[IMPACT+: This series features IMPACT articles that take a longer look at vital financial topics that affect Americans. A version of this article also appeared on InsuranceERM]
The International Association of Insurance Supervisors (IAIS) is approaching a deadline to adopt the Insurance Capital Standard (ICS) and conclude that the Aggregation Method (AM), which was created by the United States, provides comparable outcomes to the ICS. After a decade of hard work and good faith negotiations by all parties, it is time for regulators to close this chapter and move on to new regulatory challenges, secure in the knowledge that they have collectively enhanced insurance group supervision and solvency standards.
Yet supervisors have still not reached an agreement on whether the IAIS should recognize the AM as “comparable” to the ICS. The IAIS defined “comparable outcomes” to mean the AM would “produce similar, but not necessarily identical, results over time that trigger supervisory action on group capital adequacy grounds.”
This overarching definition provides a roadmap on how to get to a result that respects systems that are conceptually distinct but achieve the same outcomes – enhanced solvency standards for internationally active insurance groups. This is especially true when one is evaluating two measures that are as fundamentally different as the ICS, which is similar to Solvency II, and the AM, which leverages local solvency regimes, like the National Association of Insurance Commissioners’ (NAIC) Principles Based Reserving (PBR), Risk Based Capital (RBC), and Statutory Accounting Principles (SAP).
In 2019, the IAIS agreed the criteria for the comparability assessment should not automatically preclude the AM from achieving comparability, nor should it get a “free pass.” That guiding principle has been put in question by the creation of detailed comparability criteria that overemphasizes quantitative similarity at the expense of a more holistic, outcomes-based approach.
This push for quantitative similarity is complicating negotiations. Here’s why: the ICS uses a market-consistent valuation. The AM, which will be implemented in the U.S. through the GCC, the NAIC’s group capital calculation, uses a cost-amortization method of valuation for assets and liabilities. Because of differences between cost-amortization valuation and market-consistent valuation, the AM and ICS may not always respond to certain market movements or interest rate fluctuations in the same way. This is especially true when an insurer’s portfolio consists of long-term liabilities and long-term assets.
Adopting a market-consistent valuation approach is not an option in the United States. The United States has been clear about that. After considering the risks and activities of the U.S. insurance market and the need for insurers to continue to play a “substantial role in facilitating their customers’ long-term financial planning,” the Federal Reserve announced its adoption of an aggregation-based group capital approach for Fed-supervised insurers. The NAIC has also been clear that a market-consistent valuation approach was not appropriate for the United States because of its potential to unduly penalize long-term products.
When evaluating the comparability of the ICS and AM, it’s important to consider how the AM will work in practice. From the U.S. perspective, stability is an intended strength of the U.S. system, not a flaw. While the U.S. regulatory system is dynamic and has evolved over time to protect consumers, it has also developed to appropriately reflect the nature of long-duration insurance liabilities in the United States. A cost-amortization method provides a stable solvency framework that incentivizes life insurers to match long-term liabilities with prudent, long-term investments. U.S. life insurers must look beyond the short-term returns to ensure they can honor their promises to customers far into the future.
At the same time, the need for stability doesn’t trump the need for regulators to have an accurate presentation of solvency amid shifting market movements. Interest Maintenance Reserve (IMR) and Asset Valuation Reserve (AVR) were developed by the NAIC to ensure regulators have a clear view of solvency amid fluctuations in interest rates and credit losses. IMR and AVR are implicitly included in the AM because they are required components of U.S. statutory accounting.
Additionally, Asset Adequacy Testing requires life insurers to determine whether reserves and the assets supporting those reserves are adequate under moderately adverse conditions, encompassing a range of economic scenarios. This analysis is filed alongside the AM (GCC), providing regulators with a comprehensive view of the company’s financial strength. With these essential tools in place, it is evident that in addition to being “comparable” to the ICS, the AM has already been integrated into a comprehensive solvency framework that, like most frameworks, employs a variety of resources to ensure solvency.
After 10 years of work, global regulators need to come together, adopt the ICS, deem the AM comparable to the ICS, and then celebrate all they have done to enhance global group supervision.
As the ICS moves to the implementation phase, different jurisdictions will adopt what works for their respective markets. In the EU, internationally active insurance groups will likely seek to use bespoke internal capital models that do not use the ICS. The United States will implement through the NAIC’s GCC and Federal Reserve’s Building Blocks Approach. What matters most is that enhanced group capital standards have been adopted globally and consumers are better off for it. The outcome is what counts – not whether it’s done through the ICS, an internal model, or the AM. That is a job well done by global supervisors.
Mariana Gomez-Vock is Senior Vice President, Prudential Policy & International. In her role, Mariana provides strategic guidance and oversight of a variety of public policy issues, with a special focus on financial regulatory issues. Her leadership and subject matter expertise were critical as ACLI worked to achieve group capital calculations at the state, federal and international level that preserved life insurers’ ability to provide American families with long-term financial protection and retirement security products.
