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Nov 2017

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Interview with a Regulator: Supporting economic growth and protecting policyholders

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Source: Asia Insurance Review | Nov 2017

Japan Regulation

As a curtain raiser to this month’s IAIS Annual Conference in Kuala Lumpur, we present an exclusive interview with Mr Hiroshi Ota, a leading Asian regulator as Deputy Commissioner for International Affairs, Financial Services Agency (FSA), Government of Japan, and Vice Chair of the Executive Committee of the International Association of Insurance Supervisors (IAIS). Mr Ota discusses the challenging environment in Japan as well as globally, and shares insights on issues such as cyber security, FinTech/InsurTech, convergence of regulations as well as what the role of insurance supervisors are today.
By Dawn Sit
 
 
Q: What are the key challenges regulators face in today’s fast changing disruptive environment?
In Europe and the US, policy decisions and discussions have been taking place recently in the direction of the normalisation of monetary policies. The current financial environment based on the abundance of liquidity under the prolonged low interest rate policies may start to change. Concerns exist also on several geopolitical risks. 
 
   Insurers are, by far, large investors in securities, being susceptible to price changes in the market. The possible inQ: crease of interest rates can engender losses from their securities portfolios, which needs to be carefully monitored. Supervisors should also be mindful of possible increase of credit costs in the non-financial sector, caused by higher pressures in funding.
 
   On the domestic front, if the low-interest environment is here to stay longer, the profit margins of insurers would be squeezed and give downward pressure to their return. It should also be noted that the workforce population is in the decreasing trend and therefore the domestic insurance market will shrink in the long-run. The competitive environment would also change, due to the development of IT technologies and the increasing number of new entrants.
 
   Under these circumstances, JFSA needs to assess the strategies of insurers to achieve a higher sophistication of asset management combined with proper risk management, particularly having an eye on the improvement of quality of long-term insurance liabilities. At the same time, changes in longevity, IT technologies and emergence of cyber risks are new business opportunities for insurers. How to react to those changes is an important business decision for insurers. JFSA will engage in dialogues with them to assess their preparedness.
 
Q: How is Japan’s FSA keeping up? How would you compare Japan’s insurance regulations against its regional and global counterparts?
For JFSA, the ultimate goal of regulatory policy is the enhancement of national welfare by contributing to the sustainable growth of the national economy and wealth. As the population is shrinking and getting older, it has become clear that stabilising the financial system alone is not sufficient to achieve the goal. We need to place more emphasis on 1) improving financial intermediation and benefits that financial services provide to users; 2) maintaining safety and soundness through secured profitability by smart risk taking; and 3) improving insurers’ capability to identify and respond to emerging risks.
 
   Since a decade ago, JFSA has been exercising the supervision which focuses on a combination of rules and principles, and more emphasis on incentivising financial institutions to voluntarily make improvements. Those shifts in priorities should further take place. 
 
   Recently, the Advisory Group of JFSA has made recommendations on supervisory approaches. The Group recognises the importance of 1) dialogues between JFSA and financial institutions, which would prompt financial institutions to aim higher taking on programmes that are tailored to their specific circumstances; 2) prudential supervision which determines if there is the right balance between risk, return and capital, and if the current business model is sustainable in a changing environment; and 3) supervisory perspective which encompasses not only form, the past and elements but also substance, the future and a holistic view. 
 
   The Group recommended an organisational structure and supervisory framework that would enable JFSA to pursue the ultimate goal. Based on those recommendations, JFSA is working now to build a concrete plan for restructuring. 
 
Q: As Vice Chair of IAIS and the important role it is playing in the global insurance arena, what are your aspirations for the IAIS globally and in Asia?
In the time when the globalisation of insurers is rapidly taking place, it is desirable that national supervision and regulations converge as much as possible, maintaining at the same time the specific elements that reflect the particularities of each jurisdiction. 
 
   The IAIS is the field for supervisors where members liberally express their opinions and work with each other to achieve standards internationally implementable for the insurance sector. However, this is not the end of the mandate of the IAIS. It is also responsible for supporting the implementation of those standards in each member country. 
 
   In Asia, the rapid development of the insurance market is taking place in many countries, and as a consequence, the development of insurance legislation and supervision is of paramount importance. 
 
   I am confident that, together with supervisory communities in the Asia-Oceania region such as Asian Forum of Insurance Regulators (AFIR), the IAIS can make a great contribution in the further implementation of international standards like Insurance Core Principles (ICPs), and by doing so, the adequate protection of policyholders and the increased benefits that they can enjoy.
 
Q: What do you see as the key emerging issues that both the IAIS and JFSA will have to tackle in the near future? Are regulators prepared?
There are many issues that both the IAIS and JFSA have to tackle, but with regard to emerging issues, cyber security is one of them. 
 
   The number as well as the scale of cyber-attacks is increasing in recent years, causing greater damage than before. On this issue, the IAIS has published in August 2016 an issues paper on cyber risk to the insurance sector, and it intends to tackle it further. 
 
   JFSA also published a paper in 2015 “Policy Approaches to Strengthen Cyber Security in the Financial Sector”. Further on, based on that paper JFSA invited many financial institutions including insurers and conducted the first industry-wide cyber security exercise in October last year, with the aim to upgrade the capabilities of the financial industry to respond to cyber-attacks. JFSA intends to run this exercise on a continuing basis.
 
Q: Do you think disruption in the insurance industry is happening too fast? How are regulators keeping up? 
– In terms of balancing FinTech/InsurTech innovation and regulations (“RegTech”), are Asian regulators doing enough?
– What is the JFSA’s experience in this area? 
In the past, Japan seems to have failed to reap the fullest benefit from the digital revolution created by the combination of the Internet and mobile technologies. This time, at JFSA, we should plan how we can secure a regulatory environment that is conducive to sustainable economic growth and financial stability with the possibility of a major FinTech/InsurTech revolution in mind.
 
   Financial business may be in the process of preparing an environment which will facilitate the shift from the B2C type business models, which provide one-size-fits-all standardised products to mass customers driven by supply-side logic, to a C2B style business model, which creates shared values based on the accumulation and analysis of customer information. Here I refer to C2B meaning that each customer possesses the initiative that drives the business.
 
   The digitalisation of human life, the progress in automated accumulation of customer life-logs, and the emergence of AI capable of processing Big Data and deep learning together would make it possible for the insurance industry to provide better products and services corresponding to the needs of their customers. 
 
   For example, by analysing personal health data measured and transmitted by wearable devices, insurers can provide services which re-bundle insurance products with non-insurance services such as health advice to prevent lifestyle-related disease. The same can be said for car insurance, or many other insurance products. 
 
   Applying FinTech/InsurTech in this way, the accuracy of customer monitoring could be improved and thus data asymmetry and moral hazard issues can be resolved. Businesses focused on customer analysis at the entry-point can be converted to that which relies more on on-going monitoring, enabling the provision of services to a wider range of customers. Financial services can even provide incentives, in the form of lower insurance premiums, for lifestyle and business operation improvement, creating additional values both for the customers and the insurers.
 
   As to what actions are needed for insurance regulators to take to achieve this value creation, possible principles which could guide regulators’ policy choices may be as follows:
  1. Regulators should be guided by their ultimate goal of best promoting national welfare by contributing to the sustainable growth of the national economy and wealth. Regulators’ choices should be consistent with this goal.
  2. Regulators should improve the environment and eliminate obstacles in a forward-looking manner to facilitate the growth of players who create new values shared with customers and win customer confidence.
  3. When addressing new issues in user protection, regulators should not fall behind and let damages grow, but should also avoid premature and excessive intervention. The goal should be to take timely and appropriate measures. 
  4. Innovation may possibly turn branch networks and processing systems held by incumbents into legacy assets. Regulatory authorities should urge financial institutions to direct their businesses with foresight, but should not restrain innovations just to let incapable insurers stay in the market.
 
   JFSA has already taken several actions regarding FinTech/InsurTech. It established in 2015 “FinTech Support Desk”, as a one-stop contact point for inquiries and opinions pertaining to businesses involving FinTech in relation to the current business environment. 
 
   Just recently, it established “FinTech PoC (Proof-of-Concept) Hub” to eliminate the hesitation and concern that FinTech firms and financial institutions are inclined to have in conducting unprecedented tests. The Hub will offer continuous support in cooperation with other relevant authorities as necessary by forming a special working team within the FSA for each selected PoC project. 
 
   Since March this year, it established FinTech cooperation frameworks with several financial regulators overseas, including the UK, Singapore, Australia and Abu Dhabi Global Market. 
 
   Finally, the Panel of Experts on FinTech Start-ups was established and had several meetings to discuss possible measures to create a “FinTech ecosystem” and the possible impacts on financial services by the trend of FinTech.
 
   From now on, we should make best use of those actions and frameworks to have tangible results such as further enhancement of the quality of the service, or insurers’ flexible response to changes.
 
Q: What more should the IAIS and insurance supervisors do in ushering and managing change in the industry?
– There are some fears that since the global financial crisis, the pendulum has swung too far towards insurance supervision/regulation. What is your own assessment on this, bearing in mind that regulation should help the industry’s growth while protecting the consumers? 
Insurance liabilities tend to be of a long maturity, and in response, the assets held by insurers tend to be long-term. Compared with other business categories in the financial sector like banks, insurance is a business of which long-term stability is particularly important. What insurers aim for should not be a short-term profit, but long-term growth backed by a stable revenue base. Insurance regulations should also be designed to support the role that insurers play in the society, while adequately protecting their policyholders. 
 
   Nearly 10 years have passed since the start of the last financial crisis, and regulators and supervisors worldwide seem to have started considering the shift from strengthening the regulations to a more balanced approach between financial system stability and economic growth. In this regard, JFSA has long regarded finance and the economy as an inseparable pair, and claimed that financial regulations should promote the sustainable growth of the economy. We are pleased to see this recognition now widely gaining support in many countries.
 
   There is no business chance where there is no risk-taking. The role of insurance supervisors is not to overly forbid risk takings of insurers applying extreme stress scenarios, but to assess through dialogues the balance between risks and profits, as well as the adequacy of insurance protections and financial intermediary functions, in view of supporting the economic growth. 
 
   This supervisory approach necessitates a high level of skills and expertise of staff. We are happy to share our experience with other supervisors through various opportunities, including bilateral discussions and seminar participation, and also we wish to learn from experiences and practices of overseas supervisory colleagues. 
 
Q: How would you envision the global (and Japan’s) insurance industry and regulations in 2020?
The year 2019 would be a year when several important IAIS projects are scheduled to be completed, such as Insurance Capital Standard (ICS) version 2.0, the revision of ICPs and ComFrame, and measures to mitigate systemic risks through the activities-based approach and the revision of G-SIIs assessment methodology.
 
   Currently, the IAIS member authorities as well as the IAIS Secretariat allocate a significant amount of resources to complete those projects. Insurers in many countries are also putting in a great deal of effort to help those projects. The year 2020 would be the first year for the insurance sector to implement the completed frameworks at a national or group level.
 
   Among those several projects, the one which would have the largest impact to insurers worldwide, especially to internationally active insurance groups, is the Insurance Capital Standard (ICS). The ICS is a risk-based solvency framework intended to appropriately recognise the financial conditions of insurers by consistently evaluating assets and liabilities based on economic value. At 2020, it would be still too early to be able to assess the real effect of ICS implementation. At that time, both industry and supervisors would be working hard to prepare the incorporation of the ICS.
 
   While the standards are developed and implemented, the environment surrounding the insurance industry is evolving. In advanced economies, the population will continue to shrink and get older, while in emerging economies, penetration rates of insurance products will rise further, based on the possible increase of household income and improved understanding of the insurance scheme. 
 
   IT technologies will advance, which helps further development of FinTech/InsurTech. Such environmental changes are a challenge, but also a chance to create new business models for insurers. Domestically as well as globally, I look forward to find many insurers actively react to the changes and contribute to the economy in 2020.  A 
 
This views expressed here are solely of the author in his private capacity and do not necessarily represent the views of the Financial Services Authority, or any other entity of the Government of Japan.
 
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