## Executive Summary

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---

### Regulatory reforms and supervisory framework
- Insurance Supervision Law (ISL) effective January 1, 2006, expands scope to include group/conglomerate supervision, corporate governance, risk management and market conduct of insurance intermediaries.
- ISL provides for corrective and preventive regulatory measures and empowers the Federal Office of Private Insurance (FOPI) to exchange information with domestic and foreign regulators.
- Regulatory approach is risk-based and principle-based, aligned with the Swiss insurance industry structure.
- Swiss Solvency Test (SST) recognized as at the forefront of risk-based solvency regimes and enables risk-based and differentiated supervision.
- Key FOPI implementation items issued or in drafting include:
  - corporate governance guidelines tailored to the insurance industry,
  - regulatory intervention levels,
  - roles of external auditors and actuaries,
  - intra-group transaction rules.

### Market structure
- As at August 31, 2006, there were 214 (re)insurers: 23 Swiss life insurers, 4 foreign life insurers, 78 Swiss non-life insurers, 40 foreign non-life insurers, and 69 reinsurers.
- Switzerland has the highest per capita expenditures for insurance in the world—about SwF 7,000 (excluding social security contributions).
- More than 70 percent of Swiss insurers’ global premiums were sourced from abroad (SwF 133.5 billion of SwF 187 billion global premiums in 2004).
- In 2005, Swiss insurers employed about 42,186 staff in Switzerland and 92,774 staff abroad.
- Market concentration (2005):
  - Five largest non-life insurers: 72 percent of gross premiums written.
  - Five largest life insurers: 82 percent of premiums earned.
  - Swiss Re, European Re and Converium: about 79 percent share of the Swiss reinsurance market.
- Strategic shifts:
  - Trend to specialize in traditional core business; most direct insurers withdrawn from active reinsurance operations.
  - Exits orderly; new niche players entered market without restrictive entry barriers.
- Cantonal insurers:
  - Insurance for buildings mandatory in 19 cantons, provided by monopolistic cantonal insurers not regulated by FOPI.
  - Total sum insured for buildings in 26 cantons exceeded SwF 2,000 billion; content cover about SwF 700 billion.
  - Potential economic losses from earthquakes estimated at approximately SwF 80 billion in the region of Basle.
  - Earthquake insurance mandatory in Zurich; other 18 cantons maintain a voluntary earthquake pool with the sum insured totaling SwF 1,200 billion.
  - SIA and IRV joint initiative to implement mandatory earthquake insurance with reinsurance protection by January 1, 2008.

### Industry performance and balance sheets
- Recovery since the 2001/2002 stock market crash due to restructured investment strategies and more stable capital markets.
- Investments in shares and mutual funds reduced to less than 8 percent (SwF 43 billion) of capital investment at end-2005.
- Direct insurance industry paid SwF 1.3 billion for a severe storm in August 2005 and remained profitable.
- Gross premiums of direct Swiss insurers totaled SwF 50.5 billion for 2005.
- Domestic non-life lines (2005 market shares):
  - Motor insurance: 23 percent
  - Fire and natural hazards insurance: 15 percent (loss ratio of 140 percent for 2005)
- Product movements:
  - Unit-linked life insurance grew by 83 percent in 2005.
  - Occupational pension insurance declined 8.2 percent.
  - Health insurance remained at current levels.
- Asset allocation and capitalization (end-2005):
  - Total assets held by direct insurers: SwF 450.3 billion.
  - About 50 percent invested in fixed income securities.
  - Investments in shares reduced to 8 percent of total assets.
  - Intra-group loans and investments in related companies: SwF 55.7 billion (12.4 percent of total assets).
  - Combined life and non-life equity: SwF 26.5 billion.
  - Surplus of the direct industry rose by SwF 1.7 billion in 2005 to reach SwF 4.1 billion.
  - Equity increased by SwF 0.8 billion in 2005.
  - Total reserves held by the direct insurance industry: SwF 596.1 billion, of which life reserves accounted for SwF 513 billion.

### Institutional arrangements and supervisory capacity
- FOPI responsibilities under ISL:
  - Regulates and supervises all private (re)insurance entities, groups and conglomerates, and intermediaries domiciled in Switzerland.
  - Exemptions: insurers with registered office outside Switzerland if they only operate insurance in Switzerland; entities subject to special supervision under Swiss Federal Law for specific activities (including occupational pension plans and intermediaries dependent on a policy holder pursuing exclusively the interests of the policy-holder).
  - Old age and survivors’ insurance, Swiss National Accident Insurance Fund and military insurance not subject to FOPI supervision.
- Health insurance supervision:
  - Dual supervision: basic health insurance regulated by the Federal Office of Public Health (FOPH); FOPI responsible for supplementary private health insurance.
  - Insolvencies of three health insurance associations (KBV; Accorda; and Zurzach) attributable to their basic health insurance portfolios.
- FOPI structure and resourcing:
  - Restructured mid-2004 into separate supervisory sections for non-life, life, intermediary, group and conglomerate, and health and reinsurance.
  - Established headcount of 90 staff monitoring over 200 insurers, about 60 supplementary health insurance funds and more than 8,000 registered intermediaries.
  - Supported by departments: Supervisory Development, Legal Services, Financial Accounting, Financial Investments and International Affairs.
- Planned institutional change:
  - New integrated financial market authority (FINMA) expected to be operational by 2009 under a draft FINMA Act endorsed by the Federal Council on February 1, 2006, to integrate SFBC, FOPI and MLCA while retaining sectoral roles and streamlining sanctions.
- Role of self-regulation:
  - Professional bodies and SROs (e.g., Swiss Institute of Certified Accountants, Swiss Insurance Association (SIA), Swiss Actuarial Association, Swiss Insurance Brokers Association) complement FOPI.
  - SIA established a distinct SRO to administer AML/CFT regulations approved by FOPI.

### Implementation of IAIS Insurance Core Principles and conditions for effective supervision
- Switzerland articulated Financial Centre and Financial Market Policy in September 2006 with objectives:
  - (a) facilitate international competitiveness,
  - (b) ensure functionality, efficiency and stability,
  - (c) maintain integrity.
- Guiding principle: practical, proportionate and effective regulations and utilize regulatory differentiation to preserve competitiveness and reputation.
- Overall assessment:
  - Updated regulatory framework has a very high level of observance with the Insurance Core Principles, but implementation is in transition.
  - Broad legislative framework established; FOPI issuing and drafting implementing decrees and guidelines.
- Key supervisory implementation challenges and resource implications:
  - Balance ISL objective to protect insured and limit insolvency risks against financial market policy objectives of preserving international competitiveness and controlling regulatory/supervisory costs.
  - Critical need for adequate regulatory resources at FOPI to supervise a large and internationally diversified industry, including:
    - retention of experienced key personnel,
    - rapid development of regulatory capacity,
    - good insights into company-specific internal models for effective SST implementation,
    - strengthened direct supervision of (re)insurers beyond self-governance and enhanced external audits,
    - adequate resources for effective and timely off-site surveillance and risk-focused on-site examinations.
  - Significant resource implications if FOPI is appointed supervisor / lead supervisor for cross-border supervision of insurance groups/conglomerates, recognizing regulatory equivalence with the EU.

### Audit oversight, ombudsman, and auditors' conduct
- Audit Oversight Act (enacted in December 2005) established the Federal Audit Oversight Authority (FAOA) responsible for licensing and supervising auditors carrying out statutory audits. Audits of public companies are subject to this special regime.
- FAOA expected to be operational by end-2007.
- Law specifies qualifications and duties of auditors and regulates auditors’ professional conduct, including independence, quality assurance, documentation and the scope of audits.
- Swiss Ombudsman of Insurance, established by the SIA, deals with complaints and facilitates dispute resolution; parties not bound by the Ombudsman’s findings and remain free to take further legal steps.

### The Supervisory System (ISL, FOPI, regulatory approach)
- ISL enacted January 2006, designed to protect the insured from abuses and the insolvency risks of insurers.
- Federal Council executes ISL and appoints FOPI.
- ISL replaces preventive product approval/monitoring with a risk-based solvency framework; product approval retained for occupational pensions and supplemental health insurance.
- Regulatory balance and cost-conscious regulation:
  - Clarify authority, circumstances and processes for addressing potential conflicts in objectives and preserve FOPI operational autonomy.
  - Regulatory processes should be transparent, affected parties involved, and economic impact considered early.
- Supervisory philosophy and self-assessment:
  - FOPI’s supervision philosophy is risk-based, principle-based, and competition-oriented.
  - Onus on boards and senior management for robust risk management and effective corporate governance.
  - FOPI initiated Self-Assessment Modules (SAM) to evaluate corporate governance; industry benchmarks for corporate governance, risk management and internal controls to focus supervision on material deviations.
- International cooperation:
  - February 2006, FOPI concluded a Memorandum of Understanding (MoU) with Members and Observers of CEIOPS.
  - Pursuant to this MOU and EU equivalence recognition, FOPI may be appointed lead supervisor or co-supervisor for cross-border supervision of insurance groups and financial conglomerates domiciled in Switzerland.
- Resource needs:
  - Expanded FOPI mandate requires adequate regulatory resources to implement ISL reforms and fulfill lead/co-supervisor roles.

### The Supervised Entities (licensing, control changes, captives, governance)
- Licensing and fitness checks:
  - FOPI may require comprehensive business plans including identity of beneficial owners and fitness and propriety of directors, auditors and key management staff.
  - Licenses only granted if legal requirements met and insured interests safeguarded; insurers must inform FOPI of changes in business plans.
- Changes in control and portfolio transfers:
  - Insurers must notify FOPI of changes in or acquisitions of share ownership exceeding 10 percent, 20 percent, 33 percent or 50 percent of capital or voting rights.
  - FOPI may prohibit a holding or impose conditions if the holding might endanger the insurer or insured interests.
  - Prior FOPI approval required for transfers of insurance portfolios in full or in part; acquiring insurer must inform each insured party individually within 30 days of the transfer of their right to terminate contracts.
- Captives:
  - Direct captives regulated same as direct insurers; reinsurance captives exempted from the SST.
  - FOPI may require SST application where reinsurance captives have complex group structures or substantial financial risks.
- Corporate governance and controls:
  - ISL empowers FOPI to establish rules on corporate governance and internal controls; SO sets requirements for fitness and propriety of board members and management.
  - Chairman of the Board of Directors should not also serve as chief executive officer.
  - Insurers required to set up effective internal audit independent of management.
  - External auditors have whistle blowing obligations to the FOPI.

### Ongoing Supervision (reporting, on-site visits, group supervision, intra-group transactions)
- Regulatory reporting and off-site surveillance:
  - FOPI should implement more timely and comprehensive regulatory reporting as a priority.
  - Insurance entities furnish annual reports for Solvency I and semi-annual consolidated/group accounts; insurance groups/conglomerates submit quarterly financial and asset-liability management reports.
  - Current information submitted is insufficient for effective assessment (e.g., FOPI lacks new business premiums written by life insurers).
  - Consider implementing more timely, e.g., quarterly, reports of selected key regulatory data such as solvency and asset-liability management, potentially based on insurers’ internal management and risk control reports.
- On-site visits:
  - Current on-site visits typically last two to three days focusing mainly on meetings with management and experts.
  - Consider expanding scope to validate internal models used for SST and include independent assessment of risk management and corporate governance practices.
  - Completion of SAM will aid implementation of risk-based on-site inspections.
- Group and conglomerate supervision:
  - ISL group/conglomerate supervision recognized as equivalent to relevant EU Directives and with the Principality of Liechtenstein.
  - FOPI’s consolidated supervision encompasses all entities within Swiss-based groups; conglomerate supervision applies when “significant” bank or securities operations exist alongside insurance activities.
  - Five largest insurance-based conglomerates as at end-2005: Baloise-Holdings, Swiss Life, Swiss Re, Winterthur Group and Zurich Financial Services Group.
  - Currently, nine Swiss groups are placed under group supervision.
  - Double gearing addressed under both Solvency I and group SST.
- Intra-group transactions:
  - SO empowers FOPI to require reports on significant intra-group transactions and establishes minimum values considering group size and complexity.
  - Intra-group transactions include: loans; guarantees and off-balance sheet operations; hybrid instruments qualifying as capital resources; capital investments; reinsurance; cost allocation agreements; and other risk transfer operations.
  - Transactions exceeding FOPI minimum values are deemed significant.
  - Legal authority to act provided under Article 51 of the ISL.
- Enforcement resources:
  - ISL empowers FOPI to enforce corrective and preventive measures, but FOPI may be limited by regulatory resources.
  - Consider allocating personnel to administer sanctions ordinance, including proposed administrative sanctions (e.g., confiscation or occupational ban) under draft FINMA Act.

### Prudential Requirements (SST, actuaries, valuation, technical provisions)
- Risk management standards:
  - ISL empowers FOPI to establish risk management standards and supervise insurers’ risk-management practices; insurers must identify and manage all relevant risks.
  - Initiatives underway to fine tune methodologies and parameters for risk-based supervision underpinned by the SST.
- Accountable actuaries:
  - All insurance companies required to designate accountable actuaries responsible for assessing risk management and appropriateness of premium rates and investments. Role formalized under Solvency I.
  - FOPI will define the appointed actuary role under SST in forthcoming statement: “The appointed actuary is responsible to the extent of his training and experience, and based on the size and risk structure of the insurance company.”
- SST framework and implementation timeline:
  - SST adopts principle-based solvency regulation and facilitates risk-based supervision, requiring FOPI insights into company-specific models and incentives for insurers to quantify and manage risks.
  - Pending Solvency II finalization, SST will apply in parallel with Solvency I.
  - As of January 1, 2006, SST is mandatory for large insurance companies. Business in foreign branches must be taken into account.
  - Small insurers, reinsurers as well as insurance groups/conglomerates expected to fully implement SST in 2008.
  - Target capital requirement expected to come into force as of 2010.
- Target capital and scenarios:
  - SST establishes target capital as a pillar two requirement serving as an early warning signal.
  - Market, credit and insurance risks modeled to arrive at target capital; complemented by scenario evaluation using FOPI-prescribed and insurer-specific scenarios to assess solvency from an ALM perspective.
  - If available risk-bearing capital is less than target capital, insurers must either build necessary capital over a certain period or reduce risks; shortfall does not automatically mean insolvency.
- Valuation and internal models:
  - Under SST, assets and liabilities valued on a market consistent basis. For technical provisions, market consistent value = best estimate (BE) plus market value margin (MVM).
  - MVM calibrated using a cost of capital (CoC) approach.
  - FOPI issued guidelines for calculating technical reserves for life insurance and is drafting guidelines for non-life insurance.
  - Use of internal models is default; standard models only allowed if they adequately quantify insurer risks.
  - Internal models mandated for reinsurers, captives, insurance groups and conglomerates, insurers with substantial business written by foreign branches and life insurers writing substantial financial options and guarantees.
  - Verification of internal models will be a supervision challenge.
- Natural hazard premiums and pooling:
  - Premiums for natural hazard under fire insurance based on industry tariff rates; scope and premium rates uniform and binding on all insurers.
  - Federal Council to issue detailed rules on premium calculation basis, scope of cover, limits on liability and statistics to be compiled by insurers.
  - FOPI checks that premium rates are fair in terms of risks and costs.
  - Intention to pool risks nationally to allow insured in exposed zones to have basic coverage at affordable premiums.
- Separation of safety fund for life insurance and occupational pension insurance:
  - Separation earmarked SwF 118.7 billion as technical provisions for pension policies.
  - On April 30, 2004, FOPI issued directive setting principles and process for separation; each insurer must present separation concept for approval satisfying four principles:
    - (i) equal partition of risks,
    - (ii) equal partition of expected returns,
    - (iii) partition of hidden reserves in the same proportion as the proportion of the amounts of the separated funds,
    - (iv) consideration of future cash flows.
  - Objective: ensure separation does not compromise insured persons’ interests; insurer’s explicit proposition to split each asset category checked by FOPI and an external expert and subject to external audit.
- Priority of policyholders and tied assets:
  - Policyholders and beneficiaries insured by insurers in Switzerland have priority in respect of claims against tied assets, segregated from insurers’ other assets.
  - Requirement does not apply to reinsurers.
  - Insurers operating third party motor vehicle insurance must be members of the Swiss National Bureau of Insurance and the National Guarantee Fund, which covers third party injuries caused by unknown drivers.

### Markets and Consumers (intermediaries, disclosure, fraud)
- Supervision of intermediaries:
  - ISL empowers FOPI to supervise insurance intermediaries and inspect them; FOPI maintains a public register of intermediaries with more than 8,000 registered since January 2006.
  - Intermediaries can only be registered if they demonstrate relevant professional qualifications and adequate professional liability insurance. Rules on qualifications, training and examination established in collaboration with the industry.
- Disclosure and intermediaries’ liability:
  - ISL and amended ICL regulate disclosure requirements of intermediaries vis-à-vis the insured; ISL holds intermediaries liable for negligence, errors, or incorrect information.
  - Enhanced disclosure requirements under the ICL deferred till January 1, 2007.
- Unit-linked policies (ULPs):
  - FOPI advised to introduce enhanced disclosure and market conduct requirements for ULPs because policyholders bear investment risks and some ULPs may offer minimal or no life insurance coverage.
  - Intermediaries should ascertain ULPs meet policyholders’ financial/protection needs and risk appetite; intermediary training recommended.
  - Significant growth of ULPs in 2005 underscores need for regulatory rules and intermediary training.
- Fraud and cooperation:
  - FOPI may require insurers to report insurance fraud to law enforcement authorities. Claims fraud punishable under the Criminal Code, obliging insurers to report fraud and take preventive measures.
  - Mandatory internal control systems in FOPI guideline contribute to fraud prevention.
  - FOPI does not promote exchange of information between insurers on fraud but leaves this to the SIA.
  - FOPI cooperates with other competent authorities in countering fraud; direct cooperation with foreign authorities focuses on fit and proper requirements. In criminal cases, Department of Justice is the appropriate channel.

### Anti-Money Laundering, Combating the Financing of Terrorism (AML/CFT)
- FOPI Ordinance on AML/CFT will come into effect on 1 January 2007 and aligns Swiss AML/CFT regime with FATF standards.
- ISL empowers FOPI to approve changes in control and beneficial ownership.
- Self-regulation preferred: SRO established by the SIA administers regulations pursuant to FOPI Ordinance on AML/CFT.
- FOPI cooperates closely with domestic FIU and other domestic AML/CFT supervisory authorities such as the SFBC and the MLCA. Swiss FIU cooperates with domestic enforcement authorities and foreign FIU.
- Transitional provision transferring supervisory responsibility for insurance brokers in respect of AML/CFT to FOPI has yet to be implemented; many brokers will remain subject to MLCA supervision due to other non-insurance businesses.
- AML/CFT will be integrated under the FINMA.

### Recommended Action Plan (by ICP themes)
- The Supervisory System — ICPs 2-5
  - Consider greater clarity regarding the authority, circumstances and processes in addressing potential conflicts in supervisory objectives.
  - Enhance FOPI independence and accountability through:
    - (a) public disclosure of the reasons if the Director of the FOPI is removed from office; and
    - (b) establishment of an internal audit function within the FOPI.
  - Push ahead with regulatory reforms under the ISL.
  - Strengthen regulatory resources to effectively supervise a sophisticated and globally diversified reinsurance industry and implement the regulatory reforms.
  - Consider formal regulatory cooperation and information exchanges with foreign regulators outside the EU/EEA.
- Ongoing Supervision — ICPs 11-17
  - Build adequate regulatory resources and cost-effective systems and processes to:
    - (a) enhance global market analysis;
    - (b) conduct risk-focused on-site inspections;
    - (c) enforce preventive and corrective measures;
    - (d) conduct group/conglomerate supervision; and
    - (e) conduct direct supervision of intermediaries.
  - Consider quarterly reports on selected key financial indicators, particularly on solvency and asset-liability-management, to facilitate ongoing off-site surveillance and timely intervention.
  - Allocate adequate and skilled resources to enforce preventive and corrective measures under the ISL.
- Prudential Requirements — ICPs 18-23
  - Maintain the momentum in implementing the SST as planned.
- Markets and Consumers — ICPs 24-27
  - Introduce enhanced disclosure and market conduct requirements for ULPs.
  - Plan for effective implementation of the IAIS standards on public disclosures to facilitate market discipline.

*Source: Excerpt from IMF staff report content unit titled "The Audit Oversight Act, enacted in December 2005, established the Federal" (page content provided).*

### Executive Summary ......................................................................................................

### Executive Summary

### Regulatory reforms and supervisory framework
- The Insurance Supervision Law (ISL) came into effect on January 1, 2006, reorienting the regulatory focus and expanding scope to include group/conglomerate supervision, corporate governance, risk management and market conduct of insurance intermediaries.
- The ISL provides for corrective and preventive regulatory measures and empowers the Federal Office of Private Insurance (FOPI) to exchange information with both domestic and foreign regulators.
- The regulatory approach is risk-based and principle-based, aligned with the Swiss insurance industry structure.
- The Swiss Solvency Test (SST) is recognized internationally as being at the forefront of risk-based solvency regimes and enables risk-based and differentiated supervision.
- Key implementation items issued or in drafting by FOPI include:
  - corporate governance guidelines tailored to the insurance industry,
  - regulatory intervention levels,
  - roles of external auditors and actuaries,
  - intra-group transaction rules.

### Market structure
- As at August 31, 2006, there were 214 (re)insurers: 23 Swiss life insurers, 4 foreign life insurers, 78 Swiss non-life insurers, 40 foreign non-life insurers, and 69 reinsurers.
- Switzerland has the highest per capita expenditures for insurance in the world—about SwF 7,000 (excluding social security contributions).
- More than 70 percent of Swiss insurers’ global premiums were sourced from abroad (SwF 133.5 billion of SwF 187 billion global premiums in 2004).
- In 2005, Swiss insurers employed about 42,186 staff in Switzerland and 92,774 staff abroad.
- Market concentration:
  - In 2005, the five largest non-life insurers accounted for 72 percent of gross premiums written.
  - The five largest life insurers accounted for 82 percent of premiums earned.
  - Swiss Re, European Re and Converium consistently maintain about 79 percent share of the Swiss reinsurance market.
- Strategic shifts:
  - Emerging trend for insurers to specialize in traditional core business; most direct insurers have withdrawn from active reinsurance operations.
  - Exits have been orderly and new niche players have entered the market without restrictive entry barriers.
- Cantonal insurers:
  - Insurance for buildings is mandatory in 19 cantons, provided by monopolistic cantonal insurers not regulated by FOPI.
  - Total sum insured for buildings in 26 cantons exceeded SwF 2,000 billion; content cover is about SwF 700 billion.
  - Potential economic losses from earthquakes are estimated at approximately SwF 80 billion in the region of Basle.
  - Earthquake insurance is mandatory in Zurich; the other 18 cantons maintain a voluntary earthquake pool with the sum insured totaling SwF 1,200 billion.
  - SIA and IRV launched a joint initiative to implement mandatory earthquake insurance with reinsurance protection by January 1, 2008.

### Industry performance and balance sheets
- Recovery since the 2001/2002 stock market crash due to restructured investment strategies and more stable capital markets.
- Investments in shares and mutual funds reduced to less than 8 percent (SwF 43 billion) of capital investment at end-2005.
- Direct insurance industry paid SwF 1.3 billion for a severe storm in August 2005 and remained profitable.
- Gross premiums of direct Swiss insurers totaled SwF 50.5 billion for 2005.
- Domestic non-life lines (2005 market shares):
  - Motor insurance: 23 percent
  - Fire and natural hazards insurance: 15 percent (loss ratio of 140 percent for 2005)
- Significant product movements:
  - Unit-linked life insurance grew by 83 percent (driven by 2005 investment performance and new products offering capital protection or guaranteed minimum return at contract expiry).
  - Occupational pension insurance declined 8.2 percent due mainly to withdrawal of insurers and guaranteed products.
  - Health insurance remained at current levels.
- Asset allocation and capitalization (end-2005):
  - Total assets held by direct insurers: SwF 450.3 billion.
  - About 50 percent invested in fixed income securities.
  - Investments in shares reduced to 8 percent of total assets.
  - Intra-group loans and investments in related companies: SwF 55.7 billion (12.4 percent of total assets).
  - Combined life and non-life equity: SwF 26.5 billion.
  - Surplus of the direct industry rose by SwF 1.7 billion in 2005 to reach SwF 4.1 billion.
  - Equity increased by SwF 0.8 billion in 2005.
  - Total reserves held by the direct insurance industry: SwF 596.1 billion, of which life reserves accounted for SwF 513 billion.

### Institutional arrangements and supervisory capacity
- FOPI responsibilities under ISL:
  - Regulates and supervises all private (re)insurance entities, groups and conglomerates, and intermediaries domiciled in Switzerland.
  - Exemptions: insurers with registered office outside Switzerland if they only operate insurance in Switzerland; entities subject to special supervision under Swiss Federal Law for specific activities (including occupational pension plans and intermediaries dependent on a policy holder pursuing exclusively the interests of the policy-holder).
  - Old age and survivors’ insurance, Swiss National Accident Insurance Fund and military insurance are not subject to FOPI supervision.
- Health insurance supervision:
  - Dual supervision: basic health insurance regulated by the Federal Office of Public Health (FOPH); FOPI responsible for supplementary private health insurance.
  - Insolvencies of three health insurance associations (KBV; Accorda; and Zurzach) were attributable to their basic health insurance portfolios.
- FOPI structure and resourcing:
  - Restructured mid-2004 into separate supervisory sections for non-life, life, intermediary, group and conglomerate, and health and reinsurance.
  - Established headcount of 90 staff monitoring over 200 insurers, about 60 supplementary health insurance funds and more than 8,000 registered intermediaries.
  - Supported by departments: Supervisory Development, Legal Services, Financial Accounting, Financial Investments and International Affairs.
- Planned institutional change:
  - A new integrated financial market authority (FINMA) expected to be operational by 2009 under a draft FINMA Act endorsed by the Federal Council on February 1, 2006, to integrate SFBC, FOPI and MLCA while retaining sectoral roles and streamlining sanctions.
- Role of self-regulation:
  - Professional bodies and SROs (e.g., Swiss Institute of Certified Accountants, Swiss Insurance Association (SIA), Swiss Actuarial Association, Swiss Insurance Brokers Association) complement FOPI.
  - SIA established a distinct SRO to administer AML/CFT regulations approved by FOPI.

### Implementation of IAIS Insurance Core Principles and conditions for effective supervision
- Switzerland articulated its Financial Centre and Financial Market Policy in September 2006 with objectives:
  - (a) facilitate international competitiveness,
  - (b) ensure functionality, efficiency and stability,
  - (c) maintain integrity.
- Guiding principle: achieve practical, proportionate and effective regulations and utilize regulatory differentiation to preserve competitiveness and reputation.
- Overall assessment:
  - Updated regulatory framework has a very high level of observance with the Insurance Core Principles, but implementation is in transition.
  - Broad legislative framework established; FOPI issuing and drafting implementing decrees and guidelines.
- Key supervisory implementation challenges and resource implications:
  - Balancing ISL objective to protect insured and limit insolvency risks against financial market policy objectives of preserving international competitiveness and controlling regulatory/supervisory costs.
  - Critical need for adequate regulatory resources at FOPI to supervise a large and internationally diversified industry, including:
    - retention of experienced key personnel,
    - rapid development of regulatory capacity,
    - good insights into company-specific internal models for effective SST implementation,
    - strengthened direct supervision of (re)insurers beyond self-governance and enhanced external audits,
    - adequate resources for effective and timely off-site surveillance and risk-focused on-site examinations.
  - Significant resource implications if FOPI is appointed supervisor / lead supervisor for cross-border supervision of insurance groups/conglomerates, recognizing regulatory equivalence with the EU.

*Executive Summary — _cr07203*

### 19.      The Audit Oversight Act, enacted in December 2005, established the Federal

### 19.      The Audit Oversight Act, enacted in December 2005, established the Federal

### Audit oversight, ombudsman, and auditors' conduct
- The Audit Oversight Act (enacted in December 2005) established the Federal Audit Oversight Authority (FAOA) responsible for licensing and supervising auditors carrying out statutory audits. Audits of public companies are subject to this special regime.
- The FAOA is expected to be operational by end-2007.
- The law specifies the qualifications and duties of auditors and regulates auditors’ professional conduct, including independence, quality assurance, documentation and the scope of audits.
- The Swiss Ombudsman of Insurance, established by the SIA, deals with complaints and facilitates dispute resolution. Parties are not bound by the Ombudsman’s findings and remain free to take further legal steps.

### B. The Supervisory System (ISL, FOPI, regulatory approach)
- The ISL, which came into effect in January 2006, is designed to protect the insured from abuses and the insolvency risks of insurers.
- The Federal Council is charged with the execution of the ISL and appoints the FOPI.
- The ISL replaces preventive product approval/monitoring with a risk-based solvency framework; product approval is retained for occupational pensions and supplemental health insurance.
- Regulatory balance and cost-conscious regulation:
  - The ISL objective must be balanced with regulatory costs, international competitiveness and innovative capacity as provided under the draft FINMA Act and guidelines issued by the Federal Department of Finance, the Swiss Federal Banking Commission, and FOPI.
  - Regulatory processes should be transparent, affected parties involved, and economic impact considered early. Consider clarifying authority, circumstances and processes for addressing potential conflicts in objectives and preserving FOPI operational autonomy.
- Supervisory philosophy and self-assessment:
  - FOPI’s supervision philosophy is risk-based, principle-based, and competition-oriented.
  - Onus is on boards and senior management for robust risk management and effective corporate governance.
  - FOPI initiated Self-Assessment Modules (SAM) to evaluate corporate governance; industry benchmarks for corporate governance, risk management and internal controls will be established to focus supervision on material deviations.
- International cooperation:
  - In February 2006, FOPI concluded a Memorandum of Understanding (MoU) with Members and Observers of CEIOPS.
  - Pursuant to this MOU and EU equivalence recognition, FOPI may be appointed lead supervisor or co-supervisor for cross-border supervision of insurance groups and financial conglomerates domiciled in Switzerland, reducing regulatory burden for Swiss groups operating in the EU.
- Resource needs:
  - FOPI has an expanded mandate (corporate governance, risk management, solvency controls, group/conglomerate supervision, direct supervision of intermediaries) and needs adequate regulatory resources to implement ISL reforms and fulfill lead/co-supervisor roles.

### C. The Supervised Entities (licensing, control changes, captives, governance)
- Licensing and fitness checks:
  - ISL strengthened FOPI's legal basis for licensing insurers; FOPI may require comprehensive business plans including identity of beneficial owners and fitness and propriety of directors, auditors and key management staff. Licenses only granted if legal requirements met and insured interests safeguarded. Insurers must inform FOPI of any changes in business plans.
- Changes in control and portfolio transfers:
  - Insurers must notify FOPI of changes in or acquisitions of share ownership exceeding 10 percent, 20 percent, 33 percent or 50 percent of capital or voting rights.
  - FOPI may prohibit a holding or impose conditions if the holding might endanger the insurer or insured interests.
  - Prior FOPI approval required for transfers of insurance portfolios in full or in part; FOPI-specified conditions apply if FOPI orders a portfolio transfer.
  - The insurer acquiring the portfolio must inform each insured party individually within 30 days of the transfer that they have a right to terminate their contracts.
- Captives:
  - Direct captives regulated same as direct insurers while reinsurance captives are exempted from the SST. FOPI may require SST application where reinsurance captives have complex group structures or substantial financial risks.
- Corporate governance and controls:
  - ISL empowers FOPI to establish rules on corporate governance and internal controls; the SO sets requirements for fitness and propriety of board members and management.
  - Chairman of the Board of Directors should not also serve as chief executive officer.
  - Insurers required to set up effective internal audit independent of management.
  - External auditors have whistle blowing obligations to the FOPI.

### D. Ongoing Supervision (reporting, on-site visits, group supervision, intra-group transactions)
- Regulatory reporting and off-site surveillance:
  - To facilitate off-site surveillance, FOPI should implement more timely and comprehensive regulatory reporting as a priority.
  - Insurance entities furnish annual reports for Solvency I and semi-annual consolidated/group accounts; insurance groups/conglomerates submit quarterly financial and asset-liability management reports.
  - Current information submitted is insufficient for effective assessment (e.g., FOPI lacks new business premiums written by life insurers).
  - FOPI should consider implementing more timely, e.g., quarterly, reports of selected key regulatory data such as solvency and asset-liability management, potentially based on insurers’ internal management and risk control reports, to minimize cost and effort and pave the way for IAIS public disclosure standards.
- On-site visits:
  - Current on-site visits typically last two to three days focusing mainly on meetings with management and experts.
  - Consider expanding scope to validate internal models used for SST and include independent assessment of risk management and corporate governance practices.
  - Completion of SAM will aid implementation of risk-based on-site inspections.
- Group and conglomerate supervision:
  - ISL group/conglomerate supervision is recognized as equivalent to relevant EU Directives and with the Principality of Liechtenstein.
  - FOPI’s consolidated supervision encompasses all entities within Swiss-based groups; conglomerate supervision applies when “significant” bank or securities operations exist alongside insurance activities.
  - The five largest insurance-based conglomerates as at end-2005 are: Baloise-Holdings, Swiss Life, Swiss Re, Winterthur Group and Zurich Financial Services Group.
  - Currently, nine Swiss groups are placed under group supervision.
  - Double gearing is addressed under both Solvency I and group SST.
- Intra-group transactions:
  - SO empowers FOPI to require reports on significant intra-group transactions and establishes minimum values considering group size and complexity.
  - Intra-group transactions include: loans; guarantees and off-balance sheet operations; hybrid instruments qualifying as capital resources; capital investments; reinsurance; cost allocation agreements; and other risk transfer operations.
  - Transactions exceeding FOPI minimum values are deemed significant.
  - No explicit provisions within FOPI’s power to address undesirable intra-group transactions specifically; legal authority to act provided under Article 51 of the ISL.
- Enforcement resources:
  - While ISL empowers FOPI to enforce corrective and preventive measures, FOPI may be limited by regulatory resources. Consider allocating personnel to administer sanctions ordinance, including proposed administrative sanctions (e.g., confiscation or occupational ban) under draft FINMA Act.

### E. Prudential Requirements (SST, actuaries, valuation, technical provisions)
- Risk management standards:
  - ISL empowers FOPI to establish risk management standards and supervise insurers’ risk-management practices; insurers must identify and manage all relevant risks.
  - Initiatives underway to fine tune methodologies and parameters for risk-based supervision underpinned by the SST.
- Accountable actuaries:
  - All insurance companies required to designate accountable actuaries responsible for assessing risk management and appropriateness of premium rates and investments. Role formalized under Solvency I.
  - FOPI will define the appointed actuary role under SST in forthcoming statement: “The appointed actuary is responsible to the extent of his training and experience, and based on the size and risk structure of the insurance company.”
- SST framework and implementation timeline:
  - SST adopts principle-based solvency regulation and facilitates risk-based supervision, requiring FOPI insights into company-specific models and incentives for insurers to quantify and manage risks.
  - Pending Solvency II finalization, SST will apply in parallel with Solvency I.
  - As of January 1, 2006, SST is mandatory for large insurance companies. Business in foreign branches must be taken into account.
  - Small insurers, reinsurers as well as insurance groups/conglomerates are expected to fully implement SST in 2008.
  - The target capital requirement is expected to come into force as of 2010.
- Target capital and scenarios:
  - SST establishes target capital as a pillar two requirement serving as an early warning signal.
  - Market, credit and insurance risks modeled to arrive at target capital; complemented by scenario evaluation using FOPI-prescribed and insurer-specific scenarios to assess solvency from an ALM perspective.
  - If available risk-bearing capital is less than target capital, insurers must either build necessary capital over a certain period or reduce risks; shortfall does not automatically mean insolvency.
- Valuation and internal models:
  - Under SST, assets and liabilities valued on a market consistent basis. For technical provisions, market consistent value = best estimate (BE) plus market value margin (MVM).
  - MVM calibrated using a cost of capital (CoC) approach.
  - FOPI has issued guidelines for calculating technical reserves for life insurance and is drafting guidelines for non-life insurance.
  - Use of internal models is default; standard models only allowed if they adequately quantify insurer risks.
  - Internal models mandated for reinsurers, captives, insurance groups and conglomerates, insurers with substantial business written by foreign branches and life insurers writing substantial financial options and guarantees.
  - Verification of internal models will be a supervision challenge.
- Natural hazard premiums and pooling:
  - Premiums for natural hazard under fire insurance based on industry tariff rates; scope and premium rates uniform and binding on all insurers.
  - Federal Council to issue detailed rules on premium calculation basis, scope of cover, limits on liability and statistics to be compiled by insurers.
  - FOPI checks that premium rates are fair in terms of risks and costs.
  - Intention to pool risks nationally to allow insured in exposed zones to have basic coverage at affordable premiums.
- Separation of safety fund for life insurance and occupational pension insurance:
  - Separation earmarked SwF 118.7 billion as technical provisions for pension policies.
  - On April 30, 2004, FOPI issued directive setting principles and process for separation; each insurer must present separation concept for approval satisfying four principles:
    - (i) equal partition of risks,
    - (ii) equal partition of expected returns,
    - (iii) partition of hidden reserves in the same proportion as the proportion of the amounts of the separated funds,
    - (iv) consideration of future cash flows.
  - Objective: ensure separation does not compromise insured persons’ interests; insurer’s explicit proposition to split each asset category checked by FOPI and an external expert and subject to external audit.
- Priority of policyholders and tied assets:
  - Policyholders and beneficiaries insured by insurers in Switzerland have priority in respect of claims against tied assets, segregated from insurers’ other assets.
  - Requirement does not apply to reinsurers.
  - Insurers operating third party motor vehicle insurance must be members of the Swiss National Bureau of Insurance and the National Guarantee Fund, which covers third party injuries caused by unknown drivers.

### F. Markets and Consumers (intermediaries, disclosure, fraud)
- Supervision of intermediaries:
  - ISL empowers FOPI to supervise insurance intermediaries and inspect them, though FOPI has no plan for routine inspections.
  - FOPI manages a public register of intermediaries; more than 8,000 have been registered since January 2006.
  - Intermediaries can only be registered if they demonstrate relevant professional qualifications and adequate professional liability insurance. Rules on qualifications, training and examination established in collaboration with the industry.
- Disclosure and intermediaries’ liability:
  - ISL and amended ICL regulate disclosure requirements of intermediaries vis-à-vis the insured; ISL holds intermediaries liable for negligence, errors, or incorrect information.
  - Enhanced disclosure requirements under the ICL deferred till January 1, 2007 in response to industry feedback on need for high degree of standardization.
- Unit-linked policies (ULPs):
  - FOPI advised to introduce enhanced disclosure and market conduct requirements for ULPs because policyholders bear investment risks and some ULPs may offer minimal or no life insurance coverage.
  - Intermediaries should ascertain ULPs meet policyholders’ financial/protection needs and risk appetite; intermediary training recommended.
  - Significant growth of ULPs in 2005 underscores need for regulatory rules providing relevant and adequate information to policyholders and adequate intermediary training.
- Fraud and cooperation:
  - FOPI may require insurers to report insurance fraud to law enforcement authorities. Claims fraud punishable under the Criminal Code, obliging insurers to report fraud and take preventive measures.
  - Mandatory internal control systems in FOPI guideline contribute to fraud prevention.
  - FOPI does not promote exchange of information between insurers on fraud but leaves this to the SIA.
  - FOPI cooperates with other competent authorities in countering fraud; direct cooperation with foreign authorities focuses on fit and proper requirements. In criminal cases, Department of Justice is the appropriate channel, notably under legal assistance agreements with other jurisdictions.

### G. Anti-Money Laundering, Combating the Financing of Terrorism (AML/CFT)
- FOPI Ordinance on AML/CFT will come into effect on 1 January 2007 and aligns Swiss AML/CFT regime with FATF standards.
- ISL empowers FOPI to approve changes in control and beneficial ownership.
- Self-regulation preferred: SRO established by the SIA administers regulations pursuant to FOPI Ordinance on AML/CFT.
- FOPI cooperates closely with domestic FIU and other domestic AML/CFT supervisory authorities such as the SFBC and the MLCA. Swiss FIU cooperates with domestic enforcement authorities and foreign FIU. Cooperation with foreign supervisors possible informally unless MOUs executed.
- Transitional provision transferring supervisory responsibility for insurance brokers in respect of AML/CFT to FOPI has yet to be implemented; many brokers will remain subject to MLCA supervision due to other non-insurance businesses. AML/CFT will be integrated under the FINMA.

### V. RECOMMENDED ACTION PLAN (by ICP themes)
- The Supervisory System — ICPs 2-5
  - Consider greater clarity regarding the authority, circumstances and processes in addressing potential conflicts in supervisory objectives.
  - Enhance FOPI independence and accountability through:
    - (a) public disclosure of the reasons if the Director of the FOPI is removed from office; and
    - (b) establishment of an internal audit function within the FOPI.
  - Push ahead with regulatory reforms under the ISL.
  - Strengthen regulatory resources to effectively supervise a sophisticated and globally diversified reinsurance industry and implement the regulatory reforms.
  - Consider formal regulatory cooperation and information exchanges with foreign regulators outside the EU/EEA.
- Ongoing Supervision — ICPs 11-17
  - Build adequate regulatory resources and cost-effective systems and processes to:
    - (a) enhance global market analysis;
    - (b) conduct risk-focused on-site inspections;
    - (c) enforce preventive and corrective measures;
    - (d) conduct group/conglomerate supervision; and
    - (e) conduct direct supervision of intermediaries.
  - Consider quarterly reports on selected key financial indicators, particularly on solvency and asset-liability-management, to facilitate ongoing off-site surveillance and timely intervention.
  - Allocate adequate and skilled resources to enforce preventive and corrective measures under the ISL.
- Prudential Requirements — ICPs 18-23
  - Maintain the momentum in implementing the SST as planned.
- Markets and Consumers — ICPs 24-27
  - Introduce enhanced disclosure and market conduct requirements for ULPs.
  - Plan for effective implementation of the IAIS standards on public disclosures to facilitate market discipline.

*Source: Excerpt from IMF staff report content unit titled "The Audit Oversight Act, enacted in December 2005, established the Federal" (page content provided).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07203.pdf_