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FSA/PN 129/2006
30 November 2006

The insurance industry’s management of risk has progressed substantially over recent years, but firms still need to further improve the effectiveness of their risk management frameworks.

This was the main conclusion of a review by the Financial Services Authority which looked at how firms are developing their risk management techniques in the face of a changing socio-economic environment marked by evolving risks ranging from more volatile investment conditions and increases in longevity through to terrorism threats and climate change.

The review, whose findings are published today in an FSA Insurance Sector Briefing, also looked at the impact of the introduction of Individual Capital Adequacy Standards (ICAS) in bringing about improvements in risk management by insurers.

The FSA would like firms to use the Sector Briefing to review where they are, relative to the Review’s findings, in developing their overall risk management framework. It also sets out ten questions which senior management may wish to consider when reviewing the effectiveness of their own risk management practices.

Sarah Wilson FSA Insurance Sector Leader said:

"Since our previous review of insurers’ risk management practices in 2003, there has been substantial progress. Our new risk-based capital adequacy regime under the ICAS framework may have acted as one catalyst for change for some firms but should not be viewed as a substitute for good risk management practices. Instead we would expect ICAS to be used as one of many tools in an integrated approach to risk and capital management.

"We believe that, whilst ICAS has placed the UK industry in good stead for the implementation of the new EU risk-based capital adequacy regime, firms must have in place fully integrated risk and capital management frameworks across their business activities to benefit fully from the implementation of Solvency II.

"We hope firms will find useful pointers from the outcome of the Review and will consider the questions we have posed in assessing and developing their risk management practices."

Notes for Editors

1. Insurance Sector Briefing: Risk Management in Insurers [PDF] is available on the FSA Website. The Review looked at 26 firms and included visits and a desk-based study of documentation. Firms were selected from across the life and general insurance sectors and included proprietary and mutual firms, Lloyd’s agents, and Protection & Indemnity (P&I) clubs as well as firms closed to new business.

2. The report on the 2003 review of insurers’ risk management practices is available on the FSA Website.
   Review of UK insurers’ risk management practices [PDF]

3. The questions for consideration by senior management of firms are:

   1. How can the board and senior management provide more effective and informed oversight of your firm’s risks?

   2. Are risk considerations given appropriate profile in your firm’s business and strategic planning processes?

   3. What should your firm be doing to realise the benefits of further integration of risk, capital and business management activities?

   4. How can your firm improve the knowledge and understanding of your board and senior management to raise the quality of discussion and challenge on more complex matters?

   5. Are your firm’s risk appetite statements and risk policies sufficiently comprehensive and well understood and workable?

   6. Does your firm have a clear view of how it wants to develop its risk management practices?
      

   7. Are there enough opportunities for independent and informed challenge to risk management processes and outcomes?

   8. Is there enough objectivity in your risk identification and assessment processes?

   9. Does your firm’s management information provide sufficient and timely material on risk issues and does it prompt appropriate action?

   10. Is there enough clarity of how responsibilities for risk management activities are allocated in your firm?

4. The main findings of the Review were:

   • Governance and oversight: There has been progress by many firms in enhancing their governance and oversight of risk management but there are still areas where further improvements may be needed, for example boards’ self-assessments of skills. While most firms now have a more developed network of oversight committees, frequently members of those committees lack appropriate knowledge and experience to provide sufficiently informed challenge on risk matters.

   • Risk appetite: Most firms have documented their approach to risk management through risk policies, procedure manuals and risk appetite statements. However ‘risk appetite’ is often not well understood throughout many firms to a level of clarity that provides a reference point for all material decision making. There is a big step between defining and applying risk appetite, particularly for operational risk.

   • Implementing risk management: Risk management activities often lack consistency of approach or are disproportionately focused on particular risk areas. Inadequacy of challenge on risk issues may limit the extent to which the board, senior management and the FSA can rely on outputs. Some risk management functions do not appear to be going beyond co-ordinating activity.

   • Management information: Lack of insightful analysis in many firms restricts the ability of management to identify trends and appropriately prioritise risk mitigation activity.

   • Impact of ICAS: There has been progress in the development of suitable quantification techniques for risk-based capital, but for many firms there is still much to do, particularly to improve board and management understanding of risk-based capital.

5. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.

6. The FSA aims to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve its business capability and effectiveness.