Cornerstones: Solvency Monitoring in Differing Circumstances Michael M. Barth, PhD, CPCU Associate...
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Transcript of Cornerstones: Solvency Monitoring in Differing Circumstances Michael M. Barth, PhD, CPCU Associate...
Cornerstones:Cornerstones:Solvency Monitoring inSolvency Monitoring inDiffering CircumstancesDiffering Circumstances
Michael M. Barth, PhD, CPCUMichael M. Barth, PhD, CPCU
Associate Professor of FinanceAssociate Professor of Finance
Georgia Southern UniversityGeorgia Southern University
Recent IAIS ReleasesRecent IAIS Releases
October 2004 – October 2004 – A New Framework for A New Framework for Insurance Supervision: Towards a Insurance Supervision: Towards a Common Structure and Common Common Structure and Common Standards for the Assessment of Insurer Standards for the Assessment of Insurer SolvencySolvency
February 2005February 2005 – Cornerstones for the – Cornerstones for the Formulation of Regulatory Financial Formulation of Regulatory Financial RequirementsRequirements
IAIS Objectives IncludeIAIS Objectives Include
Assisting regulator and regulated in assessing Assisting regulator and regulated in assessing risk and solvencyrisk and solvency
Enhancing the transparency and comparability Enhancing the transparency and comparability of insurers worldwideof insurers worldwide
Supporting a level playing field while reducing Supporting a level playing field while reducing regulatory arbitrageregulatory arbitrage
Increasing the opportunities for international Increasing the opportunities for international cooperationcooperation
Increasing overall confidence and efficiencyIncreasing overall confidence and efficiency
Common StandardsCommon Standards
Common standards should not mean the same Common standards should not mean the same standards for all insurersstandards for all insurers Loss frequency vs loss severityLoss frequency vs loss severity Market disruptionMarket disruption Market’s ability to absorb both the losses and the Market’s ability to absorb both the losses and the
cost of loss preventioncost of loss prevention Cost associated with monitoringCost associated with monitoring
Translating common standards across Translating common standards across international boundaries international boundaries
Assessing RiskAssessing Risk
Development of appropriate models and Development of appropriate models and techniques that can be used in multiple techniques that can be used in multiple jurisdictionsjurisdictions Technical reserves (?)Technical reserves (?) Investment risk (?)Investment risk (?) Systematic business risk (?)Systematic business risk (?) Political risk (?)Political risk (?)
Processes for determining risk may be more Processes for determining risk may be more exportable than products themselvesexportable than products themselves
TransparencyTransparency
Transparent systems and opaque systems are Transparent systems and opaque systems are complementary and serve different functionscomplementary and serve different functions
Degree of solvency monitoring by outside (e.g., Degree of solvency monitoring by outside (e.g., non-regulatory) bodies affects designnon-regulatory) bodies affects design CompetitorsCompetitors LendersLenders News, trade pressNews, trade press Reinsurers and other business partnersReinsurers and other business partners Other financial services regulatorsOther financial services regulators
Self-fulfilling prophecies and inaccuracy in Self-fulfilling prophecies and inaccuracy in systems affect the ability to be transparentsystems affect the ability to be transparent
Opaque Solvency Opaque Solvency Monitoring SystemsMonitoring Systems
Should be opaque to masses but transparent Should be opaque to masses but transparent to other regulators (e.g., FAST, CAMEL)to other regulators (e.g., FAST, CAMEL)
If insurers are gaming the system, then the If insurers are gaming the system, then the system is not workingsystem is not working
Early Warning System meant to provide early Early Warning System meant to provide early warning of what MIGHT happen, not what is warning of what MIGHT happen, not what is inevitableinevitable
Opaque systems can be used to direct Opaque systems can be used to direct resources more efficiently without causing resources more efficiently without causing disruption that regulator is trying to avoiddisruption that regulator is trying to avoid
Regulatory ArbitrageRegulatory Arbitrage
Best defense is cooperation among Best defense is cooperation among regulators IN AN APPROPRIATE regulators IN AN APPROPRIATE FORUMFORUM
Sliding scales of regulatory interest and Sliding scales of regulatory interest and interferenceinterference
Regulatory forbearanceRegulatory forbearance
How Does U.S. Stack Up? How Does U.S. Stack Up? (IMHO)(IMHO)
Regulatory IndicatorsRegulatory Indicators IRIS, FAST, RBCIRIS, FAST, RBC Model laws (e.g., RBC model)Model laws (e.g., RBC model) State law provides teethState law provides teeth AuditsAudits
Non-regulatory regulatorsNon-regulatory regulators Rating agenciesRating agencies Trade pressTrade press Competitors, business partnersCompetitors, business partners
Cornerstone 1Cornerstone 1
The solvency regime addresses the The solvency regime addresses the robustness of the insurer to meet its robustness of the insurer to meet its liabilities both short term and over a liabilities both short term and over a longer time spanlonger time span
Short term and long term: What does that mean?
Ratio systems are relatively short-sighted, but insolvencies often occur over time
AM Best et. al. also provide long-term information
Cornerstone 2Cornerstone 2
The solvency regime is sensitive to risk, The solvency regime is sensitive to risk, and is explicit as to which risks and is explicit as to which risks individually and in combination, lead to a individually and in combination, lead to a regulatory financial requirement and how regulatory financial requirement and how they are reflected in the requirementthey are reflected in the requirement
Pretty much describes the concept of risk-based capital and the accompanying RBC law
Cornerstone 3Cornerstone 3
The solvency regime is explicit on how, The solvency regime is explicit on how, for each of the risks that attract a for each of the risks that attract a financial requirement, individually and in financial requirement, individually and in combination, prudence is reflected in combination, prudence is reflected in these requirements.these requirements.
That is the plan, anyway.
Cornerstone 4Cornerstone 4
The solvency regime requires a valuation The solvency regime requires a valuation methodology which makes optimal use of methodology which makes optimal use of and is consistent with information and is consistent with information provided by the financial markets and provided by the financial markets and generally available data on insurance generally available data on insurance technical risks.technical risks.
For a transparent system, yes.
This does not address the needs of an opaque system
Does the generally available data provide accuracy?
Cornerstone 5Cornerstone 5
The solvency regime includes the The solvency regime includes the definition of technical provisions. definition of technical provisions. Technical provisions have to be prudent, Technical provisions have to be prudent, reliable, and objective and allow reliable, and objective and allow comparison across insurers. The regime comparison across insurers. The regime should require as a minimum that should require as a minimum that sufficient assets are available to cover sufficient assets are available to cover the technical provisions and other the technical provisions and other liabilities.liabilities.
Relatively easy to standardize across borders
Cornerstone 6Cornerstone 6
The solvency regime requires the The solvency regime requires the determination of a “best estimate” of the determination of a “best estimate” of the costs of meeting the obligations arising costs of meeting the obligations arising from the insurance portfolio, taking into from the insurance portfolio, taking into account the time value of money. The account the time value of money. The discount rate for this calculation is discount rate for this calculation is determined by reference to the relevant determined by reference to the relevant risk free interest rates on the financial risk free interest rates on the financial markets.markets.
Best estimate or confidence interval?
Cornerstone 7Cornerstone 7
The solvency regime establishes a range The solvency regime establishes a range of solvency control levels and the of solvency control levels and the supervisory instruments associated with supervisory instruments associated with each of the control levelseach of the control levels
What is meant by “control level”?
RBC requires company to submit a report at the Company Action Level – is that “control”?
The bar for “increased regulatory scrutiny” should be relatively easy to trigger
Cornerstone 8Cornerstone 8
The solvency regime allows a set of The solvency regime allows a set of standardised [standardized] and more standardised [standardized] and more advanced approaches to determine the advanced approaches to determine the solvency requirements, and includes the solvency requirements, and includes the use of internal models if appropriate.use of internal models if appropriate.
The level of “standardization” should differ from system to system. Opaque systems may be particularly suited to advanced approaches. This also allows the monitoring system to be more forward thinking and dynamic by encouraging innovation
ConclusionsConclusions
The US system, a combination of both The US system, a combination of both public and private early warnings and public and private early warnings and capital standards, goes a long way capital standards, goes a long way towards meeting these goalstowards meeting these goals
Harmonization across international Harmonization across international borders seems like a long way offborders seems like a long way off
What ain’t broke, don’t fix What ain’t broke, don’t fix If it ain’t perfect, keep tryingIf it ain’t perfect, keep trying