The adoption of the National Association of Insurance Commissioner's (NAIC) Risk Management and Own Risk and Solvency Assessment (RMORSA) model act has immediate implications for U.S. insurers. Now is the time for carriers to begin assessing how this newly passed legislation will affect their enterprise-risk-management (ERM) processes, as well as the value they can gain by integrating RMORSA's requirements into how they manage their businesses.
RMORSA's implementation represents a fundamental shift in the regulatory scrutiny of the insurance industry's ERM and capital-management practices. The act, which each jurisdiction now needs to adopt into state law, requires insurers to maintain a comprehensive risk-management framework embedded into company operations that covers current and prospective solvency positions under stressed scenarios.
A RMORSA is not just another insurance filing. For a regulator to accept one, the link between that assessment and the management of the business must be clear. But to maximize their business benefits, insurers should use the RMORSA to enhance the risk-to-reward aspects of insurance business management, both over a one-year and a longer time horizon.
ERM frameworks and RMORSAs are intimately related. An ERM framework formally describes the people, functions, risk appetites and limits, policies and processes that insurers use to identify and manage risk; a RMORSA assesses the resulting implications of the activities the company undertakes to manage risk. Taken together, the ERM framework and a RMORSA portray an insurer's Risk and Solvency Profile.
One element of preparing a RMORSA is the comparison of normal business analyses and metrics with stressed ones.
NORMAL-STATE ANALYSIS
At present, insurers focus heavily on measures and metrics from both sides of the balance sheet. Accordingly, many RMORSAs are likely to use profile analytics; however, there are risks associated with such analytics.
For example, data quality has a direct bearing on analytical effectiveness and consequent decision-making. It is imperative that the data extracted from source systems and used to prepare a RMORSA be validated by internal audit, regulators or external advisors.
The form in which the analytics are presented is also tricky. For example, insurers currently prepare many analytics on a net (of reinsurance and hedging) basis only. A lesson of the recent financial crisis is that both gross and net exposures should be subjected to analysis, as reinsurance assets and hedges may not return 100 cents on the dollar during extreme events.
Further issues can arise from how companies select measures and metrics to track and present risks. One currently popular method is the use of stress tests and scenarios.
STRESS TESTS & SCENARIOS
A stress test assesses the impact on key metrics due to changes in one or two select variables. While stress testing can be enlightening, it is heavily assumptions-dependent and often based on limited historical data. Therefore, if the chosen variables are not adequately stressed, the results will be of limited—if any—use.
Scenario analyses can offer more insight and take two general forms. The first is based on discrete realistic disaster scenarios, which are hypothetical extreme events based on realistic assumptions. These treat exposure interactions statically and are not forward-looking; this can limit their use in strategic activities like business planning.
By using strategic-scenario analysis, which starts with firm-specific risks and then identifies key uncertainties and trends of those risks upon which narrative scenarios are derived, these scenarios can be accumulated against, tracked and managed. This form of analysis creates different scenarios that are projections of different potential futures and can provide important milestones that can be tracked to determine if an event or trend is developing and how an insurer is responding to it.
Insurers that seize the opportunity the RMORSA offers to design or redesign their risk-management functions and processes will promote effective regulatory relations and help position their companies to better navigate the uncertainty of the current difficult market environment.
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