In October 2012, the International Association of Insurance Supervisors (IAIS) invited feedback on a consultation paper that, among other proposals, put forward measures for identifying globally systemic insurance institutions (G-SIIs) – businesses whose distress or disorderly failure would cause significant disruption to the global financial system or global economy.
Around the same time, the European Commission also released for consultation its proposals on a possible recovery and resolution framework for non-bank financial institutions.
Designed to reduce systemic risk within and across the global insurance sector, both proposals are of great importance to insurers and to the market in general.
The IAIS’s proposals consist of three main types of measures.
The framework proposes that, in addition to the foundation for G-SII policy measures (the existing IAIS Insurance Core Principles), the Financial Stability Board’s (FSB) Supervisory Intensity and Effectiveness recommendations would form the basis of the IAIS’s approach to enhanced supervision.
At the same time, the IAIS’s Common Framework (ComFrame) will aim to foster global convergence of regulatory and supervisory measures and approaches for IAIGs – irrespective of whether or not they are identified as G-SIIs.
The authorities will analyze activities that cause systemic importance of G-SIIs and take necessary measures to reduce this importance.
The framework also proposes that authorities should oversee the development of a Systemic Risk Reduction Plan (SRRP) by each G-SII – and also monitor its implementation.
Consequently, it is anticipated that this enhanced supervision will ensure the G-SIIs rapidly achieve the higher standards of risk management demanded by their G-SII status.
Special emphasis should be placed on group-wide supervision and liquidity planning, the proposals state.
In 2011, the FSB published its Key Attributes for Effective Resolution Regimes, an international standard for resolution of globally significant financial institutions. The IAIS paper suggests these attributes form the basis for improved resolvability of G-SIIs, forcing G-SIIs to:
- establish crisis management groups
- create detailed recovery and resolution plans
- conduct resolvability assessments
- adopt institution specific cross-border cooperation agreements.
Higher Loss Absorption
Also under the IAIS proposals, G-SII supervisors will require these firms to hold more capital or to increase loss absorption by other means – to reflect the greater risk the G-SII’s pose to the global financial system. Mandating a Higher Loss Absorption (HLA) capacity for a G-SII will help reduce its probability of failure, the IAIS suggests.
Implications for insurers
These developments mean insurers should begin to:
- ensure they have risk management systems and processes capable of measuring the impact that severe stresses may have on their business model
- map critical functions to legal entities to ascertain which business critical processes and operations are essential in the event of a systemic event
- assess their ability to maintain and fund critical functions and the resultant implications to conserve or restore the firm’s own funds
- examine the sufficiency of funding arrangements and ensure adequate access to contingency funding
- explore whether they need to restructure liabilities, business lines and asset transformation activities
- ascertain the assumption of credit risk
- determine trigger and stress scenarios.