The productivity and performance of the treasury function within insurance companies have undergone a transformative evolution, driven by the emergence of what is now termed Treasury 4.x. In this digital era, characterized by rapid technological advancements, Insurance Treasury is transitioning towards a more dynamic and strategic role. Treasury 4.x is distinguished by its capacity to envision and operate within various financial scenarios, reflecting a forward-thinking approach. The contemporary Insurance Treasury aligns itself with the principles of "Fit-for-purpose" – emphasizing a centralized organizational structure embedded seamlessly within the financial supply chain. Highly automated processes, often referred to as "exception-based management," are integral to this paradigm shift, enabling treasuries to focus resources on critical issues and exceptions, thereby enhancing efficiency and minimizing manual intervention. This evolution underscores the imperative for insurance treasuries to leverage cutting-edge technologies and embrace a proactive, scenario-driven mindset, ensuring adaptability and resilience in the face of dynamic market conditions. 

Innovation of Payment Landscape

In the ever-evolving landscape of payment innovation within the treasury functions of insurance companies, a pivotal focus has been placed on migrating to the ISO 20022 XML messaging standard and moving away from FIN MT messages. This migration, driven by SWIFT, is not just a strategic choice but an industry-wide mandate, compelling all financial institutions, including insurance companies, to transition to the ISO standard by November 2025. This migration is a cornerstone in revolutionizing payment processes, offering a standardized and enriched data format that not only enhances interoperability but also facilitates more robust and information-rich communication. As insurance companies navigate this time-sensitive transition, a review of address logic within payment files becomes even more critical. The insurance companies are mandated to review and refine address logic within payment files by November 2026. Ensuring that the company is compliant with evolving financial messaging standards will not only improve the overall efficiency, speed and compliance of payments, but it will also provide the opportunity to redefine the best-in-class cash management operating model. 

In additional to the industry migration to a new messaging standard, the introduction of Central Bank Digital Currency (CBDC) could impact the traditional roles of treasuries by offering new means of payment, settlement, and potentially altering liquidity management strategies. CBDCs could enhance efficiency in cross-border transactions, simplify reconciliation processes, and influence investment strategies. Insurance treasuries might need to adapt their systems and processes to incorporate CBDCs effectively, ensuring compliance with regulatory requirements and taking advantage of potential benefits associated with this digital form of currency. We are also witnessing an increase in momentum around the use of distributed ledger technology within the wholesale banking domain. In December, JP Morgan announced it was live on Partior, the Singapore-based interbank payment network that uses blockchain and is designed as a multi-bank, multi-currency system for wholesale use, with each bank controlling its own node. This is clear evidence we are starting to gain real traction around potential solutions using both blockchain and CBDC’s that will further increase the number of payment rails available to support the payments ecosystem.  

Finally, the payment landscape of insurance companies sees further innovation with Faster Claims Payment (FCP). This solution streamlines the disbursement of claims, decoupling it from traditional monthly processes. FCP integrates seamlessly with the Vitesse payment platform, ensuring direct access to insurer funds and significantly reducing delays in payments. This paradigm shift promotes efficiency and enhances customer satisfaction through its accelerated claims payment system. The innovative payment landscape, however, could highlight a potential impact for processes of insurance treasuries. Increased application of faster and real-time payments requires insurance treasuries to have sufficient liquidity readily available to meet the immediate financial obligations. This demands careful planning of cash reserves to ensure uninterrupted claim processing while maintaining financial stability and stresses the importance of effective cash management for navigating any potential downside impact of FCP. 

Changing Macroeconomic Environment

The insurance treasury is profoundly influenced by macroeconomic events, and the convergence of several geopolitical challenges has introduced heightened uncertainty and downside risks. Elevated geopolitical tensions, particularly the intensified strategic rivalry between the United States and China, the Russia-Ukraine war, and the recent Middle East conflict, pose significant threats to the insurance industry's stability. These events bring the potential for energy price shocks, amplifying concerns about increased insurance industry losses stemming from geopolitical and economic upheavals. Furthermore, the scheduled elections in 76 countries, with pivotal ones in the United States, Taiwan, and India, add an additional layer of uncertainty. Political transitions can introduce policy shifts, impacting regulatory environments and potentially altering economic landscapes, further complicating risk assessment for insurance treasuries. As the global geopolitical landscape remains dynamic, insurance treasuries must navigate these challenges prudently, emphasizing resilience and adaptability in their financial strategies to mitigate potential adverse impacts. 

Interest rate changes command a substantial impact on the treasury functions of insurance companies, and the recent shifts in central bank policies have introduced a dynamic landscape. The conclusion of the central banks' rate tightening cycle, coupled with the Federal Reserve's announcement of rate cuts for 2024 and beyond, signals a pivotal change. While these rate cuts are aimed at supporting economic recovery, they pose challenges for insurance treasuries that traditionally benefit from higher interest rates. The insurance industry faces the paradox of modest GDP growth across advanced economies, with the downside risk of a potential rebound in inflation and further geopolitical shocks. The relatively elevated interest rates, however, offer a silver lining for (re)insurers, providing a boost to future recurring income. As maturing assets are reinvested at higher rates, this strategic advantage could help mitigate some of the challenges posed by the shifting interest rate environment, fostering resilience and adaptability in the treasury functions of insurance companies. 

Taking into account the aforementioned macroeconomic changes, insurance treasuries must ensure they possess local treasury experts capable of supporting multiple regions with adapting to shifting business dynamics.

Changing Market Rates

The impact of changing market rates on the asset management activities of insurers is profound, extending to collateral management practices. Market rate fluctuations exert direct influence on the valuation and performance of their investment portfolios, notably affecting the required Variation Margin (VR) and Uncleared Margin Rules (UMR) on derivatives holdings. As rates oscillate, the value of derivative positions can vary significantly, necessitating adjustments in margin requirements to effectively manage risk exposures and collateral obligations. 

Additionally, these changes in market rates affect the liquidity position of insurers, prompting the need for more dynamic models to optimize liquidity management. Given the importance of maintaining sufficient cash and liquid assets, insurers must adapt their strategies to ensure they can meet obligations promptly, especially considering the impact of FX fluctuations on assets denominated in non-base currencies. This entails employing more dynamic models to gauge liquidity needs accurately and employing strategies such as RePo agreements to enhance flexibility in accessing cash when required. Thus, navigating the complexities of changing market rates requires insurers to employ a comprehensive approach that integrates risk management, liquidity optimization, and currency hedging strategies. 

Data Analytics and Predictive Modelling

The integration of artificial intelligence (AI) and predictive analytics has revolutionized the treasury function within insurance companies, particularly in the realm of cash flow forecasting. These advanced technologies enable insurance treasuries to analyze vast datasets, identify patterns, and make more accurate predictions regarding future cash flows. AI algorithms can process information rapidly, taking into account a multitude of variables, such as market trends, policyholder behavior, and economic indicators. This enhanced predictive capability is instrumental in optimizing liquidity management, allowing insurance companies to proactively anticipate cash needs and allocate resources efficiently. The importance of AI and predictive analytics in cash flow forecasting cannot be overstated, as it empowers treasuries to make informed decisions, mitigate financial risks, and navigate the complexities of the insurance landscape with greater precision and agility.

Regulatory Compliance

Regulatory compliance is pivotal for insurance company treasuries, significantly influencing financial strategies and operations. The complex regulatory landscape, including directives like the Insurance Recovery and Resolution Directive, Solvency II, and EMIR Refit, aims at ensuring financial stability, consumer protection, and market integrity. These requirements, from solvency standards to reporting obligations, impact how treasuries manage assets, liabilities, and capital. Non-compliance can lead to severe consequences, prompting insurance treasuries to invest in sophisticated systems for continuous monitoring. Striking a balance between compliance and strategic financial goals is crucial for navigating the regulatory environment and ensuring long-term organizational sustainability. 

Additionally, insurance companies operating across different jurisdictions face fragmented compliance regulations, consisting of local laws and regulations. This has become a prominent challenge experienced by insurance company treasuries and visible in various treasury processes, from payments to liquidity management. Establishing robust processes and conducting regular compliance reviews could help insurance companies to address the fragmented compliance framework. By proactively addressing compliance challenges and embracing innovative solutions, insurance companies could achieve robust global operations and success in an increasingly interconnected world.   

For more information about Treasury 4.x, download our latest whitepaper: Treasury 4.x - The age of productivity, performance and steering.

Climate change risks are relatively newly identified risks that insurers are facing. These risks can negatively impact both assets and liabilities of insurers. Already in 2018, the European Commission requested the European Insurance and Occupational Pensions Authority (EIOPA) to investigate how climate change risk could be integrated into the Solvency II Framework.

After various previous publications¹ of (draft) opinions, the investigation resulted in EIOPA’s opinion to include climate change risk scenarios in Own Risk and Solvency Assessment (ORSA)². It basically points out that forward-looking management of climate change risks is essential, and that EIOPA expects insurers to integrate climate change risk scenarios in their ORSA. EIOPA indicates it will start monitoring the application of this opinion two years after publication, i.e. as of April 2023. However, some National Competent Authorities already require insurers to take climate change risks into account.³

So, what will be expected of insurers?

In general terms, insurers are expected to:

• Integrate climate change risks in their system of governance, risk management system and ORSA
• Assess climate change risk in ORSA in the short and long term
• Disclose climate-related information

But what does this mean in practice? We will further explained this per topic.

Integrating climate change risks

The integration requirement ensures that climate change risk becomes an integral part of the day-to-day business and the risk management framework. The EIOPA opinion does not provide much detail on what this entails. Draft amendments to the delegated regulation, published by the European Commission, provide more insight into what insurers can expect.

The draft amendments relate especially to the implementing measures of the system of governance laid out in the Solvency II Directive. This means that responsibilities regarding climate change risk need to be clearly allocated towards the key functions within the organization, and appropriately segregated to ensure an effective system of governance.

This means climate change risk should be included in the following functions/processes:

• Risk Management
  For all the relevant risk management areas – covering both the asset and the liability side of the balance sheet, and including liquidity, concentration and operational risk – climate change risks need to be identified, measured, monitored, managed and reported on.
• ORSA
  The ORSA is a mandatory part of the required system of governance for insurers and will therefore also have to take climate risks into account. In order to properly assess the potential impact of climate change risks and the resilience of the insurers’ business model, these climate change risks need to be analyzed over a longer horizon. EIOPA has therefore advised to include climate change scenarios in the ORSA. This will be discussed in more detail in the next section of this article.
• Internal Control and Internal Audit
  Changes in the system of governance, risk management and ORSA to incorporate climate change risk also requires extension of the internal control system and the scope of internal audit.
• Actuarial Function
  The actuarial function will be responsible for the appropriateness of assumptions, methodologies and models used to assess the impact of climate change risks in underwriting. Especially in the context of ORSA and the assessment of the influence climate risk has on future reserving and capital needs. In addition, the actuarial function will be responsible for the sufficiency and quality of the data used within these calculations.

Consequently, written policies regarding risk management, internal control, internal audit, outsourcing (where relevant) and contingency plans need to be updated to include everything outlined above with regards to climate change risk.

Assess climate change risk in ORSA in the short and long term

Insurers will be required to assess climate change risk in ORSA by analyzing at least two climate scenarios. For the implementation we suggest a four-step approach, largely based on the guidance provided by EIOPA.

Step 1 – Risk identification

EIOPA expects insurers to take a broad view of climate change risks and include all risks stemming from trends or events caused by climate change. EIOPA provides a list of these risks, which distinguishes between:

• Transition risks
  These are defined as follows: ‘Risks that arise from the transition to a low-carbon and climate-resilient economy’. This includes the following aspects: Policy, Legal, Technology, Market sentiment and Reputational risks.
• Physical risks
  These are defined as: ‘risks that arise from the physical effects of climate change’ and are subdivided in acute and chronic physical risks.

Materialization of these risks for insurers will translate into impact on traditional risk categories, such as underwriting risk, market risk, credit and counterparty risk, operational risk, reputational risk and strategic risk. To help insurers get started with the implementation of climate change risks in ORSA, EIOPA has provided examples of a mapping in the annex of their opinion.

Step 2 – Materiality assessment

Insurers will be required to include all material climate change risks in ORSA. Under Solvency II, risks are considered material if ignoring the risk could lead to different decision making. This means that insurers are required to assess the materiality of each risk to determine whether these need to be included. If an insurer concludes that a certain climate change risk is immaterial, the insurer must be able to explain how that conclusion was reached.

The materiality assessment should be a combination of a qualitative and a quantitative analysis. The qualitative analysis is to provide insight in the relevance of the climate change risk drivers and the way they impact the traditional prudential risks (underwriting risk, market risk etc.). The quantitative analysis will be used to determine the extent to which assets and liabilities are exposed to transition and physical risks.

Step 3 – Defining scenarios

The inclusion of the forward-looking, risk-based approach to ORSA requires insurers to define a set of climate change risk scenarios. EIOPA expects insurers to assess material climate change risks utilizing ‘a sufficiently wide range of stress tests or scenario analysis, including the material short- and long-term risks associated with climate change’. The goal of these scenarios is to assess the resilience and robustness of the insurer’s business strategies, including the impact of risk mitigating measures.

EIOPA states that insurers may develop their own climate scenarios or build on existing ones and provides a number of sources of publicly available scenarios containing pathways for physical and transition risks. The decision for internal scenario development versus building on publicly available may depend on many factors like expected materiality or company size. For example, the underwriting risk for a life insurer is probably less exposed to transition risk than the underwriting risk for a non-life insurer, and a smaller insurer may not have sufficient expertise and resources.

The scenarios must project a multitude of external factors to properly capture the effects of climate change risks. Factors such as demographics (e.g. in case of natural disasters), economic development (e.g. as a result of technological breakthrough) and government policies to reduce carbon emissions, just to name a few. The climate change scenario set should contain at least two long-term climate scenarios:

• Global temperature increase remains below 2◦C, preferably no more than 1.5◦C, in line with Paris Agreement;
• Global temperature increase exceeds 2◦C.

In addition, a reference scenario is needed to be able to determine the impact of the stress scenarios.

The assessment is to be performed for several time horizons. Given the nature of climate change risks, horizons need to be in the order of decades. EIOPA provides examples for length of time horizons, ranging from instantaneous (‘current climate change’) to projected views of climate change for the next 80 years (‘long-term climate change’).

Step 4 – Climate change risk modeling

Modeling climate change risks in ORSA introduces two challenges:

• Assessment of transition and physical risk impacts
  Materialization of transition and physical risks will have to be translated to impact on assets and liabilities. In a discussion paper, EIOPA provides examples of different methodologies for the assessment of transition impacts on assets, that have already been developed by academics, research institutes and regulators⁴. In general, these methodologies use carbon-sensitivities of financial instruments to assess the impact of climate change risk scenarios.
  The basis for the determination of physical risks is the change in temperature over time. This change needs to be translated into impact on frequency and severity of acute natural disasters (e.g. storms, floods, fires or heatwaves) and chronic effects (e.g. rising sea levels, reduced water availability, biodiversity loss and changes in land and soil productivity). The next step is to translate these effects into impact on assets and liabilities. The translation into financial impact on companies in which insurers invest can especially be challenging. Larger companies often have a greater diversity of activities and are more spread out geographically. In addition, companies will not only be hindered by the materialization of physical risks in their own activities, but their supply chain can also be affected. However, some scoring models already exist in which companies are ranked based on their sensitivity to physical risks.⁵
• Long-term multi-period modelling
  Incorporation of the climate change risk scenarios in ORSA aims to assess the viability of current business models and strategies and the adequacy of the insurers’ solvency. For longer horizons, insurers may use a lower precision for balance sheet projections and conduct assessment at a lower frequency than short-term risk assessments.
  The lower precision allows for simplifications as long as the long-term character of the climate change scenarios is preserved. Simplifications may include projecting simple ratios instead of full balance sheets, or assessment of climate change impact on assets and technical provisions in isolation. However, projection of the full balance sheet ensures internal consistency and may provide much more information, especially when assessing the impact of potential management actions to mitigate the impact of climate change risks.

Disclose climate-related information

Insurers are expected to provide explanation on the short- and long-term climate change risk analysis in the ORSA report. This should include:

• An overview of all material risks, how materiality is assessed and an explanation for each risk that is considered immaterial.
• The methods and assumptions used by the insurer in both the materiality assessment of the climate change risks and in ORSA.
• The outcomes and conclusions of the scenario analysis, both quantitative and qualitative.

In addition, climate change risk related disclosures should be consistent with the Non-Financial Reporting Directive (NFRD).⁶

How can Zanders help?

As mentioned in the introduction, climate change risks are relatively new to the insurance sector. The same holds for other financial industries like the banking sector and asset management sector. As a consultancy firm for the financial industry, we support various types of financial institutions with the implementation of ESG and climate-related strategies and regulations. In doing so, we can benefit from our experience gained in the insurance, banking and asset management sectors.

We can assist with the implementation of climate change risk management, including:

• Identification of climate change risk exposures and materiality assessment
• Integration of climate change risks in your system of governance and risk management system
• Incorporate climate change risk into your ORSA, including
  • Mapping climate change risks to traditional prudential risk categories
  • Development of climate change risk scenarios
  • Climate change risk modelling
• Support in setting up or adjusting disclosures

Sources

_{[1] Previous EIOPA publications related to climate change risk:}

• _{Opinion on Sustainability within Solvency II, 30 September 2019}
• _{draft Opinion on the supervision of the use of climate change risk scenarios in ORSA, 5 October 2020}

_{[2] Opinion on the supervision of the use of climate change risk scenarios in ORSA, 19 April 2021}

_{[3] See:}

• _{DNB>Insurers>Prudential supervision> Q&A Climate-related risks and insurers (February 2021)}
• _{PRA: Supervisory Statement 3/19 – Enhancing banks’ and insurers’ approaches to managing the financial risks from climate change (April 2019)}

_{[4] Second Discussion Paper on Methodological principles of insurance stress testing, 24 June 2020
[5] See footnote 4
[6] Guidelines on non-financial reporting: Supplement on reporting climate-related information, 17 June 2019}

In the 150 years of its existence, Swiss Re has grown to be one of the world’s largest providers of reinsurance and insurance-based forms of risk transfer. Reinsurers are mostly associated with insurance for extreme loss events, such as natural catastrophes. However, Swiss Re’s services cover the entire insurance spectrum: Swiss Re is the counterparty to risks which primary insurance companies and large corporates decide to mitigate.

Liquidity risk

Usually, liquidity is not the first topic that comes to mind as a key risk for reinsurance companies. “The general view was, and kind of still is, that reinsurance companies do not run a lot of liquidity risk, like a bank,” Martin Ramseyer says. For banks, the main driver of liquidity risk is a sudden customer run on deposits. The risk for reinsurers is rather that claims can reach the order of billions, sometimes to be paid out at short notice relative to the magnitude. If sufficient assets cannot be liquidated at a reasonable price within the required time frame, the company not only puts its reputation at stake but also risks bankruptcy – regardless of its solvency or profitability.

From a capital perspective, expanding services across businesses yields a risk diversification benefit. But that benefit does not extend to liquidity, Ramseyer clarifies: “There are many legal limitations imposed by different jurisdictions that limit our abilities to move assets between subsidiaries within the group.” A joint effort of risk and treasury was initiated several years ago to create a framework to measure and manage funding liquidity risk. Initially, the primary objective was to identify potential liquidity constraints for the major legal entities. Calculations gradually grew more extensive, and the framework evolved into an important scenario analysis mechanism used to support executive management decisions. Its execution had become time-consuming, and the operational risk inherent in manual calculations increasingly relevant. The time was ripe to streamline and automate liquidity risk analysis and the reporting process. Andreas Tonn became the business project manager for the system selection and implementation.

Implementation

The choice was made for a vendor solution. “The core advantage is that they provide a framework, which reduces implementation time and facilitates the translation of needs into requirements,” Tonn says. “But as you will never find the perfect tool, it is important to have a clear focus.” Liquidity risk measurement models for the insurance business in vendor systems are still in evolution phase. Flexibility was therefore a key priority for Swiss Re, as the majority of the logic needed to be implemented from scratch. Swiss Re embarked on an intensive proof-of-concept phase, and asked vendors to provide a working demonstration that addressed all aspects of its liquidity risk framework. They chose Wolters Kluwer’s RiskPro, as it proved both mature and sufficiently flexible at the same time.

A phased implementation approach was chosen to gradually introduce the solution into the reporting cycle. However, after the first release, it became apparent the project team would need additional business support if it was to cover all the aspects thoroughly within the stated time frame. “Our internal resources were too committed to other tasks and could not provide support to the extent an intensive project requires,” Tonn says, “but external resources are actually only beneficial to a project if they bring the right expertise to the table.” There were very positive experiences with Zanders on other treasury projects so a request was made for support.

Jeroen van der Heide from Zanders was asked to join the project team: “His ample experience with functional design of various systems across risk domains convinced us that he would indeed accelerate our project.”

Andreas Tonn, business project manager for the system selection and implementation

Challenges

As with many system implementations, getting the data delivered in a systematic fashion was a challenge: different departments have different priorities and downstream reporting is often not on top of their list. Afterwards, the interpretation for modeling was not always clear either as it was complicated by the global reach of the company in which data ownership spans across time zones. For example, intra-group funding was previously measured using a net aggregate approach. With the implementation of RiskPro, the choice made sense to model each debt contract based on its characteristics as booked in the system. Understanding how to calculate the impact of all implicit options automatically for different scenarios required detailed discussions across teams and continents.

The project team has worked relentlessly during the past year in close cooperation with business and IT colleagues. A total of six minor and major releases were accomplished, during which the necessary data and calculations with respect to investments, collateral, reinsurance portfolios, debt, internal cash flows, and contingent funding requirements were added to the system. The RiskPro results were embedded in existing reporting templates, and the change analysis process between reporting dates was partly automated. They were very satisfied with the Zanders support: “Of great benefit was Jeroen’s talent to quickly gain insight out of a huge amount of information, and present the newly created results in such a way to make them understandable to the business user and fit right into existing business processes. That has been a very valuable business contribution.”

Looking towards the future

With the system up and running, the team is able to provide reporting and analytics for the major legal entities within the group and across business segments and branches, rather than only for those with the largest impact from a risk perspective. “It allows us to understand and represent the liquidity dynamics in a more systematic way across the group,” Ramseyer says. The next step is to increase the quantity and quality of the information flow between local business units and treasury. “It will really enhance the risk awareness of local boards and empower them in their active steering efforts. With their feedback they will help improve the framework in return.”

Developments within Treasury Business Services don’t stop there. The system contains the vast majority of Swiss Re’s economic balance sheet down to the transaction and cash flow level. “The vendor software is designed to be an integrated risk system. With the market data and contract data available in full detail, we have a suitable basis to extend the scope of the solution to other domains,” Tonn says. The plan for the next two years, therefore, is to gradually support other analyses, for example with respect to currency risk, funding cost, liquidity planning, and ALM. The consistency between and efficiency of the analyses will improve, enabling the treasury teams to dedicate more time to proactive analysis and steering. Zanders will continue to support these efforts: “Given his successful contribution to the project and his interest to continue to support Swiss Re, we asked Jeroen to manage next year’s project,” Tonn says, “But first things first: we are very much looking forward to the daily use of the implemented solution.”