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Cornerstones:
Solvency Monitoring in
Differing Circumstances
Michael M. Barth, PhD, CPCU
Associate Professor of Finance
Georgia Southern University
Recent IAIS Releases
 October 2004 – A New Framework for
Insurance Supervision: Towards a
Common Structure and Common
Standards for the Assessment of Insurer
Solvency
 February 2005 – Cornerstones for the
Formulation of Regulatory Financial
Requirements
IAIS Objectives Include
 Assisting regulator and regulated in assessing
risk and solvency
 Enhancing the transparency and comparability
of insurers worldwide
 Supporting a level playing field while reducing
regulatory arbitrage
 Increasing the opportunities for international
cooperation
 Increasing overall confidence and efficiency
Let’s Tweak This Thing…
What Ain’t Broke, Don’t Fix
Common Standards
 Common standards should not mean the same
standards for all insurers
 Loss frequency vs loss severity
 Market disruption
 Market’s ability to absorb both the losses and the
cost of loss prevention
 Cost associated with monitoring
 Translating common standards across
international boundaries
Assessing Risk
 Development of appropriate models and
techniques that can be used in multiple
jurisdictions
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Technical reserves (?)
Investment risk (?)
Systematic business risk (?)
Political risk (?)
 Processes for determining risk may be more
exportable than products themselves
Transparency
 Transparent systems and opaque systems are
complementary and serve different functions
 Degree of solvency monitoring by outside (e.g.,
non-regulatory) bodies affects design
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Competitors
Lenders
News, trade press
Reinsurers and other business partners
Other financial services regulators
 Self-fulfilling prophecies and inaccuracy in
systems affect the ability to be transparent
Opaque Solvency
Monitoring Systems
 Should be opaque to masses but transparent
to other regulators (e.g., FAST, CAMEL)
 If insurers are gaming the system, then the
system is not working
 Early Warning System meant to provide early
warning of what MIGHT happen, not what is
inevitable
 Opaque systems can be used to direct
resources more efficiently without causing
disruption that regulator is trying to avoid
Opaque Warning Systems
Should Provide Scores
Regulatory Arbitrage
 Best defense is cooperation among
regulators IN AN APPROPRIATE
FORUM
 Sliding scales of regulatory interest and
interference
 Regulatory forbearance
How Does U.S. Stack Up?
(IMHO)
 Regulatory Indicators
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IRIS, FAST, RBC
Model laws (e.g., RBC model)
State law provides teeth
Audits
 Non-regulatory regulators
 Rating agencies
 Trade press
 Competitors, business partners
Cornerstone 1
 The solvency regime addresses the
robustness of the insurer to meet its
liabilities both short term and over a
longer time span
Short term and long term: What does that mean?
Ratio systems are relatively short-sighted, but
insolvencies often occur over time
AM Best et. al. also provide long-term information
Cornerstone 2
 The solvency regime is sensitive to risk,
and is explicit as to which risks
individually and in combination, lead to a
regulatory financial requirement and how
they are reflected in the requirement
Pretty much describes the concept of risk-based capital and
the accompanying RBC law
Cornerstone 3
 The solvency regime is explicit on how,
for each of the risks that attract a
financial requirement, individually and in
combination, prudence is reflected in
these requirements.
That is the plan, anyway.
Cornerstone 4
 The solvency regime requires a valuation
methodology which makes optimal use of
and is consistent with information
provided by the financial markets and
generally available data on insurance
technical risks.
For a transparent system, yes.
This does not address the needs of an opaque system
Does the generally available data provide accuracy?
Cornerstone 5
 The solvency regime includes the
definition of technical provisions.
Technical provisions have to be prudent,
reliable, and objective and allow
comparison across insurers. The regime
should require as a minimum that
sufficient assets are available to cover
the technical provisions and other
liabilities.
Relatively easy to standardize across borders
Cornerstone 6
 The solvency regime requires the
determination of a “best estimate” of the
costs of meeting the obligations arising
from the insurance portfolio, taking into
account the time value of money. The
discount rate for this calculation is
determined by reference to the relevant
risk free interest rates on the financial
markets.
Best estimate or confidence interval?
Cornerstone 7
 The solvency regime establishes a range
of solvency control levels and the
supervisory instruments associated with
each of the control levels
What is meant by “control level”?
RBC requires company to submit a report at the
Company Action Level – is that “control”?
The bar for “increased regulatory scrutiny” should be
relatively easy to trigger
Cornerstone 8
 The solvency regime allows a set of
standardised [standardized] and more
advanced approaches to determine the
solvency requirements, and includes the
use of internal models if appropriate.
The level of “standardization” should differ from system to system.
Opaque systems may be particularly suited to advanced
approaches. This also allows the monitoring system to be more
forward thinking and dynamic by encouraging innovation
Conclusions
 The US system, a combination of both
public and private early warnings and
capital standards, goes a long way
towards meeting these goals
 Harmonization across international
borders seems like a long way off
 What ain’t broke, don’t fix
 If it ain’t perfect, keep trying