Case Study- Consolidated Oversight -

Regional Training Seminar IAIS-ASSAL-FIDES

26 November 2009, Lima Peru

Takao Miyamoto, IAIS Secretariat

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Agenda

1. Recap of Presentation on 23rd

2. Case Background

3. Group Discussions

4. Group Presentations & Final Remarks

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International Framework

Insurance Core Principles (ICP) 17: The supervisory authority supervises its insurers on a solo and a group-wide basis.

Insurance Core Principles (ICP) 17: The supervisory authority supervises its insurers on a solo and a group-wide basis.

Insurance Core Principles (ICP) 5: The supervisory authority cooperates and shares information with other relevant supervisors subject to confidentiality requirements.

Insurance Core Principles (ICP) 5: The supervisory authority cooperates and shares information with other relevant supervisors subject to confidentiality requirements.

Principles on Group-wide SupervisionPrinciples on Group-wide Supervision

More elaboration

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Group-wide Supervisor

• Different approaches to group-wide supervision• But one important approach is to designate “group-

wide supervisor” • Group-wide supervisor should take leading role

with other involved supervisors’ cooperation• Generally clear who is group-wide supervisor for a

particular group– Several supervisors may qualify

Guidance Paper on the Role and Responsibilities of a Group-wide Supervisor

Guidance Paper on the Role and Responsibilities of a Group-wide Supervisor

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Group-wide Supervisor

• Supervisor in jurisdiction where– Group is based– Supervisor has statutory responsibility to supervise

head of group

• Location of group’s head office• If registered head office is not operational head, location

where– Main business activities of group are undertaken– Main business decisions are taken– Main risks are underwritten– Group has largest balance sheet total

General principle

Other factors

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Principle 4: Authority and Power

Principle 4: Supervisors should have the skills and the appropriate authority to carry out supervision on a group-wide basis.

Principle 4: Supervisors should have the skills and the appropriate authority to carry out supervision on a group-wide basis.

Preconditions• Appropriate legislation need to be in place for

supervisors to supervise groups within jurisdictions

Two main approaches• Direct: Supervisor has explicit authority and power

over head of group• Follow-up: Supervisor has adequate authority and

power through access to necessary information

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Principle 2: Fitness and ProprietyPrinciple 3: Risk Mgt & Internal Control

Principle 2: The fitness and propriety of the board and senior management of the group, as well as the propriety of significant shareholders, should be assessed on a group-wide basis.

Principle 2: The fitness and propriety of the board and senior management of the group, as well as the propriety of significant shareholders, should be assessed on a group-wide basis.

Principle 3: Adequate risk management and internal controls should be in place within the group and should be assessed on a group-wide basis to enhance the assessment of the solo entities.

Principle 3: Adequate risk management and internal controls should be in place within the group and should be assessed on a group-wide basis to enhance the assessment of the solo entities.

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Principle 1: Capital Adequacy

Principle 1: Capital adequacy should be assessed on a group-wide basis.

Principle 1: Capital adequacy should be assessed on a group-wide basis.

Main issues• Intra-group transactions & double gearing• Off-balance sheet items• Fungibility of capital and transferability of assets• Diversification• Level playing field

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Principle 5: Cooperation and Information Exchange

Principle 5: Necessary provisions and arrangements should be in place to allow efficient and effective supervision through cooperation and exchange of information among supervisors of the group.

Principle 5: Necessary provisions and arrangements should be in place to allow efficient and effective supervision through cooperation and exchange of information among supervisors of the group.

Examples• Memorandum of Understanding (MoU)• Supervisory College

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Agenda

1. Recap of Presentation on 23rd

2. Case Background

3. Group Discussions

4. Group Presentations & Final Remarks

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Structure of Insurance Group

• Property and Casualty insurer (“INS”) operates in jurisdiction A

• INS is member of group comprising– Parent holding company (“HOLD”)– Unregulated financing company (“FIN”)– Reinsurance company (“REIN”)

• INS is wholly owned by HOLD• INS has 60% ownership share in FIN and HOLD

owns other 40%• REIN is wholly owned subsidiary of FIN

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Structure of Insurance Group

• HOLD is incorporated in jurisdiction A• Insurance framework of jurisdiction A

– Does not regulate holding companies directly– But provide sufficient powers for supervisor to use

approach commonly known as “follow-up approach”

– That is, information on unregulated entities is obtained through regulated entity

• FIN is incorporated in jurisdiction B• REIN is incorporated in jurisdiction C

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Business

• Initially, FIN’s primary business comprised entering into interest rate swaps with major corporations, including banks, insurers and other non-financial companies

• During last 5 years, FIN began to expand into other credit derivative lines, including credit-linked notes and credit default swaps (“CDS”)

• FIN’s operations have so far appeared highly profitable

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Business

• Three years ago, as part of group’s expansion plans, FIN received large loan from INS and used proceeds to form REIN

• REIN’s primary role is to provide reinsurance coverage to INS

• REIN also provided significant loans to FIN to assist in expanding credit derivative business

• REIN continues to write profitable business as rates have been on an uptrend

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Supervisory Assessment

• INS has several on-site assessments by its insurance supervisor (“Supervisor A”) over last several years– INS is third largest insurer in jurisdiction A in

regard to total assets• Supervisor A deemed INS to have adequate capital

resources given it is reinsured by REIN• Supervisor A received management accounts from

INS in relation to REIN• Supervisor A determined that REIN is heavily

capitalised and would be able to honor reinsurance obligations

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Supervisory Assessment

• Last year, Supervisor A heard rumor that FIN was being investigated in relation to FIN’s accounting and asset valuations

• Supervisor A heard that insurance supervisor in jurisdiction B (“Supervisor B”) was concerned because several large insurers in jurisdiction B were relying on FIN for credit protection

• These stories caught Supervisor A’s attention since FIN comprised major asset on INS’s balance sheet and large intercompany loan

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Supervisory Assessment

• Supervisor A used follow-up approach to request INS to obtain information regarding stories

• Supervisor A received written correspondence from HOLD’s board providing assurance that there was no basis for rumor

• Correspondence appeared to provide sufficient details and Supervisor A felt no need to pursue this matter further

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Group Financial Distress

• As result of AAA credit rating, FIN was not required to post collateral for counterparties for credit protection

• However, it turned out that FIN misreprented financial position– FIN failed to record significant mark-to-market

losses• Consequently, FIN’s credit rating was downgraded• Rating action immediately triggered margin calls on

credit derivatives• To avoid failure, FIN borrowed funds from REIN

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Group Financial Distress

• Shortly thereafter, catastrophic windstorm hit jurisdiction A

• INS required reinsurance protection provided by REIN

• REIN was unable to settle obligations on account of lliquidity

• Supervisor A discovered that it was mislead by HOLD’s board– FIN was under investigation at time of inquiry

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Agenda

1. Recap of Presentation on 23rd

2. Case Background

3. Group Discussions

4. Group Presentations & Final Remarks

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Tasks

(Question 1)• Group doest not appear to have been supervised

from group-wide perspective• What difference would it have made if it had been

supervised on group-wide basis?

(Question 2)• Based on “Guidance Paper on the Role and

Responsibilities of a Group-wide Supervisor”, who should have performed task of supervising group?

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Tasks

(Question 3)• Assume that Supervisor A was group-wide

supervisor• Evaluate Supervisor A’s performance with respect

to “Principles on Group-wide Supervision”– Note where Supervisor A’s actions were both in

accordance and not in accordance with principles

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Questions and Answers

Thank you very much!

www.iaisweb.org

takao.miyamoto@bis.org