New reporting timetables, model validation requirements, the application of the matching adjustment (MA) or volatility adjustment (VA), and accounting for credit and longevity risks are among the leading risk and capital modelling issues preoccupying UK life insurers as the 2016 Solvency II deadline draws nearer, a new study has found.
Towers Watson’s annual Risk Calibration Survey shows the time pressures that firms will be under to meet Solvency II reporting timelines and the need to accelerate current processes as a result. Over two-thirds of those surveyed expect to completely re-engineer their end-to-end reporting processes, a majority expect increased investment in automation and supporting technology and nearly half expect to make greater use of advanced capital modelling techniques such as Least-squares Monte Carlo methods .
Progress has been made in validating models but most firms still have further to go. Attention has switched over the last year to broader model validation requirements. These include the degree of usability of the internal model for the business, the need to demonstrate independent and robust challenge, and determining the right level of reporting detail for the Board.
Three quarters of firms said they intend to use a MA (60%) or a VA (15%) when valuing their annuity businesses, but such intent is accompanied by indecision about whether to make use of transitional measures. Tim Wilkins, a senior consultant at Towers Watson, commented: “Trial MA submissions to the PRA have provided an early indication of the level of detail involved. We expect there to be pre-application processes for both VA and MA, and both are likely to be restricted in scope and require careful justification. This creates considerable uncertainty and firms should keep abreast of developments.”
Although the majority of risk factor calibrations are now relatively stable, model developments have continued for both credit and longevity risk. Credit models have had to respond to increasingly diverse asset portfolios and the need to model the MA. Meanwhile, longevity models are being developed to take into account a wide range of different risks, such as model risk and the risk of major medical advances. Paul Bowker, a mortality expert at Towers Watson, noted that whilst many firms have made good progress with the run-off approach for longevity risk, other firms are seeking a one year Value at Risk (VaR) approach and, in some cases, are having difficulty achieving a credible outcome.
“A key challenge under the one year VaR approach is to develop a method that appropriately captures all of the risks that may occur over a one year time horizon,” he said.
Overall, surveyed firms believed they had made satisfactory progress over the last year towards achieving the Solvency II deadline. Most said they are also looking beyond day one readiness and considering capital management in a Solvency II world more widely. Among the range of alternative risk management options being considered, for example, 50% or more of respondents said they were actively investigating material changes to strategic asset allocations, revised hedging strategies and changes to their reinsurance approaches.
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