Unpacking the IAIS’ Adoption of the Insurance Capital Standard

Episode Summary

Host Rob Chaplin and Skadden colleague Caroline Jaffer debut the first episode of a yearlong series on global prudential solvency requirements, which will form the basis of the forthcoming Encyclopaedia of Prudential Solvency publication. In this episode, they discuss the International Association of Insurance Supervisors’ (IAIS’) December 2024 adoption of the Insurance Capital Standard (ICS), which Rob notes is a “watershed moment” in global insurance regulation. Rob and Caroline outline key components of the IAIS and the ICS, as well as detail what supervisory authorities and internationally active insurance groups (IAIGs) can expect next regarding the ICS.

Key Points

• The IAIS’ Regulatory Standards: The IAIS adopts three tiers of regulatory standards: Insurance Core Principles (ICPs), the Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) and policy measures for global systemically important insurers.
• The Insurance Capital Standard (ICS): Adopted by the IAIS in December 2024, the ICS is a measure of capital adequacy for IAIGs. It is made up of three components: valuation, capital resources and capital requirements.
• What’s Next for the ICS?: In 2025, the IAIS will begin developing a detailed ICS assessment methodology, which it will use to determine implementation, with in-depth targeted jurisdictional assessments targeted for 2027.

Voiceover (00:01):
From Skadden, The Standard Formula is a Solvency II podcast for UK and European insurance professionals. Join us, as Skadden partner Robert Chaplin leads conversations with industry practitioners and explores Solvency II developments that matter to you.

Rob Chaplin (00:17):
Welcome back to The Standard Formula podcast. We are delighted to be broadcasting this episode from our office here in New York. You can see Madison Square Garden and the Empire State Building behind us. Today we’ll be discussing the International Association of Insurance Supervisors, or IAIS, and the Insurance Capital Standard, or ICS. This episode kicks off our new year-long podcast series on global prudential solvency requirements, which will form the basis of our forthcoming publication, The Encyclopedia of Prudential Solvency.

(00:57):
The IAIS’s adoption of the ICS in its final version in December 2024 is truly a watershed moment in global insurance regulation. It marks the culmination of a decade of development, consultation and monitoring to create a comprehensive, globally comparable capital standard applicable to insurance groups worldwide. Joining me today to unpack the IAIS’s adoption of the ICS is my colleague Caroline Jaffer, who recently joined Skadden’s Financial Institutions Group from the Bank of England.

(01:34):
Caroline, it’s great to have you here. Please kick us off by explaining what the IAIS is and what its primary functions are.

Caroline Jaffer (01:43):
Thanks, Rob. It’s a pleasure to join the team and be here with you today to discuss this important topic.

(01:48):
Established in 1994, the IAIS is a voluntary membership organization comprising insurance, regulatory authorities, central banks, ministries and Finance, and other insurance related international organizations from over 200 jurisdictions, which collectively represent 97% of global insurance premiums. The IAIS is responsible for setting international insurance regulatory standards, and to this end adopts three tiers of regulatory standards.

(02:17):
First, the Insurance Core Principles, or ICPs, which are high level principles that prescribe essentially regulatory components that should be present in the member jurisdictions and so serve as the global standard for insurance supervision.

(02:31):
Second, the Common Framework for the Supervision of Internationally Active Insurance Groups or ComFrame, which provides guidance, supervisory standards and supervisory minimum requirements for the supervision of internationally active insurance groups. ComFrame standards build upon and supplement ICPs.

(02:49):
And thirdly, policy measures for global systemically important insurers, which were developed in response to the 2007, 2008 financial crisis to ensure enhanced group-wide supervision and coherent international capital standards can be applied to global insurers whose distress or disorderly failure could cause significant disruption to the global financial system and economic activity.

(03:13):
The IAIS works closely with its members as well as other international standards-setting bodies for financial regulation to develop, draft, test, and ensure that its policies are effectively implemented.

(03:26):
Rob, now that we know a little about the IAIS, would you give us an introduction to the ICS and internationally active insurance groups, or IAIGs?

Rob Chaplin (03:35):
Thanks, Caroline. The ICS was introduced by the IAIS as a prescribed capital requirement, or PCR, that forms the quantitative component of ComFrame and is a measure of capital adequacy for IAIGs. It constitutes the minimum standard to be achieved and that supervisors represented in the IAIS will implement or propose to implement taking into account specific market circumstances in their respective jurisdictions. The ICS serves as a group-wide PCR, which is a solvency control level below which supervisors will intervene on group capital adequacy grounds. The ICS is made up of three components.

(04:22):
First, valuation. The ICS provides a bespoke method to value insurance assets and liabilities. The ICS balance sheet is based on the audited, consolidated, generally accepted accounting principles, or GAAP, accounts with adjustments to achieve the objectives of the ICS.

(04:42):
Second, qualifying capital resources. The ICS segregates qualifying capital resources into two tiers based on several criteria, which we’ll come to later.

(04:55):
Third, a standard method for the ICS capital requirements. The ICS sets out the capital requirement is calculated by aggregating risk charges across the major risk categories, which are calibrated to a target criteria of 99.5% value at risk over a one-year time horizon, a familiar concept from Solvency II. As the ICS makes up part of ComFrame, it applies only to IAIGs.

(05:26):
IAIGs are generally identified by their relevant group-wide supervisor, examples of which include the Prudential Regulation Authority in the UK and the Bermuda Monetary authority in Bermuda, in cooperation with other involved supervisors. Group-wide supervisors and other involved supervisors must pay regard to two criteria when identifying IAIGs.

(05:52):
First, whether the group is internationally active, which requires that group writes premiums in three or more jurisdictions and has gross written premiums outside its home jurisdiction comprising at least 10% of its total gross written premiums.

(06:09):
And second, whether the group is sufficiently big. In particular, whether the group’s total assets are at least $50 billion or the group’s total gross written premiums are at least $10 billion. If the group meets these criteria, it’s classified as an IAIG and will therefore fall under the scope of the ICS.

(06:31):
Caroline, why don’t you now explain the first component of the ICS which deals with valuation?

Caroline Jaffer (06:37):
Sure, Rob. When setting out how insurers should value their assets and liabilities, supervisory authorities should adopt a regulatory standard at least as stringent as the market adjusted valuation, or MAV. The MAV is based on audited, consolidated general purpose gap or statutory accounting principles accounts and makes adjustments for insurance liabilities and reinsurance balances, financial investments, being assets, and instruments, being liabilities, and deferred taxes to minimize volatility in the IAIG’s solvency position that could be caused from market movements.

(07:16):
Under MAV, the insurance liabilities, which are usually the largest item on an insurer’s balance sheet, are calculated as the current estimate plus the margin over the current estimate, or MOCE. The current estimate is calculated as the probability weighted average of the present values of the future cash flows connected to insurance liabilities, discounted using an IAIS prescribed yield curve, which depends on the currency and type of liability, more on that later.

(07:44):
When determining the probability weighted average of the present values of future cash flows, supervisory authorities should take into account the timing, frequency and severity of claim events, claims amounts and claims inflation, the time needed to settle claims, the amount of expenses and policyholder behavior.

(08:03):
To determine the appropriate discount the IAIS prescribes an adjusted yield curve based on a risk-free yield curve as its starting point. Because the methodology used to discount insurance liabilities is a key element in the valuation of current estimates and has a significant overall impact in the final outcome of the ICS calculations, the ICS adopts a three-bucket approach to ensure results provide an appropriate balance between risk sensitivity and stability, as well as a consistent approach between assets and liabilities. The approach involves classifying liabilities into top bucket, middle bucket, and general bucket depending on the nature of the liabilities and assets backing them and applying discount rates as appropriate for each category.

(08:45):
The second half of the MAV equation, the MOCE is a margin added to the current estimate of insurance obligations to account for the inherent uncertainty involved with calculating cash flows associated with insurance liabilities. MOCE is calculated as a percentile of probability distribution of losses in capital resources. The 85th percentile is used to compute the life component of the MOCE and the 65th percentile is used for the non-life component.

(09:13):
Rob, please walk us through the ICS’s standards relating to capital resources, its second component.

Rob Chaplin (09:19):
Sure, Caroline. The ICS sets out two tiers of capital resources, which can be used by insurers to meet regulatory capital requirements. The most critical characteristics to understanding how capital resources are tiered under the ICS are their availability to absorb losses, level of subordination, permanence, and absence of encumbrances or mandatory servicing costs. The two tiers of capital resources are segregated according to such characteristics and others as follows.

(09:53):
First, tier one capital resources are capital resources of the highest quality. Tier one capital resources are in turn split into tier one unlimited financial instruments, which are capital resources that are, amongst other things, fully paid up in the form of issued capital such that it is the first instrument to absorb losses as they occur. The most subordinated claim in the event of the IAIG’s winding up, entitling the holder to a proportional share of the residual assets based on their ownership of the issued share capital. Perpetual, that is without a maturity date. Free from any obligation to distribute, meaning non-payment of a distribution must not constitute an event of default. And not undermined or made ineffective by encumbrances.

(10:48):
The second subcategory of tier one capital resources are tier one limited financial instruments, which are of lower quality compared to tier one unlimited financial instruments. Are, amongst other things, fully paid up, subordinated to policyholders and other non-subordinated creditors and holders of tier two instruments, but they may rank senior to holders of tier one unlimited financial instruments. Perpetual, only callable at the option of the insurer after a minimum of five years from the date of issue and supervisory approval has been obtained prior to the exercise of the call. Subject to an IAIG’s full discretion to forego and cancel distributions and such distributions are paid out of distributable items, and not undermined or made ineffective by encumbrances.

(11:44):
The second category of capital resources are tier two capital resources, which are capital resources that are of lower quality relative to tier one resources and are split into non-structurally subordinated tier two capital resources, which are capital resources that are, amongst other things, fully paid up, subordinated to policyholders and other non-subordinated creditors of the IAIG and subject to repurchase by the issuer at any time with prior supervisory approval. And structurally subordinated tier two capital resources, these capital resources, unlike tier one and non-structurally subordinated tier two capital resources which are issued by the IAIG’s holding company, which issues a financial instrument to external investors and channels the proceeds to its insurance subsidiaries. Structurally subordinated tier two capital resources are subject to the same conditions as their non-structurally subordinated counterparts put with certain clarifications to those conditions.

(12:56):
Caroline, please tell us about the third component of the ICS capital requirements.

Caroline Jaffer (13:01):
Thanks, Rob. The capital requirements component of the ICS prescribes the amount of financial resources an IAIG must hold to absorb potential losses and ensure policyholder protection in assessing risks using both a stress approach and a factor-based approach. Under the standard method, capital requirements are calculated by combining subcategories of risk under broader categories of major risks, including insurance risk, credit risk, market risk, and operational risk. The stress approach uses the IAIG’s current balance sheet pre-stress and the IAIG’s balance sheet post-stress, assuming the stress happens instantaneously. The risk charge for each individual risk is determined as the decrease between the amount of capital resources on the pre-stress balance sheet and the amount of capital resources on the post-stress balance sheet. Stresses are applied individually with individual stress balance sheets being calculated to determine the risk charge with respect to each individual stress.

(14:00):
The factor-based approach is determined by applying factors to specific exposure measures. Each subcategory of risk in a risk category is assigned a factor that reflects the capital requirement for IAIGs when faced with higher or lower stress levels. In keeping with the IAIS’s intention for the ICS to be a globally comparable capital standard, risk charges are calculated with geographic and demographic divergences in mind. The individual risk charges are combined in a way that recognizes risk diversification using correlation matrices. The ICS target criteria is a 99.5% value at risk over a one year time horizon of adverse changes in the IAIG’s qualifying capital resources.

(14:46):
Insurance risks apart from catastrophe risk are split into life and non-life risks. Life risks account for mortality risk, longevity risk, morbidity and disability risk, lapse risk and expense risk. These utilize the stress approach for measurement. Non-life risks account for premium and claims reserve risks. The premium risk charge addresses unexpected losses from insured events that are yet to occur, whereas claims reserve risk covers unexpected changes to payments or claims or events that have already occurred. These are measured by applying factors.

(15:19):
Charges for credit risks arise from the risk of adverse change in the value of capital resources due to unexpected changes in actual defaults, as well as in deterioration of an obliges credit worthiness, shorter default, including migration risk and spread risk due to defaults. This is measured using a factor-based approach.

(15:38):
Market risks, risk charges cover six risks. Interest rate risk, equity risk, real estate risk, currency risk, non-default spread risk, and asset concentration risk. All of which are calculated using a stress-based approach. Except for asset concentration risk, which is calculated using a factor-based approach.

(16:00):
Rob, now that we’ve covered the three primary components of the ICS, could you explain what supervisory authorities and IAIGs can expect next for the ICS?

Rob Chaplin (16:10):
Certainly, Caroline, while the IAIS is the global standard-setter for insurance supervision, the IAIS does not have the legal authority to mandate implementation of its standards into jurisdictional legislations. Nonetheless, the IAIS has noted that its members are committed to implementing IAIS standards and supervisory material, while also adapting it to their specific market circumstances.

(16:38):
This year in 2025, the IAIS will begin developing a detailed ICS assessment methodology, which it will use to determine implementation assessment. The methodology will specify an appropriate level of granularity and articulate the quantitative and qualitative to be used in the assessment. In 2026, the IAIS will coordinate with its members for each to produce a baseline self-assessment of their progress in implementing the ICS. And in 2027 the IAIS aims to begin carrying out in-depth targeted jurisdictional assessments.

(17:20):
That about covers today’s topic, which marks the beginning of a new chapter for The Standard Formula podcast series. Having covered Solvency II and its application in the UK, our focus for the coming year will be on global Prudential solvency. We’ll regularly publish episodes discussing prudential solvency regimes across the globe, and we’ll also be publishing chapters of the Encyclopedia of Prudential Solvency electronically and in hard copy following each podcast episode. So do stay tuned for more. If you have any questions or comments for us, we are keen to hear from you. We hope you enjoyed this episode. Until next time.

Voiceover (18:02):
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