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Risk-Based Capital Framework for Insurers and Takaful Operators

30 August 2024

On 28 June 2024, Bank Negara Malaysia (“BNM”) issued an Exposure Draft of the Risk-Based Capital Framework for Insurers and Takaful Operators (“ED”) in Malaysia, commonly referred to as RBC2 Framework. This ED sets out the proposed changes to the Risk-Based Capital Framework for Insurers issued by BNM on 17 December 2018 and takes into consideration the developments in global regulatory capital standards since the introduction of the current RBC framework and aims to achieve greater alignment with the Insurance Capital Standard (“ICS”) issued by the International Association of Insurance Supervisors (IAIS). Some of the features of the proposed RBC2 Framework are set out below.
1. Introduction
1.1 The policy document arising from the ED (“policy document”) aims to:
  1. ensure that the risk-based capital framework appropriately reflects the underlying risk exposures of licensed insurers and licensed takaful operators based on measurement approaches that are sufficiently risk sensitive and responsive to changes in the market conditions;
  2. ensure that licensed insurers and licensed takaful operators maintain a capital adequacy level that is commensurate with their risk profile at all times; 
  3. promote a consistent capital adequacy measurement for the insurance and takaful sector, taking into account the similarities in the underlying risks, while considering the differences between the underlying business models of insurance and takaful; and
  4. achieve greater alignment with key elements of the global capital standards such as the ICS and the relevant standards issued by the Islamic Financial Services Board (IFSB), with modifications appropriate to the Malaysian market.
1.2 The policy document sets out the following requirements:
  1. computation of the capital adequacy ratio, including the total capital available and the total capital required; 
  2. valuation basis for the liabilities of insurance/takaful contracts1 (“insurance/takaful liabilities”);
  3. supervisory solvency intervention levels; and
  4. regulatory reporting to BNM.
1.3 The policy document is applicable to:
  1. a licensed insurer, including a professional reinsurer; and
  2. a licensed takaful operator, including a professional retakaful operator; 
(severally a “licensed person” and collectively “licensed persons”) and for an insurance/ takaful group, the requirements in the policy document must be applied to all licensed persons within the insurance/takaful group at the entity level.
1.4 Notwithstanding paragraph 1.3 above, the requirements in the policy document are not applicable to business outside Malaysia generated by a licensed person that operates as a branch in Malaysia, subject to the following conditions being met: 
  1. there is an explicit undertaking from the branch’s head office to satisfy the liabilities arising from business outside Malaysia in the event that the branch is unable to fulfil its obligations; 
  2. the branch belongs to a group with a strong financial position;
  3. the branch is subjected to consolidated supervision by a home supervisory authority; and 
  4. effective home-host supervisory cooperation arrangements between BNM and the branch’s home supervisory authority are in place.
1.5 Notwithstanding paragraph 1.3, the requirements in the policy document are not applicable to investment-linked unit funds and Participants’ Individual Funds2, unless otherwise specified in the policy document and via any other legal instrument issued by BNM.
1.6 The policy document once effective, will supersede the following policy documents:
  1. Risk-Based Capital Framework for Insurers (BNM/RH/PD 032-12) issued on 17 December 2018; 
  2. Risk-Based Capital Framework for Takaful Operators (BNM/RH/PD 0334) issued on 17 December 2018;
  3. Guidelines on Valuation Basis for Liabilities of General Takaful Business (BNM/RH/GL 004-21) issued on 7 January 2011; 
  4. Guidelines on Valuation Basis for Liabilities of Family Takaful Business (BNM/RH/GL 004-20) issued on 7 January 2011;
  5. Letter on Specification pursuant to Section 47 of the Financial Services Act 2013 (FSA) and Section 57 of the Islamic Financial Services Act 2013 (IFSA) on Deductions of Reinsurance (RI) or Retakaful (RT) Cessions issued on 20 December 2018;
  6. Letter on Non-Closure of Inactive Claims Files and Specification pursuant to Section 47 of the Financial Services Act 2013 (FSA)/Section 57 of the Islamic Financial Services Act 2013 on Reduction of Case Reserves issued on 16 October 2018; and
  7. Letter on Regulatory Treatment of BNM Mudarabah Certificate (BMC) for Licensed Insurers and Licensed Takaful Operators issued on 29 July 2015.
1.7 The policy document is to be read with the 15 instruments and policy documents issued by BNM that are listed in paragraph 6.1 of the policy document.
2. Definition of “fund”

For the purposes of the policy document, the expression “fund” refers to an insurance/takaful fund that is established and maintained in accordance with paragraph 8 of the Policy Document on Management of Insurance Funds (BNM/RH/PD 032-15) and paragraph 9 of the Policy Document on Takaful Operational Framework (BNM/RH/PD 033-7) (excluding the insurance/takaful fund referred to in paragraph 1.5 above) and the shareholders’ fund.
3. Capital Adequacy
3.1 A licensed person must compute the capital adequacy ratio (“CAR”) at the entity level, which represents the adequacy of total capital available to support total capital required, taking into account the availability of capital in each fund to support other funds (i.e. fungibility of capital).
3.2 A licensed person must compute the CAR as follows:
CAR = TCA
TCR
where: 
 
TCA refers to the total capital available at the entity level3; and
TCR refers to the total capital required at the entity level4.
4. Total Capital Available
4.1 A licensed person must determine the capital available for each fund as the aggregate of Tier 1 and Tier 2 capital, including the regulatory adjustments under paragraph 14 of the policy document, less the deductions under paragraphs 15.1 and 15.3 of the policy document.
4.2 A licensed person must also determine the total capital available (TCA) at the entity level as the aggregate of the capital available for each fund as computed in paragraph 9.1 of the policy document (see paragraph 4.1 above), less a deduction to reflect the restrictions on fungibility of capital in participating life insurance funds and Participants’ Risk Funds5 as specified in paragraph 15.6 of the policy document.
4.3 licensed person must classify capital instruments into Tier 1 and Tier 2 capital based on the following principles:
  1. available to absorb losses;
  2. has loss absorbing capacity under different scenarios;
  3. subordinated to policy owners/takaful participants and creditors;
  4. demonstrates permanence;
  5. not rendered ineffective by encumbrances; and
  6. not rendered ineffective by mandatory servicing costs.
4.4 The aforementioned principles and eligibility criteria for Tier 1 and Tier 2 capital are set out in paragraphs 10.2 to 10.14 of the policy document.
4.5 Tier 1 Capital
4.5.1 The capital instruments that shall be classified by a licensed person as Tier 1 capital include, but are not limited to, the following:
  1. ordinary shares (or working fund, in the case of a licensed person that operates as a branch in Malaysia);
  2. non-cumulative irredeemable preference shares;
  3. capital reserves6;
  4. accumulated other comprehensive income; and
  5. adjusted retained earnings (including valuation surplus in insurance/takaful funds).
4.5.2 In relation to paragraph 4.5.1(e) above, a licensed person must determine the adjusted retained earnings as the sum of: 
  1. the retained earnings reported in the regulatory statistical returns; and
  2. the difference between:
  1. the net insurance/takaful contract liabilities reported in the regulatory statistical returns; and
  2. the net insurance/takaful liabilities determined based on the requirements in Part E of the policy document.
4.6 Tier 2 Capital
4.6.1 The capital instruments that shall be classified by a licensed person as Tier 2 capital include, but are not limited to, the following:
  1. cumulative irredeemable preference shares;
  2. mandatory convertible loan stocks and other similar capital instruments;
  3. irredeemable subordinated debts;
  4. subordinated term debts; and
  5. qard received by the takaful funds.
4.6.2 In relation to paragraph 4.6.1(d), a licensed person must ensure that the amount of subordinated term debts recognised under the Tier 2 capital at the entity level does not exceed 50% of the Tier 1 capital at the entity level.
4.6.2 A licensed person is further required to ensure that the total amount of Tier 2 capital at the entity level does not exceed the total amount of Tier 1 capital at the entity level.
4.7 A licensed person must obtain BNM’s written approval prior to the issuance of any new capital instrument (namely a capital instrument that is not listed in paragraphs 4.5.1 and 4.6.1 above) and its recognition as Tier 1 or Tier 2 capital under the policy document and is issued with the direct approval of the shareholders or, if permitted by law, approved by the board or by other persons duly authorised by the shareholders of a licensed person.
4.8 Regulatory adjustments and deductions to be made in relation to Tier 1 and Tier 2 capital, are set out in paragraphs 14 and 15 of the policy document.
5. Total Capital Required
5.1 A licensed person must compute the capital required for each fund, where the target risk level underlying the capital charges broadly corresponds to a Value-at-Risk (VaR) at 99.5% confidence level over a one-year period.
5.2 In computing the capital required for each fund, a licensed person must include capital charges for insurance/takaful, market, credit and operational risks as required under paragraphs 18 to 22 of the policy document, taking into account diversification benefits within each risk component and between the risk components as described in paragraph 23 of the policy document.
5.3 A licensed person must determine the total capital required (TCR) at the entity level as the aggregate of the capital required for each fund as computed in paragraph 16.2 of the policy document.
5.4 Paragraphs 17 to 23 of the policy document sets out the requirements of a licensed person in relation to the following:
  1. Management actions;
  2. Capital charges for insurance/takaful risk;
  3. Capital charges for market risk;
  4. Capital charges for credit risk;
  5. Look-through approach for market and credit risks;
  6. Capital charges for operational risk; and
  7. Aggregation.
6. Valuation of Insurance/Takaful Liabilities
6.1 A licensed person must determine the insurance/takaful liabilities to ensure that adequate funds are available to meet all contractual obligations as they fall due.
6.2 In relation to paragraph 6.1 above, a licensed person must ensure that the insurance/takaful liabilities consist of: 
  1. Central estimate liabilities, and
  2. Provision of risk margin for adverse deviation (“PRAD”).
6.3 A licensed person must determine the central estimate liabilities and PRAD separately for– 
  1. the expired portion of risk, which relates to all claim events that have already occurred before or at the valuation date, whether already reported (i.e. “case reserves”) or not reported (i.e. “incurred but not reported (IBNR) reserves”), where the obligations to meet the cash flows arising from these claim events have not been extinguished; and
  2. the unexpired portion of risk, which relates to future claim events that are expected to occur after the valuation date and within the contract boundary.
6.4 A licensed person must ensure that the value of the net insurance/takaful liabilities (i.e. after deducting reinsurance/retakaful recoveries) at the fund level is not less than zero.
6.5 Paragraphs 25 to 35 of the policy document sets out the requirements of a licensed person with respect to the following:
  1. Data and information used for valuation;
  2. Recognition and derecognition of insurance/takaful contracts;
  3. Boundary of a recognised insurance/takaful contract;
  4. Central estimate liabilities;
  5. Reinsurance/retakaful recoveries;
  6. Discount rates;
  7. Provision of risk margin for adverse deviation;
  8. Specific requirements for life insurance/family takaful contracts;
  9. Specific requirement for general insurance/general takaful contracts;
  10. Specific requirements for takaful contracts; and
  11. Specific requirements for inward reinsurance/retakaful contracts.
7. Supervisory Solvency Intervention Levels
7.1 The ED states that BNM will be revising the supervisory solvency intervention levels taking into account the proposed enhancements to the capital adequacy requirements in the ED. The solvency intervention level is to be set at 100% of the TCR which normally corresponds to the target risk level specified in paragraph 5.1 above. BNM has also stated in the ED that it will intervene on capital adequacy grounds if a licensed person’s CAR falls below the prescribed intervention level. BNM also reserves the right to set another solvency intervention level, where appropriate.
7.2 A licensed person is also expected to set an Internal Target Capital Level (ITCL) that reflects a capital level commensurate with its own risk and solvency position.
8. Reporting
8.1 A licensed person must submit the following to BNM:
  1. its CAR computation based on the financial year end position within three months after the end of each financial year. The financial year end CAR computation must be certified by its appointed actuary, chief executive officer and external auditor; and
  2. its quarterly CAR computation (certified by its appointed actuary and chief executive officer) within 21 calendar days after the end of each quarter.
8.2 In relation to paragraphs 8.1(a) and 8.1(b) above, a licensed person must submit its CAR computation, including the value of insurance/takaful liabilities and the components of TCA and TCR, in accordance with the RBC forms which will form part of its RBC report to BNM.
8.3 The RBC report must also include, at minimum, the information set out in Appendix 127 of the policy document. The RBC report must be certified by its appointed actuary and chief executive officer.
8.4 Notwithstanding the above, BNM may require a licensed person to compute and report its CAR to BNM on a more frequent basis.
​​​​​ 
Feedback to BNM
 
As part of the ED, BNM has asked insurers and takaful operators to conduct a second quantitative impact study (“QIS2”) to assess the impact of the proposed new framework on solvency positions. Licensed persons are requested to provide their QIS2 response to BNM by 31 December 2024. BNM intends to implement the new RBC2 framework from 1 January 2027, with potential parallel reporting commencing as early as the reporting period beginning 1 January 2026.
 
The Exposure Draft for Risk-Based Capital Framework for Insurers and Takaful Operators has been published on BNM’s website and can be accessed here.
 
 
Alert by Hafidah Aman Hashim (Partner) and Sharifah Shafika Alsagoff (Partner) of the Islamic Finance Practice of Skrine.
 
 
1 The term “insurance/takaful contract” refers to a basic (standalone) policy/takaful certificate (either individual policy/takaful certificate or group policy/takaful certificate) and extensions of cover (either riders or add-ons)
2 The term “Participants’ Individual Fund” refers to a takaful fund established to allocate a portion of a takaful participant’s contributions for the purpose of investment or savings.
3 Computed in accordance with the requirement under paragraph 9.2 of the policy document.
4 Computed in accordance with the requirement under paragraph 16.3 of the policy document.
5 The term “Participants’ Risk Fund” refers to a takaful fund established to pool a portion of a takaful participant’s contributions for the purpose of meeting takaful claims associated with events or risks specified in the takaful certificate.
6 The term “capital reserves” refers to reserves created from equity transactions between the licensed person and its shareholders arising from adjustments in accounting for business combinations, mergers and acquisitions;
7 Appendices 1 to 12 are appended to the policy document and are set out in the ED.

This alert contains general information only. It does not constitute legal advice nor an expression of legal opinion and should not be relied upon as such. For further information, kindly contact skrine@skrine.com.

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