Aligning insurance supervision with insurance business practice, insurance regulators across the globe have been working toward a common goal of improving the processes for understanding and measuring risks inherent in the business of insurance. The International Association of Insurance Supervisors (IAIS) is promoting a concept called Own Risk and Solvency Assessment (ORSA) as a key component of regulatory reform. An ORSA will require insurance companies to issue their own assessment of their current and future risk through an internal risk self-assessment process and it will allow regulators to form an enhanced view of an insurer’s ability to withstand financial stress.
The ORSA concept is now embedded in the IAIS standards and is in various stages of implementation in the United States, Europe and other jurisdictions. Resulting from the NAIC Solvency Modernization Initiative (SMI), large- and medium-size U.S. insurance groups and/or insurers will be required to regularly conduct an ORSA starting in 2015.
ORSA: WHAT IS IT?
In essence, an ORSA is an internal process undertaken by an insurer or insurance group to assess the adequacy of its risk management and current and prospective solvency positions under normal and severe stress scenarios. An ORSA will require insurers to analyze all reasonably foreseeable and relevant material risks (i.e., underwriting, credit, market, operational, liquidity risks, etc.) that could have an impact on an insurer’s ability to meet its policyholder obligations.
The “O” in ORSA represents the insurer’s “own” assessment of their current and future risks. Insurers and/or insurance groups will be required to articulate their own judgment about risk management and the adequacy of their capital position. This is meant to encourage management to anticipate potential capital needs, and to take action before it’s too late. ORSA is not a one-off exercise; it is a continuous evolving process and should be a fundamental part of the risk-management system for an insurer. Moreover, there is no mechanical way of conducting an ORSA; how to conduct the ORSA is left to each insurer to decide, and actual results and contents of an ORSA report will vary from company to company. The output will be a set of documents that demonstrate the results of management’s self-assessment.
NAIC U.S. ORSA
In light of the financial crisis of 2007-2008, U.S. insurance regulators began to modify their supervisory framework. In 2008, the NAIC launched the SMI—a critical self-examination to update the U.S. insurance solvency framework. SMI focused on key issues such as capital requirements, governance and risk management, group supervision, statutory accounting and financial reporting, and reinsurance. As part of the SMI, the NAIC re-evaluated risk-based capital (RBC) in the United States and determined that RBC will continue to form the backstop function for insurer solvency to: (1) guarantee regulator action; and (2) provide the legal authority to intervene without extensive litigation.
Regulators decided that additional capital assessments evaluating prospective solvency should be added to the system. Additional capital assessments will be included in ORSA to complement RBC as a financial regulatory safeguard. The NAIC ORSA Guidance Manual, which was adopted by the NAIC Executive (EX) Committee and Plenary in March 2012, provides information for insurers on performing its ORSA and documenting risk policies and procedures.
Pursuant to the NAIC ORSA Guidance Manual and the recently adopted Risk Management and Own Risk and Solvency Assessment Model Act (#505), an insurer and/or the insurance group of which the insurer is a member will be required to complete an ORSA “at least annually to assess the adequacy of its risk management and current, and likely future, solvency position.” The ORSA will apply to any individual U.S. insurer that writes more than $500 million of annual direct written and assumed premium, and/or insurance groups that collectively write more than $1 billion of annual direct written and assumed premium.
While the NAIC ORSA Guidance Manual is deliberately non-prescriptive, because each ORSA will be unique and will vary depending on risks that are unique to that insurer/group, insurers subject to the ORSA requirements are instructed to examine their own risk profile in three major sections. Section 1 – Description of the Insurer’s Risk Management Framework, should be a high-level summary of its own risk-management framework, including risk appetite, tolerance and limits and internal controls. Section 2 – Insurer’s Assessment of Risk Exposure, should include detail showing the insurers’ process for assessing risks (both qualitative and quantitative assessments should be performed) in both normal and stressed environments. Section 3 – Group Risk Capital and Prospective Solvency Assessment, should demonstrate that current and future capital is sufficient to support the identified risks.
Companies must keep the ORSA up-to-date through an annual update and review. All foreseeable and materials risks should be included in the assessment. Insurers will need to develop processes to perform a self-assessment in the stressed environment using either a stress test methodology or stochastic model.
To avoid duplicative international regulatory requirements, an internationally active insurer may be able to satisfy the ORSA filing requirements, or sections, by providing the most recent and substantially similar report provided by the insurer or another member of an insurance group, of which the insurer is a member, to a supervisor or regulator of a non-U.S. jurisdiction.
When the NAIC Executive (EX) Committee and Plenary adopted Model #505 on Sept. 12, 2012, it was expected that each jurisdiction would adopt risk-management and ORSA requirements into state law prior to 2015. Model #505 provides the requirements for completing an annual ORSA and provides guidance and instructions for filing an ORSA Summary Report.