Driven by the need for the Swiss insurance supervision system to be considered equivalent with the EU’s new Solvency II directive (SII), on 8 July 2015 FINMA released a consultation on new Own Risk and Solvency Assessment (ORSA) requirements for Swiss (re)insurers and captives. What does this require? Will it be a heavy burden? Will companies already covered under SII have to do anything in addition? Below I look at some of the key features, impacts and differences to the SII ORSA.
The path to equivalence with SII goes through ORSA
The European Insurance and Occupational Pensions Authority (EIOPA) recognised the Swiss insurance supervisory regime as equivalent with the EU SII directive on 5th June 2015, a critical decision ensuring that Swiss insurers and reinsurers can play on a level playing field with their European peers. A pre-requisite of this decision was the revision of the Insurance Supervision Ordinance (ISO) in a number of key areas including the introduction of new ORSA and Disclosure requirements. The amended version of the ISO has been in-force since 1 July 2015 with FINMA releasing new circulars for consultation on these topics on 8 July 2015.
Swiss ORSA: Overview
In a rather concise circular of just six pages (compared to 25 for the latest SII ORSA guidelines from EIOPA), FINMA does not provide a detailed recipe for how to approach an ORSA but outlines the key requirements, leaving it up to insurers to define an appropriate process, the complexity of which should be proportionate to the nature, scale and complexity of the business. The definition and concept of the Swiss ORSA is largely consistent with the SII view i.e. that the ORSA should provide a forward looking, consistent and global view of the insurer, its risks, capital adequacy, and dependency between risk and capital. As with SII, the aim is to improve board understanding of risk and capital, encourage business planning and strategic decisions to be made based on an assessment on these factors, ensure sufficient capital beyond a one-year time horizon, and generally improve risk management and risk mitigation processes. The intention is that this is not just another regulatory submission, but the bringing together of all risk management processes in a company and culminating in an annual ORSA report to FINMA.
Subtle differences to SII in key areas
So what are the key features of the Swiss ORSA? Again these are more or less consistent with the SII ORSA but with some subtle differences:
- Scope: Whilst all regulated companies will be required to perform an ORSA, (re)insurers in supervisory categories 4 and 5 will in general be exempt from reporting to FINMA. In addition, reinsurance captives are explicitly allowed to perform a simplified ORSA. SII does not provide any allowance for exemption or simplification, except for the rule of proportionality. An insurer’s ORSA process is to be defined in an “ORSA Policy”, here the Swiss requirements are less explicit than the SII requirements which dictate the contents of this policy.
- Ownership and use: The Swiss ORSA will be mandated, signed and used for decision making by the board of directors. However, the Swiss ORSA guidelines appear to be slightly less demanding of the board involvement than SII, which also requires the board to “Steer, design and challenge” the ORSA, and to sign off on the ORSA policy. Some European regulators are pushing for even more board involvement and this is a key challenge for European insurers. In addition, whilst there is likely to be some kind of “use test” i.e. a test that the ORSA is embedded in company decision making, the Swiss guidelines are again less prescriptive than under SII, in particular the explicit requirement to use the ORSA results in “Product development and design” is absent, although most companies would naturally do this anyway.
- Prospective view and planning period: The Swiss ORSA will consider the whole business planning period, starting from the current situation and including at least two additional periods (SII requires “more than one” but in practice regulators will require more). Stress scenarios used to test solvency are thus multiyear and go further than the one-year Swiss Solvency Test (SST) observation period.
- Risk Profile: As per SII, Swiss insurers will need to define their “risk profile”, assessing all risks to which the insurer is exposed over the planning period, whether this can be done quantitatively or only qualitatively. It also includes risks borne from a group’s holding structure and hence covers the issues of capital fungibility. The Swiss circular is however more explicit on categorising risks, and assessing risk concentrations and dependencies than the SII guidelines.
- Capital requirements: Capital adequacy will need to be tested for each defined scenario, each future planning year, and for all capital perspectives used by management for financial control in addition to regulatory capital, (i.e. including a company’s own definition of required capital or credit rating requirements). As per SII, this will mean that small/medium insurers may be able to rely solely on the regulatory capital requirements without additional capital measures if they do not already calculate these. Where the Swiss requirements appear to differ from SII, is that there does not appear to be an explicit equivalent requirement for companies to assess whether they are “continually compliant” with regulatory capital and technical provision requirements over the planning period, although this may be implied. Also, justification for using a Standard Model over an Internal Model for regulatory capital calculation is not covered under the Swiss ORSA (but is covered under SST requirements). Finally the required reverse stress test under Swiss ORSA is defined as a stress which will “jeopardise” the solvency of the company rather than one which will cause the insurer to “cease being a going concern” as per SII, a subtle difference.
- Risk mitigating measures: Measures which mitigate risks identified in the Risk Profile should be considered and documented with reference to the company’s risk appetite and risk tolerance, similar to SII.
- Reporting: Insurers will need to document the annual ORSA process internally and produce an annual report on the results for FINMA. However, there is no explicit requirement for separate reporting internally and externally as under SII. In reality though this will probably be the case. Insurance Groups should provide their first report no later than January 31st 2016 whereas insurers of regulatory categories 2 and 3 have until January 31st 2017.
In summary, the Swiss ORSA requirements are in essence very similar to the SII requirements but are less specific on some of the details. Our experience is that regulators in Europe have applied a wide variety of interpretations to the SII guidelines with some setting higher goals than others; it will therefore be interesting to see the approach FINMA takes to supervising the new requirements. Regardless, for many companies without a significant EU presence and SII experience, the new Swiss ORSA is likely to require a step change in the way risk is managed and reported. Where not already in place, this will mean formalising risk management practices, significant additional involvement from the board in risk topics, gaining business consensus on risk appetite and tolerances, additional scenario analysis and capital projections, and proving that a consideration of risk is made in all key business decisions, the latter being a key challenge in our experience. For EU insurers, these processes may already be on their way to being institutionalised due to Solvency II requirements. However, subtle differences in requirements, additional reporting and further regulatory discussions will undoubtedly require additional effort and resources.
- FINMA Circular 2016/xx ORSA (in German)
- Article: Impact of revised FINMA Circular on insurer investment guidelines
- Insurance Services at KPMG