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September 2012 Bermuda Re/insurance


Around the same time Basel II was first published in 2004 following


its consultative period, the UK financial services regulator, the Financial Services Authority (FSA), introduced its Individual Capital Adequacy Standards (ICAS) framework for insurers. Under this framework, which has obvious similarities to the three pillar approach of Basel II, insurers and reinsurers were required to formally assess their risk management practices and the level and quality of capital they needed to survive potentially significant events and to pay liabilities as they fall due.


Further, the European financial regulatory institution for insurers, the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPs), was also discussing a version of Basel II for insurers and reinsurers with operations in the EU. It became known as Solvency II. The first draft of this regime was published in July 2007.


These examples indicate that the concept of ERM and regulators’ interest in firms demonstrating their own capital adequacy have been on the horizon for some time. However, the economic events that occurred between the first draft of Solvency II in 2007 and the present day have accelerated and amplified regulatory interest in firms’ attitudes towards risk-taking, and the adequacy of the practices they adopt in managing, their risks.


Putting the regulatory reform pieces together


“The economic events that occurred between the first draft of Solvency II in 2007 and the present day have accelerated and amplified regulatory interest in firms’ attitudes towards risk-taking.”


Global financial crisis


The continuing global financial crisis has highlighted the negative repercussions associated with financial industry interconnectedness. Not surprisingly, G20 leaders pushed to introduce a uniform global regulatory framework. This early vision, however, is now being superseded by the threat of a double-dip recession, resulting in national- level regulations being implemented with different timelines.


While the actual regulations may be implemented inconsistently, what has clearly emerged is a new reality in which regulators globally are engaging in more coordinated and intensive oversight than ever before.


Globally, restrictions on risk-taking are rising in many areas, including proprietary trading and swaps and derivatives trading. This in turn affects hedge funds, securities companies and private equity firms. Internationally, bank profitability is being impacted by greater controls on overdraft charges, interchange fees and other consumer fees, while Basel III will further restrict capital availability.


As a result, even without a common global regulatory framework, financial services organisations need to operate as though a common regulatory requirement exists due to the coordination arising from the so-called colleges of regulators who oversee their activities.


Accountability


A further fallout from the onset of the 2007–2010 financial crisis is an increase in the requirement to demonstrate accountability for risk management and control on the part of boards of directors, senior executives and senior management.


The initial urgency of regulatory reform on both sides of the Atlantic has given way to a ‘hurry up and wait’ interlude, leaving the industry unable to prepare definitively for new rules yet to come.


The Financial Crisis Inquiry Commission in the US concluded in its February 2011 report that one of the contributing factors to the crisis was a “systemic breakdown in accountability and ethics”. The report continues: “It was the failure to account for human weakness that is relevant to this crisis” and “we clearly believe the crisis was a result of human mistakes, misjudgments, and misdeeds that resulted in systemic failures …”


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