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1. Buenos Aires
November 22-24, 2011
Serap Oguz GONULAL
World Bank
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2. Agenda
 Challenges of insurance sector in emerging
economies
 Solvency II
 Main regulatory elements
 International experience
 Implementation plan
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3. Challenges of insurance sector in emerging
economies-1
• Buyer issues
• Generally very low awareness of the value of insurance
• Compulsory insurance often seen as a tax
• Capital market issues
• Market small or nascent
• Rather low capital base and solvency margins
• After adjustments on the asset side, many companies are
insolvent
• Insurance market issues
• Small and highly fragmented market – in terms of insurance
premium
• Lack of awareness of importance of reserving
• Lack of data and lack of awareness of value of data
• Competition on prices should be replaced with competition on
quality of service
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4. Challenges of insurance sector in emerging
economies-2
• Claims payment standards
• Low claims payment capacity, particularly for smaller
companies
• Long delays in settling claims - which undermines consumer
confidence and results in low insurance penetration (trust)
• Absence of a regulatory process to ensure good claim
settlement standards
• Relations between companies and agencies are not
regulated
• The regulator doesn’t play the role of a developer
• Lack of willingness?
• Lack of technical capacity?
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5. Typical Supervisory Challenges in Emerging
Economies-1
 Supervisors may have multiple objectives (protect policy
holders, promote insurance development, protect state
owned insurance companies)
 Data issues
 Data needed by the supervisor for analysis and monitoring of
the industry unreliable or non existent
 Financial data is not timely, and often received too late by the
supervisor to take action on it
 Legal issues
 Outmoded legislative requirements that do not reflect the
attributes of a modern supervisory system nor recognize the
needs of a healthy, vibrant insurance industry
 The legal system itself may contribute to a lack of determination
by the supervisor if the enforcement of legal contracts within
the country tends to be a frustrating and difficult process
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6. Typical Supervisory Challenges in Emerging
Economies-2
 Supervisory personnel issues
 Supervisory personnel require training and upgrading of skills;
 Supervisory personnel are not adequately compensated, even by
local standards, thus making it difficult to attract and retain high
caliber personnel
 Supervisory personnel lack access to computer systems to analyze
and monitor financial information efficiently and effectively
 Standards of financial reporting, auditing and actuarial reporting are
not consistent and cannot be relied upon by the supervisor
 Boards of directors frequently lack independence from shareholders
and management and so are often not in a position to provide
direction and leadership
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7. Agenda
 Challenges of insurance sector in emerging
economies
 Solvency II
 Main regulatory elements
 International experience
 Implementation plan
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8. Main regulatory elements under Solvency II
1. Official supervisory oversight – on and offsite monitoring and
enforcement
2. Solvency (inc. reserving), guaranteed return and consumer
protection rules
3. The professions – actuaries, auditors and financial journalists
4. The governance structure – management and supervisory boards
The relative weighting of these depends on:
 Legal framework – particularly strength of capital rules (i.e. how
much leverage is allowed) and wind up rules
 Stage of development of governance mechanisms and professions
 History of failures
In emerging markets the supervisor is almost always key!!
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9. Solvency II-Why ?
 No clarity on the objectives of supervision
 Solvency is based largely on mathematical reserve
calculation – no explicit allowance for asset side risks
 Rules based investment limits – can restrict
innovation and capital market development
 Limited guidance on supervisory interventions
 Net approach – no explicit allowance for reinsurance
 A need for improvement in the regulation
and supervision of insurance companies
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10. Philosophy
 Liability fair value (with resilience) - the management
team is ultimately responsible for the reliable and
adequate calculation of technical provisions
 Liability uncertainty, asset risk and operational risk –
mainly covered by capital requirement
 Solvency Capital Requirement (SCR) & Minimum
Capital Requirement (MCR)
 Pillar II – supervisor can force solvency capital
increase
 Supervisor intervenes if solvency less than SCR –
license revoked if less than MCR
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11. New ICPs - ICP16 & 17
 Solvency II:
 Two levels of capital requirements under Solvency II: Solvency Capital Requirement
(SCR) and Minimum Capital Requirement (MCR)
 SCR is a target level of capital while the MCR is a minimum threshold below which
companies are not permitted to trade (conceptually similar to Solvency I capital)
 Between SCR and MCR: ‘ladder of intervention’ allowing regulators progressive
interventions
 In reality, most companies will exceed target SCR to minimize regulatory intrusion
 New ICPs:
 ICP 16 (Entreprise Risk Management for Solvency Purposes): The supervisor
establishes enterprise risk management requirements for solvency purposes that
require insurers to address all relevant and material risks
 ICP 17 (Capital Adequacy): The supervisor establishes capital adequacy requirements
for solvency purposes so that insurers can absorb significant unforeseen losses and to
provide for degrees of supervisory intervention
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12. Solvency II
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13. Pillars I and II
framework
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14. Agenda
 Challenges of insurance sector in emerging
economies
 Solvency II
 Main regulatory elements
 International experience
 Implementation plan
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15. International perspectives on solvency
modernisation: the USA
National Association of Insurance Commissioners (NAIC) Solvency Modernization Initiative (SMI)
NAIC: voluntary association of insurance regulators; primary vehicle for interstate coordination re. insurance
regulation
1994: introduced a Risk-Based Capital (RBC) system, as a factor-based approach that considers an insurers' size
and risk profiles when determining capital requirements
What's changing: Based on a review of international developments in insurance supervision, solvency
assessment, and international accounting standards, will upgrade the US solvency framework
The impact: The SMI will:
 Strengthen the supervision of re/insurance groups
 Introduce requirements for enterprise risk management and prospective solvency assessment, taking
account of related international action and insurance core principles adopted by the International
Association of Insurance Supervisors (IAIS).
 Allow for ratings-based collateral for "certified" reinsurer
 Introduce principles-based reserving in life insurance
 Refine the current RBC system
 However, not expected to move to full economic-based methods of Solvency II
Source; Swiss Re-Sigma
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16. International perspectives on solvency modernisation-
Europe
Solvency II - European Economic Area (EEA)
 What's changing: Solvency II is the new proposed EU legislation which will govern the
risk- and economic- based capital requirements of insurance companies operating in the
EEA as well as define enterprise-wide risk management requirements.
 Replaces Solvency I, introduced in the 70s , and based on defining capital requirements by
specifying simple, factor-based solvency margins.
 Solvency I capital margins were designed to act as a buffer to absorb potential risks and
protect policyholders, but experience showed they do not always reflect the true risks of
insurance portfolios
 The impact: Solvency II combines
 total balance sheet and economic-based solvency assessment,
 strong reliance on qualitative risk management requirements, and
 enhanced market discipline through increased disclosure requirements and
transparency.
 This represents a paradigm shift in insurance supervision, the outcome of which should
be insurance companies with a better understanding of the risks they take and regulatory
incentives that promote state-of-the-art risk management and greater transparency
 Current status: after 5 rounds of industry testing, technical standards are being finalized
for implementation on 1 January 2013
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17. International perspectives on solvency
modernisation- Switzerland
 Swiss Solvency Test (SST): economic-based regulatory approach that takes an
all-risks view of the re/insurer’s business
 Came into effect in 2006; mandatory for all companies by 1 January 2011; applies
to all Swiss-based companies
 Scope of regulation:
 Obliges groups, conglomerates and reinsurers to use an internal model to
calculate their solvency requirements
 Groups and conglomerates must report their available and required capital
twice a year to Swiss regulator FINMA.
 Similarity with Solvency II:
 Basic concepts of SST and Solvency II are similar
 Both based on a three-pillar approach that includes quantitative and
qualitative risk management requirements
 Both value assets and liabilities on a market consistent basis
 Both take an all-risks approach and acknowledge the benefits of
diversification that reinsurance provides
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18. International perspectives on solvency
modernisation - Asia
 Current status:
 Risk-Based Capital (RBC) regime applied in Japan (1997), Indonesia (2000), Taiwan
(2002), Singapore (2004), Malaysia (2009), Thailand (2011) and South Korea (2011)
 Regulatory regime similar to Solvency I – i.e. based on a solvency ratio/margin
approach – used in many other Asian countries
 China, Hong Kong, the Philippines and Vietnam considering moving to an RBC
regime
 India has not yet announced plans to change its solvency regime
 What's changing:
 Tightening of insurance supervision and regulation, including solvency
modernization
 Higher minimum capital requirements, adoption of RBC solvency systems, and
introduction of dynamic stress tests and use of scenarios
 Increased focus on consumer protection
 Alignment of accounting standards with the International Financial Reporting
Standards
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19. International perspectives on solvency modernisation -
Asia
 China:
 Expected to move towards a RBC approach, though no timeline has been announced
 Expected to consider diversification and its benefits
 Also expected that capital requirements will be driven by higher charges on
underwriting risk
 Singapore:
 Introduced an RBC approach in 2004
 While no plans have been announced regarding a move towards Solvency II,
Singapore's authorities generally respond quickly to global standards and are
expected to be interested in equivalency amongst Asian regimes
 Further solvency development should address issues of diversification and
operational risk, as well as Group calculation.
 South Korea:
 Has also been closely observing Solvency II developments in Europe
 Having just introduced a RBC approach in April 2011, solvency regime is quite close
to Solvency II
 Future solvency developments expected to address Group-level calculation and
diversification
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20. International perspectives on
solvency modernisation- Australia
 New development:
 Australian Prudential Regulation Authority (APRA) introduced the Life and
General Insurance Capital (LAGIC) which has strong parallels to Solvency II
 Implementation planned for the beginning of 2013
 Right now APRA is working on refinements as the industry is going through
the second Quantitative Impact Study (QIS)
 Scope of regulation: Aplies to all Australian insurance companies
 What's changing:
 As with Solvency II, LAGIC is a three-pillar regulatory regime with a risk-
based approach
 Considers market, credit, operational, insurance and liquidity risks
 Current status :
 APRA will respond to the industry about its second QIS in November 2011
 Final Standards due in April 2012 and Final Reporting Standards in October
2012
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21. Agenda
 Challenges of insurance sector in emerging
economies
 Solvency II
 Main regulatory elements
 International experience
 Implementation plan
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22. Initial steps
 Set up prudential standards:
 Focus on risk management through improved risk measurement and a link
to capital planning
 Fundamentally the business of insurance is about informed and controlled
risk-taking, and legal framework should respond to that ( no regulation for
the sake of regulation but for the better regulation)
 First: Pillar 2’ supervisory review process to heighten focus on risk
management; involves introduction of improved disclosure through ‘Pillar 3’, so
that market discipline complements regulation
 Second: market-consistent valuation standards, including in assessing the scale
of liabilities to policyholders
 Third: capital requirements must reflect risk in both assets and liabilities
(including any interactions between the two); must reward real risk
diversification; and must take account of the extent to which risk-transfer
instruments mitigate and transform risks that a firm retains
 Fourth: firms allowed to use own internal models to determine their regulatory
capital requirements, subject to appropriate controls over the adequacy of those
models
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23. Technology requirements of Solvency II
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24. Impact of Technology
 Ability to screen large volumes of financial information, analyze trends in ratios and
monitor large amounts of financial data require use of modern electronic technology
 Modern insurance supervisory office typically receives electronically a well designed
package of financial data annually from insurers, with supplemental data on a
quarterly basis
 Often, a specific software is available to companies, instead of a “statutory form”
 Typically the data received from insurers is stored electronically in a data base, so
that the application software can carry out pre-programmed routines such as
calculation of ratios and indicators
 Ability to carry out ad hoc analysis and screening of information in the data base
 Important, because difficult to say in advance what types of situations might arise
which will trigger a need for customized analysis
 For example, if a major, publicly traded corporation becomes insolvent, it would
be useful to be able to quickly find out which institutions have investments in
that entity and whether any investments are sufficiently large to imperil the
financial position of an insurer.
 Or in case of concerns with a particular type of insurance product, specific tests
could be developed to test this hypothesis against the companies’ financial data
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25. RBS in emerging economies
 Simplified Solvency II approach – IRIS, basic RBC (plus margin),
formal intervention and enforcement levels
 On site inspection based in part on IRIS ratios
 Move from rules based to principles based in steps based on
level of supervisory, professional and governance capacity
 Maintain investment limits initially
 Allow a move away from strict limits based on company
by company assessment of skills and CM development –
but replace with capital requirements (may be 100% for
related party assets)
 Apply gross accounting in statutory returns (i.e. reinsurance
shown separately)
 Require full reinsurance for catastrophe risk
 Have a formal crisis recovery plan
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26. Risk Based &Solvency II
 Risk Based Supervision is an approach to supervision
in which the action of the regulator is determined by:
 the risk profile of the institution
 the extent to which the institution can manage the risk
with minimal impact on policyholders and market
interest
 Risk based supervision is predicated on the
relationship between risk and capital: the higher the
risk profile of the insurer, the higher the capital it
must hold
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27. Risk Based –Solvency II
 Solvency I is a weak predictor
 Solvency II
 Tool for companies for managing risk and capital
 Early warning system for supervisors and for
companies
 Internal Models: only solution to determine
required capital and risk for complex companies
and groups
 Ideally, insurers and regulators should develop
solvency framework together
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28. Moving towards risk based /Solvency II
 With an increased risk focus in insurance
supervision, the regulator will:
 direct its attention to essential areas of supervision and
make effective use of limited resources
 concurrently aim for wider supervisory coverage by
introducing more automated routines
 The goal is to create an effective and well-
balanced supervision of the insurance sector
based on solvency and other issues of
importance for insurance supervision
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29. SII directive: Aim of introducing risk-based supervision
 Improvement to prioritizing tools of supervision in
progress using a different angle compared with our
present classification system
 The new prioritizing tool will become a complement
to supervisory planning, aimed at better capturing
trends and risk on markets and in companies
 The purpose of the Solvency II project is to:
 review all the prudential rules in the insurance field
 devise a solvency system more sensitive to the risks
incurred by insurance companies
 enable supervisors to protect policyholders' interests as
effectively as possible in accordance with common
principles
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30. Rules based/Risk based
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31. Risks in insurance
 Aside from the direct business risks, significant risks to insurers are
generated on the liability side:
• These risks are referred to as technical risks and relate to the
actuarial or statistical calculations used in estimating liabilities
• On the asset side of the balance sheet, insurers incur market,
credit, and liquidity risk from their investments and financial
operations, as well as risks arising from asset-liability mismatches
• Life insurers also offer products of life cover with a savings
content and pension products that are usually managed with a
long-term perspective.
The supervisory framework must address all these
aspects
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32. THE STAKEHOLDERS
REGULATORY FRAMEWORK
INSURANCE SECTOR
POLICYHOLDERS
APROACH
MACRO ECONOMY
OUTLOOK
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33. Key regulatory issues for insurance-1
• Preventing pyramid schemes arising from
competitive pressure on guaranteed returns -
ensuring reserves (called math. reserves) are
adequate ( Life)
• Ensuring that sufficient capital is in place to cover
normal credit, market, liquidity, underwriting,
and operating risks ( life and non-life)
• Securing assets – including asset quality –
preventing related party lending and asset
concentration ( life and non-life)
• Ensuring enough competition to sustain
innovation and efficiency – minimum capital,
entry conditions (Life and non-life)
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34. Key regulatory issues for insurance 2
• Ensuring adequate internal controls - record
keeping is accurate and backed up (Life and non-
life)
• Having a crisis mechanism in place – guarantee
funds etc while minimizing moral hazard
• Set up claims management
• Better coordination between the regulator and
the sector
• Built up technical capacity in the regulator as
well as in the insurance sector
• Training
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35. How to measure success
 Key indicators and benchmarks
• Penetration measures
• Expense structures
• Delivery alternatives
• Product choice and transparency
• Rate of insolvency – true financial position
• Claim paying track record
• Profits relative to domestic cost of capital
• Investments – risk/ return performance
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36. The regulators as developers
• Striking a right balance between developing and
regulating the industry
• Considering the interests of policy holders as
primary objective while framing regulation
• Shouldering the responsibility of developing a
nascent insurance market
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37. Moving towards Solvency II-Why?
to increase policyholders protection
 A requirement to get a risk-sensitive level of
required capital
 Greater market discipline through increased
public disclosure
 More information on firms to allow supervisors
to have a total view of the business model
 Much stronger emphasis on risk management
and forward-looking risk governance leading to
a stronger risk culture in firms
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38. Conclusion
 We need a system designed to create incentives for sound risk
management
 Insurance regulators/supervisors should benefit from best practices and
 Strengthen their risk management capabilities
 Create sustainable products
 Remain competitive in the global market place
 The supervisory architecture
 Solvency should be highest priority
 RBC
 Data quality
 Consistent accounting and actuarial valuation
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