Restricted Early-warning Indicators, Supervisory Intervention and Cross-border Resolution of Insurance Groups Regional Seminar on Supervision of Insurance Groups Santiago, Chile, November 2013 Gunilla Löfvendahl Senior Financial Sector Specialist

Restricted 2 Agenda On a legal entity and group-wide level  Learn from past crises - typical problems and possible solutions  Identifying problems early, responding with adequate supervisory tools  Supervisory ladder of intervention, cooperation and resolution, and orderly exit from the market

Restricted 3 HIH failure (2001) - Findings New supervisory methods and structure, with loss of corporate memory and industry expertise Assumption that most large and complex groups were well managed and controlled, with concentration on exceptions Mismanagement of HIH  Under-pricing and provisioning  Creative reinsurance arrangements Bad corporate culture  Blind faith in an ill-equipped leadership consisting of dominant personalities  Risk not properly identified and unpleasant information hidden or sanitised  Lack of independence and critical analysis Aggressive accounting practices and lack of audit independence Fraud, extravagance and questionable transactions

Restricted 4 Palmer Report recommendations (2002) Powers and quality of the supervisor  High degree of supervisory independence and ability to act quickly and decisively  Strengthen intervention powers, using them vigorously, also informally  Reasonable degree of senior management and board involvement in important decisions  Broader mix of expertise, including from the outside  Capacity to review sufficiency of reinsurance arrangements and adequacy of liabilities, such as outstanding claims  Planning for future contingencies (creation of business cases, training etc)

Restricted 5 Palmer report continued Supervisory process  Strengthen supervisory risk-rating process and more frequent meetings to review institutions  Amend methodology to acknowledge that apparently well-managed groups can experience financial problems – early detection  Regular meetings with boards and relevant board committees of supervised entities (discuss expectations and findings)  Regular meetings with approved actuaries and auditors  Review relationship with foreign regulators and, where necessary, establish MoUs Focus  Group-wide supervision, looking at the legal entities, including non- regulated  Monitor intra-group transactions  Move from high-level on-site inspections (discussions) to more detailed reviews of evidence

Restricted 6 Royal Commission recommendations (2003) Corporate governance  Look at remuneration policy and disclose benefits  Clear definition of duties and functions of board and senior management Capital adequacy  Minimum solvency requirements on entity as well as group level  Require approved actuary reports of financial condition  Greater disclosure of information about financial positions, and risk- and reinsurance management strategies Supervisory capacity, methodology and focus  Build supervisory competency and review competitiveness in the labour market (salaries etc)  More sceptical questioning and aggressive approach to prudential supervision  Preparedness to enforce compliance (also timely returns)  Continual questioning of assumed financial viability of institutions  Random but frequent investigations of reinsurance arrangements

Restricted 7 European failures (2002*) – Findings Main apparent causes: underwriting and reserving risk Root causes: management or governance issues - more focus on the underlying causes makes it easier to detect the effects early  Indications of lax risk management or systems and control should generate a search for a potential deeper malaise  Enough autonomy for insurers belonging to groups  Appropriate experience and skills of board and management  Performance assessment and bonus policy that do not encourage excessive risk taking Not only rely on quantitative factors Anticipate how risks can interact in complex ways, including causal links between different types of risk and unexpected correlations – large exposures on a group-level Move to risk-based approaches, with more forward-looking tools and greater international cooperation * Joint work of 15 countries in the European Union: Report on 20 out of 270 cases of failed insurers or near misses, looking at causing risks and existing supervisory practices on prevention and early detection

Restricted 8 Great Financial Crisis - Findings Insurers mainly affected on the asset side - life insurers predominantly hit (higher asset/equity ratio) and greatest problems in guaranteed products Credit-related non-life lines more hit due to business insolvencies (monoline/financial guarantees) Pro-cyclicality of capital risk charges (reduction of available capital, sale of risky assets, aggravating the asset prices in a downward spiral) Pro-cyclicality of accounting standards (fair value) Gaps in the supervision of groups, eg AIG Systemic risk (risk seriously impairing the overall economy) – insurers systematically risky? Risk of run on insurers - no significant increase in lapse rates although in principle possible for life insurers Liquidity risk management – claims normally well-managed but securities lending, collateral requirements (triggered by downgrade), and redeemed policies could pose such risks Safeguards in case of troubled insurance groups – possible simplification of group structure, orderly resolution process, orderly exit and guarantee schemes

Restricted 9 IMF recommendations (May 2010) The Making of Good Supervision: Learning to Say “No“ Sceptical but proactive: Question also in good times (counter- cyclical) Comprehensive: Identify emerging risks at the edge of the regulatory scope (unregulated entities, off-balance sheet structures, systemic risk) Adaptive: Be in constant learning mode (new markets, services, products and risks) - form views on how changes will affect institutions Conclusive: Follow-up findings (on- and off-site) – take sanctions if not remedied

Restricted 10 IMF recommendations continued - How Ability to act  Legal authority, including operational independence  Adequate resources, including skilled staff  Clear strategy regarding the approach to supervision  Robust internal organisation, including well-defined decision making, oversight and accountability  Effective working relationships with other agencies Will to act  Constant dialogue with industry, including boards  Take action and fulfil the supervisory role

Restricted 11 Insurance Core Principles – the tools are there ICP 17 Capital Adequacy: The supervisor establishes capital adequacy requirements for solvency purposes so that insurers can absorb significant unforeseen losses and to provide for degrees of supervisory intervention. ICP 10 Preventive and Corrective Measures: The supervisor takes preventive and corrective measures that are timely, suitable and necessary to achieve the objectives of insurance supervision. ICP 11 Enforcement: The supervisor enforces corrective action and, where needed, imposes sanctions based on clear and objective criteria that are publicly disclosed. ICP 12 Winding-up and Exit from the Market: The legislation defines a range of options for the exit of insurance legal entities from the market. It defines insolvency and establishes the criteria and procedure for dealing with insolvency of insurance legal entities [ ] the legal framework gives priority to the protection of policyholders…..

Restricted 12 Solvency control levels and other triggers Regulatory requirements should be at a sufficient level so that insurers’ obligations to policyholders continue to be met as they fall due Capital resources reduce the probability of insolvency and loss to policyholders - increase capital or reduce risk if not sufficient Solvency control levels provide triggers for action by insurers and supervisors Should be at least two control levels:  Prescribed capital level (PCR): above which intervention would be on other grounds than capital adequacy  Minimum capital level (MCR): strongest supervisory action if corrective action is not taken promptly Should allow for intervention at a sufficiently early stage for a realistic prospect of being rectified in a timely manner Group solvency levels – PCR and MCR?

Restricted 13 Early-warning indicators Capital is not everything – have a range of early-warning indicators, both quantitative and qualitative that should trigger action Examples of indicators? How could they be identified?

Restricted 14 Supervisory monitoring tools ICP 9 Supervisory review and reporting ICP 4 Licensing ICP 6 Changes in control and portfolio transfer  Acquisitions and mergers  Portfolio transfers ICP 23 Group-wide supervision

Restricted 15 ICP 10 Preventive and Corrective Measures Legal and operational capacity to act timely Decision-making lines of the supervisor should be structured so that action can be taken immediately in the case of an emergency situation Detect vulnerability in the insurer’s ability to protect policyholders Prevent a breach of legislation Deal with non-compliance or where an insurer enters into unsound practices Require insurer to develop an acceptable plan for prevention and correction of problems Ensure that the measures are taken

Restricted 16 Early prevention and detection tools Activities subject to prior approval Continual fit and proper requirements Requirements of sound corporate governance, internal control and risk management Prospective reporting and analysis Business plan and strategy for new business Established contacts with other involved supervisors Informal contacts with management Public disclosure/transparency

Restricted 17 Preventive and corrective supervisory measures Increased supervisory activity or reporting Independent review by auditors or actuaries Correction of reporting errors Capital and business plan for restoration of capital resources Measures to reduce risk (eg reinsurance) Strengthen or replace the insurer’s management and/or risk management framework and governance

Restricted 18 ICP 11 Enforcement Formal directions to take (or desist) actions - failure to comply should have serious consequences (combine with fines and punitive actions) Should at a minimum include  Restrictions on business activities  Measures to reinforce the financial position of the insurer  Consequences when failing to provide information in a timely fashion, withhold information or provide information that is intended to mislead Should not delay necessary preventive or corrective measures to be taken Powerful supervisory tools that should be used in a fair and equal manner Not sufficient to have powers delegated under legislation (powerful tools are only powerful if used) – will to act Issues related to groups? Determine that the insurer is complying with the measures once action has been taken or measures have been imposed

Restricted 19 Enforcement or sanction measures Restrict business activities  Stop the writing of new business  Withhold approval for new activities or acquisitions  Restrict the transfer of assets Directions to reinforce financial position  Require capital levels to be increased or measures that reduce or mitigate risks  Restrict disposal of insurer’s assets  Restrict/suspend dividend or other payments to shareholders Remove directors and managers - bar individuals from acting in responsible capacities in the future Compulsory portfolio transfer or conservatorship Revoke the licence – require the company to wind-up Direct a company to stop unlicensed business

Restricted 20 Resolution and G-SIIs Define insolvency and the limit when it is no longer permissible to continue business Resolution could be used for cross-border groups before that point is reached – should be used for G-SIIs, which need to be resolvable Orderly resolution requires appropriate actions prior to the non-viability stage – on-going cooperation and information sharing Normal resolution tools that can be used on all insurers (enough for G-SIIs?):  Portfolio transfer  Run off Establish resolution authorities and cross-border management groups (CMGs) – top level or resolution powers in more than one part of the group Appropriate powers to intervene at holding company level Powers to terminate large volumes of financial contracts – insurance policies? Ensure continuation of non-insurance operational business that is significant to the systemic function Temporary public financial support may be needed

Restricted 21 ICP 12 Winding-up and Exit from the Market Procedure for dealing with winding-up and insolvency Appoint administrator or liquidator to take over the roles and duties of board and senior management  Run-off with supervisory involvement  Liquidation in court procedure Protect the rights and entitlements of policyholders/beneficiaries in the event of insolvency  Protection scheme/guarantee fund  Preferential rights

Restricted 22 Conclusions Independence and resources Comprehensive supervision, including group and macroprudential level Early identification and intervention Power and will to act using adequate tools