A. Scope and Approach of This Note

1. This TN provides an update and an assessment of the supervisory framework and practices for the Italian insurance sector since the last assessment concluded in 2013. The note is part of the Italy 2019 FSAP and draws on discussions in Rome from March 7 to 28, 2019. The FSAP’s overall conclusions and recommendations are set out in the Financial Sector Stability Assessment.

2. The note focuses on key issues, with reference to international standards but without presenting a detailed assessment of Italy’s observance. As an update to the full assessment of observance of the ICPs of the IAIS in 2013,³ the note focuses on developments such as the implementation of the EU Solvency II framework,⁴ the enhancements in the supervisory framework, key vulnerabilities for the Italian insurance market and how IVASS addresses them. Please also refer to the Technical Note on Systemic Risk Oversight Framework and Macroprudential Policy which is part of this FSAP mission for a more comprehensive discussion of the macroprudential issues for the entire Italian financial sector. The discussion in this note is limited to the macroprudential surveillance function of IVASS relating to the insurance sector. Unless stated otherwise, references in this note to the IAIS ICPs are to the version issued in October 2011, as revised as of November 2018. The institutional arrangements for financial sector regulation and supervision in Italy are presented in Section B.

3. The note draws on information supplied by the authorities and extensive discussions in Italy. Meetings were held with the President, Secretary General and staff of the Italian insurance supervisory authority, IVASS; a selection of insurance companies; industry and professional bodies; audit firms; and rating agency. IVASS provided extensive statistical and other information and shared examples of supervisory work.

4. The author is grateful to the authorities and private sector participants for their excellent cooperation. The preparation of this TN benefited greatly from their readiness to share insights and information. The author is especially grateful to the staff of the IVASS for their outstanding cooperation and support for the work of the FSAP.

B. Overview—Institutional and Market Setting

The Insurance Market

5. The Italian insurance market is the fourth largest in Europe by insurance premium volume in 2017;⁵ there is room for growth in the non-life sector. Insurance penetration rate (i.e., premiums as a percentage of GDP) was 8.34 percent,⁶ the seventh highest in Europe, indicating room for further growth, particularly in the non-life sector where the penetration rate is below the European average. Table 2 and Figure 1 set out the trend in the development of the sector in recent years. Total assets of the sector at the end of June 2018 were EUR 910 billion, equivalent to 53 percent of GDP, compared to about 215 percent of GDP for the banking sector.

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Italy: Development of Insurance Sector

Citation: IMF Staff Country Reports 2020, 233; 10.5089/9781513552149.002.A001

Source: IVASS and Insurance Association of Italy (ANIA) data.

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6. The sector comprises 100 direct insurers as of end-June 2018; there has been no reinsurer operating in Italy since 2009. (Unless otherwise indicated, the 2018 statistics are as of end-June 2018.) Of the 100 direct insurers, 36 are life insurers, 52 non-life, and 12 composite insurers. The industry has consolidated significantly in the past decade through mergers and takeovers, resulting in a reduction in the number of insurers from 162 in 2007 to 100 in 2018. The life insurance premium income has been stagnant after a surge in 2014 and 2015, when low interest rates drove consumers to unit-linked products (ULPs) offered by insurers.⁷ The stringent regulatory requirements imposed by Solvency II also influenced the insurers’ preference for ULPs which attract lower capital charges compared to traditional products.

7. The sector is highly concentrated. Seventy-seven insurers belong to 29 insurance groups. The top five insurance groups have 65 percent life insurance market share (by premium), and the top ten groups have 80 percent. There is a similar level of concentration in the non-life market: the top five and top ten insurance groups dominate 67 percent and 85 percent, respectively, of the non-life market.

8. Life insurance products are trending towards less capital-intensive ULP or hybrid products; distribution is predominantly through bancassurance. Life insurance business is mainly single premium, savings products. The sales of traditional participating policies have declined steadily from 79 percent of total life insurance premiums in 2014 to 66 percent in 2018. The sale of ULPs has increased from 21 percent to 31 percent during the same period, reflecting the increasing emphasis on the ULP business to meet customers’ demand for returns, and the insurers’ desire to reduce capital strain resulting from the guarantees inherent in the traditional products. The ULPs may be sold on a stand-alone basis, or a hybrid product, which is a bundled policy combining elements of capital-guarantee of the traditional policies with the direct investment participation of the ULP. Banking and postal office distribution (collectively referred to as the bancassurance channel) accounted for about 60 percent of total premiums collected in 2017.

9. The prolonged low interest rate environment has less impact on the Italian life insurers than elsewhere. This is mainly because of the following two factors:

• About 80 percent of life insurance business is sold as single premium policies which have short policy terms. There is no long term annuity business, due to the reliance on the public pension system. Thus, the average liability duration is seven years, much shorter than the typical double-digit duration for life insurance liabilities elsewhere, enabling insurers to match the assets and liabilities durations fairly well; and

• Insurers have progressively reduced the minimum guaranteed returns offered in life insurance policies and also shifted towards less capital-intensive products where the risk is fully or partially borne by policyholders. About 35 percent of the products enforce only guarantee return of capital (i.e., no guarantee on investment return), and 35 percent have an interest rate guarantee between 1 percent to 2 percent.

10. The non-life sector is seeking new areas of growth. The current business make-up is conventional. Motor insurance, including the compulsory third party liability insurance (TPL), accounted for 52 percent of non-life gross written premium (GWP) in 2018. Accident and Health⁸ (18 percent) and Property (15 percent) were the second and third largest classes of non-life insurance. While Italy is prone to the risks of earthquakes and floods, consumers tend to rely on public assistance rather than private insurance. Competition has capped market growth. Insurers are experimenting with technology and innovation for “blue-ocean” opportunities. For example, some insurers use FinTech to issue “instant insurance” products: low-premium and short-duration policies that can be activated by the client instantly as the need arises, such as accident insurance for skiing or soccer. Despite the increased interest in FinTech, the use of direct distribution channel including internet is still limited, producing only about five percent of total premium. About three quarters of the non-life products are distributed through insurance agents.

11. There is high participation by foreign insurers in the Italian market. European Economic Area (EEA) insurance undertakings may conduct insurance business in Italy through the Freedom to Provide Services (FOS) or Freedom of Establishment (FOE) arrangements. These entities collected 17 percent of total insurance premiums in 2017, mostly in life insurance. IVASS is the conduct supervisor for these FOS/FOE entities in Italy while their home supervisors are the prudential supervisors. Conversely, with one exception, Italian insurers have limited cross-border activities. Only nine have opened branches or provided cross-border services in other EU countries on a significant scale. The exception is Generali, which operates in 50 countries, and has a significant local market share in a number of European jurisdictions. The cross-border activities and the division of supervision responsibilities between home and host supervisors have led to the necessity for close cooperation among EU supervisors.

12. The investment portfolios of life and non-life insurers reflect the differences in the nature of their business. For this analysis, assets in separate accounts backing unit linked business are excluded (see Figure 2). In aggregate, 46 percent of insurance general account assets are invested in government bonds (including 39 percent in Italian government bonds (Buoni del Tesoro Poliennali (BTP)), nearly twice the 24 percent average for insurers in the EU region. Further analysis shows that there are significant differences in investment strategies based on business models. Life insurers have 50 percent of their assets in BTPs, although the percentage has been reducing gradually in recent years. By comparison, non-life and composite insurers have a much lower level of holdings, at 28 percent and 25 percent, respectively. Non-life and composite insurers also have more significant investments in equities, at 6.5 percent and 25 percent, respectively, compared to life insurers.

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Italy: Composition of Assets in General Account

Citation: IMF Staff Country Reports 2020, 233; 10.5089/9781513552149.002.A001

Source: IVASS data.

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13. Separate account assets are mostly invested in mutual funds, accounting for over 80 percent of total separate account assets in 2018.

14. High concentration of investments in BTPs is the key risk to the insurance sector. The increased credit spread on BTPs has heightened supervisory attention on insurers’ resilience since May 2018. IVASS has conducted top-down stress tests, the latest being as of September 30, 2018, based on several scenarios of the 10-year BTP and the German Government bond yield spread. Insurers have been de-risking by gradually reducing the holdings of BTPs (see Figure 3), both in their general accounts and separate accounts. But the exposure to BTPs is likely to remain high in the medium term.

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Italy: Government Bonds in Insurance Sector

Citation: IMF Staff Country Reports 2020, 233; 10.5089/9781513552149.002.A001

Source: IVASS data.

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15. The insurance sector has returned to profitability in 2012 after a tremulous period since the financial crisis in 2007. Both life and non-life sectors have seen stable profits in the past four years (see Figure 4).

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Italy: Profitability of Insurance Sector

Citation: IMF Staff Country Reports 2020, 233; 10.5089/9781513552149.002.A001

Source: IVASS.

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16. The interconnectedness with banks is not high. Bank deposits account for a small share of insurers’ assets. The main sources of interconnectedness with banks is through investments and product distribution. Excluding ULPs, less than 8 percent of insurer’s assets are invested in other financial institutions, of which 41 percent relate to Italian banks. In the aggregate, the exposure to banks is limited, although there is a slight increasing trend, possibly due to the need for diversification away from government securities. In terms of ownership structure, 10 domestic and 9 foreign banks have shareholdings in 31 insurers. The holding is less than 10 percent in 10 of the cases. While banks (including post offices) accounted for 60 percent of the distribution of life insurance products, it poses little impact on the stability of the financial system.

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Investments in other financial institutions

Citation: IMF Staff Country Reports 2020, 233; 10.5089/9781513552149.002.A001

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A. Overview of the Implementation of the 2013 Recommendations

25. Most recommendations of the 2013 assessment have been implemented. The 2013 assessment of insurance sector regulation and supervision noted that there was a high level of observance of the ICPs. Most were assessed as observed or largely observed and only five ICPs were rated as partly observed.¹² Four of the ICPs rated as partly observed have been addressed through the implementation of the EU-wide prudential and conduct standards since 2016, such as the Solvency II Directive, the IDD, the Packaged Retail and Insurance-based Investment Products (PRIIP) Regulations. The mission assessed the remaining ICP previously rated as partly observed (ICP 2– Supervisor) to be largely observed; areas where IVASS can improve are discussed in paragraphs 27 and 28. A summary of the 2013 FSAP recommendations and the actions taken since then on the five ICPs previously rated as partly observed are set out in Appendix II to this note.

26. The implementation of Solvency II has addressed many of the gaps identified in regulation; supervisory procedures of intermediaries have also been enhanced and further improvements are underway. Solvency II has transformed the approach to capital adequacy, valuation of assets and liabilities, the regulation of investments, insurance group supervision, governance, risk management and internal controls systems. All these issues were the subject of recommendations in the 2013 assessment (also see Section B below). IVASS has strengthened its offsite and onsite supervision of insurers, and enhanced its supervisory framework for intermediaries (also see Sections C and E below). IDD and PRIIP Regulations have introduced new and more extensive disclosure requirements relating to the sale of relevant policies.

27. IVASS has improved its organizational structure and functions, but more action is needed to strengthen its independence.

• As described in the Regulatory and Supervisory Arrangements section of this note, there is an inconsistency in laws relating to the working relationship between IVASS and MISE. On the one hand, IVASS is prohibited from disclosing entity-specific information to MISE. On the other hand, the Minister for MISE is the approving authority on the withdrawal of authorization and winding-up of an entity, which requires IVASS to disclose entity-specific information to the Minister. The inconsistency in laws should be rectified by amending the Code of Private Insurance (enacted in 2005) to remove the Minister’s approving power relating to withdrawal of approval and winding-up of insurers to ensure full independence of IVASS, as envisaged in the IVASS Statute (enacted in 2012).

• Having fit and proper individuals at the helm of an insurance entity is central to effective governance of the entity. This is a fundamental principle of Solvency II. The competence to set the fit-and-proper assessment criteria should be with an independent supervisor. Currently, however, this competence is vested to the Minister for MISE.¹³ It is recommended that the Code of Private Insurance be amended to enhance the fit and proper requirements, pursuing an alignment with the banking sector framework¹⁴, and transfer this competence from the Minister to IVASS.

28. IVASS has met the demand of increasing workload despite the statutory limit on its manpower. There have been many external and internal initiatives since 2013 that have put a substantial strain on IVASS’ human resources. To name a few, the validation of internal models for the initial implementation of Solvency II, the ongoing supervision of the use of the models, the development and implementation of forward-looking onsite and offsite supervisory methodology, the increased cross-border supervisory coordination for group supervision, and expanded macroprudential analysis. There is no apparent abatement in demand on resources. IVASS has met the challenge on resources partly through staff secondment from BdI. For example, 6 out of the 60 professional staff in the Prudential Supervision Directorate are seconded from BdI. The low staff turnover rate and the ensuing continuity and retention of institutional knowledge has also helped. Nonetheless, it is recommended that IVASS should review and justify the manpower needed to deliver its strategic plan, and then amend the IVASS Statute if necessary.

B. The Implementation of Solvency II

29. IVASS has adopted Solvency II in full, and has added to the minimum requirements in two areas. The implementation of Solvency II has changed many aspects of Italian prudential regulation, aligning it more closely to the IAIS ICPs. It has resulted in more risk-based capital standards, extensive new requirements on the valuation of assets and liabilities, a new approach to the regulation of insurers’ investments, a comprehensive new approach to group supervision and new requirements on governance, suitability of substantial shareholders and key persons, risk management and internal controls systems. IVASS has adopted in full, with specific enhancements in two areas:

• For the determination of the solvency requirements calculated using the standard formula, specific guidance is provided for the application of the loss-absorbing capacity of deferred taxes.¹⁵

• The calculation of solvency requirements presented in the annual Solvency and Financial Condition Report (SFCR) are subject to an audit requirement.

30. The industry aggregate solvency ratio has improved under Solvency II. Immediately upon the implementation of Solvency II, the solvency ratio, i.e., the ratio of eligible capital to Solvency Capital Requirement (SCR), improved from 229 percent to 236 percent for the industry as a whole (see Table 3). The improvement is due to the conservatism inherent in the solvency requirements for life insurance business under the previous Solvency I framework, which resulted in an increase in solvency ratio from 132 percent to 247 percent for (pure) life insurers. For (pure) non-life insurers, the solvency ratio declined from 265 percent to 179 percent, indicating less stringent requirements previously. For composite insurers, the solvency ratio in aggregate declined from 347 percent to 239 percent. On entity basis, the solvency ratios of eight insurers with market share of 0.5 percent fell below 100 percent upon Solvency II adoption. This has since been rectified.

31. Fourteen insurers at solo level have been approved to use full or partial internal models. Four are authorized to use full models, and 10 are authorized to use partial models. These 14 insurers represent 69 percent of the industry SCR and 40 percent of the industry technical provisions. In addition, eight solo non-life insurers have been authorized to use undertaking specific parameters (USP) instead of the standard formula parameters for the non-life business lines. The remaining 79 solo insurers using the standard formula represent 27 percent of the industry SCR, and 57 percent of the industry technical provisions. In terms of insurance groups, three groups have been authorized to use partial internal models and two groups authorized to use USP.

32. The Volatility Adjustment (VA) is the only long-term guarantees (LTG) measure used by Italian insurers. Seventy-four Italian insurers applied VA at the end of 2016.¹⁶ The VA is also the measure most widely used in Europe (730 insurers, mostly carrying on life business), together with other LTG measures. On average, the impact of the use of VA was an improvement of 9 percentage points in the solvency ratio for the Italian insurers at the end of 2016, compared to as high as 50 to 80 percentage points in some EU countries. This correlates to the relatively short liability duration of the Italian life insurance business.

33. Supplementing the minimum solvency requirements, IVASS has the power to impose dividend restriction and capital add-on. IVASS may restrict payment of dividends and other forms of distribution of capital.¹⁷ IVASS has used this power twice in the last two years out of prudential concerns. IVASS also has the power to require capital add-on based on deficiencies in risk governance, subject to the condition that the measure is (a) not punitive, (b) temporary, and (c) applied on a collaborative process. IVASS exercises its power to impose capital add-on judiciously since it is a measure of last resort. IVASS imposed the add-on on one insurer in 2018, after two years of intense supervisory activity. The insurer is required to report the add-on in its SFCR.

34. Solvency II brought several positive changes to business practices. In addition to the risk-based solvency regime, Solvency II raised the standard for governance, which resulted in a number of changes to the insurance industry practices, many in the risk management areas. Despite the considerable amount of effort and cost involved to implement Solvency II, the industry recognizes the benefits it has brought to their operations, and acknowledges the quantitative skills and practical attitude that IVASS has demonstrated during the internal model approval process. The areas where Solvency II has brought significant changes include:

• Group structure: Some insurance groups simplified and streamlined their structure by eliminating intermediate levels and merging entities, to make the cost and capital structure more efficient.

• Quality of governance: The complexity of the new regime¹⁸ resulted in the need to have multi-disciplinary competence in the board of directors, and qualified professionals at the management level, to understand and manage the risks inherent in insurance and financial business. Solvency II also introduced the independence of control functions, requiring insurers to have independent check-and-balance in the areas of risk management, actuarial and compliance, beyond the traditional internal audit.

• Risk management: Solvency II requires insurers to implement strategic planning, capital management, risk appetite framework, and Own Risk and Solvency Assessment (ORSA). It strengthens the role of the risk management function by requiring it to be integrated into all aspects of the organization. The contribution of the Chief Risk Officer at board meetings has become increasingly important to ensure that decisions are made in full awareness of their impact on the risk profile and the solvency capital requirement.

• Products: For life business, insurers placed more emphasis on products with lower capital charges and reduce the traditional products with interest guarantees. Within the traditional portfolio, the mode of interest guarantee has been reduced from between 2 to 3 percent, to less than 1 percent (see Table 4).

• Investment: Solvency II removed the quantitative limits on assets representing technical provisions and introduced the prudent person principle. The new principle placed the responsibility on the management to identify, quantify, and manage risks according to the entity’s risk appetite. Insurers have updated their investment process, asset and liability management and liquidity risk management policies in line with the nature, scale and complexity of their business.

35. Industry identified practical challenges in Solvency II. During the mission’s discussions with the industry, a number of practical issues were raised of which IVASS is aware and will discuss with EIOPA. These include:

• Clarity is needed in the application of the proportionality principle of Solvency II. IVASS has set criteria for proportionality in governance. But more need to be done in other aspects, such as reporting and Pillar I requirements.

• The cat risk under the standard formula does not take into account policy limits, which is common in Italian non-life policies. This has resulted in unnecessary reinsurance premium and capital requirement.

• Similarly, the standard formula for non-life premium risk is based on average commission rates. Where actual commission rates are higher than those inherent in the formula, capital requirement is inadvertently imposed on the excess commission.

36. Harmonization of implementation details of Solvency II will eliminate national differences and level the playing fields across borders. While Solvency II is a maximum harmonization directive, adoption by national authorities differs in detail.¹⁹ Even when the rules are the same, interpretation by national authorities may be different. Thus, further effort to ensure consistency in application is needed to eliminate potential opportunity for regulatory arbitrage. It is recommended that IVASS raise this issue at the EIOPA level.

37. IVASS should initiate a discussion at EIOPA level to review the regulatory reporting requirements. Industry fed back during discussions with the FSAP team that the number of reports could be reduced and/or streamlined to avoid duplicate reporting of similar information. It is timely for IVASS to raise the issue at EIOPA level to review the reporting requirements after three years of experience with Solvency II, from the perspective of the usefulness and adequacy of information collected, and the need, if any, to improve the reporting template.

38. Finally, financial figures are prepared on three different bases; rationalization of the accounting basis will be helpful. For financial reporting and taxation, insurers are required by corporate law to use Italian GAAP at solo entity level (except for listed entities which there are none currently). At consolidated group level, insurers are required to use International Financial Reporting Standards (IFRS), whether or not the group is listed. Assets and liabilities for solvency purposes are on Solvency II basis. Seventy-seven of the 100 insurers need to prepare three sets of accounts: GAAP, IFRS and Solvency II, since they belong to groups. IVASS has had discussions with the Government and the industry on the adoption of IFRS to simplify the situation, as is the case with banks. The discussions did not come to any conclusions because of the uncertainty of then-pending IFRS 17 on insurance contracts. ²⁰ Subject to endorsement at the EU level, IFRS 17 is expected to have significant impact on the financial statements. IVASS should continue the dialog with Government and the industry on this subject, balancing the benefit of simplification, the need to narrow the divergence between regulatory reporting (Solvency II) and financial reporting (GAAP), and the high IFRS 17 implementation cost. IVASS should also ensure those who are on IFRS start the planning for implementing IFRS 17 immediately, because the implementation is complex.

C. Insurance Supervision

39. IVASS has developed a risk-based supervisory framework to align its supervisory intensity with the risk and impact assessment. The effort started in 2015 in anticipation of Solvency II, and for alignment with ICP 9. The supervisory review process, including the risk assessment framework (RAF), was completed in 2017 and incorporated into its internal Supervisory Handbook in 2018. The risk assessment process is automated, but supervisors are expected to exercise their judgment and override the auto-generated ratings where necessary. The rationale for the overrides is documented, and subject to review. With these enhancements to its supervisory framework, IVASS now fully complies with EIOPA’s guidelines on supervisory review process.

40. The main source of information for offsite analysis is the regulatory reporting. The Prudential Supervision Directorate performs regular analysis of both quantitative and narrative information submitted by the regulated entities. The quarterly and/or annual quantitative information based on Solvency II templates includes balance sheets, performance, assets, technical provisions, capital requirements, group information, etc. on three bases: local GAAP (required by corporate laws), IFRS (for insurers belonging to an insurance group) and Solvency II. Annual narrative information required includes SFCR, ORSA, Regular Supervisory Report, and report on frauds. IVASS reviews the narrative reports thoroughly and takes necessary action. For example, as a result of the review of ORSA reports in 2018, IVASS requested improvements from 8 insurance groups and 41 solo entities (37 of which belong to the 8 groups); coordinated comments from five supervisory colleges where IVASS is the group supervisor and conveyed the feedback to the insurance groups; and conducted follow-up onsite inspection to two entities. Other sources of information include customer complaints and the outcome of the macroprudential analysis on the key trends in the macroeconomic factors that can affect the insurance sector. The goal of the offsite analysis is to facilitate early detection of the need for supervisory intervention.

41. Technology facilitates efficient data analysis, information sharing, report-generation and ad hoc inquiries. IVASS embraces SupTech for greater efficiency and more proactive monitoring of risks. Regular and ad hoc reports generated by the database include: high level dashboards and firm dossiers for its directors; and detailed supervisory reports, capital adequacy indicators, trends in lapses and assets for supervisors and inspectors. The database can also generate special reports using a query software.

42. Onsite inspections are also risk-based; there is no minimum required frequency of inspections. Inspection Directorate conducts onsite inspections of insurers and insurance intermediaries. Each year, an inspection plan is prepared following risk-based principles, with input and agreement from offsite supervisors. The plan indicates the entities to be inspected and the scope of the inspections, taking into consideration: the risk and impact assessments by the offsite supervisors; date of the last inspection; the need for a follow-up inspection (for example, to verify the adoption of USP for SCR calculations, or to verify implementation of required remedial action); extraordinary events (such as mergers, acquisitions, transfers of portfolio); certain risk profiles; certain types of business; issues highlighted by macroprudential analysis; and the size of the entity. The inspection plan is approved by the board.

43. The number of inspections has increased over the past three years. The number of entities inspected over the past three years represents about 80 percent of the insurance market. The average duration of an inspection of an insurer is 40 to 44 days (shorter for a follow-up inspection), and 10 days for an intermediary.

44. After the inspection, IVASS issues and presents an inspection report to the Board of Directors of the entity. The Supervisory Handbook requires the inspection team to complete the inspection report within three months following the completion of the field work. The report outlines the findings of the inspection and recommendations for improvement; and approved by the Board. In case of considerable deterioration of the financial condition and/or serious breach of consumer protection rules, the report may be delivered together with a supervisory letter.

45. IVASS should consider a minimum frequency of inspection. The Italian market is concentrated. A few large insurers have large market shares. In the absence of a minimum frequency of inspection, a risk-based approach to prioritize inspection inevitably leads to a situation where many small insurers are not being inspected for many years. As Table 5 shows, the inspection program covered 80 percent of market by premium, but only 56 percent by number of undertakings, over a three-year period. It is not difficult to envisage that a number of small insurers will not have been inspected even over an extended period. This is a risk in itself. This outcome may be acceptable from a financial stability point of view, given that the market impact of the failure of these entities is likely to be minor, albeit there might be social, reputational and possibly political impacts. But, it is not congruent with the strong consumer protection ethos of IVASS.

D. Group Supervision and Cross-Border Cooperation

46. IVASS applies subgroup supervision to three subgroups. Under Solvency II, group supervision is applied only at the level of the ultimate parent company in an EEA country. Where there are subgroups at national level, the respective supervisory authorities may apply subgroup supervision only if justified by objective differences in the operations, the organization or the risk profile between the subgroup and the group. After consultation with the relevant group supervisors and the groups themselves, IVASS decided to apply subgroup supervision to three of the ten Italian subgroups. To avoid duplication in supervision, these subgroups are subject to a proportionate supervision, carried out in close coordination with the relevant group supervisor. For example, they are not required to submit quarterly templates or the group SFCR. IVASS has assessed and decided not to apply subgroup supervision of the Italian subgroups of non-EEA groups.

47. The scope of group supervision includes all risks and all related entities, whether or not regulated, located in EEA or not. On a case by case basis, IVASS may exclude from the scope non-EEA entities when there are legal obstacles to the transfer of relevant information; or entities that are of negligible interest or whose inclusion would be inappropriate or misleading. So far, there have been no cases of exclusion. In total, there are 21 Italian groups and three subgroups subject to group supervision in the following areas: group solvency calculation, the system of governance, ORSA, the risk concentration and intra-group transactions.

48. IVASS maintains a register of ultimate parent undertakings on its website, whether they are re/insurer, insurance holding company, mixed financial holding company, or ancillary undertaking. The purpose is to provide transparency and information to policyholders. Currently, there 29 insurance groups in the register, including 8 subgroups of EEA and non-EEA countries. They are subject to offsite supervision, onsite inspections and IVASS’ power of direction.

49. IVASS participates in 22 supervisory colleges and acts as the group supervisors in six of the colleges. In its role as the group supervisor, IVASS coordinates the activities of the relevant college. In consultation with the other supervisors involved, IVASS establishes a coordination arrangement on the organization of the college and procedures on cooperation and exchange of information during ongoing supervision and during crises. IVASS draws up annual work plan, host and chair meetings, and coordinate feedback from members of the college. Since two of the groups are insurance-led financial conglomerates, BdI participates in the college activities. For two other groups belonging to banking-led financial conglomerates. IVASS cooperates with BdI, and participates in one of the banking colleges. To deal more efficiently and in depth with specific technical issues, IVASS may establish specialist teams within the college. All colleges meet at least annually, and IVASS provides dedicated platforms to share information to ensure confidentiality and security. As host supervisor in 16 colleges, IVASS assesses the risk profile of the Italian companies of the group and shares its assessment with the group supervisor and within the college. IVASS also participates in joint onsite inspections agreed on and organized by college members on specific topics.

50. The supervisory colleges have developed a common approach to assess risks, at group and solo level. Since 2014 the risk assessment has been performed as a regular college activity by each member supervisor, based on a tool developed by the group supervisor and agreed within the college. The group supervisor collects the risk assessment carried out by each member supervisor and performs a risk analysis for the whole group. The results are discussed during the college meetings and taken into account in the annual review of the college work plan.

51. There are no constraints on the sharing of non-public information with non-EEA supervisory authorities. Information is exchanged in accordance with memoranda of understanding (MoU) and confidentiality agreements signed between IVASS and the relevant non-EU supervisory authorities. Information may also be exchanged within the cross-border colleges of supervisors according to the coordination arrangements agreed in the college. IVASS is a signatory to the IAIS Multilateral Memorandum of Understanding on Cooperation and Information Exchange (MMoU). IVASS has also signed MoU or confidentiality agreements with a number of supervisory agencies.

52. Overall, arrangements for group supervision and cross-border cooperation are adequate.

E. Insurance Conduct of Business and Intermediary Supervision

53. IVASS identified three key market conduct risks:

• Timeliness of paying claims: There are precise legal deadlines for the payment of compulsory MTPL claims. Most of IVASS fines are related to late MTPL settlements. In 2017, 76 percent of ordinances, corresponding to 48 percent of the number of fines, were related to MPTL. In terms of amounts, the 2017 MTPL fines amounted to EUR 6.2 million (EUR 7.9 million in 2016). An example of poor life insurance claim practice is unnecessarily burdensome request for documentation for surrenders as well as for death benefits.

• Tied-in sales: These are insurance policies sold together with a non-insurance product, often a loan/mortgage whose repayment is protected by a payment protection insurance. In 2018, IVASS also investigated uncorrelated policies, i.e., insurance policies (health, property, liability, etc.) sold together with a loan, without any link between the two financial products. Such investigations were carried out in cooperation with AGCM which has investigated involved insurers for unfair practices, and involved intermediaries for aggressive selling practices.

• Complex products: Products could be either complex in wording, or complex in substance. The former is being addressed through joint effort between IVASS and Consumer Association and other stakeholders including ANIA to simplify policy wording to enhance understandability and therefore facilitate suitability assessment. The latter is more difficult to address, involving issues of product design and suitability.

54. The IDD, which came into effect in October 2018, substantively strengthened the standard for business conduct, and is directly relevant in addressing the conduct risks mentioned above. The IDD is a minimum harmonization directive on the conduct of insurance distribution, including (a) the knowledge and competence of distributors, (b) product oversight and governance (POG), (c) non-life product disclosure in an Insurance Product Information Document (IPID), (d) disclosure on product bundling, (e) additional disclosure on IBIPs, and (f) disclosure of the nature of remuneration. In particular, POG aims to ensure that products and services marketed and sold are designed to meet the needs of identified customer groups and are targeted accordingly. IVASS is in the process of developing a market conduct supervisory handbook, incorporating the new requirements.

55. Insurers, including those operating in Italy under FOS and FOE, are subject to regular reporting requirements for IVASS to monitor their conduct of business. The requirements include: half yearly reports on customer complaints lodged with the insurers, quarterly reports on premiums by lines of business (for FOE), and annual reports on key figures of FOS/FOE activity in Italy (premiums and technical provisions by lines of business), the latter disseminated by EIOPA to the relevant supervisors on the basis of Solvency II quarterly reporting template as submitted to EIOPA by the Home Supervisor. Other less structured sources of supervisory information include customer complaints lodged with IVASS, onsite inspection findings, mass and social media, consumer associations, web-surfing, and communication with other supervisors.

56. IVASS’ sanction power has been enhanced since October 2018. In addition to pecuniary fines, IVASS is able to issue “cease and desist” orders to insurers. IVASS is allowed to take into account the history of repeat offences in setting the level of sanction.

57. All insurance intermediaries are registered with IVASS and subject to supervision. There are over 225,000 registered individual and corporate agents, brokers and other intermediaries. IVASS holds the insurers responsible for the conduct of their distributors, although IVASS exercises direct supervision as well. Eligibility for registration includes minimum professional qualifications, free of criminal records and not in undischarged bankruptcy. IVASS may take the following actions against errant intermediaries:

• Request the principal insurer to conduct audits or impose disciplinary action.

• Summon the intermediaries for discussions.

• Issue warning letters.

• Issue market-wide letters.

58. IVASS is in the process of developing indicators for poor conduct for intermediaries as well as for insurers. The goal is to:

• assess the insurer’s ability to monitor the distribution channels, detect signals of irregular conduct of distributors, identify root causes and remove effects, and implement actions to mitigate the risks of misconduct of their distributors;

• monitor the level of market compliance and take prompt action to counteract irregular conducts and possible contagion effects;

• capture distribution trends, and detect distribution channels whose actions may affect the interests of customers; and

• acquire a sound data set, useful for statistical surveys at market/enterprise/sales channel level.

These indicators are mainly based on regular supervisory reporting and statistics on customer complaints and analysis of business sold by lines of business. IVASS is also exploring more direct ways to detect market misconduct, such as mystery shopping, although there appears to be legal obstacles.²¹ The ultimate goal is to incorporate these market conduct indicators into the risk-based supervisory framework in prioritizing supervisory activities.

59. There is overlap in supervision and distribution rules relating to IBIPs. Pre-IDD, unit- and index-linked products were considered financial products regulated by CONSOB under the Markets in Financial Instruments Directive (MiFID and later MiFID II). Post-IDD, IBIPs are classified as insurance products and fall under IDD framework. IVASS and CONSOB are working together on the coordination of the division of responsibilities. At legislative level, IVASS is the competent supervisor on (a) conduct of distribution of IBIPs through insurers, agents and brokers, (b) POG of insurers manufacturing IBIPs, (c) POG of agents and brokers distributing IBIPs, and (d) pre-contract information on IBIPs in addition to key information disclosure (KID). CONSOB is the competent supervisor on (a) conduct of distribution of IBIPs through banks and post office, (b) POG of banks distributing IBIPs, and (c) KID. Since IDD has already taken effect, IVASS should expedite the discussion with CONSOB to provide clarity to the market aiming, to the extent possible, to a common regulatory framework to apply to all distribution channels.

60. IVASS has a strong mandate in consumer protection. The Consumer Protection Directorate handles 20,000 complaints each year. The insights gleaned from these complaints enhances its supervisory capability. However, handling complaints is resource intensive. A new insurance arbitration function will be established within IVASS with dedicated human resources by 2020. IVASS should re-evaluate its involvement in complaint handling in light of the new arbitration function, as part of its overall manpower review.

61. Brexit could have a significant impact on Italian consumers and IVASS has started preparation for its occurrence since early 2018. There were 126 British undertakings licensed to do business in Italy under the FOS/FOE arrangements. Of these, 53 were active at the end of 2017, mainly in non-life insurance. In 2017, 9.7 million Italian customers paid EUR 1.7 billion in premiums to British insurers. In fact, one British insurer is a market leader in a niche line of liability insurance (medical malpractice) in Italy. Justifiably, IVASS is concerned about the impact of Brexit, particularly from the consumer protection perspective. Leveraging on EIOPA’s Brexit platform, IVASS has mapped the contingency plans of the 58 (the United Kingdom and Gibraltar) undertakings active in Italy. IVASS has also held discussions with the 11 most significant British non-life insurers and one life insurer²² operating in Italy regarding their Brexit contingency plans. The discussions revealed that the key exit strategies are: establishing a Societas Europaea; or portfolio transfer. Other actions taken by IVASS include:

• Requested British insurers operating in Italy as well as Italian insurers operating in the United Kingdom to:

  • – send adequate personalized information on the impact of Brexit to their Italian (or British in the case of Italian insurers) policyholders and beneficiaries;

  • – publish similar information on their websites; and

  • – provide appropriate instructions to their distributors regarding the information to be provided to their current and potential customers.

• Published on IVASS website information on Brexit and its impact on policyholders.

62. Overall, arrangements for insurance conduct of business supervision are adequate and IVASS has demonstrated its willingness to take action in cases of detected misconduct. To maximize effectiveness with finite resources, it is recommended that:

• IVASS should expand its ability in direct detection of market misconduct, rather than solely relying on indirect detection through complaints and collection of statistics.

• Consider monitoring policy lapse rate measured in terms of number of policies, as an indicator for the suitability of products sold, based on the rationale that a policyholder is more likely to surrender a policy that does not suit his needs. A further analysis of the lapse rate by policy year may be useful in detecting possible misconduct situations where intermediaries encourages customers to terminate their policies after the commission period expires and take up similar or the same policies so that from the intermediaries receive commissions again.

• Division of responsibilities with CONSOB in the area of IBIPs should be finalized as soon as possible and communicate to the market to provide clarity. Differences between MiFID II and IDD relating to IBIPs should be harmonized.

• As part of the overall manpower review exercise (see section A), IVASS should review its involvement in the resource-intensive complaint handling, in light of the new mandate in insurance arbitration.

F. Macroprudential Surveillance and Stress Testing

63. There is a formal process to conduct macroprudential surveillance. A Macroprudential Analysis Division (MPAD) was set up in 2013 with the tasks to:

• perform macroprudential analysis on the Italian insurance market;

• develop macroprudential tools;

• identify, assess and monitor macroprudential risks;

• assess the effects of stressed situations potentially emerging in the financial markets towards insurance undertakings; and

• report the results internally and externally.

It has developed a set of indicators and standardized tools, including quarterly risk dashboard, quarterly assessment of vulnerabilities, monthly liquidity monitoring, ad hoc surveys, and annual industry stress test. It monitors the share prices and credit spreads. When the need arises, it performs more frequent analysis and top-down stress testing to ensure the stability of the insurance market.

Risk Assessment

67. The key risk assessment function is the quarterly macro trend analysis. MPAD monitors the trend of major macroeconomic and financial indicators, focusing on the risks related to the insurance sector and the key performance indicators of the insurance sector, such as solvency ratio, combined ratio, return on equity, share price, composition of the eligible own funds, composition of assets, minimum interest rate guarantees, etc. This analysis provides a high-level view of the insurance sector against the macro trends.

68. MPAD performs top-down stress tests to assess the resilience of the sector. The shocks are based on the asset values on a specific date, determined based on the maximum value and the 75^th percentile (or higher when warranted) of the historical series of the BTP-Bund spread. The stresses are applied to Italian Government bonds, corporate bonds and equities. To simplify the process, no shocks are applied to SCR, post-stress balance sheets do not take into consideration any fiscal effects, and technical provisions (other than those for the unit- and index-linked business) are not recalculated but revalued considering the effect of volatility adjustment; hence the analysis doesn’t take into account the potential ability of the technical provisions to reduce the discretionary benefits under the stressed conditions. IVASS has performed top-down stress tests at December 31, 2016 and December 31, 2017. In light of increased pressure on BTP yield spread since May 2018, MPAD has performed ad hoc stress tests during 2018. The latest was as of September 2018 (see Table 6). As can be seen, there would be a number of insurers whose solvency ratios would drop below 100 percent under a more severe shock that involves an increase in Italian sovereign spreads to above 399 bps.

^{Box 1.}

Monitoring Climate Change Risk

According to EIOPA Financial Stability Report December 2018, 13 percent of European insurers’ assets are exposed to climate-related risks. Such risks may arise from a transition to a more carbon-neutral economy, or erosion of real estate value particularly in high-risk areas.

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Source: EIOPA.

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IVASS analyzed the exposure to climate-sensitive investments in the Italian market, and found that the exposure is substantially lower at 2 percent of total industry assets. IVASS also conducted a qualitative survey on the current and future impact of climate change on the insurance business.

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Source: IVASS.

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Key Findings:

• The impact depends on the specific line of business in which entities are engaged.

• The probability of impact of the risk is assessed through internal model or standard formula.

• Risk mitigation is generally through reinsurance. Only one entity tapped capital market through cat bond.

• Not all entities have developed risk management and investment policy relating to climate change. Those who have are mainly large/cross border entities who have already adopted ESG (Environmental, Social, and Governance) principals in their internal management processes and investment strategies, or other entities that deal with climate risks in their risk management framework.

• On the supply side, climate change risk is still included in guarantees linked to natural events; some entities distribute eco-friendly insurance products or services (e.g., discounts on “green” vehicles).

• Social commitment is widespread, and the initiatives reported are numerous, such as reducing the amount of CO₂ emission through energy efficiency; reduction of the environmental impact of business trips; control of waste and policies on reuse and recycling; reduction of use of paper and water.

• The impact of climate change on the lines of business linked to health and life expectancy is to be monitored, but on long term perspective.

The author of this box is Mimi Ho, based on information provided by IVASS.

69. MPAD also performs bottom-up stress tests to assess the resilience of the sector to specific adverse scenarios. The bottom-up stress tests coincide with the EIOPA stress tests conducted once every two years. For the 2018 stress test, four insurance groups participated in the EIOPA stress test, and IVASS selected eight more insurance groups for its own stress test. These 12 insurance groups represent 74 percent of the market. Due to the high exposure to Government bonds, the Italian market is more vulnerable under the yield-curve-up scenario. On the other hand, the liability duration is low (seven years) and well-matched with assets duration, which make the Italian market less vulnerable under the yield-curve-down scenario compared to the other European markets (see Box 2). IVASS has taken action to address the vulnerabilities by asking the vulnerable insurers to mitigate the risk of their portfolios and repeat the stress test at the end of 2018. The affected insurers have since reduced their exposure to BTP and directed new investments to other EU government bonds. While the 2018 year-end stress test results were not yet available at the time of the FSAP visit, the solvency position of the affected insurers were improved at the end of 2018.

70. Other assessment tools used by MPAD include:

• Sensitivity analysis–to assess the effect of a single change in a material risk, such as a 100 bps increase in spread, on the financial position of the sector.

• ORSA analysis–to include macroprudential perspectives in the review of ORSA reports, thus enabling IVASS to identify the key factors, assumptions and strategies affecting the industry.

• SFCR review–IVASS performs a comparative analysis of the SFCRs published by the largest insurance groups. The qualitative information of the reports is evaluated. The results are presented in a Letter to the Market, where IVASS suggested areas for improvement.

• Others–monitoring the use of derivatives on a semi-annual basis; analysing the effectiveness of reinsurance; evaluation of the systemic risk related to the interconnectedness within the insurance sector; and workshop with the stakeholders.

71. Notwithstanding the decline in the concentration of exposures to Italian government bonds in the insurance sector, supervisors should explore policy options to encourage further diversification. IVASS has engaged in a dialogue with the most exposed insurers aiming to increase the resilience of the sector. This has contributed to reduce the exposure of the sector to Italian sovereign bonds (see Figure 3). However, IVASS sensitivity analysis suggest that the risk is meaningful for a number of institutions. IVASS should continue to closely monitor insurers’ exposures to the sovereign and explore policy options to encourage further diversification.

Risk Reporting

72. The results of the macroprudential surveillance are communicated internally and externally and contribute to the Financial Stability Report published by BdI. Senior Management of IVASS receives regular reports on macro trends, risk dashboard, liquidity analysis, equity and spread trends, stress test results, sensitivity analysis, ORSA analysis, SFCR review, etc. IVASS colleagues have access to non-entity specific information through a dedicated intranet page. Entity-specific information is shared only with relevant staff. Externally, the information contributes to the Financial Stability Report published by the BdI. Selected results are also communicated to the industry through the Letters to the Market and IVASS’ annual report.

73. Overall, IVASS’ approach to macroprudential surveillance is comprehensive and well executed. The quarterly risk dashboard could be further improved by including indicators for the quality of insurance business, as developed by the market conduct supervisors.

^{Box 2.}

EIOPA 2018 Stress Test

EIOPA conducts EU-wide stress tests every other year. The 2018 stress test covered 42 insurance groups from 12-member states. Four Italian insurance groups participated in the stress test. In addition, IVASS selected another eight insurance groups in an internal stress test. The 12 Italian groups constitute 74 percent of market share.

The 2018 EIOPA stress test was based on data as of December 31, 2017, under three scenarios:

	Financial shocks:		Insurance shocks:
1. Yield curve up (YCU):	10Y swap	+85 bps	Mass lapse	+20%
	10Y BTP	+205 bps	Cost of claims	+2.24%/year
	EU Financial BBB	+301 bps
	Italian equity	-40%
2. Yield curve down (YCD):	10Y swap	-80 bps	Longevity	+ 15%
	10Y BTP	-20 bps	rates
	EU Financial BBB	-36 bps
	Italian equity	-19%
3. Natural catastrophe (nat cat):	Four European windstorms, a set of two central and eastern European floods and a series of two Italian earthquakes. The aggregate insured loss from these events = EUR 48 billion.

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	Financial shocks:		Insurance shocks:
1. Yield curve up (YCU):	10Y swap	+85 bps	Mass lapse	+20%
	10Y BTP	+205 bps	Cost of claims	+2.24%/year
	EU Financial BBB	+301 bps
	Italian equity	-40%
2. Yield curve down (YCD):	10Y swap	-80 bps	Longevity	+ 15%
	10Y BTP	-20 bps	rates
	EU Financial BBB	-36 bps
	Italian equity	-19%
3. Natural catastrophe (nat cat):	Four European windstorms, a set of two central and eastern European floods and a series of two Italian earthquakes. The aggregate insured loss from these events = EUR 48 billion.

The nat cat scenario has very little impact on Italian insurance groups due to low exposure to nat cat coverages. The comparison of the stress test results for the 12 Italian insurance groups against the EIOPA results (inclusive of the four Italian groups) are as follows:

Assets over liabilities ratio: The results are largely comparable. The Italian insurers appear to be more vulnerable to the YCU scenario, while the European insurers tend to be more vulnerable to the YCD scenario.

Excess of assets over liabilities: The results are largely comparable. The Italian insurers appear to be more vulnerable to the YCU scenario.

Solvency capital requirement (SCR): Under the YCU scenario, the SCR increased for the Italian insurers, while it decreased for the European insurers. Overall, the SCR appear to be more stable for the Italian sector.

Solvency ratio: The Italian insurers are much more affected by the YCU scenario, and fare better under the YCD scenario, as compared to their European counterparts. The solvency ratios of two small groups could not meet the 100 percent ratio under the YCU scenario.

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The author of this box is Mimi Ho, based on information provided by IVASS.