In the first of a series of articles on the Financial Regulations, Peter Hodgins and Liesel van den Heever of Clyde & Co's Corporate Insurance team consider the key features of the Financial Regulations and their likely impact. The detailed requirements of the Financial Regulations will be addressed in future editions of this publication in the coming months.
The new requirements, if properly implemented, are likely to cause a transformational shift in the way the insurance industry operates in the UAE and introduce a risk-based fiscal regime which better reflects modern solvency and reporting requirements.
Historically, prudential regulation in the UAE has been lacking with relatively limited requirements contained in the Federal Law No. 6 of 2007 (the Insurance Law) on minimum capital and reserving. Insurance companies were previously subject to a rather uniform approach in respect of maintaining capital, a security deposit, a solvency margin and minimum guarantee according to the type of insurance transacted, as well as technical provisions estimated at the end of each financial year. The UAE Insurance Authority (the Authority) announced the Draft Combined Regulations in December 2013, which combined seven previously separate but related draft regulations. Following consultation over the draft, in December last year the Authority issued the Financial Regulations for Insurance Companies (the Financial Regulations). They have subsequently been supplemented with a pro-forma solvency template and e-Forms. Each of these documents is available on the Authority's website.
Navigating the Financial Regulations
For a reader looking at the Financial Regulations for the first time, the immediate impression is their scale when compared to other regulations. There are separate regulations for the conventional insurance market and the Takaful market and each run to over 110 pages.
The main operative provisions of the Financial Regulations are set out in Part One which comprises the following 7 sections:
- Basis of Investing the Rights of the Policyholders;
- The Solvency Margin and Minimum Guarantee Fund;
- The Basis of Calculating the Technical Provisions;
- Determining the Company's Assets that meet the accrued insurance liabilities;
- The Records which the Company shall be obligated to Organize and Maintain as well as the Data and Documents that shall be made Available to the Authority;
- The Principles of Organizing Accounting Books and Records of Each of the Companies, Agents, and Brokers and determining Data to be maintained in these Books and Records; and
- The accounting policies to be adopted and the necessary forms needed to prepare reports and financial statements and presentations.
Each of the sections consists of a series of regulations supported by one or more addendum which provides further details on particular points of issue. Please see table one for the quick overview of the contents of each of the above sections.
In addition, there is a glossary of defined terms in the preamble to the Financial Regulations, and Part Two details the general provisions relating to the timelines for implementation and the penalties for non-compliance.
Key features of the Financial Regulations
The Financial Regulations are the single most important piece of regulation enacted for the insurance sector since the creation of the Authority pursuant to the Insurance Law. They are a tailored set of regulations designed specifically for the UAE market and not simply a cut & paste of the European Solvency I or Solvency II models (although they contain features from both). Running to over 100 pages, the Financial Regulations are also easily the most comprehensive set of regulations issued by the Authority.
A detailed analysis of the requirements of the Financial Regulations will be set out in the future editions of this publication. However, by way of overview, the following bullet points summarise the key features of the Financial Regulations.
New Prudential Requirements
The key feature of the Financial Regulations is that they create a fundamentally different prudential regime to that previously set out in the Insurance Law. The Minimum Capital Requirement (MCR) from the Insurance Law and Cabinet Resolution No. 43 of 2009 has been retained, requiring a fixed MCR of AED100 million for insurers and AED250 million for reinsurers. This is now supplemented by two additional capital requirements:
- the Minimum Guarantee Fund (MGF) which comprises an amount which is the higher of: (i) not less than one third of the Solvency Capital Requirement; or (ii) the higher of a minimum amount to be specified by the Authority for each type of business and a specified percentage of the net earned premium for each type of business; and
- the Solvency Capital Requirement (SCR) being a risk-based capital calculation that utilises the solvency template published by the Authority. The SCR introduces, for the first time in the UAE, a risk-based capital component for insurers.
Insurers are required to maintain the higher of the MCR, the MGF and the SCR.
The introduction of a risk-based capital requirement also requires that insurers establish a documented risk management framework including appropriate policies and procedures and allocated responsibilities and controls.
The imposition of limitations on the type of assets into which an insurer may invest, are the aspect of the Financial Regulations that have received the most comment in the media to date. The Financial Regulations require assets to be diversified and adequately spread and therefore include restrictions on the types of assets which may be used for investment purposes and also incorporate limitations on the percentage of each type of asset that may be held with a single counterparty in order to address concentration risk. Thus, for example, investments in real estate are restricted to 30% of an insurer's total portfolio and investments in UAE equities is limited to 30% of the portfolio and not more than 10% of the portfolio may be held in a single issuer.
Importantly, insurers may not hold more than 50% of total invested assets outside of the UAE and 100% of technical provisions must be held in assets within the UAE.
With an eye on the difficulties that befell the AIG Group during the financial crisis, the Financial Regulations prohibit the use of derivatives except for hedging purposes.
Outsourcing of Investment Management Activities
The Financial Regulations also prohibit the outsourcing of investment management activities to entities outside of the UAE. In order to outsource to a third party investment manager, systems and controls must be in place to ensure that the insurer has adequate oversight of the outsourced provider and to ensure that the outsourced provider operates in accordance with the insurer's stated risk appetite.
Compliance with the Financial Regulations will require many insurers to establish new internal governance structures, including the creation of two new Board of Director level committees: an Investment Committee and an Audit Committee.
In line with the focus on international regulators on the role of key individuals within financial services organisations, the Financial Regulations impose significant requirements on the Board of Directors (and, in particular, the Chairman of the Board) and senior management to understand the risks to which insurers are exposed and to develop and implement appropriate systems and controls to manage such risks. There are also detailed requirements as to the role and obligation of the Actuary, Investment Committee, the Internal Audit Department, the External Auditor and, to a lesser degree, the Compliance Officer.
Details of each of these roles and their respective obligations will be detailed in a separate article in a future edition of this publication. However, it appears safe to assume that, in line with the approach of other financial services regulators, the Authority will seek to action against individuals (as well as the insurer itself) for non-compliance with the Financial Regulations.
Emphasising the role of the Actuary
The role of the actuary is central to the Financial Regulations and, for the first time in the UAE, the actuary is required to be involved in monitoring the investment activities of Insurers (in addition to their more traditional involvement in the liability side of the business). Insurers must appoint an Actuary that is registered with the Authority and, in an attempt to stop insurers from shopping around for favourable actuarial reports, they must notify the Authority of the reasons for any change in the appointed Actuary.
Documentation and reporting
The number of documents to be produced by insurers that are referenced in the Financial Regulations is significant. For example, Section One of the Financial Regulations refers to 7 different documents that will need to be produced (the investment and risk management policies, the investment procedures, the stress testing framework and policy, the contingency funding plan, outsourcing agreements, the quarterly report on the investments of the insurer and the annual investment risk analysis report). Details of each of the documents referred to in the Financial Regulations will be set out in an article in a future edition of this publication. However, insurers will be well-advised to carefully review the Financial Regulations to ensure that they have in place proper documentation to ensure compliance.
The Financial Regulations also impose very significant reporting requirements for insurers. The key reports that have to be submitted to the Authority include:
- Quarterly report and analysis of the insurer's investment portfolio (Section 1, Article 10(1));
- The annual risk analysis report on the insurer's investment portfolio, strategy and management process (Section 1, Article 10(2));
- The annual submission of the completed solvency template within 4 months from the financial year end (Section 2, Article 9(1));
- The quarterly submission of a report on the SCR within 45 days from the end of each quarter (Section2, Article 9(2));
- In the event of non-compliance with the solvency requirements, insurers are required to immediately report to the Authority and submit a realistic recovery plan (Section 2, Article 8);
- The quarterly submission of a report of the technical provisions within 45 days from the end of each quarter (Section 3, Article 5(1));
- The annual submission of a report of the technical provisions to be submitted at the same time as the audited annual financial results (Section 3, Article 5(2));
- The quarterly financial statements in the form set out in the addendum to the Financial Regulations within 45 days from the end of the quarter (Section 7, Article 3(3)); and
- The annual financial statements as required to be produced pursuant to the Companies Law (Section 7, Article 3(1)).
In addition to the foregoing, the Authority has power to request additional reports and documentation. The most important power in this regard is to request a Financial Condition Report addressing matters such as the actuarial certification of the technical provisions, a risk based analysis of the insurer's investment strategy and portfolio, an analysis of the SCR, an evaluation of the reinsurance structure and management process and an analysis of underwriting, pricing and ERM policies and procedures.
There are detailed requirements as to the records that must be maintained by insurers. However, it is important to note that records may be kept in either hard copy or electronic format for a period of not less than 10 years. The retention period is extended where ongoing investigations or court proceedings are underway, in which event the records must be maintained for an additional two years from the conclusion of the investigation or the final settlement of the claims.
The Financial Regulations therefore relax requirements of the Insurance Law which, at least implicitly, required original hard copy documents to be maintained. However, the extended retention period will require that many documents to be stored for longer than is currently the case.
Timetable for Implementation
The Financial Regulations were issued by the Authority on 28 December 2014 and published in the Official Gazette on 28 January 2015. They are stated to come into effect on the day after publication in the Official Gazette (i.e. on 29 January 2015).
The Financial Regulations provide for a phased implementation of the various sections:
Click here to view table.
The inherent complexity of the requirements of the Financial Regulations, coupled with the structural requirements that need to be implemented, mean that insurers would be advised to start work towards complying with the Financial Regulations sooner rather than later. The Authority has sought to encourage such proactive behaviour stating in Article 7 of Part Two of the Financial Regulations:
"During the alignment periods of this regulation the Company shall provide the Authority with the financial reports, solvency templates and reports as required by the Authority that demonstrate progress in aligning its operations according the requirements and regulations herein. These reports shall be provided within the same period as the interim and annual audited financial statements."
In addition, we would note that:
- The solvency template is clearly capable of being modified by the Authority. Insurers that comply with Article 7 of Part Two of the Financial Regulations will have an opportunity to provide comments and potentially shape the evolution of the template.
- Section 1 of the Financial Regulations (Investment Limits) includes provisions enabling the Authority to exempt insurers from certain of the asset allocation limits. In this regard, investments in real estate may be permitted up to 40% and derivatives may be permitted in excess of 1% with the permission of the Authority. Again, it seems likely that such permissions will be more forthcoming if raised early by the insurers.
What is the Authority seeking to achieve?
Sultan Bin Saeed Al Mansouri, the UAE minister of the economy and the chairman of the Insurance Authority described the purpose as to “put the UAE at the forefront of the Middle East with regard to adopting the latest solvency requirements similar to the European model”.
It is clear that the intention of the Authority is to create a stronger insurance industry. As well as greater focus on risks and their management, the new solvency system also creates a more prospective focus, requiring insurers to think about any future developments, such as new business plans or the possibility of catastrophic events which might affect their financial standing.
The Authority may also be seeking to achieve some other goals, namely:
- A reduction in the number of licensed insurers in the UAE (currently 67) through the withdrawal or consolidation of smaller players that cannot afford to implement the requirements of the Financial Regulations.
- Enhancing the amount and quality of data about the insurance market in the UAE. The submission of the reports outlined above will provide the Authority with far greater information about the operations of insurers.
- Increasing the powers of the Authority to require information from the industry. There are broad powers contained in the Financial Regulations to enable the Authority or its appointed representatives to conduct examinations of accounts and books and records of an insurer as well as to interview employees and other agents of an insurer with regard to its affairs. The Authority also has the power to require: (i) a Financial Condition Report to be produced (see above); and (ii) external auditors to conduct additional work at the insurer's expense.
- Segregation of life and non-life business – it appears that the requirements of the Insurance Law for composite insurers to split have been shelved for the time being. However, the Financial Regulations do require the internal separation of these operations. For example, the books and records of life business must be maintained separately from non-life business. Similarly, separate investment strategies and accounting books must be maintained for these lines of business.
- More active involvement of the Board of Directors in the day-to-day management of risk.
- The establishment of greater retentions by insurers through the imposition of capital charges based on the credit risk of reinsurers to whom business is ceded. However, there remains a debate as to whether the charges are sufficient to deter fronting arrangements.
The new Financial Regulations are an important step forward in promoting the establishment of a modern and advanced regulatory framework for the UAE insurance sector and more professionalism in the assessment and management of risk locally. However, they will also create additional costs due to the complexity of monitoring, managing and reporting which could place pressure on smaller companies in the UAE.
The new reporting requirements will act as an "early warning" system for the Authority, as well as improving the ability of individual firms to cope in a financial crisis by requiring a more forward looking approach in their operations. The criteria for assessing risk and evaluating solvency necessitate consideration of underwriting risk, market and liquidity risk, credit risk, and operational risk, as well as prescribing in detail the use of stress and scenario testing in calculating the capital requirement.
Although there is a phased implementation timetable for the implementation of the Financial Regulations, Insurers would be well advised to start work on ensuring compliance now. The governance and reporting requirements will require investment in the systems and controls of the insurer. Indeed, whilst the solvency requirements may not come into force until 2018, insurers are already required to start using the solvency template. Similarly, insurers who may require exemptions from the investment restrictions would be advised to enter discussions with the Authority at the earliest opportunity.
Table One: What's in each section – Quick Guide
Section One - Basis of Investing the Rights of the Policyholders
This Section addresses the requirements for the investments of insurers. It includes detailed asset allocation limits specifying the limits for investments in defined asset classes and concentration limits for exposures to a single counterparty. It provides for the mark-to-market valuation methodology to be used in respect of assets and provides details where a mark-to-model methodology may be used.
Section One also includes governance requirements for the establishment of an Investment Committee to oversee the establishment and implementation of investment risk management systems and controls. It also includes specific requirements in relation to the outsourcing of investment management activities to third party entities in the UAE.
Section Two - The Solvency Margin and Minimum Guarantee Fund
Section Two sets out the solvency requirements for insurers in the UAE. It utilises three different models for determining the solvency of insurers:
- the Minimum Capital Requirement (MCR) which remains unchanged at AED100 million for insurers and AED250 million for reinsurers;
- the Minimum Guarantee Fund (MGF) being: (i) not less than one third of the Solvency Capital Requirement; and (ii) the higher of a minimum amount to be specified by the Authority for each type of business and a specified percentage of the net earned premium for each type of business); and
- the Solvency Capital Requirement (SCR) being a risk-based capital calculation that utilises the solvency template published by the Authority.
Section Two specifies the assets (using a definition of "Own Funds") which can be used to satisfy the solvency requirement. Details of the SCR are required to be reported quarterly to the Authority and the completed solvency template must be submitted on an annual basis.
Unsurprisingly, given the introduction of a risk-based capital model, there are also details in Section Two for the risk management system which insurers must implement in to order identify and manage the risks inherent in their businesses.
Section Three - The Basis of Calculating the Technical Provisions
As the name suggests, Section Three includes detailed provisions as to the technical provisions that must be established by the insurers and the manner of their calculation. Section Three also include details of the Actuary's role in relation to the technical provisions and the requirement to report to the Authority on an annual and quarterly basis on the details of the technical provisions.
In the addendum there are further details as to the calculations to be used for IBNR and the Mathematical Reserve. In addition, addendum three sets out a template of the actuarial report to be provided to the Authority.
Section Four - Determining the Company's Assets that meet the accrued insurance liabilities
Section Four is the shortest section of the Financial Regulations. It sets out the application of the "prudent person" principle for investment activities and includes specific requirements in respect of assets to be held for the purposes of life insurance contracts where investment risk is borne by the policyholder. The addendum to this Section addresses the valuation of assets for the purposes of the solvency margin, including specific rules for: investments in non-insurance subsidiaries and associates, real estate, debt / government securities, equity shares, traded derivatives, loans secured by insurance policies and other assets.
Section Five - The Records which the Company shall be obligated to Organize and Maintain as well as the Data and Documents that shall be made Available to the Authority
This Section sets out the record keeping requirements for insurers. It includes details as to the type and format of records which must be maintained. It formally recognises that electronic copy documents may be maintained. The Section also establishes a minimum retention period of 10 years for records and specifies broad powers of inspection for the Authority. It should also be noted that there are separate requirements for insurance agents contained within this Section.
Section Six - The Principles of Organizing Accounting Books and Records of Each of the Companies, Agents, and Brokers and determining Data to be maintained in these Books and Records
Section Six sets out the requirements for the accounting books and records of insurers and insurance agents, including obligations to maintain backup records at a separate location. It also sets out the powers of the Authority to inspect the accounting books and records.
This Section also includes details of the requirements for the Audit Committee Internal Audit Department, External Auditor and Compliance Officer.
Section Seven - The accounting policies to be adopted and the necessary forms needed to prepare reports and financial statements and presentations
Section Seven requires the preparation of financial statements in accordance with International Financial Reporting Standards and using the accounting policies and forms set out in the appendices. Financial statements must be submitted in the format provided on an annual basis in Arabic and English and quarterly in, at least, Arabic.