The document discusses the increasing convergence of enterprise risk management (ERM) principles and risk-based regulation internationally. It notes that Solvency II regulation in Europe has spurred reviews of regulatory policies in other jurisdictions. Many regulators now view traditional rules-based solvency standards as inadequate and are pushing companies to adopt more risk-aware cultures. The principles of ERM and risk-based regulation are growing in various countries and regions around the world. The Middle East in particular seems poised to adopt more ERM-focused regulation in the future.

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O
ver recent years, ERM has begun to leave an
indelible mark on actual and proposed changes
to regulation in many international jurisdictions.
Solvency II in Europe has become something of a gal-
vanising force. If everything stays on track, 30 European
countries will be united in late 2012 by a single set of
rules governing what constitutes an acceptable level of
solvency.
Its ambition, both in terms of scale and scope, is acting
as a catalyst, spurring regulators in other jurisdictions to re-
view their supervisory policies – not least because Solvency
II encompasses the concept of judging the “equivalence” of
regulatory regimes in other territories. The global conver-
gence of risk and principles-based regulation and ERM is
growing as a result.
Does this mean that we are heading for a world where
prudential regulation of the industry is identical in all
major centres? Not quite. There is no doubt, however,
that traditional rules-based solvency standards are widely
viewed as inadequate. They bear no relation to the actual
risk profile of any given business. They mean that capital
may be tied up unnecessarily. And they can encourage an
attitude of box-ticking regulatory compliance.
Convergence of objectives
Risk-based regulation moves the onus of assessing a firm’s
explicit level of solvency from the regulator to the company
management. As a result, firms are expected to become
much more risk-aware in their management and culture.
This is consistent with the idea that ERM is not separate
from the business: it is a way of doing business. One regula-
tory implication, therefore, is that risk management has to
be – and seen to be – part of everyone’s day job. For many
companies, this entails a significant culture shift, one that
only senior managers can bring about.
What does such a culture shift involve? There are numer-
ous definitions of ERM that would suggest a whole range of
areas where understanding and performance might need
to be improved, including internal environment, objective
setting, event identification, risk assessment, risk response,
control activities, information and communication, and
monitoring.
In combination, tackling these (and others could well
be advanced) represents a lot of work for most companies.
Regulation, in itself, is not necessarily an incentive to do so.
The bigger carrot for the ERM-led approach is the opportu-
nity for competitive advantage and for firms to manage not
Where ERM goes,
regulation will follow
The principles of enterprise risk management (ERM)
have become a driving force in international insurance
solvency regulation. It will pay companies in developing
markets – such as MENA – to anticipate changes ahead,
says Mr Mike Wilkinson, Head of Risk Management
Consulting at international actuarial and business
consultancy EMB.
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just their capital, but their entire business, more effectively
in order to improve returns.
But an increasing number of regulators around the world
are set on pushing companies within their jurisdictions
towards that carrot.
Europe and Africa
Solvency II is a major testing ground for regulatory moves
towards ERM. However, the inherent complexity of the
exercise is compounded by the tremendous diversity of
companies and countries within today’s European Union.
The decision to offer firms a choice between a standard
formula and an internal model for capital calculations is
a practical approach to dealing with this diversity, as is the
inclusion of a “proportionality” principle so that smaller,
less complex companies are not treated in exactly the same
way as multinational giants.
Included in the three pillars of the Directive, however,
is a requirement for an “own risk solvency assessment”
(ORSA). This will force even those companies which choose
the standard formula to submit an objective assessment of
capital sufficiency for all the risks to which they are exposed.
And whichever route they take, Solvency II requires them to
consider all their business risks, not just the insurance risks.
Various country regulators and market bodies (including
Lloyd’s of London) within Europe have actively encouraged
firms within their jurisdiction to pursue the internal model
option so that capital is more closely aligned to the risks
within the business. A key component for regulatory ap-
proval of such models is the “use test” whereby companies
must demonstrate that the model is being used to support
important decision-making, not just calculate capital.
In South Africa, which operates as an insurance hub for
sub-Saharan Africa, the regulator has issued draft regula-
tions to be implemented by 2014 (with interim measures
to be applied by 2012). The regulations are structured to be
consistent with Solvency II. According to the draft regula-
tions, all companies are expected to move towards a full
internal model within five years of implementation.
Asia
The Australian regulator was a very early pioneer of a
risk-based regulatory framework. This, again, is based on a
choice between an internal model or a formula approach
to calculating capital.
Many Asian regulators are watching the Solvency II pro-
cess closely. Japan, with the biggest insurance industry in
Asia, currently has a formula system, although the regulator
has demonstrated a growing interest in exploring a regional
equivalent to Solvency II within the last year. The Chinese
regulators are also experimenting with internal models and
risk-based solvency regulation.
Throughout the Middle East, there is an increasing drive
towards ERM. The influence and demands of rating agencies
are also significant factors within the region. Consequently,
the region as a whole and certain countries in particular,
such as Bahrain, have invested considerable time and effort
in moving towards world-class regulation.
The next step will be wider supervisory enforcement.
Currently, the emerging regulatory bodies are preoccupied
with more fundamental issues, such as ensuring that people
moving into the industry are suitably qualified to meet the
growing demand for insurance products.
The Americas
State-by-state supervision of the insurance industry has led
to a more fragmented approach in the US. However, in
the wake of the financial crisis, the Obama administration
has made a more unified approach to financial regulation
a priority with the result of the proposed creation of the
Federal Insurance Office. The National Association of In-
surance Commissioners has had a Solvency Modernisation
Initiative (SMI) Task Force in place since 2008 and earlier
this year released a SMI roadmap which sets out plans for
an ERM/ORSA type tool by the end of 2011 and the devel-
opment of model law and group-wide supervision rules
by the end of 2012.
The Bermuda Monetary Authority has been pursuing
the phased introduction of risk-based capital requirements
since 2008. Recent activity has included the release of a
consultation paper on the approach to an insurer’s own
risk and solvency assessment regime (similar to Solvency
II), to be referred to as the Commercial Insurer’s Solvency
Self-Assessment.
In Latin America, Brazil is leading the drive towards risk-
based solvency regulation with rules regarding underwriting
risk becoming effective in 2008 and credit risk by the end
of 2010. While an internal model cannot yet be used to
determine an insurer’s capital requirement, any company
that has such a model receives a discount. The other major
markets in Central and South America, such as Mexico,
have also developed proposals for new solvency regulations.
What next?
From all this activity, it is clear to see the direction in which
global solvency regulation is moving.
While some Middle East insurers are already familiar
with the ERM expectations of rating agencies, the need to
prepare for ERM-inspired regulation also seems almost
inevitable. Concentration on a few key areas of ERM will
stand the industry in good stead as it gets on with growing
capacity and market penetration:
• Governance – Allocate clear senior responsibility and
authority for risk management, ideally at board level.
Start creating an environment for effective communica-
tion and data capture.
• Decision-making – Align risk management to the busi-
ness strategy and the interests of stakeholders.
• Risk modelling – Aim to model key risks and the de-
pendencies between them. In tandem, be aware of the
need to be able to stress test the key assumptions and
scenarios within models.
• Integration and resourcing – Organise the capital
management function so that it is working closely with
other departments such as reinsurance, reserving, pricing
and asset management. Experience from those countries
where risk-based regulation is being implemented also
shows a growing demand for risk professionals and
actuaries.
• Benchmarking – Build in external benchmarks to verify
internal views of risk.
Since the discipline involved in complying with emerging
insurance regulations and implementing ERM are increas-
ingly overlapping, such forward planning is likely to prove
a worthwhile investment in any case.
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