U.S. industry group balks at higher capital standards for insurance companies

September 2, 2015

A U.S. financial services trade group has urged industry regulators to reject additional capital requirements for big insurance firms, as proposed by the International Association of Insurance Supervisors.

The Financial Services Roundtable, representing major banking, insurance, payment, and investment-product firms, presented its concerns about the proposal in a letter to Federal Reserve governor Daniel Tarullo. The letter was also given to the Federal Reserve Board, the Federal Insurance Office, and the National Association of Insurance Commissioners, all of whom represent the United States on the IAIS.

The roundtable said the proposal for a higher loss absorbency (HLA) standard — additional capital beyond basic requirements and other surcharges, was premature and that any new standards should be preceded by a cost-benefit analysis similar to one conducted by the Basel Committee of international bank regulators on capital surcharge for global systemically important banks. The IAIS standards would take effect in November.

The IAIS and its impact for the insurance industry 

The IAIS is a global regulatory body representing insurance regulators and supervisors. Its goal is to promote effective and globally consistent supervision of the insurance industry by maintaining fair, safe and stable insurance markets. Its functions are quite similar to what the Basel Committee does for banks, although the IAIS works on a larger scale and through a less centralized structure that represents more than 200 jurisdictions.

Higher loss absorption capacity is intended to reduce the possibility that a global systemically important insurance company would experience financial distress threatening to the wider economy. The increased capacity is intended to internalize some of the cost of a firm’s failure, minimize negative external factors, discourage certain activities seen as threat to the financial system, and allow for a timely supervisory intervention.

Higher loss absorbency through increased capital requirements is one of the three main components of the IAIS initiatives proposed for the globally significant or systemically important insurance companies (G-SIIs).

The other two are enhanced supervision, and effective resolution. They include recovery and resolution plans, establishment of a crisis management group that would coordinate efforts in a crisis event, and a common framework for the supervision of insurance companies. These initiatives all bear strong similarities to the U.S. Dodd-Frank Act’s proposed regulations and the Basel Committee’s suggestions for banks.

In 2010, the IAIS developed the Common Framework for the Supervision of Internationally Active Insurance Groups. In 2013, the association agreed to develop a risk-based global insurance capital standard, and to include it as a component of the common framework. In 2014, it developed the basic capital requirements that are applicable to G-SIIs, and which are to serve as the basis for the loss-absorbency requirements.

The IAIS has stated that it intends to use more carrots than sticks by providing incentive-based measures over prohibitions. It hopes to limit non-traditional insurance and non-insurance activities that are most likely to be the source of systemic risks in the insurance sector.

Definitions still a work in progress 

The Financial Services Roundtable argues in its letter that finalizing the HLA requirement would be premature, given that IAIS is currently revising the definition of “the non-traditional insurance, and non-insurance activities” on which the HLA calculation methodology is ultimately based.

Additionally, the letter notes that the IAIS is intending to revise its assessment criteria by this November “to ensure, among other things, that it appropriately addresses all types of insurance and reinsurance, and other financial activities of global insurers.” The international association, in consultation with the FSB, and national authorities, had identified in July 2013, a list of nine global systemically important insurers (G-SIIs) – a list to be revised annually — using an assessment methodology that it had developed, and policy measures that apply to them.

Although a continuous revision of the assessment methodology to fine-tune measurement of G-SII criteria is expected, a finalization of the HLA standards before such revisions are completed could indeed risk putting the cart before the horse.

The letter urges IAIS to retract its proposal. It asks the U.S. regulators to conduct an independent analysis on the need and the impact of the HLA requirements, taking into account the particularities of the U.S. insurance industry.

Other challenges 

The IAIS has stated that absence of a global solvency standard, the relatively unexplored nature of the systemic risk drivers and the extent to which they are captured by existing solvency standards, and the level of HLA and allowable instruments for meeting HLA requirements are the current challenges that need to be resolved before finalizing the HLA standards.

The U.S. state insurance view 

In April, 2015, the National Association of Insurance Commmissioners (NAIC) provided the general view of the U.S. state insurance regulators in a public document (PDF). The NAIC agreed that HLA requirements would prove useful for the industry, provided they apply only to those activities that are specifically focused on assessing potential systemic risk within the insurance sector, and not be applied at large to the traditional insurance business itself. The NAIC has also warned against the negative effect a single uniform capital standard would yield, arguing that the insurance industry is based on a significantly different business model than that of the banking industry, and even exhibits differences among insurers themselves.

It was unclear whether the U.S. regulators will react to the letter, or simply wait for the IAIS’ completion of the HLA standards by November before taking any steps.

(This article was produced by Thomson Reuters Regulatory Intelligence. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @RiskMgment)

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