By NBF News

With the adoption of risk based supervision, the National Insurance Commission (NAICOM) aims to beef up regulatory processes even as it targets good corporate governance, Rosemary Onuoha writes

The global economic crisis brought a lot of lessons such as 'that lenders, borrowers and regulators erred; that better financial risk management is required; that no company is too big or too old to fail; that central banks, other regulators and governments cannot be bystanders; as well as that greater regulation and monitoring of exposure are required.

In order to avert future financial crisis, especially in the insurance subsector, the National Insurance Commission (NAICOM) adopted a risk based supervision method going forward.

Explaining what risked based supervision entails for the industry, Mr. George Onekhena, Deputy Commissioner Finance & Accounts of NAICOM, stated that it is an approach to supervision in which the action of the regulator is determined by both the risk profile of relevant institution and the extent to which such institution can manage associated risk with minimal impact on policyholders and market interest.

For Mr. Fola Daniel, Commissioner for Insurance, risk based supervision is predicated on the relationship between risk and capital, adding that the higher the risk profile of the insurer, the higher the capital it must hold. Supervisors perform risk based supervision by looking at all material risks that are faced by insurers and how it controls those risks, Daniel noted.

For Onekhena, change imperative for NAICOM in the adoption of risk based supervision, includes demand for more effective regulation; need to optimise use of limited resources as well as need to prove effectiveness to stakeholders. According to him, risk based supervision is an approach that can facilitate Naicom's success in addressing these change imperative. He explained that risk based supervision treats operators differently depending on each operator's demonstrated ability to manage risks. It does not penalise well-managed entities by making them operate under standards designed to keep weak, poorly managed ones solvent. What prudential supervision is about is helping protect other people from the failure of the institution by trying to ensure that the institution is adequately run. In the words of Onekhena 'An adequately run institution needs to know why it is in business. It needs to have a strategy and some idea of where its revenue will come from. It needs to know what kind of risks it faces and, preferable to try to measure them. It needs to know what kinds of risks it wants to face and take measures to eliminate the rest. And it needs to have some way of telling how much capital it needs to deliver an acceptable risk-adjusted return to shareholders.'

Onekhena noted that it is a shift from rule based compliance enforcement to the development of more flexible systems based on judgments about risk; establishment of organisational requirements and procedural standards for risk management; development of comprehensive risk measurement models to guide supervisory attention or select cases for intervention.

The way forward
Daniel stated that the current shift from the traditional compliance based supervision to risk based supervision was precipitated by the financial crisis that has seen the failures in many financial institutions, adding 'The general understanding is that supervisors failed to ensure that institutions understood and dealt with risks that they were undertaking and also failed to ensure that institutions could raise capital from conventional sources when the need arose. Under risk based supervision, Daniel noted that there is a process of continuously updating risk assessment through on-site reviews, off-site reviews and market intelligence that creates an early warning or rating system for the supervisory authority to anticipate and deal with emerging issues.

'If adequately implemented, risk based supervision has the potential for closer monitoring of insurance institutions thereby reducing the chances of failure,' Daniel stated. He reiterated that migrating from compliance based supervision to risk based supervision will require supervisory agencies to overcome practical challenges which include legal framework, structure of the supervisory agency, guidance and training for supervisors, as well as risk rating model and a measurement tools. Implementing risked based supervision, according to Daniel, will also require experienced and knowledgeable supervisors to exercise subjective judgment on continuous basis.

In his words 'A final formidable challenge on the road to effective migration relates to what risk rating model and measurement tools should be adopted.'Umaru Ibrahim, managing director and chief executive officer of Nigeria Deposit Insurance Corporation (NDIC) said regulators needed to be proactive, hence risk based supervision was imperative in the light of the recent developments in the financial sector. According to him, the crisis in the financial sector can be attributed to jettisoning of corporate governance and paying little attention to risk management by banks. 'Under the present dispensation, we accord priority to consolidated supervision, communication and report writing and risk management,' he said.