United States: Group-Wide Global Insurance Capital Standards First Step - Basic Capital Mandate For G-SIIs


As the first step in the development of group-wide global insurance capital standards, the International Association of Insurance Supervisors (IAIS) released for public consultation its proposal on basic capital requirements (BCR) for global systemically important insurers (G-SIIs) on December 16, 2013. As announced jointly by the Financial Stability Board (FSB) and the IAIS on July 18, 2013, BCR will be developed and provide a foundation for the higher loss absorption /absorbency (HLA) requirements for G-SIIs. HLA requirements are scheduled to be completed by the end of 2015. Public comments on the proposed BCR are due February 3, 2014. A copy of the proposal can be found at www.iaisweb.org.

BCR have been renamed "basic capital" from "backstop capital" to reflect the fact that there currently is no global risk-based capital regime against which a backstop could apply. However, after the risk-based group-wide global insurance capital standard (ICS) for internationally active insurance groups (IAIGs) is developed by the end of 2016, the IAIS will reassess the role of BCR and consider the need for true backstop requirements that are aligned with the "front-stop" ICS.

Following the initial comment period, field testing of the BCR will commence during the second quarter of 2014, with a second consultation period in July/August 2014 and IAIS approval in September 2014. The FSB will then review and, if acceptable, the BCR will be submitted for endorsement to the G20 summit in November 2014.

BCR are expected to apply to G-SIIs commencing in 2015, with their applicability to IAIGs to be determined in 2014. The development timeline is ambitious, but the IAIS is confident that it will be met and that the constraints referred to in the proposal resulting from the timeline can be addressed.

Applicability and Approach

The substantive principles guiding the development of BCR are that major risk categories be considered, there be comparability of outcomes among companies and across jurisdictions and the BCR have resilience to stress.

BCR will apply to all group activities, including non-insurance subsidiaries, with the consolidated group balance sheet as the starting point, and determine whether the qualifying capital resources exceed the required capital. It uses a factor-based approach to determine the required capital, multiplying factors by proxy measures of major risk exposures and adding the results together. Focusing on the need to recognize major categories of risks without being overly granular, the proposal identifies the key risk categories as insurance liability risks, asset risks and non-traditional insurance and non-insurance (NTNI) risks. Having BCR capture NTNI risks is a key part of the proposal and a direct response to the financial crisis, although the proposal states that BCR should reflect only the NTNI risks that impact the group's insurance operations, with systemic risks being addressed by the HLA requirements. Asset liability matching is a fourth major risk category, particularly for life insurers, but the IAIS indicates that in light of the timeline, it will be particularly challenging to address. The IAIS believes that between five and ten factors would be appropriate and will consider the use of existing pre-calibrated factors from other solvency and capital frameworks, such as Solvency I and Basel III. Field testing will help determine the appropriate balance among simplicity, risk sensitivity and comparability, all of which are referenced in the BCR mandate.

Qualifying capital resources supporting the BCR may include both core and additional capital, and the BCR proposal refers for guidance to the IAIS insurance core principles (ICPs), in particular ICP 17, and the October 2013 draft of the Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame), in particular Module 2, Elements 5-3 through 5-9.

Under the IAIS framework for G-SII policy measures, the calculation will be as follows:

  • insurance entities – BCR;
  • non-insurance financial entities – Basel III, specifically the rules being developed under the Basel III leverage ratio framework, and where Basel III does not apply – BCR;
  • non-insurance non-financial entities – BCR, which includes non-insurance subsidiaries, but excludes non-financial, non-material activities where appropriate.

With current valuation methodology differing significantly among jurisdictions, field testing of two key alternatives will be used to identify the most appropriate approach. The alternatives presented are:

  • the generally accepted accounting principles for financial reporting purposes (GAAP) balance sheet and additional adjusted balance sheet components – including what are broadly referred to as technical provisions, financial instrument assets and reinsurance recoverable assets; and
  • the company's consolidated group-wide valuation bases used in its own economic capital models, with this second alternative proposed not as a basis for BCR but rather to provide additional data for comparison.

The BCR proposal states clearly that internal models will not be used because of the need for simplicity and comparability.

For insurance liability valuations, the intent is to use current estimates of liabilities, and the key adjustment will be for the technical provisions, which the IAIS believes are a main source of lack of comparability among insurance groups. They will be valued on a current estimate basis, in accordance with the definition in ICP 14.8 and excluding any prudential margins, which could be moved to capital resources.

For asset valuation, the proposal is to use GAAP reporting in each relevant jurisdiction, subject to adjustments to be determined in field testing, with further adjustments using ComFrame Module 2, Element 5-3.

Other key goals for field testing are to discourage unintended consequences or gaming of the BCR process and to ensure that the opportunities for regulatory arbitrage of capital requirements between the banking and insurance sectors, where a financial services product may be provided under multiple regulatory regimes with different capital requirements, are not increased.

As always during field testing, confidentiality remains a major concern for insurance companies, and the proposal provides simply that appropriate agreements and protocols will be put in place for field testing.

Standard and Breach

The BCR adequacy ratio will be the ratio of qualifying capital resources divided by required capital and will be met if the ratio exceeds 100 percent, although a footnote to the release states that the benchmark could be set at a different level. Supervisors are expected to take a heightened interest in G-SIIs should their HLA be breached, since it is then possible their BCR would also be breached. The home and host supervisors would determine the appropriate corrective actions to restore compliance by the G-SIIs, which could include raising additional capital or some form of de-risking.

It is also under consideration that when a backstop ratio is ultimately developed, it would become part of the supervisors' approval of a company's capital management plan, which would incorporate the proposed payment of dividends.

Going forward, in this period of global regulatory overhaul and reaction, we will continue to follow group capital standard developments and group supervision, both domestically and internationally.

If you have any questions about this Alert, please contact Elizabeth W. Powers, Alice T. Kane, any member of the Insurance - Corporate and Regulatory Practice Group or the attorney in the firm with whom you are regularly in contact.

This article is for general information and does not include full legal analysis of the matters presented. It should not be construed or relied upon as legal advice or legal opinion on any specific facts or circumstances. The description of the results of any specific case or transaction contained herein does not mean or suggest that similar results can or could be obtained in any other matter. Each legal matter should be considered to be unique and subject to varying results. The invitation to contact the authors or attorneys in our firm is not a solicitation to provide professional services and should not be construed as a statement as to any availability to perform legal services in any jurisdiction in which such attorney is not permitted to practice.

Duane Morris LLP, a full-service law firm with more than 700 attorneys in 24 offices in the United States and internationally, offers innovative solutions to the legal and business challenges presented by today's evolving global markets. Duane Morris LLP, a full-service law firm with more than 700 attorneys in 24 offices in the United States and internationally, offers innovative solutions to the legal and business challenges presented by today's evolving global markets. The Duane Morris Institute provides training workshops for HR professionals, in-house counsel, benefits administrators and senior managers.

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