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Insurance Group Regulation - A Comparative Case Study: Australia and the United States

Monday 18 May 2009

John Trowbridge, Executive Member - National Association of Insurance Commissioners International Issues Forum, Washington

The biggest single issue in insurance regulation today, as a consequence of the GFC, is what some are calling, colloquially, ‘the AIG problem’. This problem can be expressed more precisely as:

  • How to continue to maintain the integrity of the solo supervision of insurers while also carrying out effective group supervision that protects the integrity of the group including all regulated and unregulated subsidiaries.

This question has caught the attention of insurance regulators around the world because it has demonstrated two critical features of insurance regulation as it applies today in both the United States and numerous other countries:

  • The first feature is the extraordinary strength of solo supervision: for more than 150 AIG subsidiaries in many different countries, not one policyholder has yet been left stranded, notwithstanding the difficulties of the parent company.
    • The explanation? Solo supervision of insurance companies around the world is alive and well. The evidence? The assets of these insurers have been quarantined by regulators within the insurers, out of reach of the parent.
    • This is to the credit of insurance supervisors in the US and many other countries.
  • The second feature is the absence of effective group supervision (because one subsidiary, an unregulated one, was able to damage the group severely): is this a failure of the structure of the regulatory system, of one or more individual regulators, of the company itself, or of all three?

It is not for me to answer this last question, but it is appropriate for all regulators to consider how to respond so that this kind of situation does not recur.

The group regulation issue

‘The AIG problem’

  • How to maintain integrity of solo insurer supervision
    • undertake effective group supervision?

Two critical features of the AIG experience:

  • Extraordinary strength of solo supervision 
    • US and elsewhere.
  • Absence of effective group supervision
    • could have happened in many countries.

As I see it, the lessons from AIG, and indeed other financial groups such as Fortis, ING, RBS and HBOS, will lead to a range of regulatory initiatives that will include, in time:

  • either more effective supervision of specialist insurance groups and cross-sectoral financial groups, or restrictions on the scope of activities of specialist insurance groups;
  • continuing interest in and development of accounting standards and audit practices in insurance;
  • greater supervisory interest in remuneration practices of groups; and
  • greater emphasis on, and scrutiny of, governance and risk management practices in all financial institutions.

We are interested today, however, in the first point, how we might supervise insurance groups more effectively.

The way I propose to consider this question is by reference to the Australian system, which had its own AIG, in the name of HIH, a major Australian-based general insurer whose collapse in 2001 caused considerable financial, economic and political disruption at the time:

The failure of HIH highlighted the risk to insurers from contagion effects within a corporate group. The Government appointed a Royal Commission to investigate the collapse and subsequently accepted its recommendations. They included that a framework for the supervision of corporate insurance groups be developed that would be effective but also would not unduly restrict the commercial aspirations of such groups.

As a result, the Government legislated to give APRA the power to authorise non-operating holding companies (NOHCs). APRA has subsequently responded by introducing what we believe is a comprehensive approach to the supervision of insurance groups.

I will try to explain the position by firstly describing my understanding of the similarities and difference between the US and Australian environments.

United States and Australia — Similarities


Both countries have a federal system of government, with the constitutional ability to regulate insurance nationally —

US has: 51 States
Australia has: 8 States and Territories


The industry is dominated by private sector insurers and insurers, both local and foreign Some business is State-controlled (i.e. workers compensation, motor liability), some in the private sector and some in the public sector

Prudential regulation

Covers solvency, governance and risk management of insurers

Group regulation

Parent companies of groups (including non-operating holding companies) are licensed.

At this point, the two countries diverge, for there are many important differences.

Insurance Markets — Differences

  United States Australia

Motor is one class – Liability and property damage combined

Motor is two classes – Liability and property damage separate contracts

Wordings regulate Wordings not regulated (except WC and motor liability)

File and write Arrangements prevalent

No price controls (except motor liability – State regulated)

Solo Insurance Regulation — Differences

United States Australia
State Regulators Single national regulator

- prudential, rating, products, market conduct

'Twin Peaks' -
  • Prudential - APRA
  • Market Conduct - ASIC

Single industry
- insurance only

Industry integrated –
banking + insurance + pensions

Group Insurance Regulation — Differences

  United States Australia

Identity of regulator

— solo insurers

— parent

State regulators

Choice by insurer?

Need not be an insurance regulator?



Structure of regulation

Parent and subsidiaries treated separately

Group treated holistically

We can see from these differences, and in particular the existence in Australia of one regulator only for each insurance group and its local subsidiaries, that introducing group regulation in Australia was always going to be easier, much easier, than in the United States.

Let us now go back a step to look at some of the aims and characteristics of group supervision.

The prudential goal of group supervision is to ensure that the group is financially sound and that group activities and inter-relationships do not adversely affect the financial soundness of the licensed insurers within the group.

Expressed another way, the primary regulatory aim of group supervision is to minimise contagion risk to licensed insurers within a group from other group operations and thereby reduce the probability of failure of the group’s licensed insurers.

More generally, there are usually three benefits that insurers look for from group supervision and three main risks that regulators are seeking to guard against in undertaking group supervision.

The potential insurer benefits are:

  • mobility of capital;
  • recognition of diversification benefits; and
  • reduced or streamlined regulatory requirements.

The regulator’s position is based around protection for policyholders from contagion risks within the group, and the three main such risks are:

  • Inappropriate capital or ownership arrangements at group level (e.g. debt financing or short term ownership, as are often the case with private equity investors).
  • Unregulated entities in the group that can compromise the solvency of the group.
  • Intra-group transactions such as loans, guarantees, double leveraging, etc.

Group supervision — characteristics

Prudential goal: Minimise contagion risk within a group
Insurer perspective –
potential benefits
  • Mobility of capital
  • Diversification - recognised
  • Streamlined regulation
Regulator perspective –
main forms of contagion risk
  • Inappropriate capital structure or ownership
  • Exposure to unregulated entities
  • Intra-group transactions

The APRA framework

APRA’s approach is to achieve each of these supervisory goals while also facilitating mobility of surplus capital. We recognise some diversification benefits in claims liability valuations and we have gone out of our way to simplify the reporting required of insurance groups.

APRA’s prudential supervision of insurance groups stems from its wish to promote the protection of Australian policyholders by reducing the risk of financial contagion across members of a corporate group.

An insurance group can be headed by either a licensed insurer (an operating holding company) or an APRA-authorised non-operating holding company (NOHC), the latter being more common. The group contains all insurance subsidiaries (both domestic and international) and any other controlled entities integral to its insurance business including related service entities.

AIG is one of many insurance groups which exhibits this structure.

Foreign subsidiaries of an Australian general insurance group do not need to comply with APRA requirements on an individual basis. Material subsidiaries operating in other industries, unrelated to the insurance business, need to be deconsolidated from the insurance group.

Group-specific requirements

APRA’s requirements that are specific to insurance groups relate to:

  • non-consolidated subsidiaries. The value of the equity exposure is deducted from the insurance group’s capital base;
  • capital upgrades. When determining the capital base of the insurance group, individual components of capital measured in a subsidiary must not be upgraded to a higher category of capital when included in the measurement of the Level 2 insurance group’s capital base;
  • intra-group capital transactions. APRA may exclude from an insurance group’s capital base components of capital arising from intra-group transactions where APRA believes these components do not contribute to the financial strength of the group; and
  • unregulated subsidiaries that are under-capitalised. Where a subsidiary of an insurance group is under-capitalised, APRA may require the group to deduct from its capital base an amount to cover the deficiency.

This is important: APRA deals with unregulated subsidiaries in two steps:

  • information on the subsidiary has to be made available to APRA on request; and
  • if APRA believes it is under-capitalised or otherwise a threat to the financial strength of the group, APRA in effect demands that the parent hold enough extra capital to offset the under-capitalisation. You could call this ‘the AIG clause’.

In summary, the position is:

Group-specific requirements

Non-consolidated subsidiaries

Equity deducted
Capital upgrades No upgrade of capital quality from sub to parent

Intra-group capital transactions

Adjust for double counting etc.

Unregulated subsidiaries

Parent may be required to hold extra capital

APRA defines an insurance group in a way designed to include all entities in the group conducting insurance and related business, both locally and internationally.

As a starting point, normal accounting consolidation rules are followed but investments in non-insurance entities are de-consolidated and the investment deducted from capital. APRA has the ability to determine which entities should be consolidated and which should not.

Group solvency

The foundation of APRA’s approach to group solvency is that insurance groups should meet essentially the same minimum capital requirements on a group basis as apply to individual licensed insurers. APRA does not require foreign subsidiaries of an Australian insurance group to meet Australian prudential standards on a stand-alone basis but does expect every foreign subsidiary to meet its respective local regulatory capital requirements.

Capital Mobility

The minimum capital requirement of an insurance group represents the capital necessary to support the risks assumed in the group as a whole. An insurance group needs to have adequate capital to cover its foreign operations as well as its local operations but APRA does not specify the disposition of capital within individual companies, i.e. APRA does not prescribe where capital is to be held within an insurance group, provided each licensed insurer in the group meets its own individual capital requirements and the group satisfies the overall group requirements.

Should foreign regulators choose to recognise APRA’s regime, Australian groups with foreign subsidiaries stand to benefit from a degree of capital mobility that is not available today. To gain that benefit, the onus will be largely on the group and its regulators in other jurisdictions to ascertain how APRA’s group supervisory activities might be reflected in adjustments to levels of local capital. APRA is willing to assist such recognition in other jurisdictions.

To summarise —

Group solvency — the foundation

APRA’s approach is —

  • An insurance group should meet the same solvency requirements
  • Each Australian subsidiary insurer should meet the normal  Australian solvency requirements for individual licensed insurers.
  • Each foreign subsidiary insurer should meet the normal local solvency requirements for individual licensed insurers.

Capital mobility: APRA is indifferent as to where surplus group capital is held

Character of group supervision

Supervising insurance groups on a consolidated basis is a viable approach for understanding and minimising contagion risk within such groups.

The capital base of a group can be assessed on the basis that the group is treated as if it were a single consolidated entity.

An inherent difficulty in developing a group solvency regime is the lack of standardisation of capital requirements for insurers around the world and the absence of a globally agreed approach to consolidated insurance group supervision. APRA believes it has resolved this difficulty by:

  • relying on insurance groups to ensure that their foreign subsidiaries meet at least the minimum capital adequacy requirements placed on them by their host supervisors; and
  • seeing that the group as a whole meets an overall group solvency requirement.

The basis of APRA’s group capital adequacy is that it should apply as if there were no separate legal entities within the consolidated insurance group. That is, the capital adequacy requirements are applied as if the consolidated insurance group is one company conducting all the insurance business written by all the underlying companies which have been consolidated. In accordance with this basic premise, APRA does not mandate where capital is to be held within the consolidated insurance group other than in relation to the capital adequacy requirements that already apply to stand-alone APRA-regulated insurers.

The group framework covers foreign subsidiaries and branches of Australian insurance groups. Group capital adequacy has to be met on a group-wide basis but this does not mean that each and every foreign subsidiary has to meet Australian capital adequacy requirements on a stand-alone basis. The consolidated insurance group must have adequate capital to cover its foreign risks but APRA does not mandate that this capital be held in the foreign subsidiaries.

Finally, a discussion on group supervision would be incomplete without referring to the lessons of the last two years. As noted at the outset, we appear destined to see either more effective supervision of specialist insurance groups and cross-sectoral financial groups, or alternatively restrictions on the scope of activities of specialist insurance groups. This is because the global financial crisis has brought to light the need to examine further such topics as:

  • unregulated entities;
  • conglomerates;
  • vulnerability of some lines of business;
  • limits on the mobility or fungibility of capital; and
  • a clearer understanding of the power of solo supervision in stress situations which has, for example, protected AIG policyholders despite the travails of the parent.

If it is any consolation, HIH collapsed in 2001, the Australian Government gave APRA the requisite legislative powers for group supervision in the same year and it took us until 2009 to introduce the full suite of solvency and other group regulatory arrangements! And I also have a confession: all of the above applies to general insurance (P&C) only at this stage. APRA’s legislative power over life insurance NOHC’s is being granted this year and therefore full application to the life insurance industry will not occur until 2010.

Let us hope that the Australian journey on group supervision makes the US path a little easier.

The Australian Prudential Regulation Authority (APRA) is the prudential regulator of the financial services industry. It oversees banks, credit unions, building societies, general insurance and reinsurance companies, life insurance, private health insurers, friendly societies, and most members of the superannuation industry. APRA currently supervises institutions holding $6 trillion in assets for Australian depositors, policyholders and superannuation fund members.