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“Given the significant changes from the current environment, it is clear that insurers need to have implementation projects in place to address the significant new requirements, as SAM is less than three years away.”

A New Solvency Regime

The Financial Services Board (FSB) is in the process of developing a new solvency regime for the South African insurance industry to be in line with international regulatory standards.

The basis of the Solvency Assessment and Management regime (SAM) will be the principles of the Solvency II Directive, as adopted by the European Parliament, but adapted to South African specific circumstances where necessary. As an overarching principle, the recommendations arising from the SAM project should meet the requirements of a third country equivalence1 assessment under Solvency II. The proposed effective date for SAM is January 2014.

Reference: The underlying criteria to meet third country equivalence are that the regulatory framework is fully risk based and provide a similar level of policyholder protection as Solvency II. Equivalence is a flexible process based on principles and objectives and incorporates the principle of proportionality.

The FSB aims to promote the financial soundness of insurance companies through the effective application of international regulatory and supervisory standards. The primary purpose of the SAM regime is the protection of policyholders, with the following additional objectives:

Aligning insurers' capital requirements with their underlying risks.
Developing a risk based approach to supervision.
Providing insurers with incentives to adopt more sophisticated risk management processes.

As with Solvency II, SAM will follow principles-based regulation using a three pillar structure as follows:

Pillar I	Quantitative requirements, dealing with the valuation of assets and liabilities and the setting of capital requirements. This may be based on a standardised model prescribed by the supervisor or an insurer's own internal model if approved by the supervisor.
Pillar II	Qualitative requirements, including standards and guidance on governance, internal controls, risk management and the supervisory processes.
Pillar III	Public and supervisory reporting and disclosure requirements.

SAM project structure
The approach to the implementation of SAM is through a consultative process with the various stakeholders across the insurance industry. The SAM project governance structure is set out below. Various SAM task groups have been established to undertake technical work and make recommendations on specific issues.

Steering Committee	The highest body responsible for coordination and driving the implementation of SAM. The Steering Committee meets at least quarterly and includes nominated representatives from various industry bodies.
Quantitative Requirements Subcommittee (Pillar I)	Tasked with making recommendations on quantitative requirements including capital models, technical provisions, valuation bases and the use of internal models.
Risk Management and Governance Subcommittee (Pillar II)	Tasked with making recommendations on risk management, internal controls and corporate governance standards.
Reporting and Disclosure Subcommittee (Pillar III)	Tasked with making recommendations for supervisory and public reporting and disclosure requirements.

Policy approach
The FSB will develop initial proposals for primary and subordinate legislation through the work of the SAM task groups. Primary legislation will contain the fundamental policy of principles of legislation that are unlikely to change and provide for the basic or minimum powers to regulate a specific activity or sector. Legislative and other authority to implement and enforce the Act will be delegated to the FSB. The development of subordinate legislation is amongst the powers delegated to the FSB. The reason for delegating such authority is to allow for expert input in developing the subordinate legislation, as well as flexibility in responding to industry developments.

During the development stages of the legislation, comment will be requested from the SAM task groups, National Treasury and the general public. It is expected that the final draft of the primary legislation will be available for industry comment by the end of 2012 and public consultation in the second half of 2013, before the Bill is enacted.

The FSB will conduct an economic impact assessment of the proposed SAM regime in conjunction with National Treasury. The first phase of the economic impact assessment will consider what national objectives (e.g. transformation, access to finance, micro insurance) need to be taken into account and how the principles of proportionality 2 should be applied to these objectives. The second phase will involve a quantification of the potential impact and will be conducted following an initial survey of the potential impact of SAM (i.e. SA QIS1). It is expected that the final report of the economic impact assessment will be available by the end of 2012.

Reference: A principle of proportionality will be applied to reflect the nature, scale and complexity of the risk insurers face.

The outcome of the SAM project may require amendments to existing tax legislation in respect of short-term and long-term insurers. Tax issues will be investigated by a tax task group, which includes representatives from National Treasury, SARS, the Actuarial Society of South Africa (ASSA) and the insurance industry.

Interim measures
Currently, South African insurance regulation and supervision do not fully comply with all the requirements of the Insurance Core Principles (ICP) of the International Association of Insurance Supervisors (IAIS). To address the more important issues and requirements, the following interim measures have been introduced as part of SAM:

Pillar I Quantitative requirements for short-term insurers	Aspects of technical provisioning as well as capital requirements for short-term insurers are currently determined on a factor-based approach. Consideration will be given to interim measures that revise the approach in calculating provisions (such as incurred but not reported (IBNR) claims) and capital requirements to a more risk-based approach, using the elements previously undertaken as part of the Financial Condition Reporting (FCR) project. The final quantitative requirements are expected to be issued by September 2011 for implementation in 2012.
Pillar II Qualitative requirements for long-term and short-term insurers	Currently, there are limited statutory requirements around governance, internal controls and risk management for both long-term and short-term insurers. Interim requirements will be developed in the areas of governance, internal controls, risk management and stress testing, which are expected to be issued for consultation in 2011 and implementation in 2012.
Pillar III Statutory reporting for long-term and short-term insurers	Certain interim amendments have been made to the insurance regulatory returns to obtain appropriate information for a more risk-based approach to supervision and reporting, e.g. changes in the type of business disclosures (for life insurers), credit and concentration risk disclosures. Amendments to the long-term and short-term insurance regulatory returns have been issued effective for 2011.
Insurance group regulation	SAM will encompass supervision at both the solo entity and insurance group level. This will necessitate interim legislation for group supervision, which currently does not exist. This legislation will define an insurance group and the scope of insurance group supervision. Legislation for group supervision is expected to be effective in 2012.

Audit requirements
Currently, there are requirements for external auditors to provide assurance over certain sections of the long-term and short-term regulatory returns. Although the final audit requirements under Solvency II are still to be finalised, it is expected that the requirements will be more extensive than the current requirements. For example, audit assurance may be required for each per class of business, whereas currently, assurance is only required for the total for all classes of business.

In South Africa, the audit requirements for SAM will have to be agreed upon by the FSB, the auditing profession and the Independent Regulatory Board for Auditors (IRBA), once the primary and subordinate legislation are finalised.

Implications for the industry
The development of the SAM recommendations and changes towards a risk-based regulatory regime will require significant resources and time from the industry. Insurers will have to develop systems to assess capital adequacy, implement appropriate governance structures including risk management, and address reporting and disclosure requirements.

Insurers will be able to calculate the capital requirements by using their own internal model as an alternative for the standard model. This is however subject to FSB approval, which includes a detailed pre-application process. The FSB issued an Internal Model Approval Process (IMAP) Guide in April 2011, to provide guidance on the approval process.

Given the significant changes from the current environment, it is clear that insurers need to have implementation projects in place to address the significant new requirements, as SAM is less than three years away.

Reference: FSB SAM Roadmap (version 1). asa

Francois Kruger CA(SA) is the Insurance Technical Partner at PricewaterhouseCoopers, Southern Africa and a Chairperson of the SAM Reporting Task Group.

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