Standard and Poor’s View of the New UAE Insurance Regulations

Kevin WillisDirectorInsurance ratings

08 June 2015

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• Impact of new insurance laws

• Relevance to S&P ratings

• Q&A

Agenda:

The Emirates Insurance Authority has published a new Insurance Law and we see the required steps of:

1. standardised solvency capital calculations;

2. a structured investment portfolio;

3. compulsory independent actuarial review of all solvency calculations and technical reserves;

4. introduction of a risk management function;

5. a structured investment portfolio;

6. implementation of additional reporting requirements;

as all positive for the credit characteristics of the market, and particularly for policyholders. The major caveat that needs identifying in our opinion is the discipline of its adoption by the market and the discipline of the supervisory process.

UAE Insurance Law

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Standard & Poor’s Rating Scales and Meaning

Source : Standard & Poor’s Guide to Credit Rating Essentials

Investment Grade

SpeculativeGrade

AAA Extremely strong capacity to meet financial commitments. Highest rating

AA Very strong capacity to meet financial commitments

A Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances

BBB Adequate capacity to meet financial commitments, but more subject to adverse economic conditions

BBB- Considered lowest investment grade by market participants

BB+ Considered highest speculative grade by market participants

BB Less vulnerable in the near term, but faces major ongoing uncertainties to adverse business, financial and economic conditions

B More vulnerable to adverse business, financial and economic conditions, but currently has the capacity to meet financial commitments

CCC Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments

CC Currently highly vulnerable

C A bankruptcy petition has been filed or similar action taken, but payments of financial commitments are continued

RAn obligor rated 'R' is under regulatory supervision owing to its financial condition. During the pendency of the regulatory supervision the regulators may have the power to favor one class of obligations over others or pay some obligations and not others

The following table shows a general summary of the opinions reflected by Standard & Poor’s ratings

For complete definitions of Standard & Poor’s ratings, and its criteria, please refer to www.understandingratings.com

Refer to our article:

“What May Cause Insurance Companies To Fail--How This

Influences Our Criteria” (published 13 June 2013)

Insurance Defaults Are More Commonly Triggered By Regulatory Responses Than Debt Default

“We observe that…insurance company failure most often becomes apparent when the regulator takes action because the insurer's financial position has become untenable.

The timeliness element of obligations in insurance policies is typically much less clearly specified than for debt obligations. Also, insurers tend to have low debt burdens, but high policy obligations. So, nonpayment of a debt obligation generally isn't what prompts a default.”

Standard & Poor’s Insurer Financial Strength Ratings

Refer to our article:

“Insurers: Rating Methodology” (published 7 May 2013)

Business Risk Profile includes our Insurance Industry Country Risk Assessment (IICRA)

• Economic risk• Political risk• Financial system risk• Payment culture and the rule of law• Return on equity• Product risk• Barriers to entry• Market growth prospects• Institutional framework

Standard & Poor’s Insurer Financial Strength Ratings

IICRA: Insurance Industry Country Risk Assessment

• Institutional framework

“The regulatory framework addresses how sophisticated and effective the authorization and ongoing supervision requirements of insurers are in the relevant industry-country, including group- and entity-based solvency requirements, as well as incentives for good risk management and onus on management to assess the insurer's own risk. Regulatory track record assesses the depth and frequency of monitoring of insurers and the regulator's track record of intervening to reduce or mitigate the effects of insurer failures.

…We assess transparency by evaluating the frequency & timeliness of reporting, the quality & standardization of financial reports. We examine the quality of accounting and disclosure standards (adoption of IFRS/U.S. GAAP/public regulatory returns. The assessment is also informed by the extent and effectiveness of a country's auditing requirements.”

Standard & Poor’s Insurer Financial Strength Ratings

S&P Ratings Methodology

Deriving the Financial Risk Profile

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Insurance and Reinsurance minimum paid up capital unchanged to AED 100 m and AED 250 m respectively

• Introduction of minimum guarantee fund and minimum solvency capital requirement

• New regulatory capital requirements to be calculated on a 99.5% VaR confidence level over one-year

• Breaches of guarantee fund or solvency capital to be reported to Insurance Authority along with recovery plan

• Own funds to be restored within six months of breach• Breaches of minimum guarantee fund will have to be rectified within

three months of recognition

S&P views proposed timelines on restoring required capital levels as in line with other risk-based regulations, such as Solvency II in Europe

Minimum and solvency capital requirements

Calculation of Capital Adequacy

UAE Insurance Law• 99.5% VaR over a one year period• Firms are required to complete a solvency template

Standard & Poor’s capital adequacy criteria state as follows:“we seek to capture the present value of expected economic losses (change in shareholder equity/policyholder surplus) experienced over a year, to a degree of certainty that is commensurate with the rating. The confidence levels establishing the degree of certainty for each individual risk are:

• Confidence levels over a one year period:

(Generated based on five-year default data)

Rating Confidence VaR levelAAA 99.9%AA 99.7%A 99.4%

BBB 97.2%

• Significant increase in regulatory capital for some insurers

• No direct impact on S&P capital adequacy modelling

• Possible indirect impact as a consequence of actions to address regulatory capital position:• capital increases;• risk transfer and mitigation;• change in asset allocation

Capitalization – Regulatory Capital Requirements

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New regulation sets out asset distribution & allocation limits.

Board & regulators are to set risk appetite and credit quality limits respectively.

All investment should be aligned with risk appetite and credit quality limits.

Standard and Poor’s thinks this as a move in the right direction:• But sees upper limits as high against international standards • Welcomes the push towards more attention to credit quality • Thinks secure investment emphasis will lead to improved credit

quality portfolios

But:• UAE traded markets are still underdeveloped• Prices and yields will be more volatile on large movements of funds• Grace period of two years for equity and three years for real estate

is given to insurers

Investment portfolio limits

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Regulations Market 31Dec14

Equity type holdings 50% 38%Real estate 30% 22%Government securities (UAE) 100% naGovernment securities A-rated 80% na------Counterparty limitsEquity 10%Real estate noneGovernment securities 25%

Summary of new regulations for investments

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Investment leverage (volatile assets*/total adjusted capital) Positive<10%Neutral 10-100%Negative >100%

DiversificationPositive<15% by sector; <5% by obligorNeutral 15-30% by sector; 5-10% by obligorNegative >30% by sector; >10% by obligor

*Volatile assets are any unrated obligor, or obligor rated BB+ or lower

Siummary of S&P Investment Risk Criteria measures

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• Under the new law authority credited actuary’s need to review and approve insurer’s technical reserves

• Audited financial statements to include reviewed technical reserves

• Underwriting prudence and robust technical risk pricing to result from actuarial approvals

• Standard and Poor’s recognises that this is no guarantee against companies suffering underwriting deficits.

Compulsory independent actuarial review of all technical reserves

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• Risk based regulation leads to documentation of risk management framework and strategies

• Standard & Poor’s views stand-alone risk management divisional function as norm in more mature markets but not requisite for smaller local insurers

• Standard & Poor's thinks that insurers manage risk types better through focused risk management function

• S&P Insurers Rating Methodology states “ERM examines whether risk management practices are executed in a systematic, consistent, and strategic manner that provides for the control of losses within an optimal risk-reward framework. ERM analysis allows for a prospective view of the insurer's risk profile and capital needs”

Risk management function:

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• Quarterly and Annually submission of regulatory returns• Quarterly returns to be audited by actuary and submitted within 45 days

from quarter end• Annual returns to be certified by an actuary and endorsed by external

auditors and company’s chairman

• Financial Condition Report might be required on ad-hoc basis

• But: • Additional requirements for independent actuarial approvals and

extensive regulatory reporting are likely to lead to operational constraints and additional costs.

• If so, could these cost factors prompt consolidation?

Regulatory reporting requirements:

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Standard & Poor's sees 2015 as a year of change for the UAE insurance market.

The need to respond to competitively unprofitable underwriting and adapt to a much deeper supervisory framework will be positive for medium/long term policyholder security.

Summary

Thank You

Kevin WillisDirectorT: +971 4 372 7103kevin.willis@standardandpoors.com