Panel 6 IAIS Framework for Prudential Regulation

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Panel 6 IAIS Framework for Prudential Regulation

• IAIS-ASSAL Training Seminar
• 24 November 2009, Lima Peru
• Jason Park Principal Administrator
• International Association of Insurance
  Supervisors (IAIS)

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Presentation Overview

• IAIS Framework for Insurance Supervision
• Adopted standards and guidance papers
• Structure of regulatory capital
  requirements(2008)
• Use of internal models for regulatory capital
  purposes(2008)
• Enterprise risk management for capital adequacy
  and solvency purposes(2008)
• Structure of capital resources for solvency
  purposes(2009)
• Current work in progress
• Valuation of assets and liabilities for solvency
  purposes(2010)
• Investments(2010)
• Future work

3
Basic concept (1)

• Insurer solvency is central to risk management by
  insurers and to the supervision of insurers
• Regulatory capital requirements are a fundamental
  part of a solvency regime
• Capital functions as a shock absorber against
  unforeseen losses
• Sufficient capital is critical to ensure the
  fulfilment of insurers obligations to
  policyholders
• A solvency regime comprises interdependent
  quantitative (financial) and qualitative
  (governance and market conduct) components

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Basic concept (2)

• Assessment of an insurers financial position for
  supervision purposes addresses the insurers
  technical provisions, regulatory capital
  requirements and available capital resources
• Technical provisions represent the amount that an
  insurer requires to settle all commitments to
  policyholders arising over the lifetime of the
  portfolio
• Regulatory capital requirements refers to the
  financial requirements set as part of the
  solvency regime that determine the amounts of
  capital that an insurer must hold in addition to
  its technical provisions
• Technical provisions and regulatory capital
  requirements should be covered by adequate and
  appropriate assets need to consider asset
  quality
• Capital resources may be very broadly regarded as
  the amount of the amount of assets in excess of
  the amount of liabilities

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Solvency requirements are integral in the
Framework for insurance supervision
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ISRs a comprehensive and cohesive set of
solvency assessment documentation
International Solvency Requirements (ISRs)
ISR 1 Capital requirements (adopted)
ISR 2 Capital resources (adopted in 2009)
ISR 3 Valuation of assets liabilities (due Oct
2010)
ISR 4 Investments (due Oct 2010)
ISR 5 Enterprise risk management (adopted)
ISR 6 Internal models (adopted)
STANDARDS
ISR 1 Capital requirements (adopted)
ISR 2 Capital resources (adopted in 2009)
ISR 3 Valuation of assets liabilities (due Oct
2010)
ISR 4 Investments (due Oct 2010)
ISR 5 Enterprise risk management (adopted)
ISR 6 Internal models (adopted)
GUIDANCE PAPER
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Presentation Overview

• IAIS Framework for Insurance Supervision
• Adopted standards and guidance papers
• Structure of regulatory capital
  requirements(2008)
• Use of internal models for regulatory capital
  purposes(2008)
• Enterprise risk management for capital adequacy
  and solvency purposes(2008)
• Structure of capital resources for solvency
  purposes(2009)
• Current work in progress
• Valuation of assets and liabilities for solvency
  purposes(2010)
• Investments(2010)
• Future work

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Standard and Guidance on the structure of
regulatory capital requirements (1)

• Standard on the Structure of Regulatory Capital
  Requirements
• outlines 15 principles-based requirements for a
  solvency regime in relation to regulatory capital
  requirements
• Guidance Paper on the Structure of Regulatory
  Capital Requirements
• provides additional guidance on these
  principles-based requirements

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Standard on the structure of regulatory capital
requirements (2)

• Requirement 1
• A total balance sheet should be used to recognise
  interdependence between assets, liabilities,
  regulatory capital requirements and capital
  resources.
• Requirement 2
• Regulatory capital requirements should be at a
  level such that policyholders obligations
  continue to be met as they fall due.
• Requirement 3 4
• The solvency regime should include a range of
  solvency control levels which should be coherent
  with the associated corrective actions.
• Requirement 5 6
• Prescribed capital requirement (PCR) is the
  solvency control level above which no action to
  increase capital or reduce risk will be required.
  PCR should exceed technical provisions and other
  liabilities at a specified safety level over a
  defined time horizon.

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Standard on the structure of regulatory capital
requirements (3)

• Requirement 7 8
• Minimum capital requirement (MCR) is the solvency
  control level at which the strongest action is
  invoked if no further capital is made available.
  The MCR should have a minimum bound below which
  no insurer is regarded to be viable.
• Requirement 9
• The solvency regime should be open and
  transparent on the objectives of the regulatory
  capital requirements and the bases on which they
  are determined.
• Requirement 10
• The solvency regime should allow a set of
  standardised and if appropriate other approved
  more tailored approaches such as the use of
  partial or full internal models.
• Requirement 11
• The solvency regime should be explicit as to
  where risks are addressed (split between
  technical provisions and regulatory capital
  requirements) as well as how risks and their
  aggregation are reflected.

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Standard on the structure of regulatory capital
requirements (4)

• Requirement 12
• The solvency regime should set appropriate target
  criteria for the calculation of regulatory
  capital requirements which should underlie the
  calibration of the standardised approach.
• Requirement 13
• For more tailored approaches, the target criteria
  should also apply to ensure broad consistency
  among insurers.
• Requirement 14
• Any variations to the regulatory capital
  requirements imposed by the supervisors should be
  transparent and proportionate according to the
  target criteria.
• Requirement 15
• The solvency regime should be supported by
  appropriate public disclosure and additional
  confidential reporting to the supervisor.

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Total balance sheet approach to recognise
interdependencies
Supervisory assessment of the financial position
Public financial reporting
Available capital
Capital
Capital requirement
Technical provisions
Value of assets for supervisory purposes
Risk margin
Liabilities
Liabilities
Best estimate policy obligations
Assets
Liabilities and capital requirement
Financial position
Assets
Liabilities
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Solvency control levels to trigger timely
supervisory interventions
Prescribed capital requirement (PCR)
Capital resources
Required capital
Minimum capital requirement (MCR)
Risk margin
Technical provisions other liabilities
Current estimate
Insurers financial position
Regulatory capital requirements
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Progressive intervention levels to ensure timely
corrective measures an example
Capital Adequacy Ratio Capital Available
Capital Required

• Prescribed capital requirement (PCR) level
• Supervisory intervention not required

190
160

• Submission of business plan to improve capital
  buffers
• Increased on-site supervision
• Additional stress and scenario testing

130

• Limit shareholder dividends
• Restrict new business acquisition
• Delay approval of new products

100

• Minimum capital requirement (MCR) level
• Winding-up of operation

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Internal models a more tailored approach to
determine regulatory capital

• What are internal models?
• A risk management system developed by an insurer
  to analyse and quantify its risk position and to
  determine the commensurate economic capital
• The internal model approach is suitable only if
  certain preconditions are met
• Level of sophistication of insurers / markets
• Corporate governance structures
• Competent / accountable insurance professionals
  and management
• Supervisory resources and expertise
• Standards and guidance paper apply only in
  jurisdictions where internal models are
  recognised for regulatory capital purposes

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General provisions on the use of internal models
for regulatory capital requirements

• Roles of supervisors
• Establish modelling criteria ensure consistency
  among all insurers.
• Set eligible levels of regulatory capital
  requirements (including MCR and PCR) for which IM
  are accepted extra care if this includes MCR.
• Review and approve the use of IM.
• Roles of insurers
• Ensure risk modelling techniques are appropriate
  to the nature, scale and complexity of risks.
• Demonstrate ongoing compliance with the three
  tests statistical quality, calibration and use
  (next slide).
• Notify supervisor of any material changes to the
  IM.
• Ensure proper documentation of the IM.
• Provide supervisory reporting and public
  disclosure.

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Initial and ongoing validation and approval
essential to ensure model remains fit for purpose

• Appropriateness of quantitative methodology-
  model inputs, parameters, assumptions
• Model addresses overall risk position
• Data accurate and complete

• Demonstrate that the regulatory capital computed
  using the model satisfies the specified modelling
  criteria

• The internal model is fully embedded into the
  risk strategy and operational processes
• Board and management have control over
  construction and use of the internal model
• Adequate governance and internal controls
  (documentation and disclosure)

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ERM framework underpins robust solvency
assessment (1)

• What is Enterprise Risk Management ?
• Process of identifying, assessing, measuring,
  controlling and mitigating risk in respect of the
  insurance enterprise as a whole
• Sound governance is a pre-requisite for solvency
  regime to operate effectively
• Enterprise risk management underpins effective
  solvency assessment and capital management

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ERM framework underpins robust solvency
assessment (2)

• Key Requirements
• The overall governance structure should include
  an Enterprise Risk Management (ERM) framework
  which is integrated with business operations and
  culture.
• Appropriate to the nature, scale and complexity
  of the business and risks.
• Addresses all reasonably foreseeable and relevant
  material risks.
• Led and overseen by board and senior management.
• Supported by accurate and appropriately detailed
  documentation of risks.
• Risk management policy, risk tolerance statement,
  and own risk and solvency assessment (ORSA)
  including continuity analysis.

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Draft standard and guidance on capital resources
for solvency purposes

• Key Requirements
• Capital resources should exceed capital
  requirements.
• Capital resources should be defined and should be
  consistent with total balance sheet approach with
  due regard to quality of capital resources.
• Solvency regime should establish criteria for
  assessing suitability of capital resources due
  regard to loss absorbency on going-concern and
  wind-up basis.
• Solvency regime should require the insurer to
  assess the quality and adequacy of its capital
  resources to meet regulatory capital requirements
  and any additional capital needs.
• - Adopted in Oct 2009

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Presentation Overview

• IAIS Framework for Insurance Supervision
• Adopted standards and guidance papers
• Structure of regulatory capital requirements
• Use of internal models for regulatory capital
  purposes
• Enterprise risk management for capital adequacy
  and solvency purposes
• Structure of capital resources for solvency
  purposes
• Current work in progress
• Valuation of assets and liabilities for solvency
  purposes
• Investments
• Future work

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Draft standard and guidance on valuation of
assets and liabilities for solvency purposes

• Joint working group between Solvency Actuarial
  Issues Subcommittee and Insurance Contracts
  Subcommittee developing draft paper.
• Work will take into account developments in the
  IASB Phase II Insurance Contracts project.
• Key principle is
• The IAIS believes that it is most desirable
  that the methodologies for calculating items in
  general purpose financial reports can be used
  for, or are substantially consistent with, the
  methodologies used for regulatory reporting
  purposes, with as few changes as possible to
  satisfy regulatory requirements.
• Due for adoption in October 2010.

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Draft standard and guidance on investments

• Review of current standard on ALM and guidance on
  investment risk management.
• Adoption delayed to October 2010 to incorporate
  observations from the financial crisis such as
• Liquidity risk, concentration risk, SPVs,
  structured products.
• Some concepts currently being considered
• Regulatory investment requirements to ensure
  sufficiency, liquidity and security of
  investments
• Role of ALM under the broader ERM and IM
  frameworks
• Diversification of investment portfolios
• Risk measurement
• Role of stress/scenario testing

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Presentation Overview

• IAIS Framework for Insurance Supervision
• Adopted standards and guidance papers
• Structure of regulatory capital requirements
• Use of internal models for regulatory capital
  purposes
• Enterprise risk management for capital adequacy
  and solvency purposes
• Structure of capital resources for solvency
  purposes
• Current work in progress
• Valuation of assets and liabilities for solvency
  purposes
• Investments
• Future work

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Further work

• Establishing a Group Supervisory Framework
• Reform of the ICPs by 2011
• Extending the solo level ISRs to groups
• Updating the existing Standards and Guidance to
  take account of the Global Financial Crisis
• New Standards and Guidance on Supervisory Review
  and Reporting
• Common Assessment Framework
• New working group formed to take forward research

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• Thank you for your attention.
• Any questions/ comments?
• jason.park_at_bis.org
• Note The adopted standards and guidance papers
  can be downloaded from www.iaisweb.org.