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Insurance Authority Prudential Regulations

The recently issued Insurance Authority Prudential Regulations, 25 and 26 of 2014 (collectively the"Regulations"), have been a long awaited and much discussed development in the basic methodology underlying the manner in which the financial affairs of insurers in the UAE are regulated. The new requirements represent a sea change on a going forward basis, and impose a fiscal regime not unlike the soon to be implemented European system known as Solvency II. All UAE insurers are now required to adjust their financial models, record keeping, and investment portfolios to ensure compliance with the new Regulations, and as such will now be held to internationally accepted fiscal and accounting standards.

At their core, the Regulations - actually two separate Regulations applying to traditional insurers and Takaful insurers respectively - can be divided into three primary areas of concern, each with its own sub-categories. These three primary areas are Capital Adequacy (CA), Policyholder fund (PF) requirements, and Data Keeping (DK). From a strategic viewpoint, the focus of these rules collectively represents a move towards establishing a risk based approach, wherein insurers are required to maintain certain levels of capital in specified, diversified investment categories, as well as maintaining accurate and consistent data keeping and reporting protocols. This regime is expected to markedly improve the overall capital condition of the UAE insurance market and it component insurers, and is intended to both mitigate the negative effects of market turmoil upon insurers' ability to meet their obligations as well as providing the insurers and the regulator earlier warning should such disruptions potentially represent an unwarranted level of risk.

The provisions dealing with Capital Adequacy contain three modules: Solvency, Asset Liability Management (ALM), and Technical Provisions.

The Solvency Requirements essentially include provisions related to the Solvency Margin, Minimum Capital Requirements, Minimum Guarantee Fund, Solvency Capital Requirements, and assessment of Solvency in key risk areas. All insurers are required to immediately advise the IA if they fail to meet requirements in these metrics. As stated by the IA, in announcing the implementation of these Regulations, "Solvency Capital Requirements shall be calibrated to make sure that the company observes all measurable potential risks, provided that this includes that current business and new business that the company is expected to practice within the next twelve (12) months. Solvency must correspond to the value vulnerable to risks in basic own funds of the company at a confidence rate of (99.5%) over one year."

The ALM requirements provide guidelines on how insurers may allocate their investments. Specific limitations on various classes of aggregate investments are set out. These broadly include the following: 30% in real estate, 30% in equities of UAE companies, 20% in equities in non-UAE companies, 100% in UAE government instruments, 80% in highly rated foreign government instruments, 30% in various classes of secured loans, 1% in derivatives or complex financial instruments, and 10% in other investments. Additionally, there are sub-limits set forth which constrict the amount that may be invested with any one particular sub-class within each investment class. Notably, the regulations require a minimum of 5% be invested in cash deposits with a UAE bank.

Furthermore, there are regulatory exceptions that account for variance in material factors that will impact the calculations of the investment percentages. For example, real estate valuation must now be stated as market value, not book value, of the relevant property, potentially resulting in an allocation imbalance where prior to, there would have been none. For this reason, application may be made to the IA for some variance in the proscribed percentage limitations.

A regulatory challenge is posed by requirements that non UAE sovereign investments be made in instruments with ratings equal to that of the corresponding UAE based instrument; however there is no guidance as to how different ratings of the individual Emirates' instruments may affect this provision.

Assets must also be valued using "mark to market" principles whenever possible. When "mark to model" rules are used due to the inability to utilize a mark to market rationale, such must be based on independently tested, evaluated, and actuarially certified criteria. Real estate valuations must be conducted by independent accredited firms, with two or more separate appraisals conducted for assets with a value of 30 million AED or greater.

All insurers are required to establish detailed investment strategies conforming to a view fulfilling of insurance and capital adequacy obligations, as are impacted by key risks, including market, credit, and liquidity risks. Each insurer's Board of Directors is charged with establishing, implementing, and monitoring their company investment strategies and regulatory systems. Additionally, every insurer is now required to conduct a stress test as to all of its investments on an annual basis.

The Technical Provisions include modern actuarial reserving principles that are designed to mitigate volatility such as URP (unexpired risk provision) and IBNER (incurred but not enough reported, that being a subset of the more general IBNR). For those unfamiliar with these terms, they each essentially deal with the unknown level of risk inherent in the existence of insurable losses that will ultimately be payable by the insurer, but have yet to be fully identified or accurately reserved, due to their not having been reported or having not yet occurred (but will in all probability occur in the future during an in force policy period). This will be of most relevance to high frequency classes of insurance cover, such as health care and motor vehicle. Enhanced URP reporting requirements could address the pricing/risk shortfall, which is of significant concern in the UAE, especially in the property cover market.

Actuarial oversight is given high priority, with actuarial certification of the adequacy of the mathematical reserving practices required at least annually. The metrics to be identified in these reports are set forth with a high degree of specificity. Claims handling is also referenced, to the extent that such must reflect the development and changing exposure that might result at different points in each claims' pendency.

The Policyholder fund requirements pose a significant challenge to life insurance issuers, particularly those offering Unit Linked and Variable Universal Life (VUL) products. Substantial, if not wholesale reformation, of many insurers' current business models are now required to ensure compliance. Another concern is the prevalent UAE practice whereby some companies utilize outsourced fund management services rather than handle these functions on an in-house basis. This poses both a challenge and an opportunity; while the insurer is able to pass the regulatory challenges to the outsource provider and can select a different provider should the first choice not prove viable, ultimately the regulatory risk is borne by the insurer who loses oversight over whether the entity to whom the task is outsourced is truly in compliance. Thus, diligence is required on the part of the outsourcing insurer, not only to ensure that the outsource-entity is prudently managing the policyholders funds but that they are in compliance with all regulatory requirements.Furthermore, insurers now need to take great care to verify that their compliance with the regulatory framework remains consistent with the underlying terms and conditions of the life contracts that they have marketed and sold to their customers.

The Data Keeping provisions consists of three sub modules: regulatory data, financial statement data, and accounting data. These provisions require that standardized accounting and data recording procedures be maintained, appointment of internal and external auditors and a compliance officer, and both quarterly and annual reporting to the IA. These requirements set forth an exhaustive list of what must be maintained with respect to each insurer's underwriting, claims, investment, accounting, risk management, and executive functions. Records must be maintained for a period of ten years beyond the last transaction with regard to that claim or policy. A detailed template for financial reporting requirements is also provided.

The Regulations are structured with Addendums following each Section. These Addendums must be carefully reviewed by anyone seeking to understand or comply with these Regulations as much of the detail is found in the Addendums. Note that the Regulations also require Insurance Agents to maintain various records, but those provisions are far less detailed than those relating to Insurers.

We expect that the small and medium sized companies that do not have the requisite international experience in compliance with such risk based regulatory schemes will face a greater challenge to adapt. However the inclusion of a one to three year phase in period to comply with the requirements will enable insurers some leeway in which to effectuate the necessary changes. Despite this, insurers should not be lulled into a false sense of complacency; the IA has the authority to question companies as to how they intend to comply at any point going forward.

One other observation regarding the new Regulations is that, while they bring the UAE insurance financial requirements more in line with international standards, the improvement of corporate governance is an additional area wherein enhanced regulatory intervention might be needed to elevate local practices towards those prevalent in fully developed markets.

To download the article by Thomson ReutersWest Law Gulf CLICK HERE

To download the articleby LexisNexis CLICK HERE
Published: March2015
Publication: Thomson Reuters West Law Gulf, LexisNexis
Title: Insurance Authority Prudential Regulations
Practice: Insurance & Reinsurance
Authors: Barry Greenberg, Raghad Hammad
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