Compliance in the insurance industry

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Compliance in the insurance industry Ethical BoardroomBy Mohammed Hasan Khan, Chief Risk and Compliance Officer, RAK Insurance



At a time when the regional economy in the GCC is endeavouring to recuperate from a series of financial crises, low oil costs and is confronting remarkable difficulties coupled by a wave of risky political risks, insurance regulators in the region are working towards bringing the industry’s supervisory rules and monitoring standards to higher levels.

These difficulties are turning out to be all the more genuine, as political and conflict dangers are on the ascent in the wake of the most recent local uprisings. The development of a solid, modern and transparent insurance market has also proved to be a critical component of the financial reforms and the development of the industry in this region. As the Takaful (the name for Islamic-compliant insurance) market is expected to grow nearly 15 per cent every year in the following five to seven years and the insurance penetration rate to ascend from one to three per cent in the same time frame, the overall insurance market (conventional and Takaful) in the region will be no less than 10-times bigger in the following 10 years.

Regulatory landscape and recent developments

Insurance regulators in the Gulf have presented or are presenting various new directions anticipating what would support the financial soundness of the industry over the long haul. They are following international best practices by moving towards risk-based solvency capital regimes. Changes – for example calculation of solvency and minimum capital requirements, the compulsory independent review of solvency and technical reserves, focus on active risk management, as well as the introduction of more structured investment portfolios with maximum asset exposure limits – are finally being implemented.

The UAE and Qatar are introducing more exhaustive regulations, while Bahrain, Kuwait and Oman are, as of now, focussing on particular viewpoints, for example, an increase in capital requirements as well as enhancements in asset quality and reporting requirements for both conventional and Takaful insurers.

These developments are respected by both the industry and experts as positive for the credit attributes of the market place and for policyholder protection. However, regardless of expanding economic partnership and policy coordination within the GCC, insurance regulations and supervisors are still at different stages of maturity within the region.

These changes are likely to provide more alleviations to the financial soundness of the industry over the long haul, prompting better security for policyholders and enhanced credit profiles for insurers, resulting from better capital management and advanced operational controls.

Recent reforms in the UAE insurance market

The UAE has a dedicated supervisory body, the UAE Insurance Authority (IA). Insurance business transacted in the region’s specialised financial services hub, the DIFC in Dubai, is supervised by an independent framework set up by the designated regulatory body in this zone.

The IA recently issued regulations governing the financial status of insurance and Takaful companies, a move widely seen as developing the industry and bringing it in line with Solvency II in Europe.

The IA’s release of decisions is beckoning the next wave of major regulatory developments in the GCC insurance industry since the actuarial reviews imposed on the Saudi market in 2013. The reforms have been awaited among players in the UAE, who have been calling for changes to the way businesses operate in the cut-throat environment.

Since becoming an independent body in 2007, the IA has introduced rules on various areas, from banc assurance and brokerages to Takaful. But the latest regarding solvency and capital adequacy are arguably the
most highly anticipated and discussed in recent years with the potential of creating far-reaching results.

I am highlighting some key sections of the new UAE regulations, focussing on the solvency margin and minimum guarantee fund; asset liability management and the basis of calculating technical provisions determining the company’s assets that meet the accrued insuring obligations.

  1. Solvency

    “Insurance regulators in the region are working towards bringing the industry’s supervisory rules and monitoring standards to higher levels”

The solvency requirements include provisions related to solvency margin, minimum capital requirements, minimum guarantee fund, solvency capital requirements and assessment of solvency in key risk areas.

There is no change to the minimum paid-up capital requirements for direct insurers and for reinsurers. Regulations on solvency margin requirements were developed based on the key principles of Solvency II, in particular, the use of the one-year view and the 99.5 per cent risk tolerance of solvency risk, which align with European regulations. These are aimed at providing an early warning system to detect flaws in companies’ financial conditions.

The solvency measures will empower management to better comprehend their organisation’s operations by recognising which dangers are most critical and expend the most capital. CEOs should be able to modify capital necessities through measures, for example, changing their reinsurance programmes, adjusting investment allocations and adapting their underwriting profile. An understanding of risk-based solvency calculations should allow insurers to better protect themselves against financial shocks and limit volatility in their operations.

  1. Asset liability management

The asset liability management (ALM) requirements provide ceilings on how insurers may allocate their investments. The purpose of these requirements is to ensure that companies diversify their assets and avoid high-risk concentration. Furthermore,  each company must create an investment committee that ensures adequate separation of functions between implementation, registration, delegation, settlement and related auditing activities.

Another significant requirement is for each insurance company to develop a policy for investment and risk management that complies with the risk tolerance level determined by their board of directors, which will need to approve and review the policy annually. The policy has to cover the general investment strategy and appropriate risk management regulations, including the mechanism to control such regulations. In addition, all companies will need to conduct a stress test of all its investments on an annual basis.

“With the standards now becoming law, compliance and enforcement will thus be the key words for the UAE insurance industry”

The asset composition of most insurers’ investment profiles is currently highly weighted towards real estate and equity assets and investment allocation to higher-risk assets has historically driven volatility in the level of shareholders’ equity of UAE insurers. Insurers’ balance sheets remain vulnerable to market shocks, particularly given that assets are concentrated in the UAE and benefit from little geographical diversification.

The new rules should provide greater stability of returns to insurers’ investment profiles and this way lessen unpredictability emerging from fluctuating asset prices on their operations and balance sheets. Given that capital necessities of domestic insurers are to a great extent driven by investment risk, de-risking of the asset base will improve the financial strength of the companies.

  1. Technical provisions

These regulations are aimed at regulating the principles of calculating technical provisions and standardising them for fair comparison and objective analysis of the positions of companies by the IA, as well as to provide statements that reflect the financial positions of the companies.

The IA has stipulated that all UAE insurers must come into line with International Financial Reporting Standards (IFRS). Companies will need to conform to standardised actuarial practices and reserves will be subject to yearly actuarial reviews.

Actuarial oversight is given high priority, with actuarial certification of the adequacy of the mathematical reserving practices required at least quarterly and annually. The metrics to be identified in these reports are set forth with a high degree of specificity.

A requirement for actuarial-led reserve setting, monitoring and reporting will enhance reserve adequacy and improve underwriting profitability by encouraging insurers to set premiums in line with underwriting risks and become increasingly selective about the risks they underwrite. These enhanced regulations and implied additional costs of monitoring, managing and reporting may also encourage consolidation among some smaller market players, potentially reducing competitive pressures and aiding market stability.

Enforcement is key

The regulations are extensive and represent a sea-change for UAE insurers. The condition for this is compelling implementation. The IA will require the appropriate resources and expertise to actively regulate the market according to these new standards and must be prepared to take appropriate action in the case of breaches.

With the standards now becoming law, compliance and enforcement will thus be the key words for the UAE insurance industry going forward.

Impact on the industry

Insurers could be hit by rising compliance costs as a range of regulatory reforms sweeps through the sector. Regulators across the region have announced a number of reforms amid stiff competition in the insurance sector. But the costs of revamping internal systems could deal some insurers a tough blow; in the short term, the cost of regulatory compliance will rise as insurers will need to add expertise and improve their systems to meet the new regulatory requirements. The smaller and less well-capitalised insurers will find the new regulations particularly challenging, while larger companies should be able to cope with the additional demands.

About the Author:

Mohammed Hasan Khan is Chief Risk and Compliance Officer at Ras Al Khaimah National Insurance Company