South African reinsurance: proposed future regulatory framework

The Financial Services Board (“FSB”), the authority that regulates the activities of insurers and reinsurers in South Africa, is looking at proposals to alter the regulatory framework  under which reinsurance business will be carried out in South Africa in future. This may have an  impact on foreign reinsurers and Lloyd’s underwriters that do write or intend writing reinsurance  business in South Africa.

Currently, in order to carry out reinsurance business, a person or entity must be registered to do  so. The Short-term Insurance Act, 1998¹ (“STIA”), prohibits any person from carrying our short-term  insurance business (i.e. indemnity insurance) unless that person is licensed to do so. The FSB cannot issue a license unless the applicant is a public company incorporated in South Africa.  There are also ongoing requirements for a registered insurer or reinsurer, in order to maintain its  license, to ensure that its business is in a financially sound condition and that it possesses sufficient assets; can provide for its liabilities so as to ensure that these can be met of any  given day. The only exception to the above requirements is Lloyds’s underwriters who do not have to  obtain a license. This is part of a dispensation granted to Lloyds in the STIA.² Thus the ability  to carry out reinsurance business in South Africa is an onerous process with excessive reporting  requirements.

The current framework is about to change probably for the better The actual impact of the FSB’s intended proposals remains uncertain at this stage. The FSB, in  keeping with its usual practice of engaging with the industry, is expected to publish a“position paper”, for  comment, imminently that will set out what it intends doing and how it will go about implementing the proposals. The relooking at the reinsurance framework is a part of the  FSB’s gradual implementation of the “twin peaks” model and the proposals are part of the Solvency Assessment and 

Management Project that is seeking to introduce a risk- based solvency regime for insurers based on  Solvency II.  In November 2014, the FSB published a “high level” newsletter setting out briefly the  “initial policy proposals”.³

The FSB has stated4 that the following principles informed its initial policy proposals:

• An appropriate and effective regulatory and supervisory framework that affords the necessary  protection for insurers and policyholders
• Minimising/avoiding regulatory arbitrage
• Alignment with international standards and meeting of international trade obligations
• Level playing fields and a competitive reinsurance market
• Maintenance and enhancement of current skill levels
• Ongoing development of the local reinsurance industry as a hub for reinsurance business into  Africa 

The high-level proposals are:

• Allowing foreign reinsurers to operate in South Africa through a branch:
  • It is hoped that this will increase the supply of reinsurance in the South African market
• The treatment of reinsurers in the solvency calculation for direct insurers:
  • Designed so that foreign reinsurers and cross border business do not receive an undue advantage  compared to local insurers
  • By either downgrading the cedant’s credit rating or notionally capping its reinsurance assets
• Some of the limitations that will be placed on reinsurance business:
  • No composite licenses⁵ will be allowed
  • The amount of outwards retrocession that locally incorporated reinsurers and direct insurers may  place with foreign insurers on a cross-border basis will be limited - to prevent fronting by  foreign insurers
  • Locally incorporated direct insurers will not be permitted to accept inwards retrocession  business from other local (re)insurers without formal regulatory approval (temporary & reviewable  at discretion of regulator) to prevent market spirals that may threaten financial stability
  • Acceptance of intra-group and related party reinsurance will not be permitted without formal  regulatory approval – to prevent contagion risk – Reinsurers may not write direct insurance
• Different options are being explored in relation to Lloyds:
  • Continue to operate under the existing dispensation
  • Continue to operate under the existing dispensation, but with additional governance and reporting  requirements
  • Require Lloyds to establish either a local branch or a locally incorporated subsidiary

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The above proposals, whilst still in its early stages of development, will no doubt when  implemented, entirely change the face of reinsurance in South Africa. Whether this will have the  desired effect remains to be seen. It  also remains to be seen what content is given to the above  initial policy proposals when the “position paper” is published and also how this will change after the intended consultation process, particularly with  local reinsurers. Despite the solvency incentives being mooted for placing reinsurance business  locally, seemingly the protection of local reinsurers by the FSB appears to be coming to an end.  This may open up South Africa as a hub for reinsurance business, particularly foor reinsurance  business into the rest of Africa.