IAIS capital standards may mean more onerous requirements

Ongoing efforts by the International Association of Insurance Supervisors (IAIS) to devise an international set of capital standards will require a delicate balancing act between the re/insurance industry and local regulatory bodies and jurisdictions, Brad Kading, president of the Association of Bermuda Insurers and Reinsurers (ABIR), told PCI Today.

He noted that IAIS is looking to impose capital standards which, in some cases, may differ from those of local regulators, risking confusion for companies in the process.

“The challenge for IAIS capital standards is to recognise that many jurisdictions in the world already have their own group capital requirements in place today,” Kading said.

“Australia, Canada, Bermuda, the European Union, Switzerland—they all have longstanding group capital standards in place. If you try to come up with something new, you run the risk of ignoring the local market issues that led to specific jurisdictions creating their own group capital measures.”

The IAIS started looking at the possibility of introducing the first international capital standard (ICS) for internationally active insurance groups (IAIGs) across the world two years ago. It issued a consultation paper at the end of 2014 and originally planned to publish proposals on the first version of ICS by mid-2017.

It said when it started the process that it would seek implementation to IAIGs from 2020 after refinement and final calibration in 2018 and 2019.

The initiative was partly informed by the fact that banking regulators have been developing minimum banking capital standards for the best part of 30 years. Research shows that the insurance sector is now, by many measurements, more global than the banking sector. It thus follows that, for many reasons including policyholder security and fears of systemic risk, the sector would benefit from ICS.

The IAIS is an international standard-setting body, similar to the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO). It this has no role in enforcing implementation of the ICS—that would be the responsibility of national authorities, supported by peer reviews.

Kading believes that the IAIS must ensure it fully takes into account existing standards in jurisdictions before setting its own.

“The most practical way for the IAIS to implement a group capital standard is to recognise that existing regimes have their own measures and then come up with a measured proposal that should logically reflect existing standards in place,” he said.

“The body should then evaluate them against the new proposal and assess if they’re equivalent in outcomes. If so, then let those standards carry forward as the IAIS standard is rolled out.”

Kading suggested that, over time, as long as the IAIS proposal makes sense, jurisdictions would evolve their own systems towards meeting an IAIS standard over a reasonable period of time. He said that the idea that jurisdictions would simply adopt an IAIS standard as it is would be unlikely to produce a positive outcome, given the IAIS’s goal of moving jurisdictions towards a common standard.

“It seems to us to be practical politics when rolling out a capital standard to first assess individual jurisdictions with capital standards. As long as there is equivalence to the IAIS standard you let them co-exist until such time, after a testing period that takes place perhaps, they then make adjustments. You end up seeing a natural evolution over time.”

He added that the other issue would be the calibration of IAIS capital standards and whether it should be set at an insolvency threshold. According to Kading, it should be set at a low level—a number that, if breached, means that the group is, or is going to be, insolvent.

He warns that to set it higher would risk resistance from jurisdictions required to move towards adopting it.

“Jurisdictions will not move towards an IAIS standard if the outcome of that is much higher capital requirements on the domestic industry.

“That’s the issue you’ll hear most often from the US—that rolling out a new IAIS capital standard would lead to higher capital requirements,” said Kading.

What the Fed does today

Several related initiatives are underway in the US at the moment. The Federal Reserve is also working on capital requirements for the insurance groups that it represents. It is specifically looking at systemically important insurance groups and those that own banking enterprises.

He believes the Federal Reserve’s development of its group capital standards will naturally influence the National Association of Insurance Commissioners (NAIC’s) development of its own group capital calculations.

“The NAIC has its own group capital calculation now. Most observers think that it’s a stepping-stone to a US group capital requirement, so as the Fed progresses then the NAIC is likely to also progress. It will be interesting to see how synchronised or coordinated these standards are over time,” Kading said.

He added that the NAIC has also started to work on a refinement of its regulation of reinsurance. A number of years ago it created a reinsurance regulatory modernisation framework, which introduced a two-tiered system of regulation of non-US reinsurers.

The first tier was based on an analysis of a reinsurer’s home jurisdiction to determine if that jurisdiction has regulatory standards compatible with, and which produce equivalent outcomes to, US systems.

As part of that process, the NAIC identified a small number of jurisdictions around the world that met those standards, including Bermuda.

Once a jurisdiction qualified, the second part of the NAIC programme was to assess individual reinsurers to determine whether they had the financial standing to become certified under that system. Once certified they could operate with US clients by posting less than 100 percent collateral.

“That NAIC regime has been out there for a while now. Not all states have adopted it yet; there are two major hold-out states: Illinois and Texas,” Kading said.

“But the NAIC believes that it can progress on that. Recently the NAIC added a new wrinkle to that measure by coming up with proposals to regulate reinsurance at the ceding insurance level by saying that cedants could have additional capital charges tied to the financial standing of the reinsurers because of business risks. A new consultation paper was published last week, with a formal consultation period.

“That’s a fairly dramatic change in the NAIC approach to the regulation of reinsurance credits. They appear to be adding a measure that would impose additional capital on a cedant if the cedant’s reinsurer doesn’t meet a certain financial test.

“That’ll be the big news throughout 2017 I think. This may be a complete overhaul tied to the US/EU Covered Agreement negotiations, we will have to wait and see,” he concluded.