Executive summary
- ORSA assesses overall solvency needs on the insurer's own basis, not only against the regulatory calculation.
- It is prospective: it projects the risk profile and capital position across the business-planning horizon.
- It must be integrated with strategic decision-making, which requires timing it before decisions rather than after.
- Deviations between the insurer's risk profile and the assumptions underlying the standard formula must be assessed.
- The board is accountable for the assessment and for the actions it implies.
The three questions ORSA answers
- What are the overall solvency needs of this insurer, given its actual risk profile, strategy and risk tolerance?
- Will regulatory capital requirements and technical-provision requirements be met continuously across the planning horizon, including under adverse conditions?
- To what extent does the insurer's risk profile deviate from the assumptions underlying the standard capital calculation?
The first question is the one most often answered poorly. It asks for the insurer's own view, which may legitimately differ from the regulatory figure in either direction. An assessment that simply reproduces the regulatory calculation with a modest add-on has not answered it.
The prospective element
The regulatory solvency calculation is a one-year measure at a point in time. ORSA extends across the business plan, typically three to five years, and asks whether the position remains adequate throughout. This matters because the profile changes: new business strains capital before contributing to it, reserves develop, reinsurance programmes renew at different prices, and asset allocations shift.
- Project own funds and capital requirements year by year under the business plan, not only at the horizon.
- Identify the point of minimum coverage; it is often mid-horizon rather than at the end.
- Run the same projection under adverse conditions and under a scenario in which the plan simply does not materialise.
- State the management actions assumed, their timing and their feasibility under the conditions modelled.
Scenario design that is worth the effort
Generic scenarios produce generic conclusions. Useful ORSA scenarios are constructed from the insurer's own vulnerability analysis: which combination of events would most threaten this balance sheet, given this portfolio, this reinsurance structure and this asset allocation.
- Combine events rather than testing them individually; a catastrophe alongside a reinsurer default alongside a spread widening is a different test from any one of them.
- Include at least one scenario driven by an operational or conduct event, which is often absent despite being a common cause of real distress.
- Include a reverse stress test identifying what would render the business model unviable, independent of whether it is considered likely.
- Test the sensitivity of conclusions to the dependence assumptions used, since these are weakly evidenced and strongly influential.
Board ownership in practice
Board ownership is a formal requirement and, more usefully, the mechanism that makes the process consequential. It is visible in specific behaviours: the board sets or challenges the scenarios before they are run, questions the assumed management actions, and records decisions taken as a result.
It is equally visible in its absence. Where the assessment arrives as a completed document for approval at a single meeting, with no prior discussion of scenario design and no decisions recorded as arising from it, the process has satisfied a requirement without informing anything.
Practical example
An insurer plans to grow a property portfolio by 30 per cent over three years. The regulatory solvency ratio today is 178 per cent. Projected under plan, it dips to 149 per cent in year two as new-business strain and increased catastrophe capital bite, before recovering to 165 per cent. Under a combined scenario of a major catastrophe in year two and a 100 basis point spread widening, it falls to 112 per cent.
The single-point regulatory figure of 178 per cent conveyed none of this. The projection identifies a specific year of vulnerability and a specific combination that produces it, which supports concrete choices: adjust the growth path, purchase additional catastrophe cover for year two, or accept the exposure with a monitoring trigger set above the projected trough.
Limitations and caveats
- Multi-year projections compound assumption error; the year-three figure is considerably less reliable than the year-one figure.
- Management actions assumed in stress may be constrained by market conditions or by the same events affecting the balance sheet.
- Dependence assumptions between risk modules drive combined-scenario results and are difficult to evidence.
- Requirements and supervisory expectations differ by jurisdiction and evolve; consult the current official text.
Conclusion
ORSA is the only process that requires an insurer to state its own view of its capital needs across its own planning horizon, on its own assumptions, with board accountability.
That combination is unusual and valuable. Whether it produces value depends almost entirely on whether it runs before the plan is fixed or after.
References
- Guidelines on own risk and solvency assessment — European Insurance and Occupational Pensions Authority
- Insurance Core Principle 16: Enterprise Risk Management — International Association of Insurance Supervisors
- Solvency II Directive 2009/138/EC, Article 45 — European Commission, 2009
Author bio
Jonas Mohamed Osman Abdelghafour, known as Yonas Osman is an actuary, FRM and financial risk professional specialising in banking, insurance, model risk, capital modelling and quantitative risk management.