A risk-based approach, a combination of risk-based supervision (RBS) and risk-based capital (RBC) regulation, has been identified as an imperative to enhance insurance market development in any country, including Nigeria. Thus, the need to introduce a risk-based approach (and to depart from a static and rules-based approach to define acceptable behaviour) has been on the front burner of NAICOM’s insurance market development mandate over the years without real success.
RBS is a dynamic approach to assessing the probability and severity of material risks facing an insurer. In RBS, the supervisor is equipped with tools and knowledge to examine the business of insurers through offsite monitoring and onsite inspection processes: evaluation of risk profile and adequacy of risk management systems, quality and effectiveness of corporate governance, market conduct, etc.
RBC is the measure of the minimum amount of capital an insurer must hold (enough to absorb potential losses) arising from the risk it is exposed to. RBC regulation offers only a point-in-time assessment of capital levels and is essentially a retrospective view of capital, which differs from the Solvency II approach, which, being a prospective view of capital, uses a one-year capitalization time horizon.
This opinion article highlights why a risk-based approach works better as an imperative for insurance market development than a rule-based approach.
There are two reasons to transition to a risk-based approach:
The insurance market in Nigeria has long grappled with stagnant innovation and a deficit in technical expertise, particularly evident in the absence of novel product developments and a shortage of qualified actuaries within both insurance firms and regulatory bodies. These deficiencies have impeded market growth and resilience, preventing the sector from embracing international standards and adopting progressive practices.
Additionally, the prevailing rules-based approach has fostered short-term management priorities, prioritising compliance over adaptability. This rigidity limits the industry’s ability to dynamically respond to emerging risks and evolving customer demands. Hence, there is a growing consensus for transitioning towards a risk-based approach to cultivate a more robust, efficient, and inclusive insurance market that can better meet international best practices and cater to the evolving needs of stakeholders.
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NAICOM had been planning since 2015 to move from rules-based supervision to that of RBS for insurers’ operations in 2017. This laudable plan and timeline did not materialise, despite having carried out preparative and proactive steps for the take-off of the RBS, such as the release of guidelines for the RBS with feedback mechanisms from insurance companies, enterprise risk management and a code of corporate governance, and also conducting a verification exercise of capital resources within individual insurers, etc.
If a risk-based approach is implemented, there will be no need to re-introduce the suspended Tier-Based Minimum Solvency Capital (TBMC) in the future, as it has been severely criticised for not providing a level playing field for all insurers, negating the true concept of RBC, etc.
Furthermore, it is quite unfortunate that the long-awaited review of the Insurance Act 2003, Consolidated Insurance Bill 2020, to provide the expected legal framework to back not only the implementation of a risk-based approach but also the failed recapitalisation exercises, could not be signed into law under the 9th National Assembly, similar to other recorded failed attempts to review the Act in 2008, 2016, and 2018.
The same Bill is still gasping for breath to see the light of the day in the current 10th National Assembly. Therefore, there is uncertainty about the 2024 proposed date of implementation of the risk-based approach to support the development of the insurance market.
Benefits of a risk-based approach in Insurance Market Development
A risk-based approach could advance insurance market development in the following ways:
Develops and improves the professionalism, in-house capacity, and technical skills of insurers and regulators. This allows leadership to think of risks rather than rules leading to innovation.
Aligns incentives with business actions, e.g. Management can be rewarded for decisions that better manage risks.
Encourages and rewards investment in data collection and analysis;
Can offer proportionate relief to low-risk innovations that reach underserved and unserved segments, thereby facilitating inclusive insurance (e.g., microinsurance).
Encourages insurers to manage their risks more effectively by aligning capital requirements with the level of risk they are exposed to.
Challenges of a risk-based approach to insurance market development
The challenges of a risk-based approach to advancing insurance market development are as follows:
There is likely to be apprehension among the insurance stakeholders (i.e., pushback from insurers, clients, and brokers), especially at the initial stages of the implementation of RBS, particularly in the areas of risk management and governance, data collection, and actuarial expertise.
As the RBS process is data intensive and focuses heavily on off-site surveillance, it is unlikely that insurers will be able to provide data in a seamless and automated manner to the regulator on a regular basis due to existing poor data quality and inappropriate IT systems.
Possible lack of sufficient regulatory guidance on transitional measures for the industry; inadequate training and development programmes to instil a risk-based approach or culture;
The regulator seems to be ahead of the industry’s preparedness and the availability of resources, capacity, and skills for the application of RBS.
This is a complex approach that can be difficult and expensive to implement, particularly for smaller insurers with limited resources. This could even be applicable to NAICOM if the government policy on compulsory 50 percent deduction from internally generated revenue of all government enterprises, including NAICOM, is implemented.
The introduction of a risk-based approach in the Nigerian insurance industry has been well overdue. Thus, its implementation would improve the development of the insurance market in Nigeria, leading to insurers’ ability to underwrite large volumes of business and material risks in order to be competitive globally going forward.
Dr Pius Apere (PhD/FCII); (Actuarial Scientist and Chartered Insurer): Chairman/CEO Achor Actuarial Services Limited
