For more than a decade South African life assurers have used a very effective solvency measure that takes into account the size of the business, the spread of the business and the diversity of the risks. For short-term insurers, on the other hand, the regulator has stipulated a simple 25% of premiums as the solvency requirement, and has accepted an IBNR allowance of 7% of premiums. With the introduction of financial condition reporting (FCR) this will change and the solvency requirements of South African short-term insurers will, in future, reflect the risks involved more accurately.

Effectively FCR will force the short-term insurance industry to plan and manage capital with a longer-term view. Companies writing long-tailed business, such as liability covers, will have to commit large amounts of capital to solvency, as well as allow for substantially higher IBNR reserves. Initial estimations from the FSB indicate that the introduction of FCR will result in additional capital being required for the industry.

The problem with the traditional 25% requirement is that, while it's more than sufficient for basic generic business like motor and household, it?s inadequate for long-term risks like liability and credit protection business. FCR will address this discrepancy, bringing the way that solvency requirements are calculated for local short-term insurers in line with those of their international counterparts.

Essentially FCR - which is being developed by the Financial Services Board (FSB), in consultation with the Actuarial Society of SA, the accounting and auditing profession, and the insurance industry - recognizes that different classes of business inherently have different risks, requiring that solvency margins be matched more closely to the risk involved and not merely a percentage of premium.

When FCR was first proposed, insurers had the option of either using the FSB's prescribed method or of developing their own internal model to calculate solvency, with the proviso that they were able to demonstrate that it would be at least as conservative as the prescribed method. However, there has since been a shift of emphasis and insurers are now expected to develop their own model, which has to be signed off by the FSB - unless the insurer can prove that it is unable to afford to develop its own model.

Under the internal model method, short-term insurers' solvency needs to be calculated by means of stochastic modelling, which uses simulations in order to determine the adequacy of reserves as opposed to the traditional point estimates of solvency. This means that the use of actuaries (which, within life companies, has long been prescribed by legislation) will be almost imperative for short-term insurers in future.

While the date of implementation has yet to be finalized (estimated to be around 2006/7) insurers need to familiarize themselves with the requirements laid down by the FSB. And, since it is estimated that a number of companies will require increased levels of solvency in terms of the new requirements, insurers need to start using the prescribed model to try and determine what the impact is going to be on their solvency.

While FCR will undoubtedly increase short-term insurers? running costs it will also have many positive spin offs in terms of building consumer confidence in the industry and improving its image as a whole. It will also give insurers themselves a better perspective of their long-term business model, in that they will find it easier to demonstrate to potential investors that the business is fairly and accurately valued.

Short-term insurers could need additional capital in the wake of FCR