Early-warning Systems and Progressive Intervention Levels

Regional Seminar on Risk-based Supervisory Practices and Regulatory Capital

San José, Costa Rica, 6-8 September 2011

Gunilla Löfvendahl Senior Financial Sector Specialist

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Risks and effects

Inadequate or failed internal

processes people or systems

Inappropriate risk decisions

Financial outcome

Policyholder harm

Incorrect evaluation of financial outcomes

External risks (inherent)Internal risks (management and control)

Risk appetite decisions

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Risk assessment table to classify/prioritise inherent risks

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Solvency control levels

Solvency control levels are triggers for different degrees of supervisory intervention

Intervention should be at a sufficiently early stage so that there is realistic prospect for the situation to be rectified in a timely manner

Criteria used to set levels should be transparent Should be at least two control levels:

– Prescribed capital level (PCR): intervention on other grounds than capital adequacy

– Minimum capital level (MCR): strongest supervisory action if corrective action is not taken promptly

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Setting the level of PCR and MCR

PCR:– Insurer can absorb losses from adverse events over a

defined period

– Technical provisions remain covered at the end of the period

– Need to consider whether insurer can access additional capital/other risk mitigation tools

– Going-concern basis

MCR– Ultimate safety net for the protection of policyholders– Different from accounting concept of insolvency (assets >

liabilities)– Lower bound for PCR (can be calculated differently)– Gone-concern/winding-up basis

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Quality of capital resources

Loss absorbency under going-concern (availability and permanency) – main function

Loss absorbency under winding-up (subordination and priority)

The quality can be regulated in different ways– categorise into tiers (quality classes)– rank capital elements

The quality of corresponding assets is also important and can be regulated in different ways– investment incentives through risk-weighting– catalogue of admissible asset (risk-based)

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Typical early-warning indicators

Low solvency margin relative to firm’s risks Rapid growth, declining profitability High expenses, low profitability Sudden increase in technical reserves Marked decrease in technical reserves Significant divergence from budget and business plans Concentrated investments, particularly in related entities Timing of payments, in particular claims Consumer or intermediary complaints Large, irrational or inconsistent reinsurance arrangements Crude underwriting strategy (pricing and risk selection)

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Indicators (continued)

Excessive bonus or unusual remuneration and incentives Change of business strategy New sources and classes of business Changes to or delays in implementing original business

plan Vulnerability to legal or fiscal changes Mergers, acquisitions or other significant transactions that

may put on pressure Poor quality information or delays in producing the

information Failure to implement supervisory advice or requirements Non-cooperation with supervisor

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Preventive and corrective measures ICP 14 (new 10)

Have legal and operational capacity to bring about timely action

Make use of adequate preventive and corrective instruments that are suitable and necessary to achieve the objectives of insurance supervision

Have a progressive scale of actions and remedial measures

Have the capacity and standing to communicate with companies and require information

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Preventive supervisory tools

Licensing procedure Continual fit and proper requirements Requirements of sound corporate governance, internal control and risk management Periodic reporting requirements Disclosure/transparency Business plan and strategy for new business Off- and on-site supervision Informal contacts with management

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Corrective supervisory measures

Require compliance with rules and rectification of breaches

Require correction of reporting errors Impose plan of redress (acceptable steps and

timetable) Prescribe capital injection Prescribe additional or other reinsurance Prescribe portfolio transfer or merger Require change of management

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Enforcement or sanctionsICP 15 (new 11)Formal directions to take (or desist) actions : Failure to comply should have serious consequences Possibility to combine sanctions with fines against

individuals and insurers Sanctions are powerful supervisory tools that should be

used in a fair and equal manner It is not sufficient for supervisors to have powers

delegated under legislation – powerful tools are only powerful if used

Determine that the insurer is complying with the measures once action has been taken or measures have been imposed

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Enforcement or sanction measures Restrict business activities

– Stop the writing of new business– Withhold approval for new activities or acquisitions

Direct the company to stop unsound practices Direct a company to stop unlicensed business Remove directors and managers - bar individuals from acting in

responsible capacities in the future Require capital levels to be increased

– Restrict disposal of insurer’s assets– Restrict/suspend dividend or other payments to shareholders– Compulsory portfolio transfer or conservator ship

Revoke the licence – require the company to wind-up Combine with fines

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Winding-up and exit from the marketICP 16 (new 12)

Determine when it is no longer permissible to continue business

Lay down procedure for dealing with winding-up and insolvency (define insolvency)

Protect the rights and entitlements of policyholders/beneficiaries in the event of insolvency

– Protection/guarantee fund

– Preferential rights

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Appointing an administrator/liquidator

Take over the role and duties of the board and senior management

Before and/or after a winding-up

– Before: take over the control in order to protect the rights of the policyholders (usually no new business but still supervised)

– After: Protect the assets to satisfy the interests of all stakeholders (court process with little involvement of the supervisor)

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Policyholder protection schemes

Pool of money (pre- or post-funding by the industry) to be used to meet the obligations of a failed company (predefined classes or lines of business)

Non-life: claimants / Life: claimants and policyholders Payment during winding-up or/and after (whole or

remaining part of the claim Moral hazard risk

– Lax supervisory treatment – Impudent industry behaviour– Less consumer due diligence

Supervisory decisions and enforcement actions should be taken irrespective of protection scheme

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Discussion examples

Information sources (what, when and where) Supervisory actions

– Insufficient technical provisions

– Low solvency margin

– Risky investments (including risk-conscious)

– Unsound market conduct and mis-selling

– Other