Insurance Solvency Regulation in Latin America

January 2015
Insurance solvency regulation in Latin America:

modernizing at varying speeds
Economic Research&Consulting
01 Executive summary
02 Generations of
solvency regimes
05 Solvency regimes in
Latin America
17 Outlook and risks
20 Conclusion
Executive summary
Economic risk-based solvency regulation
is coming to Latin America.
Latin America is part of a global move towards economic risk-based solvency

regulation. Three countries in the region are already in advanced stages of
implementing economic risk-based capital (RBC) models: Mexico, Brazil and Chile
are expected to adopt frameworks similar in design to the EUs Solvency II over
the next one to three years. The remainder of the countries operate regimes akin to
the European Unions (EU) Solvency I framework, although Colombia, Costa Rica
and Peru are laying the groundwork for comprehensive regulatory reform while
simultaneously incorporating risk capital requirements in a piecemeal fashion. The
other countries in the region have made no firm commitment to modernize.
New solvency regulations are likely to

have far-reaching consequences for the
regions re/insurance industry.
The impact of the regulatory changes will vary from country to country depending
on the final model designs. For some, diversification effects and reinsurance capital
solutions will help mitigate the impact of additional risk capital charges. The changes
will also affect insurers differently. In general, smaller and less diversified carriers
(both geographically and by line of business) will be at a distinct disadvantage. Some
will become candidates for mergers and acquisitions while others may choose to exit
the market altogether. Insurers will also be incentivized to focus on less capitalintensive products, which may lead to a shift in the overall product mix. The use of
reinsurance as a capital management tool may also grow in the region.
The trend of regulatory modernization will

likely continue in the coming years
The trend towards economic risk-based solvency regulation is set to continue in the
coming years. There is no formal or concerted regional harmonization project in Latin
America, but two forces are driving the modernization agenda forward. The first is
the influx of internationally active insurance groups that have, to a large extent,
already internalized global best practices in capital and enterprise risk management
(ERM). The resulting competitive pressures are prompting many local insurers to
modernize their risk management practices and systems in advance of regulation.
The second is the influence of international standard setters such as the International
Association of Insurance Supervisors (IAIS) that promote harmonization of
supervisory standards across the globe.
although restrictive measures, macro

instability and a lack of institutional
capacity are countervailing forces.
Three stumbling blocks could delay or derail solvency regulatory reform in Latin
America. First, restrictive measures reducing market incentives to modernize are
prevalent in several jurisdictions like Argentina, Brazil and Venezuela, and the
prospect of their spread to other countries in the region is a concern. Second, to the
extent that macro instability complicates the task of implementing economic riskbased solvency regimes, countries experiencing economic difficulties may be less
inclined to undertake reforms. Finally, the more demanding institutional requirements
of economic risk-based solvency regimes may put them beyond the reach of smaller
or less wealthy countries in the region.
Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds 1
Generations of solvency regimes

Solvency I vs. Solvency II
Solvency regimes are assuming
ever-greater scope and complexity.
Regulatory trends in the insurance industry have run broadly parallel to developments
in the wider financial sector, with solvency regimes assuming ever-greater scope
and complexity. The European Union (EU) has developed the most comprehensive
approach to insurance industry regulation so far with its Solvency II Directive (see
Box 1 for details). This new regulatory framework sets out more dynamic and risksensitive solvency capital requirements than under the current Solvency I framework.
It also incorporates qualitative aspects largely omitted from earlier generations of
solvency regimes that address risks stemming from inadequate internal control,
reporting and risk management systems.
Solvency II has become an important

reference point for regulatory
modernization.
Solvency I remains the default model for most countries around the world (see
Figure 1). However, more and more countries are migrating towards economic riskbased capital (RBC) requirements, and many are taking measures to bring qualitative
risks under their supervisors purview. For several countries on the path of regulatory
modernization, Solvency II has become an important reference point.
Advanced economies have made the

biggest strides towards economic
risk-based solvency regulation.
Migration has not been uniform across or within regions. RBC requirements are the
norm in advanced economies, though only Australia and Switzerland currently allow
re/insurers to use internally-developed models to determine their economic capital.
Australia, Bermuda, Canada, Singapore and Switzerland are the first countries to
have implemented corporate governance and risk management requirements for
solvency processes. The EU will follow suit in January 2016 when Solvency II is due
to come into force. Re/insurers in the US will face similar requirements from 2015
onwards.1 The current US RBC solvency regime, in place since the 1990s, is a legal
entity-level capital requirements framework that prescribes ladders of regulatory
intervention as an insurers capital approaches a minimum level.
Among the emerging markets, countries

in Asia have made most progress.
Among emerging markets, Asian countries have made significant progress in

upgrading their solvency regimes. Latin America currently counts one country
(Brazil) with a partial RBC model in place, while Mexico and Chile are expected to
implement economic risk-based solvency regimes by 2015 and 2016, respectively.
Countries in Central and Eastern Europe are moving at varying speeds depending
on their broader policy inclination. Africa is the farthest from the regulatory frontier;
so far only South Africa is undertaking comprehensive reforms.
Figure 1
Global comparison of capital regimes
(status as of late 2014)
No data
Solvency margin
RBC
Transition to economic, risk-based solvency regime
Economic, risk-based solvency
Source: Swiss Re Economic Research&Consulting.
1 Evolving Insurance Regulation: The kaleidoscope of change, KPMG, March 2014.
2 Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds
Solvency II is an economic risk-based

solvency framework, requiring more
capital to be held for riskier insurance
and investment activities.
Box 1: What is Solvency II?

Solvency II is a harmonized economic risk-based solvency framework that promotes
group supervision for the European Economic Area. When implemented in 2016, the
new rules will apply to insurance and reinsurance companies (but not to pension
funds) on a consolidated group and solo legal entity basis (ie, not branches). Solvency
II establishes three pillars of supervision. The first is quantitative and covers economic
valuation, available capital, the solvency capital requirement (SCR) and a minimum
capital requirement. The SCR is defined as the capital sufficient to cover a re/insurers
obligations for one year on a 99.5% confidence level (ie, equivalent to a 0.5% target
default probability). It targets all quantifiable risks to available capital underwriting,
financial market, credit, and operational and takes full account of diversification and
risk mitigation. The SCR can be calculated using a predefined Standard Formula or
internal models (full or partial) approved by the supervisor. Furthermore, assets and
liabilities are evaluated on an economic, market-consistent basis, in contrast to book
value accounting used in older generations of solvency regimes.
Figure 2
Solvency II economic balance sheet
Assets at market value
Risk
margin
Best
estimate
liabilities
Hybrid debt
Available capital
Economic net worth
Solvency capital
requirement
Free capital
Source: Swiss Re.
It imposes tougher standards of risk

management and governance.
The second pillar aims to embed risk governance into a firms corporate structure
and day-to-day operations. To that end, it sets out procedural and organizational
requirements for risk management and internal control functions such as audit,
actuarial control and finance. An Own Risk and Solvency Assessment (ORSA)
requires that firms conduct self-assessments of short- and long-term risks to
solvency, including those that are not quantifiable (eg, reputational risks) or directly
related to solvency (eg, liquidity risk). ORSA also assesses the adequacy of capital
resources to meet solvency requirements under a variety of scenarios. Senior
management is ultimately held responsible for ensuring coherence between a firms
business strategy and its risk tolerance.
It aims to enhance transparency for

supervisors and the public.
The third pillar ensures that all relevant solvency-related information is disclosed to
the public and reported to the supervisory authorities. The underlying premise is that
market forces provide additional incentives for disciplined underwriting and risk
management. This is achieved through annual reporting to investors and other
stakeholders of insurers solvency and financial conditions.
Generations of solvency regimes
Figure 3
The three pillars of Solvency II
Solvency II
Pillar I
Quantitative requirements
Pillar II
Qualitative requirements
Pillar III
Market discipline mechanism
Market-consistent valuation of assets

and liabilities
Calculation of available capital
Capital requirements based on
Standard Formula or internal model
approaches
Internal model validation
Public disclosure requirements

solvency and financial condition report
Information to be provided for
supervisory purposes
Consistent information on a timely
basis
System of governance
Internal control
Consistent risk management
Own Risks and Solvency Assessment
(ORSA)
Supervisory review process
Supervisory intervention
Source: Swiss Re.
Solvency regimes in Latin America

Overview
There are three broad groupings of
solvency regimes in Latin America.
Mexico introduced Solvency II-type

legislation in 2013.
Latin American countries can be grouped into three broad categories based on their
current phase of regulatory modernization: (1) those countries in the process of
implementing economic risk-based supervisory frameworks (Mexico, Brazil and Chile);
(2) those transitioning to such a regime (Colombia, Costa Rica and Peru); (3) and the
regions remaining countries that have undertaken few or no actions to modernize.
Mexico
A new insurance law to consolidate existing regulations into a single coherent
framework aligned with international standards was introduced in 2013. The
Insurance and Surety Institutions Law (Ley de Instituciones de Seguros y de Fianzas,
LISF) was five years in the making prior to receiving congressional approval in
February 2013. Since its publication in April of that year, the insurance regulator,
the Insurance and Surety National Commission (CNSF), has been working in
consultation with re/insurers and industry associations to draft enabling legislation
(Circular nica de Seguros y de Fianzas, CUSF).
The implementation timeline is fairly tight.
According to the original timeline, LISF was due to be implemented in April 2015.
However, three quantitative impact studies (QIS) have revealed certain technical
issues that call for structural changes to the solvency model. As a result, in October
2014 it was reported that the Ministry of Finance had agreed to extend the grace
period for certain LISF provisions to January 2016, thereby giving the CNSF and
the industry enough time to test and calibrate the new SCR.2 In addition, the CSNF
announced two further QIS to be held in 2015. Insurers will still be required to run
the new SCR calculations and submit their results to the CNSF as of April 2015.
However, they will not be penalized for failing to meet the new requirements. The
April 2015 launch date will remain in place for qualitative requirements, but that
should not cause undue pressure on the industry.3
The new framework will have the familiar

three-pillar structure.
LISF establishes a three-pillar solvency framework incorporating elements of Europes

Solvency II, US insurance regulation and the Swiss Solvency Test (SST). Pillar I
establishes quantitative capital requirements covering all major risk exposures (see
Box 2 for details). Pillar II encompasses aspects of corporate governance, specifically:
(1) ERM; (2) internal control systems; (3) internal audit functions; (4) actuarial
functions; and (5) outsourcing policies.4 In order to meet these qualitative requirements,
re/insurers must undertake organizational and procedural changes (eg, create an
investment committee), and upgrade their risk measurement, reporting and control
systems. An annual Institutional Risk and Solvency Self-Assessment (the local
equivalent of ORSA) to which the supervisor will be privy, determines a companys
risk appetite, monitors compliance and proposes solutions to any shortcomings.5
A Solvency and Financial Condition Report, available to the public, is intended to
increase transparency and to provide an added layer of supervision.6
In the meantime, Mexican insurers

operate under a factor-based model.
Pending LISF implementation, Mexican insurers will continue to operate under a

factor-based solvency framework that contains certain risk-sensitive components.
On top of minimum paid-up capital requirements, insurers are required to meet
solvency margins equal to the greater of net annual premiums written or claims
incurred during the past three years, multiplied by some factor. That factor varies by
line of business and is adjusted for the credit quality of reinsurance counterparties.
2 Se pospone entrada en vigor de la CUSF, en aspectos especficos, El Asegurador, 20 October 2014,
http://www.elasegurador.mx/index.php/12-cnot/peaprincipal/578-se-pospone-entrada-en-vigor-dela-cusf-en-aspectos-especificos.
3 The third qualitative impact study completed in July 2014 indicated that 65% of market participants
were in compliance with the new rules. The average remaining time to full implementation was estimated
at seven months, which places most insurers well within schedule. See Informe Sectorial Del Estudio de
Impacto Cualitativo 3, CNSF, August 2014.
4 See LISF Article 69 of April 2013.
5 Autoevaluacin de Riesgos y Solvencia Institucionales (ARSI), see CUSF Chapter 3.2,
http://207.248.177.30/regulaciones/scd_expediente_3.asp?ID=05/2356/061114.
6 Reporte sobre la Solvencia y Condicin Financiera (RSCF), see CUSF Chapter 24.1 of July 2013.
The capital requirements to cover earthquake and hurricane exposures are based
on net retained probable maximum loss (PML) estimates, thereby giving due
consideration to the Mexicos high exposure to natural catastrophe risk. In addition,
Dynamic Solvency Testing (DST) requires that insurers test their capital positions
against periodically-updated stress scenarios.7 This ensures that solvency margins
capture a wider array of risks and that the contingency plans stay current with
changing circumstances. Both PML and DST have been incorporated into the LISF.
Brazil is adopting RBC regulation in

a piecemeal fashion.
The regulator plans to implement ORSA

requirements in 2015.
Brazil
Unlike Mexicos big bang approach of comprehensive regulatory reform, Brazils
insurance market regulator, the Superintendence of Private Insurance (SUSEP), is
implementing new rules and directives in a piecemeal fashion. The underwriting
component of the risk capital requirement remains factor-based, but correlation and
pricing-risk coefficients were built into the model in 2007 for non-life insurers and in
2013 for life and pensions insurers.8 Charges for credit and operational risks have
been in place since 2010 and 2013, respectively.9 Finally, market risk regulation will
be added in 2015 and capital charges will be phased in over the subsequent three
years (50% by end-2017 and 100% by end-2018).10 Draft regulation indicates that
market risk capital will be calculated using a value-at-risk methodology and factor in
concentration and liquidity risks.
SUSEP has recently taken steps to strengthen the areas of supervision and corporate
governance. In April 2014, it applied for transitional equivalence with Solvency II,
which applies to reinsurance and group supervision activities. To that end, SUSEP
has set up a working group tasked with developing an ORSA framework.
Implementation is targeted for 2015.11
Figure 4
Evolution of Brazils minimum capital
requirement (MCR)
2010
CNSP Resolution 227
MCR = max (BC+AC; SM)
1. Base capital (BC)*
2. Solvency margin (SM)
3. Additional capital (AC)
Underwriting risk
Credit risk
2013
CNSP Resolution 282
MCR = max (BC+RC; SM)
2. Solvency margin (SM)
3. Risk capital (RC)**
Underwriting risk
Credit risk
Operational risk
2013
CNSP Resolution 302***
MCR = max (BC; RC)
2. Risk capital (RC)**
Underwriting risk
Credit risk
Operational risk
Market risk
*Base capital = minimum fixed level of capital + variable capital depending on the region of operation.
**Risk capital (formerly additional capital) = requirement reflects re/insurers underlying risk profiles.
***Will be replaced by CNSP Resolution No. 316, issued in September 2014 and take effect in 2015.
Source: CNSP, SUSEP, CNSeg.
Pillars II and III require reinforcement.
Public disclosure in Brazil is extensive and timely, though a scarcity of financial and
human resources often constrains SUSEPs ability to scrutinize companies more
deeply and frequently.12 In particular, insurance subsidiaries of large financial groups
and conglomerates, which dominate the local market, are supervised on a
standalone basis rather than at the group level. This may cause certain vulnerabilities
7 See: CNSF Circular S-20.12 of May 11 2004.

8 See: CNSP Resolution No. 158/06 and SUSEP Circular No. 411/10.
9 See: CNSP Resolution No. 228/10, CNSP Resolutions No. 280/13, 282/13, 283/13, and 302/13, and
CNSP Resolutions No. 316/14.
10 Latin America: insurance risk and regulatory developments, Ernst & Young, 2014.
11 See: http://www.solvencyiinews.com/tag/susep
12 Brazil: Detailed Assessment of Observance of Insurance Core Principles of the International Association
of Insurance Supervisors, International Monetary Fund, 2012.
and contagion risks from other entities in the group to go undetected. Similarly, rules
on corporate governance and ERM apply at the solo level, and are still fairly nascent.
Chiles transition to an economic

risk-based regime has been ongoing
for more than 10 years.
Chile
Chiles insurance regulator, the Superintendence of Securities and Insurance (SVS),
committed to a risk-based supervisory regime as early as 2004. Since then, SVS
has laid the groundwork for a Solvency II-type framework by bolstering its own
institutional capacity and refining the methodology for calculating RBC. Enabling
legislation was finally drafted and presented to Congress in September 2011, kicking
off a series of consultation rounds and impact studies. Two revised draft methodology
documents and a quantitative impact study have been concluded so far, with final
congressional approval expected in 2015. Pillar I provisions will be subsequently
phased in over the course of three to five years.
Implementation of Pillars II and III

provisions has proceeded much faster.
Unlike legal reforms to capital adequacy requirements, those pertaining to Pillars II

and III do not require congressional approval. Revised risk-based supervisory
standards for corporate governance and ERM were introduced in 2011 and 2012,
respectively, and are currently being implemented.13 Once in force, insurers will be
obliged to self-assess their corporate governance structures and ERM procedures
and align them with the revised standards, for example, through the creation of chief
risk officer (CRO) positions and risk committees, or by the strengthening of internal
audit functions. Qualitative assessment of a companys ERM procedures then feed
into capital requirements via capital add-ons. On Pillar III, the adoption of IFRS
accounting standards in 2012 has helped improve transparency and comparability
of financial statements.
Risk-based capital will replace the

existing solvency margin.
Until Pillar I legislation is enacted, Chilean insurers will continue to operate under a
factor-based capital model similar to Solvency I but with some local adaptations.14
As in Mexico, insurers are required to post a fixed amount of minimum capital that
is adjusted for inflation. The solvency margin is a factor of net premiums written or
claims incurred, whichever is higher. Factors vary by line of business and the credit
quality of reinsurance counterparties. In addition, Chilean insurers must comply with
a Statutory Debt Relationship which stipulates that total debt cannot exceed a
certain multiple of capital (five times for non-life insurers, 15 times for life insurers),
and that debt to third parties (excluding technical reserves) cannot exceed total
capital.15 This long-standing provision and the minimum capital requirement will be
carried over into the new economic risk-based solvency regime.
13 Regulation for corporate governance and ERM is set out in Norma de Carcter General (NCG) 309 and
NCG 325, respectively.
14 The Ley De Seguros was approved by the lower house Cmara de Diputados and is being reviewed by
the Senates upper house.
15 See SVS Circular No. 215 of August 1982.
Mexico, Chile and Brazils economic RBC

models are unique while sharing the
broad contours of Solvency II.
Box 2: Economic risk-based solvency models in Mexico, Brazil and Chile

The three countries at the forefront of Latin Americas regulatory reform process
differ in their adaptation of economic RBC models. Mexicos draft model is a blend of
Solvency II, the Swiss Solvency Test (SST), elements of the US framework and local
adaptations drawn from the existing framework. Brazil employs a hybrid approach,
whereby insurers must post the higher of minimum base capital and risk capital.
Chile also retains a minimum base capital requirement and a debt leverage
requirement. Like Mexico, Chiles model will use a value-at-risk (VaR) methodology to
determine risk capital requirements, including for the underwriting component. In
Brazil, the underwriting component is factor-based but accounts for pricing/
provision risks as well as correlation between classes of business and region. All
three solvency capital regimes permit partial or full internal models, provided that
these are approved by the respective supervisor.
Table 1
Comparison of prospective solvency regimes
Key criteria
Mexico16
Brazil17
Chile18
Standard model SCR

calculation
Sum of 1-year 99.5% value-at-risk

(VaR 99.5%) corresponding to loss
distribution for six risk categories
(insurance, counterparty,
catastrophe, pension, surety,
operational).
Underwriting, market, credit,
catastrophe risks, liquidity,
concentration and operational risks
(expected in 2015).
Correlation between lines of
business considered through
copula models.
Higher of: (1) base capital, which

varies by region for primary insurers;
and (2) risk capital. Underwriting risk
capital uses a similar square root
formula as the SCR under Solvency II.
Highest of: (1) base capital; (2)

capital to meet maximum debt
leverage ratio; and (3) RBC-model
based on sum of 99.5% VaR per
risk category.
Non-life underwriting (2007), credit

(2010), life and pensions (2013),
operational (2013) and market
(expected by the end of 2014) risks.
Correlation between risk types and
lines of business.
Underwriting, market, credit and

operational risks (effective date to
be determined).
Economic valuation as per IFRS

standards since 2012. Marketconsistent valuation with the
introduction of RBC.
Standards for corporate
governance (NCG No. 309) and
ERM (NCG No. 325) with capital
implications.
Risk types covered
Diversification
Valuation
Economic valuation of assets and

liabilities (expected in 2015).
Economic valuation of assets and

liabilities, as per IFRS since 2010.
Corporate governance
and ERM
Establishes a corporate governance

system (Sistema Gobierno
Corporativo) that ensures
compliance with ERM processes
and procedures, including ORSA,
audit and actuarial functions.
Proposals for an ORSA framework

are expected in November 2014;
implementation targeted for 2015.
Correlation between risk types and

lines of business.
Source: National superintendencies of insurance.
16 Based on Ley de Instituciones de Seguros y de Fianzas published on April 4th 2013, see:
http://www.diputados.gob.mx/LeyesBiblio/pdf/LISF.pdf
17 Based on CNSP Resolution No 316/14.
18 Based on the latest draft methodology document, see: Borrador de Metodologa para la Determinacin
del Capital Basado en Riesgo (CBR) de las Compaas de Seguros (segunda versin), Superintendencia
de Valores y Seguros de Chile, January 2014.
Colombia, Peru and Costa Rica are

undertaking piecemeal reforms to
align with international best practices.
Colombia, Peru and Costa Rica

Similar to Brazil, Colombia, Costa Rica and Peru are introducing incremental changes
to their existing solvency frameworks to gradually align with international best
practices. All three countries are supplementing their factor-based capital models
with additional risk capital charges. None has presented a timeframe for transition to
an economic risk-based solvency regime, but the respective national superintendencies
of insurance have made regulatory modernization a priority.19 The Peruvian
Superintendence of Banking, Insurance and Private Pension Funds (SBS) is using
Solvency II as its reference guide, while the Colombian Superintendence of Finance
(SFC) and the Costa Rican General Superintendence of Insurance (SUGESE) are
pursuing more eclectic approaches.20
Colombia supplements a factor-based

solvency margin with credit and market
risk charges...
Colombia incorporated credit (asset) and market risk capital charges in its factorbased solvency framework in 2010 and 2012, respectively.21 Similar to Solvency I,
the underwriting risk component is a function of premiums, claims and, in the case
of certain life lines of business, mathematical reserves. To calculate credit risk capital,
assets are weighted in accordance with their underlying credit quality (eg, 0% for
risk-free assets and 8.5% for sub-investment grade assets). Market risk capital is
based on a value-at-risk (VaR) methodology. The standard formula assumes perfect
correlation between risk components, such that the final solvency capital
requirement is a simple summation of the three risk capital charges. However,
companies may employ internally-developed models that include diversification
effects provided that these are approved by the SFC.
...Peru goes one step further and

includes operational risk.
Similar to Colombia, Perus solvency capital requirement is equal to the higher of: (1)
an inflation-adjusted minimum capital requirement; and (2) a solvency margin based
on annual premiums written and net claims incurred. Separate capital charges for
credit, market and operational risk were introduced in 2009.22 For all three risk
capital calculations, insurers can choose between a fixed-factor standard formula
and an internal risk-based model that is subject to approval by the SBS. In 2014, the
SBS added a concentration risk component to the market risk capital requirement
that accounts for vulnerabilities arising from over-exposure to certain investments.
Furthermore, like Chile, Peru has a statutory debt limit for insurance companies,
whereby total debt is not allowed to exceed total solvency capital.
Costa Rica goes farthest with three

additional capital charges covering
catastrophes risks, reinsurance and
asset-liability mismatches.
Costa Rica has gone farthest in the adoption of additional risk-capital charges. The
Regulation on the Solvency of Insurance and Reinsurance Entities, which dates back
to 2008 but was significantly modified in 2013, subjects local re/insurers to credit,
operational and market-risk charges.23 Like Colombia, Costa Rica employs a VaR
methodology for market risk exposures and credit-risk weighting of invested assets.
Like Peru, the market risk component factors in concentration risks. In addition,
Costa Ricas solvency framework differs from Colombia and Perus in three important
respects. First, it includes a separate solvency capital requirement for catastrophe
risks, which is calculated as the probable maximum loss (PML) of catastrophe
exposures net of reinsurance. Second, it has a separate capital requirement for
reinsurance operations that accounts for credit and concentration risks. And finally,
it takes into consideration maturity and currency mismatches on insurers balance
sheets, also through a separate capital charge.
19 See Memoria annual 2009, SBS, y AFP, 2009.
20 Perus SBS created a Special Committee on Basel II-Solvency II in 2008 with the aim of aligning
regulation to the European model. Colombias Internal Supervisory Framework (Marco Integral de
Supervisin) draws on Canadian insurance regulation as well as Solvency II. See: Prioridades de Poltica
de la Industria Aseguradora, Fasecolda, June 2013. Costa Ricas supervisory model is based on IAIS
principles. See Informe Final de Labores en el Cargo Intendente General de Seguros, SUGESE, 2012.
21 See Decreto No. 2954 of August 2010 and SFC Circular Externa 045 of November 2012.
22 See Articles 298 to 305 of the Ley General del Sistema Financiero y del Sistema de Seguros y
Orgnica de la Superintendencia de Banca y Seguros (# 26702) of 2013.
23 Reglamento sobre la Solvencia de Entidades de Seguros y Reaseguros, Superintendencia General de
Seguros, July 2013 (updated on October 3 2014). Guidelines for calculating risk capital requirements
were introduced in August of 2013 following five years of development. See Lineamientos Generales
Para La Aplicacin del Reglamento sobre la Solvencia de Entidades de Seguros y Reaseguros,
Superintendencia General de Seguros, July 2013.
All three countries are striving to

overcome capacity constraints.
RBC in Argentina, Venezuela and the

regions smaller economies remains
a distant prospect.
Notwithstanding these accomplishments, the three countries are not expected to

have fully-fledged economic risk-based capital regimes for some time yet. There are
currently no formal commitments to switch from fixed-factor solvency margins and
none of the three has applied for Solvency II equivalence. Insufficient institutional
and human capacity, particularly the availability of actuarial talent, is a binding
constraint, though the countries superintendencies are taking steps to address
this.24 They are also seeking to bolster supervision of corporate governance, ERM
and economic valuation, which are relatively underdeveloped from a risk and
solvency perspective and vary widely among insurers.25
Argentina, Venezuela and the rest of Latin America
Argentina and Venezuela the third and fourth largest insurance markets in the
region, respectively and most of the other countries in Latin America have
undertaken few modernizing reforms in the recent past. Like Colombia, Costa Rica
and Peru, these countries operate under factor-based capital models (ie, some factor
of net premiums or claims written over a specific period of time). However, few have
specific surcharges for non-technical investment or operational risks, and those that
do (eg, Panama) so far only consider asset risks. Rules and guidelines pertaining to
corporate governance and ERM are scattered and lack a clear solvency focus.26
While many of the countries have expressed support for the risk-based supervisory
agenda, none has committed to a concrete timetable.
Argentina has an ambitious reform plan

but has made no firm commitments.
In 2012, the insurance regulator in Argentina, the National Superintendence of

Insurance (SSN), introduced an eight-year Strategic Plan for Insurance (Plan Nacional
Estratgico del Seguro 20122020, PlaNeS) to modernize and strengthen the
existing supervisory framework.27 The plan includes objectives to explore the
possibility of introducing risk capital provisions, risk-based supervision and IFRS
accounting standards for re/insurers. A working group was subsequently established
to study the implications of IFRS adoption, and the SSN has reportedly been
evaluating the applicability of solvency and regional capital models.28 However,
no timetable for either RBC or IFRS adoption has been forthcoming as of yet.
Venezuela has not published any

solvency reform proposals since 2010.
Venezuelas authorities have not presented any new solvency reform proposals since
the enactment of the landmark Insurance Activity Bill in 2010 (Ley de la Actividad
Aseguradora, LAA). That law paved the way for improvements to reserve and
minimum capital provisions, yet neither the LAA nor any legislation since has made
specific mention of RBC models or supervision.29 Venezuela adopted IFRS accounting
standards in 2008 for all companies including insurers, with certain modifications to
account for the high inflation environment. Companies are required to present pricelevel adjusted financial statements when the rate of inflation is 10% or more.
Modernization in the regions smaller

countries is advancing very slowly.
The remaining countries in the region have made minimal progress towards an
economic risk-based solvency regime. This is in large part a function of their
relatively small markets and institutional constraints.
24 For example, the SBS has launched an Institutional Strengthening Programme (20132016). See
Memoria anual 2012, Superintendencia de Banca, Seguros, y AFP, 2012. See Colombia: Financial
System Stability Assessment, International Monetary Fund, February 2013.
25 See Memoria anual 2010, SBS, 2010, and Memoria anual 2013, SBS, 2013. Costa Rica has had
comprehensive corporate governance regulation in place since 2009, but not an ORSA process. See
Reglamento de Gobierno Corporativo, Superintendencia General de Valores, July 2009.
26 Argentina: Detailed Assessment of Observance of Principles for Insurance Supervision, International
Monetary Fund, September 2012.
27 Plan Nacional Estratgico del Seguro 20122020: Documento de Proyecto, Superintendencia de
Seguros de la Nacin, May 2012.
28 A un ao de la implementacin del PlaNeS: Plan Nacional Estratgico del Seguro 20122020,
Superintendencia de Seguros de la Nacin, October 2013, p 66.
29 Ley de la Actividad Aseguradora, Superintendencia de la Actividad Aseguradora, 39.481, 2010.
Colombia, Costa Rica and Perus

solvency frameworks are similar.
Box 3: Economic risk-based solvency in Colombia, Costa Rica, and Peru

The solvency frameworks of Colombia, Costa Rica and Peru share the same basic
structure: (1) a minimum paid-up capital requirement, in each case adjusted for
inflation; (2) a factor-based solvency margin for underwriting risks; and (3) additional
risk capital charges for certain non-technical risks. Costa Rica differs in that it uses
technical reserves net of reinsurance rather than net premiums or claims to calculate
the underwriting portion. Also, it has a separate capital requirement for catastrophe
risk, whereas this are included in the reserve requirements in Peru and Colombia.
Table 2
Comparison of current solvency regimes
Key criteria
Colombia30
Costa Rica31
Peru32
Standard model SCR

calculation
Higher of (1) minimum required

base capital plus minimum
additional capital by line of business;
and (2) risk SCR determined using
a function of underwriting, risk, and
asset SCRs.
Higher of (1) minimum base capital

requirement by carrier (personal
insurer, general insurer, cpmposite
and reinsurer); and (2) linear sum of
underwriting and risk capital
requirements.
Underwriting SCR
Non-life: higher of (1) annual net

premiums written multiplied by a
factor, and (2) net claims incurred
during the previous 36 months
multiplied by a factor.33
Life: mathematical reserves
multiplied by a factor, net of
reinsurance.
Asset (2010), market (2012).
Non-life: sum of technical provisions

by line of business multiplied by a risk
factor, net of reinsurance.
Life: sum of mathematical reserves
multiplied by a risk factor, net of
reinsurance.
Higher of: (1) minimum fixed

capital; (2) solvency margin.
Capital for non-technical risks
is to be held in Guarantee Fund
(Fondo de Garanta). A separate
statutory debt limit equal to total
effective capital.
Life and Non-life: higher of (1)
annual net premiums written
multiplied by a factor, and (2) net
claims incurred during the
previous 36 months multiplied by
a factor.
Credit and catastrophe (2009),

operational and market (2014).
Not applicable.
Credit, market, and operational

(2013).
Not applicable.
Economic valuation in accordance

with IFRS since 2003.34
Corporate governance regulation has
been in place since 2009. It does not
include an ORSA.36

since 2013.
Code of Best Practice in Corporate
Governance since 2002 and
Comprehensive Risk Management
Regulation since 2008.37
Risk capital components

Diversification
Valuation
Corporate governance
and ERM
So far only for approved internal

models.
(expected end-2015).
Code of Best Practices in Corporate
Governance since 2007. It does not
include an ORSA.35
Source: National superintendencies of insurance.
30 Based on Decreto No. 2954 of August 2010 and Circular Externa 045 of November 2012
31 Based on: Reglamento sobre la Solvencia de Entidades de Seguros y Reaseguros, SGUESE, September
2008, and Lineamientos Generales Para La Aplicacin del Reglamento sobre la Solvencia de Entidades
de Seguros y Reaseguros, SUGESE, July 2013.
32 Based on Ley General del Sistema Financiero y del Sistema de Seguros y Orgnica de la
Superintendencia de Banca y Seguros (# 26702).
33 To determine net premiums, gross premiums are multiplied by the retention rate (net claims/gross
claims), which cannot be less than 50%.
34 See Article 12 of Ley Reguladora del Mercado de Seguros (#8653) of August 2008.
35 SFC Circular Externa 028 of 2007 and SFC Circular Externa 007 of 2011.
36 See Reglamento de Gobierno Corporativo, Superintendencia General de Valores, July 2009.
37 See Cdigo de Buen Gobierno Corporativo para las Sociedades Peruanas, Superintendencia del
Mercado de Valores, November 2013; and SBS Resolution No. 037 of 2008.
Figure 5
Solvency regimes in the main Latin American
markets as of November 2014
Country
Risk category
Argentina
Bolivia
Brazil
Solvency margin
Solvency margin
Underwriting
Market
Credit
Operational
Underwriting
Market
Credit/asset
Operational
Solvency margin
Market*
Asset*
Solvency margin
Market*
Credit*
Solvency margin
Underwriting
Market
Credit/asset
Operational
Chile
Colombia
Costa Rica
Ecuador
Mexico
Panama
Peru
Uruguay
Venezuela
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Solvency margin
Solvency margin
Market*
Credit/asset*
Operational*
Solvency margin
Solvency margin
Solvency margin Underwriting Market Credit/Asset Operational

*Stripped patterns indicate transition to economic risk-based solvency regimes.
Note: expectations of future changes in solvency regulation are based on latest information and are subject to change.
Source: IFRS, IMF, National Superintendencies of Insurance, AXCO.
Implications of solvency regime changes

Economic risk-based solvency regulation
will have implications for four key areas.
The model design process is ongoing

and fluid
but capital requirements are ultimately

expected to increase.
The net effect of the new solvency regulations in their respective countries will
vary depending on the country-specific model designs and market circumstances.
Nevertheless, some general inferences about the potential impact on (1) capital
requirements; (2) insurance product mix; (3) industry concentration; and (4)
reinsurance demand can be drawn from current trends and past precedents.
Capital requirements
It is too early to say what the impact of new solvency rules on solvency capital
requirements will be. The model design process is ongoing and fluid, with many
methodological aspects still to be determined. Moreover, several features of the
respective economic risk-based solvency regimes or RBC models should help
mitigate the impact of additional capital charges. The sequence and pace of
regulatory reform will also determine the ease of adjustment for insurers.
Regarding the overall level of capital required, there is broad consensus that the
balance of risks lies to the upside.38 The results of the fifth and latest European
Insurance and Occupational Pensions Authority (EIOPA) quantitative impact study,
which estimated an increase in the solvency capital requirement of around 140%
38 See for example: Mexico Insurers: March 2014 Financial Ratios, Fitch Ratings, July 2014; 2014 Outlook:
Chilean Insurance Sector, Fitch Ratings, December 2014; Insurers predict rise in premiums from changes
to supervision model, BNamericas, April 2012.
with the introduction of Solvency II in Europe, may influence this view.39 In the case
of Mexico, the authorities have yet to reveal the technical details of their QIS 3
concluded in August 2014, although they have highlighted significant challenges to
implementation.40 Also, much of the adjustment will be front-loaded since Pillars II
and III will still be implemented in April 2015 unlike most provisions of Pillar I
which have been pushed back to January 2016 and will entail significant costs.
Sequencing and pacing should facilitate
adjustment for insurers.
The more gradual approaches adopted by Brazil and Chile should soften the impact
for insurers in those markets. In Brazil, the piecemeal introduction of an economic
risk-based solvency regime from 2007 does not appear to have put undue pressure
on insurers capital positions or bottom lines. Rather, insurers have been granted
considerable time to make necessary adjustments, such as raising capital, derisking balance sheets or diversifying their product mixes. The phase-in of market
risk capital, likely by the end of 2014, is thus not expected to create a major shock.
There are also early indications of pre-emptive measures by insurers in Chile in
anticipation of the forthcoming economic risk-based solvency regulation, despite
the still uncertain timeframe of the legislative agenda.41
Diversification will help mitigate

the impact of new capital charges.
Diversification and risk mitigation are integral to economic risk-based solvency

regimes and will help mitigate additional risk capital charges. Diversification applies
to risk categories (ie, underwriting, market, operational and credit) and to lines of
business. In the fifth QIS of the EUs Solvency II framework, diversification effects
were shown to be between 20% and 36% of the SCR for non-life and life insurers,
respectively. Brazil, Chile and Mexicos economic risk-based solvency models allow
for diversification effects between lines of business and risk types. If the latter are
demonstrated to be weakly or negatively correlated, substantial capital savings may
result (see Box 4 for an illustration).
Reinsurance can be an effective and

efficient form of capital relief.
Similarly, reinsurance offers significant capital relief under Standard Formulae of

the new economic risk-based solvency frameworks, and often at a lesser cost than
other financing tools such as equity or subordinated debt.42 The trade-off between
alternative capital management tools is summarized in Figure 6. Compared to other
forms of capital-raising, reinsurance reduces the SCR and also frees up own funds
for alternative uses. Further, the new rules imply that reinsurance will be more closely
linked to risk transfer than under previous regimes, these having been generally
based on book value accounting rather than market-consistent valuations.
Figure 6
Solvency capital management tools
Assumed underwriting and market risks
Raise capital
New capital
Sources
Example
Shares
Impact
Hybrid
capital
Own funds
Reduce risk exposures
Unlock hidden
Retained earnings
capital
Cut dividends Reinsurance
Share buyback
Own funds
Own funds
Own funds
(
SCR)
Emphasis on increasing own funds
Exit exposures
Sale of assets
Exit businesses
SCR
Risk mitigation
Reinsurance
Hedging
SCR
Emphasis on reducing SCR and stabilizing own funds
Source: Swiss Re.

39 EIOPA Report on the fifth Quantitative Impact Study (QIS5) for Solvency II, European Insurance and
Occupational Pensions Authority March 2011.
40 Informe Sectorial del Estudio de Impacto Cuantitativo 2, CNSF, June 2014.
41 For example, see: Consorcio Seguros raises capital ahead of new regulations, BNamericas, February
2013.
42 For a discussion of the economics reinsurance capital solutions, see: E. Gurenko and A. Itigin,
Reinsurance as Capital Optimization Tool under Solvency II, World Bank, 2013. Also: O. Mayo and
B. Heinen, Reinsurance as a capital management tool under Solvency II, Swiss Re, 2013.
Box 4: Example applying the Standard Formula to a Mexican life insurer

A stylized example illustrates the potential impact of diversification effects and
reinsurance relief on the solvency capital requirements using the EUs Solvency II
standard formula. The life insurer in Mexico is assumed to mirror the market average,
with the following characteristics:
Annual premium revenue of MXN 8.2 billion and assets of MXN 12 billion;
Product mix consists of individual and group life products; and
Investment portfolio comprises 95% A-rated Mexican sovereign bonds and
5% cash.
Reinsurance can help a life insurer with

an average risk profile...
The insurer enters into a 50% quota share on all risk insurance products for a
7% margin and 60% profit participation.
Based on Solvency II standard RBC model formula, the insurer could reduce its SCR
for life underwriting risk by 36% from MXN 16 billion to MXN 10 billion, with the
largest impact on mortality risk. Diversification between risk categories generates
capital savings of between 3040%, depending on whether reinsurance cover is
purchased. In the final SCR, the RBC model adds MXN 3 billion of market risk capital,
MXN 300 million of operational risk capital and, assuming reinsurance, MXN 60
million of counter-party default risk capital, for a total of ~MXN 3.3 billion of additional
capital requirement. Diversification between modules subtracts MXN 2 billion (MXN
1.9 billion with reinsurance).
...realise substantial capital relief.
Figure 7
Life solvency capital requirement (LHS) and
overall solvency Capital requirement (RHS),
in millions of pesos
Diversification across
risk segments
Without reinsurance
With reinsurance
5 4
0.3 0.3
3 3
2 1.9
2 2
16
16
1 0.6
10
17
10
12
SCR Final
= 5.8
Operational
2.8
Diversification
3.5
Non-Life
Default
Diversification
0.6
Market
Cat
0.4
Life SCR
Expense
4.1
Life SCR
Lapse
3
Disability
Reinsurance
capital savings =
Mortality
Diversification across
modules
0.1
0.1
= 5.5
Source: Swiss Re.
The industry product mix may shift

towards capital light products...
Product mix
The differential capital treatment of risk categories and/or business lines may
influence the demand and supply of certain insurance products. On the supply side,
insurers may be incentivized to concentrate on less capital-intensive products. For
example, market risk capital add-ons favour unit-linked products over those that
contain financial guarantees since the former pass the market risk exposure on to
policyholders.43
43 A. Al-Darwish, M. Hafeman, G. Impavido, M. Kemp, and P. OMalley, Possible Unintended

Consequences of Basel III and Solvency II, International Monetary Fund, August 2011.
The higher underwriting risk capital associated with more actuarially complex
products such as life annuities, may also discourage their development.44 The
introduction of RBC models could therefore trigger or reinforce a shift away from
pension schemes with mostly defined benefits to those that rely on policyholder
contributions. In Brazil, such a trend has been manifest in the displacement of
traditional defined benefit plans by unit-linked pension and life insurance products
known as PGBL (Plano Gerador de Benefcio Livre) and VGBL (Vida Gerador de
Benefcio Livre), which do not offer a minimum rate of return or a lifetime income
(see Figure 8). Mexico has experienced a similar trend with the share of defined
benefit plans falling from 93% in 1995 to 27% in 2013.
as seen in Brazil and Mexico.
VGBL
PGBL
Traditional plans
2013
2012
2011
2006
2010
2001
2005
1996
2000
2014
2013
0%
2012
0%
2011
20%
2010
20%
2009
40%
2008
40%
2007
60%
2006
60%
2005
80%
2004
80%
2003
100%
2002
100%
1995
Figure 8
Pension schemes in Brazil (LHS) and
Mexico (RHS)
Hybrid
Defined contribution
Defined benefit
Source: FenaPrevi (for Brazil) and Consar (for Mexico).
High capital charges will translate into

higher prices for consumers.
On the demand side, high capital requirements and/or costs associated with new
regulations could be passed on to consumers in terms of higher prices.45 In a region
where affordability is a key driver of spending decisions, higher costs could have a
significant impact on insurance demand.46
Smaller carriers and mono-line insurers

may be disadvantaged by the new rules.
Industry consolidation
Tighter capital regulation will impact insurers differently. Some will be better placed
to absorb the additional costs of meeting the new capital requirements. In general,
larger multi-national carriers will have an advantage by being able to call upon parent
or affiliated companies for capital and operational support. In contrast, smaller- and
medium-sized firms may find it harder to raise capital and achieve cost savings
through scale. Mono-line insurers will be at an added disadvantage because they
will reap fewer diversification benefits. Faced with such pressures, smaller or weaker
firms may be forced to exit the market or merge with others. Less diversified insurers
may seek to acquire non-correlated businesses in order to gain some diversification
benefits or to accelerate a shift in their product mix.
44 In Brazil and Mexico, pension funds are subject to the same capital requirements as insurance
companies.
45 This is a concern of the Chilean insurance industry association, the A.A.C.H. See: Insurers predict rise in
premiums from changes to supervision model, BNAmericas, 4 April 2012.
46 A customer survey conducted by Swiss Re in 2013 found affordability to be the main reason why Latin
Americans do not take out savings products for retirement. See: Latin America Customer Survey Report
2013: Capturing future opportunities, Swiss Re, 2013.
Consolidation is most likely in the more

fragmented markets.
Consolidation as a result of tighter solvency regulation is most likely in Latin Americas

more fragmented markets, notably Mexico and Brazil (see Figure 9). For example,
at the end of 2013 roughly two fifths of primary insurers in Mexico were mono-line
and around half had turnover of less than USD 100 million. Of these smaller, less
diversified carriers, the majority (70% in both cases) were local. Moreover, average
minimum capital adequacy levels of foreign insurers were almost three times higher
compared to the average for local carriers.47 Against this backdrop, the implementation
of LISF in Mexico is likely to lead to increased mergers and acquisitions activity.
Figure 9
Industry concentration in select
Latin American markets, 2013
100%
80%
60%
40%
20%
0%
Peru
Colombia
Venezuela
Top-5 Market share
Mexico
Chile
Foreign participation
Argentina
Brazil
Mono-line
Source: National Supervisory Authorities, National Insurance Associations.
Reinsurance has not been widely used

as a capital management tool in Latin
America
but the search for capital savings

will likely stimulate more demand.
Reinsurance demand
Reinsurance has not been widely used as a regulatory capital management tool in
Latin America. This may be partly due to a silo mentality driving individual business
units to make reinsurance purchasing decisions independently of one another and
with little regard to capital implications. This, in turn, may be symptomatic of the lack
of integrated risk and capital management practices across much of the region.48
Against this backdrop, the strengthening of ERM frameworks and by extension the
diffusion of capital optimization practices may drive a rise in demand for
reinsurance solutions.
The advent of economic risk-based solvency regulation in Latin America is also
expected to stimulate demand for proportional and non-proportional reinsurance.
All generations of capital models allow for reinsurance capital relief via reductions in
net retained risk exposure. The Solvency II Standard Formula has the added feature
of volatility-reducing non-proportional adjustment factors. Standard excess of loss
(XOL) treaties can be used against specific capital-intensive exposures (albeit for
now only for non-life insurers), thereby allowing for more targeted and efficient
capital relief than under fixed factor models, which favour proportional reinsurance.
This should go some way to boosting the attractiveness of non-proportional
reinsurance in a region where it makes up just a small share of the product mix
(around 6% in Mexico and Brazil). Much will depend on the final scope and
specifications of countries respective solvency regimes. In Mexico, for example,
proportional reinsurance solutions will likely remain the instrument of choice given
that the current draft framework permits insurers to release catastrophe reserves in
addition to regulatory capital.
47 Based on CNSF definitions, see: http://www.cnsf.gob.mx/paginas/informacionfinanciera.aspx

48 As observed by the Global risk management survey: eighth edition, Deloitte, 2013.
Outlook and risks

Forces of regulatory modernization
There are two longer-term convergence
forces at play in insurance in Latin
America.
Competition for foreign investment drives

top-down reform
The trend towards similar economic risk-based solvency regulation in Latin America
is set to continue. Other countries are expected to follow in the steps of Mexico,
Brazil and Chile. As noted, Colombia, Costa Rica and Peru are gradually approaching
the regulatory frontier and are likely to switch over to a risk-based supervisory
framework in the not-so-distant future. Argentina, Venezuela and most other
countries in the region are farther behind and show no sign of initiating reforms
anytime soon. Their experiences are a reminder that convergence is not a foregone
conclusion and that much depends on a countrys policy orientation and political
climate. Nevertheless, there are two longer-term convergence forces at play in Latin
America. These are: (1) a quasi race to the top brought about by increased foreign
competition; and (2) the influence of international standard setters and supervisory
networks.
Competitive pressures
Within the context of a trend of financial liberalization across Latin American since
the 1980s and 1990s, there has been an apparent drive by the regulators to enhance
the relative attractiveness of their markets to foreign investment and also to bolster
the competitiveness of local players at home and abroad. Robust and transparent
solvency frameworks serve both purposes.49 In the case of Solvency II, so-called
equivalence with EU directives not only helps to level the playing field for foreign
subsidiaries, it also grants Latin American insurers access to the EU common market.
Investment has so far been overwhelmingly from north to south, but the rapid
growth of regional insurance groups, the so-called Multi-Latinas, could see the
start of two-way traffic.
and competition for market share

drives it bottom-up.
Competition works bottom up also. The combination of excess capacity across most
Latin American insurance markets with historically low interest rates has put greater
stress on operational efficiency to preserve profit margins. Loose monetary policies
in advanced economies and heavy inflows of foreign capital into Latin America have
eroded investment margins across the region. At the same time, an influx of
multinational insurance firms seeking higher growth opportunities abroad has
contributed to soft market conditions.
Insurers in Mexico, Brazil, Chile and

Colombia face fierce competition from
foreign firms.
In particular, in Mexico, Brazil, Chile and Colombia local carriers face fierce
competition from foreign entrants that often have leaner cost structures and stronger
balance sheets. They typically hail from jurisdictions with advanced solvency
frameworks in place (the US, European countries, Switzerland or Bermuda). Most
have already instituted advanced ERM and corporate governance structures, which
gives them an advantage over local counterparts in adapting to the shifting regulatory
environment.50 For their part, local insurers appear to be pre-empting their regulators
by adjusting their capital structures, improving corporate governance and upgrading
their ERM and IT systems, all to be more competitive. From this perspective, therefore,
local regulators are simply keeping up with evolving realities on the ground.
Competitive pressures are likely

to persist.
Competitive pressures are likely to persist for some time. Latin Americas significant
growth potential and expanding middle classes remain compelling value propositions
for many current and prospective entrants, notwithstanding the regions weaker
economic outlook. Pressure to conform to international best practice will also likely
endure, not least because of the planned application of group-wide supervision to
International Active Insurance Groups (IAIGs). This means that multi-national insurers
may be subject to a risk-based Global Insurance Capital Standard (ICS) irrespective
of the rules prevailing in their host countries. Higher interest rates accompanying the
US recovery will provide only partial relief as there is typically a lag in the transmission
to insurers investment portfolios.51 Also, many Latin American governments have
49 See: http://www.strategic-risk-global.com/why-brazil-is-optimistic-about-solvency-iiequivalence/1407306.article.
50 2014 EY Latin America insurance outlook, E&Y, 2014.
51 See sigma No. 3/2014 for a discussion of the interest rate legacy for the insurance sector.
Outlook and risks
cut policy rates in recent months to boost economic growth. Assuming the tide
of financial globalization sweeping Latin America does not retreat, improving
operational efficiency will remain key.
International standard setters are actively

promoting regulatory convergence.
The influence of standard setters and supervisory networks

On the push end of the convergence process are international institutions such as
the International Monetary Fund (IMF), and standard setters such as the Financial
Stability Board (FSB) and the International Association of Insurance Supervisors
(IAIS), whose stated aim is to promote globally consistent supervision.52 By
highlighting deviations from insurance core principles and recommending ways to
align with them, these organizations act as both signposts and guides for local
insurance regulators and supervisory bodies. In certain cases, their recommendations
have provided the impetus for change. For example, Chiles IMF Financial Sector
Assessment Program (FSAP) of 2004 is widely cited as the spark that set off that
countrys regulatory reform process.53 Furthermore, these organizations provide
forums for supervisors to share experience and policy ideas, thereby furthering the
diffusion of international best practices.
The financial crisis has acted as an

additional catalyst.
The financial crisis in 2008 led the international supervisory bodies to refine the
existing insurance core principles (ICPs) and redouble efforts towards global
harmonization. For their part, national regulators moved to bolster their regulatory
regimes after the crisis exposed shortcomings in Solvency I, notably in mitigating
credit and market risks. Accordingly, Brazils SUSEP, Chiles SVS and Mexicos CNSF
all signed the IAISs multi-lateral memorandum of understanding in the years
following the crisis. To date, Brazil is the only Latin American country that has been
assessed under the revised ICPs. Its 2012 FSAP review indicated a relatively low
level of compliance with ICPs, with poor scores for capital adequacy (ICP 17) and
valuation (ICP14), and a zero score for ERM for solvency purposes (ICP16).54
Partially in response to the reports recommendations, in 2013 Brazils regulator
SUSEP set up a working group to study Pillar II initiatives.55
Openness and liberalization create an

enabling environment for reform.
Competitive pressures and the influence of international standards are in part a

function of an economys level of openness and engagement with international
supervisory community. Latin American countries differ widely in these respects.
The founding members of the Pacific Alliance group (Chile, Colombia, Mexico and
Peru) have taken a decidedly liberal stance to foreign competition by opening up
their insurance markets and subscribing to bilateral free trade and investment
agreements, which typically carry enhanced market access commitments. For
instance, Colombias free trade agreement with the US signed in 2006 and ratified
in 2011 led indirectly the removal of key market access restrictions.56 Similar
agreements have been forged between the US and Peru (2009), Chile (2004) and
Mexico (1994).
52 See IAIS mission statement: http://www.iaisweb.org/.

53 For example, see: Borrador de Metodologa para la Determinacin del Capital Basado en Riesgo (CBR)
de las Compaas de Seguros (segunda versin), SVS, January 2014.
54 Brazil: Detailed Assessment of Observance of Insurance Core Principles of the International Association
of Insurance Supervisors, International Monetary Fund, 2012.
55 Relatrio de Gesto do exerccio de 2013, Superintendncia de Seguros Privados, 2014.
56 Specifically, heading VII of Ley 1328 of 15 July 2009, effective as of July 2013, led to: (1) the removal of
the statutory restriction preventing Colombian residents from purchasing insurance products while
abroad (with the exception of certain compulsory classes); and (2) for certain specialty lines of business,
foreign insurers can now offer non-admitted insurance in country (subject to registration in a newly
created registry RAIMAT).
Stumbling blocks
Restrictive measures reduce incentives
for insurers and supervisors to innovate.
The risk of protectionism is most acute

in countries pursuing interventionist
economic policies.
Local insurers and supervisors may

struggle to marshal the human, financial,
and technological resources to properly
implement the new rules.
Macro-economic instability complicates

the application of RBC.
Restrictive measures
Just as liberalization and engagement with the international insurance community
have spurred regulatory reform in some countries, so their absence may explain the
lack of progress in others. Restrictive measures, such as the attempt to limit foreign
participation and/or to retain more premiums in country, reduce incentives for
insurers and supervisors to modernize. Similarly, disengagement from the international
insurance community limits the dissemination of best practices. At a lesser extreme,
the high costs of adjustment for local companies could persuade policymakers to
delay or slow the pace of reform.
The threat of restrictive measures is most pronounced in Argentina, Brazil, Ecuador
and Venezuela. In Argentina, for example, admitted reinsurers can only provide
cross-border reinsurance for individual risks over and above the USD 50 million and
a foreign reinsurer cannot register as local if it is headquartered in a known tax haven
or a country where the tax rate is below 20%.57 In Ecuador, a proposal to amend
insurance legislation requiring that all ceded risks be placed with local reinsurers
(of which there are currently only two) was subsequently rejected by Congress in
July 2014. In Brazil, two important restrictions were imposed on the reinsurance
industry in 2011: (1) a resolution mandating local insurers to place 40% of their risk
with local reinsurance companies, and (2) a resolution prohibiting local re/insurers
from transferring more than 20% of the insurance premiums per coverage to foreign
companies from the same economic group.58
Capacity constraints
Perhaps the greatest obstacle to implementation of Solvency II-type regimes are the
significant capital, human and system resources required to measure and manage
risk. These are generally in short supply in Latin America, particularly data availability
and actuarial talent. In Colombia, for example, the IMF estimated that there were less
than 120 professional actuaries in the country in 2013.59 Further, the substantial
investments in human capital and technology needed to bring both regulatory
bodies and insurers up to standard may be harder to come by in the current
economic climate.
Macroeconomic instability
Macroeconomic instability complicates the task of insurance regulation in general
and the implementation of RBC in particular. Put simply, increased macro risk implies
more volatile risk capital requirements. For example, high inflation rates such as in
Venezuela and Argentina, make it harder to estimate future underwriting risks and,
by extension, capital requirements on longer-tail exposures. It also makes the
application of backward-looking VaR models less reliable as a guide to future price
behaviour. Meanwhile, greater price volatility in Latin American financial markets can
generate higher and more erratic capital charges. Tight restrictions on foreign
investment means carriers largely invest in local debt (mostly sovereign) and equity
securities. These are often illiquid and difficult to price. Applying mark-to-market
accounting to trading-book assets would therefore likely lead to large swings in
market risk capital requirements, particularly during periods of heightened volatility.
57 See SSN Resolution 35.615 of February 2011.

58 See CNSP Resolution No. 232/11 and CNSP Resolution No. 225/10.
59 Colombia: Financial System Stability Assessment, International Monetary Fund (Feb 2013).
Conclusion
Latin Americas countries are moving in
the direction of risk-based insurance
supervision, at varying speeds.
Latin America is steadily moving in the direction of economic risk-based solvency

regimes for insurers, but at varying speeds. Mexico, Brazil and Chile are in the lead
and are advancing at a brisk pace. If their respective governments can maintain the
momentum, these countries may well have economic risk-based solvency regimes in
place by the time Solvency II takes effect in the EU. The middling economies of
Colombia, Costa Rica and Peru have made significant progress to date, but still have
a long way to go and face formidable hurdles along the way. Argentina and
Venezuela are trailing behind as they have yet to undertake major reforms and they
have made few credible commitments to that end.
The study highlights four key implications

to solvency regime change.
This study finds four key implications of economic risk-based solvency regulation in
Latin America. First, the addition of risk-based charges is likely to lead to higher
overall capital requirements. Second, insurers will likely adjust their product and
business mix in order to optimize their regulatory capital consumption. Third, smaller,
mono-line insurers will struggle under the new rules, being unable to benefit from
diversification effects or economies of scale. Such pressures are expected to result in
increased mergers and acquisitions in the region. Finally, efforts to achieve capital
savings are also likely to generate increased demand for reinsurance.
Convergence is expected to continue,

but the path will be challenging.
The competitive pressures to conform to international best practices and the

influence of global standard setters are expected to sustain reform momentum.
However, the path ahead has many pitfalls. Restrictive measures limit the incentives
for local re/insurers and supervisors alike to undertake reforms. The lack of
institutional capacity is a major constraint in Latin America, as is vulnerability to
macroeconomic instability.
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The editorial deadline for this study was 11 December 2014.
Authors:
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Insurance Solvency Regulation in Latin America

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Insurance Solvency Regulation in Latin America

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Insurance solvency regulation in Latin America:

Latin America is part of a global move towards economic risk-based solvency

New solvency regulations are likely to

The trend of regulatory modernization will

although restrictive measures, macro

Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds 1

Generations of solvency regimes

Solvency II has become an important

Advanced economies have made the

Among the emerging markets, countries

Among emerging markets, Asian countries have made significant progress in

Source: Swiss Re Economic Research&Consulting.

1 Evolving Insurance Regulation: The kaleidoscope of change, KPMG, March 2014.

2 Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds

Solvency II is an economic risk-based

Box 1: What is Solvency II?

Assets at market value

Source: Swiss Re.

It imposes tougher standards of risk

It aims to enhance transparency for

Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds 3

Generations of solvency regimes

Market-consistent valuation of assets

Public disclosure requirements

Source: Swiss Re.

4 Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds

Solvency regimes in Latin America

Mexico introduced Solvency II-type

The implementation timeline is fairly tight.

The new framework will have the familiar

LISF establishes a three-pillar solvency framework incorporating elements of Europes

In the meantime, Mexican insurers

Pending LISF implementation, Mexican insurers will continue to operate under a

Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds 5

Solvency regimes in Latin America

Brazil is adopting RBC regulation in

The regulator plans to implement ORSA

Pillars II and III require reinforcement.

7 See: CNSF Circular S-20.12 of May 11 2004.

6 Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds

Chiles transition to an economic

Implementation of Pillars II and III

Unlike legal reforms to capital adequacy requirements, those pertaining to Pillars II

Risk-based capital will replace the

Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds 7

Solvency regimes in Latin America

Mexico, Chile and Brazils economic RBC

Box 2: Economic risk-based solvency models in Mexico, Brazil and Chile

Standard model SCR

Sum of 1-year 99.5% value-at-risk

Higher of: (1) base capital, which

Highest of: (1) base capital; (2)

Non-life underwriting (2007), credit

Underwriting, market, credit and

Economic valuation as per IFRS

Risk types covered

Economic valuation of assets and

Economic valuation of assets and

Establishes a corporate governance

Proposals for an ORSA framework

Correlation between risk types and

Source: National superintendencies of insurance.

8 Swiss Re Insurance solvency regulation in Latin America: modernizing at varying speeds