In early September 2020, the RBNZ repeated earlier statements which raised the issue of declining solvency ratios among NZ insurers. To quote RBNZ Deputy Governor and General Manager of Financial Stability, Geoff Bascand,
“Over the years, we have observed a declining trend in solvency margins, that may be illustrative of a key difference in approach between insurers and the prudential regulator. Insurers must balance the need to maintain a sensible level of capital strength against the expectations of investors for a return on investment. Higher levels of capital make for a more resilient insurer, but at the cost of lower return on equity.”
In a speech to the ICNZ he raised the issue of the minimum solvency ratio. Currently insurers are regulated to maintain a ratio of at least 1, although most insurers hold a margin above this. This requirement is a straightforward rule for insurers to follow, but at times can leave insurers unsure of what levels of capital to maintain above this point. How do they balance the needs and expectations of their owners while not running foul of the RBNZ? Based on the quote above, it appears this balance is being tested. In his speech he said that the RBNZ were investigating the potential to include capital trigger points at some level above 1, which would provide further guidance to insurers on what levels of capital the RBNZ deems prudent. This decision is under consideration as the solvency standards are reviewed alongside the Insurance (Prudential Supervision) Act.
“Thought will be given to a more graduated approach where there is more than one level of capital requirement. Using such an approach, the different levels of capital requirement provide trigger points for intervention. The closer the trigger point is to the minimum capital requirement, the greater the level of supervisory intensity or intervention.”
While a graduated approach may give more guidance to insurers on what levels of capital the RBNZ is comfortable with, the result may lead to insurers holding higher levels of capital to maintain a similar margin above any intermediate trigger points, essentially increasing the minimum “acceptable” level of capital.
This note looks at these recent statements, and provides some data to investigate if the RBNZ’s concerns seem valid. We also provide some information regarding insurance regulatory developments in New Zealand.
The Solvency Standards were first introduced in New Zealand in October 2011, with the issuing of separate standards for Life and Non-Life business. Some additional standards were created for unique situations eg AMI after the Canterbury Earthquakes, and for insurers in run-off, however the large majority of insurers in New Zealand will be reporting under the Life or Non-Life solvency standards. The first issues of these standards were amended up until December 2014, before new standards were issued in December 2014. These are the current standards still in use today, with amendments up to November 2018. These amendments have including things like allowing for lease related assets and liabilities under IFRA-16. There have been no major structural changes since the first issue.
Both the Life and Non-Life standards were originally calibrated to a 1 in 200 year probability of sufficiency (with the exception of the Non-Life Catastrophe Risk Capital Charge), which meant that a solvency margin of $0 – where Actual Solvency Capital is equal to the Minimum Solvency Capital – would give the insurer a 99.5% probability of remaining solvent over the year. This is the minimum allowable solvency margin under the legislation, and any margins above this is at the discretion of the insurer. As we will explore in the next section, there is a wide variation in the actual levels of solvency of each insurer, which can be the driven by a number of factors. Both the desired target capital position and the actual capital position can vary significantly between insurers. Issues like an insurer’s risk appetite regarding regulatory intervention, underlying insurance exposures, ability to raise capital or desired financial strength rating will influence them.
A number of reports and reviews into the way the RBNZ regulates the NZ insurance market have recently been commissioned and filed, which outline recommendations for changes to the way the current Solvency Standards should operate. These reviews, combined with the impending introduction of IFRS 17 has prompted the RBNZ to launch a review of these Insurance Solvency Standards. We elaborate on this review below.
The following section looks at historical trends in solvency ratio for a selection of NZ insurers. This selection accounts for approximately 85% of non-life written premium in New Zealand (the balance being written by overseas branches and small insurers/captives). We have collated this information from publicly available financial statements.
The bold dotted black line in Figure 1 shows the weighted average of the selected insurers. This has been broadly stable over the period, with the exception of a jump and reduction across the 2014-2016 years – this was driven by changes to IAG’s solvency ratio over this period, with the amalgamation of AMI and Lumley under one insurer, as well as changes to individual licence conditions.
Figure 2 shows the same data for general insurers only (excluding the health insurers Southern Cross and nib nz). The same commentary applies, with no clear trend apart from the IAG changes seen in 2014-2016.
Figure 3 shows the trend in Health Insurance solvency ratios. The bold black line showing the average of the two is heavily weighted towards Southern Cross. The downwards trend of Southern Cross is interesting, and it is the only non-life insurer which has a clear downwards trend in solvency ratio. Currently it still has the largest solvency ratio, and the largest solvency margin (in $) of all the insurers.
While we found no evidence of a declining trend in solvency ratios for general insurers, below we take a look at the trend in life insurer solvency ratios over the same periods.
The historical view of life insurer solvency positions in NZ is complicated by a number of mergers/sales between insurers – such as the Cigna/One Path and AIA/Sovereign transactions. Despite this the thick black dotted line, showing the weighted average of these insurers, appears relatively stable ranging between 127% and 141%.
Insurers are faced with a challenge from the RBNZ whereas they have to hold a minimum solvency ratio of 100%, but receive no further guidance from the regulator to what level they become concerned.
In our view it is difficult to see a clear trend of a reduction in solvency positions across the insurers we have looked at. However, we note that the RBNZ will have access to a broader source of information and analysis. We believe it’s worth stating that an insurer’s solvency position can fluctuate for a variety of reasons. Indeed, it could be reasonable to expect insurer solvency positions over this period to reduce following the introduction of IPSA and a new regulatory framework. The introduction of IPSA may have led to insurers being initially conservative with their capital positioning, and now with comfort and familiarity are striking fairer balance between policyholder and shareholder interests. In addition the incidence and subsequent settlement of Canterbury earthquake claims has significantly influenced insurers risk profiles and hence minimum solvency capital over this period.
Any additional guidance the RBNZ can provide regarding their expectations will no doubt assist insurers’ boards when considering appropriate levels of capital to hold.
IPSA & Solvency Standard Reviews
The RBNZ has recently announced the relaunch of its review of the Insurance (Prudential Supervision) Act (IPSA) combined with a review of the associated Insurer Solvency Standards.
Since the current standards were issued in 2014, the RBNZ has cited a number of reports/reviews that encourage review. These include;
- The International Monetary Fund’s review of New Zealand’s financial sector. This review recommended closer adherence to the International Association of Insurance Supervisors Insurance Core Principles. Insurance Core Principles 17 (Capital Adequacy) is particularly relevant to solvency and requires, among others, a total balance sheet approach and a graduated approach to supervision.
- The Trowbridge/Scholtens review of the Reserve Bank’s supervision of CBL (in liquidation). This review also recommended a graduated approach to supervision, along with clarified approaches to asset charges and solvency projections.
- A thematic review of the appointed actuary regime for insurers. Among other things, this review recommended certain improvements to insurer financial condition reports (which are empowered by provisions in the solvency standards).
- The publication of new insurance accounting standards (IFRS 17) by the International Accounting Standards Board. These make major changes to the presentation of balance sheets and the determination of capital, so have a direct bearing on solvency.
- A review of the structure and level of registered bank capital requirements.
- The experience of RBNZ supervisors in overseeing the action of the standards.
- Feedback from insurers and other market participants on a wide range of issues.
A series of consultation papers seeking feedback will be released over coming months, with the first consultation papers already being released. Submissions on these are due by 18 February.
Further steps in the consultation process will be:
Consultation will be followed by Cabinet decisions, where required, and drafting of the legislation. The legislative process is expected to occur in the second half of 2023 at the earliest.
The review of Insurance Solvency Standards was launched in October 2020, with a goal of a final standard being issued in late 2023.
These are both important developments for insurers and will shape the prudential regulatory landscape for the next decade or longer. We will follow the consultation closely and provide further updates as they develop. In the meantime if you have any questions please do not hesitate to contact us.
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