Devil in the detail: Implications of the tier based minimum solvency capital
The tier based minimum solvency capital (TBMSC) is a new legislation in Nigeria aimed at setting capital levels for insurance businesses. It supposedly starts 1st January 2019. The prescriptive capital levels are set by tiers (1-3). Each tier groups types of insurances for the life and non-life sectors. For instance tier 3, for non-life, includes insurance companies underwriting no more than fire, motor, general accident, agriculture, engineering (mandatory). This tier requires the insurer to have a minimum capital of N3 billion; tier 2 will include all these types of business (in tier 3) plus more and so on; requiring those insures in tier 2 to hold more capital – N4.5 billion, and N6 billion for tier 1.
Whilst some in the industry have poured scorn on the legislation, citing high capital base and tight implementation deadlines as drawbacks, others welcome it as long overdue for an industry lacking in analytical and risk managing directives. Whatever the reception, the fact remains the implications for the regulated and the regulator (the insurance industry and NAICOM) are huge.
The single most significant impact for the insurer is the need to have/maintain the minimum level of capital for the tier operated in. The first huddle for some companies will be the raising of the capital. Once raised however, the challenge will be in sustaining this solvency capital taking into account their risk profile. To do this, it will require concerted efforts and investments by the individual insurers in ensuring that their operations and management processes along with reports are streamlined and efficient. In effect, they will need to invest/improve their analytical and reporting processes (from source data, through analyses to management reports) to enable effective quantitative (numerical) insight whilst ensuring qualitative (decision-making) strategy. All this whilst maintaining a structure for disclosure to all stakeholders.
Companies will have to improve their risk management process. Ultimately, it implies ascertaining the levels of capital required to keep their businesses solvent (regardless of the tier minimum) before ensuring it exceeds that minimum level. This requires discernment of the risks their businesses are exposed to, inevitably requiring sophisticated mathematical models and analytical tools. Companies will also conduct high levels of automation and streamlining of business processes to ensure timely & accurate reports.
Similar to the banking sector’s introduction of the capital re-basing over a decade ago (that saw the merger and acquisition of so many banks), lesser insurance companies will be susceptible to take-over. As such, some companies will have to raise new capital.
The ability of decision makers of these companies to manage the businesses and steer it on sure-course in the environment of risks will also be tested. They must manage their own risk self-assessment. Management will require financial models for scenario analyses, stress testing and ultimately simulations to assess financial impact of varying risks in a controlled environment. This ensures companies are steered on the correct risk mitigating route and guide the direction of the business as required, such as when market conditions indicate clear and present concerns.
Lastly, insurers must have the structure in place for good governance, clear audit trail, accountability and disclosure. They will have to keep sight on the future with forecasts and projections. Big data analytics is a cutting edge technology that will help with these.
In the case of the regulator, the Insurance Core Principles (ICP) by the International Association of Insurer Supervisors broadly defines some of its roles. These include identifying underlying trends within the insurance sector (by collecting economic and cross-sectoral data), performing market analysis on historical trends as well as the current risk environment, performing both qualitative and quantitative analyses on the data so that macro risks are properly assessed, and analyzing the extent to which economic vulnerabilities/risks impinge on prudential safeguards for the financial stability of the insurance sector. To carry out these, NAICOM must have the capable analytical tools and competent experts to decipher them. This should include big data analytics (for fraud detection/prevention and product innovation) as well as the stated aforementioned models (required by the insurers) for their own reporting and analyses.
NAICOM must also have a streamlined process of diagnosing the financial “health” of regulated companies, and swift automated actions based on these findings (quantitative and qualitative).
The regulator must be steps ahead of the curve to prepare for some rigidity & lack of robustness inherent in this legislation. During the transition from the Solvency I regulation to Solvency II in Europe, some issues (such as inadequate focus on individual risk management) were significant. This regulation’s main driver for capital-requirement is “business-type” not “risk”. This might seem alright initially, however dangers of insolvency potentially lie in anomalous events occurring where the risk impact in a period (claims incurring on a particular business-type say) exceeds the set-aside capital. In such an event, a company would have stood in far better stead had its inherent risks driven capital-requirement calculations.
Business internal processes also bear operational risks and these must be reflected in the regulation. Take the claims or underwriting departments in insurance companies as examples. Either one can adopt prudence or less prudence in their approach. If the claim-reserve is calculated with accuracy and prudent margins, that company is more likely to meet its obligations than a less accurate/prudent one. Similarly, a less prudent approach to underwriting will result in cavalier risks and potential exposure to huge future claims. A mechanism should exist to directly incorporate these risks in the capital-requirement calculations.
In conclusion, the implications of the TBMSC are much further reaching than most in the industry realize. The key requirements to making the legislation work are sophisticated analyses, risk-based models & simulations for decision making and structured approaches to regulatory disclosure.
Olufemi-Ekundayo is currently the MD of POBEK Advisory Ltd – an actuarial and financial advisory consultancy in Lagos.
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