[Satwik is a student at National Law University Odisha.]
In 2010, the Financial Stability Board (FSB) recommended the International Association of Insurance Supervisors (IAIS) to identify insurers that were “too big to fail” and whose failure would result in massive disruption of the economy. Thereafter, insurers like American International Group, Allianz SE, and some other insurers were categorized as Global Systemically Important Insurers (G-SIIs) by the IAIS. The categorization was done based on their size, interconnectedness, and Non-Traditional Insurance and Non-Insurance (NTNI) activities, which include leverage and liquidity transformations and Credit Default Swaps.
The idea behind GSIIs is to identify insurers that are susceptible to systemic risks and to mitigate any risks and distress involved in the event of their failure. For this, the IAIS has put in place a Holistic Framework for Systemic Risks in the Insurance Sector. Additionally, IAIS recommended all the member countries lay down regulatory further frameworks for Domestic Systemically Important Insurers (D-SIIs). The classification of D-SIIs was to be done based on their size, interconnectedness, importance, and numerous other factors.
The Insurance Regulatory and Development Authority of India (IRDAI) has recently designated three insurance institutions as D-SIIs. However, there is a lack of a framework to regulate and identify the D-SIIs in India. The author discusses several approaches taken by IAIS and IRDAI, argues in favour of the need to have a regulatory framework for D-SIIs and further suggests reforms.
Approach Taken by IAIS for Identification of G-SIIs
The IAIS first introduced policy measures for G-SIIs in 2013. These measures laid out individual indicators, some of which included size, connectedness, NTNI activities, and substitutability. The assessment methodology employed by IAIS was to assess the insurer institutions on each indicator and reach a final score. These measures also included supervision, resolvability, loss absorption mechanisms, and liquidity planning. However, these measures were revised in 2016. This revision was done to increase the transparency of the process and further maintain uniformity of evaluation among insurers.
The revised measures focused on qualitative and quantitative assessments of insurers, as each differed from the other in terms of size, structure, and risk exposure. Furthermore, the 2016 policy measures revised the existing indicators. Moreover, the revised measures introduced various phases of the assessment process, which involved data collection annually, quality control, and the collection of additional data for assessment. However, this measure was discontinued in 2019, and IAIS introduced a holistic framework for assessing G-SIIs.
The introduction of the framework was done because of the changed approach of IAIS in examining and mitigating the risks associated with insurers. The policy measures were based on the theory that systemic risks will arise not only from individual insurers but also from the disruptions faced by the insurers collectively at a sector-wide level.
The new holistic approach of IAIS included advancements vis-à-vis supervision and monitoring exercises. This framework allows enhanced supervision of insurance institutions and intervention policies utilizing the Insurance Core Principles and Common Frame for insurance institutions that are active internationally. These are supervisory materials that further enhance the supervision of insurers, regardless of the jurisdiction and level of sophistication involved in the insurance market. Moreover, the holistic framework can be tapered to fit the needs of a particular jurisdiction to align with the legal structure and the financial markets.
Measures Undertaken by IRDAI
As of March 2023, IRDAI has designated three insurance institutions as D-SIIs, namely, Life Insurance Corporation of India, General Insurance Corporation of India, and New India Assurance Company. This decision was taken owing to interconnectedness, size, and complexity of the insurers. Furthermore, IRDA stated that these insurers have to raise their level of corporate governance, flag risks, and execute sound risk management. Additionally, IRDAI stated in a circular that D-SIIs have to submit a peer-reviewed report and carry out asset liability management and stress testing as part of the information needed for annual actuarial valuation.
The IRDAI constituted a 6-member committee in 2019 to establish a supervisory regulatory framework. However, there has been no structured framework for the identification and regulation of D-SIIs in India till now.
Cause for Concern
India needs a regulatory framework to counter the various challenges it faces, like inadequate capital, lack of regulation and supervision, maintaining solvency margin, etc. There is a need for substantial supervision, enhanced monitoring, and a proper timeline for implementation. While designating D-SIIs there needs to be an in-depth analysis and thorough collection of data. Additionally, there is a need for separate assessment techniques for life insurance and general insurers owing to the differences between their coverage, duration, etc.
Moreover, the assessment should be done not only based on indicators like size, complexity, interconnectedness, and market importance, as has been done by IRDAI, but also basis new indicators such as emerging risk trends, behaviour of policyholders, underwriting, and solvency. This will further result in a comprehensive collection of data and assist in identification of D-SIIs. Moreover, these indicators are in line with the holistic framework introduced by IAIS. Furthermore, the IRDAI circular designating D-SIIs states that the D-SIIs will have enhanced supervision. However, there is a lack of clarity on exactly what these enhanced supervisions are.
The D-SIIs are considered “too big to fail.” This notion fuels the impression that these insurers will have government backing during times of distress. This is also known as capital injection. However, this very expectation gives rise to numerous risks, such as a reduction in market discipline and competitive distortion. These further substantiate the need for a framework to regulate the identification and functioning of D-SIIs to deal with systemic risk or moral hazard issues. Additionally, this was also one of the reasons why the Reserve Bank of India put in place a framework for Domestic Systemically Important Banks (D-SIBs).
The rising interconnectedness of the insurers and their links to other important financial institutions is another cause for concern. In the event of the failure of one insurer, the functioning of several insurers will be affected. Additionally, the failure of an insurer would have wide ramifications if certain critical services performed by it cannot be substituted by another insurer.
The complexity of the insuring institutions further warrants a well-established framework. The higher the complexity, the more time and resources are consumed to resolve the issue. Having a framework can help establish a proper set of procedures to be followed in the event of such problems.
Furthermore, the International Monetary Fund has stated in its report that India faces issues with respect to a risk-based framework. This is a cause for concern, as a lack of a risk-based framework hinders the proper assessment of risks. Additionally, the implementation of a proper risk assessment framework will further complement risk management.
The COVID-19 pandemic had an enormous impact on all sectors. This impact was felt in the insurance sector as it raised both short and long-term challenges. From operational challenges to dips in revenue and depleting reserves, insurers had to attend to various concerns such as business continuity, crisis management, capital adequacy, etc. To counter these unprecedented impacts, there needs to be a framework or a plan that ensures the proper functioning of insurers, especially D-SIIs, which are “too big to fail.”
Suggested Reforms
There needs to be a regulatory framework in place that incorporates indicators that assess risks that arise not only from individual insurers but also from all insurers collectively. Additionally, there should be proper data collection at multiple levels and an adequate observation period before any decisions are made.
Moreover, a Systemic Risk Management Plan (SRM) should be in place. The SRM plan will specifically address the assessment, mitigation, and neutralization of the risks. Furthermore, such a plan should set out all measures in a structured manner, like higher loss absorption and improved resolutions. Better and more effective resolutions guarantee that there are no major disruptions and ensure the absorption of losses by creditors in the event of liquidation. A well-established resolution avoids the waste of time and resources.
Currently, Financial Service Providers (FSP) do not fall under the ambit of the insolvency regime in India, i.e., the Insolvency and Bankruptcy Code 2016 (the Code). However, the Central Government can notify certain FSPs, in consultation with their regulatory authority, to be resolved under the Code. Alternatively, there can be a separate insolvency mechanism for insurers and other FSPs instead of resolving them under the general insolvency law. In both scenarios, the intent will be to have the best possible resolution for insurers. However, the technicalities might differ.
India can follow the footsteps of Singapore while designing a framework for D-SIIs. The Monetary Authority of Singapore (MAS) has recently released a consultation paper that lays down the guidelines for D-SIIs. The proposed framework is in accordance with the IAIS recommendations. Additionally, MAS has also proposed a two-year observation period wherein they will collect the data of the insurers before designating them as D-SIIs. This provides adequate time for decision-making.
It is pertinent to note that Singapore has a specific framework for financial institutions and the banking sector that helps them identify D-SIBs. MAS has aligned the proposed framework for D-SIIs with the already existing framework for D-SIBs wherever needed. The IRDAI can follow the approach taken by the MAS and structure the D-SII framework around the existing framework of D-SIBs, which are in line with the Basel Committee recommendations, appropriately. Moreover, framework should be reviewed periodically to ensure that they are up to global standards and take into consideration sector-wide development.
Conclusion
The closeness of insurance institutions to banks and the real economy warrants intensive supervision of these institutions, which would further strengthen the financial infrastructure of the country. Implementation of a proper framework will assist in comparability and decrease disparity among insurers in different jurisdictions. Additionally, with the addition of regulatory measures, the insurers and the regulatory authorities will be better prepared to handle any unprecedented risk that might arise and further prevent any disorderly failure and its impact on the real economy.