The BCR is the first building block to the development of a global insurance capital standard (ICS), which will apply to all internationally active insurance groups (IAIG) from 2019. However, this paper makes it clear that the BCR will only apply to global systemically important insurers (G-SIIs), with confidential reporting to home supervisors commencing from January 2015.
There are currently only 9 G-SII in existence, although the BCR field testing exercise was also completed by 33 volunteer insurance groups covering a wide range of products and geographical markets. Not all were able to submit on time, and the figures quoted in the paper relate to the G-SII only. We believe that a number of participants experienced challenges with some aspects of the field test, such as fair value data.
Implications for firms
While the G-SIIs have been closely involved in the development of the BCR, there remains some uncertainty concerning the practical operation of this requirement when compared to other local jurisdictional solvency measures. For example, the IAIS has not yet decided the calibration level at which the BCR will ultimately be set.
Until consultation begins on the HLA requirements, firms will be unable to assess where the IAIS capital requirements sit compared to their local jurisdictional requirements. Nevertheless, the fair value approach that has been outlined will present challenges for some jurisdictions, which could result in significant work for affected GSII and the IAIGs that will need to comply with the eventual ICS. We also expect that the wider risk management and governance requirements, that will accompany the ICS consultation later this year, will further impact these firms.
The paper suggests that the IAIS is leaning towards Solvency II principles, with adjustments proposed to underlying group balance sheets in two key areas – the valuation of financial instruments (assets and liabilities) on a fair value basis and insurance contracts valued at the probability-weighted average of the present values of the future cash flows, discounted using the relevant interest rate term structure.
This approach remains of concern to US insurers; the US National Conference of Insurance Legislators has this week proposed the opposition of both the creation of any ICS that it believes fails to accommodate the US approach to insurance solvency regulation and to fair value and market consistent valuation approaches. However, the ICS will not be consulted on until December this year, and the BCR remains the first step on the journey to its development.
The IAIS proposes that the BCR will be calculated on a consolidated, group-wide basis, with three basic components – insurance, banking, and other financial activities. However, the calibration is not fully established in some of these components, making it difficult for firms to assess at what level the BCR will actually bite. The components are:
Life, non-life and non-traditional insurance are both divided into four categories, with three broad categories of assets identified. A factor charge (which is specified) is then applied to each category, and the aggregated results will then be subjected to an undefined scalar to target an undefined confidence level. There is no explicit allowance for diversification, nor is there any explicit consideration of asset liability matching, both of which will be taken into account in the final ICS.
Banking (regulated and non-regulated)
The Basel 3 leverage ratio will be used to impute the capital requirement, but this could change to either the risk-weighted assets requirement or the higher of these figures depending on the final insurance calibration.
Other financial activities
Any existing capital requirements will be used, together with a factor of up to 25 basis points on off balance sheet assets under management. For other activities, an operational risk charge (unquantified) will be applied.
At this stage of testing, for the eight G-SIIs which submitted data, the average level of the proposed BCR is 73% of their existing prescribed capital requirement (PCR). For all participants, the BCR to PCR was 74%.
Although the starting capital position will be derived from the consolidated position, adjustments will be required to align capital resources with the approach outlined above for the calculation of the BCR. The IAIS has not yet concluded on whether the capital available to cover the BCR will be purely core capital or also include additional capital.
For the G-SII participants, the reported total qualifying capital resources represented 427% of the proposed BCR (core qualifying capital resources: 376%). For all volunteers considered, these figures are 404% and 355% respectively.
The BCR is to be presented to the G20 in November, with a view to private reporting by the G-SII starting from January 2015.
The second step in the process to a full ICS is the development of Higher Loss Absorbency (HLA) requirements. The intention is to consult on these in December this year with a view to finalisation in December 2015.
The ICS will initially be consulted on in December 2014, but will not be finalised until late 2018. Prior to the introduction of the ICS, G-SIIs will be expected to hold capital in excess of the BCR and HLA combined from 2019.
To discuss the implications further please contact: