QIS5 - Too Good an Opportunity to Miss

Starting in August 2010, the fifth Quantitative Impact Study (QIS5), where the European Commission tests the proposed calibration of Solvency II, will be conducted.

The Commission hails QIS5 as the last, not-to-be-missed opportunity for European (re)insurers to have their voice heard concerning the design and calibration of Solvency II. They are hoping for a very high degree of participation and the FSA is equally keen for UK insurers to engage in this study.

Firms anticipating seeking internal model approval particularly need to carry out QIS5, in part because they will still need to disclose standard formula calculations for an initial period once Solvency II comes into force, but more importantly for UK firms, because the FSA has indicated that it is a pre-requisite for entry into their internal model approval process.

Insurers are facing two questions with respect to QIS5, namely:

• How will we organise our participation in QIS5?
• Are there ways to leverage QIS5 in the context of our Solvency II project, and use it as a step towards compliance? We have dubbed this QIS5+.

Organising your QIS5 participation

As a bare minimum, companies need to perform a number of steps to complete the QIS5 submission. Leveraging year-end processes and existing regulatory reporting, much of the required information can be gathered relatively easily for most jurisdictions.

Experience of previous QIS exercises shows that most firms create a small team, driven by actuaries involved in year-end reporting, to gather the necessary information, perform some additional calculations and complete the template spread sheets. Changes in the requirements have rendered a plain rerun of the QIS4 models impossible, as many adjustments are necessary.

The following steps need to be followed at a minimum:

• Collect relevant reports from the year-end process, e.g., annual report, liability adequacy test.
• Gather data to fill in the reporting templates.
• Gather policy data/model points needed for projections.
• Determine parameters and assumptions for the models.
• Review and where necessary adjust existing models from earlier QIS exercises.
• Perform calculations where existing results are insufficient.
• Use simplified methods where applicable.
• Complete and submit templates.

In view of existing workload, smaller firms sometimes find it challenging to squeeze extra work into the diaries of already stretched teams of professionals. Outsourcing QIS5 participation to a service provider is then an option, but in-house teams need to stay closely connected, to achieve the intended learning benefits of participation. Better still, the (re)insurer can free up time for in-house experts by (partly) assigning daily, routine work to junior external staff under their supervision. In-house experts are then freed up to take a leading role in the QIS5 participation, supported by some expert external advice. Deloitte has had good experiences with this kind of 'infusion' approach.

QIS5+: Leveraging your efforts

Participation in QIS5 represents an opportunity from at least two other perspectives. First of all, there is the process by which the QIS5 submission is prepared. The impact study offers an opportunity to design (if it has not been done already) and test the process by which the periodic Solvency reporting will be produced in the future. Secondly, QIS5 can be used to assess the availability and quality of the data needed to feed into actuarial calculations. Let's look at each of these points in detail:

Preparing the submission – process

Many (re)insurance firms view Solvency II compliance as, roughly speaking, being able to repeat the QIS5 simulation within the deadlines imposed by the legislation, at a quarterly or even monthly frequency and in a fully auditable way. Although this does not give due credit to the challenges raised by the second pillar (governance, ORSA), there is some truth in this way of looking at it. Indeed, at a high-level, the process is as follows:

• policy data needs to be extracted from commercial source systems and to be prepared for uploading into actuarial and risk calculation engines (market value balance sheet, SCR);
• parameters of a diverse nature (market data, risk characteristics, expenses, etc.) must be specified;
• actuarial and risk calculations must be performed; and
• the reporting itself (internal, external) must be produced.

Even from this broad overview of the process, it is clear that many different departments will be involved (IT, Finance, Actuarial/Risk) and that a clear, concise description of the roles and responsibilities of each is mandatory to make the 'close' process a smooth one. We recommend that even before starting QIS5, a process manual is prepared setting out, inter alia, the following information:

• A detailed listing of all tasks that need to be completed:

• Practical steps that need to be performed to complete each of these tasks (data sources, calculation tools, etc.).
• Roles and responsibilities (who is responsible for preparing, validating, signing off).
• Anticipated bottle necks, stumbling blocks and mitigating factors.
• Crucial dependencies impacting the critical path (X is needed before Y can be done, but is itself dependent on Z).
• Potential (internal) control points and reconciliations

Such a manual can then be tested during the QIS5 process itself and, taking in account lessons learned, can evolve into a reusable document for repeating the exercise in the future.

Clearly stating responsibilities at the outset also enhances awareness of Solvency II throughout the organisation, an important objective of participation in QIS5.

Data

We now turn to the question of data. From an IT perspective, the different steps in the Solvency II value chain can be visualised as follows:

• Based on the QIS5 data requirements, a 'data dictionary' can be built. That is an overview of all the data elements that need to be fed into the QIS5 calculations, even in the standard model approach. The building of such a dictionary is usually a structuring exercise, since it forces the company to think about the consistent definition of data elements in different source systems.
• Once data needs are inventoried, one can identify the different information sources available. Depending on the age of the source system, the quality of its content, and its future in the organisation, this readily provides information on the impact of Solvency II on the firm's IT strategy.
• Once extracted, data will typically need to be transformed before being uploaded into the actuarial and risk calculation engines (for example, translation of policy data into model points). Data quality needs to be assessed at this point, and missing data provided where needed. This latter point is a very delicate one, since it can significantly impact the outcome of the calculations. All this needs to be done by following rigorous, auditable procedures.
• Actuarial and risk calculations then need to be performed and reports populated. Can your current actuarial engines provide the required output? How will the output be archived for audit purposes? What other, internal management reporting can be generated using this information?

Conclusion

In short, participation in QIS5 offers a host of real life (rather than merely theoretical) opportunities to address Solvency II implementation in advance of the Directive coming into force. It is an opportunity too good to miss to assess your firm's readiness for Solvency II and to design and test some of the processes that you will need to have in place to achieve compliance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.