Part II: Financial Regulations For Insurance Companies

Author:Mr Peter Hodgins
Profession:Clyde & Co

The UAE Insurance Authority (the Authority) published the Financial Regulations for Insurance Companies (the Financial Regulations) in December 2014. They have subsequently been supplemented with a pro-forma solvency template and e-Forms. Each of these documents is available on the Authority's website.1 In this second Article in our series on the Financial Regulations, Peter Hodgins and Liesel van den Heever consider the detailed requirements with which insurers will be required to comply.2

This Article addresses the requirements of the Financial Regulations in relation to:

The insurer's investments; The new solvency requirements for insurers; Risk management; Technical provisions; Corporate Governance; and Documentation and Reporting. The Insurer's Investments

Much of the commentary on the Financial Regulations to date has focused on the limits on asset investments. This is perhaps unsurprising given the reputation of certain Insurers for focusing on generating profit through their investments rather than the technical underwriting aspects of their business.

In relation to the investment activities of Insurers, the aim of the Financial Regulations is stated in Article 1(1) of Section One:

"The Company must ensure that the assets are diversified and adequately spread and allow the Company to respond adequately to changing economic circumstances. In particular for developments in the financial and real estate markets or major catastrophic events; the Company must assess the impact of irregular market circumstances on its assets and must diversify the assets in such a way as to reduce such impact."3

The Financial Regulations therefore introduce controls on Insurers' investment activities and set out guidance in respect of general requirements for investments and Insurers' investment policies, including: the characteristics and diversification of Insurance Companies' investments, asset distribution and allocation limits, investment related risks, the domiciling of investments, and the use of derivatives.

Controls on Investment Activities

There are a number of key controls on investment risk imposed by the Financial Regulations:

Insurers are required to submit reports in relation to their investment activities to the Authority on a quarterly and annual basis (Section 1, Article 10).

Concentration risk is addressed by the imposition of restrictions on investments with the same issuer and/or in the same asset classes (see below for details of the asset allocation limits).

Insurers are required to establish an Investment Committee (see below for details of the role of the Investment Committee).

There needs to be adequate segregation of duties in relation to the execution, recording, authorisation and reconciliation of investments (Section 1, Article 1(3)). Insurers are required to have a defined risk appetite and to establish investment and risk management policies to ensure that investment activity is carried on in accordance with the defined appetite (Section 1, Article 2(1)).4 Procedures must be in place to ensure compliance with the asset allocation limits (Section 1, Article 2(3)). The policies should also provide for, at least, annual stress testing to ensure that the investment strategy remains appropriate to the circumstances of the Insurer (Section 1, Article 2(5)). A separate investment strategy is required for entities conducting both life and non-life business (Section 1, Article 2(8)). Insurers are required to have a "Contingency Funding Plan" to address how current and future liabilities will be met in the event that it does not have sufficient assets or liquidity of assets (Section1, Article 2(9)). There are restrictions on the holding of assets outside of the UAE (see below). The outsourcing of investment activities to a third party investment manager is restricted to investment managers in the UAE and subject to the overriding principle that the Insurer remains primarily responsible for the performance of the outsourced investment manager (see below). Asset Allocation Limits

Insurers are only permitted to invest in assets for which the risk can be "properly identified, measured, monitored, managed, controlled and reported" (Section One, Addendum 1(2)). However, it is the asset allocation limits provided in Article 3 of Section One that have received the most comment in the market. This Article provides both a maximum limit on exposure to particular asset classes and also a sub-limit for single counter-party exposures as follows:

Article 3(2) of Section 1 states that the above limits applies to "Total Invested Assets" (which is defined as the sum of all assets held for investment purposes, including derivatives and other hedging instruments and cash). However, we understand that the Authority has indicated that assets in excess of the above limits will not be admissible for the purposes of calculating the solvency of an Insurer.

Article 7(A)(1)(a) of Part Two of the Regulations, provides that Insurers which exceed the maximum limits of 30% for investment in real estate have until 29 January 2018 to make adjustments to comply with the limits set. The compliance period for insurers that have exceeded the maximum limits of other types of assets is until 29 January 2017. Analysis published by A.M. Best suggest that the asset allocation limits are reflective of the average distribution of assets by insurers in the UAE. This invariably means that there are companies that will need to divest assets in order to comply with these requirements.

Valuation of Assets

The valuation requirement for investment assets is set out in Addendum 1 to Section 1.

Where possible, assets must be valued on a mark-to-market basis using the "more prudent" side of the bid/offer spread or mid-market rate (Section 1, Addendum 1(5)). Where there is a material difference between the bid/offer spread and the mid-market rate, Insurers must consider adjusting the valuation or making reserves against the credit risk (Section 1, Addendum 1(5)).

Where mark-to-market is not possible, Insurers are required to use mark-to-model valuations (Section 1, Addendum 1(6)). Such models must be independently tested from the party that developed the model, approved by the Investment Committee and independently certified by an Actuary. The senior management of the Insurer are responsible for ensuring that the Investment Committee is aware of all positions that are subject to the mark-to-model valuation, and the materiality of the uncertainty that such valuations create.

There are specific rules specifying the valuation process for real estate set out in Section 1, Addendum 1(6)).

Outsourcing of Asset Management Activities

An Insurer will only be permitted to outsource investment management to an investment manager inside the UAE, and is required to monitor...

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