As part of its Solvency Modernization Initiative (SMI), theNational Association of Insurance Commissioners over the last 15months has been developing requirements for all insurance companiesregulated in the U.S. to conduct an Own Risk and Solvency Assessment (ORSA) and report theirenterprise risk management (ERM) practices and related findingsto their respective regulators.

The plan is moving forward. At the NAIC’s fall meeting in early November, an ORSA Guidance Manual outlining proposed risk-assessment andreporting guidelines was submitted by the Group Solvency Task Forceto the Financial Condition Committee.

Considering this progress, it is likely that a final reportingproposal will be adopted by the NAIC in some form in 2012. Withthat in mind, it’s helpful to gain a high-level overview of thissignificant proposed regulation and the issues likely to be fleshedout next year.

WHAT IS AN ORSA?

The ORSA concept requires every insurance company to carry out aregular assessment of all of its risk company-wide and evaluate itscurrent and likely future solvency position. The purpose ofimplementing an ORSA requirement is to help regulators understandhow insurers identify, assess, monitor and mitigate risk.

The NAIC ORSA Guidance Manual details the anticipatedrequirements for companies to perform their ORSA. As currentlyproposed, more specific analysis and reporting will need to beperformed as outlined within the “Form B” of the Insurance HoldingCompany System Annual Registration Statement of the NAIC’sInsurance Holding Company System Regulatory Regulation (No. 450).Proposed requirements include:

1. A detailed description of the company’s risk-managementpolicies.
2. Quantitative measures of risk exposures, “in normal andstressed environments,” requiring companies to perform complexmodeling.
3. An assessment of the company’s economic capital and prospectivesolvency for the entire insurance group, in addition toentity-specific calculations.

Through the ORSA process, each insurer determines the amount ofcapital it needs based on its own risk tolerance and businessplans. The company must also demonstrate that it can continue inbusiness over the next few years, even under stressedconditions—that is, assuming a range of adverse events orcatastrophes may occur.

KEY BENEFITS

The main thrust behind the ORSA initiatives has been the needfor regulators to gain greater insight into insurers’ financialstrength.

By requiring companies to implement robust ERMpractices and assess their capital needs in line with their uniquerisk portfolios, regulators hope to improve capital adequacy acrossthe industry—and perhaps hedge against potential futurecatastrophes and economic crises.

Adopting an ORSA requirement, regulators may also createfinancial incentives for companies to manage their risk. Down theroad, companies that can demonstrate solid risk-managementpractices could potentially benefit from more flexible capitalrequirements than what may be required by historical, fixed-dollarstatutory thresholds.

COMMENTS AND CRITICISMS

The NAIC’s original draft of proposed ORSA reportingrequirements was made subject to public comment through March. Morethan a dozen commentaries were provided from individual stateregulators and major industry organizations, including the AmericanCouncil of Life Insurers, the National Association of MutualInsurance Companies, and the Property Casualty Insurers Associationof America.

Many concerns have been raised with the proposed specificreporting requirements of Form B, expected to be onerous andchallenging for many insurers. The pure size and complexity of aformal report and the potential expense to produce it are immediateworries for hundreds of companies. As drafted, the proposal asksfor extremely broad information, which may be time-consuming anddifficult to answer accurately.

Another worry raised early in the year was the frequency andtiming of any filings. In particular, if an ORSA requirement isultimately transformed into a Model Act enacted on a state-by-statebasis, assessment results may have to be provided to multiplestates at different times of the year. Commentators urged the NAICto consider a uniform reporting system that will streamlineprovision of key data to either a home-state regulator or centraldedicated repository.

Proportionality, relevance to individual company size and lineof business, have also been at issue. While an insurer would beexempt from the ORSA requirement if it (a) has less than $500million in annual direct-written premium and (b) it is not a memberof a group of affiliated insurers that has $1 billion or more inannual direct-written premium, the draft manual, as written,applies to all companies and lines of business, regardless ofnature of underwriting risk assumed.

Despite concerns and criticisms, current ORSA proposals continueto move through the NAIC approval process, under the assumptionthat the cost and efforts to produce the risk analysis will be faroutweighed by the potential wide-ranging benefits.