Embracing the internal capital adequacy assessment process
Australian insurers are preparing for the introduction of the Australian Prudential Regulation Authority’s (APRA) new life and general insurance capital standards (LAGIC). The new standards are expected in early 2012. These will include the requirement for insurers to have an Internal Capital Adequacy Assessment Process (ICAAP). Under the proposed timetable, this will need to be in place from 1 January 2013.
LAGIC, which includes the ICAAP requirements, is part of a global drive to strengthen capital management within financial services organisations. It is similar to the Own Risk Solvency Assessment (ORSA) being introduced to insurers in Europe (under Solvency II), the US and Canada. It also aligns with the Basel II requirements for banks (APRA introduced the ICAAP to Australian authorised deposit-taking institutions in 2008).
The ICAAP will formalise the requirements for an insurer to assess its own capital needs and manage its own capital levels, based on its own unique business profile. APRA requires a clear link between business strategy, risk management and capital management.
APRA is not expected to mandate the format of the ICAAP, as it will be a principles-based, rather than rules-based approach. Therefore we are expecting to see a broad spectrum of results across the industry. As APRA expects the ICAAP to be embedded in the business, even the simplest ICAAP’s will need to be thought through to reflect the insurers approach to capital management.
The advantages
The ICAAP requires organisations to articulate, in one cohesive analysis, the risks facing their business, the risk management framework in place to address those risks and the capital required to support the risks being taken. This analysis will provide more transparency over the current risk profile and appetite, and provide the business with recommended actions to address future changes in the risk profile.
Strengthening the link between strategy, risk and capital, and understanding the options or levers available to the business under a future risk profile, will enable the organisation to act nimbly and gain competitive advantage in a stress event.
If the adoption of the ICAAP results in more business-aligned risk management practices, with risk functions working more closely with business units, the insurer will realise a better return on its risk management function, as it identifies strengths, weaknesses and best practice within its organisation.
The ICAAP should be a continuous, not an annual, process. The continuous dialogue between risk and business lines facilitates quicker response times to emerging risks and more effective communication of risk and risk management to the Board.
The ICAAP will require insurers to support capital forecasts through more advanced stress testing. Advanced models will allow for multi-dimensional scenarios and reverse stress testing. This will determine the impact of multiple events on the business, identifying the weaknesses/risks and areas of competitive advantage/resilience.
The ICAAP should be action-oriented, providing increased granularity of capital restoration options. Where capital constraints are identified, the ICAAP should identify the levers available, providing recommendations such as reallocation of resources and de-risking.
The challenges
It is acknowledged that the introduction of the ICAAP may increase regulatory burden on a business. The Board and senior management are expected to own this process. If not properly managed, attention may be diverted away from business as usual activities.
The ICAAP will need to be consistent with operations, so embedding it within the business and forcing management to consider the risk and capital implication of each business decision, will be one of the key challenge.
Investment may be required in more experienced staff, training, IT development, modelling and forecasting capabilities. All staff must be prepared and equipped and the Board must be involved and educated, so as to champion the evolution of the ICAAP for their organisation.
There will need to be effective communication between the key stakeholders. Management must present clear, compelling and relevant messages, to ensure that the business embraces the ICAAP, including integrating it with business operations to improve performance and efficiency.
The next step
It is important that ICAAP gets on the Board agenda early, so that a target end-state can be determined and a gap analysis conducted with a clear roadmap established. A best-fit solution will need to be determined for each organisation, supported by a cost-benefit analysis. It’s not a one-size-fits-all approach. The Board will need to demonstrate ownership of the establishment and maintenance of the ICAAP (including appropriate governance structure around the process), and be able to articulate the key elements and assumptions adopted.
Developing an effective ICAAP provides insurers with a critical tool, that is forward-looking, scans the horizon for emerging risks and identifies resolutions and contingency plans. It will provide certainty over capital strength and bring closer alignment of objectives across the business. Insurers should embrace the ICAAP process and view it as an opportunity to truly integrate risk, strategy and capital.
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- Insurance
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- Brian Grieg, KPMG
- Author:
- Brian Greig
- Article Posted:
- December 15, 2011
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