East Africa’s insurance industry grappling with disruptive regulations

The insurance industry globally is currently racing to comply with significant changes in the regulatory environment and accounting standards. IFRS 17 Insurance Contracts effective on January 1, 2022 is one such change. The sector, amongst the most highly regulated, is central to financial services, providing risk coverage, wealth, investment and fund management opportunities to a wide public.

In East Africa, the sector is under strict regulations on, amongst others, capital, commissions paid to intermediaries, application of the ‘cash and carry’ rules and management expenses.

RISK-BASED CAPITAL (RBC)

The Insurance (Capital Adequacy) Guidelines requires insurers to maintain a capital adequacy ratio of at least 200 per cent of the minimum capital by 2020.

Insurers are required to monitor the capital adequacy and solvency margins on a quarterly basis and file the results with the relevant authorities.

The main objective here is to safeguard the insurer’s ability to continue as a going concern and to provide stakeholders adequate returns by pricing insurance and investment contracts commensurate with the level of risk.

Non-compliance with the required capital ratios can lead to sanctions by regulators, who specify assets that are admissible in the determination of the capital. As a result, insurers need to relook the quality of their assets to meet these requirements. For instance, premium debtors are not admissible and attract a significant capital charge.

OVERRIDE COMMISSIONS

In January 2019, Kenya’s Insurance Regulatory Authority (IRA), through a circular re-cautioned insurers, brokers, medical insurance providers and insurance against the payment of commissions and/ or administrative fees above the limits prescribed by the Insurance Act. The payment of override commissions has been used by sector players to win and retain business.

However, the practice can result in, amongst other things, unfair competition and affect insurance product prices across the industry.

The regulator has indicated punitive measures against non-compliance which could include temporary or permanent withdrawal of business licences.

CASH AND CARRY RULES

The “cash and carry” principle requires that premiums should be paid upfront or at the point at which the cover is issued in order to ensure that insurer is able to settle claims appropriately. The practical expediency of the cash and carry principle continues to draw mixed reactions from the different players in the insurance industry as there are parties who still need credit to finance the policies.

Further, strict application of the rule has been hampered by the low level of insurance penetration in the region despite the growth in population. Inability to apply this rule has resulted in significant premium debtors in insurance business, hence depletion of working and regulatory capital for the insurers.

EXCESS EXPENDITURE

The Kenyan Insurance Act, 2015 states that “No insurer shall spend in any financial year as expenses of management an amount in excess of the prescribed limits, and in prescribing those limits regard shall be made to the size and age of the insurer and the provision generally made for management expenses in the premium rates of insurers”.

A recent analysis of the available industry statistics indicates that expenses of management in insurance business are far greater than the prescribed limits. Attempts by the regulator to enforce the above rule has not borne much fruit due to the high inflation rate and increased standards of living, which has a direct correlation with the level of management expenses incurred by the insurance companies.

PREPARATION OF IFRS 17 ADOPTION

The standard sets out the accounting requirements that insurers should apply in reporting information about insurance contracts they issue and reinsurance contracts they hold. It requires a more granular analysis of the components of an insurance contract and the actuarial models used in projecting future cash flows, discounting of cash flows and adjusting them for non-financial risk in assessment of insurance liability.

Adoption of the standard requires investment in robust IT systems with capabilities to handle huge volumes of data for the required outputs, finance, IT and actuarial specialists, and indeed those charged with governance, will be deeply involved.

Besides the onerous disclosures, the content and presentation of insurers’ financial statements will change significantly.

Evidently, there have been some significant shifts in insurance regulations in recent years across the insurance operations. This bears testament to the dynamic landscape in which insurers make their decisions in pursuit of growth.

Today, insurance executives running organisations that have traditionally found their strength in business models designed to stand the test of time, are finding that the challenge now lies in embedding within them, the flexibility to respond to regulatory and other operational changes.

Those charged with governance in East Africa’s insurance sector are confident that not one, but a number of strategies will be required to build resilience in these fast-paced and disruptive times.

Their focus rests on strengthening and maintaining their core, whilst putting in place operational processes that allow them to adapt nimbly to the changing environment.

Mbai is an Audit Partner with KPMG Kenya. [email protected]