Solvency Assessment and Management: Pillar I - Sub Committee
Capital Resources Task Group
Discussion Document 25 (v 4)
Own Funds – Supervisory approval of ancillary own funds
EXECUTIVE SUMMARY
1. INTRODUCTION AND PURPOSE
This document aims to provide a technical overview on the options available in formulating
the subordinate legislation for the supervisory approval of ancillary own funds.
The capital resources under the solvency assessment methodology (SAM) is made up of
own funds, which are equal to the sum of basic own funds and ancillary own funds. Ancillary
own funds are defined in the primary legislation as:
“1. Ancillary own funds shall consist of items other than basic own funds which can be called
up to absorb losses.”
and that
“1 The amounts of ancillary own fund items to be taken into account when determining own
funds shall be subject to prior supervisory approval.”
Primary legislation also calls for subordinate legislation to detail the criteria for the granting
of supervisory approval.
This document first details the international standards as set out by the IAIS. It then outlines
the Solvency II level 1 principles and how they have been incorporated into the SAM primary
legislation. This is followed with a review of the international guidance and standards on the
criteria for the supervisory approval of ancillary own funds. The document concludes with
available approaches and recommendations.
2. INTERNATIONAL STANDARDS: IAIS ICPs
ICP 17 details the insurance core principles that apply to capital adequacy. As part of this it
details principles relating to the determination and assessment of capital resources. This is
broken down into 2 sections.
2.1. Identification of capital resources potentially available for solvency purposes
(17.10)
The core principle states that “The solvency regime defines the approach to
determining the capital resources eligible to meet regulatory capital requirements and
Solvency Assessment and Management: Pillar 1 - Sub Committee - Capital Resources - Task Group
Discussion Document 25 (v 4) - Own Funds – Supervisory approval of ancillary own funds
their value, consistent with a total balance sheet approach for solvency assessment
and having regard to the quality and suitability of capital elements.”
The 17.10.6 of ICP 17 states that capital resources should be broadly regarded as
the difference between assets and liabilities on the basis of their recognition and
valuation for solvency purposes.
17.10.7 states that when regarding capital resources as the difference between
assets and liabilities consideration should also be given as to whether contingent
assets should be included (Note that these are not contingent assets as defined by
IAS 37. See 17.10.11 below).
17.10.11 then concludes that “It may be appropriate to include contingent elements
which are not considered as assets under the relevant accounting standards, where
the likelihood of payment if needed is sufficiently high according to criteria specified
by the supervisor. Such contingent capital may include, for example, letters of credit,
members’ calls by a mutual insurer or the unpaid element of partly paid capital and
may be subject to prior approval by the supervisor.”
2.2. Criteria for the assessment of the quality and suitability of capital resources
(17.11)
The core principle states that “The solvency regime establishes criteria for assessing
the quality and suitability of capital resources, having regard to their ability to absorb
losses on both a going-concern and wind-up basis.”
17.11.7 lists four characteristics that should be considered when determining the
ability of capital to be loss absorbing. These are:
 Subordination
 Availability
 Permanence
 Absence of encumbrances and mandatory servicing costs
Section 17.11.18 deals with the availability of capital, in particular the availability of
contingent elements of capital. It states “Where a solvency regime allows contingent
elements of capital to be included in the determination of capital resources, such
inclusion would be expected to be subject to meeting specific supervisory
requirements or prior supervisory approval. When assessing the appropriateness of
inclusion of a contingent element of capital, regard should be had to:
 the ability and willingness of the counterparty concerned to pay the relevant
amount;
 the recoverability of the funds, taking into account any conditions which would
prevent the item from being successfully paid in or called up; and
 any information on the outcome of past calls which have been made in
comparable circumstances by other insurers, which may be used as an
indication of future availability.”
3. EU DIRECTIVE ON SOLVENCY II: PRINCIPLES(LEVEL 1)
Page 2 of 9
Solvency Assessment and Management: Pillar 1 - Sub Committee - Capital Resources - Task Group
Discussion Document 25 (v 4) - Own Funds – Supervisory approval of ancillary own funds
Solvency II Level 1 Article 89 defines Ancillary own funds as
“1. Ancillary own funds shall consist of items other than basic own funds which can be called
up to absorb losses.
Ancillary own funds may comprise the following items to the extent that they are not basic
own fund items:
(a) unpaid share capital or initial fund that has not been called up;
(b) letters of credit and guarantees;
(c) any other legally binding commitments received by insurance and reinsurance
undertakings.
In the case of a mutual or mutual-type association with variable contributions, ancillary own
funds may also comprise any future claims which that association may have against its
members by way of a call for supplementary contribution, within the following 12 months.”
With regard to the supervisory approval of ancillary own funds Article 90 states
“1. The amounts of ancillary own fund items to be taken into account when determining own
funds shall be subject to prior supervisory approval
2. The amount ascribed to each ancillary own fund item shall reflect the loss absorbency of
the item and shall be based upon prudent and realistic assumptions. Where an ancillary own
fund item has a fixed nominal value, the amount of that item shall be equal to its nominal
value, where it appropriately reflects its loss-absorbency.
3. Supervisory authorities shall approve either of the following:
(a) a monetary amount for each ancillary own fund item;
(b) a method by which to determine the amount of each ancillary own fund item, in which
case supervisory approval of the amount determined in accordance with that method shall
be granted for a specified period of time.
4. For each ancillary own fund item, supervisory authorities shall base their approval on an
assessment of the following:
(a) the status of the counterparties concerned, in relation to their ability and willingness to
pay;
(b) the recoverability of the funds, taking account of the legal form of the item, as well as any
conditions which would prevent the item from being successfully paid in or called up;
(c) any information on the outcome of past calls which insurance and reinsurance
undertakings have made for such ancillary own funds, to the extent that information can be
reliably used to assess the expected outcome of future calls.”
It has been recommended for SAM to adopt the Solvency II Article 89 and 90 with no
adaptations.
Page 3 of 9
Solvency Assessment and Management: Pillar 1 - Sub Committee - Capital Resources - Task Group
Discussion Document 25 (v 4) - Own Funds – Supervisory approval of ancillary own funds
4. MAPPING ANY PRINCIPLE (LEVEL 1) DIFFERENCES BETWEEN IAIS ICP & EU
DIRECTIVE
Although the Solvency II definition of ancillary own funds does not explicitly refer to
contingent assets, because the definition of capital resources under both Solvency II and
ICP 17 are the same, the only assets that could fall under ancillary own funds would be
contingent. Note that this does not refer to contingent assets as defined under IAS 37. ICP
17 refers to contingent assets and capital interchangeably and defines them as “contingent
elements which are not considered as assets under the relevant accounting standards,
where the likelihood of payment if needed is sufficiently high according to criteria specified
by the supervisor.” Therefore it is quite clear that the reference to contingent assets is not as
defined under IAS 37 and rather can be equated to the Solvency II definition of ancillary own
funds. Furthermore the examples of contingent assets under ICP 17 and ancillary assets
under Solvency II are also the same. Therefore for all intents and purposes contingent
assets as defined under ICP 17 can be considered the same as ancillary own funds under
Solvency II. It is recommended that the term contingent assets not be used in drafting of the
subordinate legislation to avoid any confusion.
Solvency II covers all of the principles under ICP 17 with regard to the supervisory approval
of ancillary own funds. In addition, it states that the loss absorbency should be based on
prudent and realistic assumptions, and that the supervisory body can approve an amount, or
a method by which to determine the amount. ICP 17 broadly states that ancillary own funds
should be subject to supervisory requirements or prior approval, and therefore the Solvency
II requirement does not contradict ICP 17.
5. STANDARDS AND GUIDANCE (LEVELS 2 & 3)
A summary of the IAIS standards and guidance papers can be found under section 1
International Standards: IAIS ICPs. IAIS has set high level standards and guidance. The
section details the different approaches used under different regulatory regimes and
compares them to each other and the IAIS standards and guidance.
5.1
CEIOPS CPs (consultation papers)
CEIOPS issued advice for level 2 implementing measures on Solvency II : Own
Funds – Supervisory approval of ancillary own funds (former CP 26). In this paper
CEIOPS describes their process for the supervisory approval of ancillary own funds
in accordance with Article 90 as described under section 3.
Solvency II core principles state that the amount recognised should reflect the loss
absorbency of the item and that it is determined on the basis of prudent and realistic
assumptions. CEIOPS therefore believes that the approval should be based on the
substance of the item and not the form in which it is presented or described. CEIOPS
has specified principles and criteria which would apply to types of ancillary own
funds, rather than prescriptive rules. This they feel provides clarity to (re)insurers and
the supervisor, as well as allowing the supervisor to take into account market
conditions and innovations.
The (re)insurer is responsible for:



Determining the amount for approval,
the methods to determine the amounts,
and providing the related documentation
Page 4 of 9
Solvency Assessment and Management: Pillar 1 - Sub Committee - Capital Resources - Task Group
Discussion Document 25 (v 4) - Own Funds – Supervisory approval of ancillary own funds
The supervisor is responsible for approval of either the amounts or the methods to
determine the amounts, on the basis of documentation and any other information
which it deems appropriate.
The supervisor can request further information from the (re)insurer. Based on the
information the supervisor either grants approval, approval of part of the amount or
refuses approval. The supervisor will provide an explanation when refusing to grant
approval or granting partial approval.
The supervisor has the power to review and revise the approval at any point in time
if it believes or is informed that the ability or willingness of the counterparty to pay
has altered significantly.
CEIOPS suggests that there needs to be the following safeguards:





The board of the (re)insurer will be required to confirm to the supervisor
annually at each mandatory calculation of the SCR that there have been no
changes to the structure of the arrangement, contractual terms, status of the
counterparties or other event that could affect the recoverability of the own
funds should a call be made.
It is the (re)insurers responsibility to inform the supervisor of any significant
changes in the recoverability of ancillary own funds, and to provide the
supervisor as soon as possible with the relevant documentation.
At any time the supervisor should be empowered to carry out a supervisory
review.
The supervisor may make approval subject to conditions:
o Approval may be for a specified period of time.
o If approving the method the supervisor shall also refer to the initial
amount determined using the method, the period of time and
conditions when it needs to be updated.
o CEIOPS as of yet does not prescribe a timeframe but intends to revisit
the issue after solvency II implementation.
In the event of an application for approval, silence on the part of the
supervisor cannot be taken as approval. Approval would only be effective
when directly and explicitly confirmed.
The Approval Process
A three step approval process is proposed:
 Step 1: The supervisory authority reviews the amount of funds that the
(re)insurance undertaking is legally able to call, and that is legally
enforceable, under its articles of association, in the contracts that govern the
commitment to provide funds and, where relevant, the national law.
 Step 2: The supervisory authority assesses whether the amount proposed is
realistic as compared to the amount that the (re)insurance undertaking is
likely to recover as and when the (re)insurance undertaking needs the basic
own funds which the counterparty has committed to provide.
 Step 3: The supervisory authority assesses whether the amount is prudent,
considering all potential losses and stress events, on the basis of information
available.
Page 5 of 9
Solvency Assessment and Management: Pillar 1 - Sub Committee - Capital Resources - Task Group
Discussion Document 25 (v 4) - Own Funds – Supervisory approval of ancillary own funds
The following criteria should be considered by the supervisory authority during this
three step process to determine whether there are any obstacles to recoverability.
Criteria
(A)The status of the counterparties concerned, in relation to their ability and
willingness to pay.
a) Ability to pay
The assessment of the ability of counterparty’s to pay should consider both default
risk and risk of delay in the transfer of funds.
i)
Default risk
The supervisor assesses the probability of default of the counterparty and the
loss given default. One possible way of performing this could be to use the
SCR counterparty risk module in those cases where the counterparty is
subject to a credit rating.
Where the counterparty is not subject to a credit rating or such a credit rating
is not suitable for the supervisory assessment, the supervisor assesses
default risk by considering the following criteria:
 Whether there are any interests other than those of the (re)insurance
undertaking, and what impact those other interests may have on the
ability of the counterparty to transfer funds. For example, are there
other parties who take precedence, is the commitment subordinated?
 Whether the transfer of funds to the (re)insurance undertaking might
harm the reputation of the counterparty.
 Whether any regulatory requirements impact on the ability of the
counterparty to transfer funds.
 Whether the legal structure of the counterparty prejudices the transfer
of funds.
 Whether the contractual relationship of the counterparty and the
(re)insurance undertaking prejudices the transfer of funds. For
example, are there encumbrances, or rights of set-off?
 Whether recoverability is reinforced through the availability of
collateral or counter-guarantees.
 Whether there are other exposures to the counterparty or it has
provided other commitments that are ancillary own funds, so that the
total exposure to that counterparty poses significant risk.
ii)
Risk of delay in transfer of funds
The supervisor assesses the liquidity position of the counterparty by
considering the following criteria:
 Whether the prompt transfer of funds to the (re)insurance undertaking
might harm the reputation of the counterparty.
 Whether any regulatory requirements impact on the ability of the
counterparty to transfer funds promptly.
 Whether the legal structure of the counterparty prejudices the prompt
transfer of funds.
 Whether the contractual relationship of the counterparty and the
(re)insurance undertaking prejudices the prompt transfer of funds. For
example, are there encumbrances, or rights of set-off?
Page 6 of 9
Solvency Assessment and Management: Pillar 1 - Sub Committee - Capital Resources - Task Group
Discussion Document 25 (v 4) - Own Funds – Supervisory approval of ancillary own funds

In cases where the counterparty is a legal entity rather than an
individual, whether there are assets in the counterparty available to be
transferred or liquidated for the purposes of the transfer of funds.
b) Willingness to Pay

The supervisor should assess the economic situation of the (re)insurer and
the reason for the call.
 The supervisor should assess the existence of incentives and motivations for
the counterparty to pay.
 The supervisor should assess whether the past and proposed flows of funds
between the counterparty and the (re)insurance undertaking demonstrates
the willingness to make prompt transfer of funds
 The supervisory authority assesses the nature of the counterparties and their
involvement in the (re)insurer. In many cases a distinction between corporate
and non-corporate counterparties would be considered.
(B)The recoverability of the funds, taking account of the legal form of the item,
as well as any conditions which would prevent the item from being
successfully paid in or called up.
In addition the supervisor should assess the systems, controls and processes the
(re)insurer has in place to make and enforce payment of the call.
(C) Any information on the outcome of past calls which (re)insurers
undertakings have made for such ancillary own funds, to the extent that
information can be reliability used to assess the expected outcome of future
calls.



Where the (re)insurance undertaking has sufficient data to allow a statistical
assessment, the supervisory authority will consider whether this information
can reliably be used to assess the expected outcome of future calls. Data
could include both market data (by country; for the entire market) and internal
data.
The supervisory authority assesses the experience of the undertaking in
recovering payments under similar commitments with the same or similar
counterparty. The presence or otherwise of consecutive calls may be relevant
to the amount of funds expected to be recovered in the future. This
assessment should be made on a case-by-case basis.
The supervisory authority does not approve unlimited amounts.
There should be an on-going review of the amount approved, and the supervisor has
the power to revise the amount, or the method, which it has previously granted
approval.
The (re)insurer has the duty to report to the supervisor any change in circumstances
that is relevant to the supervisors assessment as soon as such information becomes
apparent.
Public Disclosure under Pillar III
The following should be disclosed:
Page 7 of 9
Solvency Assessment and Management: Pillar 1 - Sub Committee - Capital Resources - Task Group
Discussion Document 25 (v 4) - Own Funds – Supervisory approval of ancillary own funds






5.2
an annual specification of the ancillary own fund items,
the amount for each ancillary own fund item,
the nature of the counterparty for each ancillary own fund item and if there
are no legal or practical obstacles to disclosure, considering the form and
nature of the instrument being called up, the name of the counterparty,
the name of the counterparty and a statement that it belongs to the same
group where this is the case
the name of the supervisory authority that has approved the amount, and
the period for which the approval has been granted.
Other relevant jurisdictions (e.g.OSFI, APRA)
[It is not expected that all jurisdictions should be considered, only those that are
particularly relevant in the South African context].
OSFI does not allow ancillary funds/contingent capital to count as capital resources,
it restricts capital resources to fully paid up capital. This can be found in the Guideline
for the Minimum Continuing Capital and Surplus Requirements for Life Insurance
Companies, December 2010.
5.3
Mapping of differences between above approaches (Level 2 and 3)
CEIOPS recommendation complies with the IAIS standards and guidance. OSFI
does not allow ancillary own funds items to back the capital requirements.
6. ASSESSMENT OF AVAILABLE APPROACHES GIVEN THE SOUTH AFRICAN
CONTEXT
6.1
Discussion of inherent advantages and disadvantages of each approach
Allowing contingent assets (ancillary own funds) to be included in the own funds, at
small percentages can allow for greater flexibility of insurers to raise capital. This
should not pose a large risk as long as the approval process has the necessary rigor,
which the CEIOPs process has. It will also put South African (re)insurers on the
same competitiveness level as European (re)insurer from a capital resources
perspective.
The disadvantages are that it does allow riskier assets to back the capital
requirements, however it should be easy to minimise the risk if the allowable
percentage is kept small and the approval process is vigorous. In addition as it is not
foreseen that a large percentage of own funds will be ancillary own funds and as the
process will put additional strain on the supervisor, it is questionable whether the
additional capital flexibility and competitiveness is worth it; although the number of
(re)insurers applying should not be large.
6.2
Impact of the approaches on EU 3rd country equivalence
Either way EU 3rd country equivalence should not be affected.
Page 8 of 9
Solvency Assessment and Management: Pillar 1 - Sub Committee - Capital Resources - Task Group
Discussion Document 25 (v 4) - Own Funds – Supervisory approval of ancillary own funds
6.3
Comparison of the approaches with the prevailing legislative framework
The current legislative framework does not allow for the contingent assets or ancillary
own fund item to back the capital requirements.
6.4
Conclusions on preferred approach
It is not foreseen that there will be large number of insurers that will apply for ancillary
own funds, this process should be manageable. Therefore in order to make sure that
South African (re)insurers are on a level playing field as EU (re)insurers the
conclusion is that the CEIOPs approach should is appropriate.
7. RECOMMENDATION
It is recommended that the CEIOPs requirements for the approval of ancillary own funds be
adopted without any amendments.
Page 9 of 9