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Will recovery and resolution requirements be applied to insurers?

On 7 March, the International Association of Insurance Supervisors (IAIS) issued a major consultation package covering proposed revisions to a number of IAIS Insurance Core Principles (ICPs) (relevant to the supervision of all insurers within a member country’s jurisdiction) and ComFrame-related material (which relates to the group-wide supervision of internationally active insurance groups (IAIGs)). This is the first of three scheduled releases planned for 2017.

While the IAIS has no powers to enforce compliance, most IAIS member countries aim to ensure ICP compliance. Most countries in the EEA are members of the IAIS in their own right, with EIOPA also a member. As such, any significant changes introduced by the IAIS are likely to be reflected in European requirements in due course.

The current release covers material related to:

  • Governance (ICP 5 - Suitability of Persons, ICP 7 - Corporate Governance and ICP 8 - Risk Management and Internal Controls)
  • The Supervisor and Supervisory Measures (ICP 9 - Supervisory Review and Reporting and ICP 10 - Preventive Measures, Corrective Measures and Sanctions)
  • Supervisory Cooperation and Coordination (ICP 3 - Information Sharing and Confidentiality Requirements and ICP 25 - Supervisory Cooperation and Coordination) and
  • Resolution (ICP 12 – Exit from the Market and Resolution).

Of these papers, the ones of most interest to firms will be the proposals on recovery (ICP 10) and resolution (ICP 12). These papers bring recovery and resolution considerations into the supervision of all insurers (and insurance groups). This is a marked step change from applying only to the nine globally systemically important insurance groups (G-SIIs).

In accordance with the overriding proportionality principle that applies to all ICPs, ICP 10 states that supervisors “may” require an insurer to produce a recovery plan. This suggests that many smaller insurers/insurance groups will not be subject to any recovery requirements. However, IAIGs are required to both develop a recovery plan and “take actions for recovery”.

ICP 12 specifically includes reference to the proportionate use of supervisors’ resolution powers, subject to the “no creditor worse off than in liquidation” principle. Resolution plans need to be drawn up only where this is deemed necessary by the solo/group-wide supervisor, although where the supervisor identifies specific risks to resolution, insurers must (where appropriate) develop contingency plans to mitigate these risks. For IAIGs, resolution plans must in particular address the continuity of critical economic functions.

Solvency II does not specifically address recovery and resolution requirements, so the publication of ICP 10 and 12 may add weight to EIOPA’s views expressed in its recent discussion paper (CP-16/009) regarding the need to harmonise insurer recovery and resolution regimes across EEA countries. The EIOPA report largely follows the key attributes approach originally set out by the Financial Stability Board (FSB) and highlights that most of the resolution powers listed by the FSB are not widely available in existing regulatory frameworks.

Despite recognising that existing resolution powers (such as portfolio transfers run-off) have worked well, EIOPA notes that these have not been tested by the failure of large cross-border insurance groups. However, its tentative conclusion that a minimum harmonisation of recovery and resolution regimes should be implemented runs counter to the common view amongst the insurance community that such a framework is not required, not least due to the ladder of intervention powers granted by Solvency II on breaches of solvency and minimum capital requirements.

It remains to be seen whether, and how quickly, local supervisory processes will react, especially as the ICPs and updated ComFrame material will only become effective from 1 January 2020. However, given EIOPA’s interest in this area, insurers could consider:

  • Identifying any critical economic functions it performs (for example payments to pensioners or compulsory insurance coverage) and potential impact to the wider economy were those services to be disrupted
  • How these functions could be preserved in a resolution situation
  • Identifying potential barriers to recovery/resolution and consider whether and how these could be reduced without significant disruption to ongoing business. This could include financial, legal and operational barriers
  • Whether current stress testing and reverse stress testing is sufficiently robust with respect to management actions available in a stress scenario
  • Expanding their ORSA reporting to address key elements of this work.

Lessons arising from the first year of Solvency II college meetings

On 1 March, EIOPA published its annual report to the European Parliament on the functioning of supervisory colleges in 2016, setting out its priorities in this area for 2017. There are currently 92 cross-border insurance groups with a head office in the European Economic Area (EEA).

A surprising finding was that there are a number of non-EEA parented groups for whom there is no group supervision undertaken – neither at worldwide nor EEA level. As part of reprioritising its involvement with colleges, EIOPA will focus on these groups and also any group whose failure would have a significant impact on European financial markets – linking with the work EIOPA has been undertaking regarding the potential need for harmonisation of resolution and recovery frameworks for insurers across the EEA. The determination of which groups fall into this systemic category will be based on their scale, market position, risk exposure, complexity and the perceived quality of supervision.

While many colleges are already using the new information afforded by Solvency II as part of their ongoing work, EIOPA is concerned that in a number of colleges’ risk assessments are more retrospective in nature than forward looking. Accordingly, EIOPA's work programme for 2017-2019 encourages discussion of business models, planning and risk analyses under stressed conditions.

While most of the findings are directed to supervisors, there are some areas for firms to address. In particular, EIOPA notes some inconsistencies in the own risk and solvency assessment (ORSA) reports that may result in insurers needing to adapt their reporting. The main area highlighted is inconsistency between solo and group ORSAs, although concerns are also raised regarding: embedding the ORSA; links between risk appetite, tolerances and limits; appropriateness of stress scenarios and sensitivity analysis; inclusion of non-EEA countries in the group ORSA; assessment of appropriateness of the standard formula and links with future business plans.

EIOPA also highlights an inconsistent use of long-term guarantees and transitional measures and states that it will assess the quality of reporting of their use in the public solvency and financial condition reports (SFCRs) due to be published shortly.

EIOPA also gives a few clues on its early warning indicators tests being developed for internal model firms (and groups). For example, EIOPA states that “a benchmark study for market and credit risk models is underway and a comparative study for non-life underwriting risk is about to start” and that projects on volatility adjustment and sovereign risk are on-going.

Looking forward, EIOPA has identified two themes for colleges to address in 2017:

  • Further developing the effectiveness, efficiency and impact of exchange of information and joint risk assessment in colleges.
  • Ensuring the robustness and reliability of the SII balance sheet, with particular reference to valuation principles, the use of options and their impact on the both solvency positions of the group overall and the major insurers within it.

Both the ORSA points above and this final bullet could result in increased supervisory demands on firms to explain their rationale for the approaches adopted.

EIOPA's risk assessment of the EU insurance industry

EIOPA released its risk dashboard on 28 February. The dashboard considers a series of risk categories - macro risk, credit risk, market risk, liquidity and funding risk, profitability and solvency risk, risks resulting from interlinkages and imbalances, insurance (underwriting) risk and market perceptions – and identifies whether the risk is perceived to be growing or diminishing.

There are no significant changes from the previous risk dashboard released in March 2016 and no surprises. The high risk categories are macro risk and market risk; insurance risk is the only risk category graded low with everything else graded medium. All of the risks are shown as being “constant” with the exception of liquidity and funding risk, due to a decrease in the catastrophe bonds issuance indicator.

The findings are no real surprise and consistent with the stress test results released in December. The macro-economic environment remains fragile and the low-yield environment continues to be a major challenge for insurers. In addition, it is unclear that the political uncertainty (including European elections and Brexit) has been fully factored into financial markets.

Importantly, EIOPA notes that market perception of the insurance industry is fairly stable, with no major market reaction to the transition to Solvency II.

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