A major milestone has now been achieved: the IAIS has published the first version of the standard to be tested in extended field testing (ICS Version 1.0 for extended field testing). Main participants are IAIGs, but other interested organisations and individuals may also participate and submit their feedback on ICS Version 1.0 to the IAIS until the end of September. The IAIS hopes that this will provide helpful information and suggestions for the further development of ICS Version 2.0. The standard is to be finalised by the end of 2019 and is expected to be implemented internationally from 2020 onwards.

In contrast to the previous year, the participants can test various combinations of options in the areas of valuation, as well as own funds and capital requirements using a simulation tool. This shows that the IAIS has not yet formed a final opinion on these issues and that important decisions could still be made and improvements implemented before the end of 2019.

Parallels to Solvency II

The ICS shows clear parallels to the European supervisory regime Solvency II . As is the case under Solvency II, the solvency requirements are calibrated in such a way that they correspond to the value at risk (VaR) of the own funds subject to a 99.5% confidence level over a one-year period.

Moreover, the ICS valuation is based on a market-adjusted approach and insurance obligations are also evaluated in a market-consistent manner. To this end, the current interest yield curve is used with the inclusion of adjustments that are conceptually similar to the volatility adjustment applied under Solvency II.

Interest rate risk

Given the current low-interest rate policy, the interest rate risk is of great importance. The ICS determines this risk using various stress scenarios. 2017 will be the first time that the field testing requires the application of the dynamic Nelson-Siegel model (DNS model) for determining yield curves and the use of algorithms for calculating the stress scenarios. The number of shocks has been limited to five: two symmetric twist scenarios (non-linear twists of the yield curve from up to down or down to up), two symmetric level scenarios (parallel shifts of the yield curve from up to down or down to up), and a mean reversion scenario (reversion of the interest rate to its historical mean).

Valuation of liabilities

A worldwide agreement on a common yield curve for the valuation of liabilities is needed to ensure not only risk-based valuation but also market-adjusted valuation (MAV). This year’s field test includes three options: the Blended option, the High Quality Asset (HQA) option and the Own Assets with Guardrails (OAG) option. A common feature of all three options is that each yield curve is extrapolated from a currency-specific maturity that is considered only just still sufficiently liquid towards a long-term forward rate (LTFR) of 3.5% with a maturity of 60 years.

The Blended option is conceptually the closest to Solvency II and is the standard option which all participants have to apply in the field testing. In this option, the liabilities are divided into two categories (general bucket and top bucket). These categories are then measured using different yield curves. The yield curves take account of an adjustment in the form of a spread which is determined based on currency-specific portfolios.

In contrast to this, the IAIS has decided that for the time being the HQA option will merely be tested. This option is based on the work of the Financial Accounting Standards Board (FASB) which is currently modifying the accounting standards for insurance contracts in the USA. There is no subdivision of liabilities into categories in this option, which means that only one adjustment is applied for each currency. The main difference compared with the Blended option is that the choice of instruments that can be used to compose the currency-specific portfolios is restricted to assets rated AA or above.

The OAG option was proposed by a group of company representatives and is also being tested for the first time. The field testing gives participants the opportunity to allocate their liabilities to company-specific sub-portfolios and evaluate these using a risk-free yield curve predefined by the IAIS which is adjusted by a spread, the "adjusted life-time spread". This spread is determined based on all assets of all asset classes of the insurance undertaking with certain guardrails to be taken into account.

Convergence of market-adjusted valuation methods

In addition to the market-adjusted valuation approach, there is also the GAAP Plus approach which is derived from the accounting standards of the respective country (Generally Accepted Accounting Principles (GAAP)). GAAP Plus is based on the consolidated balance sheet. Adjustments specified for the individual countries are then made to the consolidated balance sheet with a view to bringing it more closely into line with the MAV approaches. Two versions for discounting are used under GAAP Plus: the HQA option and the OAG option.

In addition, there are different methods for calculating the capital requirements of individual risks under GAAP Plus and MAV, in particular the real estate risk, the credit risk and the interest rate risk.

Outstanding issues

There are also other issues on which the IAIS has to find a consensus. The calculation of own funds entails a number of unanswered questions, for example whether the ICS should consider structural subordination generally equivalent to contractual subordination. Another unsettled issue is whether there should be special rules for certain financial instruments issued by mutuals. The IAIS hopes that the simulation tool will provide some answers in this regard.

The question whether the ICS should be considered a minimum requirement or a financial reporting standard has also not been resolved yet. The answer to this question will have far-reaching implications on how binding the ICS will ultimately be.

Objectives

Parallel to field testing, the IAIS will have to work intensively on achieving the goals set for ICS Version 2.0. These include, for example, the formulation of a specific framework for using alternative methods, i.e. internal models (see interview with Frank Grund) for the calculation of capital requirements as a supplement to the standard method. However, the overarching objective is still the ultimate goal defined by the IAIS in 2015 requiring a higher level of convergence in the methods used by all parties involved. Ultimately, there is to be one global valuation approach with comparable outcomes. BaFin will continue to participate actively in the work of the IAIS, which, in turn, will continue to depend on the voluntary involvement of the undertakings.