The U.S. Senate Committee on Banking, Housing and Urban Affairs met on September 12, 2019 for the purpose of discussing areas of concern regarding the regulation and supervision of the global insurance industry. In addition to Committee members, representatives of Team USA (NAIC, Federal Reserve and Federal Insurance Office) provided commentary.
A key issue addressed was the Insurance Capital Standard (ICS) currently being developed by the International Association of Insurance Supervisors (IAIS) as a means to improve group wide supervision of large insurance groups and facilitate communication among global supervisors. The objective is to provide a quantitative view of capital at the group level and identify contagion risk across the group. The next step in the process is a five-year monitoring or field testing period for the ICS set to begin during the fall of 2019. The objective of monitoring, the first step towards implementation, will be to evaluate results and any unintended consequences. Feedback from insurers will contribute to improving the ICS and understanding its impact. It is important to note that the ICS will not be used to evaluate capital adequacy nor initiate a supervisory action.
From the U.S. perspective, the ICS must recognize the insurer business model and the state based system of insurance regulation in the United States. Consequently, the involvement of all U.S. participants is critical. The NAIC continues to have concerns with an ICS structure that relies on market adjusted valuations. Eric Cioppa, Superintendent of the Maine Bureau of Insurance and President of the NAIC, stated that a market based ICS “could undermine the ability of firms to fulfill policyholder obligations and potentially disrupt financial markets. It also assumes capital fully fungible between entities.” Risks from the ICS may thus arise by encouraging insurers to sell assets instead of supporting underlying long term products and investments. It is necessary that the ICS be formed on an outcome based approach to achieve comparability of non-U.S. and U.S. regulatory regimes. An ICS that is based on the European Solvency II will negatively affect U.S. insurers operating in non-U.S. jurisdictions and possibly domestic operations.
An alternative path to global group capital proposed by the U.S. is an Aggregation Method based on the U.S. legal entity Risk Based Capital (RBC) system. The IAIS has at least agreed to review the Aggregation Method during the monitoring period, though the end result of whether or not it would be considered “comparable” will remain a critical question to be answered. Cioppa summed up this discussion saying, “it is premature if not irresponsible to make definitive commitments to a standard that presently all members of Team USA view as inherently flawed”.
Concurrent to the ICS development, U.S. state regulators have made significant progress on a U.S. Group Capital Calculation using an Aggregation Method, while the Federal Reserve moves forward with a Building Block Approach for insurers under their jurisdiction. Thomas Sullivan, Associate Director, Board of Governors of the Federal Reserve, stated that “the Board proposed applying a building block approach to insurers we supervise rather than the ICS in its current formulation”. The dual U.S. approaches both based on current state-based standards should go a long way to inform the ICS discussion from the U.S. perspective.
The Committee also heard testimony on a proposed Holistic Framework introduced by the IAIS in late 2018 as a way to view systemic risk in the insurance marketplace. The holistic approach focuses on forward looking activities and counter party exposures. Previous contemplated methodologies to systemic risk were entities based and often size was a determining factor. Questions to be resolved include proper application to insurers, proportionality, and the value of cross sector monitoring. The IAIS position is that the Holistic Framework will end the need to identify global systemically important insurers (G-SII’s). Progress on a holistic approach continues with more information forthcoming.
The topics discussed in front of the Committee bring forward once again the importance of global regulatory cooperation in the insurance industry. The significance of a competitive insurance marketplace coinciding with strong consumer protections is vital for the overall financial markets, economic and social stability. International and domestic insurers are well served by actively following these developments and understanding how global and domestic capital approaches affect their organization.
Locke Lord will continue to monitor and report on progress in these areas, and closely follow how comparability will be defined and if the international proposals will ultimately be deemed suitable to Team USA.