PrefBlog

The International Association of Insurance Supervisors has released the comments received to its 2018 ICS 2.0 Consultation. Assiduous Readers will remember that the comment period closed at the end of October, 2018 and included the following questions that are critical to the question of Deemed Maturities for Insurance issues:

The consultation document, downloadable from the above page, contains the critical (for our purposes) question:

173. The IAIS is considering whether to set an additional criterion requiring Tier 1 Limited instruments to have a principal loss absorbency mechanism (PLAM). Such mechanisms would provide a means for financial instruments to absorb losses on a going-concern basis through reductions in the principal amount and cancellation of distributions. Without such mechanisms these instruments might only provide going concern loss absorbency through cancellation of distributions.

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The consultation document, and the files with respondents’ answers to the questions, may be downloaded from the IAIS Insurance Capital Standards page. The ‘critical questions’, ##52-54, are found in Section 6 Reference ICS – Capital resources (public). The IAIS notes that:

The IAIS received 56 submissions in response to the 2018 ICS Consultation Document of which 18 were requested by the respondents to be kept confidential. Therefore, the comments that are posted here publicly are a subset of those that the IAIS will be taking into account as it moves forward with the ICS.

Q52 Section 6 Is a PLAM [Principal Loss Absorbency Mechanism] an appropriate requirement for Tier 1 Limited financial instruments? Please explain any advantages and disadvantages of requiring a PLAM.

There were 17 responses, 8 yes and 9 no.

OSFI answered “No”:

A PLAM is one option considered to assess loss absorbency in a going concern. However, OSFI’s view is that PoNV (point of non viability) loss absorbency could also be considered. Specifically, the IAIS could consider loss absorbency on a going concern basis, as well as on a gone concern basis with contractual or statutory) PoNV triggers. It is possible that an insurer could fail before a PLAM trigger occurs due to the lagging nature of PLAM triggers. Moreover, PLAM triggers could have adverse signalling effects in respect of the financial condition of the issuer, which could precipitate non-viability.

This advocacy of ‘point of non viability loss absorbency’ is consistent with the NVCC rules OSFI has imposed on banks and with its answer to the 2016 consultation. Assiduous readers will remember that I consider the ‘adverse signalling effects’ of a PLAM trigger to be a feature, not a bug; high triggers are good things, and I’m not the only one who says so:

Moreover, high-trigger CoCos would presumably get converted not infrequently which, in terms of reducing myopia in capital markets, would have the merit of reminding holders and issuers about risks in banking.

Broadly speaking, Europeans were in favour of PLAM, although some expressed concerns about complexity: China Banking and Insurance Regulatory Commission (CBIRC); European Insurance and Occupational Pensions Authority (EIOPA); Insurance Europe; Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); General Insurance Association of Japan; Financial Supervisory Service (FSS) & Financial Services Commission (FSC); Legal & General; Association of British Insurers. Comments included EIOPA’s remark:

Requiring a PLAM, i.e. write-down or conversion features, provides a means for the principal of a financial instrument to absorb losses on a going-concern basis. Without such mechanisms these instruments only provide going concern loss absorbency through cancellation of distributions.

Naysayers were dominated by American regulators and firms: Dai-ichi Life Holdings, Inc., American Council of Life Insurers, National Association of Mutual Insurance Companies; Prudential Financial, Inc.; American Property Casualty Insurance Association (APCI); MetLife, Inc; Property Casualty Insurers Association of America (PCI); and the National Association of Insurance Commissioners (NAIC). The Americans have a high degree of concern regarding the continued eligibility of “surplus notes”, as exemplified by the response of the National Association of Mutual Insurance Companies:

PLAM is an addition to the discussion that NAMIC strongly opposes. NAMIC does not see any value in a PLAM requirement. It is simply a way to further complicate the ICS 2.0 providing no value. It seems to be designed to reduce the value of allowing surplus notes to qualify as Tier 1 capital resources.

The elephant in the room is AIG and the European bank bail-outs that left Tier 1 noteholders unscathed, at least relatively. How can anybody say with a straight face that loss absorbency via cessation of dividends is sufficient in the face of those memories?

Q53 Section 6 If a PLAM requirement is not introduced, what amount should be included in ICS capital resources for instruments that qualify as Tier 1 Limited, to reflect going concern loss absorbency? Please explain.

OSFI’s answer is a disgrace:

Capital composition limits address the concerns related to loss absorbency of Tier 1 Limited instruments and therefore their full face amount should be included in the ICS capital resources.

In other words, OSFI would have us believe that since Limited Tier 1 Capital is a limited proportion of the insurers’ high quality capital, it doesn’t really matter whether it’s actually high quality or not. Disgusting.

EIOPA and BaFin stepped into the breach:

Without a PLAM requirement, it is difficult to see how the principal of an instrument absorbs losses in a going concern basis.

Interestingly, the Property Casualty Insurers Association of America (PCI) stated:

In support, PCI cites the response of OSFI-Canada to a similar question in the prior ICS consultation

and quoted in full the dovish response to the 2016 consultation … including the grudging support for a NVCC solution.

Others stated that cessation of distributions worked just fine, e.g., American Property Casualty Insurance Association (APCI):

Tier 1 Limited instruments already provide loss absorbency on a going concern loss basis through cancellation of distributions. Reducing the principal amount of these instruments is only necessary during resolution.

Q54 Section 6 Are there other criteria that could be added to enhance the ability of financial instruments to absorb losses on a going concern and / or on a gone concern basis? Please explain.

OSFI had nothing to say. BaFin and EIOPA had identical answers again:

• In T1, mandatory cancellation of distributions on breach of capital requirement (i.e. a lock-in feature).
• In T2, mandatory deferral of distributions and redemption of principal on breach of capital requirement (i.e. a lock-in feature).
• Requirement for early repurchase (within 5 years from issuance) to be funded out of proceeds of new issuance of
same/higher quality (all tiers).

I don’t quite understand this response. Does “cancellation” mean cancellation forever and ever on T1, as opposed to a temporary “deferral” on T2? How about redemptions? Would such instruments have any rights if the issuer actually did go bankrupt ten years later? And I don’t understand what they mean by an early purchase requirement at all.

So, there you have it. I don’t find anything particularly surprising here; there might be some meaning behind the heavy American participation in this consultation, but an outsider such as myself would be foolish to speculate on just what that meaning might be.

This entry was posted on Friday, April 5th, 2019 at 10:51 pm and is filed under Contingent Capital, Regulation, Regulatory Capital. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.