FCR could give investors cold feet

– Herman Schoeman, MD of Guardrisk

Few would question the wisdom behind the introduction of financial condition reporting (FCR) to the short-term insurance industry. However, cognizance must be taken of the danger that proposed FCR legislation could harm the very industry that it seeks to protect. If FCR is too onerous investors may simply choose to walk away from the industry and that would be disastrous.

The initial findings of Deloittes Actuarial and Insurance Solutions (who were commissioned by the Financial Services Board (FSB) to calibrate the standard model to be used to calculate FCR required) indicate that substantial amounts of capital need to be injected into the industry. However, on the upside, some companies will enjoy the release of substantial amounts of capital.

So far the calibration process for FCR has raised as many questions as it’s provided answers. For starters, the proposed January 2007 implementation date looks increasingly unrealistic since much more consultation is evidently necessary and several key points still need to be debated.

Preliminary proposals suggest that solvency be set at a 99.5% level of adequacy, which effectively means that a company would be able to survive the worst loss it could face in a 200 year scenario; or that one in every 200 companies could potentially go bankrupt.

But is it appropriate to apply a standard, which is even regarded as onerous for very large insurance industries in highly developed economies, to a developing country and a relatively small short-term insurance market like South Africa? Since there is a direct correlation between the solvency level test and the amount of capital that needs to be invested; the more extreme the solvency required the exponentially higher the capital investment requirement is. Naturally, the impact of this on individual insurers will depend on several factors including the company’s size, the risk level of its book, expenses, commission and reinsurance. However, the FSB also needs to bear the macro-economic factors in mind. And specifically the basics of corporate finance theory: that an investment creates value for its shareholders only to the extent that returns on the capital required exceed investor requirements. It follows that if capital requirements are too stringent, return on investment will not be high enough to satisfy investors who may choose to take their money elsewhere.

Another issue that requires consultation is that of the appropriate point for FSB intervention. Currently FSB intervention is proposed if less than 150% of the minimum capital requirement is held. For life companies, capital adequacy requirement (CAR) is set at 100% and though the FSB would be talking to the company if it was below 150% there would be no actual intervention. In contrast, a short-term insurer wanting to avoid FSB intervention could be required to hold 200% of capital required.

Undoubtedly, in the wake of FCR, there will be severe pressure on some insurers to grow their assets in order to be able to meet their liabilities and minimum capital required. This means that assets attributable to shareholders will be significantly reduced. While the necessity of FCR is not in question, the implementation – if not carefully crafted – could have serious implications for the entire short-term insurance industry. Granted, it is still early days and a lot of debate and discussion is envisaged in the coming months.

For further information please contact:
Herman Schoeman, MD of Guardrisk
Telephone: +27 11 669-1001

Issued by:
Melanie Davis, PR@Work
Telephone: +27 11 615-3309 / +27 83 225 7450