solvency - final summary

8/4/2019 Solvency - FINAL Summary

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For :

PROF. DATO DR. KAMARUDDINSHARIFBy:NOORHAYATI MAAMOR - ZP00767

ZUBYDAH HAMZAH ZP00708


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10.1 Introduction

10.2 The Need For Solvency

10.3 The Principle of Solvency10.4 Traditional Approaches to Insurance

Solvency

10.5 Risk-Based Capital

Malaysian context


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RatiosMethod

Risk-

Based

Method


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One form of prudential

regulation aimed at

ensuring that regulated

entities operate safely and

soundly.

Includes requirements for

minimum risk managementstandards, requirements for

fitness and propriety of

managers and owners, and

requirements for sensitivity

analysis to forecast the

effect of plausible scenarios

Solvency requirement is a key regulatory toolin contemporary Takaful regulation, especiallyin view of the increasing complexities of

Takaful business and operations.


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Ratio-based Approaches:-Solvency margins calculated on thebasis of ratios of premiums, claimand liabilities

relatively easy to handle;

requirements vary with level ofbusiness;

arbitrary values; usually identical treatment of

different classes of business; various forms of risk not captured

(exchanged rate, marketfluctuation, etc);

no consideration of individualcases.

Risk-based Approaches:-Assessment of the capital adequacyof individual insurers on a risk-adjusted based (in analogy to BaselII)

technically much more demanding;

expensive experts required;

classification of capital into two ormore tier of different quality;

identification of different risk

classes; capital requirement based on

defined probability of failure;

use of internal risk model or of astandard model.


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1. To increase the likelihood that a Takaful undertaking wouldbe able to meet all its contractual obligations andcommitments;

2. To act as an early warning system for regulatoryintervention and immediate corrective action, taking intoaccount that the supervisory authority may sometimes have

access only to incomplete information, and that evencorrective actions may take time to generate the desiredimpact;

3. To provide a buffer so that even if the Takaful participants

are to suffer a loss in the event of failure of a Takafulundertaking, the impact can be limited orreduced; and

4. To foster confidence amongst the general public, inparticular Takaful participants, in the financial stability ofthe Takaful sector

THE NEED FOR SOLVENCY REQUIREMENTS


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1. Assets and liabilities are measured according to prescribed valuation rules;examples it is likely that some assets would be excluded or revaluedownwards for solvency purposes, reducing the amount of surplusavailable and the true regulatory surplus would be only the amount bywhich the available excess of assets over liabilities exceeded the requiredmargin of solvency or regulatory capital requirement.

Relationship between shareholder surplus and regulatory surplus

The view for shareholders. ..and for the regulator

2. Continuous requirement.

THE PRINCIPLE OF SOLVENCY

Assets

Liabilities Liabilities

Shareholdersequity

Regulatorycapital

Regulatory surplus

Regulatory capitalrequirement

Valuation adjustments


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TRADITIONAL APPROACHES TOINSURANCE SOLVENCY

Insensitive toward the capital an institution required

for its business

Motor damage predictable

Others losses are large ie latent diseases or

environmental pollution

Minimum

paid-up

capital

requirements

Ratios to premiums, claims or liabilities ie 20%

If based on premiums, extra risk takers subjected to

lower solvency requirements

Does not capture other risks ie exchange rate, credit

risks, market risks.

Required

minimum

solvency

margins

Takaful an obvious example, as its investment universe is limited


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TRADITIONAL APPROACHES TOINSURANCE SOLVENCY

Great reliance on conservative judgment of

actuaries

Now, greater role valuation of liabilities

Solvency reqs complicated protection and

savings element

Life

insurance

IAIS/IFSB note that in light of the specific

structure of takaful operator, modifications is

required

Takaful


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RISK-BASED CAPITAL

Used by rating agencies ie S&Ps, AM Best,

Moodys and Fitch

Ratings depend on capital adequacy on risk-

adjusted basis

Basel Accords Classification of capital into tiers of different quality

Consistent rules on assets and liabilities calculation

Identification of different classes of risks

Setting of capital requirements based on prob. Of failure

Internally developed capital models

Regulators active role in risk assessments


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Dominated by large no. of small companies

Intense & inefficient competition

Insurers operates in tight margins

Spending money in capital models

Skilled resources

Creation and assessment of models

DIFFICULTIES OF RISK-BASED CAPITAL IMPLEMENTATION


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RegulatoryCapital

Assets

Takaful Model allows forcapital to be contributed tothe risk fund in the form ofqard hassan

THE NATURE OF CAPITAL FOR TAKAFUL

Assets

Liabilities

Assets

Liabilities

Qard

Operators fund Risk fund

Deficit Qard

Operatorsfu

nd

Operatorsfund

Combined

Risk

fund

Risk

fund

Assets

Qard

Liabilities

Liabilities

Qard

Qard hassanasset and liability

cancel out

RegulatoryCapital


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Takaful Operator may consider:

Capital in the operators fund that is available for transfer

as qard hassan but has not actually been transferred

Calls on participants for additional contributions


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Resolutions of BNMs SAC

In the event that the reserves are not sufficient to cover deficits in theParticipants Special Account (PSA), then the takaful operator mustcover the deficits by giving financial help from the shareholders fundby way of qard hasan. (38th Meeting)

SAC approved the Central Bank of Malaysias proposal to impose onthe takaful operators the responsibility for the solvency of takafulfunds and to secure the benefits and savings of the participantsthrough asset injection from the shareholders funds into the takafulfunds to cover any deficit that occurs based on the reason given. Thesecurity and injection of asset may be implemented by the takaful

operator based on commitment to donate (iltizam bit tabarru`), i.e.,the operator undertakes to give donation to cover all the claims(liabilities) on the takaful fund in the case of deficit. (46th Meeting)

Source: BNM


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Different tiers of capital

The Basel Committee convention capital is divided intotiers of quality

Top quality paid-up share capital plus premiums, pluscumulative retained earnings

Low quality preference shares and subordinated debtinstruments, for takaful, potential qard hassan and theability to make calls


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Solvency Requirements

Categorization of Risks by IAIS (International Association ofInsurance Supervisors)

Underwriting

Premiums charged inadequate to meet liabilities

Credit

Failures of counterparties to meet obligations

Market

Assets failing to realize values assigned

Liquidity

Institution being solvent and unable to mobilize liquidity

Operational

Inadequate or failed internal process, systems or

people

For takaful, the risk thatfees received are lessthan the managementexpenses


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DISCUSSIONS


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THE ROLE OF WAKALAH IN STRENGTHENING THECAPITAL ADEQUACY & SOLVENCY OF TAKAFUL FUNDS

Under the wakalah contract, the contractual responsibilitiesof the takaful operator are as a trustee (amin) and not as aguarantor (kafil).

The takaful operator is not responsible in the case of anyloss of deficit in the takaful funds in the course of thetakaful operation, unless such losses or deficits are causedby negligence or fraud of the operator.

Therefore, it can be said that solvency is not the directresponsibility of the takaful operator, but rather that of thetakaful fund or ultimately the takaful participants.


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IMPOSITION OF DUTY TO GIVE FINANCIALSUPPORT ON THE OPERATOR ?

The policy basis for imposing the responsibility for solvencyon the operator reflects the current environment in takafulbusiness, i.e.:

Takaful operators are licensed Islamic financial institutions ina regulated industry; Takaful operators market their takaful products to theparticipants with the understanding that claims can be metfrom the takaful funds, and that they are expert in managing

the funds; Takaful operators make profits from their duty and expertisein the management of the takaful funds, and this shouldinclude solvency valuation and management;


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CROSS SUBSIDY BETWEEN VARIOUS TAKAFUL FUNDS?

The SAC disallowed the practice of using the surplus orreserves from one takaful fund to crosssubsidise the deficit inanother takaful fund because:

The risk profiles and nature of liabilities in each fund aredifferent. The participants in each fund may not have agreedto take different or higher risk profiles into their scheme The original intent of the participants in the tabarru`contract is to be considered in determining whethercrosssubsidy is intended to be covered by the fund or not

If there is no express provision for crosssubsidy in the termsof the tabarru`, then crosssubsidy is not allowed, because theparticipants are understood to intend to provide only for thosewith similar risk profile in their scheme only.


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CROSS SUBSIDY BETWEEN VARIOUS TAKAFUL FUNDS?

Another mechanism to overcome the problem of deficits intakaful funds that is being considered by some takafuloperators or perhaps the regulator is the practice of

crosssubsidy between various takaful funds. In this mechanism, the surplus or available reserve of a typeof takaful fund / scheme will be used to cover any deficit inanother takaful fund / scheme under the management of thetakaful operator. The idea is, to try to cover the deficit from the participants

tabarru funds first, regardless of the type of fund or its riskprofile, before resorting to the injection of asset or fund fromthe operator by way of qard.


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ENHANCED SOLVENCY FRAMEWORK FOR TAKAFUL

Source : Global Islamic Finance Forum 2010


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THE END

solvency - final summary

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