AT the request of the Group of 20 and the Financial Stability Board (FSB), the International Association of Insurance Supervisors (IAIS) developed an assessment methodology to identify any insurers whose distress or disorderly failure, because of their size, complexity and interconnectedness, would cause significant disruption to the global financial system and economic activity.
Any such insurers would be regarded as systemically important on a global basis.
The FSB has identified nine groups as global systemically important insurers (G-SIIs) based on the IAIS methodology. The groups are: AIG, Allianz, Aviva, AXA, Generali, MetLife, Ping An Insurance, Prudential Financial and Prudential Plc.
The decision on possible G-SII designation of major reinsurers has been deferred until July 2014 to provide more time to evaluate the circumstances of the individual reinsurance companies in question. The IAIS has said that whereas, the G-SII methodology focuses on nontraditional or noninsurance (NTNI) activities, for reinsurers the issues relating to substitutability and interconnectedness are more complex than for insurers and require further study and analysis.
Assessment methodology
Last year we outlined how the IAIS developed its methodology to assess the systemic importance of insurers and the industry continues to raise concerns that the definition of nontraditional insurance business remains unclear, saying that what is traditional in one jurisdiction may be untraditional in another, especially regarding selection of products such as variable annuities. Understanding what is meant by the terms becomes critically important since the IAIS has said that its main goal is for G-SIIs to derisk from NTNI activities. Companies are saying that it is impossible to meet this goal without a full understanding of the calculations and definitions.
This issue further becomes important to resolve given many jurisdictions are now contemplating extending such requirements to local domestic systemically important insurers (D-SIIs). For example, the Prudential Regulation Authority (PRA) in the United Kingdom has recently announced a review of its principles for business, and adopted some new fundamental requirements that will guide the PRA in its supervision of firms. One of the new fundamental requirements for insurers is that they will need to prepare for resolution, so that if required, the insurer can be resolved in an orderly manner with a minimum disruption of critical services. Such a move is a significant development likely to be followed similarly by many other supervisors.
G-SII policy measures
The IAIS has also developed a framework of policy measures for G-SIIs. The framework is based upon the general framework published by the FSB with adjustments to reflect the distinct features of the insurance sector. As with the assessment methodology, the policy-measures framework reflects the factors that make insurers, and the reasons they might be systemic, different from other financial institutions.
Additional measures G-SIIs must undertake include:
Enhanced supervision: The first measures to be applied to G-SIIs relate to enhanced supervision, built on the IAIS’s core principles and the FSB’s paper on Supervisory Intensity and Effectiveness. These include the development of a systemic risk-management plan and an enhanced liquidity plan. The purpose of the systemic risk-management plan is to demonstrate how the group will manage, mitigate, and possibly reduce its systemic risk. The group-wide supervisor is required to have direct powers over holding companies to ensure that a direct approach to consolidated and group-wide supervision can be applied. It is expected that the Common Framework for the Supervision of Internationally Active Insurance Groups, or ComFrame measures, when completed, will also apply to G-SIIs.
Effective resolution: The second of the reforms to be outlined this year require the development of crisis-management groups, the elaboration of resolution and recovery plans, the conduct of resolvability assessments, and the adoption of institution-specific cross-border cooperation agreements. The IAIS proposals take account of the specifics of insurance through the inclusion of plans for separating NTNI activities from traditional insurance activities, the potential use of portfolio transfers and run-off arrangements, and the recognition of existing policyholder protection and guaranty schemes. The FSB is expected to release more specific guidance on resolution plans for insurers in the near future and is expected to release an insurance specific annex to its paper on Key Attributes.
Higher loss absorption (HLA) capacity: As outlined by the IAIS, in 2015 G-SIIs will be subject to basic capital requirements (BCRs). The BCRs will serve as the foundation for HLA requirements for G-SIIs, which will apply in 2019. Both the BCRs and HLA requirements are part of the IAIS Common Framework for the Supervision of Internationally Active Insurance Groups field-testing for 2014 and 2015. The IAIS has said that in applying the HLA capacity, consideration should be given to whether a firm’s and noninsurance financial activities have been effectively separated from the traditional insurance business. Where possible, the HLA may be targeted at the entities where the systemically important activities are located.
Basic capital requirements
The FSB has requested that the IAIS develop Backstop Capital Requirements (BCR) as part of the G-SIIs framework by the end of 2014. There is considerable debate as to how to approach the BCRs. Currently, the IAIS is looking at a factor-based approach and in December 2013 launched the first of two consultations on the BCR. The second is scheduled to commence in July 2014, following the results of the March to June 2014 field test.
The IAIS has developed principles to guide the development of the BCR. The three substantive principles are: that major risk categories should be considered; that there is comparability of outcomes across jurisdictions; and that the BCR has resilience to stresses. Within that core structure, proxy measures the valuation of will be selected and their factors calibrated. The proposed proxy measures for insurance liabilities and assets are the current estimates basis which are to be measured on the generally accepted accounting principles in each jurisdiction with some adjustments. The starting point for the BCR is the consolidated group-wide balance sheet, including noninsurance entities. Material off-balance sheet exposures also need to be considered.