Saqib Jamil, FSA, CERA
Insurance Default Risk – Need for Capitalization
 Insurance is a mechanism of transferring risk from one
party to another.
 This transfer of risk exposes policyholders to another risk:
insurance company default risk.
 The risk of default can only be mitigated if the authorities
ensure that an insurer maintains sufficient capital to
address any unforeseen events.
Structure of Presentation
 From the Capital
Perspective
 Compared Solvency I and Insurance Laws in Pakistan
 Applied Results of Solvency I to companies in Pakistan
 WHAT IF Solvency II is implemented in Pakistan
Comparing
Solvency I First Directive 1973
(European Union)
&
Insurance Ordinance and Rules of
Pakistan
First Directive – 1973 (European Union)
 The first among such regulations was released in 1973 for
non-life insurance business
 The regulations issued had the following requirements
with regards to the solvency of an insurer:
 It required each insurer to maintain a solvency margin above
the technical reserves
 And it also required that each insurer maintain a guarantee
fund
First Directive – 1973 (European Union)
 The Solvency Margin is calculated as higher of:
 Minimum Solvency Fund
 Premium Factor* (18% of Premium**)
 Claim Factor* (23% of Claims Paid**)
* Deducting the outward reinsurance relating to Gross Figures provided that
the Net Figures is not less than 50% of Gross Figures
**These percentages have changed several times
Non Life Capital Requirement - Pakistan
 According to Article 36 (3) of Pakistan Insurance
Ordinance 2000 the minimum solvency requirement of
non life company is the greatest of:
 such required minimum amount as may be prescribed by the Commission;
 such percentage as may be prescribed by the Commission of its earned premium
revenue in the preceding twelve months, net of reinsurance expense subject to a
maximum deduction for reinsurance of fifty per cent of the gross figure; and
 such percentage as may be prescribed by the Commission of the sum of its
liability for unexpired risk and its liability for outstanding claims, net of
reinsurance subject to a maximum deduction for reinsurance of fifty percent in
each case.
Minimum Capital Requirement
 Insurance Rules (2002) Section 13 (a) requires insurance
companies to maintain a Minimum Fund of Fifty Million
 SRO 16(1)/2012 prescribes to increase the Solvency
Capital Requirement as follows:
On or After
Rupees
31 December 2012
One hundred million
31 December 2013
One hundred and twenty five million
31 December 2014
One hundred and fifty million
Minimum Capital Comparison
 There cannot be a one to one comparison between the
Minimum Capital Requirement of EU and Pakistan as this
being subject to several other factors.
 The Minimum Capital Requirement should be linked to
inflation, which is high particularly in Pakistan
Premium and Claim Basis
 Article 13 (3) in the Insurance Rules 2002 combined with
Article 36 (3) Insurance Ordinance 2000 have asked
companies to maintain the following:
 20% of earned premium revenue in the preceding twelve months, net of
reinsurance expense subject to a maximum deduction for reinsurance of fifty per
cent of the gross figure; and
 20% the sum of its liability for unexpired risk and its liability for outstanding
claims, net of reinsurance subject to a maximum deduction for reinsurance in
each case of fifty per cent of the gross figure.
Comparison for Premium and Claim Basis
 The premium and claims factor are some what similar,
however this has been increased by European Union
in particular where the claim variability is high for
example Miscellaneous line of business.
 For claim analysis, EU requires a 3-year claim
average which can create issues if there is variability
in claims due to any reason in a particular year.
Results of Solvency I
applied to
Companies in Pakistan
Solvency Ratio for companies in Pakistan
7
6
Number of Companies
5
4
3
2
1
B/w 1 and 1.5
b/w 1.5 and 2
b/w 2 and 3
b/w 3 and 5
Solvency Ratio
b/w 5 and 8
b/w 8 and 12
Above 12
Solvency Ratios for Companies
Amounts in `000
Asset minus liab
Required Margin
Solvency Ratio
Top 3 companies
12,996,682
3,724,574
349%
Top 10 companies
22,212,969
5,609,331
396%
Industry Average
24,491,005
6,042,911
405%
Investments of Non Life Companies
9%
15%
Cash and Bank Deposits
Equities and Bonds
Fixed Assets
76%
Break down of Captive and Non
Captive Investments
41%
Captive Investments
Non Captive Investments
59%
Solvency Ratio for companies in Pakistan
– Revised allowing for Captive
Investments above 5%
9.00
8.00
Number of Companies
7.00
6.00
5.00
4.00
3.00
2.00
1.00
B/w 1 and 1.5
b/w 1.5 and 2
b/w 2 and 3
b/w 3 and 5
Solvency Ratio
b/w 5 and 8
b/w 8 and 12
Above 12
Solvency Ratios for Companies - Revised
Amounts in `000
Asset minus liab
Required Margin
Solvency Ratio
Top 3 companies
37,736,546
3,724,574
10.13
Top 10 companies
64,525,519
5,609,331
11.50
Industry Average
67,429,305
6,042,911
11.16
Are we ready?
Solvency II – Capital Perspective
 Following the liquidity crisis, European Insurance and Occupational
Pensions Authority (EIOPA) proposed a new set of regulations which are
more popularly known as the SOLVENCY II.
 These proposals are based on the idea that it is not possible to calculate the
required solvency using a single method for each company. And so it allows
each business to set up its own model for calculating the required solvency
in the long run.
Solvency II – Capital Calculation
 The two most important features of the solvency II regulations are:
 The choice to an insurer to either follow the standard formula for
calculating solvency (provided by EIOPA) or to use (after approval from
authorities) its own internal model if it feels that the internal model
presents a better picture of the risks.
 Whichever model is used the regulations require that the capital is
maintained such that it is able to meet all its obligations with a 99.5%
probability.
Quantitative Impact Studies (QIS)
 Quantitative Impact Studies are a series of studies conducted to analyze the
impact of the new requirement aiming at raising the quality and the level of
capital base, enhancing risk capture, containing excessive leverage and
introducing the new liquidity standards. These studies are organized by
EIOPA which has been established as a consequence of the reforms to the
structure of supervision of the financial sector in the European Union.
Quantitative Impact Studies (QIS)
 QIS measures the impact of risk and allows for diversification at a
confidence level of 99.5% (that is failing to provide adequate capital only
once in 200 years). This undertaking requires an economic, marketconsistent approach to the valuation of assets and liabilities.
 Although QIS are not final numbers for Solvency II, these are taken as best
proxy by the EU committee. The full implementation of Solvency II
recognizes that eventually insurers will need to use internal models.
 As indicated above the use of any internal model needs approval from the
regulator.
Solvency Capital Requirement under QIS
Ratio of QIS provision under Solvency I
and Solvency II
Comparison of solvency ratios across
business segments (all undertakings, EU
median)
Median solvency
ratio
Solvency I
QIS
Ratio of QIS and
Solvency I
Life
200%
230%
115%
Non-Life
277%
193%
70%
Composite
267%
230%
86%
Reinsurance
366%
221%
60%
Captive
331%
167%
50%
Catastrophic Risk
 The Median Catastrophic Risk charge for EU countries as
a percentage of Premium & Reserve Risk is 80%, however
this varies to as high as 300%.
 The Catastrophic Risk charge would be particularly
important as this depends upon the reinsurance treaty,
diversification among different regions/ lines of business,
catastrophic cover etc.
 Companies should calculate their catastrophic risk charge.
Conclusion
 Most of the companies in Pakistan are highly capitalized
from the Premium and Reserve Risk Perspective.
 Regulators should review Investment Guidelines as
companies have invested heavily in Captive Business.
Conclusion
 However, catastrophic cover which varies from case to
case will change the capitalization.
 Companies should calculate Catastrophic Risk Capital to
ensure that they would be ready to cover risks at 99.5%
confidence interval.
Q&A