S1.2_Gonulal_Argentina 2011

Buenos Aires
November 22-24, 2011
Serap Oguz GONULAL
World Bank
 Challenges of insurance sector in emerging
 Solvency II
 Main regulatory elements
 International experience
 Implementation plan
Challenges of insurance sector in emerging
• Buyer issues
• Generally very low awareness of the value of insurance
• Compulsory insurance often seen as a tax
• Capital market issues
• Market small or nascent
• Rather low capital base and solvency margins
• After adjustments on the asset side, many companies are insolvent
• Insurance market issues
• Small and highly fragmented market – in terms of insurance
• Lack of awareness of importance of reserving
• Lack of data and lack of awareness of value of data
• Competition on prices should be replaced with competition on
quality of service
Challenges of insurance sector in emerging
• Claims payment standards
• Low claims payment capacity, particularly for smaller companies
• Long delays in settling claims - which undermines consumer
confidence and results in low insurance penetration (trust)
• Absence of a regulatory process to ensure good claim settlement
• Relations between companies and agencies are not
• The regulator doesn’t play the role of a developer
• Lack of willingness?
• Lack of technical capacity?
Typical Supervisory Challenges in Emerging
 Supervisors may have multiple objectives (protect policy holders,
promote insurance development, protect state owned insurance
 Data issues
 Data needed by the supervisor for analysis and monitoring of the
industry unreliable or non existent
 Financial data is not timely, and often received too late by the
supervisor to take action on it
 Legal issues
 Outmoded legislative requirements that do not reflect the attributes of
a modern supervisory system nor recognize the needs of a healthy,
vibrant insurance industry
 The legal system itself may contribute to a lack of determination by the
supervisor if the enforcement of legal contracts within the country
tends to be a frustrating and difficult process
Typical Supervisory Challenges in Emerging
 Supervisory personnel issues
 Supervisory personnel require training and upgrading of skills;
 Supervisory personnel are not adequately compensated, even by
local standards, thus making it difficult to attract and retain high
caliber personnel
 Supervisory personnel lack access to computer systems to analyze
and monitor financial information efficiently and effectively
 Standards of financial reporting, auditing and actuarial reporting are
not consistent and cannot be relied upon by the supervisor
 Boards of directors frequently lack independence from shareholders
and management and so are often not in a position to provide direction
and leadership
 Challenges of insurance sector in emerging economies
 Solvency II
 Main regulatory elements
 International experience
 Implementation plan
Main regulatory elements under Solvency II
Official supervisory oversight – on and offsite monitoring and
Solvency (inc. reserving), guaranteed return and consumer protection
The professions – actuaries, auditors and financial journalists
The governance structure – management and supervisory boards
The relative weighting of these depends on:
 Legal framework – particularly strength of capital rules (i.e. how much
leverage is allowed) and wind up rules
 Stage of development of governance mechanisms and professions
 History of failures
In emerging markets the supervisor is almost always key!!
Solvency II-Why ?
 No clarity on the objectives of supervision
 Solvency is based largely on mathematical reserve
calculation – no explicit allowance for asset side risks
 Rules based investment limits – can restrict innovation and
capital market development
 Limited guidance on supervisory interventions
 Net approach – no explicit allowance for reinsurance
 A need for improvement in the regulation and
supervision of insurance companies
Liability fair value (with resilience) - the management
team is ultimately responsible for the reliable and
adequate calculation of technical provisions
Liability uncertainty, asset risk and operational risk –
mainly covered by capital requirement
Solvency Capital Requirement (SCR) & Minimum
Capital Requirement (MCR)
Pillar II – supervisor can force solvency capital increase
Supervisor intervenes if solvency less than SCR – license
revoked if less than MCR
New ICPs - ICP16 & 17
 Solvency II:
 Two levels of capital requirements under Solvency II: Solvency Capital
Requirement (SCR) and Minimum Capital Requirement (MCR)
 SCR is a target level of capital while the MCR is a minimum threshold below
which companies are not permitted to trade (conceptually similar to Solvency I
 Between SCR and MCR: ‘ladder of intervention’ allowing regulators progressive
 In reality, most companies will exceed target SCR to minimize regulatory
 New ICPs:
 ICP 16 (Entreprise Risk Management for Solvency Purposes): The
supervisor establishes enterprise risk management requirements for solvency
purposes that require insurers to address all relevant and material risks
 ICP 17 (Capital Adequacy): The supervisor establishes capital adequacy
requirements for solvency purposes so that insurers can absorb significant
unforeseen losses and to provide for degrees of supervisory intervention
Solvency II
Market risk, credit risk, operational
risk, insurance risk, liquidity risk
Pillar 1-Quantitative
Pillar 2-Qualitative
Requirements & Rules on
Pillar 3-Supervisory
Reporting and Public
Capital requirements
Regulation on financial
services supervision
Valuation Assets and
Own Risk and Solvency
Assessment ( ORSA)
Own Funds
Capabilities and powers of
regulators, areas of activity
Disclosure requirements
Pillars I and II framework
 Challenges of insurance sector in emerging economies
 Solvency II
 Main regulatory elements
 International experience
 Implementation plan
International perspectives on solvency
modernisation: the USA
National Association of Insurance Commissioners (NAIC) Solvency Modernization
Initiative (SMI)
 NAIC: voluntary association of insurance regulators; primary vehicle for interstate coordination re.
insurance regulation
 1994: introduced a Risk-Based Capital (RBC) system, as a factor-based approach that considers an
insurers' size and risk profiles when determining capital requirements
 What's changing: Based on a review of international developments in insurance supervision,
solvency assessment, and international accounting standards, will upgrade the US solvency
 The impact: The SMI will:
 Strengthen the supervision of re/insurance groups
 Introduce requirements for enterprise risk management and prospective solvency assessment,
taking account of related international action and insurance core principles adopted by the
International Association of Insurance Supervisors (IAIS).
 Allow for ratings-based collateral for "certified" reinsurer
 Introduce principles-based reserving in life insurance
 Refine the current RBC system
 However, not expected to move to full economic-based methods of Solvency II
International perspectives on solvency modernisationEurope
Solvency II - European Economic Area (EEA)
 What's changing: Solvency II is the new proposed EU legislation which will govern the riskand economic- based capital requirements of insurance companies operating in the EEA as
well as define enterprise-wide risk management requirements.
 Replaces Solvency I, introduced in the 70s , and based on defining capital requirements by
specifying simple, factor-based solvency margins.
 Solvency I capital margins were designed to act as a buffer to absorb potential risks and protect
policyholders, but experience showed they do not always reflect the true risks of insurance
 The impact: Solvency II combines
 total balance sheet and economic-based solvency assessment,
 strong reliance on qualitative risk management requirements, and
 enhanced market discipline through increased disclosure requirements and transparency.
 This represents a paradigm shift in insurance supervision, the outcome of which should be
insurance companies with a better understanding of the risks they take and regulatory
incentives that promote state-of-the-art risk management and greater transparency
 Current status: after 5 rounds of industry testing, technical standards are being finalized for
implementation on 1 January 2013
International perspectives on solvency
modernisation- Switzerland
 Swiss Solvency Test (SST): economic-based regulatory approach that takes an all-risks
view of the re/insurer’s business
 Came into effect in 2006; mandatory for all companies by 1 January 2011; applies to all
Swiss-based companies
 Scope of regulation:
 Obliges groups, conglomerates and reinsurers to use an internal model to calculate
their solvency requirements
 Groups and conglomerates must report their available and required capital twice a
year to Swiss regulator FINMA.
 Similarity with Solvency II:
 Basic concepts of SST and Solvency II are similar
 Both based on a three-pillar approach that includes quantitative and qualitative risk
management requirements
 Both value assets and liabilities on a market consistent basis
 Both take an all-risks approach and acknowledge the benefits of diversification that
reinsurance provides
International perspectives on solvency
modernisation - Asia
 Current status:
 Risk-Based Capital (RBC) regime applied in Japan (1997), Indonesia (2000), Taiwan
(2002), Singapore (2004), Malaysia (2009), Thailand (2011) and South Korea (2011)
 Regulatory regime similar to Solvency I – i.e. based on a solvency ratio/margin
approach – used in many other Asian countries
 China, Hong Kong, the Philippines and Vietnam considering moving to an RBC
 India has not yet announced plans to change its solvency regime
 What's changing:
 Tightening of insurance supervision and regulation, including solvency
 Higher minimum capital requirements, adoption of RBC solvency systems, and
introduction of dynamic stress tests and use of scenarios
 Increased focus on consumer protection
 Alignment of accounting standards with the International Financial Reporting
International perspectives on solvency modernisation Asia
 China:
 Expected to move towards a RBC approach, though no timeline has been announced
 Expected to consider diversification and its benefits
 Also expected that capital requirements will be driven by higher charges on
underwriting risk
 Singapore:
 Introduced an RBC approach in 2004
 While no plans have been announced regarding a move towards Solvency II,
Singapore's authorities generally respond quickly to global standards and are
expected to be interested in equivalency amongst Asian regimes
 Further solvency development should address issues of diversification and
operational risk, as well as Group calculation.
 South Korea:
 Has also been closely observing Solvency II developments in Europe
 Having just introduced a RBC approach in April 2011, solvency regime is quite close
to Solvency II
 Future solvency developments expected to address Group-level calculation and
International perspectives on
solvency modernisation- Australia
 New development:
 Australian Prudential Regulation Authority (APRA) introduced the Life and General
Insurance Capital (LAGIC) which has strong parallels to Solvency II
 Implementation planned for the beginning of 2013
 Right now APRA is working on refinements as the industry is going through the
second Quantitative Impact Study (QIS)
 Scope of regulation: Aplies to all Australian insurance companies
 What's changing:
 As with Solvency II, LAGIC is a three-pillar regulatory regime with a risk-based
 Considers market, credit, operational, insurance and liquidity risks
 Current status :
 APRA will respond to the industry about its second QIS in November 2011
 Final Standards due in April 2012 and Final Reporting Standards in October 2012
 Challenges of insurance sector in emerging economies
 Solvency II
 Main regulatory elements
 International experience
 Implementation plan
Initial steps
 Set up prudential standards:
 Focus on risk management through improved risk measurement and a link to capital
 Fundamentally the business of insurance is about informed and controlled risktaking, and legal framework should respond to that ( no regulation for the sake of
regulation but for the better regulation)
First: Pillar 2’ supervisory review process to heighten focus on risk management; involves
introduction of improved disclosure through ‘Pillar 3’, so that market discipline
complements regulation
Second: market-consistent valuation standards, including in assessing the scale of
liabilities to policyholders
Third: capital requirements must reflect risk in both assets and liabilities (including any
interactions between the two); must reward real risk diversification; and must take
account of the extent to which risk-transfer instruments mitigate and transform risks
that a firm retains
Fourth: firms allowed to use own internal models to determine their regulatory capital
requirements, subject to appropriate controls over the adequacy of those models
Technology requirements of Solvency II
The insurer IT system must capture the
data as needed to assist in efficiently
calculating and valuing quantitative
Demonstrate controls, transparency in
disclosure and governance of system to
the regulator
IT system need to be capable of
reporting on solvency assessment and
demonstrate the use of regular tracking
and forecasting in the strategic decision
making process of the insurer
Impact of Technology
 Ability to screen large volumes of financial information, analyze trends in ratios and
monitor large amounts of financial data require use of modern electronic technology
 Modern insurance supervisory office typically receives electronically a well designed
package of financial data annually from insurers, with supplemental data on a quarterly
 Often, a specific software is available to companies, instead of a “statutory form”
 Typically the data received from insurers is stored electronically in a data base, so that the
application software can carry out pre-programmed routines such as calculation of ratios
and indicators
 Ability to carry out ad hoc analysis and screening of information in the data base
 Important, because difficult to say in advance what types of situations might arise which
will trigger a need for customized analysis
 For example, if a major, publicly traded corporation becomes insolvent, it would be
useful to be able to quickly find out which institutions have investments in that
entity and whether any investments are sufficiently large to imperil the financial
position of an insurer.
 Or in case of concerns with a particular type of insurance product, specific tests
could be developed to test this hypothesis against the companies’ financial data
RBS in emerging economies
 Simplified Solvency II approach – IRIS, basic RBC (plus margin),
formal intervention and enforcement levels
On site inspection based in part on IRIS ratios
Move from rules based to principles based in steps based on level of
supervisory, professional and governance capacity
 Maintain investment limits initially
 Allow a move away from strict limits based on company by
company assessment of skills and CM development – but replace
with capital requirements (may be 100% for related party assets)
Apply gross accounting in statutory returns (i.e. reinsurance shown
Require full reinsurance for catastrophe risk
Have a formal crisis recovery plan
Risk Based &Solvency II
 Risk Based Supervision is an approach to supervision in
which the action of the regulator is determined by:
 the risk profile of the institution
 the extent to which the institution can manage the risk with
minimal impact on policyholders and market interest
 Risk based supervision is predicated on the relationship
between risk and capital: the higher the risk profile of the
insurer, the higher the capital it must hold
Risk Based –Solvency II
 Solvency I is a weak predictor
 Solvency II
 Tool for companies for managing risk and capital
 Early warning system for supervisors and for
 Internal Models: only solution to determine required
capital and risk for complex companies and groups
 Ideally, insurers and regulators should develop
solvency framework together
Moving towards risk based /Solvency II
 With an increased risk focus in insurance supervision,
the regulator will:
 direct its attention to essential areas of supervision and make
effective use of limited resources
 concurrently aim for wider supervisory coverage by
introducing more automated routines
 The goal is to create an effective and well-balanced
supervision of the insurance sector based on solvency
and other issues of importance for insurance
SII directive: Aim of introducing risk-based supervision
 Improvement to prioritizing tools of supervision in
progress using a different angle compared with our present
classification system
 The new prioritizing tool will become a complement to
supervisory planning, aimed at better capturing trends and
risk on markets and in companies
 The purpose of the Solvency II project is to:
 review all the prudential rules in the insurance field
 devise a solvency system more sensitive to the risks
incurred by insurance companies
 enable supervisors to protect policyholders' interests as
effectively as possible in accordance with common principles
Rules based/Risk based
Rules based
Risk based
• Compliance audit
• Compliance reviews and examinations
• Move towards;
• risk based supervision
• focused reviews
• cross sector reviews
• reliance on the work others
• board of directors
• other regulator
Risks in insurance
 Aside from the direct business risks, significant risks to insurers are
generated on the liability side:
• These risks are referred to as technical risks and relate to the
actuarial or statistical calculations used in estimating liabilities
• On the asset side of the balance sheet, insurers incur market,
credit, and liquidity risk from their investments and financial
operations, as well as risks arising from asset-liability mismatches
• Life insurers also offer products of life cover with a savings
content and pension products that are usually managed with a
long-term perspective.
The supervisory framework must address all these
Key regulatory issues for insurance-1
• Preventing pyramid schemes arising from competitive
pressure on guaranteed returns - ensuring reserves
(called math. reserves) are adequate ( Life)
• Ensuring that sufficient capital is in place to cover
normal credit, market, liquidity, underwriting, and
operating risks ( life and non-life)
• Securing assets – including asset quality – preventing
related party lending and asset concentration ( life and
• Ensuring enough competition to sustain innovation
and efficiency – minimum capital, entry conditions
(Life and non-life)
Key regulatory issues for insurance 2
• Ensuring adequate internal controls - record keeping
is accurate and backed up (Life and non-life)
Having a crisis mechanism in place – guarantee funds
etc while minimizing moral hazard
Set up claims management
Better coordination between the regulator and the
Built up technical capacity in the regulator as well as in
the insurance sector
How to measure success
 Key indicators and benchmarks
• Penetration measures
• Expense structures
• Delivery alternatives
• Product choice and transparency
• Rate of insolvency – true financial position
• Claim paying track record
• Profits relative to domestic cost of capital
• Investments – risk/ return performance
The regulators as developers
• Striking a right balance between developing and
regulating the industry
• Considering the interests of policy holders as
primary objective while framing regulation
• Shouldering the responsibility of developing a
nascent insurance market
Moving towards Solvency II-Why?
to increase policyholders protection
 A requirement to get a risk-sensitive level of required
 Greater market discipline through increased public
 More information on firms to allow supervisors to have
a total view of the business model
 Much stronger emphasis on risk management and
forward-looking risk governance leading to a stronger
risk culture in firms
 We need a system designed to create incentives for sound risk management
 Insurance regulators/supervisors should benefit from best practices and
 Strengthen their risk management capabilities
 Create sustainable products
 Remain competitive in the global market place
 The supervisory architecture
Solvency should be highest priority
Data quality
Consistent accounting and actuarial valuation
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