IAIS develops BCR; U.S. weighs whether they are evolutionary or revolutionary

The International Association of Insurance Supervisors (IAIS) completed its first step in process to develop group-wide global insurance capital standards during its conference in Amsterdam. This week it announced that it had concluded development of the first-ever global insurance capital standard – Basic Capital Requirements (BCR) for global systemically important insurers (G-SIIs).
The BCR has also been endorsed by the G-20’s own Financial Stability Board (FSB).
“With design of the BCR now complete the IAIS has concluded the first of several steps in its process to develop group-wide global insurance capital standards,” said Peter Braumüller, chair of the IAIS Executive Committee, which also includes Federal Insurance Office (FIO) Director Michael McRaith, a Treasury official, and two U.S. state regulators.
Treasury and the Federal reserve Board as well as the Securities and Exchange Commission sit on the international FSB.
This comes as expected–now it is up to the countries to absorb it or otherwise fit it into their regulatory methodologies.
In the U.S., that means the primary regulator, whether the states or the Fed, depending on whether the insurer owns a thrift/savings & loan has been deemed a systemically important financial institution subject to enhanced prudential regulation.
The adoption in whole or part should be interesting as not all U.S. attendees appear to be on the same page, although some would wish it so.
McRaith, according to those live-tweeting the event at #iais2014 (let’s be clear; this blogger could not attend and turned to social media and attendee feedback) apparently said on a panel on capital standards that there was “a great desire” to move forward with them as long as “no one has to change.”
McRaith also called the BCR development a significant milestone as it is the first ever group capital standard, according to Tweets from attendees. He also focused on the importance of the globalized insurance markets and also noted, according to Tweets, that he was not worried about a monoculture developing with this capital standard.
The IAIS is developing no less than three separate capital standards for SIFIs: the BCR and the higher loss absorption (HLA) for G-SIIs, and the Insurance Capital Standard (ICS) for Internationally Active Insurance Groups (IAIGs.)
The BCR will serve as the comparable foundation for the HLA. Together, BCR and HLA will provide a consolidated group-wide capital requirement that will apply to G-SIIs only. When the ICS is finalized, it will replace the BCR in its role as the foundation for HLA. Got it?
The ICS is expected to be adopted in late 2018 and the HLA from 2019 onward, initially based on BCR as a foundation, moving later to ICS.
From 2019, G-SIIs will be required to hold capital no lower than the BCR plus HLA.
Missouri Insurance Director John M. Huff, in his keynote address,speaking on behalf of the NAIC, notably wavered from the perceived absolutism of a capital principle. He called upon global regulators to “acknowledge that our approaches to capital can be very different.”
Huff called upon the global community to give jurisdictions time needed to “develop standards appropriate to the insurance industry, and resist the pressure to homogenize regulation to treat all products and all investments the same.”
“In the U.S. as an example, with the exception of SIFIs, … the goal of the insurance capital requirements is not to prevent failure of a firm but to ensure the impact to policyholders is minimized. In other words, firms are allowed to fail but policyholders still need to be protected,” Huff stated.
He cautioned that if regulators require too much capital, then prices for consumers go up.
“A delicate balance needs to be achieved, and we must leverage other supervisory powers to complement capital such that we do not become over reliant on it,” Huff stated.
McRaith did acknowledge that a wide variety of views must be taken into account in development of global standards, according to a Tweet from an IAIS official.
Huff partially echoed that sentiment in his remarks: “When it comes to core principles, let’s truly make them principles where there is broad agreement they are critical to policyholder protection …true international norms that individual members can implement in a way appropriate for their home jurisdiction.”
“When it comes to the capital requirements, …we need to recognize that given the timelines, we need to work with present supervisory systems rather than thinking such standards could be used to dramatically reshape those established under existing law. As we move forward on these issues, practical and implementable change will be evolutionary, not revolutionary,” Huff stated.
Based on end-2013 data received during field testing, the average level of the BCR is 75% of the reported jurisdictional group-wide Prescribed Capital Requirement for G-SIIs, and 67% for all 2014 field testing volunteers, the IAIS stated.
Beginning in 2015, the BCR will be reported on a confidential basis to group-wide supervisors and be shared with the IAIS for purposes of refining the BCR.
The development of HLA requirements to apply to G-SIIs is due to be completed by the end of 2015. The final step is the development of a risk-based group-wide global ICS, due t by the end of 2016 and applied to IAIGs from 2019.
BCR is calculated on a consolidated group-wide basis for all financial and material non-financial activities. It is determined using a “factor-based” approach with 15 factors applying to defined segments and their specified exposure measures within the main categories of a G-SII’s activity – traditional life insurance, traditional non-life insurance, non-traditional insurance, assets and non-insurance.
All holding companies, insurance legal entities, banking legal entities and any other companies in the group will be included in the consolidation.
For more information, see PDFs on the iAIS website here.

FSOC annual report testimony on Hill Tues., while FSOC eyeing Stage 2 nonbank, meets in closed session

The Financial Stability Oversight Council (FSOC) will have a busy day Tuesday, June 24, as it meets in a closed, executive session and as Treasury Secretary Jack Lew testified before the House Financial Services Committee (HFSC)  on a hearing  entitled “The Annual Report of the Financial Stability Oversight Council.” Lew will be the only witness.

Although insurance is a subset of FSOC’s realm and of its annual report, there may be questions  from lawmakers on  the prudential regulation by the Federal Reserve of large insurers and asset managers, discussion on the application of domestic and proposed international capital standards and on FSOC’s internal business. HFSC passed measures last week on party line voting, to try and put the brakes on FSOC’s designation process and open it up to more federal officials and Congress.

MetLife is still in stage 3 of its potential designation as a nonbank systemically important financial institution (SIFI.) However, according to a readout of the March 27 FSOC meeting, which was closed, there was a discussion in late March on not only a stage potential designee but also a stage 2 financial company.

MetLife has already acknowledged it is in stage 3 and discussions are likely to continue Tuesday.  Of interest, the company, now stage 2 analysis, is perhaps an insurer or reinsurer.

Although the minutes did not disclose the sector, presentations on the unidentified  company were given by John Nolan, deputy director for Financial Stability in the Federal Insurance Office (FIO), who provided an update on the status of the ongoing analysis of the company. Randall Dodd, senior policy advisor at FIO, Todd Cohen, policy advisor at Treasury; and Scott Alvarez, General Counsel of the Federal Reserve, were available to answer questions on the company. However, the minutes do not reflect any presentation made by the office of the FSOC voting  member with Insurance Expertise, so it could be FIO’s and the Fed’s take on an asset manager with insurance holdings, or perhaps a large reinsurer.

The Financial Stability Board, in concert with the International Association of Insurance Supervisors (IAIS)  is coming out with its reinsurance global systemically important insurers (G-SIIs) around November of this year.  As far as domestics, Berkshire Hathaway could  possibly be among them because of its size, although the percentage of insurance as part of Berkshire Hathaway may not meet specific FSOC threshold material for insurance companies.

The annual report for 2014 again discussed again interest rate risk for insurance companies:

“Despite a significant rise in longer-term interest rates this past year, the insurance industry continued to report investment margins that were below historic averages,” the annual report of FSOC stated.

“If historically low interest rates persist, insurance companies could face a challenge generating investment returns that are sufficient to meet the cash flow demands of liabilities,” the report continued. Interest rates remained well below historical averages and continued to weigh on life insurance investment yields.

Legacy products in particular (including annuities, long-term care, and universal life insurance with secondary guarantees) have been less profitable in the current interest rate environment, as they were originally priced and sold under differing market conditions, as insurers have found out, the report noted.

The current low interest rate environment also may affect the use of captive reinsurance: the low rates affect the present value of insurers’ contract obligations (increasing the present values

of future obligations), and therefore may encourage use of reinsurance for insurance products with liability valuations that are interest-rate-sensitive

FSOC recommends that the Federal Insurance Office (FIO) and state insurance regulators continue to monitor and assess interest rate risk resulting from severe interest rate shocks.

FSOC also reported that Life insurance revenue from insurance and annuity products decreased to $583 billion in 2013 from the record $645 billion set in 2012.

Although  Expanded product distribution channels and a more favorable interest rate environment led to higher fixed annuity sales,  a number of one- time transactions and increased reinsurance cession overcame the improved fixed annuity sales and led to the decrease in total revenues.

Life insurers’ average portfolio yields continued to decline in 2013, but at a slower rate than in 2012, the report stated. Nonetheless, the life insurance sector’s net income rose 6.8% to $41 billion, a record high, benefitting from rising equity markets.

FSOC also delved into concerns regarding captive reinsurance. It pointed out that regulators and rating agencies have noted that the broad use of captive reinsurance by life insurers may result in regulatory capital ratios that potentially understate risk.

During times of financial market volatility when reserve and capital levels for some products should increase, an insurance company that uses captive reinsurance may not be required to hold higher reserves and capital. This could become a financial stability concern if a large, complex insurance organization were to experience financial distress,” the annual report stated.

The concerns have some offsets: The implementation of principles-based reserving (PBR) by the states  may eliminate the need to use captive reinsurance for the purpose of reducing reserves that are significantly higher than expected losses, according to the report.

The Federal Reserve  issued a “Supervision and Regulation Letter” (SRL)  in December 2013 concerning the effects of risk transfer activities on capital adequacy, which would apply to captive reinsurance risk transfer transactions for insurance companies it supervises when they become subject to the Federal Reserve’s risk-based capital framework.

The FIO is still monitoring both the role and impact of captives in the sector and the potential for regulatory improvements at the state level, as well.

Property/Casualty sector revenue from insurance products increased 3.9% to $544 billion in 2013, a record high.

Rates charged by insurers to policyholders increased moderately in most commercial lines of P/C business led by strong sales of workers’ compensation and demand for personal auto insurance. Net income increased to a record level of $70 billion, or an increase of 91.5% from 2012, as expenses and losses paid on claims declined and there were no major storms during the hurricane season in 2013, the annual report stated.

S&P questions G-SII merits while acknowledging uncertainty in outcome of designation

Standard & Poor’s  is asking whether the global systemically important  insurers (G-SIIs) designation’s costs outweighs it benefits and appears in its analysis to be sliding toward the answer of yes, at least for some.

Of course, the effects of the designation have not played out at all, yet, so anyone who analyses any effects couches their prognosis in terms of uncertainty.

“The merits of the G-SII designation for global financial stability are not clear, in our view, and may not outweigh its costs for insurers and their regulators,” stated Standard & Poor’s (S&P) Financial Services LLC in a June 3rd report on its global credit portal.

S&P said it concluded after some analysis that “ultimately, the net impact of the designation may be negative for some G-SIIs and positive for others. The picture will become clearer as the new regime takes shape and the G-SIIs take management actions to respond.”

S&P analysts considered the positive and the negative and did find potential for both, but ultimately questioned whether insurers pose a systemic risk like some of  the large banks have been found to do.

This sentiment, and the question analysts posed, whether naming certain insurers as G-SIIs enhances financial stability and warrants the resulting costs to insurers and their regulators, colored the report’s analysis.

In fact, the analysis suggest that the creation of G-SIIs could possibly destabilize parts of the industry itself if there is too much  regulatory focus on these largest, most interconnected global insurers while the rest of the industry goes its own way, in a way, less scrutinized.  “We further believe that the creation of G-SIIs could divert regulatory resources toward these entities while more risk accumulates at the non-G-SIIs,” the analysts said.

The analysts do suggest there is a place for a systemic risk scrutiny domestically, though: “We believe that systemic risk was more evident in insurance at a national, rather than global, level during the financial crisis, when U.S. bond and mortgage insurance and trade credit insurance in some European markets posed systemic concerns.

It may be that the FSB [G-20 Financial Stability Board]  would never have pursued the G-SII regime were it not for AIG’s failure, S&P analysts stated. It was “a failure that resulted, in our view, from its shadow banking activities, which other insurers largely avoided,” S& P said.

Potential identification of systemically risky/important  global reinsurers by the International Association of Insurance Supervisors (IAIS)  in concert with the FSB, is expected in November.

“The FSB has postponed the announcement of reinsurer G-SIIs twice, which may be indicative of differing views on the potential candidates,” S&P stated.

The IAIS is expected to deliver the basic capital requirement (BCR) n November, but S&P  believes significant later modifications are likely as work continues on the other elements,  including the higher loss absorbency for G-SIIs (by 2015). IAIS said that ComFrame field testing is progressing well, with many meetings taking place over the next month to analyze data and prepare for the next BCR consultation in July.

S&P says that although basic capital requirement, higher loss absorbency, and advocated global insurance capital standard won’t be “hard” capital tests that require insurers to act on deficiencies until 2019, it expects the development of these myriad capital standards to influence regulatory supervision before then.

The ratings agency questioned also this need for capital loadings for G-SIIs.

“It’s understandable for banks, where recent empirical evidence has shown what a failure can cost taxpayers…While insurers, including some large insurers, have failed in the past, their resolutions have generally come at limited cost to taxpayers, in our view…. In light of the lack of data on the cost of these resolutions in general and for taxpayers, it’s unclear to us how the IAIS will calibrate the G-SIIs’ capital loadings,” they stated.

S&P has taken no rating actions on insurers thus far as a direct consequence of a G-SII designation so far.

However, insurers should not expect a ratings boon from S&P for their global designations, at least:

“We anticipate that governments would play a role in resolving failing G-SIIs (and D-SIIs), but don’t see the same incentive for governments to provide capital support to the insurance sector. Accordingly, we factor no government support into insurers’ ratings unless they are government-owned,” S&P stated.

“In our view, the G-SIIs generally aren’t too big to be allowed to fail because we believe it’s possible to resolve their liabilities post-failure without disrupting the financial system and without the injection of taxpayers’ money. Capital injections generally aren’t necessary when resolving insurers because, relative to banks, they have low financial leverage, lower liquidity risk, low interdependency, and extensive use of subsidiaries (rather than branches). The infrequency of insurer bailouts historically bears this out,” the S&P analysts team stated in the research report.

Policy measures under consideration for G-SIIs include heightened oversight, resolution plans, and capital loadings to absorb potential losses.

The U.S. G-SIIs are Prudential Financial, AIG and  MetLife.

Domestic systemically important insurers (SIFIs), as designated by the Financial Stability Oversight Council (FSOC)  are expected to match up with these, according to S&P, with a MetLife designation coming down the pike. MetLife has been in Stage 3 of the FSOC review process for months.

S&P states that  heightened oversight is already a reality: AIG’s lead supervisor, the Fed, has already allocated a dedicated staff of nine to the task–and “colleges” of most of the G-SIIs’ main supervisors are already in place, S&P points out.

Insurers must submit detailed resolution plans to their group supervisor by July, for example.

The primary analyst for this S&P research report, which looks at the nine G-SIIs globally, is in London, with a team in New York, Frankfurt and Singapore.

Under Standard & Poor’s policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action).

What do you think the overall effect will be on G-SIIs, or for that matter, U.S. insurance SIFIs?
AUthor: Liz Festa, June 5, 2014