Articles - Solvency II Reporting and where its heading

The summer of 2018 will be remembered as one where we were spoiled with brilliant sunshine and a fantastic performance by the England football team at the FIFA world cup in Russia. After the tournament, I opted to pass the time until the return of premiership football by comparing the Solvency II Solvency Financial Condition Reports (SFCRs) of 57 solo insurance entities. I hoped to gain some insight into the state of the industry and Pillar III disclosures. So what have I found?

 By David Otudeko, Financial Services Risk and Regulation at PwC

 Forewood by Kareline Daguer, Director, PwC: I have the pleasure of introducing my colleague David Otudeko to my readers. David mentioned in passing that he had done some research into Solvency and Financial Condition Reports dated December 2017 and I suggested he sent me his work. Little did I know that this paper in fact was a 20 pages essay with plenty of complicated graphs. After some consideration we felt the key messages were worth spreading further. So I will let you hear from David himself on where he thinks Solvency II reporting is heading.

 2017 SFCRs appear much improved compared to 2016. The firms sampled used quantitative reporting template (QRT) figures in the body of their reports, disclosing prior year figures where appropriate. Clearly influenced by EIOPA’s December 2017 Supervisory Statement, most firm’s SFCRs (88%) had detailed summaries covering key sections of their reports, but outliers remain. The report summaries of 12% of the sampled firms lacked detail and some firms’ SFCRs were low quality scanned copies uploaded on their websites. The QRT tables of one SFCR sampled were split across multiple pages, making it difficult to read as a whole.

 On the capital front, 95% of available own funds of firms sampled were Tier 1 capital, 5% Tier 2 and 1% Tier 3 with one firm using ancillary own funds (AOF). However, as the sample used in this study consisted purely of solo firms, this trend is understandable and one would expect a different weighting of capital by tier at holding company level in insurance groups. The average solvency coverage ratio of firms sampled was 184% and no insurer reported a ratio below 100%, which suggests the industry does not lack capital. The bigger challenge faced by insurers is business model sustainability in light of current market conditions, where more aggressive investment strategies are being chosen in a hunt for enhanced yield.

 Linked to the above is an increase in life insurer’s illiquid assets investments which, while riskier (as they cannot be cashed in quickly), provide high returns and a good match for their long term liabilities. Investment types vary but current regulatory focus is on equity release mortgages (ERMs) - a growing investment class for the sector. My analysis supports this assertion of growth.

 Between 2016 and 2017 there was an 11% increase in the loans and mortgages asset category in the balance sheets of insurers sampled and an increase of 43% in loans and mortgages to individuals over the same period. Life firms dominated this picture, with the majority of growth coming from large players in the bulk purchase annuity (BPA) market. To address what it perceives as risks to its statutory objectives the PRA has released Consultation Paper 13/18 on the treatment of ERMs. It focuses on the value of matching adjustment benefit claimed by firms (which is significant in many cases), the modelling of the no negative equity guarantees (NNEG) that accompany these products and how this impacts transitional measures on technical provisions (TMTP) relief. Life insurers with well diversified illiquid asset investments may well be able to absorb the impact of calibration changes proposed, but those with majority ERM investments could feel the squeeze more.

 After two rounds of SFCRs one hopes that insurers now see its production as less of a tick box compliance exercise and more of an opportunity to showcase their businesses to stakeholders. As insurers digest the meaning of IFRS 17, SFCRs will continue to be a key source of public information for the next few years. It is therefore in insurers’ interests to make these documents useful, relevant and of good quality by focusing on user needs. Such reports could provide more insightful information to stakeholders and perhaps make the industry more attractive to investors. Like IFRS 17, Solvency II was once new to the industry and required the development of new data models, governance structures and disclosure processes. Insurers could leverage the hard work done to comply with Solvency II to implement IFRS 17, particularly in areas where both standards overlap. As a result, Solvency II compliance, including the development of SFCRs and other Pillar III disclosures, could have provided the perfect training ground for insurers as the industry moves toward IFRS 17 reporting in the next few years.

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