• Sharebar
Thursday, November 1, 2007
Worthwhile cost

Short-term insurers are required to hold capital equal to 25% of their net written premiums under current legislation. But this is a very simplistic approach and does not take into account the underlying risk profile of each insurer. It means the capital requirement is no indication that an insurer will not experience financial difficulties in the future, nor that the Financial Services Board (FSB) is therefore able to judge accurately the financial soundness of a given insurer.

This has led to the introduction of Financial Condition Reporting (FCR) from 2009 onwards. A considerable amount of work has been done on this and the FSB has published a comprehensive report which was open for public comment until 31st May this year.
As Anton Reinke, actuarial consultant for Centriq comments, “The introduction of FCR has shifted the authorities towards a risk-based regulatory framework that is becoming increasingly popular on an international basis.”
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,” he explains. “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 are:
• Prescribed Model
• Certified Model
• Internal Model
The one used by each insurer will depend on various factors. These will 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. Risk management strategies must also 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 to which the insurer is most exposed.
The FCR report provides a detailed description of the insurer’s key risks and matters affecting its financial situation. This involves providing the insurer with implications of issues identified and where these are negative appropriate suggestions to attend to them. 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 the company’s potential for financial failure is minimised,” notes Mr 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. It will 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. Mr Reinke says that Centriq agrees with the opinion of the FSB that the benefits of FCR will nevertheless outweigh the costs.

Copyright © Insurance Times and Investments® Vol:20.10 1st November, 2007
616 views, page last viewed on March 21, 2020