SRI LANKA: Implementing Risk-Based Supervision (RBS) in Insurance

The insurance sector in Sri Lanka is relatively underdeveloped compared with that in other countries, with total insurance premiums representing about 3.2 percent of the financial system at the time of project inception. Although the sector has grown strongly in recent years, it is thought that less than 10 percent of the population has any form of insurance. Moreover, the market for insurance is highly competitive. Although foreign insurance companies are free to enter the market, they have had only a modest impact. Starting in 2010 there was growth in new businesses, especially due to the introduction of new life insurance products such as investment-linked products and a range of retirement products.
Furthermore, the insurance sector’s contribution to the achievement of the targets under the “Mahinda Chintana,” the Sri Lankan national vision and strategy, is envisaged in terms of raising the level of contractual savings to close investment and saving gaps through the provision of life and non-life investment products to household and institutional savers. In this regard, the insurance industry provides a positive stimulus to economic growth and enhances the overall efficiency of the financial system by reducing transaction costs, creating liquidity, and facilitating economies of scale in investment. Starting January 1, 2011, reinsurance claims and commissions were exempted from value added tax, thus providing further stimulus to the growth of the insurance sector. The expansion of the insurance sector at the rapid rate of over 30 percent in 2011 underscored the need to strengthen the capital base of insurance companies, improve the supervisory capacity of the Insurance Board of Sri Lanka (IBSL), and transform its rules-based supervisory system to a risk-based supervisory model.
The IBSL is the insurance sector regulator and supervisor. In 2009, it took initial steps to transform its rules-based supervisory system to a risk-based supervisory system. This transformation was thought to be vital in order to accurately assess the varying risk profiles of insurers and also to be in line with international best practices and the emerging standards of the International Association of Insurance Supervisors. FIRST had previously supported this transformation by delivering TA to develop a framework for a risk-based capital (RBC) regime
In 2013, the IBSL requested FIRST TA to strengthen the supervisory function of the IBSL through the implementation of an RBS framework and to enhance the IBSL’s supervisory capacity in the areas of reinsurance, reinsurers, loss adjusters, investments, and investment-linked products. As a follow-up to the earlier FIRST-financed RBC project, this assistance aimed to develop and implement an RBC regime for the insurance sector in Sri Lanka. Along with implementing an RBC requirement, the IBSL wished to move to a risk-based supervisory approach in line with international best practices and standards.
Implementation of such a framework requires the development of RBS materials and an enhancement in the skill sets of the IBSL staff. They needed to build expertise and capacity in each of the key risk management areas (credit, including related company risks; market; liability; reinsurance; and operational risks), and to develop supervisory materials including regulations and manuals for supervising insurance companies through a risk-based approach. One of the objectives of this project was to complete the final draft of the RBC rules through a pilot.
Furthermore, the IBSL had recently been conferred an additional regulatory mandate to cover the supervision of reinsurers and loss adjusters and to review reinsurance contracts, and it needed capacity building in these areas. As well, the IBSL had recently granted permission to insurance companies to make investments outside Sri Lanka, which widened the range of investments acceptable as admissible assets and refined the definition of investments, necessitating greater technical capability in investment appraisal and monitoring by the IBSL and the issuance of amended guidelines on investment-linked products.
Final rules for the minimum RBC regime were delivered to the IBSL, which approved them in March 2014. The proposed RBC requirements underwent an extensive road test before their adoption. The test allowed insurance companies to identify and take corrective actions, develop internal risk management frameworks, and raise additional capital, if required. Furthermore, the test allowed the IBSL to amend any requirements where necessary based on the outcome of the test, and to fine-tune the final rules before approval.
The final rules now require insurance companies to manage their risks more effectively and cause these companies to put in higher-quality capital, calibrated in line with the risks they take. This will enhance the soundness and safety of insurance companies through better management and through adequate and appropriate capitalization. At the end of the project, 75 percent of registered insurance companies complied with the minimum RBC requirement.
This work resulted in a draft RBS Framework and Supervision Manual, which was submitted to the ISBL for approval. Training on the framework and the manual was also provided.
Implementation of an RBS framework by the IBSL will help it to accurately assess the varying impacts and risk profiles of insurers nd to supervise them accordingly. Applying a supervisory system that is more sensitive to the risks incurred by insurance companies enables the IBSL to protect policyholders’ interests more effectively and efficiently.
The team provided training to IBSL staff on risk evaluation and on the new chapters of the Supervision Manual, as well as on reinsurance contracts and on regulating pure reinsurers and reinsurance programs. The activity also resulted in a proposed Board Paper on the registration of pure reinsurers, along with proposed amendments to the Regulation of Insurance Industry Act, a Board Paper on RBS of reinsurance programs, and a Board Paper on registering loss adjusters, as well as proposed terms and conditions for reinsurance programs and industry guidance, and related chapters to be added to the Supervision Manual. After several reviews, the loss adjusters’ paper has been submitted to the ISBL Board for approval, and the others have been accepted by the senior management of the IBSL with a view to Board submission in the near term.
The TA helped the IBSL to produce (i) a proposed Board Paper on the supervision of insurers’ investments with proposed rule changes and a relevant addition to the Supervision Manual, and
(ii) a proposed Board Paper on the regulation of linked long-term products with a relevant addition to the Supervision Manual, as well as guidelines for supervising such products. Training was also provided to ISBL staff on investments and linked products and on the effective application of the manual. IBSL staff also benefited from TA for two risk-based on-site inspections of insurance companies.
Following the completion of this TA, with effect from the first quarter of 2014, all insurers have been required to submit two sets of financial returns (in accordance with both the rules- based and the RBC regimes). As of 2016, the RBC framework has become fully effective and replaced the previous solvency margin requirements.