Case Study - Consolidated Oversight - Regional Training Seminar IAIS-ASSAL-FIDES 26 November 2009, Lima Peru Takao Miyamoto, IAIS Secretariat

1 Agenda 1.Recap of Presentation on 23rd 2.Case Background 3.Group Discussions 4.Group Presentations & Final Remarks

2 International Framework Insurance Core Principles (ICP) 17: The supervisory authority supervises its insurers on a solo and a group-wide basis. Insurance Core Principles (ICP) 17: The supervisory authority supervises its insurers on a solo and a group-wide basis. Insurance Core Principles (ICP) 5: The supervisory authority cooperates and shares information with other relevant supervisors subject to confidentiality requirements. Insurance Core Principles (ICP) 5: The supervisory authority cooperates and shares information with other relevant supervisors subject to confidentiality requirements. Principles on Group-wide Supervision More elaboration

3 Group-wide Supervisor Different approaches to group-wide supervision But one important approach is to designate “group- wide supervisor” Group-wide supervisor should take leading role with other involved supervisors’ cooperation Generally clear who is group-wide supervisor for a particular group –Several supervisors may qualify Guidance Paper on the Role and Responsibilities of a Group-wide Supervisor

4 Group-wide Supervisor Supervisor in jurisdiction where –Group is based –Supervisor has statutory responsibility to supervise head of group Location of group’s head office If registered head office is not operational head, location where –Main business activities of group are undertaken –Main business decisions are taken –Main risks are underwritten –Group has largest balance sheet total General principle Other factors

5 Principle 4: Authority and Power Principle 4: Supervisors should have the skills and the appropriate authority to carry out supervision on a group-wide basis. Preconditions Appropriate legislation need to be in place for supervisors to supervise groups within jurisdictions Two main approaches Direct: Supervisor has explicit authority and power over head of group Follow-up: Supervisor has adequate authority and power through access to necessary information

6 Principle 2: Fitness and Propriety Principle 3: Risk Mgt & Internal Control Principle 2: The fitness and propriety of the board and senior management of the group, as well as the propriety of significant shareholders, should be assessed on a group-wide basis. Principle 3: Adequate risk management and internal controls should be in place within the group and should be assessed on a group-wide basis to enhance the assessment of the solo entities.

7 Principle 1: Capital Adequacy Principle 1: Capital adequacy should be assessed on a group-wide basis. Main issues Intra-group transactions & double gearing Off-balance sheet items Fungibility of capital and transferability of assets Diversification Level playing field

8 Principle 5: Cooperation and Information Exchange Principle 5: Necessary provisions and arrangements should be in place to allow efficient and effective supervision through cooperation and exchange of information among supervisors of the group. Examples Memorandum of Understanding (MoU) Supervisory College

9 Agenda 1.Recap of Presentation on 23rd 2.Case Background 3.Group Discussions 4.Group Presentations & Final Remarks

10 Structure of Insurance Group Property and Casualty insurer (“INS”) operates in jurisdiction A INS is member of group comprising –Parent holding company (“HOLD”) –Unregulated financing company (“FIN”) –Reinsurance company (“REIN”) INS is wholly owned by HOLD INS has 60% ownership share in FIN and HOLD owns other 40% REIN is wholly owned subsidiary of FIN

11 Structure of Insurance Group HOLD is incorporated in jurisdiction A Insurance framework of jurisdiction A –Does not regulate holding companies directly –But provide sufficient powers for supervisor to use approach commonly known as “follow-up approach” –That is, information on unregulated entities is obtained through regulated entity FIN is incorporated in jurisdiction B REIN is incorporated in jurisdiction C

12 Business Initially, FIN’s primary business comprised entering into interest rate swaps with major corporations, including banks, insurers and other non-financial companies During last 5 years, FIN began to expand into other credit derivative lines, including credit-linked notes and credit default swaps (“CDS”) FIN’s operations have so far appeared highly profitable

13 Business Three years ago, as part of group’s expansion plans, FIN received large loan from INS and used proceeds to form REIN REIN’s primary role is to provide reinsurance coverage to INS REIN also provided significant loans to FIN to assist in expanding credit derivative business REIN continues to write profitable business as rates have been on an uptrend

14 Supervisory Assessment INS has several on-site assessments by its insurance supervisor (“Supervisor A”) over last several years –INS is third largest insurer in jurisdiction A in regard to total assets Supervisor A deemed INS to have adequate capital resources given it is reinsured by REIN Supervisor A received management accounts from INS in relation to REIN Supervisor A determined that REIN is heavily capitalised and would be able to honor reinsurance obligations

15 Supervisory Assessment Last year, Supervisor A heard rumor that FIN was being investigated in relation to FIN’s accounting and asset valuations Supervisor A heard that insurance supervisor in jurisdiction B (“Supervisor B”) was concerned because several large insurers in jurisdiction B were relying on FIN for credit protection These stories caught Supervisor A’s attention since FIN comprised major asset on INS’s balance sheet and large intercompany loan

16 Supervisory Assessment Supervisor A used follow-up approach to request INS to obtain information regarding stories Supervisor A received written correspondence from HOLD’s board providing assurance that there was no basis for rumor Correspondence appeared to provide sufficient details and Supervisor A felt no need to pursue this matter further

17 Group Financial Distress As result of AAA credit rating, FIN was not required to post collateral for counterparties for credit protection However, it turned out that FIN misreprented financial position –FIN failed to record significant mark-to-market losses Consequently, FIN’s credit rating was downgraded Rating action immediately triggered margin calls on credit derivatives To avoid failure, FIN borrowed funds from REIN

18 Group Financial Distress Shortly thereafter, catastrophic windstorm hit jurisdiction A INS required reinsurance protection provided by REIN REIN was unable to settle obligations on account of lliquidity Supervisor A discovered that it was mislead by HOLD’s board –FIN was under investigation at time of inquiry

19 Agenda 1.Recap of Presentation on 23rd 2.Case Background 3.Group Discussions 4.Group Presentations & Final Remarks

20 Tasks (Question 1) Group doest not appear to have been supervised from group-wide perspective What difference would it have made if it had been supervised on group-wide basis? (Question 2) Based on “Guidance Paper on the Role and Responsibilities of a Group-wide Supervisor”, who should have performed task of supervising group?

21 Tasks (Question 3) Assume that Supervisor A was group-wide supervisor Evaluate Supervisor A’s performance with respect to “Principles on Group-wide Supervision” –Note where Supervisor A’s actions were both in accordance and not in accordance with principles

22 Questions and Answers Thank you very much!