Every step along the way EIOPA tightened some of the rules, with the upcoming January 1st date presenting the final model that insurance companies and pension funds need to implement.
Solvency II consists of three areas of focus, each called a “pillar”:
- Pillar 1 consists of quantitative requirements.
- Pillar 2 provides the requirements for governance and risk management.
- Pillar 3 looks at reporting.
Solvency II therefore is both an IT challenge, an administrative challenge, and an organizational challenge.
Let’s focus on the IT aspects here. Pillars 2 and 3 are all about the organization and the oversight. Much of this is about internal procedures and checks by compliance authorities. This is supported by IT, but this can be done through existing operations. The first pillar, though, has massive IT consequences. Pillar 1 forces insurance companies and pension funds to make highly accurate calculations about the amount of capital they need to retain given the risks and liabilities they have. This involves intense IT support, so as to calculate quickly and accurately. Hold back too much funding, and you’re hurting your bottom line. Hold back too little, and you’re exposed to risks you can’t afford.
While preparing for the quarterly or annual reports, risks and risk reserves will need to be recalculated many times over. These are massive models that tend to run not for hours, but in many cases even for days (!). Last minute changes can be very hard to implement if your models need to run for a day or so. Reducing the runtime of the models therefor is interesting for companies so as to remain flexible in making adjustments even at a late stage.
The challenge we face now, is that the market is not stable. Organizations are not stable. In fact, even legislation is not stable. Over time, also after January 1st, things will need to get adjusted. This means that gearing up for January 1st and leaning back when you’re ready for that date, may not be the best approach. A lot more will happen during 2016 and in the following years. Insurance companies and pension funds will need to organize themselves to absorb those changes as they come along. The bar will be set higher and higher over the following years, so intense calculations remain essential so as to stay compliant. The models will become increasingly complex, the lead times undoubtedly will become shorter (more “what if” scenarios in less time), the IT-power needed to run all this will become staggering.
Insurance companies and pension funds can decide to do all this in-house, and they will be looking at massively increased IT investments so as to be able to cope with peak demand. Given that these peaks take place only during limited time slots, this expensive IT investment (CapEx) not only will be idling for much of the time, it will also need to be added to pretty much on an ongoing basis. This racks up massive IT-costs. Flexible models, like e.g. cloud hosting of peak capacity, will allow for lower internal IT investments, and a shift of these expenses to OpEx that doesn’t burden a balance sheet. By building in this flexibility the company can also absorb increased pressure from authorities on modeling and reporting on an as-needed basis.
Starting January 1st 2016 EIOPA will check whether the insurance companies and pension funds are ready for Solvency II. And then the real work starts: EIOPA will gradually up the ante.
IT needs to be ready for January 1st, but then it will need to be ready for what’s to come…
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