Will European Insurers' ERM Developments Continue Without A Solvency II Push?

Primary Credit Analyst: Miroslav Petkov, London (44) 20-7176-7043; miroslav.petkov@standardandpoors.com Secondary Contacts: Charles-Marie Delpuech, London; charles.delpuech@standardandpoors.com Oluwatosin S Adesiyan, London (44) 20-7176-3279; oluwatosin.adesiyan@standardandpoors.com Olivier Karusisi, London; olivier.karusisi@standardandpoors.com

Table Of Contents
Solvency II Instils ERM Discipline Companies Adopt A More Sophisticated Approach To SRM Insurers Improve Their Understanding Of Cat Models Low Interest Rates Test The Effectiveness Of Life Risk Management Good ERM Practice Spreads To The Gulf Companies Move To Plug ECM Deficiencies Criteria Update Brings Changes In Our ERM Assessments Will Insurers Be Tempted To Take Their Foot Off The ERM Pedal? Related Criteria And Research APPENDIX: Breakdown Of EMEA Insurers' ERM Scores In 2013

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European insurers have made great strides in improving their enterprise risk management (ERM) frameworks and practices. For many companies, those improvements have been driven largely by the arrival of the Solvency II Directive. However, the delay in the start date of Solvency II has prompted some insurers to rein back their risk management efforts--a development that could adversely affect Standard & Poor's Ratings Services' assessments of their ERM activities. Over the past two years we've observed continuing improvement in the ERM frameworks of insurers in Europe, the Middle East, and Africa (EMEA). In particular, we note further improvements in the management of risk appetite and the use of economic capital models (ECMs) for decision-making. Overview The EU's Solvency II Directive has spurred insurers across Europe to improve their risk management practices. Among the improvements are greater control of risk appetite; better governance and reporting; and the use of economic capital models. However, the delayed start date of Solvency II has prompted some insurers in the region to reduce their efforts in developing ERM. Should this trend take hold, our ERM assessments on European insurers could be negatively affected.

Solvency II Instils ERM Discipline

Notwithstanding its delayed introduction, Solvency II remains a major driver of ERM improvements in Europe. In our view, the Directive has firmed up insurers' approaches to risk appetite, risk governance, and risk reporting, along with their application of internal models. The introduction of the Own Risk and Solvency Assessment (ORSA) process, for instance, has helped to embed risk appetite in insurers' operations. And we now see more detailed and focused risk reporting. More importantly, Solvency II has brought risk management to the fore in insurers' strategic planning. This is one of the main factors behind our upwardly revised ERM scores for a number of insurers. However, following the delayed start date for Solvency II, we note that some insurers have reduced the pace of their risk management developments. We will monitor the effect that this delay may have on the role of ERM in the management of insurers, particularly if the delay is extended. We would view negatively any evidence of a reduced role for economic capital in insurers' capital management arising from the delay. In our opinion, insurers should consider both regulatory and economic capital positions in their capital management decisions. We believe the real value of ERM arises when insurers develop their risk management not only because it is a regulatory requirement, but also because they believe it delivers more effective management of their business. The

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delay of Solvency II could therefore help us identify companies committed to developing their risk management framework and managing their business on an economic basis. If we find that the delay of the Directive diminishes the role of ERM among certain insurers, we may review their existing ERM assessments.

Companies Adopt A More Sophisticated Approach To SRM

Compared with our previous report on ERM (see "Embracing Enterprise Risk Management Makes A Difference For Insurers In EMEA," published June 16, 2011, on RatingsDirect), we see a more widespread application of economic pricing frameworks and the use of models for strategic decisions such as designing reinsurance programs. In our view, these developments have improved insurers' strategic risk management (SRM) capabilities, an important component within our ERM assessment. We see more extensive development and use of pricing adequacy monitoring systems for both life and non-life business. We consider these systems to be important for insurers to optimize their risk/return profile, which is one of our main considerations when assessing SRM. Insurers use these systems to assess the optimal profitability of their businesses. We now note that many companies have enhanced their systems by improving the consistency with which they measure the profitability of different business lines relative to internal targets. Helped by improvements in the allocation of capital, this affords greater accuracy in determining the cost of capital in these internal targets. Our assessment of pricing adequacy systems does not just focus on their level of sophistication. More importantly, we assess how insurers use these systems to improve the risk/return profile of their business by enforcing adequate pricing relative to the specific risk and capital characteristics of different lines of business. We also assess how insurers monitor underwriters' performance and address underperforming lines of business. We recognize that there are difficulties in developing and applying such systems in practice, and in our discussions with insurers we focus on how they allow for the limitations of those systems. We observe that some insurers are using more sophisticated approaches for designing their reinsurance programs. A number employ internal models to regularly assess the value of these programs and optimize their risk/return profile. These assessments aim to measure an insurer's own view of its risk exposure against current market conditions to manage its risk profile relative to its risk appetite, while at the same time optimizing the costs and benefits of the reinsurance protection. Also, some insurers have been utilizing the widespread availability and value of alternative risk transfer instruments such as ILS and side cars. While we accept that qualitative considerations, such as stability in the reinsurance program and the importance of maintaining a good relationship with reinsurers, remain key, we view positively the increasing use of sophisticated quantitative analysis in designing those programs.

Insurers Improve Their Understanding Of Cat Models

The arrival of Solvency II has led to an increased focus on the use of third-party models, and particularly catastrophe (cat) risk models. Under the Directive, insurers must demonstrate extensive understanding of such models. This is particularly relevant for those insurers that do not license these models and typically rely on brokers to assess their cat risk exposure. We note that insurers have strengthened their governance in respect of the results provided by brokers

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or consultants. Also, they have broadened the extent of their review and will proactively challenge the modeling results. However, despite these improvements, we consider that using a third party to run the cat risk model limits an insurer's understanding of the model. Thus it's less likely that we will view the cat risk controls of such insurers as positive. The increased disclosure from cat risk modeling companies gives insurers the opportunity to further improve their understanding of those models, perform their own validation, and ultimately apply the necessary adjustment to ensure that the models are appropriate for their risk profiles. We observe variable standards of validation at present, but anticipate that over time insurers will considerably improve their knowledge of the models. Nevertheless, we recognize that despite the improved disclosure, a significant part of the workings of the models will remain confidential and this will limit the insurers' level of understanding of those models.

Low Interest Rates Test The Effectiveness Of Life Risk Management

In Europe, low interest rates test the life insurance industry and the effectiveness of insurers' risk management. In this environment, some traditional savings products that include long-term financial options and guarantees are not economically viable. The introduction of Solvency II with its economic valuation of liabilities originally provided some impetus for redesigning those products. However, due to the delay of the Directive and the likely introduction of a transitional measure in the valuation rules (see "Europe's Insurers Welcome EIOPA's Assessment On Long-Term Guarantees, But Solvency II Uncertainty Remains," published July 31, 2013), insurers' risk management and economic value considerations are likely to become major influences on any changes in the design of these products. Understandably, insurers will need to weigh those considerations against the customer demand for traditional products. A crucial test for the effectiveness of insurers' risk management is whether they will have the will to discontinue or redesign such products in the face of this pressure. Should we find that insurers continue to write business on an uneconomic basis because of this market pressure, it is likely to have a negative effect of our view of their SRM.

Good ERM Practice Spreads To The Gulf

Historically, risk management capabilities have been an area of a weakness within the rating profile of some Gulf insurers. However, insurers in the region have recognized that they need to improve their risk management capabilities and the leading companies are working on developing ERM frameworks consistent with those of their European peers. In this respect, we've observed improvements in insurers' risk management governance and development of risk policies and risk appetite. However, many companies lack local resources so make use of consultants to develop certain elements of their risk management frameworks. In our ERM assessment for those companies, we will focus on how they demonstrate ownership of their risk management. In particular, if insurers buy ERM "off the shelf," we will review to what extent the programs are suited to their risk profiles. Market and real estate risk management are areas that have generated material losses for some Gulf insurers in the past. More recently, insurers in the region have improved the assessment of their market risk exposure and have

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clarified and established their tolerance to market risks. Nevertheless, in our view, bigger challenges lie ahead for many companies in improving their underwriting risk management because they have historically relied on reinsurers for their pricing and risk limits. While we view positively the ERM improvements of Gulf insurers, we believe that even the market leaders will take several years to develop and embed a risk management framework that is on a par with their European peers.

Companies Move To Plug ECM Deficiencies

Since our initial report on the findings of our ECM assessments (see "A Review Of Europe's Economic Capital Models For Insurance: What's Differentiating The Good From The Basic?," published June 26, 2012), we have assessed the ECM models of a considerable number of the insurers that are eligible for those reviews. (They must have an ERM assessment that is "strong" or better [see "A New Level Of Enterprise Risk Management Analysis: Methodology For Assessing Insurers' Economic Capital Models," published Jan. 24, 2011].) Based on our surveillance of the models we reviewed in our previous report, we note that insurers have moved to address the relative weaknesses in the models' frameworks, governance, and validation. Indeed, validation is an area where we see a material improvement, although we believe further improvements may be required before we can raise insurers' "M-factors." (The M-factor indicates our level of confidence in the results of an insurer's ECM compared with the results of our risk-based capital model.) We also find that insurers have improved their understanding of cat risk models, helped by the improved disclosure from cat risk model providers (as discussed above). Otherwise, the main findings of our previous review of ECM have not changed, namely: Solvency II remains a major force behind ECM model developments in Europe; We observe "good" modeling (according to our ECM criteria) for insurer's largest risks; and The main modeling difficulties are in the allowance for risk dependencies--particularly with regard to their calibration--due to the lack of sufficient and relevant data; and the modeling of the long-term financial exposure of life business.

Criteria Update Brings Changes In Our ERM Assessments

In May 2013, as part of our updated insurance criteria, we revised our ERM criteria (see "Enterprise Risk Management," published May 7, 2013) and ERM score classification. The subfactors of our ERM analysis--Risk Management Culture, Risk Controls, Emerging Risks Management, Risk Models, and Strategic Risk Management--remain the same. Prior to May 2013, we assigned subscores of "excellent," "strong," "adequate," or "weak" to each of these subfactors. These four subscores are now replaced with three classifications: "positive," "neutral," and "negative." Our overall ERM assessments were previously classified as "excellent," "strong," "adequate with positive trend," "adequate with strong risk controls," "adequate," and "weak." Under the new criteria, we classify insurers' ERM scores as "very strong," "strong," "adequate with strong risk controls," "adequate," or "weak." The highest ERM score is now "very strong," replacing "excellent," and we no longer have the classification "adequate with positive trend."

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Will European Insurers' ERM Developments Continue Without A Solvency II Push?

We assess as "very strong" those companies that have positive assessments across all elements of our ERM analysis (Risk Management Culture, Risk Controls, Risk Models, Emerging Risk Management, and Strategic Risk Management), and that have at least a good assessment for their internal capital model. Since our previous report on ERM in EMEA in 2011, the main change is that there are now insurers in the highest ERM category. We now assess six companies as having "very strong" rather than "strong" ERM frameworks (see table 1, chart, and Appendix). This reflects our view of these companies' ECMs and their ERM assessments under our revised criteria. Overall, there is an increase in the total number of "strong" and "very strong" scores, which reflects our view of the improvements in insurers' ERM frameworks. We revised upward our scores for three insurers to "strong," mainly due to our revised SRM subscores. Also, there is an increase in the number of "adequate with strong risk controls" scores, reflecting our view of the improvements in risk controls and that the insurers that were assessed as "adequate with positive trend" are now assessed as "adequate with strong risk controls." Despite the increase in the three categories, we observe a relatively stable distribution of ERM scores. This is because the increase is balanced by our assessments of newly rated insurers, the majority of whom carry an "adequate" ERM score.
Table 1

Migration Of EMEA Insurers' Enterprise Risk Management Scores In 2013 Versus 2011
2013* Adequate (with strong controls) 1 8

2011 Strong Adequate (with positive trend) Adequate (with strong controls) Adequate Weak Not assessed Total *As of Oct. 18, 2013.

Very strong 6 0

Strong 13 2

Adequate 0 1

Weak 0 0

Total 20 11

12

15

0 0 0 6

0 0 0 16

8 0 3 32

82 4 17 106

0 4 2 6

90 8 22 166

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Will European Insurers' ERM Developments Continue Without A Solvency II Push?

Among our rated portfolio, reinsurers and London market companies have the strongest ERM capabilities. This reflects their significant investments and the focus of management in this area, driven by the more challenging risk environment that these companies operate in. Insurers' ERM assessments in Eastern Europe, the Middle East, and Africa (EEMEA) remain generally lower than those of their Western European peers. At present, we assess no EEMEA insurer's ERM as "strong" or "very strong." Although these insurers are enhancing their risk management frameworks, we believe the improvements lag behind Western European insurers that have been using ERM in decision-making for a longer period. That said, the improvements in these insurers' ERM practices has led to a reduction in the number of "weak" scores (see table 1).

Will Insurers Be Tempted To Take Their Foot Off The ERM Pedal?
Looking ahead, we believe insurers' ERM practices will continue to improve. However, we will closely monitor how the delay in Solvency II affects the speed of ERM developments. Companies could use this period to apply ERM improvements that benefit their business. Equally, they could sit back and wait until the regulator forces them to act, thereby diminishing the role of ERM in managing their insurance operations. Evidence of the latter could negatively affect our ERM assessments.

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Related Criteria And Research

The articles listed below are available on RatingsDirect. Enterprise Risk Management, May 7, 2013 A Review Of Europe's Economic Capital Models For Insurance: What's Differentiating The Good From The Basic?, June 26, 2012 Embracing Enterprise Risk Management Makes A Difference For Insurers In EMEA, June 16, 2011 A New Level Of Enterprise Risk Management Analysis: Methodology For Assessing Insurers' Economic Capital Models, Jan. 24, 2011

APPENDIX: Breakdown Of EMEA Insurers' ERM Scores In 2013

Our group ERM assessments apply to all core and highly strategic subsidiaries. The group ERM assessment also applies to strategically important subsidiaries where we have assessed their ERM as being fully integrated with that of the group. All those subsidiaries are not included in the table.
Table 2

Breakdown Of Rated EMEA Insurers' ERM Scores In 2013*

Strongest To Weakest Company name Allianz Group Aspen Insurance Holdings Ltd. Hannover Rueck SE Munich Reinsurance Co. Royal & Sun Alliance Insurance PLC Swiss Reinsurance Co. Ltd. AEGON N.V. Allianz Risk Transfer AG Amlin PLC AXA Basler Versicherung AG Catlin Group Ltd. Gard P&I (Bermuda) Ltd. Hiscox Insurance Co. Ltd. If P&C Insurance Ltd. (publ) ING Verzekeringen N.V. Lloyd's Prudential PLC SCOR SE Scottish Equitable PLC Talanx AG Zurich Insurance Co. Ltd. ERM score Very strong Very strong Very strong Very strong Very strong Very strong Strong Strong Strong Strong Strong Strong Strong Strong Strong Strong Strong Strong Strong Strong Strong Strong

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Table 2

Breakdown Of Rated EMEA Insurers' ERM Scores In 2013* (cont.)

Allianz PLC Allianz Worldwide Care Ltd. Alte Leipziger Lebensversicherung a.G. Assicurazioni Generali SpA Aviva PLC Canopius Managing Agents Ltd. - Syndicate 4444 Ceska pojistovna a.s. Deutsche Rueckversicherung AG Ecclesiastical Insurance Office PLC Friends Life Group PLC Gjensidige Gothaer Insurance Group Helvetia Insurance Group International General Insurance Co. Ltd. Irish Life Assurance PLC Legal & General Assurance Society Ltd. Mapfre S.A. MetLife Europe Ltd. The North of England Protecting & Indemnity Association Ltd. Royal London Mutual Insurance Society Ltd. Santam Ltd. SNS Reaal Verzekering N.V. St. James's Place U.K. PLC Standard Life PLC Sveriges Angfartygs Assurans Forening (The Swedish Club) Swiss Life AG Tryg Forsikring A/S Tryg Garantiforsikring A/S U K Insurance Ltd. VHV Vereinigte Hannoversche Versicherung a.G. VIENNA INSURANCE GROUP AG Wiener Versicherung Gruppe Wuestenrot & Wuerttembergische AG Abu Dhabi National Insurance Co. (PSC) Achmea B.V. Aetna Health Insurance Company of Europe Ltd. African Reinsurance Corp. African Trade Insurance Agency AG2R Prevoyance AGA International S.A. Ageas SA/NV Al Sagr Cooperative Insurance Co. Al-Ahleia Insurance Co. S.A.K. Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate, strong risk controls Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate

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Will European Insurers' ERM Developments Continue Without A Solvency II Push?

Table 2

Breakdown Of Rated EMEA Insurers' ERM Scores In 2013* (cont.)

Allianz Nederland Group Amlin Europe N.V. April Group S.A. The Arab Investment and Export Credit Guarantee Corp. ASR Nederland N.V. Assuranceforeningen SKULD (Gjensidig) Aviabel Cie. Belge d'Assurances Aviation S.A. Caisse Centrale de Reassurance CJSC Insurance Co. TRANSNEFT CNP Assurances Compagnie d'Assurances et de Reassurances Tuniso-Europeenne Compania Espanola de Seguros de Credito a la Exportacion S.A. Congregational & General Insurance PLC Covea Insurance PLC CSOB Pojistovna a. s. D.A.S. Delta Lloyd N.V. DEVK Doha Insurance Co. Q.S.C. Dubai Islamic Insurance & Reinsurance Co. (Aman) Energogarant JSIC Euler Hermes Group Eurasia Insurance Co. FIATC Mutua de Seguros y Reaseguros a Prima Fija y Sociedades Filiales Financial Assurance Co. Ltd. Garantia Insurance Co. Ltd. Generali PanEurope Ltd. Gulf Insurance Co. K.S.C. Hannover Reinsurance Africa Ltd. Hannover ReTakaful B.S.C. Ingosstrakh Insurance Co. Insurance Company Tsesna-Garant JSC Irish Public Bodies Mutual Insurances Ltd. Insurance Co. Kazkommerts-Policy JSC JSC Oil Insurance Co Kommunal Landspensjonskasse Kuwait Reinsurance Co. K.S.C. La Mondiale Lansforsakringar Sak Forsakrings AB LEXGARANT Insurance Co. Ltd. Lion of Africa Insurance Co Ltd. Liverpool Victoria Friendly Society Ltd. Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate

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Will European Insurers' ERM Developments Continue Without A Solvency II Push?

Table 2

Breakdown Of Rated EMEA Insurers' ERM Scores In 2013* (cont.)

Lloyds Banking Group Life Insurance Operations Malath Cooperative Insurance & Reinsurance Co. Mediterranean & Gulf Cooperative Insurance and Reinsurance Co. Millenniumbcp Ageas Grupo Segurador S.G.P.S. S.A Milli Reasurans T.A.S. Moscow Reinsurance Co. Nacional de Reaseguros S.A. National General Insurance Co. (PSC) Nationale Borg-Maatschappij N.V. Noor Takaful Family PJSC Noor Takaful General PJSC Norwegian Hull Club Novae Group PLC Nuernberger Beteiligungs-AG OJSC Sogaz Oman Insurance Co. (PSC) Oman United Insurance Co. S.A.O.G. Orient Insurance P.J.S.C. OSAO RESO Garantia Pinnacle Insurance PLC Polskie Towarzystwo Reasekuracji S.A. Pomosch Insurance Company Ltd. Powszechny Zaklad Ubezpieczen S.A. Pozavarovalnica Sava d.d. PRI Pensionsgaranti Mutual Insurance Co. Qatar Insurance Co. S.A.Q. Rosgosstrakh OAO Salama/Islamic Arab Insurance Co. (P.S.C.) Saudi National Insurance Co. Saudi Re for Cooperative Reinsurance Co. Shipowners' Mutual Protection & Indemnity Association (Luxembourg) The Shipowners' Mutual Strike Assn. (Bermuda) Ltd. SIAT - Societa Italiana Assicurazioni e Riassicurazioni SpA Sirius International Group Ltd. Societa Cattolica di Assicurazione Societe Centrale de Reassurance Societe Centrale Prevoir The Steamship Mutual Underwriting Assn. (Bermuda) Ltd. Storebrand Livsforsikring AS Sunderland Marine Mutual Insurance Co. Ltd. Takaful Re Ltd. Tawuniya/The Company for Cooperative Insurance Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate Adequate

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Table 2

Breakdown Of Rated EMEA Insurers' ERM Scores In 2013* (cont.)

The Standard Club Europe Ltd. West of England Mutual Insurance Association (Luxembourg) Towarzystwo Ubezpieczen i Reasekuracji WARTA S.A. Triglav Insurance Co. Ltd. Tryggingamidstodin hf. Unipol Group UNIQA Insurance Group AG Adequate Adequate Adequate Adequate Adequate Adequate Adequate

The United Kingdom Mutual Steamship Assurance Association (Bermuda) Ltd. Adequate UNUM Ltd. Versicherungskammer Bayern Versicherungsanstalt des oeffentlichen Rechts Wataniya Insurance Co. Weqaya Takaful Insurance & Reinsurance Co. Al Buhaira National Insurance Co. (PSC) Belarusian National Reinsurance Organization Doha Bank Assurance Co. LLC Grain Insurance Co. JSC Warba Ins. Co. K.S.C. Wethaq Takaful Insurance Co. K.S.C. (Closed) Adequate Adequate Adequate Adequate Weak Weak Weak Weak Weak Weak

*As of Oct. 18, 2013. EMEA--Europe, the Middle East, and Africa. ERM--Enterprise risk management.

Additional Contact: Insurance Ratings Europe; InsuranceInteractive_Europe@standardandpoors.com

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