After studying this module, you should be
able to:
- Understand why the insurance and protection
savings industry needs to be regulated
- Understand the role of SAMA
- Understand article two of the regulations
Principles and Practices of Insurance
Introduction
National economies vary from free market, open economies to state
controlled nationalised economies. However, even in the freest of free
market economies governments find it necessary to control and regulate
their insurance industry.
Insurance companies are entrusted with huge amounts of money - in
the $50 Billion to $200 Billion range in the case of the largest U.S. life
insurance companies, such as the Prudential Insurance Company of
America, Metropolitan Life Insurance Company and New York Life
Insurance Company. The insurers are thus custodians of public funds
and they have to be regulated in an effort to ensure that the public and
its funds are dealt with honestly and also to prevent the insurers from
taking unwarranted risks in the name of investments with the money
they are holding.
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Principles and Practices of Insurance
The Purpose of Regulation
The primary purposes of insurance regulation historically have been:
(1) To maintain the insurers’ financial solvency and soundness so they can
carry out their long term obligations to policyholders and pay claims.
(2) To guarantee a fair treatment of current and prospective policyholders
and beneficiaries by both insurers and the people who sell their
policies.
(3) The need to make certain types of insurance compulsory as a way of
achieving broad financial protection to the general population.
In this section, we start with a look at the background to the introduction
of regulation in the Kingdom of Saudi Arabia, why government controls
are necessary, why some classes of insurance are compulsory, and how
these issues are dealt with in the Kingdom.
6.1 - Why the insurance industry needs to be regulated?
Consumers buy insurance to protect themselves against what is generally
a small probability of a catastrophic loss, effectively transferring the risk
of any loss to an insurance company. In turn, the insurance company
spreads the risk it assumes over a large pool of policyholders, using
capital reserves to shoulder any compensation costs to policyholders
who may incur an unexpected loss.
Concepts of insurance dates back to 3000 B.C. There are several examples
of pre-Islamic history whereby families, tribes or related members
throughout the Arabian Peninsula pooled their resources as a means to
help the needy on a voluntary and gratuitous basis. These practices were
validated by Prophet Mohammad (Peace Be Upon Him) and incorporated
into the institutions of the early Islamic State in Arabia around 650 AD.
Examples of these early Islamic practices include the following:
• Merchants of Mecca formed funds
to assist victims of natural disasters
or hazards of trade journeys.
• Surety called “daman khatar al-tariq”
was placed on traders against losses
suffered during a journey due to
hazards on trade routes.
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Principles and Practices of Insurance
• Assistance was provided to captives and the families of murder
victims through a grouping known as a’qila.
• Contracts, called “aqd muwalat”, were entered into for bringing about
an end to mutual amity or revenge.
• Confederation was brought about by means of a “hilf ”, or an
agreement for mutual assistance among people.
However, it was during 1500’s to 1700’s, when more modern types of
policies began to develop for life, marine and fire insurance
The roots of Lloyds’s of London began at Lloyd’s Coffee in 1688,
where shippers and merchants would negotiate and obtain insurance
on shipping fleets and their cargo.
During the period of the British colonisation and trade with U.S. colonies,
some insurers cooperatively agreed to set reserves, in order to maintain
solvency and build public trust and confidence. This was the first major
step towards regulation, although it initially was self-regulation. Early
government regulation included reporting requirements, taxes on
insurers, and granting charters.
Later, in the 1800s, as rapid urbanisation and industrialisation took place
across Europe and America, many governments established regulations
to set standards and guard against problems of insolvency, after a number
of catastrophic fires led to insurance bankruptcies. Regulations also were
used to discourage opportunistic and financially unsound companies.
Throughout this period, governments and their regulators became
anxious about insurance policy rates that were either too high or too
low. The regulators wanted to keep the industry competitive but also
balanced. If markets and prices were too competitive, regulators believed
that low rates could be predatory and would lead to a decreased number
of insurance companies, many failing due to bankruptcy. In such cases
policyholders would suffer as there would be insufficient funds available
to pay for policyholders’ losses. On the other hand, if rates were too
high insurance companies would be seen as price-gouging by not
offering affordable rates to the masses which could lead to the public
avoiding insurance which, in turn, could impact the public well-being.
During this time period, regulators also started to become concerned
with preventing price discrimination.
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Principles and Practices of Insurance
The period following World War II through to the end of the 20th
Century saw increasing and more sophistication of regulation in the
insurance and financial sector as a whole. Largely driven by the need
for consumer protection regulation encompasses many aspects of the
industry, from robust financial requirements of insurers and reinsurers
to codes of conduct for agents and brokers.
Some economists have criticised regulation by pointing out that
efficiently working markets are the best means for consumers to get
what they want at the lowest price and highest quality. While this
may be true, regulations have been shown to be necessary in order to
protect consumers, correct market imperfections and be a backstop
for preventing a variety of harms caused to consumers. Regulations
can help consumers by providing recourse for common problems
and complaints, helping industries institute universal standards and
guidelines, and, most importantly, increasing consumer welfare.
“Competition can be depended on to keep rates from being excessive, and
good management will keep them from being inadequate; regulation of
insurance rates is an infringement on the right of management to make
business decisions.”
Do you agree or disagree with this statement? Why?
6.2 - The Historical Background of the Insurance Industry in
the Kingdom
The Control of Cooperative Insurance Companies Regulation, which
was enacted as Royal Decree No M/32 on 1 August 2003, is the first
Saudi Arabian legislation regulating insurance. While in recent years over
75 insurance operators were writing business estimated in excess of SAR
2.7 billion in the Kingdom, they were able to do so without virtually any
regulation at all. Now, this has been completely transformed. What used
to be an unregulated, free-for-all has become one of the most closely
regulated insurance markets in the region.
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Principles and Practices of Insurance
The past lack of regulation does not mean that the Saudi Arabian
government took a non-interventionist approach to the insurance
industry. Rather, its past reluctance to legislate in relation to insurance
arose from the uncertain status of insurance under Sharia’h Law. While,
for example, the prohibition of charging or paying interest is based
on clear statements in the primary sources of Islamic Law, there is no
reference to insurance in the Islamic Law texts which are regarded as
authoritative in Saudi Arabia. This is not surprising, since these texts
were compiled in the period from the 13th to 17th centuries of the
Gregorian calendar, that is, at a time when insurance was just evolving
as a business in Europe.
In Saudi Arabia, the debate of whether or not contracts of insurance are
legitimate under Sharia’h law was narrowed down to the key issue that to
profit from an insurance transaction runs counter to Islamic law, while
collective risk sharing is acceptable and in the community’s interest. This
is based on Decision No 51 of 23 March 1977 of the Supreme Council
of the Senior Ulema, a Saudi Arabian government body of religious
scholars, who ruled that cooperative (or mutual) insurance is “a form
of contract of donation”, and, because no one is supposed to profit
from cooperative insurance transactions, the Senior Ulema considered
insurance in this form to be acceptable under Islamic Law.
In 1985, the state-owned National Company for Cooperative Insurance
(NCCI) -which is now named TAWUNIA -was formed by Royal Decree
as a Saudi Arabian joint stock company, with the Public Investment
Fund, the Pension Fund and the General Organization for Social
Insurance as its shareholders. This was done in response to the Senior
Ulema’s recommendations that a cooperative insurance company should
be established in the Kingdom of Saudi Arabia to offer an alternative to
commercial insurance.
In keeping with NCCI’s articles of association, the company maintains
separate accounts for both its policyholders and for its shareholders.
Therefore, it is actually a hybrid between a true mutual insurer, which
is wholly owned by its policyholders and not traded on a stock market,
and a commercial insurer, but nevertheless sufficiently mutual to meet
the Senior Ulema’s recommendation that it should conduct its business
on a cooperative basis.
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Principles and Practices of Insurance
Although there was never a statutory prohibition of commercial
insurance in the Kingdom, the Saudi Arabian Ministry of Commerce
did not issue commercial registrations to any person or company, other
than NCCI, to conduct insurance business in the country. Yet, a fair
number of foreign-registered insurance organisations operated in Saudi
Arabia. The majority of these were Bahraini-exempt companies, that
is, companies registered in Bahrain with the express purpose of not
conducting business there. The companies’ day-to-day business in Saudi
Arabia, such as writing policies and settling claims, was done through a
local agent. In other words, the majority of insurance operators in Saudi
Arabia were foreign-based but marketing and underwriting risks within
the Kingdom.
13 ptIn accordance with the strict letter of the law, conducting any kind
of business in Saudi Arabia without holding the requisite commercial
registration is unlawful. Notwithstanding this, the Ministry of
Commerce exercised a loose supervisory function over foreign insurers
who conducted business in the country, and there certainly was nothing
clandestine in the manner in which those organisations operated.
For example, all government construction contracts contain a proviso
that the contractor must have Contractor’s All-Risks Insurance with an
insurer who is represented in Saudi Arabia, and it was quite acceptable
to insure such risks with Bahrain-based, Saudi-operating insurers other
than NCCI. Despite this pragmatic approach to a predicament created
by an interpretation of the Islamic law principles, which are relevant in
this context, having an insurance industry which is essentially offshore
and not subject to strict supervision naturally created problems.
While a handful of the foreign insurers who wrote business in Saudi
Arabia were of a blue-chip background, there were many who were
financially unsound and sometimes unscrupulous. Not surprisingly,
there were incidents of insurers collecting premiums and disappearing
overnight. Furthermore, because the business was essentially foreign,
local retention of risk and reinsurance within the Saudi market was
low, with over 70 per cent of the premiums generated in Saudi Arabia
leaving the country. Nevertheless, until quite recently, no serious effort
was made to impose real control on the Kingdom’s insurance market.
The current reforms were driven by two important changes that were
taking place within the Kingdom.
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Principles and Practices of Insurance
As insurance was an unrecognised business in the Kingdom, how did
insurers get around the problem to enable them to write business in
Saudi Arabia?
The main reasons for allowing and regulating insurance are:
1. The medical compulsory Insurance.
2. Joining the World Trade Organization.
For many years, all health-care
in Saudi Arabia has been free
to citizens and foreign residents
alike. Since there are an estimated
six million foreign workers and
their dependents in Saudi Arabia,
this clearly imposes a considerable
burden on the nation’s healthcare
system and on the economy as a whole. To alleviate the problem, the
government introduced the Cooperative Health Insurance Act, Royal
Decree No M/10 of 13th August 1999, which makes it mandatory
for employers to take out private medical insurance for their foreign
employees and their dependents.
In principle, the government could have just made private health
insurance for foreigners obligatory and left the Saudi insurance market
in its existing, disorganised state. However, the Regulation requires
that insurers providing cover under the scheme must be Saudi-
registered cooperative insurance companies. Because there was only
one entity which fulfils this requirement, namely the NCCI, the effect
of the legislation could have been the introduction of a state-owned
monopoly. However, the expansion of state-owned industry is not in
line with the overall government policy. Rather, the Saudi government
has been working to encourage an increase in the private sector’s role
in the economy as a whole not to decrease it. Additionally, setting up
the provision of health insurance to an estimated four to six million
persons within a relatively short period would have been a logistical
exercise well beyond the capacity of any single entity.
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Principles and Practices of Insurance
The second key driver to the introduction
of insurance regulation in the Kingdom
was King Abdullah’s determination to
have Saudi Arabia accede to the World
Trade Organization (WTO). A part
of the Kingdom’s agreement to join
the WTO was the opening up of its
insurance sector to foreign interests.
In truth, this is a paradox, because in
its past unregulated state the Saudi insurance market was open to all
comers, albeit not in any official basis. If one viewed the opening up
of the Saudi insurance market solely from the perspective of being
able to establish a licensed Saudi Arabian insurer, it was closed to both
foreigners and Saudis alike, since there was no framework for the setting
up of such entities, other than NCCI, of course.
World Trade Organization website: www.wto.org
So, the Control of Cooperative Insurance Companies Regulation came
into force on 20th November 2003. With the issue of the Implementing
Rules on 23rd April 2004, a new industry in the Kingdom was born.
6.3 - Regulation of Insurance in the Kingdom of Saudi Arabia
Recall from the previous section, when the decision was made for Saudi
Arabia to open its doors to insurance it was done so on the basis of the
improving the consumers’ welfare, it being in the public interest, to enable
the nation to deal with its healthcare insurance problem, and also to bring
about an open market, fairness and a level-playing field between foreign
and domestic insurance companies in line with WTO agreements.
On 30th of July 2003, the Saudi Council of Ministers passed historic
legislation opening the Kingdom’s insurance sector to foreign
investment and the Control of Cooperative Insurance Companies Law
came into force on 20 November 2003. However, the issuance of the
Implementing Rules, which were meant to be published on 21 October
2003, was delayed until 23 April 2004. Therefore, because much of the
detail of the legislation is contained in the Implementing Rules, the new
regulatory scheme did not become effective until 23 April 2004.
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Principles and Practices of Insurance
The objective of the law and the implementing Regulations we expressed
in the Article two of the Regulations:
‘Article Two’
Objectives of the law and its implementing Regulations
1. Protection of policy holder and shareholders
2. Encouraging fair and effective competition
3. Enhancing the stability of the insurance market
4. Enhancing the insurance sector in the Kingdom and provide training
and employment opportunity to Saudi nationals.’
The government regulator of the Saudi insurance sector is the Saudi
Arabian Monetary Agency (SAMA), which, since its formation in 1957,
has proven to be a successful and stringent regulator of the Saudi banking
sector. Indeed, SAMA has brought this young nation’s monetary system
well within modern standards.
SAMA website: www.sama.gov.sa
With respect to insurance, SAMA’s duties and powers are wide-ranging.
They include the preparation of the Implementing Rules of the
Regulation, licensing of insurers wishing to operate in Saudi Arabia,
and, generally, policing and control of the Saudi insurance sector. This
also includes insurance brokers, insurance agents, insurance consultants,
surveyors, loss adjusters and actuaries, all of whom must now apply to
SAMA for a licence to carry on business in Saudi Arabia. When viewed
broadly, SAMA’s insurance regulatory powers in the Kingdom includes
the following:
1. Regulations for the establishment of insurance and reinsurance
companies in the Kingdom;
2. The supervision of the technical aspects of insurance and reinsurance
companies’ operations;
3. Regulation of the distribution of surplus funds to shareholders and
policyholders;
4. Determining the capital and solvency requirements for each class of
insurance business required by companies;
5. Regulation of the companies’ investments both inside and outside of
the Kingdom;
6. Actuarial and rating approval.
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Principles and Practices of Insurance
7. Education and qualification requirements of insurance company
personnel, brokers and agents.
8. Content of policy forms.
9. Code of Conduct, insurance sales and information disclosure.
10.Contract interpretation and enforcement.
11.Compulsory purchase of insurance coverage.
Now let’s look at each of these regulatory areas in more detail and with
specific reference to the Kingdom’s legislation.
1. Regulations
for the establishment of insurance and
reinsurance companies in the Kingdom
The Regulation restricts insurance activities in the Kingdom to Saudi-
registered companies which are incorporated by Royal Decree as public
joint stock companies, with a minimum paid-up capital of SAR100
million for primary insurers, and SAR200 million for reinsurers.
Applications for licences must be lodged with SAMA, which, if the
application is approved, refers the matter to the Ministry of Commerce
and Industry for the formalities of incorporation in accordance with
the Saudi Arabian Companies Regulation.
Licensing Requirements – Insurance and Reinsurance
Companies
Before licensing, the prospective insurer or reinsurer must complete an
application and submit it to SAMA for review. The application package
should include the following:
1) Completed licensing application
2) Memorandum of Association
3) Articles of Association
4) Organisational structure
5) Feasibility study
6) Five-year business plan which must include as a minimum:
i) Classes of insurance that will be undertaken by the Company.
ii) Ability to cede or accept reinsurance treaties for classes the
Company intends to insure.
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iii)Marketing plan.
iv)Projected costs and financing to start the Company’s operation.
v) Projected underwriting growth taking into consideration solvency
margin requirements.
vi)Expected number of employees and a Saudisation plan for training
and employment.
vii) Annual costs based on projected growth rate.
viii) Projected financial statement related to the growth rate.
ix)Technical Provisions statement for the proposed growth of the
insurance operation certified by a qualified actuary.
x) Branch distribution plan in the Kingdom.
7) Any agreements with outside parties.
8) An irrevocable bank guarantee issued by a local bank for the capital
required (Such a guarantee must be renewed until the capital is paid up.)
9) A non-refundable application fee of SR 10,000 for Companies.
Licensing Requirements – Individual Insurance Professions
The regulations identify specific insurance professions requiring
licensing. These include:
• Actuaries
• Insurance agents
• Insurance Brokers
• Insurance Consultants and Advisors
• Claims or loss assessors, adjusters and claims settlement specialists
• Key Company personnel dealing with and advising the public.
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Principles and Practices of Insurance
These professionals must meet the following requirements:
1) A university degree as a minimum, and five years relevant insurance
experience, or an insurance professional designation acceptable to
SAMA.
2) Pass the examination approved by the SAMA to engage in the
qualification acceptable to SAMA.
Once the application has been received SAMA will advise the
applicant within 30 business days confirming the application is
complete or further information is required. When the application
is complete, SAMA will advise the applicant of its decision within
90 business days. Upon approval of the license a licensing fee is
required:
Insurance Companies SR 100,000
Reinsurance Companies SR 200,000
Insurance and Reinsurance Companies SR 300,000
Insurance and Reinsurance Providers
(Except Actuaries and Insurance Advisors)
SR 25,000
Actuaries and Insurance Advisors SR 5,000
The regulations also aim to ensure that companies involved in the
provision of insurance and reinsurance services, other than insurers
and reinsurers, are financially sound. As a result minimum capitalisation
requirements for these companies are required. In addition, to ensure
that the public and other industry members are protected, insurance
and reinsurance services providers have to obtain a professional
liability policy covering liability risks for negligence, wrongdoing and
dereliction of duties.
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Principles and Practices of Insurance
The minimum requirements for capitalisation and professional
liability insurance cover are given in the following table:
Type of Insurance
Service Provider
Minimum capitalisation
Requirement
Minimum Professional
Liability Cover
Reinsurance Brokerage SR 3,000,000 SR 6,000,000
Insurance Brokerage SR 3,000,000 SR 3,000,000
Claims Settlement
Specialists (Third Party
Administrator)
SR 3,000,000 SR 1,000,000
Insurance Agency SR 500,000 SR 1,000,000
Loss Assessors and Loss
Adjusting
SR 500,000 SR 3,000,000
Insurance Advisor SR 150,000 SR 500,000
Actuary SR 150,000 SR 6,000,000
2. The supervision of the technical aspects of insurance and
reinsurance companies’ operations
As well as fairly strict licensing conditions on companies and individuals,
the regulations place high, but not unreasonable, capitalisation
requirements on companies wishing to operate within the Kingdom’s
insurance sector. It is quite likely that these stringent requirements will
lead to a large-scale exodus of insurers from the Saudi Arabian market,
leaving a few well-structured and highly regulated insurance companies.
Certainly, this is the intention of the regulations. Because the legislation
requires insurers to be incorporated as public joint stock companies,
the Kingdom will see a fair number of new companies coming onto the
stock market (IPOs) within a relatively short period.
Foreign Ownership
There are no restrictions on foreign participation in insurance companies
registered under the new framework. However, full foreign ownership
of a Saudi insurance company is at present precluded, because under
the current regulations publicly traded stock may not be owned by
non-Saudi interests. Therefore, at present, foreign interests can only
participate in a Saudi insurance company as founding shareholders.
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Principles and Practices of Insurance
Neither the Regulation nor the Implementing Rules specify how much
of an insurance company’s stock must be floated, but Saudi Arabian
banks with foreign shareholders, which operate under similar principles,
have between 30 and 40 per cent of their stock traded publicly, and
there have been indications that the requirement in respect of insurance
companies will be 25 per cent.
Classes of Insurance
Insurers must be licensed by SAMA to write specific classes of
business, which are broadly grouped as general insurance (including
accident, liability, motor, property, marine, aviation, energy and
engineering), health insurance, and protection and savings insurance,
or for two or more of these, depending on the proposals put forward
by the applicant in the feasibility study and business plan, which must
be submitted with the licence application. Once a company is duly
licensed, the offering of any products in the market must be pre-
approved by SAMA.
Valuation of Investments, Assets and Technical Provisions
As far as finances are concerned, the Implementing Rules contain
detailed provisions governing investments, solvency margins, evaluation
of assets and technical provisions. Saudi insurers are required to maintain
50 per cent of their assets in Saudi Riyals, although this may be reduced
with SAMA’s prior approval. Saudi insurers may not invest more than
20 per cent of their assets outside of Saudi Arabia. Certain types of
investments, for example those in derivatives, require pre-approval of
SAMA. A company is required to have written investment and risk
assessment guidelines approved by its board.
Transnational Transactions
Under the terms of the Implementing Rules several restrictions are
imposed on transnational transactions. Thus SAMA’s approval must be
obtained before a Saudi insurer associates with non-Saudi insurance
funds. Saudi insurers, brokers and agents who wish to place cover
with Lloyd’s or non-Saudi insurance companies must obtain SAMA’s
permission. At least 30 per cent of cover must be reinsured within
the Kingdom, although this percentage may be reduced with SAMA’s
consent.
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Principles and Practices of Insurance
Reinsurance regulations
The Implementing Rules set out detailed guidelines relating reinsurance
and are particularly specific regarding the use of non-Saudi reinsurers
with who cover may be placed. Certainly, dealing with a reinsurance (or
insurance) company not licensed in the Kingdom will not be tolerated
and heavy fines will be imposed. Consumer protection is naturally the
main reason for such stringent rules. An insurer that engages treaties
outside the Kingdom must adhere to the following criteria:
1) The foreign reinsurer is licensed to transact the type of reinsurance
proposed in the Kingdom in its own country of domicile.
2) The insurance regulator of the foreign reinsurer must authorise the
exchange of relevant information with SAMA.
3) The foreign reinsurer must maintain separate records and financial
statements of all Saudi operations and these must be made available
to SAMA upon request.
4) The insurance company must provide SAMA with the reinsurer’s
latest financial statements and the latest regulatory report issued by
the reinsurer’s insurance regulatory authority.
5) The insurance company must select a reinsurer with a minimum S&P
(Standard and Poors) rating of BBB (or equivalent internationally
acceptable rating).
In addition, whether the reinsurance agreements are with foreign based
or Saudi based reinsurers, all reinsurance agreements must be filed with
SAMA.
Technical Provisions
Naturally, the Technical Provisions must be calculated in accordance
with generally accepted accounting standards and approved by the
actuary. When reporting, the following technical provisions must be
included as a minimum:
1) Unearned premium reserve
2) Unpaid claims reserve
3) Incurred but not reported (IBNR) claims reserve
4) Unexpired risk reserves
5) Catastrophe risk reserves
6) General Expense reserve
7) Reserves related to Protection and Savings insurance, such as disability,
old age, health, death, medical expenses, etc.
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Principles and Practices of Insurance
The reserves must be calculated in a specified manner as approved by
the regulations.
3.
Regulation of the distribution of surplus funds to
shareholders and policyholders
A key aspect of the introduction of regulated insurance in the Kingdom
is the cooperative nature of the industry. Therefore the regulations
require that Saudi insurers must operate on this cooperative basis. As
a model for what constitutes cooperative insurance, the Regulation has
pointed to NCCI’s articles of association, which insurance companies
registered in the Kingdom are supposed to use as a blueprint for their
articles of association.
The key to the distribution of surplus funds lies in how the net surplus
is calculated. This calculation is made in the following steps:
Step 1) Determine the Earned Premiums, and income generated from
reinsurance commissions and other insurance operations.
Step 2) Determine the Incurred Indemnification.
Step 3) At the end of each year calculate the Total Surplus representing
the difference between Step 1 and Step 2, less any marketing,
administrative expenses, the necessary technical provisions, and
other general operating expenses.
Step 4) The Net Surplus is then calculated by taking the Total Surplus
and adding or subtracting the policyholders’ investment return,
and subtracting the general expenses related to the management
of the policyholders’ investment funds.
Step 5) Once the Net Surplus has been calculated 10% of the net
surplus is to be distributed to the policyholders directly either
in the form of a direct payment or as reduction in premium for
the next year.
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Principles and Practices of Insurance
10%
20%
70%
Policy Holders
Reserve
Stock Holders
The remaining 90% of the Net Surplus is to be transferred to the
shareholders income statements. Twenty percent (20%) of the net
shareholders’ income is to be set aside as a statutory reserve until reserve
amounts are equal to 100% of the paid capital.
In addition to these rules, SAMA must approve the Company’s
calculations and net surplus distribution and timing.
4. Determining the capital and solvency requirements for each class of
insurance business required by companies
Solvency is the minimum standard of financial health for an insurance or
reinsurance company, where assets exceed liabilities. For the protection
of policyholders and the assurance of stability within the marketplace,
regulators, such as SAMA, are particularly concerned about monitoring
company solvency.
Statutory Deposits
Initially, each company must make a Statutory Deposit of 10% of the
paid up capital. If SAMA believes there to be a greater than normal
risk with the company or the type of business it is participating in, then
it may request a statutory deposit of up to 15%. The deposit must be
made within 3 months of the company’s license being issued, in a bank
designated by SAMA.
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Principles and Practices of Insurance
Asset Valuation and Solvency Margins
The principal assets of general insurers tend to be:
(1) The loss reserves.
(2) The unearned premium reserves.
(3) Investments.
For companies involved in the Protection and Savings area of insurance,
the assets are primarily accounted for by the policy reserves, which is
the insurer’s obligation to policyholder for the policyholders’ savings and
expected policy payments. The much lower capital-to-assets ratio for
protection and savings companies than general insurers (6% to 35%)
reflects the differences in the risk for the products that the two groups
sell. Variability of claims costs are much lower for protections/savings
(and health and life insurers) than they are for general insurers. As a
result, the regulations require a much smaller cushion (or amount of
capital per Riyal of assets) needed to avoid the probability of insolvency
for the protection/savings industry.
Additionally, within general insurance the riskiness of business can vary
considerably. In view of the risk differences between general insurers
and protection and savings companies, the assets of each class of
business must be considered separately.
The assets that can be included in the solvency calculation must be
related to the business of insurance. For example, if a company has
issued bonds or has assets obtained from loans, then these cannot be
included as they have non-insurance related liabilities attached to them.
The regulations provide a table of acceptable assets and the conditions
to their valuation.
Also, the Regulations demand that companies that fall below their
required solvency margins notify SAMA immediately and agree upon a
plan with SAMA to restore the margins to their approved levels within
the next financial quarter. If the margins fall significantly and the
company has not been able to restore them to the acceptable levels then
SAMA will require the company to do some or all of the following:
a. Increase the Company’s capital,
b. Adjust their insurance premiums,
c. Reduce costs,
d. Stop underwriting business,
e. Asset liquidation.
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Principles and Practices of Insurance
Furthermore, SAMA may enforce other actions and may appoint an
advisor to provide private consultation and advice to the company or
even order a cease and desist order to stop the company underwriting
business. SAMA can also withdraw the company’s license if the solvency
margin falls below 25% or the company fails to rectify its solvency
problem.
5. Regulation of the companies’ investments both inside and
outside of the Kingdom
As insurance companies are tasked with the stewardship of their
policyholders’ money, either for savings and investment or for
ensuring funds are available to cover their policyholders’ losses, it is
important that these funds are managed prudently. To help ensure wise
investment management the regulations demand that the insurance
and reinsurance companies invest these funds wisely.
Each company must have a clear, written investment policy governing
the investment policy and methods of managing their investment
portfolios. At least 50% of the company’s investments must be
invested in Saudi Riyals. And the investment policy must include
a diversification strategy, which gives consideration to the risks
faced by the company and the environment in which it operates.
Risk management of the investments is critical and the investment
diversification plan should, at a minimum, include consideration of
the following:
Risks:
a. Market risk
b. Credit risk
c. Interest rate risk
d. Currency exchange risk
e. Liquidity risk
f. Operations risk
g. Country risk
h. Regulatory and legal risk
i. Reinsurance risk
j. Technology risk
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Principles and Practices of Insurance
Within the regulations, SAMA has provided a set of investment standards
which the companies must work within. These set the limits of the
types of investment and their concentration. Specifically, companies
are not permitted to use financial instruments such as derivatives and
off-balance-sheet items, other than for efficient portfolio management
and only with SAMA’s approval.
6. Actuarial and rating approval.
The regulations require that each company appoint an Actuary who
holds that designation of ‘Fellow’, or contracts the services of an
actuarial firm with the permission of SAMA.
The actuary or actuarial firm plays an important role in maintaining the
company’s sound financial position. Indeed, the regulations provide an
outline to the duties of the actuary:
a. Obtain all required previous information from the previous actuary.
b. Examine the Company’s financial position.
c. Evaluate the Company’s ability to meet its future obligations.
d. Determine adequate risk retention levels.
e. Price the Company’s insurance products.
f.
Determine and approve the Company’s technical provisions.
g. Provide advice and recommendations related to the Company’s
investment policy.
h. Any other actuarial recommendations as he or she sees fit.
As a qualified professional, the Actuary is deemed to be professionally
liable for his/her advice and technical services provided to the Company.
The actuary is viewed by the regulations as the pivotal individual for the
supply of financial and technical information to SAMA.
7. Education
and qualification requirements of insurance
company personnel, brokers and agents.
The regulator, SAMA, also oversees the education and qualifications of
all insurance industry professionals.
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The Institute of Banking (IOB) is currently the education and training
arm of SAMA. The IOB has already been very successful in developing
professional education programs for the financial services industry in the
areas of banking, investment, banking operations and English language.
The IOB also, currently manages insurance exams for the Chartered
Insurance Institute and the Bahrain Insurance Institute. Currently, the
IOB is developing a program for training and education in conjunction
with SAMA and the major insurance companies.
IOB website: www.iobf.org
Ultimately, however, the regulations place the responsibility of ensuring
that insurance employees are trained, educated and qualified by the
companies themselves.
Also, related to this is the requirement within the regulations that the
percentage of Saudi employees be at least 30% at the end of the first
year of the company’s operation and that this percentage be increased
annually according to the Saudisation plan submitted to SAMA.
8. Content of policy forms.
The regulations have not specified the use of a standard form of policy
for each class of insurance as is often done in other jurisdictions.
However, the regulator, SAMA, must approve all of the policy wordings
used by each insurer and reinsurers. In addition, the company must
adhere to minimum coverage levels as agreed with SAMA for each class
of business.
Naturally policies must be written in such a way that they are clear
and unambiguous and can be read by the public at large. In line with
conventional policy documentation the policy schedules must contain,
at a minimum, the following:
a. The policy number,
which must also be provided in all related
documents,
b. Policyholder’s name and address,
c. The period of cover,
d. Description of coverage and limits,
e. Deductibles and retentions,
f.
Endorsements, warranties and riders,
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g. Conditions and exclusions
h. The
insurance rates, premium amounts, the basis of premium
calculation and the amount of commission paid to a broker or agent.
i. Clear identification of the property or activities being insured.
In addition, the standard text of the policy must contain the types of
coverage, general terms, conditions and exclusions. The endorsements
and riders must indicate any additional coverage, conditions and
exclusions, identifying where they change the main agreement. Also, in
line with convention, the company’s seal and signature must be printed
on the policy and attachments.
9. Code of Conduct, insurance sales and information disclosure
Consumer protection and the development of consumer confidence
in the insurance industry are critical to the spirit of the regulations.
Therefore, it is no surprise that the regulations have several Articles
which direct companies on how they should relate to policyholders to
ensure clarity and eliminate any misunderstandings regarding the policy
coverage and premium.
Communication with Policyholders
If they wish it, policyholders must be allowed to view the policy terms,
conditions and exclusions, before agreeing to the insurance contract.
Once the policy is issued the contract cannot be changed by the company
unless there is a material change in the risk. Policyholders can amend
the policy by written request and, if agreed, this must be followed by an
addendum issued by the company.
Cancellation, Denying and Non-Renewal of a policy
The company cannot cancel insurance during the policy period unless
for a reason specified in the cancellation clause of the policy. If the
company does cancel a policy it must refund any pre-paid premium on a
pro-rata basis and the policyholder must be given at least 30 days written
notice before the effective date of the cancellation. The company must
also advise the policyholder the reason for the cancellation of the policy.
If the policyholder cancels the policy before it expires then the company
may refund any pre-paid premium on a ‘short period-rate’ basis.
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The insurance must be issued without discrimination and unfair treatment.
For example, an insurance company cannot deny insurance to a person of a
certain race due to the colour of his or her skin. Neither can insurers deny
coverage to a person or company solely because of the decisions of other
companies. Acceptance and denial of insurance can only be made on the
basis of the risk and the activities surrounding the risk itself. This would,
however, include the loss history of the risk and/or policyholder. The same
factors apply to cancelling or non-renewing a policy. The insurer must
have credible reasons for cancelling, denying or non-renewing insurance.
Utmost Good Faith
The term utmost good faith is a key principle of insurance and the
regulations apply the principle of utmost good faith. In other words,
insurance contracts require that both the company and the policyholder
disclose all relevant information to each other. This principle requires
policyholders to respond truthfully to whatever questions the insurance
company asks. Also, the policyholder must disclose any relevant
information to the insurer about the risk or activities to be insured,
even if the insurer does not directly ask the question. Likewise, the
insurance company must disclose the policy wording, terms, condition
and exclusions to the policyholder before the contract is issued. This
must include a description of the basis of indemnification of the
policyholder in the event of a loss.
10. Contract interpretation and enforcement.
While it is the duty of each company to interpret the policy and settle
claims in line with standard insurance conventions, the regulations
require companies to show evidence of fairness and adhere to minimum
standards for claims settlement.
Each company must have its own claims department with procedures for
accepting, evaluating and processing claims. The company must maintain
records of each claim, whether they are paid, unpaid or rejected.
The regulations require that each company settle individual policyholders’
claims within 15 days of receiving all requested necessary documentation
related to the claim. If the case warrants an extension of an additional 15
days may be provided by the regulator. For commercial policyholders’ claims
the settlement must be made within 45 days. If this period is exceeded, the
regulator must be advised and provided with reasons for the delay.
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Companies must respond to policyholders’ complaints within 15 days.
All complaints must be registered and their outcome documented. A
semi-annual report must be prepared and provided to the regulator.
11. Compulsory purchase of insurance coverage.
The Insurance Implementation Regulations do not cover the
administration of compulsory insurance purchasing, such as automobile
insurance. However, as compulsory insurance tends to be a legal
requirement, in the case of automobile insurance, health insurance and
social insurance it is worth a short discussion.
Governments in a free market economy try not to interfere in the
workings of the market place. The basic rules of supply and demand
and a competitive environment are generally sufficient to ensure good
order. However, almost every government finds it necessary to intervene
in the insurance market place and make some types of insurance
compulsory.
Failing to insure when it is compulsory will result in a criminal offence
and punishment. Typically, a fine, which should be large enough to
deter people from avoiding buying insurance and ultimately a prison
sentence, is possible.
In society, there is a general principle that the innocent victims of accidents
should be able to receive compensation from the guilty or negligent
party who caused those injuries. It is often to support this principle that
governments make some classes of insurance compulsory.
Compulsory insurance assist innocent victims to receive compensation
in three broad areas:
Funds
If a person causes injury to another, the injured party can seek
compensation from the guilty party and states have legal systems in
place to aid this process. This process is defeated however, if the guilty
party has no funds (‘a man of straw’) or hides his funds. Governments
feel it necessary therefore to make insurance compulsory in certain cases
as a means of ensuring that there will be funds available to compensate
the innocent victim of accidents.
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Society’s Duty
In the event that no financial compensation is available the consequences
can be severe for the victim and his family. In case of death or
disablement to the family ‘breadwinner’, the family may have to rely on
other family members or charity for support. If these are not available
or inadequate, society through their government has a duty to look after
its people. Insurance will provide the necessary financial compensation
and reduce the burden on family or society.
Public Demands
In some cases there are issues that the public consider unjust, because
victims are denied access to financial compensation. Insurance is
a method to help justice by ensuring that such compensation is
available.
Recently, the Kingdom of Saudi Arabia made automobile insurance
(third party liability) and medical expenses insurance compulsory for
all drivers and residents/citizens. Why do you think the government
made these types of insurance obligatory?
Do you think that the reasons fit in to the above categories or are there
other reasons?
Automobile Insurance
In KSA, third party motor insurance has been compulsory since
November 2002. Originally, the requirement was everyone who
holds a driving licence to have Rukhsa insurance providing unlimited
indemnity for death or bodily injury to a third party and a minimum
SR5M indemnity for third party property damage. Rukhsa insurance is
linked to the driver. However, this was changed in 2006, when Rukhsa
insurance was replaced with the conventional automobile insurance
based on the vehicle at risk.
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Health/Medical Insurance
In most countries, the government is involved in providing healthcare
in some form or another. It may be supervising or nationalising health
insurance or the means of providing healthcare.
If health insurance is compulsory then the government, private insurance
companies or a combination of private and public, may provide it. The UK
has a different approach, as the government owns hospitals and provide
healthcare to citizens free at the point of delivery. The government, who
raise the revenue through taxation and national insurance contributions
pay doctors and other health service workers. Private hospitals are available
for those who are willing to pay the extra costs.
In the Kingdom of Saudi Arabia, the government requires that all
residents have medical expenses insurance. From September 2002, it
became mandatory for expatriates to have private medical insurance.
Injuries at Work
Unfortunately, accidents at work are a very common source of injuries
and could result in a great deal of litigation. To ensure that workers are
protected many governments around the world have made compulsory,
one or both of the following systems in place: a workers’ compensation
plan and/or an employer’s liability insurance contract.
Workers’ compensation usually involves the government providing a
schedule of benefits that it is compulsory for the employer to pay in the
event of injury to an employee during the course of his employment.
Sometimes, the Workers’ Compensation plan is run by the government
similar to a state-run insurance company and sometimes it is merely a
supervisor of the law. Generally, in these plans, liability is not an issue
as it is a ‘no fault’ system i.e. it is not necessary to prove fault, it is
sufficient to show that the injury occurred at work.
Compensation is the amount detailed in a schedule of benefits, typically
wages during any period of incapacity and possibly a lump sum for
certain injuries. The employer can take out an insurance policy to
indemnify him for his liability under any workmen’s compensation
rules.
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Under an employer’s liability system, (used in the UK) there is no guarantee
of benefits. An employee must prove liability i.e. that the employer is
responsible for any injury or illness. If successful, the employee can claim
any amount considered appropriate. It is compulsory for the employer
to have an insurance policy, with an approved insurer to ensure that
funds are available to meet any award. It is worth mentioning that the
courts have shown that they consider the employer’s responsibility to
be very wide.
In Saudi Arabia, GOSI regulations cover injuries at work. They provide
compensation according to a scale of benefits considered adequate
to meet the basic requirements of an average labourer. An employer
may need workers’ compensation insurance to cover work related
injuries repudiated by, or in excess of GOSI. If the GOSI benefits are
inadequate for an employee perhaps, with a large family or additional
responsibilities the employee may take legal action for additional
compensation. Employers in KSA may therefore also require full
employer’s liability insurance to give them this extra protection.
Other Compulsory Insurances
Motor vehicle accidents, injuries at work and healthcare are areas that
most countries have legislation but governments often require insurance
as part of a licensing or authorising process for particular professions.
Examples include:
• Legal and medical professions
• Insurance brokers
• Keepers of dangerous animals (zoos, circuses)
• Riding Schools
• Funfairs and Amusement Parks
Insurance is also a requirement for many contracts, which effectively
makes insurance compulsory for the contracting party. In the Kingdom,
for example, government contracts will normally stipulate that the
contractor must have a minimum insurance arrangement with their
approved insurer. Most banks will require insurance to be placed on a
house if they are financing the purchase of the home with a mortgage
loan. They may also, require that the buyer has life insurance to ensure
that the loan can be paid off if he or she dies unexpectedly.
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Principles and Practices of Insurance
Summary
The three main reasons for insurance regulation are:
(1) To maintain the insurers’ financial solvency and soundness so they
can carry out their long term obligations to policyholders and pay
claims.
(2) To guarantee the fair treatment of current and prospective
policyholders and beneficiaries by both insurers and the people who
sell their policies.
(3) The need to make certain types of insurance compulsory as a way of
achieving broad financial protection to the general population.
In the Kingdom, the current Insurance Regulations were on 1 August
2003. This brought an end to the previously unregulated industry
that was largely based outside of the country. The introduction of the
new regulations was largely driven by two factors: the introduction
of compulsory private health insurance for foreign residents, and as a
part of the agreements for Saudi Arabia to accede to the World Trade
Organisation (WTO).
The Insurance Implementation Regulations do not cover the
administration of compulsory insurance purchasing such as automobile
insurance. However, other laws require the purchase of insurance such
as automobile insurance, health insurance and social insurance.
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Principles and Practices of Insurance
Progress Check
Directions: Choose the best answer to each question.
1. The insurance sector requires government regulation in order to:
a. protect policy holders.
b. protect insurance companies.
c. protect brokers.
d. encourage fair competition between insurance companies.
2. The landmark decision that led opening the Kingdom’s insurance
sector to foreign investment was in:
a. 1977
b. 1999
c. 2002
d. 2003
3. What is the key difference between a Sharia’h recognised Cooperative
insurance company and a typical commercial insurance company?
a. Cooperative distributes profits to policyholders only
b. Cooperative distributes profits to shareholders only
c. Cooperative distributes profits to policyholders and shareholders
d. Commercial distributes profits to policyholders only
4. What were the two key drivers that brought about the introduction
of insurance as a regulated industry within the Kingdom?
a. Motor insurance and personal accident
b. Contactors all risk and medical malpractice
c. Marine and joining gulf union
d. Medical and joining the WTO
5. Which government agency is responsible for regulating insurance in
the Kingdom of Saudi Arabia?
a. The Capital Market Authority.
b. The Ministry of Banking, Finance and Insurance.
c. The Institute of Banking.
d. The Saudi Arabian Monetary Agency.
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Principles and Practices of Insurance
6. Match each type of Insurance business with the minimum required
professional liability limits:
a. Insurance Brokerage 1. SAR 6,000,000
b. Actuary 2. SAR 3,000,000
c. Insurance Agency 3. SAR 1,000,000
a. a1; b2; c3
b. a2; b1; c3
c. a3; b2; c1
d. a2; b3; c1
7. Under the Law on Supervision of Co-operative Insurance Companies,
which one of the following statements is true?
a. Insurance companies must be 100% wholly owned by Saudis with
the entire net surplus being accounted for as Retained Earnings and
/ or returned to the shareholders as dividends.
b. All insurance companies must be “co-operative”, which means that
the company is totally owned by the policyholders with the entire net
surplus being returned to the policyholders as dividends and/or kept
in the company as Retained Earnings.
c. There are no restrictions on the ownership structure of insurance
companies operating in Saudi Arabia as this would conflict with
World Trade Organisation agreements.
d. Foreign owned companies must trade at least 30% of their stock on
the Saudi Arabia stock market.
8. How much of the Net Surplus is paid to policyholders?
a. 10%
b. 20%
c. 70%
d. 100%
9. An Insurance Company, in respect to its general and health insurance
business, shall maintain a margin of solvency equivalent to:
a. The Premium Solvency Margin
b. The Claims Solvency Margin
c. The Minimum Capital Requirement
d. The highest of a), b), or c)
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