FINANCIAL SERVICES   Evolving InsuranceRegulation Time to get ahead...      February 2012       kpmg.com
Giles Williams                          Jim Low                                Simon Topping  Partner                     ...
Contents                                                                          Foreword	                               ...
2 | Evolving Insurance Regulation | February 2012  Foreword  Welcome to the second edition of Evolving Insurance Regulatio...
Evolving Insurance Regulation | February 2012 | 3Regulatory pressures                                                     ...
Executive Summary  Against the backdrop of the                                                    Despite 2011 being a mil...
Evolving Insurance Regulation | February 2012 | 5From the plethora of legislationcurrently being proposed weknow that ther...
Latest developments  in the IAIS  IAIS completes major milestone                                                 to be con...
Evolving Insurance Regulation | February 2012 | 7   co-operation to allow for a more                                      ...
8 | Evolving Insurance Regulation | February 2012  •	 What is the role and future of the                                  ...
It would be ineffective andImplications for firms                                                                         ...
10 | Evolving Insurance Regulation | February 2012      Risk Management Continuum                                         ...
Evolving Insurance Regulation | February 2012 | 11The ORSA should be revised totake into account the lessonslearned from t...
12 | Evolving Insurance Regulation | February 2012  events of the GFC that further analysis                               ...
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
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Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
Kpmg Evolving Insurance Regulation 2012 02
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Kpmg Evolving Insurance Regulation 2012 02

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The focus of the 2nd edition extends from risk management and prudential change to include the insurance regulatory reform initiatives.

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Kpmg Evolving Insurance Regulation 2012 02

  1. 1. FINANCIAL SERVICES Evolving InsuranceRegulation Time to get ahead... February 2012 kpmg.com
  2. 2. Giles Williams Jim Low Simon Topping Partner Partner Principal Financial Services Financial Services Financial Services Regulatory Centre Regulatory Centre Regulatory Centre of Excellence, of Excellence, of Excellence, EMA region Americas region ASPAC region KPMG in the UK KPMG in the US KPMG in China About this report This report was developed by KPMG’s network of regulatory experts. The insights are based on discussion with our firms’ clients, our professionals’ assessment of key regulatory developments and through our links with policy bodies. We would like to thank members of the editorial and project teams who have helped us develop this report: Editorial team Contributing Project team Editor Weronika Anasz, KPMG in China Clive Briault, KPMG in the UK Kate Forgione, KPMG in the UK Mike Hamilton, KPMG in Canada Rachael Kinsella KPMG in the UK Meghan Meehan, KPMG in the US Frank Oberholzner, KPMG in Germany Annelize Snyman, KPMG in South Africa Brittany Spriggs, KPMG in the US Rob Curtis David Sherwood Martin Noble Mary Trussell Director US Head of Insurance Senior Manager Partner Liz White, KPMG in the UK Insurance Regulatory Insurance Insurance Giles Williams, KPMG in the UK Financial Services Financial Services Financial Services Accounting Advisory Regulatory Centre Regulatory Centre Regulatory Centre Services of Excellence, of Excellence, of Excellence, KPMG in the UK EMA region Americas region ASPAC region KPMG in the UK KPMG in the US KPMG in China© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  3. 3. Contents Foreword 2 Executive Summary 4 Latest developments in the IAIS 6 – ComFrame – Systemic Risk Perspectives: ASPAC 14 – sia Pacific country updates: Regulatory, A solvency, IFRS and consumer protection Evolving global solvency developments: 24 beyond compliance, towards value creation – isk and finance transformation R Perspectives: Americas 28 – mericas country updates: Regulatory, A solvency, IFRS and consumer protection Moving the consumer protection agenda to the front line 38 – Key regulatory initiatives to impact insurers Perspectives: EMA 48 – Solvency II update – Consumer protection changes – Insurance Mediation Directive 2 (IMD 2) – Packaged Retail Investment Products (PRIPs) – Retail Distribution Review (RDR) – Latest developments in the UK and South Africa Financial reporting, valuation and disclosure – the latest developments 56 Abbreviations 63 Acknowledgements 64© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  4. 4. 2 | Evolving Insurance Regulation | February 2012 Foreword Welcome to the second edition of Evolving Insurance Regulation. Economic pressures This publication is part of a series which focuses on the emerging regulatory developments currently facing the financial services Insurers have been affected by the industry and accompanies KPMG firms’ other publications on banking general economic malaise. Sluggish and investment management. economic growth, enduring high inflation and the failure to resolve the This year the focus extends from risk management and prudential Eurozone crisis continue to present change to insurance regulatory reform initiatives currently underway extreme challenges. Much of the around the world, including the increased focus by many jurisdictions world continues to have historically on the new consumer protection agenda and the likely implications low interest rates, impacting capital of these reforms on the insurance sector. markets, bond prices and shareholder returns. Political and systemic risk has increased due to continuing Eurozone concerns and budgetary difficulties At the beginning of 2011, many were in the US. This instability is creating hoping that the worst of the Global pressure for the banking system, Financial Crisis (GFC) might be nearing an particularly in Europe, where credit end. By contrast, 2011 further highlighted availability and liquidity remains an the fragility of the global economy. issue. This has a knock-on effect on The fiscal vulnerabilities of a number the wider economy. of Eurozone countries contributed significantly to continuing uncertaintyJeremy Anderson in global markets. In turn, this has led toGlobal Chairman, increased political volatility, social unrestKPMG’s Financial Services Practice and civil disturbance in many countries. While emerging economies in Asia and other regions continue to flourish, they For many insurers, regulatory nonetheless remain interconnected with requirements will present the fortunes of western markets. challenges to their existing Given the unrelenting pace of reform, distribution models and the strategic challenges facing cost structures. insurers continue to build. The pressure confronting insurers can beFrank Ellenbürger broadly grouped into five key drivers:Global Head of KPMG’s economic, regulatory, consumer,Insurance Practice strategic and operational. Insurers have significant challenges to face in 2012. The economic outlook remains uncertain and consumer expectations are higher than ever. Financial regulation is complex and interconnected and the unevenness of global requirements will ensure application remains problematic for many firms. However, for those insurers prepared to rise to these challenges, by transforming their business and embracing the new consumer agenda, the rewards could be great.© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  5. 5. Evolving Insurance Regulation | February 2012 | 3Regulatory pressures Strategic and Consumer pressuresThe G20 and other political and operational pressures The industry continues to face thesupervisory bodies continue to drive Achieving operational excellence and challenges of generally low levels offinancial services sector reform – improving balance sheet performance consumer satisfaction and increasedboth globally and at a local level. In will be key strategic objectives for consumer uncertainty. In particular,response to many of these pressures many firms in 2012. Following a tough pension provision is increasinglyand to country specific issues, year in 2011, insurers are reviewing becoming a political and social issuesupervisors have focused heavily on their risk appetite limits, reassessing in many regions. The GFC and recentimproving their respective structures product lines and geographical exposure consumer financial sector mis-sellingand frameworks. The adoption of new to vulnerable areas, while continuing scandals in some countries haveInternational Association of Insurance to manage capital requirements and weakened investor confidence inSupervisors (IAIS) standards in increasing transparency demands the market. For firms, this is a starkOctober 2011 was a catalyst for many from regulators. This is all happening reminder that consumer protectionsupervisors to commence reform, against a backdrop of a general skills goes beyond transparency in financialparticularly in the Americas and Asia. shortage in the global insurance products to include the integrity of the The US market is undergoing industry, where the demand for sales process and consumer targeting.significant changes as a result of the talent to respond adequately to these The forthcoming customer protectionDodd-Frank Act (DFA) and from new increased financial, risk and regulatory regulatory initiatives are aimed atdevelopments arising from the challenges is intense. restoring consumer confidence,Solvency Modernisation Initiative, Maintaining and growing the establishing greater harmonisation,such as the Own Risk and Solvency business continues to be the key increasing competition and creating aAssessment (ORSA). This is likely objective for most insurers. In many level playing field in financial markets.to introduce a step-change in risk markets, consumer sentiment is Regulators hope to achieve this bymanagement practices by US insurers. at an all-time low. Historically stable taking action against firms that In Asia, prudential issues and consumer bases have been disrupted mistreat their customers. This willchanges to International Financial by poor practices and revolutionised focus on customer relations and theReporting Standards (IFRS) continue in some markets by the step-change provision of the right incentives toto be the main areas of focus for most in distribution channels. Firms are curtail inappropriate selling practices.firms. In Europe, insurance firms are becoming aware that they will need Although the regulatory focus oncontinuing to invest in development of to re-structure their operations and consumer protection has, until recently,adequate infrastructure and systems develop new capabilities to meet been largely Europe-centric, weto meet the extended 2014 Solvency rising customer expectations, while expect this trend to extend acrossII implementation date. In addition, working within the bounds of other regions in the near future, albeita raft of new customer protection regulatory constraints. manifesting itself differently. Forregulatory initiatives is due to be For many insurers, regulatory insurers, consumer confidence andimplemented, which will require requirements will present challenges trust are essential to promote long-firms to begin actively engaging in to their existing distribution models term financial stability, growth,such reforms. and cost structures. While insurers efficiency and innovation within their have endeavoured to enhance their firms. Insurance leaders face a series customer proposition (for example of tough judgement calls – particularly through simplifying their product concerning the strength of their portfolio and pricing across multiple relationships with customers – and channels), achieving such aims has will need to develop new strategies not always been easy. This will likely to maintain competitive positions. require a re-focusing on achieving internal operational efficiencies, to optimise capital, reduce cost structures and foster a customer- focused organisational culture. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  6. 6. Executive Summary Against the backdrop of the Despite 2011 being a milestone change differs across markets in the Eurozone and sovereign debt year for global financial regulation region, but the overriding direction of crises, 2012 is undoubtedly shaping implementation, the insurance sector travel for many Asian supervisors is the up as a challenging year for insurers is far from having a truly harmonised set implementation of the IAIS Insurance and financial markets generally. of international regulatory requirements. Core Principles (ICPs). These were This publication examines ways This report provides an update on the formally adopted in October 2011 and for firms to balance the competing latest developments in the IAIS, in will prove challenging for both supervisors particular their attempts to build a and firms to implement. We outline demands of both existing and new common framework for the supervision the progress being made in various prudential requirements, in addition of Internationally Active Insurance jurisdictions and the likely challenges to the growing importance of Groups (IAIG). We examine proposals facing insurers in those markets. consumer protection oversight. by the G20 and the Financial Stability From the plethora of legislation Board (FSB) to improve financial stability currently being proposed, we know and governance of the financial services that there will be a divergence of sector – most notably the additional global and national regulatory agendas. requirements on financial institutions Insurers need to act now to re-assess deemed to be of Global Systemic their business models and operating Importance (G-SIFIs) – and analyse what structures to be able to effectively further efforts could be undertaken to manage the required changes. Risk and achieve greater efficiencies in this area. finance functions will be required to The ASPAC Perspective provides transform into dynamic and influential a detailed overview of the important parts of the organisation. Strategic regulatory changes occurring in risk decision-making will need, more than management and solvency, IFRS and ever, to be informed by quality and consumer protection across the diverse timely information derived from risk Asia-Pacific region. Clearly the pace of management systems and processes.© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  7. 7. Evolving Insurance Regulation | February 2012 | 5From the plethora of legislationcurrently being proposed weknow that there will be adivergence of global and nationalregulatory agendas. Insurersneed to act now to re-assesstheir business models andoperating structures.Evolving global solvency will be influential in how financial services Of course, no analysis of thedevelopments: beyond compliance companies do business in their markets developments affecting the globaland towards value creation explores with both clients and peers, especially insurance market would be completethe global solvency issues, providing as consumers themselves increasingly without examining the continuinginsights into what this may mean for expect to receive informed, fair and efforts by the International Accountinginsurers going forward. It is clear that in efficient service when it comes to Standards Board (IASB) and the Financialan increasingly uncertain world, insurers insurer-customer relationships and Accounting Standards Board (FASB)will require a simple, high performing products. We analyse the likely strategic to progress and seek convergence onrisk management system that is fully implications of the consumer protection the IFRS insurance contracts project.embedded within their respective firms agenda and provide a detailed review of Undoubtedly, this work will be an importantand driving informed decision-making. what increased consumer protection component to ensure global consistencyEffective risk management has never regulation could mean for insurers in in the provision of financial informationbeen more important in building and terms of the products offered and and reporting. In particular, the issue ofsustaining a competitive advantage. distribution channels used. insurance liability volatility and the The move to improve risk management While the speed of implementation presentation of such results remains aframeworks is not confined to European of reform is likely to vary considerably key area of debate around the globe.and Asian firms. Significant prudential across regions, the European Commission The review of the latest accounting,and consumer protection developments (EC) has been active in developing valuation and disclosure developmentsare also occurring in North and South new consultation proposals on consumer provides a snapshot of the elementsAmerica. The Americas perspective protection. These are expected to be already agreed and those still be to beoutlines the likely changes across various released in the first half of 2012, with resolved. We review the latest positionsmarkets and the expected impact such significant implications for insurers. on a number of the key areas stillreforms will have for insurers in these The EMA perspective analyses the being debated, such as discount rates,countries. The impact of these changes important conduct changes likely to unbundling, reinsurance, residual marginswill further influence the business affect insurers, particularly the second and disclosure issues. An overview is alsomodels and operating structures of Insurance Mediation Directive (IMD 2) provided of the similarities and differencesmost insurers in these markets and our and the Packaged Retail Investment between the IAIS standard on valuationinsights provide valuable information Products (PRIPs) consultation. Though and the proposals currently advancedregarding the likely changes such final rules are still being drafted, it is under IFRS, the impact of theseinitiatives may have. critical for companies to act now in developments on local markets, and The primary focus of supervisors in assessing the strategic and operational US GAAP and regulatory convergence.most jurisdictions for 2012 will continue impact such proposals may have acrossto be concentrated on capital, liquidity their businesses. These changes are 2012 will be a dynamic year. It’s timeand governance requirements. However, likely to have significant implications for to get ahead of the regulatory changeglobal policymakers, such as the G20, insurers’ products and distribution agenda – are you prepared?are increasingly turning their attention networks.to issues such as customer protection An update is provided on the latestas part of their financial services reform South African developments, along withinitiatives. The G20 has utilised the insights on the impact such proposalsOrganisation for Economic Co-operation may have on insurers and wider financialand Development (OECD) to develop services markets. This includes a detailedprinciples to address the conduct agenda. perspective of the South African market’sWe analyse what impact moving the current regulatory changes. It is likelyconsumer protection agenda to the that many of the Solvency II initiativesfront line may mean for insurers and the legislated will have wider implications forlikely changes required to strategic and insurers undertaking business on theoperational models. These developments African continent. © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  8. 8. Latest developments in the IAIS IAIS completes major milestone to be considerable, especially in less The primary goal of ComFrame The IAIS, at their Annual General Meeting well-developed markets such as Eastern should be to establish a in Seoul on 1 October 2011, endorsed Europe, Africa, the Middle East and many framework for better supervisory their Insurance Core Principles (ICPs). parts of Asia and South America. These new ICPs herald a new regulatory co-operation, allowing a more environment for insurers and supervisors, ComFrame begins to take shape integrated and international essentially requiring supervisory regimes The IAIS continues to develop the approach. worldwide to establish risk-based ComFrame proposal – a comprehensive solvency requirements. This reflects supervisory framework for the supervision a total balance sheet approach on an of internationally active insurance groups economic basis, addressing all reasonably (IAIGs) – and in July 2011 presented its foreseeable and relevant material risks. initial concept paper. These solvency capital reforms are supplemented by required enhancements The IAIS has outlined the aims of in the role and activities of insurer risk ComFrame as: management, which effectively link the • Developing methods of operating front-end processes of accepting and group-wide supervision of IAIGs in monitoring risk more closely with the order to make group-wide supervision overall strategic goals and risk appetite more effective and more reflective at Board level. of actual business practices; For many jurisdictions, enacting • Establishing a comprehensive such changes into local frameworks framework for supervisors to address will require significant effort and the group-wide activities and risks and impact on the insurance sector is likely also set grounds for better supervisory© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  9. 9. Evolving Insurance Regulation | February 2012 | 7 co-operation to allow for a more paper released in June 2011. Many KPMG continues to strongly support integrated and international approach; recognised that ComFrame needs to the overall aim of the IAIS: to foster and exist in order to address issues in the global convergence of regulatory and• Fostering global convergence of supervision of IAIGs and that the project supervisory measures and approaches regulatory and supervisory measures is therefore a significant development to insurance supervision. The primary and approaches. in international insurance supervision. goal of ComFrame should be to Supervisors are now trying to provide establish a framework for better ComFrame is split into five modules: further detail on the key components supervisory co-operation, allowing a of ComFrame. However, differences more integrated and international Module 1: among supervisors are beginning to approach. There are a number of key Scope of application surface, especially regarding solvency issues which remain to be addressed: Module 2: issues, for example: Group structure and business from • The use and scope of a total balance • What is a globally accepted level a risk management perspective sheet approach of policyholder protection? • Should a consolidated or aggregated If ComFrame is to achieve international Module 3: accounting measure be used? convergence and consistency in Quantitative and qualitative • How should risks actually be supervisory requirements, one of requirements measured? the most important issues to resolve Module 4: • How can a common methodology will be that of establishing an Supervisory process and co-operation on capital requirements be achieved? appropriate level of policyholder Module 5: • How can a common approach to protection – or put another way, Jurisdictional matters stress and scenario tests be achieved? determining the risk appetite of • How can a common methodology supervisors with regard to the failure to the supervisory assessment of an IAIG. An open and informedAlthough there are various approaches process be achieved? debate concerning minimumused globally to supervise IAIGs, the standards of global policyholdersituation still remains that no multilateral It is clear from various meetings of protection, and thereby capitalsystem is used by global supervisors the IAIS committees that a number requirements, is needed.to monitor IAIGs adequately. Some of key concerns still remain among As the international standard settersupervisors have taken a different jurisdictions: for insurance, it would be a curiousapproach by focusing heavily on a • What is the scope of an insurance decision for the IAIS to advocate ashareholding-centric model to analyse group? new, globally accepted commongroup structures. • What is the group capital assessment framework and not articulate the level As the international standard setter for designed to achieve? of policyholder protection it offers. Ininsurance, the IAIS has so far developed • How should solvency control levels addition to discussion and agreementa generic approach to building a global be determined? on the level of protection to whichframework for the supervision of IAIGs, • Should ComFrame require different policyholders are entitled, moreincluding developing the ICPs (of which intervention levels? debate is needed on the componentssome ICPs, such as ICP 23, specifically • Should ComFrame require a single of an effective global group-wideaddress group-wide supervision). methodology in determining capital supervisory regime, for example, Notwithstanding, the IAIS still lacks a requirements, or should multiple the determinants of key tools formultilateral response to the supervision methodologies be allowed? If so, how? an effective insurance supervisoryof IAIGs and ComFrame is intended • Does ComFrame mean one group regime. Failure by supervisors toto fill this void. Encouragingly, there supervisor or multiple supervisors reach satisfactory conclusions onwas generally broad support from IAIS involved in the supervision of an these important components willmembers and observers for the structure IAIG? What are the legal implications mean regulatory failure.and outline presented in the concept arising? © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  10. 10. 8 | Evolving Insurance Regulation | February 2012 • What is the role and future of the should be given priority, especially as In November 2011, the IAIS released its IAIS as an international standard it is still unclear how ComFrame will preliminary findings and took a focused setter? interact with current supervisory view of whether insurers could pose The GFC highlighted the uncertainty structures. systemic risk – effectively being confined regarding the role, remit and ability of to the impact of non-core insurance the IAIS to facilitate, or be involved in, • Can there be greater international activities such as credit protection and any formal review process of an IAIG. co-operation amongst all standard asset leverage. However, it remains Key lessons learned by the industry setters? to be seen whether the G20, FSB and from the GFC were matters of IAIG It is clearly important that the IAIS national authorities will take a wider data confidentiality and information liaises closely with not only the view. For example, the EU Crisis and mechanisms to freely exchange Basel Committee for Banking and Management Directive is expected to sensitive information amongst International Organization of Securities apply to all credit institutions and could be supervisors. Commissions (IOSCO), but also the followed by a similar Directive for insurers. As the IAIS is developing ComFrame, Joint Forum and the Financial Stability In the meantime, the US authorities greater clarity and articulation Board (FSB) and G20 forums, if it is are expected to designate major insurers concerning its role and powers would to appropriately develop ComFrame. to be SIFIs, and to require them to be beneficial to both IAIS Members How IAIG supervision is envisaged to undertake resolution planning. The and Observers. For example, it remains interrelate with other sectors such as Dodd-Frank Act contains provisions for unclear as to whether the principal aim banking and conglomerates is critical non-bank financial institutions – which of the IAIS is to increase the intensity to avoid duplication and achieve includes insurance firms designated of supervision of the largest and most maximum efficiencies from supervisory by the Financial Stability Oversight complex global insurance groups, or processes. Further consideration Council (FSOC) as systemically important whether the primary intention is to of how ComFrame would be – to develop resolution plans. achieve greater global consistency. ‘operationalised’ on a conglomerate The first approach focuses on raising basis would therefore be beneficial. standards, and the latter focuses on wide and consistent application of Systemic Risk minimum standards. In their latest publication, arising from the G20 Cannes Summit held • What is the envisaged in November 20111, the G20 and FSB implementation of ComFrame? have outlined their clear intention to The path to implementation remains apply capital surcharges and a Recovery unclear. It has not yet been clearly and Resolution Plan (RRP) framework articulated how ComFrame is to all Significantly Important Financial envisaged to operate, for example, Institutions (SIFIs) – including insurers. whether ComFrame is intended to Additionally, the FSB is seeking national perform like the Basel Accord for authorities to put common powers Banking (with the intention that and tools in place for the resolution individual countries will implement of insurers. This takes into account ComFrame into their local law and that these tools may need to differ regulation and thereby replacing from the powers and tools necessary existing requirements) or whether a to resolve banks and recognises much looser supervisory arrangement that most national authorities is intended. Such uncertainty may slow already have powers in place to the overall development of ComFrame. transfer the business of insurance Resolution to such important matters undertakings. 1. Communiqué: G20 Leaders Summit. Cannes, 4 November 2011.© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  11. 11. It would be ineffective andImplications for firms disproportionate to apply a banking style RRP frameworkIn KPMG’s August 2011 publication, • The capital structure of the insuranceRecovery and Resolution Plans for industry does not lend itself to to the insurance sector.Insurers – the need for a broader ‘run-on-the-bank’ type risksdebate, we articulated our view that a • The matching principle of assetsfundamentally different policy approach to liabilities has always been ashould be adopted for insurers, cornerstone of most insurance asset-compared to the banking industry. liability management practices The report highlighted that given • Insurance supervisors, have a betterthe significant differences between understanding and insight into thebanks and insurance firms; it would intrinsic risk in business models andbe ineffective and disproportionate the activities of insurers throughto apply a banking style RRP framework using catastrophe modellingto the insurance sector. Instead, a • Failure of an insurer’s particularmuch more pragmatic set of policy strategic plan or strategy does nottools is required to achieve an enhanced usually have the same immediatesupervisory framework for insurers. effects as it does in banking givenTo reflect the inherently different the liquidity considerations involvedoperating models and therefore • The engagement of rating agenciessystemic differences that exist and particularly their role inbetween banks and insurers, policy determining the level of reinsuranceoptions for recovery and resolution counterparty worthiness has hadfor the insurance sector should be a moderating influence over thede-coupled. For example: management and risk appetite of• Insurers are not direct participants of many insurers the payments and settlement system • In some markets, such as the US• Insurers are not dependent on the model of insurance regulation is short-term market funding, ie. unlike such that more than one regulator is banks, insurers do not borrow in the typically responsible for supervising short-term to finance risks over the a large insurer providing additional long-term scrutiny and challenge © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  12. 12. 10 | Evolving Insurance Regulation | February 2012 Risk Management Continuum Risk Spectrum Preservation of franchise value Franchise risk/profit deterioration Franchise destruction Overview and Operations Risk Assessment Stress Testing Recovery Plan Resolution Plan Governance Structure and Current Exposures As-Is State Recovery Plan Resolution Plan • usiness and B • ignificant operations S • ignificant risk S • tress and reverse S • ontingent capital C • x-ante options and E strategic overview and activities exposures stress and liquidity priority (LOCs) • isk appetite, R • egal and functional L • Material’ business ‘ • olicies describing P • sset sales A • isposition D thresholds and structure units and legal permissible and business protocols and metrics • ey activity K entities activities and dispositions prioritisation based • isk management R inter-dependencies • ystematically S required corrective • xternal E on stress results oversight • aterial asset M important operations actions communication plan • iquidation DOAs L • eriodic (ie., annual) P mapping and technologies • vents triggering E • vents triggering E • egal and tax L with additional • redit and counter- C (trade settlement, etc.) recovery plan resolution plan planning refresh, review and party exposures • iabilities mapped L execution execution • egal entity review L approval as required • IS and critical M to entities • oordination with C • rocess and system P • upervisory S vendor relations • oncentration of C parent and liquidity deficiency reporting authorities • nconsolidated BS U business review priority Leverage Existing Materials Business plan ALM reporting – ORSA analysis Scenario analysis Liquidity contingency Regulator takes and overview credit concentration plans control as receiver Risk Appetite Legal entity ORSA/Internal Other stress testing Capital management Bankruptcy, bridge Statement documentation Model reports and insurer, purchase and documentation assumption Risk vision and policy excerpts Current view of ability to release capital and liquidity Develop and document contingent management actions Ability to ‘unplug’ legal and review ability to release capital and liquidity in response entities or economic to stress critical functions and wind-down the firm Stress builds from BAU To severe To fatal Building an appropriate policy models would also provide further of RRPs could be practically applied as framework – providing the link supervisory mechanisms to facilitate part of the ORSA analysis that insurers between RRPs and better risk effective assessment of the risk would be expected to review and include, management management techniques, capital and applicable to all firms. Specifically, a A fresh approach by policymakers is solvency positions of supervised entities. distinction can be drawn between policy required to properly address some of Our view is that the ORSA should be options to take forward aspects related the weaknesses in insurance supervision revised to take into account the lessons to recovery (which would provide a learned from the GFC. Perhaps the learned from the financial crisis. Many direct link with the ORSA), and issues greatest lesson learned is that all of the requirements set out in the IAIS pertaining to actual resolution, which insurers, irrespective of notional Enterprise Risk Management for should be considered separately by designations as systemically important, Solvency Purposes Insurance Core supervisors. need to ensure better risk management Principle (ICP 16) reflect, largely, the The following new analysis could be practices are applied. Importantly, from structure of requirements as prepared expected of insurers: a supervisory perspective, the need to for the ORSA by the Solvency Sub- address the deficiencies of current Committee pre-GFC. This also largely Potential economic impact supervisory risk management tools applies for the Solvency II ORSA considerations: remains urgent. framework. We suggest that, given The ORSA is a new policy tool being Supervision needs to view an insurer’s the lessons learned, the IAIS considers introduced requiring insurers to risk management as a continuum. augmenting its current ICP 16 to provide undertake an assessment of their own Using the continuum outlined above, a policy framework for FSB consideration risks, complemented by an assessment one of the most effective supervisory which can provide a pragmatic and of the capital required to meet such tools available to supervisors in the proportionate link between notions of risks. The focus of this assessment could assessment of risk management is the RRPs and improved risk management now incorporate risks posed to the Own Risk and Solvency Assessment for all insurers. By expanding the ORSA wider economic environment. In some (ORSA). Additionally, allowing internal requirements, the conceptual framework markets, supervisors are already moving© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  13. 13. Evolving Insurance Regulation | February 2012 | 11The ORSA should be revised totake into account the lessonslearned from the financial crisis.towards requiring forward assessments as they were not designed for the type A practical policy option available toof the financial condition of an insurer, of extreme market event that occurred. supervisors is to formalise links betweenunder a range of scenarios. For example, Many firms’ stress tests failed to the strategic objectives and options ofin the UK, the Individual Capital adequately consider the magnitude insurers with risk appetite, establishingAdequacy Standards (ICAS) requires of shocks, the duration of the shock, formal reporting mechanisms. Extendingextensive testing of capital, insurance, risk concentrations and the extent of such arrangements to, for example,market, credit, liquidity and operational correlation (and contagion) between instances of acquisitions and mergers,risks, in addition to other relevant risks different positions, risk types and may also assist regulators to bettersuch as reinsurance, strategic risks, markets. Nevertheless, while there assess the systemic relevance of firms,and corporate governance risk. Such has been much discussion of the flaws as well as enabling insurers to articulaterequirements will ostensibly be extended and inappropriate usage of stress potential impacts to the business model.in Solvency II, (in the US via the ORSA tests prior to the crisis, there has These requirements could usefully formrequirements), and for those firms using also been concurrent recognition that part of the ORSA set of requirementsan internal model – including the capital such tests must be an essential tool expected of insurers.methodology proposed for calculating in building a resilient financial sector.capital requirements. A widening of The challenge for supervisors and Greater focus on non-core insurancethese existing and proposed supervisory importantly, for firms, is to set tests activities and off-balance sheet items:tools to take account of potential which are appropriately severe and Part of the ORSA analysis shouldeconomic impact considerations broad but not so implausible as to be of therefore be focused on examining thewould largely complement the analysis no use. As part of their ORSA analysis, impact that non-core insurance activitiesperformed. In this context, it would be firms should consider building in more and off-balance sheet items may havea cost effective and proportionate hypothetical sets of assumptions for on the financial condition of the firm.method for the insurance industry. how exposures may change in light Such an approach should adopt a total Regulators will look to groups – of unexpected shocks. balance sheet approach, where theparticularly those in Europe – seeking impact of the totality of the insurer’sinternal model approval, to demonstrate Risk appetite and strategy: material risks are fully recognised on anthey have a comprehensive understanding At its basic level, risk appetite defines economic basis. The GFC demonstratedof their business, contractual the level of risk a firm accepts. This that failure to appropriately recognisearrangements, structures, capital and is set from Executive and Board level the risks such activities can pose to aintra and extra group relationships. and is intertwined with the company’s group highlights a material weakness inThe extension of such analysis could strategy. A poor risk appetite or risk the overall risk management capabilitiesrequire insurers to have mechanisms tolerance setting and lack of goal clarity and functions of a group. Specificin place to restore the group in the case for the insurer can cause considerable requirements of this nature couldof solvency and/or going concern issues financial distress. One of the lessons therefore form part of the broader– or at least to consider such scenarios from the GFC has been that supervisors, ORSA requirements.within their ORSA or internal model and a number of insurance groups, The investments ICP (ICP 15) alreadyanalysis – and in a worse case situation, were not cognisant of the inherent exists and essentially requires insurersto deconstruct the group in an orderly underlying risks, particularly those risks to invest in assets with risks it canmanner. To be in a position to affect which may have systemic relevance. properly assess and manage. Thisappropriate mechanisms, insurers How risk appetite is effectively used especially concerns the use of morewill need insight into the potential and monitored is less well understood by complex and less transparent assettriggers. These are likely to require supervisors, as this has not traditionally classes and investment in markets orscenario analysis to understand the formed a key component of the financial instruments that are subject to lesspressure points and the likely sequence statutory returns of most supervisory rigorous governance or regulation.of events. jurisdictions – in particular, how the risk However, the current proposals are not It was also evident that many pre-GFC appetite of an insurer fits with the specific on which assets may requirestress tests were not fit for purpose, strategic direction of the company. further regulation, and it is clear from the © 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
  14. 14. 12 | Evolving Insurance Regulation | February 2012 events of the GFC that further analysis identify scenarios that are most likely to be seen as a replacement. Preventative would be beneficial. For example, cause an insurer to fail) should also form action should remain integral to consistent requirements relating to part of a firm’s overall risk management prudential regulation. inherently risky financial instruments analysis and assessment and could that are likely to require greater scrutiny therefore form part of the ORSA. The Requiring an analysis of the by both firms and supervisors. These benefit of requiring such analysis is concentration of business written: include: special purpose vehicles, that it can provide both management HIH, the Australian insurance group that hedge funds, derivatives, private equity, and supervisors with the necessary ultimately collapsed in 2000, was a good structured credit products, insurance information to assess the adequateness example of the impact of its collapse linked instruments, and hybrid instruments of the management actions proposed, being detrimental to the local insurance that embed derivatives and dynamic in order to avoid business failure. This market in Australia. (HIH was the hedging programs. A first step would leads to an element of specific focus – dominant provider of indemnity coverage be to require firms to undertake specific that of resolvability and associated to the building industry). However, the analysis of such instruments within planning. Insurance failures are typically consequences of its collapse were not their ORSA assessments, with particular resolvable through an orderly run-off, on a global scale. The failure of HIH regard to whether such assets lead to but exceptions to this have occurred starkly demonstrated the impact that a an increased systemic risk scenario. and remain plausible. There may concentration of business underwritten therefore be a case for putting in place in a particular market or segment can Mandatory use of reverse stress ex ante arrangements to ensure an cause on the local economic system. The testing: orderly conclusion to various scenarios. dominance of HIH’s professional indemnity The use of reverse stress testing, or Such developments would complement business was allowed unchecked, test-to-destruction analyses (which prudential requirements, but should not amassing a disproportionate market share. The industry, as well as regulators, need to be reflective of their role and responsibilities in the wake of the Global Financial Crisis.© 2012 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. Nomember firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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