Hannover Re’s chief risk officer and chief actuary reveals how his firm is getting ready for Solvency II

Q: How are your preparations for Solvency II going?

A: Under the umbrella of our parent, Talanx Group, we have been in the pre-application phase with our German supervisor, BaFin, since September 2008. We are in direct contact over the approval of our internal model and have done more than 70 interviews. We are the third-largest insurance group in Germany, behind Allianz and Munich Re, and the regulators are also being educated by the market leaders.

Q: Will you be involved in Quantitative Impact Study (QIS) 5?

A: We have been very actively participating in all the QISs and will be doing so in QIS5. As a member of the Chief Risk Officer (CRO) Forum, we are also involved in the design of QIS5 through its direct contact with Ceiops. We try to have an influence, especially in proposing things that matter for reinsurance, such as the treatment of non-proportional reinsurance in QIS5 and natural catastrophe considerations. So we are actively involved on both sides, on the design of QIS5 with the other members of the CRO Forum, and then of course later on when it starts and the processing of Hannover Re Group data and solo data are applicable.

Q: How have you been preparing your internal model and systems?

A: We started to develop our internal model in 1999 and had our first external assessment in 2004. Since then, we have continuously developed it, especially the softer factors like documentation and parameter tracking. In our experience, the internal model approval is only one-third quantitative. The other two-thirds are qualitative, with the emphasis on processes, systems, validation procedures and compliance with German MaRisk – the minimum risk management requirements for insurance companies. Of particular importance is how we will deal with the results of the internal model, which is the ‘use test’. We have to show it will really be used for management and risk management decisions, rather than being a detached engine.

Q: How will you embed model output into day-to-day decision making?

A: As an actuary or risk manager, you have to educate the decision makers on what the model output can do and what it can’t do. Then you can guide them in how to apply the model results into final decisions, such as whether you should place more aggregates in Florida hurricanes, whether you should increase agribusiness or cut back on credit risk. All these decisions can be made from a more informed level.

Q: How do you think models should influence decision making?

A: Whatever comes out of internal models should never ever be transformed into a direct decision because we all know the modelled results are not precise. But they are the best we can get. Modelled results should be discussed in the respective decision-making committees. This is what we try to do at Hannover Re. The major parts of the results of our internal model are discussed in our regular risk committee meetings, which take place every quarter, and then if necessary this is forwarded to the entire board for the final decision.

Q: How does financial modelling in insurance differ from that in banking?

A: We have our own approach. We have natural catastrophe simulation models, reserving models and dynamic financial analysis, which is able to model the probability and randomness of insurance events really well. An earthquake in San Francisco is random and independent from an earthquake in Japan. Financial events are not independent. There is this pro-cyclicality phenomenon where if something goes wrong, the entire market goes down. That’s what you have to tell regulators when they try to compare the internal models of insurance to those of banking.

Q: What is the end goal with enterprise risk management (ERM)?

A: With ERM you can save capital. The Bermuda Monetary Authority is assessing ERM systems and giving a score based on that. If you get the full score, the capital add-on to your quantitative risk is only 1%. But if you go below the score necessary to get any credit you will get a charge of 10%. So here you have a direct link between ERM and the internal model. I’m a real promoter of this system under Solvency II – it would make a lot of sense.

Q: How did you combine the role of chief actuary and chief risk officer?

A: It involved some discussion with the German supervisor because of the segregation of tasks under Solvency II. The actuarial function I have combined with my risk management department is the reserving controlling part. What I do not do as chief actuary of Hannover Re and chief risk officer is the pricing. So the pricing actuaries that were previously reporting to me are now reporting to the underwriting board member.

Q: What for you are the major challenges ahead with Solvency II?

A: The inability of the supervisors to cope with all the information they get. My personal expectation is that the market is producing mountains of paper, spending billions on expenses, and is trying to get their job done, but the supervisor will lack the capacity and knowledge to deal with this in a professional manner. GR