IAIS Releases Consultation Paper on Basic Capital Requirements for G-SIIs

On July 9, 2014, the International Association of Insurance Supervisors (IAIS) issued a public consultation document on Basic Capital Requirements (BCR). The BCR will apply to Global Systemically Important Insurers (G-SII). According to the IAIS, a key principle is that G-SIIs should be required to hold higher levels of regulatory capital than those not designated a G-SII. Comments on the public consultation document are to be submitted by August 8, 2014.

This proposal represents just part of the IAIS's work to develop capital standards for G-SIIs and for Internationally Active Insurance Groups (IAIG), pursuant to the directions from Financial Stability Board (FSB).

The IAIS is currently developing the following capital standards:

  • Basic Capital Requirements (BCR). This will apply to G-SIIs only and together with a company's higher loss absorption capacity (HLA) will form the group-wide capital requirement for G-SIIs on a consolidated basis (insurance and non-insurance entities). Development is to be completed by the end of 2014 with confidential reporting of the BCR to start in January 2015.
  • Higher Loss Absorption Capacity (HLA). The purpose of HLA is to reduce the probability a G-SII will fail by ensuring that G-SIIs have a higher share of their balance sheets funded by the types of capital that increase the company's resilience as a going concern. Initially, the BCR will be a foundation for HLA. Development is to be completed by the end of 2015. A consultation paper is scheduled to be released in December 2014.
  • Insurance Capital Standards (ICS). This is to be a risk-sensitive global standard that will apply to IAIGs. Its development is expected to be informed by the BCR. It is expected that the ICS will eventually replace the BCR and apply to G-SIIs as well as the foundation for HLA. Development is to be completed by the end of 2016.

The first of the standards to be developed, the BCR is now in its second consultation period. Its development has been part of the field testing conducted by the IAIS. Field testing began in March 2014 with 33 volunteer insurance groups.

According to the consultation document, the BCR will be calculated on a consolidated basis, meaning all holding companies, insurance entities, banking entities and other service companies will be included. The BCR will consist of three basic components:

  • Insurance (including non-traditional (NT) insurance activities);
  • Banking (applies the Basel III Leverage Ratio or the Basel III Risk-Weighted Assets requirements); and
  • Non-insurance financial and material non-financial activities.

According to the IAIS, the development was guided by six principles:

BCR Principle 1 - Major risk categories should be reflected

BCR Principle 2 - Comparability of outcomes across jurisdictions

BCR Principle 3 - Resilience to stress

BCR Principle 4 - Simple design and presentation

BCR Principle 5 - Internal consistency

BCR Principle 6 - Optimize transparency and use of public data

Some decisions have yet to be made. For example, the IAIS noted that, although "BCR Qualifying Capital Resources" include both "core" and "additional" capital, it has not determined whether both kinds will be assessed against the BCR Required Capital. The BCR ratio is equal to Qualifying Capital Resources for the BCR over Required Capital for the BCR. Some decisions remain about how Core Capital will be defined, including issues about Margin Over Current Estimate (MOCE) (the MOCE) reflects inherent uncertainty related to future cash flows) and how to define and handle non-qualifying reinsurance (i.e., whether agreements with unlicensed or non-registered reinsurers or those that do not include sufficient transfer of risk should be non-qualifying).

A Market Adjusted Valuation Approach is being used for the BCR for comparability reasons, but may be revisited when the ICS is developed. For now, the values are those reported by a G-SII on an audited, consolidated balance sheet on either an IFRS or GAAP basis. The IAIS indicates that not every balance sheet item will have to be revalued to a market-based methodology, but adjustments may be needed for insurance and reinsurance liabilities as well as for different financial instruments.

The document also indicates that resilience to stress has been difficult to assess because only static information has been available in field testing. This is will be considered further before the BCR is finalized.

The consultation document indicates that timeframe for development is causing practical difficulties. For example, while the document indicates that asset-liability matching (ALM) is a "major risk category," particularly for life insurance, the IAIS notes that the development timeframe posed a challenge for addressing this risk category. The IAIS ultimately determined that it would not be appropriate to include ALM in the determination of the BCR, given the "simple design" of the BCR formula.

The G-20 is expected to review and endorse the BCR proposal in November 2014. The IAIS recognizes that, after the G-20endorsement, it will be up to the legislative authorities in each jurisdiction to implement the BCR. In 2019, the ICS is scheduled to be applied to IAIGs and HLA, initially based on the BCR and later on ICS, is scheduled to begin applying to G-SIIs.