The Financial Services Board (FSB) is mulling over a new method of statutory financial reporting for the short-term insurance industry, to ensure the financial soundness of short-term insurers.
In 2009 the regulator plans to introduce Financial Condition Reporting (FCR), which is a risk-based regulatory framework.
Currently, short-term insurers are required to hold capital equal to 25% of their net written premiums. But experts contend that "this is a very simplistic approach and does not take into account the underlying risk profile of each insurer".
WHAT IT MEANS
 Insurers will have to put rigorous risk management practices into place
|
"Therefore, meeting this capital requirement is no indication that an insurer will not experience financial difficulty in the future and vice versa. Similarly, the FSB cannot accurately judge the financial soundness of an insurer based on this capital measurement," says Anton Reinke, actuarial consultant for Centriq, a black-owned insurer in risk finance.
"The introduction of FCR has shifted the FSB towards a risk-based regulatory framework that is becoming increasingly popular internationally," he says.
A number of countries have adopted a similar regulatory approach, including Australia, the UK, the US, Germany and Canada.
"In a nutshell, FCR considers the underlying risk of the insurer to determine the capital levels needed," he says. These capital levels should minimise the possibility of future financial difficulty, if calculated correctly. Also, this should lead to a more efficient allocation of capital between different risks, Reinke says.
"FCR forces insurers to put rigorous risk-management strategies into practice and to consider all the risks that may affect their business, not only the underwriting risk."
There are various models that can be applied to determine the capital levels that will be required by the insurers. These are the prescribed model; the certified model; and the internal model.
He says the model used by each insurer will depend on various factors, including cost, the complexity of the business written, the availability of skills and resources as well as the accessibility of reliable data.
"However, it will not be enough to have a capital model purely to satisfy regulatory requirements. The capital model together with the risk management strategies must be implemented in the day-to-day running of the business.
"By forming an integral part of the business, the capital model can give feedback to management on the risks that the insurer is most exposed to," Reinke says.
The FCR report provides a detailed description of the insurer's key risks and matters affecting its financial situation. This involves providing the insurer with the implications of issues identified and, where the implications are negative, the proposal of suggestions to attend to these issues.
The report supplements, but does not replace, statutory returns. "The insurer must demonstrate in the report that all significant risks have been taken into account and that adequate capital is available so that the insurer's potential for financial failure is minimised," Reinke says.
The FCR report needs to be submitted to the registrar of short-term insurance on an annual basis. It is necessary that the board of directors and the CEO of the short-term insurance company all sign off on the report.
"However, with change comes cost and it is inevitable that FCR will cost money and this can be substantial. The cost is likely to consist of additional internal resources and skills and the cost of the capital model. This is likely to have the biggest effect on smaller insurers."
The additional cost is likely to translate into higher premiums, which will be funded by the policyholders. Ironically, these are the same policyholders that the FSB is trying to protect.
Reinke says that Centriq agrees with the opinion of the FSB that the benefits of FCR can outweigh the costs, if implemented correctly.
Reinke says that insurers should obtain professional advice in order to determine the effect that the FCR would have on their specific circumstances.
