A Proportionate Approach to Insurance Regulation: From Inclusive Markets to Systemically Important Entities

Transcription

1 A Proportionate Approach to Insurance Regulation: From Inclusive Markets to Systemically Important Entities Craig Thorburn Skype: craig_thorburn

2 IAIS Background Inclusion Joint Working Group (JWG) between IAIS and MicroInsurance Network established in 2005; Issues Paper on Microinsurance in 2007 Key conclusion ICPs and Standards are sufficiently broad but can be implemented in a manner that achieves observance but potentially conducive for or even quite prohibitive of access to insurance. Issues Paper on Mutuals, Cooperatives and Other Community Based Organisations (MCCOs) issued in 2010 Followed up on a recommendation of the 2007 issues paper Application Paper finalisation in October 2012 Future steps: Core Curriculum Module for training purposes Thematic Self Assessment Tool SIFIs FSB mandate to IAIS to develop methodology for identifying G-SIFIs, then additional measures to apply to them. G-SIB process for banks largely completed D-SIFI processes moving forward, most visibly in the US through the FSOC. IAIS working on G-SII processes including Identification (including measures and dimensions of SIFI-ness Supervisory measures to be applied to SIFIs 2

3 TECHNICAL EXPLANATIONS 3

4 What is Proportionality? Words nature, scale and complexity are used universally in the ICPs to invoke the proportionality principle. But what does this mean? The opposite of disproportionate Legal exposition Risk sensitive or risk based? 4

5 The opposite of disproportionate : That a regulation or a supervisory action is not unduly onerous when compared to the objective that it is intended to achieve. Unduly onerous requirements would involve more than necessary cost, effort, or complexity compared to what is required to achieve the objective. Tests of onerous -ness, intended objective, Dimensions of cost, effort and complexity. 5

6 Legal History - Proportionate Generally acknowledged to pass four tests: There must be a legitimate aim for a measure The measure must be suitable to achieve the aim (potentially with the requirement to show evidence that it will have that effect) The measure must be necessary to achieve the aim, that there cannot be any less onerous way of doing it; and The measure must be reasonable considering the competing interests of different groups at hand Not the same as nature, scale and complexity 6

7 Nature, scale and complexity in the Application Paper 4.2. there are references to the goal of using proportionate approaches that enhance inclusive insurance markets. In some cases, the motivation is to ensure that the relevant supervisory objective is available or achieved effectively in practice. In contrast, disproportionate obligations can sometimes be ineffectively implemented and not deliver the intended result to ensure costs are not prohibitive in practice not a material barrier to inclusive insurance markets. Dimension of practical implementation added. 7

8 Rules Processes Powers and actions 4.4. proportionality should be applied in each of the following contexts: Designing and implementing regulatory requirements; Assessing insurers and intermediaries adherence to regulatory requirements; and Exercising supervisory powers Where relevant and appropriate, requirements laid down in the ICPs should be applied in a manner that takes into account the nature, scale and complexity of the risks inherent in the individual insurance business Only when stated (ICPs paragraph 8) although some references seem to have broader invocation of the clause (eg ICP 9, guidance indicates it applies to the ICP and then 9.2 applies it to the framework defined as on and off site activities. 8

9 4.6 The supervisor, when assessing the nature of risks, considers, among other things: The type of business from which risks originate ; or Any risk mitigation instruments applied 4.7 When assessing the scale of a risk, the supervisor takes regard to both the likelihood of the risk being realized and the impact of that risk when realized. 4.8 The supervisor uses more sophisticated and elaborated tools to analyse and quantify more complex risks. The management of risks by insurers would also be expected to be more sophisticated when risks and risk profiles are more complex In assessing what is proportionate, the focus needs to be on the combination of all three criteria. Defining nature, scale and complexity and reinforcing the and. 9

10 Introducing supervisory perspective to objectives Introducing supervisory perspective to objectives Similar considerations would apply when considering the application of the relevant ICPs to obligations on intermediaries and for consumer protection In order to be considered proportionate, a measure has to be, at least, suitable, necessary and appropriate to attain the supervisory objectives of a jurisdiction. It should not go beyond what is necessary to achieve the objectives (be disproportionate ) Risk of, or to, the insurer is only one part of the consideration. Risk to the overall supervisory objectives (as identified in Standard 1.3) is also very relevant 10

11 Not simply risk based approaches Risk based approaches are often characterized by supervisory ladders, early warning or rating systems, etc as examples of ways that link the supervisory intensity to as the risk increases. ICPs use the term risk based or risk sensitive approaches instead of the proportionality words. Can this be assumed to be deliberate? During discussion of the Application Paper, some contended that it was not equivalent. One option: System of supervision does not change, it is self responding. To distinguish between risk based approaches and proportionate approaches, could consider Risk based approaches respond to the risk of the insurer Proportionate approaches add the supervisory objective filter. 11

12 Summary Tests Dimensions Scope Legitimate aims Measure is relevant, suitable, necessary, appropriate to achieve the aim/objectives Reasonable in various dimensions Cost Effort Complexity Practical to implement Rules Supervisory processes Supervisory actions Applies to insurers, intermediaries, or any other entity and to any supervisory objective. 12

13 Proportionality in practice ICPs already invoke proportionality in certain cases. Very important in terms of (i) Rules, (ii) Supervisory processes, (iii) Supervisory practices Consider risks in terms of nature, scale and complexity. Easy to think of technical insurance risk, but also applies to other risks and perspectives, eg the supervisory perspective to AML or fraud or consumer protection. Not every risk is defined by the product. Consider risks to supervisory objectives. 13

14 Remember the mathematics A A is proportional to B if: A increases as B increases A decreases as B decreases. B 14

15 Nature, Scale and Complexity Supervisory Intensity Nature, Scale and Complexity ICPs tend to consider A = the intensity of supervisory (and regulatory) activity B = the nature, scale and complexity (considered together) of. Usually of risk, the entity, but sometimes something else. Application paper advocates consideration of supervisory objectives (Standard 1.3). 15

16 What of do the ICP references look to? What The insurer, individual insurers, insurers, an entity conducting insurance activities, the cedant, the supervised entities, the group, the insurance group Business of the insurer, the insurer s business, the insurer s business and its risk profile, operations of the insurer, insurer s operations, operations of the legal entity, groupwide risks, the insurer s business and risks, insurer s activities, business transacted where relevant, the business, the Number of References 23 cedant s business, risk, associated risks etc to do so references 5 The financial system as a whole 1 Unclear, not stated 2 Diverse references, some more meaningful than others

17 DISCUSSION THROUGH EXAMPLES 17

18 Illustrative Examples SIFIs and the implications Graduated licenses as points of entry 18

19 EXAMPLE 1: SIFIS AND THEIR IMPLICATIONS 19

20 Measurement Criteria Proxy for nature, scale and complexity, but not identical G-SIFIs D-SIFIs 20

21 G-SII Measures Structural Measures: Analyse what causes the SIFI to be systemic and develop a SRRP (Systemic Risk Reduction Plan) through, for example, separating NTNI (Non Traditional Non Insurance) activities In the event that separation takes time or is not sufficiently feasible then restrictions and prohibitions on systemically important activities would be relevant Enhanced Supervision Particularly with special emphasis on group wide supervision (ComFrame) including a reference to having direct powers over the holding company (G-SIFI Measures Paper) and on liquidity planning and management Increased resolvability Recovery and Resolution Plans (RRPs) would be needed and supervisors would need to have a crisis management group in place to conduct resolvability assessments and have cooperation agreements with other relevant supervisors. Higher Loss Absorption (HLA) Intended to reduce the probability of failure (G-SIFI Measures Paper) Targeted HLA Group wide HLA 21

22 IAIS SIFI Process Identify SIFIs in the insurance sector Size Internationality Non Traditional Non Insurance activities Interconnectedness Apply measures that could be a combination of some or all of Structural Measures: Enhanced Supervision Increased resolvability Higher Loss Absorption (HLA) Supervisory Intensity Measures define actions or intensity Measures or risk defined in greater specificity for systemic focus Nature, Scale and Complexity 22

23 An observation Supervisory measures focus on avoiding the need for resolution Having the right supervisory frameworks and tools in place is important. If initiatives such as ComFrame, G-SIFI (G-SII) methodology and the ORSA are developed into mechanisms that are sufficiently robust in dealing with risks to insurers and their policyholders, the less supervisors will be preoccupied with the need to deal with resolution. (IAIS Supervisory Forum Report October 2012). Focus on objective of orderly resolution, or no resolution at all? 23

24 Diagrammatic Consideration Supervisory Intensity If tools are not sufficient de-sifi SIFI Threshold Nature, Scale and Complexity Entities that fall above the threshold are SIFIs and need to be adequately supervised. Additional tools are designed to apply. Can the entity be supervised and remain SIFI? Key will be if it can be resolved effectively. Tendency is for effort to reduce entity from being SIFI. HLA is an increased intensity tool to reduce probability of failure. 24

25 EXAMPLE 2: A GRADUATED LICENSE SYSTEM 25

26 Financial Inclusion a state in which all working age adults have effective access to credit, savings, payments, and insurance from formal providers. Effective access involves convenient and responsible service delivery, at a cost affordable to the customer and sustainable for the provider, with the result that financially excluded customers use formal financial services rather than existing informal options. (Source: Global Partnership for Financial Inclusion (2011) Global Standard-Setting Bodies and Financial Inclusion for the Poor: Toward Proportionate Standards and Guidance) Financial inclusion contributes to financial stability. The Principles for Innovative Financial Inclusion (Principles), endorsed by the G20 leaders in 2010, help create an enabling policy and regulatory environment. 26

27 Barriers and Innovations Less than full inclusion means there is some barrier leading to some people being underserved. Innovations are needed to overcome, remove, or work around barriers. 27

28 1. Insurance should be formal 2. Innovations have to be facilitated 3. Proportionality in practice is important as is a pathway to formalization for the informal 4. Roles and responsibilities need to be allocated and defined 5. Definitions need care 28

29 Insurance should be formal Informal: Either exempt, so not defined as insurance in the law, or illegal. Barriers sometimes mean existing formal insurers move away from the client group making them underserved. Their needs remain, but without formal cover; They find solutions in informal mechanisms and informal schemes. 29

30 Consider Standard 1.3. Revisit exemptions and exclusions in the context of the objectives of insurance supervision the protection of policyholders and the development of safe, fair, stable insurance markets (Standard 1.3); Normally these customers would not justify exclusion; By extending formal services to this client group, let us not make the services second grade only. 30

31 Apply proportionality but There is a limit to how far you can go. There is a minimum size below which it is inappropriate for an entity to retain insurance risk for technical and business reasons. Levels should be set on the basis of size, nature and complexity of the risk not just size of the entity. Below this level, insurance risk should not be retained. 31

32 Zone of no retention Supervisory Intensity Technical Barrier: Despite being small and simple, if an insurance portfolio is too small it does not provide any material pooling benefit sufficient to justify the effort. Nature, Scale and Complexity 32

33 Zone of no retention Supervisory Intensity Nature, Scale and Complexity Technical Barrier: Despite being small and simple, if an insurance portfolio is too small it does not provide any material pooling benefit sufficient to justify the effort. Business Barrier (reflected in regulation): Minimum requirements for business processes to retain and manage a business risk. 33

34 Zone of no retention Supervisory Intensity Zone of no retention The simple but challenging truth There is a place where, for technical and business reasons, it is just not safe to be in the long term. Below this, entities can still operate as distributors Proportionality can help a lot but has an absolute minimum bound Nature, Scale and Complexity 34

35 Dedicated licenses Some jurisdictions offer a special license for dedicated microinsurers or specialist microinsurance intermediaries More focused scope of licenses Some additional tasks possible, not only reducing obligations Proportionate requirements (not concessional compared to risk) with limitations. 35

36 Options the full service insurance license Supervisory Intensity Minimum Requirement Zone of no retention Nature, Scale and Complexity A Entities are permitted to offer any product they like and invest freely Subject to normal prudential and consumer protection restrictions risk management systems, pricing, reinsurance, investment policies, actuarial controls, corporate governance, internal controls, distribution responsibilities etc. 36

37 Implication Supervisory Intensity Minimum Requirement Excess to proportionality Zone of no retention M A Microinsurer focussed entities have a less complex risk profile and may be smaller Normal prudential and consumer protection restrictions are disproportionate and a barrier Nature, Scale and Complexity 37

38 Considerations Supervisory Intensity Excess to proportionality Zone of no retention B Minimum Requirement M Nature, Scale and Complexity A Dedicated Microinsurer License at point B Conditions for B : You can only do microinsurance / you cannot do exotic insurance You can only invest in more restricted options You have to have risk management etc in line with these restrictions Insurer A can offer microinsurance but without other restrictions so is not subject to conditions. 38

39 Considerations Supervisory Intensity Minimum Requirement Zone of no retention C M B N Nature, Scale and Complexity A More restricted Dedicated Microinsurer License at point C Conditions for C : You can only do a defined product / no variations You can only invest in very restricted options You have to have very defined risk management in line with these restrictions Insurer B can offer product innovations but needs to have a product development and risk assessment capacity. 39

40 Implementation needs a definition Target market definitions Product definitions Producer definitions Distribution definitions 40

41 Example Microinsurance defined in terms of client characteristics; Specialist microinsurers have to check customer eligibility if they have a restricted license Possibly, specialist microinsurers have to recheck on an ongoing basis that the client is still eligible on renewal Ineligible clients have to transfer cover to full service insurers and back as their circumstances change Additional monitoring requirements to maintain fair market is likely to introduce its own barrier. NOT RECOMMENDED for supervisory purposes, convenient for policy statement purposes and occasional survey style measurement only. 41

42 Example Microinsurance defined in terms of products; Product approval case by case Product defined by parameters Product established in terms of listed products Product established in terms of excluded list 42

43 Product approval case by case Microinsurance is insurance for the poor where each product is approved as intended for the poor. Supervisors act as gatekeeper on concessional treatment and ensuring lower obligations remain consistent with product needs through product approval requirement. Advantages Close control over products and access to concessions Ability to discern each proposal on its merits ensures supervisors can follow innovation proposals. Disadvantages Supervisory resource intensive Potential for delays to inhibit interest in proposing innovation Not aligned to IAIS best practice regarding supervisor endorsing each product Conclusion: Not recommended 43

44 Product defined by parameters Microinsurance is insurance with a sum insured less than A or a premium less than B, and for a product term less than C.. Advantages Parameters can be linked to reduced risk leading to easier design of risk management requirements. Easy to implement and count products. Special treatment can be clearly specified and applied. Disadvantages Some products not targeted to the underserved could still qualify for concessions. Some underserved needs may be outside the definition. Parameters may act as their own new barrier. Defined space may not be commercially viable. Conclusion:????????? 44

45 Product defined by Product List Microinsurance is insurance of type A, B, C or D (standard products) no matter who buys them.. Advantages As for parametric definition Possibly, closer targeting to underserved but difficult to have sufficient a menu to cover all possibilities. Offers opportunity for lower entry point. Disadvantages As for parametric definition plus Official list tends to define product innovation efforts and limits it to a generic process. Conclusion:????????? 45

46 Example rules for Product + Provider Category Example: MFIs that offer Credit Life Insurance Issue: Entities need to be able to Measure Risk Exposure and respond to excessive levels Catastrophic risk: Pandemics A pandemic should not render the entity insolvent. Practical Requirement: Add up total sum insured and reduce by a factor that is a function of the number of lives and the extent that they are co-located. Limit applied compared to total capital (multiplied by a factor). Mitigation: Entities could reduce requirement by effective risk transfer to other insurance carriers or diversification of portfolio. Incentive: Entities that can do more specific calculations would get lower results (providing incentive to improve risk management as size increases). 46

47 Parameterising assumes single mortality rate independent of age for the base experience and for the pandemic experience. Calculations adjust for numbers of lives and transmission of pandemic within and between communities. 47

48 Base Case Example Percentage of total To From Distribution of Loans by Size Size Range (local currency) Small MFI issues 12 month loans at 20% interest rate in 4 communities of 500 people each lending to 25% of the population at any one time. All loans insured Mortality 2% with pandemic effect 10% Plus 300% for in community transmission 20% probability of transmission to other communities 48

49 Spreadsheet Model Simulations of Pandemic Exposure for Credit Life Insurers Inputs Loan size distribution on issue From To Percentage Communities and Exposures Average size of communities 500 persons Band range Proportion of population with loans outstanding 50 percent Proportion of loans insured 100 percent Average Loan Size Number of communities insured Average loan term Base mortality rate 2 percent 12 months Pandemic Impacts Average interest rate Extra mortality rate from pandemic 10 percent 20 % p.a overall observed mortality rate 4.5 percent without contagion, and in one community 100 Transmission loadings of pandemic within community plus 300 percent Total number of loans insured at any one time: 1000 implies mortality increase to 42 percent in first community Total loan face value insured: 37,700 from one community to another 20 percent Total insured loan outstanding: 19,784 implies mortality increase to 10 assuming loans issued evenly over time and all paid current in other communities Extra mortality rate with contagion overall observed mortality rate 18 percent Outputs Reserve and capital required to meet expected claims at 99 percent level per 1000 Loan face value for normal experience only i.e. plus percent for pandemic impact without contagion , for pandemic impact with contagion , compared to net premium absent pandemic risk of Capital at risk i.e. plus percent of net premium for normal experience only for pandemic impact without contagion for pandemic impact with contagion 3, Note: Calculations assume loans issued evenly and that new loans replace those being paid off in the portfolio such that the proportion of the community with loans at any one time is constant. This means that the average loan outstanding can be determined on these assumptions. It is also assumed that borrowers who insurer, when it is optional, are not biased in the sample choice either in terms of their mortality experience or their loan size compared to the uninsured group. Can be made available in electronic form. Can be an education tool in workshops 49

50 Base Case Basic premium for the portfolio is equal to base mortality rate multiplied by number of loans outstanding that are insured multiplied by average amount of loan outstanding In example, is 198. Expected Cost of Claims at 99% level 334 before pandemic impacts or 1.69 times the net premium implying capital at risk over and above the net premium of with pandemic but no transmission impacts or an additional 100% over the no pandemic case. 2,212 with pandemic and transmission an additional 562% over the no pandemic case. Pandemic and Contagion No contagion pandemics No pandemics Premium 50

51 Sensitivity Variations that make no material difference to results Loan term or interest rate Variations that reduce the pandemic cost estimates Change in pandemic parameters such as severity and contagion Reduced exposure to risk through diversifying into more communities is most significant Increased size of the pool through business growth helps. Variations that help everything Business growth Higher base mortality, with higher base cost, reduces relative impact of adversity. 51

52 So rule can be expressed as a table of factors Table to reflect business size (numbers of lives) and diversification to reflect number of communities (and possibly, if desired, mortality rate). In our base case, the entity could use the factor sheet to determine For every 1,000 of loan issued that is insured and in-force, the entity must hold a reserve of In addition, it must have spare funds / capital / of a further 107 per 1,000 if it does not carry appropriate reinsurance. With reinsurance for pandemic risks, it needs lower capital at a minimum requirement of 25 per 1,000 of loan face value. 52

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