Monday Nov 25, 2024
Monday Nov 25, 2024
Wednesday, 31 July 2013 00:06 - - {{hitsCtrl.values.hits}}
The risk-based capital framework in Sri Lanka is currently being assessed through an industry test run and during the next two years, there will be a parallel run with both the current and new regimes running simultaneously in order to further calibrate the risk-based capital rule. It is the industry’s expectation that at the beginning of 2016, risk-based capital will be the industry norm.
In this context, the hosting of Sri Lanka’s first-ever seminar on risk-based capital could not have come at a better time – organised by the Asia Insurance Review and endorsed by the Insurance Board of Sri Lanka, the two day forum which commenced yesterday in Colombo enlightened Sri Lanka’s insurers on a myriad of factors in relation to the adoption of the framework, with several key industry personnel, both local and international, sharing their experiences and thoughts on the subject.
Themed ‘Getting ready to make that leap from solvency margin to RBC,’ the inauguration of the session offered participants a brief overview of Sri Lanka’s insurance industry, the progress made thus far in converting to a risk based capital regime within the country, some comments from industry regulators and the outlining of some key factors of the regime.
Insurance Association of Sri Lanka President Prakash Schaffter in his opening remarks noted that the seminar was extremely appropriate, given the context of Sri Lanka’s insurance market as it is currently in the middle of the RBC test run, with plans of going live by 2016 and went on to give a quick overview of the country’s 100-year-old industry.
“We are a small yet dynamic market. Sri Lanka has also proved to be an attractive investment for foreign insurers. World renowned international names have taken decisions to invest in Sri Lanka, with one in fact entering the market very recently and we are proud of the fact that we are considered to be a favourable place to invest in by industry giants such as these,” he stated. “The timing of this conference could not have been better from the perspective of insurance in Sri Lanka.”
IAIS 17
International Association of Insurance Supervisors (IAIS) Secretary General Yoshihiro Kawai, although unable to be present in person, addressed the gathering via a video presentation. Describing IAIS, he explained that the organisation, 
established in 1994, composes of insurance regulator and supervisors from 140 countries and over 200 jurisdictions.
The IAIS’s objective is to promote effective and globally consistent insurance supervision for the benefit and protection of policyholders and contribute to global stability. It conducts four important activities, namely setting international insurance rules, standards and principles, encouraging members to comply with said standards, contributing to financial stability and involvement in external interactions with important stakeholders and partners.
“IAIS’s core principles consist of a globally accepted insurance supervisory framework and are used for assessing insurance systems across the world by World 
Bank and IMF. The current 26 core principles were comprehensively reviewed in 2011,” he added.
In the case of RBC, the most important insurance core principle is IAIS 17, the principle on RBC. “We make it we make it clear that the capital standards are based on a total balance sheet approach – to see it in totality – not only seeing the capital but liabilities and assets as well and it requires an assessment of the company’s material risk in totality and recognising risk in totality.”
“The foundation of the total balance sheet approach requires consistent measurement and valuation of assets and liabilities. It has to have an explicit identification of risk and all risks have to be recognised in this approach,” he explained, adding that there are three key components to this. “Technical proficiencies, required capital and capital resources. Technical provision is the amount insurance companies should put aside for future payment for claims. Required capital is a financial requirement set by supervisors in addition to technical provision and capital resources refer to assets in excess of all liabilities so that insurance companies hold these assets as a buffer.”
RBC implementation in SL
Insurance Board of Sri Lanka Chairperson Indrani Sugathadasa delivered the official address at the inauguration and stressed on the importance of adopting the RBC regime, outlined Sri Lanka’s current progress and highlighted some obstacles that need to be overcome in order to successfully implement it.
“Despite the challenging global economy and adverse weather conditions, such as drought and floods that prevailed in Sri Lanka in 2012, the insurance industry was able to continue on an upward growth trajectory, recording a gross written premium of approximately US$ 700 million,” she noted.
Sugathadasa added that the industry has seen double digit growth in the past three years, reflective of the improvement in macroeconomic conditions since the advent of peace in Sri Lanka. During the past five years, the average growth of total assets of the insurance sector has been 17% and in 2012, it grew by 15.5%, which is almost double the value in 2008.
Yet, despite the phenomenal gross written premium and asset growth, insurance penetration in Sri Lanka remains low at 1.1%, compared with 4.1% in India, 3% in China and 8.1% in the US. “However, when taken in the context of a healthy double digit growth rate and with only 12% of the population with insurance covers, the low level of penetration in Sri Lanka highlights the vast potential that currently exists in the country.”
Implementation of risk based capital is intended to increase transparency and prudential regulatory oversight while establishing appropriate risk management systems. Under the risk based capital regime, the market participants will be focused on managing risk rather than managing rules. The Insurance Board of Sri Lanka, after examining various models across the globe, initiated the RCB project in Sri Lanka with the assistance of the World Bank. The project, which commenced in 2009, included an analysis of the Sri Lankan insurance market, a qualitative report and a quantitative report culminating in a RBC framework for Sri Lanka.
“From inception, the industry has championed the effort to move from a rules-based regime to a risk-based regime. Way back in 2007, before the global financial crisis fully materialised, industry leaders in Sri Lanka promoted the introduction of risk based capital. During that time, the Insurance Board, which is the regulator, was also examining the prospects of strengthening prudential supervision of the insurance sector,” she explained.
“This partnership between the industry and the regulator has resulted in seamless progress in the transition from the rule-based to risk-based regime. The insurance industry, and in particular the insurance association of Sri Lanka, has been fully committed and proactively involved in the critical input to this entire process and has been instrumental in shaping the framework that we have today.”
The risk-based capital framework in Sri Lanka is currently being assessed through an industry test run and the analysis by the consultant actuary of the IBSL will provide a better understanding of how the final rules for risk-based capital should be fine-tuned by the end of the year. During the next two years, there will be a parallel run with both the current and new regimes running simultaneously in order to further calibrate the risk-based capital rule.
However, one of the key challenges associated with the implementation of the risk-based capital framework is the expanded role of actuaries and the current dearth if such professionals in the country. “There is a serious problem in Sri Lanka in this regard. Not only will actuaries play an important role in assisting insurance industry adopt the framework but will also do so in full implementation of risk-based capital in the future,” she pointed out.
The exact impact in terms of additional capital required will depend on the risk associated with the existing business of each individual insurer and the risk management practices already in place. “Although certain opinions were expressed in the media that smaller companies will struggle to adopt risk based capital, we are pleased to note that some of them have already begun preparing themselves for increasing capital, segregation, listing and adopting risk based capital. On our part, the Insurance Board of Sri Lanka needs to overcome supervisory challenges of the introduction of new processes and tools related to risk based capital as well as familiarisation of the RBC model through hands-on practical training in order to build up supervisory capacity,” Sugathadasa stated.
Private sector: Motor for growth
Senior Minister for International Monetary Co-operation and Deputy Minister of Finance and Planning Dr. Sarath Amunugama delivered the keynote address, stating that he regarded RBC seminar as very important because many elements have to come together for a country to grow on a sustainable basis. “You must not only have peace and pro-growth policies but all those other financial and other services which have to be integrated with the growth process must also develop on their own.”
“In the past, we experienced the lack of growth. One of the benefits of the peace dividend that we obtained, though it was not that spectacular, is that we have been able to revise our insurance rates, freight rates, bond interest rates and a whole raft of economic and financial activity that have now turned more and more in our favour.”
This is a time when you must assess the role of insurance and risk management in assisting this global trend, he urged those present, adding that from here, many reforms and changes should be undertaken that will help in developing the country.
He emphasised on the importance of the private sector as the driving force of future growth, noting that growth cannot take place as envisaged unless the private sector plays its role. “This is something you have to examine. Why is it not moving fast enough, what are the policy inhibitions, the practical difficulties that are preventing the private sector? Although there are plans for growth this and next year, why cannot this be fast-tracked, because on that growth depends the total growth effort of Sri Lanka.”
Economic growth in Sri Lanka is a joint enterprise, he added, calling on the private sector to be the motor of growth in this country.
Amunugama shared an observation he had made about the insurance sector – that many Sri Lankan companies and institutions analyse their own performance and requirements purely as an inside operation. He stressed that the time has come to look at the global trend, employing highly specialised agencies and companies that consider it its role to look into big companies, how total savings can be made and how the activities can be made more efficient.
This, he noted, is vital in the present global scenario where there is acute global competition and it is very necessary that the old concept that the board knows best needs to be put aside. “The board may know best but the time has come when all other major enterprises today need very hard, serious and critical analyses of performance within themselves. The Government needs it too. Both sectors must now get real and seek every possible benefit in each of these sectors as we grow.”
Can’t afford to be a slack economy
There is going to be a big trade war, Amunugama predicted, and urged companies to look at their assets and make sure that they produce the best possible performance. “We can’t afford to be the slow, slack economy that is happy with some progress – that can’t go on for long. How do we cut costs, increase efficiencies and use all this new information coming in? I think in Sri Lanka we are still very much in little boxes.”
He stated that risk must be connected to a deep analysis of what the risks are going to be and how they can be met. As an example, Amunugama pointed out that nobody came in to invest in new computers and new technological innovation at one stage. Everyone was thinking of the old financial services and old manufacturing services but then, the insurance companies and some of the financial companies sensed that the technology sector would emerge as a major component of the Western economy and those who forecasted accurately and acted on it made a lot of money.
“What are the areas that insurance can move into and sponsor faster growth – these major issues need to be addressed. The Central Bank and Insurance Surveillance Board are doing an excellent job but we have to now look at the much bigger picture of information coming in and the sectors into which we can move in fast,” he stated.
Sri Lanka has a very big role in science and technology growth, in making use of the huge market in India – these are new areas that need study and insurers, Amunugama noted, have the responsibility to be looking and focusing at these new areas and diverting attention and funds so that they can be funded. The challenge now in Sri Lanka is to forecast and plan for stimulating areas of financial growth and make use of the huge markets of India and China. “We will be one country that can boast of FTAs with two major markets and major frontrunners of global growth – India and China. I think we can be positive in Sri Lanka. We have to think out of the box and I think Sri Lanka has a very good future.”
Life insurance solvency reform
AIA Group CFO Garth Jones presented the industry keynote and spoke about Life insurance company solvency reform in Asia, pointing out that over-regulation and overcapitalisation are just as dangerous for the sustainable provision of insurance cover as under-regulation and undercapitalisation. “We consider these areas deeply at AIA because they are at the heart of our business,” he explained.
He then listed out three clear guidelines for regulatory solvency reform in Asia. The first was around considering intended and more importantly, unintended consequences. The second was about flexibility and the third, around simplicity and pragmatism.
“It is important to understand the intended objective but also the potential unintended consequences of any changes to a regulatory solvency framework. Regulatory requirements need to be proportionate to their intentions and therefore, to reflect the practical, real world risks and threats. Total protection of every insurance client against every conceivable risk – present or future – is now a valid workable basis for regulation,” he stated.
“We must concentrate on optimisation arrived at from deep industry experience applied through certain risk management techniques. Considering how solvency measures can change in different circumstances in the future, particularly through interest rate cycles, is also very important.”
Regulatory flexibility needs to be maintained to deal with changing circumstances, Jones explained. The future cannot be foretold, therefore, insurers cannot be expected to provide in advance for all future circumstances. The pace of innovation is rapid and in such an environment, it is essential to have a regulatory solvency framework that can be adapted readily to changing circumstances with the flexibility to accommodate the most suitable approach to individual companies.
Thirdly, Jones pointed out that a well designed regulatory solvency framework must be simple and practical, making it understood by all concerned and relatively easy to implement and forecast. In markets where complex models have been used, there has been the need to rapidly expand the resources of both the industry and the regulator, often, at considerable expense. “Here in Sri Lanka, we have seen have seen some of the resulting challenges ourselves resulting in changes in regulation already and the difficulties that small companies in particular have had in dealing with them.”
Life insurance is a complex business that operates within a long term timeframe. “We can understand and be analytically objective about the drivers of change that are relevant to the business and continuously update our thinking about solvency of the industry and companies within it – this is fundamental to proper risk management and requires that all parties can understand the risk within the business and how best to manage them.”
On the development of RBC in Asia, he explained, Asia as a region is different from the West in many ways. What is appropriate for Asia is very different from what is or is not appropriate in other parts of the world. In addition, while a suitable regulatory solvency regime or markets within Asia maybe similar, it makes perfect sense for the basis adopted by each country to be tailored to the environment of that particular country as one size does not fit all when it comes to insurance.
Regulatory solvency regimes do not fit well with situations where the markets are not functioning properly because of a lack of liquidity, he added.
He finally shared some necessary features of a prudent solvency regulatory framework, which are as follows:
Avoid imposing excessive capital charges and compounding already prudent margins in technical provisions.
Focus on the company’s long term capabilities and intentions and do not penalise prudently written products with long-term guarantees.
It should be simple and straightforward basis of calculation and avoid highly technical models
Assets and liabilities should be measured consistently in line with IAIS 17
The solvency basis should be stable and should only change gradually over time to reflect changes in circumstances
Surplus should not be distorted by short term market fluctuations that are not reflective of the nature of insurance companies’ long term risks
The ability to adapt the basis in a flexible way is critical
There is a need for regulators to be able to manage crises by avoiding pro-cyclicality which has become a major issue in recent years and there is a need for regulators to be sufficiently flexible to have appropriate counter-cyclical actions.
Pix by Lasantha Kumara
