LONDON, August 17 (Global Risk Regulator) – Signs that global regulators are likely to prefer more intense supervision and oversight to imposing capital surcharges on the world’s biggest insurers are a positive move in the right direction, insurance industry representatives said today.

The IIF report appears against the background of remarks this week by International Association of Insurance Supervisors (IAIS) secretary general Yoshihiro Kawai suggesting that insurers deemed to be global systemically important financial institutions (G-SIFIs) might, unlike their banking equivalents, escape capital surcharges designed to ensure the taxpayer won’t have to pick up the tab if they fail (see GRR August 16 email news item “Insurers may escape capital surcharges in G20 reforms”). Instead, Kawai told Reuters news agency, that relying on intensity of supervision and sound recovery and resolution plans might be more appropriate for the insurance business model.

The IAIS, the Basel, Switzerland-based organisation that brings insurance supervisors together to develop global standards for insurers, is working on rules for insurer G-SIFIs. It hopes to issue provisional versions of the rules soon. The rules are being prepared for the Financial Stability Board (FSB), the body of officials charged with coordinating implementation of the global financial reforms agreed by the Group of Twenty (G20) largest economies.

The FSB and the Basel Committee of global banking supervisors set out their plans in July to boost the loss absorbency of the world’s largest banks through capital surcharges. These plans will be put to G20 leaders for endorsement at their summit in the French Mediterranean resort of Cannes in November. Work on other financial firms, including insurers, continues.

The IIF’s Portilla said the IAIS’s apparent position could help with ensuring strong oversight of the problem caused by regulatory regimes giving preferential treatment to the debt of sovereign countries. Many banks and insurance companies hold the debt of countries such as Greece, Portugal, Ireland and other countries tested recently by the markets.

IIF insurance working group member Axel Lehmann pointed out that under the European Union’s planned Solvency II regime for insurers zero capital is assigned to the sovereign debt of the European Economic Area, or EEA, which comprises the 27 EU member states plus Norway, Iceland and Liechtenstein. A ratings-based scale is used for non-EEA countries. For Basel III, the tougher, post-crisis capital and liquidity rules developed by the Basel Committee for banks, zero capital is typically assigned to EEA and US sovereign debt.

“Therefore insurance firms have a strong incentive to hold these kinds of assets,” said Lehmann, who is also group chief risk officer with giant Swiss insurer Zurich Insurance. “Indeed for Solvency II institutions, the bias towards sovereign debt is exacerbated by the fact that capital charges even for non-EEA debt are substantially lower than similarly rated corporate debt.”

The distortion may lead to over-weighting of sovereign bonds, particularly of EEA nations, in the portfolios of European banks and insurers, raising the question of whether the new regulations “are really consistent with solid risk management practices and with what is needed to ensure that insurers are run both prudently and in a way which enables them to meet the demands of our customers.”

“Especially in the light of the current market environment there is a clear need to coordinate any changes in the regulatory treatment of sovereign debt between the banking and insurance sector,” Lehmann said.

Meanwhile, implementation of Basel III will require banks to raise as much as $750 billion, possibly even more, in new capital in coming years, he noted.

While the expectations of banking regulators may be that insurers will play a major role in any bank equity debt issuance, the IIF believes that the willingness and ability of the insurance sector to provide a ready market for new capital and funding may be quite limited, Lehmann said.

“Even if insurers were willing to increase their exposure to bank assets in the form of debt, new insurance regulation and sound risk management will tend to militate against any further increase, particularly of long-term funding. Bank debt already makes up a significant portion of insurers’ portfolios,” he said.

(The Implications of Financial Regulatory Reform for the Insurance Industry – IIF, www.iif.com)

David Keefe (dkeefe@globalriskregulator.com)