Insurance Group Supervision Bakι, Azәrbaycan -- Çərşənbə 14 mart 2012 ACP -- Élie Sibony, François Tempé 1

2Group Supervision Abbreviations < : lower than;  : belonging to;  : sum; ASM : available solvency margin comp. : company (which can be other than an insurer). Dir. : Dir.1998/78, when no otherwise specified EU : European Union ins. : insurer, insurance K : capital (O.F. and K are taken as synonymous) KR : capital requirements MCR : under S2, Minimum Capital Requirement MoU : Memorandum of Understanding MS : Member State (of the EU) O.F.: own funds RSM : required solvency margin SCR : under S2, Solvency Capital Requirement S1, S2 : Solvency I, Solvency II (present and future EU insurance regulation) TPs : technical provisions

3 Insurance Group Supervision Plan 1. Why insurance group regulation ─and co- operation between involved supervisors─ are necessary 2. How Dir. 98/78 (and Dir. 2002/87) deals with the issue: insurance groups (and financial conglomerates) regulation 3. Group Solvency in S2: a brief overview

4 1.Why insurance groups regulation is necessary (see also slides 33-36). ASM = 35 TPs = 200 Assets = 235 RSM; = 40 ; For the sake of the following example, it is assumed that RSM = 20% of TPs (net of reinsurance). The chart below summarizes the balance sheet of an insurer A, for which the ASM < RSM : the insurer’s ASM is unsufficient Group Supervision

5 setting up of an insurance subsidiary: 1 st phase… Shares issued by B, held by A RSM = 40 Assets A = 205 ASM A = 35 TP A Insurer A sets up a subsidiary: an insurer B… 30 ASM B = 30 Assets brought by A A: parent insurer B: subsidiary insurer … with a view to transferring half of its TPs to B Group Supervision

6 setting up of an insurance subsidiary: 2 nd phase… RSM of B = 20 Assets A 105 ASM A = 35 TP A A has transferred to B half its TPs, + the assets covering these TPs ASM B = 30 Assets brought by A in payment of shares issued by B A B TP B Assets brought by A in coverage of the transferred TPs RSM of A = 20 Group Supervision

7 … or setting up of a reinsurance subsidiary Assets 105 ASM A = The pattern is similar if A sets up a reinsurer B, to which it cedes (for instance) half its TPs ASM B = 30 Insurer A Reinsurer B TP ceded by A RSM of A = 20 (RSM = 20% of net TPs) TP A 200 Credit on B 100 RSM of B = 20

8 Group Supervision The setting up of such entities, in the absence of capital adequacy rules for groups, lowers the RSMs that apply to entities The insufficiency of ASM is wrongly « resolved » by the setting up of a subsidiary —where the actual own funds haven’t been increased, and neither have the risks been reduced. Whence the need for a group regulation that tackles the problem.

9 Group Supervision What should be defined by a group regulation Group capital adequacy rules should define - what are the group own funds requirements; - what are the group available, or admissible own funds: ASM of A = 35 ASM of B = 30 Adm. O.F. of A + B = ? RSM of A = 20 RSM of B = 20 O.F. requirements of A + B = ?

10 Group Supervision Why is co-operation between group supervisors necessary the group (adjusted) solvency is then the difference between - the admissible O.F. of the group, and - the O.F. requirements of the group. If A and B are supervised by different supervisors —e.g. A and B are in different countries— these supervisors will have to co-operate, in order to (inter alia) calculate: - O.F. requirements of A+B, - admissible O.F. of A+B.

11 Insurance Group Supervision 2. How Dir. 98/78 (and Dir. 2002/87) deals with the issue: insurance groups (and financial conglomerates) regulation 2.1. Insurance Group Capital Adequacy 2.2. Insurance Group Supervision: other rules Group Supervision

12 How Dir. 98/78 deals with the issue Dir. 98/78 proposes 3 methods: - deduction and aggregation method - requirement deduction method - accounting consolidation-based method We propose to concentrate on the 3 rd one, because - it seems to be the most used in the EU - in Solvency 2, the treatment of groups also uses a consolidation-based method Group Supervision

13 Insurance Group Capital Adequacy in Dir. 98/78: the consolidation-based method As a general way: i) admissible O.F. = consolidated O.F., minus possible non transferable O.F.; ii) O.F. requirements =  of requirements of each subsidiary / controlled entity requirements are reduced to their proportional part for non controlled entities / participations that are not subsidiaries Group Supervision

14 Group Supervision Ex.: a 100% owned subsidiary example of A holding 100% of B: KR 60 O.F. 100 KR 30 O.F. 50 ins. A O.F. c o n s o l i d a t e d 100 KR 60 KR ins. B group A + B

15 Ex.: a 100% owned subsidiary As we can see, the group regulation gives an overview of the group solvency that does differ from the overviews of each solo entity: - at solo level, we have solvency ratio of A = 100 / 60 = 167% ; solvency ratio of B = 50 / 30 = 167% ; - at group level, we have solvency ratio of the group = 100 / 90 = 111%. Group Supervision

16 Group Supervision Back to 1 st example: A holds 100% of B at solo level: RSM of A = 35 / 20 = 175% RSM of B = 30 / 20 = 150% RSM 20 O.F. 35 RSM 20 O.F. 30 ins. A O.F. c o n s ins. B group A + B RSM 20 at group level: KR of the group = = 35/40 = 87,5%

17 Group Supervision ex.: a 70% owned insurer example of A holding 70% of B: KR 60 O.F. 100 KR 30 O.F. 50 ins. A 115 KR 60 KR ins. B group A + B minority interests c o n s o l i d a t e d O.F

18 Group Supervision ex.: a 30% owned insurer minority participations: A holds 30% of B KR 60 O.F. 100 KR 30 O.F. 50 ins. A 100 KR ins. B group A + B 30% of the KR of B are added c o n s o l i d a t e d O.F.

19 Group Supervision ex.: financial conglomerate: a 70% owned bank The same rules apply, considering the KR of the bank: KR 60 O.F. 100 KR 30 O.F. 50 ins. A 115 KR 60 KR Bank B conglomerate A + B minority interests c o n s o l i d a t e d O.F

20 Group perimeter, group solvency requirements RSM B: 100% RSM E: 0% Group Supervision ins. A ins. B comp. C comp. D ins. E ins. G 60% 15% 25% 60% ins. F 25% The following RSMs are considered: RSM F: 25% RSM G: 0%

21 it may be that some O.F. cannot serve outside of their entity, e.g.  minority interests  subordinated loans  surplus funds / profit reserves, that can only either cover the losses of the entity, or be distributed to the policyholders... Group Supervision - Case of non transferable O.F.:

22 Group Supervision These O.F. are said to be « non transferable ». Since they can only guarantee the solvency of the insurer to which they belong ─and indirectly, the solvency of the insurer’s subsidiaries─ but not the solvency of a parent insurer, of sibling insurers etc, these non transferable O.F. are admitted only to the extent of the required capital of their entity. In other words, the surplus of ‘non transferable’ O.F. to the KR of the insurer cannot be regarded as O.F. at group level Non transferable own funds

23 Group Supervision Shares and other O.F. Shares  100% to A A B  A Consolidated A + B Other O.F., not provided by A, and that are not transferable Shares and other O.F. of A Other O.F. of B not provided by A Non transferable O.F.: consolidated O.F., vs … 100%

24 Group Supervision A but admissible A + B … vs admissible O.F. KR 40 The « non transferable » O.F. are admitted only to the extent that is necessary to cover the KR of their insurer B  A

Insurance group supervision: other rules Entities to which supplementary supervision applies: - any insurer which holds a participation in another insurer (Dir. art.2.1) ; participation ≈ a direct or indirect holding of 20% or more of the capital or voting rights of an undertaking (Dir.art.1.g), - any insurer the parent of which is an insurance holding company or an insurer established outside EU (Dir.art.1.2). Group Supervision

26 Insurance groups supervision: other rules (cont.) Scope of supplementary supervision: - any related undertaking of the insurer (Dir.art.3.2) ; related undertaking ≈ an undertaking in which the insurer holds a participation; or a subsidiary of the insurer (Dir.art.1.h). Cooperation between supervisors: - between insurance supervisors: when related insurers, or insurers holding a common participation, are established in different MSs (Dir.art.7.1) ; - between insurance and banking supervisors: when an insurer and a bank are related or have a common participation (Dir.art.7.2). Group Supervision

27 Cooperation between supervisors (cont.) - When there are group entities located in countries outside EU, the signature of MoUs with supervisors outside EU is envisaged (cf. Dir.art.10.a) ; - When there are group entities located in countries outside EU, the signature of MoUs with outside EU supervisors is envisaged (cf. Dir.art.10.a). Intragroup transactions: Transactions between which persons? (Dir.art.8.1). Group Supervision Insurance groups supervision: other rules (cont.)

28 Supervision of intra-group transactions Transactions between the following persons should be supervised: between an insurer and - an undertaking related to the insurer (i), - a participating undertaking in the insurer (ii), - a related undertaking of a participating undertaking in the insurer (iii); between an insurer, and a natural person who holds a participation - in the insurer / in any of its related undertakings (iv), - in a participating undertaking in the insurer (v), - in a related undertaking of a participating undertaking in the insurer (vi). Group Supervision

29 Supervision of intra-group transactions ins. A comp. Z (iii) 22% comp. T (ii) 76% comp. X (ii) 23% comp. Y (i) 24% Ms. MX (iv) 24% Mr. MY (iv) 26% comp. U (no case) 31% Mr. MT (v) 21% Ms. MZ (vi) 34% comp. W (no case) 71% Group Supervision

30 Supervision of intra-group transactions (cont.) A indirectly holds 24% * 71% = 17.04% of the capital of W. A indirectly holds 71% * 24% = 17.04% of the capital of T. However, A controls 24% of the voting rights in T. Group Supervision ins. A comp. Y (i) comp. Z (i) comp. T (i) comp. W (no case) 24% 71% 24%

31 Supervision of intra-group transactions Which transactions? The following transactions should be supervised (art.8.1) loans, guarantees and off-balance sheet transactions, elements of ASMs, investments, reinsurance, agreements to share costs Significant transactions should be reported at least once a year (art.8.2) Group Supervision

32 Why supervise intra-group transactions? Recitals 9 and 11 of Dir.98/78 note that « the distribution of financial resources within that group », or « intra-group transactions », can affect the solvency or financial position of an insurer that belongs to a group ; accordingly, supervisors should be entitled to supervise these transactions, and to take « appropriate measures at the level of the [solo insurer] where its solvency is jeopardised ». Art.16 of Dir.2002/87 on conglomerates provides that supervisors should be entitled to require the necessary measures, if intra-group transactions are a threat to the regulated entities’ financial position. Group Supervision

33 Why supervise intra-group transactions? (cont.) Example: insurers A and B are part of a group. It may be assumed that A and B are located in the same country, and are thus supervised by the same supervisor. It is assumed that both A and B are insolvent: their balance sheet is as follows. Accordingly, Supervisor or Court decides that A and B are wound up. Securities, bank deposits… = 90 TPs = 100 BA Securities, bank deposits… = 90 TPs = 100

34 Intra-group transactions may be detrimental to PHs In the previous example both A and B can settle their debts to PHs at 90% of their value. However, the outcome may differ if some time before the winding-up order, some transaction took place between A and B, as the charts below show: Securities = 60 TPs = 100 B A Securities, bank deposits… = 120 Loan to B = 30 TPs = 100 Debt to A = 30

35 Securities = 60 TPs = 100 B A Securities, bank deposits… = 120 Loan to B = 30 TPs = 100 Debt to A = 30 Intra-group transactions may be detrimental to some PHs (cont.) In the winding-up of B, because PHs’ claims rank prior to A’s claim, B first settles its debts to PHs at 100% of their value, and then pays 20 to A. A only recovers 20 from B. A thus settles its debts to PHs at only 80% of their value.

36 Securities = 20 TPs = 100 A after transaction Securities, bank deposits… = 80 Loan to B = 30 TPs = 100 Debt to A = 30 Of course, you could imagine an even worse situation TPs = 100 Securities, … = 50 B after transaction A and B before transaction

37 3. S2, group capital adequacy: a brief overview As a general way: i) admissible O.F. = consolidated O.F., minus non transferable O.F. (quite similar to Solvency 1) ; ii) O.F. requirements: - some solo requirements ─the MCR─ are not kept at group level - others ─the SCR─ are not merely added, in order to take account of diversification benefits Group Supervision

38 Group Supervision S2: a brief overview e.g. A is a motor insurer, B is a health insurer, A holds 100% of B, the correlation ratio between motor and health risks is set to be equal to 25%: SCR 20 O.F. 35 SCR 10 O.F. 15 ins. A O.F. 35 ins. B group A + B MCR 10 group SCR 24,5 MCR 7 no MCR

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