By Tina Lasrado.
The European Union’s Solvency II Directive is often referred to as “Basel for insurers.” Under the directive, insurance companies must understand and actively consider their risk exposures to current and future investments over extended timeframes, and ensure they have sufficient capital reserves to cope with potential risks.
Solvency II is actually broader than the European insurance industry because it impacts the entire global buy-side of the value chain. Whenever an in-scope insurer outsources part of its asset management mandates to a third party, the related investment manager is then accountable for providing the portfolio data the insurance company must report to meet its regulatory obligations. In turn, asset-servicing firms that support the funds and insurers, such as custodian banks and fund administrators, will be called upon to provide much of the data needed to achieve compliance. Solvency II therefore requires a collaborative, community-wide effort, encompassing a range of skill sets, expertise and tools, in order that insurers are able to meet their regulatory obligations.
To address these issues, affected institutions must address a number of common challenges, including:
- Mapping risk exposure and building their internal risk models
- Following the Own Risk Solvency Assessment (ORSA) obligation
- Understanding asset and liability positions, so as to maintain adequate capital and liquidity levels to offset their risk exposure
- Providing transparency into the methodologies used to make complex calculations to demonstrate to regulators where the data comes from and how it was derived
- Maintaining a master set of data and updating it when necessary.
The key to compliance lies in timely, accurate and transparent pricing and reference data. Entity reference data supports the cross-asset roll up of investments and transactions with clients, industrial sectors, asset classes and countries. It is essential firms are able to link securities with their issuers and thereby report trading exposures, calculate capital requirements and ensure portfolio compliance. Given the regulatory burdens firms now face and the need for rapid and frequent reporting, it is vital that organisations can source and leverage the requisite data efficiently.
Solvency II seeks to tackle systemic risk by introducing more onerous capital adequacy ratios and modelling requirements, leverage and liquidity requirements to ensure insurance companies have sufficient reserves to cope with financial stresses.
To be compliant, insurers must:
- Undertake market-based valuations of their assets and liabilities on a security-by-security basis
- Calculate their Solvency Capital Requirement (SCR) and Minimum Capital Requirement (MCR)
- Profile their risk exposures out to a maximum of 120 years
- Map the necessary identification codes required for reporting purposes
- Obtain “look-through” data on funds and other investment structures to identify the ultimate asset and their resulting exposure
- Complete the Quantitative Report Template (QRT)
- Generate a composite rating or provide a Credit Quality Step (CQS)
Meeting this complex array of requirements presents insurers and their service providers (i.e. the third-party investment managers, fund administrators and custodian banks) with a host of data challenges.
Whatever the service support chain looks like – whether it is a Tier 1 insurer handling all the investment management and ancillary services in-house, or a smaller firm outsourcing some or all of these functions – the actual dataset required to achieve compliance will be the same. So what are the core data elements needed to meet your Solvency II responsibilities?
To power the capital adequacy calculations, risk mitigation, disclosure tools and workflows demanded by the directive, market practitioners need access to a comprehensive range of pricing and reference data capabilities:
- Classifications and Identifiers – Complete coverage of the CIC, LEI and NACE datasets, along with global ratings data to formulate the CQS.
- Fund Look Through – Insurance companies need full details of their holdings within each fund, in order to aggregate their exposure to assets held both directly and indirectly by those funds, and thereby optimize their capital requirements.
- Benchmark Curves – Solvency II-specific benchmark curves are needed to perform more accurate risk calculations, better manage capital adequacy requirements through accurate valuations, and assist in meeting the QRT reporting
Coverage, quality and timeliness of the requisite data will be essential. This means having access to prices for the full array of liquid and illiquid securities traded on listed markets, as well as timely and transparent pricing spanning the gamut of hard-to-value securities.
Full reference data coverage is similarly vital. For example, many of the Solvency II disclosure tests depend on proper instrument classification. This classification requires 11 different data elements, including name, duration, currency, maturity date and CIC. Other key content sets include identifiers to specify each issuer (such as LEI and issuer name), issuer sector, geography, collateral posted, and credit rating. Given the global nature of insurers’ portfolios, coverage across securities, issuers, and markets must be both global and able to support multiple code standard variations for cross-referencing.
As with other regulatory initiatives being introduced, Solvency II puts a premium on data quality in terms of the accuracy and reliability of data items, as well as clear provenance of the information used. Asset and liability valuations, which serve as the foundation for a firm’s risk assessment and capital adequacy calculations, are under particular scrutiny. Justifiable and auditable prices based on clear methodologies are now a must-have. In addition, the relevant data needs to be properly formatted and mapped to the QRT template to ensure accurate and timely reporting.
Ultimately, no single provider is likely to have a complete solution to meet all the data challenges industry participants will face. Instead a collaborative approach built on partnerships between data vendors, analytics providers, ratings agencies, asset servicers and the insurers themselves is essential for complying with Solvency II.