By Dr Pius Apere
Risk-based Supervision (RBS) is gradually becoming the dominant approach to regulatory supervision of financial institutions around the world. Risk-based supervision (RBS) is a system in which the supervising authority allocates time and resources to firms based on the level of risk inherent to their balance sheet. The supervisor is expected to assess systemic risk that affects the industry as a whole (e.g. credit risk, market risk, operational risk etc.) and then analyses the level of risk specific to each firm (e.g. insurance underwriting risk). It takes a holistic approach by studying the business units within the enterprise, each of which may carry varying levels of risk.
In other words, RBS approach requires supervisors to review the manner in which insurers are identifying, analyzing and controlling risks (i.e. assessing the probability and severity of the material risks to which insurers are subjected to and the effectiveness of the controls in reducing the probability of risk events). The RBS is contrasted with compliance-based supervision where the latter involves applying the same minimum standards across the industry, checking for and enforcing compliance with rules, legislation, regulations or policies that apply to an entity. The risk-based capital (RBC) methodology is an integral part of the RBS framework and the former requires actuarial expertise/inputs in its determination.
The principle of proportionate risk-based approach is also an important consideration for the application of RBS, especially in markets with conventional insurers, small insurers or micro-insurers and insurance products with lower risk profiles. This requires that supervisors assess compliance with a regulatory framework in a manner proportionate to the nature, scale and complexity of the risks inherent in the business of insurers, as there is no “one-size-fits-all” approach for the application of RBS.
Ideally, the Insurance regulators are expected to develop a strategy for implementing risk-based supervision (RBS) in consistent and/or compliance with the Insurance Core Principles (ICPs) of the International Association of Insurance Supervisors (IAIS).
2. Risk-based Capital (RBC)
Risk-based capital can be employed in two different contexts (i.e. from the regulatory perspective and for the purpose of financial management of an insurance company). Firstly, it is used within a regulatory framework to determine an acceptable minimum level of capital which an insurance company must hold, as part of its solvency assessment, to support its overall business operations in consideration of its size and risk profile. Secondly, it is used in financial planning and control within an insurance company to help determine the overall optimum level of capital and to provide a basis for efficient allocation of this capital across its various activities or operations.
The measurement of capital from the regulatory standpoint differs significantly from that for internal company management purposes, with the regulatory value placed on the capital deemed to be held by an insurance company being less, usually considerably less, than the capital that the management itself considers it possesses. The RBC requires a company with a higher amount of risk to hold a higher amount of capital. Thus, an insurance regulator needs to develop a RBC model for the industry that will be used to capitalize insurance companies.
3. Risk Management and Corporate Governance under RBS
RBS focuses on the link between risk management and the management of capital adequacy and solvency. This requires an insurer to address relevant and material risks by recognizing the importance of an Enterprise Risk Management (ERM) framework in underpinning robust insurance enterprise-wide solvency assessment with the aim to enhance confidence in assessing the insurer’s financial strength. The solvency assessment would require each insurer to identify the risks to which it is exposed, to identify the risk management process and controls in place and quantify its ongoing ability to continue to meet the regulatory capital requirements.
There is a close and an inseparable link between corporate governance and risk management as the latter is a critical part of corporate governance. It is important for firms to come up with clear rules and procedures that govern all risk management activities since the failure of risk management function is almost always blamed on improper corporate governance. Thus, the Board of Directors and senior management need to show an understanding of the company’s risks in depth. Therefore, it is also appropriate to align the goals of corporate governance with those of risk management, giving rise to “risk governance”, for effective implementation of RBS.
4. Nigeria’s Insurance Sector moves towards a Risk-based Supervision
The Nigerian insurance regulator, NAICOM, had been planning since 2015 to move from a compliance-based supervision to that of risk-based supervision (RBS) of insurers in 2017. This laudable plan and timeline did not materialize, having carried out preparative and proactive steps for take-off of the RBS such as release of guidelines for RBS with feedback mechanism from insurances companies, enterprise risk management and code of corporate governance, and also conducted a verification exercise of capital resources within individual insurance companies.
A prerequisite for good and effective RBS is that an insurance regulator needs to have a good knowledge of the insurance companies, insurance industry and the operating environment. These can all be observed by creating a risk profile of an insurance company by considering the company’s activities, the risks in those activities, quality of risk management process and the capital required to support operations. The current management of NAICOM has a good knowledge of the critical problem facing the insurance industry, the dearth of actuarial professionals that is likely to hinder the successful implementation of the RBS. Thus, NAICOM has already put in place a training programme for building actuarial capacity for the insurance industry ahead of commencement of the RBS policy in August 2021 as being announced by the Commissioner for insurance (CFI) during 2021 seminar for insurance Journalists held on 3rd June 2021.
If RBS is implemented with an appropriate RBC methodology, even without adopting stochastic modelling techniques to determine the RBC at the initial stage of RBS regime, there will be no need to re-introduce the suspended Tier-Based Minimum Solvency Capital (TBMC) in the future, since an insurance company would not be able to underwrite large risks without the required capital. However, a new Insurance Act has to be introduced to provide the legal basis to support the implementation of the RBS framework.
For effective implementation of RBS, there is need to bridge the insurance and/or risk management knowledge/experience gap that exists within the Non-Executive Directors (NEDs) in some Boards of the Nigeria insurance industry. This is because the presence of NEDs without insurance and/or risk management expertise in a board may create an environment where decisions are made in a manner not so well thought-out, thereby making it difficult for the Board’s effective oversight functions without bias or compromise and communication with executive management and stakeholders. The limited insurance training programmes organized by the regulator for Directors in the industry might not be sufficient in the RBS regime. Thus, it would be appropriate to have at least one insurance professional as a NED (e.g. probably the Independent NED) on the Board of an insurance company, going forward.
5. Challenges in Introducing Risk-based Supervision
The challenges the insurance industry is likely to face with the introduction of RBS regime include the following:
1. There is likely to be an apprehension among the insurance players/stakeholders (i.e. pushback from insurers, clients and brokers) especially at the initial stages of implementation of RBS, particularly in the areas of risk management and governance, data collection, and actuarial expertise;
2. RBC being viewed as a compliance item rather than a business tool;
3. The RBS process focuses heavily on off-site surveillance. It is therefore extremely data intensive and thus it is unlikely that insurance companies will be able to provide data in a seamless and automated manner to the regulator on a regular basis due to existing poor data quality and inappropriate IT systems;
4. Possible lack of sufficient regulatory guidance on transitionary measures for the industry, inadequate training and development programs to instill a risk-based approach/culture; and
5. The regulator seems to be ahead of the industry’s preparedness and the availability of resources, capacity, and skills for the application of RBS, having considered NAICOM’s readiness as revealed during 2021 seminar for insurance Journalists.
The introduction of RBS regime in Nigeria insurance industry has been well overdue relative to some other African countries like Kenya, Uganda, South Africa etc. This is likely to improve the financial and operational efficiency of the insurance companies and their ability to underwrite large volume of business and material risks, going forward. Thus, RBS regime will enable the Nigerian Insurance industry to compete globally and contribute significantly to the country’s economy (i.e. the GDP).
Dr Pius Apere (PhD/FCII)
(Actuarial Scientist and Chartered Insurer)
Chairman/CEO Achor Actuarial Services Limited