At the heart of the prudential Solvency II directive, the own risk and solvency assessment (ORSA) is defined as a set of processes constituting a tool for decision-making and strategic analysis. It aims to assess, in a continuous and prospective way, the overall solvency needs related to the specific risk profile of the insurance company. Risk Management and own risk and solvency assessment is a similar regulation that has been enacted in the US by the NAIC. Other jurisdictions are enacting similar regulations to comply with the Insurance Core Principle 16 enacted by the IAIS.
Context
The second pillar of Solvency II plans to complete the quantitative capital requirements with quality requirements and a global and appropriate risk management system. The reform provides measures on governance, internal control and internal audit in order to ensure sound and prudent management practices from insurers. Impacts in terms of risk and solvency should supply into upstream strategic decisions. The internal assessment process of risks and solvency, known as the ORSA, is the centerpiece of this plan.
In an operational way, the ORSA is part of global process of enterprise risk management (ERM).
It is part of a cyclical and iterative system involving the board of directors, senior management, internal audit, internal control and all employees of the company. It aims to provide a reasonable insurance on compliance with the strategy of the company against risks.
The ORSA is voluntarily defined broadly by the regulation to encourage insurers to question themselves on the framework of an internal system dedicated to control and risk management. It must in all cases be succinct, easy to update and respect the principles of materiality and proportionality.
Regulatory references
Since 2003, Solvency II regulation follows the Lamfalussy process, which distinguishes 3 levels of measures, starting from the big principles to the enforcement measures necessary for the operational implementation. The ORSA regulatory update from the NAIC follows the Solvency Modernization Initiative aimed at updating the US regulatory system.
Solvency II
Level 1 measures
Level 1 text is the regulatory basis of the reform. It was adopted in 2009 on the same text by the European Parliament and European Council.
The ORSA is defined in Article 45 of the Directive.
Article 45 of Solvency 2 directive framework (extracts)
As part of its risk-management system every insurance undertaking and reinsurance undertaking shall conduct its own risk and solvency assessment.
That assessment shall include at least the following:
(a) the overall solvency needs taking into account the specific risk profile, approved risk tolerance limits and the business strategy of the undertaking;
(b) the compliance, on a continuous basis, with the capital requirements, and with the requirements regarding technical provisions;
(c) the significance with which the risk profile of the undertaking concerned deviates from the assumptions underlying the Solvency Capital Requirement.
Level 2 measures
Level 2 measures are technical implementing measures to complement the principles defined in the level 1 text, in view of the operational implementation requirements. Level 2 measures should be adopted by the European Commission on a proposal from EIOPA (European Insurance and Occupational Pensions Authority). In order to advance the development of the reform, EIOPA consults the market, including through Consultation Papers.
The ORSA does not fall within Level 2 measures and as such in 2009, during the broad consultation on Level 2 measures, there were no Consultation Papers devoted exclusively to the ORSA. However, a significant number of them refer to it, for example:
Consultation paper No. 17 on the calculation of capital add-on
Consultation paper No. 24 on the principle of proportionality
Consultation paper No. 33 on the governance system
Consultation paper No. 56 on the validation of internal models
... etc.
Thus, if Level 2 measures do not specify the requirements for the ORSA, they can be used to better understand the interactions of the ORSA with other requirements and clarify the role of the ORSA within the Solvency II system of insurers.
Level 3 measures
Level 3 measures will be directly adopted by EIOPA. They generally correspond to non-binding recommendations. Since the creation of EIOPA in January 2011, its responsibilities were, however, extended to the production of Level 3 binding measures.
