Solvência e Avaliação Econômica

Prévia do material em texto

How do We Square the Circle between Accounting and
Solvency?
Jacques Aigrain
Swiss Re, Mythenquai 50/60, Zurich 8022, Switzerland.
E-mail: esther_baur@swissre.com
The paper makes a clear case for economic valuation. Whether it is companies’ internal
models, rating agencies, regulators or standard-setting organisations, differing stakeholder
views on the required and available capital are converging towards economic and risk-
based capital and valuation models. Even though the measurement of insurance liabilities
on a fair value basis remains a challenge, there seems to be no viable alternative at this
point. Economic valuation will help foster innovation and advance the search for the most
efficient risk transfer mechanisms, regardless of their form. Solvency II not only contains a
clear commitment to economic valuation. It also effectively addresses some key issues
highlighted by the current financial market crisis. Consequently, it should be implemented
in the European Union without delay. Full credit should be given for diversification effects
on a global scale, which will strengthen the motivation to actively manage portfolio
diversification and will encourage stronger risk management.
The Geneva Papers (2009) 34, 42–46. doi:10.1057/gpp.2008.38
Keywords: solvency; economic valuation; insurance regulation; accounting; fair value
Introduction
Insurance supervision and accounting standards need to be brought to the next level
on a global scale. In our industry, concerns about transparency, complexity and
performance are common, and the credit crisis has uncovered a number of challenges,
particularly in the field of accounting.
The proposed Solvency II Framework Directive in Europe and the International
Accounting Standards Board (IASB) work on International Financial Reporting
Standards (IFRS) Phase II for insurance provides an opportunity to address the key
issues by better reflecting economic realities and the market-consistent valuation of
assets and liabilities in insurance accounts. With Solvency II, Europe has a great
opportunity to take the lead in insurance supervision with capital requirements based
on economic principles. In the United States, where insurance supervision is very
fragmented, the industry has been advocating to modernise the overall regulatory
framework.
Europe set to lead the world in insurance supervision
The European Commission released the draft Solvency II framework in July 2007, and
the proposed directive now has to pass through the European Parliament and
The Geneva Papers, 2009, 34, (42–46)
r 2009 The International Association for the Study of Insurance Economics 1018-5895/09
www.palgrave-journals.com/gpp/
European Union (EU) Council of Ministers. When Solvency II comes into force in or
after 2012, the EU will operate with the most modern (re)insurance regulatory
standards in the world, because it will be based on economic principles and an all-risk
approach. It is hoped that the spirit of the framework will not be sacrificed in the
interest of particular interests in the political debate or the current turbulence in the
financial markets. First results of QIS 4, the quantitative impact study on Solvency II
carried out earlier this year, demonstrate that it is a sound framework for the
insurance industry – one that will hold even under extreme scenarios. In fact, Solvency
II is expected to deliver appropriate solutions for many of the issues identified in the
context of the credit crisis. Open issues and detailed implementation measures should
therefore be resolved in the spirit of the fundamental principles.
Solvency II addresses key regulatory issues
Solvency II will dominate the European insurance agenda over the next few years, and
it has already had an impact on the risk culture in the industry. Each pillar of the
Solvency II framework contributes to improve the risk culture. Pillar I emphasises risk
and economic-based solvency requirements. It is based on economic principles and will
bring a better understanding of the actual risks an insurance company is facing. For
the first time, all the risks that an insurance company faces are expected to be
consistently quantifiable, providing an overview and the ability to assess dependencies
and diversification effects. Solvency II should make the risk distribution among
primary insurers, reinsurers and capital markets more efficient because all risk
transfer solutions would be accepted independent of the legal outline. This is because,
from an economic viewpoint, they all entail a reduction in risk and therefore allow for
a reduction in required solvency capital. An important factor for an adequate
definition of solvency capital requirements is the recognition of diversification on a
global scale.
The current debate focuses strongly on the quantitative aspects of Pillar I.
Nevertheless, the principles for insurers’ internal control and risk management and the
strong supervision rights granted to regulators under Pillar II to review internal
governance and control mechanisms, particularly for European groups, and the focus
on transparency and disclosure under Pillar III are equally important components of
the overall framework. As a result, Solvency II will bring more transparency to
shareholders and better protection for policyholders.
Many of the recent technical issues observed in the banking context, such as
Group supervision and the valuation of assets and liabilities, are already being
addressed in the Solvency II debate, and the technical details are being discussed
in the Chief Risk Officers Forum or Chief Financial Officers Forum.
Views on capital will converge
The IASB issued a discussion paper on accounting for insurance contracts under
Phase II in 2007. Comments and contentious issues are currently being debated within
Jacques Aigrain
How do We Square the Circle between Accounting and Solvency?
43
the IASB. Most commentators have expressed the view that IFRS Phase II and
Solvency II should be based on the same recognition principles to permit
reconciliation between the models. The Solvency II valuation rules are conceptually
in line with IFRS Phase II and some synergies remain in the planned timetables.
Efforts to develop reconcilable approaches between financial and regulatory reporting
would not only increase credibility that the industry’s accounts reflect true economic
realities, but also represent a significant cost saving for the industry. However, it must
be borne in mind that financial reporting and regulatory reporting, such as Solvency
II, have different objectives and address different stakeholders’ needs.
IFRS is a measure of performance over a given period focusing on a going concern
scenario, whereas Solvency II focuses on the balance sheet in order to determine the
available prudential buffer to protect policyholders from an insurer’s insolvency.
Both frameworks are conceptually based on the same principles to determine the
economic value of assets and liabilities of an insurance company. There are a number
of key issues that need to be resolved, however, to align the two frameworks to a
greater extent. One critical area is around the IASB proposal to use a current exit price
model. Given that insurance companies typically do not transfer their insurance
liabilities but rather hold them to satisfy valid policyholder claims, many industry
representatives have been arguing to allow for entity specific inputs where market
prices are not available. This is also true in the area of policyholder behaviour, relative
cost efficiency and diversification, which are other areas of focus.
Adjustments to the calculation of own funds are likely to be required for solvency
purposes to reflect the run-off characteristics of funds available to policyholders after
a distressed situation. It is essential to ensure that any adjustments are easily
reconcilable. Accordingly, the frameworks must be based on the same building blocks
enabling both systems to retrieve relevant data fortheir purposes.
Solvency II and IFRS: economic valuation of insurance liabilities as a common
challenge
A key challenge for both IFRS and Solvency II has been the measurement of insurance
liabilities. In the insurance industry, views about valuing insurance liabilities are not
aligned around the world. Discounting of reserves and the discount rate to be used, for
example, have been a heatedly debated topic in the industry for many years. The IASB
and the EU commission appear to agree on a consistent approach for discounting life
and non-life reserves. Whereas in Solvency II there appears to be agreement in
principle that technical provisions are to be calculated by a best estimate plus risk
margin (MVM) calculated using the cost of capital approach, the IASB is still in the
process of developing methods to estimate insurance liabilities for financial reporting
purposes. Others – for example, some U.S. companies – support separate models for
accounting purposes, partly because current generally accepted accounting principles
(GAAP) in the United States has separate models and partly because of different views
on the discounting of reserves for non-life and life insurance.
The valuation of insurance liabilities on a fair value basis, where the value is
determined by the price for which a liability can be transferred to another market
The Geneva Papers on Risk and Insurance — Issues and Practice
44
participant, is difficult because insurance liabilities are typically not traded and there
are rarely observable market transactions.
The recent financial market turmoil highlighted the challenge of using market value
input for the valuation of many financial instruments, when markets are illiquid.
Illiquid or near-illiquid markets continue to make it difficult to arrive at reliable model
estimates. The IASB, at the direction of the Financial Stability Forum, has formed an
advisory panel to provide guidance on valuing financial instruments when markets are
illiquid. The Institute of International Finance has proposed a high-level dialogue to
address concerns about the extent to which current interpretations of mark-to-market
requirements may contribute to market uncertainty. Despite the challenges of applying
fair value to financial instruments in illiquid markets, there seems to be no viable
alternative at this point.
The implementation of a current exit price model under the current IASB proposal
would inevitably lead to so-called fair value measurement of assets and liabilities under
Solvency II. If we believe that the regulatory framework for economic models should
be based on fair value, we must be ready to accept the consequences of fair value
accounting. Therefore, the industry needs to work closely together with standard-
setting organisations and regulatory authorities to find a pragmatic solution on how to
deal with mark-to-market and mark-to-model accounting issues for insurance
liabilities, where market prices are typically not available.
Conclusions and outlook
There is no doubt about the direction of future insurance regulation and reporting.
Whether it is companies’ internal models, rating agencies, regulators or standard-
setting organisations, differing stakeholder views on the required and available capital
are converging towards economic and risk-based capital and valuation models. This
approach is necessary to provide sufficiently relevant and reliable information on the
financial position of an insurer or reinsurer, and it ensures consistency with the
measurement of traded financial market instruments. All these efforts should
acknowledge that financial strength should be measured with (internal) economic
risk-based models, that diversification benefits should be recognised, and that
economic capital relief should be granted for effective risk mitigation. We have seen
encouraging progress in this area with Solvency II.
The upcoming EU Directive will enhance the risk culture of the industry and lead to
a more rational and transparent marketplace. Solvency II effectively addresses some
key issues highlighted by the current financial market crisis. Consequently, it should
be implemented in the EU without delay. While the IASB is also moving towards a
more economic valuation of liabilities, the current proposal does not yet reflect the
underlying economic view of insurance contracts in certain aspects.
Harmonisation and mutual recognition of regulatory bodies and global reporting
standards are essential factors in making the market more efficient in terms of both
capital allocation and the costs of compliance. Insurers and reinsurers will be able to
steer their balance sheet management solely on economic considerations. Full credit
should be given for diversification effects on a global scale, which will strengthen the
Jacques Aigrain
How do We Square the Circle between Accounting and Solvency?
45
motivation to actively manage portfolio diversification and will encourage stronger
risk management.
At the same time, the insurance industry needs to highlight the difference to banking
to avoid spillover effects. Insurance is not typically subject to the kind of liquidity risk
that affects banks because the business is funded primarily by premiums received for
providing insurance protection. Pay-outs are triggered by loss events, and not by
policyholders’ will, so there can be no ‘‘run’’ on an insurance company like on a bank.
Further, the insurance industry is not faced with systemic risk and contagion as is the
banking sector, because insurance hazards are typically uncorrelated. We are
witnessing this with the stable performance of cat bonds in the current market
environment. In addition, the duration of (re)insurance liabilities is typically long-term
in nature and does not cause similar short-term re-financing and liquidity issues as has
been seen in the banking sector recently.
Economic valuation will help foster innovation and advance the search for the most
efficient risk transfer mechanisms, regardless of their form, be it in insurance or a
capital market format (e.g. securitisation). Market mechanisms and sound competi-
tion will create a level playing field for all insurers, ultimately delivering benefits to
policyholders, insurance companies and society at large.
About the Author
Jacques Aigrain, a dual Swiss–French citizen born in 1954, received a PhD in
economics in 1981, from the Sorbonne in France and a master’s degree in economics
from Dauphine University. After various positions with JPMorgan, he joined Swiss
Re in 2001 as Head Financial Services Business Group. Following his appointment as
Deputy CEO in summer 2004, he was appointed Chief Executive Officer of Swiss Re,
from 1 January 2006. He is also President of the Board of Directors of The Geneva
Association.
The Geneva Papers on Risk and Insurance — Issues and Practice
46
	How do We Square the Circle between Accounting and Solvency?
	Introduction
	Europe set to lead the world in insurance supervision
	Solvency II addresses key regulatory issues
	Views on capital will converge
	Solvency II and IFRS: economic valuation of insurance liabilities as a common challenge
	Conclusions and outlook