11 December 2018

BIS: Proportionality in the application of insurance solvency requirements

This paper outlines various regulatory approaches to proportionate solvency regulation. It is based on a survey of 16 insurance authorities, of which eight have adopted a proportionate approach, allowing certain insurers to apply simplified regulatory requirements.

Insurance supervisory authorities have been modernising their supervisory and regulatory regimes since the 1990s. As solvency regimes become more risk-based, the complexity of the requirements have increased significantly. Today, some solvency regimes have developed into rather complex frameworks. This is not unreasonable from a prudential point of view, given that such complexity is necessary in order to determine as accurately as possible the amount of capital insurers need to hold to withstand unexpected losses under stress circumstances.

Yet complex regulations are not optimal for all insurers. Smaller or less complex firms may find that the regulatory costs put them at a competitive disadvantage to larger or more complex insurers. Regulatory regimes should be agnostic as to the types of insurer or their business models in order to be fair to all market players. Diversity in the insurance market will ultimately benefit consumers in terms of choice as well as price competitiveness. This is how proportionate regulation can help.

The concept of proportionality is often confused with risk-based regulation and risk-based supervision. In general terms, proportionality involves taking measures that go only as far as necessary to achieve their aims. From a regulatory standpoint, proportionality means subjecting smaller or less complex insurers to simplified requirements that achieve prudential objectives, namely protection of policyholders’ interests and maintaining financial stability, without being unduly burdensome.

In most of the surveyed jurisdictions, the risk profile of insurers is the main criterion that insurance regulators typically use to identify insurers that are eligible for simplified solvency requirements. The other commonly used criteria are the size of an insurer and the complexity of its business model. In certain countries, specific types of insurer such as micro-insurers, mutual insurers and funeral benefit insurers are subjected to separate, simplified solvency requirements. 

In practice, there is a wide range of ways in which solvency requirements can be simplified. For example, an alternative and simpler formula can be used to calculate regulatory capital requirements for certain risks; or certain types of insurer can be partially exempted from supervisory reporting. Typically, regulators would only allow the application of proportionate regulation if the outcome is at least as prudent as the standard approach. Jurisdictions that allow proportionate capital resource requirements typically use the same criteria as for regulatory capital requirements in identifying eligible insurers. Most regulators that allow proportionate supervisory reporting also allow proportionate public disclosure requirements.

Importantly, a proportionate regime should be consistent with key prudential policy objectives. In particular, proportionate regulation should not be misunderstood to mean relaxing rules at the expense of compromising the safety and soundness of insurance firms. In fact, regulators may consider accompanying the simplification of some regulatory requirements with additional stringency (eg in terms of capital adequacy requirements). Moreover, a sound regulatory framework should provide insurance regulators with the necessary flexibility to apply the full set of standard rules to eligible insurers even if they meet the criteria for simplified rules. There are sound prudential reasons to do so if the insurance authority regards those insurers as posing higher risks to policyholders than their peers.

A proportionate framework should also aim at preserving a level playing field. Proportionality may help mitigate competitive distortions arising from excessive regulatory burdens on small and less sophisticated firms. However, the concept of proportionality should not be used to justify overprotection of certain firms from legitimate competitive forces.

To develop a sound proportionate solvency framework, insurance regulators need to consider several critical issues. These include the extent to which simplified regulatory requirements may weaken incentives for insurers to manage their business properly, the trade-off between simplification and risk sensitivity and the absolute minimum level of complexity that may be needed to achieve prudential objectives. In addition, insurers should not be able to cherry-pick between standard and proportionate requirements.

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