News Regulations17 Sep 2020

New Zealand:Central bank outlines new approach towards supervising insurers' capital adequacy

| 17 Sep 2020

Solvency margin settings is one area in which regulatory provisions might be made more specific, according to Mr Geoff Bascand, deputy governor and general manager of Financial Stability at the Reserve Bank of Wellington.

In a speech delivered to the Insurance Council of New Zealand in Wellington earlier this week, he said that more specific provisions and definitions and clearer guidance on some matters would reduce scope for outcomes to be quite so dependent on firm’s interpretation of sufficient self-discipline.

He said that the RBNZ intends to re-start the review of the solvency standards alongside the broader review of the Insurance (Prudential Supervision) Act (IPSA) next month.

New approach towards capital adequacy

He said, “Thought will be given to a more graduated approach where there is more than one level of capital requirement. Using such an approach, the different levels of capital requirement provide trigger points for intervention. The closer the trigger point is to the minimum capital requirement, the greater the level of supervisory intensity or intervention.

Current approach towards capital adequacy

He said, “A criticism of the approach towards capital adequacy within the current solvency standards is that it represents something of an “all or nothing” solvency measure whereby a solvency ratio above 100% (or any alternative regulated figure) is taken to be adequate and a ratio of less than 100% is taken to be inadequate.”

Any buffer above the statutory minimum is currently at the discretion of the insurer, although the Reserve Bank can impose higher solvency margin licence conditions.

Declining trend in solvency margins

Mr Bascand pointed out that over the years, the RBNZ had observed a declining trend in solvency margins that may be illustrative of a key difference in approach between insurers and the prudential regulator. Insurers must balance the need to maintain a sensible level of capital strength against the expectations of investors for a return on investment. Higher levels of capital make for a more resilient insurer but at the cost of lower return on equity.

Prudential regulators tend to focus on low probability but high impact risks, or ‘tail end risks’, and a concern about the what-ifs in the event of extreme impacts. Of course, checks and balances exist within insurers, but without prudential oversight, competitive forces alone are not always compatible with adequately addressing tail end risks.

He said, “In other words, the risk-appetite of equity-holders will not always be compatible with the risk-appetite of society. The outcome of this is that solvency buffers above the minimum are getting thinner which, by definition, means that the risks of insurers breaching minimum solvency requirements are increasing. The retention of capital, largely because of dividend payments being withheld, has seen a recent, but probably temporary, change in this overall trend.”

He also said that an over-arching consideration for the review of solvency standards will be an assessment of the impact that changes from the introduction of IFRS 17 will bring. IFRS 17 is the international financial reporting standard that, by 1 January 2023, will replace IFRS 4 on accounting for insurance contracts. This change represents a fundamental impact, because solvency standards are based on accepting financial values generated from the production of insurers’ financial statements.


 

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