Insurance capital standards are emerging from international and US regulators

The fourth quarter of 2014 saw considerable activity by both international and US regulators regarding the development of insurance company capital standards. The International Association of Insurance Supervisors (IAIS) issued Basic Capital Requirements (BCR) as a first step towards a more comprehensive framework of group-wide global insurance capital standards. The IAIS released for public comment a consultation document entitled Risk-Based Global Insurance Capital Standard. The National Association of Insurance Commissioners (NAIC) released a concepts discussion paper to document its current thinking on potential capital requirements methodologies.

The capital standards being proposed now would apply to entities designated by the Financial Stability Board as Global Systemically Important Insurers (G-SIIs)1 and to Internationally Active Insurance Groups (IAIGs). However, it is not difficult to imagine that down the road some of the concepts being discussed could find their way into risk based capital (RBC) requirements applicable to all US insurers. Therefore, we recommend that all companies should monitor these capital standards developments as they continue to emerge.

Insurance Capital Standards Clarification Act of 2014

In other capital standards related activity, the Insurance Capital Standards Clarification Act of 2014 was signed into law. This legislation provides the Federal Reserve Board with the flexibility to deviate from bank-based capital requirements and apply insurance-based capital standards to any insurance companies that fall under the Federal Reserve Board’s authority, such as savings and loan holding companies with insurance affiliates or companies designated as systemically important by the Financial Stability Oversight Council.

Measuring capital under BCR

The IAIS developed basic capital requirements (BCR) based on six guiding principles as follows:

  1. Both insurance and non-insurance risks should be reflected,
  2. Results should be comparable across all jurisdictions with minimal discretion applied by the various jurisdictions,
  3. BCR should be resilient to stress and provide valid results in a wide variety of stress scenarios,
  4. BCR should be sufficiently granular but should also be simple and practical,
  5. The BCR structure should be consistent, and
  6. The results should be transparent.

The ultimate measure under the BCR approach is a BCR ratio calculated as Total Qualifying Capital Resources divided by Required Capital. Total Qualifying Capital Resources are determined on a consolidated group-wide basis and generally consist of qualifying financial instruments plus retained earnings and surplus. Qualifying capital is classified as either core or additional capital, and additional capital must not exceed 50% of required capital.2 Required Capital is determined on a consolidated group-wide basis and calculated by applying pre-defined factors to a company’s exposure to various risk categories, including insurance and non-insurance exposure. The factors are applied to a proxy measure depending on the nature of the risk exposure. For example, the risk exposure measure for many insurance exposures is defined as the net current estimate (i.e., the expected present value of the cash flows required to fulfill the insurance obligation). For invested assets, the risk exposure measure is defined as fair value determined in accordance with generally accepted accounting principles in each relevant jurisdiction. Based on voluntary field testing, the reported Total Qualifying Capital Resources for the voluntary group represents over 400% of the BCR.

Developing insurance capital standards

BCR is just the first step in the development of international insurance capital standards. The second step is the development of Higher Loss Absorbency (HLA) standards which are targeted to be completed by the IAIS in late 2015. BCR and HLA will apply to G-SIIs only. The third step is the development of a risk-based group-wide global Insurance Capital Standard (ICS), which has a broader scope and will apply to IAIGs. ICS is due to be completed by the end of 2016, with full implementation targeted for 2019. ICS will eventually replace BCR and become the foundation for capital standards applicable to IAIGs. HLA standards will establish additional capital requirements for G-SIIs reflecting their systemic importance to the international financial system.     

The NAIC is developing a conceptual approach that would be applicable to internationally active US insurance groups. The NAIC approach would differ substantially from the IAIS approach primarily in that it would focus on risk rather than application of a rigid standardized formula, and assets and liabilities would not be valued on a market-adjusted basis. The NAIC concepts discussion paper describes two group capital methodologies: RBC Plus and Cash Flow.3

  • The RBC Plus method is conceptually similar to the existing legal entity based RBC risk factor framework; however, the accounting basis for this method would be holding company level consolidated US GAAP; different from the legal entity statutory accounting base in place today.
  • The Cash Flow method involves estimating projections of cash in-flows from assets and cash out-flows from liabilities. Such cash flow projections would be based on normal and stressed scenarios. Parameters and assumptions used in internal models would be approved by regulators and the risks considered would likely bear a strong relationship to the risks identified and evaluated in ORSA reports.

The NAIC is collaborating with the Federal Insurance Office and the Federal Reserve Board to put forth to the IAIS a US approach to insurance group capital.

Conclusion

There is much more work to be done by international and US regulators and other insurance industry participants to finalize capital standards. The development of capital standards becomes even more complex as they will apply not just on a legal entity basis but to consolidated groups, and to both insurance and non-insurance risks. Many US insurance industry participants are critical of the IAIS proposals as being too rigid, formulaic, and a one-size-fits-all approach. But at this point, it clearly is a matter of when, not if, insurance capital standards will be established on a group-wide basis for internationally active US insurance groups.

For more information on this topic, or to learn how Baker Tilly insurance industry specialists can help, contact our team.


  1. G-SIIs are one class of global systemically important financial institutions defined by the Financial Stability Board as “institutions of such size, market importance, and global interconnectedness that their distress or failure would cause significant dislocation in the global financial system…”

  2. Refer to IAIS publication Basic Capital Requirements for Global Systemically Important Insurers dated October 23, 2014 for details of the BCR calculation (http://www.iaisweb.org/index.cfm?event=getPage&nodeId=25233).

  3. Refer to the NAIC paper US Group Capital Methodology Concepts Discussion Paper dated November 16, 2014 (http://www.naic.org/documents/committees_g_cfwg_exposure_disc_paper_us_grp_cap_method_concepts.pdf).