 By David Gregson, OAC Actuaries and Consultants
Solvency II offers a launch pad for innovation in financial modelling systems. Can existing enterprise-wide models keep up with regulatory requirements anddrive competitive advantage? It is not difficult to imagine when ‘real-time’ Economic Capital calculations could be used to determine long-term strategy and provide daily solvency ‘dashboard data’ to enable risk management visibility across an organisation.
Using the latest enterprise-wide modelling, executives would see at a glance the profitability of proposed product lines, the effectiveness of an organisation’s decision making, and the potential impact of possible scenarios onratings agencies assessments.
The Use Test and the ‘Own’ element of Own Risk and Solvency Assessment introduced by Solvency II, together with the enabling power of fast changing technologies, is creating such a desire boards will soon expect to instantly analyse and test the strategic impact of various scenarios on business performance.
Believe it or not, the computing power necessary to embed modelling into the fabric of a business, beyond the sole control of actuaries, and to supply up-to-the-minute information, is a lot closer than many would think.
From science fiction to fact
Expanding use of the model beyond the realm of the actuary will lead to a better functional understanding of the model’s output as well as greater Board assurance.To achieve such an outcome, tough decisions will need to be made.
Plagued with competing priorities, financial directors are torn between:
(a) Investing in an existing model to achieve compliance by bolting on to complex legacy systems which could result in demand outstripping the model’s original capability and capacity.
(b) Introducing an entirely newenterprise-wide model to drive shareholder value and business growth.
Contract pricing, cash flow projection, resource planning and financial control are good examples of what an enterprise-wide model should deliver without the need for separate systems, when different types of risks are viewed holistically.
(c) Commissioning a new model on an incremental basis to test quality and integration issues as well as return on investment.
By designing a risk model in the right way there is no reason why a new solution used to answer one business problem should not deliver a range of information for use across the organisationin the future.
The solution to Solvency II and the necessary changes to the way life insurance is modelled should be based not on what can be doneto the model but, rather, what the model can do for the business.
What can currently be achieved with life financial modelling?
(a) Extending use of the model beyond the actuarial department
One life insurance provider which felt increasingly challenged by the shifting regulatory landscape decided to review its bolt-on approach, particularly when its increasingly sophisticated products became difficult to model. Ultimately, the model itself grew so complex that designing, testing and understanding the process within the business without loss in performance was impossible.
A new model was the only solution to deliver the flexibility, ease of use and accuracy of projections needed. In fact, the platform upon which the model was built was so easy to use that anyone familiar with spreadsheet macros could be trained on the system. The model is being rolled out to pricing and profitability functions, demonstrating that, with the correct tools and editing constraints, a model can be used by other departments.
(b) Adapting the model to meet the needs of the Use Test
When a retirement benefits provider introduced a new live retirement annuity quote system, actuarial input was needed whenever there was a change in the basis. Speed was essential to ensure quotations reflected fluctuating interest rates. In order to give the company a competitive advantage in such a price sensitive market, an advanced, reliable, transparent and easily updated mortality model was required.
The adopted solution, which was built and tested by the actuarial department, allowed this business to make the necessary changes to its model much faster. The model was formatted for use with the company’s web-based quotation engine by embedding actuarial code into Dynamic Link Library (DLL) functionality. Now, when a customer enters their details into the quotation system, the figure generated is based on constantly-changing parameters provided by actuaries behind-the-scenes.
DLL outputs can be used more widely which has led to additional benefits arising from the model’s configuration. The company is using the DLL data to support strategic decision-making.
Generating visibility across the organisation
But financial modelling is only the start. Modelling can control all aspects of financial projection and evaluation to become the heart of a business. Another retirement benefits provider has introduced a model that extends across its information technology, data, control, risk and actuarial functions.
Solvency II promises to increase the knowledge held by business owners of the risks facing an organisation. Whilst the idea of using enterprise-wide modelling to instantly calculate the impact of hypothetical future strategies is still just a glimmer on the horizon, it is intriguing to think that Solvency II implementation could be the catalyst for directors to have complete control of projected balance sheets using an application on a mobile device.
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