Early-warning Systems and Progressive Intervention Levels

1
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

2
Risks and effects
Internal risks (management and control)
External risks (inherent)
Inadequate or failed internal processes people or
systems
Inappropriate risk decisions
Financial outcome
Policyholder harm
Incorrect evaluation of financial outcomes
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 gt 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 firms 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 insurers 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