Case Study - Consolidated Oversight -

1. Case Study- Consolidated Oversight - Regional Training Seminar IAIS-ASSAL-FIDES 26 November 2009, Lima Peru Takao Miyamoto, IAIS Secretariat

2. Agenda • Recap of Presentation on 23rd • Case Background • Group Discussions • Group Presentations & Final Remarks

3. International Framework Insurance Core Principles (ICP) 5: The supervisory authority cooperates and shares information with other relevant supervisors subject to confidentiality requirements. Insurance Core Principles (ICP) 17: The supervisory authority supervises its insurers on a solo and a group-wide basis. More elaboration Principles on Group-wide Supervision 2

4. Group-wide Supervisor Guidance Paper on the Role and Responsibilities of a Group-wide Supervisor • Different approaches to group-wide supervision • But one important approach is to designate “group-wide supervisor” • Group-wide supervisor should take leading role with other involved supervisors’ cooperation • Generally clear who is group-wide supervisor for a particular group • Several supervisors may qualify 3

5. Group-wide Supervisor General principle • Supervisor in jurisdiction where • Group is based • Supervisor has statutory responsibility to supervise head of group Other factors • Location of group’s head office • If registered head office is not operational head, location where • Main business activities of group are undertaken • Main business decisions are taken • Main risks are underwritten • Group has largest balance sheet total 4

6. Principle 4: Authority and Power Principle 4: Supervisors should have the skills and the appropriate authority to carry out supervision on a group-wide basis. • Preconditions • Appropriate legislation need to be in place for supervisors to supervise groups within jurisdictions • Two main approaches • Direct: Supervisor has explicit authority and power over head of group • Follow-up: Supervisor has adequate authority and power through access to necessary information 5

7. Principle 2: Fitness and ProprietyPrinciple 3: Risk Mgt & Internal Control Principle 2: The fitness and propriety of the board and senior management of the group, as well as the propriety of significant shareholders, should be assessed on a group-wide basis. Principle 3: Adequate risk management and internal controls should be in place within the group and should be assessed on a group-wide basis to enhance the assessment of the solo entities. 6

8. Principle 1: Capital Adequacy Principle 1: Capital adequacy should be assessed on a group-wide basis. • Main issues • Intra-group transactions & double gearing • Off-balance sheet items • Fungibility of capital and transferability of assets • Diversification • Level playing field 7

9. Principle 5: Cooperation and Information Exchange Principle 5: Necessary provisions and arrangements should be in place to allow efficient and effective supervision through cooperation and exchange of information among supervisors of the group. • Examples • Memorandum of Understanding (MoU) • Supervisory College 8

10. Agenda Recap of Presentation on 23rd Case Background Group Discussions Group Presentations & Final Remarks 9

11. Structure of Insurance Group • Property and Casualty insurer (“INS”) operates in jurisdiction A • INS is member of group comprising • Parent holding company (“HOLD”) • Unregulated financing company (“FIN”) • Reinsurance company (“REIN”) • INS is wholly owned by HOLD • INS has 60% ownership share in FIN and HOLD owns other 40% • REIN is wholly owned subsidiary of FIN

12. Structure of Insurance Group • HOLD is incorporated in jurisdiction A • Insurance framework of jurisdiction A • Does not regulate holding companies directly • But provide sufficient powers for supervisor to use approach commonly known as “follow-up approach” • That is, information on unregulated entities is obtained through regulated entity • FIN is incorporated in jurisdiction B • REIN is incorporated in jurisdiction C 11

13. Business • Initially, FIN’s primary business comprised entering into interest rate swaps with major corporations, including banks, insurers and other non-financial companies • During last 5 years, FIN began to expand into other credit derivative lines, including credit-linked notes and credit default swaps (“CDS”) • FIN’s operations have so far appeared highly profitable 12

14. Business • Three years ago, as part of group’s expansion plans, FIN received large loan from INS and used proceeds to form REIN • REIN’s primary role is to provide reinsurance coverage to INS • REIN also provided significant loans to FIN to assist in expanding credit derivative business • REIN continues to write profitable business as rates have been on an uptrend 13

15. Supervisory Assessment • INS has several on-site assessments by its insurance supervisor (“Supervisor A”) over last several years • INS is third largest insurer in jurisdiction A in regard to total assets • Supervisor A deemed INS to have adequate capital resources given it is reinsured by REIN • Supervisor A received management accounts from INS in relation to REIN • Supervisor A determined that REIN is heavily capitalised and would be able to honor reinsurance obligations 14

16. Supervisory Assessment • Last year, Supervisor A heard rumor that FIN was being investigated in relation to FIN’s accounting and asset valuations • Supervisor A heard that insurance supervisor in jurisdiction B (“Supervisor B”) was concerned because several large insurers in jurisdiction B were relying on FIN for credit protection • These stories caught Supervisor A’s attention since FIN comprised major asset on INS’s balance sheet and large intercompany loan 15

17. Supervisory Assessment • Supervisor A used follow-up approach to request INS to obtain information regarding stories • Supervisor A received written correspondence from HOLD’s board providing assurance that there was no basis for rumor • Correspondence appeared to provide sufficient details and Supervisor A felt no need to pursue this matter further 16

18. Group Financial Distress • As result of AAA credit rating, FIN was not required to post collateral for counterparties for credit protection • However, it turned out that FIN misreprented financial position • FIN failed to record significant mark-to-market losses • Consequently, FIN’s credit rating was downgraded • Rating action immediately triggered margin calls on credit derivatives • To avoid failure, FIN borrowed funds from REIN 17

19. Group Financial Distress • Shortly thereafter, catastrophic windstorm hit jurisdiction A • INS required reinsurance protection provided by REIN • REIN was unable to settle obligations on account of lliquidity • Supervisor A discovered that it was mislead by HOLD’s board • FIN was under investigation at time of inquiry 18

20. Agenda Recap of Presentation on 23rd Case Background Group Discussions Group Presentations & Final Remarks 19

21. Tasks • (Question 1) • Group doest not appear to have been supervised from group-wide perspective • What difference would it have made if it had been supervised on group-wide basis? • (Question 2) • Based on “Guidance Paper on the Role and Responsibilities of a Group-wide Supervisor”, who should have performed task of supervising group? 20

22. Tasks • (Question 3) • Assume that Supervisor A was group-wide supervisor • Evaluate Supervisor A’s performance with respect to “Principles on Group-wide Supervision” • Note where Supervisor A’s actions were both in accordance and not in accordance with principles 21

23. Questions and Answers Thank you very much! www.iaisweb.org takao.miyamoto@bis.org