Transcript Learning from Financial Crises and Preparing for the Next One

Early-warning Indicators, Supervisory Intervention
and Cross-border Resolution of Insurance Groups
Regional Seminar on Supervision of Insurance Groups
Santiago, Chile, 19-21 November 2013
Gunilla Löfvendahl
Senior Financial Sector Specialist
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Agenda
 On a legal entity and group-wide level
 Learn from past crises - typical problems and possible
solutions
 Identifying problems early, responding with adequate
supervisory tools
 Supervisory ladder of intervention, cooperation and
resolution, and orderly exit from the market
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HIH failure (2001) - Findings
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New supervisory methods and structure, with loss of corporate memory and industry
expertise
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Assumption that most large and complex groups were well managed and controlled, with
concentration on exceptions
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Mismanagement of HIH
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Under-pricing and provisioning
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Creative reinsurance arrangements
Bad corporate culture
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Blind faith in an ill-equipped leadership consisting of dominant personalities
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Risk not properly identified and unpleasant information hidden or sanitised
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Lack of independence and critical analysis
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Aggressive accounting practices and lack of audit independence
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Fraud, extravagance and questionable transactions
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Palmer Report recommendations (2002)
 Powers and quality of the supervisor
 High degree of supervisory independence and ability to act quickly
and decisively
 Strengthen intervention powers, using them vigorously, also
informally
 Reasonable degree of senior management and board involvement
in important decisions
 Broader mix of expertise, including from the outside
 Capacity to review sufficiency of reinsurance arrangements and
adequacy of liabilities, such as outstanding claims
 Planning for future contingencies (creation of business cases,
training etc)
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Palmer report continued
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Supervisory process
 Strengthen supervisory risk-rating process and more frequent meetings to
review institutions
 Amend methodology to acknowledge that apparently well-managed
groups can experience financial problems – early detection
 Regular meetings with boards and relevant board committees of
supervised entities (discuss expectations and findings)
 Regular meetings with approved actuaries and auditors
 Review relationship with foreign regulators and, where necessary, establish
MoUs
Focus
 Group-wide supervision, looking at the legal entities, including nonregulated
 Monitor intra-group transactions
 Move from high-level on-site inspections (discussions) to more detailed
reviews of evidence
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Royal Commission recommendations (2003)
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Corporate governance
 Look at remuneration policy and disclose benefits
 Clear definition of duties and functions of board and senior management
Capital adequacy
 Minimum solvency requirements on entity as well as group level
 Require approved actuary reports of financial condition
 Greater disclosure of information about financial positions, and risk- and reinsurance
management strategies
Supervisory capacity, methodology and focus
 Build supervisory competency and review competitiveness in the labour market
(salaries etc)
 More sceptical questioning and aggressive approach to prudential supervision
 Preparedness to enforce compliance (also timely returns)
 Continual questioning of assumed financial viability of institutions
 Random but frequent investigations of reinsurance arrangements
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European failures (2002*) – Findings
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Main apparent causes: underwriting and reserving risk
Root causes: management or governance issues - more focus on the underlying
causes makes it easier to detect the effects early
 Indications of lax risk management or systems and control should generate
a search for a potential deeper malaise
 Enough autonomy for insurers belonging to groups
 Appropriate experience and skills of board and management
 Performance assessment and bonus policy that do not encourage excessive
risk taking
Not only rely on quantitative factors
Anticipate how risks can interact in complex ways, including causal links
between different types of risk and unexpected correlations – large exposures
on a group-level
Move to risk-based approaches, with more forward-looking tools and greater
international cooperation
*
Joint work of 15 countries in the European Union: Report on 20 out of 270 cases of failed insurers or near
misses, looking at causing risks and existing supervisory practices on prevention and early detection
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Great Financial Crisis - Findings
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Insurers mainly affected on the asset side - life insurers predominantly hit (higher
asset/equity ratio) and greatest problems in guaranteed products
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Credit-related non-life lines more hit due to business insolvencies (monoline/financial
guarantees)
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Pro-cyclicality of capital risk charges (reduction of available capital, sale of risky assets,
aggravating the asset prices in a downward spiral)
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Pro-cyclicality of accounting standards (fair value)
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Gaps in the supervision of groups, eg AIG
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Systemic risk (risk seriously impairing the overall economy) – insurers systematically risky?
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Risk of run on insurers - no significant increase in lapse rates although in principle possible
for life insurers
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Liquidity risk management – claims normally well-managed but securities lending,
collateral requirements (triggered by downgrade), and redeemed policies could pose such
risks
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Safeguards in case of troubled insurance groups – possible simplification of group
structure, orderly resolution process, orderly exit and guarantee schemes
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IMF recommendations (May 2010)
The Making of Good Supervision: Learning to Say “No“
 Sceptical but proactive: Question also in good times (countercyclical)
 Comprehensive: Identify emerging risks at the edge of the
regulatory scope (unregulated entities, off-balance sheet
structures, systemic risk)
 Adaptive: Be in constant learning mode (new markets, services,
products and risks) - form views on how changes will affect
institutions
 Conclusive: Follow-up findings (on- and off-site) – take
sanctions if not remedied
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IMF recommendations continued - How
 Ability to act
 Legal authority, including operational independence
 Adequate resources, including skilled staff
 Clear strategy regarding the approach to supervision
 Robust internal organisation, including well-defined
decision making, oversight and accountability
 Effective working relationships with other agencies
 Will to act
 Constant dialogue with industry, including boards
 Take action and fulfil the supervisory role
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Insurance Core Principles – the tools are there
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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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ICP 10 Preventive and Corrective Measures: The supervisor takes preventive
and corrective measures that are timely, suitable and necessary to achieve the
objectives of insurance supervision.
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ICP 11 Enforcement: The supervisor enforces corrective action and, where
needed, imposes sanctions based on clear and objective criteria that are
publicly disclosed.
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ICP 12 Winding-up and Exit from the Market: The legislation defines a range
of options for the exit of insurance legal entities from the market. It defines
insolvency and establishes the criteria and procedure for dealing with
insolvency of insurance legal entities [ ] the legal framework gives priority to
the protection of policyholders…..
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Solvency control levels and other triggers
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Regulatory requirements should be at a sufficient level so that insurers’
obligations to policyholders continue to be met as they fall due
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Capital resources reduce the probability of insolvency and loss to policyholders
- increase capital or reduce risk if not sufficient
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Solvency control levels provide triggers for action by insurers and supervisors
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Should be at least two control levels:
 Prescribed capital level (PCR): above which intervention would be on other
grounds than capital adequacy
 Minimum capital level (MCR): strongest supervisory action if corrective
action is not taken promptly
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Should allow for intervention at a sufficiently early stage for a realistic prospect
of being rectified in a timely manner
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Group solvency levels – PCR and MCR?
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Early-warning indicators
 Capital is not everything – have a range of early-warning
indicators, both quantitative and qualitative that should trigger
action
 Examples of indicators?
 How could they be identified?
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Supervisory monitoring tools
 ICP 9 Supervisory review and reporting
 ICP 4 Licensing
 ICP 6 Changes in control and portfolio transfer
 Acquisitions and mergers
 Portfolio transfers
 ICP 23 Group-wide supervision
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ICP 10 Preventive and Corrective Measures
 Legal and operational capacity to act timely
 Decision-making lines of the supervisor should be structured so that
action can be taken immediately in the case of an emergency situation
 Detect vulnerability in the insurer’s ability to protect policyholders
 Prevent a breach of legislation
 Deal with non-compliance or where an insurer enters into unsound
practices
 Require insurer to develop an acceptable plan for prevention and
correction of problems
 Ensure that the measures are taken
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Early prevention and detection tools
 Activities subject to prior approval
 Continual fit and proper requirements
 Requirements of sound corporate governance, internal control
and risk management
 Prospective reporting and analysis
 Business plan and strategy for new business
 Established contacts with other involved supervisors
 Informal contacts with management
 Public disclosure/transparency
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Preventive and corrective supervisory measures
 Increased supervisory activity or reporting
 Independent review by auditors or actuaries
 Correction of reporting errors
 Capital and business plan for restoration of capital resources
 Measures to reduce risk (eg reinsurance)
 Strengthen or replace the insurer’s management and/or risk
management framework and governance
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ICP 11 Enforcement
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Formal directions to take (or desist) actions - failure to comply should have
serious consequences (combine with fines and punitive actions)
Should at a minimum include
 Restrictions on business activities
 Measures to reinforce the financial position of the insurer
 Consequences when failing to provide information in a timely fashion,
withhold information or provide information that is intended to mislead
Should not delay necessary preventive or corrective measures to be taken
Powerful supervisory tools that should be used in a fair and equal manner
Not sufficient to have powers delegated under legislation (powerful tools are
only powerful if used) – will to act
Issues related to groups?
Determine that the insurer is complying with the measures once action has
been taken or measures have been imposed
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Enforcement or sanction measures
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Restrict business activities
 Stop the writing of new business
 Withhold approval for new activities or acquisitions
 Restrict the transfer of assets
Directions to reinforce financial position
 Require capital levels to be increased or measures that reduce or mitigate risks
 Restrict disposal of insurer’s assets
 Restrict/suspend dividend or other payments to shareholders
Remove directors and managers - bar individuals from acting in responsible capacities in
the future
Compulsory portfolio transfer or conservatorship
Revoke the licence – require the company to wind-up
Direct a company to stop unlicensed business
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Resolution and G-SIIs
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Define insolvency and the limit when it is no longer permissible to continue business
Resolution could be used for cross-border groups before that point is reached – should be
used for G-SIIs, which need to be resolvable
Orderly resolution requires appropriate actions prior to the non-viability stage – on-going
cooperation and information sharing
Normal resolution tools that can be used on all insurers (enough for G-SIIs?):
 Portfolio transfer
 Run off
Establish resolution authorities and cross-border management groups (CMGs) – top level
or resolution powers in more than one part of the group
Appropriate powers to intervene at holding company level
Powers to terminate large volumes of financial contracts – insurance policies?
Ensure continuation of non-insurance operational business that is significant to the
systemic function
Temporary public financial support may be needed
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ICP 12 Winding-up and Exit from the Market
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Procedure for dealing with winding-up and insolvency
Appoint administrator or liquidator to take over the roles and duties of board
and senior management
 Run-off with supervisory involvement
 Liquidation in court procedure
Protect the rights and entitlements of policyholders/beneficiaries in the event of
insolvency
 Protection scheme/guarantee fund
 Preferential rights
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Conclusions
 Independence and resources
 Comprehensive supervision, including group and
macroprudential level
 Early identification and intervention
 Power and will to act using adequate tools
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