New Risk Based Capital (RBC) for supervision of local insurance industry
The new Risk Based Capital (policy) or RBC is focused on managing the risks rather than complying with rules by insurance companies as well as by the regulator. It is also a flexible framework for maintenance of minimum capital requirements based on riskiness of respective insurance company. After reviewing the status of local insurance industry, the RBC frameworks were developed, which consist of risk factors exposed by insurance companies such as Credit Risk, Concentration Risk, Market Risk, Operational Risk and Liability Risk.
It also includes quantified capital charges for those risk factors and valuation methodology for assets and liabilities of insurance companies. Generally long term insurance companies are more impacted by RBC than general insurance companies due to inherent long term nature of the business. The RBC framework has been tested and refined since 2011 and full implementation of RBC is from early 2016. RBC reporting to the regulator consists of templates and questionnaires developed for life and general insurance businesses separately over the past years.
The following are advantages/benefits expected to accrue to insurance industry by introducing RBC:
1) Staff of insurance companies and officials of the regulator are expected to learn to identify potential risk and mitigating factors which is expected develop a culture of risk awareness in the industry.
2) Encourage efficient use of capital to improve return based on the risk exposure, as high risk business or products require higher capital requirement.
3) Could be used as a tool to assist decision- making by managing a balance between risks and rewards including optimization product portfolio.
4) It provides incentives for strengthening risk management practices which will lead to international best practices. This will contribute to an enhanced international image for the insurance industry.
5) Training for education and skills development of insurance industry representatives and officials of the regulator under RBC project.
6) Regulator could use RBC as a flexible tool to respond to changes or anticipated changes of the insurance industry or an insurance company.
7) Regulator could benchmark insurance companies and analyse the overall position of the insurance industry.
Following are some challenges that could be encountered by the insurance industry with the introduction of RBC:
1) Some additional costs including requirements to increase the capital, based on the risk profile of some insurance companies.
2) Requirement to upgrade IT system to obtain reliable and consistent data specially for risk management, capital management and also to provide additional public disclosures.
3) Creating/establishing governance and risk management processes which are capable/flexible to adopt for any change in market condition and strategic developments.
4) Establishing continuous and consistent approach to risk management, cultural change and providing required training throughout the company.
5) Availability of adequate actuarial support from an actuary who has sufficient exposure and knowledge in RBC.
6) Retention/availability of skilled personal with the regulator and providing continuous guidance to the industry for changing scenarios.
The implementation of RBC is intended to increase transparency, increase prudential supervisory oversight and establish appropriate risk management systems. Those will create a more stable industry with greater public confidence. Going forward, there is a requirement for some amendments to be made to framework, templates and questionnaires through learnings of submissions of insurance companies in previous years to make those more appropriate.
Further there could be new issues emerging as a result of implementation of RBC which are required to be sorted out promptly. The insurance industry was going through a challenging phase in the recent past with increase in capital requirements, segregation of composite companies, future listing requirements, implementation of RBC and gradual introduction of Risk Based Supervision (RBS). Majority of the industry players so far have faced those challengers successfully and shown good resilience.
However with all those changes the industry is expected to witness further consolidation, M&A (Mergers and Acquisition) activities, effective financial risk management, better risk governance and efficient use of capital of insurers. The insurance market in Sri Lanka has shown a positive growth for recent years with a higher growth rate in 2015. Current low penetration levels in insurance allow more opportunities for further growth in the future, if supported by appropriate products, marketing and innovations.
(The writer is a former Director Supervision of Insurance Board of Sri Lanka who headed the implementation of the RBC Project in Sri Lanka. He can be contacted on nihalr@hotmail.com)