New rules funnel insurance cash into government debt

Industry insiders said the proposals, which are expected to become law in June, could further pull the lever on trading at the Nairobi Securities Exchange (NSE) even as they tap an extra Sh200 billion to Sh400 billion into government debt this year alone.

The new regulations have been prompted by the instability in Kenya’s insurance industry, which has long been under-capitalised, leading to multiple company failures and consequent losses to insurance buyers.

The scale of the change looks set to deliver a seismic shock to the insurance industry itself, with an impact analysis from the Association of Kenya Insurers indicating that 49 per cent of insurers will be unable to meet the minimum conditions set by the new rules, and that just 11 per cent will be sufficiently capitalised to be free of regulatory intervention.

The hurdle for most insurers is the unusually high level at which the capital adequacy ratio has been set. The ratio is calculated as the percentage of ‘available capital’ compared to the ‘capital needed’ to run the business.

The new rules have set the ratio at 200 per cent, meaning insurers could from June be required to have twice as much capital as they need to cover their insurance risks. This ratio far exceeds the norms in countries such as Canada, South Africa and Malaysia.

Hidden in the fine print are structures for calculating the capital needed and for determining the available capital that build-in unusually high risk deductions.

The requirements have been set at high levels by global standards for assets such as property and equity investments, with some risks like interest rates additionally double counted.

For insurance companies adding up asset values to calculate ‘available capital’, the risk factor assigned to property is 40 per cent, meaning that only 60 per cent of its value can be counted.

This makes Kenyan property apparently among the riskiest in the world, with most other nations setting a risk factor of 20 per cent or lower on property.

This is despite the fact that Kenya’s real estate prices have been far more resilient than in most other markets due to limited availability of debt financing, and the general property shortage.

Equities listed on the NSE also carry a somewhat higher than normal risk factor, at 30 per cent, but government bonds, despite their current B rating, which defines them as high risk, carry no risk factor at all under the new regulation, and can be counted at full value.

Elsewhere in the world, the risk attached to government bonds is aligned to their credit risk ratings from the international credit risk agencies such as Standard and Poors, so that debt that is deemed as risky as Kenya’s would normally carry its own risk factor.

Under the new regulations, and for insurers struggling to make the 200 per cent bar, equity and property holdings are set to become a distinct burden, worth 30 to 40 per cent more if they are sold and the money is rerouted into government debt.

For most insurers, property represents a long term investment, and few have yet reduced their portfolio holdings of property, although the regulation has already seen some retreat from new property investments.

Source: Business world