Early-warning Indicators, Supervisory Intervention and Cros

Early-warning Indicators, Supervisory Intervention and Cross-border Resolution of Insurance Groups

Regional Seminar on Supervision of Insurance Groups

Santiago, Chile, 19-21 November 2013

Gunilla Löfvendahl

Senior Financial Sector Specialist

2

Agenda

On a legal entity and group-wide level

Learn from past crises - typical problems and possible solutions

Identifying problems early, responding with adequate supervisory tools

S

upervisory ladder of intervention, cooperation and resolution, and orderly exit from the market

3

HIH failure (2001) - Findings

New supervisory methods and structure, with

loss of corporate memory and industry expertise

Assumption

that most large and complex groups were well managed and

controlled, with

concentration on

exceptions

Mismanagement of HIH

Under-pricing and provisioning

Creative reinsurance arrangements

Bad corporate culture

Blind faith in an ill-equipped leadership consisting of dominant personalities

Risk not properly identified and unpleasant information

hidden or

sanitised

Lack of independence and critical analysis

Aggressive accounting practices and lack of audit independence

Fraud, extravagance and questionable transactions

4

Palmer Report recommendations (2002)

Powers and quality of the supervisor

High

degree of supervisory independence and ability to act quickly and decisively

Strengthen intervention powers, using

them vigorously, also

informally

Reasonable degree of senior management and board involvement

in

important decisions

Broader mix of expertise, including from the

outside

Capacity to review sufficiency of reinsurance arrangements and adequacy of liabilities, such as outstanding claims

Planning

for future contingencies (creation of business cases, training

etc

)

5

Palmer report continued

Supervisory process

Strengthen supervisory risk-rating process and more frequent meetings to review institutions

Amend

methodology

to acknowledge that apparently well-managed groups can experience financial problems – early detection

Regular meetings with boards and relevant board committees of supervised entities (discuss expectations and findings)

Regular meetings with approved actuaries and auditors

Review relationship with foreign regulators and, where necessary, establish

MoUs

Focus

Group-wide supervision, looking at the

legal entities, including

non-regulated

Monitor intra-group transactions

Move

from high-level on-site inspections (discussions) to more

detailed reviews

of evidence

6

Royal Commission recommendations (2003)

Corporate governance

Look at remuneration

policy and

disclose benefits

Clear

definition of duties and

functions of board and senior management

Capital adequacy

Minimum solvency requirements on entity as well as group level

Require

approved actuary

reports of financial condition

Greater disclosure of information about financial positions, and risk- and reinsurance management strategies

Supervisory capacity, methodology and focus

Build supervisory competency and review competitiveness in the labour market (salaries

etc

)

More sceptical questioning and

aggressive

approach to prudential supervision

Preparedness to enforce compliance (also timely returns)

Continual questioning of assumed financial viability of institutions

Random but frequent investigations of reinsurance arrangements

7

European failures (2002*) – Findings

Main apparent causes: underwriting and reserving risk

Root causes: management or

governance

issues - more

focus on the underlying

causes makes it easier

to detect the effects

early

Indications

of lax risk management or systems and control should generate a search for a potential deeper

malaise

E

nough

autonomy for insurers belonging to

groups

Appropriate experience and skills of board and

management

Performance assessment and bonus policy that

do

not encourage excessive risk

taking

Not only rely on quantitative factors

A

nticipate how risks can interact in complex ways, including causal links between different types of risk and unexpected correlations – large exposures on a group-level

Move to risk-based approaches, with more forward-looking tools and greater international cooperation

*

Joint work of 15 countries in the European

Union:

Report on 20 out of

270

cases of failed insurers or near misses, looking at causing risks and existing supervisory practices on prevention and early detection

8

Great Financial Crisis - Findings

Insurers

mainly affected

on the asset

side - life

insurers predominantly

hit (higher asset/equity ratio) and greatest problems in guaranteed products

Credit-related non-life lines more hit due to business insolvencies

(

monoline

/financial

guarantees)

Pro-cyclicality

of capital risk charges (reduction of available

capital,

sale of risky assets, aggravating the asset prices in a downward spiral

)

Pro-cyclicality of accounting

standards (fair value)

Gaps in the supervision of groups,

eg

AIG

Systemic risk (risk

seriously impairing

the

overall economy

) –

insurers systematically

risky

?

Risk of run on insurers - no

significant increase in lapse

rates although in principle possible for life insurers

Liquidity

risk management –

claims normally well-managed but

securities

lending,

collateral

requirements (triggered

by

downgrade),

and redeemed

policies could pose such risks

Safeguards in case of troubled insurance

groups – possible simplification of group

structure, orderly

resolution process,

orderly exit and guarantee

schemes

9

IMF recommendations (May 2010)

The Making of Good Supervision: Learning to Say “No“

Sceptical but proactive

:

Question also in

good times (counter-cyclical)

Comprehensive

: Identify emerging risks at the edge of the regulatory scope (unregulated entities,

off-balance sheet

structures, systemic

risk)

Adaptive

: Be in constant learning mode (new markets, services, products and risks

) - form views

on how

changes

will affect institutions

Conclusive

: Follow-up findings (on- and off-site)

– take sanctions if not remedied

10

IMF recommendations continued - How

Ability to act

Legal authority, including operational independence

Adequate resources, including skilled staff

Clear strategy regarding the approach to supervision

Robust internal organisation, including well-defined decision making, oversight and accountability

Effective working relationships with other agencies

Will to act

Constant dialogue with industry, including boards

Take action and fulfil the supervisory role

11

Insurance Core Principles – the tools are there

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.

ICP 10 Preventive and Corrective Measures:

The supervisor takes preventive and corrective measures that are timely, suitable and necessary to achieve the objectives of insurance supervision.

ICP 11 Enforcement:

The supervisor enforces corrective action and, where needed, imposes sanctions based on clear and objective criteria that are publicly disclosed.

ICP 12 Winding-up and Exit from the Market:

The legislation defines a range of options for the exit of insurance legal entities from the market. It defines insolvency and establishes the criteria and procedure for dealing with insolvency of insurance legal entities [ ] the legal framework gives priority to the protection of policyholders…..

12

Solvency control levels and other triggers

Regulatory requirements should be at a sufficient level so that insurers’ obligations to policyholders continue to be met as they fall due

Capital resources reduce the probability of insolvency and loss to policyholders - increase capital or reduce risk if not sufficient

Solvency control levels provide triggers for action by insurers and supervisors

Should be at least two control levels:

Prescribed capital level (PCR): above which intervention would be on other grounds than capital adequacy

Minimum capital level (MCR): strongest supervisory action if corrective action is not taken promptly

Should allow for intervention at a sufficiently early stage for a realistic prospect of being rectified in a timely manner

Group solvency levels – PCR and MCR?

13

Early-warning indicators

Capital is not everything – have a range of early-warning indicators, both quantitative and qualitative that should trigger action

Examples of indicators?

How

could they be

identified?

14

Supervisory monitoring tools

ICP 9 Supervisory review and reporting

ICP 4 Licensing

ICP 6 Changes in control and portfolio transfer

Acquisitions and mergers

Portfolio transfers

ICP 23 Group-wide supervision

15

ICP 10 Preventive and Corrective Measures

Legal and operational capacity to act timely

Decision-making lines of the supervisor should be structured so that action can be taken immediately in the case of an emergency situation

Detect vulnerability in the insurer’s ability to protect policyholders

P

revent a breach of legislation

D

eal with non-compliance or where an insurer enters into unsound practices

Require insurer to develop an acceptable plan for prevention and correction of problems

Ensure that the measures are taken

16

Early prevention and detection tools

Activities subject to prior approval

Continual fit and proper requirements

Requirements of sound corporate governance, internal control and risk management

Prospective reporting and analysis

Business plan and strategy for new business

Established contacts with other involved supervisors

Informal contacts with management

Public disclosure/transparency

17

Preventive and corrective supervisory measures

Increased supervisory activity or reporting

Independent review by auditors or actuaries

Correction of reporting

errors

C

apital and business plan for restoration of capital resources

Measures to reduce risk (

eg

reinsurance)

Strengthen or replace the insurer’s management and/or risk management framework and governance

18

ICP 11 Enforcement

Formal directions to take (or desist) actions - failure to comply should have serious consequences (combine with fines and punitive actions)

Should at a minimum include

Restrictions on business activities

Measures to reinforce the financial position of the insurer

Consequences when failing to provide information in a timely fashion, withhold information or provide information that is intended to mislead

Should not delay necessary preventive or corrective measures to be taken

Powerful supervisory tools that should be used in a fair and equal manner

Not sufficient to have powers delegated under legislation (powerful tools are only powerful if used) – will to act

Issues related to groups?

Determine that the insurer is complying with the measures once action has been taken or measures have been imposed

19

Enforcement or sanction measures

Restrict business activities

Stop the writing of new business

Withhold approval for new activities or acquisitions

Restrict the transfer of assets

Directions to reinforce financial position

Require capital levels to be increased or measures that reduce or mitigate risks

Restrict disposal of insurer’s assets

Restrict/suspend dividend or other payments to shareholders

Remove directors and managers - bar individuals from acting in responsible capacities in the future

Compulsory portfolio transfer or conservatorship

Revoke the licence – require the company to wind-up

Direct a company to stop unlicensed business

20

Resolution and G-SIIs

Define insolvency and the limit when it is no longer permissible to continue business

Resolution could be used for cross-border groups before that point is reached – should be used for G-SIIs, which need to be resolvable

Orderly resolution requires appropriate actions prior to the non-viability stage – on-going cooperation and information sharing

Normal resolution tools that can be used on all insurers (enough for G-SIIs?):

Portfolio transfer

Run off

Establish resolution authorities and cross-border management groups (CMGs) – top level or resolution powers in more than one part of the group

Appropriate powers to intervene at holding company level

Powers to terminate large volumes of financial contracts – insurance policies?

Ensure continuation of non-insurance operational business that is significant to the systemic function

Temporary public financial support may be needed

21

ICP 12 Winding-up and Exit from the Market

Procedure for dealing with winding-up and insolvency

Appoint administrator or liquidator to take over the roles and duties of board and senior management

Run-off with supervisory involvement

Liquidation in court procedure

Protect the rights and entitlements of policyholders/beneficiaries in the event of insolvency

Protection scheme/guarantee fund

Preferential rights

22

Conclusions

Independence and resources

Comprehensive supervision, including group and

macroprudential

level

Early identification and intervention

Power and will to act

using adequate tools