Session 9: Panel on Assets

1. Session 9: Panel on Assets Jeffery Yong IAIS Secretariat Regional Training Seminar IAIS-ASSAL San Salvador, 24 November 2010

2. Agenda • Introduction - lessons from the financial crisis • International standards • Summary Session 9: Panel on Assets

3. Lessons from the financial crisis – mainly on asset side of the balance sheet Note : This list is not exhaustive. Session 9: Panel on Assets

4. Proposed structure of the new ICPs EXISTING ICPS ICP 18 Risk Assessment and Management ICP 19 Insurance activity ICP 20 Liabilities ICP 21 Investments ICP 22 Derivatives and similar commitments ICP 23 Capital adequacy and solvency NEW ICP STRUCTURE ICP 14 Valuation ICP 15 Investment ICP 16 Enterprise risk management for solvency purposes ICP 17 Capital Adequacy Standard on valuation Standard on investments Standard on ERM for solvency purposes Standard on capital requirements Standard on internal models Guidance on valuation Guidance on investments Guidance on ERM for solvency purposes Guidance on capital requirements Guidance on internal models Session 9: Panel on Assets

5. Total balance sheet approach to recognise interdependencies Supervisory assessment of the financial position Public financial reporting Available capital Capital Capital requirement Technical provisions Value of assets for supervisory purposes Risk margin Liabilities Liabilities Best estimate policy obligations Assets Liabilities and capital requirement Financial position Assets Liabilities Session 9: Panel on Assets

6. An example of asset composition Session 9: Panel on Assets

7. Agenda • Introduction - lessons from the financial crisis • International standards • Summary Session 9: Panel on Assets

8. The supervisory regime establishes requirements that are applicable to the investment activities of the insurer. The supervisory regime is open and transparent as to the regulatory requirements that apply and is explicit about the objectives of those requirements. Financial requirements alone not sufficient – need to complement with quantitative/qualitative requirements to limit investment risks by insurer. Factors to consider when setting requirements: Quality of risk management and governance Quality of capital resources Disclosure framework Cost of compliance Risk sensitivity of solvency regime Transparency facilitates comparisons across jurisdictions – particularly important for cross-border insurance groups Explicit objectives can help to identify consistency with other requirements – regulatory capital requirements, determination of capital resources and valuation of assets and liabilities. Basis for establishing regulatory investment requirements Session 9: Panel on Assets

9. Limits on asset types Form - % of investments; capital charges; deductions from capital resources Easy to enforce and explain to court Deter insurer from investing in inappropriate assets BUT – stifle innovation; disincentivise risk management; one-size does not fit all Principles on investment strategy More flexibility for insurer to choose strategy that meets its risk profile and objectives Less frequent revisions in response to market developments BUT – innovative instruments riskier than originally assessed; difficult to enforce actions – open to interpretations Rules-based vs. Principles-based Rules-based Principles-based Session 9: Panel on Assets

10. Minimum requirements - security, liquidity and diversification Security • Restrict investment exposure to high risk investments (default, lost of value, custodianship) • Limits of using external credit ratings – conduct own due diligence • Derivatives – assess underlying assets and counterparty risk Liquidity • Able to realise/liquidate investments at any point in time • Insurance groups – due regard to impediments to cross-border transfer of assets particularly in winding up Diversification • Diversify within risk category – pooling of same risks (e.g. shares of different companies) • Diversify between risk categories – uncorrelated investments (e.g. different asset classes, geographical spread etc.) Session 9: Panel on Assets

11. Investments should be appropriate to the nature of liabilities Unit-linked policies Policy guarantees & options Currency of liabilities ASSETS Timing of liability cashflows Amount of liability cashflows Mismatching risk  higher technical provisions and/or capital requirements Session 9: Panel on Assets

12. The solvency regime requires the insurer to invest only in assets whose risks it can properly assess and manage. The solvency regime establishes quantitative and qualitative requirements on the use of more complex/less transparent assets and investments in lightly/non-regulated markets. Invest only in assets that the insurer can identify, measure, monitor, control and report – including reliable valuation. Assess maximum loss possible – look through underlying assets. Particular attention on complex asset classes – implicit obligations of support, increased correlation in times of stress. E.g.- pre-approval of an insurer’s derivative investment plan – describe controls and test process. Risk assessibility Session 9: Panel on Assets

13. Requirements on specific financial instruments Off Balance Sheet Structures • Consider whether should permit – circumventing requirements? • Investment strategy of OBS may be different from the insurer’s • May impact ability to meet policyholder obligations especially in times of stress • Difficult to assess inherent risk underlying the reference instrument – e.g. subprime mortgages • Impose quantitative/qualitative requirements on investments/originator • Consider treatment in other financial sector, “skin in the game”, transparency of underlying asset, insurer’s control system Structured Credit Products • Obtain information on insurer’s policies and procedures on the use of derivatives – rationale for transactions • Should be used for risk management and not speculative investment – consider prohibition • Suitable counterparties and tradability of the derivative Derivatives Session 9: Panel on Assets

14. Agenda • Introduction - lessons from the financial crisis • International standards • Summary Session 9: Panel on Assets

15. Summary of key points • During the recent global financial crisis, insurers were mainly affected due to their investment activities. • Regulatory and supervisory requirements on investments need to incentivise insurers to have sound investment policies without being too restrictive. • Sound asset-liability management policies has proven to be a powerful tool to manage risk. Session 9: Panel on Assets

16. Some final thoughts • Need to avoid insurers becoming too-big-to-manage or too-complex-to-understand • Insurers should have better understanding on risk interdependencies • Avoid mistakes in other sectors Session 9: Panel on Assets

17. Thank you for your attention. Any questions/ comments? jeffery.yong@bis.org www.iaisweb.org Session 9: Panel on Assets