Risk-based approach as an imperative for insurance market development in Nigeria

Introduction

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 in the front burner of NAICOM’s insurance market development mandate over the years without real success.

RBS is a dynamic approach of 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 a 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 Solvency II approach, being a prospective view of capital, using a one-year capitalisation time horizon.

This paper highlights why risk-based approach works better as an imperative for insurance market development than the rules-based approach.

Reasons to transition to risk-based approach 

The insurance market development in Nigeria has often been constrained by an absence of innovation (e.g. new product development), limited technical skills (e.g. qualified actuaries) at insurers as well as at supervisory and policy making levels, and short-term management priorities due to the adoption of rules-based approach. Thus, there had been a clarion call over the years for the introduction of a risk-based approach to create a robust, efficient, and inclusive insurance market in line with international best practice. 

NAICOM had been planning since 2015 to move from a rules-based supervision to that of RBS of insurers’ operations in 2017. This laudable plan and timeline did not materialise, having carried out preparative and proactive steps for take-off of the RBS such as release of guidelines for RBS with feedback mechanism from insurances companies, enterprise risk management and code of corporate governance, and also conducted 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, [that it] negates the true concept of RBC etc. Furthermore, it is quite unfortunate that the long-awaited review of Insurance Act 2003, Consolidated Insurance Bill 2020, to provide the expected legal framework to back not only the implementation of risk-based approach but also the failed recapitalization 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 on the 2024 proposed date of implementation of the risk-based approach to support the insurance market development.

Benefits of risk-based approach in insurance market development

Risk-based approach could advance insurance market development in the following ways:

1. Develops and improves professionalism, in-house capacity and technical skills of insurers and regulators. This allows leadership to think of risks rather than rules leading to innovation;
2. Aligns incentives to business actions e.g.  Management can be rewarded for decisions that better manage risks;
3. Encourages and rewards investment in data collection and analysis ;
4. Can offer proportionate relief to low-risk innovations that reach underserved and unserved segments, thereby facilitating inclusive insurance (e.g. micro- insurance).
5. Encourages insurers to manage their risks more effectively by aligning capital requirements with the level of risk being exposed to.

Challenges of risk-based approach in insurance market development

The challenges of risk-based approach in advancing insurance market development are as follows:

1. There is likely to be an apprehension among the insurance stakeholders (i.e. pushback from insurers, clients and brokers) especially at the initial stages of implementation of RBS, particularly in the areas of risk management and governance, data collection, and actuarial expertise; 
2. As 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;
3. Possible lack of sufficient regulatory guidance on transitionary measures for the industry, inadequate training and development programs to instil a risk-based approach/culture;
4. The regulator seems to be ahead of the industry’s preparedness and the availability of resources, capacity, and skills for the application of RBS. 
5. This is a complex approach which can be difficult and expensive to implement, particularly for smaller insurers with the limited resources. This could even be applicable to NAICOM if the Government policy on compulsory 50 per cent deduction from internally generated revenue of all government enterprises including NAICOM is being implemented.

Conclusion 

The introduction of a risk-based approach in Nigeria insurance industry has been well overdue. Thus, its implementation would improve the insurance market development in Nigeria leading to insurers’ ability to underwrite large volumes of business and material risks in order to be competitive globally, going forward.

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