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Moving From Minimum Capital Model to Risk-Based Capital (Rbc) Model



Phase 2: End of phase 1, evaluate, learn from experience and switch to applying risk-based supervision method, aiming at 3 main pillars: financial safety index, corporate governance, information transparency.

3.2.1.4. Perfecting business evaluation criteria

Based on the monitoring results, the monitoring agency needs to take timely measures for each insurance company depending on the monitoring results. Therefore, it is necessary to have a set of criteria for evaluating insurance companies based on the assessment of risk categories, assessment of risk prevention measures of the company as well as additional criteria such as capital, solvency, and revenue to give a rating level for each insurance company.

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In the past, Vietnam did not have a set of criteria for assessing insurance companies. The handling was often based on each individual violation, not considering the overall situation of the insurance company. However, it is also recognized that assessing each criterion separately also has many potential risks. For example, an insurance company may have a solvency margin that is not within the warning threshold, calculated on the retained insurance premium level. But that insurance company itself repatriates a large part of the collected premiums abroad to an unqualified reinsurance company. When the risk occurs, the reinsurance company is not able to pay, so the original insurance company must pay all the responsibility to the insurance buyer, but if it has to pay the reinsurance part, it is very likely that the insurance company will also lose its ability to pay. Therefore, if only assessing the solvency part, it is not necessarily accurate for the insurance company, but there must be an overall assessment. The evaluation criteria should cover business performance indicators, liquidity indicators, capital indicators, and profit indicators.

In any monitoring method, it is necessary to indicate the position of the insurance company or the level of pure risk for each insurance company. The position of each insurance company is the result of the monitoring process. The thesis proposes to develop criteria for evaluating non-life insurance companies as follows:

Moving From Minimum Capital Model to Risk-Based Capital (Rbc) Model

- First of all, it is necessary to establish calculation weights for insurance companies: Identify factors affecting the financial situation of insurance companies, which factors have the most impact, and give weights to those factors;

- Insurance companies calculate and report the calculation results to the Ministry of Finance;

- The Ministry of Finance shall base on the reports of insurance companies and combine the monitoring results of the supervisory agency to classify insurance companies.



Develop 5 types of rankings and implementation solutions for each type as follows:

Type 1: are enterprises with good operating results, early warning indicators are all within the allowable range. For insurance enterprises and foreign branches ranked in type 1, perform:

+ Continue to consolidate and maintain business operations; research and expand business operations, open more branches based on the principles of efficiency and fair competition;

+ Continue to increase the use of information technology systems in business operations, management and administration; improve the quality of customer care services;

+ Strengthen internal control and internal audit.

Type 2: are enterprises whose early warning indicators are all within the allowable range but whose operating results are not good, and whose risk prevention indicators are only at an average level. For insurance enterprises and foreign branches ranked in type 2, the following must be implemented:

+ Develop and implement business plans focusing on strong market segments;

+ Streamline the operating system, cut down on operating and management costs;

+ Handling and recovering bad debts;

+ Increase capital; restructure investment portfolio towards limiting investment in risky assets, building and implementing effective reinsurance plans.

Type 3 : are businesses that are not profitable and are at risk of insolvency without risk prevention measures. For insurance companies and foreign branches classified as type 3, the following must be implemented:

+ Narrow down business operations and close unprofitable branches; limit business expansion;

+ Transfer one or several insurance operations;

+ Do not distribute profits to shareholders (members) contributing capital.

+ For insurance companies at risk of insolvency, follow the provisions in Clause 1 and Clause 2, Article 19 of Decree No. 46/2007/ND-CP. For foreign branches at risk of insolvency, follow the provisions in Clause 6, Article 19 of Decree No. 123/2011/ND-CP.



Type 4: are early warning indicators that are beyond the allowable level, with no risk prevention measures. For insurance companies and foreign branches ranked in type 4, the following must be implemented:

+ Conversion of business form, merger, acquisition by another organization;

+ For insurance companies and foreign branches that are at risk of insolvency, and after implementing measures still fail to restore solvency, they will be placed under special control. The Ministry of Finance has decided to establish a Solvency Control Board to apply measures to restore solvency according to the provisions of Article 80 of the Law on Insurance Business.

Type 5: after applying measures but still unable to restore solvency, the insurance company carries out bankruptcy procedures, the foreign branch carries out dissolution and closure procedures according to the provisions of law.

With the DNBH classification assessment method, supervisors can have a consistent assessment and handling method throughout the market.

The set of criteria for assessing insurance companies can be developed and applied from 2015. When the complete conversion to risk-based supervision is completed, this set of criteria will be rebuilt to match the calculation method of the new supervision method.

3.2.1.5. Moving from a minimum capital model to a risk-based capital (RBC) model

To implement risk-based supervision, in addition to regulating minimum capital, it is necessary to calculate capital based on risk. If only regulating minimum capital, the supervisory agency will provide the required capital level for insurance companies that do the most business. The reality is that there will be insurance companies that do not use all of that capital, if that insurance company only does basic business (for example, motor vehicles), the loss level is not too large, and the number of participants in the risk is large. These insurance companies can only use the capital for investment. In the current Vietnamese market, insurance companies mainly invest in the form of deposits. Regulating capital levels based on risk will help insurance companies use capital effectively.

Vietnam is calculating capital according to the minimum capital model, taking into account the risk-based capital level by stipulating that opening an additional branch requires an increase of VND 20 billion. However, these regulations are also approximate and do not have a clear basis for calculating capital needs when insurance companies deploy new types of business. Current regulations in Vietnam only focus on risks for insurance activities, while risks in other activities such as credit risk, market risk, and disaster risk



nature… has not been given due attention. It is recommended that the current insurance market supervisory agencies in Vietnam should provide a specific roadmap to transition to risk-based capital (RBC) supervision.

The regulation of capital levels based on risks is appropriate to the business operations of each insurance company; ensuring financial safety for insurance companies. To do this, it is necessary to classify types of risks, identify factors affecting capital risks. Develop risk assessment categories that the supervisory agency will monitor and the assessment level of each risk category. Currently, countries build from 4 to 8 categories. Based on the information conditions obtained from Vietnamese insurance companies, the thesis proposes to choose 6 risk categories, which are: insurance risk, business risk, liquidity risk, interest rate risk, investment risk, compliance risk. However, to calculate capital based on risks, only rely on the following 4 risks, which are risks with high risk of occurrence such as:

(1) Insurance risk (Including insurance price risk and reserve fund risk)

Insurance price risk : This risk level of non-life insurance companies in Vietnam is very high due to the use of unfair competitive measures such as: lowering fees, reducing deductibles, expanding insurance coverage; unprofessional insurance assessment procedures and methods; limited capacity of insurance assessment specialists; passivity in reinsurance,...

Insurance reserve risk : This risk arises from the inherent limitations of enterprises - the capacity of the calculation team, information technology system, ... even the business thinking in the management of insurance enterprises and the shortcomings of related management regulations. Insurance enterprises often choose the simple method of provisioning, making incomplete provisions for compensation reserves. This has made the provisioning of technical reserves between insurance enterprises arbitrary, according to the wishes of the enterprises and not unified. Incomplete provisioning is also a big risk for insurance enterprises.

(2) Business risk (corporate governance risk ): stemming from limitations in management capacity, incomplete and inconsistent systems, processes and internal control systems, this risk is high for Vietnamese non-life insurance companies.

( 3) Investment risks (including market risks and credit risks): Vietnam's financial market is still young, so risks arising from the unstable development of



market factors, investment environment, legal environment. In addition, there are limitations in capacity, experience and professionalism in investment activities of some enterprises themselves, so the risk potential for many enterprises is quite large.

Currently, credit institutions in Vietnam have low credit ratings. According to a recent announcement by banker of The Financial Times, Vietnam has 43 banks surveyed but only 11 banks are in the list of 1000. Of which, Vietinbank is ranked 362, Vietcombank is ranked 467, BIDV is ranked 522, Saigon Thuong Tin is ranked 777, Eximbank is ranked 802. Many banks have high levels of bad debt. Therefore, credit risk is also a risk for insurance companies because the investment structure of insurance companies focuses mainly on deposits at credit institutions.

(4) Liquidity risk : liquidity risk is governed by the above investment risk and the unstable development of related market factors, so it is still a major danger for many Vietnamese insurance companies, even though bank deposits account for a significant proportion in the asset structure of enterprises.

In fact, depending on the level of development of the market, each bloc such as the EU, Northern Europe, America, etc. has different calculation formulas depending on the risks considered as the main risks of that market. According to the general formula, the risk level is calculated based on the level of covariation of the square of the types of risks.

Proposed calculation formula:


RBC = √(R1 2 +R2 2 + R3 2 + R4 2 )

RBC refers to 4 main forms of risk, including:

+ R1: Insurance risk

+ R2: Business risk

+ R3: Investment risk

+ R4: Liquidity risk

The level of intervention depends on the RBC capital ratio (Current Capital/RBC) as follows:

- If above 150%: No intervention required;

- From 120 - 150%: Insurance companies must send reports to the supervisory agency;

- From 110 - 120%: Insurance companies must submit additional capital action plans to the supervisory agency;

- From 90 - 110%: The supervisory agency has the right to operate the enterprise;

- Below 90%: The supervisory agency is obliged to take over the management of the enterprise (level)

coercive degree).



In the initial stage, Vietnam should apply both minimum capital and risk-based capital because the risk-based capital calculation level in the initial stage may not be close to the risk level, due to the lack of data system of insurance companies in the past as well as information system to analyze the risk level, market factors, and the legal environment is still unstable. To ensure safety, both types of capital should be applied. When the market develops to a more stable stage, it may be necessary to apply only the risk-based capital level.

3.2.1.6. Calculation of Solvency Margin

Solvency margin is an important indicator for each insurance company when determining financial soundness. According to current international practice, there are 3 ways to calculate solvency margin as presented in chapter 1. Vietnam is currently implementing its own calculation method. Current regulations in Vietnam allow the net risk factor not to exceed 4:1 and the gross risk factor not to exceed 8:1. In other words, current regulations in Vietnam stipulate the maximum leverage ratio rather than the solvency regulation according to the 3 international approaches. Therefore, the proposed amendment is for the following reasons:

The maximum leverage requirement is not a solvency requirement. Maximum leverage limits potential risk but does not address the critical issue of the extent to which assets exceed liabilities and how that excess relates to overall risk. The relationship between assets and liabilities should be a direct measure of solvency, not a ratio of premiums to equity.

The net risk ratio and gross risk ratio stipulated in Decree 46/2007/ND-CP are high compared to international standards (2.5: 1). Therefore, Vietnam allows insurance companies to accept higher risks than the average of other countries. That will make the insurance buyer bear a higher risk level.

Instead of calculating risk weights for assets and liabilities to calculate the total minimum capital, Vietnam is determining the solvency margin of enterprises based on the discount of recognized assets when calculating the solvency margin according to predetermined coefficients. The discounting of asset values ​​does not take into account the risk on the liability side.

The solvency requirement is essentially a requirement that assets exceed liabilities to a certain extent and will become larger as the debt level of the enterprise increases with the scale of the business. The minimum level at which assets exceed liabilities is called the margin.



Solvency. This concept reflects that the larger the debt, the higher the equity required to compensate for unforeseen fluctuations. The nature of insurance products is a guarantee, the equity scale corresponding to the debt scale is the guarantee for that guarantee. It is proposed, with current conditions in Vietnam, to move towards applying a solvency margin of 1, but with adjusted coefficients to suit Vietnam. When calculating the solvency margin, in addition to the retained premium factor, it is necessary to take into account the loss compensation reserve factor.

3.2.1.7. Develop monitoring indicators and early warning indicators

Insurance companies, like other businesses, must operate for profit. One of the market monitoring objectives of the supervisory agency for any business operating in any field is to focus on whether the financial capacity of the business is strong enough to withstand market shocks. Therefore, the supervisory agency needs a set of monitoring criteria that includes general assessment criteria that any business must have and criteria specific to each business activity, in this case, the insurance business.

The effectiveness of monitoring depends on the appropriateness of the indicators used, the standards for comparison and comparison, and the quality of information . Currently, Vietnam is applying the early warning indicator system according to Decision 153/2003/QD-BTC, however, this system has shortcomings as analyzed in Chapter 2.

The way other indicators are calculated has now changed due to changes in the accounting regime. For example, the provisioning under the accounting regime is not only calculated on retained insurance premiums but also on reinsurance premiums while the financial mechanism only requires provisioning on retained insurance premiums. The margin for each indicator currently applied according to the general margin of the US is not suitable for Vietnam.

The thesis proposes to amend and supplement the system of monitoring and early warning indicators for non-life insurance companies:

(1) Add evaluation criteria

+ ROA = Profit after tax / total assets

This ratio measures the profitability of each asset of the insurer. The assets of the insurer are formed from loans and equity, both of which are used to finance the operations of the insurer. The efficiency of capital investment



Profitability is expressed through ROA, the higher the ROA the better because the insurer is earning more money on less investment.

+ ROE = Net profit / equity

Return on investment is an important overall measure of financial performance for any organization. Low or negative return on investment over a period of time will certainly harm the financial health of the insurance company.

At the same time, the survival of the insurance industry depends on shareholders agreeing to invest capital in insurance companies. If they do not receive reasonable profits, especially considering the uncertainty of non-life insurance companies, over time they will withdraw their investment capital and the insurance industry will gradually disappear because there is a comparison between the insurance sector and other sectors to choose investment.

+ Leverage ratio = Total assets/Equity

+ Quick ratio = Cash and cash equivalents/total current liabilities

This ratio can be described as a useful indicator of the ability of the insurer to meet its financial obligations without prematurely maturing long-term investments or borrowing money.

(2) Determine the appropriate reference amplitude

Early warning indicators have provided a useful perspective to address emerging difficulties in the financial market. However, the reference ranges have not been suitable for Vietnam in recent times. For example, the total premium revenue over fund capital indicators have a reference range of <900%, the net premium revenue over fund capital indicator has a reference range of <300%. In practice, Vietnamese insurance companies do not exceed this reference limit because the US applies a risk-based capital model, while Vietnam applies a minimum capital model. According to the assessment of the Non-Life Management and Supervision Department, the revenue over fund capital indicator with the highest result is PJICO, which is only 480%, while some companies like Liberty have 1.75%. Therefore, it is necessary to research and propose a reference range suitable for the situation of the Vietnamese non-life insurance market so that the assessment efficiency from the early warning indicator system is better. To do this, we rely on market data from inception (20 years); calculate ratios for the monitored companies and then rank the companies on the basis of using about 10% of the initial ratio as the basis for the reference bands.

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