through policy administration, claims management and asset management systems (Cummins, James et al., 422).

The impacts of Solvency II Directive are quite evident on risk management decisions among various companies. However, it requires complicated approaches and studies before the implementation of the decisions.

Explain the implications of the Directive for risk management practice – the aim of the Directive is to help improve risk management practices in insurers

Risk management structures ought to incorporate Policies and procedures created in order to establish fundamental risk indices in line with the insurers’ anticipated concerns. Implementation of an insurer’s risk management framework starts with a perception of the risks that directly affect its business. Insurers then need to set a strategy to manage these risks. For an insurer, efforts from strategic approaches and reporting systems may be a necessity to get the accurate picture of its risk, describe its risk eagerness and organize its levels of management so as o achieve effective risk management that is compatible with the business structure and feed the risk perspectives into enterprise decisions (Klein, 397).

Data management and data quality constitute part of the most indispensable constituents of regulative solutions. Solvency II takes advanced approaches to risk management, fiscal accounting and collective administration. This approach requires insurance companies to put comprehensive standards, policies and processes in place for the use, development and management of data (Munch & Smallwood, 267). In support of the new processes, legislative calls for statistical information in relation to the risks are entailed on more thorough and more frequent generation. Insurers need to demonstrate the ability to instil the risk awareness and risk sensitivity into all sectors of their key activities. Each company strives towards formulation of effective business decisions on a continuous basis. Nonetheless, a significant number of these firms consume much of its resources on manual collection and creation and cleaning of data, and reports on limited time to explore the data to establish deeper insights, which have potential benefits in the long run. For this reason, holistic, integrated methods of data management are vital o ensure that information flows smoothly throughout the entire organization. This approach would in turn enable the deciding bodies within these firms to garner fundamental insights from the collected data, combine the insights with ideas from other business segments including marketing functions, claims and insurance cover functions (Munch & Smallwood, 267).

The data-driven approaches accumulate substantial benefits for every organization implementing the strategy. The regularity that comes as a result of Solvency II regulations technically results in regularity across the entire information processing activity. It predicts potential of all the firms that accurately apply the regulations at a rough stage. It will furthermore create significant capacity for improved strategic planning, performance management and compensation schemes, which add value to companies on a risk-adjusted foundation. In many cases, it will allow organizations to identify portfolios that are less than optimal in their performance and to focus on building portfolios that are more advantageous to long term sustainability (Munch & Smallwood, 267).

Alignments under the economic financial statements approaches imply greater understanding of the risks at the groundbreaking stages and potential of developing risk-based reporting standards with financial accounts reporting principles. This approach can deliver a competitive advantage and, as a result, maximize potential benefits. By investing in an enterprise risk management and compliance solution, insurance companies can optimize the use of Solvency II resources and turn the compliance burden into a number of strategic opportunities (Klein, 397).

For the insurers, Solvency II regulations could help establish products that are largely recognized due to their strengths of capital position within the market, its transparent presentation of operations and profound risk management initiatives. Tremendous benefits are exhibited from these products portraying improved market share and withholding of the existent customers. Besides, rating agencies promote insurers’ to management of risks as well as capital in ways that enhance quality of income. The AM Best states that an insurer that can demonstrate strong risk management practices integrated with its core operating processes, and can effectively execute its business plan, will maintain favourable ratings in an increasingly dynamic operating environment (Klein, 397).

The Solvency II demands comprise collective and extremely complicated quantitative calculations, risk management and administrative processes, majorly focusing on auditing abilities as well as transparency. The companies are required to implement significant physical alterations which would influence business operations as to how the administration of the business is conducted it also incorporates implementation of other very crucial cultural changes, as a model of ensuring that Solvency II principles form part of everyday operations in the business. To guarantee achievement, insurers normally institute programs to address a good number of varied issues. These challenges are covered in more depth in the following sections (Cummins, James et al., 422).

Within the implementation of risk management initiatives across the entire organization, insurance companies face the substantial challenges concerning data management. While it is well recognized that the integrity of internal data is very much the lifeline of insurance companies, there are significant challenges to aggregating data to create analytical metrics (Cummins, James et al., 422). Nearly one-half (41 percent) of executives questioned in a survey conducted by the EIU in the year 2009 considered improving data quality and data availability to be one of the three major areas of focus in the management of risk within their organization (Scott, 35). They reiterated that insufficient data and integrity among the firms is a hampering factor o implementation of the risk management strategies.  In turn, it is in their opinions that there is demand for acquisition comprehensive infrastructure to improve the complicated nature of the risks and the size of these firms. Actually, the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) have extensively pointed out the significance of the quality of data, which has earned much attention from the European Union Insurance providers as per the committee’s experience. This committee purports that the insurance companies should demonstrate various important attributes concerning the data provided. These attributes form part of the effective models in establishing adequate risk management strategies and they include; 

  • Develop a data dictionary comprising all the relevant sources of the data and other attributes.
  • Institute structures for Quality examination and betterment.
  • Move fast towards the rectification of any identified issues.
  • Develop systems involved in continuous quality assurance (Boyce, & South, 1A).

Over time, various parts of organizations adopt different risk management frameworks and systems. This results in disintegration of the risk-related data, creates difficulty in the consolidation of important information from all sections of the firms as well as accurate visualization of the various types of risks exposures. Complex, elaborate and entwined specialized and original systems, together with the poor information obtaining and citations, have further cut down the certainty in capital calculations. This makes it impossible to reflect the true risk profile of the business, so the organization will end up holding either too much or insufficient capital (Cummins, James et al., 422).

Business administrations, risks and Compliance engages in addressing both data and the entire data processing issues so as to set the pace correcting issues This improves the quality of data greatly by;

  • Using the operational systems, consortiums, other external sources as well as the specialized administrative models to retrieve and verify the authenticity of the data.
  • Creating basic foundations regarding business definitions of each risk factor and their connected data essentials through an all-inclusive Governance, Risk and Compliance (GRC) statistical formation.

On the processing end, this model encourages constant workflow definitions for the firms through utilization of common literary sources of risks and controls, insurance policies and processes, occurrences and other events. By use of common solution based actions, the outcomes of the approaches comprises is an incorporated platforms that regulates and upholds risk inclined data in files with universal definitions, and consolidates information from all risk management systems to deliver an enterprise view of the entire organization’s risk exposures and associated capital requirements.

Risk management is a vital component of the company administration hence requires stringent regulations and policies that keenly monitor and control the possible risks in the business environment. Solvency II could be a model to enhance these risk management strategies.

Analysis against Solvency II Directive

Most insurance companies have grown larger with the growth in time. This has contributed to the manifestation of a number of risk management authorities, divergent models and several modelling schemes and styles. Many companies use multiple modelling systems simultaneously to handle their risk and exposure modelling needs. The outcomes are a combination of unconnected results that in the long run create conflicting risk productivity. In addition, risks are often related to each other; and understanding exactly how these links affect the business is important. Regrettably, majority of the insurers are short of the potential of aggregating models and correlating risk at a firm level (Munch & Smallwood, 267).

Solvency II demands numerous quantities of excessive reporting from insurance corporations generated within very limited periods of time and that these reports must be rigorously checked and documentation conducted very keenly. The insurers require mechanisms of distributing the reports to every sector within the business inclusive of the management and other external stakeholders in a manner that is effective and utterly timely. Business intelligence and reporting applications are essential to provide these reporting capabilities and dashboards for decision makers (Boyce & South, 1A). The reporting tools ought to incorporate guides for the supervisory (Pillar 3) essentials, which include the Solvency and Financial Situation Reports. This should be submitted o the company over lookers. To sum it up, Solvency II largely contributes to reducing returns on Capital owing to the securitization of spreads in the insurance companies (FOPI, 1). There has been notable decline on the securitization spreads as well as Falling spreads on covered bonds. A survey conducted by the Association of Financial Markets in Europe (AFME) in 2012 revealed that current solvency II draft rules would cause them to stop investing in securitizations, others planning to dramatically reduce allocations to the securitization sector as shown in the table below (Boyce, & South, 1A)

Table 1: Fixed Income Asset Allocation of Listed Insurers (%)

 200720092011
Corporates24.127.633.1
Securitization7.16.16.0
Covered Bonds4.06.310.0
Sovereigns24.232.042.0

Source: AFME, Bank of America Merrill Lynch

Solvency II focuses on the review of managerial techniques and evaluation of systemic risks of the Solvency system. Within the system, risk based capital regulation is required to comply with the dynamic business environment. The prevailing attention on Solvency II discloses that there is enhanced concentration on the effects of capital policies as well as their connections to the monetary and insurance cycles. Solvency II seems appropriate for further analysis with special attention on the essentials of pillar II due to critical assessments in relationship with the absolute risk capital standards. To be significant is whether findings in pillar II are associated to systemic risks. Macro pr micro oriented perspectives of risk management are determined dependent on the probable remedial measures of the administrative authorities and the associated issues within the insurance corporations. It in turn institutes the most appealing dilemma in terms of Solvency II. Essentially these regulatory interventions are geared towards correction prospective risks in the insurance cycles as well as within the entire market, thus enhance protection of policy holders.

Supervisory authorities should, when considering whether certain own funds of a related undertaking cannot effectively be made available for the group, base their decisions on whether there are any restrictions that affect either the exchangeability of the corresponding own fund items (i.e. whether they are dedicated to absorb only certain losses) or their transferability (i.e. whether there are significant obstacles to moving own fund items from one entity to another). For the purposes of this assessment, supervisory authorities should pay particular attention to any minority interest in the eligible own funds covering the Solvency Capital Requirement of a subsidiary insurance or reinsurance undertaking, third country insurance or reinsurance undertaking, insurance holding company or mixed financial holding company.

In order to ensure that the policyholders and beneficiaries of insurance and reinsurance undertakings belonging to a group are adequately protected in the case of the winding-up of any undertakings included in the scope of group supervision, own fund items that are issued by insurance holding companies and mixed financial holding companies in the group should not be considered to be free from encumbrances unless the claims relating to those own-fund items rank after the claims of all policyholders and beneficiaries of the insurance or reinsurance undertakings belonging to the group. Solvency is largely appreciated among corporations within the European Union member States but to a much larger extent, it is considered quite challenging. The view of these companies over the Solvency II directive has issued numerous challenges in the decisions and the implementation of the directive across the European Union. However, it has become an important phenomenon in the neighbouring States such as the United States, which considers the solvency idea as extremely prudent and worth taking into consideration.

Conclusion

Generally, European Union Solvency II Directive is a model that enhances performance and risk management procedures in insurance companies among the member States of the European Union. It is implemented in three key pillars namely Pillar 1, Pillar II and Pillar III, which enlightens the framework operations at every level of the Solvency II implementation process. Among its Pillars in the implementation of Solvency II framework, Pillar II provides the view of the basic causes for insolvencies of the insurance companies being poor management. Particularly, anticipation of systemic risks and management assessments are considered as part of the extended risk based capital standards due to the concerns in relation to Solvency II. Management issues in relation to insurers’ insolvencies are related to unrealistic management expectations, herding behaviour, issues in relation to insurance groups and excessive risk taking based on studies of near misses and actual failures. Management expectations can be a product of gambling on future economic developments influencing the investment policies of the insurers.

References

Book

Pindyck, R.S. & Rubinfeld, D.L. (2005). Microeconomics, 6th edn, Pearson, New Jersey

Edited Book

Scott, Harrington. “Market Discipline in Insurance and Reinsurance” in Market Discipline across Countries and Industries, ed. C. Borio, MIT Press.

Journals

Barth, James et al. “Bank regulation and supervision: what works best?’”Journal of Financial Intermediation, 2004: 13(2), 205–248.

Cummins, James et al. “Regulatory Solvency Prediction in Property-Liability Insurance: Risk-Based Capital, Audit Ratios, and Cash Flow Simulation”. Journal of Risk and Insurance, 1999: 66(3): 417–458. Print.

Eling, Martin. & Holzmüller, Ines. “An Overview and Comparison of Risk-Based Capital Standards”. Journal of Insurance Regulation, 2008: 26(4), 31 -60.

Klein, Roger. “Insurance Regulation in Transition”, Journal of Risk & Insurance, 1995: 62(3), 363-404.

Munch, Patricia. & Smallwood, Dennis. “Solvency regulation in the property-liability insurance industry: empirical evidence”, Bell Journal of Economics, 1980: 11(1), 261-279.

Internet Sources

Boyce, Mark, S. & South, Andrew, H. “Solvency Could Push European Insurers Away From Securitization”, 2012. Web.http://www.biztositasiszemle.hu/files/201212/solvency_copy_wga.pdf

FOPI, Audit Concepts, Technical documents on audit concepts in relation to SST Internal Models edn, Swiss Federal Office of Private Insurance, 2008. Web. http://193.231.20.119/doctorat/teza/fisier/203.