SAIA

South African Insurance Association

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Engineering annual-paid-monthly - SAIA Bulletin June 2019

The purpose for the implementation of the Solvency Assessment and Management (SAM) framework is to protect the insured by enforcing regulations, therefore ensuring that insurance companies reserve adequate capital to meet short-term and long-term claims.

With the introduction of SAM into the non-life insurance market, the market is faced with numerous new challenges. When set conditions are not adhered to, it will result in an increase of the solvency capital requirements (SCR). The onus of regulating the SCR and reducing the capital required is traditionally dealt with by the actuarial and accounting staff of an insurer. The implementation of SAM would now require that the impact on solvency should be understood and controlled even at an underwriting level.

This article emphasises the capital requirement for default risk in relation to a type two exposure (unrated counterparty, with reference to policyholders’ debtors). It will focus specifically on an annual-paid-monthly premium under an open contract all risk policy.

The Prudential Authority prescribes that annual-paid-monthly must be recognised as follows: “the full annual premium should be recognised as soon as the policy incepts, and a premium debtor for the portion of premiums that will only become due in the future should be raised. If the contract boundary is assumed to be one year, premiums expected to become due after the valuation date, but within the contract boundary, should be reflected in the projected future cash-flows of the technical provisions. Premiums that have already become due, but have not been received, should also be reflected as a premium debtor in the balance sheet, unless non-payment has already resulted in the policy being cancelled or lapsed.”

The market has already adopted the above definition. The question is whether the underwriters are aware of the capital requirements for the premium debtor on the balance sheet?

This is calculated as follows:

15% X (premium debt) + 90% X (premium debt due for more than 3 months)

As an underwriter, one needs to consider ways to improve this. The ideal scenario would be to eliminate the premium debtor on the balance sheet, thus eliminating the requirement to reserve additional capital.

After many hours of debating with colleagues, three options emerged:

Option one
Offer only once-off contract all risk policies

  • ADVANTAGE
    • Full risk premium is paid at the start of the contract
    • No debtors
    • No additional capital required
  • DISAVANTAGE
    • No alternative payment methods for clients
    • Client’s cash flow is restricted

Option two
Annual policy with premium financing

  • ADVANTAGE
    • Client is essentially paying annual-paid-monthly
    • Full risk premium is paid at the start of the contract
    • No debtors
    • No additional capital required
  • DISADVANTAGE
    • Additional cost for client due to premium financing
    • Two policies/contracts (contract all risk + premium financing)

Option three
True monthly, automatically renewed for 11 months

Intermediaries might not find option three favourably as the underwriter may technically exercise the right of not offering a renewal invite. However, the traditional annual-paid-monthly has a 30-days cancellation clause, thus giving the underwriter the same privilege.

All the terms and conditions such as contract turnover, premium adjustments and maintenance period should essentially go unchanged as it is only the payment terms that are being altered.

  • ADVANTAGE
    • No difference between true monthly and annual-paid-monthly
    • No additional capital required
    • No debtors
  • DISADVANTAGE
    • SASRIA adjusting to new ideas or offer SASRIA annually

As underwriters we can choose to adhere to our trusted traditional methods or explore out-of-the-box solutions that can assist in reducing your company’s SCR.

It’s time to make lemonade.

For more information contact Keith Barlow-Jones: kbarlowjones@guardrisk.co.za