Session 4 Preventive and Corrective Measures

Regional Training Seminar IAIS-ASSAL San Salvador, El Salvador, 22-25 November 2010 Takao Miyamoto, IAIS Secretariat

Agenda

1. Fundamental Activities – – Legal & Operational Capacities Ongoing Supervision 2. Methods of Applications – – – Manuals Ladder of Intervention Timeliness 3. Examples 4. Other Considerations – IMF Paper 1

Rationale

Conservative approach – Based on extensive and restrictive regulation – Protect policyholders from loss but higher costs – Stifle innovation Permissive approach – Foster entrepreneurial behavior – Excessive risk taking – Increase failures – Affordable products Strike a balance… Importance of timely & effective preventive & corrective actions 2

Fundamental Elements

• Legal authorities – Monitor & understand developments in insurers and industry – Exercise preventive & corrective measures • Operational capacities – Budget & human resources – Skilled staff – recruitment, constant skill development – Remunerations…?

– Mix of long-term career supervisors & experienced mid career industry professionals…?

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Specific Functions

• Obtain well-designed periodical & supplementary supervisory filings – Without timely, accurate, meaningful information, no well considered supervisory decisions – Financial information – sufficient to calculate all standard early warning ratios and solvency positions – Non-financial information (e.g. reinsurance arrangement, shareholders and related parties, off-balance sheet) – Impose more frequent & detailed reporting – Revise content of reporting • Carry out onsite inspections – “Eyes and ears” of supervisory agency 4

Specific Functions

• Inspect business plans – Assess risk inherent in plans for coming years – Assess ability to deal with issues that have been raised – Provide insight into depth of management • Other measures – Impose solvency requirement – Order improvement actions – Impose sanctions & penalties for noncompliance – Withdraw license 5

Agenda

1. Fundamental Activities – – Legal & Operational Capacities Ongoing Supervision 2. Methods of Applications – – – Manuals Ladder of Intervention Timeliness 3. Examples 4. Other Considerations – IMF Paper 6

Manuals

• Develop comprehensive policy & procedural manuals for use of all staff members – Help to ensure transparent, consistent & effective application of available supervisory mechanisms – Provide understanding of all key supervisory measures & powers, including criteria for application how & when they would normally invoked – Set out all key policies so that staff members are fully aware of them and understand importance • Make (key concepts) available to public – Foster mutual understanding 7

Ladder of Intervention

• “Action plan” – Consider various scenarios in advance – Develop appropriate strategies for supervisory actions in different situations • Early prevention is less costly – Can be triggered by high-risk situations that have not yet given rise to actual situation of noncompliance – Should include reasonable numbers of stages • Ultimate corrective measures • Make (key concepts) available to public – Important planning document for insurers – Remove uncertainty & encourage self-governance – Fend off political pressure 8

Timeliness

• Potential time lag – Persons responsible realise symptoms & problems – Communicate to appropriate level – Supervisors receive information by insurers or through onsite inspections – Examine within supervisory authority & make decision – Insurer’s management formulates & implements actions – Actions take effect • Timely measures are essential – Situations can change rapidly – Formulate & implement plans within time frame appropriate to the situation – Set framework for follow-up 9

Relationship with Industry

• Best results can be achieved when supervisors and insurers’ managers share common principles • Credibility & respect from industry – Constructive & knowledgeable comments of supervisors – Timely & suitable actions in professional & transparent manner • Less & less necessary to draw on formal authority • Rather, moral suasion can work well – Reduce “getting around laws” 10

Agenda

1. Fundamental Activities – – Legal & Operational Capacities Ongoing Supervision 2. Methods of Applications – – – Manuals Ladder of Intervention Timeliness 3. Examples 4. Other Considerations – IMF Paper 11

Prompt Corrective Action

Class Solvency Margin 1 Action / Order Less than 200% – Formulation & implementation of management plan 2 Less than 100% – Formulation & implementation of plan to improve solvency – Prohibition & restriction on dividend to shareholders and/or policyholders – Revision of method, including coefficients, to calculate insurance premiums for new contracts – Prohibition & restriction on bonuses to directors & senior management – Restriction on other operating expenses 12

Prompt Corrective Action

2 3 Less than 100% – Prohibition & restriction on certain asset management methods – Curtailment of business at certain existing offices – Abolition of certain offices except head & main offices – Curtailment of business activities of subsidiaries – Disposal of stock of subsidiaries & others – Reduction & new undertakings of auxiliary business – Other measures deemed necessary Less than 0 % – Suspension of whole or part of business 13

Early Warning System

From standpoint of solvency From standpoint of liquidity Prompt Corrective Action Early Warning System Measures to strengthen Profitability Measures to improve Credit Risk Management Measures to improve Market Risk Management Measures to improve Liquidity Risk Management •In-depth interview for cause & improvement •Request for report •Business improvement order 14

Administrative Actions

First Step: identify appropriate measures to take • Seriousness & maliciousness of conduct – Extent of damage to public interests – Extent of damage to customers’ interests – Maliciousness of conduct – Length & frequency of conduct – Existence of intention – Organised involvement – Concealment of conduct – Involvement with antisocial forces 15

Administrative Actions

• Appropriateness of governance & internal control – Recognition & initiatives of board of directors – Establishment & work of internal audit – Effectiveness of compliance & risk management structures – Recognition & education of staff • Mitigating factors – Whether insurers make efforts in voluntary fashion prior to administrative responses Second step: determine actions • Additional considerations – Whether voluntary efforts is appropriate – Whether intensive efforts & focus is necessary – Whether it is appropriate to allow to continue business operations 16

Agenda

1. Fundamental Activities – – Legal & Operational Capacities Ongoing Supervision 2. Methods of Applications – – – Manuals Ladder of Intervention Timeliness 3. Examples 4. Other Considerations – IMF Paper 17

Food for Thought

The Making of Good Supervision: Learning to Say “No” (IMF, 2010) Ability to act – Legal authority – Adequate resources – Clear strategy – Robust internal organisation – Effective working relationship with other agencies Will to act – Clear & unambiguous mandate – Operational independence – Accountability – Skilled staff – Healthy relationship with industry – Effective partnership with boards 18

Citation from IMF Paper

• “…we identify two pillars that support good supervision: the ability to act and the will to act. The will to act has been prominently featured in discussions of the supervisory response to crisis, present and past…” • “…the “ability” to supervise … must be complemented by the “will” to act. Supervisors must be willing and empowered to take timely and effective action, to intrude on decision-making, to question common wisdom, and to take unpopular decisions. Developing this “will to act” is a more difficult task…” 19

Citation from IMF Paper

• “Very simply, there must be a willingness to take action and fulfill the supervisory role. On its face, this seems like an easily obtained consensus; however, supervisors find themselves under almost constant criticism for getting in the way of innovation and for being stodgy and “antimarket.” • “Supervisors are expected to stand out from the rest of society and not be affected by the collective myopia and consequent underestimation of risks associated with the good times …” • “…the relationship between supervisors and the financial industry is a unique blend of familiarity (supervisors are in constant dialogue with the industry) and authority (the right and responsibility) to say no.

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