International capital standards

The drive for more cross-jurisdiction uniformity in the regulation of insurance firms is gathering pace—particularly around capital standards.

By Chuck Coatsworth, Actuary, Life Technology Solutions, Milliman.

The International Association of Insurance Supervisors (IAIS) has been aggressively pushing its proposed capital standards of late. But the group is increasingly running into opposition, exposing the differences in approach between Europe and the United States as it does so.

European insurers are still adjusting to the demands of Solvency II, and aren’t keen on the idea of a new regime that deviates too far from that. In the United States, meanwhile, the concern is that the IAIS proposals are too close to the Solvency II model, and will require significant adjustments in capital structure, investment strategies, and product portfolios.

The IAIS has an ambitious timetable. It wants regulators to adopt its reporting framework by 2019, with the full regime due for implementation sometime in 2020. It is driven by the fear that another financial crisis could see major insurers falling between regulatory cracks, especially if they write multinational business.

Global regulators and politicians are focused on preventing a major failure on their watch. Both know there will be public condemnation and a renewed populist backlash if another Lehman-Brothers-style collapse occurs. When it comes to the insurance sector, two concerns regulators frequently express are liquidity and pro-cyclicality. The two are, of course, linked.

If another financial crisis hits, or a major catastrophe strains the balance sheets of general insurers, will they be able to realize the assets they hold in order to remain solvent?

The speed with which some assets can turn illiquid was demonstrated recently in the UK, when several large commercial property funds froze redemptions in the immediate aftermath of the Brexit vote and the collapse in the value of British sterling.

The other fear is that, faced with a crisis, major financial institutions could all jump the same way at the same time, exacerbating the negative forces already swirling around the system.

Solvency II and the IAIS proposals are responses to those fears, and regulators remain determined to close the gaps between the regulatory approaches in major jurisdictions. The IAIS may not have the power to enforce adoption of its preferred regime. But with the ultimate backing of the Financial Stability Board, itself established by the G20 finance ministers, it will be hard to ignore.

We know that change is coming, especially for reporting, monitoring, and stress testing. If the final requirements are similar to others already in use, then it’s mainly risk, actuarial, financial, and compliance that will be affected. On the other hand, if the result of the debate and consultation is very different to a jurisdiction’s current regime, then just about all functional areas will be impacted because of knock-on effects, including product portfolio, pricing, and investment strategy.

That has certainly been the experience of insurance groups that have implemented Solvency II. They have developed robust internal models, and have invested in the systems needed to cope with regular, even daily, capital monitoring and risk management. U.S. insurers, particularly those affected by these proposals, need to start investing in similar models and systems.

U.S. carriers are only just moving toward principle-based reserving, something that has been in place in many European jurisdictions for a decade or more. It seems certain that the new regime will build on this as it strives for greater harmonization. It should therefore be embraced now, as an incentive to invest in structures and systems that will facilitate the required calculations but, more importantly, provide insights to better understand and manage the business.


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