Most people don’t spend much time thinking about insurance, but it’s fundamental to the smooth working of society. At its most fundamental, insurers provide consumers and businesses the ability to pool and share risk. This helps reduce the cost of many mundane, but vital, activities like driving a car, buying a house, or planning for retirement. With the right oversight, policyholders get the protection they want, insurance companies turn a profit, and society benefits by having more people own cars, buy homes, and enjoy their retirement. Additionally, the insurance industry invests about $6 trillion into the U.S. economy, vital for financing growth, according to a recent report from the U.S. Chamber of Commerce.
After the financial crisis, regulators intensified their scrutiny of capital requirements for financial institutions, including insurance companies. The International Association of Insurance Supervisors (IAIS) began taking a closer look at the funds insurers need to have on hand to ensure that they can keep paying premiums and avoid default in the face of market stress or unpredicted disasters.
It is critical that the rules governing insurance are efficient, provide for growth, and allow flexibility. That’s true whether these are standards at the state, federal, or international levels.
The IAIS has been developing a new global insurance capital standard, known as the Insurance Capital Standard (ICS), which could determine capital requirements for insurance companies if adopted by regulators. The IAIS expects insurance firms to be in compliance with the standard by 2024. The U.S. Chamber has raised concerns that the flawed design of the ICS could unnecessarily increase costs for insurance firms, reduce the availability of many insurance products, and make it more difficult for the insurance industry to invest back into the economy.
Last week, the IAIS made two important announcements about the future of the ICS. First, they advanced the ICS for a five-year monitoring period beginning in January 2020 (during which insurance firms may confidentially report information about the workability of the draft standard to the IAIS). Crucially, the IAIS agreed to conduct an economic impact analysis and provide additional opportunities for stakeholder input to inform changes to the draft standard. Second, the IAIS released more details about how an alternative to the ICS, known as the Aggregation Method, could be deemed suitable (“outcome comparable”) for use by insurance firms to be in compliance with the global standard.
The ICS simply isn’t the efficient, pro-growth, flexible standard we need to ensure that the insurance industry provides the right coverage and allocates resources effectively—while having enough cash on hand to meet adverse conditions. Instead, a better way to reach these goals would be adoption of the Aggregation Method (AM) now under development by policymakers in the U.S. and being field tested by the IAIS.
Earlier this year, the U.S. Chamber released a report analyzing the merits of the AM. Perhaps the best feature of the AM is its flexibility. The AM is not one-size-fit-all, instead it relies on existing standards for insurance firms. It is a “bottom-up” approach meaning it would not supplant existing regulation, therefore implementation costs would be relatively low. Crucially, it would not disrupt insurance markets – it would allow policyholders to continue to access the same automobile insurance, home insurance, and retirement products like annuities that are available to them today.
By contrast, the ICS would create a number of issues if adopted instead of the AM, including:
The ICS Could Decrease Insurance Product Availability
The insurance industry in the EU has already experienced product availability impacts from the implementation of Solvency II, which uses a similar liability valuation approach as the ICS known as a Market Adjusted Valuation (MAV). In a survey of insurers from across Europe, 58% of insurers offering long-term saving products with guarantees noted a negative effect of Solvency II on their products. Important long-duration products like whole life insurance, fixed annuity products, and long-duration P&C products (such as long-dated worker’s compensation) could be more difficult for insurance companies to provide if the ICS is adopted.
The ICS Could Hamper Investment Where It Is Needed Most
The ICS could also hamper investment in infrastructure and housing. This is because the MAV could incentivize insurers to shift out of some products, especially those with long time horizons like life insurance and annuities. This change could make insurance firms less likely to invest in assets with long time horizons like infrastructure and housing, according to a report the U.S. Chamber released in March on The Role of Insurance Investments in the U.S. Economy.
The ICS Would Be Costly to Implement
Insurance companies are already under some stress given the historically low interest rate environment. Implementation of the ICS would add new stress by introducing new compliance expenses that distract insurance companies from serving their policyholders including the development of new products to meet their needs in our modern economy. The Association of British Insurers estimated that implementation of Solvency II (a large, regulatory framework and a reasonable comparison to the ICS) cost £3 billion (about $3.9 billion).
Policymakers in the U.S. Recognize the Benefits of the AM
The National Association of Insurance Commissioners (NAIC), a group of U.S. state insurance regulators, and the Federal Reserve Board are already moving towards implementing new standards that would be a realization of the AM. The Federal Reserve Board recently proposed new requirements for banks significantly engaged in insurance, the “Building Blocks Approach,” which builds on existing state-based insurance standards and federal bank capital requirements. Meanwhile, the NAIC is working on a Group Capital Calculation that is expected to be debuted early next year.
The U.S. Chamber is eager to weigh in on changes to the ICS and determining “outcome comparability” during the upcoming monitoring period. In response to the IAIS announcement last week, Executive Vice President of the U.S. Chamber Center for Capital Markets Competitiveness, Thomas Quaadman released a statement underlining the benefits of the AM:
“We are pleased to see the IAIS reaffirm its commitment for considering alternative approaches to the ICS. The IAIS made the right decision by not closing the door on the state-based regulatory system that has an established record of benefitting consumers in the United States.
We believe the Aggregation Method is a superior approach that reflects local social and economic needs, and could be implemented easily given it is built on existing jurisdictional frameworks. We look forward to reviewing the IAIS work plan for determining outcome comparability and hope there will be transparent opportunities for stakeholder engagement.”
Insurance firms need certainty as soon as possible that they can use the AM, instead of the ICS, for determining capital requirements. But at this time, they don’t know if the AM will be an acceptable way to comply and the 2024 deadline is fast approaching. This uncertainty if making it more difficult for insurance companies to plan how they will continue to fulfill their crucial role in society.