Seminar on Promoting Sound Insurers and Dealing with Those under Stress

1. Trigger points for supervisory intervention and protective measures for policyholders and financial stability Seminar on Promoting Sound Insurers and Dealing with Those under Stress Panama City, Panama, 24-26 May 2016 Gunilla Löfvendahl Senior Financial Sector Specialist

2. Agenda • Scope and objective of supervision • Insurers in trouble and troubled supervisors • Early identification and correction of problems • Supervisory enforcement, recovery and resolution • Winding-up, creditor hierarchy and policyholder protection schemes

3. Scope and objective of supervision • Protect the interests of the policyholders • Detect insurance related risks through the supervision of insurance entities and groups • Firm-specific supervisory measures aimed at mitigating or otherwise addressing these risks and their effects • Protect the financial stability • Detect emerging risks and other risks that are emanating from a wider perspective than the group, which can have an impact on the group and its entities, which could have an impact on the economy • System-wide measures (many may be outside the scope of insurance supervision) • Time dimension – what actions are available and are fit for when?

4. Insurers getting into trouble – typical situations* • Poor risk management and governance • Failure to identify and manage risks arising from other entities in the group – group risk, large exposures • Lack of autonomy for companies belonging to a group • Dominant leaders and lack of independence and control • Inappropriate experience and skills of board members • Heard behaviour and wrong incentives through remuneration • Bad risk and corporate culture • Under-pricing and provisioning • Investment returns lower than provisioning or pricing assumptions • Impact of external events (eg changes in mortality) • Impact of catastrophic losses and other risk concentrations • Reputational damage (also caused by other companies in the group), resulting in further problems * HIH (2001), European failures (2002), GFC (2008)

5. Supervisory failings in seeing the problems • Weak risk rating process and insufficient analysis and on-sites to review institutions • Assumption that large and complex groups are always well-managed and controlled • Inadequate solvency requirements on entity and group level • Lack of resources and skills to understand: • adequacy of liabilities • risk management practices • correlations and interactions of risks • reinsurance arrangements • Lack of group-wide supervision and cooperation with other supervisors • Lack of macroprudential oversight and capturing of emerging risks • Lack of supervisory tools, especially intervention powers, or the will to use them

6. Group related issues • Increasing complexity of international groups • Risk management, corporate governance and internal control (coordinated, lack of independence/knowledge) • Non-regulated entities – how to deal with those, especially if in other jurisdictions? • Insolvency of one legal entity causing problems in other group entities • Inter-connectedness through intra-group transaction (reinsurance, loans, guarantees etc) – strength/contagion – pay attention in run off (not misused to the disadvantage of other entities) • Reputational risk spreading to other companies in the group • Differences in different countries: • Measurement of assets and liabilities • Regulatory capital requirements • Intervention processes/triggers and powers • Levels of defined insolvency/limit when it is no longer permissible to continue business • Bankruptcy proceedings and competing liquidators (and creditors) • Priorities given to policyholders or protection schemes • Ring-fencing – may prevent the free flow of capital from one entity/country to another (freezing of assets) • Take appropriate action before the non-viability stage • Coordination and cooperation arrangements • Effective supervisory colleges • Management of intra-group connectivity

7. Solvency and intervention levels • ICP 17 Capital adequacy: minimum solvency control/intervention levels • Prescribed capital level (PCR)* - proactive interventions on other grounds than capital inadequacy • Minimum Capital Requirement (MCR) – considerably deteriorated situation (assets still higher than liabilities) requiring strong reactivesupervisory action if corrective action has not already been taken • Reactive requirement of additional capital or reduction of risk when levels have been breached (react before the MCR level is reached) • Proactive capital add-ons • where risks are not reflected in the standardised capital requirement • Higher Loss Absorbency (HLA) for G-SIIs, reflecting the greater risk that they pose to the global financial system (non-traditional insurance and interconnectedness) • Supervisors need to have the power to take enforcement actions before it’s too late to do something about the problems * No connection for the moment to the BCR or the ICS

8. From viability to non-viability Recovery: Action of insurer/group to remedy the problems Resolution: Action of authority to deal with serious problems in an insurer/group that imperil the viability of the insurer/group

9. ICP 10 Preventive and corrective measures • Legal and operational capacity to act timely • Decision-making lines structured so that supervisory action can be taken immediately • In which situations? • Vulnerability in the insurer’s ability to protect policyholders • Preventing a breach of legislation • Non-compliance or unsound practices • Require insurer to develop an acceptable plan for prevention and correction of problems • Ensure that the measures are taken

10. Early prevention and detection tools/measures • Activities subject to prior approval (acquisitions, portfolio transfers, new lines of business etc) • Continual fit and proper requirements – also removal of unsuitable key persons • Sound corporate governance, internal control and risk management • Sound strategy • Prospective reporting and analysis • Increased supervisory activity or reporting • Independent reviews of auditors and actuaries • Business plan and strategy for new business • De-risking or additional capital - recovery plan • Stress testing of and by the insurers • Macro stress testing of insurance market by the supervisor • Cooperation and exchange of information with other involved supervisors • Informal contacts with management • Public disclosure/transparency

11. ICP 11 Enforcement • Formal directions to take (or desist) actions - failure to comply should have serious consequences (combine with fines and punitive actions) • Should at a minimum include • Restrictions on business activities • Measures to reinforce the financial position of the insurer • Consequences when failing to provide information in a timely fashion, withhold information or provide information that is intended to mislead • Powerful supervisory tools that should be used in a fair and equal manner • Not sufficient to have powers delegated under legislation (powerful tools are only powerful if used) – will to act • Issues related to groups? • Determine that the insurer is complying with the measures once action has been taken or measures have been imposed

12. Enforcement or sanction tools/measures • Restrict business activities • Stop the writing of new business • Withhold approval for new activities or acquisitions • Restrict the transfer of assets • Directions to reinforce financial position • Require capital levels to be increased or measures that reduce or mitigate risks • Restrict disposal of insurer’s assets • Restrict/suspend dividend or other payments to shareholders • Remove board members and senior managers - bar individuals from acting in responsible capacities in the future • Compulsory portfolio transfer or conservatorship • Revoke the licence – require the company to wind up • Direct a company to stop unlicensed business

13. Resolution at group level (only G-SIIs?) • Avoid disorderly failure that would disrupt the global financial system and economy • Resolution authority with powers to restructure and resolve financial institutions in crisis • Make resolvability assessment(feasibility of resolution strategies and their credibility) • Approach depends on the cause and status of the failure (company still deemed to have value and remedies available, egintra-group transactions, reinsurance, letters of credit?) • Appropriate powers to • intervene at holding company level • terminate financial contracts and write down liabilities (“bail-in”), including for insurance policies • transfer or sell assets and liabilities • ensure continuation of non-insurance operational business significant to the systemic function (shared critical functions) • Temporary public financial support may be needed

14. Cooperation and crisis management • Orderly resolution requires appropriate actions prior to the non-viability stage • Cooperate and coordinate crisis management and resolution actions across borders: • Group-wide supervisor and involvement of other relevant supervisors in a college – determine if single or multiple point of entry • Sustained recovery and resolution planning • Cross-border Crisis Management Groups (CMGs) – home and key host supervisors, central banks, resolution authorities and finance ministries • Unclear issues: • who decides when and are there clear triggers (also qualitative)? • are policyholders consulted and can they withdraw from the contracts? • is there a claims priority? • is it a transparent process?

15. Prevention Correction Recovery Sanctions Resolution Intervention Winding - phase up and exit from the market Supervisor Control over and Supervisory control increases; insurer management control reduces insurer insuranc e lose legal entity/ control group Viable Non - viable State of insurance legal entity/ group Trigger points and supervisory action ICS to correspond with the PCR – no MCR for the moment being PCR MCR (T)LAC? HLA BCR Group level?

16. ICP 12 Winding-up and Exit from the Market • Procedure for dealing with winding-up and insolvency • Appoint administrator or liquidator to take over the roles and duties of board and senior management • Run-off with direct on indirect supervisory involvement (depending on if solvent or insolvent) • Liquidation in court procedure • Protect the rights and entitlements of policyholders/beneficiaries in the event of insolvency • Preferential rights • Protection scheme/guarantee fund

17. Creditor hierarchy and preferential rights • In the case of a bankruptcy, assets will not be sufficient to cover the claims of all creditors • Legislation could define the order of preference and should in that case give policyholders a preferential treatment (others with special ranking are usually tax authorities or similar governmental bodies, staff, and creditors with pledge or mortgage in company assets • The rights could identify a specific asset or sets of assets, or be related to all assets in general • Take special measures to protect the assets identified for policyholder purposes (e.g. assets corresponding to the technical provisions)

18. Policyholder protection schemes (PPS) • Protecting policyholders in the event of winding-up • Considerations before establishing a PPS • Is there a need and who should the fund protect (life, non-life, compulsory etc)? • Size and concentration of the insurance market? Cross-border operations? • How will it be organised and governed (private or public, management and controls)? Cooperation between PPS and insurance supervisor (eg pre-warning)? • Which companies to involve (compulsory or optional membership, national or foreign)? • Basis of funding - ex-ante (fund) or ex-post (funding needs), fixed amount or risk profile - what to include (continuity of cover or compensation)? • How to handle claims – payment directly by PPS or indirectly through insurer/successor/liquidator? • Possible negative effects of PPS • Excessive risk-taking by insurers • Policyholders less vigilant in choosing and monitoring • Possibility for arbitrage (if not all insurers are members) • Market concentration and many insolvencies at the same time – insolvent PPS • Cost vs benefit (cost transferred to policyholders resulting in non-affordable products) • Not dealing with deeper weaknesses in the insurance industry or financial market, which are causing the insolvencies to happen • Can negative effects be mitigated?