While the primary focus of preparations for Solvency II within many companies has been Pillar 1 and 2, it is important not to lose sight of the Pillar 3 disclosures. As we discuss in this article, planning and implementation for the three pillars should ideally go hand in hand. If companies leave Pillar 3 to last, the required disclosures may throw up unwelcome surprises that they do not have time to adequately manage.
Figure 1 outlines the key elements of the Pillar 3 disclosures. The combination of qualitative and quantitative reporting is divided into publicly available Solvency and Financial Condition Reports (SFCR) and confidential Reports to Supervisors (RTS). Figure 2 sets out the prescribed format. Much of the underlying analysis and information used in the SFCR and RTS will be drawn from a firm’s Own Risk and Solvency Assessments (ORSA) and its financial statements.
Consultations over the implementation measures for supervisory reporting and public disclosure (CP58), which were held during the summer of 2009, revealed considerable industry concerns about the extent of the demands and the resulting workload. However, the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) has changed very little in the draft advice presented to the European Commission. Although the reporting requirements are meant to be proportionate to the nature, scale and complexity of the entity, smaller firms may still be expected to follow an extensive standard template for disclosure, much of which may not be relevant.
The disclosure regime is also likely to be especially tough on groups as they will have to prepare SFCR and RTS both for the business as a whole and for each standalone entity. As Figure 3 outlines, much of the information could be subject to external audit.
Insurers will need to do more than simply throw data on to a page. In relation to internal models, for example, CP58 states that ‘the level and depth of information to be publicly disclosed shall be based on the principle that a knowledgeable person can get a reasonably good understanding of the design and operational details of the internal model as well as to the reliability of the internal model’.
Although firms will be able to make use of equivalent information contained in other statutory reports, in particular their financial statements, the alignment with and divergence from IFRS/local GAAP disclosure will be a challenge. While the approach to the measurement of liabilities under Solvency II and the planned IFRS for insurance contracts is heading in the same direction, there are crucial differences in scope (e.g. inclusion of investment contracts in Solvency II) and detail (e.g. intangible assets). Any inconsistencies are likely to be picked up and challenged by analysts.
A poll of more than a hundred insurance professionals carried out by PricewaterhouseCoopers in November 2009 found that most were mindful of the wide-ranging implementation challenges presented by Pillar 3.[1] When asked whether they see the main challenge as being the volume of information required, appropriate messaging, the ability to generate new splits of data or the consistency and comparability with other forms of reporting, more than 60%25 said ‘all of the above’.
1 PricewaterhouseCoopers polled 120 insurance professionals at a seminar held in London on 30.11.09.
Although it is possible that the European Commission may choose to water down some of the proposed requirements, the key planks are already embedded in the binding framework legislation. Any major easing may also run counter to many governments’ desire for greater transparency in the aftermath of the financial crisis (the exception may be smaller firms, where a relatively brief, yet relevant summary of the RTS may be more appropriate than the full template envisaged under current proposals).
Given the potential scale of the demands, it is therefore perhaps surprising how little attention has been devoted to Pillar 3. PricewaterhouseCoopers’ poll of insurance professionals found that more than 70%25 had not begun to develop an external communication strategy for Solvency II and nearly 30%25 had given Pillar 3 no consideration at all. Respondents are focusing on other priorities. Nearly 50%25 of participants said that most of their time and effort over the next 12 months would be devoted to developing an internal or partial model and 28%25 said their principal priority would be developing and implementing their risk management framework. Less than a quarter would be concentrating on defining their reporting requirements.
It is easy to see why insurers might want to assess the main implications of Solvency II before turning their attentions to communications.
For example, many companies are looking at how the risk-based regime might affect the capital efficiency of guaranteed products such as annuities. Even those firms that have put Pillar 3 on the agenda may also be uncertain about what exactly is required. However, it is important to bear in mind that certain aspects of Solvency II, such as the design of the internal model and development of management information, could have a significant bearing on how the firm discloses information under Pillar 3. As we noted earlier, it is therefore important that Pillar 3 requirements are part of any Solvency II implementation plan from the beginning. While half of the insurance professionals in our poll would like clearer guidance on the supervisory expectations for SFCR and RTS disclosure and 34%25 would like more guidance on what an ORSA should look like and how it should be presented, this should not be a reason for a firm to put Pillar 3 completely out of the picture.
The importance of a clear and well-prepared communications strategy cannot be underestimated, not least as insurers will need to leave sufficient time to discern how their company will come across under Pillar 3 disclosure, anticipate the differences between reporting bases and ensure that senior management are comfortable with the results. Reporting requirements will also have an important influence on the development of models and the application of a risk-based regime.
Clearly any approach needs to assess stakeholders’ expectations and how the solvency and financial reporting requirements interact, before determining the key messages and their likely impact (see Figure 4). Further considerations include how to align Solvency II with the existing IFRS 7 disclosure and how to make the most of the synergies between Solvency II and the proposed IFRS for insurance contracts (‘not digging up the road twice’), while anticipating and managing the differences. Views on the desired level of consistency between IFRS and Solvency II are noticeably mixed. While a third of participants in our poll felt that the International Accounting Standards Board should be aiming for as much consistency as possible to reduce the reporting burden, nearly half would only favour consistency where it is practical and does not result in an inappropriate reflection of profit.
Disclosure may have become the forgotten pillar as firms focus on the development of their modelling capabilities and risk management frameworks. However, given the weight of demands and level of market scrutiny, a strategic approach to communications is essential. The foundations are an assessment of what information is material, what particular stakeholders expect, what messages would improve their understanding of the company and how these could best be conveyed.
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