Better risk management: Major changes are on the way for the regulatory framework

The country has been one of the region’s early adopters of a risk-based capital (RBC) regulatory framework, since 2005. Despite improvements in risk weightings, however, the industry still suffers a significant gap across players in terms of risk management processes, with larger local and foreign players in line with international best practices but smaller underwriters still lagging in terms of accounting and governance.

The existing regulator, Bapepam-LK, has gone some ways in enforcing stricter rules but it will befall its successor, the Otoritas Jasa Keuangan (OJK), to tighten enforcement and transparency further. Convergence with international standards should improve operating processes over the medium term, but only if the industry is able to develop the required human resources.

BOLSTERING BUFFERS: The industry’s regulator has already set out in its master plan for the sector to 2014 strategies to improve corporate governance and risk management for all underwriters. Following significant losses linked to poor pricing of risk, particularly by state-owned insurers, the need for higher standards was evident. The industry is thus being prodded to adopt more adequate provisioning for timely claims settlement with more resilient capital buffers to deal with any deterioration in risk profiles. As underwriters move increasingly towards the mass market in both life and non-life coverage, the regulator’s focus is clearly on making risk management processes more effective and resilient across players both big and small.

Already one of the region’s first movers in migrating its regulatory structure from Solvency II to RBC as of 2005, Bapepam-LK has tightened up risk weightings in recent years. The framework, adopted by most regional peers since, institutes provisioning requirements according to the risk profile of specific policy classes rather than a uniform capital provisioning for all risk types. Despite this early-mover advantage, strict enforcement of the new standards has been slow: underwriters have had to report their RBC solvency ratios to the regulator on a quarterly basis, but no insurer has yet been penalised for falling short of the required risk-weighted capital requirements. Despite the gradual nature of implementation, the Ministry of Finance passed a regulation in April 2012 requiring all underwriters to provision for 120% of risk-based capital by January 2013. Alongside higher capital requirements being phased in by 2014 this stricter risk provisioning should sanitise the industry and prompt better capitalised and more transparent underwriting processes.

In addition, underwriters are now required to establish protection funds as emergency pools to compensate policyholders in the event of high claims. The funds are constituted by 20% of annual premiums and 20% of underwriters’ capital base, placed in bank deposits. In the event of liquidation, underwriters must use these funds to compensate policyholders once preferred creditors such as staff salaries and tax obligations are paid off. The enforcement of these two measures is meant to protect policyholders in all events, a move that should reinforce the industry’s credibility in the eyes of the insured while reducing systemic risk.

IMPROVING STANDARDS: In conjunction with the central bank, the outgoing financial services regulator Bapepam-LK has begun the process of convergence with International Financial Reporting Standards (IFRS) since 2008, when the Indonesian Institute of Accountants pledged to narrow differences between the Indonesian Financial Accounting Standards (GAAP) and the international norms. According to Fitch, underwriters’ financial statements are expected to be “substantially similar” from the start of 2012 while Bapepam-LK is requiring insurers to run simulations of financial reporting under full IFRS during the third quarter of 2012. A new regulation requiring stricter disclosure for individual policyholders was also passed in 2012.

HARMONISING PROCESSES: Whilst underwriters by and large already comply with IFRS, according to US-based insurance rating agency AM Best, the major consequence of the new rules will be the harmonisation of accounting processes across the industry, requiring uniform accounting for lapsed policies and claims. In the life segment, however, the impact is likely to be greater. Under IFRS life insurance, transactions are segregated between pure protection policies and investment-linked ones. Given that most underwriters rely on such unit-linked policies for much of their premium income, life income is expected to decline.

BEST PRACTICES: Insurance companies have already sought to emulate processes in more advanced economies like Singapore, where a growing number of local players are upgrading IT systems and implementing enterprise resource management (ERM) solutions in advance; foreign players all largely comply with international best practices. As underwriters revise their internal procedures, a final deadline for enforcement of strict IFRS is expected in early 2013 according to AM Best. Beyond accounting procedures, over the past year Bapepam-LK has been reviewing the Insurance Core Principles set by the International Association of Insurance Supervisors, a benchmark for the industry globally. While the adoption of new guidelines for risk management and investment regulations will have to wait for the input of the new regulator in 2013, underwriters expect more detailed risk management requirements by 2015, when the sector will be liberalised even more in line with the ASEAN free trade agreement.

ACTUARIAL CAPACITY: Central to the numerous new requirements will be the role of actuaries. Already well established in the life segment, a new rule from Bapepam-LK in 2012 forces non-life underwriters to adopt an actuarial process for underwriting for the first time from 2014. The aim is to strengthen provisioning methods on the non-life side. The growing frequency of natural disasters and unexpected losses in the region has prompted a growing focus on risk management and a more prominent role for actuaries.

With a mere 180 fellows and 200 associate members of the Society of Actuaries of Indonesia (PAI), most of whom work in the life segment and other financial services industries, supply for the non-life segment is woefully inadequate. The regulator estimated in October 2012 that over 500 actuaries would be required for the insurance sector to meet new requirements. The Institute of Risk Management and Insurance and PAI launched in late 2012 a new actuarial degree in conjunction with the University of Wisconsin (Madison) to expand the sector’s human capacity.

Integrating macro-prudential oversight for all financial services industries under one roof will improve the new regulator’s visibility, once initial teething challenges are overcome. Key to successful reforms, however, will be more timely collection of statistics for the industry. Indeed there is currently up to a year time lag for publishing consolidated annual figures for the industry, blurring the timely appraisal of industry trends. The new leadership of OJK has already announced its intention to emulate the frequency of financial reporting in the banking industry, aiming to move from quarterly reporting to weekly. Despite delays in enforcing strict standards, the industry as a whole is gradually developing more resilient risk management practices.

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The Report: Indonesia 2013

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