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Evolving Insurance Regulation

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					    financial services



   Evolving
 Insurance
Regulation
   On the move...
     March 2011

    kpmg.com
Giles Williams                        Jim Low                                Simon Topping
Partner                               Partner                                Principal
financial services                    financial services                     financial services
regulatory centre                     regulatory centre                      regulatory centre
of excellence                         of excellence                          of excellence
eMa region                            americas region                        asPac region
KPMG in the UK                        KPMG in the Us                         KPMG in china




About this report
This report was developed by KPMG’s
network of regulatory experts. The insights
are based on discussions with our firms’
clients, our professionals’ assessment of
key regulatory developments and through
our links with policy bodies.

We would also like to thank members of
the editorial and project teams who have
helped us develop this report:


Editorial team
Rob Curtis                            David Sherwood                         Martin Noble
Director                              Us Head of insurance                   senior Manager
insurance                             regulatory                             insurance
financial services                    financial services                     financial services
regulatory centre                     regulatory centre                      regulatory centre
of excellence                         of excellence                          of excellence
eMa region                            americas region                        asPac region
KPMG in the UK                        KPMG in the Us                         KPMG in china



Project team
Giles Williams, KPMG in the UK
clive Briault, KPMG in the UK
amber stewart, KPMG in the UK
Patricia Wylie, KPMG in the Us




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                             Contents
                                                                             Foreword                                                                                                                                              2

                                                                             Executive Summary                                                                                                                                     4

                                                                             The International Association
                                                                             of Insurance Supervisors (IAIS)                                                                                                                       6

                                                                             1. Capital adequacy including internal models                                                                                                         8
                                                                                Perspectives: ASPAC

                                                                             2. ORSA – ERM revisited                                                                                                                            16

                                                                             3. Accounting, valuation and disclosure                                                                                                            22

                                                                             4. Investments and liquidity                                                                                                                       26
                                                                                Perspectives: Europe

                                                                             5. Governance and internal controls                                                                                                                34

                                                                             6. Customer treatment                                                                                                                              36

                                                                             7. Group-wide and cross-border supervision                                                                                                         40
                                                                                Perspectives: Americas

                                                                             8. Systemic risk                                                                                                                                   48

                                                                             9. ComFrame                                                                                                                                        52

                                                                             Acknowledgements                                                                                                                                   56




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
Foreword
Welcome to our first edition of Evolving Insurance Regulation.                                                                                               although the insurance sector is
                                                                                                                                                             sometimes described as having had a
This publication is part of a series which started with the Evolving
                                                                                                                                                             ‘good crisis’, this masks two key issues.
Banking Regulation reports published in november 2009 and                                                                                                    first, a small number of global insurers
november 2010.                                                                                                                                               and reinsurers encountered substantial
                                                                                                                                                             difficulties through their participation in
   Taking a fresh look at the various regulatory reform initiatives
                                                                                                                                                             non-insurance activities, such as their
in the insurance sector, this report explores what the future                                                                                                trading in structured credit products and
regulatory landscape looks like, and what implications this has                                                                                              credit default swaps. Monoline credit and
                                                                                                                                                             bond guarantee insurers, which have
for insurance firms.
                                                                                                                                                             a different business model to other
                                                                                                                                                             insurers, also experienced significant
                                                                                                                                                             losses from their exposures to residential
                                                                                                                                                             mortgage-backed securities. in the life
                                                                                                                                                             insurance sector, falls in the sale of unit-
                                                                                                                                                             linked and single premium life insurance
                                                                                                                                                             products were accompanied by significant
                                                                                                                                                             declines in share prices.
                                                                                                                                                                second, the financial crisis has
                                                                                                                                                             highlighted the need for more effective
                                                                                                                                                             corporate governance and risk
                                                                                                                                                             management in all types of financial
                                                                                                                                                             institutions. it has reinforced the moves
                                                                                                                                                             towards a more risk-based approach to
                                                                                                                                                             solvency in insurance firms. in addition
                                                                                                                                                             a number of inadequacies in supervision
                                                                                                                                                             and regulation have been exposed,
                                                                                                                                                             including:
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                              evolving insurance regulation | March 2011 | 3




• The focus of regulation being too                                          The international association of insurance                                     so, are we ready for the journey?
  concentrated at the individual firm level                                  supervisors (iais) will introduce a new                                        We believe the industry is ready. There
  and not enough attention on group risk,                                    suite of insurance core Principles                                             is considerable focus on the future of
  and at the macro-level;                                                    from October 2011, which will have a                                           business models, the nature of the
• a lack of oversight and monitoring of                                      significant impact on the form and extent                                      products, the asset allocation strategy
  non-regulated subsidiaries/activities;                                     of prudential regulation globally. These                                       and changes to governance and systems.
• legal and legislative limitations                                          changes – and their implications for                                           Understanding the changing regulatory
  on insurance group supervision;                                            insurance firms – are the core focus                                           landscape and linking to the strategic
• limitations in the quality and content                                     of this report. We welcome these                                               changes has never been more important.
  of supervision;                                                            initiatives, particularly the moves by                                         firms that embrace the regulatory changes
• a lack of coordination of responsibilities                                 the iais to introduce greater regulatory                                       and are actively involved in shaping the
  and an absence of coordination                                             convergence and consistency especially                                         new reforms, stand to gain a competitive
  mechanisms among supervisors; and                                          for internationally active insurance                                           advantage and will be best prepared to
• a lack of effective tools to identify                                      groups, through the comframe project.                                          meet the new challenges ahead.
  and minimise regulatory arbitrage on                                       We estimate that the additional cost of
  a cross-sector and cross-border basis.                                     regulation to the global insurance sector,
                                                                             from having bespoke requirements
regulatory reform initiatives to address                                     in each jurisdiction, is currently in the
these shortcomings are in development.                                       region of Us$15bn–$25bn.
    However, it is not the financial                                             The regulatory initiatives currently
crisis alone that has inspired insurance                                     underway build on the modernisation
regulators across the globe to review                                        of solvency regimes that regulators
their regimes. The evolution of the                                          had been implementing, to shift from
industry is also playing a key role in                                       ‘tick-box’ regulatory measures towards                                          Jeremy Anderson
influencing the outcome. for example,                                        creating an environment where prudential                                        Global chairman
in developed markets, the introduction                                       standards reflect better the risks faced                                        KPMG’s financial services practice
of more sophisticated products,                                              by insurance firms on both sides of their
risk management techniques, and                                              balance sheets; and where insurance
complex financing structures impacts                                         firms have stronger incentives to
the regulators’ approach. improved                                           understand and manage their risks and
accessibility to emerging markets,                                           their financial resources.
and their gradual penetration by the                                             Moreover, some of the largest insurance
international players is already shaping,                                    firms may find themselves regarded by
and will continue to inform, local                                           their regulators as being systemically
regulatory reform. further, while much                                       important, and therefore subject to
focus has been on prudential regulation                                      additional regulatory requirements on                                           Frank Ellenbürger
and within this risk and capital                                             their financial resources and on their                                          Global Head of KPMG’s insurance practice
management, the conduct of business                                          recovery and resolution plans.
agenda is also a key feature, with                                               These issues are now the subject of
regulators needing to strike a balance                                       significant debate and development by
between the two in satisfying the                                            regulators and the industry. significant
overall consumer protection objective.                                       changes to solvency regulation are very
as regulators of largely domestic-only                                       likely to be the focus of much work going
markets move away from product                                               forward. in this report, we discuss the
regulation and tariffs, then the need                                        likely shape of reforms to come; what it
for more attention on risk-based                                             will mean for prudential regulation world-
supervision and enhanced consumer                                            wide; and the likely impact on the global
buying safeguards is self-evident.                                           insurance sector.
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
Executive Summary
The financial crisis has understandably sparked significant regulatory                                                                                       common themes emerging from the
                                                                                                                                                             international regulatory developments
action. The G20, financial stability Board (fsB) and Joint forum
                                                                                                                                                             include:
have been active in reviewing the regulatory framework for banks,                                                                                            • The move towards more risk-based
and such analysis has invariably flowed across to insurance. The                                                                                                approaches to capital and solvency
                                                                                                                                                                measurement;
international association of insurance supervisors (iais) has responded
                                                                                                                                                             • a greater focus on risk management
by accelerating its plans to promote common regulatory standards                                                                                                and governance;
and greater international cooperation.                                                                                                                       • increased use of stress and scenario
                                                                                                                                                                testing; and
   at the regional and national level, the crisis continues to influence
                                                                                                                                                             • Group supervision.
the debate in parts of asia, europe and north america regarding
the appropriateness of local prudential regulatory requirements and                                                                                          insurance supervisors are seeking to
                                                                                                                                                             harmonise the approach to each of these
existing policyholder protection regimes. There is a diverse range
                                                                                                                                                             themes and to increase cooperation and
of regulatory approaches across the regions, reflecting for the most                                                                                         coordination through formal mechanisms.
part the maturity of the respective markets. for example in some                                                                                             These include memorandums of
countries, regulators’ focus has historically been on product, tariff                                                                                        understanding and the development
                                                                                                                                                             of a project within the iais to build a
and conduct of business regulation, whereas in others, greater                                                                                               common framework for the supervision
freedom has been given with the emphasis on risk and solvency                                                                                                of internationally active insurance groups.
regulation. as markets evolve and their uniformity gradually                                                                                                 in our chapter on ComFrame, we outline
                                                                                                                                                             this framework and the significant
increases, regulatory regimes look set for greater convergence,                                                                                              efficiencies that could be gained by such
over time.                                                                                                                                                   reforms which should greatly reduce the
                                                                                                                                                             cost of regulation.
                                                                                                                                                                 in October 2010 the iais endorsed a
                                                                                                                                                             new suite of solvency, governance and
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                              evolving insurance regulation | March 2011 | 5




group principles, standards and guidance,                                    The Us has commenced its own reforms                                            conduct of business regulation. These
covering capital adequacy and internal                                       with the solvency Modernisation initiative                                      developments will increasingly force
models, enterprise risk management,                                          (sMi); such developments are more                                               insurers to re-evaluate which parts of
investments, systems and controls and                                        aligned to the iais’s new insurance core                                        the value chain to focus on. furthermore,
group supervision. The impact of these                                       Principles concerning solvency and group                                        merger and acquisition activity looks set
will have profound consequences for                                          supervision mechanisms outlined in the                                          to increase as insurers seek to modify
both insurance supervisors and the                                           Americas Perspective. in asia Pacific,                                          their portfolios as well as acquire key skills.
insurance industry. The introduction of                                      an area of significant focus for inward                                             as group supervision gathers pace, it is
a revised version of the iais’s insurance                                    investment by many international                                                causing insurance groups to review their
core Principles in October 2011 heralds                                      insurance groups, regulators are very                                           operating models, to enable a consistent
a significant step towards achieving                                         much aware of developments in risk and                                          approach to risk and capital management
international convergence and consistency                                    capital management in europe and by                                             across the group and enhance the quality
in regulatory requirements.                                                  the iais; and as examined in our ASPAC                                          and timeliness of business decision-making.
    at a global level, insurance regulators                                  Perspective, most have already effected                                         approaches to the use of internal models
are moving towards ensuring that                                             or are considering significant change.                                          are evolving and this will continue for some
insurance firms are adequately capitalised                                       Despite the iais developments of                                            time, as will the need for cultural change
with risk-based capital requirements as                                      general convergence and the current lack                                        to enable insurers to optimise through
we discuss in our chapter on Capital                                         of a formal global mandate in insurance                                         effecting more dynamic approaches.
adequacy; requiring valuations of assets                                     regulation, the diversity of local markets                                          Many international groups (in europe
and liabilities to be on a consistent and                                    means that regulators’ approaches will                                          in particular, as a consequence of
economic basis discussed in Accounting,                                      still be localised. Over time we expect to                                      solvency ii) are already considering,
valuation and disclosure; and preparing                                      see a greater uniformity in regulatory                                          if not yet implementing, large scale
the way for insurance firms to use their                                     approach to capital, risk and governance                                        strategic structuring and organisational
own internal models to calculate capital                                     arrangements in global markets, as                                              change programmes. This is taking the
requirements. These internal models will                                     internationally active insurance groups                                         form of the creation of ‘supercarriers’
be subject to stringent standards and prior                                  develop their presence in emerging                                              (the use of branch structures) to realise
supervisory approval that should provide a                                   markets.                                                                        capital diversification benefits that may
better reflection of risks than a common                                         This report highlights the major                                            not be tangible at group level, reviewing
standard formula. as we argue in our                                         changes already agreed in solvency                                              capital structures and simplifying and ring-
chapter on Group and cross-border                                            standards, governance and supervision –                                         fencing regional sub-groups to manage
supervision, the introduction of group                                       particularly group supervision. We also                                         group risk to local entities. a key aim of
supervision through the application of                                       examine the current debate concerning                                           the current structural change is to mitigate
these initiatives at group level is a key step                               Systemic risk, the new regulatory                                               the extent to which the global group
change in the overall regulatory approach.                                   common framework now being created                                              has to deal with multiple supervisors’
    such initiatives at the international level                              for internationally active insurance groups                                     requests for information as they introduce
complement the significant efforts by                                        and the likely impact this may have for                                         group supervision – this makes the iais’s
many jurisdictions in further strengthening                                  insurance groups world-wide.                                                    proposals for a common framework for
their own local requirements.                                                    The regulatory developments set                                             international groups particularly attractive.
    in europe, solvency ii is driving further                                to take place across the global industry                                            it is not only regulators who are setting
prudential regulatory harmonisation. This                                    over the coming years represent an                                              the agenda, rating agencies and analysts
could eventually be extended to non-eU                                       unprecedented and fundamental change                                            will inevitably also play a role in influencing
countries as a result of the increased                                       in the approach to regulation. The impact                                       the outcomes. This will be reinforced
emphasis on group supervision and the                                        will extend beyond mere compliance                                              through the increased emphasis on
concept of ‘equivalence’ which is part                                       changes and will strike at the heart of                                         transparency and disclosure that
of the debate in our Europe Perspective.                                     the business agenda. The requirement                                            fundamentally underpins the regulatory
in addition, europe plans to introduce                                       for the creation of shareholder value                                           change and puts regulation increasingly
greater harmonisation of conduct of                                          will mean insurers have to revise their                                         high on the competitive agenda.
business regulation which has a direct                                       business models, reassessing where                                                  regulation is clearly on the move on
impact on Customer treatment.                                                capital is deployed, in which geographic                                        many levels and the challenge has been laid
Two new directives (Packaged retail                                          markets and product lines to operate, and                                       down to the sector as a whole. for many
investment Product services directive                                        how best to redesign their products to                                          insurers these changes are now beginning
and the insurance Mediation Directive 2)                                     take account of new capital requirements.                                       to rank more highly on the strategic agenda,
are in development with anticipated                                          new risk transfer mechanisms and                                                and those firms that embrace the change
implementation dates following the                                           financing structures will emerge, as well                                       within the business will inevitably reap
introduction of solvency ii in 2013.                                         as new distribution models with evolving                                        the rewards in years to come.
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
The International
Association of Insurance
Supervisors (IAIS)
A new global framework

The iais was established in 1994 with the broad aim of harmonising
international insurance regulatory requirements. it acts as a forum
for insurance supervisors to discuss developments in the insurance
sector and topics affecting insurance regulation. The iais has now
grown to represent 190 insurance supervisory jurisdictions and is
the world standard setter for insurance.
   since 1999, insurance professionals comprising industry
associations, insurers and reinsurers, consultants, professional
associations and international financial institutions have been able
to join the iais as observers. The iais currently has more than
120 observers.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                              evolving insurance regulation | March 2011 | 7




as an international standard setter,                                         The significance of the IAIS and                                                The new suite of IAIS solvency
the iais issues insurance principles,                                        FSAP process                                                                    standards essentially requires
standards and guidance papers,                                               The iais principles, standards and
which apply to all member supervisory                                        guidance apply to individual insurance                                          supervisory regimes world-wide
authorities. The iais also works closely                                     supervisors who are members of the                                              to establish risk-based solvency
with other standard setters, notably:                                        iais. national regulators are expected                                          requirements.
• The Basel committee on Banking                                             to implement the insurance core
  supervision (BcBs)                                                         Principles (icPs) produced by the iais.
• european insurance and Occupational                                        The new icPs, which become effective
  Pensions authority (eiOPa)                                                 in October 2011, apply to insurance
• european commission, insurance area                                        legal entities and insurance groups
• financial stability Board (fsB)                                            unless otherwise stated. While they
• international accounting standards                                         do not apply to non-insurance entities
  Board (iasB)                                                               (regulated or unregulated) within an
• international actuarial association                                        insurance group, they will apply to
• international Monetary fund (iMf)                                          insurance legal entities and insurance
• international Organisation of securities                                   groups with regard to the risks posed
  commissions (iOscO)                                                        to them by non-insurance entities.
• Organisation for economic                                                      The new suite of iais solvency
  cooperation and Development (OecD)                                         standards essentially requires
• The Joint forum                                                            supervisory regimes world-wide to
• The World Bank                                                             establish risk-based solvency
                                                                             requirements. These standards reflect
The iais also provides its members with                                      a total balance sheet approach on an
training and support on issues related to                                    economic basis, which address all
insurance supervision, and organises                                         reasonably foreseeable and relevant
meetings and seminars for insurance                                          material risks.
supervisors.                                                                     even though the iais standards,
                                                                             through the icPs, currently take the
                                                                             form of high-level principles-based
                                                                             requirements, they nonetheless require
                                                                             all supervisors to enact the requirements
                                                                             into their local supervisory frameworks.
                                                                             if they do not they risk receiving an
                                                                             adverse finding from the iMf/World
                                                                             Bank who conduct the financial sector
                                                                             assessment Programme (fsaP)
                                                                             reviews.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
01

Capital adequacy
including internal
models
Raising standards

risk-based solvency regimes for insurers have existed since the                                                                                              Capital adequacy
                                                                                                                                                             However, risk-based capital regimes
1990s, with examples currently found in north america, parts
                                                                                                                                                             differ greatly between countries.
of europe, australia, and several other asia Pacific countries.                                                                                              Historically they have been mostly
from 2013, the european Union (eU) will implement a harmonised                                                                                               factor-based, and factors often do not
                                                                                                                                                             vary by company, although some vary
risk-based capital framework (solvency ii) across the european
                                                                                                                                                             by volume of business or level of asset
economic area (eea), while switzerland, Bermuda, south africa                                                                                                concentration. When setting an insurer’s
and Mexico are also in the process of modernising their solvency                                                                                             solvency capital requirements, risk-
                                                                                                                                                             based capital regimes typically measure
frameworks along similar lines.
                                                                                                                                                             asset risk, insurance risk, and business
                                                                                                                                                             risk. recently, many risk-based capital
                                                                                                                                                             regimes have increased the scope of
                                                                                                                                                             risks considered when setting capital
                                                                                                                                                             to include credit risk, market risk and
                                                                                                                                                             operational risks.
                                                                                                                                                                in addition to these capital
                                                                                                                                                             requirements, many regulatory
                                                                                                                                                             frameworks are beginning to include an
                                                                                                                                                             enhanced enterprise risk Management
                                                                                                                                                             (erM) framework that considers the
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                              evolving insurance regulation | March 2011 | 9




organisational structure of risk                                             The standard requires all solvency                                              supervisor would invoke its strongest
management, governance, reporting,                                           regimes to establish regulatory capital                                         actions, in the absence of appropriate
disclosure and transparency requirements,                                    requirements at a level sufficient to                                           corrective actions by the insurance legal
as well as considerations for group risks.                                   ensure that, in adversity, an insurer’s                                         entity. This is referred to as the Mcr.
increasingly risk-based capital regimes                                      obligations to policyholders will continue                                      The Mcr is subject to a minimum bound,
are also employing scenario and stress                                       to be met as they fall due. it requires that                                    below which no insurer is regarded to be
testing requirements.                                                        insurers maintain capital resources to                                          viable to operate effectively. The interplay
   in europe, the solvency ii programme                                      meet the regulatory capital requirements.                                       between the new capital requirements
will fundamentally change the capital                                        The standard also introduces solvency                                           and supervisory ladder of intervention
adequacy requirements. insurers will                                         control levels which are designed to                                            can be seen in Diagram 1.
need to demonstrate that they have                                           trigger different degrees of intervention                                          significantly, the iais standard
adequate financial resources which                                           by supervisors.                                                                 now requires all jurisdictions to set
reflect key quantitative requirements,                                           in the context of insurance legal entity                                    out appropriate target criteria for
such as own funds (capital), technical                                       capital adequacy assessment, the iais                                           the calculation of regulatory capital
provisions and the methods for calculating                                   advocates that regulatory authorities                                           requirements which underlie the
the solvency capital requirement (scr)                                       define regulatory capital requirements                                          calibration of a standardised approach.
and the Minimum capital requirement                                          that establish a solvency control level                                         This means that major insurance
(Mcr). The most significant is the scr                                       above which the supervisor does not                                             markets such as the Us and Japan
which aims to be set at a level where                                        intervene on capital adequacy grounds.                                          are now moving to define such levels.
eligible own funds will enable insurers to                                   The iais describes this intervention level                                      solvency ii has determined its desired
absorb losses to a confidence level of                                       as the Prescribed capital requirement                                           confidence level as 99.5 percent over
99.5 percent over a one year period –                                        (Pcr). This is analogous to the scr in                                          a one year time horizon for the scr. The
equivalent to a one in a 200-year event.                                     solvency ii. The Pcr is defined such that                                       iais standard also requires jurisdictions
   The estimated impact of solvency ii                                       assets will exceed technical provisions                                         to set criteria for the assessment of the
on european insurers ranges from                                             and other liabilities with a specified level                                    quality and suitability of capital resources,
€3.5–€4bn (Us$4.8bn–$5.5bn). This                                            of safety over a defined time horizon.                                          having regard to their ability to absorb
includes the cost to firms of undertaking                                    The other intervention level is a solvency                                      losses on both a going-concern and
substantial risk, capital and governance                                     control level at which, if breached, the                                        wind-up basis.
change programmes, and the need to
undertake capital remediation measures                                          Diagram 1: Capital requirements and supervisory intervention
as a result of supervisory assessments.
   However, at an international level,
unlike banking, there is no agreed capital                                                                                                                Economic capital
adequacy standard amongst jurisdictions.
each regulator has created its own local                                                                                                                                                                   Ladder of
                                                                                        Capital                                                          Prescribed capital
capital requirements. as many of these                                                 resources                                                            requirement                                    Regulatory
requirements are historically based, there                                                                                                                                                                Intervention
is usually no confidence level or time
horizon on which the capital requirements                                                                                                                 Minimum capital
                                                                                                                                                            requirement
are based. it has also meant that there is
no consistency in the structure of capital
requirements or the view on the adequacy                                            Technical
of capital resources for insurers at an                                           provisions and
international level – until now.                                                  other liabilities
   The new iais standard on capital
adequacy, which becomes effective in
October, begins to bring international
                                                                                source: KPMG international, february 2011.
capital adequacy standards together.
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
10 | evolving insurance regulation | March 2011




in the context of group-wide capital                                         The australian regulator, the australian                                        Regulators are also increasingly
adequacy assessment, the capital                                             Prudential regulation authority (aPra)                                          turning their attention to the
adequacy standard is less specific.                                          has in many ways been at the forefront
rather than requiring a Pcr and Mcr,                                         of change in the region with its aims                                           quality of capital available to
as it does in the context of insurance                                       of achieving a more risk-sensitive capital                                      meet insurance liabilities and
legal entity capital adequacy assessment,                                    framework that also aligns capital                                              other commitments.
it requires that regulatory requirements                                     requirements for general and life insurers.
establish solvency control levels that                                       The collapse of HiH insurance in 2001,
are appropriate in the context of the                                        the country’s second largest non-life
approach to group-wide capital adequacy                                      (general) insurer, was the catalyst for
that is applied.                                                             prudential capital reform in the general
    regulators are also increasingly                                         insurance industry. The australian
turning their attention to the quality                                       risk-based framework performed well
of capital available to meet insurance                                       during the global financial crisis, although
liabilities and other commitments. The                                       the capital base of some life insurers
capacity of insurers to absorb losses on                                     was negatively impacted by falls in the
both a going-concern and wind-up basis                                       equity markets.
will become more important, increasing
the need to have adequate scenario                                           north america
modelling capabilities.                                                      in June 2008 prior to the global financial
                                                                             crisis (Gfc) the Us launched the solvency
asPac                                                                        Modernization initiative (sMi). This sought
even though insurers in asia generally                                       to further enhance the existing risk-based
weathered the global financial crisis well,                                  capital (rBc) regime. challenged by
the experience of the past two years has                                     other global solvency reforms such as
demonstrated the need for regulation to                                      solvency ii and Basel iii in banking, the
keep pace and anticipate innovation in                                       naic (national association of insurance
financial services.                                                          commissioners) and the insurance
   across asia there is a clear trend                                        industry took the opportunity to consider
towards a more risk-based approach to                                        a more risk-based approach to insurance
insurance supervision, with risk-based                                       solvency regulation. it is understood that
capital frameworks in australia, Japan,                                      these measures may lead to insurers
Taiwan, singapore, Malaysia and Korea.                                       being required to hold different levels
   notable developments also include                                         of capital.
the china insurance regulatory                                                  The naic has stated that sMi is
commission (circ) risk management                                            not a Us implementation of solvency ii.
circular, which was updated in 2008 to                                       in many ways rBc is more akin to a
require the establishment of a risk-based                                    standard formula approach. Where
solvency monitoring framework. china                                         existing factors are inappropriate for a
also introduced regulation in October 2010,                                  specific risk on some products, the naic
which is expected to significantly enhance                                   may allow modelling approaches to
the alignment of the management of                                           substitute the specific risk factors
insurance business in a much more                                            concerned.
risk-centric way, and points to the use
of economic capital as the key risk
measurement tool.



© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                             evolving insurance regulation | March 2011 | 11




                                                                             Internal models                                                                 The calibration test requires the insurer
What are the implications?
                                                                             another major development is that the                                           to demonstrate that the regulatory
                                                                             iais capital adequacy standard includes                                         capital requirement determined by the
• The introduction of solvency control                                       general provisions on the use of an                                             internal model satisfies the specified
  levels will formalise the existing                                         internal model to determine regulatory                                          modelling criteria as established by the
  practice in many countries by having                                       capital requirements (where this is                                             supervisory jurisdiction. importantly,
  targeted regulatory capital levels.                                        allowed by the supervisor). This is a                                           the use test requires the insurer to
  These will become a hard target,                                           major step forward world-wide in the                                            fully embed the internal model, its
  over and above the stated regulatory                                       supervisory arena.The iais has made                                             methodologies and results, into the
  minimum requirements. such                                                 clear that, where a solvency regime                                             insurer’s risk strategy and operational
  formalised arrangements could                                              allows the use of internal models                                               processes.
  mean that the supervisors set a                                            to determine regulatory capital                                                     The use test can require significant
  new informal target above this new                                         requirements, the solvency regime                                               cultural and potentially organisational
  higher minimum level. This could                                           should establish appropriate modelling                                          change and will be critical for insurers to
  have capital management                                                    criteria to be used for the determination                                       get right, as shown by the experience of
  implications for many insurers.                                            of regulatory capital requirements.                                             banks. The Board and senior management
• By setting new Pcr, it is most likely                                      for example, an insurer is required to                                          must have overall control of, and
  that insurers will want to set new                                         adopt risk modelling techniques and                                             responsibility for, the construction
  minimum targets for themselves                                             approaches appropriate to the nature,                                           and use of the internal model for risk
  above this new threshold level. This                                       scale and complexity of its current risks                                       management purposes, and ensure
  will probably result in opportunity                                        and those incorporated within its risk                                          sufficient understanding of the model’s
  cost implications for many insurers.                                       strategy and business objectives in                                             construction at appropriate levels within
• The introduction of specified levels                                       constructing its internal models for                                            the insurer’s organisational structure.
  of safety over a defined time horizon                                      regulatory capital purposes. further,                                           in particular, the iais standard requires
  means insurers will now need to                                            insurers will need to validate their                                            that the insurer’s Board and senior
  begin contemplating whether to                                             internal models by subjecting them to,                                          management understand the
  have a capital management                                                  as a minimum, the following three tests:                                        consequences of the internal model’s
  framework that can model economic                                          a statistical quality test, a calibration test                                  outputs and limitations for risk and
  capital requirements.                                                      and a use test.                                                                 capital management decisions. insurers
                                                                                 The statistical quality test requires                                       will also be expected to have adequate
                                                                             insurers to assess the base quantitative                                        governance and internal controls in place
                                                                             methodology of the internal model,                                              with respect to the internal model.
                                                                             to demonstrate the appropriateness of                                               The iais standard further requires
                                                                             this methodology, including the choice                                          the insurer to document the design,
                                                                             of model inputs and parameters, and                                             construction, and governance of the
                                                                             to justify the assumptions underlying                                           internal model, including an outline of
                                                                             the model. it also requires that the                                            the rationale and assumptions underlying
                                                                             determination of the regulatory capital                                         its methodology. supervisors will be
                                                                             requirement using an internal model                                             expected to require documentation to
                                                                             addresses the overall risk position of the                                      be sufficient to demonstrate compliance
                                                                             insurer and that the underlying data used                                       with the three tests for internal models
                                                                             in the model is accurate and complete.                                          outlined above.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
12 | evolving insurance regulation | March 2011




The insurer will also be expected                                              What are the implications?                                                    insurers will also be expected to
to properly document internal                                                                                                                                have in place ongoing validation and
                                                                                                                                                             supervisory approval of the internal
model changes and report                                                       • it is expected that many supervisory                                        model. The insurer will be expected to
information necessary for                                                        regimes will begin to allow internal                                        monitor the performance of its internal
                                                                                 models to be used to determine                                              model and regularly review and validate
supervisory review and ongoing                                                   regulatory capital requirements,                                            the ongoing appropriateness of the
approval of the internal model                                                   subject to rigorous criteria. These                                         model’s specifications. importantly,
on a regular basis.                                                              changes are likely to present as                                            the insurer will be required to
                                                                                 many challenges for insurers as they                                        demonstrate that the model remains
                                                                                 do opportunities. initial preparatory                                       fit for regulatory capital purposes in
                                                                                 work with local regulators will be key                                      changing circumstances against the
                                                                                 in the roll-out of such reforms.                                            criteria of the statistical quality test,
                                                                               • The statistical quality test, calibration                                   calibration test and use test. The insurer
                                                                                 test and use test are expected to be                                        will be required to notify the supervisor
                                                                                 demanding. insurers should begin                                            of material changes to the internal model
                                                                                 to examine whether their data set                                           made by it for review. continued approval
                                                                                 and system capabilities are adequate                                        of the use of the model for regulatory
                                                                                 and appropriate.                                                            capital purposes will also be required.
                                                                               • Defining model parameters, inputs                                           The insurer will also be expected to
                                                                                 and underlying assumptions are                                              properly document internal model
                                                                                 usually very demanding for most                                             changes and report information
                                                                                 insurers. early identification and                                          necessary for supervisory review and
                                                                                 planning of such analysis will provide                                      ongoing approval of the internal model
                                                                                 organisational benefits given the                                           on a regular basis. The information
                                                                                 associated risk and governance                                              expected will include details of how the
                                                                                 inputs required.                                                            model is embedded within the insurer’s
                                                                                                                                                             governance, operational processes and
                                                                                                                                                             risk management strategy, as well as
                                                                                                                                                             information on the risks assessed by
                                                                                                                                                             the model and the capital assessment
                                                                                                                                                             derived from its operation.

                                                                                                                                                             asPac
                                                                                                                                                             in general, we expect the asPac
                                                                                                                                                             insurance industry to see significant
                                                                                                                                                             development in the use of internal
                                                                                                                                                             economic capital models. This is not
                                                                                                                                                             to say that the region lags in the
                                                                                                                                                             development of models – because we
                                                                                                                                                             see a number of companies across asPac
                                                                                                                                                             with sophisticated risk quantification
                                                                                                                                                             frameworks. However this may be
                                                                                                                                                             challenging for certain domestic insurers
                                                                                                                                                             and for smaller players.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                             evolving insurance regulation | March 2011 | 13




europe
                                                                               Issues to consider
european insurers under solvency ii
have much to gain from the internal
model use test requirements as                                                 While insurers do not have an                                                 • are your Board and senior
described above, where senior                                                  internationally recognised capital                                              management sufficiently focused
management must essentially                                                    framework comparable to the Basel                                               on the changing regulatory landscape
demonstrate the use of internal model                                          accord, the changing regulatory                                                 to maximise competitive advantages
output in the decision-making process,                                         landscape will begin to pose new                                                that may be derived from utilising
such as to support M&a activity,                                               challenges for many in the insurance                                            advanced risk and capital
investment decisions and reinsurance                                           industry:                                                                       management techniques?
buying. regulation in asPac is expected                                        • Have you thought about the impact                                           • for subsidiaries of groups, the
to follow suit by making the internal                                             capital management changes will                                              interplay of capital adequacy at
or economic capital model the key                                                 have on your business, particularly                                          the local level and how such
risk management tool. significant                                                 in regards to:                                                               arrangements can best be
investment is required however –                                                  – existing business                                                          incorporated at the group level to
particularly at senior management level                                           – new business                                                               maximise economic efficiencies
and in developing risk reporting lines –                                          – Pricing models                                                             will likely require greater focus.
to fully realise the benefits that additional                                     – capital planning and management                                            How well prepared are you to meet
risk information can provide, both in                                             – Data and systems needed for robust                                         these new demands?
setting strategy and in day-to-day                                                  real time measurement                                                    • early engagement with supervisors
management decisions.                                                             – Business to grow, divest,                                                  is critical in establishing and building
                                                                                    restructure                                                                relationships and establishing the
north america                                                                     – Targets to meet new requirements?                                          necessary awareness and
Due to the financial data collected and                                        • Do you have the planning and project                                          understanding of your needs.
the subsequent examination process                                                management capabilities to bring                                             How well does your supervisor
undertaken by Us supervisors, many                                                together the necessary interactions                                          understand your business?
remain to be convinced of the benefit                                             and linkages between Pillar i
of internal models in setting regulatory                                          (regulatory capital), Pillar ii (own
capital requirements. The move to a                                               assessment) and Pillar iii (reporting)?
full internal model approach to solvency
is therefore receiving a much more
cautious approach. While some                                                                                                                                Significant investment is required
modelling is undertaken on certain                                                                                                                           however – particularly at senior
products, the Us is wary of over-reliance
on internal models and will most                                                                                                                             management level and in
likely wait until europe has fully                                                                                                                           developing risk reporting lines
operationalised solvency ii to gauge                                                                                                                         – to fully realise the benefits that
the success of such reforms.
                                                                                                                                                             additional risk information can
                                                                                                                                                             provide, both in setting strategy
                                                                                                                                                             and in day-to-day management
                                                                                                                                                             decisions.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
14 | evolving insurance regulation | March 2011




Perspectives:
ASPAC
Diversity and progress



insurance business in asia Pacific is                                        The two key areas of significant                                                Regulators in the region have
booming. life and non-life insurance                                         development that are expected to shape                                          been watching the IAIS and
penetration rates for the region as a                                        the industry in the years to come are:
whole remain low and so there is                                             risk and capital management, and the                                            Solvency II developments with
significant room for ongoing growth.                                         impact of global developments in                                                much interest, and will continue
in fact, for much of the region in recent                                    financial reporting by insurers.                                                to do so before undertaking
decades, the story has been one of
growing the market rather than                                               Risk and capital management                                                     major reforms to their own
competing for market share. coupled                                          One of the lessons learned from the                                             prudential frameworks.
with the relatively quick emergence                                          Gfc is that prudential supervision in
of asian economies from the global                                           some countries can be a blunt tool.
financial crisis (Gfc), this region is                                       Because some solvency capital regimes
attracting significant attention from                                        are not very sensitive to risk, they
local and global players alike.                                              arguably compensate through excessive
    similar to the banking industry as                                       prudence. This can be a poor trade off,
discussed in Evolving Banking Regulation1,                                   however – higher capital requirements
a common question is, is the focus                                           are not the solution to all risks. for this
on developing more sophisticated                                             reason, we are seeing a move to more
capital adequacy and enterprise risk                                         risk-based capital regimes post Gfc.
Management (erM) warranted, given                                               in my experience, regulators in the
that players in the region emerged from                                      region have been watching the iais and
the Gfc with stronger balance sheets                                         solvency ii developments with much
compared to their peers in europe                                            interest, and will continue to do so before
and the Us? i believe that it would be                                       undertaking major reforms to their own
very short-sighted to take such a view,                                      prudential frameworks. However, risk-
because there are many lessons that                                          based solvency capital (rBc) regimes
asPac insurers can learn from their                                          for insurers have existed in the region
counterparts in europe and the Us –                                          for many years. The australian regulator
perhaps most importantly that                                                recently has been very active, and is
enhancements in risk management                                              currently reviewing its capital standards;
can assist profitable growth, rather                                         the Japanese, Korean and Taiwanese
than acting as a barrier to growth as                                        solvency capital rBc regimes are not
is sometimes perceived.                                                      dissimilar to the current Us rBc solvency
    Of course, the region is diverse. There                                  capital model; and the singaporean and
are significant differences in both the                                      Malaysian rBc regimes are, in fact,
characteristics of the insurance sector,                                     considerably more granular than rBc
and the sophistication of regulation in                                      regimes of other jurisdictions.
each jurisdiction. The jurisdiction-specific                                 now that erM and solvency capital
model of insurance regulation – which                                        standards have been approved in europe
we expect to endure in asPac for the                                         for solvency ii and internationally via
foreseeable future – has implications for                                    the iais, i believe that many jurisdictions
group-wide financial reporting and capital                                   will pick up the pace of change. This is
management. in the twenty-first century                                      particularly relevant when considering
of increasing connectivity, regulation and                                   the financial sector assessment
management of systemically important                                         Program (fsaP) reviews conducted
financial institutions (sifis) is, in many                                   by the iMf and World Bank.
ways, constrained by a country-by-                                              Being able to study solvency ii
country approach.                                                            implementation developments and
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
challenges in europe is clearly an                                            is to navigate a path through these                                             One of the key activities for
advantage to the industry in asPac, and                                       forthcoming accounting measurement                                              ASPAC insurers over the coming
lessons can be learned both in terms of                                       changes, while continuing to meet the
what to do, as well as what not to do.                                        challenges of a fast moving business                                            12 months is to navigate a path
                                                                              environment. How insurers respond                                               through these forthcoming
Financial reporting                                                           will help to shape the future of business                                       accounting measurement
The second area attracting a lot of                                           reporting, as it evolves beyond compliance
attention is the ongoing developments                                         to communicate the value that they are                                          changes, while continuing to
in financial reporting, which we discuss                                      generating for their stakeholders.                                              meet the challenges of a fast
in detail in chapter 3 (Accounting,                                               i believe that the regulatory changes in                                    moving business environment.
valuation and disclosure). in asPac,                                          financial reporting and capital management
unlike europe, where ifrs is frequently                                       – which i expect to result in greater
only adopted at Group level, local                                            standardisation and harmonisation of how
statutory reporting is often ifrs-based                                       insurers manage their business and
and already impacts small and large                                           communicate to their various stakeholders
insurers alike. australia, Hong Kong,                                         – may well begin to standardise products
singapore and Malaysia for example                                            and will result in greater consolidation in the
have already adopted models that at                                           region. The region is set for exciting and
the very least closely model ifrs, with                                       challenging times ahead.
changes made to suit country-specific
legislation or contexts. ifrs adoption
in Korea from 2011, and for some
international Japanese companies
from 2010 onwards, will increase the
significance of ifrs in the region.
    existing statutory liability
measurement rules in jurisdictions
including australia, Hong Kong, singapore
and Malaysia already allow or even                                            Martin Noble
mandate discounting for non-life                                              regulatory centre of excellence
business and the application of risk                                          asPac region
margins. a key step for regulators and                                        KPMG in china
the industry at large in these jurisdictions
will be in harmonizing (or otherwise) the
existing statutory measurement rules
with those of the iasB’s insurance
contracts standard when it is issued.
One of the key activities for asPac
insurers over the coming 12 months




1. Evolving Banking Regulation: A marathon or a sprint?
   KPMG international, november 2010.


 © 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
 member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
02

ORSA-ERM revisited
Increasing protection


across all sectors, risk management has received significant
attention. industry efforts in this regard have been, and continue to
be, considerable. Of all the new iais standards, erM is the most
significant. The standard now requires supervisors to seek high
standards of risk management and governance from insurers and,
critically, supervisors are being encouraged to challenge the insurers
they regulate on risk management issues. in particular, the iais
standard requires an Own risk and solvency assessment (Orsa)
under which an insurer undertakes its own forward looking self
assessment of its risks, corresponding capital requirements and
adequacy of capital resources.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                             evolving insurance regulation | March 2011 | 17




for the first time, world-wide supervisory                                   development; they will be responsible for                                       In delivering the ORSA, firms
regimes will now be expected to require                                      developing content, reviewing the inputs                                        will need to go further than
from insurers an erM framework that                                          of others and considering outputs related
provides for the identification and                                          to their areas as shown in Diagram 2.                                           current practice to deliver a
quantification of risk. it must be under                                         specifically, the insurer will be                                           process fit for the business
a sufficiently wide range of outcomes                                        required to have a risk management                                              and regulatory purposes.
using techniques that are appropriate to                                     policy which outlines how all relevant
the nature, scale and complexity of the                                      and material categories of risk are
risks the insurer bears and adequate for                                     managed, both in the insurer’s business
risk and capital management for solvency                                     strategy and in its day-to-day operations.
purposes. The insurer’s measurement of                                       The risk management policy will be
risk will need to be supported by accurate                                   expected to describe the relationship
documentation providing appropriately                                        between the insurer’s tolerance limits,
detailed descriptions and explanations                                       regulatory capital requirements,
of the risks covered, the measurement                                        economic capital and the processes
approaches used and the key                                                  and methods for monitoring risk. The
assumptions made.                                                            risk management policy will also need
   in delivering the Orsa, firms will                                        to include an explicit asset-liability
need to go further than current practice                                     Management (alM) policy which clearly
to deliver a process fit for the business                                    specifies the nature, role and extent of
and regulatory purposes. The functions                                       alM activities and their relationship with
involved in the process will feed into                                       product development, pricing functions
the Orsa at different stages of its                                          and investment management.


 Diagram 2: The ORSA Process


                                                                                                       ORSA process


                                                           Board driven process – understanding and challenging results




             Areas involved                                                                                                                                                                        Key output
                                                                                               Material risk assessment
            Risk management                                                                                                                                                                   Dynamic reporting

            Business planning                                                                        Economic capital                                                                               Regulatory
              and strategy                                                                             assessment                                                                                    reporting
                                                                                                                                                   Corporate and
                                                             Risk appetite                                                                          risk strategy
             Economic capital                                                                                                                                                                   Documentation
                 model                                                                              Business planning

            Standard formula/
            regulatory capital
                                                                                             Stress and scenario testing




                                                                                                          Regulators


 source: KPMG international, february 2011.


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
18 | evolving insurance regulation | March 2011




insurers will be required to have a risk                                        Diagram 3: ORSA Design
management policy that is reflected in
an explicit investment policy, which
specifies the nature, role and extent of                                            Evaluating past                                                                                 Looking towards future
the insurer’s investment activities and                                             and present                                                                                     solvency requirements
                                                                                    solvency required
outlines how the insurer complies with                                                                                                                                              Risk profile
                                                                                    Technical provisions                                                                            Solvency projections
the regulatory investment requirements                                              Decision-making                                                                                 Strategy link
established by its regulator. further, the                                          Overall solvency needs                                                                          Stress tests
insurer will need to demonstrate how it                                             SCR deviations
has established explicit risk management
procedures within its investment policy;                                                                                                   Own assessment
particularly relating to more complex and                                           ORSA design                                                                                     Application across
less transparent classes of assets, its                                                                                                                                             the business
                                                                                    Standard formula/Internal
investment in markets or instruments                                                model                                                                                           Proportionality
that are subject to lighter governance or                                           Integration – multi-                                                                            Valuation
regulation, including explicit policies in                                          disciplinary requirement                                                                        Independent challenge
                                                                                    Frequency – metrics                                                                             Documentation/ORSA report
relation to underwriting risk.
                                                                                                                                                                                    Decision-making
    The iais erM standard will also
require insurers to establish and maintain
                                                                                source: KPMG international, february 2011.
a risk tolerance statement which sets
out its overall quantitative and qualitative
risk tolerance levels. it defines tolerance                                  an Orsa is a bespoke strategic analysis                                         There is currently no single
limits that take into account all relevant                                   process which links together the outputs                                        approach to designing an ORSA
and material categories of risk and the                                      of risk, capital and strategic planning,
relationship between them; to make use                                       to determine the current and future                                             and this reflects the intent by
of its risk tolerance levels in its business                                 capital requirements of the firm, based                                         regulators who have been
strategy; and embed its defined risk                                         on the business strategy and external                                           deliberate in not providing
tolerance limits in its day-to-day                                           environment.
operations via its risk management                                              in essence the Orsa should outline                                           prescription.
policies and procedures.                                                     the clear relationship between a number
    There is also a requirement that                                         of key business processes as illustrated
the insurer’s erM framework is                                               in Diagram 3.
responsive to changes in its risk profile.
By incorporating a feedback loop, based                                      ORSA Design
on good quality information, management                                      There is currently no single approach
processes and objective assessment, to                                       to designing an Orsa and this reflects
enable the insurer to take the necessary                                     the intent by regulators who have been
action in a timely manner in response to                                     deliberate in not providing prescription,
changes in its risk profile.                                                 in order to keep this very much a firm’s
                                                                             ‘own’ assessment. That in itself provides
ORSA                                                                         significant implementation challenges
Perhaps the most significant feature of                                      for insurers.
the iais erM standard is the requirement                                         an Orsa must demonstrate how the
for an insurer to regularly perform an                                       insurer’s strategy and risk management
Orsa to assess the adequacy of its risk                                      links with its management of capital
management and current, and likely future,                                   (economic and regulatory) and the
solvency position.                                                           relationship between the insurer’s


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                             evolving insurance regulation | March 2011 | 19




tolerance limits and processes and
                                                                               What are the implications?
methods for monitoring risk. Key to this
process is demonstrating the linkages
between corporate governance and                                               • The Board and senior management                                                 amongst business units and
Board responsibilities, economic capital,                                        will need to demonstrate that they                                              group entities is a considerable
erM and business and strategic planning                                          have conducted their own review of                                              weakness of many large Orsa
processes.                                                                       the risks to which they are exposed                                             programmes.
   at its heart, the Orsa will require                                           and to assess their own solvency                                            •   identification of key resources and
input from key stakeholders, which will                                          needs. They will need to demonstrate                                            specific skill sets across all relevant
require multidisciplinary teams working                                          that the Orsa is an integral part                                               business units will be required in
closely together to deliver the Orsa. as                                         of managing the business against the                                            order to ensure successful delivery of
a minimum, this should include: risk, finance,                                   company’s chosen strategy and that                                              the technical necessary input
strategy, actuarial, audit, compliance, and                                      it is used in assisting strategic                                               and that appropriate personnel are
human resource and treasury operations.                                          decision-making. The ultimate                                                   fully engaged.
                                                                                 success of an Orsa is in being able                                         •   Given the Orsa inputs will come
increased Board and senior                                                       to demonstrate a thorough integration                                           from a multitude of stakeholders
management responsibilities                                                      of the process and outputs within                                               and the outputs will be in varied
The insurer’s Board and senior                                                   business as usual activities such as                                            formats, ensuring appropriate and
management must be responsible for                                               Board oversight and responsibilities,                                           timely management information is
the Orsa and encompass all reasonably                                            strategic planning, risk and capital                                            critical in providing a firm with the
foreseeable and relevant material risks.                                         management, governance and                                                      ability to report adequately on its
The minimum requirements include                                                 internal controls and reporting and                                             current status.
underwriting, credit, market, operational                                        disclosure elements.                                                        •   The requirement to evidence the
and liquidity risks and additional risks arising                               • Data and system issues are likely to                                            Orsa will make documentation
due to membership of a group. Where a                                            present significant challenges. The                                             extremely important particularly
risk is not readily quantifiable, for instance                                   Orsa will need to rely on robust risk                                           for external reporting purposes.
some operational risks, or where there                                           metrics and information particularly                                        •   it is expected that the rating agency
 is an impact on the insurer’s reputation,                                       for performing capital (Pillar 1)                                               community will utilise the Orsa
an insurer should make a qualitative                                             calculations. This will become even                                             report to provide them with a single
assessment that is appropriate to that                                           more important where no internal                                                source of information conveying the
risk and sufficiently detailed to be useful                                      model exists. Bringing together these                                           regulatory and internal management
for risk management. The assessment                                              inputs will require a clear and well                                            view as to the financial strengths of
is required to identify the relationship                                         articulated programme plan                                                      the firm and the sophistication of its
between risk management and the level                                            in order to obtain key stakeholder                                              risk management. it is therefore
and quality of financial resources needed                                        buy-in and support.                                                             essential that insurers aim to capture
and available.                                                                 • failing to appropriately manage                                                 all the risk management processes
                                                                                 the various cultural perspectives                                               within their organisation in order to
                                                                                 or appreciate the differences in                                                convey the most compelling evidence
                                                                                 approach, input and emphasis                                                    for external purposes.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
20 | evolving insurance regulation | March 2011




The insurer will be expected                                                 capital considerations                                                          increased modelling capabilities and
                                                                             importantly, with regard to economic                                            sophistication required
to apply reverse stress testing
                                                                             and regulatory capital, an insurer will                                         The insurer will be required, as part
to identify scenarios that would                                             be required to determine, the overall                                           of its Orsa, to analyse its ability to
be the likely cause of business                                              financial resources it needs to manage                                          continue in business, and the risk
failure... and the actions                                                   its business given its own risk tolerance                                       management and financial resources
                                                                             and business plans, and to demonstrate                                          required to do so over a longer time
necessary to manage this risk.                                               that supervisory requirements are met.                                          horizon than has previously typically
                                                                             it must base its risk management actions                                        been used to determine regulatory
                                                                             on consideration of its economic capital,                                       capital requirements. in carrying out its
                                                                             regulatory capital requirements and                                             continuity analysis, the insurer will be
                                                                             financial resources, including its Orsa                                         expected to apply reverse stress testing
                                                                             and assess the quality and adequacy of                                          to identify scenarios that would be the
                                                                             its capital resources to meet regulatory                                        likely cause of business failure (e.g.
                                                                             capital requirements and any additional                                         where business would become unviable
                                                                             capital needs.                                                                  or the market would lose confidence
                                                                                                                                                             in it) and the actions necessary to
                                                                                                                                                             manage this risk.




 Diagram 4: Board driven process



                                                                                               Board driven process




                                                                                                   Business planning
                                                                                                     and strategy




                                Standard formula/                                                                                                                       Economic capital
                                regulatory capital




                                                                                                   Risk management




 source: KPMG international, february 2011.


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 21




an insurer’s continuity analysis will be                                     asPac
                                                                                                                                                              Issues to consider
expected to address a combination of                                         none of the above will be surprising to
quantitative and qualitative elements in                                     regulators or insurers in the asPac
the medium and longer-term business                                          region, where the principles of erM are                                          • Will your Orsa be a real business
strategy and include projections of its                                      well understood, if not yet embedded                                               tool that can be used to drive
                                                                                                                                                                business strategy and decision
future financial position and analysis of                                    in current regulations. There is clear
                                                                                                                                                                making at both a Group and
its ability to meet future regulatory capital                                appreciation amongst regulators across
                                                                                                                                                                solo level?
requirements. The insurer’s continuity                                       the region that sound risk management
                                                                                                                                                              • is your organisation able to bring
analysis may, for example, include                                           is fundamental to healthy development
                                                                                                                                                                together all aspects of the business
projections over three to five years (or                                     and growth of the industry, and this is an
                                                                                                                                                                and the activities it undertakes so
another period appropriate to the insurer’s                                  area of focus for many.
                                                                                                                                                                the risk and capital implications can
business) even where regulatory capital
                                                                                                                                                                be assessed in the aggregate?
requirements are typically determined                                        north america
                                                                                                                                                              • are your processes consistently
over a one year time horizon.                                                Despite the risk-focused examination
                                                                                                                                                                embedded and managed across the
                                                                             process undertaken in the Us, the
                                                                                                                                                                business or Group to ensure delivery
strengthened supervisory oversight                                           adoption of an Orsa tool to complement
                                                                                                                                                                and integration of the Orsa?
supervisors will be expected to                                              these reviews is under consideration
                                                                                                                                                              • The Orsa is required to be forward-
undertake reviews of an insurer’s risk                                       by a task force supporting the naic’s
                                                                                                                                                                looking considering future capital
management processes and its financial                                       solvency Modernization initiative. The
                                                                                                                                                                needs, while taking into account
condition, including the Orsa. Where                                         use of an Orsa and its contents need
                                                                                                                                                                past performance and lessons
necessary, the supervisor will be able                                       to be defined together with a clear
                                                                                                                                                                learnt. How capable would your firm
to require strengthening of the insurer’s                                    understanding of its purpose and how                                               be in undertaking an Orsa now?
risk management, solvency assessment                                         it fits alongside other tools that may be                                        • is your organisation able to
and capital management processes.                                            in place such as an erM framework. a                                               demonstrate continuous compliance
in undertaking its Orsa, the insurer                                         key challenge will be the principle-based                                          with the regulatory capital and
will be required to consider the extent to                                   nature of an Orsa – that its form will                                             technical provisions requirements?
which the regulatory capital requirements                                    be different for each insurer, and there                                         • are your stress and scenario analysis
(in particular, any standardised formula)                                    is a need to for regulators and insurers                                           capabilities able to fully capture and
adequately reflect its particular risk                                       alike to understand how an Orsa can                                                evidence adequate capital and risk
profile. in this regard, the Orsa                                            be implemented in a proportional way.                                              understanding?
undertaken by an insurer will be a key                                       There are industry concerns about the
source of information to the supervisor                                      confidential information that is contained
in reviewing the adequacy of the                                             within an Orsa. at the naic conference
regulatory capital requirements of the                                       in October 2010, after a period of
insurer and in assessing the need for                                        consultation, it was decided to push ahead
variation in those requirements.                                             with the development of an Orsa tool.


Where necessary, the supervisor
will be able to require
strengthening of the insurer’s
risk management, solvency
assessment and capital
management processes.


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
03

Accounting, valuation
and disclosure
Aiming for convergence…

There has been considerable debate world-wide concerning
international financial reporting standards (ifrs) developments
by the international accounting standards Board (iasB), particularly
in regards to the valuation and measurement of insurance contracts.
   comments on the iasB exposure draft (eD) on insurance
contracts closed 30 november 2010, and the responses are
discussed in the January 2011 ifrs insurance newsletter2. While
the iasB is still striving for a final standard for this year, this heralds
a potential step-change in international insurance accounting –
holding out the encouraging prospect of converged world-wide
accounting and reporting requirements for insurance contracts. The
aim is to improve comparability, provide for greater transparency of
insurers’ financial statements (which are often criticised for being
opaque) and reduce inconsistencies in insurance financial reporting.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 23




The eD’s approach to measuring                                               asPac                                                                           a single composite margin. ifrs
insurance contracts is based on four                                         as Martin noble discusses in the ASPAC                                          adoption in the Us is still being
‘building blocks’.                                                           Perspective on page 14, local statutory                                         considered but it is clear that any such
    The first building block is an explicit,                                 reporting in asPac is often ifrs-based                                          decisions will have significant
unbiased and probability-weighted                                            and already impacts small and large                                             implications for Us insurers.
estimate (i.e. expected value) of future                                     insurers alike. aPra in australia is
cash flows that will arise as the insurer                                    considering changes to the recognition,                                         A source of contention for many
fulfils the insurance contract.                                              valuation and measurement of insurance                                          insurers is the term structure
    The second building block proposed                                       contracts following the iasB’s eD, as
is an adjustment of the future cash flows                                    part of the ifrs project. china has also                                        to be used to discount future
for the time value of money, using                                           recently introduced significant changes                                         cash flows.
discount rates that:                                                         to insurance financial reporting which
• are consistent with observable current                                     pre-dated the eD, but are generally
    market prices for instruments whose                                      consistent with it.
    characteristics reflect those of the                                         a source of contention for many
    insurance contract liability, in terms                                   insurers is the term structure to be used
    of, for example, timing, currency and                                    to discount future cash flows. asPac
    liquidity; and                                                           insurers may find calibrating assumptions
• exclude any factors that influence the                                     relating to the risk free rate and liquidity
    observed rates but are not relevant to                                   premium proposed by the eD challenging
    the insurance contract liability.                                        in markets where local debt markets
                                                                             are not deep and liquid and swap
The third building block is an explicit risk                                 markets limited.
adjustment representing the maximum
amount the insurer would rationally pay                                      north america
to be relieved of the risk that the ultimate                                 in the Us, statutory accounting
fulfilment cash flows exceed those                                           Principles (saP), via statutory reporting,
expected, determined using one of                                            remains the main focus for many insurers
three calculation techniques permitted                                       even with the joint project now underway
by the eD.                                                                   between the iasB and fasB regarding
    finally, the fourth building block is a                                  insurance contracts. The iasB has issued
residual margin, which eliminates any                                        an exposure draft and fasB a discussion
gain at inception and is ‘locked-in’ (i.e.                                   paper on this subject. The timeline for
not re-measured) and amortised over                                          completion of the exposure draft and
the coverage period on the basis of the                                      discussion paper is not known. There are
passage of time, or the expected timing                                      divergences in a number of areas, but
of incurred claims and benefits, if that                                     also similarity, a debate highlighted from
pattern differs significantly from the                                       the G20 summit in seoul3. The principal
passage of time. if blocks one to three                                      area where there is a divergence is in the
would result in a loss at inception,                                         number of the building blocks, with the
that loss is recognised in the income                                        fasB using three building blocks,                                               2. “analysis of responses to the insurance proposals”, IFRS Insurance
                                                                                                                                                                Newsletter, KPMG ifrG limited, January 2011.
statement immediately and no residual                                        combining the concepts underpinning                                             3. Convergence on the agenda, but divergence on the cards?
                                                                                                                                                                Developments from the G20 Summit in Seoul, KPMG international,
margin is required.                                                          the risk margin and residual margin into                                           november 2010.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
24 | evolving insurance regulation | March 2011




IAIS valuation                                                               The iais valuation standard is expected                                         Underlying the IAIS solvency
The iais has been undertaking its own                                        to cover both measurement and                                                   standards is a desire to achieve
work on the valuation of assets and                                          reporting requirements:
liabilities, including technical provisions,                                 • The valuation addresses recognition,                                          greater levels of transparency
for solvency purposes. Development                                             derecognition and measurement of                                              to their supervisors and the
of this standard and guidance paper has                                        assets and liabilities;                                                       public, so that insurers are more
proven to be one of the most difficult                                       • The valuation of assets and of liabilities
for iais members given the regional                                            is undertaken on consistent bases;                                            disciplined in their actions.
differences that apply to regulatory                                         • The valuation of assets and liabilities
accounting and reporting requirements.                                         is undertaken in a reliable, decision
    Despite these issues, the iais                                             useful and transparent manner;
standard will be constructed such that it                                    • The valuation of assets and liabilities
is very aligned with the iasB’s proposals;                                     is an economic valuation;
a key over-riding aim of the iais is to                                      • an economic valuation of assets and
ensure that the methodologies used                                             liabilities reflects the risk-adjusted
in calculating items for general purpose                                       present values of their cash flows;
financial reports can be used for                                            • The value of technical provisions and
regulatory reporting purposes as far as                                        other liabilities does not reflect the
possible. This will limit changes to a                                         insurer’s own credit standing;
minimum, so that regulatory reporting                                        • The valuation of technical provisions
does not diverge unless absolutely                                             exceed the current estimate by a
necessary.                                                                     margin (Margin Over the current
    a key feature of the iais deliberations                                    estimate or MOce);
has been around how the valuation of                                         • The current estimate reflects the
assets and liabilities for solvency purposes                                   expected present value of all relevant
needs to take account of a total balance                                       future cash flows that arise in fulfilling
sheet approach to solvency assessment                                          insurance obligations, using unbiased,
and the interplay between available                                            current assumptions;
capital resources and required regulatory                                    • The MOce reflects the inherent
capital. at the same time, it is recognised                                    uncertainty related to all relevant
that there may be differences between                                          future cash flows that arise in fulfilling
accounting and regulatory standards                                            insurance obligations over the full time
regarding the valuation of assets and                                          horizon thereof;
liabilities for general purpose financial                                    • The valuation of technical provisions
reporting.                                                                     allows for the time value of money.
                                                                               The solvency regime establishes
                                                                               criteria for the determination of
                                                                               appropriate interest rates to be used in
                                                                               the discounting of technical provisions;
                                                                               and
                                                                             • The solvency regime requires the
                                                                               valuation of technical provisions
                                                                               to make appropriate allowance for
                                                                               embedded options and guarantees.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 25




These requirements will herald a
                                                                               What are the implications?
significant change in many jurisdictions
regarding how insurance contracts
are measured and reported and the                                              • The iasB and iais changes to                                                  resources and costs. early budgetary
impact of this change should not be                                              valuation measurement, recognition                                            preparations and contingency
underestimated.                                                                  and reporting of insurance contracts                                          plans should now be undertaken.
    further amendments to the iais                                               – especially the move to a market-                                          • Pro-active action taken now should
valuation standard are expected as a                                             consistent and economic balance                                               lead to insurers being able to gain
result of the formal consultation process,                                       sheet complemented by risk-based                                              competitive benefits by aligning
which is expected to commence in Q1                                              capital requirements from regulators                                          data and systems with liaison and
2011. The iais is scheduled to formally                                          – will prove extremely challenging for                                        coordination activities.
adopt the valuation standard and for it to                                       many insurers.                                                              • The new valuation rules are likely
become effective as applying to all                                            • such changes are likely to require                                            to require transitional arrangements
jurisdictions world-wide from Q4 2011.                                           insurers to re-engineer their existing                                        particularly concerning changes to
                                                                                 processes to facilitate and possess                                           financial information. This will require
Disclosure                                                                       timely and robust measurement                                                 clear and concise communications
closely aligned with the valuation                                               and reporting capabilities – applying                                         with external stakeholders such as
developments are the supervisory                                                 increased pressure on both                                                    analysts, shareholders and supervisors.
review and reporting requirements,
now beginning to be discussed at
                                                                               Issues to consider
an international level. The aim is to
harmonise and converge reporting and
disclosure requirements particularly                                           • Have you fully considered the extent                                       • How prepared is your organisation
given the ifrs changes.                                                          of changes to valuation measurement,                                         for meeting the new disclosure and
   Underlying the iais solvency                                                  recognition and reporting of insurance                                       reporting requirements, particularly
standards is a desire to achieve greater                                         contracts and what impact these                                              with regard to risk and capital
levels of transparency to their                                                  changes may have on your business?                                           management information?
supervisors and the public, so that                                            • Will the move to a market-consistent                                       • Will your firm be able to meet the
insurers are more disciplined in their                                           and economic balance sheet                                                   increasing technical demands
actions. While the iais does not yet                                             complement your internal risk-based                                          expected? Do you have the right
specify reporting requirements such as a                                         capital capabilities?                                                        capabilities and skill sets of staff
public solvency and financial condition                                        • Have you undertaken impact                                                   especially in regards to actuarial,
report (sfcr) under solvency ii, it is                                           assessments to identify changes                                              risk and finance operations to fully
very likely that most supervisors will                                           to data and technology to meet                                               implement the new demands and
establish a similar framework, which                                             new calculations?                                                            changes expected?
requires a private regular (typically                                          • Have you commenced high level                                              • How will you prepare yourself to
annual) supervisory report (which may                                            modelling to understand impact                                               understand and explain differences
also take the form of simplified quarterly                                       on returns of proposed changes?                                              arising under different reporting
reports) and a public sfcr that increases                                      • Do you know the impact on back                                               systems?
the level of disclosure required of                                              office and risk management processes
insurers. at present, the Us financial                                           of changes in insurance contracts?
reporting requirements, data collection
and system analysis is considered by
many as the most comprehensive.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
04

Investments and liquidity
Improving cash flow and flexibility

insurers remained relatively stable during the financial crisis because
their business model is fundamentally different from that of banks.
Unlike banks, they are funded by upfront premiums, so they do not
generally rely on wholesale market funding for liquidity. insurance
policies are also generally long-term, with controlled outflows, and
investments are generally matched to liabilities.
   another factor which assisted insurers cope well with the crisis is
that under many rBc solvency capital regimes, insurers are required
to hold capital for asset risks. This meant that many insurers were
holding significant capital reserves to meet those risks (such as
exposure to falling equity markets or lower quality investments).
in australia, for example, such capital is required against valuation
risk, concentration risk, mis-matching risk and credit risk.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 27




Investments                                                                  a specific issue for regulators, which                                          Such focus will continue to apply
However, the Gfc highlighted across                                          arose during the Gfc, was whether                                               pressure on the robustness of
the world that there are no uniform                                          off-balance sheet vehicles truly were
investment requirements or asset class                                       off balance sheet, or whether in stress                                         the systems and controls used
restrictions from supervisors. each                                          scenarios losses should be recognised                                           in the insurer’s risk management
jurisdiction essentially has bespoke                                         due to implicit obligations of support,                                         and Asset Liability Management
requirements on the investments                                              unhedged derivatives or from structured
permitted to be held by insurers. The                                        credit products. increased scrutiny of                                          (ALM) practices.
absence of such a standard raised                                            such investments can now be expected
particular issues regarding how the                                          by regulators world-wide.
iais responded to concerns being                                                 similarly, the issue of whether an
addressed by the fsB, such as liquidity                                      insurer’s assets are sufficiently secure
given the impact of this risk on the                                         has received increased attention,
banking sector.                                                              particularly concerning whether undue
    in response, the iais standard on                                        reliance is placed on credit rating
investments addressed many of the                                            agencies. The Gfc has prompted
issues which arose immediately                                                many supervisors to require insurers
following the crisis. recognising the                                        to become more aware of the limitations
diverse positions held by regulatory                                         in relying on credit ratings and to require
authorities to investments, the iais                                         insurers to undertake more due diligence
standard allows either a principles-based                                    in assessing their counterparty credit
or a rules-based approach, or a mixture of                                   risk exposure. such focus will continue
the two, in setting regulatory investment                                    to apply pressure on the robustness
requirements. The standard allows the                                        of the systems and controls used in the
solvency ii approach of the prudent                                          insurer’s risk management and asset
person principle particularly in relation                                    liability Management (alM) practices.
to the requirements regarding the
asset portfolio, where, at a minimum,                                        Insurance groups
regulatory investment requirements                                           for insurance groups, the significant
will be expected to address the security,                                    focus of regulators is now turning to the
liquidity and diversification of an insurer’s                                degree of transferability and fungibility
portfolio of investments as a whole.                                         of capital, the inherent investment risk
    insurers will be expected to invest                                      at the insurance legal entity level and the
in a manner that is appropriate to the                                       overall risk exposures at an aggregated
nature of their liabilities and invest only                                  level across the group. Of particular
in assets whose risks they can properly                                      concern is whether investments
assess and manage. in relation to                                            undertaken by certain legal entities can
specific financial instruments, solvency                                     weaken the group and whether intra-
regimes will be expected to establish                                        group investments pose additional risks
quantitative and qualitative requirements,                                   given any explicit or implicit support
where appropriate, on the use of more                                        arrangements.
complex and less transparent classes                                             The Gfc highlighted situations
of assets and investment in markets                                          where supervisors were concerned both
or instruments that are subject to less                                      at their lack of power to prevent capital
governance or regulation. solvency ii                                        flight across national borders in stress
has outlined such measures already                                           conditions, and insurers’ inability to
for innovative arrangements such as                                          mobilise capital at short notice in stress
special purpose vehicles.                                                    circumstances. This is particularly
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
28 | evolving insurance regulation | March 2011




significant given that many regimes                                          This position reflects the inherent                                             In many countries, insurers are
focus on regulating legal entities rather                                    difference between the banking and                                              typically required to hold assets
than on groups and supervisors in many                                       insurance models. Primarily the
countries do not yet have the full legal                                     difference is between deposits and                                              substantially in excess of their
power or capability to undertake group                                       wholesale funding in banking compared                                           liabilities at a local subsidiary
supervision. This has led to supervisors                                     to the insurance model where premiums,                                          level, and these are sometimes
questioning whether diversification                                          are received and invested ahead of the
benefits are real, if they cannot be                                         crystallisation of claims and benefits                                          ring fenced from the insurer’s
achieved with certainty in stress                                            payments. This results in a fundamental                                         other operations.
conditions.                                                                  difference between the balance sheets
   all of these concerns mean that                                           of the two sectors. While insurers need
investments, particularly those held at a                                    liquidity to pay claims, the pattern of
group level, must be monitored to ensure                                     claims payments, especially for most
that they are sound, appropriate and able                                    life firms is usually reasonably stable and
to be accessed when needed to support                                        predictable. Product designs typically
capital or liquidity requirements in stress                                  contain safety mechanisms, such as
conditions. in our view, insurance groups                                    surrender charges, to protect against
that fail to adequately address these                                        spikes in liquidity. Generally, while the
issues by being able to verify benefits                                      claims payments for general insurers
such as diversification will find their                                      may be less predictable, peak risks
supervisors increasingly likely to question                                  associated with natural catastrophes are
the group’s overall financial resources                                      not generally correlated with periods of
and capital requirements.                                                    economic distress. However in stress
                                                                             conditions insurers may ‘gamble for
Liquidity                                                                    survival’ by writing unprofitable new
The Gfc resulted in a number of                                              business in order to generate cash to
initiatives by banking regulators                                            satisfy claims payments expected in
concerning liquidity requirements and                                        the near term.
these actions continue. in insurance,                                            However, liquidity risk is generally
despite pressure from the fsB to the                                         considered to be lower in insurance,
iais to examine potential reform of                                          with most supervisors focusing on
liquidity requirements, there has to date                                    asset-liability matching principles and
been no changes. even though some                                            general risk management requirements
industry participants acknowledge that                                       as a means to addressing any potential
certain activities, such as commercial                                       liquidity issues. recently, this has been
paper borrowing and stock lending                                            reinforced by increased demands from
activities, may theoretically pose liquidity                                 supervisors to stress test investment
issues, the general consensus has                                            portfolios and even to apply reverse
been that an insurer’s asset-liability                                       stress tests to better assess liquidity
management is likely to protect against                                      positions of insurers, particularly in
significant liquidity problems.                                              regards to the risk of a sudden




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 29




withdrawal of policyholders with
                                                                               What are the implications?
guaranteed surrender values.
    in addition, in many countries, insurers
are typically required to hold assets                                          • The liquidity issues are clearly                                              their investment portfolios and
substantially in excess of their liabilities                                     different for insurers compared to                                            allow greater use of innovative
at a local subsidiary level, and these                                           banks, however regulators have                                                investments. relaxation of permitted
are sometimes ring fenced from the                                               still increased their attention and                                           asset rules will be offset by
insurer’s other operations. for example,                                         enquiries regarding insurers’                                                 increasing oversight of insurers’
all carriers in singapore must hold their                                        cash flows.                                                                   asset-liability processes,
local and foreign insurance business in                                        • The use of risk measurement                                                   management oversight, governance
separate funds, with surplus assets held                                         techniques such as stress and                                                 and related systems and controls.
in each fund which are in excess of their                                        reverse stress tests and scenario                                           • increased reliance on supervisory
domestic and foreign liabilities.                                                analysis tools requires insurers to                                           oversight of the insurer’s own
                                                                                 invest properly in ensuring that                                              investment strategies will require
asPac                                                                            their short and long term liquidity                                           greater focus on clear articulation of
cash flow and liquidity risks are a                                              positions are clearly understood                                              risk appetite, the insurer’s risk profile,
particular area of focus for regulators                                          and managed.                                                                  risk tolerance and overall financial
across much of the asPac region, in                                            • changes to permitted asset                                                    objectives. insurers will need to
particular in jurisdictions where local                                          admissibility criteria in jurisdictions                                       ensure that their controls over
debt markets are less deep and liquid.                                           embracing a prudent person                                                    investments held to cover technical
Duration matching may not be achievable                                          approach are likely to provide insurers                                       provisions and capital requirements
because there are insufficient assets of a                                       with greater flexibility in managing                                          are fit for purpose.
duration to match insurers’ longer term
liabilities, giving rise to reinvestment risk.
                                                                               Issues to consider

                                                                               • How robust is your liquidity planning,                                      • Do you appreciate the implications
                                                                                 governance and modelling?                                                     for pricing, funding and regulatory
                                                                               • How adequate and robust is your                                               ratios in your firm?
                                                                                 cash-flow analysis?                                                         • Do you have sufficient awareness
                                                                               • Do you understand the risk profiles of                                        of investment guarantees and
                                                                                 different investments currently held?                                         embedded options contained in
                                                                                 are you sufficiently aware of the                                             policies?
                                                                                 extent of investment guarantees and                                         • are you sufficiently aware of the
                                                                                 embedded options contained in                                                 impact of changes on your
                                                                                 policies and the potential impacts                                            investment strategy given increased
                                                                                 these may have on your financial                                              regulatory attention to off-balance
                                                                                 resources?                                                                    sheet and ‘non-regulated’ activities?
                                                                               • are systems, data and management                                            • Do you have a clear picture of
                                                                                 reporting adequate to meet your                                               portfolio management strategies
                                                                                 needs in stress conditions?                                                   required to properly take account of
                                                                               • Have you considered your approach                                             changes in risk profile and capital?
                                                                                 to stress testing and the data                                              • are your systems and data capable
                                                                                 required?                                                                     of satisfying the new reporting
                                                                               • What are your communication plans                                             and supervisory information
                                                                                 for new requirements?                                                         requirements?



© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
30 | evolving insurance regulation | March 2011




Perspectives:
Europe
Implementing the new regime



Due to be implemented in 2013,                                               are focussed upon are the outcomes                                              Such proposals can only succeed
solvency ii will herald a new era of                                         that such regulation provides – which is                                        if there is true international
prudential regulation across europe.                                         ultimately better policyholder protection.
although the development of solvency ii                                         solvency ii will also focus on group                                         agreement around prudential
was well underway before the global                                          supervision and group solvency of                                               requirements. This is why the
financial crisis (Gfc) of 2008/09, its                                       international insurers operating in the                                         IAIS ComFrame work is so
risk-based approach and focus on                                             eU, and include provisions that will
governance, group supervision and                                            allow greater cooperation with overseas                                         important.
regulatory cooperation has been widely                                       regulators.
accepted as the best way to mitigate                                            The new regime will also pay more
future crises.                                                               attention to:
   solvency ii will, for the first time,                                     • Group supervision and to assessing
require insurers to identify, measure                                           group risk;
and proactively manage risk, as well as                                      • strengthening the powers of group
consider future developments, such as                                           supervisors;
new business plans or catastrophic                                           • fostering greater cooperation
events that might affect their financial                                        between regulators; and
standing. The new rules also require far                                     • furthering supervisory convergence.
greater levels of public and regulatory
disclosure.                                                                  The crisis did, however, influence the
   Under the new regime, insurers will                                       development of solvency ii and the
be able to use approved internal models                                      ongoing calibration of the regime.
to calculate their capital requirements,                                     an earlier version of the framework
in consultation with supervisors.                                            proposed a group support regime,
alternatively, insurers can use a standard                                   enabling insurers to pool capital
formula and in both cases will be required                                   resources across the group, rather
to hold capital against all risks to the                                     than hold funds at a member state
balance sheet, including operational,                                        level. against the backdrop of the Gfc,
credit and market risks, which are                                           some eU states opposed the concept
currently not considered by solvency i.                                      and group support was consequently
   in recognition that one-size may not                                      dropped from the final framework
fit all, solvency ii also recognises the                                     directive, with a review planned for
need for flexibility under the framework,                                    the end of 2015. in my view such
depending on the nature, scale and                                           proposals can only succeed if there is
complexity of the company. The principle                                     true international agreement around
of proportionality is intended to reflect                                    prudential requirements. This is why the
the range of insurance entities operating                                    iais comframe work is so important.
in europe, from small specialist carriers
and mutual insurers up to complex                                            So what are the main features of
international financial services groups.                                     Solvency II?
   The regime will allow for the principle of                                in essence, solvency ii is constructed
proportionality to apply to the calculation                                  using a three pillar approach as outlined
of capital requirements, to the review of                                    in Diagram 4.
the risk management and governance                                              Pillar 1 outlines the financial
processes as well as to the disclosure                                       requirements. This pillar aims to ensure
requirements. i believe this is good news                                    firms are adequately capitalised with
for all insurers as it demonstrates that                                     risk-based capital. all valuations of assets
what european insurance supervisors                                          and liabilities in this pillar are to be done
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
in a market consistent manner. This pillar                                   Equivalence                                                                     Equivalent reinsurance to receive
also includes the potential use of internal                                  solvency ii also recognises the international                                   equal treatment
models, which, subject to stringent                                          dimension of insurance and the ties                                             The Directive allows for the conclusion
standards and prior supervisory approval,                                    that exist between insurers operating                                           of mutual recognition agreements
enables a firm to calculate regulatory                                       in europe and certain other markets.                                            with third countries concerning the
capital requirements using its own                                              in order to assess the risks to european                                     supervision of reinsurance entities that
internal model which is more tailored to                                     policyholders, eU supervisors will need                                         conduct business in member states.
its risks than the standard formula.                                         to consider factors at a group level,                                           reinsurers that are covered by an
   Pillar 2 is concerned with imposing                                       potentially including group entities and                                        equivalent regime will be treated the
standards of risk management and                                             subsidiaries outside the eea. This has led                                      same as eU reinsurers, but those that
governance within a firm’s organisation.                                     the eU in its development of solvency ii,                                       are based in non-equivalent regimes
This pillar requires supervisors to                                          to consider recognising the supervisory                                         may be required to pledge assets to
challenge their firms on risk management                                     work of overseas insurance entities                                             cover unearned premiums and claims
issues. The Orsa requires a firm to                                          through the concept of ‘equivalence.’                                           provisions, or localised assets for risks
undertake its own forward looking self                                          The provision of equivalence in                                              situated in the eU.
assessment of its risks, corresponding                                       solvency ii recognises the potential to                                            Unrated equivalent reinsurers will
capital requirements and adequacy of                                         reduce the duplication of supervision                                           be treated as having a 10 percent
capital resources.                                                           between regulators and compliance for                                           probability of default, or a B/ccc credit
   Pillar 3 aims to achieve greater levels of                                insurers with operations outside the eU.                                        rating, while equivalent non-rated
transparency to their supervisors and the                                       The provisions allow the eU and                                              reinsurers will be considered BBB under
public so that firms are more disciplined                                    member state regulators to assess the                                           the standard formula for assessing
in their actions. There is a private annual                                  supervisory regimes of countries outside                                        capital requirements.
regular supervisory report and a public                                      the eea-known as ‘third countries,’ in
solvency and financial condition report                                      particular where an eU insurer transacts
that increase the level of disclosure                                        business with non-eU reinsurers; where
required by firms.                                                           it operates on a global level; or where it
                                                                             may be part of a non-european group.




 Diagram 4: Three Pillar Approach

                                                                                              Three Pillar Approach

   Pillar 1                                                                   Pillar 2                                                                   Pillar 3

   Quantitative capital requirements                                          Qualitative requirements and                                               Reporting, disclosure and
   • Balance sheet (including technical                                       supervisory review                                                         market discipline
     provisions)                                                              • Governance, risk management and                                          • sfcr and rsr
   • Minimum capital requirement (Mcr)                                          required functions                                                       • Disclosure
   • solvency capital requirement (scr)                                       • Own risk and solvency assessment                                         • Transparency
   • investment principles                                                    • supervisory review process                                               • support of risk-based supervision
                                                                                                                                                           through market mechanisms


   Market-consistent valuation                                                Business governance risk-based                                             Disclosure transparent markets
   risk-based requirements                                                    supervision

 source: KPMG international, february 2011.


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
32 | evolving insurance regulation | March 2011




Regulator can use discretion when                                            The eU will assess the equivalence of                                           Equivalence would make EU
considering group supervision                                                third-country regimes in waves of                                               supervision more effective,
solvency ii also allows for supervisory                                      assessments. in prioritising assessment
equivalence when calculating group                                           the eU will consider which countries                                            reducing the compliance burden
solvency and group supervision of                                            are most relevant in terms of providing                                         for insurers and making for
non-eU headquartered groups. The eU                                          reinsurance to eea insurers, where eU                                           more effective regulation of
regulator may require a group-wide                                           insurers have substantial amounts of
solvency assessment, risk management                                         business, and where groups operating                                            international groups.
and an Orsa, even if the entity is based                                     in the eU have foreign ownership.
outside the eU.                                                                 switzerland, Bermuda and Japan
  However, the eU regulator may                                              (for reinsurance) are to be assessed in
take account of a third country capital                                      the first wave, under the advice from
requirement in its solvency assessment,                                      european insurance and Occupational
and can use its discretion when assessing                                    Pensions authority (eiOPa). a noticeable
group solvency, it can also use alternative                                  omission from this list is the Us, where
approaches to determine the most                                             the state by state approach to insurance
effective means of supervision.                                              regulation poses challenges in assessing
  in its consultation paper on assessing                                     equivalence. The implication of the Us
third countries for equivalence, ceiOPs                                      not gaining equivalence could have a
says that third country regimes would                                        significant impact on Us insurers caught
be expected to provide a similar level of                                    by solvency ii.
policyholder protection as that provided
by solvency ii. However, when
assessing each principle and objective
not every ‘indicator’ would need to be
met, and proper consideration would be
given to the concept of proportionality.

Which countries are likely to seek
equivalence with Europe?
The inclusion of provisions for equivalence                                  Rob Curtis
reflect the eU’s recognition of the                                          regulatory centre of excellence
international nature of the european                                         eMa region
insurance market and its close ties with                                     KPMG in the UK
other markets. equivalence would make
eU supervision more effective, reducing
the compliance burden for insurers and
making for more effective regulation of
international groups.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 33




What can others learn from
the Solvency II experience?

While solvency ii has just under two                                          • Boards and senior management                                                  found it more difficult to manage
more years before becoming effective,                                           have needed clear strategic plans                                             the competing priorities that
there are already clear lessons to be                                           and purpose regarding programme                                               invariably arise between business-
learned from the experiences of many                                            sponsorship and to set clear                                                  as-usual activity and meeting project
insurers which have a read-across to                                            accountabilities and establish agreed                                         deliverables.
the nature of change that will be                                               deliverables. Most solvency ii                                              • ensuring timely and effective
required for non-european insurers                                              programmes have needed a strong                                               management information is absolutely
in implementing Orsa and internal                                               project team to provide a clear and                                           essential to most solvency ii projects.
model programmes. some of these                                                 well articulated programme plan                                               Too often reporting lines have
key lessons are:                                                                creating the necessary road-map                                               been opaque for meeting delivery
• Don’t under-estimate the time and                                             for stakeholder input and continued                                           schedules and information flows
   resources required to implement                                              involvement.                                                                  have suffered.
   the changes needed. solvency ii is                                         • a major challenge for all european                                          • Documentation requirements are
   an enormous change programme                                                 insurers has been in setting risk                                             extremely important for solvency ii,
   affecting every part of the business                                         appetite and risk limits. ensuring the                                        especially as the review of any work
   from risk and capital management,                                            integration of these elements into the                                        performed will need to be supplied
   to governance and internal controls,                                         insurer’s economic capital, Orsa and                                          invariably to external audiences
   Board oversight and responsibilities to                                      internal model framework has proven                                           namely supervisors, credit rating
   reporting and disclosure. effectively                                        to be both complex and involved.                                              agencies and analysts. The quality
   every facet of an insurer’s business                                         careful planning and analysis has                                             and cohesiveness of this material
   requires some form of enhancement.                                           been essential.                                                               must be of a high order and this
• Good planning and project management                                        • regular feedback and open                                                     ultimately places resource constraints
   is essential. Key resources and staff                                        communication channels have been                                              on insurers.
   with specific skill sets suddenly                                            key to most successful european
   become a scarce commodity. early                                             solvency ii programmes across the
   preparation and awareness by the                                             business. solvency ii projects have                                         Insurers that have not
   Board and senior management are                                              required the collective input from a                                        appropriately appreciated or
   needed to fully appreciate the scale                                         wide cast of stakeholders, and this
   and complexities involved.                                                   has become even more important                                              managed the different cultural
• Data and system issues presented                                              for groups with subsidiaries and                                            perspectives and inputs and
   significant challenges for most                                              branches in non-eea countries.                                              communicated the benefits
   european insurers. While solvency                                            achieving the right balance between
   ii expects reliable and robust                                               local and group requirements and                                            of involvement, have found it
   information to calculate Pillar 1 and                                        input has been difficult.                                                   more difficult to manage the
   technical provision requirements,                                          • for many european insurers, the                                             competing priorities that
   in addition to meeting Orsa and                                              solvency ii work has required
   reporting purposes, there has also                                           input from many business units                                              invariably arise.
   been a fair degree of uncertainty                                            and stakeholders from across the
   regarding the veracity of information.                                       business. insurers that have not
   One of the issues encountered                                                appropriately appreciated or managed
   has been the extent and use of                                               the different cultural perspectives
   management actions – particularly                                            and inputs and communicated the
   where there are data issues.                                                 benefits of involvement, have


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
05

Governance and
internal controls
Changing gears

a number of new initiatives concerning governance and internal                                                                                               in response, a number of jurisdictions,
controls which will impact insurers are being pursued by                                                                                                     such as the eU, either have or are in
                                                                                                                                                             the process of regulating remuneration.
supervisors. all of these changes are designed to instil the right                                                                                           a key focus for insurance supervisors
behaviours in insurers and establish new skill sets across key                                                                                               will be whether remuneration schemes
functional business areas of risk, finance and strategy. increasingly                                                                                        may increase risk taking within firms
                                                                                                                                                             or unduly influence management
supervisors are beginning to examine issues concerning behaviours/                                                                                           decision making. companies will need
ethics and culture. regulators are considering playing a greater role                                                                                        to review their performance and reward
in assessing behaviour and even ethics; in effect, an insurer’s culture                                                                                      strategies to ensure alignment with
                                                                                                                                                             their organisation’s overall risk strategy
is not beyond the remit of regulation.                                                                                                                       and culture.
   insurers will need to be aware of their culture and ‘tone at the top’,                                                                                        Many supervisors also have strict
as this influences behaviour throughout the organisation. The recent                                                                                         ‘fit and proper’ criteria on the suitability
                                                                                                                                                             of key persons whether owners or
furore over bankers’ bonuses is an example where regulators are                                                                                              management, namely Board members,
under immense pressure to respond to a financial sector perceived                                                                                            senior management and key persons
as lacking an appropriate ethical framework within which actions and                                                                                         in control functions. a key criterion
                                                                                                                                                             for holders of these roles is possession
decisions were grounded, or if such a framework was promulgated                                                                                              of sufficient competence and integrity in
it was not adhered to.                                                                                                                                       the fulfilment of their duties. fit and
                                                                                                                                                             proper requirements are likely to extend
                                                                                                                                                             to most outsourcing arrangements.

© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 35




increasingly supervisors want to see
                                                                               What are the implications?
operational independence of the
main governance functions of risk
management, compliance and actuarial                                           • Through on-site visits, supervisors                                           will be assessed as much as the
with approved persons being responsible                                          are increasingly examining the                                                function. insurers therefore need
for the management of such functions.                                            alignment of strategy, the insurer’s                                          to ensure high quality candidates
The likely trend is that this may even                                           own risk operating model and risk                                             capable of managing these functions
extend to the supervisor requiring that                                          function capabilities and making                                              are selected.
they pre-approve the appointment of                                              judgements about the governance                                             • new areas of regulatory interest are
such function holders.                                                           and internal control environment of                                           ethics and culture. Organisations
   similarly, supervisors are now                                                the organisations they supervise. it                                          that ignore these important
beginning to expand their expectations of                                        is therefore critical that insurers are                                       considerations may encounter
the risk governance framework employed                                           sufficiently aware of these increased                                         more intrusive supervision.
by insurers, progressively moving to a                                           expectations and are properly                                               • remuneration considerations are
‘three lines of defence’ model. Under this                                       prepared to address any weaknesses.                                           currently very topical and may
approach, functions and business units                                         • above all else, supervisors are                                               become a heightened area of
form the first line of defence, with the                                         moving towards an operating model                                             supervisory inquiry. roles between
oversight functions of risk and control                                          that requires strong accountability by                                        key function holders should be clear
forming a second line of defence, with                                           key function holders. Key individuals                                         and areas of duplication eliminated.
internal audit providing the third line of
defence, through independent assurance
                                                                               Issues to consider
over the first two lines of the model.
as such, the expectation is that internal
audit is fully independent. sitting above                                      • Do you operate a ‘three lines of                                            • Does your organisation have an
these functions are various governance                                           defence’ model?                                                               appropriate ethical framework and
committees – such as the Board risk                                            • Do you regularly review your                                                  culture for a regulated entity?
committee, remuneration committee                                                governance structure for                                                    • are you ready to demonstrate and
and other executive committees with                                              effectiveness?                                                                attest to effective internal controls,
the Board presiding over each. sitting                                         • are roles and responsibilities clear                                          e.g. over risk and capital integration?
independently to the other committees                                            between key function holders?                                               • is your management information
would be the audit committee. clear                                            • can you fulfil requirements to up-skill                                       sufficient to meet the requirements
lines of responsibility, delegated                                               the Board and senior management                                               of the Board and effective risk
authorities and accountability for                                               and demonstrate capability?                                                   management?
reporting are fundamental to sound
risk management and insurers will need
to ensure good governance in order to                                        material weakness in the company’s                                              To complement these changes in
fulfil their Orsa commitments.                                               overall governance and risk management                                          regulatory focus, the role of chief risk
   supervisors are also beginning to                                         framework and could impact upon the                                             Officer (crO) is increasingly viewed by
assess the risk operating model of the                                       insurer’s capital requirements.                                                 supervisors as a necessary function
insurers they supervise. at the centre                                          While risk management is the                                                 holder role within insurance companies.
of these considerations are the risk                                         responsibility of the Board as a whole,                                         The challenge for most firms will be to
function’s mandate and the extent to                                         some supervisors are beginning to                                               clearly articulate the responsibilities of
which controls and behaviours are                                            designate at least one member of the                                            the crO, the chief financial Officer,
embedded. supervisors are now                                                Board to oversee the risk management                                            the Head of actuarial and even
assessing the quality of risk advice                                         strategy (rMs). reinforcing the                                                 that of a chief compliance Officer.
provided, the risk coordination activities                                   responsibility of the Board, most                                               Demonstrating that these structures
that are undertaken and how they are                                         supervisors will soon be assessing                                              are working effectively will be a major
performed in practice, the extent and                                        the Board’s effectiveness in setting                                            focus for many supervisors going
quality of risk monitoring undertaken                                        strategy, risk appetite, tolerance limits                                       forward and appropriately documenting
and the challenge given to the business                                      and policy. supervisors will also expect                                        such arrangements will be an ongoing
units. This scrutiny may require insurers                                    that the Board is kept fully informed                                           challenge for many insurers.
to strengthen second line functions.                                         of reputational risk exposures and
failure to establish a ‘three lines of                                       the correlation this may have to other
defence’ model may be seen as a                                              key risks.


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
06

Customer treatment
Changing conduct of business

it is not only in prudential regulation that significant changes are
occurring. in many markets, substantial changes are being made
to the conduct of business requirements and the fair treatment
of customers.
    an example of this is in the UK, where in June 2010 signifant
changes were announced concerning the regulatory tripartite
regime involving the financial services authority (fsa), the Bank
of england and the Treasury, by effectively breaking up the fsa.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 37




it is planned that the fsa‘s responsibilities                                • selling practices must be focused on                                          The new regulations have the
will be handled by three new agencies:                                         the fair treatment of the investor;                                           potential to create a ripple effect
• reporting to the Bank of england the                                       • investment advisers should ensure
    Prudential regulatory authority will be                                    products sold correspond to the profile                                       of change, which will run right
    responsible for prudential regulation of                                   and needs of the investor, and that the                                       across organisational structures
    all financial firms;                                                       investor understands the nature of the                                        and individual corporate
• The financial conduct authority (fca)                                        service being provided by the adviser;
    will regulate the conduct of every                                       • if a product is sold without advice,                                          commercial models.
    authorised financial firm providing                                        the limits to the service provided and
    services to consumers; and                                                 risks for the investor must be clear.
• The financial Policy committee, led                                          an assessment of the adequacy of
    by the Bank of england, will be                                            the product may still be required in
    responsible for addressing macro-                                          some circumstances;
    prudential issues.                                                       • for both advised and non-advised
                                                                               sales, conflicts of interest must be
The establishment of the fca as a body                                         avoided where possible, or be
dedicated to consumer issues reflects                                          identified, managed and disclosed in
the thinking behind the fsa’s retail                                           a way that investors can understand;
Distribution review (rDr), due for                                           • for both advised and non-advised
implementation in January 2013, along                                          sales, investors must receive clear and
with the current european commission’s                                         effective disclosures of remuneration
Packaged retail investment Products                                            arrangements and all charges,
(PriPs) consultations. in undertaking                                          commissions or fees paid, in a form
the rDr and planning its subsequent                                            they can use; and
wide-ranging associated regulations the                                      • Those assessing the suitability of
fsa set out their objective as:                                                products must fully understand those
• improving the clarity with which                                             products and their features.
  regulated firms describe their services
  to consumers;                                                              What do these changes mean for
• addressing the potential for financial                                     insurers?
  adviser remuneration to distort                                            The increasingly consumer centric
  consumer outcomes; and                                                     regulatory drive has potentially significant
• increasing the professional standards                                      implications for insurers. The rDr
  of advisers.                                                               regulations in the UK will outlaw
                                                                             commission and demand that advice is
This was driven by a belief that adviser                                     paid for from customer fees. it will ensure
remuneration and a lack of transparency                                      that the consumer is clear on the type of
had acted against consumers’ best                                            advice they are receiving and that advisers
financial interests.                                                         are significantly more highly trained. The
   Meanwhile, the european                                                   impacts of such changes are likely to
commission states its objective is to                                        be significant as the changes re-define
create a framework that will provide                                         some of the commercial fundamentals
effective standards for the protection of                                    that underpin the whole pensions and
investors as “they do not understand                                         investment market. as such, the new
products because they are complex and                                        regulations have the potential to create
the accompanying literature is hard to                                       a ripple effect of change, which will run
understand”. Thus the PriP looks to                                          right across organisational structures and
ensure complete clarity on disclosure,                                       individual corporate commercial models.
such that the information is clear,                                          simple compliance with rDr will not be
concise, timely and appropriate, while                                       the end for organisations, because the
the principles on which the selling                                          regulations will demand a more strategic
requirements will be designed include:                                       and pan-organisational response.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
38 | evolving insurance regulation | March 2011




so what are these fundamental market                                         Operational                                                                     of insurance producers and consumer
shifting changes? They can be                                                This re-shaping naturally leads into the                                        information and consumer assistance
characterised in three areas; consumer,                                      extensive operational impact. alongside                                         services.
markets and operational.                                                     the potential requirement for revised                                               Over the last decade progress has
                                                                             strategies, operating models and                                                been made by Us regulators toward
Consumer                                                                     innovative customer engagement                                                  modernising many of the market
currently consumers can be segmented                                         approaches, are the core requirements                                           regulatory processes. for example, in
and targeted by providers and                                                for product re-design, re-thinking on                                           the area of product filing and review,
intermediaries in a proactive manner,                                        capital requirements, increased                                                 regulators and legislators have enacted
since the perception of the vast majority                                    demands on iT and the need for                                                  an interstate compact for certain life,
of consumers is that the advice (or sales)                                   improved data quality.                                                          annuity, disability income and long-term
process is ‘free’. Thus the customer                                             in many markets, the seeming shift                                          care products. The compact is a system
engagement process is simple and                                             in regulatory focus, from a balanced                                            that seeks to enhance the efficiency and
based upon capturing the consumer’s                                          approach of protecting the consumer                                             effectiveness of the way insurance
attention and advising/‘selling’ to them.                                    within commercially reasonable                                                  products are filed, reviewed and
With the new consumer centric                                                boundaries to a purely consumer                                                 approved allowing consumers to have
regulation the balance shifts as the                                         protection role, will have major                                                faster access to competitive insurance
consumer now needs to be persuaded                                           implications for the whole market.                                              products in an ever-changing global
to pay for something that they previously                                                                                                                    marketplace. The compact promotes
perceived to be free i.e. the engagement                                     north america                                                                   uniformity through application of national
process (and which in many cases they                                        Us regulators have always been heavily                                          product standards embedded with
attached no value to). so advice becomes                                     focused on consumer protection, but                                             strong consumer protections. insurers
the product but will the consumer want                                       the Gfc has added additional pace and                                           now have access to a single point of
to buy it?                                                                   pressure to modernise and reshape                                               filing and uniform national standards for
                                                                             market conduct requirements.                                                    eligible products. currently 38 states
Markets                                                                         Within the Us each state is                                                  representing over 60 percent of the
The impact on the market is currently                                        responsible for legislating and enforcing                                       eligible premium volume are members
characterised by imponderables:                                              insurance regulation – historically driven                                      of the compact.
• How many independent financial                                             by consumer considerations and the                                                  Traditional market conduct
  advisors (ifa) will survive by 2015?                                       safety and soundness of the insurance                                           examinations have also been evolving in
• Will product providers and fund                                            industry. However, the financial crisis                                         the Us. The Us regulators are moving
  managers create direct distribution                                        has reignited the debate over federal                                           toward increased use of market analysis
  offerings to protect their route to                                        regulation and added an international                                           tools to replace the traditional on-site
  market?                                                                    dimension to potential changes in                                               market conduct examination. as part of
• How will platforms re-shape the fee                                        domestic regulation. it should be noted                                         that evolution, regulators have developed
  distribution model?                                                        that Us insurers generally performed                                            the Market conduct annual statement
• Will new entrants cherry pick                                              much better than their banking                                                  (Mcas) to collect pertinent statistical
  consumer segments?                                                         counterparts during the crisis with                                             information from insurers to evaluate
• Will ifas gravitate to High net Worth                                      297 Us banks failing in 2009 and 2010,                                          and monitor certain areas of market
  clients?                                                                   compared to only 30 Us insurers over                                            performance. The Mcas submissions
• What will be the impact of consumer                                        the same time period.                                                           have been centralized at the naic
  use of comparison and on-line peer                                            The Us market regulatory framework                                           with 45 Us jurisdictions participating
  advice sites?                                                              is broad with resources being devoted                                           in the effort.
                                                                             to market regulatory issues. areas within                                           a number of Us life insurers were
in this market of moving parts,                                              the broad category of market regulation                                         hit particularly hard by the financial crisis.
organisations need to identify where                                         consist of oversight of insurers’ product                                       variable-annuity policies are a popular
they can succeed and re-shape their                                          development and pricing, monitoring                                             savings product in the Us, and a number
models accordingly.                                                          insurer market practices, monitoring                                            of writers of this business offered
                                                                             competition, statistical reporting,                                             guaranteed minimum death and living
                                                                             residual market administration, licensing                                       benefits. Us regulators have been




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 39




monitoring the variable annuity writers,
                                                                               What are the implications?
particularly those with the guaranteed
minimums. it is possible the Us regulators
will encourage more conservatism in the                                        • significant conduct of business                                             • fundamental changes to strategy
offering of guarantees.                                                          regulatory changes are occurring                                              and existing business operating
    as a result of the challenges in the Us                                      which will have important implications                                        models are likely to be needed for
life industry, there has been a ‘flight to                                       for product development and                                                   some markets.
quality’ resulting in a shift in consumer                                        distribution processes.                                                     • The capital impact could be
demands. annuity sales in the Us are                                           • increased regulatory focus on                                                 significant and will require careful
depressed and more traditional life                                              pushing simplicity and transparency                                           analysis.
products, particularly whole life, are                                           for consumer products will have                                             • There is also likely to be a need
experiencing a resurgence. However,                                              implications for innovation and choice                                        for better iT, data and system
it is uncertain how this recent trend will                                       in consumer products.                                                         requirements by insurers.
pan out in the long-term as the needs of                                       • The eU and UK are issuing major                                             • increased reporting and disclosure
the ‘baby boomer’ generation play an                                             changes to distribution of retail                                             requirements will most likely be
increasingly dominant role in the industry.                                      products (PriPs and rDr                                                       introduced.
    from a regulatory perspective, there                                         respectively) and will be a major
has also been enhanced scrutiny around                                           focus for many insurers.
the suitability of products in the Us,
which historically has always been high
on the regulatory radar. The regulatory                                        Issues to consider
focus has increased and expanded to
look deeper into products such as fixed                                        • How will product strategy evolve                                            • How aware are you of the potential
annuities.                                                                       to meet and take advantage of                                                 risk and capital impacts such changes
    The Dodd-frank act established                                               new rules?                                                                    may have on your business?
the consumer financial Protection                                              • How will the sales process and                                              • increased regulatory focus will
Bureau (cfPB) in July 2010 and as                                                collateral need to change?                                                    require many insurers to devote more
yet it remains unclear what insurance                                          • What are the opportunities for                                                resources to conduct of business
products, if any, will be caught under                                           services to customers?                                                        issues – are you prepared?
this federal watch dog. additionally,                                          • Will systems, data and reporting be
further insurance reform is slated on                                            in place to meet new requirements?
capitol Hill for 2011.

asPac                                                                                                                                                        The financial crisis has reignited
Models of consumer protection vary                                                                                                                           the debate over federal
significantly in asPac but generally have
not yet embraced the principles based                                                                                                                        regulation and added an
customer-centricity seen in the eU and                                                                                                                       international dimension to
UK developments discussed above.                                                                                                                             potential changes in domestic
instead, many countries still focus on
achieving consumer protection through                                                                                                                        regulation.
regulatory pre- approval of product
designs and pricing. current areas of
regulatory focus include increasingly
stringent controls over data privacy,
impacting direct marketing and cross-
selling, controls over who may sell
insurance in bank branches and increased
control of selling practices in respect of
investment linked products.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
07

Group-wide and cross-
border supervision
Driving global consistency


considerable efforts continue at an international level to harmonise                                                                                         Group supervision
                                                                                                                                                             The Gfc has highlighted the need for
prudential insurance regulations, promoting common standards
                                                                                                                                                             effective group supervision and
and approaches, as well as encouraging cooperation between                                                                                                   reinforced calls for common principles
supervisors. solvency ii will harmonise regulation in europe,                                                                                                and standards, and greater cooperation
                                                                                                                                                             between regulators, in particular for
and potentially open the way to greater cooperation and mutual
                                                                                                                                                             cross- border groups and to manage
recognition with other markets.                                                                                                                              systemic risks. last year, the G20 agreed
  Globalisation and the growth of multi-national insurance groups,                                                                                           actions to promote financial regulatory
                                                                                                                                                             reform, including greater consistency
coupled with more sophisticated products and financial markets,
                                                                                                                                                             and cooperation between countries,
has led to calls for better supervision of cross-border and global                                                                                           and a framework of internationally
insurance and reinsurance groups.                                                                                                                            agreed high standards.
                                                                                                                                                                One of the key findings from the Gfc,
                                                                                                                                                             and the role of systemically important
                                                                                                                                                             financial institutions (sifis), has
                                                                                                                                                             highlighted that monitoring an insurer
                                                                                                                                                             only at the legal entity level is not
                                                                                                                                                             sufficient. supervisors involved in
                                                                                                                                                             group-wide supervision need to be able
                                                                                                                                                             to assess all relevant information on all
                                                                                                                                                             risks to which the insurance group is
                                                                                                                                                             exposed. However, complex and highly
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 41




centralised groups make it almost                                            requirements have been demonstrated                                             However, at present, there are
impossible to rely solely on solo level                                      not only to contribute to enhanced                                              no globally consistent solvency
data to adequately address the risks at                                      market confidence and stability but also
the solo level. indeed, the global size and                                  to facilitate effective banking supervision                                     reporting or measurement tools
complexity of many iaiGs evidences the                                       by providing common understanding and                                           for assessing insurer solvency
need for formal supervisory cooperation,                                     consistent data among the supervisors.                                          amongst supervisors.
including the timely exchange of relevant
information and the need for supervisors                                     So what is changing and what impact
to close any regulatory and supervisory                                      might this have for insurers?
gaps in group-wide supervision. a key                                        Given the scale and complexity of large
issue identified during the Gfc is the                                       insurance groups, the extent of cross-
extent of supervision applied to non-                                        border activities and the importance of
regulated subsidiaries and off-balance                                       such institutions to local and international
sheet items.                                                                 financial systems, inconsistent
                                                                             implementation of regulatory and
Comparability and convergence                                                supervisory requirements among iais
The Gfc also highlighted strong                                              members means that the effectiveness
arguments in favour of greater                                               of international supervision is limited. in
convergence of supervisory practice.                                         turn this limits the effective protection of
Despite current changes in many                                              policyholders, the promotion of financial
jurisdictions, the global insurance sector                                   stability and, moreover, may permit
is still subject to different accounting,                                    regulatory arbitrage. inconsistent
capital adequacy and legal regimes                                           standards around the world, could
around the world. This has resulted in                                       allow the relocation of headquarters and
a low level of regulatory harmonisation                                      the transfer of significant risks within a
and convergence of supervisory practice                                      group to a less sophisticated and under-
when compared to the banking sector.                                         regulated jurisdictions, which could
One pertinent issue to arise from G20                                        result in a greater concentration of risks in
and the fsB driven discussions, has                                          certain jurisdictions. naturally this is of
been the frequent requests to                                                particular concern to supervisors. The lack
supervisors for hard data on insurance                                       of common supervisory standards could
activities. However, at present, there are                                   even trigger a ‘race to the bottom’ by
no globally consistent solvency reporting                                    insurers seeking less sophisticated
or measurement tools for assessing                                           regulation.
insurer solvency amongst supervisors.                                            furthermore, it can be complex,
This is in marked contrast to the banking                                    resource intensive, and at times
sector where the Basel committee for                                         impractical, for supervisors to fully
Banking supervision (BcBs) established                                       understand and assess the supervisory
common capital requirements for all                                          frameworks and practices of other
internationally active banks in 1988.                                        jurisdictions, because there is so much
These were substantially improved under                                      variation in practice. Thus, it can be
Basel ii in 2004 and will now undergo                                        difficult for supervisors to share
further reform as a result of Basel iii.                                     information and consolidate such
similarly, the international Organization                                    information to reach a common
of securities commissions (iOscO)                                            understanding of the financial and risk
apply a common capital requirement                                           positions of large insurance groups. This
for the trading book, on the same basis                                      can impact the efficient and effective
as the BcBs. such common benchmark                                           supervision of complex insurance groups.
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
42 | evolving insurance regulation | March 2011




The role of supervisory colleges only                                        iais supervisory principles, standards                                          Establishing a global solvency
serves to underline this point. Without a                                    and guidance. specific criteria measures                                        framework is very likely to mean
common solvency language among                                               (in the form of parameters and
supervisors and insurers, the effectiveness                                  specifications) will be developed.                                              the introduction of consistent
of such colleges is hampered. for                                            coupled with the generation of new                                              risk-based requirements in
example, the assessment of the financial                                     reporting and supervisory review                                                addition to new governance
condition and risk management of a large                                     requirements, the comframe will
multi-national insurance group will be                                       certainly be a key solvency development                                         (risk management) requirements.
complex if each jurisdiction imposes                                         for many years to come.
different requirements for risk                                                  The following summary sets out some
measurement and capital determination.                                       of the key areas of development now
if a specific risk is valued using a risk                                    being actively pursued by supervisors in
sensitive capital requirement in one                                         the establishment of enhanced global
jurisdiction (such as using an internal                                      mechanisms to achieve a common
model), a rule-based capital requirement                                     framework. early awareness by insurers
in another (such as a standardised or rBc                                    of such developments will provide a
approach), and other supplementing                                           competitive advantage to improve their
measures (such as investment limits)                                         risk management practices, governance
or qualitative requirements (such as                                         and capital allocation methods and
controls over governance) in another                                         generally improve their business models
jurisdiction, the scope for consolidating                                    world-wide.
each jurisdiction’s assessment of the
risks and financial positions will be                                        Quantitative aspects of solvency
limited. Hence it may be difficult for                                       assessment and supervision
supervisors to establish a comprehensive                                     • a common approach on valuation is
view of the risks to which a specific                                          a necessary precondition of effective
insurance group is subject. added to                                           common rBc requirements (valuation
this scenario is the fact that a college                                       is an integral part of solvency
for a large international group is almost                                      assessment) and it is expected that
certain to involve supervisors from                                            ifrs developments will assist in
different jurisdictions meaning a                                              providing such a common platform;
common language becomes even more                                            • establishing a global solvency
important. all of these inconsistencies                                        framework is very likely to mean
greatly add to the costs of insurers in                                        the introduction of consistent risk-
meeting multiple requirements.                                                 based requirements such as risk-
                                                                               sensitive capital requirements and/
Greater commonality                                                            or complementary investment
Therefore it is very encouraging that the                                      requirements in addition to new
iais has commenced its comframe                                                governance (risk management)
project (see chapter 9), for which one                                         requirements. such changes will be
of the principal aims is to explore the                                        necessary to facilitate comparability or
extent to which a common supervisory                                           consolidation of financial assessment
framework can be achieved, with                                                and avoid potential for regulatory
solvency assessment being at the core                                          arbitrage. common requirements
of such requirements. similar to the                                           also facilitate the coordinated
Basel accord for banking, this project                                         consideration of any pro-cyclical
will aim to go further than the existing                                       effects of regulation; and


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 43




• reporting: requirements will need
                                                                               What are the implications?
  to be constructed to establish the
  collection of data and information
                                                                               • complex group structures, including                                         • supervisors are increasingly worried
  based on consistent definitions and
                                                                                 holding company structures, will                                              that complex structures may lead
  calibrated at common levels, so as to
                                                                                 come under particular regulatory                                              to inappropriate decisions and
  promote consolidated and aggregated
                                                                                 focus. supervisors may have                                                   ineffective implementation of
  data that is useful for the supervisors
                                                                                 difficulty in clearly understanding                                           strategies in relation to individual
  in analysing the financial condition
                                                                                 the structure of complex groups and                                           entities resulting potentially in
  of groups.
                                                                                 the linkages between different parts                                          duplication, inefficiencies and
                                                                                 of the business which could have                                              additional costs.
Qualitative aspects of solvency
                                                                                 significant impacts in terms of                                             • financial, reputational or operational
assessment and supervision
                                                                                 solvency, intra-group transactions                                            risks at the centre may expose other
• legal framework: the scope of
                                                                                 and tax treatment for different                                               group entities. conversely, some
  regulation will all be reviewed
                                                                                 group entities may not be clear for                                           risks may crystallise at entity level
  including, treatment of non-regulated
                                                                                 them to understand.                                                           and could flow through to other
  holding companies/entities; the
                                                                               • Overly complex group structures                                               entities and/or the wider insurance
  extent of supervisory powers and
                                                                                 may also make the management of                                               group (contagion risks). insurance
  authority; information exchange and                                                                                                                          groups need to be fully aware of
                                                                                 the group more difficult which could
  confidentiality requirements, including                                        hamper effective communication                                                such risks and ensure they are
  insolvency laws;                                                               and coordination of activities.                                               adequately prepared.
• risk management: it is very likely that                                        Group management will need to                                               • at legal entity level, some
  risk management functions will receive                                         demonstrate that they have a full                                             subsidiaries may be insignificant
  even greater attention particularly for                                        understanding of all risks occurring                                          within a group context, yet could be
  large groups, which tend to be more                                            in each entity as well as across                                              significant entitities in their own right
  centralised. common requirements                                               the group.                                                                    within their local markets. Potential
  for the supervisory assessment of                                                                                                                            conflicts of interest could arise.
  such centralised functions, which
  encourage the improvement in those
  risk management functions rather than
  impose differential (and sometimes
  conflicting) requirements in individual
  solo entity, are likely to be required.
  formalising the role of a chief risk
  Officer may also be contemplated
  to accompany other similar function
  holders such as those applying to
  actuaries;
• Governance requirements: it is
  possible that requirements for fit
  and proper persons, outsourcing
  arrangements, internal auditor,
  external auditor and actuarial functions
  will be strengthened. requirements in
  respect of the relationship between,
  and necessary independence of,
  directors between entities within
  a group, are also likely to receive
  increased attention;
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
44 | evolving insurance regulation | March 2011




• cooperation/information exchange:                                          awareness and action by insurers should                                         Early awareness and action by
  supervisors will strengthen                                                enable adequate opportunity to engage                                           insurers should enable adequate
  cooperative mechanisms such as                                             and influence the likely direction of
  Memoranda of Understanding,                                                insurance regulation that is adequate                                           opportunity to engage and
  establishment of supervisory colleges                                      and proportionate to the needs of                                               influence the likely direction of
  and group-wide assessments; and                                            insurers, thus enabling forward-thinking                                        insurance regulation.
• non-regulated entities: requirements                                       and proactive insurers to gain a
  are likely to ensure that all relevant                                     competitive advantage.
  entities are monitored and supervised
  in an appropriate way, proportionate                                       european Union
  to the risks they are facing and/or                                        solvency ii will also encourage
  that can be transmitted to entities                                        cooperation between regulators within
  within the group and to avoid potential                                    europe, the eea, the iais and directly
  for regulatory arbitrage between                                           with third party countries through the                                          The group supervisor will work with
  jurisdictions. such considerations                                         supervision of cross-border groups.                                             other supervisors to set the capital
  will need to be given to both                                              One of the most significant elements                                            requirement, authorise any group internal
  quantitative (including intra-group                                        of solvency ii is the mandatory creation                                        model; and effectively act as the lead
  transactions) and qualitative (such                                        of supervisory colleges, whereby the                                            supervisor of the group.
  as reputation) risks.                                                      various national supervisors responsible
                                                                             for a group and its subsidiaries can                                            north america
it is therefore evident that insurance                                       cooperate and exchange information.                                             The Us risk-based solvency regime,
regulation is facing enormous change                                            Groups will have a dedicated ‘group’                                         post the solvency Modernisation
and will present significant challenges to                                   or ‘lead’ supervisor, with powers and                                           initiative (sMi) reforms currently
both supervisors and insurers. However,                                      responsibilities to organise the                                                underway, is likely to provide the Us with
like most regulatory changes, early                                          supervision of a multi-national group.                                          a good platform for seeking equivalence
                                                                                                                                                             with solvency ii. it is early days for Us
                                                                                                                                                             solvency reform, but Us authorities are
                                                                                                                                                             keen to reduce regulatory arbitrage and
                                                                                                                                                             the financial crisis has increased the
                                                                                                                                                             focus on international standards and
                                                                                                                                                             cooperation – evidenced by proposals
                                                                                                                                                             to create the federal insurance Office
                                                                                                                                                             (fiO) that can more easily interface with
                                                                                                                                                             international bodies like the iais.
                                                                                                                                                                 To what extent Us solvency
                                                                                                                                                             requirements become harmonised with
                                                                                                                                                             international standards and regimes such
                                                                                                                                                             as europe’s solvency ii framework, will
                                                                                                                                                             depend largely on the outcomes of the
                                                                                                                                                             sMi programme. There are also
                                                                                                                                                             questions over how the eU would
                                                                                                                                                             negotiate and assess the equivalence of
                                                                                                                                                             each of the 50 states. it is possible that
                                                                                                                                                             certain state regulators could agree
                                                                                                                                                             equivalence with the eU, or individual
                                                                                                                                                             member states, although this is not
                                                                                                                                                             currently believed to be an option for the


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 45




eU. The fiO is more likely to be used as
                                                                               Issues to consider
the primary gateway.
   The naic has indicated that Us
supervisors would be prepared to                                               it is clear the Gfc has caused and                                            • is the group able to achieve the
explore harmonisation with regimes like                                        will continue to apply pressure on                                              benefits of enhanced risk and capital
europe’s solvency ii, but they are not yet                                     supervisors in their assessment of                                              management expertise across the
convinced that replicating solvency ii                                         insurance groups and their operations.                                          group?
would be in the best interests of Us                                           This increased scrutiny and focus                                             • Does the group structure provide
policyholders.                                                                 means insurers and insurance groups                                             enhanced services to customers,
   following its spring 2010 meeting,                                          need to be actively considering the                                             such as enhanced risk management
the naic reaffirmed Us state supervisors’                                      shape of their business:                                                        coverage for products and services,
desire to converge solvency systems                                                                                                                            that avoid coverage gaps?
internationally, ‘where practicable.’                                          • Does the Board understand the                                               • Do you have an adequate and
However, the naic also recognised that                                           implications of changes in                                                    appropriate relationship with your
business cultures are different around                                           supervisory tone and approach?                                                supervisor – do they really
the world, which might result in different                                     • How well is the group able to ‘wall                                           understand your business?
regulatory systems. The naic are                                                 off’ exposure to certain volatile risks                                     • is management information and data
therefore keen to pursue convergence                                             from other parts of the group or to                                           sufficiently comprehensive and
where the regulatory measures are                                                maximise fiscal positions?                                                    flexible to meet multiple supervisory
outcomes-based rather than rules-based.                                        • can the group centre provide group                                            requirements?
   Us state regulators also recognise                                            entities with better sources of                                             • Have you up-scaled staff and
the need to improve group solvency, and                                          financing and increase their financial                                        compliance capability to monitor
agree that a group capital assessment                                            security?                                                                     and respond to changing rules and
should be performed, although not                                              • How well is the group able to                                                 relationships?
necessarily a group solvency calculation                                         transfer risks between entities                                             • are you sufficiently engaged in
such as a rBc.                                                                   within the group?                                                             developments to ensure appropriate
   The risk sensitive solvency                                                 • is the group able to capitalise on                                            frameworks are established?
frameworks of canada and Bermuda                                                 making group-wide technical
also make them potential candidates                                              resources, including enhanced skills
to seek equivalence with europe,                                                 and expertise at the corporate centre,
although they would most likely have                                             such as asset management, pricing,
to either make or finalise adjustments                                           erM and the management of
to their regimes.                                                                complex or major risks available to
                                                                                 group entities?




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
46 | evolving insurance regulation | March 2011




Perspectives:
Americas
Advancing transparency
and supervision

US                                                                           Orsa, whereby insurers will have to                                             It is expected that the US ORSA
europe is certainly not alone in undertaking                                 perform their own assessment of risk                                            will also require an examination
major regulatory reform. The national                                        and capital in addition to new mandatory
association of insurance commissioners                                       stress tests. it is expected that the Us                                        of how risks are managed across
(naic) is currently looking at ways to                                       Orsa will also require an examination of                                        the group and include insurance
improve solvency regulation.                                                 how risks are managed across the group                                          and non-insurance entities within
   The naic, which is not a regulator,                                       and include insurance and non-insurance
acts as a forum for the insurance                                            entities within the assessment.                                                 the assessment.
supervisors of 50 Us states. it has a                                            another significant feature of the
process to develop model insurance                                           sMi project is the life and Health
regulation and provide guidance on best                                      principles-based reserving initiative,
practices, however, it remains for each                                      which will include a new principles-based
state to decide whether to pass each                                         framework to value insurance liabilities.
model law or regulation, and each state                                      This will allow insurers more flexibility,                                      similar to the solvency ii ‘transparency’
may make changes in the enactment                                            based on their own internal model inputs,                                       principle, the canadian regime has for
process. The naic assists implementation                                     than that allowed under the required                                            several years required insurers to
of minimum standards by assisting state                                      reserve methology.                                                              publically disclose their risk-based
regulators harmonise requirements                                                The sMi changes are also likely to                                          regulatory capital levels. insurers are
across the Us.                                                               include enhancements to the present                                             also required to run future scenario
   The naic has established a solvency                                       rBc requirements, by introducing a                                              testing of capital adequacy for a range
Modernization initiative Task force                                          specific confidence level and time                                              of adverse underwriting and financial
(sMi) which will recommend areas of                                          horizon (most likely to be a tail value-at-                                     markets developments, such as
improvement for the Us solvency                                              risk (Tvar) measure. such reforms will                                          catastrophic losses, rapid or slow growth
framework, and in doing so is looking at                                     complement the extensive financial                                              in premiums, and variations in interest
risk-based capital requirements, group                                       disclosure requirements already in                                              rates and equity market prices.
solvency regulation, Orsa, corporate                                         existence.                                                                         One regulatory reaction to the
governance, risk management, statutory                                           accompanying these new proposals                                            financial crisis has been to expand the
accounting and financial reporting and                                       is a greater focus on group solvency                                            requirements for stress testing from an
reinsurance.                                                                 requirements, where the naic refer to                                           annual formal report to a program of
   following the naic spring 2010                                            a ‘windows and walls’ approach – using                                          regular and continuous stress testing
meeting in Phoenix, arizona, the sMi                                         a ‘wall’ to ensure policyholder protection                                      throughout the year.
reported that the rBc requirements                                           is maintained around legal entities and a                                          The canadian regime has also allowed
implemented in the 1990s were still                                          ‘window’ to look at how intra-group                                             limited use of an insurer’s own capital
held to be a necessary component of                                          needs are accommodated across                                                   model as an alternative to the standard
Us solvency regulation, but refinements                                      the group.                                                                      model, with regulatory approval, for
would be considered to the formula.                                                                                                                          the risk of certain investment return
More advanced methods such as                                                Canada                                                                          guarantees for segregated funds. This
modelling would continue to be                                               canada’s insurance industry held up                                             option is expected to be expanded in
introduced for risks where factor-based                                      well in the financial crisis, with no failures                                  future years to apply to overall regulatory
methods were not sufficient.                                                 or government-funded rescues for any                                            capital, similar to the approach under
   The sMi is the largest reform of                                          financial institutions. in response to the                                      solvency ii.
the Us regulatory system since the                                           increasing complexity of insurance                                                 While there were no insolvencies
introduction of rBc. in response to                                          products and a more dynamic economic                                            as a result of the financial crisis, the
international developments, primarily                                        environment, the country was a relatively                                       near failure of some overseas insurers
the solvency and group changes is within                                     early adopter of a risk-based approach to                                       with significant canadian operations
the iais and in europe with solvency ii.                                     solvency, overhauling its framework for                                         has heightened the canadian regulator’s
   One of the most significant changes                                       life insurers in the 1990s and then again                                       interest in international regulatory
being examined is the introduction of an                                     for non-life insurers in 2003.                                                  standards and cooperation. The canadian
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
regulator already participates in the iais                                   transparency and group supervision.                                             for any changes in market developments
and is likely to consider developing its                                     all key elements of the new risk-based                                          and/or strategy. appropriate oversight
regime to be more in line with solvency ii                                   solvency regime are due to be                                                   processes must also be in place to
in the future.                                                               implemented this year.                                                          monitor any material deficiencies and
    as for Pillar 2, since 1990 the Office                                                                                                                   ensure they are being reported on a
of the superintendent of financial                                           so what are the main changes?                                                   timely basis with suitable actions being
institutions (Osfi) has required insurers                                    While the present BMa capital adequacy                                          taken. fit and proper tests of key
to undertake prospective scenario testing                                    requirements are broadly consistent                                             individuals overseeing and performing
now known as Dynamic capital adequacy                                        with iais requirements, the BMa is                                              the assessment also apply which
Testing (DcaT). However the DcaT does                                        considering adoption of a market                                                includes third-party service providers
not have to be incorporated into the                                         consistent balance sheet for solvency                                           assisting with assessment procedures.
insurer’s risk management process. it is                                     purposes. it is yet to be determined
expected that Osfi will need to review                                       whether the final position will be one
their requirements given the adoption of                                     that is based on general purpose financial
the new solvency iais standards, in                                          statements, with prudential filters and
particular the Orsa requirements. in                                         disclosure of market consistent values
regards to Pillar 3 type measures, Osfi                                      (where such statements do not include
has for the past six years required life                                     fair values) for analytical purposes,
insurers to publicly disclose analysis of                                    or whether the entire balance sheet
gains and losses (earnings) by source. The                                   will comprise economic values.
new ifrs income statement is proposed                                        Meanwhile the Bermuda solvency                                                  David Sherwood
to be similar in orientation. in addition,                                   capital requirements/approved internal                                          regulatory centre of excellence
new disclosures under ifrs would further                                     models are designed to establish a level                                        americas region
strengthen the canadian requirements.                                        of safety of 99 percent Tvar over a one                                         KPMG in the Us
                                                                             year time horizon with full run-off of
Bermuda                                                                      insurance liabilities.
as the home to one of the world’s largest                                        in addition, the insurance code of
international insurance and reinsurance                                      conduct 2010 (pertaining to all insurers)
markets, Bermuda has been revamping                                          and the insurance Groups code of
its solvency framework and will be one of                                    conduct require many similar features
the first to seek regulatory equivalence                                     to solvency ii and the iais Orsa. for
with solvency ii.                                                            example, insurers are required annually
    The Bermuda Monetary authority                                           to develop policies, processes, and
(BMa) has also embarked on a                                                 procedures to assess their material                                             Bermuda has been revamping its
modernisation plan, with a particular                                        risks and self-determine the capital                                            solvency framework and will be
focus on regulatory harmonisation. in its                                    requirement they need to support
‘roadmap’ published in april 2009, the                                       their insurance activities. risk and                                            one of the first to seek regulatory
regulator set out plans to achieve mutual                                    solvency assessments (contained in                                              equivalence with Solvency ll
recognition or equivalence with key                                          the commercial insurer’s solvency
international markets, in particular with                                    self-assessment) must be an integral
europe’s forthcoming solvency ii regime.                                     part of the group’s risk management
                                                                             framework, including active liquidity
seeking equivalence with europe                                              management and stress and scenario
The BMa has set out plans for a new                                          tests. results must be clearly
risk-based solvency regime with all                                          documented, reviewed, and evaluated
the hallmarks of solvency ii, including                                      regularly by the Board and senior
recognition of internal models, own risk                                     management to ensure appropriateness
and solvency assessments, increased                                          of the risk management framework and
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
08

Systemic risk
The impact of global coordination

Much discussion about systemic risk all too often has been
dominated by developments in the banking sector. The global
financial crisis raised serious concerns internationally about financial
regulation, exposing failings in systemic risk management, a lack
of coordination between supervisors and insufficient regulation of
complex financial services groups. it also raised awareness among
politicians of the need for international regulatory convergence and
cooperation on financial market regulation.
   following the G20 summit in london in april 2009, and the
Pittsburgh summit in september 2009, leaders of the world’s
20 largest economies publically acknowledged the need for
greater consistency and cooperation between countries. They
also confirmed the need for a framework of internationally agreed
high standards of financial regulation.




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member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 49




The G20 members determined a
                                                                               What are the implications?
blueprint for reforming the regulatory
framework of the financial sector, and
requested that the financial stability                                         • considerable debate is still occurring                                      • increased focus on stress and
Board (fsB) embark on a major program                                            within the insurance industry                                                 scenario tests. reverse stress tests
of financial reforms. Much of the G20                                            regarding the extent that insurers                                            likely to prevail as the main supervisory
agreement is focussed on the banking                                             may pose systemic risks.                                                      tools that will be used by insurance
sector; however many of the initiatives                                        • contagion effect is perhaps the                                               supervisors to monitor the extent of
also apply to insurance. insurance                                               biggest differentiator between the                                            systemic risk within the system.
supervisors have been asked by the fsB                                           banking and insurance sectors, and                                          • enhanced reinsurance analysis will
to consider whether insurers, or insurance                                       why many insurers believe measures                                            be undertaken by the iais to monitor
business itself, poses a systemic risk to                                        being contemplated for banking are                                            counterparty exposures.
the financial stability of markets.                                              not appropriate to insurers, such as                                        • lack of harmonised rules across
    all G20 members agreed to                                                    the need to prepare ‘living Wills’.                                           global insurance supervisors as
implement international financial                                              • Prudential supervision, now clearly                                           regards to capital will continue to
standards and enhance the openness                                               defined with a macro and micro                                                apply pressure for further reforms
and transparency of the financial sector.                                        focus, is dominating the creation of                                          such as the iais’s comframe
among the immediate actions called                                               new supervisory structures.                                                   initiative.
for by the G20 was the establishment
of supervisory colleges for ‘significant’
cross-border firms, and tasking the fsB                                      regulation and oversight to all                                                 • interconnectedness: “linkages with
to tackle the ‘too big to fail’ problems                                     “systemically important financial                                                 other components of the system”
associated with systemically important                                       institutions, instruments and markets.”                                         • substitutability: “The extent to which
financial institutions (sifis).                                                  since the summit, the fsB has been                                            other components of the system can
    The G20 also asked the appropriate                                       working with the iais, the BcBs and the                                           provide the same services in the event
bodies – the iais for insurance – to review                                  iOscO to identify weaknesses in the                                               of a failure”.
the ‘differentiated nature of regulation’                                    financial system, and consider changes
in the banking, securities and insurance                                     to prudential regulation and corporate                                          When providing feedback to the fsB,
sectors and recommend improvements.                                          governance principles in an effort to                                           the iais recommended adding a fourth
in response, the Joint forum of the iais,                                    address systemic risk.                                                          criterion, that of time. according to the
the Basel committee on Banking                                                   as part of this work, G20 finance                                           iais, the speed of loss transmitted to
supervision (BcBs) and the international                                     ministers and central bank governors                                            third parties is of particular relevance to
Organization of securities commissioners                                     have endorsed a definition of systemic                                          insurance, as insurance claims, unlike
(iOscO) concluded that it is necessary to                                    risk developed by the fsB and                                                   banking obligations, do not immediately
address inconsistencies in supervisory                                       international Monetary fund:                                                    generate cash outflows.
frameworks across the banking, securities                                        “The risk of disruption to the flow of                                          The iais also notes that the distinct
and insurance sectors in order to ensure                                     financial services that is (i) caused by an                                     business model of insurance means that
a sounder financial system in the future.                                    impairment of all or parts of the financial                                     the policy solutions for systemically risky
    Major systemic risks and failures in                                     system; and (ii) has the potential to have                                      activities will likely differ between sectors,
the financial sector were exposed when                                       serious negative consequences for the                                           and that it will work with the fsB to develop
problems in a section of the Us housing                                      real economy.”                                                                  an appropriate policy response that is
market quickly spread to financial                                               The fsB uses three criteria to assess                                       applicable to insurers.
institutions around the world, triggering                                    the systemic risk presented by an                                                   a recent study by the Geneva
the Gfc.                                                                     institution:                                                                    association, a think tank supported by
    The G20 committed to take steps to                                       • size: “The volume of financial services                                       80 insurance industry chief executive
“ensure the soundness of systemically                                           provided by the individual component                                         Officers, concluded that when applying
important institutions” and to extend                                           of the financial system”                                                     the fsB criteria to the main activities of

© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
50 | evolving insurance regulation | March 2011




insurers and reinsurers, the activities of                                    • effective regulation and supervision                                          The traditional insurance business
insurers – namely investment management,                                        can mitigate instances where insurers                                         model is unlikely to give rise to
providing protection and guarantees, risk                                       could amplify instances of systemic
transfer and capital management – do not                                        risk, such as de-risking of equity                                            insurers posing a systemic risk.
pose a systemic risk.                                                           portfolios in unfavourable economic
                                                                                conditions or instances where capacity
The association argued that the activities                                      has been withdrawn after an event
of insurers do not pose a relevant systemic                                     such as 9/11;
risk because of:                                                              • non-insurance activities, particularly
• Their limited size;                                                           by non-regulated entities of financial
• The slow speed of their impact, which                                         conglomerates could give rise or
   allows insurers to absorb them; and                                          heighten systemic risk. in addition,
• features of their interconnectedness                                          certain insurance business such as
   mean that contagion risk would be                                            financial guarantee insurance could
   limited.                                                                     also amplify risks and may even
                                                                                contribute to contagion risk across
“Principle-based group supervision                                              sectors or for conglomerates; and
applied to all entities within an insurance                                   • Between sectors, greater
group, supported by sound industry risk                                         independencies may result in the
management practices, will mitigate                                             future and therefore increased
potential systemic risk related to these                                        efforts will be given to resolvable
activities. solvency ii represents such a                                       issues through a greater focus on
comprehensive and economic based                                                group-wide supervision, improving
regulatory framework.”4                                                         risk management within insurers
   insurers are also concerned that they                                        and undertaking macro-prudential
could be included in iMf proposals to tax                                       surveillance to ascertain the likelihood
banks and pay for future bailouts.                                              and potential for systemic risk to build
                                                                                up across jurisdictions globally.
Views of the IAIS
after much consideration and                                                  european Union
consultation, the iais considers that:                                        following the Gfc, the eU announced
• The traditional insurance business                                          plans to reform the regulatory framework
  model is unlikely to give rise to                                           at a european level and create a new
  insurers posing a systemic risk.                                            systemic risk body.
  However, other parts of the financial                                          in response to ‘uneven and often
  sector may cause the insurance sector                                       uncoordinated’ european regulation, the
  to be susceptible – although impact to                                      european commission (ec) proposed to
  the real economy is most unlikely;                                          replace the existing three supervisory




4. source: special report of The Geneva association systemic risk
   Working Group.




 © 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
 member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 51




committees for insurance, banking, and                                       consulting with the industry on                                                 The impact of being deemed
securities with new macro and micro                                          the criteria for assessing non-bank                                             systemically significant is not
regulatory bodies. The proposals have                                        institutions, such as insurers, as
now created a macro-prudential                                               systemically important. The fiO can                                             yet fully known. However, such
supervisor, the european systemic risk                                       make recommendations to the fsOc                                                an assessment is likely to lead
Board (esrB), and a micro-prudential                                         as to which insurers may be included.                                           to, increased regulatory scrutiny,
supervisory framework, the european                                              The impact of being deemed
system of financial supervisors (esfs).                                      systemically significant is not yet fully                                       increased capital requirements,
   The esfs will consist of a network of                                     known. However, such an assessment                                              the prospect of having to produce
national financial supervisors working                                       is likely to lead to increased regulatory                                       a living will and increased
alongside three new european                                                 scrutiny, increased capital requirements,
supervisory authorities, created by the                                      the prospect of having to produce a living                                      reporting requirements.
transformation of existing committees                                        will and increased reporting
for the banking securities and insurance                                     requirements.
and occupational pensions sectors.                                               insurance companies may feel the
for the insurance sector, this has seen                                      impact of the fiO through its coordination
ceiOPs evolve into the european                                              with the Us on insurance matters of
insurance and Occupational Pensions                                          national and international importance,
authority (eiOPa).                                                           its systemic risk focus, and through
   The creation of eiOPa is expected                                         legislation and/or regulation that results
to bring about further convergence of                                        from the fiO’s recommendations.
regulations and consistency of insurance
supervision in the eea. The body will                                        asPac
have greater powers than ceiOPs when                                         While both insurers and insurance
drafting technical proposals and will                                        supervisors acknowledge the need for
be able to ensure agreement and                                              greater cooperation between regulators,
coordination between national regulators                                     we do not yet see significant impetus
when supervising cross-border groups.                                        in the region for the development of
                                                                             ‘super-regulators’ and supra-national
north america                                                                standards of regulation.
Title v of the Dodd-frank act establishes
a federal insurance Office (fiO) within
the Department of the Treasury that is
intended to function in an advisory
capacity to the financial stability
Oversight council (fsOc) with regard to
systemic risks in the insurance industry
(firms and products). The fsOc is




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member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
09

ComFrame
Moving forward

in 2008 the iais embarked on an ambitious and, at the time,
controversial project to explore medium to longer term options for
the development of a supervisory framework for internationally
active insurance Groups (iaiGs) – known as comframe.
   although the genesis of comframe preceded the Gfc of
september 2008, the financial crisis nonetheless brought into sharp
focus the global prudential requirements of systemically important
insurance groups. as developments have progressed, it is now
considered that comframe will form the substantive response by
the iais to the G20, fsB and other international fora which are
seeking responses to the macro-prudential and financial stability
issues currently being sought from financial market supervisors.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 53




                                                                             1 scope of application                                                            common world-wide risk and capital
 Objectives of ComFrame
                                                                             2 Group structure and business                                                    platforms. such an environment
                                                                             3 Quantitative and qualitative                                                    should go a long way to answering
 in constructing the parameters for                                            requirements                                                                    many of the financial stability issues
 comframe, the iais articulated the                                          4 supervisory cooperation and                                                     currently being debated.
 following objectives:                                                         interaction                                                                   • consistent measurement of solvency
                                                                             5 Jurisdictional matters                                                          measures such as valuation, capital
 • Operationalise group-wide                                                                                                                                   adequacy, erM, investment and
   supervision for iaiGs in order to                                         each module is then divided down into                                             internal model criteria should reduce
   better align supervisory practices                                        further elements. for example, module 3                                           costs significantly. a common platform
   with the (good practice) trans-                                           will address elements related to quantitative                                     of requirements will provide insurance
   national approaches iaiGs actually                                        and qualitative requirements including                                            groups with enhanced capabilities
   apply in doing business;                                                  quantitative methodologies such as                                                for managing and measuring the
 • comprehensively address group-                                            valuation and capital adequacy (including                                         insurance group’s capital, solvency
   wide risks and establish better                                           internal models), qualitative methodologies                                       and risk positions (particularly in
   supervisory cooperation in order                                          including corporate governance and                                                regards to technical provisions, risk
   to allow for an integrated approach                                       internal controls and methodologies that                                          margins and internal models). it will
   amongst supervisors; and                                                  may include both qualitative and                                                  also avoid having duplicative systems
 • foster global convergence of                                              quantitative aspects including erM and                                            and requirements at the local level.
   regulatory and supervisory                                                regulatory investment requirements.                                               This should facilitate better investor
   measures and approaches.                                                      a concept paper is due by July this                                           and analyst communication and
                                                                             year and depending on developments,                                               enhance shareholder value.
                                                                             it is then envisaged that a formal                                              • Better supervisory understanding
                                                                             development phase over the next three                                             of the operations of insurance groups
The founding principles for comframe                                         years thereafter will develop the actual                                          should reduce the inefficiencies and
are to:                                                                      requirements of the new framework.                                                frictional costs for iaiGs arising from
• Become the multilateral tool of                                            a calibration and quantitative impact                                             supervisors being unable to fully
  preference for assessing iaiGs;                                            assessment stage is not expected to                                               comprehend the complexities of large
• Provide meaningful value to both                                           occur until year three of the project.                                            multi-national insurance groups and
  home and host supervisors for                                                                                                                                groups being able to better explain the
  undertaking group supervision;                                             What are the benefits for industry?                                               risks and opportunities provided by
• Be specific, but not rules-based;                                          comframe should, in time, provide a                                               group structures. Boards and senior
• Be ever-evolving (and further look                                         range of benefits for insurers by:                                                management will be able to have
  into case experiences);                                                    • Becoming the multilateral framework                                             confidence in integrating the full suite
• Be developed in close collaboration                                          for assessing internationally active                                            of modelling techniques to their risk
  with interested stakeholders; and                                            insurance groups, enhanced                                                      management framework.
• lead to more consistency and better                                          cooperation and recognition amongst
  comparability and alignment regarding                                        insurance supervisors. This should                                            a common set of requirements should
  the supervision of internationally active                                    result in consistent outcomes for                                             provide iaiGs with the ability to:
  insurance groups being undertaken                                            the measurement of solvency and                                               • Demonstrate the quality of senior
  by each jurisdiction.                                                        related requirements including capital                                          management and oversight of risk
                                                                               determinations. such measures should                                            management by outlining: how
comframe will cover not only                                                   allow supervisors to gain increased                                             current and possible future risks
quantitative aspects, such as a common                                         confidence in the supervisory methods                                           are managed and contained in the
solvency assessment, but also qualitative                                      applied, allowing a lead supervisor of                                          particular business model; how risk
and legal aspects, including investment,                                       the group to make informed decisions.                                           appetite measures are incorporated;
erM and other risk management issues.                                          in turn, this should reduce the amount                                          and the subsequent impact on capital
The comframe is split into five modules:                                       of duplication and allow groups to have                                         resources available;
© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
54 | evolving insurance regulation | March 2011




• Maximise efficiencies: by applying                                         • cost of undertaking different risk,
  consistent methodologies to capital                                          capital and governance change
                                                                                                                                                               Issues to consider
  management; possibly providing                                               programmes
  for the consistent application of                                          • Different admissibility/asset and                                               • How aware are you of the
  diversification benefits; and allowing                                       investment restrictions relating                                                  comframe developments?
  enterprise risk management                                                   to capital requirements                                                           early involvement and participation
  frameworks to be fully integrated                                          • Differences in reinsurance                                                        now during the policy formulation
  with economic capital models;                                                arrangements to accommodate                                                       stage is needed by all industry
• Outline the robustness and                                                   different jurisdictional requirements                                             participants to ensure an effective
  appropriateness of their group-wide                                        • statutory form filings and related                                                and appropriate framework that is
  Orsa;                                                                        reporting and disclosure requirements                                             outcomes focussed.
• Better implement a consistent fit-                                         • internal management, senior                                                     • Does your business have the
  for-purpose governance and internal                                          management and Board engagement                                                   technical skills that will be required
  control framework;                                                           spent on compliance and regulatory                                                from industry to provide support
• streamline reporting across the group                                        issues                                                                            and assist supervisors in their
  – both public and private reporting                                        • external auditor requirements                                                     deliberations?
  including audited and non-audited                                          • additional technical input (such as                                             • even though comframe is in the
  information; and                                                             accounting, risk and actuarial advice)                                            early development phase, what data
• Develop robust business analysis                                           • Peer reviews                                                                      and system changes would be likely
  and information tools for world-wide                                       • collateral requirements                                                           for your group in order to capitalise
  application.                                                               • cost of supervisory colleges and                                                  upon the envisaged framework?
                                                                               regulatory compliance more generally
Current costs of regulation and                                              • Different compensation scheme
supervision                                                                    requirements                                                                  The cost of having different
The cost of having different regulations                                     • consultancy, rating agencies, trade                                           regulations poses significant
poses significant detriment to shareholder                                     associations and other service providers
value, creates competitive distortions                                         used to input, support, or involved with                                      detriment to shareholder value,
and inefficiencies and gives rise to                                           global and local insurance activities.                                        creates competitive distortions
regulatory arbitrage issues. These costs                                                                                                                     and inefficiencies and gives rise
of sovereign and reputational risks in                                       These costs do not include future cost
the marketplace are ultimately borne by                                      impositions on iaiGs in the form of                                             to regulatory arbitrage issues.
consumers and policyholders generally.                                       living wills and recovery and resolution
   The additional cost in meeting                                            schemes currently being examined
these requirements for iaiGs, in the                                         by supervisors.
absence of harmonised and converged                                              We have had a number of discussions
requirements, both as measured by                                            with our clients and estimate that
direct and indirect costs, are significant.                                  such costs to the sector globally are
The additional costs associated with                                         considerable – and could range from
both prudential and market conduct                                           Us$15bn–$25bn.  By any measure such
requirements arise via the opportunity                                       costs are significant. in our view, the
cost of capital from having to meet                                          industry needs to insist that the regulatory
different jurisdictional needs and                                           changes result in a predictable, stable
subsequent costs incurred to group                                           and well defined architecture; that there
models, structures and functions.                                            is consistency in application across the
such costs comprise:                                                         different jurisdictions; and the outcomes
• Direct compliance personnel and                                            will serve stakeholders interests – both
  administrative costs                                                       investors and customers – well.


© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 55




A global
perspective

KPMG’s network of regulatory centres of excellence at the heart
of the major financial markets – Us, europe and asPac – delivers
cross-border insights in response to the unprecedented scale and
impact of regulatory change.

   Our firms’ leading global regulatory experts can provide insight
into the implications of the raft of regulatory changes and the
direction of developments around the world from the G20, Basel iii,
solvency ii, eU initiatives and the Dodd-frank act.



Providing your business with…

• insight into regulatory issues, market developments, supervisory
  approaches and implementation issues.
• access to a global team which understands regulation and its
  implications
• experienced advisers who deliver pragmatic solutions to complex
  regulatory issues
• regular updates on key developments



visit www.kpmg.com/regulatorychallenges for more discussions
on the regulatory issues facing the financial services industry.




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
56 | evolving insurance regulation | March 2011




Acknowledgements

We would like to acknowledge the contribution of our colleagues
from across our global network who helped develop this report:



lead editors
Rob Curtis                                                                   David Sherwood                                                                  Martin Noble
Director, Insurance                                                          US Head of Insurance Regulatory                                                 Senior Manager, Insurance
Regulatory Centre of Excellence,                                             Regulatory Centre of Excellence,                                                Regulatory Centre of Excellence,
EMA region                                                                   Americas region                                                                 ASPAC region
KPMG in the UK                                                               KPMG in the Us                                                                  KPMG in china
T: +44 20 7694 8818                                                          T: +1 212 954 5861                                                              T: + 852 2685 7817
E: rob.curtis@kpmg.co.uk                                                     E: davidsherwood@kpmg.com                                                       E: martin.noble@kpmg.com



asPac

Bruce Le Bransky                                                             Elisabeth Imelda                                                                Frank Dubois
Principal Adviser                                                            Partner                                                                         Director
KPMG in australia                                                            KPMG in indonesia                                                               KPMG in singapore
T: +61 3 9838 4188                                                           T: +62 21 574 2333                                                              T: +65 6411 8187
E: blebransky@kpmg.com.au                                                    E: elisabeth.imelda@kpmg.co.id                                                  E: fdubois@kpmg.com.sg

David Torrance                                                               Novi Liong                                                                      Jeremy Hoon
Partner                                                                      Director                                                                        Partner
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© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
                                                                                                                                                            evolving insurance regulation | March 2011 | 57




eMa

Joachim Kölschbach                                                           Fiona Fry                                                                       Jane Portas
Partner                                                                      Partner                                                                         Director
KPMG in Germany                                                              KPMG in the UK                                                                  KPMG in the UK
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Hugh von Bergen                                                              Paul Martin                                                                     Francesca Short
Partner                                                                      Senior Manager                                                                  Partner
KPMG in the UK                                                               KPMG in the UK                                                                  KPMG in the UK
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Michael Crawford                                                             Paul Merrey
Partner                                                                      Director
KPMG in the UK                                                               KPMG in the UK
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Drew Fellowes                                                                Blair Robertson
Partner                                                                      Manager
KPMG in the UK                                                               KPMG in the UK
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Us

Matt Smyth
Global Leader, Insurance Risk
and Performance
KPMG in the Us
T: +1 212 872 6414
E: matthewsmyth@kpmg.com




© 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.
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Contact us

Jeremy Anderson                                            Frank Ellenbürger
Global Chairman,                                           Global Head of Insurance
Financial Services                                         KPMG in Germany
KPMG in the UK                                             T: +49 89 9282 1867
T: +44 20 7311 5800                                        E: fellenbuerger@kpmg.com
E: jeremy.anderson@kpmg.co.uk

Giles Williams                                             Jim Low                                                          Simon Topping
Partner,                                                   Partner,                                                         Principal,
Financial Services                                         Financial Services                                               Financial Services
Regulatory Centre of                                       Regulatory Centre of Excellence,                                 Regulatory Centre of Excellence,
Excellence, EMA region                                     Americas region                                                  ASPAC region
KPMG in the UK                                             KPMG in the Us                                                   KPMG in china
T: +44 20 7311 5354                                        T: +1 212 872 3205                                               T: +852 2826 7283
E: giles.williams@kpmg.co.uk                               E: jhlow@kpmg.com                                                E: simon.topping@kpmg.com

Rob Curtis                                                 Jon Greenlee                                                     Martin Noble
Director, Insurance                                        Managing Director,                                               Senior Manager, Insurance
Financial Services                                         Financial Services                                               Financial Services
Regulatory Centre of                                       Regulatory Centre of Excellence,                                 Regulatory Centre of Excellence,
Excellence, EMA region                                     Americas region                                                  ASPAC region
KPMG in the UK                                             KPMG in the Us                                                   KPMG in china
T: +44 20 7694 8818                                        T: +1 703 286 8032                                               T: +852 2685 7817
E: rob.curtis@kpmg.co.uk                                   E: jdgreenlee@kpmg.com                                           E: martin.noble@kpmg.com

                                                           David Sherwood
                                                           US Head of Insurance Regulatory
                                                           Financial Services
                                                           Regulatory Centre of Excellence,
                                                           Americas region
                                                           KPMG in the Us
                                                           T: +1 212 954 5861
                                                           E: davidsherwood@kpmg.com




fsregulation@kpmg.co.uk
www.kpmg.com/regulatorychallenges




© 2011 KPMG international cooperative (“KPMG international”), a swiss entity. Member firms of the KPMG network of independent firms
are affiliated with KPMG international. KPMG international provides no client services. no member firm has any authority to obligate
or bind KPMG international or any other member firm vis-à-vis third parties, nor does KPMG international have any such authority to
obligate or bind any member firm. all rights reserved.

The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG international.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or
entity. although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate
as of the date it is received or that it will continue to be accurate in the future. no one should act on such information without appropriate
professional advice after a thorough examination of the particular situation.

Produced by KPMG’s Global financial services Practice in the UK.

Designed by Mytton Williams

Publication name: evolving insurance regulation

Publication number: 314617

Publication date: March 2011


 © 2011 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No
 member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.