Designing insurance regulations for global systemically important insurers

Regulations for global systemically important insurers

Developing regulations to supervise insurance groups and monitor risk among G-SIIs.

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Most Global Systemically Important Insurers (G-SIIs) will meet the definition of an IAIG and therefore be subject to the requirements of ComFrame. The IAIS has also confirmed that all G-SIIs will be considered to be IAIGs for ICS purposes and therefore need to comply with this group-wide capital standard. However, G-SIIs are also subject to the enhanced supervisory requirements in the G-SII package of IAIS requirements. This includes:

  • enhanced group supervision, giving the group supervisor direct powers over holding companies and oversight of the group systemic risk management plan (SRMP) and liquidity management plan
  • an additional capital requirement (the higher loss absorbency (HLA))
  • group-wide resolution planning and resolvability assessments and the establishment of crisis management groups (CMGs).

Further, there have been a number of developments, which are discussed below.

The current population of G-SIIs is now as follows: AEGON N.V, Allianz, American International Group Inc., Aviva Plc, AXA S.A., MetLife, Ping An Insurance (Group) Company of China, Ltd., Prudential Financial Inc., and Prudential plc.

G-SII Assessment Methodology

In November 2015, the IAIS released a consultation document  proposing various refinements to the G-SII assessment methodology, originally finalized in 2013. The intention is for the revised approach to be applied from the 2016 assessment process.

Key changes include the introduction of a five-phase approach (which includes a qualitative assessment phase to complement the previous quantitative-only approach), refinements to some indicators to improve their risk sensitivity and introduction of a reinsurance supplemental assessment.  In terms of the quantitative component of the methodology, the IAIS has proposed the introduction of a small number of absolute references, specifically for derivatives trading, financial guarantees and reinsurance categories.

Non-Traditional Non-Insurance (NTNI) activities

In November 2015, the IAIS released a consultation document  proposing an objective framework for identifying non-traditional insurance activities conducted by an insurance group. In this document, the IAIS changes the focus from a simple consideration of insurance products to a discussion about the various features within insurance products that could potentially have systemic risk implications.

The paper represents the first of a three-step process to clarify the NTNI concept, with the IAIS aiming to finalize all three steps in time to be included within the 2016 G-SII designation exercise.  

In determining what is potentially systemic, the IAIS has proposed a three-step approach. This involves:

  • analysing product features of insurance contracts to identify potential vulnerabilities that could be created, considering both whether this could involve substantial market or liquidity risk
  • determining how these features could lead to systemic outcomes (for example could this exacerbate shocks within the financial markets through exposure to counterparties or could an insurer’s need for liquidity create asset price volatility through forced asset sales?) and
  • considering whether there are any exacerbating factors that need to be taken into account which are relevant to systemic risk outcomes.

For the assessment of substantial market risk, the IAIS proposes a framework be applied to products based on their features. The existence of a guarantee and the extent to which an insurer can invest in assets to match the cash flows of the guaranteed payments are critical considerations.

Higher Loss Absorbency (HLA)

The IAIS consulted on its initial HLA proposal in June 2015  and, following industry feedback, approved a final form  of the HLA at its Board meeting in November 2015. This milestone is seen as critical in ultimately achieving the objective of mitigating the systemic risk posed by G-SIIs to the global financial system. 

HLA capital requirement:

The HLA represents an additional capital requirement above the ICS that will apply to G-SIIs to address their systemic risk and act as an incentive for them to reduce their systemic footprint. However, a number of challenges remain, including the level of calibration, the extent to which risk sensitivity can be achieved through a factor based approach and the responsiveness of the HLA to underlying changes in the G-SII risk profile.

The HLA factors applying to life insurance, non-life insurance and assets are all the same implying that they broadly reflect a similar level of systemic activity. Additional emphasis is placed on non-traditional and non-insurance activities through the use of higher HLA factors as these activities are most likely to cause or amplify systemic risk.

HLA Capital Resources:

The HLA element of the capital requirement will need to be met by the highest quality of capital. Given the current link with the Basic Capital Requirements (BCR), this is currently taken to mean Core capital as defined BCR purposes. However, when the HLA’s foundation changes to the ICS, the capital resources for HLA purposes will also be reviewed. Our expectation is that this then become ‘Tier 1 financial instruments for which there is no limit’.

For the combined BCR and HLA requirements, this will need to be covered by core capital and the minimum of additional capital and 50% of the BCR. The ratio of qualifying capital resources to the total capital requirement is expected to become a key metric.

Implications of G-SII rules for Insurers

The extent of inter-connectivity between the G-SII Assessment Methodology, NTNI identification, the ICS and HLA are very clear:

  • The work on the G-SII Assessment Methodology has transparency as one of its aims.  This should enable greater understanding of the drivers of the G-SII assessment score, which will be critical to lowering individual scores and reducing capital add-ons. However, it remains unclear how quickly the G-SII Assessment score will respond to changes in the underlying systemic risk profile of insurance groups.
  • As the IAIS has adopted a higher factor for NT activities compared to traditional insurance business, all current and potential G-SIIs should continue to monitor developments regarding the NT classification closely.
  • As the ICS develops, the uplift applied to the BCR may change from the current 33% assumed.  However, care will be needed to ensure that the potential revisions that will be required when the ICS becomes the foundation for the HLA do not result in a significant step change in the amount of HLA applied.
  • The HLA bucketing approach is based on a relative assessment of G-SIIs.   Given this is a very small population of groups, it is unclear how quickly an individual G-SII will be able to move to a lower ‘bucket’ of HLA factors.  This could mean that while a particular G-SII’s own systemic risk may have reduced over time, the same HLA factors could continue to apply.

The current work program in these areas makes it difficult for an insurance group currently to estimate what its likely capital requirements will be when the ICS becomes the foundation for the HLA.  Although the HLA is intended to act as a deterrent to G-SIIs from taking on more systemic risk, it is currently unclear whether this will be achieved in practice. 

Finally, we believe that greater clarity should be provided regarding how the various capital requirements (BCR, ICS and HLA) and intervention levels (Minimum Capital Requirement (MCR) and Prescribed Capital Requirement (PCR)) will interact once all components are in force. 

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