Companies that take a positive view of Solvency II will gain wide-ranging business benefits, says Richard Rodriguez

Insurers and reinsurers around the world view any new rules with understandable suspicion. Solvency II is one of those all too rare cases, however, where regulations can actually help to improve the business. The principles behind the process are increasingly recognised as best practice by ratings agencies, regulators outside Europe, actuaries and indeed anyone with an interest in the stability and profitability of the re/insurance industry.

Understanding the risks inherent in your business lies at the heart of Solvency II (mainly Operational Risk, Group Risk, Insurance Risk, Market Risk, Credit Risk and Liquidity Risk). For all but the smallest of companies, the only effective way to do this is to create financial models of the company, involving analysis of all your business processes.

This can be quite time-consuming, but the information and analysis involved has far-reaching uses. Above all, it can help you to manage your capital effectively by underpinning many core strategic activities. These include:
• Reinsurance purchase;
• Capital allocation;
• Product and pricing strategy;
• Business expansion;
• Mergers and acquisitions;
• Alternative Risk Transfer mechanisms;

Reinsurance purchase – how to identify a better strategy
By way of illustration, let’s take a look at the first of these, reinsurance purchase. This will demonstrate just one aspect of how the analysis acquired during the sort of modelling exercise that Solvency II is likely to require can be used to improve corporate performance.

Buying reinsurance is one of the most basic functions of any insurance company, and often one of the areas where a company’s analysis is weak. The programme’s effectiveness is bound to have repercussions for your whole financial performance, including the return on capital. Yet historically there have been many instances where insurers and reinsurers have not truly understood their reinsurance programme.

At the heart of any reinsurance modelling analysis itself are good quality gross loss profiles for all classes and subclasses of business written. This kind of information is often been hard to acquire because of how claims have traditionally been logged.

Once you have made the necessary changes to the way you store and retrieve data, however, it should not be too laborious to extract what you need. Gross loss profiles should preferably be organised on a class-by-class basis taking into account the characteristics of the losses, such as claim type and claim size.

The existence of high quality gross loss profiles provides the necessary platform, but not the entire picture. We need to capture all the risks inherent in the business so that any reinsurance option can then be tested with regard to its impact on overall company performance and capital.

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