The Evolving Regulatory Landscape for Actuaries

The Evolving Regulatory Landscape for Actuaries

Regulation takes centre stage

With multiple new accounting standards and regulations introduced in recent years, the focus for insurers’ finance departments has been firmly on implementing new requirements – much of which represents some of the most significant overhauls in insurance accounting for years.

With the delayed go-live date having arrived for many countries in 2023, IFRS 17 has long been front of mind for most finance departments. For a number of insurers, this may be the first opportunity they have had to see movement breakdowns in their IFRS 17 disclosures, and much work has gone into understanding those movements and tweaking disclosures where necessary to present auditors and other key stakeholders with the right picture.

The implementation deadline for accountancy standard ASU 2018-12, more commonly known as LDTI (Long-Duration Targeted Improvements), also arrived in January 2023.

Issued by the Financial Accounting Standards Board (FASB) in August 2018, LDTI defines new regulatory requirements for certain long-duration insurance products – demanding greater integration of finance and actuarial teams’ processes and systems; and introducing additional complexity in reporting.

The implementation deadline for these two major new accountancy standards came just as the UK Government has opted to press ahead with significant and highly technical changes to the in-force UK Solvency II regime, after many months of negotiations.

With such complexity across so many new rules, the additional burden for some carriers of the Insurance Capital Standard (ICS) will be particularly challenging. Announced in 2013 in response to the Great Financial Crisis of 2007-09, the ultimate goal of the ICS is to establish a single standard that includes a common methodology that produces comparable outcomes across jurisdictions.

The public consultation on the ICS as a prescribed capital requirement (PCR) closed in September 2023, marking the beginning of the International Association of Insurance Supervisors’ (IAIS) final assessment of the economic impact of the standard. Scheduled to take effect by the end of this year, the standard is expected to be the most significant regulatory development for global insurers in 2024.

During the ten years of its development, implementation approaches and timetables have come to vary across global markets.

K-ICS is expected to reshape insurers’ operational strategies significantly...

In South Korea, for instance, a modified version of the ICS, K-ICS, went live in January 2023, affecting South Korean insurers’ solvency strength to varying degrees depending on their capital structures and risk profiles. At its core, K-ICS strives to ensure that insurance companies maintain robust capital reserves, effectively protecting policyholders and aligning their risk profiles with the country’s dynamic economic landscape. In contrast to the previous risk-based capital regime in South Korea, K-ICS stands out distinctly. Firstly, it mandates insurers to adopt marked-to-market valuations for both assets and liabilities, marking a fundamental shift that ensures a more authentic assessment of insurers’ financial positions. Secondly, K-ICS introduces increased granularity by encompassing risk categories omitted in the previous regime, including longevity, surrender, expense and catastrophe risks. Additionally, it tightens the confidence level used to calibrate the regulatory capital regime, raising it from 99% to 99.5%.

K-ICS is expected to reshape insurers’ operational strategies significantly, but, according to the local regulator, the Financial Services Commission (FSC), 12 life insurers, 6 nonlife and one reinsurer had applied the transitional measures as of end-March 2023. The remaining 34 insurers there are understood to be in the process of full adoption.

Meanwhile in Japan, the concept of risk-based capital is not new there, but its new J-ICS regime introduces new regulatory capital rules based on economic value – the Economic value-based Solvency Ratio (ESR). This is in contrast to the existing solvency regime which relies on a locked-in approach to assess liability – posing limitations on liability evaluation and producing a solvency ratio that is constrained in its ability to comprehensively assess risk, and hindering carriers’ understanding of their risk positions.

The introduction of the new solvency regime brings with it a more nuanced risk assessment approach involving a thorough clarification of each risk – prompting insurance companies to develop and implement their own tailored risk strategies. It is anticipated that the FSA will introduce the new regime from FY 2025, with first disclosures expected in March 2026.

The combination of these new pressures ultimately leaves actuaries doing more with less – regardless of the sophistication of their approach to technology. This is likely to be the case for the near term, as they process, understand and explain the results, particularly under Solvency II and IFRS 17.

Navigating the Latin American regulatory environment for growth

Growth in the Latin American insurance market has been on a steady upwards trajectory, and the region still has tremendous potential – and navigating the regulatory environment will be critical for its continued success.

As the largest economy in the region, Brazil is an attractive proposition for insurers looking to expand their market presence – but to do so they face a highly complex regulatory environment – particularly for foreign insurers operating in the country. Foreign insurers must set up a local presence to operate in Brazil, which can be time-consuming and involves significant investment; while Brazilian insurance companies must meet stringent capital and solvency requirements, which can limit their ability to expand.

Regulators in the country also have strict rules related to market conduct, which can create additional compliance burdens. Intermediaries, meanwhile, face further regulatory hurdles, making it challenging for insurers to effectively manage distribution channels.

Adapting to complex and constantly evolving regulatory requirements while still maintaining profitability is a significant challenge for the industry. It should also be noted that many insurance companies in Brazil still rely on outdated technology and legacy systems, which can make difficult work of implementing new regulations and compliance requirements.

As the second largest economy in the region at present, Mexico represents a significant opportunity for insurers that are able to tackle a number of unique regulatory barriers to operate successfully in the market, amongst them restrictions on foreign ownership. Insurance companies

operating in Mexico must be majority-owned by local stakeholders under the rules there – limiting the ability of foreign insurance companies to establish wholly-owned subsidiaries in the country.

Mexican regulators have implemented a risk-based approach to insurance regulation that places an emphasis on corporate governance, risk management and internal control systems, enforcing enhanced corporate governance structures for insurance entities in the country.

Further, insurance products in Mexico are primarily sold through traditional distribution channels, such as brokers and agents, and are subject to strict regulatory requirements.

Unsurprisingly, the regulations for IFRS 17, and Solvency II in Latin America differ from country to country...

Stringent product registration requirements present another major hurdle for carriers, which need to be registered and approved by the National Insurance and Bonding Commission (CNSF).

Unsurprisingly, the regulations for IFRS 17 (known as NIIF 17 in the region), and Solvency II in Latin America differ from country to country, and insurers operating within Latin America must understand the regulations and standards that apply in each country they operate in and ensure compliance with them. Whilst Brazil and Mexico have already implemented IFRS 17, Argentina and Chile have delayed their adoption, and Peru is expected to implement it soon.

Several countries in Latin America have also introduced reforms to their insurance industry infrastructure to promote competition, including the introduction of digital platforms for insurance distribution. Efforts to ease restrictions on remote insurance sales, encouraging adoption of electronic signatures, and supporting the use of digital identity verification continues the digital transformation that was accelerated globally during the Covid-19 pandemic, with measures introduced by regulators to support these efforts. And there’s more to come, as the wave of technological innovation – from artificial intelligence to blockchain and analytics –promises to significantly impact insurers in the region, and those insurers that are ready to take on this dual challenge of regulation and digitisation will benefit profoundly.

Inflation

The recent, rapid transition from a period of low inflation to a new macroeconomic environment has ramifications for capital levels and liquidity positions, and profitability, with long-term portfolios exhibiting a particular sensitivity. Concerns about rampant inflation led the UK’s Institute and Faculty of Actuaries (IFoA) to issue a Risk Alert in Q3 2022 to its members on the impact on actuarial practice – particularly amongst general insurance actuaries, who are used to a low inflation environment and may need to make significant adjustments; the larger the gap between the claim duration and the supporting asset maturities, the larger the inflation-related risk.

The IFoA’s alert advised general insurance reserving actuaries to take new market conditions into account when advising those making decisions on reserves, including careful consideration of whether the processes, assumptions and methodologies in place continue to be suitable; and appropriately documenting any work that considers inflation.

General insurance actuaries may be less familiar with inflation and coping with this than other areas...

“The reserves constructed by general insurance companies often use variations of chain-ladder methods through the evolution of case reserves and payment streams, leading to the estimate of the total ultimate claim amounts and corresponding reserves,” it said. “Given the high inflation coming through on specific components of claims costs reaching double figures, there is a risk to the adequacy of both actuarial reserves and the underlying case estimates. General insurance actuaries may be less familiar with inflation and coping with this than other areas that focus on many longer-term outlooks.”

Pensions and life actuaries are meanwhile faced with increased challenges in managing investments or hedging strategies for inflation-linked liabilities, IFoA warned: “There may be an enhanced risk where actuaries cannot match underlying liabilities with a suitable asset or choose to adopt ‘delta-hedging’ as an approximate matching technique. Both higher levels of inflation, and possible increased volatility, may mean that monitoring and re-balancing become expensive or problematic.”

A separate study conducted by The European Insurance and Occupational Pensions Authority (EIOPA) considered in depth the effects that higher-than-expected inflation has so far had on insurers in the bloc, assessing potential future risks and vulnerabilities.

It found that, over the 12 months to October 2023, while European insurers’ assets over liabilities had trended down, they generally continued to be well capitalised. With respect to the technical provisions, though, inflation had negatively impacted non-life insurers as the cost of claims and expenses increased. And that, although life insurers have been less exposed due to the nominal nature of their liabilities, a weakened ability of potential customers to save may result in lower new business and higher lapse rates in a persistently high inflationary environment.

“A crucial question for insurers going forward is to what extent the positive effect of higher interest rates will compensate the negative effect of higher inflation,” the association noted. “EIOPA’s sensitivity analysis points to net positive results for undertakings with long-term liabilities and negative duration gaps such as life insurers. However, the erosion in the real value of payments and higher interest rates might lead to higher lapse rates and a decrease in new business. Non-life undertakings, on the other hand, are forecast not to benefit enough solely from higher rates to counterbalance the negative effects of inflation. Furthermore, the longer the inflationary environment lasts, the more impacted are both life and non-life of business.”

Significant changes to insurance accounting and capital adequacy standards make for a completely different operating landscape...

Beyond Implementation

Combined with industry-wide digital transformation, these many and significant changes to insurance accounting and capital adequacy standards make for a completely different operating landscape for the industry – compared even to just Combined with industry-wide digital transformation, these many and significant changes to insurance accounting and capital adequacy standards make for a completely different operating landscape for the industry – compared even to just a few years ago.

For territories such as EMEA, which have had the upheaval in capital requirements of Solvency II, and now a similar overhaul for income reporting of IFRS 17 and IFRS 9, the next few years may offer some much-needed respite.

However, many other global markets have yet to fully adopt their equivalent of Solvency II with some either doing so in parallel with IFRS 17 or shortly after. Those markets still have several busy years ahead of them before things settle.

Doing more in less time has been a theme in the regulatory sphere over recent years. Companies with better solutions, offering more automation and faster turnarounds will still be at an advantage but there will still be plenty of work to keep everyone busy over the short term.

Looking further ahead, as insurers get a few cycles of IFRS

17 and LDTI reporting under their belts, it is easy to imagine regulators and investors looking to tweak the frameworks to bring in further comparability. The size, scope and timing of such revisions will depend on how much comparability is achieved by the regulations as they are currently written.

All of this change is taking place amid ongoing global economic turmoil and market volatility which are placing considerable stress on capital management teams, presenting CFOs with yet another challenge as extra capital monitoring must be in place to ensure ongoing solvency.

Meanwhile, ESG risks introduce additional uncertainty, something insurers will need to factor in to ensure continued profitability and stable shareholder returns moving forward. Actuarial methods will need to evolve to adapt to novel risk realities, as actuaries begin treating climate change as a primary risk; support firms in creating new products based on changed market needs; and curb underwriting risk. Taking an early and proactive stance on all these factors will better position insurers for the long-term.