Regulation and Risk Management for Cross-Border Insurance Groups

1. Regulation and Risk Management for Cross-Border Insurance Groups Terri M. Vaughan and Randi Woods Webber February 2015

2. The Agenda: Current Issues for Cross-Border Insurance Groups • Issues in regulation and supervision • Risk management in cross-border insurance groups

3. International Developments • Industry cross-border activity • Cross-border insurance groups • Reinsurance transactions • Capital management • Regulator cross-border activity • IAIS (1994) • Financial Sector Assessment Program (FSAP) • Financial Stability Board

4. Key Projects • Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) • Insurance Capital Standard (ICS) • Global Systemically Important Insurers (G-SIIs)

5. The Problem: Challenges in Supervising Internationally Active Insurance Groups (IAIGs) • Diversity in organizational structures • Complexity/transparency • Centralized functions • Diversity in markets • Insurance markets (products, concentration, capital markets, interconnectedness with banks, etc.) • Regulation/supervision: risk tolerance, regulatory culture and approach (principles-based vs. rules-based, relative emphasis on different tools) • Transparency in financial reporting • Concerns of regulators • Regulatory arbitrage/cross-border risks-shifting • Cross-border resolution • Level playing field??

6. FSB Membership Argentina: Central Bank of Argentina Australia: Department of Treasury, Reserve Bank of Australia Brazil: Ministry of Finance, Central Bank, Securities & Exchange Commission Canada: Department of Finance, Bank of Canada, OSFI China: Ministry of Finance, People’s Bank of China, CBRC (bank regulator) France: Ministry of Economy, Finance and Foreign Trade; Bank of France, Autorité des Marchés Financiers (AMF) Germany: Ministry of Finance, Deutsche Bundesbank, Bafin Hong Kong SAR: Hong Kong Monetary Authority India: Ministry of Finance, Reserve Bank of India, Securities & Exchange Board Indonesia: Bank Indonesia Italy: Ministry of the Economy and Finance, Bank of Italy, CONSOB (securities) Japan: Ministry of Finance, Bank of Japan, Financial Services Agency Korea: Bank of Korea, Financial Services Commission 

7. FSB Membership (cont.) Mexico: Ministry of Finance & Public Credit, Bank of Mexico Netherlands: Ministry of Finance, Netherlands Bank Russia: Ministry of Finance, Central Bank, Federal Financial Markets Service Saudi Arabia: Saudi Arabian Monetary Agency Singapore: Monetary Authority of Singapore South Africa: Ministry of Finance Spain: Ministry of Economy and Finance, Bank of Spain Switzerland: Swiss Federal Department of Finance, Swiss National Bank Turkey: Central Bank of the Republic of Turkey United Kingdom: HM Treasury, Bank of England, Financial Services Authority United States: Department of the Treasury, Federal Reserve, SEC  European Union: European Central Bank, European Commission International Financial Institutions: BIS, IMF, OECD, World Bank International Standard-Setting, Regulatory, Supervisory and Central Bank Bodies: BCBS, IOSCO, IAIS, IASB, CPSS, CGFS

8. International capital models in banking and for European insurance markets • The Basel Capital Accord • Basel I • Basel II • Basel III • Basel IV??? • European Solvency Regulation • Solvency I and the European Common Market • Solvency II

9. Issues • Basel II and Solvency II (pre-crisis) • Relative emphasis on consolidated capital requirements • Fungibility of capital: "Source of strength", "Group support" • Role of group supervisor • Valuation basis • Internal models vs. standard model • Reassessment following the financial crisis • Home vs. host conflict • Market consistent valuation • Internal models

10. ComFrame and the ICS: The debate • Emphasis on centralized processes, policies, risk management • Role of group-wide supervisor • Consolidated capital requirements • Reflecting local differences? • Standard vs. internal models • Valuation basis

11. The Range of Possibilities Global markets Local markets Single regulator Local regulators Free movement of capital “Balkanized capital”

12. Other considerations • Solvency II and equivalence • Impact on US firms doing business in Europe • Reinsurance collateral (A covered agreement?) • The effectiveness of the U.S. voice in international discussions • FSOC-designated firms • Prudential, AIG, MetLife • Others???

13. Principal International – A Real-World Example of Cross-Border Risk Management • Nine Business in Ten Countries • Types of Financial Services Businesses • Life Insurance • Annuities • Mandatory Pension • Voluntary Pension • Mutual Funds • Asset Management All have very different Risk Characteristics and Capital Needs

14. From a Risk Perspective, Looking at Capital without Reserves just Doesn’t Make Sense • Life Insurance typically has high reserves • Pension business usually holds Account Values • Mutual Funds and Asset Management hold zero reserves • A better measure would be the Total Assets Required to provide the level of solvency that the regulatory expects.

15. In Pictures…

16. The Application is More Challenging than the Theory • Capital is NOT Fungible • Dividends are taxable • Often, they require regulatory approval • Most regulators want “their” capital residing in “their” country • Solvency Requirements are not Consistent Across Jurisdictions • Supervisory Colleges raise local capital requirements instead of lowering them • Regulator demanded guarantees (separate accounts, ring-fencing of assets, etc.) can result in significant trapped capital.

17. How Does PFG Try to Influence Change? • Local Industry Groups • Conversations tend to be more technical • Local Regulators • Tend to be less educated • “Xerox” copy approach to regulation • If you’re a hammer, everything looks like a nail • US Industry Groups and Government Influence • International Groups