Panel 6 IAIS Framework for Prudential Regulation

1. Panel6IAIS Framework for Prudential Regulation IAIS-ASSAL Training Seminar 24 November 2009, Lima Peru Jason Park – Principal Administrator International Association of Insurance Supervisors (IAIS)

2. Presentation Overview • IAIS Framework for Insurance Supervision • Adopted standards and guidance papers • Structure of regulatory capital requirements(2008) • Use of internal models for regulatory capital purposes(2008) • Enterprise risk management for capital adequacy and solvency purposes(2008) • Structure of capital resources for solvency purposes(2009) • Current work in progress • Valuation of assets and liabilities for solvency purposes(2010) • Investments(2010) • Future work IAIS Framework for Prudential Regulation

3. Basic concept (1) • Insurer solvency is central to risk management by insurers and to the supervision of insurers • Regulatory capital requirements are a fundamental part of a solvency regime • Capital functions as a shock absorber against unforeseen losses • Sufficient capital is critical to ensure the fulfilment of insurers’ obligations to policyholders • A solvency regime comprises interdependent quantitative (financial) and qualitative (governance and market conduct) components IAIS Framework for Prudential Regulation

4. Basic concept (2) • Assessment of an insurer’s financial position for supervision purposes addresses the insurer’s technical provisions, regulatory capital requirements and available capital resources • Technical provisions represent the amount that an insurer requires to settle all commitments to policyholders arising over the lifetime of the portfolio • Regulatory capital requirements refers to the financial requirements set as part of the solvency regime that determine the amounts of capital that an insurer must hold in addition to its technical provisions • Technical provisions and regulatory capital requirements should be covered by adequate and appropriate assets – need to consider asset quality • Capital resources may be very broadly regarded as the amount of the amount of assets in excess of the amount of liabilities IAIS Framework for Prudential Regulation

5. Supervisory assessment LEVEL 3 Supervisory assessment and intervention Common Solvency Structure and Standards Regulatory requirements LEVEL 2 Financial Market conduct Governance the insurance supervisory authority Basic conditions for the effective functioning of Preconditions LEVEL 1 the insurance sector and insurance supervision Framework for Insurance Supervision Solvency requirements are integral in the Framework for insurance supervision IAIS Framework for Prudential Regulation

6. ISRs: a comprehensive and cohesive set of solvency assessment documentation International Solvency Requirements (ISRs) STANDARDS ISR 1 Capital requirements (adopted) ISR 2 Capital resources (adopted in 2009) ISR 3 Valuation of assets & liabilities (due Oct 2010) ISR 4 Investments (due Oct 2010) ISR 5 Enterprise risk management (adopted) ISR 6 Internal models (adopted) GUIDANCE PAPER ISR 1 Capital requirements (adopted) ISR 2 Capital resources (adopted in 2009) ISR 3 Valuation of assets & liabilities (due Oct 2010) ISR 4 Investments (due Oct 2010) ISR 5 Enterprise risk management (adopted) ISR 6 Internal models (adopted) IAIS Framework for Prudential Regulation

7. Presentation Overview • IAIS Framework for Insurance Supervision • Adopted standards and guidance papers • Structure of regulatory capital requirements(2008) • Use of internal models for regulatory capital purposes(2008) • Enterprise risk management for capital adequacy and solvency purposes(2008) • Structure of capital resources for solvency purposes(2009) • Current work in progress • Valuation of assets and liabilities for solvency purposes(2010) • Investments(2010) • Future work IAIS Framework for Prudential Regulation

8. Standard and Guidance on the structure of regulatory capital requirements (1) • Standard on the Structure of Regulatory Capital Requirements • outlines 15 principles-based requirements for a solvency regime in relation to regulatory capital requirements • Guidance Paper on the Structure of Regulatory Capital Requirements • provides additional guidance on these principles-based requirements IAIS Framework for Prudential Regulation

9. Standard on the structure of regulatory capital requirements (2) Requirement 1 A total balance sheet should be used to recognise interdependence between assets, liabilities, regulatory capital requirements and capital resources. Requirement 2 Regulatory capital requirements should be at a level such that policyholders obligations continue to be met as they fall due. Requirement 3 & 4 The solvency regime should include a range of solvency control levels which should be coherent with the associated corrective actions. Requirement 5 & 6 Prescribed capital requirement (PCR) is the solvency control level above which no action to increase capital or reduce risk will be required. PCR should exceed technical provisions and other liabilities at a specified safety level over a defined time horizon. IAIS Framework for Prudential Regulation

10. Standard on the structure of regulatory capital requirements (3) Requirement 7 & 8 Minimum capital requirement (MCR) is the solvency control level at which the strongest action is invoked if no further capital is made available. The MCR should have a minimum bound below which no insurer is regarded to be viable. Requirement 9 The solvency regime should be open and transparent on the objectives of the regulatory capital requirements and the bases on which they are determined. Requirement 10 The solvency regime should allow a set of standardised and if appropriate other approved more tailored approaches such as the use of partial or full internal models. Requirement 11 The solvency regime should be explicit as to where risks are addressed (split between technical provisions and regulatory capital requirements) as well as how risks and their aggregation are reflected. IAIS Framework for Prudential Regulation

11. Standard on the structure of regulatory capital requirements (4) Requirement 12 The solvency regime should set appropriate target criteria for the calculation of regulatory capital requirements which should underlie the calibration of the standardised approach. Requirement 13 For more tailored approaches, the target criteria should also apply to ensure broad consistency among insurers. Requirement 14 Any variations to the regulatory capital requirements imposed by the supervisors should be transparent and proportionate according to the target criteria. Requirement 15 The solvency regime should be supported by appropriate public disclosure and additional confidential reporting to the supervisor. IAIS Framework for Prudential Regulation

12. Total balance sheet approach to recognise interdependencies Supervisory assessment of the financial position Public financial reporting Available capital Capital Capital requirement Value of assets for supervisory purposes Technical provisions Risk margin Liabilities Liabilities Best estimate policy obligations Assets Liabilities and capital requirement Financial position Assets Liabilities IAIS Framework for Prudential Regulation

13. Solvency control levels to trigger timely supervisory interventions Prescribed capital requirement (PCR) Capital resources Required capital Minimum capital requirement (MCR) Risk margin Technical provisions & other liabilities Current estimate Insurer’s financial position Regulatory capital requirements IAIS Framework for Prudential Regulation

14. Progressive intervention levels to ensure timely corrective measures – an example Capital Adequacy Ratio = Capital Available Capital Required • Prescribed capital requirement (PCR) level • Supervisory intervention not required 190% 160% • Submission of business plan to improve capital buffers • Increased on-site supervision • Additional stress and scenario testing 130% • Limit shareholder dividends • Restrict new business acquisition • Delay approval of new products 100% • Minimum capital requirement (MCR) level • Winding-up of operation IAIS Framework for Prudential Regulation

15. Internal models: a more tailored approach to determine regulatory capital • What are internal models? • A risk management system developed by an insurer to analyse and quantify its risk position and to determine the commensurate economic capital • The internal model approach is suitable only if certain preconditions are met • Level of sophistication of insurers / markets • Corporate governance structures • Competent / accountable insurance professionals and management • Supervisory resources and expertise • Standards and guidance paper apply only in jurisdictions where internal models are recognised for regulatory capital purposes IAIS Framework for Prudential Regulation

16. General provisions on the use of internal models for regulatory capital requirements Roles of supervisors • Establish modelling criteria – ensure consistency among all insurers. • Set eligible levels of regulatory capital requirements (including MCR and PCR) for which IM are accepted – extra care if this includes MCR. • Review and approve the use of IM. Roles of insurers • Ensure risk modelling techniques are appropriate to the nature, scale and complexity of risks. • Demonstrate ongoing compliance with the three tests – statistical quality, calibration and use (next slide). • Notify supervisor of any material changes to the IM. • Ensure proper documentation of the IM. • Provide supervisory reporting and public disclosure. IAIS Framework for Prudential Regulation

17. Statistical quality test Calibration test Use test Initial and ongoing validation and approval essential to ensure model remains fit for purpose • Appropriateness of quantitative methodology- model inputs, parameters, assumptions • Model addresses overall risk position • Data accurate and complete • Demonstrate that the regulatory capital computed using the model satisfies the specified modelling criteria • The internal model is fully embedded into the risk strategy and operational processes • Board and management have control over construction and use of the internal model • Adequate governance and internal controls (documentation and disclosure) IAIS Framework for Prudential Regulation

18. ERM framework underpins robust solvency assessment (1) • What isEnterprise Risk Management? • Process of identifying, assessing, measuring, controlling and mitigating risk in respect of the insurance enterprise as a whole • Sound governance is a pre-requisite for solvency regime to operate effectively • Enterprise risk management underpins effectivesolvency assessment and capital management IAIS Framework for Prudential Regulation

19. ERM framework underpins robust solvency assessment (2) Key Requirements • The overall governance structure should include an Enterprise Risk Management (ERM) framework which is integrated with business operations and culture. • Appropriate to the nature, scale and complexity of the business and risks. • Addresses all reasonably foreseeable and relevant material risks. • Led and overseen by board and senior management. • Supported by accurate and appropriately detailed documentation of risks. • Risk management policy, risk tolerance statement, and own risk and solvency assessment (ORSA) including continuity analysis. IAIS Framework for Prudential Regulation

20. Draft standard and guidance on capital resources for solvency purposes Key Requirements • Capital resources should exceed capital requirements. • Capital resources should be defined and should be consistent with total balance sheet approach with due regard to quality of capital resources. • Solvency regime should establish criteria for assessing suitability of capital resources – due regard to loss absorbency on going-concern and wind-up basis. • Solvency regime should require the insurer to assess the quality and adequacy of its capital resources to meet regulatory capital requirements and any additional capital needs. - Adopted in Oct 2009 IAIS Framework for Prudential Regulation

21. Presentation Overview • IAIS Framework for Insurance Supervision • Adopted standards and guidance papers • Structure of regulatory capital requirements • Use of internal models for regulatory capital purposes • Enterprise risk management for capital adequacy and solvency purposes • Structure of capital resources for solvency purposes • Current work in progress • Valuation of assets and liabilities for solvency purposes • Investments • Future work IAIS Framework for Prudential Regulation

22. Draft standard and guidance on valuation of assets and liabilities for solvency purposes • Joint working group between Solvency & Actuarial Issues Subcommittee and Insurance Contracts Subcommittee developing draft paper. • Work will take into account developments in the IASB Phase II Insurance Contracts project. • Key principle is: The IAIS believes that it is most desirable that the methodologies for calculating items in general purpose financial reportscan be used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements. • Due for adoption in October 2010. IAIS Framework for Prudential Regulation

23. Draft standard and guidance on investments • Review of current standard on ALM and guidance on investment risk management. • Adoption delayed to October 2010 to incorporate observations from the financial crisis such as: • Liquidity risk, concentration risk, SPVs, structured products. • Some concepts currently being considered: • Regulatory investment requirements to ensure sufficiency, liquidity and security of investments • Role of ALM under the broader ERM and IM frameworks • Diversification of investment portfolios • Risk measurement • Role of stress/scenario testing IAIS Framework for Prudential Regulation

24. Presentation Overview • IAIS Framework for Insurance Supervision • Adopted standards and guidance papers • Structure of regulatory capital requirements • Use of internal models for regulatory capital purposes • Enterprise risk management for capital adequacy and solvency purposes • Structure of capital resources for solvency purposes • Current work in progress • Valuation of assets and liabilities for solvency purposes • Investments • Future work IAIS Framework for Prudential Regulation

25. Further work • Establishing a Group Supervisory Framework • Reform of the ICPs by 2011 • Extending the solo level ISRs to groups • Updating the existing Standards and Guidance to take account of the Global Financial Crisis • New Standards and Guidance on Supervisory Review and Reporting • Common Assessment Framework • New working group formed to take forward research IAIS Framework for Prudential Regulation

26. Thank you for your attention. Any questions/ comments? jason.park@bis.org Note : The adopted standards and guidance papers can be downloaded from www.iaisweb.org. IAIS Framework for Prudential Regulation