A search for a supervisory framework: The risk-based supervision

The Office of Technical Assistance (OTA) of the US Department of Treasury, in a project that started in 2017, has granted the Insurance Commission technical assistance for the possible adoption of risk-based supervision in the Philippines. The US resident insurance advisor in the Philippines is Russell Lamb.

Insurance supervision in the Philippines has traditionally been a compliance-based (or rules-based) supervision. Meaning, insurers must comply with a set of prudential rules generally written into the law or the subordinate legislation, which, in the case of the Philippines, are the rules and regulations called circular letters. Noncompliance with these rules, requirements and directives are met with penalties. Recently, however, with a series of financial and regulatory failures around the world in mind, a “relatively new approach in insurance supervision” called risk-based supervision (RBS) has emerged with its roots emanating from the banking and pension supervision. In Asia, the Hong Kong Monetary Authority, for example, adopts this in the regulation of the banking industry. It probably started in the 1990s. In the US, the Office of the Comptroller of the Currency introduced a “risk-based approach” to supervision in 1996.

RBS has been described as an “innovation” in financial regulation and “interventionist.” RBS is a comprehensive, formally structured system that assesses risks within the financial system, giving priority to the resolution of those risks.

RBS requires supervisors to review the manner in which insurers are identifying and controlling risks. In other words, the aim is to capture an insurer’s risk profile (identify emerging risks) and to address them early. This is done through a risk-scoring model. It requires supervisors to assess system and individual firm risk and to respond with the supervisor’s own processes and interventions in line with the assessment. RBS involves supervisors assessing four factors: inherent risk, controls, residual risk and additional support. Tony Randle summarizes the entire concept: “A risk-based supervision approach assesses the probability and severity of the material risks to which insurers are subject; it assesses the effectiveness of the controls in reducing the probability of risk events occurring or the severity if they do occur. It further considers what the insurer has in place to deal with an event occurring even though the controls are in place and are functioning properly. The risk of failure can be approximated as the combination of all the risks [being the product of the probability of an event happening and the severity if that event happened] less the value of the additional support.” The possible adoption of RBS would find statutory support in Section 189 of the Amended Insurance Code, which states: “The main purpose of the statutory statements is to present important information about the level of risk and solvency situation of insurers.”

Russell Lamb stated that RBS “entails policy and implementation orientation toward identification of activities and practices that are of greatest risk to the soundness and the safety of an individual insurance company and the financial system as a whole.”

He adds, “RBS focuses on qualifying problems by identifying system flaws and poor management practices that cause both current and potential problems. Where problems are deemed to be significant, the regulator may employ transaction analysis to quantify them in order to determine more precisely to what extent capital and liquidity are at risk and to prescribe appropriate remedies. RBS places strong emphasis on understanding and assessing the adequacy of each company’s risk-management systems which are in place to identify, measure, control and monitor risk in an appropriate and timely manner. It is an ongoing process whereby the risks of an insurance company are assessed and determined appropriately.”

Risk-based supervision has been described as “dynamic,” requiring more engagement from the supervisor. It requires “extensive use of judgment.” Consequently, a dialogue with supervised entities is unavoidable. Thus, it requires greater understanding and anticipation of the possible risks. While compliance-based supervision (CBS) relies on the written rules which the insurer must observe, RBS is focused on principles. Specifically, the interplay between risks and capital: The higher the risk profile of an insurer, the higher the capital it must hold.

Central to RBS is risk-assessment capability of the financial examiners of the Insurance Commission as well as awareness of the controls that need to be put in place, both of which are subjective. In other words, supervisory judgement. Risk assessment is proposed to be part of a quarterly analysis program. It is proposed that among the risks to be examined include strategic risks, governance risks, legal risks, liquidity risks, credit risks, investment (market) risks, insurance risks and operational risks. These risks or issues are then graded or scored. Generally, the main elements of RBS are the following: Data capture, data analysis, supervisory judgment and management of information (meaning parameters are set to detect changing risk profiles).

In this regard, training and capacity-building are necessary. The focus of a specific examiner on particular insurers, both during on-site and off-site examinations, are also necessary. Thus, all insurers will have a company profile prepared for monitoring by the examiner. Analysis will have to be done on a quarterly or an annual basis. Among the documents proposed to be analyzed would be: The Annual Statement Analysis Worksheet, Financial Analysis Audit Guide, Actuarial Opinion Audit Guide, MD&A and MD&A Audit Guide, Peer Analysis Financial Profile Review, Ratio Results, Fin Analysis Handbook Ratio Results, Snapshot Investment Summary, Dividend Review, Holding Company Review, CPA Audit Report Review, Reinsurance Summary Review and Business Plan Review.

For the Philippines, we note that most insurance supervisors that have adopted RBS have done so gradually. And the Commission is conscious that there is a need to avoid ineffective supervision.


Dennis B. Funa is the current insurance commissioner. Funa was appointed by President Duterte as the new insurance commissioner in December 2016. E-mail: dennisfuna@yahoo.com.


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