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IAIS Releases Consultation Paper on Systemic Risk

Wave Abstract-SF
January 03, 2018

In a press release dated December 8, 2017, the International Association of Insurance Supervisors (IAIS) released an interim public consultation paper on an activities-based approach to systemic risk in the insurance sector in accordance with its Systemic Risk Assessment and Policy Workplan previously announced on February 28, 2017. IAIS Executive Committee Chair Victoria Saporta stated, "With the release of this paper, the IAIS has taken a significant step forward in progressing its Systemic Risk Assessment and Policy Workplan." In accordance with this workplan, the IAIS is developing an activities-based approach to systemic risk in the insurance sector as part of the next 3-year cycle for reviewing its approach to systemic risk scheduled to conclude in 2019. Read the full paper.

The interim consultation paper is intended to provide an opportunity for stakeholders to give input into the development of an activities-based approach and feedback on the proposed steps that the IAIS will follow in its work on deriving activities-based policy measures. The paper does not include conclusive proposals on policy measures, as this will be the subject of the next phase of work in 2018. Respondents are asked to provide feedback by February 15, 2018.

At first glance, many in the captive insurance arena will be tempted to ignore the call for comments. The paper focuses on systemic risk inherent to the global insurance industry, and it is extremely unlikely that any captive insurer would ever be identified as a global systemically important insurer (G-SII). However, we would argue that captive insurers, at a minimum, should be aware of this work and, more importantly, should be active participants in providing responses.

The global insurance industry is likely to undergo significant changes in the next decade. A recent Deloitte report, 2018 Insurance Outlook, observes, "Insurance company leaders have a lot on their plates. Political and regulatory upheavals around the world are changing some of the ground rules about how carriers may operate." Regardless of how immune the captive insurance industry may believe it is from these changes, the truth of the matter is ultimately it will impact all participants.

Therefore, shouldn't captives look to help shape how some of these new rules and regulations are implemented? We would argue that a seat at the table is always preferable to looking in from the door. In this regard, the IAIS is specifically asking the global industry to weigh in on some of the major systematic risk issues it perceives as requiring attention. It is not inconceivable that some of the major European reinsurers may ultimately be subject to these rules. Hence, captives have at least some vested interest in how these regulations come into being. From a governance perspective, captives that participate can also generate discussion at their board level on how some of these risks could impact their organizations. We explored some of this in a prior article on Captive.com—"Reinsurance Markets, Captives, and Generative Thinking."

In the consultation paper, the IAIS lays out its approach to a new methodology—activities-based approach (ABA) to systemic risk versus the current entities-based approach (EBA). The IAIS uses an apropos analogy in describing the difference between the two methodologies. The EBA operates in a domino fashion, where the failure of one institution leads to a cascade causing additional failures down the line. However, the ABA can best be described as a tsunami event where the collective risks inherent in many of the global insurers propagate or amplify the systemic risk to the entire system. The ABA assesses systemic risk in aggregate across all the different firms. 

The IAIS starts its questions with this fundamental definition and asks respondents to comment on whether the ABA methodology, as outlined, makes sense and should be used instead of the EBA approach.

The paper then goes on to set forth the steps the IAIS is using to develop the ABA policy measures. The approach uses a four-step process, as follows.

  1. Identify activities that insurers engage in that have the potential to create systemic risk sufficient to threaten global financial stability.
  2. With these activities identified, step 2 looks at evaluating existing IAIS policy measures in terms of how they might mitigate the risk.
  3. Next, a gap analysis is undertaken to identify those residual systemic risks not adequately mitigated by existing IAIS policy measures.
  4. Finally, new policy measures or enhancements to existing policies would be developed to address these residual systemic risks.

The paper then identifies two systemic issues within the global insurance industry: liquidity risk and macroeconomic exposure risk. While beyond the scope of this article, the paper goes into substantial detail concerning both these risks and seeks additional input on these issues. In all, there are 31 questions posed within the policy paper the IAIS is seeking external input on. 

It would appear the IAIS is open to receiving comments on any and all of the questions raised. For captive insurers, this means they would not need to weigh in on each question if they did not feel they could contribute anything of importance. 

Even if captives do not provide any input whatsoever, just reading the paper and having an internal discussion concerning the questions raised would be an interesting governance exercise.

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