Opinion piece by Faisal Khan, 3i Infotech
The investment management industry is witnessing an increased focus on systems and processes to mitigate risk for the investor. The investment climate is such that technology vendors are being asked by their asset management clients to contribute to end business in order to reassure investors, in the form of case studies or participation in RFPs processes. Meanwhile, regulatory changes at both national and international levels are on the increase. The burden for investment managers in terms of proving their technological - and specifically data management – efficiency in the regime of flat IT budgets while at the same time maintaining an optimum ROI has never been greater. But what of insurers? Have insurers begun to plan for testing the immense system changes that will soon be upon them, as a result of Solvency II?
Regulatory demands are placing more pressure on middle office and back office analytics, business and regulatory compliance and operations teams. In many cases this increased workload has not been met with increased investment and resources. Instead, these tasks have to be absorbed by the existing staff. This highlights the need for collaboration – from resource, system and data perspectives.
The impact of increased regulation and Solvency II
Insurers have no option but to change due to regulatory pressure. Solvency II is a good example of this and it is the most challenging and far-reaching regulation that insurance firms currently need to deal with. Solvency requirements involve more complex calculations of factor-based formulas, stress testing and financial models. They must also make significant changes to existing financial systems, change their balance sheet for reporting to a fair-value basis for Solvency II, and prepare for greater public disclosure of financial statements, risk measures and capital calculations.
It is widely acknowledged that data acquisition, accuracy, consistency and manipulation present considerable challenges. Deloitte’s “Solvency II Survey 2010” cited data infrastructure, quality and handling as the highest priority task that asset managers and insurers face. And although the FSA has recently acknowledged for the first time that these new European capital rules for insurers are now likely to come into force in January 2014, a year later than expected, it is nevertheless inevitable.
In the short to medium term, it is the data requirements of Solvency II that will be a heavier burden for insurers. As insurers progress with implementation, it is becoming obvious that many have a significant shortfall to make up in terms of asset data. The calculation of Solvency Capital Requirement (SCR) requires a range of inputs, and actuaries will be looking for detailed, accurate asset data and quantifiable credit and liquidity risk metrics. Full implementation may be over two years away, but data and technology are critical to success and insurers will soon be seeking comfort that they can provide the data they will need as they enter their testing phases in 2012. Consequently, Solvency II will add to the high level of data requirements that insurers already face.
Solvency II and system testing
One outcome of Solvency II is that new data will be generated and also the granularity of data capture and importing will rise. If an insurance company (or asset manager with insurance mandates) adjusts its computer systems, even a small change necessitates a lot of tests to validate the impact. The aim is to minimise the number of defects and errors right upfront in the software development life cycle and to do things right the first time. Once a system goes live (‘post production’), defects reported by end users result in high cost correction measures and dissatisfied customers. Despite this, most organisations minimise the importance of testing for many reasons: firstly, because it may reveal something unexpected, secondly, because it is perceived to be costly and non value add and thirdly, because it is usually very labour intensive. The higher the post-production defects, the more the effect on the bottom line of the organisation.
Testing is therefore an integral part of compliance to Solvency II requirements. Most insurers are now realizing the need for effective end to end testing within Solvency II. Nevertheless, the tendency is to avoid the issue because testing has traditionally been perceived as expensive – at a time when margins are low and compliance costs are already high. Systems testing must be done, but when margins are low, firms still try to cut corners.
The regression testing of software is just one aspect of the preparations for Solvency II. There is a higher level of testing that involves the whole issue of complying with Solvency II. In other words, do you comply with Solvency II at a regulatory level, not just operationally? Insurers are too focused on capital adequacy and risk management at the moment. They have not yet got to the point of saying: “Okay, this is what we are going to do to comply from the risk management point of view, now we are going to look at the IT functions delivering to these departments so this can happen.” Whilst the focus is on working with the regulators, the implications have not yet reached the IT mainstream.
Testing As A Service (where testing is packaged as a combination of automation expertise and tools, subject matter experts and domain assets in terms of an unit cost and firms don’t have to invest heavily upfront) is a compelling option to the CIOs, CTOs and compliance heads of insurance firms because the investment is relatively low. In the face of shrinking budgets, testing through a low cost, cloud based platform is another appealing solution.
Conclusion
Awareness of Solvency II may be increasing, but this comes at a time when the industry is already focused on UCITS IV and the AIFM (Alternative Investment Fund Manager) Directive. There is also the prospect of further regulatory change in the shape of the RDR (Retail Distribution Review) and FATCA (Foreign Account Tax Compliance Act). Effectively, any additional compliance oriented expenditure represents a missed investment opportunity elsewhere.
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