IMPROVING FINANCIAL REGULATION

INTERNATIONAL CAPITAL STANDARD

The end of the journey?

Implementation of the ICS in Europe should be via existing prudential regimes and without additional requirements

It’s almost 10 years since the IAIS launched its initiative to develop a prudential standard for Internationally Active Insurance Groups (IAIGs). As was recognised at the time, this project is very ambitious and Insurance Europe expected it would likely take many years of discussion and negotiation and significant resources from the insurance industry and supervisory community to get close to a final text.

While the early years of the International Capital Standard (ICS) development focused on more exploratory technical discussion and field testing, the key pivotal moment in terms of political commitment to the project was the Kuala Lumpur (KL) agreement in November 2017.

As part of the KL agreement, IAIS members agreed that the ICS Version 2.0 would be used for confidential reporting during a five-year “monitoring period” starting in 2020 before its finalisation and implementation as a group-wide capital requirement. In addition, the KL agreement noted the IAIS’s support of the development of the US’s Aggregation Methodology (AM) with the intention of assessing the comparability of such an approach by the end of the monitoring period.

In 2023, the IAIS consulted with industry on several changes to the ICS V2.0 technical specifications. From a European perspective, the explicit inclusion of internal models as a recognised approach to calculating capital requirements was a welcome and necessary addition to the standard, even if the use of IMs was already recognised and supported by the IAIS in the wider ICPs.

The ICS technical specifications are now understood to be stable and only relatively small technical changes and some fine tuning are expected as we approach the deadline for finalisation. Indeed, all signals are that the IAIS will be successful in keeping to its target timeline of finalising the ICS by end-2024.

On the Aggregation Methodology, it is less clear, although it seems quite likely, that the IAIS will find agreement on whether the AM provides comparable outcomes to the ICS and can be considered to be an outcome equivalent approach to the ICS. To ensure the integrity of the entire ICS project, it is imperative that the decision taken on the AM is risk-based and evidenced through robust quantitative analysis. Full disclosure of the decision-making process is also necessary.

Following finalisation of the ICS standard, it will be implemented in local jurisdictions. For European IAIGs, our expectation is that the Solvency II / Solvency UK / Swiss Solvency Test is the implementation of the ICS for Europe, UK and Switzerland without further changes and without any double reporting requirements. These are extremely robust and proven prudential frameworks based on the same principles as the ICS but with even greater prudency.

“It is crucial to distinguish the highly-regulated insurance industry from other, less regulated NBFI sectors.”

Navigating systemic risks for insurers

A number of failures of banks and other financial institutions over the past two years, including the demise of Silicon Valley Bank and Credit Suisse, have raised concerns from a number of policymakers about systemic risks in the financial sector. These concerns relate not only to the banking sector but also to the all-encompassing “non-banking financial intermediation” (NBFI) sector. The key concerns about NBFIs relate primarily to the lack of regulation, oversight and transparency of some of the operators in this sector.

Various organisations at EU and international levels, such as EIOPA, the FSB and the IAIS, have increasingly started to look at the issues NBFIs. Arguably, there are good reasons for further assessment and investigation for certain sectors, given the increase in NBFI activity and the changing market environment.

Unfortunately, very often these concerns about the NBFI sector are incorrectly projected on to the insurance industry. As a very highly regulated and highly supervised financial sector with extensive reporting and disclosure requirements, there are already extensive safeguards (including the IAIS Holistic Framework discussed below) to protect against the limited systemic risk arising from the insurance sector.

Indeed, a much better acronym is NBNIFI – non-bank, non-insurance financial intermediaries and we hope that going forward this can be widely adopted.

In recognition of this potential overspill of NBFI regulation to the insurance sector, Insurance Europe participated in the publication of a report by the Global Federation of Insurance Associations (GFIA) setting out the reasons why the insurance industry is a unique sector that is highly regulated and has a very different risk profile from banks and other financial sectors.

The IAIS Holistic Framework is the key international regulatory tool for the assessment and mitigation of systemic risk in the insurance sector. It is supported by industry and was endorsed by the Financial Stability Board in December 2022. Through the Holistic Framework, the IAIS has developed one of the most modern approaches to assessing systemic risk. As such, it should be the starting point for any discussion about potential systemic risk in the insurance sector.

And while the industry is supportive of the Holistic Framework overall, it should be borne in mind that the insurance sector does pose relatively limited systemic risks. Data requests and additional indicators, such as those on liquidity, reinsurance and credit quality that the IAIS is developing, add undue operational burden for participating insurers. It is important that the IAIS ensures that any such reporting is proportionate to the real needs and benefits that they bring.