IAIS Solicits Feedback on Capital Standard, Relaxes Requirements on Callable Instruments

Large insurers that operate across national borders should consider recent guidance on capital standards from the International Association of Insurance Supervisors (IAIS), in particular on the kinds of instruments that make up permitted capital. In a Consultation Document (CD) issued on June 23, 2023 (available here), the IAIS seeks input from stakeholders on the global Insurance Capital Standard (ICS) ahead of its implementation as a prescribed capital requirement (PCR). Although the guidance — intended for internationally active insurance groups, or IAIGs — is largely unchanged from “ICS Version 2.0,” adopted in 2019, there are some departures. One of these is a liberalization of the circumstances in which a callable financial instrument can be used to constitute capital at an IAIG.

By way of background, the ICS identifies two tiers of capital: Tier 1 capital resources, which comprise financial instruments and other “capital elements” that absorb losses on a going-concern basis and in winding up, and Tier 2 capital resources, which comprise financial instruments and other capital elements that absorb losses only in winding up. Financial instruments are classified into those two tiers “based on consideration of a number of criteria, focused on five key principles”:

• Loss-absorbing capacity (on a going-concern basis and/or in winding up)
• Subordination
• Availability to absorb losses
• Permanence
• Absence of both encumbrances and mandatory servicing costs 

Within each tier, the ICS guidance allocates financial instruments into two categories with differing qualifying criteria:

• Tier 1:
  • Tier 1 financial instruments for which there is no limit (Tier 1 Unlimited)
  • Tier 1 financial instruments for which there is a limit (Tier 1 Limited)
    
    
• Tier 2:
  • Tier 2 paid-up financial instruments (Tier 2 Paid-Up)
  • Tier 2 non-paid-up financial instruments (Tier 2 Non-Paid-Up)

Under ICS 2.0, one of the requirements that an instrument had to meet for inclusion in capital was prior “replacement” of the instrument, if called within the first five years, with replacement capital of the same or better quality. However, in the CD, the IAIS explains that during the ICS 2.0 monitoring period (which commenced in January 2020), this requirement “may conflict with the current market and/or regulatory practices.” The IAIS is proposing to relax this requirement as follows.

To be eligible for inclusion as a Tier 1 limited financial instrument, an instrument must (in addition to meeting other criteria) be callable only after at least five years. Under the prior ICS 2.0 guidance, the only exception to this was that a call could be made for tax or regulatory reasons within the first five years as long as the capital was replaced with new capital of at least the same quality. Under the CD, by contrast, tax or regulatory calls will not require replacement capital, and any other call can be made (for any reason, but with regulatory approval) within the first five years as long as replacement capital is secured.

To be eligible for inclusion as a Tier 2 financial instrument, an instrument must (in addition to meeting other criteria), if called within the first five years, be replaced by new capital of the same or better quality. However, the CD would authorize the regulator to waive this replacement capital requirement when the call is tied to a materially adverse tax or regulatory event.

Comments on the CD will be accepted by IAIS through Sept. 21, 2023.