Global regulatory efforts on insurance group capital standards are accelerating this summer, with significant activity by three oversight bodies — the Federal Reserve Board of Governors (FRB), the National Association of Insurance Commissioners (NAIC) and the International Association of Insurance Supervisors (IAIS).
For insurers falling within more than one of these regimes, navigating these evolving requirements, with their areas of overlap and tension, will require considerable care.
Federal Reserve-proposed rulemaking
In early June, the FRB issued an advanced notice of proposed rulemaking, with a comment solicitation, on capital standards for two types of insurers and their affiliates:
- Insurers under FRB supervision based on their potential threat to U.S. financial stability (so-called "systemically important financial institutions" or SIFIs); and
- insurers that are holding companies for insured depository institutions (IDIHCs) such as a savings and loan holding company.
The Dodd-Frank Wall Street Reform and Consumer Protection Act empowers the FRB to impose capital standards on insurance SIFIs and IDIHCs while permitting the FRB to "tailor" such standards for the insurance characteristics of their operations. The FRB's June guidance proposes two alternative methodologies for computing such capital requirements.
'Building block' vs. 'consolidated' approach
One, a "building block" approach, would aggregate capital requirements for each legal entity within the group, allowing for existing entity-level capital requirements (such as the NAIC's risk-based capital, or RBC, regime) to be integrated into the new structure. Non-insurers in a group would be ascribed capital requirements based on existing FRB regulations.
The other methodology, a "consolidated" approach, would identify, on a consolidated basis for the entire group, "risk segments" and from these extrapolate required capital for each segment "by applying risk factors to the amounts in each segment." These risk factors would take into account "the longer-term nature" of insurance liabilities.
Continue reading …
The IAIS proposes two possible approaches to valuing assets and liabilities for purposes of capital measurements. (Photo: iStock)
For an IDIHC that does not prepare GAAP financials (such as a mutual insurer that uses only insurance statutory accounting, or SAP), a framework oriented around SAP would have to be used, introducing additional complexity. The FRB's guidance suggests that the building block approach might be more suitable for IDIHCs, and the consolidated approach more appropriate for SIFIs.
On July 25, the FRB extended to September 16 the time period for submitting comments on the proposed rulemaking.
IAIS public consultation
The IAIS is also active this summer, although its approach has drawn criticism in both the U.S. and in Europe for its lack of consistency with other regimes such as RBC, the FRB's proposals and Solvency II.
On July 19 the IAIS issued a "public consultation document," Risk-based Global Insurance Capital Standard Version 1.0, with comments due on October 19. The 175-page paper sets out the IAIS's proposed roadmap for determining an "insurance capital standard", or ICS, for "internationally active insurance groups", or IAIGs, and discusses the IAIS's "field testing" of data provided by a pilot group of insurers over 2015-16. The ICS is a component of the IAIS's larger Common Framework, or ComFrame, which is intended to be used by regulators to oversee an IAIG's financial condition.
Unlike the FRB and NAIC approaches, the IAIS assumes capital determinations purely on a consolidated basis, explaining that "the interaction between local legal entity capital requirements and the [IAIS standards] as a consolidated group-wide" standard is a topic not covered in the July paper.
In the paper, the IAIS proposes two possible approaches to valuing assets and liabilities for purposes of capital measurements — market-adjusted valuation (MAV) and GAAP "with adjustments" (GAAP-plus). MAV would impose a group-wide approach for valuing assets and liabilities, using a uniform, bespoke base yield curve, with certain adjustments, to discount cash flows in order to value assets. The "GAAP-plus" approach, in contrast, uses existing national accounting regimes (e.g., U.S. GAAP, SAP, IFRS), with some adjustments to address possible volatility.
Continue reading …
NAIC's Group Capital Calculation Working Group has been considering the treatment of an insurance group where the top-tier company is itself an insurer, versus a similar insurance group where the top-tier company is a non-operating holding company. (Photo: iStock)
Turning to qualifying capital, the IAIS paper classifies financial instruments as, in descending order of quality, (a) Tier 1 for which there is no limit; (b) Tier 1 for which there is a limit; (c) Tier 2 paid-up; and (d) Tier 2 non-paid-up. These classes vary according to five characteristics — loss absorbing capacity; level of subordination; permanence; absence of encumbrances; and availability to absorb losses.
In its pilot group testing, the IAIS will be limiting Tier 1 limited capital resources to 10% of the ICS capital requirement or, alternatively, 20% of total Tier 1 capital resources less capital adjustments and deductions; Tier 2 capital resources to 50% of the ICS capital requirement; and Tier 2 non-paid-up capital resources to 10% of the requirement.
The heart of the IAIS paper addresses the ICS itself. The ICS section contains a detailed discussion of a range of risks faced by IAIGs including:
- mortality/longevity;
- morbidity/disability;
- lapse and persistency;
- increases in expense assumptions and expense inflation;
- "premiums and claims reserve risk" (the risks of non-life insured events' occurring and being reported);
- catastrophe risk (both natural and man-made);
- market risk, which encompasses risks relating to interest rates, equities, real estate and currencies;
- asset concentrations;
- credit risk; and
- operational risk.
Among other things, the section addresses stress testing and the use of quantitative factors in assessing these risks for a particular IAIG.
NAIC Group Capital Calculation Working Group
Back in the U.S., the NAIC's Group Capital Calculation Working Group held a conference call for interested parties on July 20, with a follow-up call scheduled for August 11. The group has been considering the treatment of an insurance group where the top-tier company is itself an insurer, versus a similar insurance group where the top-tier company is a non-operating holding company. In the case of the former, the insurer's RBC ratio could be an "estimation" of group capital.
The working group has also been considering an "inventory" approach in which all of the companies in the group are individually analyzed. The inventory approach could involve (i) adjustments to GAAP for goodwill and intangible assets and (ii) a 22.5% capital charge for non-insurers in order to produce a consolidated metric.
Looking ahead
With the FRB (at least partially) and NAIC both invested in a legal entity-oriented approach, harmonizing these with the IAIS's more group-centric model will be a challenge. In addition, the IAIS continue to push for a more bank-like tiered system of evaluating capital resources. For its part, the FRB is more open to bifurcating capital standards as between SIFIs and IDIHCs, while the NAIC is the body relying most faithfully on existing RBC standards.
Where will the pieces of this multi-jurisdictional, multi-sector puzzle end up? A capital question.
Daniel A. Rabinowitz is a New York-based partner and co-head of law firm Kramer Levin Naftalis & Frankel LLP's Insurance and Reinsurance group. This article was written with assistance from Alexander Traum, an associate in Kramer Levin's Corporate Department.
© Arc, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.