## 1zafea2022008 ## Source details **Canonical URL:** [1zafea2022008](https://www.imf.org/-/media/files/publications/cr/2022/english/1zafea2022008.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1zafea2022008.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1zafea2022008.pdf.json) --- ### Overview - The South African insurance sector is described as "large, complex, internationally active, and competitive." - Insurance accounts for 18 percent of the financial sector in South Africa. - Industry business models: traditional participation-focused models, bank-led conglomerates, asset management focused groups, and technology driven new entrants. - Most large insurance groups are expanding regionally and globally. - Note prepared as part of the 2020 FSAP; mission meetings occurred from February 27 to March 16, 2020. COVID-19 impacts summarized in Box 3. ### Institutional and regulatory reforms - Twin peaks model established by the Financial Sector Regulation Act (FSRA) promulgated in August 2017. - Prudential Authority (PA) established in April (operating within the South African Reserve Bank, SARB). - Financial Sector Conduct Authority (FSCA) established as the legal successor of the Financial Services Board (FSB-SA). - PA implemented Solvency Assessment and Management Framework (SAM) for solo insurers in January 2018 and established group-wide supervision ("level 2") and designation of large insurance groups. - New Insurance Act (IA) established comprehensive governance requirements. - FSCA implemented Retail Distribution Review (RDR) 2014 reforms, including Treating Customers Fairly (TCF), and is preparing for the Conduct of Financial Institutions (CoFI) Act. - Recommendation: additional coordination between PA and FSCA. ### Market structure and key statistics - Number of insurers: 170 insurers (67 life, 70 non-life, 9 reinsurers, 23 captives and 1 others). - Market concentration: top five insurance companies account for 72 percent of the life sector and 48 percent of the non-life market. - Life insurers' asset base (end 2018): ZAR 3 trillion. - Non-life insurers' asset base (end 2018): ZAR 136 billion. - Pension funds, pension preservation funds, and retirement annuities administered by life insurers account for about 25 percent of insurance total assets. - Friendly societies (excluded from licensing): as of December 2017 there were 196 friendly societies with total assets of ZAR 908 million (about 0.03 percent of total assets of both life and non-life industry). ### Solvency, capital, valuation and asset allocation concerns - Solvency ratios at end-2020: 182 percent for life and 173 percent for non-life. - Solvency ratios partly supported by underestimation of sovereign credit risk; sovereign downgrades increased discount rates and reduced insurance liabilities. - Life insurers highly exposed to equities and equity funds: - Linked products: 16 percent equities and 24 percent equity funds. - Non-linked products: 15 percent equities and 18 percent equity funds. - Overall equity holding in non-linked portfolio: 33 percent of total assets of non-linked portfolio (Box 3). - Linked vs non-linked asset split: linked products account for 48 percent of total investment; non-linked products account for 52 percent of total investment. - High lapse and surrender rates create liquidity risk; life insurers recorded a policy lapse ratio of 126 percent in June 2020. - SAM permits inclusion of substantial future profits in Tier 1 capital; average share of future profit (Surrender Value Gap or SVG) accounts for about 70 percent of total Tier 1. - Adoption of IFRS 17 (and IFRS 9) may materially increase insurance liabilities and impact capital — possibility of a "cliff effect" on capital ratios. - Recommendation: PA should urgently conduct an impact assessment and industry-wide stress testing focused on firms with high reliance on future profit. ### Valuation methodology and discount rates - Valuation approach: economic, market-consistent valuations for assets and liabilities; best estimate plus a risk margin derived from a defined cost of capital. - Discount rate: PA sets a government bond curve as the “risk-free” rate term structure; insurers may use PA-published government bond curve unless approved to use own estimation. - International best practice typically adjusts market government bond rates for credit risk; South African yield curve is significantly higher in the longer term (especially 20 to 40 years), implying potential underestimation of long-term insurance liabilities under current practice. - Some large insurers use alternative yield curves (e.g., LIBOR, JIBOR) with PA approval. ### SAM capital framework and risk coverage - SAM implemented from July 2018; calibrated at 99.5 percent (1 in 200 years) confidence level (up from 95 percent under SVM). - SAM covers quantified risks including equity, interest rate, currency, property, concentration, liquidity premium, mortality, mobility, longevity, and catastrophe risks. - Equity capital charges: 33–49 percent depending on sub-category, adjustible by up to 10 percentage points depending on last 3 years market trend. - Credit risk capital charges: based on insurers’ own estimation of PD and LGD; standardized approach allows firms to estimate PD and LGD without supervisory approval (not aligned with international best practice). - South African sovereign bonds are exempted from a credit risk capital charge under current rules. - Collective Investment Schemes (CIS): look-through approach required where possible; fall-back is to treat CIS as “other equity” subject to about 49 percent capital charge. ### Capital resources, tiers and prudential deductions - Capital tiers: Tier 1, Tier 2, Tier 3. Total Tier 1 must exceed 50 percent of the SCR. - Average share of Tier 2 and Tier 3 capital to total capital is less than 7 percent among life insurers. - Deductions: if intangible assets recognized, 80 percent must be deducted from capital resources and 20 percent recognized as Tier 3; insurer’s own shares fully deducted; listed ordinary shares in a controlling company in excess of 5 percent of total non-linked assets must be deducted. ### Governance, ERM, ORSA and supervisory stress testing - IA requires insurers to adopt an effective governance framework proportionate to nature, scale and complexity, protecting policyholders and ensuring risk management and internal controls. - Board duties include setting and overseeing business objectives, establishing risk appetite, ensuring independence in policyholder interests, and maintaining board composition and succession planning. - Remuneration governance must support prudential decision making and be consistent with risk appetite. - ERM requirements: frameworks must identify, assess, monitor, report and mitigate material risks, and include scenario analysis and stress testing commensurate with size and complexity. - ORSA requirements: forward-looking, risk-based, typically over a longer horizon than one year, undertaken annually and proportionate to complexity. - Supervisory stress testing history: - Pre-SAM stress tests (FSB-SA) included severe economic and non-economic shocks; last pre-SAM life industry average capital adequacy ratio was 458 percent; shocks produced an 18-percentage point decline from economic scenario and 26 percentage point decline from non-economic scenario. - FSB-SA stress test suspended in June 2016 for SAM preparation. PA introduced ERM and ORSA in July 2018; PA has not yet conducted industry-wide ORSA analysis or sector-wide supervisory stress testing under SAM. - Recommendation: PA to resume supervisory stress testing under SAM, develop clear implementation plan, optimize synergies between ORSA and sector-wide tests, and devote resources to validation of ORSA stress testing. ### Group supervision, intragroup transactions and conglomerates - Most large insurers belong to financial and/or conglomerate groups with significant intragroup transactions and business linkages. - Examples among largest five life insurers: - Old Mutual is the largest by asset size and has a minority share (20 percent) of Ned Bank. - Liberty group is owned by Standard Bank. - Sanlam, MMI, and Alexander Forbes have large asset management and other financial entities within each group. - Intragroup transactions increased by 27 percent to ZAR 358 billion from Q2 2017 to Q2 2018 (voluntary reporting). - IA empowers PA to designate insurance groups and financial conglomerates; three insurance entities designated as part of an insurance group as of June 2021. - Group-level capital calculation uses deduction and aggregation method by default; intragroup transactions are deducted to avoid multiple gearing. - PA convened supervisory colleges for major groups; colleges limited to information exchange to date. - PA is home supervisor of two IAIGs and active in IAIS committees; gap analysis planned to meet IAIS ComFrame criteria. ### Winding-up, recovery planning and policyholder protection - Gaps persist in winding-up framework: policyholders rank pari passu with unsecured creditors; no policyholder protection scheme exists. - Recent liquidations resulted in significant policyholder losses (example cited: 50 percent of benefits) and delays in claim payments. - Recovery planning is at an early stage; no requirement for recovery plans for stand-alone insurers or group-wide recovery plans. - Recommendation: Medium-term imposition of recovery planning for large insurance groups, especially those relying substantially on future profit in Tier 1, to reduce failure probability and mitigate policyholder losses. - Recommendation: Expedite legislative changes to give high legal priority to protection of policyholders' rights and entitlements. ### Conduct supervision, consumer protection, fintech/insurtech and enforcement - FSCA continues TCF outcomes-based approach with six principle-based outcomes covering customer confidence, product suitability, disclosure, fair advice, product performance and no post-sale barriers. - RDR measures: cap of 50 percent on initial commissions (clawback after 2 years), prohibition for intermediaries to receive commissions for investment-linked products (they must charge disclosed fees), and different rules for risk products. - FSCA introduced conduct-of-business statutory returns; data stored in MAGIC system for supervisory access. - Enforcement powers: administrative penalties up to ZAR 100 million, suspension/withdrawal of license, debarment, enforceable undertakings, directives, curator, statutory manager, and high court proceedings. - Enforcement activity (selected figures): - Administrative penalties over ZAR 10 million in 2016 and 2017 each year. - Debarments: 2017 — 106; 2018 — 135; 2019 — 184. - Suspensions: 2017 — 621; 2018 — 581; 2019 — 691. - Withdrawals: 2017 — 254; 2018 — 8; 2019 — 26. - Complaints trends 2016–2018: - Funeral benefits and disability insurance complaints increased (poor communications, documentation, denied claims). - Non-life: auto insurance complaints almost half of cases; slight decrease in complaints from 2016 to 2018. - Digitalization and AI/ML: - Some insurers use complex customer behavioral models and are technically ready to adopt AI and ML. - Innovation hub and a regulatory sandbox planned for 2020 (managed by financial authorities and government agencies). - Recommendation: PA and FSCA to enhance dialogue via sandbox and innovation hub and prepare regulatory responses to big data, AI and ML to address risks such as financial exclusion and underestimation of reserves. ### Resources, capacity, IT systems and coordination - PA insurance prudential supervision staffing: around 50 staff. - FSCA insurance conduct supervision staffing: around 40 staff. - PA remuneration target: 85 percent of the remuneration average of the private financial sector. - Reports of experienced staff resignations from both PA and FSCA; turnover may have adversely impacted supervision quality. - IT upgrades in progress for PA and FSCA; current limitations: manual processing by FSCA staff, poor integration of new regulatory data with historical data preventing trend and peer analysis. - Coordination mechanisms: FSRA requires PA, FSCA and SARB cooperation; MoUs established; authorities agreed to an IT system for active information exchange and committed to enhanced sharing pre-launch. - Recommendation: Build additional supervisory resources with emphasis on recruiting experienced staff and skills in IT, cyber security, and advanced risk modeling; invest in IT systems to process and integrate regulatory data. ### Targeted supervisory recommendations (selected, with priority/timeframe) - Conduct targeted inspections on estimations in insurers with high reliance on future profits in their capital resources with a view to potential revisions. (PA, ¶45) — ST H - Conduct an impact study and industry wide stress test to address potential impact of IFRS 17 adoption. (PA, ¶46) — ST H - Conduct deep analysis and/or joint inspections on high lapse and surrender products. (PA and FSCA, ¶80) — ST H - Impose recovery planning to large groups which rely substantial amount of their Tier 1 on future profit from long term products. (PA, ¶68) — MT M - Expedite the changes to the legislative framework such that high legal priority is given to the protection of the rights and entitlements of policyholders. (PA, ¶69) — MT M - Build additional supervisory resources, with an emphasis on recruiting experienced staff and enhance resources with high demand skills. (PA and FSCA, ¶33) — ST H - Continuously improve IT systems focusing on material and newly emerging risks, such lapse and surrender risks, operational and cyber risks. (PA and FSCA, ¶33) — MT M - Enhance data sharing between the authorities and analyze the risks of CIS investment by insurers. (PA and FSCA, ¶47) — MT M - Ensure appropriate capital requirements by conducting thematic review on PD estimation with close cooperation with banking supervisors. (PA, ¶48) — MT M - Encourage insurers to incorporate sovereign stress scenario in their capital and liquidity stress testing within the ORSA report and develop an optimal plan to supplement individual stress testing with supervisory stress testing. (PA, ¶57 and Box 2) — ST M - Prepare for the more active use of big data, AI and ML by insurers. (PA and FSCA, ¶81) — MT M ### COVID-19 impact and regulatory measures (Box 3) - Primary impact in H1 2020: investments; profitability of life insurers fell sharply, with investment income turning negative in Q1 2020. - Capital markets recovered in H2 2020, offsetting most insurer losses. - Median SCR ratio of life sector remained over 190 percent at end-March 2020 when JSE declined by 30 percent. - Three rating agencies downgraded government bonds to non-investment grades in March 2020, increasing sovereign bond yields and discount rates, which reduced insurance liabilities and offset investment losses for long-term policies. - Life insurers recorded a policy lapse ratio of 126 percent in June 2020. - Non-life median SCR ratio remained 180 percent as of September 2020 and over 170 percent throughout 2020. - FSCA guidance: national lockdown generally not a trigger for business interruption claims absent proof of specific COVID-19 effect; some insurers provided interim relief pending legal certainty. - PA actions: heightened reporting, surveys on hard-hit subsegments (credit insurance, business interruption), intensified engagement with distressed entities, and joint communications with FSCA outlining regulatory actions and planning guidance. *Source: 1zafea2022008 - IMF country report excerpt.* ### EXECUTIVE SUMMARY __________________________________________________________________________________ 4 ### 1zafea2022008 - EXECUTIVE SUMMARY ### Overview - The South African insurance sector is "large, complex, internationally active, and competitive." - Insurance accounts for 18 percent of the financial sector in South Africa. - The industry hosts diverse business models: traditional participation focused models, bank-led conglomerates, asset management focused groups, and technology driven new entrants. - Most large insurance groups are expanding regionally and globally. - The note was prepared as part of the 2020 FSAP and draws on desk reviews and meetings from February 27 to March 16, 2020. COVID-19 impacts were analyzed and summarized in Box 3. ### Institutional and regulatory reforms - Twin peaks model established by the Financial Sector Regulation Act (FSRA) promulgated in August 2017. - Prudential Authority (PA) established in April (operating within the South African Reserve Bank, SARB). - Financial Sector Conduct Authority (FSCA) established as the legal successor of the Financial Services Board (FSB-SA). - PA implemented a new risk-sensitive Solvency Assessment and Management Framework (SAM) for solo insurers in January 2018 and established group-wide supervision ("level 2") and designation of large insurance groups. - The new Insurance Act (IA) established comprehensive governance requirements. - FSCA implemented several Retail Distribution Review (RDR) 2014 reforms, including Treating Customers Fairly (TCF), and is preparing for the Conduct of Financial Institutions (CoFI) Act. - Additional coordination between PA and FSCA is recommended. ### Market structure and key statistics - Number of insurers: 170 insurers (67 life, 70 non-life, 9 reinsurers, 23 captives and 1 others). - Market concentration: top five insurance companies account for 72 percent of the life sector and 48 percent of the non-life market. - Life insurers' asset base (end 2018): ZAR 3 trillion. - Non-life insurers' asset base (end 2018): ZAR 136 billion. - Insurance penetration is among the highest in the world, driven by life and investment focused products; pension funds, pension preservation funds, and retirement annuities are actively sold and administered by life insurers and account for about 25 percent of insurance total assets. ### Solvency, capital, and valuation concerns - Solvency ratios at end-2020: 182 percent for life and 173 percent for non-life. - Stability of solvency ratios was partially achieved by an underestimation of sovereign credit risk; recent downgrades of South African government bonds increased discount rates used in insurance liabilities valuation for solvency calculation, thereby reducing the value of insurance liabilities. - Many life insurers are highly exposed to equities and experience very high lapse and surrender rates, with attendant liquidity risks. - Inclusion of substantial future profits from existing policies into Tier 1 capital, combined with high lapse and surrender scenarios, could affect capital resources. - Adoption of IFRS 9 and IFRS 17 may impact accounting profit and capital, as sovereign credit risks would be incorporated into both assets and liabilities valuations. - Future Profit Over Capital Resources metric is highlighted as a concern for life insurers. ### Supervisory and methodological issues - SAM relies on significant numbers of internal models and firm estimations for valuation and capital requirements calculation, creating risk of manipulation without thorough supervisory monitoring. - The PA should devote additional resources to validation of material key assumptions, such as probability of default (PD) calculation. - PA is encouraged to enhance coordination between insurance and banking teams to leverage expertise. - Consolidating gains from SAM through enhanced monitoring and industry-wide stress-testing is highly recommended. - Supervisory focus recommended on firms or groups with high reliance on future profit; introducing recovery planning for insurers, especially complex firms, is recommended. ### Conduct supervision, consumer protection, and fintech/insurtech - FSCA shifting to risk-based supervision; current activities still focus on individual cases and remediation of materialized incidents. - More attention needed on forward-looking mitigation of misconduct risk, robust governance and risk management frameworks, and enhanced PA-FSCA coordination. - Recent initiatives to enhance data sharing between the two authorities are positive. - Greater coordination on deep dives (e.g., high lapse and surrender products) could address conduct and liquidity risks more effectively. - Some insurers are using complex customer behavioral models and adopting AI and ML; an innovation hub and a regulatory sandbox were planned for 2020 managed by financial authorities and government agencies. - Authorities are recommended to enhance monitoring and prepare for regulatory actions related to big data, AI, and ML. ### Resources, skills, and supervisory capacity - Supervisory resources are under pressure, with loss of skilled and senior staff in recent years. - Regulatory reforms require continuous monitoring by supervisors with specialized skills. - Expansion of resources is recommended in enforcement, supervision of IT and operational risks, and to support monitoring of foreign activities and international cooperation. - Areas for enhanced resources: cyber, group, conduct, and cross-border risks. ### Key recommendations (from Table 1: Recommendations on Insurance Regulation and Supervision) - Conduct targeted inspections on estimations in insurers with high reliance on future profits in their capital resources with a view to potential revisions. (PA, ¶45) — ST H - Conduct an impact study and industry wide stress test to address potential impact of IFRS 17 adoption. (PA, ¶46) — ST H - Conduct deep analysis and/or joint inspections on high lapse and surrender products. (PA and FSCA, ¶80) — ST H - Impose recovery planning to large groups which rely substantial amount of their Tier 1 on future profit from long term products. (PA, ¶68) — MT M - Expedite the changes to the legislative framework such that high legal priority is given to the protection of the rights and entitlements of policyholders. (PA, ¶69) — MT M - Build additional supervisory resources, with an emphasis on recruiting experienced staff and enhance resources with high demand skills. (PA and FSCA, ¶33) — ST H - Continuously improve IT systems with focusing on material and newly emerging risks, such lapse and surrender risks, operational and cyber risks. (PA and FSCA, ¶33) — MT M - Enhance data sharing between the authorities and analyze the risks of CIS investment by insurers. (PA and FSCA, ¶47) — MT M - Ensure appropriate capital requirements by conducting thematic review on PD estimation with close cooperation with banking supervisors. (PA, ¶48) — MT M - Encourage insurers to incorporate sovereign stress scenario in their capital and liquidity stress testing within the Own Risk and Solvency Assessment (ORSA) report and develop an optimal plan to supplement individual stress testing with supervisory stress testing. (PA, ¶57 and Box 2) — ST M - Prepare for the more active use of big data, AI and ML by insurers. (PA and FSCA, ¶81) — MT M *This technical note was prepared by Nobuyasu Sugimoto, Senior Financial Sector Expert in the IMF’s Monetary and Capital Markets Department.* ### 11. Most large insurers belong to financial and/or conglomerate groups, involving ### 11. Most large insurers belong to financial and/or conglomerate groups, involving considerable intragroup transactions and business linkages. ### Group structure and market linkages - Among the largest five life insurers: - Old Mutual is the largest by asset size and has minority share (20 percent) of Ned Bank (the fourth largest bank by total assets). - Liberty group (which has the fourth largest life insurance entity) is owned by Standard Bank. - Sanlam, MMI, and Alexander Forbes have large asset management and other financial entities within each group. - Most large insurers belong to financial and/or conglomerate groups, implying considerable intragroup transactions and business linkages. ### Solvency, profitability, and regulatory framework - The Solvency Capital Requirement (SCR) under the SAM framework is risk sensitive and requires market-consistent valuations for both assets and liabilities. - Despite a weak macroeconomic environment, average solvency ratios of both life and nonlife insurers remain stable and above the minimum level (100 percent) at the solo level. - Audited group-level solvency ratios were not available at the time of the mission; figures disclosed voluntarily by some large groups are at a reasonable level against the minimum requirements. - The insurance sector is described as highly profitable with good solvency coverage ratios, albeit with some recent negative pressure. ### Asset allocation of life insurers - Life insurers’ assets are split between linked and non-linked products: - Linked products account for 48 percent of the total investment. - Non-linked products account for 52 percent of the total investment. - Linked products’ benefits are linked to the performance of the underlying asset and thus protect insurers against market risks, though residual market or investment risks may remain if limited guarantees are provided. - Investment risk in non-linked products is borne by insurance companies, with traditional participation contracts allowing some profit and loss sharing between insurers and policyholders. ### Equity exposures and capital treatment - Large share of life insurers’ holdings are in equities and equity funds: - Linked products: 16 percent allocated to equities and 24 percent to equity funds. - Non-linked products: 15 percent allocated to equity and 18 percent to equity funds. - These exposures face a high capital charge under SAM and have been discouraged since SAM implementation. - The share of equities and equity funds in insurers’ asset allocation is higher than in other countries. - Industry representatives expect allocation to equities to decline in the long term due to higher cost of capital to support equity investments, but material changes are not expected in the near term. ### Lapse and surrender behavior - Life insurers are suffering from high surrender and lapse rates. - Contributing factors: - Competitive environment with low surrender penalties. - Policyholders can easily switch to newer products with better features. - Sales practices and policyholder optimism. - Policyholders’ difficulty in continuing premium payments during economic downturns. - Mis-selling of some products, with high surrender rates generally observed within the first 12 months of inception of the policy/product. ### Interest rate, ALM, and product risks - Impact of low interest rate environment: - Not as acute as in advanced economies, but some life insurers with traditional legacy policies may face challenges if current interest rate conditions persist. - South African life insurers rely heavily on investment type products (most premiums are from investment and annuity products). - Guaranteed investment products appear actively marketed and require adequate investment returns. - Managing ALM risks is difficult in a prolonged low interest environment because liabilities’ duration is much longer than asset duration in annuity or whole life products. - Continued underwriting of long-duration products amid persistent low interest rates could expose insurers to interest rate risks similar to those in advanced economies. - Variance in risk profiles: - Firms face different nominal and real interest rate risks. - Some insurers are exposed to real, rather than nominal, interest rate risk due to a large share of inflation linked products and significant recognition of future profit from long-term products. - For insurers exposed to real interest rate risk, a higher nominal and real interest rate scenario would have a large negative impact. ### Reliance on future profits and accounting transitions - Recognition of future profits: - SAM allows insurers to recognize expected profit in future profits as part of Tier 1 own funds, subject to conditions and disclosure. - The average share of future profit (described as Surrender Value Gap or SVG) accounts for about 70 percent of total Tier 1—significantly higher than any country in the EU. - High reliance on future profit risks overstating capital ratios despite industry transparency efforts to justify estimations. - IFRS 17 implications: - IFRS 17 requires a “Contractual Service Margin” and avoids a ‘day 1’ recognition of profit; potential negative reserves are recognized as liabilities and margins are recognized gradually over the coverage period. - It is very likely that insurance liabilities under IFRS 17 could be much higher than those currently recognized under SAM’s substantial SVG—risking a cliff effect with substantial adjustments to capital ratios. - IFRS 17 implementation was set for January 2021, although the IASB proposed postponing implementation by one year to January 2022. - South Africa has adopted IFRS; there will be no endorsement process. Once IFRS 17 is implemented, insurers also have to implement IFRS 9 (currently exempted at the time of IFRS 17 implementation), which may add pressures on asset valuations. - Recommendation: - The PA should urgently conduct an impact assessment, with particular focus on firms with a high reliance on future profit in the SAM calculation, and work closely with the industry to conduct an impact study as part of the preparation for IFRS 17. ### Governance, supervisory structure, and resources - Institutional arrangements: - The FSRA established a ‘twin peak’ model: FSCA (conduct of insurers and insurance intermediaries) and PA (prudential regulation of insurers). SARB is responsible for protecting and enhancing financial stability. - Friendly societies: - Excluded from licensing and other IA requirements; can provide life and non-life insurance with maximum coverage of ZAR 15,000 per member without licensing. - As of December 2017 there were 196 friendly societies with total assets of ZAR 908 million (about 0.03 percent of total assets of both life and non-life industry). Their regulation and supervision are excluded from the analysis due to size. - Prudential Authority (PA): - Headed by a CEO appointed by the Governor of the SARB with the agreement of the Minister of Finance. - CEO must be a SARB Deputy Governor (excluding the Deputy Governor responsible for financial stability); appointment term no longer than five years with possibility of one further re-appointment. - Governor may remove the CEO under limited and specified conditions; dismissal procedures differ depending on grounds and may require submission of an independent inquiry report to the National Assembly. - A Prudential Committee (governor, CEO, other deputy governors) oversees PA management; multiple advisory and decision-making panels exist. - PA has adopted SupTech solutions and plans significant investment in: (i) data management solution for data collection, validation, storage and analysis; (ii) workflow management solution; (iii) supervised institution management system. - FSCA: - Headed by a commissioner appointed by the Minister of Finance; minister appoints at least two but no more than four deputy commissioners. - Terms determined by the minister, not longer than five years, eligible for one further re-appointment. - Minister may remove commissioner or deputies under limited and specified conditions via an independent inquiry; removal triggers submission of inquiry report to the National Assembly. - National Treasury and Parliament engagement: - PA and FSCA must provide draft regulations after public consultation to National Treasury and Parliament. - PA must submit prudential standards to Parliament through National Treasury for at least 30 days while Parliament is in session (seven days for urgent standards). - Public consultation is fully transparent, with comments and resolutions disclosed to the public. - No approval by National Treasury or Parliament is required, but Parliament deliberations must be considered by the PA; the process can delay finalization of standards from time to time. *Source: 1zafea2022008 - IMF country report excerpt.* ### 28. Both the PA and FSCA are in the process of adopting a new funding regime ### 28. Both the PA and FSCA are in the process of adopting a new funding regime ### Adoption of new funding framework and levy process - Both the PA and FSCA are adopting a new funding regime promulgated under the Financial Sector Levies Act. - Current funding: - PA is fully funded by SARB. - FSCA is funded fully by the industry levies. - Proposed framework: - The new framework and process for the PA would be similar to the current process that FSCA has. - Authorities propose draft levies for public consultation. - Initial levies are subject to the consent of minister of finance. - Subsequent changes to levies would not require the minister’s consent as long as the increase does not exceed the consumer price index plus 2.5 percent. - The draft budget and proposed levies must be submitted to parliament for scrutiny for a one-month period. - Public consultations have been conducted in fully transparent manners with all comments and resolutions disclosed to the public. - According to FSCA staff, there have not been any interventions from the national treasury and parliament on the levies and budget processes. - PA and FSCA have flexibility to allocate their budget among sectors to address changing and emerging risks; they anticipate this flexibility would remain after the shift to the new levies and budget framework. ### Human resources, capacity, and turnover - Staffing allocations: - Around 50 staff are allocated to insurance prudential supervision (most transferred to the PA from the FSB-SA, the FSCA’s predecessor). - Around 40 staff to insurance conduct supervision. - Remuneration and retention: - The PA sets its remuneration target at 85 percent of the remuneration average of the private financial sector. - The PA remuneration target is described as a reasonable level compared with financial regulators in other jurisdictions. - The PA remuneration package appears reasonably competitive; staff are, in part, motivated by factors other than monetary considerations. - Turnover concerns: - Anecdotal evidence suggests experienced staff have resigned from both the PA and FSCA. - Some industry representatives indicated that high turnover of experienced staff in the transitional stage of the twin peaks reforms has adversely impacted the quality of insurance supervision, especially for the FSCA. ### Increased workload and cross-border supervision challenges - Workload increase: - Both the PA and FSCA face significant increases in workload due to recently adopted and upcoming reforms, especially from group and conglomerate supervision. - Host supervisor limitations: - Unlike insurance regulators in advanced jurisdictions, South African authorities have a limited ability to rely on host supervisors at the subsidiary level, as many host supervisors are also substantial (quantitative and qualitative) constraints. - Authorities will need to conduct substantial (additional) work to ensure robust governance, risk management and solvency calculation in major subsidiaries abroad. ### IT systems and data integration - IT upgrades in progress: - PA and FSCA IT systems are undergoing a significant upgrade. - Data and processing issues: - Recent regulatory reforms are substantially improving data availability for both the PA and FSCA, but IT systems to process this information have not yet been fully upgraded. - FSCA staff especially rely on manual processing to handle reporting data. - New data from recent regulatory reforms and old long historical data have not yet been well integrated, preventing meaningful trend and peer analysis. - Planning: - Both institutions have medium term workplans to upgrade their IT systems and achieve greater integration between PA and FSCA systems. ### Coordination mechanisms between PA and FSCA - Legal requirement: - The FSRA requires that the PA, FSCA and SARB cooperate and collaborate when performing their functions. - Coordination objectives: - FSRA sets out coordination requirements to improve supervisory effectiveness and minimize duplication, including on a consistent regulatory strategy, supervisory actions, and the development and use of common or shared databases. - Memoranda of Understanding (MoU): - Authorities have established MoU for cooperation that describe which actions need concurrence of the other authority and which can be taken by an individual authority. - Information sharing: - Authorities recently agreed to establish an IT system to facilitate more active information exchanges between the organizations. - Authorities are committed to enhance information-sharing even before the launch of this new IT system. ### Recommendations on resources and capabilities (excerpted) - From paragraph 33 (recommendation): - The PA and FSCA should be equipped with additional resources to ensure adequate supervisory coverage. - Drivers of additional resource needs: - Recent regulatory reforms (such as SAM at the solo level) still require high quality analysis and validation of industry practices to become fully effective. - Workload of both PA and FSCA has increased significantly and will continue to increase as industry reliance on complex models is expected to increase. - Future regulatory reforms (such as group and conglomerate supervision) will have a material impact on the agencies’ workload. - Resource priorities: - Additional resources to support recruitment and retention of staff with specialized expertise (such as in the areas of IT, cyber security, and advanced risk modeling). - Investment in IT systems that can support analysis of data that has become (or is expected to become) available due to the various regulatory reforms. ### B. Solvency Requirements — Valuation of assets and liabilities - Valuation framework: - Insurers are required to adopt an economic, market-consistent approach to valuations of assets and liabilities. - Asset valuation is derived from market observable values when available; otherwise insurers may use either a mark-to-market or mark-to-model approach. - Liabilities (including insurance liabilities) are valued at the amount for which they could be transferred, or settled, between knowledgeable and willing parties in an arm’s length transaction. - In many instances, assets and liabilities (other than insurance liabilities) valued in accordance with IFRS are deemed consistent with an economic valuation approach. - Insurance liability valuation: - Insurance liabilities are valued by calculating the probability-weighted present value of future cash flows, with an additional risk margin to allow for the cost of capital associated with the uncertainty of these cash flows. - Valuation must be comprised of a best estimate plus a risk margin. - The risk margin ensures that the value of the liabilities is equivalent to the amount another insurer would be expected to pay in assuming the liabilities. - The margin is derived from a defined cost of capital, multiplied by the capital needed to cover underwriting risk with respect to the transferred business, as well as any unavoidable market risk and counterparty default risk with respect to eligible reinsurance contracts. - Large insurers use complex models to take policyholders’ behaviors (especially lapse and surrender) into account in their best estimate calculations. ### Discount rate / “risk-free” rate - Discount rate: - The discount rate yield curve for present value of future cash flows is set by the PA and derived from South African sovereign bonds. - PA requires insurers to use the government bond curve published by the PA as the “risk-free” rate term structure to discount cash-flows for valuing insurance liabilities, unless an insurer is approved to use its own estimation. - International practice and implications: - In South Africa there is no adjustment of default and credit risk implied in the market prices of government bonds. - International best practice adjusts the credit risk implied in the market price of the government bonds to derive the “risk-free” rate. - The South African yield curve is significantly higher in the longer term than that implied by international best practice, especially between 20 to 40 years. - By implication, results using the current South African risk-free rate may imply a material underestimation of the best estimate of long-term insurance liabilities. - Insurers can use alternative yield curves with PA approval; some large insurers use yield curves derived from interbank offered rates, such as London Interbank Offered Rate (LIBOR) and Johannesburg Interbank Average Rate (JIBOR). ### Capital requirements (SAM) - Implementation: - SAM capital requirements at solo level were implemented from July 2018. - SAM capital requirements are calibrated with 99.5 percent (1 in 200 years) confidence level, increased from 95 percent (1 in 20 years) used in the previous capital regime (Statutory Valuation Method or SVM). - SAM was implemented smoothly without material transitional arrangement (note: immaterial transitional arrangement is granted to hybrid capital instruments and subordinated debts issued before SAM implementation). - Risk coverage and exposures: - South African insurers are exposed to relatively high risk from (i) equity investment, (ii) high lapse and surrender, (iii) credit risk, and (iv) concentration risk. - These risks are incorporated in both standardized and internal model approaches used for calculation of capital. - SAM comprehensively covers other quantifiable risks, including interest rate, currency, property, concentration, liquidity premium, mortality, mobility, longevity, and catastrophe risks. ### Credit risk, equity, and CIS investment treatment - Credit risk: - Credit risks (default and spread risks) used in capital calculations are based on insurers’ own estimation of PD and Loss Given Default (LGD). - The standardized approach provides standardized formulas to derive default and spread risks, but the current standardized approach allows insurers to estimate their own PD and LGD without supervisory approval, which is not in line with international best practices. - South African sovereign bonds are exempted from a credit risk capital charge. - Equity exposures: - Equity exposures are subject to high capital charges (33–49 percent depending on sub-category of the equity). - These capital charges can be adjusted by up to 10 percentage points depending on the last 3 years market trend. - Derivatives, such as options and investment guarantees, are subject to an equity volatility capital charge. - Collective Investment Schemes (CIS): - Investments in CIS are subject to a ‘look-through’ approach wherever possible, requiring insurers to assess risks of underlying assets and apply capital requirements for relevant components of market risk to underlying assets. - Applies to passive funds, active funds and funds of funds. - Where a CIS is not sufficiently transparent, insurers must use the CIS investment mandate to assess market risk capital requirement. - If investment mandate prescribes ranges and managers have discretionary judgment, insurers are required to assume an asset allocation which produces the maximum overall capital requirement. - Fall-back option: treat the CIS as “other equity” subject to about 49 percent capital charge. - The fall-back approach may still not fully capture risks from highly leveraged CIS. ### Capital resources and deductions - Capital quality and tiers: - Prudential standards allow only high-quality instruments to qualify as capital resources. - Classification into three tiers (Tier 1, Tier 2, and Tier 3). - Tier 1 comprises highest quality capital and must be loss absorbent, subordinated, of sufficient duration, free from obligations/incentives to redeem, and free from mandatory costs and encumbrances. - Total Tier 1 capital must exceed 50 percent of the SCR. - Average share of Tier 2 and Tier 3 capital to total capital is less than 7 percent on aggregate among life insurers. - Regulatory deductions: - If intangible assets are recognized in valuation of assets, 80 percent of the asset value must be deducted from capital resources, with remaining 20 percent recognized as Tier 3. - An insurer’s own shares should be fully deducted from capital resources. - Listed ordinary shares held by an insurer in any company that holds a direct or indirect controlling stake in the insurer, in excess of 5 percent of the total non-linked assets, must be deducted from that insurer’s capital resources. ### Investment requirements and governance of investments - Investment principle: - The PA adopted a ‘prudent person’ investment principle, which does not specify quantitative restrictions on asset allocation. - Formerly the FSB-SA imposed prescribed investment limits (e.g., domestic investment requirements to cover aggregate value of liabilities); those requirements were lifted at implementation of the IA, SAM, and governance and risk management requirements. - Insurers can only invest in assets and instruments whose risks they can properly identify, measure, monitor, control, report, and appropriately take into account in assessment of overall solvency needs. - Principle-based investment requirements include diversification criteria (by type of asset, issuer, group, or geographical area). - Investment policy: - Insurers are required to have an investment policy. - Prudential Standard GOI 3 (Risk Management and Internal Controls) requires each insurer’s explicit investment policy to specify the nature, role and extent of investment activities and explain how the insurer complies with asset limitations. - Insurers must invest all assets covering the minimum capital requirement (MCR) in a manner that reasonably ensures the security, quality, liquidity and profitability of the whole portfolio and their availability. - The PA monitors risk management through ORSA reports. ### Targeted supervisory recommendations (specific) - Paragraph 44: - The PA should conduct targeted inspections to evaluate ‘best estimate’ calculations in insurers with high reliance on future profits in their calculation of capital resources. - Rationale: Overly optimistic assumptions (including for policyholders’ behaviors reflected in lapse and surrender rates) will undermine solvency; PA should actively challenge firms’ estimations to ensure robustness. - Paragraph 45: - The PA should conduct an impact study and industry-wide stress test to address potential impact of IFRS 17 adoption. - Rationale: It is not apparent that all firms have clearly estimated the impact on net capital and profit at the general-purpose accounting basis; an industry-wide impact study and simple scenario analysis would help firms improve resilience and stability of net capital and profit in anticipation of IFRS 17. - Paragraph 46: - The PA and FSCA should enhance data sharing on CIS investment by insurers. - Rationale: Investment in CIS accounts for a significant portion of both non-linked and linked assets; PA has limited information on underlying assets which hinders validation of capital charges and proper risk analysis; FSCA receives detailed reporting on regulated CIS and some information on foreign CIS distributed domestically—sharing this data frequently would allow PA to better analyze risks of insurers’ CIS investments. - Paragraph 47: - The PA should ensure appropriate credit risk capital charges by conducting a thematic review on PD estimation with close cooperation of banking supervisors. - Rationale: Sample analysis shows potential underestimation of PDs compared with major credit ratings and historical PD data; PA should validate firms’ historical default observations and reliability of their internal ratings. - Note: PA’s banking supervisors have significant experience from Internal Rating Based (IRB) model validation; transferring this expertise to insurance supervisors would improve review quality. ### C. Governance and Risk Management — Governance requirements - Governance framework: - The IA requires an insurer and a controlling company to adopt, implement and document an effective governance framework. - Governance and Operational Prudential Standards apply to all insurers, branches and micro insurers. - High-level principles require firms to establish an effective governance framework proportionate to nature, scale and complexity of business model and risk profile that (i) protects the interest of policyholders, and (ii) provides effective systems of corporate governance, risk management and internal controls. - The standard is limited to requirements for the solo entity—once a controlling company is designated by the PA, it must establish governance at the group level. - Board duties: - Governance standards stipulate comprehensive duties for the board of directors, which must: - Set, approve and oversee implementation of business objectives, taking into account the soundness of the insurer and the interests of policyholders. - Act with independence in pursuing the best interest of policyholders. - Regularly review business strategies. - Promote an open environment where employees who communicate concerns about illegal or irregular behavior are properly protected. - Regularly review composition of knowledge, expert skills, and experience of the board and plan for orderly succession of board members. - Standards also require a sufficient number of non-executive directors. *Source: IMF country report chapter text.* ### 50. The board of an insurer is required to establish the insurer’s overall risk appetite. It also ### 1zafea2022008 - 50. The board of an insurer is required to establish the insurer’s overall risk appetite. It also ### Board governance, audit, and remuneration - The board is required to establish the insurer’s overall risk appetite and ensure effective systems for risk management and internal control to address key risks. - The Board must set and oversee the effective implementation of a remuneration and incentive model that: - demonstrably supports prudential decision making, - is consistent with the insurer’s risk appetite, and - does not induce excessive or inappropriate risk taking. - The board is required to establish an audit committee which must: - oversee and approve internal and external audit plans to ensure all material risks are considered and statutory and financial reporting requirements are met; - monitor implementation of internal and external audit plans; - review all internal and external audit reports and ensure identified issues are managed and reflected in an appropriate and timely manner; - provide input to the scope of audit work. ### Enterprise Risk Management (ERM) - All insurers (including micro insurers) are required to establish and maintain a risk management framework approved by the board that enables identification, assessment, monitoring, reporting on, and mitigation of material risks (quantifiable and non-quantifiable). - Risk management tools must, at a minimum, include: - a process for identifying and assessing new and emerging risks; - tools for quantifying and managing material risks; - application of scenario analysis and stress testing programs commensurate with the size, business mix and complexity of the insurer’s business; - information systems that provide reliable and informative reports on measurement, assessment and management of all material risks; - a review process to ensure the risk management system remains effective in identifying, quantifying, assessing and managing material risks. - The risk management framework must comprehensively cover material risks, at a minimum where relevant: - (i) ALM, (ii) capital, (iii) concentration, (iv) credit, (v) fitness and propriety, (vi) information technology, (vii) insurance fraud, (viii) investment, (ix) liquidity, (x) operational, (xi) outsourcing, (xii) reinsurance, (xiii) remuneration, and (xiv) underwriting. - ALM policy requirements: - must clearly specify the nature, role and extent of ALM activities and their relationship with product development, pricing functions and investment management; - must recognize interdependence and correlation of risk between asset classes and different products/business lines. - Framework must account for off-balance sheet exposures (such as interest rate swaps) and contingencies where risks transferred may revert back to the insurer. ### Own Risk and Solvency Assessment (ORSA) - All insurers are required to conduct a forward-looking and risk based ORSA with objectives to assess: - (i) the resilience of solvency across a range of possible stress scenarios; - (ii) overall solvency needs of the insurer; - (iii) compliance, on a continuous basis, with solvency requirements; - (iv) the significance with which the risk profile of the insurer deviates from the implied risk profile underlying the SAM. - ORSA requirements: - must be conducted over a longer time horizon than conventional risk assessments (typically one year); - must be undertaken annually, proportionate to complexity, risk profile, and nature of operations. - Supervisory practice and limitations: - The PA reviews and provides feedback to ORSA reports; PA line supervisors review ORSA reports and provide feedback to individual firms. - The PA has not conducted industry-wide analysis and comparison of ORSA reports; assumptions and methodologies used for stress testing have not benefited from thematic or peer analysis. - Authorities have not conducted recent system-wide stress tests of the insurance industry similar to SARB’s Common Scenario Stress Tests for the banking sector. ### Insurance Stress Tests (Box summary) - Historical supervisory stress testing: - Beginning in 2010, the FSB-SA required bottom-up comprehensive solo-level stress tests including a scenario of 100 percent default by the largest reinsurer. - Later introduced semi-annual stress tests for the six largest long-term and short-term insurers, and annual economic and insurance stress tests for all insurers. - Typical stress test scenario components: - market risk combined scenario: steep drop in equity markets, significant adverse developments in level and volatility of interest rates across the term structure, significant adverse currency movements, significant drops in price levels of property and investments; - worsening of counterparty risk and concentration risk. - Last stress test (pre-SAM) results and shocks: - life insurers tested under a severe economic scenario including a 50 percent drop in equity prices, a 30 percent drop in property prices, and a 30 percent up/down of FX rate; - non-economic scenario included 30 percent increase of mortality and morbidity, a 20 percent increase in expenses, and a 40 percent increase of lapse / surrender rate; - shocks produced an 18-percentage point decline from economic scenario and 26 percentage point decline in non-economic scenario in the capital adequacy ratio of the industry average; - the average capital adequacy ratio of the life industry was 458 percent. - Changes since 2016: - FSB-SA stress test was suspended in June 2016 to prepare for SAM implementation. - Instead of supervisory stress tests, the PA introduced ERM and ORSA requirements in July 2018 that include institution-specific stress tests/sensitivity analysis or reverse stress testing. - ORSA reports should include details and outcomes of stress testing, scenario analysis used, and frequency of exercise; PA analyzes ORSA reports and provides case-by-case feedback, but there has been no industry-wide analysis or feedback on stress testing practices or results yet. - SAM does not cover some material and quantifiable risks, such as sovereign bond credit risk, lapse and surrender scenario of a specific line of business, and emerging risks such as cybersecurity risk; only a few ORSA stress tests currently cover these risks. - PA plans and recommendations: - PA plans to resume supervisory stress testing of the insurance sector based on SAM; at mission visit stage the plan was at an early stage with no formal decision on timing, scope (solo or group), severity of scenarios, or bottom-up vs top-down approach. - Ultimate objective: complement individual ORSA stress tests and monitor overall sector vulnerabilities for micro-prudential and macroprudential supervision. - Likely initial focus on large insurance groups with capacity to respond. - Recommendation: develop a clear implementation plan optimizing synergies between ORSA stress testing and sector-wide supervisory stress tests, devote more resources to validation and discussion of individual ORSA stress tests, encourage firms to improve scenario, methodology and risk management practices, and avoid excessive burden from duplicative exercises. ### Recommendations (selected) - The PA should encourage insurers to incorporate a sovereign stress scenario in capital and liquidity stress testing within the ORSA report. - A sample review showed only one group included a sovereign bond downgrade in their scenario analysis. - SAM excludes sovereign credit and concentration risks from capital charges; insurers have sizable exposures to South African sovereign bonds, making sovereign downgrade scenarios important to consider. ### Group Supervision, Interconnectedness, and Conglomerate - Designation and scope: - The IA allows the PA to designate insurance groups, bringing the controlling company and group under PA prudential supervision. - Three insurance entities were designated as part of an insurance group as of June 2021 (PA annual report 2020/21). - Designated insurers are subject to comprehensive prudential requirements, including fit and proper requirements, governance, risk management and capital requirements. - FSRA empowers the PA to designate financial conglomerates, but the PA has not yet done so. - Group-level capital requirements: - Based on a deduction and aggregation method (default option): capital resources and requirements are the aggregation of those of individual solo entities in the group. - Steps to derive group capital resources include: apply solo-level restrictions on capital instruments; eliminate intragroup transactions that generate capital resources from the issuing entity; exclude subordinated debt or hybrid capital not issued or guaranteed by the controlling company; sum adjusted capital resources of all entities as group capital resources. - For foreign insurance subsidiaries domiciled in jurisdictions the PA recognizes as “equivalent”, local capital resources and requirements are added to group calculation; for other foreign insurers, capital resources and requirements must be calculated based on SAM and added to group calculation. - Treatment of other and non-regulated entities: - Capital resources and requirements of PA regulated banks and credit institutions follow the Basel framework. - For regulated financial institutions other than banks, credit institutions or insurers, capital resources and requirements are based on relevant sectoral rules. - For non-regulated entities, capital resources are calculated on net asset value with deductions for goodwill or intangible assets; capital requirements are based on market risk capital charges of assets held. - Intragroup transactions and concentration: - Intragroup transactions are deducted from group capital calculations to avoid multiple gearing (e.g., intragroup loans deducted from capital of all group entities). - Non-fungible and transferable instruments (including encumbered assets) must be deducted from group capital resources calculation. - Head of actuarial function of controlling company must ensure no double counting of loss-absorption capacity and management actions. - SAM includes a concentration risk charge where exposure over certain thresholds are subject to additional capital requirements; threshold depends on asset class (example: 10 percent of total assets for loans to a domestic bank). Concentration risk charges apply to both intragroup and other exposures. - Supervisory colleges and ComFrame: - PA convened supervisory colleges for major South African insurance groups and shares detailed risk analysis; colleges limited to information exchange and have not enacted joint inspections or regulatory actions. - PA plans to introduce gap analysis to meet IAIS ComFrame criteria; ComFrame finalized in November 2019. - PA is home supervisor of two Internationally Active Insurance Groups (IAIGs) and is active in IAIS committees. - IAIS comprehensive assessment forthcoming; South Africa selected among 29 countries whose insurance markets play a significant role globally. - Intragroup transaction growth and implications: - Authorities observed intragroup transactions increased significantly in 2017. - Voluntary reporting data to PA indicates total intragroup transactions increased by 27 percent to ZAR 358 billion from second quarter in 2017 to second quarter in 2018. - Capital investments constitute the majority of intragroup transactions; such transactions could generate multiple gearing at solo level and would not be properly addressed until group and conglomerate regulation implementation. ### Winding-Up and Exit From the Market - Identified gaps and consequences: - The 2014 FSAP identified material gaps in framework for winding up failed insurers; these gaps remain. - Policyholders do not have priority ranking in winding up and rank pari passu with unsecured creditors. - No policyholder protection scheme is in place. - Several insurers since last FSAP have faced stressed situations; most resolved by transferring business to other insurers, but some cases under liquidation remain. - Recent liquidation cases resulted in significant losses for policyholders (such as 50 percent of their benefits) and substantial delays in payment of claims and surrender values. - Recovery planning: - Development of recovery plans for insurance firms is at a very early stage. - No requirements for recovery plans for “stand alone” insurance and no specific rule-making or supervisory expectations for group-wide recovery plans. - International standards indicate recovery plans should guide rehabilitation following severe stress, reducing probability of failure and offering measures such as capital raisings, divestitures and balance sheet restructuring. - Responsibility for preparing recovery plans lies with firms’ senior management; supervisors should review plans for credibility and feasibility and provide guidance. - Recovery planning is particularly important for larger South African insurance firms given gaps in safety net and potential knock-on effects on other financial sectors through interconnectedness. - Recommendation: - Over the medium-term, the PA should consider imposing recovery planning requirements on large insurance groups, especially those relying on substantial amounts of their Tier 1 on future profit. - Reliance on future profits creates risk of significant policyholder losses in case of failure because majority of capital resources (from future profit) will not become available. - Lack of policyholder protection schemes and legal priority against unsecured creditors complicates protection of policyholder interests. - Material loss of policyholders could cause reputational contagion to other insurers and financial sectors (e.g., affiliated banks). - Robust recovery planning can reduce probability of failure, particularly for these firms. *International Monetary Fund — South Africa FSAP (extracted content).* ### 68. It is recommended that high legal priority is given to the protection of the policyholders. ### 1zafea2022008 - 68. It is recommended that high legal priority is given to the protection of the policyholders. ### Policyholder protection - Recommendation that high legal priority is given to the protection of the rights and entitlements of policyholders. - Observation: recent liquidation cases of insurers confirm significant risk to policyholders under the current framework. - Concern: liquidation of firms that rely on significant future profit can cause policyholders to suffer significant loss and potentially trigger reputational contagion to other insurers. - Recommendation for authorities: expedite legislative changes to ensure high legal priority for policyholder protection. ### Market conduct (TCF, RDR, conduct frameworks) - FSCA continued implementation of the outcomes-based customer protection initiative initiated by FSB-SA in 2011, based on the “TCF” approach with six principle-based outcomes: - (i) customer confidence, - (ii) products meet the need of targeted customer, - (iii) proper information to the customers, - (iv) fair and appropriate financial advice and distribution models, - (v) product performance is in line with the expectation as financial institutions have led customers to expect, - (vi) no post-sale barriers for customers to change product. - The FSR Act gives FSCA an explicit objective to promote fair treatment of financial customers and empowers FSCA to make conduct standards; the forthcoming COFI Act will further support the TCF outcomes-based approach. - FSCA’s incremental approach while awaiting COFI Act implementation: - embedding TCF in existing regulatory frameworks, - prioritizing key TCF-aligned regulatory projects, - embedding TCF in supervisory and enforcement frameworks. - FSCA and PA joint review: governance-related international standards and South African frameworks, including King IV Report on Corporate Governance for South Africa, 2016; a gap analysis informed ongoing governance-related standards development. - RDR (Retail Distribution Review) implementation: - Initiated by FSB-SA; consultation started November 2014; implemented in phases since 2015. - RDR objectives: - (i) supporting delivery of suitable products, - (ii) enabling customers to understand and compare the nature, value and cost of advice, - (iii) enhancing standards of professionalism in financial advice and intermediary services, - (iv) enabling customers to benefit from fair competition for quality advice and intermediary service, - (v) supporting sustainable business models for financial advice. - FSCA prioritizes RDR objectives as key contributor to TCF Outcome 4 (fair and appropriate financial advice and distribution models). ### Conflict-of-interest measures and fee/comms rules - RDR introduced a cap of 50 percent on initial commissions; these can be clawed back after 2 years when policyholders lapse or surrender the policy. - For investment-linked products: prohibition on intermediaries receiving commissions from insurers; intermediaries must charge appropriate fee to the policyholder with clear disclosure. - For risk products: intermediaries may receive commissions from insurers for selling and administering risk policies but must agree fees for advice separately with clear disclosure. ### Risk-based supervision and data systems - FSCA introduced conduct-of-business statutory returns to generate qualitative and quantitative data for risk-based assessments; insurance conduct of business statutory returns introduced by FSB-SA in December 2016 after public consultation, a pilot process and 2 years transition. - Information is stored in the “MAGIC” system; line supervisors can access data across firms to compare supervised firm with industry average or peers. - FSCA uses ad-hoc information and reporting requests; ongoing monitoring insights inform pre-emptive responses; FSCA publishes leading practice benchmarked through comparative assessments. ### Corrective measures and enforcement - FSCA enforcement powers include: - (i) administrative penalties up to ZAR 100 million, - (ii) suspension, withdrawal and revocation of license, - (iii) debarment of individuals, - (iv) enforceable undertakings, - (v) directives, - (vi) curator, - (vii) statutory manager. - FSCA can institute proceedings in the high court, including seizing and removing assets of an institution for safe custody. - FSCA introduced “mystery shopping” to evaluate customer experience and identify customer-facing risks. - FSCA enforcement activity: - Strong use of suspensions and withdrawals of licenses in the last three years. - Administrative penalties imposed: in 2016 and 2017 penalties involved more than 20 entities and/or individuals each year and total penalties were over ZAR 10 million each year. - In 2017 and 2018, number and amount of penalties declined, possibly indicating reduction of serious infractions; however, miss-selling remains a concern. - Enforcement actions by year: - Debarments: 2017 — 106; 2018 — 135; 2019 — 184 - Suspensions: 2017 — 621; 2018 — 581; 2019 — 691 - Withdrawals: 2017 — 254; 2018 — 8; 2019 — 26 ### Dispute resolution and complaints monitoring - FSCA requires all insurers to have a dispute resolution process; case statistics and results are published annually on insurer websites and at the Ombudsman, with aggregate industry data. - Policyholders can take complaints to applicable Ombudsman offices. - Complaints trends 2016–2018: - Funeral benefits and disability insurance complaints continuously increased; most related to poor communications, poor documentation and denied claims. - Non-life: auto insurance complaints account for almost half of cases, followed by homeowner’s insurance; number of complaints decreased slightly from 2016 to 2018. - FSCA monitors and analyzes complaints received by insurers, ombudsman and FSCA; analysis is integrated into FSCA’s risk-based supervision framework. - FSCA encourages financial institutions to use complaints data to identify and remedy poor customer outcomes. ### Digitalization, AI/ML, and innovation - Some insurers use complex customer behavioral models and are technically ready to adopt AI and ML. - Authorities monitoring fintech and Insurtech via an innovation hub. - A regulatory sandbox will be launched in 2020, managed by financial authorities and a number of government agencies. - Some insurers have capacity to introduce AI and ML for core decision-making (e.g., underwriting and premium setting) but have not implemented due to potential ethical issues and financial exclusion concerns. - Recommendation for FSCA and PA: enhance dialogue with leading companies through the forthcoming sandbox and existing innovation hub. ### Recommendations (explicit) - PA and FSCA should deepen analysis on high lapse and surrender rates: - Determine extent to which high lapse and surrender rates relate to macro-economic trends (e.g., rising unemployment), changes in policyholders’ needs, or conduct-related issues (e.g., miss-selling). - FSCA has been receiving detailed information from industry that could be used for further analysis. - PA and FSCA should cooperate to analyze reasons behind high lapse and surrender rates. - FSCA and PA should enhance monitoring of use of big data, AI and ML by insurers and prepare regulatory responses to address emerging risks such as financial exclusion and underestimation of the reserves. - Insurers are competing and may adopt advanced technologies that could materialize new risk factors. - FSCA and PA should further enhance dialogue with leading companies through both the forthcoming sandbox and the existing innovation hub. ### COVID-19 impact on the insurance sector and regulatory measures (Box 3) - Primary impact: investments; profitability of life insurers fell sharply in the first half of 2020, mainly due to weaker investment income, which turned negative in the first quarter of 2020. - Capital markets recovered in the second half of 2020, which offset most insurer losses. - Solvency and asset notes: - Median SCR ratio of life insurance sector remained over 190 percent even at end-March 2020 when Johannesburg Stock Exchange Index declined by 30 percent. - Equity holding (direct equity investment and equity funds investment) account for 33 percent of the total assets of non-linked portfolio. - Three rating agencies downgraded government bonds to non-investment grades in March 2020, increasing sovereign bond yields substantially in March 2020; higher yields increased discount rates used in insurance liabilities valuation and thus reduced the value of insurance liabilities, offsetting investment losses for long-term policies. - Lapse and surrender dynamics: - Life insurers recorded a policy lapse ratio of 126 percent in June 2020 (first time in over a decade). - PA and FSCA are monitoring lapse and surrender rates of individual companies very closely. - Non-life sector: - Impact overall moderate due to more conservative asset allocation. - Median SCR ratio remained 180 percent as of September 2020 and managed to remain over 170 percent throughout the year. - Increased claims observed for certain products; some insurers with large exposures to credit insurance or business interruption policies may face solvency pressure. - Business interruption guidance: - FSCA clarified that the national lockdown itself was generally not found to be a trigger for a valid business interruption claim; businesses are required to prove specific COVID-19 effect on their operations or area. - Various insurers committed to provision of interim relief while legal certainty on business interruption claims is awaited. - PA actions: - Heightened reporting requests to analyze impact on operations, solvency and liquidity. - With FSCA coordination, PA conducted surveys on hard-hit subsegments such as credit insurance and business interruption insurance and intensified engagement with distressed entities. - Joint communications by PA and FSCA included: - i) outline of regulatory and supervisory actions, - ii) order for planning and discussions with affected clients during and after Level 3 of the lockdown period, - iii) regulatory response on business interruption insurance. *Source: 1zafea2022008 - 68. It is recommended that high legal priority is given to the protection of the policyholders.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1zafea2022008.pdf_