Global insurance regulation: a new dawn for capital requirements?
Since its creation in 2009, the Financial Stability Board (FSB) has been focusing on the banking industry with the Basel III framework. However the near failure of AIG and its $85 billion bailout by the US Federal Reserve in September 2008 proved that the insurance industry can be equally vulnerable. The August 2015 consultation regarding the Higher Loss Absorbency Requirements demonstrates the expanding FSB attention to the systemic risk associated with insurance activities.
From the crisis to Increased Capital requirements
In the aftermath of the financial crisis, the FSB commenced in March 2010 an initiative regarding global regulatory and supervisory standards on international cooperation and information exchange.
Three years later, the FSB, in consultation with the International Association of Insurance Supervisors (IAIS) and national authorities, developed policy measures to be applied to nine designated global systemically important insurers (G-SIIs). This G-SIIs list is meant to be updated every year starting from November 2014. The latest list includes the following insurers: five European (Allianz, Generali, Aviva, AXA and Prudential plc), three American (AIG, MetLife and Prudential Financial) and one Asian (Ping An Insurance).
Beyond being identified, G-SIIs are subject to more stringent rules than other insurers. The IAIS thereby recently published several papers regarding the G-SIIs capital requirements: the Basic Capital Requirements (BCR) and the Higher Loss Absorbency Requirements (HLA). These developments should be applied from January 2019 on the November 2017 G-SIIs updated list.
Gradual capital requirements encouraging to less systemic risk exposure
According to the definition of the HLA by the IAIS latest fact sheet on Capital requirements for G-SIIs published in October 2015: “The HLA was designed so that, on average, G-SIIs will then hold higher regulatory capital requirements than would be the case if they were not designated as G-SIIs.”
The HLA implies the concept of “buckets” in order to classify the G-SIIs according to their level of systemic risks. This approach will create incentives for the G-SIIs to limit their systemic risk in order not to fall in a higher “bucket” and therefore being exposed to higher levels of capital requirements.
As reported by Fitch Ratings in October and November 2015, the designated insurers could be allocated as below:
Looking at ratios, the field study for 2015 conducted by the IAIS over the 2013 and 2014 results indicates that average BCR+HLA ratio for G-SIIs is currently around 260% compared to 305% for all the volunteers of the field study.
Insurers unequally face these new capital constraints
Generally speaking, the International Capital Standards are not aligned with any existing local framework. However, among other regulations, it is believed to be closer to Solvency II. As a consequence the greatest impact would be on the American and Asian companies as European ones have already worked on reaching Solvency II requirements.
In terms of business lines, as Non-Traditional and Non-Insurance activities (NTNI) are usually more likely to generate or amplify systemic risk, the HLA focuses on them.
As an example of a Non-Traditional product, variable annuities (insurance contract guaranteeing periodic payments) will require higher charge and thus higher capital requirements. Yet most G-SIIs have larger volumes of variable annuities such as AXA, Prudential Financial and Metlife.
A lot of criticism from the insurance industry
The proposed global capital requirements is tough news to digest for the designated insurers, especially since they already have to cope with new or upcoming local or regional framework (e.g. Solvency II in the EU or C-ROSS in China).
According to the US National Association of Insurance Commissioners (NAIC), the requirements fail to be consistent with a risk sensitive approach promoted by the FSB. As an example, an over-reliance in a single capital standard could increase systemic risk as all insurers and regulators model their behaviour around those standards.
Moreover, the HLA is supposed to limit systemic risk. On that topic, the European Insurance Federation (Insurance Europe) reminds that this aim would be compromised if the requirements scope is applied to traditional insurance business which does not bear a high level of systemic risk.
According to the August 2015 HLA Consultation Paper (Theme 14), the designated companies express a lack of transparency in the process of G-SII designation scores.
Capital constraints are certainly still blurred, yet coming
The global capital requirements remain under discussion and there is still some leeway before the supposed application in 2019. But one thing is for sure, the designated players will have to put extra effort in dealing with these additional requirements. It is now becoming clearer that the HLA and the BCR will apply on top of the local frameworks. Paying attention to the future field tests will be decisive to anticipate and cope with these changes.
- IAIS, Capital Requirements for Global Systemically Important Insurers (G-SIIs):1 Basic Capital Requirements (BCR) and Higher Loss Absorbency (HLA) , October 2015
- IAIS, HLA Consultation Responses, October 2015
- IAIS, Higher Loss Absorbency Requirement for Global Systemically Important Insurers (G-SIIs), October 2015
- Financial Times (Alistair Gray), Regulators set their sights on insurance, October 2015
- Onlystrategic.com, Fitch reviews IAIS higher loss absorbency for G-SIIs, October 2015
- The US Federal Reserve, September 16, 2008 Press Release, September 2008
- National Association of Insurance Commissioners, U.S. State Insurance Regulators’ Views: International Capital Proposals, April 2015
- Insurance Europe, Insurance Europe key messages on IAIS consultation on higher loss absorbency (HLA) requirements for global systemically important insurers (G-SIIs), August 2015
- Fitch Ratings, GSII Capital Rules Deter Insurers from Greater Complexity, October 2015
- Fitch Ratings, GSII List Puts Insurers' Business Strategy in Spotlight, November 2015