Solvency asset management – What does it entail an how will it affect you?

August 1st, 2013

By Marietjie Botes

The solvency asset management (SAM) project, a joint venture of the Financial Services Board (FSB), who is also an active member of the International Association of Insurance Supervisors (IAIS), and the South African insurance industry, will introduce a new risk-based supervisory regime for the prudential regulation of both the long-term and short-term insurance sectors in South Africa. SAM will be implemented in January 2014, with its final implementation due in January 2016.

SAM, which will be adapted to South African circumstances where necessary, is based on the European Directive: Solvency II that codifies and harmonises insurance regulation in the European Union (EU). Solvency II will also be implemented in the EU in January 2014. Solvency II is primarily concerned with the amount of capital the EU insurance companies must hold to reduce the risk of insolvency, while in a South African context the SAM regime will similarly enhance insurers’ financial soundness and their participation in the global insurance market due to insurers’ global adherence to the same standards and conditions.

Both these regimes, which are somewhat similar to the Basel II banking regulations, aim to –

  • reduce the risk that an insurer will be unable to meet claims;
  • reduce the losses suffered by policyholders in the event that an insurer is unable to meet all claims fully;
  • provide an early warning to insurance supervisors to promptly intervene if capital falls below the required level; and
  • promote confidence in the financial stability of the insurance sector.

The South African Minister of Finance will soon table the Insurance Laws Amendment Bill (B16 of 2013) to address current shortcomings in the insurance sector in respect of appropriate requirements on corporate governance, risk management and internal controls to aid the insurance sector in successfully implementing SAM.

Although SAM will be fully implemented only in January 2016, insurers need to be in a position to comply with most of the SAM framework by 2015. For this reason the FSB intends to conduct a mock own risk and solvency assessment exercise during 2015. This assessment exercise will aim to assess the overall insolvency needs related to a specific risk profile of an insurance company for further decision-making and strategic analysis.

Insurers will be required to conduct a full assessment exercise and submit the assessment report to the FSB after the exercise. During this exercise an insurer’s risk appetite, the level of risk it wishes to take, as well as its risk tolerances and the risk appetite variation on the different risk factors will also be established. In order to maintain the risk profile of any insurer consistent with the risk appetite, four main strategies need to be implemented, namely –

  • abandonment of risk;
  • reduction of risk;
  • transfer of risk; and
  • acceptance of risk.

An insurer will therefore have to identify major events, both internal and external, which will have a significant impact on its risk profile and will ultimately lead to the update of its assessment exercise.

In this regard the draft Insurance Laws Amendment Bill provides that every insurer must have an outsourcing policy and further provide for certain conditions under which an insurer may outsource any of its functions or activities, such as the subrogated recovery of monies from delictual wrongdoers. Section 14L(2) of the Bill in essence provides that an insurer may not outsource any aspect of its short-term insurance business if it will materially impair the quality of its governance framework, increase its risk or its ability to manage such a risk, and its ability to meet its legal and regulatory obligations.

Section 14L(4) further provides that any remuneration paid in respect of such outsourcing must be reasonable and commensurate with the actual outsourced service or activity; may not be linked to the monetary value of repudiated claims, claims not paid or partially paid and may not result in the payment of a binder fee or commission, or be structured in a manner that will render the treatment of policy holders unfair.

Prior to entering into any outsourcing agreements the insurer must, in terms of s 14L(6), notify the registrar thereof if such outsourcing has any significant impact on the insurer’s ability to manage its risks effectively. The insurer must further furnish the registrar with all the details of the third party to whom the insurer will outsource that function and inform the registrar of any material developments during the course of such outsourcing and, most importantly, of all strategies that will be used to address any identified risks associated with such outsourcing. According to s 14L(8) the registrar may then prescribe any requirements in respect of such outsourcing, remuneration to be paid for it and even any services or activities that may not be outsourced.

But how will all these regulations in respect of risk management affect policy holders and legal practitioners doing outsourced legal work for insurers?

During the first national Insurance Fraud Conference held in Johannesburg in May 2013, the importance of data completeness and data correctness ran like a golden thread through presentations and discussions as the pivotal point in reducing insurance fraud and, ultimately, improving risk management. Increased pressure will be placed on the recruitment and retention of skilled people who understand these issues. A new degree of sophistication thus needs to be developed. Outsourced service providers, such as lawyers, who can demonstrate an understanding of the constraints the new SAM regime places on insurers, and acquires the tools to respond accordingly, will gain a competitive edge over peers. Such tools will include skilled methods of delivering returns in more innovative ways – such as implementing alternative dispute resolution methods, which might be a cost-effective alternative to standard litigation – and negotiating towards sound economic settlements based on solid legal argument. Lawyers, brokers and policy holders are well placed to help insurers prepare evidence, for example detailed affidavits, etcetera, which can help insurers with their risk and ultimately fraud management, having regard to their above-mentioned need for data completeness and data correctness and will result in insurers’ financial stability.

It is foreseen that insurers will enter into more stringent service level agreements with their outsourced service providers (lawyers) with specific terms stringently regulating cost brackets as more pressure will be placed on insurers for capital recovery to maintain the SAM regime required amount of capital to stay solvent. More attention and effort must be given to data investigation and validation to ensure data quality to subsequently prevent fraudulent claims that will, in turn, impact on an insurer’s risk management and solvency.

Due to the fact that the outsourcing of, for example legal services, inherently entails a high-risk exposure resulting from the very nature of litigation, less outsourcing of this nature is foreseen, or under more onerous conditions, and insurers will be under pressure to recruit and retain skilled outsourced service providers who understand risk management and the effects of the implementation of SAM and, more importantly, are willing and able to evolve with the needs of the changing times.

Are you ready?

Note: The Insurance Laws Amendment Bill was tabled on 21 June and meetings on this Bill will be scheduled in the third term of 2013.

Marietjie Botes BProc LLB (UP) LLM (Intellectual property) (Unisa) is an attorney at Dyason Inc in Pretoria.

This article was first published in De Rebus in 2013 (July) DR 26.