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Are Non-Life Insurance Companies in Pakistan Adequately Capitalized?. Saqib Jamil, FSA, CERA. Insurance Default Risk – Need for Capitalization. Insurance is a mechanism of transferring risk from one party to another.
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Are Non-Life Insurance Companies in Pakistan Adequately Capitalized? Saqib Jamil, FSA, CERA
Insurance Default Risk – Need for Capitalization • Insurance is a mechanism of transferring risk from one party to another. • This transfer of risk exposes policyholders to another risk: insurance company default risk. • The risk of default can only be mitigated if the authorities ensure that an insurer maintains sufficient capital to address any unforeseen events.
Structure of Presentation • From the Capital Perspective • Compared Solvency I and Insurance Laws in Pakistan • Applied Results of Solvency I to companies in Pakistan • WHAT IF Solvency II is implemented in Pakistan
Comparing Solvency I First Directive 1973(European Union)&Insurance Ordinance and Rules of Pakistan
First Directive – 1973 (European Union) • The first among such regulations was released in 1973 for non-life insurance business • The regulations issued had the following requirements with regards to the solvency of an insurer: • It required each insurer to maintain a solvency margin above the technical reserves • And it also required that each insurer maintain a guarantee fund
First Directive – 1973 (European Union) • The Solvency Margin is calculated as higher of: • Minimum Solvency Fund • Premium Factor* (18% of Premium**) • Claim Factor* (23% of Claims Paid**) * Deducting the outward reinsurance relating to Gross Figures provided that the Net Figures is not less than 50% of Gross Figures **These percentages have changed several times
Non Life Capital Requirement - Pakistan • According to Article 36 (3) of Pakistan Insurance Ordinance 2000 the minimum solvency requirement of non life company is the greatest of: • such required minimum amount as may be prescribed by the Commission; • such percentage as may be prescribed by the Commission of its earned premium revenue in the preceding twelve months, net of reinsurance expense subject to a maximum deduction for reinsurance of fifty per cent of the gross figure; and • such percentage as may be prescribed by the Commission of the sum of its liability for unexpired risk and its liability for outstanding claims, net of reinsurance subject to a maximum deduction for reinsurance of fifty percent in each case.
Minimum Capital Requirement • Insurance Rules (2002) Section 13 (a) requires insurance companies to maintain a Minimum Fund of Fifty Million • SRO 16(1)/2012 prescribes to increase the Solvency Capital Requirement as follows:
Minimum Capital Comparison • There cannot be a one to one comparison between the Minimum Capital Requirement of EU and Pakistan as this being subject to several other factors. • The Minimum Capital Requirement should be linked to inflation, which is high particularly in Pakistan
Premium and Claim Basis • Article 13 (3) in the Insurance Rules 2002 combined with Article 36 (3) Insurance Ordinance 2000 have asked companies to maintain the following: • 20% of earned premium revenue in the preceding twelve months, net of reinsurance expense subject to a maximum deduction for reinsurance of fifty per cent of the gross figure; and • 20% the sum of its liability for unexpired risk and its liability for outstanding claims, net of reinsurance subject to a maximum deduction for reinsurance in each case of fifty per cent of the gross figure.
Comparison for Premium and Claim Basis • The premium and claims factor are some what similar, however this has been increased by European Union in particular where the claim variability is high for example Miscellaneous line of business. • For claim analysis, EU requires a 3-year claim average which can create issues if there is variability in claims due to any reason in a particular year.
Solvency Ratios for Companies Amounts in `000
Solvency Ratio for companies in Pakistan – Revised allowing for Captive Investments above 5%
Solvency Ratios for Companies - Revised Amounts in `000
Solvency II – Capital Perspective • Following the liquidity crisis, European Insurance and Occupational Pensions Authority (EIOPA) proposed a new set of regulations which are more popularly known as the SOLVENCY II. • These proposals are based on the idea that it is not possible to calculate the required solvency using a single method for each company. And so it allows each business to set up its own model for calculating the required solvency in the long run.
Solvency II – Capital Calculation • The two most important features of the solvency II regulations are: • The choice to an insurer to either follow the standard formula for calculating solvency (provided by EIOPA) or to use (after approval from authorities) its own internal model if it feels that the internal model presents a better picture of the risks. • Whichever model is used the regulations require that the capital is maintained such that it is able to meet all its obligations with a 99.5% probability.
Quantitative Impact Studies (QIS) • Quantitative Impact Studies are a series of studies conducted to analyze the impact of the new requirement aiming at raising the quality and the level of capital base, enhancing risk capture, containing excessive leverage and introducing the new liquidity standards. These studies are organized by EIOPA which has been established as a consequence of the reforms to the structure of supervision of the financial sector in the European Union.
Quantitative Impact Studies (QIS) • QIS measures the impact of risk and allows for diversification at a confidence level of 99.5% (that is failing to provide adequate capital only once in 200 years). This undertaking requires an economic, market-consistent approach to the valuation of assets and liabilities. • Although QIS are not final numbers for Solvency II, these are taken as best proxy by the EU committee. The full implementation of Solvency II recognizes that eventually insurers will need to use internal models. • As indicated above the use of any internal model needs approval from the regulator.
Comparison of solvency ratios across business segments (all undertakings, EU median)
Catastrophic Risk • The Median Catastrophic Risk charge for EU countries as a percentage of Premium & Reserve Risk is 80%, however this varies to as high as 300%. • The Catastrophic Risk charge would be particularly important as this depends upon the reinsurance treaty, diversification among different regions/ lines of business, catastrophic cover etc. • Companies should calculate their catastrophic risk charge.
Conclusion • Most of the companies in Pakistan are highly capitalized from the Premium and Reserve Risk Perspective. • Regulators should review Investment Guidelines as companies have invested heavily in Captive Business.
Conclusion • However, catastrophic cover which varies from case to case will change the capitalization. • Companies should calculate Catastrophic Risk Capital to ensure that they would be ready to cover risks at 99.5% confidence interval.
