An Investigation Into The Applicability Of Risk Based Capital Method In Managing Challenges Of Undercapitalization In Zimbabwe

FACULTY OF COMMERCE

DEPARTMENT OF INSURANCE AND RISK MANAGEMENT

AN INVESTIGATION INTO THE APPLICABILITY OF RISK BASED

CAPITAL METHOD IN MANAGING CHALLENGES OF

UNDERCAPITALIZATION IN ZIMBABWEAN SHORT TERM INSURANCE INDUSTRY

BY

NDABEZINHLE THABISO TAKAZA

R115223F

A DISSERTATION SUBMITTED IN PARTIAL FULFILMENT OF THE

REQUIREMENTS TO THE BACHELOR OF COMMERCE HONOURS DEGREE IN INSURANCE AND RISK MANAGEMENT

MAY 2015

FACULTY OF COMMERCE

DEPARTMENT OF INSURANCE AND RISK MANAGEMENT

RELEASE FORM

Permission is hereby granted to the Midlands State University library to produce single copies of this dissertation and to lend or to sell such copies for private, scholarly, or scientific research only. The author reserves other publication rights; neither the dissertation nor extensive extracts from it may be printed or otherwise reproduced without the author’s written permission.

SIGNED:……………………………… DATE:…………………………

FACULTY OF COMMERCE

DEPARTMENT OF INSURANCE AND RISK MANAGEMENT

APPROVAL FORM

This serves to confirm that the undersigned has read and recommended to the Midlands State University for acceptance of a dissertation entitled,

“An investigation into the applicability of risk-based capital method in managing challenges of undercapitalization in Zimbabwe short-term insurance industry”

Submitted by Ndabezinhle Thabiso Takaza in partial fulfillment of the requirements of the Bachelor of Commerce (Hons) Degree in Insurance and Risk Management

SUPERVISOR: ………………………… DATE………/04/2015

(Signature)

CHAIRPERSON: ……………………….. DATE………/04/2015

(Signature)

Dedication

This dissertation is dedicated to the Lord Almighty, my mother Beauty Takaza and my sister

Thembelihle Takaza for their support and respect for education.

Acknowledgements

I would like to express my deep gratitude to my supervisor Mrs. Gangata whose support expertise, intellectual guidance and patience during the course of my work and throughout the period of the study. I would also like to thank Mr. Masiyiwa (chairperson) for being of great assistance despite the complicated conditions under which this research project was originating. I would like to extend my gratitude to my loving mother, sister and friends, who were there for me, gave me encouragement as well as support during difficult times at University. Lastly special mention goes to my lecturers who have been there to mold me to be what l am today, Mr.

Makaza and Miss Matsika.

God bless you all

Abstract

This research sought to investigate the applicability of risk based capital method in managing challenges of undercapitalization in Zimbabwe short-term insurance industry. The literature reviewed possible challenges being faced by insurers in adhering to rule based regulation as well as the costs and benefits of adopting Solvency II. It outlines lessons from countries that have used rule based regulation and testimonials from countries that adopted risk based capital regulation. It also highlighted that risk based capital enhances short-term insurance company’s capital allocation mechanisms and redefines their key performance indicators. To come with a sizeable sample of 11 short-term insurers out of a target population of 21 operational insurance companies, the researcher used stratified sampling technique. Since the study population comprised of insurers with different characteristics. Stratified sampling reduces bias as it allows grouping the target population so that different participants with different views are both interviewed. The researcher administered questionnaires and used personal interviews in collecting information related to the research from respondents. The results indicated that insurers are facing challenges in meeting the minimum capital requirement as well as that risk based capital can be used a tool to manage challenges of undercapitalization, however it cannot be used as a stand-alone tool but rather it is one of the tools used in determining financial solvency of an insurance company. Responses from the survey were presented using tables, bar graphs and pie charts. The study recommends that the regulator should impose a risk based capital regulation as well as modify the current regulation for short-term insurance companies so that they have the authority and legal directive to take preventive as well as corrective measures against insurers indicated by the risk based capital results in regulation insurers.

TABLE OF CONTENTS

RELEASE FORM ………………………………………………………………………………………… i APPROVAL FORM ……………………………………………………………………………………. ii

Dedication …………………………………………………………………………………………………. iii Acknowledgements …………………………………………………………………………………….. iv

Abstract ………………………………………………………………………………………………………. v List of Figures ……………………………………………………………………………………………….. x List of Tables …………………………………………………………………………………………….. xi

Chapter 1……………………………………………………………………………………………………. 1

Introduction ……………………………………………………………………………………………….. 1

1.0 Introduction …………………………………………………………………………………………. 1

1.1 Background of study …………………………………………………………………………….. 1

1.2 Statement of the problem ………………………………………………………………………. 3

1.3 Research questions ……………………………………………………………………………….. 3 1.4 Research objectives ………………………………………………………………………………. 3

1.4.1 Primary Objective ……………………………………………………………………………… 3

1.4.2 Secondary Objective ………………………………………………………………………….. 3

1.5 Significance of the study……………………………………………………………………….. 4

1.6 Delimitations ……………………………………………………………………………………….. 4

1.7 Limitations ………………………………………………………………………………………….. 4

1.8 Definition of terms ……………………………………………………………………………….. 5

1.9 Summary …………………………………………………………………………………………….. 5

Chapter 2……………………………………………………………………………………………………. 6

Literature Review ………………………………………………………………………………………. 6

2.0 Introduction …………………………………………………………………………………………. 6

2.1 Definition of concepts …………………………………………………………………………… 6

2.1.1 Minimum capital requirement …………………………………………………………….. 6

2.1.2 Capital ……………………………………………………………………………………………… 6

2.1.3 Solvency …………………………………………………………………………………………… 6

2.2The drive of regulating short-term insurance companies ……………………………. 7

2.3 Rule Based Capital Standards ………………………………………………………………… 7

3.1Challenges of adhering to Rule Based capital standards ………………………….. 7

2.4.0 Solvency II ……………………………………………………………………………………….. 9

2.4.1 Solvency II Framework …………………………………………………………………….10

2.4.2 Pillar II and Pillar III capital Management Considerations …………………….15

2.4.3 Costs associated with adopting Solvency II …………………………………………16

2.4.4 Benefits associated with adopting Solvency II ……………………………………..17

2.4.5 Solvency II and its Implications in Africa ……………………………………………20

2.5 Risk based capital ……………………………………………………………………………….21

2.5.1Challenges and Opportunities ……………………………………………………………..21

5.2Implication of Risk-based Capital ……………………………………………………….22 2.5.3Applicability of Risk-based capital ……………………………………………………..23

2.6 Summary ……………………………………………………………………………………………25

Chapter 3…………………………………………………………………………………………………..26

Research Methodology ………………………………………………………………………………26

Introduction ………………………………………………………………………………………..26

Research Design …………………………………………………………………………………26

Study Population …………………………………………………………………………………26

Sampling ……………………………………………………………………………………………27

Sampling Technique ……………………………………………………………………………27

Sample Size ………………………………………………………………………………………..28

The Research Instruments …………………………………………………………………….28

Primary Data ………………………………………………………………………………………29

3.7.1 Questionnaires …………………………………………………………………………………29

3.7.2 Interviews ………………………………………………………………………………………..30

3.8 Secondary Data …………………………………………………………………………………..31

3.8.1 Documents ………………………………………………………………………………………31

3.8.2 Journals and Publications ………………………………………………………………….31

3.8.3 Internet ……………………………………………………………………………………………31

3.9 Summary ……………………………………………………………………………………………31

Chapter 4…………………………………………………………………………………………………..32

Data Analysis and Presentation ………………………………………………………………….32

Introduction ………………………………………………………………………………………..32

Questionnaire response rate ………………………………………………………………….32

Data Analysis and Presentation …………………………………………………………….33

4.2.1 Challenges faced by short-term insurers in adhering to rule based

regulation. ……………………………………………………………………………………………….33

4.2.3 Awareness and knowledge of Solvency II …………………………………………..34

4.2.4 Readiness to adopt Solvency II framework. …………………………………………35

4.2.5 Costs of adopting Solvency II. ……………………………………………………………35

4.2.6 Benefits of adopting Solvency II. ……………………………………………………….36

4.2.7 Other benefits of adopting Solvency II in relation to setting up of minimum

capital requirements. …………………………………………………………………………………37

4.2.8 Risk-based capital method can be a solution in managing challenges of

undercapitalization of short-term insurers. …………………………………………………..38

4.3Personal interviews conducted with the regulator. ……………………………………39

4.3.2 Basis used for the calculation of minimum capital requirement for short-

term insurance companies. …………………………………………………………………………40

4.3.3 Current regulatory framework and the inclusion of Solvency. ……………….40

4.3.4 Readiness of the short-term insurance industry in relation to the

implementation of Solvency II. ………………………………………………………………….40

4.4 Summary ……………………………………………………………………………………………40 Chapter 5…………………………………………………………………………………………………..41

Conclusions and Recommendations ……………………………………………………………41

Introduction ………………………………………………………………………………………..41

Conclusions ………………………………………………………………………………………..41

5.1.1 Challenges faced by short-term insurers in adhering to rule based

regulation. ……………………………………………………………………………………………….41

1.2Short-term insurance industry awareness of Solvency II. ……………………….41

5.1.4 Risk-based capital method as a solution in managing challenges of

undercapitalization of short-term insurers. …………………………………………………..42

Recommendations ……………………………………………………………………………….42

To the regulator ………………………………………………………………………………..42

To the short-term insurance industry …………………………………………………..43

Areas of further study. …………………………………………………………………………43

Summary ……………………………………………………………………………………………44

References …………………………………………………………………………………………………45 APPENDIX 1 ……………………………………………………………………………………………..50

APPENDIX 2 ……………………………………………………………………………………………..51

APPENDIX 3 ……………………………………………………………………………………………..54 APPENDIX 4 ……………………………………………………………………………………………..55 List of Figures

List of Tables

Chapter 1

Introduction

1.0 Introduction

This chapter introduces the research. It highlights the problem to be investigated in the background of study and the statement of problem. The research questions and objectives of the study are then outlined. In addition, significance of study, delimitations, limitations and the key terms used in the study are discussed.

1.1 Background of study

The introduction of multi-currency regime in Zimbabwe affected all sectors in the economy. Policyholders lost trust in insurance companies which resulted in reduced customer base. However the Insurance and Pensions Commission (IPEC) is reforming the industry through intense regulation. All short term insurers were required to adhere to a minimum capital threshold of US $ 1.5 million stipulated by the commission before the due date which was on the 30th of June 2014 (IPEC Report, 2013). In terms of the compliance timelines insurance companies were supposed to be 50% complaint by 30 June 2013, 75% complaint by 31 December 2013 and full compliance by 30 June 2014.

According to The Herald of 3 July 2014, the Insurance Pension Commission had revealed that only 12 out of 25 operating insurance companies had complied with the minimum capital requirement of $ 1.5 million by the end of June 2014. 13 non complaint short-term insurance companies reported capital positions ranging from $ 520 000 to $ 1.49 million. On average the capital positions of the 13 insurers fell short of the minimum capital requirement by $ 390 000. Agricultural Insurance, Jupiter Insurance, Suremed Health, SFG and Horizon Insurance Company were deregistered during the quarter under review (The Zimbabwean Mail, 18 April 2014). SFG was forced to shut down by IPEC after falling insolvent. In the quarter ended 31 March 2014 total gross premium written amounted to $ 71.23 million reflecting a 6.82% increase from $ 66.68 million reported in 2013.

According to IPEC’s short-term insurance report for the third quarter ended 30 September 2014, six out of twenty four insurers reported capital positions which were below the minimum required of US $ 1.5 million. KMFS Insurance, Safel Insurance, Sanctuary Insurance, Global Insurance, Altfin Insurance and Excellence Insurance Company have failed to meet the minimum capital requirement (IPEC 30 September 2014). Their capital levels are ranging from US $ 460 028 to US $ 1.33 million and on average the capital position for the six insurers fall short by US $ 597 563 to meet the minimum capital requirement.

According to The Herald on 3 July 2014, IPEC suspended Altfin insurance company from writing new business due to undercapitalization and failure to settle claims. This followed an inspection conducted by IPEC during the quarter under review on the company which revealed that the institution’s capital position’s was worse than what they reported after disqualifying some assets which they had reported. Excellence Insurance Company was reported to have capital levels which were below the previous regulatory minimum requirement as at 30 June 2013 which was US $ 750 000 by then. In the quarter ended 30 September 2014, short-term insurance sector reported changes in volume of business written with gross premium written decreasing by 0.14% from $ 153.41 million in 2013 to $ 153.20 million in 2014. The following table shows trends in short-term insurance gross premium written between the 1st and 3rd quarter of 2014.

Figure 1.1: Trends in Short-term Insurance GPW

Source: IPEC Report 1st and 3rd Quarter 2014

The diagram illustrates trends in the GPW between two periods under review. The statistics show that companies have different underwriting capacities. In the diagram companies like Cell Insurance are underwriting more business as compared to Tristar and Heritage Insurance.

However the government is proposing a hike in the insurer’s minimum capital requirement up to $ 3 million but however this move may lead to massive retrenchments as insurance firms battle to survive (The Southern Eye, 4 March 2015).

1.2 Statement of the problem

Against the above background, to what extent can risk based capital method be used in managing undercapitalization in Zimbabwean short-term insurance industry?

1.3 Research questions

This research will answer the subsequent questions:

What challenges are being faced by short-term insurance companies in adhering to rule based regulation?

What are the costs and benefits associated with adopting solvency II in short-term insurance industry?

How applicable is the implementation of risk based capital in managing undercapitalization in Zimbabwean short-term insurance industry?

1.4 Research objectives

Primary Objective

To investigate the applicability of risk based capital in managing undercapitalization in Zimbabwean short-term insurance industry.

Secondary Objective

To identify possible challenges being faced by short-term insurers in adhering to the rule based regulation.

To evaluate the costs and benefits of adopting solvency II in short-term insurance industry.

Significance of the study

To the Researcher

The research is being carried out in partial fulfillment of the Bachelor of Commerce Insurance and Risk Management Honours Degree. The researcher will gain in depth knowledge on the area under study.

To the University

The research will provide relevant literature on the research topic that would be used by other authors and scholars to facilitate further research.

To the Industry

To highlight weaknesses that exist within the area of study and pave way for changes and improvements.

Delimitations

This research will focus on non-life insurers in Zimbabwe and will be carried in Harare where insurance headquarters with essential and necessary information are situated. The research will cover the period from January 2010 up to December 2014 and this study will be conducted as from January 2015 to April 2015.

Limitations

The following limitations may affect the depth of this study:

Time

The duration of the research would be done approximately in 4 months which is relatively restrictive. The research would be done concurrently with other semester courses. Therefore the student would have to shift some attention to other courses because of their equal importance.

Financial constraints

The student would require some money for transport to conduct some interviews and collect data from relevant players in the industry. A budget has to be set from the student’s limited pocket money to meet these financial costs in order to produce a more precise and through investigation.

Difficulties in making appointments

The student might encounter some complications in setting appointments with relevant interviewees.

Access to information

Respondents may be uncomfortable to disclose certain information regarding their business, they may consider it strictly confidential which then limits its availability in the research.

1.8 Definition of terms

Minimum capital requirement – Is the minimum level of security below which the amount of financial resources should not fall so as to ensure that financial institutions do not take on excess leverage and become insolvent.

Capital – Money invested in business to generate income.

Insolvency – This occurs when an individual or firm is unable to meet its financial obligation.

1.9 Summary

This chapter presented the topic which places a basis for the problem being investigated, the statement of problem which the researcher sets out intentions of doing the research as well as research questions which will assist the researcher in discovering solutions for the stated problem. Moreover it outlines the research objectives and the significance of the study to the researcher, university and the short-term insurance industry. However limitations and delimitations are also discussed as well as definition of key terms.

Chapter 2

Literature Review

2.0 Introduction

This chapter reviews literature from various authors on capitalization matters of short-term insurance companies. Literature review refers to an explanation of what has already been published on a topic by recognized authors and it aims at identifying gaps in knowledge as well as helps determine credibility and viability of the research by placing it in a broad framework, justifying further research. The sources of literature reviewed include published books, business journals and the internet.

2.1 Definition of concepts

2.1.1 Minimum capital requirement

McCrossan and Tomlin (2009) defined minimum capital requirement as the minimum level of security below which the amount of financial resources should not fall. Short-term insurance companies in Zimbabwe are required to have a minimum capital threshold of US $1.5 million (IPEC Report, 2014).

2.1.2 Capital

Spillance et al (2003), define capital as any economic resource measured in terms of money used by entrepreneurs and business to what they need to make their products or to provide their services to the sector of the economy upon which their operations is based. Pike and Neale (2009), define capital as funds that are invested in a company by shareholders when they purchase ordinary shares, but often used to indicate all forms of equity, and often to refer any form of finance whether equity or debt.

2.1.3 Solvency

According to Zietlow and Seidner (2007), solvency is the ability of a corporation to meet its long-term fixed expenses and to accomplish long term expansion and growth. However, Gaist and Paul (2000), argue that it is degree to which the current assets of an individual or entity exceed the current liabilities of that individual entity.

2.2The drive of regulating short-term insurance companies

According to the International Association of Insurance Supervisors (2002), the drive of regulating insurance companies is to preserve productivity, sensible, safe and steady insurance market for the benefit and protection of policyholders. Regulators are tremendously concerned on capital adequacy and solvency regimes when supervising insurance companies. In Zimbabwe, the Insurance and Pensions Commission regulates the operation of insurance companies. The principle goal of regulating short-term insurance companies is to protect policyholders. However Grace et al (2003), argues that the supervisory objective is supposed to be aimed at minimizing the social costs of insolvency. Viscusi et al (2000) mentioned that the economic foundation for regulation is based on the presence of market failure. Therefore the major substantial concern of regulators is to assist insurers in maintaining financial stability of the insurance industry.

2.3 Rule Based Capital Standards

According to Shapiro and Mathur (2014), under rule based regulation insurers are obliged to contribute similar minimum amount of capital despite the financial conditions of the company. In the United States of America, the requirements required by the sates ranged from US $ 500 000 to US $ 6 million and was reliant on the state (National Association of Insurance Commissioners). Therefore insurers had to meet the set capital requirements in order to be approved and underwrite business. However in Zimbabwe, short-term insurers are required to adhere to minimum capital threshold of US $ 1.5 million (IPEC Report, 2014).

2.3.1Challenges of adhering to Rule Based capital standards

According to Amelia (2012), the global financial crisis in 2008 highlighted the importance of having an adequate level of capital to prevent a company from becoming bankrupt. Therefore capital requirements can be in the form of regulatory capital that is capital amount required by regulators. Elizade and Prepullo (2006), argue that regulatory capital amount can be significantly different from the actual desirable capital level that is determined by sophisticated risk based capital methodology. This can lead to significantly undercapitalized companies if the companies’ actual capital is determined solely based on regulator capital.

Jackson (1999) argues that fixed minimum capital requirements can affect the real economy through reduced business activity when insurers are capital constrained. However there exist challenges in adhering to regulatory capital models.

Voluminous rules

Schmeiser and Schimit (2007) mentioned that rule-based regulation entail voluminous and detailed set of rules. Therefore it establishes a set of constraints that may not be optimal for a given insurer. This means that each and every insurer is supposed to comply with the rules that have been set in order to engage in business. However, rules are ever changing over time and it becomes a challenge for insurers to cope up with the changing rules. The Insurance and Pension Commission in Zimbabwe has been changing minimum capital requirement for short-term insurance companies repeatedly.

Inability to manage financial risk

The rule-based regulation is heavily influenced by an accounting perspective. This is reflected by measures that govern insurers’ financial structure and actions. According to Eling et al (2009) under rule-based regulation, regulators tend to focus on insurers ‘compliance with rules rather than the prudence of their management and actions as well as their overall financial risks. Therefore insurers would be concerned about achieving compliance and yet fail to manage their financial risk in doing their business.

Increased costs

Short-term insurers are faced with the challenge of high cost associated with acquiring capital. This means that insurers are worried about their capital structures and seek by all means to attain compliance. This reduces their flexibility in business as they are much concerned about meeting minimum capital requirements (Schmeiser and Schimit, 2007).

Low business confidence

Insurers are faced with a challenge of ever changing capital requirements. This will result in insurers having low confidence on their finances. Therefore low business confidence will hinder short-term insurers to expand in business as they will try to meet the required capital that is always changing (Eling et al, 2009).

However in Zimbabwe, it was realized that six out of twenty four insurers reported capital positions which were below the minimum required of US $ 1.5 million (IPEC, 30 September 2014). Amelia (2012) mentioned that undercapitalization in companies lead to business failure as companies may not have sufficient capital to meet its obligations. According to the National Association of Insurance Commissioners, fixed capital standard regime resulted in hefty company insolvencies encountered in the U.S between the 80s and 90s. Therefore it was realized that there was a need for a regime that would provide for capital adequacy standard which is related to risk and raises a safety net for insurance companies.

On the other hand short-term insurers in Zimbabwe are facing liquidity constraints and low disposable income resulting in clients taking minimal covers of insurance or no insurance at all. This can be drawn from the third quarter IPEC report for 2014, where insurers have varying GPWs. Therefore insurers are forced to acquire more capital although trends in business are very low with motor and fire being the only source of business (IPEC, 30 September 2014). Hence insurers underwriting third party insurance are obliged to have the same capital requirement of US $1.5 million similar to diversified insurance companies.

2.4.0 Solvency II

According to Christiansen and Niemeyer (2012), solvency II is the new administrative system of the European Union (EU) for insurance and reinsurance organizations. White et al (2011) argued that it is an administrative prerequisite and its aim is to guarantee financial soundness of the insurance process. Solvency II also aims to safeguard the interests of policyholders and create a stable financial system as a whole. The EU commission mentioned that Solvency II is a new regulatory framework that embraces a more dynamic risk-based approach and executes a nonzero failure framework. It also aims at contributing to the objectives of the financial services action plan in the European Union by encouraging a deeper single insurance throughout the member countries. It has a cohesive legal structure for prudential supervision for all insurance companies operating within the European Union. However this framework helps in maximizing synchronization and is consistent the banking supervision principles used in the banking industry.

White et al (2011) mentioned that the solvency II framework is similar to Basel II regulation used for the banking industry. However the two frameworks are in light of the three pillars which incorporate qualitative and qualitative requirements, market discipline as well as supervision and disclosure. Conversely, the insurance and banking industries are specifically different, therefore enactment procedure for solvency II cannot minor that of the framework used in the banking industry. The two structures represent a distinctive process, this is because they deal with distinguished business and different risks. Although similarities exist, the two structures have different requirements. Sherwood et al (2001), argues that the banking model concentrates on assets only while solvency II is a total balance sheet approach.

2.4.1 Solvency II Framework

The diagram shows the Solvency II framework:

Figure 2.4.1(a): Solvency II framework

Source: Collado et al (2011)

In pillar 1, the major concerns are the capital requirements, which are solvency capital as well as minimum capital requirement. (Piotrowska2008). Where solvency capital requirement reflects a position in capital that adsorbs unforeseen losses encountered and gives assurance of protection to policyholders. Whereas the minimum capital is designed to be a safety net and reflects the lowest capital position in which regulatory action would be triggered. The diagram below depicts the relationship between levels of capital positions.

Figure 2.4.1 (b) The relationship between levels of capital requirements

Source: Piotrowska (2008)

On the illustration technical provisions correspond to the sum put aside in order for insurers to fulfill their obligation.

Figure 2.4.1 (c) View on capital

Source: Piotrowska (2008)

On the diagram, solvency capital requirements are the amount of capital needed from shareholders and will rely upon the level of prudence. The sizes of the prudence margin and the solvency capital requirement are related. Piotrowska (2008) mentioned that the prudence margin should be calculated using a specific confidence interval for instance of 75%. However the total capital requirement represents the amount required on top of the economic value of liabilities. Therefore it should be based the on total balance sheet. Moreover it should take into account how volatility of assets and liabilities interact. Hence total capital requirements are therefore independent of the level of any prudence margin.

White et al (2011), contends that pillar 1 outlines quantitative requirements and is concerned with whether organizations are adequately capitalized with risk-based capital. The framework incorporates a balance sheet focused approach, where solvency capital consist of a series of stresses against key risks that have an effect on balance sheet components. Technical provisions are based on discounted best estimates of expected future cash flows along with assets and noninsurance liabilities. Therefore economic balance sheet becomes the foundation of solvency II reporting (KPMG Services, 2001)

In pillar 1, capital is acknowledged as own funds, therefore it begins with surplus of assets over liabilities as determined by the economic balance sheet. Hence qualifying subordinated debt is then added to own funds and the combined amount is known as basic own funds (White et al, 2011). There is an ability to apply for regulatory approval to include some forms of off balance sheet finance as incremental components of own funds. The total of the funds are classified into tiers of own funds. However limitations are used to restrict the degree to which various components of own funds can be used to meet the capital requirements. However the quantitative requirements under pillar 1 are valuation of assets and liabilities, technical provisions, solvency capital, own funds as well as investments. This can be illustrated on a diagram overleaf.

Figure 2.4.1 (d) Pillar 1 components

Source: White et al (2011)

In calculating solvency capital, organizations may decide to use either the standard formula route or internal model approach. However the use of internal model has an effect of tough standards and the regulator needs to approve organizations to calculate regulatory capital requirement using its own internal model.

Under pillar 2, the major objective is concerned with implementing standards of risk management and governance within insurance organizations. White et al (2001) argue that in pillar 2 regulators are obliged to test insurance companies on risk management issues and consider the qualitative aspects of an organization’s risk management internal control systems. Piotrowska (2008) mentioned that pillar 1 is used in conjunction with pillar 2 because not all types of risks can be adequately assessed solely through quantitative measures. Therefore it gives regulators the authority to challenge their organizations on risk management issues. Moreover it encompasses risk and solvency assessment which requires organizations to carry out their own self-assessment of the risks that they face. Therefore risk is inherent even in the operation of insurance companies hence assessments include internal dependencies that require an integrated approach to risk or solvency assessment.

Under pillar 3, great concern is placed on disciplinary effect on corporate management and transparency. The pillar defines values of disclosure on information to various stakeholders so that they obtain a full picture of an insurer’ risk (Clarke et al 2014). White et al (2011), argue that the pillar aims for superior levels of transparency for regulators and the general public. Therefore under this pillar organizations are required to create a private annual report submitted to the regulator as well as a financial condition report created to increase the level of disclosure by insurers. Insurers have to submit reports on a quarterly or annual basis and any current returns will be replaced by reports containing major information that is submitted to the regulator. This means that the overall financial position of an organization is better represented on up to date information.

However the European Insurance and Occupational Pensions Authority (EIOPA), describe the three pillars as a way of grouping Solvency II requirements. The pillars aim to promote capital adequacy, offer better transparency in the decision making process and improve the supervisory review process. This is to be attained through the adoption of a holistic approach that a focuses on better risk measurement and management, develop process and controls, and institutes an enterprise-wide governance and control structure (Collado et al 2011).

2.4.2 Pillar II and Pillar III capital Management Considerations

Clarke et al (2014) mentioned that pillar 1 in solvency II measures assets and liabilities and capital positions are considered under pillar 1. However there exist some aspects of pillar I and II that are significant from a capital management view.

Pillar II

EIOPA introduced pillar II requirements that relate to capital management (Clarke et al 2014). Therefore these requirements would not significantly change the way in which insurance companies manage their available capital. However these requirements are likely to improve governance in capital management and encourage best practices.

Therefore the requirements are captured by a system of guidelines issued for public consultation (Grant, 2014). Hence the projected guidelines require national regulation to ensure that insurers are developing a capital management policy which incorporates processes to ensure that their own funds satisfy the applicable capital regime. The guiding principle should incorporate controls on issuance of new capital instruments and lay down the approach to manage dividends and distributions.

Pillar III

In pillar III, company undertakings need to openly disclose their solvency and financial position as well as report on frequent basis. Therefore there exist a need to formulate a regular supervisory report for the regulator on an annual basis and hand in quantitative report templates on an annual and quarterly basis (Clarke et al, 2014).

2.4.3 Costs associated with adopting Solvency II

According to Canaveral and Healed (2013), insurers still have substantial work to do in order to attain compliance. Their survey indicates that there are potential pitfalls need to be addressed which are regulatory reporting process, insurer’s ability to meet Own Risk and Solvency Assessment (ORSA) requirements and data quality management. The following are the costs associated with adopting Solvency II.

Compilation of Data

In adopting Solvency II there is a need for adequate, complete and clean data. However the collection and analysis of reliable data by insurers in Africa still remains at a very low level. Oyugi and Mutuli (2013), argue that there are only few notable stock exchanges in Africa that would provide credible market data.

Regulatory authorities

There is need for regulators to put systems in place that would enhance proper management of insurance companies. This is partly attributed to a lack of adequate funding from the government.

Chauhan (2011) mentioned that in some countries, there is no independent insurance regulator. Instead insurance regulation lies as a department within Ministry of Finance, hence not given proper attention that it deserves.

Co-operation of insurers

Canaveral and Healed (2013), mentioned that many insurers operating in African market are small in size therefore there are unable to afford the costs that come with implementing Solvency II. These costs prove prohibitive to insurers in Africa who are already poorly capitalized.

Skilled resources

There is a need to train actuaries and professionals who are well placed to implement Solvency II. Therefore there are costs involved in training an actuary to qualify. However Africa suffers from brain drain, where actuaries of African origin prefer to practice in markets outside Africa. However, Bernardino (2011), argue that Solvency II is a major overhaul of valuation of balance sheet and calculation of the capital requirements. He argues that Solvency II is complex and there is a need to spend time to understand the requirements and how they will be implemented operationally. According to the Group of North American Insurance Enterprise (GNAIE), solvency II might lead to an uneven regulatory playing field leading to unfair competition. This is to say that there is no regulatory equivalence among insurers situated in different countries. Non-European companies writing the same type of business want to be treated identically from a solvency standpoint, regardless of domicile.

2.4.4 Benefits associated with adopting Solvency II

Solvency II offers various benefits that can be achieved on its implementation. These benefits range from flexibility to manage financial risks as well as creating better product pricing and design.

Product pricing and design

Insurers would now be in a position to develop new products and set equitable prices. There will be required to hold sufficient capital that would be used in backing risk features their products. Therefore insurers would be required to have a better understanding of their risks and should update the model to reflect these risks (Clarke et al, 2014).

Therefore his will make it clear which products are applicable for the insurer’s solvency positions and which are not. However from the underwriting perspective products with high volatility claims will need to be backed with more capital. Solvency II gives incentives to diversify insurance portfolios that are less dependent on long-term effects. Products with high market risk exposure may have to be redesigned or replaced. Solvency II will result in the development of products, balancing capital needs and client’s demands therefore shifting towards less capital intensive products. Solvency II is risk based and leads to alignment of pricing, risk and capital management. The design of new insurance products will take the riskreturn profile into account.

Investment Strategy

Solvency capital intensive assets classes may be replaced by less intensive instruments (Munich Re, 2014). Mismatch will be charged with solvency capital, triggering higher demand for example for fixed income instruments aligning assets with liability duration. Moreover, the clearest impact of the framework will be derived from the introduction of capital requirements for investments risks. Therefore the new capital charges for investment risk would persuade insurers to acquire less investments as compared to the previous regulations. This is to say that they will consider better investments for example increasing their shares on high rated fixed income securities (Clarke et al, 2014).

Risk transfer mechanisms

Solvency II encourages the use of all risk mitigating devices for instance the use of reinsurance. Therefore for these to be accepted as risk minimizing devices the framework requires that insurers quantify their actual contribution to risk reduction (Morgan Stanley Research Report, on 22 September 2010). Therefore the framework is likely to recognize a wider range of risk hedging and risk transfer devices than the previous solvency I framework which only allowed a consistent diminution for the use of reinsurance. Insurers will be in a position to optimize their risk transfer solutions.

Reserving

In solvency II there exist reserving risk, these are the risk that technical provisions will not be adequate and have to be backed up by a capital charge (Collado et al, 2011). Technical provisions are considered by aligning the capital requirement to the reserve or capital risk. Hence the need to feature reserves into the solvency calculations in accordance to their risk profile makes it essential to approximate the expected value and volatility of future payments. Therefore the market consistent valuation are expected to improve transparency of reserves and hence smooth the progress of understanding reserve risk. This is likely to promote sufficient reserving.

Organizational impact

Solvency II will require a more formal approach in managing the operations of organizations and decision making that necessitate insurers to reveal that risk awareness has been rooted into the structure of the organization (Clarke et al, 2014). The framework will also require more multifaceted and extensive analysis along with a more organized approach to risk management which is likely to increase the demand on actuarial and risk management functions.

Flexibility in managing financial risk

Solvency II gives insurance companies greater flexibility in managing their financial risk. Klein (2011) argues that the management of financial risk is in accordance with certain standards and regulators can employ greater discretion in taking appropriate actions against insurers that take on excessive financial risk.

The following diagram is a summary of the expected benefits of Solvency II to both the insurer and the policyholder.

Figure: 2.4.4 Solvency II expected benefits

Source: Moornman et al (2010)

On the table above, Solvency II poses benefits to both the insurer and the consumer. The insurer would experience reduced losses suffered by policyholders, reduction in costs, and increase in business confidence as well as the fact that it enables internal risk and capital assessment models. While to the consumer they will enjoy broader range of products, reduced costs of insurance and investment products as well as reduced risk of failure or default by an insurer.

2.4.5 Solvency II and its Implications in Africa

According to Chauhan (2011), the adoption of solvency II will depend on whether a country is prepared to use solvency II. Most African countries will probably go the standard formula route and not the internal model. Therefore the regulator will need to have capacity to review internal models. According to Collado et al (2011), solvency II will result in a change in the way insurance companies operate within the insurance industry. It will have a broad ranging implication on a global scale. Developments have been made in harmonizing regulations with countries in quest of achieving a framework similar to that of solvency II.

2.5 Risk based capital

According to the Society of Actuaries (2003), risk-based capital represents a sum of capital that relies on an evaluation of risks that an organization is supposed to hold in order to protect policyholders against adverse developments. It is a method of measuring the minimum capital adequate for an organization to support its overall operations in considering its size and risk profile. Standard and Poor (2002), argue that risk-based capital is used in both the banking and insurance industry. Therefore regulators and company management may each use different methods, procedures and formulas for estimating risk-based capital. However as an indicator of financial strength of a company, risk-based capital information is also of interest to customers, creditors and investors.

Risk based capital restricts the level of risk an organization can take. It requires that organization with higher levels of risk are supposed to hold large amounts of capital to back those risks. Therefore capital provides a cushion to an organization against challenges of insolvency. Riskbased capital is planned to be a minimum regulatory capital standard and not essentially the full amount of capital that an organization would want to hold to meet its obligations. According to the National Association of Insurance Commissioners (NAIC), risk-based capital is typically calculated by applying factors accounting aggregates that represent various risks to which a company is exposed. However, some of risk based capital could be determined by other methods.

2.5.1Challenges and Opportunities

Bradley et al (2015), argue that based on experience in more developed insurance markets, changes in regulation produce both challenges and opportunities for insurers. In the short run they argue that, it is anticipated that there will be more investment demand on insurance companies. Therefore insurers have the prerogative to make the best use of these investments to define long term opportunities. Dubios et al (2013) mentioned that, in Europe for example, some insurers have used Solvency II as a means to further enhance their risk management systems, capital allocation mechanisms and reporting infrastructure as well as redefine their key performance indicators. This in turn has convinced shareholders and analysts that investments due to regulatory changes should not be for mere compliance but rather as a means of enhancing competitive advantage.

The imminent implementation of the new risk based capital framework is increasing pressure on insurers in Singapore therefore there is a need to find the right focus between compliance and value for their business (Dubios et al, 2013).

Figure 2.5.1: Optimal Balance

Source: Dubios et al (2013)

The diagram illustrates the optimal balance between risk, profitability and capital. Dubios et al (2013), argue that finding such a balance is easier said than done, therefore the ultimate goal is not establishing an arbitrary relationship between risk and reward but ensuring the outcome of each risk/reward decision will yield the best results that regulatory and market constraints will allow.

2.5.2Implication of Risk-based Capital

Business Model

The implementation of risk-based capital may cause insurers to re-evaluate their portfolio of businesses, to rethink the markets they choose to compete in, and reconsider their product and distribution models (Clarke et al, 2014). These actions in turn may affect the types and amount of business that will be written in the future.

Risk based capital framework increases the level of transparency within the business making insurers better aware of their portfolio’s risk and reward profile (National Association of Insurance Commissioners). This can result in insurers withdrawing non-performing business lines and products and be more sophisticated.

Structuring

According to Dubios et al (2013), insurers may opt to change their corporate structure to improve capital efficiency and to reduce the number of regulation they are required to deal with. Cross border insurance groups will move to manage and respond to various regulatory requirements.

Governance

Currently in Zimbabwe, short term insurers are regulated by the Insurance and Pensions Commission (IPEC). However under the risk based capital framework, insurers must have an effective system of governance in place that incorporates a transparent organizational structure, a clear allocation of responsibilities and an effective system for information disclosure (KMPG Services, 2015).

Asset and liability management

Under the risk-based capital framework, decisions made regarding the assets invested in the business written should not be taken into isolation to reduce the risk of asset and liability mismatch (Clarke et al, 2014).

2.5.3Applicability of Risk-based capital

Risk-based capital requirements exist to protect firms, their investors and customers and the economy as whole. Placement of risk-based capital requirements ensure that each financial institution has enough capital to sustain operating losses while maintaining a safe and efficient market (National Association of Insurance Commissioners). The applicability of risk based capital method of regulation in the Zimbabwean short-term insurance industry can be derived from testimonials of other countries which have implemented the framework. According to the Dinnie et al (2012), insurers in South Africa are required to have assets in their country which in aggregate value are not less than the aggregate value of its liabilities plus the regulated capital adequacy requirements.

Moreover South African insurance regulators thus the Financial Services Board (FSB) have introduced a risk based solvency regime for insurers based on Solvency II (The South African Insurance Industry Survey, 2014). Since then insurance companies have been operating efficiently and productively. It was reported in December 2013 that Santam and Sanlam, insurance companies in South Africa were to enter into emerging markets partnerships focusing on expansion in these markets. However Clarke et al (2014) mentioned that implementation of risk based capital will help insurers to re-evaluate their portfolio of businesses, to rethink the markets they choose to compete in, and reconsider their product and distribution models.

According to the National Association of Insurance Commissioner (NAIC), the implementation of risk-based capital framework was driven by a series of huge business insolvencies that occurred in late 80s and early 90s in the U.S. The framework was developed to offer a capital adequacy standard that is related to risk and provides regulatory authority for timely action. However risk based capital regime can help Zimbabwean insurers in such a way that they will be regulated according to the risk they take which will result in productivity and efficiency.

The current regulation in Zimbabwe is more aligned to rule based capital standards. In the third quarter IPEC report of 30 September 2014, it was reported that there are still short-term insurance companies who are still not compliant with the minimum capital requirement of US $1.5 million. However it was further realized that short-term insurers have varying gross premium written with companies like Cell Insurance being on top and Tristar Insurance Company among other with significantly low gross premium written for the quarter under review (IPEC, 30 September 2014).Nevertheless these companies experience different risks in underwriting their business. Therefore the proposed minimum capital requirement by IPEC is not equitable to short-term insurers in Zimbabwe. Hence risk based capital regime would be a better solution for undercapitalization in short-term insurance industry in Zimbabwe. Risk based capital framework will therefore enhance short-term insurance companies’ risk management systems capital allocation mechanisms and redefine their key performance indicators (Dubios et al, 2013).

2.6 Summary

This chapter reviewed literature by reputable authors and scholars and their views on Solvency II and Risk-based capital framework for regulating short-term insurers. Literature on how other regulators in other countries implement risk based capital was reviewed in this chapter. Most authors sported the idea of risk based capital framework in regulating short-term insurers.

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Chapter 3

Research Methodology

3.0 Introduction

This chapter discusses the research design and methodologies that were used to collect data and it presents a detailed description of research instruments, sources of data, sampling techniques and the procedure applied in conducting the research.

3.1 Research Design

Research design is a structure which channels a researcher in the course of collecting data, examining it as well as its interpretation (Keith et al, 2007). It is a framework that is used for the collection, measurement and analysis of collected data (Cooper and Schindler, (2003). Collis and Hussey (2009), argue that determining a research design will give a detailed plan which one will use to guide and focus his research. Designing a research helps the researcher in planning and implementing the study in a way that will help the researcher to obtain intended results (Burns and Grove, 2001). A descriptive research was used in this study because it presents an opportunity to fuse both quantitative and qualitative data. In this survey, questionnaires were administered to collect information from respondents on their views in relation to the applicability of risk based capital method in managing challenges of undercapitalization in Zimbabwean short-term insurance industry.

3.2 Study Population

Cooper and Schindler (2003) define a population as a universe of objects whose attributes or factors are to be investigated. The study population is also defined as a precisely defined body of people or objects under consideration for statistical purposes (Collins and Hussey, 2009).

The target population for this research consists of the Insurance and Pension Commission (IPEC) and 21 operational short-term insurance companies following the deregistration of Altfin, KMFS and Global Insurance Company (The Financial Gazette, 17 March). In this research finance managers were targeted respondents of the operational non-life insurance companies. This is because they are knowledgeable of the capital positions of their companies and they are involved in decision making of the overall operations of their companies.

However, a sample representative of the population was selected as the researcher could not collect data from the whole population due to financial constraints and limited time.

3.3 Sampling

Adams et al (2007), explain sampling as the procedure or method of selecting an appropriate sample for the purposes of establishing characteristics of the population under study. Kothari (2004) defines sampling as the selection of part of a collective totality on the basis of which judgment or inference about the aggregate or totality is made.

3.4 Sampling Technique

Random Sampling Method

Random sampling is broken down into four basic methods. Simple random sampling is a technique which ensures that each aspect of the population under study has an equal chance of being chosen to become part of the representative sample (Allison, 2011). Systematic sampling is done when elements are elected from a population using a uniform interval. Stratified sampling involves dividing the population into strata with each stratum having comparatively uniform elements. Stratified sampling is used when the population is assumed to consist of a number of smaller subgroups or sub populations such as male or female, which are thought to have an effect on the data to be collected (Sekeran and Boagie, 2009). Cluster sampling involves splitting the population into group called clusters and is usually used when the population covers an area that can be divide by regions.

Non Random Sampling

Non random sampling involves the selection of participants irregularly from a list of the entire population, which involve random selection through the use of random number tables (Langdridge, 2004). Non random sampling can be carried out through four different ways which are snowball, quota, judgmental and convince sampling. Allison (2001) mentioned that snowball sampling entails identifying one or more individuals from the population of interests and the using these participants as informants to identify further members of the group. These participants are then used to identify further contestants and so on until you have enough people in your sample. Langdridge (2004), described convenience sampling as one of the commonest approaches to sampling but probably the worst as it does not produce representative findings.

Sample Size

Saunders et al (2007), argue that a sample size is determined based on a 95% confidence interval. However Langdridge (2004) mentioned that there is no simple figure, but the rate will vary depending on which statistical technique is being used to analyse your data. According to Haralambos and Halbon (1990), a sample size should be more than 33% of the target population.

In this study the researcher used stratified sampling. The target population was divided in stratus, this is because the target population comprised of companies with different characteristics. Therefore for the purposes of this study the researcher used 50% per stratum. Stratified sampling gives equal chance of selection from a given stratum or a group of population and it also reduces bias as it allows grouping the target population so that different participants with different views are both interviewed. The researcher used a sample of 12 respondents which is 54% of the target population. Respondents comprised of finance mangers as well as the regulator. This is because they are knowledgeable on the capital positions of their organizations and they are involved in decision making of the overall operations of their companies.

The Research Instruments

Pierce (2009) argues that a research instrument is a survey designed to measure variables, characteristics or information of interest. Data collection instrumentation such as surveys and interview guides must be identified and described. Data collection steps comprises of the limitations for the study, collecting information through unstructured or semi-structured observations and interviews, documents and visual materials as well as establishing the protocol for recording information (Creswell, 2009).

Primary Data

According to Lancaster (2005), primary data are facts used in research originally obtained through the direct efforts of the researcher through surveys, interviews and direct observation.

Primary data used in this research are questionnaires and interviews.

3.7.1 Questionnaires

Corporate Research and Consultation Team (2008), argue that a questionnaire is a tool for collecting and recording information about a particular issue of interest. It is mainly made up of a list of questions, but should also include clear instructions and space for answers or administrative details. Questionnaires were administered to selected short-term insurers and were delivered by the researcher in person for collection at the dates agreed with respondents; affording respondents time to give objective and well thought responses.

Advantages of Questionnaires

The researcher is able to contact large numbers of people quickly, easily and efficiently using questionnaires since all he has to do is identify the group that will be targeted and give them the list of questions.

A questionnaire is easy to standardize. For example, every respondent is asked the same question in the same way. The researcher therefore can be sure that everyone in the sample answers exactly the same questions, which makes this a very reliable method of research.

Respondents are able to complete postal questionnaires in their own time and telephone call backs can be arranged for a more convenient time.

Questionnaires are relatively quick and easy to create code and interpret especially if closed questions are used.

Disadvantages of Questionnaires

(a) The format of questionnaire design makes it difficult for the researcher to examine complex issues and opinions. Even when open ended question are used, the depth of answers that the respondent can provide tend to be more limited than with almost any other method of research. (b) Where the researcher is not present, it’s always difficult to know whether or not a respondent has understood a question properly.

Response rates can be low especially in postal questionnaires and refusal rates high in telephone administered questionnaires.

Questionnaires are time consuming for respondents, more costly and more labour intensive than other methods.

3.7.2 Interviews

These are conversations initiated by the interviewer for the specific purpose of obtaining relevant information (Panneerselyam, 2005). Personal interviews can be structured, formally with a set series of questions or unstructured, informally as casual conversations. This requires good interpersonal skills to build some trust and confidence from the respondents so as to get unbiased responses.

Advantages of Interviews

The risk of receiving improper information is low because the interviewer can always ask follow up questions to confirm what is used.

Interviews permit the respondent to express himself freely and the interviewer can also benefit from non- verbal communication.

Interviews are time effective.

Disadvantages of Interviews

The significant drawback of the interview is the presence of the interview’s influence. This may influence the manner in which questions are going to be answered.

Interviews prove to be expensive in terms of transportation.

Good interpersonal skills are needed to build some confidence and trust in the respondent.

3.8 Secondary Data

Secondary data relates to information that already exist in some form of documents, journals and publications. It can be categorized into unprocessed and complied secondary data. Unprocessed data is that which little has been done, while complied secondary data is that which has received some degree of selection and summarizing (Lancaster, 2005).

Documents

Documents are of great essence as a form of research. Therefore the researcher can trace opinion, beliefs and assertions through documents that are written by different authors (Blaxter et al, 2001). Documents were used in this research as European insurers are advanced in literature pertaining this topic.

Journals and Publications

Various professional journals were consulted in coming up with the research. These publications enlighten the researcher on the background of solvency study. They also gave hints into what other scholars in insurance and related fields have done as far as solvency is concerned.

Internet

The university came in handy by allowing the researcher to carry out his research through access to internet in the library. The advantage that internet provided to the success of the research was its ease of access and the ability to screen out unnecessary data. The internet also helped in providing some of the recently researched data that the library could not have.

3.9 Summary

The chapter only concentrated on summarizing the various methods used to gather the data used for the research. These range from primary to secondary data, in which secondary data was mainly consulted on the literature review and primary data analysis which forms the next chapter.

Chapter 4

Data Analysis and Presentation

4.0 Introduction

This chapter presents an account of the findings and analysis of the study on a concept by concept basis. Findings are analysed in relation to the suggestion set out at the beginning of the study. As set out in chapter three, data was drawn from questionnaires and personal interviews. Quantitative data was presented in the form of tables and graphs whereas qualitative data from open ended questionnaires was thematically analysed.

4.1 Questionnaire response rate

According to De Vaus (2002) response rate is a measure of how many people sampled, actually completed the survey expressed as a percentage from zero to hundred. It is habitually assumed that the higher the response rate the more reliable are the results of the sample. A total of 12 questionnaires were distributed in the data collection stage of the research to the chosen sample of the study as set up in chapter 3. Out of these 8 were returned, thereby representing a 66.67% response rate. The response rate in illustrate in diagram below.

Table 4.1: Response Rate

Source: Primary data

4.2 Data Analysis and Presentation

4.2.1 Challenges faced by short-term insurers in adhering to rule based regulation.

The researcher probed the above mentioned question in order to know the number of short-term insurance companies that have faced challenges of adhering to rule based regulation. The pie chart overleaf (figure 4.2.1) depicts the data on short term insurers that have faced challenges of adhering to rule based regulation. 75 % of the respondents faced challenges of adhering to rule based regulation whereas 25% of the respondents did not. The researcher learnt that the main problem with rule base regulation is that it does not give insurers an incentive to properly manage the risks that they take on. Respondents mentioned that holding regulatory capital may not be an issue for huge insurers but for the smaller players, it puts pressure on the company’s board of directors to attain a respectable return on the capital from their shareholders.

Figure 4.2.1 Short-term Insurers that have faced challenges of rule based regulation

Source: Primary data

4.2.2 Solutions implemented to deal with rule based regulation challenges.

The researcher designed this question to find out strategies that they use to deal with challenges of adhering to rule based regulation. Respondents mentioned that perpetually changing capital requirements are their biggest challenge. Therefore they have to acquire more capital in order to meet with the ever changing capital requirement. Respondents mentioned that they use convertibles, bonds, and sale of stock in order to raise capital so that they meet the capital required.

4.2.3 Awareness and knowledge of Solvency II

All respondents are aware of the new regulatory system with varying degrees of knowledge of the framework, in which only 80% of the respondents have a standing knowledge of Solvency II. A considerable number of finance managers were able to outline the aim of the Solvency II regime that is to ensure financial soundness of insurance undertakings. Moreover, respondents were able to outline that the new solvency rules stipulate that the minimum amounts of financial resources that insurers must have in order to cover the risks to which they are exposed. The diagram overleaf illustrates the awareness and knowledge of solvency II regime.

Figure 4.2.3 Awareness and knowledge of Solvency II

Source: Primary data

4.2.4 Readiness to adopt Solvency II framework.

The researcher asked this question to determine the preparedness of insurers in relation to adopting of Solvency II. Most organizations are prepared to use the new Solvency II regime. In the research 80% of the respondents mentioned that they are prepared whereas 20% of the respondents said that they are still not. During the survey the researcher observed that small organizations are the ones which are not yet prepared to use the Solvency II framework. However insurance giants such as Old Mutual have developed programmes for the adoption of the Solvency II framework. The diagram overleaf illustrates the preparedness of short-term insurers to use Solvency II.

Figure 4.2.4 Preparedness to use Solvency II

Source: Primary data

4.2.5 Costs of adopting Solvency II.

The question sought to find out the costs that are associated with adopting Solvency II. 62.5% of the respondents strongly agreed that for the successful adoption of Solvency II there should be compilation of adequate, complete and clean data. Whereas 37.5% of the respondents agreed to the described cost of compilation of data. Establishment of systems, 25% of the respondents strongly agree whereas 75% agree that there is need for regulators to put systems in place that would enhance proper management of insurance companies. Formation of co-operations, 12.5% strongly agree, 75% agree and 12.5% of the respondents are unsure of the need to form cooperations among short-term insurers. Training, 75% strongly agree whereas 25% agree that there is need to train actuaries and industry professionals. In the survey, respondents also highlighted that adopting Solvency II can pose challenges to the Zimbabwean insurance industry.

The diagram overleaf shows findings of the costs associated with adopting Solvency II.

Figure 4.2.5 Costs of Adopting Solvency II

Source: Primary data

4.2.6 Benefits of adopting Solvency II.

The researcher probed about the benefits of adopting Solvency II. Internal risk and assessment models, increase in flexibility in managing financial risk, increase in confidence in managing financial stability of the insurer as well as better product and design were structured benefits described by the researcher in which respondents were supposed to agree or disagree depending on their knowledge. Internal risk and capital assessment models, 25% strongly agreed whereas 75% of the respondents agreed that Solvency II enables internal risk and capital assessment models. Flexibility in managing financial risk, 87.5% of the respondents strongly agreed whereas 12.5% agreed that solvency II increases flexibility in managing financial risk. Confidence and stability, 37.5% of the respondents strongly agreed whereas 62.5% agreed that Solvency II increases confidence in financial stability of the insurer. Better pricing product, 12.5% of the respondents strongly agree, 75% agree whereas 12.5% are unsure that Solvency II enables better product pricing and design. The diagram overleaf shows a pictorial representation of the findings.

Figure 4.2.6 Benefits of adopting Solvency II

Source: Primary data

4.2.7 Other benefits of adopting Solvency II in relation to setting up of minimum capital requirements.

The researcher asked this question to find out other benefits that can be derived in adopting Solvency II in relation to setting up minimum capital requirements. In the survey, one respondent mentioned that Solvency II gives the insurer a chance to demonstrate to the regulator that it need not hold excessive amounts of capital to back its liabilities.

However, the insurer can either show that it has sufficient reinsurance or that its overall business risk is properly diversified thus lowering the need to hold too much capital.

4.2.8 Risk-based capital method can be a solution in managing challenges of undercapitalization of short-term insurers.

The researcher asked this question to find out what the respondents think in relation to risk-based capital method as a solution in managing challenges of undercapitalization of short-term insurers. Therefore 90% of the respondents agreed with that risk based capital can be used as a solution whereas 10% were in disagreement. However, respondents emphasized that risk-based capital restricts the amount of risk an insurer can take and requires an organization with higher amounts of risk to also hold higher amounts of capital. The diagram overleaf illustrates what the respondents think in relation to risk based capital.

Figure 4.3.8 Risk based capital method as a solution in managing undercapitalization

Source: Primary data

4.3Personal interviews conducted with the regulator.

The researcher conducted a structured interview with an interviewee form Insurance and Pensions Commission (IPEC). The Insurance and Pensions Commission regulates short-term insurance companies by enforcing minimum capital requirements in order to make sure that insurers hold enough capital to meet their obligations.

4.3.1Reasons why short-term insurance companies fail to meet the minimum capital requirement.

The researcher learnt various reasons why short-term insurers fail to meet the minimum capital requirement. Rate undercutting, poor returns on investments, premium debtors, lack of shareholder participation as well as lack of product innovation are the reasons that were highlighted by the respondent. Respondent mentioned that the above mentioned reasons results in companies charging inadequate premiums which affects the insurer’s capacity to reserve adequately for future claims and they result in financial instabilities.

4.3.2 Basis used for the calculation of minimum capital requirement for short-term insurance companies.

The researcher asked this question to find out the current method which is being used by the regulator in calculating the minimum capital requirement. However the respondent mentioned that balance sheets of registered short-term insurers are considered and then they set an average minimum capital requirement for the registered insurers.

4.3.3 Current regulatory framework and the inclusion of Solvency.

The respondent mentioned that the current regulatory framework in Zimbabwe can be merged with the provisions of Solvency II. He mentioned that it can be made possible if fixed capital adequacy requirements is set arbitrarily by the regulator and insurers voluntarily undertake their own risk and solvency assessment. .

4.3.4 Readiness of the short-term insurance industry in relation to the implementation of Solvency II.

The respondent mentioned that implementing pillar 1 of Solvency II in Zimbabwe would be very difficult undertaking due to lack of experience and poor data collection systems of most insurers. However he also mentioned that pillar 2 and 3 aspects can be implemented with minimal difficulty. Therefore in terms of preparedness in the industry, it was learnt that it would take some time for Solvency II to be implemented because of the high costs that are associated with adopting such a framework.

4.4 Summary

The chapter outlined the findings from primary research conducted by the researcher. Tables, bar graphs and pie charts were used to present the findings in a coherent and easy to understand manner. The researcher used qualitative analysis to analyze quantitative data especially where views and opinions were the subject matter.

Chapter 5

Conclusions and Recommendations

5.0 Introduction

In this chapter, the entire research project is summarized, conclusions based on the study are drawn, and recommendations are given in line with the research findings.

5.1 Conclusions

The following conclusions can be drawn from the research findings:

5.1.1 Challenges faced by short-term insurers in adhering to rule based regulation.

Short-term insurers face challenges in adhering to rule based regulation. These challenges include voluminous rules and ever changing regulations. In this form of regulation insurers are required to hold certain amounts of capital, thus regulatory capital. However holding regulatory capital may not be an issue for huge insurers but for small players, it puts pressure on the company’s board of directors to attain a respectable return on the capital from their shareholders. Therefore this results in reckless risk taking which not only endangers the insurance company itself but also has knock-on effects on the industry as a whole as policyholders lose faith

5.1.2Short-term insurance industry awareness of Solvency II.

The researcher learnt that the issue of solvency II is well known subject within the insurance industry. Managers from different short-term insurance companies have got some standing knowledge on the operation of the Solvency II framework. Respondents that were part of the research showed knowledge on the subject as they mentioned the aims, costs as well as benefits of Solvency II.

5.1.3 Costs and benefits of adopting Solvency II.

The implementation of Solvency II presents costs and benefits to the short-term insurance industry. Compilation of data, establishment of systems, formation of co-operations and training programmes are the costs associated with adopting Solvency II. Whereas better product pricing, confidence in financial stability and flexibility in managing financial risks are the benefits that arise from adopting Solvency II.

Therefore when adopting Solvency II, the short-term insurance industry and the regulator need to consider the costs as well as benefits of the framework for it to be successfully implemented.

5.1.4 Risk-based capital method as a solution in managing challenges of undercapitalization of short-term insurers.

In the researcher, most of the respondents agreed to the fact that risk based capital can be used as a solution in managing challenges of undercapitalization. Risk based capital represents an amount of capital based on an assessment of risks that a company should hold to protect customers against adverse developments. However it can concluded that risk based capital is not designed to be used as a stand-alone tool in determining financial solvency of an insurance company, rather it is one of the tools that give regulators legal authority to take control of an insurance company.

5.2 Recommendations

The following recommendations are made based on the above conclusions.

5.2.1 To the regulator

Modify the current regulation for short-term insurance companies

The regulator can incorporate an own risk and solvency assessment (ORSA) model in the current regulation. This is because own risk and assessment model is an excellent process for capturing and addressing risks long before they crystallize. Compared to retrospective solvency assessments being conducted in the insurance sector today, ORSA ensures the continued growth and security of the insurance sector. Therefore such a model may be all we need to restore consumer confidence in the insurance industry. Additionally a merger of the current regulation and ORSA model will bring about productivity and efficiency in the industry.

The regulator should adopt a risk based capital based regulation

The regulator can implement a regulatory framework which is similar to solvency II or SAM which is being used in South Africa. In risk based capital system regulators have the authority and legal directive to take preventative as well corrective measures that vary depending on the capital deficiency indicated by the risk based capital results when monitoring the performance of insurance companies.

Therefore these preventative and corrective measures are designed to provide for early regulatory intervention to correct problems before insolvencies become inevitable thereby minimizing the number and adverse impact of insolvencies.

5.2.2 To the short-term insurance industry

Short-term insurers should create effective risk management systems

Short term insurers should also play a part if ever the risk based method is to be adopted. Insurers are supposed to establish effective risk management systems within their organizations. These systems should include strategies, processes and reporting procedures to monitor and manage as well as report the firm’s risk continuously. Therefore when the risk based method is implemented, insurers will be in a position to conform to the new framework.

Establishment of work programmes

Short-term insurers should establish work programmes for the implementation of risk based capital method. The new regime will have various implications on the various functional departments, as such management should establish a programme to equip their employees to accommodate the new regime in their operating systems.

Initiate product development

Short-term insurers are supposed to improve on their products that they offer using product development. This is done in order to increase profits so that they increase their capital through internally generated funds.

Areas of further study.

There is need for further research on cost minimizing strategies for successful implementation of Solvency II in Africa.

Summary

This chapter drew conclusions from research findings. It was concluded that short-term insurers are facing challenges in meeting the minimum capital requirement because insurers are required to hold certain amount of capital. However it was revealed that it is not an issue with huge insurers but poses a threat to small players. Moreover it was concluded that risk based capital can be used as one of the tools of managing challenges of undercapitalization.

References

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APPENDIX 1

MIDLANDS STATE UNIVERSITY

P. BAG 9055, Gweru.

TEL: (263) 54 227411

FAX: (263) 54 260442

FACULTY OF COMMERCE

DEPARTMENT OF INSURANCE AND RISK MANAGEMENT

To Whom It May Concern:

Dear Sir/Madam

Ref: Request for information needed for research

My name is Ndabezinhle Takaza (Registration Number – R 112 223 F), l am a student at [anonimizat] University studying a Bachelor of Commerce in Insurance and Risk Management

Honours Degree. I am currently undertaking a research project for my final year entitled “AN

INVESTIGATION INTO THE APPLICABILITY OF RISK BASED CAPITAL METHOD IN MANAGING CHALLENGES OF UNDERCAPITALISATION IN ZIMBABWEAN SHORT TERM INSURANCE”.

To this end, I intend to collect data by use of the attached questionnaire. All information you provide will be treated with strict confidentiality and used solely for academic purposes

.

Should you require more details about the researcher, you are free to contact the chairperson of the Department of Insurance and Risk Management, Mr. S.Masiyiwa on his email [anonimizat] or mobile number 0772 754 721.

Your co-operation will be strongly appreciated Yours sincerely

…………………………………..

Takaza Ndabezinhle T 0772 117 330

[anonimizat]

APPENDIX 2

A QUESTIONNAIRE FOR SHORT-TERM INSURERS

Tick where appropriate

Have you ever faced any challenges in adhering to rule based regulation?

Yes No

If you have answered YES above, to what extent has it affected your organization?

(i) Greater extent (ii) Moderate extent (iii) Lesser extent

(iv) Not at all

If you have answered (i), (ii) or (iii), what challenges have you faced in adhering to rule based regulation?

………………………………………………………………………………………………

………………………………………………………………………………………………

………………………………………………………………………………………………

………………………………………………………………………………………………

What solution has your organization implemented to deal with the challenges?

………………………………………………………………………………………………

………………………………………………………………………………………………

………………………………………………………………………………………………

………………………………………………………………………………………………

Are you aware of the Solvency II framework?

Yes No

If your answer is yes, please give brief details.

………………………………………………………………………………………………

………………………………………………………………………………………………

………………………………………………………………………………………………

………………………………………………………………………………………………

Is your organization prepared to use Solvency II framework?

Yes No

What do you think are the costs of adopting Solvency II?

It requires compilation of data.

Strongly agree Agree Disagree Strongly disagree Unsure

There is need for regulators to put systems in place that would enhance proper management of insurance companies.

Strongly agree Agree Disagree Strongly disagree Unsure

There is need to form co-operations among short-term insurers.

Strongly agree Agree Disagree Strongly disagree Unsure

There is need to train actuaries and industry professionals.

Strongly agree Agree Disagree Strongly disagree Unsure 8) What do you think are the benefits of adopting Solvency II?

It enables internal risk and capital assessment models.

Strongly agree Agree Disagree Strongly disagree Unsure

Increases flexibility in managing financial risk.

Strongly agree Agree Disagree Strongly diagree Unsure

Increases confidence in financial stability of the insurer.

Strongly agree Agree Disagree Strongly disagree Unsure

It enables better product pricing and design.

Strongly agree Agree Disagree Strongly disagree Unsure

What do you think are other benefits of adopting Solvency II in relation to setting up of minimum capital requirements?

…………………………………………………………………………………………….

………………………………………………………………………………………………

………………………………………………………………………………………………

………………………………………………………………………………………………

Do you think risk-based capital method can be a solution in managing challenges of undercapitalization of short term insurers?

Yes No

If yes, please give brief details of your answer

………………………………………………………………………………………………

………………………………………………………………………………………………

………………………………………………………………………………………………

APPENDIX 3

Interview Guide for Short-term Insurers

Have you ever faced any challenges in adhering to rule-based regulation?

What are the challenges that you have faced in adhering to such a regulation?

What solutions has your organization implemented to cater for these challenges?

Are you aware of the Solvency II regulatory framework?

What do you think are the costs of adopting Solvency II?

What do you think are the benefits of adopting Solvency II?

Do you think risk-based capital method can be a solution in managing undercapitalization of short-term insurers?

APPENDIX 4

Interview Guide for the Regulator

What might be the reasons why short-term insurance companies fail to meet the minimum capital requirement?

What basis is used for the calculation of minimum capital requirement for short-term insurance companies?

Does the current regulatory framework allow for the inclusion of Solvency II?

How prepared is the short-term insurance industry in adopting the Solvency II framework?