Our regular readers will be aware that we’ve been following the work of the International Association of Insurance Supervisors (IAIS) which has been looking at ways to identify and manage what they term G-SII’s or Globally Systemically Important Insurers. By insurer you can also read reinsurer and any entities involved in re/insurance type business. Of particular interest to the IAIS in this effort are re/insurers involved in what they term non-traditional, non-insurance activities (NTNI).
In an article on the IAIS’ work on this G-SII initiative back in May of this year, we identified that under the non-traditional, non-insurance banner sit instruments such as insurance-linked securities, catastrophe bonds, industry-loss warranties and catastrophe derivatives. It could also include collateraized reinsurers established by hedge funds and those operating innovative hedge fund type investment policies, given the naturally greater degree of interconnectedness with the financial markets. Chair of the IAIS Executive Committee Peter Braumüller said at the time; “The potential for systemic risk within the insurance sector needs to be considered where insurers deviate from the traditional insurance business model and more particularly where they enter into non-traditional insurance or non-insurance activities.”
The IAIS then clarified their opinion of alternative risk transfer tools such as ILS and cat bonds in a follow-up paper in July, which we covered here, where they said there is potential for some of the non-traditional markets to lead to a level of systemic risk between reinsurance and the broader financial market, particularly if their usage grows significantly. In this statement they specifically referenced ILS and cat bonds saying that if the sector grows significantly there could be a systemic risk worth monitoring.
So it seems the approach of the IAIS will be to monitor the use of alternative risk transfer tools and structures and take them into consideration when assessing any re/insurer for systemic riskiness. The fully-collateralized and segregated nature of these instruments will likely mean that they do not come under intense scrutiny, unless the assessed re/insurer has real issues in other areas causing concerns of systemic risk. Or, if the market grows considerably then cat bond, ILS and other alternative instrument use could become a greater contributor to the IAIS’ assessment metrics.
So, the next step in the consultation process, which we urge you to make sure you’re informed on and have your say, is the publication of a set of policy measures which the IAIS are proposing as a series of measures that any re/insurer who is identified as potentially systemically risky would be asked to undertake. As such, it’s in everyone’s interest in the re/insurance market and non-traditional reinsurance sectors to ensure they are aware.
“These proposed policy measures are intended to reduce moral hazard and the negative externalities stemming from the potential disorderly failure posed by a G-SII,” said Braumüller. “Each of the proposed policy measures has also been designed to take account of the specific nature of the insurance business model and is the result of intensive and thorough discussion at the IAIS.”
The proposed framework of policy measures for G-SIIs is based upon the general framework published by the Financial Stability Board but adjusted to reflect the factors that make insurers different to other financial institutions.
There are three main types of measures within the proposal:
- Enhanced Supervision:
This is no surprise, increasing the supervision on a re/insurance entity which is deemed systemically risky makes perfect sense. The proposal says:
These measures build on the IAIS Insurance Core Principles and the FSB’s Supervisory Intensity and Effectiveness recommendations and include the development of a Systemic Risk Reduction Plan and enhanced liquidity planning and management.
- Effective Resolution:
Putting in place a plan to resolve the systemic risks is the next type of measure, allowing the IAIS to work with the re/insurer to resolve the issues which raised their activities as risky. Re/insurers will be given 18 months to put any measures they are given under this section or as part of a Systemic Risk Reducation Plan (SRRP) into place.
The proposal says:
Based on the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions, which include the establishment of Crisis Management Groups, the elaboration of recovery and resolution plans, the conduct of resolvability assessments, and the adoption of institution-specific cross-border cooperation agreements. The IAIS proposals take account of the specificities of insurance through the inclusion of plans for separating non-traditional, non-insurance (NTNI) activities from traditional insurance activities, the potential use of portfolio transfers and run-off arrangements, and the recognition of existing policyholder protection and guarantee schemes.
- Higher Loss Absorption (HLA) Capacity:
The final set of measures are around capital adequacy and this could result in a re/insurer being mandated to ensure that they have a greater capacity to absorb losses, thus needing greater levels of capital to meet potential claims. It’s interesting that this is one of the measures, as much of the Solvency II regulations involve proving and maintaining capital adequacy. For the ILS and cat bond sector, as well as collateralized reinsurers, this may be a moot point as they maintain precisely enough capital to cover the risks they write.
The proposal says:
This proposal utilises a cascading approach. In the first step if, and to the extent to which, the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities, targeted HLA will be applied to the separate entities. Under the second step, whether or not NTNI activities have been separated, an overall assessment of group-wide HLA needed will be undertaken and the group wide supervisor will determine whether the HLA capacity held at the NTNI entities is sufficient or needs to be further increased.
The proposed measures seem sensible at first glance, but it is vital that market participants are aware of this process and ensure that their voices are heard if there are any issues that are not clear or are not agreed with.
We urge you to read the latest information which you can find on the IAIS website here. Comments are due by the 16th December 2012.
Here are some links to our earlier articles on this story (oldest first):