Expand. Evolve.A discussion of insurance regulation around the globe August/September 2016
In May of this year, the National Association of Insurance Commissioners (NAIC) International Insurance Forum was held in Washington, D.C. In a YouTube video promoting the event, NAIC President and Missouri Insurance Director John M. Huff states, “We all think about insurance on the local level, but more and more it’s becoming a global industry, and some of the decisions being made around the world can have real consequences for the jurisdictions we regulate.”
The role of the actuary is expanding with the globalization of the insurance industry. Therefore, there is a growing need for actuaries to understand the regulatory environment around the world. We have asked regulators and actuaries from across the globe to share insights on the regulatory environment and to opine on how ever-changing regulations impact the way actuaries must think and act.
Participants in this discussion are:
Q: What is the general regulatory framework in the country(ies) with which you are most familiar? If you are familiar with more than one national regulatory framework, can you address the high-level contrasts?
In the United States, the general regulatory framework for the regulation of insurance is done at the individual state level. Insurance laws are promulgated by the state legislatures, as are the powers given to the insurance regulatory official, the insurance commissioner. Typically, the insurance commissioner is given the power to promulgate insurance regulations that are necessary to apply or execute the law. In the United States, the insurance commissioner is appointed by the governor in all but 11 states and the U.S. Virgin Islands. In those 12 jurisdictions, the voting public elects the insurance commissioner.
Typically, insurance laws may be divided into two categories, namely laws dealing with the markets and market conduct, and laws dealing with solvency, such as reserving laws and risk-based capital requirements. Laws dealing with markets and market conduct include laws requiring certain contract provisions that must be included in an insurance contract, whether insurance products and insurance premiums need to be approved by the insurance commissioner prior to being sold, and requirements on licensing of insurance agents who sell insurance products to consumers. Laws may be separate or specific to particular markets or lines of business, such as property/casualty, health, retirement/pensions/annuities and life insurance.
I am most familiar with the Canadian insurance regulatory environment, as I worked for the Canadian federal financial services regulator, the Office of the Superintendent of Financial Institutions (OSFI), for six years. OSFI’s principal mandate is as an integrated regulator (banking and insurance) on prudential matters, i.e., solvency issues. Canadian market conduct issues are addressed by Canadian provincial regulators.
From my international regulatory work on Canada’s behalf at the International Association of Insurance Supervisors (IAIS), I also am familiar with the proposed International Capital Standards (ICS) being considered by the IAIS for internationally active insurance groups (IAIGs).
Equally, I am familiar with the Solvency II regime governed by the European Insurance and Occupational Pensions Authority (EIOPA). From my time in industry, I also am familiar with the U.S. Statutory Accounting and Generally Accepted Accounting Principles (GAAP) regimes, IFRS 4 Phase II proposed by the International Accounting Standards Board (IASB), and the regimes in offshore locales.
The contrasts, which are pronounced when comparing regulatory regimes, are the degrees of latitude from which the actuary has to choose assumptions and criteria for liabilities valuation, according to guidelines in actuarial standards. Equally, the relationship between the value of liabilities and the value of risk-based capital can differ among different insurance regulatory jurisdictions.
Finally, although stress and scenario testing exists for insurers, particular jurisdictions publish the scenarios created by the regulators and disclose which insurers passed or failed the test (e.g., the European Union). In Canada, these stress and scenario testing exercises are not disclosed to the public. Similarly, in Canada, the results of these exercises and the names of insurers that fail the test are not disclosed publicly.
Having worked on different continents, I am familiar with a few regulatory frameworks. Currently, I am most familiar with the New Zealand regulatory prudential supervision framework. I am also familiar, but to a lesser extent, with the Australian and Solvency II frameworks.
For this interview, I will focus mostly on the New Zealand life insurance solvency framework. The Reserve Bank of New Zealand promotes the maintenance of a sound and efficient financial system. In that role, it supervises the banking and insurance sectors, licenses insurance companies, and provides and updates from time to time a prudential supervision framework.
This framework, in summary, contains two standards: the fit and proper standard and the solvency standard. The former sets out the requirements for a fit and proper policy for directors and relevant officers (which includes appointed actuaries), and the latter sets out the rules and guidelines for calculating the required capital an insurer must hold.
In terms of differences among frameworks, New Zealand has relatively simple solvency requirements that are driven by the relatively simple nature of the life insurance business sold. The other key aspect, from a slightly different angle, is the consultative approach the regulator takes to developing prudential regulations for New Zealand.
The insurance industry in China is governed by two levels of regulations: a basic insurance law established by the National People’s Congress, and various insurance regulations issued by the insurance supervisory authority, China Insurance Regulation Commission (CIRC).
The CIRC reports to and carries out administrative functions delegated by the State Council, with the following responsibilities:
- Formulate strategy for the development of the insurance industry.
- Establish insurance laws and regulations.
- Issue licenses to insurance institutions and approve senior management appointments of such organizations.
- Approve mergers, acquisitions and share purchases.
- Supervise solvency; oversee bankruptcies and liquidations; manage policyholder protection fund.
- Approve new products, policy forms and premium rates.
- Oversee market conduct and issue penalties for irregularities.
The CIRC regulations focus on three areas: corporate governance, solvency and market conduct supervisions. Supervisory tools used are:
- Corporate internal control requirements
- Solvency requirements, investment regulations
- On-site inspections, use of policyholder protection fund
The newly established solvency requirement (C-ROSS) also includes a three-pillar approach similar to EU Solvency II, with the following distinctive features to reflect the emerging market characteristics of China:
- Use accounting value for asset valuation to ease the management understanding (with only one set of asset value).
- Smooth out risk-free yield curve in liability discounting to reflect the incomplete, less perfect and inefficient financial market.
- Use a relatively simple standard formula approach with more factor-based capital calculations to ease the implementation burden due to lacking resources and expertise in the market.
- Use a more qualitative risk assessment to assess nonquantifiable risks to allow for the rapidly changing nature of the business.
- Use the result of the second pillar (risk assessment) to modify the first pillar numerical result to enforce better risk management practices in the industry.
Q: How have you seen the insurance regulatory environment evolve?
As insurance products have become more complex in recent years, the complexity has led to increased regulatory activity centered around the appropriate measurement and assessment of new or additional risks posed by the complex product features. Recent examples include variable annuities with guaranteed death and living benefits, guaranteed lifetime income benefits attached to fixed and indexed annuities, and long-term care benefits added to life insurance policies. This has led state insurance regulators to replace the existing formula-based valuation methodology with a principle-based valuation methodology for life insurance on a prospective basis. In addition, the financial crisis of 2008 led Congress to pass federal legislation that establishes additional regulation and capital requirements for insurance companies designated as systemically important financial institutions (SIFIs). Likewise, for U.S. insurance companies that write insurance business in multiple countries and are designated as globally systemic important institutions (G-SIIs), additional regulatory requirements, including additional capital standards, will apply.
The insurance regulatory regimes have been evolving and have been influenced by changes in the banking regulatory regimes (Basel II and Basel III). As a consequence, certain regulatory regimes are using a best- estimate approach for the valuation of insurance liabilities, with minimal provisions for adverse deviations (PfADs). The risk-based capital regimes in these jurisdictions attempt to make more provisions for adverse deviations, generally using stochastic modeling.
Today’s Canadian regime still allows the actuary discretion to use PfADs in reserve calculations according to actuarial standards promulgated by the Canadian Institute of Actuaries and the Canadian Actuarial Standards Board.
OSFI Canada has proposed to alter its current Minimum Continuing Capital and Surplus Requirements (MCCSR) for Canada’s risk-based capital regime, which is to be updated and replaced by a new regime called Life Insurance Capital Adequacy Test (LICAT) in 2019.
When I arrived in New Zealand in 2009, after working in Europe and Asia for almost a decade, I was surprised there was virtually no solvency regime in place and the regulator had just initiated the process of putting one in place. To my knowledge, it was probably the last Western country to adopt one. I wondered why, especially given that the New Zealand regulator had been quite progressive with implementing banking supervision regulations. This situation might have been due partly to the progressive attitude of the New Zealand Society of Actuaries, which had recognized the lack of a solvency regime and the risk to the industry and the profession. Long before the regulator had started developing the prudential supervision regulation, the society had developed and issued a Professional Solvency Standard for life and nonlife insurance. This was successful, and most companies over time started reporting their solvency margin in their financial statements based on this standard.
Since 2009, the act and associated standards have evolved rapidly from concept to implementation and are now fairly mature. The supervision regime was put to the test when the Canterbury Earthquakes hit New Zealand between 2010 and 2013, following the introduction of the act and standards in 2010.
The regulator has been very consultative with the industry in developing the act and standards. It actively seeks and discusses feedback from the industry. New Zealand is a small market, which makes such consultation processes more practical. This active consultation approach to developing prudential supervision, in combination with the presence of the actuarial Professional Solvency Standard and the Australian solvency framework, resulted in a smooth transition period for the act and standards in 2010, and the subsequent licensing process. The Australian industry is fairly similar to the New Zealand insurance industry (particularly from the perspective of designing the prudential supervision), and many of the insurers in New Zealand are Australian owned. In addition, the Australian insurance companies performed well during the global financial crisis.
The insurance market in China grew rapidly over the course of the past few years, and now it is the third-largest insurance market in the world. Its growth was supported by the State Council’s issuance of “Ten Opinions” (also known as the “Ten New National Opinions”) in 2014, which was intended to accelerate the development of the insurance industry. The mid- to long-term outlook of the market is very optimistic, with a projected premium growth rate of 15 percent on average.
To be able to better serve the market, the CIRC proactively is adopting new regulations to encourage competition, growth and wider social and economic developments. In turn, this reshaping of the regulations has brought them closer to the international standard and toward more liberalized, market- driven and transparent supervision.
The CIRC currently is advocating a reform strategy of “open front end, control back end.” Several significant milestones have been achieved. For example, the official launch of C-ROSS on Jan. 1, 2016, and the liberalization of pricings for life insurance products and nonlife motor insurance products in 2015, allow for more investment choices for insurance funds.
The CIRC also is trying to expand the insurance product offerings to supplement the national social and economic developments. Tax advantage health insurance was piloted in 2015. There also are plans to apply more tax advantage incentives to other health and pension insurance products. The first regulation on internet insurance was issued in 2015. The first catastrophe insurance regulation (on earthquake insurance) was issued in May 2016 to encourage natural catastrophe coverage.
The systemic risk regulation has been on CIRC’s top list since Ping An was selected as one of the G-SIIs in 2013. Globally, the CIRC is actively involved in the development of G-SII related regulations drafted by IAIS. Domestically, the consultation paper of domestic systemically important insurer (D-SII) policy measures was issued in April 2016, with the D-SII assessment methodologies consultation planned for the near future.
More widely, the reformation of the whole financial supervisory structure is on the way. China currently has three separate regulatory authorities for financial sectors: China Banking Regulatory Commission (CBRC) for banking, CIRC for insurance and China Securities Regulatory Commission (CSRC) for securities. Following the financial regulation reforms in the United States and the United Kingdom, there are voices calling for a more integrated framework. The State Council of China is considering reform options to consolidate or enhance coordination among these three regulatory bodies, especially on the macroprudential front.
Q: Solvency and capital adequacy are concerns for regulators. How are current regulatory approaches addressing these issues?
As previously stated, current regulatory approaches are not well suited to address the complexity that is evolving in new product development. To address this issue, regulators in the United States are moving to a principle-based valuation methodology for both reserves and capital that will be applied on a prospective basis.
Current regulatory approaches go further than the calculation of reserves and risk-based capital. All advanced regulatory regimes (United States, Canada, United Kingdom, European Union, Australia, Bermuda) have a requirement for insurers to conduct, discuss with the boards of directors and, ultimately, file with their regulator an Own Risk and Solvency Assessment (ORSA).
The ORSA is a process by which management calculates its required solvency capital and compares it against its risk profile. In addition, in certain regulatory jurisdictions where required, an insurer also is expected to calculate its own economic capital calculation in line with its assumptions regarding its risks and financial strength.
Additionally, in many jurisdictions, there is a significant process and expectation for stress and scenario testing to be used to assess the financial strength of an insurer’s balance sheet. Requirements exist in particular jurisdictions for the actuary to opine on the financial strength of the insurer in question through examining various insurance risks and macroeconomic scenarios (e.g., Canada, United States, European Union).
So, more emphasis is being placed on dynamic approaches to assess the solvency of insurers in all jurisdictions. In Canada, according to statute, the appointed actuary has a fiduciary responsibility to OSFI to ascertain the financial strength of the insurer through the Dynamic Capital Adequacy Test (DCAT) report.
Overall, I view the approach of the New Zealand regulator as fairly pragmatic, given the type of life insurance products sold and relatively high degree of Australian ownership.
The vast majority of life insurance sold is yearly, renewable risk business. There is some legacy par business. The solvency approach the regulator has adopted, given this type of life insurance business, is discreet and rule based (as opposed to stochastic and principle based), and doesn’t explicitly attempt to value options and guarantees. This seems to work well for the risk business and is relatively cost efficient.
However, now that interest rates in New Zealand also are dropping to historically low levels, par business guarantees are close to being in the money. The framework, in my opinion, does not deal with this situation well compared to Solvency II, for example.
The development and implementation of C-ROSS is a significant achievement in the insurance regulatory history in China.
CIRC launched the C-ROSS project in 2012 with combined efforts from the regulator, consulting firms and insurance industry (including Ping An as one of the project members). The first version of the technical standard was released in February 2015 to start a transition period. The C-ROSS officially was implemented on Jan. 1, 2016. The top-level design of C-ROSS is consistent with the IAIS requirement specified in Insurance Core Principles. Its three-pillar structure is similar to European Solvency II and the Basel system. But the contents under the three pillars brought in many elements of localization, reflecting China’s emerging market characteristics.
The new risk-based C-ROSS addressed many of the concerns with the old Solvency I system. It provided better supervisory tools for the growing complexity of risks faced by the insurance industry. It supported a regulatory reform strategy that enabled the regulator to “control back end” (solvency and risk management evaluation). It offered a safety net for CIRC to relax “front-end control,” with more freedom for industry to concentrate on market competition. The C-ROSS enhanced the insurance supervision in China, making it more consistent and comparable to other international frameworks.
Q: Please provide insight into regulatory concerns that are likely to impact the roles of actuaries.
Certainly the implementation of a principle-based valuation method will have a big impact on the actuarial profession. To carry out a principle-based valuation will, in most cases, require use of financial models run over many economic scenarios to determine the appropriate level of reserves and capital. The principle-based approach to valuation will allow a company to use its own experience data to the extent it is credible, which will place more burden on actuaries to conduct frequent experience studies. A recent regulatory concern has been the extended period of very low interest rates and the impact it is having on the insurance industry. Regulators are concerned whether insurance companies will be able to earn rates of interest on their asset portfolios that are able to fund the minimum guaranteed rates of interest on their liability portfolios.
From a regulatory perspective, the emphasis on solvency is a key concern. Actuaries can better anticipate these concerns by ensuring their own scenario and stress testing is based on tail events, which may not be immediately considered to be plausible, but probable.
Those insurers that considered the possibility of a systemic event that would see equity markets drop 35 percent had created sufficient surplus on their balance sheets to withstand the most extreme events in the most recent global financial crisis.
The key regulatory solvency concern for actuaries in New Zealand and the regulator, in my view, is in relation to declining interest rates and the par business guarantees. Although all par business is closed book, the assets under management and annual premium income are still significant enough to be a threat to life insurance companies with large par books.
In addition, three mostly Australian life industry trends that will have or are having an impact on solvency and capital are:
- Worsening claims experience—especially for critical illness products.
- Loss-making disability income products.
- Change in ownership—bank assurers selling (parts of) their life insurance business and superfunds stepping into life insurance.
The first two will have an impact on assumptions and loss recognition rules. The latter can impact the regulatory reporting and compliance for actuaries in these businesses.
Two significant regulatory events are the implementation of C-ROSS and the liberalization of pricing. It’s a big challenge, within a short time frame, for actuaries to upgrade all of the system/analysis/process/work to incorporate these changes. I would name these two events the top regulatory concerns for the actuaries in China today.
The solvency plus liberalization of pricing have positioned actuaries to assume bigger and wider roles, even for traditional functions, such as product development, pricing, financial projection, risk management and capital management. These actuarial works require more dynamic analysis and incorporate knowledge ranging from risk management to business environment. We have seen insurers quickly expand and strengthen their actuarial functions under these new rules. This in turns creates lots of job opportunities for actuaries.
Q: How has globalization impacted regulatory issues in your country?
Companies that write business in multiple countries typically are subject to the different regulatory requirements of each country. On examination of such a company, there may be regulators from different countries looking at the solvency of the company. A mechanism of regulatory cooperation and communication is needed to carry out such examinations, which led to the development of supervisory colleges to address this issue. As mentioned, if a company in the United States is a G-SII, the regulators involved in an examination may include state regulators, federal regulators and regulators for other companies—all meeting and communicating through a supervisory college.
Globalization has had an impact on every major insurance regulatory regime. In Europe, Solvency II has become the standard by which European insurers and those non-European insurers wishing to do business in Europe must govern themselves. Some jurisdictions (notably Bermuda) have chosen to apply for and have received Solvency II accreditation (or equivalence). At this time, Canada has not applied for Solvency II accreditation (or equivalence).
Finally, unlike the banking regulators (Basel Committee on Banking Supervision), which have been promoting more converged capital standards for banks over many years, the IAIS has started to create proposals for an Insurance Capital Standard (ICS) that will apply to roughly 100 insurance groups around the world that are active internationally. ICS would not apply to insurers who are not IAIGs.
When developing the New Zealand prudential regulation, the regulator paid a significant amount of attention to the structure of the Australian solvency framework. This is due mostly to the fact that a significant number of New Zealand registered life insurers are Australian owned, and the Australian life insurance business is comparable to the New Zealand life insurance business.
Additionally, the New Zealand and Australian life insurance industries are fairly unique compared to other countries due to the absence of saving products in the life insurance industry and the relatively short-term risks.
Globalization and its impact are inevitable. We viewed the impact of globalization on regulations in two ways: “bringing in” and “going out.”
In terms of “bringing in,” CIRC adopted new regulations toward consistency or compliance with the standards set by the international rule makers. For example, the C-ROSS is developed with the reference to IAIS Insurance Core Principles and solvency regulation developments in the European Union and United States.
In terms of “going out,” CIRC encouraged insurance companies to increase the investment in the oversea markets (with appropriate compliance and controls) and the involvements in the international regulation setting (to reflect Chinese views and ideas). CIRC has strengthened significantly its cooperation with international organizations, including the IAIS, International Organization of Pension Supervisors (IOPS) and Asian Forum of Insurance Regulators (AFIR). Particularly, because Ping An has been selected to be a G-SII since 2013, Ping An and CIRC are actively involved and contributed to the policy setting of G-SII and IAIG regulation framework.
Q: What should actuaries and insurance professions know about regulation?
First and foremost, regulation is constantly changing. In the United States and in Europe, there are new regulatory methodologies that have been developed—principle-based valuation in the United States and Solvency II in Europe—that are being implemented and will subject insurance companies to new and different regulations. The designation of a company as systemic adds another level of regulatory complexity. Finally, it is up to the actuary and insurance profession to keep abreast of and comply with the new laws.
Information constantly changes in our world. Through local professional associations, actuaries should continue to monitor these regulatory developments and, where necessary, advocate for regulatory reform that promises to create a strong and robust insurance industry.
Actuaries are responsible for compliance with the solvency and capital standard through the legislated Appointed Actuary role. This role requires significant experience and knowledge of the standard. The New Zealand Society of Actuaries offers courses for Appointed Actuaries to ensure a sufficient level of knowledge.
In addition, insurance companies are businesses, and actuaries play a significant part in the financial success of the business. Besides being compliant and solvent, a business needs to be as profitable as possible within its risk appetite. The actuary manages the tools and systems to make these trade-offs clear and measurable to the ultimate business decision-makers. Continuous professional development and other actuarial literature—in addition to a good understanding of the key drivers of the business—are the key ingredients to perform well as an actuary.
Q: Are there changes in regulatory requirements such that actuaries will be challenged to think and act differently?
In the United States, the implementation of a principle-based valuation methodology certainly will challenge actuaries to think and act differently. Financial models will become an integral part of the valuation process. Certain products with inherent market risks will need to be modeled over thousands of economic scenarios in order to establish the reserve and capital levels. Frequent company experience studies will need to be carried out to develop credible and relevant experience data so that such data can be used in the modeling process.
Actuaries will need to recognize that their fiduciary responsibility extends further than for the benefit of company shareholders and management. Insurance, especially the life insurance business, is a long-term business that seeks to protect the interests of policyholders.
The introduction of ORSA will allow all actuaries to think and act differently, as the creation of economic capital models permits actuaries to play a broader role in the strategic planning of an insurer.
In New Zealand, the first small wave of changes from the implementation of the new solvency standard has been implemented (including those from the Canterbury Earthquakes), and no major changes are expected in the short term. However, I would not be surprised if some changes will be introduced with regards to par business if the interest rate stays low or drops further.
The Reserve Bank is reasonably clear about when it will provide updates, sometimes indicating in which areas, and regularly asks for submissions. It actively discusses these submissions with the life insurers before finalizing changes.
The actuary’s life has significantly changed by the implementation of the C-ROSS and the liberalization of pricing. C-ROSS requires actuaries to think beyond a simple liability driven to a relatively sophisticated risk-driven framework. The liberalization of pricing requires actuaries to evaluate broader risk profiles (under various scenarios) and the long-term financial impact of the products. Bringing these new regulations together, actuaries need to change from static thinking toward dynamic thinking for the work and the advice we provide. More work has been directed to better understand, evaluate and manage various risks in the business environment. More actuaries are involved in asset/liability management (ALM), enterprise risk management (ERM) and capital strategies.
Concluding Comments from Albert Moore
Thank you for providing your perspectives. There are many interesting areas for thought and lessons learned. Regulatory risk is an opportunity for actuaries to understand the constantly changing regulatory environment. Actuaries in New Zealand demonstrate the value of proactively contributing to the insurance regulation regimes and continuous consultation on emerging topics. Actuaries in China respond to a three-pillar supervisory structure designed to ensure solvency, capital adequacy and consumer protections. Actuaries in Canada continue to address regulation that requires less prescription and more principles-based approaches for regulation. In the United States, there is an evolution from a primarily prescribed approach toward greater principles-based analysis. All are being challenged to understand how our fiduciary responsibility extends further than the benefit of company shareholders and management to include the public interest.
Copyright © 2016 by the Society of Actuaries, Schaumburg, Illinois.