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Thursday March 22, 2012

Better RBC framework for insurance sector


FOR the insurance industry, a number of planned enhancements to the Risk-Based Capital Framework (RBC framework) were completed in 2011.

This included the necessary changes to converge the valuation rules for financial instruments under the RBC framework with the Financial Reporting Standards 139.

Following the adoption of the FTSE Bursa Malaysia KLCI as the main index for the equity market in July 2009, the calibration of market risk charges for indexed investments was also reviewed to ensure that the treatment for the new index reflects the relative volatility of the constituent stocks..

However, these changes had minimal impact on the capital adequacy positions of insurers. Work on more fundamental enhancements to the RBC framework is continuing, including proposals to refine the valuation methodology for life insurance liabilities and the treatment of reinsurance arrangements.

Another important area of review is ensuring consistency between current capital buffers provided under the RBC framework and the implementation of more robust internal capital management processes for insurers.

This will also take into account ongoing developments in the Common Framework for the Supervision of Internationally Active Insurance Group (ComFrame) that are being advanced by the International Association of Insurance Supervisors (IAIS). One of ComFrame’s objectives is to foster global convergence of regulatory measures, including regulatory capital, and supervisory approaches for internationally-active insurance groups, a number of which have significant operations in Malaysia.

The IAIS has also released the revised Insurance Core Principles that further define sound practices in solvency assessments which will inform the bank’s work. Bank Negara will review the RBC framework with the objective to further improve the alignment of capital with risk and support a more consistent approach to capital standards for financial groups, and at the same time preserving a prudent level of capital that is appropriate for the operating environment in Malaysia.

In April 2011, the central bank issued a concept paper on Risk-Based Capital Framework for Takaful Operators (RBCT).

During the industry consultation, a number of issues were raised, including syariah-compatible options that could incentivise takaful operators to build strong takaful funds, the treatment of Qard as a component of capital available and the calibration of risk charges for general takaful and expense liabilities.

Following the feedback received, the RBCT proposals are being refined to take into account the objectives of prudential and syariah principles. At the same time, the trigger point for shareholders’ provision of Qard to restore deficits in the takaful fund was clarified through the issuance of the revised Guidelines on Takaful Operational Framework in September 2011.

This guidelines help ensure that standardised practices are adopted by takaful and retakaful operators in addressing deficits in takaful and retakaful funds in a timely manner.

In the insurance industry, all insurers must set and observe on a continuing basis individual target capital levels that are determined by the insurer and agreed with the bank. Progress has similarly been observed in the capital management processes of insurers.

This progress was uneven among insurers, leading the bank to require a few insurers to undertake corrective measures, including improving systems to capture risk and adopting prudent earnings retention policies to shore up capital reserves. This was followed by the issuance of the concept paper on Guidelines on ICAAP for Insurers in September 2011 on the expectations on insurers for sound capital and risk management.

In February 2012, the bank released an updated concept paper on sound risk governance practices, incorporating industry feedback on the earlier paper, developments in international standards and leading practices in risk governance, and supervisory observations on existing domestic practices.

Key areas of emphasis in the concept paper issued by the bank are on: (i) the role of the board in setting and controlling an institution’s risk strategy and risk appetite; (ii) promoting a sound understanding of the institution’s group structures to ensure that exposures arising from interactions with other group entities are clearly understood and managed; (iii) incentive and remuneration systems that are aligned with a sound risk culture; (iv) clear mandates, independence and appropriate stature of the chief risk officer and the risk management function; and (v) effective and rigorous oversight of internal risk assessments and models, including processes that adequately challenge the integrity, limitations and reasonableness of any judgments applied.

The bank expects to finalise the standards for adoption in the second half of 2012.

Bank Negara continued to observe sustained improvements in the corporate governance practices of banking institutions and insurers.

In particular, the boards of directors are playing a more active role in setting and overseeing the effective implementation of risk policies, business strategy and capital management.

There has also been an increase in the number of independent directors represented on the boards, with greater attention by the nominating committees to improve the mix of relevant competencies and experience of boards.

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