The International Association of Insurance Supervisors (the “IAIS”) has announced the second of what is intended to be a triennially updated “assessment methodology” for identifying global systemically important insurers (“G-SIIs”). In a new paper, “Global Systemically Important Insurers: Updated Assessment Methodology,” issued on June 16, the IAIS updates the first such methodology, published in 2013, and states that the next version is expected to become effective in 2019. The 2016 methodology was proposed in November 2015 in a public comment solicitation.

The “Updated Assessment Methodology” release was accompanied by a companion paper issued the same day, “Systemic Risk from Insurance Product Features” (the “Companion Paper”). The Companion Paper analyzes how certain features of insurance products, and the investment and risk-management practices used by an insurer related thereto, may contribute to systemic impact upon the failure of the insurer. Among other things, the two papers explain the IAIS’s abandonment of the concept of “Non-Traditional Noninsurance” (“NTNI”) and its replacement with a new framework for analyzing risk-transmitting insurance products as part of the updated assessment methodology.

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Generally, the IAIS, a standard-setting body comprising insurance regulators in multiple jurisdictions across the world (including the National Association of Insurance Commissioners and its 56 U.S. jurisdictions), issues three levels of insurance regulatory guidelines, each applying to a progressively narrower subset of insurers. Insurance Core Principles, or ICPs, apply to all insurers. Insurers that are “internationally active insurance groups” (“IAIGs”) fall under the Common Framework for the Supervision of IAIGs, or ComFrame, which focuses on groupwide risks. Narrower still, the assessment methodology issued on June 16 is intended to identify those insurers “whose distress or disorderly failure would potentially cause significant disruption to the global financial system and economic activity, i.e. global systemically important insurers (G-SIIs).”

The new methodology to determine if an insurer should be classified as a G-SII comprises five phases and will be carried out on an annual basis.

In Phase I, the IAIS will collect data from insurers, including both primary insurers and reinsurers, that meet at least one of the following criteria:

  • Total assets of more than US$60 billion and a ratio of premiums from jurisdictions outside the home jurisdiction to total premiums of 5% or more.
  • Total assets of more than US$200 billion and a ratio of premiums from jurisdictions outside the home jurisdiction to total premiums greater than 0%.

Generally, this will represent approximately the world’s 50 largest insurers. This data solicitation will occur by early April each year.

During Phase II.A., insurers submit data to the relevant regulatory authorities by mid-May each year. After verifying this data for each insurer, the IAIS will use the data to calculate scores for each of the 17 indicators set forth below, which are multiplied by the respective weights and then summed to an overall score for each insurer.

The 17 indicators, with their respective weighting factors, are as set forth in the table below. 

Click here to view table.

Note 1. These indicators were once included within the NTNI category and are now included as separate items.
 
Note 2. The three indicators for Financial Guarantees, Derivatives Trading (CDS or similar derivative instrument protection sold) and Reinsurance, for the 2016 methodology, now use so-called absolute reference values to “better assess systemic importance of the [insurer universe] within the broader insurance sector or financial system” as opposed to assigning values for these indicators that are insurer-specific. The IAIS explains that these indicators, when insurer-specific, do not effectively reflect the sectorwide trends in these areas since the financial crisis. Accordingly:

  • The absolute reference value for Financial Guarantees is the ratio of the current par value of structured finance bonds insured relative to the average annual total from 2005 to 2007.
  • The value for Derivatives Trading (CDS or similar derivative instrument protection sold) is the ratio of the total current global CDS market to the total global CDS market in 2007.
  • For Reinsurance, the value (which applies only to certain insurers with “significant third-party reinsurance activities”) equals the net premiums for the third-party reinsurance premiums of such insurers divided by global third-party reinsurance sector net premium.

Note 3. In a change from 2013, the IAIS will deduct from the Minimum Guarantees on Variable Products indicator an amount equal to the portion of the Derivatives indicator attributable to hedging instruments entered into by the insurer to hedge the risk of minimum guarantees. This is intended to eliminate double counting of derivatives used to hedge such exposures.

Note 4. This indicator considers the penalties associated with making withdrawals from or surrenders of insurance products and the time restraints imposed on policyholders for surrenders.

Note 5. In the Companion Paper, the IAIS writes that the following factors should be considered when applying supervisory judgment in the interpretation of the score on this indicator – (i) the degree to which liabilities of firms are cash flow-matched in practice and (ii) the derivatives to hedge guaranteed returns for variable products.

Note 6. In the Companion Paper, the IAIS writes that the following factors should be considered when applying supervisory judgment in the interpretation of the score on this indicator – (i) the purpose of the policy; (ii) the surrender value relative to market value of underlying assets; (iii) the supervisory interventions: stays and lowering surrender value; (iv) the maximum contractual stays; (v) the replacement of cover; (vi) the tax penalties; (vii) the existence of policyholder protection schemes and mechanisms; (viii) the liquidity of assets; and (ix) the derivative collateral requirements. 

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Using these scores, in Phase II.B. the IAIS sets a quantitative threshold for purposes of determining those insurers that will move on to Phase III. The threshold will be set in a manner consistent with statistical measures of central tendency and with comparisons of systemically important firms in other sectors, and taking into account trends for the particular potential G-SII.
 
During Phase III, the IAIS and the relevant authorities will gather and analyze additional quantitative or qualitative information not captured in Phase II indicators and will perform a “more nuanced” assessment of the insurer as measured by these indicators. For these purposes the IAIS may request additional information from the insurer.
 
Factors receiving particular attention in Phase III include data on large exposures and data on intragroup commitments, cross-sectoral assessment such as CDS sold outside of the insurance sector and comparisons to the broader financial sectors, and analysis of counterparties and interconnections. Among other things, the IAIS will consider, in addition to gross notional value, the insurer’s net fair value and potential future exposure from derivatives transactions.
 
As part of this “more nuanced” assessment in Phase III, the Companion Paper details the assessment’s replacement of the NTNI category with certain analytical approaches to govern the more qualitative features of the assessment. The Companion Paper considers the utility of the three principles set forth in the companion paper to the IAIS’s 2013 assessment methodology with respect to what constitutes an NTNI product. In the 2013 companion paper, the IAIS set forth the following three principles with respect to determining NTNI products:

  • Products providing credit guarantees to financial products can be considered NTNIs.
  • Products that expose the insurer to substantial market and liquidity risk, such that the insurer is required to have a more complex risk-management practice and use derivatives to hedge such risk, can be considered NTNIs.
  • Capital market activities that result in maturity or liquidity transformation, leverage, or imperfect transfer of credit risk beyond the scope of traditional insurance activities can be considered NTNIs.

The new Companion Paper notes that since the IAIS has ceased to use the NTNI concept, the first two principles will no longer be used and are superseded by the more detailed discussion of “macroeconomic exposure” and “substantial liquidity risk” found in the Companion Paper. “Macroeconomic exposure” is similar to the 2013 paper’s use of the term “substantial market risk” in that both refer to the systemic risk that the broader financial system poses for individual insurers. However, macroeconomic exposure, unlike substantial market risk, integrates the concept of transmission channels for systemic risk (i.e., the channels by which an insurer’s losses can be transmitted to third parties).

At the conclusion of Phase III, the IAIS will generate a list of prospective G-SIIs, each of which will be invited to participate in Phase IV of the 2016 methodology.

In Phase IV, the IAIS and the relevant authorities will offer any insurer on the preliminary G-SII list an opportunity to exchange information with the IAIS. In advance of this exchange, the IAIS will share confidentially with the prospective G-SII information regarding that insurer’s status through the first three phases. The IAIS will inform the prospective G-SII of (i) the insurer’s score on each of the Phase II indicators, (ii) descriptive statistics for each Phase II indicator, including the median scores and the distribution of scores within the insurer universe (unless such disclosures could reveal confidential information regarding another insurer), (iii) the insurer’s overall score and the Phase II quantitative threshold set by the IAIS, and (iv) the data and analysis that were considered by the IAIS when evaluating the insurer in Phase III and the outcome of that analysis. This information-sharing was not contemplated by the 2013 methodology. During this exchange, the prospective G-SII may ask questions and present additional information relating to any aspect of the 2016 methodology.

Following the annual completion of Phases I-IV of the 2016 methodology, the IAIS will recommend a list of identified G-SIIs to the Financial Stability Board (the “FSB”). This recommendation will include the analysis supporting that recommendation and the application of “higher loss absorbency” (“HLA”). Generally, HLA refers to an incremental level of required capital to be imposed on G-SIIs, addressed under other IAIS publications. The FSB then determines whether to accept the IAIS recommendation and whether and when to publish the recommendation. The IAIS will recommend to the FSB that an insurer be identified as a G-SII the first year that the 2016 methodology produces that outcome, and such identification will create a two-year minimum presumption of G-SII status regardless of whether the assessment conducted in such subsequent years indicates that the insurer is no longer a G-SII.