How is the solvency of insurers (and reinsurers where relevant) supervised?
Insurance & Reinsurance (3rd edition)
The solvency of insurers and local reinsurers is monitored by SUSEP. The supervision is based on very advanced legislation, where the concept of risk-based supervision is applied. This model is supported by three pillars: transparency of financial statements and accounting information, adequate corporate governance and sufficient capitalization.
A company that intends to start insurance or reinsurance business in Switzerland has, during the licensing process, to provide evidence to FINMA that it meets the applicable solvency margin, Art 9 ISA. In addition, the company must hold a so-called organisational fund to cover all costs in connection with the establishment, the set-up, or an extraordinary expansion of the business. The amount of the required organisational fund is normally 50 per cent of the amount of the required solvency margin, ISO 10.
In the course of the ongoing business of the insurance company, an appointed actuary is responsible for the calculation of the solvency margin at any time, ISA 24. FINMA supervises the adequacy of the solvency margin regularly through annual reports that have to be provided to FINMA, ISA 25.
The Solvency margin of insurance companies is assessed in accordance with the Swiss Solvency Test (SST). Following SST, the solvency margin is determined by the risk exposure of the insurance company (target capital) and the creditable (to the solvency margin) own capital (risk bearing capital) of the company. Further details are set out in ISO 21 et seq and in FINMA Circular RS 2017/3.
Proposed amendments by Pre-Draft ISA (not exhaustive):
- The term “solvency margin” is going to be displaced by the (more precise) term “sufficient solvency”. The solvency is sufficient if the risk-bearing capital is equal to or higher than the target capital (ISA 9). ISA 9a and 9b contain provisions on the future calculation of the risk bearing capital and the target capital; the amendment takes into account internationally acknowledged principles and equivalence with Solvency II.
The criteria of the Risk-Based Capital Ratio (“RBC Ratio”) requirements for all authorised insurers is one hundred percent (100%) pursuant to the IBA which is based on the adoption of the solvency regime from the European Union based on the ratio of the prudential and financial soundness of insurers. The RBC Ratio is the ratio that an insurer shall maintain in excess of its liabilities as solvency surplus against future payments and other contingent liabilities. The Statutory RBC Ratio is the minimum ratio which the South Korean regulatory authorities promulgate from time-to-time for insurers to meet their liabilities as accounted for on their accounting books.
In practice, the RBC Ratio is unofficially benchmarked at one hundred and fifty percent (150%) and in the event that the ratio falls below that percentage, then the FSS will notify, monitor and/or require corrective measures to be taken by the insurer to improve its solvency.
Recently, Korean Insurance Capital Standard (“K-ICS”) has been announced for implementation on 1 January 2022 which will replace the RBC Ratio requirements and is based on the regime of Solvency II of the European Union and International Capital Standards as promulgated by the International Association of Insurance Supervisors. Along with introduction of IFRS-17, K-ICS is expected to have a significant impact on the insurance regulatory environment and the insurance industry in South Korea.
The solvency supervision of insurance and reinsurance companies constituted in Peru is carried out through the use of two concepts: The Effective Equity and the Solvency Capital. The Effective Equity is obtained through a formula in which, among others, capital accounts are added and the amounts invested in subordinated bonds and in shares in insurance companies dedicated to other branches are deducted. The Solvency Capital is determined by the SBS based on the annual amount of the premiums, the average annual claim load or the minimum capital required for the specific type of company in the insurance system.
Using both concepts, the equity requirement for insurance and/or reinsurance companies is that these companies must have at all times an Effective Equity that cannot be less than the Solvency Equity.
Other specific requirements related to indebtedness and constitution of guarantee funds and reserves may be added to this equity requirement.
Finally, it should be noted that in the development of the supervision of the solvency of insurance companies, the SBS will review the information sent monthly, together with its financial statements, in relation to (i) the effective equity, (ii) the surplus or deficit of the effective equity, (iii) the effective equity destined to cover credit risk, (iv) information on solvency margin, and (v) information on debt limit.
Article 90 of the PRC Insurance Law allows insurers to apply for insolvency liquidation. However, Article 92 of the Insurance Law limits the liquidation of life insurers. An insurer must maintain the minimum capital which is equivalent to its insured risks and business scale. An insurer shall also maintain the actual solvency margin based on its assets and debts which are admitted by CBIRC. The insurers are divided into 4 levels, i.e. A, B, C, D, based on their solvency risks. CBIRC will also issue regular reports on solvency of the insurers.
Danish insurers and reinsurers are obliged to perform their own supervision and self-reporting of their solvency, cf. The Danish Financial Institutions Act (implementing the EU Solvency II Directive).
Additionally, the EU Solvency II Directive sets out requirements for the supervision of the solvency of insurance companies. The EU Solvency II Directive requires companies to hold both a minimum capital requirement (see question 10 below) and a solvency capital requirement. In Denmark, the Danish FSA has the task of monitoring and ensur-ing that insurance companies comply with the EU Solvency II Directive.
The Danish FSA supervises the solvency of the insurers and reinsurers through risk as-sessments.
The ACPR is responsible for verifying that (re)insurers operating in France meet their solvency requirements, in accordance with the three pillars system set out in Solvency II. These three pillars are:
- Pillar 1 provides the methodology thanks to which one calculates the technical provisions and capital requirements by reference to the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR);
- Pillar 2 sets out the detailed self-assessment that (re)insurers need to perform in relation to their own capital needs (the “Own Risk and Solvency Assessment” or ORSA). The ORSA report, which is submitted to the ACPR for review, is then used internally to ensure that appropriate risk management systems and governance are put in place;
- Pillar 3 imposes a reporting and disclosure duty upon (re)insurance companies in relation to the financial risks they hold, their capital adequacy, and the risk-management measures they have adopted.
Before completing the whole overview of Solvency II (expected in 2021), the European Commission adopted delegated regulations (“DA”) regarding the treatment of simple, transparent and standardised Securitisation investments by insurers and the review of items of the Capital Requirement Standard Formula (“SCR”).
On 1 June 2018, the Commission adopted the Delegated Regulation with the STS amendments, including changes regarding new risk calibration, an alignment of the definitions regarding securitisation of the Solvency II DA with the STS Regulation and a repeal of certain articles of the Solvency II DA relating to risk retention and due diligence.
On 8 March 2019 (two months late), the European Commission also adopted the amended Solvency II DA, regarding the SCR Standard Formula, with a scrutiny period for Parliament and Council of three months, which can be extended once. This amended Directive addresses three main themes: the proportionate and simplified application of the requirements, the removal of unintended technical inconsistencies and the removal of unjustified constraints for financing.
In general, solvency refers to an insurer's level of own funds, meaning the undertaking's assets which are free of any foreseeable liabilities. It is important for insurers to have adequate own funds available to cover any unexpected losses they might incur, thereby ensuring that policyholders' claims are covered. The solvency regime is established by the Solvency II Directive. The Directive is made up of three pillars: quantitative requirements, qualitative requirements and provisions on market discipline, transparency and disclosure obligations.
An insurer's solvency, which falls into pillar 1 of the Solvency II Directive, is considered to be sufficient if the level of own funds meets at least the required solvency margin (own-funds requirements). Own funds are made up of basic own funds and ancillary own funds. Basic own funds consists of the excess of assets over liabilities and subordinated liabilities while ancillary own funds are own-fund items other than basic own funds which can be called up to absorb losses.
BaFin is responsible for supervising that insurers fulfil these requirements.
Capital requirements of an Insurer are dealt with by the Control Law and its ordinance. In addition the Commissioner issues from time to time circulars regarding the capital requirements for an insurer. Currently Israeli Insurance Companies must adopt Solvency II requirements.
The Commissioner reviews each company’s adherence to the capital requirements. If a company does not stand by the required capital requirements, it will not be allowed to distribute dividends, and may also have to decrease its level of operation.
The solvency of general insurers and reinsurers is supervised by APRA, which publishes legally binding prudential standards regulating the solvency of these entities. Prudential Standards GPS 110 to 118 and LPS 110 to 118 establish the minimum capital requirements for general and life insurers and reinsurers respectively.
To ensure continuous supervision, the prudential standards further require each entity to complete an annual Internal Capital Adequacy Assessment Process. This involves entities providing to APRA an annual report outlining the finding of a stress test of potential risk exposures and capital resources. Prudential Standard CPS 220 further requires general and life insurers and reinsurers to implement a forward looking scenario analysis as part of their risk management frameworks.
With Solvency II in January 2016, and subsequent IVASS Regulation of 6 June 2016 n.24, insurers are free to choose the most appropriate investment instruments, subject to the precondition that their immediately available capital is adequate to cover the risk underlying such investments and to meet the solvency tests.
Prudential controls follow a risk-based supervisory approach, aimed at verifying that the controlled company adequately manage the risks accepted on a continuous basis and have adequate capital safeguards in place to cover unexpected losses. Prudential controls include checking whether the undertaking has an adequate organizational and governance structure, a balanced technical, financial and capital structure, and whether it complies with supervisory provisions. For this purpose, IVASS carries out off-site and on-site controls.
Insurance companies are required to accumulate policy reserves and appoint an insurance administrator with a predetermined actuary’s license, who gets involved in work related to actuarial science. Regulations on the solvency margin ratio were introduced in 1996, and the solvency margin index has become an assessment standard for the supervisory authorities to execute early corrective actions, with broad supervisory reach against targeted companies, including orders to submit an improvement plan. The solvency margin ratio has been introduced on a consolidated basis.
Field tests of economic value-based solvency regimes have been conducted three times in the past, and the most recent field test – the results of which were announced in March 2017 – was conducted in accordance with the ICS field test specifications of IAIS (as of June 2016). In March 2016, the European Union announced its adoption of the equivalence recognition between Solvency II with temporary equivalence and the Japanese reinsurance supervision and group solvency.
As of 1 January 2016, insurance and reinsurance companies in Poland are subject to the Solvency II Directive. The Solvency II regime takes account of the types of risk to which insurance companies and reinsurance companies are exposed in connection with their activity. There are three pillars defined under this system:
- Pillar 1, which refers to financial requirements and provides for two solvency thresholds: the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR).
- Pillar 2, which refers to governance and supervision. Insurers and reinsurers should adopt an effective risk management system, which includes the so-called “Own Risk & Solvency Assessment” (ORSA). There are also special rules for the conduct of supervisory reviews and interventions.
- Pillar 3, which refers to reporting and disclosure. Insurers and reinsurers must make public disclosures regarding the risks incurred by them, their capital adequacy and the risk-management measures adopted by them. They must also provide detailed reports to the KNF.
Article 7 of DFL 251 contemplates a minimum capital requirement of 90,000 Unidades de Fomento (USD 3,750,000 approx) which must be subscribed and paid in full at the time the company or insurance company is incorporated.
The above must be taken into account the limits of indebtedness and restrictions on investment matters. As for the former, article 15 of DFL 251 contemplates a maximum limit of total indebtedness in relation to the patrimony of the company, which in the case of General (and special general) Insurance Companies may not exceed 5 times its patrimony, and in the case of Life Insurance Companies may not exceed 15 times.
With regard to the latter, there are rules on restrictions on the investment of reserves and assets (a detail in Articles 21 to 26 of DFL 251).
In addition, as regards the solvency of insurance companies, Articles 65 to 87 of DFL 251 provide for a special procedure for the adjustment of capital deficits, investment deficits and overindebtedness, in addition to a special procedure for reorganisation and liquidation.
The LISF, which entered into effect in 2015, sets forth a new solvency regime different from the scheme established in the former insurance law and regulation. The new regime incorporates a similar mechanism to that under Pillar I of Solvency II (quantitative requirements), which in general terms may be considered as a ‘tailored suit’, allowing each insurance company to design an internal actuarial model to calculate its solvency capital requirement based on its own risk experience and exposure and implement internal controls to detect any change or variation to such requirement. Notwithstanding the self-regulation right granted by the LISF, the implementation of the internal actuarial model is subject to the prior approval of the CNSF and in practice, the CNSF has not been approving internal actuarial models.
The LISF also establishes the obligation of insurance companies to develop an internal policy for monitoring its solvency, operations and investments, in accordance with its risk profile. This new system allows each insurance company to select and accept those risks, according to their particular situation.
Moreover, the LISF sets forth the obligation of the insurance companies to carry out stress tests on a regular basis to evaluate their capital adequacy. The results of such tests shall be reviewed by the board of directors of each insurance company and submitted to the CNSF.
The board of directors together with the company’s top tier officers are responsible for approving and implementing the guidelines required for the calculation and adequacy of the capital solvency requirement and implements the necessary measures to maintain such capital adequacy, including the provision of funds in case there is a capital deficiency.
The CNSF has the authority to settle regulations defining the form in which the insurance companies will report and provide evidence of compliance with the solvency capital requirements mentioned above, as well as the procedure to provide the CNSF the information regarding the particular technical characteristics of the internal calculation model adopted by the insurance company.
UK (re)insurers are subject to the European Solvency II regime (introduced on 1 January 2016). Solvency II is a forward-looking risk-based capital regime which was implemented across the EEA from 1 January 2016. Solvency II replaces the previous Solvency I regime (set out in various separate insurance and reinsurance directives) which required insurers to use a formula-based approach when calculating solvency requirements rather than assessing individual risks. Solvency II uses a market consistent approach to value insurers' assets and liabilities (i.e. the price at which a willing buyer would take them).
The regime applies to most insurers and reinsurers with head offices in the EEA. The Solvency II directive is a 'maximum harmonisation' directive aiming to implement a consistent regulatory framework across the EEA. The directive is supplemented with a Delegated Act – an EU Regulation which is directly applicable in each EEA state. The regime is also supported by Technical Standards which are directly applicable, and guidelines produced by the European Insurance and Occupational Pensions Authority (“EIOPA”) which apply to member states on a 'comply or explain' basis.
The Solvency II framework is broadly structured into three pillars: quantitative requirements (Pillar 1); qualitative requirements and supervisory review (Pillar 2); and transparency requirements (reporting and disclosure) (Pillar 3).
In the UK the PRA has responsibility for ensuring that firms comply with Solvency II.
The Insurance Law introduced the requirement for insurers to guarantee sufficient insurance coverage for the protection of policyholders or their beneficiaries. Both the Board of Directors’ Decision No. 25 of 2014 on the Financial Regulation of Insurance Companies and the Board of Directors’ Decision No. 26 of 2014 on the Financial Regulation of Takaful Insurance Companies (together the 'Financial Regulations') establish the regulations insurers must adhere to in relation to their solvency and minimum capital requirements.
In addition to the provisions outlining minimum capital requirements for insurers and reinsurers (as discussed in detail below), the Financial Regulations impose the need for insurers to ensure that their assets are diversified with new limits in respect of aggregate exposures in individual asset classes and sub-limits for exposures to a single counterparty being imposed. The maximum limits for aggregate exposure in a particular asset class include 30 percent in real estate, 80 percent in government securities issued by A rated countries, 100 percent in UAE government securities and 30 percent for loans secured by life policies. It should be noted that the Financial Regulations also impose a minimum 5 percent to be invested in cash deposits with a UAE state bank.
In relation to the governance and enforcement of the Financial Regulations, an insurer is required to provide the IA with quarterly reports in relation to its investment portfolio and annual risk analysis reports in respect of investments, to be submitted with the insurer’s annual audited financial accounts. The Financial Regulations impose extensive obligations on insurers in relation to the maintenance of books and records, which must be made available for inspection to the IA at all times.
The NBB describes its supervisory review process as “ a risk-based audit approach which is forward-looking and proportionate to the size, nature and complexity of the risks incurred by the undertakings.” It includes three stages of supervision: risk assessment, supervisory programme and supervisory measures.
The complex supervisory process derives from the 2016 Law and the NBB’s implementing regulations, as well as a summary on its website.
Insurance undertakings must disclose information to the NBB to allow it to review the insurer’s system of governance, its activities, the valuation bases used for solvency purposes, the risks to which it is exposed and its risk management systems, capital structure, needs and management. The insurance undertaking must disclose all relevant information spontaneously, regularly or upon the NBB’s request.
The NBB requires submission of reports, including the Solvency and Financial Condition Report (SFCR), the Regular Supervisory Report (RSR), and the Own Risk and Solvency Assessment (ORSA). Other information to be provided to the NBB includes the report of the management committee regarding the effectiveness of the governance system, various reports on activities of the external control functions, a list of out-sourced critical activities, functions and operational tasks, and various lists (loans, managers and independent control functions). Finally, an insurance undertaking must provide actuarial reports, documents related to its internal model, etc.
The NBB may also carry out inspections on the premises of the insurance undertaking or, in case of out-sourcing, of its service providers; it has power to interview employees and management.
Furthermore, the NBB reviews and evaluates the strategies, processes and reporting procedures adopted to comply with laws, regulations and administrative provisions. It also evaluates the adequacy of the undertaking’s methods and practices to identify possible events and future changes in economic conditions that could have adverse effects on the overall financial standing of the undertaking.
The NBB may subject the insurance undertaking to specific prudential stress tests if it considers that the general stress tests under Solvency II do not provide satisfactory results.
Finally, the NBB may subject insurance undertakings to specific supervisory measures, such as orders to remedy the situation within a certain period, administrative fines or “name-and-shame” measures.
States monitor insurers’ solvency in various ways. Among the primary monitoring tools is the requirement that insurers file quarterly and annual financial statements with state insurance departments that include substantial details regarding insurers’ assets, investments, liabilities, and income. Other tools include the mandatory submission by insurers to (i) annual audits by independent certified public accountants and (ii) periodic examinations by state regulators.
States have also adopted the NAIC’s risk based capital (“RBC”) method that was developed as an additional tool for regulators to analyze the finances of insurance companies and to assess the minimum amount of capital appropriate to support each insurer’s business operations, taking into account various risk factors such as credit, asset, underwriting, and other risks (e.g., interest rate risk). The RBC approach requires a company with a higher amount of risk to hold a higher amount of capital.
OJK requires insurance and reinsurance companies to:
(a) maintain their financial health (e.g. by maintaining certain solvability levels, technical reserves, investment adequacy levels, equity and collateral funds); and
(b) submit quarterly and annual reports to OJK.
Specifically, a company’s solvability level must be at least 100% of the company’s Risk Based Capital (RBC). A company is also required to set an annual target for its internal solvability level of at least 120% of its RBC, taking into account the company’s risk profile and stress test. OJK may, after considering the company’s risk profile and stress test, require the company to increase and satisfy its internal solvability level target.
The solvency of insurers, Indian reinsurers, Branch Offices of Foreign Reinsurers and syndicates of reinsurers operating through service companies set up under the Lloyd’s India branch is required to be calculated in accordance with the applicable regulations issued by the IRDAI. The respective entities are required to file a periodical statement of solvency with the IRDAI in accordance with the format prescribed under the applicable regulations.
The solvency of insurance and reinsurance companies are supervised by the OIC through several requirements and controls under the LIA and NLIA. Major requirements and controls include:
(a) Requirement to maintain capital funds throughout the period of undertaking the insurance business, in proportion to assets, liabilities, obligations, or risks, at the rate announced by the OIC (which may be determined based on each or all sizes or categories of assets, liabilities, obligations, or risks). These capital funds must not be used to incur any obligations.
(b) Requirement to maintain liquid assets in proportion to assets, liabilities, obligations, or reserves not less than the rate announced by the OIC.
(c) Requirement to submit to the OIC financial statements on a quarterly and annual basis, as well as annual reports showing the operation results of the companies.
(d) Requirement to place with the OIC a security deposit, as a collateral, of the amount required for each type of insurance.
(e) Requirement to allocate premiums to an insurance reserve at the rate announced by the OIC. The OIC is also empowered to require the companies to place certain amounts of these reserves with the OIC as it deems appropriate.
Security deposits and insurance reserves placed with the OIC under paragraphs (d) and (e) are not subject to the execution of judgment so long as the insurance company is not yet dissolved, (including the time where the insurance company remains in existence as necessary for its liquidation). In the event where the insurance company is dissolved, creditors who are entitled to receive payment of insurance debts (such as insureds and beneficiaries) would have a preferential right over the said security deposits and insurance reserves placed with the OIC under paragraphs (d) and (e), as well as the right to receive payment of debt out of these assets before other preferential creditors.
The FMA supervises the solvency of insurance and reinsurance undertakings in accordance with the VAG.
The supervisory regime introduced with the implementation of the Solvency II Directive and the supplementary Commission Delegated Regulation (2015/35) obliges insurance and reinsurance undertakings to calculate their solvency capital requirements on the basis of a balance sheet that recognises assets and liabilities at market value. The assessment does not follow national rules but is carried out on the basis of international accounting standards. Taking market values as basis allows for a better risk assessment and depiction of the actual economic situation of the insurance undertaking.
Undertakings are required to hold sufficient own funds to cover the solvency capital requirements as set out by the VAG and have to calculate the solvency capital requirements at least once a year and report the result to the FMA.
The standard formula for calculating the solvency capital requirements is laid out in Articles 177 to 181 VAG. It follows a modular approach, dividing the overall risk exposure into different sub-modules, for which a capital requirement is then determined individually.
Alternatively, undertakings can also use full and partial internal models to calculate the requirements after obtaining approval from the FMA (cf. Articles 182 to 192 VAG).
Insurers and reinsurers regulated by the Central Bank are required to meet the capital and solvency requirements set out in Solvency II, as transposed by the 2015 Regulations into Irish law.
To comply with the enhanced Solvency II regulatory reporting requirements in respect of solvency, Irish authorised (re)insurers are required to submit the following information to the Central Bank:
- a solvency and financial condition report (“SFCR”);
- detailed annual and quarterly reports supplementing information contained in the solvency and financial condition report;
- a regular supervisory report, at least every three years, containing specific information regarding the business and performance of the insurer, its system of governance, risk profile, capital management and information relating to its valuation of assets, technical provisions and other liabilities for solvency purposes;
- an annual own-risk and solvency assessment supervisory report, setting out the results of the own risk and solvency assessment performed by the life insurer; and
- other reports required by the Central Bank.
In addition to the insurers' own supervision and their self-reporting-obligations, the NFSA supervises insurers' and reinsurers' solvency through risk assessments based on the state of the financial markets and the financial system as a whole, as well as continuous risk assessments of individual insurance undertakings. The monitoring of individual insurers focuses on governance and risk management, capital situation, products and behaviour towards customers, and is based both on the information that companies are obliged to report to the NFSA themselves, as well as carrying out their own investigations by reviewing random sample groups and following up tips about irregularities.