Global

Details

  • Industry: Financial Services, Insurance
  • Type: Survey report
  • Date: 7/25/2012

Unlocking the value of Economic Capital 

Unlocking the value

Companies that embrace an EC framework and use it throughout their business will undoubtedly have a competitive advantage in the long term. They will ensure appropriate returns are achieved for risks they take on, and will be less likely to take on risks that they don’t fully understand. Moreover, through the full integration of an EC framework, they will have a better understanding of the limits of EC modeling and when not to rely on it.


63 percent of companies operating in the region have implemented an EC framework, with the remaining 37 percent intending to introduce a framework within the next three years.


The EC survey indicates almost all the top global insurers are already using EC methods to support their risk management systems, with 100 percent of those surveyed in Europe, North America and South Africa adopting it to some extent. In Asia, there are significant differences in the stage of development between the international groups operating in the region, regional groups that operate across Asia and domestic companies focused on a particular market.


While most respondents are using EC for risk management, many have not yet realized the potential advantage of using it to support wider business decisions.

So, what factors inhibit companies from unlocking these benefits?

Two possible reasons may be a lack of understanding at the top of the organization of the underlying EC methods and the lack of timely information to facilitate effective decision making.

Lack of management understanding

Worryingly, 40 percent of responses indicate that management understanding of the EC framework is limited (i.e. rated less than or equal to two, with one being no understanding and five being fully understood). Generally, European companies ranked management understanding higher than other territories, which is not surprising given that Solvency II requires firms to explicitly demonstrate this as part of their Own Risk and Solvency Assessment (ORSA) and internal model approval requirements. However, even in Europe, it is clear that management understanding needs improvement.

Lack of timely information

To use EC information effectively, it must be up-to-date and reported on a timely basis. The rapid changes in financial markets since the 2008 financial crisis and the associated volatility they brought to insurers’ balance sheets have clearly highlighted that previous standards of annual or ad hoc reporting will no longer be acceptable for company management.

 

In Europe, quarterly reporting has now emerged as the industry standard, with 60 percent of companies reporting this frequently. In North America, no respondents indicated they were reporting more frequently than quarterly and more than half said they report only once or twice a year. In Asia, 63 percent said they were reporting quarterly and, in South Africa, 50 percent are reporting quarterly.

 

Clearly, the industry has more work to do in this area. An unfavorable comparison could be made to the hedge fund industry, where it is the norm to have daily reporting on positions. On any given day, the finance director of a hedge fund will know precisely what the risk sensitivities are and what would happen if key risk factors moved in a particular way.

 

While reporting daily is not yet realistic for insurers, senior management needs to make a judgment call on what level of frequency is required to effectively capitalize on the benefits of an economic framework. The more infrequent and out-of-date the reporting, the less likely it will be seen as a credible tool that can add value to the business.

 

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