RBNZ's just-launched insurance capital review to be based on principles similar to bank capital review

RBNZ's just-launched insurance capital review to be based on principles similar to bank capital review
Geoff Bascand

The Reserve Bank (RBNZ) says the new capital requirements it’s planning to impose on insurers will be “conservative” by international standards, “reflecting the RBNZ’s regulatory approach”.

This conservatism is one of the eight principles the regulator is seeking feedback on as a part of its review of insurance solvency standards

Another principle is that capital requirements should be “set in relation to the risks that may impact insurer balance sheets”.

The RBNZ is commencing this solvency standards review as it relaunches its review of the Insurance (Prudential Supervision) Act (IPSA), put on hold a few times since 2017 - most recently due to Covid-19.

The RBNZ said the principles for the solvency review have been adapted from those used in its bank capital review, as it wants to take a broadly consistent approach towards regulating the insurance and banking sectors.

The eight principles are:

  1. We will have regard to international comparability, particularly LAGIC (Australia), Solvency II (Europe), International Capital Standard (IAIS) and the Insurance Core Principles (IAIS), with the caveat that principle number 2 will take precedence.
  2. We take a substance over form approach and tailor our requirements to New Zealand. This principle will take precedence over international comparability.
  3. Capital must readily absorb losses before losses are imposed on policyholders.
  4. Capital requirements should be set in relation to risks that may impact insurer balance sheets.
  5. Insurers should be subject to a single method of determining capital requirements and the use of judgement should be limited to the extent possible.
  6. Capital requirements of New Zealand insurers should be conservative relative to those of international peers, reflecting the Reserve Bank's regulatory approach.
  7. The solvency framework should be practical to administer and minimise unnecessary complexity and compliance costs.
  8. The solvency framework should be transparent to enable effective market discipline.

RBNZ Deputy Governor and Manager of Financial Stability, Geoff Bascand, last month also expressed the RBNZ’s intention to take a more graduated approach towards solvency.

“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,” Bascand 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."

Submitters have until November 12 to provide feedback on the principles.

Thereafter, the RBNZ will look at the structural changes.

Then it will write a draft standard and get feedback on it, before issuing an interim standard by the end of 2021. This will allow insurers to “prepare with confidence” for the introduction of the IFRS 17 (International Financial Reporting Standard) accounting standard, and implement the major recommendations of the IMF Financial Sector Assessment Programme review and Trowbridge-Scholtens review of the RBNZ’s supervision of the failed company, CBL Insurance.

Throughout 2022 and 2023 the RBNZ will focus on the details of the capital changes and other components of the standard, and issue a final standard by late 2023.

IPSA

The RBNZ isn’t yet asking for feedback on the IPSA review, but will over the next year release consultation papers on the following:

  • Scope of the legislation - Which organisations and products should be captured? Do the definitions of “insurance”, “carrying on business” etc. need to be modified?
  • Overseas insurers - How should overseas insurers operate in the New Zealand market? What sort of supervision regime should be in place?
  • Statutory funds - To what extent should statutory funds be a feature of New Zealand regulation? Are the current forms effective and appropriate?
  • Solvency regime - Are the enabling provisions for solvency standards and requirements supportive of good regulation and supervision? Do definitions in IPSA need amending?

The process of taking new legislation through Parliament is expected to occur in the second half of 2023 at the earliest.

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7 Comments

Low interest rates can reduce a company’s net assets and reduce future profitability due to a lower investment return on cash and fixed interest investments. Life insurers are particularly affected.

ACC announces $8.7 billion deficit for year as interest rates plummet

ACC has posted an $8.7 billion deficit for the year, with record-low interest rates taking a major chunk of out its long-term forecasts.The corporation presented its 2018-19 financial results to Parliament on Wednesday, with a huge increase in its "outstanding claims liability" (OCL) producing its highest-ever deficit and overshadowing other results.The OCL is the amount of ACC estimates all its current claims will cost over the next 100 years. Lower interest rates mean the fund has to invest more now to cover costs down the track.

How can a decrease in the rate of interest have the effect of destroying the capital efficiency of cash flows? Well, the present value of the cash flow is just the price one must pay when buying it. Paying a higher price for the same cash flow is a clear indication of the decrease in the efficiency of the purchase. It shows that the terms of trade of the purchaser has deteriorated. In spite of the utter simplicity of this concept it has been the source of great confusion and theoretical errors.

In each instance the capital efficiency of the float has been seriously undermined. As a result the ability of the insurance companies to increase their capital base has been destroyed. The diagnosis is that the industry is a dead man walking. The prognosis is 'sudden death syndrome'. When it becomes known that it has been denuded of capital, the industry will follow Lehman Brothers to Hades (where the god of the dead, Hephaistos, reigns).

An ad hominem argument can be made that this scenario is indeed inevitable. The rate of interest is reduced through Fed open market purchases of government debt. Thereafter the account carrying insurance premiums will be compounding at a reduced rate. It will increase more slowly. In addition, the capital efficiency of the industry is ruined. It has to pay more for generating the same premium-income while getting no relief in the form of risk reduction. In effect, the insurance industry is forced to shoulder ever more risks without the possibility of increasing premium income. Insurance companies are forced by Quantitative Easing, so called, to take ever greater risks just to keep abreast. But there is a limit to this imprudence. At one point the industry will find that it could no longer meet claims. Under ZIRP insurance companies are deprived of any return to assets with no compensation in the form of a reduction of liabilities. Link.pdf

Exactly right.
The actions of the FED have been bankrupting the whole insurance industry sector, and the RBNZ is proceeding exactly along the same line, with its reckless monetary policy. Such actions potentially destroy the very business model on which the insurance industry is based.
It is a proof of the RBNZ's sheer incompetence that, at the same time, they claim to be interested in promoting the stability of the insurance sector by launching their insurance capital review. A completely contradictory approach. It would be extremely funny if it was not so eye-wateringly stupid, dangerous and/or disingenuous.
Be ready to see the consequent surreptitious nationalization of the insurance sector, as it is going to happen too with the banking sector. The actions pf the RBNZ are going to create immense damage to the long term health of the whole NZ financial sector. It is incredible that they can get away with it.

And what stops another AMI Geoff? Not your efforts, above.

Southern Response is a Government-owned company, formerly part of AMI Insurance. It was created in 2012 to help deal with the high costs and claims volumes of the Canterbury earthquakes, which had a profound impact on AMI Insurance and its Canterbury client base.
AMI ended up receiving capital support from the New Zealand government in April 2011, and on April 05, 2012, AMI then separated into two companies - AMI (the Good Bit!) and Southern Response (the Bad Bit).

It's all very well for policyholders of Souther Response to criticise their treatment at the hands of the "Government Insurer", but had they been left to their chosen company, AMI, they would have got very little compensation, if any at all.

(PS: Why did AMI hold such an over proportional weight of Christchurch property insurance? Because they undercut everyone else in the misguided belief that "It won't happen here!". to get the business and 'make good returns' to pay salaries and bonus' etc. Nothing in the above is going to stop that happening again)

Being over represented in Chch ought not of itself to have sunk them IF they had accurately calculated their maximum probable event loss AND arranged adequate reinsurance. There is from my perspective a fascinating investigative opportunity for an enterprising journo into both of those provisos and also the decisions of AMI’s executive leading up to the EQ sequence and the period after it.

BW. Suggest your dig at Geoff is not entirely fair given the RB mandate at the time did not include investigation into the adequacy of AMI’s event loss estimations and therefore adequacy of its RI program and consequent effect on its solvency ratio.

I was an AMI customer for over 30 years, when the EQ hit, and still am with AMI. They had a very good reputation as being a fair and reasonable company, which was probably well deserved. They started in Christchurch, as SIMU, so it was hardly surprising CHC was vulnerable to AMI, and vice versa. SR was very difficult to deal with, and we still haven't been paid. Hopefully now SR is part of EQC, yes that's correct, SR is no longer stand alone, and is 100% funded by EQC, perhaps things will change!