Summer 2012

Insured Interest
Insurance
PRECISE. PROVEN. PERFORMANCE.

Internal audit set for wider role in governance reviews?

Internal audit has a vital role to play in providing independent assurance that an organisations risk management, governance and internal control processes are operating effectively.
Internal auditors deal with issues that are of fundamental importance to the survival and prosperity of any business. For example, at present, many internal audit functions are playing a key role in validating the progress of insurance firms towards Solvency II compliance. It is our view that internal audit may have an even bigger role to play in the postSolvency II environment, if certain challenges can be overcome. The FSA has been using skilled persons reports with much greater frequency in recent years. Such reports can be commissioned in those cases where the FSA identifies a problem, or a potential problem, within a particular firm, and commissions an experienced professional to conduct a ground-up review. Indeed, in April 2012, the FSAs Julian Adams (Director of Insurance Supervision, Prudential Business Unit) noted that we should expect the Prudential Regulation Authority to make greater use of such reviews, where it is the most appropriate way to address a particular risk. We see no reason why suitably resourced, independent, qualified and robust internal audit functions cannot perform such reviews. Several years ago, the then CEO of the FSA, John Tiner seemed to agree with this view. When discussing the role of internal audit, he indicated that where the internal audit function was strong the FSA may seek to rely on the oversight of internal audit rather that requiring a prolonged supervisory visit. They may also rely on internal audit for special work rather than calling on a skilled persons report. There are some provisos, however. At present, many internal audit functions lack the full range of required skills, not least the actuarial expertise, necessary to undertake such reviews. There is also a resource issue, with recruitment in the marketplace made difficult by a lack of available skilled practitioners. The talent pool becomes smaller still when firms are looking for people who can combine knowledge and experience of both internal audit and the insurance industry. In addition independence of the function needs to be strong. These are problems which can be overcome, however, for example, by using appropriate outsourced internal audit providers to either perform selected tasks or to undertake the internal audit function in its entirety.
gary.oliver@moorestephens.com

Inside
Independent validation sits at the heart of the model approval process.
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The path for those who pass through the gateway could be something of a minefield.
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Internal audit will need access to a wide range of skills in order to carry out audit work in the post-Solvency II environment. It will also need to be able to demonstrate a robust, risk-based approach if the regulators are to place reliance on its work.

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Internal models need bespoke independent validation

Building and implementing a robust internal model is just one part of the challenge facing the insurance industry under the FSAs Internal Model Approval Process (IMAP). Obtaining independent validation of the model is quite another. With Solvency II due to enter into force on 1 January, 2014, time is of the essence.
Independent validation sits at the heart of the model approval process. Validation applies to all aspects of the model, including the modelling process, statistical and data issues and the governance process around it. It is a broad concept not just focusing on the calculation kernel but encompassing both the quantitative and qualitative aspects. Moreover, it is not a one-off requirement. The FSA, together with other regulators, requires that internal models be reviewed on an ongoing basis, to take account of changes after initial validation. Validation is a bespoke undertaking. Requirements will vary from firm to firm, depending on volume and complexity of business, among other things. Validation cannot be carried out overnight. Nor can
david.edison@moorestephens.com

it be undertaken by those who have been involved in building and developing a firms model. Many firms lack personnel with the technical expertise to carry out validation and who fall within acceptable independence parameters, especially the scarce actuarial resource facing todays insurance industry. Internal model verification must be seen as an asset, not an imposition. It is not simply a question of meeting regulatory requirements. It is also about maximising commercial efficiency and maintaining a competitive edge. The services of firms able to carry out external independent reviews of internal models will be at a premium over the coming months.

CFC reform for better or for worse?

The UK governments long-awaited reform of the Controlled Foreign Companies (CFC) rules is nearing finalisation, with the draft legislation set out in Finance Bill 2012 awaiting parliamentary approval and royal assent within the next few months. The new regime is intended to make the rules easier for multinationals to operate from the UK. But, with the provisions in the Finance Bill running to no fewer than 112 pages, this may be a classic case of the devil being in the detail. The draft rules are designed to ensure that the profits of a CFC arising from genuine overseas activity will be outside the CFC charge. A new Gateway test will be introduced to specifically identify those CFC profits which are within the scope of the regime. Under the draft legislation, the CFC charge will only be on that part of a CFCs profits which are chargeable. This is in
michael.butler@moorestephens.com

contrast to the all or nothing approach under the old regime which required investigation of the CFC in its entirety, rather than just the constituent part or parts of it deemed to be deserving of closer inspection. There is no doubt that the offshore insurance captives of insurance companies based in the UK are among the main targets of the new rules. Neither can there be any doubting the governments overall intention to clarify the rules. What remains to be seen is whether, in so doing, it has made them infinitely more complex. The path for those who pass through the gateway could be something of a minefield.

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Solvency II as a business initiative

Solvency II is currently scheduled to be implemented in 2013 (with compliance by 1 January 2014) at an estimated overall cost to the industry of 2 billion.
But delay in the Omnibus II decision and parliamentary approval could push implementation into 2015, and there may be a transition period during which Solvency I and II rules run together. Lloyds has delayed submission of its model from April to July this year. Lloyds and the FSA are meanwhile maintaining their programme of activity. Insurance companies should take the delay in the same spirit. They should continue with their plans, using the extra time to resolve issues such as improving data quality, refining modelling, and further strengthening governance and risk management. Those businesses that have made an early start on compliance should already be seeing the benefits, such as more effective purchase of reinsurance, better capital efficiency, increased awareness of risk management, improved business understanding, stronger corporate governance, and improved reputation and competiveness. However, many firms are only reporting that they are feeling the heavy burden of regulation, rather than realising the benefits, and this may be because we are in a phase of frictional change. Much effort is going into the design aspects of building a Solvency II compliant framework without the opportunity to embed into the underlying business processes. Firms should take advantage of the delay and achieve business as usual as quickly as possible in order to accelerate the onset of some of the by-product benefits of Solvency II. They should see it as a business initiative, not purely a compliance one.
simon.gallagher@moorestephens.com

Those businesses that have made an early start on compliance should already be seeing the benefits.

Building on actuarial strength

The ability to deliver actuarial solutions has assumed significant importance in the insurance industry, largely driven by regulatory demands and, specifically, by the need to achieve Solvency II compliance. In order to help its clients meet the commercial and regulatory challenges that lie ahead, Moore Stephens recently recruited Keith Tucker, an experienced actuary with over thirty years experience working with companies involved in both general insurance and life business. Keiths role will be to support the development of Moore Stephens actuarial services to each of these sectors, Solvency II is the dominant driver behind the greater and more effective deployment of actuarial skills in the insurance industry. Moore Stephens aim is to develop still further its strong actuarial capabilities, which can be used both in a stand-alone capacity and as part of an overall one-stop-shop offering to the insurance industry, encompassing everything from audit to consultancy, from IT to data and risk management.
david.edison@moorestephens.com

and to further strengthen our Solvency II offering.

Moore Stephens is well-positioned to help the insurance industry use proven technology, as well as still-developing disciplines such as data mining and predictive analytics, to maximise business efficiency, identify commercial opportunities, and achieve regulatory compliance. The deeper you dig, the more of value you are likely to find.

Insurance

Insured Interest Summer 2012

Personal effects: Gavin Davey

Gavin Davey specialises in providing IT assurance services to both the Lloyds market and general insurers. He has extensive experience of all aspects of IT internal audit and statutory audit support services and, specifically, Solvency II data governance and integrity.
Gavin recently joined Moore Stephens as an IT audit director in the firms insurance team. His experience is not limited to the insurance sector, however. It embraces industries as diverse as oil and gas and gaming. But Gavin has specialised in insurance for a number of years, and is willing to bet that there will be continuing demand within the industry for the foreseeable future for IT assurance expertise. Gavin says, Limited resources may be devoted by many insurance businesses to IT assurance. The staff may lack the specialist IT audit skills which the regulators are increasingly demanding of market practitioners, and that is where an external IT audit specialist can add genuine value by taking the pulse of a business and helping it to move forward along profitable lines.
gavin.davey@moorestephens.com

Gavin says he has been impressed by Moore Stephens in his time with the firm to date. The people are very friendly, he explains. Everybody talks to everybody else, and there are no closed doors. As a newcomer, I have quickly been made to feel very welcome, and part of the team. Gavin and his wife run a smallholding in Peterborough which boasts three dogs, three sheep, four chickens and three horses. Gavin also enjoys maintaining his 18th century house, although he admits he has no choice in the matter because of the difficulty in finding tradesmen willing to take on any jobs. He is a Tottenham Hotspur fan, which means that there is little in the way of adversity and unfairness in any walk of life which is likely to break him.

Insurance glossary: F is for facultative

Facultative reinsurance is a form of cover whereby the original insurer decides what level of risk it is prepared to retain on any one policy without turning white. Then it offers to share the risk for a price (usually nil) with a reinsurer, which will then decide how much of the risk it wants to reinsure (always nil). You cant place facultative risks under an open cover. You just cant. Hannover Re recently came close when it announced that it was the first insurer to transfer a portfolio of facultative risks to the capital markets through a new sidecar venture. But nobody could understand what that meant, so nothing changes. Clearly identifying what you want to do with your sidecar should help to prevent a mistake such as buying a lightweight single-seater combination to achieve that lifelong ambition of taking your partner and children on a tour of the scenic alpine passes avoiding low bridges.
We believe the information in Insured Interest Summer 2012 to be correct at the time of going to press, but we cannot accept any responsibility for any loss occasioned to any person as a result of action or refraining from action as a result of any item herein. Printed and published by Moore Stephens LLP, a member firm of Moore Stephens International Limited, a worldwide network of independent firms. Moore Stephens LLP is registered to carry on audit work in the UK and Ireland by the Institute of Chartered Accountants in England and Wales. Authorised and regulated by the Financial Services Authority for investment business. DPS20186 June 2012.

It is a little-known fact, meanwhile, that facultative is an anagram of evict a fault. This is the basis of no-fault insurance, an attempt to take the fault out of liability. Nice try. You can take the liability out of fault, but you cant take the fault out of liability. No-fault laws vary greatly, but do tend to have some elements in common, particularly the absence of fault. Adjust risk appetite to suit.

For more information please go to: www.moorestephens.co.uk Follow us on Twitter: @MooreStephensUK