Need for Global Insurance Standards Driven by Financial Crisis, Solvency II

By | June 7, 2011

While the European Union is primarily focused on the approach of the Solvency II regulations in 2013, there are two additional regulatory bodies who are also considering some new rules that will affect not only the EU, but also the global insurance industry.

The International Financial Reporting Standards (IFRS) board is in the process of reworking its accounting standards. The International Association of Insurance Supervisors (IAIS) is in discussions on new global regulations for its members.

Matthew Elderfield, Deputy Governor of Central Bank of Ireland, whose office is responsible for overseeing and implementing Ireland’s insurance regulations, mainly focused on Solvency II in his presentation at the European Insurance Form in Dublin. But he also stressed the importance of the IAIS in developing a global regulatory framework.

He noted that the IAIS has “long been an international standards setter,” and is now, in similar ways to EIOPA [European Insurance and Occupational Pensions Authority], adapting its focus to “the new post crisis global regulatory agenda.” Its “key long term project,” ComFrame, is an evolving regulatory and corporate environment set of standards aimed at bringing more cohesion to global insurance regulation.

In Elderfield’s view Solvency II “has effectively become the de facto auditing international standard for solvency,” and through the “equivalence mechanism,” it is also in the position of becoming the standard for non-European countries as well. As a result the IAIS is reassessing its own standards in light of Solvency II.

“The other driver is the need to insure effective group supervision of insurance companies,” he said. “The financial crisis exposed some notable gaps in the framework that applied to big insurance groups,” which has prompted a regulatory response. ComFrame was launched “to deliver common international standards for internationally active groups.”

However, he added that there’s “really a long way to go,” as he doesn’t see ComFrame “cutting across Solvency II any time soon.” It will need to evolve “swiftly, from high level principles,” and address real “quantitative standards, so that it provides a robust framework, which supervisors can rely upon as an alternative to regional standards, such as Solvency II.”

The IAIS’s ComFrame is initially focused on the “question of systemically important financial institutions, and how to apply the financial stability framework to insurance companies.” As he said in his presentation at the 2010 EIF Conference, Elderfield recognizes the impracticality of applying the regulations relevant to banks to the insurance industry, “due to the inherently different nature of insurance and insurance failures.”

Financial regulatory supervisors have broadly recognized that the insurance sector does not “create the same systemic risk as banking.” However, he indicated that there are certain insurers that “should nevertheless be categorized as systemically important.” Insurers, particularly large ones, where there are limited substitute alternatives, or who engage in financial transactions beyond the scope of regular insurance transactions, such as dealing in derivatives.

He added that while size alone may not have “a transformative effect on the nature of the risk,” it can be a “pragmatic way of conducting the exercise” of gauging its financial condition, but the case for making it an automatic criteria “remains weak,” he said.

When it comes to “non-insurance” activities, such as dealing in derivatives and financial guarantees, however, he indicated that the systemic risk is evident, and should be carefully evaluated. This “interconnectedness” poses some problems. If a bank, in which an insurer has invested, fails, “the trajectory of contagion is from a bank failure into the insurance industry, and not the other way round.” The best way to avoid this occurring is to make sure there is sufficient “diversification,” both at the individual and the sectoral level, as Solvency II will require.

A related concern, again involving systemic risk, is the relationship between reinsurers and their cedants, as the failure of a large reinsurer would affect the carriers who have ceded business to it. They “would suddenly face the loss of reinsurance cover affecting their balance sheet.”

Elderfield noted that, while increasing solvency, i.e. capital, requirements might be part of the solution, this could also affect capacity. A better solution could be to review “the adequacy and the international consistency of investment and reinsurance concentration standards.”

There is perhaps a “common theme” in a busy regulatory agenda, he concluded. There is “the need to insure careful balance between – on the one hand – to learn the lessons of the financial crisis that are relevant to insurance regulation, and – on the other hand – avoiding an automatic regulation of banking standards to the insurance industry.” Both a “careful regulatory judgment” and close consultation with the insurance industry are required to construct regulations that will achieve an appropriate balancing of interests.

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