Equivalence with Solvency II: Revision of FINMA Regulations for (Re-)Insurers

This article aims to provide an overview of the amendments in FINMA regulations for (re-)insurers between 2015 and 2016. The amendments followed the entering into force of the revised Swiss Insurance Supervision Ordinance (ISO) on 1 July 2015 which was instrumental to secure the European Commission’s recognition of the Swiss insurance supervision system’s equivalence with the EU’s Solvency II Directive of 5 June 2015. In addition to these required amendments, FINMA had the intention to streamline and simplify some aspects of existing regulations and thus consolidated a number of FINMA circulars. Finally, this article points out a few other recent or ongoing revisions that are relevant for the (re-)insurance industry.

By Petra Ginter (Reference: CapLaw-2017-25)


1) First Part of Revisions in 2015 (with Amendments Entering into Force on 1 January 2016)

a) Overview

In summer 2015, FINMA submitted its first part of the revision package for consultation, including a partial revision of the FINMA Insurance Supervision Ordinance (ISO-FINMA) and a series of FINMA circulars (including two new ones). At the same time, FINMA also announced that the SST temporary easing measures granted in 2012 would expire at the end of 2015 and would not be renewed with some of the adjustments being incorporated into permanent regulation.

b) Revised ISO-FINMA

Based on the delegation to FINMA in the revised ISO, the revised ISO-FINMA contains specific industry rules that deviate from the minimum structuring requirements for the annual financial statements set forth in the accounting rules of the Swiss Code of Obligations (CO). The rules in the CO are predominantly aligned to the due dates of the various balance sheet and income statement positions. For the (re-)insurance industry whose main purpose is the risk transfer over time, the due date is, however, of less relevance. The minimum structure of an industry balance sheet should rather reflect the relations between expected obligations on the liability side (insurance technical reserves) and the required values on the assets side. The revised rules in the ISO-FINMA take better account of the specifics of the (re-)insurance business and improve transparency of the financial situation of (re-)insurers.

c) Revision of FINMA Circulars

  • FINMA Circular 2016/5 “Investment guidelines – insurers” (revised): The circular was reduced in scope and restructured to use a more principle-based approach, including some changes in content. In particular, the investment options for direct insurers, which are obliged to secure claims arising from insurance policies by ring-fencing specific assets, have been expanded. Insurers are now also permitted to invest tied assets in private debt, senior secured loans, insurance-linked securities, infrastructure loans and commodities (including gold). In addition to their own assessments of creditworthiness, insurers may also rely on ratings from uncertified rating providers (usually banks) for a transition period of two years. The long-standing practice to account for claims against reinsurers in the tied assets was finally codified in the circular. Limits for internal reinsurance (IGRs) are, however, lower than limits for external reinsurance (retrocessions).
  • FINMA Circular 2016/4 “Insurance groups and conglomerates” (revised) consolidated four existing circulars (2008/27 “Organisation – insurance groups”, 2008/28 “Structure – insurance groups”, 2008/29 “Internal business transactions – insurance groups” and 2008/31 “Insurance group reports”) into one and also integrated the FINMA guidelines on group or conglomerate supervision of (re-)insurance companies to create a standardised regulatory framework. FINMA Circular 2008/30 “Solvency I – insurance groups” was repealed in its entirety. The threshold of having to report a substantial participation was changed from an absolute figure to a relative threshold. The creation, acquisition or sale of an exceptionally risk bearing participation (in particular a non-traditional and non-insurance business activity) as well as usually special purpose vehicles are considered substantial irrespective of their size. The substance of reporting intra-group transactions (IGTs) is now determined based on the published equity capital on a group basis as opposed to the solvency margin (as Solvency I was abandoned). Minimum threshold percentages have been introduced for the ad hoc (2%) as well as ordinary, annual (0.1%) reporting of IGTs.
  • FINMA Circular 2016/6 “Life insurance” (revised) consolidated two existing circulars (2008/39 “Unit-linked life insurance” and 2008/40 “Life insurance”). The key changes relate to pricing aspects, requirements for biometric risk, pricing basis and models, as well as the technical interest rate.
  • FINMA Circular 2016/3 “ORSA” (new) contains implementing rules on the requirement for (re-)insurers, (re-)insurance groups and conglomerates as well as branches of foreign (re-)insurers to carry out an “Own Risk and Solvency Assessment” (ORSA). This requires them to compile an overall picture of the company from a forward-looking perspective, including details of the risk situation, capital adequacy and the relationships between risk and capital. The ORSA goes beyond the one year time horizon as well as the solvency requirements. It shall cover risks the (re-)insurer is exposed to at the beginning of the planning period, is expected to be exposed to during the planning period based on risk appetite and tolerance or might be exposed to due to deviations from the plan, such as e.g. if the business plan cannot be pursued as initially envisaged. The ORSA is thus an important business steering instrument for the board of directors and the management.
  • FINMA Circular 2016/2 “Disclosure” (new) provides for the public disclosure of information to facilitate comparisons and increase transparency among the (re-)insurers from a policyholders’ perspective. The circular sets out the requirement for (re-)insurers, (re-)insurance groups and conglomerates as well as Swiss branches of foreign (re-)insurers to publish a report on the financial situation on an annual basis. Prior to the amendment of the ISO, (re-)insurers were not obliged to publish their solvency figures.

d) SST Adjustments (Revised FINMA Circular 2008/44 “SST”, Appendix 4)

The circular on temporary adjustments to the Swiss Solvency Test (SST) (2013/02 “SST Adjustments”), which was limited to three years, expired automatically on 31 December 2015. FINMA’s Board decided not to extend or replace it. However, some of the temporary adjustments included in the circular were incorporated permanently into the existing FINMA Circular 2008/44 “SST”. They relate to the intervention thresholds, which define how, and how quick, (re-)insurers are required to act when certain thresholds are no longer met. The adjustment in the circular replaced the temporary with longer permanent deadlines for restoring compliance with the thresholds. In addition, in the orange zone (SST below 80%), dividend payments are no longer permitted. The temporary option in the circular to value insurance obligations using a yield curve subject to counterparty credit risk ceased to apply. The Swiss Federal Council believed that valuation should in principle be carried out using a risk-free yield curve. Assuming that interest rates will remain low for an extended period, FINMA could no longer justify further temporary measures in this area. FINMA further argued that the importance of this measure has progressively declined since its introduction. As of 1 January 2015, it improved the SST ratio across the market as a whole by only a few percentage points. Circular 2008/44 “SST” was revised again in the second part of revisions (see section 2)b) below).

2) Second Part of Revisions (with Amendments Entering into Force on 1 January 2017)

a) Overview

In summer 2016, FINMA opened the consultation for a second revision package in the (re-)insurance sector concluding the revision work initiated in 2015. The revision comprised four FINMA circulars (one new and three fully revised and tightened). One FINMA circular was abolished.

b) Revision of FINMA Circulars

  • FINMA Circular 2017/5 “Business plans – insurers” (new): This new circular was based on existing business plan practice laid down in various documents and provides for a better overview of the existing requirements. The new provisions refer to the business plan approval stage and to any changes made to them. Some of the business plan forms have also been revised materially. Such as e.g. Form C (activity abroad) for which an “activity abroad” shall be determined based on the location of the risk rather than, as in the past, the active business conduct. This change allows for a better distinction between “local activity” and “activity abroad” also when services are offered through internet platforms. No Form C filing is required any longer to conduct a reinsurance activity abroad. I.e., the (re-)insurance carrier is responsible to ensure and appropriately document that such activity is permitted by the regulation in the respective country. Capital outflows (e.g. dividends) in excess of 150% of the statutory net income are subject to notification under Form D.
  • FINMA Circular 2017/2 “Corporate governance – insurers” (revised): This circular sets out corporate governance principles for the organisation, management and control of (re-)insurance companies. Each individual (re-)insurance carrier of an insurance group is now required to comply with the rules under the circular. An implementation at the level of the ultimate parent company is no longer sufficient. Specifically, the circular contains provisions on the composition and organisation of the board of directors, the required number of board members (at least three) and their independence (at least one third needs to be independent) which have to be complied with by 31 December 2019. The circular further defines the key responsibilities of the heads of the control functions (RM, Compliance and Audit). It also incorporates the provisions previously set out in circular “Internal audit – insurers” which was revoked. FINMA has waived the requirement that all business areas and functions of (re-)insurance companies are audited by internal audit at appropriate intervals. Instead, audit frequency will now be aligned to risk.
  • FINMA Circular 2017/3 “SST” (revised): Current practice, which had previously been defined in a variety of other documents, is now set out in this fully restructured circular. The revision also takes into account adjustments to supervisory practice and the use of models (internal vs. standard) for the SST. It clarifies the provisions of the ISO in relation to the SST and regulates the principles, processes and reporting requirements for the SST. When calculating the SST ratio, the market value margin (MVM) is subtracted from risk-bearing capital instead of added to the target capital, resulting in higher SST ratios and closer alignment to Solvency II. (Re-)insurers have to value the legally binding minimum liabilities at t=1, i.e. assuming going-concern for t=0 and run-off at t=1. Such change in the valuation approach for assets and liabilities at t=1 could lead to substantial changes to the calculation process and potentially higher / lower SST capital requirements. The respective transition period ends on 1 January 2020. Finally, the circular provides for revised disclosure requirements in the SST report.
  • FINMA Circular 2017/4 “Appointed actuary” (revised): This circular defines the requirements related to the work carried out by the appointed actuary. The circular does not introduce new requirements besides the nomination of a deputy of the appointed actuary. The latter must, however, not be authorised.

3) Further Relevant Revisions for (Re-)insurers

a) FINMA Circular on Remuneration Systems (2010/1) (Revised)

The amended FINMA Circular “Remuneration Systems” (2010/1) that sets forth minimum standards for remuneration systems for financial institutes entered into force on 30 June 2017. FINMA expanded the scope of application of the circular to (re-)insurance companies, (re-)insurance groups and conglomerates from CHF 2 billion to CHF 15 billion in required target capital. This means that only the two large insurance groups Zurich and Swiss Re must implement the provisions set out in the circular.

b) FINMA Circular on Direct Transmission (2017/6) (New)

By introducing article 42c into the Swiss Financial Market Supervision Act (FINMASA), the legislator allows supervised institutions to transmit non-public information directly to foreign authorities and entities under certain conditions. Before that, supervised institutes could in most cases only transmit non-public information to foreign authorities based on a prior authorization. Otherwise, such transmission possibly qualified as a criminal offence according to article 271 of the Swiss Penal Code (PC) (non-permitted activity for a foreign state). The new FINMA Circular 2017/6 “Direct transmission” sets forth the standards applicable to article 42 FINMASA in addition to those already laid down in the provisions on the exchange of information with foreign financial market supervisory authorities. FINMA intends to assist financial institutions in autonomously applying article 42c FINMASA and to ensure that the rules set out in this provision are implemented in a uniform manner.

The circular aims to facilitate the transmission of information to financial market supervisory authorities to whom FINMA has already provided international administrative assistance and/or where the courts have already ascertained that international administrative assistance can be provided to those authorities (by assuming that these authorities adhere to the principles of specialty and confidentiality). In addition, the circular focuses in particular on defining the scope of article 42c(1) and (2) FINMASA. It limits the scope of para. 2 by specifying that only information essential for the execution or approval of transactions may be transmitted. In accordance with article 42c(3) FINMASA, the transmission of information of substantial importance must be reported to FINMA beforehand. The circular closes with listing examples of information for transmission which a) must be reported to FINMA and b) do not require any prior reporting. The circular requires (re-)insurers to issue until 30 June 2017 an internal guideline that governs the process required for compliance with article 42c FINMASA which is subject to regulatory auditing.

c) Revision of Outsourcing Practice (Not Yet in Force)

In view of the growing importance of outsourcing in the banking and insurance sector, FINMA put the new version of its Circular 2008/7 “Outsourcing – banks” out for consultation which ended on 31 January 2017. The draft circular now also covers (re-)insurance companies. Where appropriate, the requirements for banks, securities dealers and (re-)insurance companies have been harmonized. Despite FINMA’s announcement that the circular eases the requirements for (re-)insurance companies, the new requirements are far reaching and e.g. go beyond Solvency II.

In general, FINMA expects intra-group outsourcing to be treated with the same caution and subject to the same level of monitoring as external outsourcing. The key implication is that all requirements defined in the circular will now apply equally to intra-group outsourcing. The circular only covers outsourcing of “significant” outsourcing which needs to be determined independently for banks and insurers. For (re-)insurers significant means the functions that are inherent / mandatory for the (re-)insurance company. In principle, all significant functions can be outsourced. However, the Risk Management and Compliance function, which are newly deemed as significant functions, can only be outsourced in specific areas. The (re-)insurer has to define and document the requirements for service providers before the conclusion of an outsourcing contract which includes a risk analysis. For cross-border outsourcing the auditor and FINMA must have audit rights.

4) Conclusion

A majority of the FINMA proposals outlined above were well received by the industry. However, the industry also suggested material changes through specific submissions some of which were not taken up by FINMA in the final regulations. Recognition of the principle of proportionality in applying the circulars is explicitly stated and clarified. FINMA has also simplified the wording of its circulars wherever possible which clearly can be seen as a positive development. Unfortunately, FINMA has also missed some opportunities for clarifications, such as e.g. the rules on derivatives in the FINMA Circular “Investment guidelines – insurers” (that apply to insurance and reinsurance companies) which have not been substantially revised and continue to be unclear. The same applies to the implementing rules in the FINMA Circular “Direct transmission” which did not provide for the clear conditions according to which the supervised institutions can directly transmit non-public information without risking to trap into any criminal behaviour. The change of the valuation approach for assets and liabilities at t=1 under the new FINMA Circular “SST” could lead to substantial changes to the calculation process and potentially higher / lower SST capital requirements and thus was criticised by the industry without success. Finally, the draft FINMA Circular “Outsourcing” which has not yet entered into force is expected to introduce significant operational burden to (re-)insurers, with some of them going beyond the requirements of Solvency II. Hopefully these rules will be reconsidered in due time.

Petra Ginter (petra_ginter@swissre.com)