One of the pleasures of being an auditor and consultant is the exposure to a cross section of the insurance industry – from large personal lines and commercial specialists to small and niche players, we get to meet them all. One thing that has stood out from these interactions is the multitude of opinions regarding the necessity for Solvency Assessment Management (SAM).
Many industry players still see compliance with SAM as a tick-box exercise, and some as a waste of resources.
I will be honest - I am a big fan! Having grown up in the changing world of regulatory reporting, having experienced the transition from the arbitrary 10 percent capital requirement and seven percent short- term incurred but not reported (IBNR) provision, to risk-based capital and best estimates, I think we are operating in a better regulatory environment than ever before. Although some people have described SAM as “poppycock.”
I would like to share my reasons for believing that, although SAM might not be Super, Amazing and Magnificent, it should be inspiring confidence in the insurance sector and empowering progressive change. In my view, SAM is beneficial to the policyholder, the shareholder, management, the board and the employee – it is obviously advantageous to us as the consultants, considering the costs associated with SAM implementation.
On 31 December 2015 the market capitalisation of the JSE listed insurance sector securities was R517.3 billion. The value of these investments is a function of the future cash flows - normally in the form of dividends - and the certainty of those future cash flows.
By managing risk, SAM is immediately increasing the certainty of those future cash flows, translating to more value. Quite simply, SAM is making the South African insurance industry more valuable to the investor.
This is the function of the Own Risk and Solvency Assessment (ORSA), which should be examining the risk and return payoff in light of a predefined risk appetite.
An insurer intentionally underwrites the right risk and manages, mitigates or avoids unwanted risk - such as catastrophe risk or poor credit risk. Appropriate risk disclosure allows the investor to understand the type of risks their funds are exposed to, this allows for a more conscious allocation of resources within the market.
Furthermore, appropriate measures of performance against a risk appetite will reveal to the investor whether their funds are being managed within the promised structures.
With the looming risk of a credit rating downgrade for South Africa, attracting foreign direct investment is proving to be difficult. It would be even tougher if South Africa were lagging the international community in terms of insurance regulation.
Similar risk-based capital regimes are being developed in most of our direct competitors in the international community – Brazil, Russia, India and China. The SAM framework aligns to best standards of international prudential regulation.
Each working group has compared the topic of their team to the practices of the EuropeanUnion and, in many cases, to the practices of the Canadian and Australian authorities, to name a few. Solvency II equivalence is on the cards and is essential to maintain foreign investor confidence in the sector.
The economic impact study (EIS) performed by the Financial Services Board (FSB) regarding the implementation of SAM had the following to say about the economic impact: “… the study suggests that the implementation of SAM is likely to lead to better risk management at a direct cost that is small when seen in context of the size of the South African insurance industry. This additional cost to the insurance industry will lead to a neutral to slightly positive impact for the economy as a whole, while also contributing to a more sustainable and stable financial sector.”
The estimated ongoing cost of SAM for the insurance industry is around R500 million per annum. This equates to less than 0.1 percent of the insurance sectors’ annual revenue.
Despite the obvious benefits for the shareholder and investor in the South African insurance industry, these are merely an unintended consequence. From the outset, the intention of the Financial Services Board has been “the protection of policyholders and beneficiaries.”
For the policyholder the requirements related to independence at the C-level, as well as the control functions, are key aspects that act in the public interest. Whether it be an independent challenge to gung-ho management, critical actuarial analysis of proposed schemes or assurance over processes – all these things act in the interest of policyholders.
Many of these practices were not widespread in the insurance industry before the release of Board Notice 158: Governance and Risk Management Framework for Insurers.
Insurance is a promise of compensation for specific potential future losses in exchange for payment. Much like for investors, a reduction in the risk associated with this promise increases the value of the promise.
Effectively we all have real and contingent assets on our balance sheets related to the promises of life and non- life insurers. The changes in prudential regulation should go some way to restoring confidence in the promises of insurers.
A key aspect of SAM is the risk management system, which should comprise “…the totality of strategies, policies and procedures for identifying, assessing, monitoring, managing, and reporting of all reasonably foreseeable current and emerging material risks to which the insurer may be exposed.”
Furthermore, this should be documented in clearly articulated policies. The operational effectiveness of these should be assured regularly by the mandatory internal audit function.
The completeness of these should be assessed by the independent governance structures. Awareness of SAM throughout the organisation is required.
Consequently, employees, management and directors should be reassured under SAM. By including emerging risks, this clearly forces the risk committee (and others) to consider what is not already encompassed, to try to anticipate the unexpected.
The risk of treating SAM as a compliance exercise increases the risk that it will add no value. Hasty reporting to the board will not be useful and is likely to discourage further interest.Tick-box reporting to the shareholder will not promote meaningful shareholder engagement.
Treating SAM as a low priority project for employees will encourage them to minimalise the effort they take to embed it properly in the organisation. Worst of all, treating risk management as a checklist is a sure way to waste money and expose the organisation to threat.