Insurance

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‘There’s huge room for improvement in reporting in the insurance industry,’ saidan analyst interviewed as part of a survey of market professionals carried outby PricewaterhouseCoopers in the autumn of 2009.1 ‘It’s very difficult to gaina clear economic view of where profitability comes from,’ said another participant.The deficiencies in insurance reporting are arguably one of the main reasons whyshares in the sector continue to be undervalued and the cost of capital is generallyhigher than it should be (see Figure 1). PricewaterhouseCoopers’ survey highlighted

Where’sthe benefit?Effectivecommunicationin a Solvency IIworldRather than strengtheningrisk and capital disclosure,Solvency II could lead to areporting overload. How caninsurers strike a balance betweenmeeting regulatory expectationsand providing information thatwould help them to conveythe true strength and potentialof the business?

Figure 1 | Underperforming the market

1 ‘Making sense of the numbers: Analysts’ perspectiveson current and future reporting in the insurance industry’,published by PricewaterhouseCoopers on 25.11.09(www.pwc.com/insurance).

FTSE 100 Insurance companies in FTSE 100

Source: PricewaterhouseCoopers analysis

Dec 06 Dec 07 Dec 08

1,000

0

particular dissatisfaction with theadequacy of disclosures relating to cashflow, business strategy and risk-basedcapital (see Figure 2), areas which arecoming under heightened scrutiny in thewake of the financial crisis.

Insurers are keenly aware of theimportance of effective communicationsin bolstering ratings and attractinginvestment. A poll of more than ahundred insurance professionals carriedout by PricewaterhouseCoopers inNovember 2009 found that nearly 90%believe that the quality of reportingaffects enterprise value and the amountof capital invested in the industry.2

The problem is that insurers have alwaysfound it difficult to slice and dice thenumbers and convey their profitpotential in a way that makes sense toanalysts and other stakeholders,especially those that do not specialise inthe sector. It is telling that while bankshave a range of comparable ratios toconvey efficiency and profitability, andother service sectors such as retail havestandard indicators such as like for likesales and revenue per square metre,insurance has no such readilycomparable performance metric.

The growing stakeholder demands onrisk and capital management disclosurecan only increase these challenges.

More than 60% of participants in our pollof insurers identified future risk capitaland the impact of key risks/stressfactors as the areas of reporting in mostneed of improvement. While thepotential impact of risk on performanceis an increasingly critical area of marketcommunications and internalmanagement information, few have anymore than a limited ability to analyse therisk factors affecting their profitability.Granularity is a particular challenge, withless than 20% of participants able to drillthe analysis of their main risk factorsdown to business unit level.

Enhanced disclosure or moredead trees?

The publicly disclosed Solvency andFinancial Condition Reports (SFCR)required under Solvency II Pillar 3 havebeen seen as an opportunity to enhancethe quality and breadth of marketcommunications. However, theimplementation measures proposed bythe Committee of European Insuranceand Occupational Pensions Supervisors(CEIOPS) in Consultation Paper 58(CP58) has attracted criticism as beingoverly onerous and prescriptive (CP58attracted more responses than all the other 23 papers issued in July 2009put together).

More than half of the participants in ourpoll of insurers felt that CP58 would puttoo much reporting in the public domain,and that this will not be used by themarket. Only around 30% believe thatthe proposed disclosure would result inbetter ratings for those that get it right.The rest either disagreed or did notknow, indicating that most are doubtfulabout the cost benefits of the SFCR.Other complicating factors include theextent to which Solvency II disclosurewill be consistent with a future IFRS andhow much they will conflict with oneanother.

PricewaterhouseCoopers Countdown to Solvency II: giving you the edge

2 PricewaterhouseCoopers polled 120 insurance professionals at a seminar held in London on 30.11.09.

Figure 2 | Analyst survey 2009: usefulness and adequacy of insurance reporting

There are still significant gaps between adequacyand usefulness on insurance risk disclosures andstrategy communication.

Inco

me

statem

ent

Balan

ceshee

t

Cashflow

Seg

men

tal

Insuranc

e risk

expo

sures

Risk-ba

sed

capital

Man

agem

ent

commun

ication

on strateg

y

Results

presen

ted on

non-GAAP

basis

Market

positio

n

Value crea

ting

inform

ation

(e.g. d

istribution

chan

nels)

Gov

erna

nce

inform

ation

Corpo

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resp

onsibility

repo

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Reg

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The adequacy of risk-based capital reporting hasdecreased since 2007

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

n Usefulness 2009 n Adequacy 2009 Usefulness 2007 Adequacy 2007

Source: PricewaterhouseCoopers analysis

Granularity is a particularchallenge, with less than20% of participants ableto drill the analysis of theirmain risk factors down tobusiness unit level.

The Pillar 3 reporting requirementspresent particular issues for smallerand unlisted firms. Public disclosure ismeant to be proportionate to the nature,scale and complexity of the entity. Inkeeping with the terms of the frameworklegislation, it would seem reasonablethat a relevant and applicable summaryof the privately disclosed Report toSupervisors (RTS) would therefore besufficient, especially as there is likely tobe a limited shareholder base to reportto, it is questionable whetherpolicyholders pay attention to suchreporting and other stakeholders suchas brokers and IFAs have their ownseparate communication channels.Typical information might include thebreakdown of an investment portfolio.If the summary proved to be inconsistentwith the RTS or too brief to be of value,supervisors would have ampleopportunity to insist on changes.However, under current proposalssmaller firms are required to follow anextensive standard template fordisclosure. The underlying concern isthat proportionality is being treated asa selective concession within theimplementation measures rather thana legal right.

While the responses to CP58 do notappear to have had significant impact onthe recent guidance issued by CEIOPSto the European Commission, noteverything is finalised. In particular, theCommission does not have to acceptCEIOPS’ advice.

Turning to your advantage

Whatever the Commission decides,there are enough requirements alreadycontained in the framework legislationto ensure that the Pillar 3 reportingrequirements will still be taxing. Theoverriding challenge is therefore howto ensure that implementation formspart of a coherent and cost-effectiveapproach to disclosure. Among the keyconsiderations will be discerning whatinformation is of most value to particularstakeholders and what messageand form of reporting would improvetheir understanding of the company.In seeking to reduce the burden ofpreparation and underlying risk andcapital analysis, it will also be important

to look at how to make the mostefficient use of the overlaps betweenthe SFCR, RTS and Own Risk andSolvency Assessment and to avoidinconsistencies between them.

Market leaders are going further bydeveloping new and improved ways(both quantitative and qualitative) toconvey how management viewsparticular risks, how they are managed

and how they influence strategy. AsFigure 3 outlines, for non-life businessthis includes looking beyond relativelyintangible 1 in 200-type measures toassess the impact of particular riskfactors on expected profit. For lifebusiness this could include informationon how potential variations in areassuch as premium loadings andmanagement charges might affectmargins. Examples for both sectors

PricewaterhouseCoopers Countdown to Solvency II: giving you the edge

Figure 3 | Insightful analysis (non-life)

Example Tolerance Points

1. Not achieving expected profit

2. Profit warning to market

3. Loss in financial year

4. Credit rating watch

5. Impairment – Credit rating downgrade

6. Regulatory intervention

(Assign probabilities)

Figure 4 | Insightful analysis (life)

Source of income

Annual management charges

Investment management expenses

Premium loadings

Maintenance expenses

Tax

Risk charges

Claim costs

Non unit reserve changes

Risk Factorsinfluence/competency

A. Market Softening L

B. Natural Catastrophe M

C. Investment Risk Appetite – Low M

D. Strategic Initiative A M/H

E. Strategic Initiative B M

F. Operational risk incident M

(Defining probabilities of risk & return)

Source: PricewaterhouseCoopers

Source: PricewaterhouseCoopers n Potential warning n On target

1 in 10 yeardownsideoutcome

1 in 10 yearupsideoutcome

50 60 70 80 90 100 110 120 130 140 150

Expected profit

1

E0

3

456

2

Capacity to

include the key drivers of capitalrequirements (both economic andregulatory), stress tests/sensitivitiesbeing applied by the company, theirprojected impact and how managementwould seek to mitigate these. Perhapsthe greatest challenge is how toreconcile this analysis to other capitalmeasures and performance metrics.The benefits are the ability to provideanalysts and stakeholders with a clearview of how value is being created withinthe business and how various riskscould affect this.

Less is more

Stakeholder communications underSolvency II are likely to be extensiveand demanding, yet the benefits areuncertain. For all companies, the bestway forward will be a pragmaticapproach that addresses what wouldbe of real value to different stakeholdersand directs attention to genuinelyrelevant information about the firm’s riskand capital management. Market-leading companies are likely to take thisfurther by developing metrics that bridgerisk and performance and seeking toprovide a clear explanation of how thisaffects the management and strategyof the company.

PricewaterhouseCoopers Countdown to Solvency II: giving you the edge

Giving you the edge

PricewaterhouseCoopers is helpinga range of insurers to get to gripswith the practicalities of Solvency IIimplementation. If you would like toknow more about how to developeffective communications in aSolvency II world, please contact:

Mark BattenPartnerPricewaterhouseCoopers (UK)+44 (0) 207 804 5635mark.c.batten@uk.pwc.com

Brian PurvesPartnerPricewaterhouseCoopers (UK)+44 (0) 207 212 3902brian.purves@uk.pwc.com

www.pwc.com/solvencyIIPricewaterhouseCoopers (www.pwc.com) provides industry-focused assurance, tax and advisory services to build public trust and enhance value for our clients and their stakeholders. More than163,000 people in 151 countries across our network share their thinking, experience and solutions to develop fresh perspectives and practical advice.

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