Global framework

Global capital standards

In 2016 the International Association of Insurance Supervisors (IAIS) vigorously pursued its objective of developing a global risk-based capital standard for large internationally active insurance groups (IAIGs) for the first time by 2020.

A consultation paper emerged from these endeavours and was published on 19 July 2016, laying the foundation for the initial version of a risk-sensitive capital standard (Insurance Capital Standard – ICS 1.0). For the subsequent years until 2020, this capital standard is intended to form the basis for the expanded field test, among other things. The wide-ranging feedback from interested parties across the globe is being incorporated into the continuing deliberations on ICS 1.0. The IAIS is aiming to complete the standard in the summer of 2017.

The work will also take on board the results of the IAIS field test in which more than 40 insurance undertakings are currently taking part voluntarily. They will contribute to the development of a comparable global capital standard and to the appropriate calibration of the capital requirement. However, both 2017 and 2020 can only be the initial stages on the journey to the ultimate goal: global comparability of the capital requirements and own funds of IAIGs.

The discussions are therefore focusing not just on measuring and discounting assets and liabilities in the most similar manner possible, but also on the question of how own funds can be determined using consistent criteria and how the risk capital requirement can be defined. This involves taking into account both technical risks and other risks to which an insurance undertaking can be exposed, such as market risks.

Widely differing capital standards are in place across the globe today which all have the same objective in principle, namely the protection of the policyholder, but they are trying to achieve this using different approaches. Developing a uniform standard is therefore a challenging undertaking.

The planned ICS is being designed as the minimum standard for a solvency requirement. The IAIS members are therefore free to exceed it for the purposes of national implementation. BaFin is working together with its European colleagues to ensure that the ICS reflects the Solvency II requirements as closely as possible, so that ultimately Solvency II can be regarded as implementing the ICS.

The IAIS is not currently not continuing with the revision of the higher loss absorbency requirements (HLA) for global systemically important insurers (G-SIIs), the first version of which was published at the end of 2015, since ICS 1.0 has priority. Only when the latter has been finalised will the IAIS resume work on the HLA alongside ICS 2.0, not least because the ICS is also intended to form the basis for calculating the HLA in the long term.

Identification of G-SIIs

The Financial Stability Board (FSB) published its annual update of the list of global systemically important insurers (G-SIIs) on 21 November 2016.

It followed an intensive analytical process which involved a large number of supervisors from different countries in the IAIS committees. After G-SIIs were identified for the first time in 2013 on the basis of a new methodology¹, the IAIS collected participants' experiences in the subsequent years and used them to revise the identification methodology. The IAIS published the new methodology on 16 June 2016².

The IAIS members had agreed to introduce a five-stage procedure focusing on individual groups, the entity-based assessment (EBA), which was used for the first time in 2016. As part of this procedure, a central quantitative scoring based on data requested from a sample of around 50 insurance undertakings (Phase I), applies absolute reference values (ARVs) for three of 17 indicators used by the identification methodology (Phase II). This enables the IAIS to reflect the fact that for individual activities of the undertakings included in the sample, the sample may not be representative of the market as a whole or that an activity may have become materially less significant since the financial crisis. During the procedure the IAIS constantly reviews the possible need to revise other indicators as well. For a subsection of the sample, i.e. undertakings with a points score above an annually specified threshold, it also carries out a deeper analysis to take account of additional factors which may be only inadequately reflected in the indicators employed (Phase III). This emphasises the fact that the identification of G-SIIs goes beyond the use of a mere algorithm and that the IAIS is analysing the respective results in a broader context than previously. Another improvement worthy of particular mention is that the new procedure enables the insurance groups concerned to be involved in their assessments at an earlier stage by means of an intensive exchange of information and opinions (Phase IV), i.e. before the IAIS makes a recommendation to the FSB based on an overall review of all the findings from the different phases (Phase V). The IAIS has also undertaken to publish material items of information resulting from the process, once the FSB has made a designation.

The IAIS is aiming to complete a further revision of the methodology for identifying G-SIIs in 2019.

Activity-based assessment

The IAIS has also launched a new project concerned with a methodology for identifying systemic risks based on activities (activity-based assessment – ABA) rather than on individual undertakings. This addresses the question of what other aspects of systemic importance exist that were previously not included in the identification of G-SIIs.

Direct systemic risk

Background: in the wake of the financial crisis, the FSB had entrusted the IAIS with the task of identifying systemically important insurers and developing a methodology for this purpose, as in the banking sector. An approach of this kind focuses on direct systemic risk, i.e. the risk posed by an individual insurer or an individual insurance group which may have consequences for the entire financial system.

The risk may be caused by the activities of the undertaking or the features of its products. Depending on the size and degree of interconnectedness of an insurer, it may directly trigger disruptions affecting the whole system. A direct systemic risk therefore generates a first-round effect: the insurance undertaking itself exposes the entire system to a direct systemic threat.

Indirect systemic risk

A direct systemic risk of this kind must be distinguished from an indirect systemic risk. An indirect systemic risk refers to the potential negative consequences for the whole financial system triggered by the activities of one or more insurers that react simultaneously to negative external events or shocks to which they were exposed. In the case of an indirect systemic risk, a second-round effect arises: systemic consequences for the entire global system arise only when the activities or reactions of a number of insurers to negative events or shocks are combined.³

ABA for indirect systemic risks

While the IAIS has been monitoring direct systemic risks since 2013 by means of G-SII designation, it is now also turning its attention to indirect systemic risks by applying the ABA approach. Work on the ABA has only just started and represents a project for the longer term.

One of the issues to be addressed is the identification of activities that could generate second-round effects in the event of a collective response. The IAIS has a wide range of preparatory work to turn to for this purpose, including knowledge gained from the G-SII process to date. The EBA takes individual activities into consideration as well. It also would seem appropriate to design an ABA as a supplement to an EBA, so that a hybrid overall approach covering all aspects of systemic risk is available for the insurance sector.

Regulatory policy measures

A final, but decisive, element for containing systemic risks is the establishment of regulatory policy measures, including the higher loss absorbency capacity (HLA) of G-SIIs.

Consideration must be given to whether the Supervisory Authority already has sufficient instruments with respect to indirect systemic risks or whether special tools are required. The focus continues to be the protection of policyholders – and the laws currently in force already provide a wide range of effective instruments which, at the same time, contribute to financial stability.

In view of the complexity of indirect systemic risks and their interaction with direct systemic risks, supervisors must carefully analyse the relevant activities and possible regulatory policy measures. Changes or additional measures should therefore not be expected in the short term.

European framework

Pan-European pension products

During the course of 2017, the EU Commission is planning to put forward a proposal for a simple, effective and competitive EU product for private pension provision – a Pan-European personal pension product (PEPP). This idea is also reflected in the European Commission's Green Paper on a Capital Markets Union⁴. The Commission's objective is to encourage EU citizens to increase their savings for private pensions. It also sees this as a method of strengthening the single market, since capital employed for the purpose of private pension provision can itself contribute in turn to the financing of the economy.

The Commission issued a call for advice to EIOPA for this reason in 2014. The paper which EIOPA then prepared and completed in mid-2016⁵ contains the first specific proposals for the possible structure of a PEPP. The European Commission then conducted a public consultation exercise on an EU legal framework for private pensions. The consultation concluded in October 2016. In parallel, the Commission held a public hearing on a possible pan-European pension product. The Commission's initiative met with great approval throughout the hearing.

According to the current plan, a European product of this nature would stand alongside the existing systems of old-age provision and would be defined by a regulation at EU level.

The detailed specification of the requirements represents a challenge: they must be formulated in such a way that the product is admissible as a pensions product in all member states and is also approved as such. Approval could be important, for example, if it is intended to allow holders the opportunity to benefit from tax advantages. It must also be ensured that there is no blurring of the dividing line between pension products (long-term investment with the aim of generating an income for the client in old age) and pure investment products (focused exclusively on returns). In BaFin's opinion, a clear distinction must continue to be evident in this respect.

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