Ms Susan Dingwall and Mr Martin Schneider of Norton Rose Fulbright LLP summarise the latest regulations issued by the Insurance Authority of the UAE and highlight some salient points.
In February 2015, the Insurance Authority (IA) of the UAE announced that it had issued Decision Number (25) of 2014 (for conventional insurance companies) and Decision Number (26) of 2014 (for takaful operators), which contain a detailed set of regulations stipulating the prudential standards to be adopted by conventional insurers and takaful operators respectively.
Designed to enhance the performance of the UAE insurance market and to better protect the rights of policyholders and shareholders, these new regulations seek to bring the standards imposed with respect to the financial, investment, technical and accounting operations of conventional insurers and takaful operators into line with international best practice.
Each Decision is broken down into seven sections containing the regulations (each dealing with a separate prudential aspect), with an addendum for each section which is to be read together with the regulations and adds detail and guidance. We briefly summarise each section below and highlight some of the key points.
To avoid unnecessary repetition, where we have used the term “insurance companies” in this article we refer to both conventional insurance companies and to takaful operators.
Section 1: Investment of policyholders’/ participants’ funds
The opening section of the Decisions is designed to protect the interests of policyholders/ participants, shareholders and insurance companies by imposing controls on the investments made by insurance companies. These controls are intended to preserve liquidity, profitability, security and diversity in an insurance company’s investment portfolio while preventing investments which are incompatible with the nature of the insurance company’s business or activities, or which may undermine its financial position.
The following are a number of the most significant rules which seek to meet these objectives:
• Insurance companies must ensure that an active investment committee is in place;
• Investment and risk management policies must be put in place and reviewed on an annual basis by the board of directors;
• Regular stress testing must be carried out on all investments;
• Branches of foreign insurance companies must demonstrate to the IA that stress testing frameworks are in place at their head offices;
• Insurance companies underwriting both life and non-life classes must operate separate investment strategies for each class;
• The IA has the power to restrict or prohibit an insurance company from making certain investments;
• Asset allocation percentages, limits of exposure to a single counter-party and ratings are prescribed in the regulations;
• Total invested assets held outside of the UAE may not exceed 50% of the total invested assets or 100% of the total technical provisions for policies outside the UAE only, whichever is greater; and
• Insurance companies must submit to the IA quarterly reports and analyses of their investment portfolios (authenticated by their external auditor), as well as an annual risk analysis of the portfolio.
With respect to takaful operators, additional rules have been imposed regarding the distinct investment strategies that must be adopted to ensure compliance with the requirement to invest in Shariah-compliant assets.
Section 2: The solvency margin and minimum guarantee fund
In this section, the regulations specify the level of an insurance or reinsurance company’s minimum capital requirements, and impose a mechanism (based on the principles of the EU Solvency II Directive) for the calculation of their solvency requirements, which will enable the increased control and oversight of an insurance company’s ability to meet its obligations to policyholders/ participants. The stated key objective of the solvency model being created is to provide an early warning system to detect flaws in the companies’ financial conditions, alongside the aim of strengthening their ability to weather financial shocks.
Takaful operators are subject to a number of additional rules with respect to solvency, which recognise the segregation of funds in a Shariah-compliant insurance structure.
In the event that an insurance company is unable to maintain its compliance with the solvency requirements, it will have to immediately report to the IA and submit a realistic recovery plan to re-establish the level of funds to cover these requirements. If non-compliance continues for a set period of time, the Authority may intervene. In addition to this emergency reporting obligation, insurance companies must report regularly on their compliance with solvency requirements.
Section 3: The basis for calculating technical provisions
This section is designed to bring insurance companies in the UAE into line with internationally applied standards on the calculation of technical provisions, and to impose a standardised approach which will aid the oversight of the industry by the IA. It stipulates the preferred methodology for calculating the following:
• Unearned premium reserves;
• Unexpired risk reserves;
• Outstanding loss reserves;
• Incurred but not reported reserves;
• Allocated loss adjustment expense and unallocated loss adjustment expense reserves; and
• Mathematical reserves.
These regulations are aimed at producing a fairer presentation of financial statements and promoting sound underwriting practices.
In addition, insurance companies are required to appoint an actuary (registered by the IA), to review their technical provisions so that the assessment of technical provisions reflects their actual financial position. The regulations expressly provide that such an actuary shall be liable for the advice and technical services provided to the company which has appointed him.
Section 4: Determining the insurance company’s assets that meet the accrued insurance liabilities
The regulations set out in this section determine the way in which an insurance company should value its assets, both for the purpose of assessing its solvency and to ensure that its assets are aligned with its financial obligations to policyholders/ participants.
Section 5: The records which the insurance company is obliged to maintain and make available to the Authority
Aimed at ensuring that the IA can effectively carry out its supervisory function, this section sets out the records which insurance companies and insurance agents must maintain, their format and the period for which they should be retained.
It also empowers the IA (or a person assigned by it) to carry out on-site examinations of all accounts, records, documents and transactions relating to the insurance affairs of an insurance company. In addition, the IA may, by notice in writing, request that any employee of an insurance company provide information or appear before it to discuss any matter it specifies.
Section 6: Principles for organising insurance companies’, brokers’ and agents’ accounting books and records
Section 6 specifies the types of accounting books and records an insurance company and insurance agents should maintain, as well as imposing an obligation on insurance companies to establish an internal audit function and arrange for the independent audit of their accounts.
Similarly to Section 5, this section provides the IA with the power to carry out inspections of an insurance company’s or insurance agent’s books and accounts.
Section 7: Accounting policies to be adopted
This section provides for standardisation in the area of insurance companies’ financial statements. These are to be prepared in accordance with International Financial Reporting Standards, which will increase the level of transparency and disclosure in insurance companies’ financial affairs. The IA includes in the Decisions the forms to be used in the preparation of insurance companies’ financial statements.
With respect to takaful operators, Section 7 specifies that they shall charge fees based either on a mixed mudharaba/ wakala model or on a pure wakala model, and provides for upper thresholds on those fees to be charged to the participants’ funds. In addition, it includes rules for the allocation of surpluses and the rectification of deficits in the participants’ funds, and states that takaful operators must establish a policy for determining and distributing surpluses and deficits as between participants and shareholders which takes into account the standards published by the Accounting and Auditing Organisation of Islamic Financial Institutions (AAOIFI).
Commentary
In the UAE market – which has grown significantly in recent years, is the biggest in the Gulf and is aiming to compete with more established markets – there was an urgent need for regulation which would drive insurance companies to adopt international standards of best practice.
The Decisions add a substantial body of regulation to the existing legislative framework governing the conduct of insurance companies in the UAE. They should, if properly implemented and adopted, help bring about the standardisation and transparency that will enhance the IA’s supervisory abilities and strengthen the market generally. A well-developed regulatory framework with clear standards will also make the market more competitive.
Insurance companies have between one and three years to adopt the various standards imposed by the regulations contained in the Decisions. It will be interesting to observe how well the market adapts to this enhanced regulatory environment and which insurance companies will emerge stronger as a result of the changes being implemented.
Ms Susan Dingwall is a Partner and Mr Martin Schneider is an Associate with Norton Rose Fulbright LLP.