Jimmy Joyce - Society of Actuaries in Ireland

Regulation – Revolution or
Reformation
Society of Actuaries in Ireland
24 April 2002
J Joyce

The Changing Regulatory Scene
in Life Assurance
• National
Unified Supervision of Financial Services
• EU ) Financial Reporting
• International ) Solvency Supervision
• Impact on Life Assurance Regulation

Central Bank and Financial Services
Authority Bill 2002
• McDowell Report
• Society of Actuaries’ Views
• Monetary Functions / Financial Services Supervision
• Prudential / Market Supervision

Irish Financial Services Regulatory
Authority
• Structure
• Unified Supervision of Financial Services
• Banking and Insurance – Contrast
• Regulatory Style – Business Based or Risk Based
• Lessons from British Financial Services Authority
• Implications for Life Assurance Supervision

Present Basis of Life Assurance Regulation
• Financial Reporting
• Solvency Supervision
• Modified Statutory
• Deferral and Matching
• Income and Expenditure based
• EU Life Directives
• Market Value of Assets
• Diversification & Admissibility
Rules
• Prudent Valuation of Liabilities
• Prudential Margins
• Solvency Margins
Professional Input
Auditor
Appointed Actuary
Why Change

Why Change
• Financial Reporting
Understandable / relevant/ reliable
Comparable across
– time
– companies
– institutions
Is Insurance Special
To Reflect Reality
- Market Based
- Balance Sheet Based
• Solvency Supervision
To Reflect Reality
- Based on Financial Reports
- Transparent Capital Adequacy
- Risk Based Capital
Consequences
- Profit
- Volatility

Financial Reporting
• All listed EU Companies to use International Financial
Reporting Standards (IFRS) by 2005
– including insurers and banks
– EU regulations by end 2002
– International Accounting Standards Board (IASB)
project on Insurance Accounting
Draft statement of Principles 2001
Exposure Draft 2002
Final Draft 2003
Implementation 2005

Fair Value
Fair Value is the amount for which an asset could be
exchanged or a liability settled between knowledgeable,
willing parties in an arms length transaction.
Why Fair Value
Accounting rather than actuarial
Accounting Principles - understandability, relevance,
reliability,comparability.
Actuarial Principles - asset/liability approach
- market based assessment

Issues for Long Term Insurance
– Definition of insurance contract
– Optionality in benefits
– Dependence of benefits on assets held
– Allowance for future premiums
– Practical issues (market information, calculation)

Insurance IAS – Will it happen
• Exposure Draft still incomplete
– IASB March meeting did not reach even a tentative
conclusion on deferral / matching versus asset / liability
for “performance reporting” of insurance contracts

Insurance IAS – Will it happen …
• Letter from US, German and Japanese life assurance trade
bodies to IASB
– Approach eliminates ability of management and stakeholders to
focus on operating results
– Approach will produce misleading and deceptively volatile results,
s,
not related to underlying economics or future cashflow
– Volatility could cause policyholders to take actions not in their r best
interest
– Stockholders will make inappropriate judgements on the real
stability of insurers
Parallels with FRS 17

Financial Reporting Questions
• EU decision for 2005
– Can deadline be met for insurance companies
– If not, can Insurance Accounts Directive continue to
apply
• Readiness for Fair Value Reporting
– Listed insurers
– More general application

Prudential Supervision
Changes in Course of Implementation
• Solvency 1 Exercise
• EU Directive of March 2002
– Minimum Harmonisation
– Early Intervention
– Indexation of Minimum Guaranteed Fund
– Items eligible for Solvency Margin
– Unit Linked Business
– Permanent Health Insurance
– Reinsurance
– Deteriorating Financial Position

Solvency I
Solvency II
Why Solvency II
• Criticisms of Current Approach
– Lack of transparency
– Narrow scope of risks considered
– Insensitivity to company specific risk profiles
– Need for convergence of prudential rules across sectors
– Integration with financial reporting
• Parallel Work at international level
– International Association of Insurance Supervisors
– International Actuarial Association

Solvency II Process (1)
• Initiated by EU Commission / Insurance Committee.
• Solvency II Working Group
– Formation of specialist groups
– Consultancy Study (methodologies to assess the overall financial
position of an insurance undertaking from the perspective of
prudential supervision)
– Review of the prudential system in Banking (New Basle Accord)
– Review of Risk Based Capital systems
– Consideration of Prudential Regimes in EU
– Template for new EU systems by end 2002

Solvency II Process (2)
• Specialist Groups
– Restricted Working Groups on Technical Reserves
– Conference of Insurance Supervisors Group
» Risk interrelationship analysis
» Regulatory breaches
» “Near misses” analysis
» Case studies
» Diagnostic / preventative / curative tools
» Preliminary conclusions

New Basle Accord
• Three Pillar Approach
– Minimum capital requirement
– Supervisory review process
– Measures to foster market discipline
• Minimum Capital Requirements
– Credit risk
– Market risk
– Operational risk
• Determination of Capital Requirements
– Standardised approach
– Internal models

IAA Principles for Prudential Regulation
• Prudential reporting requires margins in excess of those in
general purpose accounts
• Excess margins should be transparent
• Capital requirements should relate to risks not to provider
(bank, insurer etc)
• Prudential supervision should encourage / reward good
risk management
• Capital requirement should take account of assets held and
policy options
• There should be trigger points to act as warning signs

Future Prudential Reporting
General purpose
Regulatory accounts
Free Assets
Shareholder Equity
Prudential
Margins (risk
based capital)
GAAP Margins
Required Regulatory Assets
Fair Value Liability
Best Estimate
Liability

Final Thoughts
• Timescale
• Policy for Irish Regulator
• Implications for Irish Regulator
• Revolution or Reformation