The Committee on Capital Markets Regulation (Committee) appreciates the opportunity to comment on the International Association of Insurance Supervisors’ Public Consultation Document, “Global Systemically Important Insurers: Proposed Assessment Methodology.”
Below are responses the Committee submitted to individual paragraphs in the IAIS Proposed Methodology (Appendix A).
Q-1. Introduction – General Comments.
The Committee on Capital Markets Regulation (Committee) appreciates the opportunity to comment on the International Association of Insurance Supervisors’ (IAIS) Public Consultation Document regarding Global Systemically Important Insurers: Proposed Assessment Methodology (Proposed Methodology).
Since 2005, the Committee, composed of 33 members, has been dedicated to improving the regulation of U.S. capital markets. Our research has provided an independent and empirical foundation for public policy. In May 2009, the Committee released a comprehensive report entitled The Global Financial Crisis: A Plan for Regulatory Reform, which contains fifty-seven recommendations for making the U.S. financial regulatory structure more integrated, more effective, and more protective of investors in the wake of the financial crisis of 2008. Since then, the Committee has continued to make recommendations for regulatory reform of major areas of the U.S. financial system.
The Committee has been active in commenting on proposed regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), and in particular, commented last December on the Financial Stability Oversight Council’s (FSOC) proposed rule regarding its Authority to Require Supervision and Regulation of Certain Nonbank Companies under § 113 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The FSOC’s proposed rules have since been finalized, and a number of the comments the Committee makes below are similar to those we made in response to FSOC’s proposal.
Q-3. Introduction – Response to Paragraph 2 of Proposed Methodology.
“At the Summit meeting in Seoul, November 2010, the G20 leaders endorsed a report by the Financial Stability Board (FSB) on reducing the moral hazard posed by systemically important financial institutions. The report recommends several policies which should combine to:
- Improve the authorities’ ability to resolve SIFIs in an orderly manner without destabilising the financial system and exposing the taxpayer to the risk of loss,
- Require higher loss absorbency for SIFIs to reflect the greater risks that these institutions pose to the global financial system,
- Apply more intensive and co-ordinated supervision of SIFIs,
- Strengthen core financial infrastructures, and
- Provide other supplementary prudential and other requirements as determined by the national authorities.”
The Proposed Methodology refers to recommendations of the FSB, endorsed by the G20 in November 2010, regarding policies to address systemically important financial institutions (G-SIFIs). As described in the IAIS’ cover note to the Proposed Methodology, with regard to G-SIFIs that are global systemically important insurers (G-SIIs), these policies will be the subject of a separate proposal and public consultation later in 2012.
The Committee believes that designation of G-SIIs is an issue integrally related to the policies to which these entities will be subject. We believe that designations should not occur until substantive supervisory plans have been developed, and regulators have had the opportunity to compare such proposed supervisory plans to other available regulatory responses, including for example local regulations applicable to the G-SIIs. Note the Committee made a similar to the recommendation to the FSOC.
Q-13. Introduction – IAIS Position on Insurance and Financial Stability Issues – Response to Paragraph 12 of Proposed Methodology.
“Insurers are, however, also exposed to risks faced by other financial institutions including credit risk, operational risk, and market risk as well as interest rate and exchange rate risks. Nevertheless, the unique aspects of the insurance business model described above enabled most insurers to withstand the financial crisis of 2008-09 better than other financial institutions. While the effects of the crisis were certainly felt by the insurance industry, insurers engaged in traditional insurance activities in general were able to absorb the impact and demonstrated no impact on the broader financial system from a systemic risk perspective.”
The Proposed Methodology reflects the IAIS’ conclusion that “insurers engaged in traditional insurance activities in general were able to absorb the impact and demonstrated no impact on the broader financial system from systemic risk.” The Committee agrees with this statement, and further believes that, more generally, non-bank financial institutions should be reviewed on an industry-by-industry basis, and where their industry is not systemically important, such firms should not be subject to designation at all. We have noted in the past that the traditional insurance industry fared well relative to banks during the financial crisis, and that numerous features of traditional insurers support the idea they do not pose systemic risk (for example, high level of substitutability, self-funding through insurance premiums, and lack of leverage or reliance on short-term funding).
Q-15. Introduction – IAIS Position on Insurance and Financial Stability Issues – Response to Paragraph 14 of Proposed Methodology.
“While the separation of insurance from non-insurance activities may be comparatively easy, the demarcation between traditional and non-traditional lines of business (or products) can be blurry. Different jurisdictions allocate different activities to different fields. For example, a number of jurisdictions classify variable annuities closer to traditional life insurance, while others, in light of the dominant investment component in these products, see them closer to non-traditional insurance activities. Without being exhaustive, Table 1 proposes an illustrative allocation of various business activities, accounting for the fact that some business activities fall in-between the traditional and non-traditional categories.”
The Committee believes that variable annuities are “traditional”, consistent with their treatment in the United States, in that they are well-established insurance products, highly regulated in all 50 states. However, we also believe that the IAIS’ discussion of whether variable annuities are “traditional” or “non-traditional” is not relevant to the determination of an insurer’s systemic status. Rather, the focus of the IAIS’ analysis should be on whether the insurer’s activities pose risk of loss to other systemically important institutions.
Q-19. Introduction – IAIS Position on Insurance and Financial Stability Issues – Response to Paragraph 18 of Proposed Methodology.
“In summary, neither long experience of insurance markets nor information arising from the global financial crisis provides any evidence of traditional insurance either generating or amplifying systemic risk within the financial system or in the real economy. The potential for systemic importance is only considered to arise in any non-traditional or non-insurance activities which may be undertaken by a small number of insurers.”
The IAIS acknowledges that “The potential for systemic importance is only considered to arise in any non-traditional or non-insurance activities which may be undertaken by a small number of insurers.” We agree with this statement, and note that in the United States, although the FSOC has not yet designated U.S. non-bank SIFIs, it is widely expected that the FSOC will designate few, if any, U.S. insurers. We are concerned however about the potential for confusion arising from different designations by FSOC and the IAIS. As described in the IAIS’ “Frequently Asked Questions”, G-SIIs will ultimately be determined by the FSB and national authorities, in consultation with the IAIS. These authorities will be expected to apply the agreed upon policy measures to designated entities. Thus, if a U.S. insurer is not designated by FSOC as systemically important, this fact should be taken into consideration, and perhaps be even determinative, in guiding the IAIS’ potential designation of the same entity. At the very least, the timing of the two determinations should be coordinated so that IAIS knows what FSOC’s position is before making its determination.
Q-29. Assessment Methodology for Systemic Importance of G-SIIs – Data Issues – Data Quality – Response to Paragraph 27 of Proposed Methodology.
“Unlike the banking sector where BIS statistics cover various areas of banking activities on a global basis, the IAIS has few precedents for collecting data on a global basis for the insurance sector. One such precedent is the data collected for IAIS Global Reinsurance Market Reports which the IAIS has been collecting for almost ten years. However, the nature, scope and scale of the data collected to test the G-SII assessment methodology is a significant new undertaking for the IAIS. The IAIS encountered several challenges to collecting consistent and high quality data, including:
- Insurers’ management information systems do not necessarily provide all consolidated data items which were requested by the IAIS.
- Accounting differences exist, including differences in valuation of some assets, derivatives, insurance contracts and technical provisions.
- Jurisdictional or regional differences exist in the interpretation of some insurance business terms.
- Definitions provided for some data items require more specificity.”
The Committee recognizes the difficulties that IAIS has encountered in collecting data to develop the Proposed Methodology. We would recommend that, similar to the approach FSOC has taken, the IAIS seek to limit its data collection for any initial review to information available from public sources. Where further analysis of a particular insurer is required, the IAIS could request the information from relevant local regulators. Only in very rare circumstances would we expect the IAIS might need to request data from individual firms. Data collection can be an extremely intrusive and time-consuming exercise for the firms involved, and we would encourage the IAIS to pursue all other avenues before imposing this burden on firms.
Q-35. Assessment Methodology for Systemic Importance of G-SIIs – Methodical Assessment Process – Indicator-based Assessment Approach – Response to Paragraph 33 of Proposed Methodology.
“The IAIS has identified indicators which contribute to capturing the degree and nature of each insurer’s systemic importance in each of the five categories from multiple-dimensions. The following table describes the 18 indicators chosen for the proposed assessment methodology and the reasons for choosing them. To capture impact given failure, indicators are mostly incorporated as absolute value figures, although in some cases ratios are also used to capture a relative impact given failure, typically comparing the size of a given activity with a relevant aggregate measure.”
The Committee supports use of bright-line rules, rather than the more subjective, principles-based approach in the Proposed Methodology, in determining an entity’s systemic status. The use of bright-line rules as a determining factor avoids the moral hazard and market uncertainties associated with using a subjective and unpredictable set of criteria, and also avoids attaching any stigma or signal to the firm. In addition, designation of a firm based on anything other than a bright-line test would potentially leave the determination open to challenge.
The Proposed Methodology, in contrast to FSOC’s determination process, does not take a bright-line approach. Rather, it proposes to measure 18 “indicators” across a variety of categories including size, global activities, interconnectedness, non-traditional activities, and substitutability. The Proposed Methodology suggests weighting ranges for the various indicators. For the reasons set forth above, we believe IAIS should revise its approach to provide clear and replicable guidelines for determination of systemic status.
Q-66. Assessment Methodology for Systemic Importance of G-SIIs – Methodical Assessment Process – IFS Assessment Approach – Response to Paragraph 41 of Proposed Methodology.
“In essence the IFS assessment approach segments the business portfolio of an insurer into its traditional insurance, semi- and non-traditional insurance as well as non-insurance financial and industrial activities. Then, the assessment approach associates risk weights commensurate with the systemic importance of the various business activities of insurance companies. The risk weights are multiplicative factors of total assets broken down along the segmentation of the business portfolio of insurance companies. The risk weights reflect the IAIS position that systemic importance in insurance is primarily associated with the conduct of non-insurance financial and non-traditional insurance business. The IFS assessment approach is being considered as part of the supervisory judgment and validation process and provides for a validation of the outcomes of the indicator-based assessment approach.”
Consistent with our recommendations in response to the indicator-based assessment approach above, we believe the Proposed Methodology should be revised to provide clear and replicable rules for designation of systemic status. The IAIS’ proposal of a second subjective assessment approach to be used to validate the first approach would lead to further uncertainty and potential for market signaling.
Q-69. Assessment Methodology for Systemic Importance of G-SIIs – Methodical Assessment Process – Cut-Off Point – Response to Paragraph 44 of Proposed Methodology.
“Following the ranking of insurers according to the indicator-based assessment approach, it is necessary to establish a cut-off point between G-SIIs and non-G-SII candidates. When the FSB and national authorities, in consultation with the IAIS, determine the cohort of G-SIIs, an informed decision on the cut-off point will be made, based on data sets as of year-end 2011 (see paragraph 72). The IAIS is of the view that, amongst other options, a comparison of relevant public data common to the top-ranked insurers and the current 29 G-SIBs which are related to interconnectedness and common capital market activities could be a reference in finding a cut-off point from the perspective of regulatory arbitrage considerations. It is also worthwhile to consider historical instances where insurers would likely have been considered as globally systemically important.”
Consistent with our recommendations in response to the indicator-based and IFS assessment approaches above, we believe the Proposed Methodology should provide a clear and replicable rule for determining the cut-off point between G-SIIs and non-GSIIs.