Insurers’ corporate governance under Solvency II

The implementation of the Solvency II Directive in 2014 will introduce a new risk-based approach to corporate governance within the insurance industry and will require a change both in the mindset of the management, as well as in certain processes, when compared to the way insurance businesses are run locally.

The directive will require insurers to apply an effective risk management system into their organisational structure and decision-making processes to enable them to identify, assess, manage, monitor and report both their current and future risks.

Malta boasts a fast-developing international insurance industry. The insurance management sector alone, according to the latest statistics provided by the insurance management industry association MIMA, writes €1.3 billion in gross premiums. The introduction of the Solvency II regime would present challenges to this growing industry both from an operational and regulatory aspect. Solvency II has what are known as three pillars. Broadly the first pillar deals with the numerical requirements of the Directive, the second deals with rules on how insurers’ business should be run and governed and the third focuses on disclosure requirements.

One of the main points highlighted in the Malta Country Report published recently by the Malta Financial Services Authority was that in order to ensure the readiness by Maltese insurers for the upcoming regime there needs to be an understanding of the second pillar requirements “taking into consideration the undertaking’s nature, scale and complexity for proper implementation of the proportionality concept”.

The concept or principle of proportionality can be considered crucial to Malta and should arguably be applied consistently throughout the implementation of the new regime. The principle is based on the identification and proper assessment of the risk profile of the insurer allowing for a calibration of the application of the directive’s provisions in proportion to the risk profile of the insurer. This avoids the situation where an insurance business with simple lines of business is made to comply with the same set of rules required by larger more complex entities to which they may be more relevant.

Solvency II identifies certain essential elements that must form part of an adequate system of governance for insurers. These include an effective risk management system that identifies and manages potential risks of the insurer, an internal control and compliance framework, an independent internal audit function, and an actuarial function that undertakes assessment of underwriting policy and reinsurance arrangements.

The current regulations cover, to a certain extent, matters such as internal control and compliance to a satisfying degree when compared to the proposed rules. This also includes the requirement to have clearly documented and defined risk management policies setting out a risk management strategy covering the risk management objectives, key risk management principles, general risk appetite and assignment of risk management responsibilities.

It is the attention to risk in all processes that marks the departure from the old regime to the new. One of the features of this proposed risk management system as envisaged by the new Solvency regime is the ‘Own Risk and Solvency Assessment’, better known as ORSA.

The directive provides an outline of what the ORSA process would include, such as the analysis of overall solvency of the firm taking into account the specific risk profile, approved risk tolerance limits and the business strategy of the undertaking; as well as the compliance, on a continuous basis, with the capital requirements established by the directive. Detailed guidance on what the actual process would involve is still largely lacking.

The European Insurance and Occupational Pensions Authority (EIOPA) issued a position paper which provided a description of the ORSA as being the entirety of the processes and procedures employed to identify, assess, monitor, manage and report the short and long term risks a (re)insurance undertaking faces or may face, and to determine the own funds necessary to ensure that the undertaking’s overall solvency needs are met at all times.

From a practical perspective the assessment would necessarily have to be disclosed in written form and would form part of the extensive documentation which would need to be submitted to the relevant competent authorities. Reporting is in fact one of the other major developments of the new regime with a higher level of disclosure both to the supervisory authorities as well as the customers being required.

Guidance is still being sought by market players both on a local and European level on what regulators are to expect from insurance firms to comply with the new rules.

It will be interesting to see how this will develop and how the Maltese insurance industry will meet the requirements of this new state of play.

ccachia@jmganado.com.

Dr Cachia is a lawyer at Ganado & Associates in the insurance and pensions team.