At Last, a Carrot at the End of the Stick? Willis Re Reports on Standard
New Criteria on Insurers’ Economic Capital Models
London, UK, March 28, 2011 – With supervisors and rating agencies putting increasing emphasis on enterprise risk
management, Willis Re, the reinsurance broking arm of Willis Group Holdings (NYSE: WSH), has published a
report on Standard & Poor’s (S&P) new criteria for assessing insurers’ economic capital models. The Willis
Re report, available here, finds that the latest S&P release incentivises insurers to adopt more
sophisticated internal capital models by giving them the opportunity to use the modelling results to potentially
reduce their capital requirements.
The new criteria offer insurers the possibility of reducing their rating agency capital requirement by replacing a
proportion of S&P’s standard formula with their own internal capital calculation, that proportion depending upon the
credibility that S&P places on the firm’s economic capital model. The Willis Re report discusses the
structure of the new criteria and their relevance for insurers worldwide, with a particular focus on
EU companies that will soon be subject to a parallel set of requirements under Solvency II.
The report, “Standard & Poor’s Economic Capital Model Review Promises Capital Rewards”, identifies the main features
of the “ideal” economic capital model according to S&P and provides insights into how the agency
is likely to apply its new methodology in practice.
Commenting on the new criteria, David Simmons, Managing Director, Analytics and Head of International & Specialty Enterprise
Risk Management for Willis Re, said: “By at last offering the carrot of lower capital requirements
to add to the stick of their existing ERM review, Standard & Poor’s has further increased
the incentive for insurers to adopt tailored and more sophisticated capital models. But the bar is
set quite high. Strong risk management remains key and only models embedded in business decision-making of
companies judged to have strong ERM processes will be eligible for review.”
While S&P’s criteria resemble Solvency II conditions for supervisory approval of internal models, the report notes that
there are differences. S&P does not approve models but rather weights their credibility. Willis Re says
that it now looks likely that Solvency II implementation will be phased, assuming that the transition
allowances recently set out in the Omnibus II Directive are followed. “Many companies, particularly in the
London market, have invested heavily in their internal economic capital modelling, partially in expectation of gaining
regulatory capital relief. This proposal promises a means to release real value from that investment by
influencing their rating agency capital,” said Simmons.
Key findings in the report include:
- S&P’s review will have a markedly qualitative character. S&P will assign scores of “basic”, “good”, or “superior”
to each component of an insurer’s economic capital model. These scores will then be aggregated into
a comprehensive assessment summarised by a single number, the “M-factor”, which measures the model’s credibility in
S&P’s view. The M-factor will be used to blend S&P’s capital model requirements with those from
the insurer’s model. This is materially different from Solvency II, where approved internal models will fully
replace the standard formula for the solvency capital requirement.
- Stochastic modelling per se may not
be enough to obtain S&P’s approval and should be augmented by stress tests including, but not
limited to, worst historical experience.
- S&P believes that capital fungibility should be explicitly and carefully
modelled before taking any diversification benefits into account in the determination of economic capital – a
crucial requirement for multi-national insurance groups.
- The immediate impact of the new criteria is likely to
be relatively small, says Willis Re, as S&P will probably adopt a conservative attitude in deciding
its M-factors. This is likely to change in the future, however, as insurers’ models increase in
sophistication and S&P’s comfort in them grows.
About Willis Re
One of the world's leading reinsurance brokers, Willis Re is known for its world-class Analytics capabilities, which
it combines with its Capital Markets and Reinsurance expertise in a seamless, integrated offering that helps
clients increase the value of their businesses. Willis Re serves the risk management and risk transfer
needs of a diverse, global client base that includes all of the world's top insurance and
reinsurance carriers as well as national catastrophe schemes in many countries around the world. The broker's
global team of experts offers services and advice that help clients make better reinsurance decisions, access
worldwide capital markets and negotiate optimum terms. For more information, visit www.WillisRe.com.
Willis Group Holdings plc is a leading global insurance broker. Through its subsidiaries, Willis develops and delivers
professional insurance, reinsurance, risk management, financial and human resource consulting and actuarial services to corporations, public
entities and institutions around the world. Willis has more than 400 offices in nearly 120 countries,
with a global team of approximately 17,000 employees serving clients in virtually every part of the
world. Additional information on Willis may be found at www.willis.com.
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