Insurers challenged on quantifying capital for operational risk

Since January 2005, insurance firms have been required to use the Individual Capital Adequacy Standards (ICAS) regime. Under this, firms have to provide the FSA with an Individual Capital Assessment (ICA) which states the risks that a firm incurs in running its business and the level of capital that the firm believes it needs to support those risks. Once received, the regulator reviews the submission and sets the firm an Individual Capital Guidance (ICG).  Should the firm fall below its ICG, the FSA may intervene so that the firm can restore its capital position to the ICG level in order to limit the probability that the firm will become insolvent and pose a risk to policyholders.

The FSA have now issued ICGs to seven life and twenty general insurance groups or firms, with many more in an advanced stage. Early indications are that most ICGs are higher than firm's ICAs. As a result, Strachan stated that the FSA have been working with firms to "minimise the differences."

Strachan said that whilst the FSA "have been encouraged to see evidence of improving risk management systems", the element of quantifying capital for operational risk is "one of the most difficult challenges for both life and general insurers."

"Consequently it is not surprising that this is one of the least developed areas within firms' ICAs", Strachan commented. "But for risk and capital management to be properly integrated, the rigour of this assessment must improve, and as such we are very interested in hearing how firms plan to develop their processes in this area. The hardest decisions are often around whether loss scenarios fall within or outside of the 99.5% confidence level. This is quite clearly a judgement call, but our expectation is that firms will be able to explain how they arrived at their decision."

The full text of David Strachan's speech, "Challenges for the insurance industry", is available on the FSA website.