Evolution of solvency regulation

What You Can Expect From ORSA, A Regulatory
Presentation by Arthur J. Schwartz, FCAS, on October 9,
2013, to Casualty Actuaries of the Mid-Atlantic Region
(CAMAR) at Mercer Community College, West Windsor,
My comments represent my personal opinion only.
My comments do not necessarily reflect the opinion of
anyone at my employer, the North Carolina
Department of Insurance. Also, my comments do not
necessarily reflect the opinion of anyone at the
Casualty Actuarial Society or CAMAR (Casualty
Actuaries of the Mid-Atlantic Region).
Value Added Material
My presentation today contains much VAM, beyond
anything which may be obtained from publicly
available information on the NAIC’s website, which I
obtained from verbal discussions with regulators in
key states as well as NAIC staff, all of whom are closely
involved in the NAIC’s Solvency Modernization
Initiative (SMI)
What is the NAIC’s Solvency
Modernization Initiative (SMI)?
The NAIC seeks to improve solvency
regulation by a) looking inward and
improving current tools b) looking outward
at international developments and c)
identifying potential new tools
Why is SMI happening now?
• The recent financial crisis occurring in roughly the
2007-2009 years spurred the international
Financial Stability Board to recommend to the
International Association of Insurance
Supervisors that they take steps to minimize the
impact of another financial crisis.
• The International Monetary Fund developed a
Financial Sector Assessment Program, which is
also pushing international regulators of banks
and insurers to improve and strengthen
regulatory oversight
Evolution of solvency regulation
• Out with the old tools
• In with the new tools
Evolution of solvency regulation
“Ring out the old, ring in the new, Ring, happy bells, across the snow:
The year is going, let him go; Ring out the false, ring in the true.” Alfred,
Lord Tennyson
Evolving regulation of solvency tools
• Older tools are static, publicly
available, backward looking
(historical data), and easy for
regulators to monitor (such as
FAST ratios with fixed maximums
and minimums which almost
never change as economic
conditions change) and reserve
reviews (which originally required
a single number) and Risk Based
Capital (RBC is a cookbook
calculation of a single number
and requires regulatory
intervention if capital falls too
low, but that is almost always too
late to save the company)
• Newer tools require stochastic or
deterministic testing of
hypothetical future scenarios,
quantitative and qualitative
assessment of future risks,
confidential information, and
require significant actuarial
involvement by regulatory
actuaries (reserve reviews with
ranges; risk focused exams, and
Key change in the SMI
• All insurers are starting to notice that NAIC
financial examinations are sifting from a
review of historical data, which had limited
usefulness for regulators and the managers of
regulated insurers, to a risk focused approach
Which insurers have to create an
• A key part of the SMI is ORSA which stands for
Own Risk and Solvency Assessment. ORSA
Summary Reports are required from certain
insurers to regulators beginning January 1,
2015. Insurers required to create an ORSA are
those with a minimum of $500 million in
annual premium per company or $1 billion in
annual premium per group.
Which companies are required to
submit an ORSA Summary Report?
Although arbitrary, these minimums were intended to capture the larger
insurers which could possibly cause a systemic financial crisis.
These minimums are considered unlikely to change in the foreseeable future.
Smaller companies should be aware of ORSA because the ORSA Model law
authorizes the Commissioner to require ORSA of any company including
financially distressed companies.
In addition, if premium volume grows at ten percent annually for three years,
the ORSA requirement will be triggered at current premium of $376 million
(company) or $752 million (group), respectively.
Number of Companies or Groups affected by ORSA
District of Columbia
New York
New Jersey
North Carolina
All states
Meeting company Meeting group
threshold of $500 threshold of $1
Million in annual Billion in annual
Note> one group in the Delaware total of 11 is equally shared with Pennsylvania
A key part of the SMI is ORSA which
ORSA stands for Own Risk and
Solvency Assessment.
ORSA Summary Reports are required from
certain insurers to regulators beginning January
1, 2015.
ORSA is an Enterprise Risk
Management process “on wheels”
Rather than a mathematical exercise in
capital modeling, regulators are going to
want to see that a culture of risk awareness
flows through every employee and that
everyone’s compensation is tied into risk.
In addition instead of merely performing
ORSA internally, insurers are going to be
responsible for explaining and defending
ORSA to regulators.
What’s different than ERM or capital
Companies or groups subject to ORSA can
expect a very significant amount of scrutiny and
discussion with regulators including regulatory
actuaries (some of whom may be employed by
the DOI, while others may be consultants)
What’s different between ORSA and
financial examinations?
• ORSA will be required in addition to financial
• ORSA Summary Report will be required
annually but a financial examination is
expected to be required only once every five
Who pays for ORSA examinations?
• The cost of the regulatory review of ORSA will
be handled by states on the same basis as the
cost of financial examinations.
NAIC’s ORSA Guidance Manual (most
recently as of March 2013)
Each ORSA report has three sections:
Section 1 Describing risk
Section; 2 Insurer’s Assessment of Risk;
Section 3 Assessment of risk capital and
prospective solvency.
• Regulators are looking for a company to
identify the risks its subject to, which may be
both qualitative and quantitative risks.
Section 2
• Quantifying or handling the risk. Can risk
metrics be established? Can the risk be
mitigated? Capital is allocated based on some
metric. The results of stress tests are
Section 3
• Economic capital is discussed with a 1 in 100 year to 1
in 250 year perspective. “Best practices” include
comparing Economic capital; Rating Agency’s capital
(such as Standard & Poor’s); AM Best’s BCAR; current
capital; and RBC capital. Economic capital is often
calculated based on expected cash flows. One surprise
to regulators has been the credit that insurers take for
writing diverse lines of business; this credit is often as
large as 40% to 50% of capital. Some regulators take
the view that no credit is due for diversification
because of a potential financial crisis situation.
Differences between Solvency II’s
• the European version is
very prescriptive of the
types of risks that must
be considered and
measured and the tests
• Solvency II applies to
almost all insurers with
European regulators
believing even small
insurers can hire a
• The NAIC path is very
flexible and contains
verbal guidelines rather
than quantitative
• NAIC mostly applies only
too larger insurers
because of the cost and
time which smaller
insurers would require
Drawbacks to ORSA
• Most insurers already have an ERM or capital
modeling plan in place. It is not common to
open this plan to review by regulators from
whom key data or information could leak to
competitors or the public.
• The increased cost to industry, and to top
management, who will be required to meet
with regulators to discuss their involvement in
the ORSA
Benefits of ORSA to Industry
1) the company’s plans may improve through
having an outside entity, independent of rating
agencies, (regulators) review them
2) there will definitely be a need for increased
employment of actuaries and quantitative risk
analysts by companies & groups, as well as more
examiners and actuaries by DOI’s
Benefits of ORSA to Industry
3) There will be a need for actuarial consulting
forms to create software packages which can
handle the quantitative aspects of ORSA
4) through stress testing and examining
correlations between lines or products,
companies can identify weak areas and make
contingency plans --- before they happen
Benefits of ORSA to Regulators
1) through scenario testing and risk focused
exams we can see where the company is going
rather than a rear-view perspective (which is
probably outdated by the time it is completed)
2) the ORSA Summary Report presented to
regulators is exactly the same as what they are
presenting to their own Board of Directors
How long will it take regulators to
review ORSA with a company?
Currently, it’s estimated to take about one week
and will involve interviews with Board of
Directors, C level executives, and possibly other
In the ORSA’s submitted to the NAIC so
far what factors distinguish the strong
ORSA’s from the weak ORSA’s?
• 1) Strong ORSA Reports show that a culture of
risk awareness has been fostered in the
employees at all levels
• 2) Strong ORSA reports list qualitative issues
and discuss how the managers would deal
with them; for example suppose an
immediate capital deficiency occurred
Strong ORSA’s (continued)
• 3) Strong ORSA reports show a feedback loop
between different divisions in the company.
For example if Marketing identifies an
underserved market or Claims discovers an
unusually large number of claims with a
certain type of injury or Underwriting
identifies certain customers posing a higher or
lower degree of risk, that info gets passed to
pricing and reserving actuaries who can issue
guidance back to the other divisions.
Further Reading
• NAIC’s “ORSA Guidance Manual As of March
• NAIC’s “ORSA Model Law”
• NAIC’s “2012 Own Risk and Solvency
Assessment Feedback Pilot Project”
If you have further questions or cannot locate a
“Further Reading”
Arthur J Schwartz, Associate Property and Casualty Actuary, North
Carolina Department of Insurance, 919-807-6646
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