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March 2012

 

Research and recommendations on NED engagement with Solvency II

 

A survey of NEDs run by Telos Solutions and ILAG confirms that NEDs are less than confident about their ability to get on top of Solvency II, which so far, looks riddled with complex technicalities.  Now is the time for boards to take control: they need to start managing ‘top-down’ instead of getting submerged by technical outputs that have been developed ‘bottom-up’.  The development of a brief board manifesto for Solvency II enables rapid and proportionate creation of the ORSA, and a switch to the strategic management of risk.

 

Summary

Firms need to call a pause for breath in the headlong technical rush that has been Solvency II so far.  Boards can create a short Solvency II manifesto in order to establish top-down, rapid, and proportionate control of the development of their ORSA (‘Own Risk and Solvency Assessment’).  This article explains the background to this recommendation.

 

NEDS Survey

Most development work on Solvency II so far has focussed on the technical aspects of risk framework, risk appetite and modelling - usually as a project within the finance function, with major input from the actuaries.  This is all fine for Pillars 1 and 3, but Pillar 2 of Solvency II require a shift to board control and overall risk strategy rather than detailed numbers.

We’re a consulting firm but, although we do cover technical content, our main interest is in overall effectiveness.  Our experience of Solvency II was that it was so technical that it didn’t seem to be working for boards, and NEDS in particular.  This was confirmed by a straw poll that Graham Berville conducted with some of his fellow NEDS, which suggested that they were concerned about being forced to absorb a lot of technical material.

We believed we could help firms with the gap that had opened up, but decided to validate our intuitions by running a survey with NEDs first.  We teamed up with ILAG for the exercise, and by early October 26 NEDs representing 32 different companies had completed our on-line survey.

We sent a full report to all participants and shared our findings with FSA, who also sent a speaker to our ILAG workshop on the subject in February this year.

 

The purpose of the research was to establish:

  • The extent to which the apparent gap described above exists across the whole industry
  • If the gap does exist, what are its key characteristics?
  • What lessons can be drawn in terms of how the risk framework and Solvency II can be engineered most effectively at board level?
  • What are the major concerns of directors – where do they feel most exposed?
  • What are the time parameters of dealing with the above issues?

 

Findings

Rather than go through all the findings I’ll concentrate on the ones that we thought were most significant, and that point to actions that need to be taken now.

Throughout the survey, respondents tended to respond robustly to yes/no questions, but the more open-ended follow-ups display far less certainty and lower confidence.  We suspect the main reason for this is the cultural tendency to respond automatically to a “how are you doing?” question with “fine!” or “great!”.  Given the volume of authoritative information on the issue, they probably feel that they “should” be positive too.

The first question we asked was: “If asked, are you confident that you could describe the purpose of Solvency II accurately? 25 out of the 26 responded “yes”, but when we asked for a brief description of it we received 26 completely different answers, all of which contained one or more of the words” “risk”, “capital”, “solvency”, ”reporting” “governance” and “Europe”.

As we said in our report, these answers reminded us of three blind men who were placed in front of an elephant and asked to describe what it was.  One described a leg, another the tail, and the third its trunk – all of the answers were accurate to a degree but none described the elephant itself.

 We asked about the areas in the business that will be most affected.  Not surprisingly, the actuarial, risk and board functions topped the list.  HR and IT were at the bottom alongside Marketing.  But looking forward, HR will have a major role because of the requirement for more explicit governance requirements, as will IT because of the need to provide a visible audit trail of what has been done to manage risk (standard document management systems are not designed to do this).

Almost everyone thought that the amount of time they would have to spend on their duties would increase because of Solvency II, by an average of about 6 hours per month.

We asked when NEDs thought that firms should be preparing them to cope with Solvency II, and the resounding answer is “now”.

Although most of the ‘closed’ questions yielded positive answers, only 7 were positive that their personal needs had been completely taken into account.  14 answered “somewhat”, and 5 “hardly at all”.

The number of days per year, required from financial services companies is already greater than for other companies, and this will serve to widen the gap.

When combined with the previous question about timing, this is a clear indication that firms need to be taking action now in helping their NEDs engage properly with Solvency II.

We don’t have enough space here to go into the full breadth of responses generated in response to the more open-ended questions.  However there were two broad themes that ran through most of the responses:

  1. When asked about what they needed in future, some variant of “feeling confident” was the most common sentiment amongst the responses. This clearly suggests that NEDs are not confident today.
  2. NEDs struggle to understand how Solvency II is supposed to work in practical management and board governance terms, particularly in relation to the acronym-ridden technical explanations that they have seen so far.

 

Recommendations

Our main recommendation is that firms urgently need to switch to a ‘top-down’ approach to managing Solvency II so that boards can start engaging with the subject in the manner intended.  The key activity is the development of the ORSA, which FSA agrees is the “beating heart” of Solvency II – and developing the ORSA is a fundamentally top-down process.  This is reinforced by EIOPA (the European implementation body) who have said:

“ORSA is a risk management process owned by the board which changes the viewing angle from bottom-up to top-down and connects business strategy and capital planning.”

But there is a danger here: if you rush developing your ORSA on the back of the existing technical minefield and lack of genuine ownership at board level, it could rapidly turn into another long, painful, and costly process.  What is needed is a short pause for breath so that the board can establish its own credentials relating to Solvency II.  It needs to be clear about what Solvency II means for this firm in terms of proportionality, how the board will integrate it into its own governance processes, and who amongst the executive team will be doing what, in order to support the board.

A Solvency II ‘manifesto’ like this needn’t take long to develop and need only be a couple of pages in length. Taking the time to establish this solid foundation will pay huge dividends in terms of rapid development of the ORSA and, most importantly, give individual NEDs and the board the confidence that they have control.

 

Brian Wood is Chief Executive of Telos Solutions

www.telossolutions.co.uk

 

 


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