Tag Archives: IAIS

What Should Future of Regulation Be?

It is of course much easier to look back and second-guess regulatory actions. It is far more difficult to propose a way forward and to do so in light of the emerging hot-button issues, including data and the digitization of the industry, insurtech (and regtech), emerging and growing risks, cyber, the Internet of Things (IoT), natural catastrophes, longevity and growing protectionism. The way forward requires consideration of the primary goals of insurance regulation and raises critical questions regarding how regulators prioritize their work and how they interact with one another, with the global industry and with consumers.

We offer below some thoughts and suggestions on these important questions and on how regulation might best move forward over the next 10 years.

Establish a reasonable construct for regulatory relationships.

Relationships matter, and it is imperative for there to be careful consideration of how regulators organize their interactions and reliance on each other. We have some examples in the form of the Solvency II equivalence assessment process, the NAIC’s Qualified Jurisdiction assessment process (under the U.S. credit for reinsurance laws), the NAIC’s accreditation process for the states of the U.S., the U.S.-E.U. Covered Agreement, ComFrame, the IAIS and NAIC’s memorandum of ynderstanding and the IMF financial sector assessment program (FSAP). Each of these provide varying degrees of assessment and regulatory cooperation/reliance.

These processes and protocols, however, have largely emerged on an ad hoc, unilateral basis and in some cases have had a whiff of imperial judgment about them that may not be justified – and certainly is off-putting to counterparties. We would urge regulators to give careful consideration to the goals, guiding principles and the process for achieving greater levels of cooperation and reliance among global regulators.

We hope these efforts would include an appreciation that different approaches/systems can achieve similar results that no jurisdiction has a monopoly on good solvency regulation. There must also be respect for and recognition of local laws and a recognition that regulatory cooperation and accommodation will benefit regulators, the industry and consumers. Most importantly, regulators need to work together to develop confidence and trust in one another.

The IAIS first coined the phrase “supervisory recognition” in 2009. In March of that year, the IAIS released an “issues paper on group-wide solvency assessment and supervision.” That paper stated that:

“To the extent there is not convergence of supervisory standards and practices, supervisors can pursue processes of ‘supervisory recognition’ in an effort to enhance the effectiveness and efficiency of supervision. Supervisory recognition refers to supervisors choosing to recognize and rely on the work of other supervisors, based on an assessment of the counterpart jurisdiction’s regulatory regime.”

See also: Global Trend Map No. 14: Regulation  

The paper noted the tremendous benefits that can flow from choosing such a path:

“An effective system of supervisory recognition could reduce duplication of effort by the supervisors involved, thereby reducing compliance costs for the insurance industry and enhancing market efficiency. It would also facilitate information sharing and cooperation among those supervisors.”

This is powerful. We urge global insurance regulators to take a step back and consider how they can enhance regulatory effectiveness and efficiency by taking reasonable and prudential steps to recognize effective regulatory regimens − even where these systems are based on different (perhaps significantly different) rules and principles, but which have a demonstrated track record of effectiveness.

As noted above, we have seen some efforts at supervisory recognition. These include Solvency II’s equivalence assessment process, the NAIC’s accreditation process for other U.S. states, the NAIC “Qualified Jurisdictions” provisions for identifying jurisdictions that U.S. regulators will rely on for purposes of lowering collateral requirements on foreign reinsurers, the E.U.-U.S. Covered Agreement and the IAIS’s Memorandum on Mutual Understanding. Some of these processes are more prescriptive than others and have the danger of demanding that regulatory standards be virtually identical to be recognized. This should be avoided.

One size for all is not the way to go.

The alternative approach to recognition of different, but equally effective systems is the pursuit of a harmonized, single set of regulatory standards for global insurers. This approach is much in vogue among some regulators, who assert the “need for a common language” or for “a level playing field” or to avoid “regulatory arbitrage.” Some regulators also argue that common standards will lead to regulatory nirvana, where one set of rules will apply to all global insurers, which will then be able to trade seamlessly throughout all markets.

There are, however, a variety of solvency and capital systems that have proven their effectiveness. These systems are not identical, and indeed they have some profoundly different regulatory structures, accounting rules and other standards such as the systems deployed in the E.U. (even pre-Solvency II), the U.S., Canada, Japan, Bermuda, Australia, Switzerland and others. Attempting to assert a signal system or standard ignores commercial, regulatory, legal, cultural and political realities.

Moreover, we question some of the rationale for pursuing uniform standards, including the need for a common language. We suggest that what is really needed is for regulators to continue to work together, to discuss their respective regulatory regimes and to develop a deep, sophisticated knowledge of how their regimes work. From this, trust will develop, and from that a more effective and efficient system of regulation is possible. The engagement and trust building can happen within supervisory colleges. We have seen it emerge in the context of the E.U.-U.S. regulatory dialogue. We saw it in the context of the E.U.-U.S. Covered Agreement. No one, however, has made a compelling case for why one regulatory language is necessary to establish a close, effective working relationship among regulators.

Similarly, the call for a level playing field sounds good, but it is an amorphous, ambiguous term that is rarely, if ever, defined. Does the “playing field” include just regulatory capital requirements? If so, how about tax, employment rules, social charges? How about 50 subnational regulators versus one national regulator? Guarantee funds? Seeking a level playing field can also be code for, “My system of regulation is heavier, more expensive than yours, so I need to put a regulatory thumb on the scales to make sure you have equally burdensome regulations.” This argument was made for decades in the debate surrounding the U.S. reinsurance collateral rules. We hear it now regarding the burdens of Solvency II. It must be asked, however, whether it is the responsibility of prudential regulators to be leveling playing fields, or should their focus be solely on prudent regulatory standards for their markets.

Finally, the dark specter of regulatory arbitrage is often asserted as a reason to pursue a single regulatory standard, such as the development of the ICS by the IAIS. But one must ask if there is really a danger of regulatory arbitrage today among global, internationally active insures? Yes, a vigilant eye needs to kept for a weak link in the regulatory system, something the IMF FSAP system has sought to do, supervisory colleges can do and the IAIS is well-equipped to do. But using regulatory arbitrage as an argument to drive the establishment of the same standards for all insurers does not seem compelling.

Proportionality is required.

Often, regulators roll out new regulatory initiatives with the phrase that the new rules will be “proportionate” to the targeted insurers. Too often, it seems there is just lip service to this principle. Rarely is it defined – but it is tossed out in an attempt to say, “Do not worry, the new rules will not be excessive.” Greater debate and greater commitment to this principle is needed. Clearly a key component of it must be a careful cost/benefit analysis of any proposed new standard, with a clear articulation of the perceived danger to be addressed – including the likelihoods and severity of impact and then a credible calculation of the attendant costs – economic and otherwise to industry and to regulators. In October 2017, the U.K. Treasury Select Committee published a report criticizing the PRA for its excessively strict interpretation of Solvency II and its negative effect on the competitiveness of U.K. insurers. The report concluded that the PRA had enhanced policyholder protection at the expense of increasing the cost of capital for U.K. insurers, which hurt their ability to provide long-term investments and annuities. Although the PRA emphasized its mandate of prudential regulation and policy holder protection, the Treasury Committee reiterated its concern with how the PRA interpreted the principle of proportionality.

Simplicity rather than complexity.

Over the past 10 years, there has been a staggering increase in proposed and enacted regulatory requirements, many of which are catalogued above. There is a danger, however, that increasingly complex regulatory tools can create their own regulatory blind spots and that overly complex regulations can create a regulatory “fog of war.”

Andrew Haldane, executive director at the Bank of England, in August 2012 delivered a paper at a Federal Reserve Bank of Kansas City’s economic policy symposium, titled “The Dog and the Frisbee.” He graphically laid out when less is really more by talking about two ways of catching a Frisbee: One can “weigh a complex array of physical and atmospheric factors, among them wind speed and Frisbee rotation” − or one can simply catch the Frisbee, the way a dog does. Complex rules, Haldane said, may cause people to manage to the rules for fear of falling in conflict with them. The complexity of the rules may induce people to act defensively and focus on the small print at the expense of the bigger picture.

Focusing on the complexity of the banking world, Haldane compared the 20 pages of the Glass-Steagall Act to the 848 pages of Dodd-Frank together with its 30,000 pages of rulemaking, and compared the 18 pages of Basel 1 to the more than 1,000 pages of Basel III. The fundamental question is whether that additional detail and complexity really adds greater safety to the financial system or has just the opposite effect and significantly increases the cost. Haldane’s analysis provides compelling evidence that increasing the complexity of financial regulation is a recipe for continuing crisis. Accordingly, Haldane calls for a different direction for supervisors with “…fewer (perhaps far fewer), and more (ideally much more) experienced supervisors, operating to a smaller, less detailed rule book.”

Although Haldane’s analysis and discussion focuses on the banking system, his assessment and recommendations should be considered carefully by global insurance regulators. The sheer volume and complexity of rules, models and reports that flood into regulatory bodies raise the real question of who reviews this information, who really understands it and, worst of all, does a mountain of detailed information create a false confidence that regulators have good visibility into the risks – particular the emerging risks – that insurers are facing? A real danger exists of not seeing the forest for the trees.

See also: To Predict the Future, Try Creating It  

Regulation should promote competitiveness rather than protectionism.

At a time when competition has been growing not only from within the established companies but also more importantly from outside the traditional companies, protectionism will only inhibit growth and stifle better understanding of risk in a rapidly changing business environment. The goal must be to make the industry more competitive and to encourage transfer of innovation and create better ways to address risk, distribution of products and climate changes. Protectionism will only limit the potential of growth of the industry and is both short-sighted and self-defeating.

Recognition of the importance of positive disruption through insurtech, fintech and innovation.

The consensus is that the insurance industry is ripe for disruption because it has been slow (but is now working hard) to modernize in view of an array of innovative and technological advancements. Equally, regulators are trying to catch up with the rapid changes and are trying to understand the impacts through sandbox experiments and running separate regulatory models. The pace is fast and presents challenges for the regulators. Solvency and policyholder protection remain paramount, but cybersecurity, data protection, artificial intelligence and the digital revolution make advancements every day. Where this will lead is not clear. But changes are happening and regulators must work to understand the impact and need to calibrate regulatory rules to keep up with the industry and encourage innovation.

Regulation must be transparent.

Too often, regulation is drafted in times of crisis or behind closed doors by regulators believing they know better how to protect policy holders and how to prevent abuse of the system. As we have said, getting it right matters. A strong and healthy industry is the best way to protect consumers and policy holders. Industry engagement is essential and acknowledging and actually incorporating industry’s views is critical. This is particularly true given the dramatic changes in the insurance sector and the need to adopt regulation to new economics, business practices and consumer needs and expectations

This is an excerpt from a report, the full text of which is available here.

Building a Strong Insurance Risk Culture

More than seven years after the onset of the global crisis, the financial sector continues to attract unwanted headlines, with the spotlight shifting somewhat from banks to insurers. Consequently, regulators are taking a heightened interest in organizations’ risk management and underlying cultures. In 2014, the International Association of Insurance Supervisors (IAIS) called for insurers to demonstrate “the ability to promote a sound risk and compliance culture across the group.”

The Financial Stability Board (FSB), an international body that monitors and makes recommendations about the global financial system, has also issued guidance on risk culture, stating: “Supervisors should satisfy themselves that risk cultures are based on sound, articulated values and are carefully managed by the leadership of the financial institution. Furthermore, the FSB stated: “Institutions with a strong culture of risk management and ethical business practices are less likely to experience damaging risk events and are better placed to deal with those events that do occur.”

Why risk culture matters

Risk culture can be described as the way in which decision-makers (at all levels within an insurer) consider and take risks. When risk appetite is fully agreed and understood, all employees are conscious of risk in their everyday decision-making, appreciate the trade-offs between risk and reward and consider the interests of the wider organization above their individual objectives.

However, defining risk culture and establishing a sound risk management framework is a considerable challenge. Traditionally, “risk” within insurance is seen as solely the domain of the actuary, and employees in customer-facing or product design positions may have never acknowledged there is a risk management element to their work. Consequently, many organizations fail to prevent excessive or inappropriate risk-taking, which can, in some cases, cause significant losses, penalties and negative publicity. One example is the recent U.K. payment protection scandal, where insurance companies and bancassurers have to pay billions in compensation for mis-selling of policies.

In organizations with weak or undeveloped risk cultures, responsibility for risk management is unclear, with lack of board oversight and direction, low awareness of risks among employees and deficiencies in risk monitoring, reporting and controls. The risk management function itself is typically under-resourced and under-qualified, while key individuals such as the chief risk officer (CRO), the chief financial officer (CFO) and the approved actuary often have multiple risk decision-making roles that create an excessive workload.

Perhaps more importantly, individuals are not measured or given an incentive for risk performance, and there is an over-tolerant attitude to breaches or mistakes, with those taking excessive
or inappropriate risks rarely disciplined, implying that such behavior is acceptable.

Within a branch network or telephone service center, staff may be under considerable pressure to meet targets, which can lead to sales of products that are not always a) in the customers’ best interests and b) in line with strategic goals. Incentive schemes are partly to blame; they reward salespeople primarily for goals set by their immediate managers, which may prioritize volume over quality. (These can apply both to direct sales and those made through intermediaries.)

See Also: The Key to Building Effective Risk Culture

Insurance companies’ reputations are also at daily risk from poor service quality resulting from slow, inaccurate or unfair claims handling or marketing messages that over-promise benefits (such as speed of replacement for stolen or damaged goods or availability of rental cars to replace damaged vehicles). A poorly designed online sales process can easily cause customers to self-select the wrong products.

Compliance reporting for regulations — including Solvency II and International Financial Reporting Standards (IFRS) — can also highlight weaknesses in risk management. Insurers may be unable to demonstrate that controls are in place and are being adhered to, and they fail to produce accurate reporting that paints a true picture of the business.

Consequently, regulators are raising the bar by demanding more risk-sensitive capital regimes as well as stress and scenario requirements. They are also, increasingly, requiring a clearly articulated risk appetite statement and better assessments of risk management frameworks and risk culture, as well as expecting senior executives to be rewarded directly for encouraging sensible risk-taking behavior that supports long-term corporate financial interests.

From awareness to action

Ultimately, culture is all about action — not policies or documentation. With regulators showing an increasing interest in risk culture and behavior, how can companies take a barometer of their current capabilities to make relevant improvements?

There are three important questions to address:

  1. Does the organization have appropriate structures and processes in place to define the desired culture?
  2. Are those structures and processes adequate to create the desired culture?
  3. Do structures and processes drive effective behaviors in practice?

An in-depth evaluation involves close scrutiny of risk and compliance policies, past interactions with regulators and detailed observations of staff behavior at all levels. By seeking the views of a cross-section of employees and managers, leaders can better understand employees’ attitudes toward risk management and how risk management policies, procedures and systems work in practice, highlighting any gaps.

Data analysis can reveal patterns of customer complaints, regulatory fines and requests for closer supervision and monitoring across different departments and locations. Such incidents should be monitored constantly and their root causes identified to offer a continuous indicator of cultural performance. This is a sizable investment requiring strong endorsement from leaders.

Insurance companies with strong risk cultures are likely to exhibit four key characteristics:

1. Tone at the top

The board and executive management should drive risk culture, with leaders exhibiting total consistency in words and actions, taking a visible lead in risk management activities — and being fully accountable when risk parameters are breached. By making risk a formal standing agenda item at board and management forums, the company’s leaders can demonstrate risk management’s importance to all stakeholders. They must ensure all employees are aware of the organization’s approach to risk management, reward positive behavior and act decisively when inappropriate risks are taken (if necessary through disciplinary action). It is very helpful to keep in touch with front-line activity through regular visits to branches and contact centers.

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2. Communication

Although leaders set the tone, they can’t be alone in delivering messages about the importance of risk. Senior managers of divisions and business units are also part of the communication process, which must filter down through the organization — and between departments — to the most junior people. In this way, everyone can understand the risk appetite and capacity at the individual, team, department and company level. In addition to recording sales calls, staff should engage in focus groups, surveys and one-on-one interviews to ensure they are continually aware of the risk culture and are conforming to procedures.

Rather than acting as static recipients of advice, all employees should be encouraged to share information and feel safe to challenge unacceptable behavior and to escalate issues. This calls for clear channels for whistle-blowing, implying it is acceptable to criticize the business’ activities without fear of retribution.

3. Responsiveness

In a risk-aware culture, issues are escalated and dealt with swiftly and decisively before they can become major problems, with a central point of contact for all employees for the management and treatment of risks. And, crucially, any learning from such incidents is assessed and built into future policies and behavior to avoid a recurrence. If something slips through the cracks, management should analyze why staff did not comply with protocols and re-educate people on the importance of such checks and balances — as well as stressing the need to act within the “spirit” of risk management.

4. Commitment

Risk must become second nature to all, not something that applies only to actuaries or a central risk team. High-profile cultural transformation programs often fail to achieve lasting change because they don’t focus sufficiently on individuals or explain how people should behave to be more risk-aware. To make cultural change happen, leaders must understand the day-to-day dilemmas faced by staff — such as management pressure on sales numbers — and address these issues directly. Performance management and related compensation systems are key to gaining commitment and should balance local branch/office sales targets with wider organizational goals, as well as rewarding good risk management behavior. That will deter staff from taking unnecessary risks in pursuit of short-term profit. Whether selling in person, by phone, online, directly or through intermediaries, the same principles of fairness and appropriateness must apply.

The approval process for new marketing initiatives has to be robust to ensure the business has the capability to meet any promises. Risk management also requires new skills to identify, assess and mitigate risks, which calls for tailored training and coaching.

Good for compliance, good for the business

As well as increasing the chances of remaining compliant, a strong risk culture gives the board and shareholders greater confidence in an insurer’s integrity and in its ability to meet customer expectations. Comparison websites may have made the sector more price-driven, but customers still appreciate doing business with companies that are seen to be acting in a customer’s interests, often through a company offering relevant products, attentive customer service and a swift, fair claims process.

See Also: Building a Risk Culture

Having invested in risk processes and frameworks, insurance companies must also devote resources to building a risk culture, to bringing frameworks to life and to ensuring adherence to policies. Once this has been achieved, all employees — not just actuaries — will be able to say they are risk managers.

In a strong risk culture…

  • The board and executive management drive risk culture
  • Every employee understands and embraces the organization’s risk appetite and risk management framework
  • Threats or concerns are identified and escalated swiftly, with employees comfortable (and encouraged) to raise issues
  • Individuals are clear about the risks inherent in their strategic and day-to-day decisions
  • Every employee continuously learns from the experiences of others
  • Personal and organizational interests are aligned via appropriate performance metrics; links to remuneration risk behavior is monitored regularly, with swift corrective actions taken after any breaches;  and staff are encouraged to consult with a superior when it is unclear whether a particular action is outside the organization’s risk tolerance

Questions for insurers

  • Is your board able to articulate the kind of risk culture it wants, and can it explain this clearly to all employees?
  • Does your board have a road map toward a strong risk culture, and can it demonstrate steps it is taking in this direction?
  • Are risks being identified, measured, managed and controlled in a manner consistent with the organization’s risk appetite?
  • Does your staff understand and adhere to the organization’s risk appetite — as it relates to their particular roles?
  • Do employee incentives promote long-term financial sustainability?
  • Do employees at all levels have the skills to manage risk effectively?

Reprinted from (Regulatory Challenges Facing the Insurance Industry in 2016,) Copyright: 2016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in the U.S.A. The KPMG name and logo are registered trademarks or trademarks of KPMG International.

All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the facts of a particular situation.

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Key Regulatory Issues in 2016 (Part 1)

The complexities of the current regulatory environment undoubtedly pose significant challenges for the broad spectrum of financial services companies, as regulators continue to expect management to demonstrate robust oversight, compliance and risk management standards. These challenges are generated at multiple (and sometimes competing) levels of regulatory authority, including local, state, federal and international, as well as, in some cases, by regulatory entities that are new or have been given expanded authority. Their demands are particularly pressing for the largest, most globally active firms, though smaller institutions are also struggling to optimize business models and infrastructures to better address the growing regulatory scrutiny and new expectations.

Across the industry, attentions are focused on improving overall financial strength and stability, guided by the recommendations of international standards-setting bodies and U.S. regulatory mandates that encompass governance, culture, risk management, capital and liquidity. Though historically under the purview of individual states, the insurance sector in the U.S. has been responding to influences at both the international and federal levels. The efforts of the International Association of Insurance Supervisors (IAIS) to develop insurance core principles (ICPs), a common framework for the supervision of internationally active insurance groups (IAIGs) and capital standards, have all laid the foundation for global regulatory change. These efforts have been further supported by new authorities given to the Federal Reserve Board, the Financial Stability Oversight Council and the Federal Insurance Office and by the designation of certain nonbank insurance companies as systemically important financial institutions (SIFIs). Following are some of the key regulatory issues we anticipate will have an impact on insurance companies this year:

1. Strengthening Governance and Culture

Despite heightened attention from regulators and organizations to strengthen governance structures and risk controls frameworks, instances of misconduct (i.e., professional misbehavior, ethical lapses and compliance failures) continue to be reported across
the financial services industry, including the insurance sector,
with troubling frequency. Boards and senior management are
now expected to define and champion the desired culture within their organizations; establish values, goals, expectations and incentives for employee behavior consistent with that culture; demonstrate that employees understand and abide by the risk management framework; and set a “tone from the top” through their own words and actions.

Line and middle managers, who are frequently responsible for implementing organizational changes and strategic initiatives, are expected to be similarly committed, ensuring the “mood in the middle” reflects the tone from the top. Regulators are also assessing an organization’s culture by looking at how organizations implement their business strategies, expecting firms to place the interests of all customers and the integrity of the markets ahead of profit maximization. They will consider business practices and associated customer costs relative to the perceived and demonstrable benefit of an individual product or service to the customer, giving attention to sales incentives and product complexities.

State and federal insurance regulators have joined the global push for enhanced governance, and, in 2016, insurers can expect heightened attention in this area through the Federal Reserve Board’s (Federal Reserve) supervision framework and its enhanced prudential standards (EPS) rule; the Financial Industry Regulatory Authority’s (FINRA) targeted review of culture among broker-dealers; and the National Association of Insurance Commissioners’ (NAIC) Corporate Governance Annual Disclosure Model Act, which became effective Jan. 1, 2016, and requires annual reporting following adoption by the individual states. Given the regulatory focus on conduct, insurers might experience some pressures to put in place governance and controls frameworks that specifically recognize and protect the interests of policy holders.

2. Improving Data Quality for Risk Data Aggregation and Risk Reporting

Financial institutions continue to struggle with improving their risk-data aggregation, systems and reporting capabilities, which means insurers, in particular, will be challenged to handle any coming changes in regulatory reporting, new accounting pronouncements, enhanced market opportunities and increasing sources of competition because of legacy actuarial and financial reporting systems. These data concerns are augmented by information demands related to emerging issues, such as regulatory interest in affiliated captives. In addition, there are expected requirements of anticipated rulemakings, such as the Department of Labor’s Fiduciary Rule, which necessitates a new methodology or perspective regarding product disclosure requirements and estimations of the viability and benefits of individual products. There is also the Federal Reserve’s single counterparty credit limit (SCCL) rule, which requires organizations, including nonbank SIFIs, to track and evaluate exposure to a single counterparty across the consolidated firm on a daily basis. Quality remains a challenge, with data integrity continually compromised by outmoded technologies, inadequate or poorly documented manual solutions, inconsistent taxonomies, inaccuracies and incompleteness.

Going forward, management will need to consider both strategic- level initiatives that facilitate better reporting, such as a regulatory change management strategic framework, and more tactical solutions, such as conducting model validation work, tightening data governance and increasing employee training. By implementing a comprehensive framework that improves governance and emphasizes higher data-quality standards, financial institutions and insurance companies should realize more robust aggregation and reporting capabilities, which, in turn, can enhance managerial decision making and ultimately improve regulatory confidence in the industry’s ability to respond in the event of a crisis.

See Also: FinTech: Epicenter of Disruption (Part 1)

3. Harmonizing Approaches to Cybersecurity and Consumer Data Privacy

Cybersecurity has become a very real regulatory risk that is distinguished by increasing volume and sophistication. Industries that house significant amounts of personal data (such as financial institutions, insurance companies, healthcare enrollees, higher education organizations and retail companies) are at great risk of large-scale data attacks that could result in serious reputational and financial damage. Financial institutions and insurance companies
in the U.S. and around the world, as well as their third- party service providers, are on alert to identify, assess and mitigate cyber risks. Failures in cybersecurity have the potential to have an impact on operations, core processes and reputations but, in the extreme, can undermine the public’s confidence in the financial services industry as a whole. Financial entities are increasingly dependent on information technology and telecommunications to deliver services to their customers (both individuals and businesses), which, as evidenced by recently publicized cyber hacking incidences, can place customer-specific information at risk of exposure.

Some firms are responding to this link between cybersecurity and privacy by harmonizing the approach to incidence response, and most have made protecting the security and confidentiality of customer information and records a business and supervisory priority this year. State insurance regulators have a significant role in monitoring insurers’ efforts to protect the data they receive from policyholders and claimants. In addition, they must monitor insurers’ sales of cybersecurity policies and risk management services, which are expected to grow dramatically in the next few years. Insurers are challenged to match capacity demands, which may lead to solvency issues, with buyers’ needs and expectations for these new and complex product offerings. The NAIC, acting through its cybersecurity task force, is collecting data to analyze the growth of cyber-liability coverage and to identify areas of concern in the marketplace. The NAIC has also adopted Principles for Effective Cybersecurity: Insurance Regulatory Guidance for insurers and regulators as well as the Cybersecurity Consumer Bill of Rights for insurance policyholders, beneficiaries and claimants. Insurance regulatory examinations regularly integrate cybersecurity reviews, and regulatory concerns remain focused on consumer protection, insurer solvency and the ability of the insurer to pay claims.

4. Recognizing the Focus on Consumer Protection

In the past few years, the Consumer Financial Protection Bureau and the Federal Trade Commission have pursued financial services firms (including nonbanks) to address instances of consumer financial harm resulting from unfair, deceptive or abusive acts or practices. The DOL Fiduciary Rule redefines a “fiduciary” under the Employee Retirement Income Security Act to include persons — brokers, registered investment advisers, insurance agents or other types of advisers — that receive compensation for providing retirement investment advice. Under the rule, such advisers are required to provide impartial advice that is in the best interest of the customer and must address conflicts of interest in providing that advice. Though intended to strengthen consumer protection for retirement investment advice, the rule is also expected to pose wide-ranging strategic, business, product, operational, technology and compliance challenges for advisers.

In addition, the Securities and Exchange Commission (SEC) has announced it will issue a rule to establish a fiduciary duty for brokers and dealers that is consistent with the standard of conduct applicable to an investment adviser under the Investment Advisers Act (Uniform Fiduciary Rule). The consistent theme between these two rules is the focus on customer/investor protection, and the rules lay out the regulators’ concern that customers are treated fairly; that they receive investment advice appropriate to their investment profile; that they are not harmed or disadvantaged by complexities in the investments markets; and that they are provided with clear descriptions of the benefits, risks and costs of recommended investments. In anticipation of these changes, advisers are encouraged to review their current practices, including product offerings, commissions structures, policies and procedures to assess compliance with the current guidance (including “suitability standards” for broker/dealers and fiduciary standards for investment advisers, as appropriate) as well as to conduct impact assessments to identify adjustments necessary to comply with the DOL Fiduciary Rule. Such a review should consider a reassessment of business line offerings, product and service strategies and adviser compensation plans.

5. Addressing Pressures From Innovators and New Market Entrants

The financial services industry, including the insurance sector, is experiencing increased activity stemming, in large part, from the availability of products and services being introduced to meet the growing demand for efficiency, access and speed. Broadly captioned as financial technology, or FinTech, innovations such as Internet-only financial service companies, virtual currencies, mobile payments, crowdfunding and peer-to-peer lending are changing traditional banking and investment management roles and practices, as well as risk exposures. The fact that many of these innovations are being brought to market outside of the regulated financial services industry — by companies unconstrained by legacy systems, brick-and- mortar infrastructures or regulatory capital and liquidity requirements — places pressures on financial institutions to compete for customers and profitability and raises regulatory concerns around the potential for heightened risk associated with consumer protection, risk management and financial stability.

For insurance companies, the DOL Fiduciary Rule will affect the composition of the retirement investment products and advice they currently offer and, as such, creates opportunity for product and service innovation as well as new market entrants. Insurers will want to pursue a reassessment of their business line offerings, product and service strategies, and technology investments to identify possible adjustments that will enhance compliance and responsiveness to market changes. Regulators will be monitoring key drivers of profit and consumer treatment in the sale of new and innovative products developed within and outside of the regulated financial services industry.

This piece was co-written by Amy Matsuo, Tracey Whille, David White and Deborah Bailey. 

2016 Outlook for Property-Casualty

For U.S. property-casualty insurers, 2016 will be a year of continuing disruptive change. Digital technologies, such as social media, analytics and telematics, will continue to transform the market landscape, recalibrating customer expectations and opening new ways to reach and acquire clients. The rise of the “sharing economy,” under which assets like cars and homes can be shared, is requiring carriers to rethink traditional insurance models. Combined with an outlook for slower economic growth, increased M&A and greater regulatory uncertainty, the stage is set for innovative firms to capitalize on an industry in flux. Insurers that stay ahead of these shifts should reap substantial benefits, while laggards risk falling behind, or even out of the race.

Competitive pressures in the insurance industry have been building as cost-effective solutions in digital communication, distribution and infrastructure become widely available. Digital technology is eroding the advantages of scale enjoyed by established insurers and empowering smaller players to compete for market share through more flexible pricing models and new distribution channels. The recent launch of Google Compare, which enables customers to comparison shop for insurance, is the start of a larger wave of “InsuranceTech” activity in 2016.

At the same time, customer expectations and behaviors are evolving at a rapid pace, often faster than traditional mechanisms can react. Driven by their interactions in other digitally enabled industries, such as retail and banking, property-casualty customers are increasingly demanding a more sophisticated and personalized experience – including digital distribution, anytime access, premiums accurately reflecting usage and individual risk and higher levels of product customization and advice. Policyholders are also seeking coverage of broader risks, such as cybersecurity risk and under-protected property exposure.

Significant change to insurance ecosystem

Almost eight years after the global financial crisis, most major economies are still operating at well below potential. Although the U.S. is doing better than many countries, forecast growth of less than 2.5% for 2016 is unlikely to boost employment or wage growth significantly. With little sign that inflation is picking up, the Fed is intent on keeping interest rates near their current lows for the foreseeable future. Meanwhile, concern around the slowdown in China and other key emerging markets will continue to dampen U.S. growth prospects.

Despite sluggish economic conditions, property-casualty insurers should do well next year because of the favorable underwriting performance of the commercial lines sector and rising personal lines premiums. Softness in reinsurance pricing may increase opportunities for companies to cede capacity into the reinsurance and alternative capital markets, as well as achieve more stable reinsurance protection through broader terms and conditions. The industry will enter 2016 with a strengthened balance sheet and a strong base of invested assets from several years of solid reserve development and benign catastrophe experience.

But that is where the good news ends. In 2016, return on investment for firms is likely to continue to slip from its 2014 peak because of a combination of capital accumulation, competitive pricing, weakening investment returns and rising loss costs. Losses and expenses are growing faster than revenue, forcing companies to actively seek new solutions. In personal automobile and workers’ compensation, rising frequency and severity are beginning to erode loss ratio performance.

Competition is putting downward pressure on pricing, particularly in the commercial property and liability lines. This is compounded by slowing growth in commercial exposures because of economic weakness.

Regulatory headwinds ahead

In 2016, property-casualty insurers will face heightened political and regulatory uncertainty. An open presidential election for both parties, along with congressional and state elections, creates the potential for radical change with taxation and regulatory repercussions. Meanwhile, the Fed is preparing new capital standards for significant insurance companies, and HUD and the Federal Insurance Office may intensify investigations into the affordability and accessibility of personal lines insurance to customers from different backgrounds. The IAIS is also pursuing international capital standards through field testing, and the results may come into clearer focus in 2016.

The NAIC and states may separately advance their expectations of best practices in risk management, governance and solvency as current programs enter their second year of full rollout. All jurisdictions will likely push for better information, reporting and compliance in such areas as accounting, solvency, fair practices, transparency, governance and marketplace equity.

Impact of external forces on the US property-casualty market in 2016 (0 = Very low impact, 10 = Very high impact)
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Coping with transformative change: priorities for 2016

In such a fluid, fast-changing environment, insurance firms need to build a road map for strategic transformation aligned to new customer imperatives. Refining legacy products and approaches is not enough – what is required is a fresh, outside-in approach that starts with the customer and carries through to digital trends and market shifts, both inside and outside the insurance industry.

1. Position Your Organization for Digital Leadership

Preparing for further digital disruption


As digital service models become more common in other industries, the property-casualty sector will need to align to the rising expectations of consumer and commercial customers. Digital technologies, such as mobility, social media and telematics, will continue to disrupt all parts of the property-casualty insurance value chain – from client acquisition to claims and servicing. Although the industry is ripe for digital transformation, many traditional insurers still display a low level of digital maturity, struggling to develop digital strategies that enhance the customer experience, extract efficiencies and drive future growth.

Priorities for 2016

Lay the groundwork for digital transformation. To meet changing expectations, insurers need to digitize interactions with customers, employees and suppliers. Building new distribution channels and working closely with existing distribution partners to enhance the customer experience is a strategic imperative.

Build a back-office to support the digital frontline. In 2016, carriers must continue to invest in back-office systems to enable digital enterprise platforms. These should be designed to allow
for future expansion, omni-channel distribution and an improved customer experience, while minimizing customer service costs and protecting against escalating cyber risks.

Start new market initiatives now. As back-office systems are being readied, leading insurers should not wait for full integration, but push forward with next-generation portals, redefining customer experience, data access, queries and navigation. With the rise of real-time risk monitoring, there is a knowledge shift taking place between customers and insurers. Insurers need to tap into client and industry data sources to take full advantage of this new risk-information flow.

2. Prepare for the next wave of M&A activity

M&A will accelerate in 2016

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Uncertain economic and regulatory conditions have caused insurers to cut costs and expand product and geographic diversification. Under growing pricing pressure and competition from non-traditional sources, in 2015 insurers turned to transformative mergers to achieve these goals. This surge in M&A activity is
expected to continue in 2016, as acquirers seek to build scale and access US markets.

Priorities for 2016

Establish a well-defined process for post-merger integration. Mega consolidations require immense integration of systems and data. Companies involved in M&A should assemble the necessary building blocks to create single technology platforms, self-service customer portals and omni-channel distribution systems. Replacing duplicative technology, outdated service centers and first-generation mobile-enabled distribution will remove cost redundancies and inefficient processes. Successful mergers could create lower-cost infrastructures, which will enable these combined entities to invest in data sources and analytical tools that improve pricing, risk analysis and claims management.

Gain greater access to insurance buyers through M&A. Consolidation in the insurance broker and independent agent markets has tipped the balance of power toward distribution. In response, insurers in 2016 will look to gain direct customer access by purchasing specialty distribution and continue the trend of underwriters acquiring managing general agencies with exclusive books of business to increase premiums in less price-sensitive lines. Access to captive distribution should help tilt the scales back toward underwriters.

Take steps to protect against tougher competition. Insurers that refrain from the M&A frenzy will require a strategy to compete more effectively against larger, better capitalized companies. Recruiting human capital will become paramount, as will accessing distribution that provides high-retention, profitable business.

M&A activity in 2016 will make insurers vulnerable to takeovers, particularly those with the potential to provide an acquirer with greater product diversification, wider market access, stronger analytics and increased cost efficiencies.

3. Create a culture of continuous innovation

The innovation imperative

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The rise in usage-based insurance, digital distribution channels and other disruptors is shaking up the industry. Widespread data availability and advanced analytical techniques are enabling new market entrants to absorb risk that was once the exclusive territory of insurers. Larger and more efficient capital providers entering the industry are siphoning off premium that ordinarily flowed to insurers. To stay relevant, traditional insurers need to shed their conservative orientation and cultivate a culture of innovation.

Priorities for 2016

Explore new technologies and start-up models. Competition is heating up as an array of new Fintech companies offer services that were once the exclusive domain of traditional insurers. To cope, insurers will need to adopt, acquire or even fund new technologies and experimental models that may even compete with their existing businesses. Recently introduced property-casualty insurance products, such as insurance for cyber risk, ridesharing and drone exposures, suggest that insurers can rise to the innovation challenge.

Be prepared to cannibalize parts of your business, before competitors do. The property-casualty insurance industry has not been known as a change leader. A growing asset base is a vital sign of stability for clients, but, as a business grows, more processes are added, creating bureaucratic layers that stymie innovation. To offset these institutionalized barriers to change, insurers will need to develop a culture of innovation that allows for internal competition.

4. Shift from a product to a service orientation

Staying relevant in a fluid marketplace

Changing customer needs are making many of today’s insurance services less relevant. With a few notable exceptions, the traditional product suite has been relatively static and has not kept pace with evolving risks. Personal lines insurers are seeing reduced demand for their services because of advanced safety technology, the growth of the sharing economy and changing demographics and customer behaviors. Likewise, commercial lines insurers are coming to grips with new industries, emerging risks and a client base with significant access to their own risk data. Access to better data and analytics empowers customers to retain more risk, and much of the risk at the other end of the spectrum has been taken by capital market alternatives, leaving traditional carriers scrambling for the leftovers.

Priorities for 2016

Think outside-in, not inside-out. To adapt to this fast-evolving marketplace and differentiate themselves from competitors, insurers must enhance their service capabilities while developing products better able to serve new customer needs and behaviors. By providing services that build on the customer experience and changing expectations, insurers can foster stronger, more holistic relationships with clients and ultimately improve policy retention and generate higher margins.

Take a value-added, advisory approach. Customers are increasingly looking to their insurance partners for risk advice, not just insurance products. To enhance their brand and improve performance, insurers must be ready to provide customer-centric services to satisfy these expectations. Insurers will need to analyze their clients’ exposures and develop risk-mitigation strategies and insurance coverage tailored to their needs. The rise of real-time risk data in both personal and commercial lines provides an opportunity for innovative insurers to address uncovered or mispriced risks.

5. Build a next-generation distribution platform

The rise of omni-channel distribution

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Independent and captive agents have dominated the property-casualty insurance industry for decades. Even today, many insurance buyers rely on a trusted adviser to assist them with personal and business insurance purchases. But the days of a single distribution channel are over for many insurers. Consumers are demanding omni-channel access to insurance products. Insurance buyers want the same flexibility to learn, compare, purchase and report a claim as they have become accustomed to in other industries.

Priorities for 2016

Come to grips with pricing transparency. Creating an effective omni-channel platform is critical, as it allows insurers to promote their customer service capabilities, product differences and claims-response times more widely. But the rise of aggregator and non-traditional comparison models has also made it easier for buyers to shop for the best rates. In a digitally enabled environment of price transparency, there will be further pressure in 2016 for insurers to streamline costly and duplicative infrastructure.

Consider acquiring captive distribution. As insurance products become more commoditized, insurers may want to acquire captive distribution to add customers and boost business. By acquiring managing general agents (MGAs), insurers can gain access to experienced underwriters able to secure and retain profitable business, along with the systems and tools for underwriting and processing that business. Insurers will need to integrate these systems into core underwriting platforms to avoid duplicating costs.

Rethink compensation plans for distributors. Private equity-financed broker consolidation, going on for nearly a decade, will continue to shift bargaining power in favor of distributors. Agent and broker control of profitable businesses has allowed some large distributors to negotiate greater compensation. This power shift is happening at a time when rate softening has become the norm. As a result, insurers in 2016 should consider changing the industry’s level-commission compensation standards in favor of greater up-front payments that reward access to new profitable customers.

6. Drive performance through analytics

The new role of analytics

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Disparities in frequency and severity trends among several large personal auto insurers highlights the importance of data and analytics in driving underwriting results. Harnessing large volumes of data from real-time sources can help insurers develop new products and refine pricing strategies. When combined with a robust operating strategy, advanced analytics can significantly increase underwriting profitability and provide a valuable market differentiator.

Priorities for 2016

Apply proven analytics to the homeowners market. In 2016, personal lines insurers will increasingly apply analytical capabilities developed in the personal auto sector to the homeowners market. Greater adoption of technological innovation in the home creates an opportunity for both real-time risk assessment and pricing strategies, similar to the trend unfolding in the personal auto market. As insurers move back into the homeowner market, they will be better equipped to understand and price risks.

Use analytics to manage commercial market risks. As risks rise, small business owners are seeking broader insurance coverage and a simpler sales process. Insurers with the analytical capabilities to manage evolving risks and the technological know-how to create an automated sales experience will be better equipped to meet fast-changing customer needs. The experience in using analytics in the small commercial market will provide insurers with a blueprint for gaining efficiencies in the larger commercial market.

7. Develop and attract the right talent to lead change

Coping with a widening talent gap

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Existing insurance teams often are not prepared for today’s fast-changing digital marketplace. But filling the talent gap can be challenging, because the insurance industry is not often the first choice of new graduates from top colleges and universities. With finance, technology and consulting attracting most of the promising students, a talent chasm is forming in the property-casualty industry. Insurers must recruit and retain next-generation innovators and leaders – while retooling existing teams with new skills.

Priorities for 2016

Develop new roles to facilitate change. As insurers embrace innovation and adopt more advanced digital platforms, they will need to establish new business roles to drive these initiatives. For instance, the stronger focus on analytics is increasing the demand for data scientists – able to apply predictive analytics and other sophisticated quantitative tools to support underwriting and claims- handling processes.

Create an environment that rewards innovation. A culture of innovation will help attract Millennials and entrepreneurial talent with fresh perspectives. Bringing in new ideas and skills will be essential for insurers pursuing technological innovation in an industry not known for change. To acquire and retain this new crop of talent, insurers will need to set up systems to reward innovation and risk-taking in alignment with new strategic imperatives.

Expand risk advisory capabilities. Customers are increasingly interested in working with true risk advisers and finding insurance solutions that match their lifestyles. Traditional product approaches directed at individual risks are falling out of favor as customers seek more holistic solutions. In 2016, insurance teams will need to develop expertise in health, wealth and risk advisory, so that they can bundle products and provide value-added services to customers.

8. Make risk management a C-suite priority

Coping with complexity

Economic, financial and political uncertainty, combined with linked global markets and disruptive technological change, has created a more complex and volatile landscape for insurance firms – heightening the need for best-in-class risk management. Faced with a challenging environment and driven by regulatory demands, insurers have made risk management a C-suite and board-level priority, with risk managers being held accountable for improved financial performance and value creation.

Priorities for 2016

Keep on top of changing regulations. Emerging regulatory regimes include calls for greater uniformity at the state, federal and global levels, but the ultimate form of these requirements is far from settled. As always, insurers will need to stay on top of shifting regulatory frameworks, communicate the industry impacts and respond to changes as they emerge.

Watch for emerging risks, such as cyber-attacks. With access to growing volumes of sensitive data, both large and small insurers are seeking greater cyber risk protection. Corporate boards are becoming increasingly aware of the damage a cyber-attack can cause, including potential liability at the board level and the destruction of reputation and brand. Risk managers must stay ahead of the ever-increasing sophistication of hackers.

Remember, protection is only as strong as the weakest link in the chain. Even if an insurer is well insulated from cyber-attacks, its outside vendors may be vulnerable. Vendors that have access to an insurance company’s systems, such as its underwriting platform, can inadvertently provide hackers with a conduit to valuable company data. Risk managers must be careful with data released to third party vendors for any reason, especially when that data is subsequently returned to the company.

This article was written by David Hollander, Thomas Cranley, Gail McGiffin and Jay Votta. To access the full white paper, click here.

10 Questions on Capital Standards

PwC U.S. risk and capital management leader Henry Essert and PwC global insurance regulatory director Ed Barron recently sat down to discuss the proposed International Capital Standards (ICS) for insurers. They addressed at length what the ICS is and what it could mean to insurers. Here are their thoughts on the standard, as well as some background information on capital management and related issues in the insurance industry.

1. Why have an ICS?

The ICS is about creating a consistent capital measure across globally active insurers and is being promoted as a solution for group-wide supervisors to better manage capital allocation around an international business.

Insurers generally have developed their own capital standards, and what they have developed applies globally across groups. However, regulators need a capital measure to oversee insurers, and most of the regulatory measures are at the legal-entity level. During the last financial crisis, problems arose when parts of a troubled financial institution fell through a regulatory crack.

Even before that, many insurance regulators were concerned that they did not have a good picture of companies as a whole because capital is measured differently in different jurisdictions. This makes it hard for a supervisory college to identify where there may be shortfalls in capital.

2. Who wants it?

Primarily regulators and, by extension, policymakers and politicians/elected representatives. At the end of the 2008 crisis, many of them were concerned about avoiding or better handling any subsequent crises. This prompted politicians (via the Financial Stability Board) to direct regulators to improve the regulatory system for all of financial services, particularly as it relates to capital standards. And, while the banking industry has received the most attention, the insurance industry is part of a wider move for change in financial services; in fact, the FSB is now firmly focusing on the sector.

However, many elected officials in the U.S. are now concerned about adopting a “foreign” calculation that differs from what regulators in their jurisdiction have used. To run their business and generate a good return on capital, multinational and other groups need to have some way to measure how much capital they need in total on a consistent basis. They have devised their own ways of doing this calculation using a combination of current regulatory calculations and their own capital models (which are sometimes called economic capital models). They tend to do these calculations on their own without outside prompting and have concerns that the ICS calculation could conflict with what they are already doing. There has been extensive regulatory change in recent years, and the ICS is yet another initiative that insurers have to address – and in a very aggressive timeframe.

3. Does it reflect current practices or does it break from them?

Practices differ by country, so there is no single current practice standard to compare with, and the ICS is intended to be a truly global group measure. The current ICS proposal is not the same as any practice in any jurisdiction currently, but most people would say it is closer to European Solvency II approach than to the current U.S. practice. Accordingly, ICS (as it currently stands) would be a considerable change to the U.S. market. This is why the Federal Insurance Office (FIO) is leading a workstream on setting up a GAAP+ concept that will be more closely aligned to U.S. practice.

4. Who’s going to enforce compliance?

The International Association of Insurance Supervisors (IAIS) does not have any executive powers; its role is strictly to develop regulatory guidelines and best practices for national supervisors to adopt, either in whole or part. Application of the ICS is up to individual supervisors, and the question remains if they will act in many major jurisdictions. In theory, the ICS will apply (via ComFrame) to only internationally active insurance groups (IAIGs), of which there are roughly 50 worldwide. However, many observers expect that when the ICS becomes an industry standard, other companies also will use it to calculate and report their capital adequacy.

Several jurisdictions do not have an IAIG. Therefore, we assume they would not be pressured into introducing an ICS concept. However, because most jurisdictions readily adopt many IAIS principles, we would not be surprised to see some of the principles within ComFrame and the ICS “trickle down” to smaller markets, especially where there is not necessarily global activity but a high concentration of regional activity (e.g., Asia).

The reason countries tend to adopt IAIS guidelines is because, when the IMF/World Bank conducts its Financial Sector Assessment Program (FSAP) reviews, it uses IAIS principles as the benchmark for assessing the insurance sector. Therefore, it is in many people’s interest to adopt IAIS standards to achieve strong FSAP results (which feed into sovereign rating, etc.).

5. Who at insurers will be most affected?

If the calculation is similar to others already in use, then primarily risk, actuarial, financial and compliance will be affected. If, on the other hand, the calculation is very different, then just about all functional areas could be affected because of a knock-on effect on product portfolio, pricing, investment strategy and so on. In either case, boards will need to demonstrate they understand the numbers and what they mean, particularly as they relate to
strategic decisions.

Taking a look at the bigger picture, the ICS is only part of a larger regulatory package for IAIGs called Comframe. Other aspects of Comframe, like governance, risk management policies and Own Risk and Solvency Assessment (ORSA) also will have an effect on many areas, regardless of where the ICS ends up.

6. How much investment/effort would implementation and compliance require?

This depends on the nature of both the calculation that is adopted and its enforcement. It is almost certain that the calculation will be complex. But, if the calculation is similar to what groups are already using, either because it is similar to the main regulatory calculation groups use or is similar to their own internal, economic capital calculation, then the investment/effort will be less significant.

More importantly, if it winds up being similar to current calculations, then the new ICS would not have a major impact on how the company’s business profitability is measured. However, if the calculation is different, implementation/compliance and business impact will be significant.

Investment and effort may not necessarily be limited to basic compliance. Insurers can look to their experience with Solvency II, which entailed more than just change to capital standards, and required significant investment in new technology, as well as potential changes to organizational structures.

7. Will product offerings change? Are there certain products that may disappear?

If calculations are different than those now in use, then, yes, there would likely be impacts on premiums for some products, and some may even become nonviable. Many life companies are concerned that if certain types of calculations (notably, market-consistent calculations) are used, then long-term savings products may be too costly to remain viable. At the least, if certain products do not disappear, then their design may need to change (which would change the balance of insurers’ product portfolios).

8. What’s been the reaction of ratings agencies and analysts?

Ratings agencies typically have their own capital calculation formula and, for the most part, at the group level. It is not clear if they will replace their own with ICS but could do so if they think the latter is a comparable or better formula.

Equity analysts typically are concerned with the ability to pay dividends or buy back stock, which happens at the parent company level. Accordingly, they typically do their analysis at the group level. They have not been a vocal part of this discussion but probably would find an ICS helpful.

In fact, most stakeholders are likely to support the concept of a global capital standard for the insurance industry, but there almost certainly will be differences of opinion about what one should look like as details are hashed out about how the standard will actually work.

9. With all this in mind, is a true ICS likely?

It’s too early to say for certain one way or the other, but even the regulators who question the necessity of an ICS seem reconciled to the notion that one should be developed. The debate now is what the one true ICS should look like, and how the calculation should be done is the main area of disagreement between and among geographies. For other aspects of the Comframe regulatory package, like governance, risk management policies and ORSA, there is significantly less disagreement.

10. What should insurers be doing now?

Building the ICS calculation formula and finalizing the rest of Comframe probably will take several years. The following are likely to be key steps in the journey:

  • In the early stages, companies will want to understand how the different, proposed ICS options may affect them, to determine which option they favor.
  • As regulators further develop the different options’ details, they will want to study how different factors in the proposed formulas will affect companies. They will ask insurers to conduct studies of these different factors for their business (i.e., field testing).
  • Once the nature of the ICS becomes clear, companies will need to implement the formula (and eventually, the rest of Comframe).
  • All stakeholders should remain aware of ICS developments to assess where there is consensus and disagreement. If there continues to be significant divergence in how required capital is calculated across regimes, and if ICS adds complexity rather than reducing it, then most insurers will need to factor these developments into how they are modernizing or plan to modernize their risk, actuarial, financial and technology platforms to operate effectively and efficiently in the new environment.
  • Insurers may need to redesign and reprice their products, as well as potentially rethink their business strategies. It is possible that they will need to divest certain businesses and add others.

What are current capitalization requirements?

Current capital requirements in the U.S. are set at a legal-entity level. There are no global requirements for a company that operates in more than one country, and calculation formulas for capital requirements typically vary in each jurisdiction. Solvency II gets close to mandating a group standard. However, it uses the concept of “equivalence” to deal with differing capital regimes between the EU and the rest of the world, rather than enforcing Solvency II capital standards on a third country. In other words, if a country outside of the EU is deemed equivalent, then the group headquartered in the EU can use the capital standard of the operation outside the EU within its group calculation on the grounds that EU regulators are comfortable with the system in that
third country.

Are those requirements adequate if there’s another market shock like 2008 or a series of catastrophic events?

During the 2008 shock, some significant companies did not have enough capital, and governments intervened. In many cases, the formulas that set the capital requirements that proved insufficient are still in use.

However, that doesn’t necessarily mean current requirements would be inadequate for future shocks. There’d need to be a model to test if current requirements are adequate for a defined market shock like 2008, but we would need to define exactly what “a series of catastrophic events” means before modeling its impact.

What results in undercapitalization?

The more risky the business, the theory is that insurers will need to hold more regulatory capital against the risk. To be undercapitalized is normally a reflection of poor reserving or liquidity management.

More specifically, companies hold assets to defease their liabilities, which are calculated based on a more or less average level of claims. Additional assets are set aside (not available to pay shareholder or policyholder dividends) to pay for claims should they be higher than the average. This amount of additional assets is the regulatory required capital. If these assets set aside prove insufficient during a crisis, then undercapitalization results.

What is an adequate level of capital reserves (and, if the level varies by sector, what is the appropriate level for each)?

Figuring out the answer to this question is what the whole ICS global and country level debate is all about.

Which sector (reinsurance, P&C, life) has the biggest challenges remaining adequately capitalized?

There is no perception that this is a bigger issue for one sector compared with another. Problems have occurred in all sectors. Some future crisis events will affect all sectors, like credit risk events; others are more harmful for PC (wind storms) or life (pandemics).

Do different sectors have different standards? In other words, does life have a lower standard than P&C?

No, the same formula is used across the sectors. The formula will cover risks that are common across sectors with the same calculation. Different types of risk are covered by having different factors assigned to different exposures. Some of these will apply only to business/exposures written by life companies or PC companies.

Which are better capitalized, groups or subsidiaries (or does it vary)?

Each subsidiary typically has an amount of actual and required capital it holds on its own balance sheet. The group actual and required capital is the sum of these. Many companies hold actual capital in the subsidiaries just sufficient to cover the regulatory requirement in that subsidiary. They would hold any significant excess at the parent company. So for these types of companies, that would mean the group is better capitalized than the subsidiaries. But that is not always the case.

A group parent company typically can send capital to subsidiaries, subject to meeting its own capital requirements if it is an insurance company. However, the normal capital flow is from subsidiaries to the parent, but the flow is constrained by the subsidiaries’ own capital requirements. (Laws differ from country to country about how readily a company can move capital from one entity to another when it has a group capital position.)

Are there certain insurance lines that are difficult to adequately capitalize?

There are certain coverages for which the level of required capital is too high to make premiums affordable. Where this occurs, some form of government intervention typically occurs (e.g., flood insurance in certain areas). This is unlikely to change with or without an ICS.

However, when the objective is policyholder protection, capital is not the only tool. Better risk management is also key, with tools such as the ORSA and governance protocols being paramount. If it is hard to quantify a certain risk type, then strong risk management principles should augment the degree of policyholder protection.