Mini Case Study on Insurance Core Principles - ICP23 Capital Adequacy and Solvency -

1. Mini Case Study on Insurance Core Principles- ICP23 Capital Adequacy and Solvency - Insurance Training Seminar IAIS - ASSAL Buenos Aires, Argentina, 1-4 November 2005 Makoto Okubo – Member of the Secretariat International Association of Insurance Supervisors (IAIS)

2. Definition of Solvency – IAIS glossary Definition of Solvency – IAIS glossary Ability of an insurer to meet its obligations (liabilities) under all contracts at any time Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

3. Definition of Solvency – IAIS glossary Ability of an insurer to meet its obligations (liabilities) under all contracts at any time • To remain solvent an insurer must: • Manage its risks • Ensure asset cash flows are available to meet liabilities when payable • Maintain a safety margin of assets over liabilities Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

4. ICP23 Capital adequacy and solvency The Supervisory authority requires insurers to comply with the prescribed solvency margin This regime includes capital adequacy requirements and requires suitable forms of capital that enable the insurer to absorb significant unforeseen losses Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

5. Elements of a Solvency Regime • EC a : Solvency regime addresses in a consistent manner: • valuation of liabilities, including technical provisions and the margins contained herein • quality, liquidity and valuation of assets • matching of assets and liabilities • suitable forms of capital • capital adequacy requirements Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

6. Allowance for risk mitigation or transfer EC b: Allowance for risk mitigation or transfer considers its effectiveness and the security of counterparty • Any allowance for reinsurance should consider: • the effectiveness of the risk transfer • the likely security of the reinsurance counterparty • See ICP19 – Insurance activities Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

7. Suitable Forms of Capital EC c: Suitable forms of capital are defined • Assessing the Suitability of Capital: • Ability of supervisors to restrict its distribution • Freedom from encumbrances and security interests • Freedom from requirements or incentives to redeem or repay the funds • Freedom from mandatory fixed charges against earnings • Legal subordination to the rights of policyholders and other creditors Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

8. Capital Adequacy Requirements • EC d : Capital adequacy requirements are sensitive to: • size, complexity and risk of an insurer’s operations • accounting requirements that apply to the insurer • Risk mitigated by capital: • Underwriting risk • Credit risk • Market risk • Operational risk Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

9. Capital Adequacy Requirements (cont.) EC e: Minimum capital adequacy requirements should be set at a sufficiently prudent level EC f: Capital adequacy requirements are established at a level so that an insurer can absorb significant unforeseen losses Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

10. Solvency Control Levels • EC g : Solvency control levels are established: • Supervisor intervenes and requires corrective action or impose restriction, where solvency position reaches below control levels • Control level is set so that corrective action can be taken in a timely manner • A control level is required • Often expressed in relation to minimum (i.e. 150%) • Insurers should also set targets (not less than the control levels) • See guidance paper on solvency control levels(2003) Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

11. Issues Related to Groups EC h : Inflation of capital (multiple gearing, intra-group transactions, etc.) is addressed • Group issues include: • Contagion risk • Related-party transactions • Double or multiple-gearing of capital • Solvency regimes need to consider both solo and group-wide capital adequacy • See Joint Forum “Supervision of Financial Conglomerates”(February 1999) Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

12. Issues Related to Branches • Branch is not a separate legal entity, so has no capital of its own • Some regimes require assets be held in trust within the jurisdiction • Amount equal to liabilities in respect of policies written in the jurisdiction, plus a margin equivalent to the capital that would be required of a local insurer with the same book of business EC i : Solvency regime addresses requirements upon an insurer operating through a branch Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

13. Advanced criteria AC j: Solvency regime provides for periodic, forward-looking analysis of an insurer’s ability to meet its obligations under various scenarios AC k: Supervisor assesses the structure of solvency regime against those of a peer group of jurisdictions and works towards consistency Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

14. Mini Case Study • Imagine your are member of a mission team of the IMF/World Bank for an FSAP assessment of the insurance sector • Assessment for the ICP23 Capital Adequacy and Solvency (90 min. for group discussion) • Each group will interview the commissioner of country X or Y (5-10 min. per group) • Each group will make a presentation (5-10 min. per group) Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency

15. www.iaisweb.org International Association of Insurance Supervisors Questions and Answers makoto.okubo@bis.org or visit www.insurance-finance.com This presentation is prepared based on the Insurance Core Curriculum Module 23A – Solvency Principles and Structures (Authors: Michael Hafeman and Craig Thorburn, July 23, 2004) Mini Case Study on Insurance Core Principles – ICP23 Capital Adequacy and Solvency