Financial Stability Institute paper tackles proportionate solvency regulation

The Financial Stability Institute (FSI) has published a paper that outlines various regulatory approaches to proportionate solvency regulation. The paper, FSI Insights No. 14 Proportionality in the Application of Insurance Solvency Requirements, explains that a proportionate regime should be consistent with key prudential policy objectives and should also aim at preserving a level playing field. It notes that there are a number of ways in which solvency requirements can be simplified. The report states that as solvency regimes become more risk-based, the complexity of the requirements have increased significantly, and 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,” it states. But it adds that 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 FSI paper states. It goes on: “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.” The paper 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. Jurisdictions that do not follow such an approach typically consider that their risk-sensitive solvency frameworks are sufficient to achieve the aims of proportionate rules. In practise, there is a wide range of ways in which solvency requirements can be simplified, the report explains: “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.” The report stresses that 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,” the report states. It adds: “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.”

Financial Stability Institute paper tackles proportionate solvency regulation

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