New capital model for Short-term insurers

There is a new method of statutory financial reporting for the short-term insurance industry that will be required in the near future.

Currently short-term insurers are required to hold capital equal to 25% of their net written premiums. However, this is a very simplistic approach and does not take into account the underlying risk profile of each insurer. Therefore, meeting this capital requirement is no indication that an insurer will not experience financial difficulty in the future and vice versa. Similarly the Financial Services Board (FSB) can not accurately judge the financial soundness of an insurer based on this capital measurement.

This has led to the introduction of Financial Condition Reporting (FCR) from 2009 onwards. A considerable amount of work has been done on FCR and the FSB has published a comprehensive report which was open for public comment until 31 May 2007.

Anton Reinke, actuarial consultant for Centriq, the first BEE insurer in risk finance, highlights some important aspects concerning FCR.

"The introduction of FCR has shifted the FSB towards a risk-based regulatory framework that is becoming increasingly popular on an international basis," says Reinke. Various countries are busy adopting or have already adopted a similar regulatory approach. These include Australia, the UK, America, Germany and Canada. . 
 
"In a nutshell, FCR considers the underlying risk of the insurer to determine the capital levels needed." 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.  "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 insurer. These models are:

* Prescribed Model
* Certified Model
* Internal Model
 
The model used by each insurer will depend on various factors. These factors include 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.
 
The FCR report provides a detailed description of the insurers key risks and matters affecting its financial situation. This involves providing the insurer with 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," explains Reinke.

He goes on to say that 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 impact 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.

Centriq recommends that insurers consider obtaining professional advice in order to determine the affect that the above will have on their specific circumstances.

The advice offered above is given in good faith by the institution and serves as a guideline but is without warranty.