In the wake of the global financial crisis in 2008, significant regulatory change aimed at preventing/mitigating future crises was implemented. While the U.S. insurance regulatory framework did remarkably well in the protection of insurance consumers and companies in the United States during the financial crisis, it was, and will be affected by these reforms. Today, the results are having a profound impact on companies’ balance sheets and risk management practices. Although primarily aimed at larger, global insurers, the changes are so extensive that they may impact medium and small insurers to some extent. The question that most (re)insurers are asking today is how can they cope with the myriad regulatory, legislative and ratings changes and continue to maximize opportunities and maintain profitable growth.
The most profound changes in the regulatory sphere are occurring on the international front, where new solvency frameworks are evolving at the global level and capital requirements are emerging as the major factor for (re)insurer consideration. (Re)-insurers that successfully prepare for and manage those requirements may be best positioned to pursue growth opportunities in their home markets and overseas.
The International Association of Insurance Supervisors (IAIS) has been working on the development of a risk-based global Insurance Capital Standard (ICS) for Internationally Active Insurance Groups (IAIGs) as part of their development of a Common Framework for the Supervision of IAIGs - an initiative known as ComFrame.
The IAIS has also been working on the development of Basic Capital Requirements (BCR) and Higher Loss Absorbency (HLA) requirements for Global Systemically Important Insurers (G-SIIs). The BCR, which is to initially form the basis of the HLA, was developed in October of 2014, and will apply to all group activities (including non-insurance activities) of G-SIIs. The IAIS has very recently begun a public consultation to finalize the development of the HLA requirement.
The IAIS has also recently decided to delay the release of the ICS from 2016 until 2017 (when the first version of the capital rules will be released) and 2019 (when the second version is to be released with the adoption of ComFrame). Members of the IAIS are currently scheduled to begin implementing ComFrame in early 2020.
The National Association of Insurance Commissioners (NAIC) has been continuously engaged in the formulation of the IAIS standards, but has expressed several concerns due to the different accounting, legal and regulatory systems that exist. The NAIC does not want the ICS, which is to be a consolidated group-wide standard, to favor one regulatory approach over another, but to represent a best outcomes approach. While acknowledging that it is important to have adequate capital at the group level, it is the NAIC’s position that this cannot be a substitute for adequate capital at the legal entity level and would require that any global standard would be supplemental to the risk-based capital (RBC) requirements that apply at the legal entity level in the United States. The NAIC is working through the ComFrame Development and Analysis (G) Working Group (CDAWG), which was formed early last year, to provide on-going input with respect to all developments in this regard.
In the United States, the convergence of Own Risk and Solvency Assessment (ORSA) regulatory requirements, which take effect this year, and rating agency A.M. Best’s new emerging risk-based analytics have significant implications in 2015 and beyond. The rating agency is placing greater emphasis on stochastic risk-based analytics in its ratings process and will increasingly focus on management’s ability to execute its business plans and reasonably deliver on its financial projections. Insurers will need to more tightly link their business plans with both capital and earnings adequacy assessments from a risk-adjusted perspective to maintain and enhance their Best’s Ratings while complying with new regulatory requirements.
Federal involvement in the oversight of the financial services industry is expanding, causing some to question whether this trend will continue and impinge upon the authority of the individual states to regulate insurance. Additionally, large and small U.S. property and casualty insurers will be expected to further develop their financial forecasting, capital modeling and risk tolerance metrics for both capital and earnings.
European insurers are facing a more complex regulatory environment from national, regional and superregional authorities. The approaching date for implementation of Solvency II, January 1, 2016, is taking center stage. Member states are expected to transpose the directive requirements into local requirements with equivalence decisions this year.
The upcoming Insurance Mediation Directive (IMD2), issued by the European Commission, aims to ensure professionalism and competence among insurance intermediaries with minimum professional requirements such as appropriate knowledge of markets and products, good reputation, professional indemnity insurance and sufficient financial capacities to protect customers. The overall goal at the end is the protection of customers’ interests. Insurance intermediaries need to provide clear explanations to customers on the advice given.
The objective of the new European Data Protection rules is to give individuals control over their personal data, and to simplify the regulatory environment for business activities. Every day, individuals, firms and public authorities transfer personal data across borders. Conflicting data protection rules in different countries would disrupt international exchanges. Individuals might also be unwilling to transfer personal data abroad if they were uncertain about the level of protection in other countries. Common European Union (EU) Data Protection rules will be established to ensure that personal data enjoys a high standard of protection everywhere in the EU.
The Asia Pacific region comprises a diverse mix of countries encompassing nearly one third of the earth’s landmass and one half of its population. Given the broad spectrum of economic development and political realities across the region, the approach to insurance market regulation varies widely on a country-by-country basis.
Directionally, most country regulators are taking steps to build more robust regulatory and solvency frameworks. For example, Malaysia, South Korea, Taiwan and Thailand are in their second round of RBC schemes while Japan is on its third iteration. Australia and Malaysia have implemented Internal Capital Adequacy Assessment Process (ICAAP) requirements and Singapore is implementing an ORSA framework. Australia, Indonesia, Japan, Philippines, Taiwan and New Zealand have specific catastrophe risk-related solvency requirements. Hong Kong is incorporating the IAIS’ ICP into its first RBC framework anticipated in 2018. China’s Insurance Regulatory Commission will institute sweeping changes in January 2016 through its three-tiered China Risk Oriented Solvency System (C-ROSS) framework that will introduce RBC and dramatically impact how (re)insurers conduct business.
Other countries, such as the Philippines and Indonesia, have instituted rules that may impede the development of a healthy, profitable insurance market. The Indonesian regulator’s recent steps to reduce capital outflows, with a focus on reinsurance premiums ceded to international reinsurers, remain highly debated. Concerns center largely on domestic reinsurers’ abilities to absorb a large catastrophic event due to weak capitalization. The Philippines, in addition to an RBC framework, has a minimum paid-up capital requirement (starting in 2006 and revised in 2013) that increases every two years that will result in a PHP 2 billion (approximately USD 44 million) minimum threshold in 2020. The policy applies uniformly across the industry regardless of premium volume, line of business or geographic scope and therefore its impact is more strongly felt by smaller carriers. The Philippines Insurer and Reinsurer Association is outspoken against the minimum capital requirement and lobbies instead for a standalone RBC metric.
The costs associated with compliance and disclosure will continue to rise as insurance regulators increase their scrutiny on industry solvency. Insurers that operate on an international scale, for example, may wrestle with the complexity of multiple capital requirements and the return targets of investors. Smaller companies, often with fewer resources, may be forced to allocate a higher percentage of senior management’s time to compliance. It will become increasingly more important for insurers to avoid unnecessary and redundant activity when seeking regulatory approval.
In addition to the increased administrative cost of compliance, higher risk-based capital requirements often reduce the strategic flexibility of insurance company operations and ultimately lower returns.
While these evolving quantitative and qualitative reporting requirements are burdensome (particularly during the first few iterations), they help regulators more effectively track and manage risk and reduce harm to policyholders. There is also, of course, the potential for overregulation leading to reduced competition in the form of higher premiums and fewer product options.
A delicate balance must be struck between the interest of government regulators, insurers and policyholders. When successful, appropriate regulations can improve underwriting discipline, protect consumers and build more resilient markets.