FSC enhances capital adequacy framework for insurance companies
The Financial Services Commission (FSC) has updated and enhanced different capital adequacy metrics for the $517- billion insurance sector as it executes its new risk-based supervision framework.
These changes come at a time when the sector implements International Financial Reporting Standards (IFRS) 17, which came into effective on January 1 and replaced IFRS 4. This new accounting standard has significantly changed the reporting and presentation of the financial statements for insurance companies. While it does not change how the businesses fundamentally earn their money, it has resulted in a new paradigm for interpreting the financial performance of these firms.
“IFRS 17 has, among other things, changed the method for valuing insurance liabilities and will impact financial statements of the Financial Services Commission’s (“FSC”) registrants. The IFRS changes and the FSC’s approach to use the revised standard as the basis for statutory financial reporting required that the FSC update its regulatory capital adequacy framework,” the FSC informed in Jamaica Observer in an e-mail.
One such development was the transition from the Minimum Continuing Capital and Solvency Requirement (MCCSR) to the Life Insurance Capital Adequacy Test (LICAT) as the measure for life insurance companies on January 1. These metrics are meant to ensure that life insurance companies hold sufficient capital to meet their obligations to policyholders and withstand possible losses.
The MCCSR has been the standard for life insurance companies which were required to surpass a regulatory minimum of 150 per cent, while the new LICAT metric will only require companies to surpass a new target of 100 per cent. The framework for adoption in Jamaica was based on the Canadian transition which took place in 2018.
However, the two regulatory ratios are very different from the way they are calculated to the type of measurements used in each scenario. Under the MCCSR metric, it is calculated as the available capital (tier one + tier two capital) divided by the required capital for the business. The LICAT approach involves the sum of available capital, surplus allowance and eligible deposits divided by the base solvency buffer. According to a LinkedIn article by consulting actuary Clayton Zaluski, the base solvency buffer consists of several areas of risk such as market, credit, insurance and operational risks. The MCCSR was done under a factor-based approach compared to LICAT, which is driven by risk-based scenario testing.
When asked if the new capital framework would mean more capital would become available to life insurance companies, the FSC responded, “In determining the level of capital requirement for the industry, the consultants adopted a two-step approach under the QIS project. The objectives of the first step were to use the CA-LICAT as a model to design a capital regime that is appropriate for Jamaica that reflects the risks faced by insurers and maintains the industry’s capital position relative to the current PCR [prescribed capital requirement] of 150 per cent. The objective of the second step was to maintain the industry’s total capital requirements at a similar level under IFRS 17 as under IFRS 4 [the previous accounting basis].”
Scotia Jamaica Life Insurance Company Limited (SJLIC) is the first life insurance company to publicly report their capital adequacy under LICAT with the firm being at 261.90 per cent as of April 2023. In January, SJLIC was at 749.15 per cent under the MCCSR framework, which shows the significant shift that has occurred between the two metrics. SJLIC doubled their MCCSR ratio in 2022 as they received a $2.5-billion equity injection from The Bank of Nova Scotia Jamaica Limited and paid no dividends during the year.
“Looking at the capital adequacy for the life insurance business, it would have been impacted rather by the higher interest rate environment. So that would have been a driver for the injection that was made into the subsidiary. Under that new capital adequacy requirement, you’ll also notice that Scotia Jamaica Life, our life insurance company, still maintains it capital adequacy position there,” said Scotia Group Chief Financial Officer Gabrielle O’Connor last month about the changes.
Sagicor Life Jamaica Limited reported under the MCCSR framework for its first quarter report where it was at 247.5 per cent. Sagicor Life didn’t pay a dividend to Sagicor Group Jamaica Limited in 2022 but did pay $2.21 billion in management fee for shared services. There are six life insurance companies in Jamaica with Guardian Life as the most profitable having a MCCSR of 302 per cent at the end of 2022.
The FSC also amended the regulatory minimum for general insurance companies under the minimum capital test (MCT) which saw it being reduced from 250 per cent to 150 per cent over the last two years. This has been accompanied by an overhaul of the framework for calculating the MCT ratio and more flexibility in allocation of assets due to a greater risk-based regime. As a result, this has opened up insurance companies to billions of dollars in capital which can be reallocated to different asset classes.
The FSC move has been welcomed by the general insurance sector which has been hit hard by the lack of reinsurance capacity this year. Reinsurance acts as a way for general insurers to reduce their exposure to negative events by ceding some of the risk to global reinsurance companies. Due to the reduced reinsurance capacity, premiums charged among the 12 general insurance companies have gone up on vehicles, property, and other insurance offerings.
Insurance intermediaries such as brokers and agencies have also seen their regulatory capital requirements amended by the regulator. Thus, a broker will have to maintain minimum paid-up capital of $10 million and $5 million for a corporate agent, or 2.5 per cent of the annual premiums generated in the prior year.
While additional legislative amendments are being contemplated by the FSC, the industry is adjusting to the Insurance (Amendment) Regulations 2022, which includes the necessity for plain language to be incorporated in all interactions between customers and insurers. The British Caribbean Insurance Company Limited has already published the first phase of its ‘Mission Clarity’ as it seeks to rewrite policy booklets to be much simpler to understand.
The life insurance sector generated $255.60 billion in revenue for 2022 with profit before tax (PBT) coming in at $69.6 billion. Total assets were marginally up to $403.1 billion with capital standing at $152.2 billion. The return on capital was 19.9 per cent, which was just slightly below the 20 per cent benchmark set by the regulator.
The general insurance sector earned $54.70 billion in revenue for 2022 and had PBT of $3.6 billion. Total assets grew 10 per cent to $113.80 billion with capital standing at $30 billion. The return on capital was 8.6 per cent with the underwriting ratio surpassing the 100 per cent threshold at 103 per cent.