Securities and Exchange Commission of Pakistan (SECP) conducted a review of the international practices of insurance supervisors and regulators which affirmed the fact that regulators around the world have formulated long term strategic direction for achievement of ultimate vision for any industry or sector.
Realizing the importance of having long term vision with a clear strategic direction, the Insurance Division in March 2023, started to work on the strategic direction for insurance industry of Pakistan with an aim of strengthening the three pillars of the entire insurance ecosystem i.e. policyholders, insurance providers and development of insurance intermediaries.
In order to adopt an inclusive approach and to create a shared strategic direction with buy-in of all stakeholders, SECP's team conducted an offsite visit to the insurance industry in June 2023. Meetings with industry experts were held to provide an overview of the draft strategic direction and foster an open, collaborative environment where the regulator listens to stakeholders, encourages their participation, and collaborates to shape the future of the insurance industry.
The visit and interactions with industry experts with diverse backgrounds proved quite fruitful as it provided SECP with insights into the issues faced by the insurance sector through the lens of stakeholders with practical experience. The visit also shed light on practical issues faced by regulates upon the introduction or amendment of legislation, suggesting a way forward to bridge the gap and facilitate regulatory compliance. Based on industry feedback, the draft strategic direction for the Insurance Division's next five years was amended and named “Journey to an Insured Pakistan.”
To develop an industry-wide consensus on 'Journey to an Insured Pakistan' through an inclusive and collaborative approach, SECP convened a roundtable discussion in Karachi in August 2023. Top executives from Pakistan's insurance companies, including CEOs and board members, participated. The primary objective of the roundtable was to foster a collective industry perspective on the future trajectory of Pakistan's insurance sector.
During the discussion and feedback session, input was collected from each participant effectively. The Commissioner of Insurance personally addressed specific questions and concerns raised by participants. The Commissioner stressed the importance of industry collaboration with the regulator to achieve the strategic plan and encouraged industry leaders to take the lead on crucial agenda items. The participants emphasized several key areas during the session, including the imposition of sales tax on life insurance and reinsurance business, the unavailability of reinsurance, the establishment of an insurance pool, facilitating digital distribution, regulatory impact analysis, complaint analysis, nationwide awareness campaigns, and human resource capacity building.
In response to industry feedback gathered during the roundtable discussion, the five-year strategic plan, “Journey to an Insured Pakistan'', has undergone additional refinement. The final plan was again shared with CEOs and shareholder representatives. Furthermore, SECP plans to unveil this five-year strategic plan during the International InsureImpact Conference 2023 (IIC 2023), scheduled for December 2023. The goal of launching the plan during a dedicated session of the conference is to encourage further deliberation from the insurance industry players and engage with industry experts and practitioners.
Theme
Journey to an Insured Pakistan
Vision
Inclusive, innovative and sound insurance sector by 2028
Mission
Develop and regulate insurance sector by balancing protection of policyholders with industry growth through regulatory excellence
Targeted Outcomes of Five-Year Plan
Through the plan, SECP expects to achieve following operational and strategic outcomes:
Operational Outcomes
• Elevate the Individual lives covered under individual life policies to greater than 15 Million
• Enhance the Insurance Penetration Rate from current rate of 0.87% to 1.5%
• Increase in Takaful contribution to more than 30%
• Expand the coverage of Motor Third-Party Liability (MTPL) insurance to encompass more than 20%
• Raise the Local Retention to exceed more than 60%
• Augment the digital distribution channel's market share to surpass 5%
• Foster the growth of private health insurance premiums to represent more than 15% of the total premium
• Facilitate the availability of agriculture insurance for non-loanee farmers
• Promote the introduction of disaster insurance products.
• Facilitate availability of annuity products for VPS investors/ individual retirees
Strategic Outcomes
• Achieve premium growth from Rs. 553 billion to Rs. 1,221 billion by the year 2028.
• Effectively lower the overall cost associated with regulatory compliances.
• Substantially reduce the ratio of customer complaints.
• Successfully implement Risk-Based Capital (RBC)
• Successfully implementation of International Financial Reporting Standards 17 (IFRS-17)
• Amended Insurance Ordinance
• Settlement of Sales Tax issue
• Digitalized regulatory approvals
Key Priorities
To achieve the targeted outcomes of the five-year plan, SECP has identified the following key priorities and formulated comprehensive operational approaches across following key domains.
Key Priority Areas Operational Approach
Ease of Doing Business Rationalization of:
o Regulatory Returns
o Regulatory approvals
o Licensing requirements
o Solvency Limits
o Review of Management Expense Limits
Legislation Modernization Insurance Ordinance amendments Bill Finalization
Amendments in Motor Third Vehicles Act 1939 regarding third party insurance
Facilitate Access to Capital Encouragement of listing
and Reinsurance Enabling the raising of subordinated debt
Facilitate raising of alternative capital-ILS
Review of existing paid up capital requirement
Facilitate creation of Insurance pool
Optimization of reinsurance capacity
Public sector insurers capacity building
E cient reconciliation mechanism for co-insurance/re-insurance
Facilitate industry for re-insurance arrangements
Policy Holders Protection Standardization of retail products policy document
and Market Conduct Simplification of Illustrative directive
Transparent complaint handling
Introduction of minimum service standards
Implementation of uniform certification requirements for insurance agents
Review of certification requirements for insurance surveyor
Review of conduct requirement of insurance surveyors and brokers
Financial Stability and Implementation of IFRS-17
Risk Based Supervision Implementation of RBC Regime
Risk based surveillance and inspection
Innovation, Digitalization Regulatory Sand Box
and Access to Data Launch of motor insurance repository
Launch of insurance policy finder
Enhance scope of life / non-life insurance repository
Availability of all consumer insurance products at EMLAAK
Enhanced Scope and Amendments in Motor Third Party Ordinance 1939
of Mandatory Insurance Amendments in provincial laws regarding compulsory Group Life & Health insurance
Engagement for implementation of Motor Third Party Insurance
Implementation
Support Availability and Facilitate registration of new digital/micro-insurers and Takaful Take-up of Takaful, Inclusive, Operators
Disaster and Agriculture Reports on Inclusive and Agriculture Insurance
Insurance Introduction of MGA/TSP Regime (Retail products)
Facilitate takaful companies for re-takaful arrangements
Advocacy and Engagement Regular engagement with stakeholders for achieving the objective of the five-year plan
with Stakeholders Interaction with taxation authorities to resolve taxation issues
Regular roundtables with IAP, insurtech, digital intermediary/web aggregators, microfinance players
Collaboration with fund management industry for VPS and annuity market
Awareness through Innovation Innovation fund for insurance awareness
Takaful specific awareness
Capacity Building Energize role of Insurance Association of Pakistan
Facilitate capacity building and training of SECP regarding actuarial skills through coordination with PSOA, IFOA, SOA, international regulators and agencies
Reliance Insurance Company Limited
Aspires to be a Company of International Repute
A. Razak Ahmed | CEO & MD, Reliance Insurance Company Limited FCII (London) | Chartered Insurer
Let’s start the Journey
Reliance Insurance Company Limited (RICL)’s corporate philosophy revolves around achieving competitiveness and reputation on both national and international levels. The commitment to excellence, professionalism, and cost efficiency underscores the company's dedication to providing top-tier services to businesses, industries, and commerce, through a customer-centric approach and adherence to international standards.
Reliance Insurance Company Limited (RICL) was incorporated in 1981 with a Share Capital of Rs. 2.5 Million by two prominent industrialist groups in Pakistan, Al-Noor Group and Amin Bawany Group. Al-Noor Group, led by now (Late) Mr. Ismail H. Zakaria, and Amin Bawany Group, founded by now (Late) Mr. Mohammed Amin Ahmed Bawany, are known for their successful implementation of numerous industrial and commercial projects. The company's Authorized Capital has now reached Rs. 1,000 million, with a paid-up share capital of Rs. 665.379 million. This strong financial position underscores the company's reliability and stability. Reliance Insurance is growing steadily and stands on a sound footing with regards to its capital and intends to continue enhancing its capital base in the coming years commensurate with its growth. General Reserves stands at Rs.310 million.
RICL has earned a strong reputation and is recognized as one of the most reputable and distinguished names in the sector. Its Head Office is in Karachi, Pakistan, and boasts an extensive and dynamic branch network covering major cities and towns throughout the country. This widespread presence ensures that the company can provide prompt service to its customers, no matter where they are located.
RICL offers a wide range of insurance products and services. The company underwrites various classes of insurance and provides risk coverage for a variety of needs. These offerings include both traditional insurance products, such as Fire & Allied Perils, Marine Cargo, Marine Export, Motor Vehicles, Personal & Group Accident, Workmen's Compensation, Burglary, and Cash in Safe or Transit, as well as non-traditional covers like Machinery Breakdown, Loss of Profits, Terrorism and Contractor All Risks.
In May 2016, RICL commenced its Window Takaful Operations (WTO), offered within the framework of conventional insurance company. This initiative was undertaken under the guidance of renowned, qualified, and certified Sharia Scholar. Window Takaful allows conventional insurance companies to offer Takaful products alongside their regular offerings, ensuring they comply with Islamic principles.
RICL recognizes the importance of reinsurance and maintains sound reinsurance treaty arrangements with reputable foreign and local reinsurance companies of global repute.
Notable reinsurance partners include Swiss Re, Hannover Re, Kuwait Re, Peak Re, and Trust Re.
Reliance Credit Rating Company Ltd and Pakistan Credit Rating Agency Ltd Insurance’s strong financial position and prudent management practices have been recognized by reputable rating agencies in Pakistan. Specifically, both VIS have assigned the company a Financial Strength Rating (IFS) of "A+" (Single A+), and the outlook on this rating is deemed "Stable." The "A+" rating indicates a strong financial strength and capacity of Reliance Insurance to fulfill its obligations to policyholders and contractual commitments.
Our Board of Directors comprises ten individuals, each equipped with the knowledge, experience, and skills essential for providing effective oversight and strategic direction to the Company. With the exception of the Chief Executive Officer, all Directors are non-executive, including three independent Directors. The collective expertise of our Directors spans various fields of business and professions, reflecting a rich and diverse background.
Their skill set and understanding enable them to navigate and address a wide range of business and corporate challenges. Of significance is their ability to critically review, analyze, and challenge management performance, contributing substantially through their extensive experience and practical insights. The Board is headed by Mr. Irfan Zakaria Bawany - an extremely energetic and visionary personality.
The management of Reliance Insurance is fully conscious of the challenges lying ahead and has developed a comprehensive strategy which focuses on sustained growth in operations with a particular focus on the bottom line and offering reasonable returns to its valued shareholders.
Reliance Insurance's focus on technological innovation is indeed a crucial aspect of staying relevant and competitive in the insurance industry. Technology can greatly improve the customer experience in the insurance sector. Automation and data analysis can streamline many of the back-end processes in insurance, such as underwriting, claims processing and policy management. These improvements can lead to cost savings and reduced processing times, making the company more efficient. Reliance Insurance's commitment to technological innovation indicates a proactive approach to adapting to future changes in the insurance landscape.
We, at Reliance Insurance are optimistic about future business prospects and strongly believe that we shall grow steadily and solidly in the years to come because of our positive businesslike approach and also the continued support of our valued clients, re-insurers and the shareholders. The Company is well positioned and fully focused to remain among one of the leading insurers of Pakistan not only in terms of volume but also in terms of financial strength, profitability, ethical conduct and social contribution. RICL is fully conscious of the challenges taking place and are taking necessary steps towards prudent & sound growth among others focusing on increasing the market share.
Proposed Risk Based Capital Regime for Insurance Sector of Pakistan
Solvency of an insurer measures its ability to meet its obligations to policyholders when they fall due. It is assessed by the adequacy of the insurer’s financial resources, including capital resources, against the insurance protection it provides to policyholders. Risk-based capital (RBC) requirements strengthen the protection of policyholders by relating capital adequacy to the risk exposure of the insurer. Generally, an insurer exposed to higher risks is required to hold a higher amount of capital.
It has been recognized globally that the capital adequacy framework should consider risk factors of different insurers, and be conducive to enhancing the corporate governance, enterprise risk management (ERM) and public disclosure practices of insurers. The International Association of Insurance Supervisors (IAIS) – the global standard-setter for the insurance industry, issued Insurance Core Principles (ICPs) in relation to RBC requirements in late 2011. All insurance supervisors, including the SECP, in order to ensure conformity with best international practices are obliged to comply with ICPs.
In December 2022, SECP issues a concept paper on proposed Capital Regime for Pakistan’s Insurer sector to move from existing solvency regime towards an RBC regime, establishing a clear and consistent valuation standard (including explicit best estimates of technical provisions and risk margins) and risk-sensitive capital requirements covering all types of risks.
It is important to note that the move towards developing an RBC framework does not necessarily imply a need to increase or decrease capital for individual insurers. The framework seeks to be consistent with international practice i.e. make capital requirements more sensitive to the level of risk that individual insurers are bearing.
Background Current Paid up Capital and Solvency Requirements
In Pakistan, the current regulatory framework i.e. the Insurance Ordinance, 2000 (the “Ordinance”) and the Insurance Rules, 2017 (the “Rules”), prescribe paid-up capital requirements as well as rule-based solvency requirements for life and non-life insurers. Briefly stating the capital as well as solvency requirements currently applicable on insurers are as follows:
Non-Life Insurers: Under the current requirements, non-life insurers are required to have minimum paid-up capital of Rs.500 million in order to underwrite non-life insurance business. The solvency requirements for non-life insurers is provided in section 36 read with section 32 of the Ordinance and rule 12 and 15 of the Rules.
Life Insurers: Life insurance business is allowed to be undertaken by insurers with paid-up capital of Rs. 700 million. The solvency requirements for life insurers is provided for in section 35 read with section 32 of the Ordinance and rule 12 and 14 of the Rules. The solvency regime for lifeinsurers is applicable on all the funds of the life insurers i.e. the shareholders fund and each of its statutory funds.
Solvency of the shareholders’ fund is to have admissible assets less liabilities equal to or greater than Rs. 165 million. For each of the statutory funds, the regime requires having admissible assets less liabilities equal to or greater than the policyholder liabilities and a prescribed solvency margin for each fund. For computing, the solvency margin, a factor-based set of solvency requirements that move in line with type of policies has been prescribed, wherein the required solvency margin equals a first factor times the mathematical reserves plus a second factor times the sum at risk under the policies issued by the life insurer.
Whilst the solvency regime applicable in Pakistan is considered to take into account, to some extent, liquidity risk, market risk, credit risk, insurance risk etc. in calculation of solvency of an insurer through the admissibility of assets test, it does not quantify the levels of all risks borne by the insurers and therefore does not effectively deliberate on the adequacy of the insurer’s capital keeping in view the risks undertaken. In other words, the currently applicable solvency requirements do not take into account the risk factors pertinent to an individual insurer.
The current approach to capital and solvency requirements makes Pakistan an outlier in Asia and internationally since most countries in Asia have adopted a more risk-based approach to capital requirements. Some notable countries where the RBC Regime has already been implemented include China, Japan, Malaysia, Philippines, Indonesia, Thailand and Sri Lanka. Additionally, India and Saudi Arabia have also initiated work on launching the RBC regime for insurers.
Proposed Risk Based Capital Framework
SECP’ has proposed a regime comprising three broad pillars: (a) Minimum Capital Requirements (Pillar 1); (b) Supervisory Review (Pillar 2); and (c) Market Discipline (Pillar 3). Pillar 1 Minimum Capital Requirements has been elaborated in detail by SECP with some discussion on pillar 2. Figure 1 is a broader representation of proposed RBC framework with Pillar 1 i.e. Minimum Capital Requirements elaborated in detail:
Under the proposed RBC regime, the adequacy of capital will be measured through the Capital Adequacy Ratio (the “CAR”). The formula for computation of CAR is as follows:
An insurer must at all times meet the minimum capital adequacy requirement at company level and at statutory fund level (in case of life insurer).
At the company level the CAR will measure the adequacy of Total Capital Available (the “TCA”) in all the funds of the insurer to support its Total Capital Required (the “TCR”).
At the fund level the CAR will measure the adequacy of Total Capital Available within each individual fund to support the Total Capital Required for risks within that fund. However, in case of life insurer, undertaking participating business the CAR maintained at company level will be as per the following formula:-
Where:
• CAR All funds, is the CAR taking into account all the statutory funds and the shareholders’ fund; and
• CAR all funds excluding PAR, is the CAR taking into account all the statutory funds and the shareholders’ fund, excluding the statutory fund(s) related to participating life insurance business.
ICP 17 guidelines on Capital Adequacy stipulates at least two explicit control levels. The highest control level is described as the Prescribed Capital Requirement (“PCR”). PCR is defined as the solvency control level above which the supervisor does not intervene on capital adequacy grounds. The PCR may be expressed in probabilistic terms (e.g. 99.5% Value-at-Risk (“VaR”) over a one-year time horizon) or as a fixed value, and is calculated for specific insurers and expressed in monetary units. The other intervention level is the Minimum Capital Requirement (“MCR”), which is set at a level lower than the PCR. The MCR is the solvency control level at or below which the supervisor would invoke its strongest actions, in the absence of appropriate corrective actions by the insurer concerned. The MCR is a minimum bound, below which no insurer is regarded to be viable.
Based on the aforesaid guidelines, the envisaged proposed framework of RBC regime for Pakistan will cover two explicit solvency control levels i.e. the PCR and MCR which may be represented in the form of two different levels of Capital Adequacy Ratio. The proposed framework will also cover the appropriate regulatory intervention in case an insurer breaches any of these solvency control levels. For the purposes of this paper, it is clarified that the level of CAR for PCR and MCR is to be decided in the future phases of the development of the framework expectedly on the basis of data analysis and quantitative impact study.
Calculation of Total Capital Available (TEA)
TCA refers to qualified capital that is available to absorb the different risks undertaken by insurers. The starting point for arriving at TCA is based on the financial statements of the insurer being evaluated and by making a series of adjustments to the capital reported therein. These adjustments may result in increasing or decreasing the reported capital of the insurer and would provide a more economic and consistent view of capital available, which in turn would allow for a more comparable capital adequacy evaluation on an overall industry basis.
Components of Available Capital
The TCA of an insurance company is the aggregate of Tier 1 capital (also referred to as “Core Capital”) and Tier 2 capital (also known as “Supplementary Capital”) of the insurer minus deductions. The division of TCA into Tier 1 and Tier 2 capital is based on the degree of permanence and whether it is free and clear of any encumbrances. It is proposed that for the insurance sector in Pakistan will have a similar two-tier approach to capital.
Tier 1 Capital
The Tier 1 capital of an insurer under the proposed RBC regime shall be the aggregate of the following:
• Fully paid up (common shares) capital
• Balance in share premium account
• Reserve for Issue of Bonus Shares
• Net un-appropriated / un-remitted profits including retained earnings of Ledger Account C & Ledger Account D.
• General reserve
• Retained earnings in Ledger Account A and Ledger Account B in case of participating business
Tier 2 Capital
The Tier 2 capital of an insurer under the proposed RBC regime shall be the aggregate of the following:
• Paid-up non-cumulative irredeemable preference shares
• Irredeemable subordinated debts (meeting the criteria to be prescribed by the Commission)
• Revaluation Reserves (net of deficits, if any)
• Foreign Exchange (FX) translation reserves
Limitations and Restrictions on Capital Available
Tier 1 capital is considered to be the going concern capital i.e. capital that is available to the company to absorb losses while continuing operations as going concern.
Tier 2 capital, on the other hand, is available to absorb losses in case a company ceases its operations. Basel and international solvency regimes, define limits with respect to minimum capital that must be held in Tier 1 with respect to the total capital. A study of the relevant regimes reveals differing emphasis on what qualifies as available capital within tier 2.
Based on the SBP requirements the computation of the amount of Core (Tier 1) and Supplementary (Tier 2) Capital’s may be made subject to the following limitations and restrictions:
• The sum total of the different components of the eligible Tier 2 Capital will be limited to the sum total of the various components of the eligible Tier 1 Capital.
• Revaluation Reserves shall be the reserves created by revaluation of fixed assets and equity instruments held by the insurance company. The revaluation reserves shall be net off against any deficit on account of revaluation of Available for Sale (AFS) securities. The assets and investments must be prudently valued fully considering the possibility of price fluctuations and forced sale value. Revaluation reserves reflecting the difference between the book value and the market value will be eligible up to 45% of the total Supplementary Capital subject to the condition that the reasonableness of the revalued amount is duly certified by the external auditors of the insurance Company.
• Subordinated debt will be limited to a maximum of 50% of the amount of Tier 1 capital and will also include rated and listed subordinated debt instruments (like TFCs/Bonds) raised in the capital market. To be eligible for inclusion in the supplementary capital, the instrument should be fully paid up, have a minimum fixed term maturity term of 5 years, unsecured, subordinated as to payment of principal and profit, to all other indebtedness of the insurance company deposits, and should not be redeemable before maturity without prior approval of the Commission. Further it should be subject to a lock-in clause, stipulating that neither interest nor principal may be paid (even at maturity) if such payment means that the insurer falls below or remains below its minimum capital requirements.
Deductions from Available Capital
For certain assets in the balance sheet, the realisable value under a wind-up/ liquidation scenario may become significantly lower than the economic value which is attributable under going concern conditions. Similarly, even under normal business conditions, some assets may not be realisable at full economic value, or at any value, at the time they are needed. This may render such assets unsuitable for inclusion at their full economic value for the purpose of meeting required capital.
The treatment of such assets for capital adequacy purposes may need to reflect an adjustment to its economic value. As per the guidance of ICP, such an adjustment may be affected either directly, by not admitting a portion of the economic value of the asset for solvency purposes (deduction approach) or indirectly, through an addition to regulatory capital requirements (capital charge approach). In this regard, considering the findings from the study of international jurisdictions as well as the related provisions of the SBP regime, we propose the deduction approach for some kinds of assets and 100% capital charge approach for some kinds of assets for the RBC regime in Pakistan.
As a starting point, the following are the proposed deductions from the sum of Tier 1 and Tier 2 capital of an insurer:
• intangible assets, including but not limited to goodwill, brand names and capitalised establishment costs;
• deferred tax asset balances;
• surplus assets in defined benefit pension fund;
• assets subject to encumbrances; and
• Investment in the licensed insurer’s subsidiaries
Calculation of Capital Available Capital at Fund Level
Whilst the discussion on TCA for at a company level is being discussed broadly in section 4.1, it is proposed that the TCA at the fund level will be determined as follows:
• In the case of a participating fund, retained surplus in Ledger Account A and
Ledger Account B
• In the case of any other statutory fund the surplus of the assets of the fund over
its liabilities.
Calculation of Total Capital Required (TCR)
The TCR represents the amount of capital required in order to cover risks arising from business activities such as (a) Insurance risk; (b) Credit risk; (c) Reinsurance risk; (d) Operational risk; (e) Market risk; (f) Equity risk; (g) Property risk; (h) Currency risk; and (i) Interest rate risk.
It is proposed that the TCR of a licensed insurer at the company level shall be the aggregate of its total capital charges against each category of risk.
For a life insurer, the TCR shall be the aggregate of the total capital charges for each statutory fund and the total capital charges for all assets in its shareholders’ fund.
From the review of international jurisdiction, it is proposed that every insurer shall determine capital charge for all of the risks undertaken and then shall add the resulting amounts to arrive at the TCR for the insurer as per the following formula:
The proposed framework for RBC regime is being suggested based on a standardized approach for determining the required capital for each risk as described in the following sections. The use of internal models for calculation of risk charges by insurers is not being considered in the current approach and shall be considered in the future.
Except for the operational risk capital charge, the risk charges do not apply to assets required to be deducted from TCA covered under section 4.3 above.
In the case of an investment-linked statutory fund, the insurer shall compute the TCR for the non-unit portion of the statutory fund, except for operational risk capital charges, where the licensed insurer shall compute the TCR for the entire fund.
Calculation of Different Risk Capital
Charges
Insurance Risk
The Insurance risk capital charge aims to address the risk of under-estimation of the insurance liabilities and adverse claims experience, over and above the amount of risk margin already provided for in the base valuation of insurance liabilities.
Life Insurance Business
Liability Risk Capital Charge
The insurance liability risk (covering mortality, longevity, morbidity, persistency, expense) charge shall be computed as the difference of Insurance liability calculated under stress scenario (simultaneously stressing all the assumptions) and insurance liability calculated under best estimate (“BE”) assumptions (i.e., BE Liability plus a Risk Margin (RM)). The proposed computation is as follows:
Liability risk capital charge = (V* - Value of liabilities under base scenario) where V* is the adjusted value of the long-term insurance liabilities calculated using the stress factors proposed in Table 1 below. These charge factors have been defined after study of various international regimes and are to be refined on the basis of data analysis and quantitative impact study as well as industry feedback.
Table 1: Proposed stressed factor for life insurers for determination of liability risk capital charge
Surrender Value Capital Charge
The surrender value capital charges (SVCC) aim to address lapse risk in excess of the levels assumed in the calculation of reserves and risk margins. Life insurers shall apply SVCC to set an upper limit for TCR.
Following formula/methodology is proposed to determine SVCC:
SVCC = max [zero, aggregate surrender value of the business in force in respect of policies in the statutory fund less the aggregate policy reserves of the statutory fund]
The SVCC shall be determined for participating policies, non-participating policies and unit linked long term policies separately, then aggregated. In the case of unit linked long term policies, the SVCC applies only if the guaranteed surrender values exceed the unit fund values and non-unit linked liabilities, in aggregate, as at the valuation date. In determining the SVCC for policies that are yet to acquire a surrender value or where the policy liability is negative the surrender value shall be taken as zero.
Non-life Insurance
Business
In the case of non-life insurance business, Insurance Risk is the aggregation of the “Underwriting Risk” and the “Reserve Risk”. “Underwriting Risk” is the risk of higher than expected claims. Reserve Risk” is risk associated with past years. It gauges the risk that the current reserves are insufficient to cover their run-off over the policy period.
Based on our research of relevant capital regimes, it is proposed that Insurance risk capital charge for non-life companies be determined for premium liability risk and claim liability separately, using a factor-based model. The Formula for the computation of risk charge is as follows:
Liability risk capital charge for each class of general insurance ={ of all classes of general insurance (Value of premium risk liability X risk factor) + (Value of claim liability X risk factor)
Premiums liability risk charges for each class of non-life insurance business is to be determined separately, by multiplying the net unexpired risk reserve (URR) determined at the proposed confidence interval (to be decided in the subsequent stages), by the corresponding premiums liability risk factor as prescribed.
Similarly, claims liability risk charges for each sub-class of general insurance business shall be determined separately, by multiplying the net claims liability by the corresponding claims liability risk factor as prescribed.
A non-life insurer is required to hold, among others, reserves in respect of premium liabilities, defined as the higher of unexpired risk reserve (URR) or unearned premium reserve (UPR).
Based on the review of other jurisdictions, the proposed risk factors for major lines of business for non-life insurers are provided in Table 4. These risk factors shall be further refined based on the industry feedback, data analysis and quantitative impact studies. Life Insurance companies which are doing accident and health business shall also calculate the risk charge for accident and health business as per table 4.
Credit Risk
Credit risk is the risk of losses resulting from asset defaults, related losses of income and the inability of a counterparty to fully meet its contractual financial obligations. Based on the review of SBP Basel regime, it is proposed to calculate the risk charge for credit risk using the Standardized Approach (“SA”). Under SA, the capital requirement is based on the risk assessment credit rating, made by External Credit Assessment Institutions (ECAIs) recognized as eligible by SBP for capital adequacy purposes. Accordingly, external risk rating and credit risk charges broadly in line with SBP approach have been proposed for further discussion and finalization in the data analysis and quantitative impact study phase: -
Reinsurance Risk
Reinsurance credit exposure has potential credit risk, accordingly it is proposed that every insurer shall calculate a reinsurance risk capital charge for each reinsurance counterparty using the following formula:
Reinsurance risk capital charge = Reinsurance credit risk exposure x Counterparty credit risk factor
The reinsurance credit risk exposure shall be the sum of following:
• Admissible amounts due from the reinsurance counterparty, including claims recoverable and ceding commissions;
• Reinsurance recoveries in respect of claims incurred including ceded claims liabilities
• For life insurance business, the difference between the value of the gross liabilities and the net liabilities (net of re-insurance) of the insurer in respect of its participating policies, non-participating policies, and unit linked long term policies due to reinsurance ceded to the reinsurer; and liability and the net premiums liability (net of re-insurance) of the insurer due to reinsurance ceded to the reinsurer. Counterparty risk charge is the same as prescribed for Corporates by SBP.
Operational Risk
Operational risk is the risk of loss from failure/errors of human resources and failure of processes and systems, also including external events. Based on research on various international capital regimes, it is proposed that every insurer shall calculate an operational risk capital charge of 1% of the value of all assets of the insurer, whether admissible or not, and whether held inside or outside the policyholders’ funds or shareholders’ fund.
Market Risk
The market risk capital charges aim to mitigate risks of financial losses arising from:
• the reduction in the market value of assets due to exposures to equity, mutual funds, property and currency;
• non-parallel movements between the value of liabilities and the value of assets backing the liabilities due to interest rate movements (i.e. the interest rate mismatch risk); and
The method of determination of Market risk charge i.e. Equity risk charge, mutual funds risk charge, interest risk charge, property risk charge and currency risk charge are deliberated below.
Equity Risk
Equity risk is risk of economic loss due to changes in the price of equity exposures.
Equity risks arising from exposures to derivatives such as futures, swaps and options on individual shares or stock indices are also included.
For the purpose of simplicity, the risk charge for equity securities is 12.5% and for unlisted it is 18.75% as per the SBP prescribed risk charge which will be further refined on the basis of industry feedback, data analysis and quantitative impact studies.
Investments in Mutual Funds
Investment in Mutual Funds is also exposed to market and credit risk. SBP prescribed the following three approaches for calculation of capital charge for investment in mutual funds which is proposed to be adopted for the insurer as well.
Property Risk
Property risk is the risk of economic loss due to unexpected loss from changes in the price of property exposures. Based on research of international capital regimes property risk charge for self-occupied properties is proposed to be 12.5% and for other investment properties it is proposed to be 16 with further refinement to be made during data analysis and quantitative impact study phase:
Currency Risk
Currency risk is the risk of loss due to adverse movements in the value of foreign currencies. The treatment for currency risk is proposed as per the SBP Basel and other international capital regimes. Accordingly, capital requirement for determination of currency risk is proposed as follows:
Capital Requirement = x% * max (sum of long positions, sum of short positions)
The overall foreign exchange exposure is measured by aggregating the sum of the net short positions or the sum of the net long positions; whichever is the greater, regardless of sign. Based on SBP requirements, the capital charge for foreign exchange risk is proposed to be 8% of the insurer's overall foreign exchange exposure.
Interest Rate Mismatch Risk
Interest rate mismatch is the risk arising from changes in market interest rates, which affect the prices of debt securities and policyholder liabilities. Policyholder liabilities require future liability cash flows using relevant yield curves.
Based on research of relevant regimes, in respect of interest rate mismatch risk, the capital charge to account for interest rate risks is reduced to the extent that the weighted average duration of the exposures in interest rate related assets match the weighted average duration of the insurance liabilities. The amount of capital charges required is the higher of the reduction in surplus under the increasing and decreasing rate scenario. If the reduction in surplus is higher under the increasing scenario in one fund, but higher under the decreasing scenario in another fund, then the dominant scenario at the company level should be selected and applied consistently to all funds. Any resulting negative capital charges for each individual fund should be zeroized.
A simplified approach is proposed for undiscounted liabilities in the non-life insurance and shareholders’ funds to address interest rate risks in view of the short-term nature of most of the insurance liabilities. The net value of all positions in interest rate related exposures are determined for each maturity band, to which risk charges are then applied. Exposures and proposed risk charges are classified according to their residual maturities ranging from less than one month to 20 years which will be further refined on the basis of industry feedback, data analysis and quantitative impact studies.
Investment Limits and Capital Charge on Excess Exposure
In order to minimize the concentration risk, for the RBC regime following are the proposed limits for investment/exposure by a registered insurer as per Table 21 below. Any investment/exposure above the proposed limit will attract charge of 100% for the purpose of calculation of MCR:
Valuation of Assets and Liabilities
The valuation of assets and liabilities is very important in the context of a risk-based capital regime. We are proposing the following broader parameters for valuation of assets and liabilities, however, details on valuation of liabilities and treatment of re-insurance will be shared with the industry in the 2nd phase for consolation and feedback.
Valuation of policyholders' liabilities:
Life Insurance Liabilities
As per the current insurance laws of Pakistan, insurers use the net premium valuation basis which is a reserve methodology, where net premiums are the amounts necessary to pay benefits according to certain mortality and interest rate assumptions. Company expenses are not reflected in the net premium reserve, nor are there any explicit margins for profits or adverse experience.
We propose to replace the net premium valuation methodology with gross premium valuation methodology. As per the proposed methodology every insurer shall use a discounted cash flow approach equivalent to gross premium valuation methodology to calculate the liabilities of participating policies, non-participating policies and non-linked liabilities. In this method, insurers will determine the best estimate plus a Risk Margin (RM). The best estimate shall be determined by first projecting future cash flows using realistic assumptions (including assumptions on expenses, mortality and morbidity rates, lapse rates, etc.), and then discounting these cash flow streams at appropriate interest rates. PAD is determined by using more conservative assumptions in the projection to reflect the inherent uncertainty of the best estimate.
Non-Life Insurance Liabilities
Currently the non-life insurance liabilities are calculated on the basis of claim liabilities and premium liabilities without impact of discounting and risk margins. We propose that the valuation of non-life insurer will comprise of:
• the best estimate value of the claim liabilities;
• the best estimate value of the premium liabilities; and
• a provision of risk margin for adverse deviation (PRAD) for each of the best estimated values.
Non-life insurance liability = claims liability + premiums liability
Where:
Claims liability = Best Estimate claims liability + Risk Margin Premiums liability = Maximum of {unearned premium reserve and (best estimate unexpired risk+risks margin)}
In determining the insurance liabilities, a registered insurer shall calculate the insurance liabilities net of reinsurance.
Every insurer shall value assets using a market consistent approach or, if a market consistent approach cannot reasonably be applied, assets may be valued as per IFRS. Similarly, every insurer shall value non-insurance liabilities as per applicable IFRS.
Consistency in Valuation RBC Purpose and IFRS 17
Internationally, some jurisdictions are planning to use IFRS 17 as a starting point and modify the standard for regulatory solvency purposes. There is significant opportunity to use the same cash flow models for both RBC and IFRS 17, potentially with some changes. Alignment of supervisory reporting with IFRS is mainly to maintain conceptual consistency and minimise the regulatory burden on the insurers. A key consideration is to avoid creating subtle differences in regulatory and accounting requirements to avoid maintaining multiple sets of records and to avoid multiple rounds of system changes.
The IAIS core principles also considers it most desirable that the methodologies for calculating items in general purpose financial statements are used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements. This is likely to reduce costs for insurers and thereby policyholders.
Way Forward and Implementation
Data Analysis and Quantitative Impact Study
The choice and level of risk parameters is an issue of paramount importance for developing an RBC model. Therefore, data analysis and quantitative impact study is necessary to adjust the proposed level of capital charge and stress test in line with our local environment and industry dynamics. This is dependent on judgement as well as analysis of data. To determine the risk charges, it is also necessary to develop an understanding of the loss function for each risk i.e. to measure the impact on a typical balance sheet at the desired confidence level. We are of the view that in the second phase a detailed data gathering exercise will be needed to assess the level of proposed capital charges and level of capital adequacy. Data analysis should be conducted for different types of insurers to ensure that the new regime is viable and practicable, and that it should not bring about instability to the insurance industry. Implementation Plan.
Following are the next step action items identified by SECP for implementation of the regime:
Issuance of detailed draft requirements regarding valuation of insurance liabilities will be issued as per the principles agreed in the Concept Data analysis and impact assessment of the proposed model. Technical specifications and templates would be developed and shared with the industry for seeking data. Data analysis shall be conducted for different types of insurers to ensure that the new regime is viable and practicable, and that it should not bring about instability to the insurance industry.
The third phase will be the finalization phase. In this phase, the RBC methodology and risk charge would be concluded on the basis of data analysis and impact studies. Draft regulatory framework covering the details of the RBC framework will be issued. Necessary amendments will be made in the relevant regulatory framework, particularly the Ordinance and the Rules. In addition, ongoing stakeholder management and communication with regulated entities would be required to ensure a smooth implementation process.
Copyright Business Recorder, 2023
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