The impacts of Solvency II are expected to be far reaching and extensive across the enterprise, most certainly causing a flourish of activity within the actuarial and risk management departments, but what is the expected impact in the areas under the control of the CIO? My belief is that the answer to this question will be connected to the capital adequacy requirements of Solvency II.

Essentially there are two routes that an organisation can follow regarding capital adequacy models; these being use of a ‘standard mode’ or use of an ‘internal model’. The ‘standard model’ (as with most ‘one size fits all’ models) is inflexible in that it does not take into account diversification of portfolio or geographical spread, for example and consequently the capital adequacy requirements are breathtakingly high; so much so that they are arguably just not commercially viable. This leads to the second option, which is an ‘internal’ model. These need to be approved, but the upside is that they can take into account diversification and will lead to much more realistic capital adequacy numbers. The downside of these models is that they are voracious consumers of data, not just in terms of depth, there are quality considerations too. Now we begin to see where Solvency II starts to appear on the CIO’s agenda.

As a comparison we know from Basel II experience (the banking industry’s equivalent of Solvency II) that IT resources and budget should not be under estimated. The reality from Basel II is that the banks spent between 3 to 6 times more than they originally budgeted for and 70% of that spend was on IT. So, take whatever stunningly high number you have already thought of and multiply it a few times and then be prepared to hand most of it over to the CIO! Why is this? Quite simply, because there is considerable IT support needed to maintain these ‘internal models’ in terms of the provision of data to these models. Where the model lives or how it is technically implemented is of lesser consequence. The main area of investment is likely to be data extract and integration.

An area of focus for the regulators will be the quality of data used within ‘internal models’. Their ‘yard stick’ will be that it is: appropriate; complete and accurate. They will expect objective data quality measures. Another requirement will be that automated and manual adjustments are auditable. This means that the extensive manual keying of data will struggle to meet objective quality measure as the scope for error is much higher and the scope for un auditable adjustments is always present.

The other issue with relying on manual input of data is that Solvency II will demand not only quality improvements but also the amount of data needed may preclude manual keying from a commercial and scalability perspective. The FSA have already pointed out that in their opinion the quality and breadth of data held generally by the insurance industry is not sufficient to meet current requirements let alone meeting the increased demands of Solvency II. In the opinion of Steve Bell, a partner with Ernst & Young, “the London Market will face significant challenges in achieving compliance with Solvency II data quality requirements”. I think he has a point; London Market organisations have been very good at collecting financial data but are not so good at collecting all the supplementary data needed for risk management and supporting the capital adequacy models. The worst offenders here are binding authorities where financial information is often booked on an aggregated basis and no policy record is entered. This is understandable as binding authorities are great tools for distributing the capacity and diversifying into the small scale end of the market by ‘outsourcing’ marketing and processing to the broker/coverholder, but the margins on each policy do not allow manual recording of each policy by the carrier. To meet Solvency II this situation may need to change with demands for enhanced data capture to support th models. ‘Straight through processing’ will more and more play a role; I believe that it is the only chance the carrier has of being able to balance the demands of Solvency II with the commercial reality of processing costs. The policy and all its supplemental data needs to be captured once by the coverholder and made available to the carrier (and from the carrier onwards to their reinsurers or coinsurers). Clearly ACORD helps here in defining the standards that coverholders use, thereby mitigating the development effort needed within the carrier as data transform to a common view for upload is one of the biggest headaches in managing lineslips and binding authorities.

This issue raises another question: how do we affect change? Unilaterally or ‘market led’? Experience tells us that ‘market led’ is too slow in our particular market, therefore unilaterally would seem the answer. I think the broker has an opportunity to add value here in providing all the data the carrier needs in a standard, consistent and electronic form. I could even imagine brokers performing a transformation service for coverholders who are unable to provide the data in the required format.

Capturing all this extra data is an ‘end to end’ process, not just the domain of the actuary; inevitably underwriters and operations will also need to be involved. Solvency II data quality requirements will inevitably drive organisations to a position of needing to have a ‘single view of the truth’. Can organisations deliver that now? I would hazard a guess that the answer to that question is ‘no’. There are just too many data marts and spreadsheet extracts, not to mention the different interpretations placed on the data held.

Organisations should be identifying now the data they need to ‘feed’ their ‘internal models’ and uncovering the gaps in both depth and quality and putting programmes in place to address any gaps found. They should also be considering how that data will get into their systems in both an auditable and commercially viable manner. No doubt there will be a spectrum of readiness within the market, but if the banking experience is anything to go by the work involved in bringing everyone to a state of readiness will be more than we ever imagined.