Four ways to leverage regulatory knowledge to enhance your own risk management process
In mid- May 2018, the European Insurance and Occupational Pensions Authority (EIOPA) launched its fourth bi-annual stress test exercise for the European Insurance sector. With this exercise, EIOPA aims to assess the vulnerability of the sector to specific adverse scenarios. A target group of 42 of the EU’s largest insurance and reinsurance groups have been asked to participate in this exercise with the intention to achieve an optimal mix of life and non-life business lines and a high market coverage. National supervisors have also been notified to ask additional insurance groups to participate in the exercise to gain even more insights at a national level. As the submission deadline is set for mid-August, most participating firms will already have made good progress to assess their vulnerability to these stresses. Although you might not be required to participate, these stress scenarios could be a source of inspiration to evaluate and broaden the risk management processes in your organization.
While there is no specific focus within the stress scenarios this year, the test encompasses a wide range of risks including several market and underwriting risks. Additionally, EIOPA included a cyber risk questionnaire regarding the management and exposure to this type of risk.
What happens in these adverse scenarios?
Three adverse scenarios are defined which could leave the European insurance sector vulnerable from a financial stability perspective:
- an immediate yield curve up shock combined with a significant increase in lapse rates and provisions deficiency stress
- a protracted period of extremely low interest rates combined with an increase in life expectancy due to new technologies in the healthcare industry
- a natural catastrophe scenario due to a series of weather-related events such as storms, earthquakes or floods occurring in Europe
Why not take advantage of these well thought-out scenarios for your own risk management purposes? For instance, by incorporating (a subset) of these adverse scenarios in your ORSA process, you will be able to gain insights into your own vulnerabilities without having to fully design such stress scenarios by yourself. Furthermore, by extending the forward-looking period beyond the one-year horizon (as the adverse scenarios in the stress test are instantaneous), you will also be able to get a better grip on your potential for recovery under different scenarios after such a shock has occurred.
In the World Economic Forum’s 2018 ‘ The Global Risks Report,’ cyber risk or cyber-attacks have been ranked third in terms of likelihood and sixth in terms of impact. The questionnaire of EIOPA aims at identifying trends, risks and current approaches in managing cyber risks for insurance companies. It is not specifically tested as an adverse scenario, but given the importance of this issue, it is very much worthwhile to discuss the possible impact of this threat. Based on those discussions you could choose to add this risk to your risk management dashboards, or even to design a specific adverse scenario to consider in your ORSA process.
How can we help?
Ortec Finance has extensive experience in supporting insurance companies in forward-looking risk management applications. We undertake a range of work from Monitoring to ORSA and Asset Liability Management to enable our clients to gain insight in the holistic balance sheet risk they are facing, and more importantly how to safely navigate these risks.
If you have questions or remarks regarding this article or the challenges you are currently facing, please feel free to contact your Ortec Finance account manager or Twan Possen, Senior Consultant Pension & Insurance Risk Management (+31 10 700 50 00).