Prudential Standard FSI 1 (Framework for Financial Soundness of Insurers)

Question 1

Roles and responsibilities of the board of directors

Answer 1

To ensure that:

• the regulatory minimum financial soundness requirements are met at all times.
• the insurer maintains an appropriate level and quality of Own Funds commensurate with the type, amount and concentration of risks to which the insurer is exposed.
• approvals are obtained from the Prudential Authority where required.

To have in place procedures to:

• monitor the financial soundness of an insurer,
• identify deterioration in its actual or expected capital resources / business conditions.

To seek and receive the Prudential Authority’s approval before effecting any capital reduction (other than through normal dividend payments).

Question 2

Role and responsibilities of the Head of Actuarial Control

Answer 2

To provide assurance to the board of directors regarding the

• accuracy of the calculations, and
• appropriateness of the assumptions

underlying:

• the valuation of the insurer’s technical provisions, and
• calculation of the insurer’s capital requirements.

Question 3

Role and responsibility of an insurer’s auditor

Answer 3

To audit the financial soundness of an insurer in accordance with its legal and regulatory obligations.

The insurer must report to:
- the board of directors
- the Prudential Authority
any matters identified during the performance of its responsibilities that may cause the insurer to not be financially sound.

Question 4

7 Principles underlying the Framework for Financial Soundness of Insurers

Answer 4

Insurers must hold Own Funds of sufficient quality and quantity to absorb unforeseen losses arising from the risks associated with an insurer’s activities.

The risk tolerance of the Prudential Authority that informs the regulatory minimum financial soundness requirements should be defined in terms of insurers being able to maintain regulatory solvency in the face of a range of adverse scenarios.

The regulatory approach to determining Eligible Own Funds and measuring the required level of capital for financial soundness should be risk-based and forward-looking.

In determining Eligible Own Funds, both assets and liabilities must be valued on a basis consistent with market-based methodologies, unless otherwise specified.

The level of capital required for regulatory purposes should address the risk areas to which insurers are exposed and should be proportionate to the nature scale and complexity of the business involved.

The level of capital required for regulatory purposes should take reasonable account of correlations between risks, including the benefits of diversification.

The financial soundness framework should trigger levels of Eligible Own Funds relative to required capital, below which regulatory intervention will occur.

Question 5

The risk tolerance of the Prudential Authority that informs the regulatory minimum financial soundness requirements should be defined in terms of …

Answer 5

insurers being able to maintain regulatory solvency in the face of a range of adverse scenarios.

Question 6

7 Principles underlying the Framework for Financial Soundness of Insurers:

Principle 1: Insurer’s Own Funds

Answer 6

Insurers must hold Own Funds of sufficient

• quality and
• quantity

to absorb unforeseen losses
arising from the risks associated with an insurer’s activities.

Question 7

The regulatory approach to determining Eligible Own Funds and measuring the required level of capital for financial soundness should be (2)

Answer 7

risk-based

forward-looking

Question 8

On what basis should assets and liabilities be valued on in determining Eligible Own Funds?

Answer 8

a basis consistent with market-based methodologies, unless otherwise specified.

Question 9

The level of capital required for regulatory purposes should: (3)

Answer 9

• address the risk areas to which insurers are exposed
• be proportionate to the:
  — nature
  — scale and
  — complexity
  of the business involved.
• take reasonable account of correlations between risks, including the benefits of diversification.

Question 10

The concept of capital required by an insurer for financial soundness purposes is applied at 2 levels:

Answer 10

• The prescribed Minimum Capital Requirement (MCR)

- The prescribed Solvency Capital Requirement (SCR)

Question 11

The prescribed Minimum Capital Requirement (MCR)

Answer 11

The absolute minimum level of Eligible Own Funds that the Prudential Authority considers necessary to protect policyholders.

Question 12

The prescribed Solvency Capital Requirement (SCR)

Answer 12

The level of Eligible Own Funds required to ensure that:

the value of assets will exceed technical provisions and other liabilities
at a 99.5% level of certainty
over a one-year time horizon.

Question 13

Broad calculation of the MCR

Answer 13

Based on:
taking a LINEAR SUM of
basic volume measures (e.g. written premiums, technical provisions, capital-at-risk and operating expenses)

calibrated to
a confidence level of 85%
over a one-year time horizon.

Question 14

The MCR floor and cap

Answer 14

MCR is subject to:

• a floor of 25% of SCR
• a cap of 45% of SCR.

The MCR must also be no less than:

• R15 million for life and non-life INSURERS,
• R30 million for REINSURERS with both life and non-life insurance obligations.

Question 15

Reporting Liquidity Risk

Answer 15

DOES NOT form part of SCR.

Requirements of management of liquidity is set out in PILLAR 2, under the Own Risk and Solvency Assessment (ORSA) process.

Question 16

4 Options to calculating the SCR

Answer 16

• Full Internal Model
• Standardised Formula combined with partial Internal Model
• Standardised Formula with insurer-specific parameters
• Standardised Formula

Question 17

Application of simplified calculations within the Standardised Formula

Answer 17

Insurers are permitted to use simplified calculations in some situations.

Simplifications must be proportionate to the nature, scale and complexity of the risks involved.

An insurer does not require approval from the Prudential Authority before applying a simplification,
HOWEVER, the insurer should JUSTIFY the use of a simplification.

The Prudential Authority may disallow the use of a simplification if it is not satisfied that the justification is valid / sufficient.

Question 18

Frequency of reporting for MCR and SCR

Answer 18

Insurers are required to monitor and assess their financial soundness on an ongoing basis.

Insurers must also calculate and report their MCR and SCR:

• At least on an annual basis.
• Or when their risk profile changes materially since the time of the last MCR or SCR calculation.
• Or when otherwise requested to do so by the Prudential Authority.

Question 19

How is the financial soundness of insurers measured?

Answer 19

By the excess of Eligible Own Funds over the SCR.

Question 20

SCR cover ratio

Answer 20

The ratio of Eligible Own Funds to SCR.

Question 21

Possible regulatory intervention at the breach of SCR

Answer 21

If the Prudential Authority is satisfied that an insurer has failed, or may in the following three months, fail to meet the prescribed SCR, it may exercise its powers to:

direct the insurer to rectify the actual / potential breach.

Question 22

Possible regulatory intervention at the breach of MCR

Answer 22

Strongest regulatory intervention.

If the Prudential Authority is satisfied that an insurer has failed, or may in the following three months, fail to meet the prescribed MCR it may exercise its power to:

• direct the insurer to rectify the actual breach / potential breach.
• suspend or withdraw the insurer’s licence
• exercise the resolution powers set out in Chapter 9 of the Insurance Act (2016)