Futility of new tier-based recapitalisation of Nigerian insurers
While NAICOM may be acting in good faith to accommodate all companies within the umbrella of the TBMSC, it cannot reclassify companies on the basis of solvency shortfall, which, in any case, is always transient.
In 2007, the insurance industry took a leap of faith with minimum capital requirements for composite insurance companies raised to N5 billion, general or non-life insurance companies raised to N3 billion, while N2 billion was stipulated for life-only insurance companies. The reinsurers had to raise their minimum capital to N10 billion.
Before the increased capitalisation requirements in 2007, insurers operated within the minimum capital range of N150 million and N200 million. N350 million was the capitalisation requirement for composite insurance and reinsurance companies as contained in the Insurance Act 2003.
Thus far, there has not been any agreed standard or measure for what the adequate capital position should be for players. However, there are regulatory solvency ratios that determine if a company possesses the required financial muscle to underwrite businesses under the class it is registered. The solvency ratio, which is determined based on the insurance firm’s preceding year’s balance sheet, is the size of its capital relative to all the risks the insurer has taken.
Large corporations like the Nigerian National Petroleum Corporation (NNPC) often place emphasis on balance sheet sizes of insurers as one of the requirements for bidding for their accounts. The battle to acquire such accounts is usually very intense. Any insurer that has underwritten NNPC’s assets in any particular year has seen its premium income rise significantly.
Yet, these phenomenal top-line growths do not translate to the bottom line in any particular year. The reason for this is not far-fetched. Nigerian underwriters and brokers who lead big-ticket insurance businesses only front. This means in the absence of the local skill to underwrite such large corporations' assets, the entire risks are passed to a foreign-based reinsurer and the "fronting company" in Nigeria only receives a percentage of the premium as commission.
The renewal of the policy often becomes a challenge given the apparent lack of local capacity. In the politics and pursuit of personal interest that ensues, the NNPC “lucrative” business and other government businesses are hardly retained by one particular insurer year in, year out.
There are also other issues that put pressure on the premiums of insurers. They
include problems of uneconomic pricing, restrictive investment guidelines and few investment windows. In addition, intense competition for available businesses often drives most companies into accepting businesses with questionable risk profiles. This exposes the insurers to losses or huge risks when it cannot cover claims.
The National Insurance Commission (NAICOM)’s complaints unit has had to arbitrate so many cases between insurers and the insured. This has led to the notion that solvency ratio shortfalls constitute the main issue faced by insurance companies in the country.
Why tier-based recapitalisation
The Tier-Based Minimum Solvency Capital (TBMSC) structure was designed as a launch pad for the much-talked-about Risk-Based Supervision (RBS) programme. The objective of the new policy – which is expected to commence on October 1st, 2018 – is to produce specialist companies or niche players with adequate capital to do business efficiently.
According to NAICOM, “the recapitalization scheme is aimed at developing and applying appropriate tools that consider the nature, scale and complexity of insurers, as well as non-core activities of insurance groups, to limit significant systemic risk and thereby achieve soundness of insurance companies and contribute to the achievement of stability of the financial system.”
Owing to the outcome of the regulator’s stress tests on companies following the 2016/2017 economic recession in Nigeria, it was found out that had NAICOM implemented the policy, some companies would have been forced to either merge or be forcefully acquired. This was the reason the new minimum solvency option was arrived at with the aim to achieve the following: a) allow insurer’s to focus on their areas of strength; b) improve settlement of claims; c) enhance local retention; d) encourage market discipline, prudence and appropriate pricing; e) encourage innovation and deepen market penetration; f) encourage voluntary mergers, and build investors’ confidence; and g) build a stronger and more vibrant insurance industry.
Legal hurdles for the TBMSC
The provisions of Section 24 of the Insurance Act 2003 seem to be the legal basis for these fresh capitalisation requirements. Section 24 precisely deals with solvency margin, which is at the core of any insurance company’s health. However, the law provides room for companies to make up for any shortfalls in the solvency margins in any particular year. According to the law, failure to shore up capital as required by the solvency needs may lead to cancellation of registration.
Nevertheless, the Insurance Act 2003 stipulates that an insurance company can both be capitalised and registered as a composite company, general business or life company. And the businesses they can transact are well spelt out for the various categories of registration.
To be sure, NAICOM is empowered to introduce changes to the capital requirements as at when required. But the law does not empower the regulator to redefine the nomenclature or structure of companies capitalised and registered in compliance with the existing law. If indeed, new minimum capital requirements are to be imposed, then reasonable amount of time should be given to companies to raise the capital.
While NAICOM may be acting in good faith to accommodate all companies within the umbrella of the TBMSC, it cannot reclassify companies on the basis of solvency shortfall, which, in any case, is always transient. The TBSMC can be woven into a new legislation to amend the existing Act.
New capital requirements
For composite insurers that wish to be reclassified to either Tier 1 or Tier 2 companies, they have to recapitalise to N15 billion or N7.5billion, respectively. For general insurers that must reclassify to Tier 1 or Tier 2, they need to increase their capital base to N9 billion or N4.5 billion, respectively. Life insurance companies are expected to recapitalise to either Tier 1 or Tier 2 with increased minimum capital of N6 billion or N3 billion, respectively.
The new regulation also makes allowance for insurers who might be willing to maintain the current capital. They will play in the lowest tier, namely Tier 3.
The main differentiator under the different tiers is the class of businesses undertaken. For instance, Aviation, oil and gas, annuity and group life form the bulk of businesses that are exclusive to Tier 1 companies. The current and emerging growth areas in the industry, where there is increasing competition, are oil and gas, annuity and group life insurance.
However, the major focus now is on the companies that will be the beneficiaries of a new capital raise in the insurance industry. My observation is that the big players need more space at the top and these new capital requirements, if implemented, would create the space, especially in those emerging growth areas. No doubt that retail is the future of Nigeria’s insurance industry but the structures need to be in place.
Outlook
Technical issues aside, there is no basis for the regulator to assume that the problem of low total gross written premiums (GWPs) as a percentage of gross domestic product (GDP) will end by merely registering companies on the basis of tier-based minimum solvency. Solvency issues become existential risks for companies when these issues protract. And currently, there is no immediate regulatory oversight to address those issues. One solution is to deepen insurance penetration in the country.
Nigeria’s large population is a great potential for insurance growth. Insurance penetration in the country is at an abysmal 0.4%. But growth can be achieved through innovation. While insurers must innovate to meet the needs of Nigerians, the regulator should also expand the insurance base through legislated insurances by integrating insurance policies within the framework of services provided by government agencies.
While insurers must innovate to meet the needs of Nigerians, the regulator should also expand the insurance base through legislated insurances by integrating insurance policies within the framework of services provided by government agencies.