How is the solvency of insurers (and reinsurers where relevant) supervised?
Insurance & Reinsurance
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.
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.
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).
In addition, 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 DFSA has the task of monitoring and ensuring that insurance companies comply with the EU Solvency II Directive.
The DFSA supervises the solvency of the insurers and reinsurers through risk assessments.
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.
The Undersecretariat also supervises solvency of insurers and its Regulation no 26761 on Measurement and Evaluation of Capital Adequacy for Insurance, Reinsurance and Private Pension Companies sets out solvency requirements of insurance, reinsurance and pension companies in order to ensure that such companies keep enough equity capital to cover losses which may arise due to their existing liabilities and potential risks. Under this Regulation, capital adequacy statement has to be submitted to the Undersecretariat twice a year.
Insurers and reinsurers regulated by the Central Bank are required to meet the capital and solvency requirements set out under Pillar 1 of 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 supervising the solvency of an undertaking, the Central Bank may also require an insurer to provide it with a certificate of the value of the assets representing the technical provisions on the closing date on which the accounts and balance sheets of the insurer were provided to the Central Bank.
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.
In addition to the insurers’ own supervision and their self-reporting-obligations, the FSA 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 companies. The monitoring of individual companies focuses on governance and risk management, capital situation, products and behaviour toward customers, and is based both on the information that companies are obligated to report to the FSA themselves, as well as carrying out their own investigations by reviewing random sample groups and following up tips about irregularities.
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.
The regulatory framework for dealing with distressed or insolvent insurance or reinsurance companies is found in chapter 20 of the Financial Institutions Act. These regulations determine certain obligations for the board of directors and the CEO if the insurer enters into financial difficulties. If the directors and/or CEO become aware of such difficulties, they each have a personal responsibility to notify the FSAN, which may initiate further investigation based on this information. The FSAN can also initiate investigations without a notice, if it has reason to believe that the company's financial position is weak or threatened.
If this is the case, the FSAN consults the insurance company to determine the necessary measures to rectify the situation, if possible. The FSAN supervises the implementation of such measures and may order the company to wind-up its business if the management does not act accordingly. If the insurance company becomes insolvent, and the FSAN considers that the company cannot secure a financial basis for satisfactory operation, the Ministry of Finance must be informed immediately. This information to the Ministry shall include an assessment from the FSAN as to whether the institution should be placed under public administration.
The Ministry can then order the initiation of a public administration, which is announced at the earliest possible opportunity. An administration board is then appointed to draw up possible arrangements enabling continued operations of the institution's activities on a sufficient financial basis. This may imply that the insurer merges with, or transfers its activities to, another institution. If a restructuring scheme is not accomplishable, the administration board must prepare to wind-up the institution. As a rule, liquidation proceedings must be initiated if another arrangement is not in place within a year after the public administration was begun. On 17 February 2017 the Ministry of Finance put the Norwegian life insurer Silver Pensjonsforsikring AS under public administration as Silver did not comply with the capital requirements under Solvency II.
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.
IA Regulations No. 25 and 26 of 2014 (the “Prudential Regulations”) establish rules to be followed by insurance companies in order to ensure their solvency.
The Prudential Regulations can be divided into several primary areas of concern, which are capital adequacy, policyholder fund requirements, reporting requirements, and data keeping. From a strategic viewpoint, the focus of these rules collectively represents a move towards establishing a risk based approach, wherein insurers are required to maintain certain levels of capital in specified, diversified investment categories, as well as maintaining accurate and consistent data keeping and reporting protocols.
The provisions dealing with capital adequacy contain three modules: Solvency, Asset Liability Management, and Technical Provisions. Insurers now are strictly limited in what investments they make on a percentage basis. These limits broadly include the following: 30% in real estate, 30% in equities of UAE companies, 20% in equities in non-UAE companies, 100% in UAE government instruments, 80% in highly rated foreign government instruments, 30% in various classes of secured loans, 1% in derivatives or complex financial instruments, and 10% in other investments. Additionally, there are sub-limits set forth which constrict the amount that may be invested with any one particular sub-class within each investment class. Notably, the regulations require a minimum of 5% be invested in cash deposits with a UAE bank.
All insurers are required to establish detailed investment strategies conforming to a view fulfilling of insurance and capital adequacy obligations, as are impacted by key risks, including market, credit, and liquidity risks. Each insurer’s Board of Directors is charged with establishing, implementing, and monitoring their company investment strategies and regulatory systems. Additionally, every insurer is now required to conduct a stress test as to all of its investments on an annual basis.
The reporting requirements set forth a high level of active managerial oversight and also require actuarial monitoring, with actuarial certification of the adequacy of the mathematical reserving practices required at least annually. The metrics to be identified in these reports are set forth in the Regulation with a high degree of specificity. Insurers must also maintain standardized accounting and data recording procedures, appoint internal and external auditors and a compliance officer, and file both quarterly and annual reports with the IA.
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.
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).
Regulation is strict regarding minimal capital requirements and technical reserves, which is controlled by quarterly presentation of financial statements to the regulator (CMF). In addition, from time to time the regulator makes in-site inspections, and requests clarifications in respect of any queries regarding statements or any other antecedent. The CMF is implementing a new model for risk-based supervision, the main objective of which is to preserve solvency within the insurance market. For that purpose, it has sent to the insurance market for consultation, diverse drafts on methodology, and other aspects.
Under this same perspective of the new supervisory model, the regulator has recently established reinsurance management principles which are applicable without prejudice to the norms in force, under which companies shall only reinsure with local reinsurers or with foreign reinsurers with a risk rating not lower than BBB or its equivalent. Accepted classification houses are Standard & Poor’s, FITCH, MOODY’S and A.M. Best. Otherwise, reinsurance is not considered for the purposes of establishing the technical reserves of the insurance company.
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 establish (?) 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, Art 10 ISO.
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, Art 24 ISA. FINMA supervises the adequacy of the solvency margin regularly through annual reports that have to be provided to FINMA, Art 25 ISA.
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 Art 21 et seq ISO and in the recent FINMA Circular RS 2017/3 (released on 7 December 2016).
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.
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.
Licensed insurers are required to maintain a separate insurance fund for each class of business they carry out. This applies to both Singapore policies as well as offshore policies. Life insurers must also maintain separate funds for investment-linked, participating and nonparticipating policies.
MAS adopts a risk-based regulatory capital framework for insurers. The capital which an insurer is required to hold is dependent on its risk exposures (i.e. Total Risk Requirements ('TRR')) for each insurance fund and in aggregate. TRR is calculated in three components: C1 – insurance risks; C2 – asset portfolio risks, such as market and credit risks; and C3 – asset concentration risks.
MAS conducts a review of its regulatory capital framework from time to time to re-calibrate the capital requirements to better reflect an insurer's activities and risk profile. MAS is currently reviewing its regulatory capital framework. Key revisions include the downward calibration of capital requirements for equity investment, credit spread, counterparty default and operational risks. The revised framework is also expected to establish a prescribed capital requirement and a minimum capital requirement at insurance fund and insurer level.
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.
Capital requirements of an Insurer are dealt with by the Control Law. In addition the Commissioner issues from time to time circulars regarding the capital requirements for an insurer. Currently Israeli Insurers 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 Supervision Act transposes the Solvency II Directive into Belgian insurance and reinsurance law and also takes into account the principle of proportionality as set out in the Solvency II Directive, meaning that the Belgian system of solvency supervision corresponds to the one in the Directive. The vast majority of the EIOPA guidelines have also been confirmed by the NBB and are transposed into Insurance Circular Letters or internal insurance procedures.
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.
The solvency of insurers (and reinsurers) is primarily the responsibility of the regulators under whose jurisdiction the insurer has been incorporated or, where the insurer is operating in Canada as a Branch, the responsibility of OSFI, our federal regulator. Where OSFI is the principal regulator, the local jurisdictions, while retaining jurisdiction, will generally look to OSFI to supervise the solvency and governance of its companies.
As regulated by the Ordination Supervision and Solvency of Insurance and Reinsurance
Companies Act 2015 and its developing regulation (Royal Decree 1060/2015), solvency
of local/Spanish insurers (and reinsurers) is mainly supervised through:
- The regular submission of the relevant information (i.e. mainly accounting, financial
and other statistics) within the periodicity, format, and content set out by law. This
said, the Spanish regulator is also entitled to demand submission of any such
information to local entities at any time.
- In addition, supervision is made through inspections by the Spanish Insurance
Regulator, following a specific procedure set out by law where, for instance, the
entity under inspection is able to submit allegations/clarifications to the regulator.
Portuguese insurance undertakings are subject to the requirements imposed by the Solvency II Directive, which have been strengthened so as to ensure financial stability of the insurance sector (in order to protect policyholders, insureds and beneficiaries). PIRL imposes certain rules with regard to prudential supervision, in line with the Solvency II Directive:
a. Minimum capital requirements for insurance undertakings (which may vary depending on the type of insurance products distributed);
b. Minimum solvency requirements for insurance undertakings (calculated on the basis of the risk-assessment system);
c. It is mandatory to implement of a risk-assessment system, capable of identifying, measuring, monitoring, managing and communicating risks to which the insurance undertakings might be exposed.
ASF might make use of its powers mentioned above so as to ensure the solvency of insurance and reinsurance undertakings in Portugal. On another perspective, PIRL sets forth that insurance and reinsurance undertakings must perform a self-assessment of their own solvency, which shall be communicated to ASF. Furthermore, insurance and reinsurance undertakings are required to disclose an annual solvency and financial report.
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.