Saudi Arabia: Risk-Based Capital and ORSA as a Long-Term Solution

In Saudi Arabia the central bank is preparing stricter rules for insurance companies in order to create a smaller number of stronger market players operating in the country. Whilst nothing is finalized it would appear that the solution will be to increase the paid-up capital.

If the intention is to reduce the number of insurers in the country, then certainly increasing the paid-up capital is one way to do this. Even though existing shareholders may be willing to put up the capital, without a corresponding increase in profitable business the ROE would drop. The question would then be are shareholders happy with a lower ROE? If yes, then increasing the paid-up capital would not be an effective solution to force a consolidation in the marketplace. Indeed, in some countries in the MENA region insurance companies are more akin to investment/asset management companies rather than an insurer where profits are mainly contributed by investment returns rather than underwriting profits.

It is unlikely that this intention to strengthen the solvency of the insurer perhaps is not a long-term solution. In many ways the oversight of the actuarial function is very strong already in Saudi Arabia, with detailed instructions and review of such aspects as Financial Conditions Report (FCR), data and assumptions back testing (called pre-FCR report), persistency report, mid-year review of company position, asset liability mismatch report.

What perhaps is missing is a risk-based capital (RBC) approach, where each insurer has capital requirements relating to the risk they are taking on. These risks would include asset risks (each asset class would have its own risk factors), liability risks (life, health and general) and operational.

These risk factors would be determined from reviewing the actual experience in Saudi Arabia to obtain statistics as to the mean and standard deviation of the various factors, and then fit to a statistical distribution. Analysis would then be made as to the statutory minimum capital which all insurers must adhere to.

Beyond RBC would be Own Risk Solvency Assessment (ORSA), whereby each insurer would review its risk profile and determine various levels and checkpoints. For instance, there would be an internal target capital level (ITCL) which relates to the particular risks of the insurer and ensures that undermost conditions between valuation dates the insurer will remain solvent. Below the ITCL there may be points where capital would need to be injected in order to ensure the capital adequacy (CAR) remains above the statutory minimum ratio. Above the ITCL would be checkpoints below which the investment mix might change, the new business mix or levels might be adjusted or restricted and unnecessary expenses controlled. There would also be checkpoints where below that level the Board of Directors would be alerted, and more frequent reporting mandated.

This structure would both ensure that capital levels remain adequate for each particular ensure as well as allow for niche players who might not require as much capital as the larger players.

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