Alexander Forbes - Annual Report 2006

Notes to the group financial statements
for the year ended 31 March 2006

58.

Insurance risk

The group issues contracts that transfer insurance risk or ﬁnancial risk or both. Insurance contracts are those that transfer signiﬁcant insurance risk, being the possibility of having to pay beneﬁts on the occurrence of an insured event that are at least 10% more than the beneﬁts payable if the insured event did not occur. Such insurance contracts are issued by the group’s ﬁve insurance subsidiary companies, namely, Guardrisk Insurance, Guardrisk Life, Euroguard Insurance, Alexander Forbes Insurance and Alexander Forbes Life, as detailed below.

The group also issues contracts which are classiﬁed as investment contracts. These contracts transfer ﬁnancial risk with no signiﬁcant insurance risk. Financial risk is deﬁned as the risk of a possible future change in one or more of a speciﬁed interest rate, ﬁnancial instrument price, commodity price, foreign exchange rate, index of process or rates or credit index or other variable. The group’s multi-manager investment subsidiary company, Investment Solutions, operates under a long-term insurance licence however, for accounting purposes, the contracts issued by this subsidiary company to policyholders are classiﬁed as investment contracts. The assets arising from these investment contracts are directly matched by linked obligations to the policyholders and the assets and linked obligations are separately reﬂected in the group balance sheet as “Financial assets held under multi-manager investment contracts” and “Financial liabilities held under multi-manager investment contracts” respectively.

Three of the group’s insurance subsidiary companies, namely Guardrisk Insurance, Guardrisk Life and Euroguard Insurance, provide cell captive insurance facilities for clients. These facilities are classiﬁed as special purpose entities and the recognition of transactions relating to these facilities in the ﬁnancial statements depends on the nature of the cell captive insurance arrangement. The insurance companies participate with some of the cell shareholders in the underwriting risks of the business written in the cells. The assets and liabilities relating to these risk taking activities are included in the relevant line items in the group ﬁnancial statements and are included in the insurance related liabilities shown below. Surplus funds in the cells are invested in investment portfolios and are separately reﬂected in the group balance sheet as “Assets of cell captive insurance facilities” with a corresponding liability reﬂected as “Liabilities of cell captive insurance facilities”.

The remaining two insurance subsidiaries transact conventional short-term and long-term insurance business under limited risk taking mandates.

The names of the insurance subsidiary companies issuing insurance contracts and the nature of their insurance operations are detailed below.

Name of subsidiary company	Country of operation	Nature of insurance operations	Note reference
Guardrisk Insurance Company Limited	South Africa, Namibia and Mauritius	Cell captive and contingency short-term insurance	58.2
Guardrisk Life Limited	South Africa and Mauritius	Cell captive and promoter long-term insurance	58.2
Euroguard Insurance Company Limited	Gibraltar	Cell captive short-term insurance	58.2
Alexander Forbes Insurance Company Limited	South Africa	Personal lines short-term insurance	58.3
Alexander Forbes Life Limited	South Africa	Long-term insurance	58.4

The insurance contracts liabilities of insurance subsidiaries included within the group balance sheet at the year end are detailed below.

	2006 Rm	2005 Rm
Nature of liability
Net unearned premium provision from short-term insurance contracts	16	14
Gross unearned premium provision	17	19
Reinsurers’ share of unearned premium provision	(1)	(5)
Net outstanding claims provision from short-term insurance contracts	31	25
Gross outstanding claims provision	38	104
Reinsurers’ share of outstanding claims provision	(7)	(79)
Net IBNR provision from short-term insurance contracts	13	23
Gross IBNR provision	14	23
Reinsurers’ share of IBNR provision	(1)	—
Policyholder liability under long-term insurance contracts (life fund)	10	8
Gross policyholder liability	73	65
Reinsurers’ share of policyholder liability	(63)	(57)

Net liabilities under insurance contracts	70	70

	58.1	General management of insurance risk
		In addition to the management of insurance risk by each subsidiary (as detailed below in sections 58.2, 58.3 and 58.4), the group has the following general insurance risk management controls. Underwriting committees The group has underwriting committees which consider both underwriting and counter party exposures of short-term and long-term insurance contracts in order to control the risk exposure of the group. These committees review the underwriting processes of the insurance subsidiaries including the pricing and acceptance criteria, underwriting limits and monitor the emerging trends and issues. The appropriateness and results of the reinsurance programmes relevant to the insurance contracts and the matching of assets and liabilities arising from the insurance contracts is reviewed. These committees also consider and approve the appropriateness and viability of major product development initiatives and the conformity of these products with regulatory, legal, tax and accounting requirements. Individuals with specialised industry and product knowledge are members of these committees and external experts are also co-opted when necessary. These committees report directly to the relevant operational boards of directors and comprise executive and non-executive directors and independent specialists. The underwriting committees and their relevant operational boards monitor compliance by the insurance subsidiaries with their limited risk taking mandates. Audit committees The group has audit committees speciﬁcally for the insurance subsidiaries. These committees serve to satisfy the group and operational board of directors that adequate internal and ﬁnancial controls are in place and that material risks are managed appropriately. These committees report directly to the relevant board of directors and comprise a majority of non-executive directors. The committees are attended by the external and internal auditors. Statutory actuaries The statutory actuaries of the long-term insurance subsidiaries report annually on the capital adequacy and the ﬁnancial soundness at the year end date and for the foreseeable future. All new premium rates are reviewed by the statutory actuaries and dividends are approved prior to payment to ensure that the insurance subsidiaries remain ﬁnancially sound thereafter. Capital adequacy requirements A minimum level of solvency is held within each insurance subsidiary to meet the regulatory capital adequacy requirements. For the long-term insurance subsidiaries, the capital adequacy requirement (“CAR”) is calculated to determine whether the excess of assets over liabilities is sufﬁcient to provide for the possibility of actual future experience departing from the assumptions made in calculating the policyholder liabilities and against ﬂuctuations in the value of assets. CAR statutory returns are submitted to the Registrar of Long-Term Insurance on a quarterly basis and valuations performed by the statutory actuary on an annual basis. As at 31 March 2006, the CAR held by the long-term insurance companies amounted to R28 million. The short-term insurance subsidiary companies are required by statute to create a contingency reserve for adverse claims developments. This reserve is calculated at ten percent of net written premiums as deﬁned by the relevant legislation and no distribution can be made from this reserve without the prior approval of the Registrar of Short-Term Insurance. As at 31 March 2006, the contingency reserve held by the short-term insurance companies for all their lines of business written amounted to R183 million. In addition to the contingency reserve, the short-term insurance companies are required by statute to maintain a solvency margin of 15% of net written premiums. Two of the insurance subsidiaries, Guardrisk Insurance and Guardrisk Life, are rated by an international rating agency, Global Credit Rating, and have ﬁnancial strength ratings of AA and A+ respectively. Concentration risk The group is not exposed to any signiﬁcant concentration risk as the insurance contracts issued by the group’s insurance subsidiaries are adequately spread across the major classes of insurance risks. In addition, each insurance subsidiary company is cognisant of concentration risk for their individual entity and each insurance product and takes steps to mitigate this risk, including purchasing reinsurance protection. Reinsurance The group uses reinsurance to manage the level of underwriting risk accepted by the group. Reinsurance vetting procedures are in place and reinsurance programmes are assessed on a regular basis to ensure appropriateness of the cover obtained, including the individual cessions and accumulations per reinsurer. The ﬁnancial condition of reinsurers (identiﬁed by their credit rating) are considered when placing reinsurance cover and evaluated on an ongoing basis. The individual insurance subsidiaries limit the level of reinsurance credit risk accepted by placing limits on their exposures to a single counterparty. The individual insurance subsidiary companies hold catastrophe reinsurance to mitigate the risk of a single event causing multiple accumulation of claims. The group has a Market Security Committee which evaluates, approves and monitors both insurance and reinsurance markets that the group operates in and reports back to the relevant operational boards with recommendations. The insurance subsidiaries are represented on this committee. Committee decisions are supported by local and international professional rating agencies and the involvement of the Financial Services Board, legal advisers and industry is sought if required.
	58.2	Cell captive arrangements – conducted by Guardrisk Insurance, Guardrisk Life and Euroguard Insurance
		Terms and conditions of insurance contracts
		The companies transact primarily as cell captive and alternative risk transfer insurers focusing on the corporate and retail markets. The following structured insurance and risk ﬁnancing solutions are offered: Cell captive: A cell captive is a contractual arrangement entered into between the company and the cell shareholder whereby the risks and rewards associated with certain insurance activities accrue to the cell shareholder. Cell captives allow clients to purchase separate classes of shares (or a “cell”) in the registered insurance company which undertakes the professional insurance and ﬁnancial management of the cell including underwriting, reinsurance, claims management, actuarial and statistical analyses and investment and accounting services. The terms and conditions of the cell are governed by shareholders agreements. There are currently two distinct types of cell captive arrangements being: • “First party” where the risks that are being insured relate to the cell shareholder’s or its group’s own operations; and • “Third party” where the cell shareholder is provided the opportunity to sell branded insurance products into its own customer base. The companies are the principal to the insurance contract, although the business is underwritten on behalf of the cell shareholder. Contingency or rent-a-captive (Guardrisk Insurance): A policy contract structured to provide entry-level insurance cover for ﬁrst party risks without capitalising a cell. The policy provides for payment of a performance bonus to the insured based on the underwriting results at the end of the policy period. Promoter policies (Guardrisk Life): A policy contract structured to provide insurance cover for ﬁrst and third party risks, without capitalising a cell. The promoter policies consist of a mixture of third party assurance business, ﬁrst party group life cover and ﬁrst party annuity contracts which fund the contract holder’s obligation for post-retirement health care liabilities in terms of accounting standard, IAS 19 (AC116). In terms of IFRS, the cell captive arrangements are classiﬁed as special purpose entities and the recognition of the cells in the ﬁnancial statements of the company depends on the nature and contractual conditions of the cell captives’ facilities. First party cell owners are regarded as having the right to obtain the majority of the future economic beneﬁts of the cell’s insurance activities and for this reason ﬁrst party cells are not consolidated in the group accounts. In the case of third party cells, the company is regarded as the principal to the insurance transaction. The company however in substance, reinsures this business to the cell shareholder as the cell shareholder remains responsible for the solvency of the cell. Such cells are included in the ﬁnancial statements but are accounted for as reinsurance ceded to the cell shareholders. Contingency facilities and promoter policies are fully recognised in the ﬁnancial statements.

		Risks that arise from insurance contracts
		Contracts underwritten in cell structures are considered to be the primary responsibility of the cell shareholder. The primary risk that the group is exposed to relating to its cell captive insurance business is the credit risk of the cell shareholder. This exposure is dealt with under credit risk. In the case of third party cell captive arrangements, the group is also exposed to insurance risk on policies issued to the cell shareholders’ customer base (to the extent that there is reinsurance failure, if present, and failure to recapitalise by the cell shareholder). In respect of the contingency policies, the risks underwritten are mainly in respect of primary layers of an insurance programme. In these facilities as opposed to traditional insurance models the premium partially funds the risk exposure. Some of the companies participate with several of their cell shareholders in the underwriting risks of their business. These companies carefully evaluate all retention of risks in terms of statistical and underwriting disciplines, as well as speciﬁc and limited board mandates for each insurance programme.

		Mitigation of insurance risk
		Insurance risk In respect of third party cell captive arrangements, the insurance risks are mitigated through the reinsurance of elements of the risk to reinsurance markets and/or the cell shareholders through the cell shareholder agreements. The risks are further reduced by the requirement for the ﬁrst and third party cells to hold minimum levels of capital. In respect of contingency policies, policyholders share in the underwriting result if there is favourable claims experience. The companies limit their exposure to unfavourable claims experience by performing actuarial analyses to establish suitable policy and cover limits as well as attachment points for reinsurance where applicable. Reinsurance strategy The companies manage the insurance risks through their underwriting strategies and reinsurance arrangements. The underwriting strategy is intended to ensure that the risks underwritten are well diversiﬁed in terms of type of risk and the level of insured beneﬁts. Facultative reinsurance facilities are in place where considered necessary and proportional reinsurance treaties are used when deemed necessary. The companies reinsure the excess over the retentions under a variety of quota share and surplus reinsurance arrangements. In certain contracts, stop loss reinsurance arrangements protect the retained line against attritional losses. In respect of contingency policies, an umbrella reinsurance facility is structured above the policies on a portfolio basis to protect the risk layers provided. The risk retained in the companies is low under the current contracts. Sensitivity analysis As a result of the nature of the business written, the level of exposure to the group to sensitivity in assumptions of insurance contract provisions is insigniﬁcant.
	58.3	Personal lines short-term insurance – conducted by Alexander Forbes Insurance
		Terms and conditions of insurance contracts
		Personal lines insurance is provided to the general public in their individual capacities. The duration of this insurance is monthly and in some cases, annual. The classes of risk underwritten by the company include property, accident, personal accident and motor.

		Risks that arise from insurance contracts
		Insurance risk
		This business activity relates to the assumption of the risk of loss from events involving persons. As such, the company is exposed to the uncertainty surrounding the timing, severity and frequency of claims under insurance contracts. As insurance events are random, actual experience may vary from what was estimated using established statistical techniques. The majority of the company’s insurance contracts are “short-tail”, meaning that any claim is settled within one year after the loss date. The company’s “long-tail” exposures are limited to personal accident, third party motor and public liability. Claims in respect of long-tail business comprises less than 0,1% of an average year’s claims cost and are not considered a major risk to the group. There is no signiﬁcant concentration of risk as the company’s risks are adequately spread across the country as well as across the major classes of insurance risk.

		Mitigation of insurance risks
		Insurance risk
		Insurance risk is managed by centralised control of pricing and acceptance criteria, underwriting limits, reinsurance and continual monitoring of emerging issues.

		Reinsurance strategy
		The company reinsures its business on a non proportional basis. The personal lines book is protected on a per risk and catastrophe basis, capping the net exposure of the company in the event of a single large loss or loss occurrence constituting a catastrophe. The personal accident book of business is proﬁtable, being a high volume low risk portfolio and is protected on a stop loss basis whereby reinsurance protection is purchased to protect the company in the event of adverse claims experience. Being monthly business this is considered a well managed portfolio.

		Sensitivity analysis
		The most sensitive assumptions in the claims provisioning for the personal lines business relate to assumptions used in the calculation of IBNR. A 50% deviation from these assumptions would result in a change to the company’s pre-taxation results of not greater than R1,5 million.
	58.4	Long-term insurance – conducted by Alexander Forbes Life
		Terms and conditions of insurance contracts
		The insurance contracts consist of annually renewable group life mortality and morbidity contracts and individual life mortality and morbidity contracts. Group business consists of insurance for retirement funds and other group schemes and covers the contingencies of death and disability. Individual life business covers death, disability and impairment contingencies. There are no surrender values or investment components inherent in any of these policies.

		Risks that arise from insurance contracts
		These contracts insure events associated with human life (for example death, or survival) over a long duration. The group assurance business is subject to mortality and morbidity risk. The risk is that future claims will exceed expectations, which could result from epidemics such as AIDS and Avian Flu, as well as unexpected changes in lifestyles and living patterns. Since the term of a group policy is typically one year and upfront costs are limited, the risk of non-recoupment of expenses due to withdrawals is limited. The company launched an individual assurance product during the current ﬁnancial year. As at 31 March 2006 it remains a relatively minor part of the company’s exposure. The product is subject to mortality, morbidity, withdrawal and expense risk. The company is exposed to concentration risk on the group assurance business as the company does not as yet have a wide spread of group schemes and a single event could result in multiple claims. The company holds catastrophe reinsurance to mitigate this risk. The company has no signiﬁcant concentration risk on the individual assurance business due to the current low level of business on this product.

		Mitigation of insurance risk
		Insurance risk In respect of group assurance business, free cover limits are set on a per scheme basis and are formula-driven, taking into account the number of lives assured and their average sum assured. Sums assured in excess of the free cover limit are medically tested. Policy terms and conditions allow for an annual review of premium rates so allowing the company to keep premiums in line with emerging claims experience. The annual premium reviews take all pertinent information from one year to the next into account. In respect of individual assurance business, the major risks are mortality, morbidity and withdrawal. Premiums on this business line are differentiated by age, gender and smoker status. Stringent socio-economic qualiﬁcation criteria apply. Future premium rates are also not guaranteed and may be adjusted if mortality and morbidity experience worsens. Market pressures and delays in implementing changes could however counter this mitigating effect. Withdrawal risk is mitigated to some extent by commission clawbacks clauses in contracts with intermediaries. Reinsurance strategy The company also manages the insurance risks through its reinsurance arrangements. The company assesses the appropriate reinsurance structures by conducting scenario analyses which project outcomes under different reinsurance structures. The retention limits are then set in accordance with the company’s risk appetite.

		Sensitivity analysis
		The most critical assumption underlying the liabilities relating to group assurance is the rate of recovery from illness or disability associated with claims in payment. The sensitivity to a recovery rate 20% lower than assumed is less than R1 million. The negative liabilities arising from the individual assurance contracts are less than R1 million and any sensitivity to the assumptions are currently insigniﬁcant.

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