Insurance Insights December 2021

As you may be aware, our Global IFRS team recently held a webcast, The pressure is rising – making the most of the limited time until IFRS 17 is effective. 

For many insurers getting ready for IFRS 17, configuration and systems integration testing is taking longer than planned, reflecting the complexities of IFRS 17, and the amendments that have been made to it, and this is delaying their ability to perform end to end dry runs.

How can these pressures be alleviated? How can they accelerate their progress and sense check whether they remain on track, including planning for the audit of their new systems and processes?

Click the link to access the webcast replay. 

On 2 December 2021, the regulator published its next step in the transition towards a new regulatory funding model for the regulation and oversight of the Island’s financial industry.  This model will be implemented from 1 April 2022 and will see an increase of 20% for fees payable to the regulator.  The fee increase is in line with the announcement made by IOM Treasury in the 2020 Budget to reduce the level of financial support the regulator receives from the IOM Government. 

Following the October FATF Plenary and FATF’s publication of latest 4^th round assessments, the Cabinet Office made changes to the AML/CFT Country Lists.  The list are published on the Department of Home Affairs website.  All licenceholders should carry out their own evaluation for any potential impact on their risk assessments and procedures arising from the changes.   In particular, it was highlighted that the USA and South Africa have been removed from List C (Equivalent Jurisdictions).  As a result of several incidences of domestic terrorism in the past 12 months, the USA has been placed on List B(ii) (Jurisdictions that may pose a higher risk of terrorist financing).  Licenceholders with business relationships/customers connected to these jurisdictions have been asked to provide the Authority details of these relationships, highlighting whether any simplified measures have been used (and detailing which measures).  Details are to be provided to aml@iomfsa.im by the end of December 2021.

On 23 November the regulator published its Strategic Plan for 2021-2024 which sets out the Authority’s blueprint for maintaining the Island’s reputation as a well-regulated finance centre. The Authority continues to undertake enhancements to its core regulatory, supervisory and enforcement activities whilst undertaking a programme of innovation to ensure it remains well-placed to support a dynamic industry. 

Following an update to the AML/CFT Handbook in July 2021, the regulator published its latest sector specific guidance note and supplemental information document on 12 November 2021, covering Long Term Insurers.  All appropriate businesses are advised to review the guidance to determine whether any updates are required to their policies and procedures.   

The European Insurance and Occupational Pensions Authority (EIOPA) has published its Risk Dashboard based on Solvency II data from the second quarter of 2021. The results show that insurers’ exposures to macro risks remain at a high level while all other risk categories, such as insurance, profitability and solvency risks, remain at medium levels and are improving. The environmental, social and governance (ESG) related risks, included for the first time in the current Risk Dashboard, are at a medium level.

EIOPA has published updated representative portfolios that will be used for calculation of the volatility adjustments (VA) to the relevant risk-free interest rate term structures for Solvency II. EIOPA will start using these updated representative portfolios for the calculation of the VA and will be published at the beginning of April 2022.

During the 2021 United Nations Climate Change Conference, EIOPA highlighted its commitment to support the insurance and pensions sectors in tackling climate change. Among other activities, EIOPA will also finalize the first European-wide dashboard on the natural catastrophe insurance protection gap in 2022.

EIOPA has published a speech by Fausto Parente, EIOPA Executive Director, regarding the statement on revised delegated act (RTS) on the Key Information Document under the Packaged Retail Investment and Insurance-Based Products (PRIIPs) Regulation.

EIOPA has welcomed the Solvency II proposals of the European Commission (EC) to give mandates to EIOPA for further action on sustainable finance. EIOPA believes that these proposals will contribute positively to a transition into a more sustainable economy and that insurers can facilitate this as part of their role as investors and risk managers.

EIOPA has published an article on the impact of cyber risks on the insurance industry. EIOPA refers to a recent study on COVID-19 and cyber risk in the financial services sector, which revealed that the sector has experienced the largest number of COVID-19-related cyber events of any sector, with insurers one of the three most affected types of financial business.

The International Association of Insurance Supervisors (IAIS) has published a Newsletter, dated October 2021. The Newsletter outlines various news, including the commitment to climate change, launch of a Climate Training Alliance and notification of upcoming Dialogue on opportunities to improve insurability.

The IAIS published a statement in advance of COP26, to confirm its continued commitment to urgently advance work to address risks and opportunities associated with climate change. The IAIS notes that insurers have a key role to play in climate change adaptation and risk mitigation.

Insurance Europe (IE) has responded to a consultation paper conducted by EIOPA on its statement on the supervision of run-off undertakings. Overall, the industry supports the strengthening of expertise on run-off businesses and welcomes EIOPA’s efforts to create a level-playing field with the same quality of standards for the run-off sector, as this will be helpful for the long-term stability and success of this segment of the market.

PRA published the results of the Systematic Risk Survey- 2021 H2. It is a biannual survey that asks market participants about perceived risks to, and their confidence in, the stability of the UK financial system. Following are key observations:

• Confidence in the stability of the UK financial system over the next three years has increased relative to recent surveys.
• The perceived probabilities of a high-impact event in the UK financial system over both the short and medium term have decreased.
• Cyber-attack risk is the most cited risk to the UK financial system, as well as the most challenging risk to manage.
• Geopolitical risk and pandemic risk were the second and third most cited sources of risk to the financial system, respectively.

PRA published technical information for UK insurance firms subject to Solvency II to calculate technical provisions. The information includes risk-free rate term structures, fundamental spreads for the calculation of the matching adjustment and, for each relevant national insurance market, the volatility adjustments. PRA also publish the symmetric adjustment to the equity capital charge (SAECC) that informs insurance firms’ capital calculations.

PRA published a report on Why they are revisiting the Solvency II Matching Adjustment (MA). The report mentions that the current design of MA is insensitive to market signals from changes in credit spreads and might miss some of the risks that insurers face, which in turn could lead to lower policyholder protection. The PRA supports the MA but is concerned that some of the returns treated as a liquidity premium by the MA might instead be compensation for uncertainty around future credit losses and that this component should have greater sensitivity to market signals. This also offers an opportunity to consider the balance between a low and risk-insensitive calibration for retained risks. A Quantitative Impact Study (QIS) tested two exploratory scenarios that explicitly recognize compensation for variability around future credit losses and are more responsive to signals about credit risk. The report added that this QIS data will help them develop future policy options and any changes in this area will be subject to consultation.

PRA published its Climate Adaptation Report 2021 in response to an invitation by the Department for Environment, Food & Rural Affairs (DEFRA) to participate under the third round of the climate change adaptation reporting power. The report sets out the response of the PRA to the risks posed by climate change to its operations and policy functions in two parts:

• Part A of the report examines the risks posed by climate change to PRA regulated firms; the progress they have made in their management of these risks; what the PRA’s response to these risks has been; and the PRA’s supervisory strategy from 2022.
• Part B of the report examines: the relationship between climate change and the Insurance and Banking Regulatory Capital regimes; whether there are gaps that should be addressed; and the PRA’s planned future work in this space.

FCA (Financial Conduct Authority) published its Climate Change Adaptation Report. In this report, FCA set out its assessment of how the financial services industry and listed companies are adapting to climate change. It has set this in a broader context: how FCA as an organization is developing its strategic approach to climate related issues, and how it sees firms and markets evolving to meet new demands and challenges, and transition to net zero.

07 October: QRT S.20.01

Development of the distribution of the claims incurred
EIOPA clarified in Q&A (#2295) that RBNS claims should be reported undiscounted in S.20.01.

12 October: Amortised cost prohibited as valuation approach under S2

EIOPA clarified in Q&A (#1955) that in accordance with Article 9(2) of Commission Delegated Regulation (EU) 2015/35, the valuation of assets follows IFRSs by default, if their valuation requirements are consistent with the valuation approach set out in Article 75 of Directive 2009/138/EC. Where those IFRSs allow for the use of more than one valuation method, insurance and reinsurance undertakings shall only use valuation methods that are consistent with Article 75 of Directive 2009/138/EC. Therefore, the application of the option to use an amortised cost approach is not appropriate.

12 October: Leased assets – use of derogation to recognise assets and liabilities under local GAAP

EIOPA clarified in Q&A (#1953) that in accordance with Article 9 (together with Article 8) of Commission Delegated Regulation (EU) 2015/35, the recognition of assets and liabilities follows IFRSs by default. Undertakings falling under the exception of Article 9(4) may use the accounting requirements they use for preparing their annual or consolidated financial statements, and which are not IFRSs.

12 October: Treatment of interest swaps in SCR

EIOPA clarified in Q&A (#2221) that according to Article 175 of Commission Delegated Regulation (EU) 2015/35 the Spread Risk Sub-Module calculates the capital requirements for spread risk on Bonds and Loans, Securitisations and Credit Derivatives. Therefore, an interest rate derivative should not be included in the Spread Risk Sub-Module.

It also added that according to Article 189(2)(f) “derivatives other than credit derivatives covered in the spread risk sub-module" are in the scope of the type 1 counterparty default risk sub-module. Therefore, an interest rate swap is in the scope of the type 1 counterparty default risk sub-module.

15 October: Risk margin excluded in calculation of currency risk SCR module

EIOPA clarified in Q&A (#2179) that the risk margin should not be included in the calculation of the capital requirement for currency risk. This is in line with Article 83(1)(a) of Commission Delegated deemed to be backing the technical provisions, which are not denominated in the local currency or in the Group currency must be included in the calculation of the capital requirement for currency risk.

19 October: Per policy expense within mass lapse risk SCR

EIOPA clarified in Q&A (#1837) that this question has been rejected because the matter it refers to has been answered in Q&A (#1678), which remains valid. Using the assumption of constant per policy expense for determining the capital requirements for mass lapse risk may in many cases be too optimistic with respect to the possibility to reduce costs. Also, the reason behind the retained correlation factor depends on the legislator intention.

21 October: Per policy expense within mass lapse risk SCR

EIOPA clarified in Q&A (#2039) that this question has been rejected because the matter it refers to has been answered in Q&A (#1678), which remains valid. Article 75 requires market consistent valuation for assets and liabilities, and assumptions on best estimate valuation, including expenses, to be consistent with the characteristics of the portfolio of insurance and reinsurance obligations. However, market data may not be available or not properly reflect the characteristics of the portfolio. For this reason, undertakings should use undertaking specific data where the calculation of technical provisions in a prudent, reliable, and objective manner without that information is not possible. As the stress scenario includes situations where many undertakings would be affected by a deterioration in their economies of scale, market consistency is not contradicted.

21 October: Per policy expense within mass lapse risk SCR

EIOPA clarified in Q&A (#1990) that this question has been rejected because the matter it refers to has been answered in Q&A (#1678), which remains valid. The non-linearity of the dependency is considered in the calibration as per EIOPA Advice. Also, the answer to Q&A 1678 said that the capital requirement for mass lapse risk should reflect the adjustments after the mass lapse event that the insurer would have to make to the expense component of the cash flow projection in the best estimate calculation.

25 October: Life-expense risk sub-module

EIOPA clarified in Q&A (#1995) that Article 140 of the Delegated Regulation requires that the amount of expenses taken into account in the calculation of technical provisions is stressed by 10%. Therefore, all expenses incurred in servicing insurance and reinsurance obligations should be stressed, which also includes commissions. Article 140 of the Delegated Regulation also requires an increase of 1 percentage point to the expense inflation rate (expressed as a percentage) used for the calculation of technical provisions.

28 October: Non-life premium and reserve risk

EIOPA clarified in Q&A (#2322) that notwithstanding any potential consequences resulting from the Own Risk and Solvency Assessment and the supervisory review process, for the calculation set out in Article 117(3) of the Delegated Regulation the application of the adjustment factor of 80 % for non-proportional reinsurance for segments 1,4 and 5 set out in Annex II does not depend on the existence/non-existence of non-proportional reinsurance. Consequently, the adjustment factor should be applied when calculating the capital requirement for underwriting risk and the hypothetical capital requirement for underwriting risk.

28 October: Look through approach in the SCR

EIOPA clarified in Q&A (#2321) that the look-through approach should be applied to the notes issued by the entity in the following situations:

• Special purpose entity issues untranched, secured, limited recourse obligation to the assets of the entity.
• The issuance proceeds are invested in underlying collateral assets (such as US treasuries) that represent exposures to market risk.
• The entity may enter a derivative transaction to transform the cash flows of the assets.
• The entity does not engage in any other business other than investing in the assets, transforming the cashflows with derivatives and issuing notes to investors.
• The notes pay out the combined cash flows produced by the collateral assets and the derivative transaction.

28 October: Loss of transitional status for own fund items due to change in IBOR

EIOPA clarified in Q&A (#2289) that the following refers to basic own-fund items that have been included in Tier 1 respectively Tier 2 basic own funds based on Article 308b(9) and (10) Solvency II.

Guideline 27 should be interpreted in such way that: changes in the terms and conditions of these items that are strictly necessary to incorporate the transition from an interbank lending rate (IBOR) to another reference rate where the transition results from the discontinuance of the former, should not lead to the loss of the transitional status. This applies also for a change from STIBOR to SWESTR.

28 October: Treatment of future discretionary benefits in SCR

EIOPA clarified in Q&A (#2279) that Article 28 of the Delegated Regulation refers to benefits only in the context of payments to policyholders and beneficiaries and mentions payments of expenses as a separate category. The notion that future discretionary benefits cover only benefits to policyholders is also supported by Recital 17 of the Delegated Regulation. Therefore, the payments to the distributors by way of commission referred to in b) are not part of the future discretionary benefits. As a result, the provision in Article 83(1)(c) of the Delegated Regulation does not apply.

28 October: Transitional equity stress

EIOPA clarified in Q&A (#2161) that Article 308b 13) of the Directive 2009/138/EC states that the transitional equity stress should be calculated as the weighted averages of:

• The standard parameter to be used when calculating the equity risk sub-module in accordance with Article 304; and
• The standard parameter to be used when calculating the equity risk sub-module in accordance with the standard formula without the option set out in Article 304.
  Parameter as referred to in paragraph 1 is 22% (Article 170 of Commission Delegated Regulation (EU) 2015/35). Parameter as referred to in paragraph 2 is 39% or 49% + symmetric adjustment (Article 169 of the Commission Delegated Regulation (EU) 2015/35).

Every month KPMG's IFRS team produces an update on the progress of the industry to date on the implementation of the new insurance accounting standard.

For more on any of the items above, or any Insurance-related queries, please get in contact with our Audit or Advisory team.