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A game of two halves? A new solvency standard for New Zealand’s insurers

Stage one: Interim Solvency Standard

The Reserve Bank of New Zealand (RBNZ) recently released a draft Interim Solvency Standard (ISS) in response to various industry issues and developments, including the new accounting standard, IFRS 17. RBNZ plans to revise the solvency standard in two stages.

A recent sessional meeting of New Zealand Society of Actuaries (NZSA) welcomed RBNZ officials and provided a forum for detailed discussion of the proposed changes to the solvency standard.

The additional burden placed on insurers to meet the requirements of the ISS (stage one of the implementation) is challenging and made even more so by a tight timeframe. The planned implementation would sit alongside other substantial effort by insurers as they make significant changes to meet IFRS 17 requirements. RBNZ noted that the date of implementation is subject to consultation and open to deferral, with the understandable limit of applying by the date at which IFRS 17 applies.

RBNZ noted that some of the changes introduced in the draft interim standard are intended to close certain gaps in risk coverage and improve calibration against RBNZ’s view of the risks. RBNZ also acknowledged that while it mainly applies the principle of going concern (measured as if the business continues to operate) there are some items measured on a gone concern basis (as if an organisation is in the process of wind-up or a company that is deemed insolvent). RBNZ feels there is a need to recognise that a 1 in 200 shock may put an insurer into a wind-up situation, requiring assessment of the capital required if the insurer were to become a gone concern.

Although not RBNZ’s direct intention, it is likely that capital requirements will increase because of these changes, in the short-term at least. Any diversification benefit to offset increases will be considered only in stage two.

The following points, discussed at the meeting, are likely to result in material capital strengthening, if there is no recalibration of capital charges made in stage one:

  • The introduction of an operational risk charge: Adding this charge, without any offsetting benefit, appears contrary to RBNZ’s intention of not significantly increasing capital levels. RBNZ acknowledged that the operational risk charge will increase capital and may create volatility between implementation stages as a result. RBNZ seems unlikely to defer the introduction, suggesting that the charge would signal the initial level of capital that is needed to inform calibration decisions in stage two.
  • Health insurance contracts treated as long term: RBNZ’s principle of consistency is driving the change in health insurance measurement. RBNZ clarified that it considers health insurance to be more aligned to long term considerations, due to features such as a lack of ability to re-price individual risks, coupled with its belief that capital requirements based solely on unearned premium is inadequate. RBNZ noted that it is open to discussion and could look to review this new requirement at stage two if necessary.
  • Removal of holistic view without diversification: We note that previously the interest rate risk for life insurance aligned with a holistic view of the scenario that dominated the insurance risk - so charges only applied if the components were interest rate sensitive in the dominant scenario (which may be gone concern). With the interest rate risk now being applied to the standardised insurance items (always going concern), it is likely that interest charges will be higher than under the current standard. RBNZ noted that the approach in the draft standard is designed to treat insurance and market risk separately, with a view ultimately towards calibrating each to 1 in 200 and providing an appropriate diversification benefit.

It is still unclear which changes will be part of the interim standard and which will continue to be deferred to stage two, potentially creating an unintended impact on capital requirements. Neither investors nor consumers will win in a game of two halves where the industry ends up behind in stage one and makes up ground in stage two.

Please get in touch if you would like any support with understanding the potential impacts of the new solvency standard on your business. In our next article, we highlight some of the changes that RBNZ has indicated will be deferred to stage two.

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