The UAE’s Insurance Authority (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. How will the rules affect insurers’ capital adequacy? Commentators weigh in.
The IA’s release of Decisions numbered 25 and 26 of 2014 could signal 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 long awaited among players in the UAE, who have been calling for changes to the way businesses operate in the cut-throat environment, where around 60 insurers compete for premiums of around AED33 billion (US$9 billion) as of 2014.
Not that the UAE market has been lacking in regulations. Since becoming an independent body in 2007, the IA has passed legislations on various areas from bancassurance and brokerages to takaful. But the latest rules concerning solvency and capital adequacy are arguably the most highly anticipated and discussed in recent years, with the potential to create far-reaching impact on insurance operations.
In line with international standards
The IA has also attached great importance to the rules. In a statement, HE Eng Sultan bin Saeed Al Mansouri, Minister of Economy and IA Chairman, said that the changes represent an “advanced and key step” toward regulating conventional insurance and takaful companies operating in the UAE. The regulations are in line with best practices in the insurance industry worldwide and put the UAE “at the forefront of the Middle East” with regard to solvency requirements in Europe, he added.
HE Al Mansouri noted that “by issuing the Regulations, the Insurance Authority seeks to complete the legislative frameworks needed to activate oversight and control over the insurance sector, achieve many goals including ensured stability and sustainability for the insurance market by ensuring the solvency of insurance companies and their ability to meet all liabilities, and create harmony among investment policies of the insurance companies and general economic policies of the UAE”.
The regulations were issued after discussions with insurers, actuaries and consultants. Companies will be given one to three years to adjust their positions in line with the requirements.
Key sections
The Decisions comprise two separate regulations, applying to conventional insurers and takaful providers. Seven key sections are covered:
1. The basis of investing the rights of policyholders;
2. The solvency margin and minimum guarantee fund;
3. The basis of calculating technical provisions;
4. Determining the company’s assets that meet the accrued insuring obligations;
5. Records which the company shall be obligated to organise and maintain as well as the data and documents that shall be made available to the authority;
6. Principles of organising accounting books and records of each of the companies and agents, and determining data to be inserted in these books and records; and
7. Accounting policies to be adopted and the necessary forms needed to prepare reports and financial statements and presentations.
This article will focus on the first four sections, which concern capital adequacy and are of particular importance to UAE insurers. These four sections of regulations cover three areas: solvency, asset liability management and technical provisions.
I. Solvency
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 of AED100 million for direct insurers and AED250 million 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% 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.
A.M. Best comments
“A fixed level of minimum capital for all companies is insufficient, given the variation in insurers’ scale and their risk profiles. The market risk-adjusted capitalisation for most insurers operating in the UAE indicate that capital requirements are well in excess of these minimum levels, demonstrating the inadequacy of the current rules. In this respect, the IA’s regulation has lagged behind other regimes, such as that of the Central Bank of Bahrain which already enforces a risk-based solvency test for insurers.
“The solvency measures should enable management to better understand their company’s operations by identifying which risks are most significant and consume the most capital. Managers should be able to adjust capital requirements through measures such as changing their reinsurance programmes, adjusting investment allocation and adapting their underwriting profile. An understanding of risk-based solvency calculations should allow insurers to better insulate themselves against financial shocks and limit volatility in their operations.”
II. Asset liability management
The asset liability management (ALM) requirements provide ceilings on how insurers may allocate their investments, as set out in Table 1.
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.
A.M. Best comments
According to A.M. Best, 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. It said: “The global financial crisis and resultant fall in asset prices demonstrated the exposure created by insurers’ aggressive investment strategies. Insurers’ balance sheets remain vulnerable to market shocks, particularly given that assets are concentrated in the UAE, and benefit from little geographical diversification.”
It added that the new rules “should provide greater stability of returns to insurers’ investment profiles and thereby reduce volatility arising from fluctuating asset prices on their operations and balance sheets. Given that capital requirements of domestic insurers are largely driven by investment risk, de-risking of the asset base should improve the financial strength of companies”.
A.M. Best said that while the 30% cap on investment allocation to equities and real estate assets each is “encouraging” in limiting an insurer’s asset risk, “the combined exposure to equities and real estate can still be deemed high (up to 80% of an insurer’s asset allocation), with many insurers likely to maintain an aggressive investment mix. However, it should be noted that the solvency requirements may impose a higher charge for holding these assets”.
To comply with the rules, insurers “will be forced to liquidate large real estate and equity holdings”, said A.M. Best.
“Insurers would be wise to plan ahead in order to achieve the right price for these assets, particularly during a period when insurers will be selling in large volumes which may depress real estate and share prices. This may be especially problematic for those insurers with large positions in thinly-traded stocks.” However, with the IA giving insurers two years to comply with the new investment guidelines, whilst affording three years for real estate, companies will have time to divest their larger, less liquid assets.
Bin Shahib & Associates (BSA) comments
“A regulatory challenge is posed by requirements that non-UAE sovereign investments be made in instruments with ratings equal to that of the corresponding UAE-based instrument; however there is no guidance as to how different ratings of the individual Emirates’ instruments may affect this provision.
“Assets must also be valued using ‘mark to market’ principles whenever possible. When ‘mark to model’ rules are used due to the inability to utilise a mark to market rationale, such must be based on independently tested, evaluated, and actuarially certified criteria. Real estate valuations must be conducted by independent accredited firms, with two or more separate appraisals conducted for assets with a value of AED30 million or greater.”
III. 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.
A.M. Best comments
“There are currently inconsistencies in UAE insurers’ financial reporting practices. Additionally, companies vary in the sophistication of their reserve calculations; in some cases, incurred but not reported (IBNR) claims are simply raised as a proportion of premiums written, whilst other companies are able to base reserving on historical loss experience. This can lead to a lack of comparability and uncertainty regarding the financial strength and operating performance for insurers.
“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. A.M. Best views this positively as the regulation should result in greater consistency and transparency in financial disclosure, with the new regulations ultimately removing inconsistencies between companies and allowing the same basis for comparison.”
BSA comments
“The technical provisions include modern actuarial reserving principles that are designed to mitigate volatility such as unexpired risk provision (URP) and incurred but not enough reported (IBNER, being a subset of the more general IBNR).
These terms each essentially deal with the unknown level of risk inherent in the existence of insurable losses that will ultimately be payable by the insurer, but have yet to be fully identified or accurately reserved, due to their not having been reported or having not yet occurred (but will in all probability occur in the future during an in force policy period). This will be of most relevance to high frequency classes of insurance cover, such as health care and motor vehicle. Enhanced URP reporting requirements could address the pricing/ risk shortfall, which is of significant concern in the UAE, especially in the property cover market.
“Actuarial oversight is given high priority, with actuarial certification of the adequacy of the mathematical reserving practices required at least annually. The metrics to be identified in these reports are set forth with a high degree of specificity.”
Moody’s comments
“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 comprehensive and represent a sea change for UAE insurers. The condition for this is effective enforcement, as market observers have previously voiced concerns about the IA showing a “lack of teeth” in this area. Related to this is the concern about the potential for deadlines to slip, “as has happened with the separation of life and non-life activities”, noted A.M. Best.
It added: “The IA will need the appropriate resources and expertise to actively police the market according to these new rules and must be prepared to take appropriate action in the case of breaches.”
With the rules now codified as law, compliance and enforcement will thus be the key words for the UAE insurance industry, going forward.