The Central Bank of the UAE published Model Management Standards and Guidance on 23 December 2022. The Standards ( “MMS”) present mandatory modelling practices to be implemented by banks in the UAE based on international standards while considering local circumstances. The MMS outlines general standards applicable to all models as well as specific requirements for the application of the standards. The Model Management Guidance (“MMG”) expands on technical aspects specific to certain model types.&nbsp;<h2>Objectives</h2>The objectives of the standards and guidance are as follows:<ul><li>To ensure models used by UAE banks meet quality standards to adequately support decision-making and reduce model risk</li><li>To improve homogeneity of model management across UAE banks</li><li>To mitigate the risk of underestimating provisions and capital requirements across UAE banks</li></ul>&nbsp;<h2>Scope of models</h2>The MMS&nbsp; applies to&nbsp;all types of models employed by institutions to support decision-making. Therefore it covers, amongst others, risk models, pricing models and valuation models. The MMS document includes the following&nbsp;non-exhaustive list of models that should be considered in scope:<figure class="image"><img src="https://res.cloudinary.com/lux-management-and-holding-fz-lle/image/upload/v1672822253/image_770786f6d7.png"></figure><h2>Model management framework</h2>Banks must have a model management framework that covers the following key areas.&nbsp;<h3>Model governance</h3>Banks are required to develop and maintain appropriate policies and procedures to ensure that model risk is managed effectively. The model governance framework must cover, at a minimum, the definition of model objectives, key steps of the model life-cycle, a model inventory,&nbsp; model ownership, a list of key stakeholders involved in decision-making, details relating to relationships with third parties involved in model development, an assessment of the adequacy of internal skills, comprehensive model documentation, and a comprehensive reporting framework.&nbsp;<h3>Data governance</h3>Banks are required to have a formal Data Management Framework to ensure the availability of accurate and representative historic data, used in the development and validation of models. The data management framework must cover the identification of relevant data sources, data collection frequency and level of granularity, data quality control, data storage and access control protocols, and policies to ensure robust system infrastructure.&nbsp;<h3>Model development</h3>Banks must have a well-documented, structured process for model development with sequential and logical steps. This process must include the following steps at a minimum, to be performed iteratively as required:<ul><li>Data preparation</li><li>Data exploration</li><li>Data transformation</li><li>Sampling considerations</li><li>Selection of suitable model methodology</li><li>Model construction</li><li>Model selection</li><li>Model calibration</li><li>Pre-implementation validation</li><li>Impact assessment</li></ul>&nbsp;<h3>Model implementation</h3>Banks must have a separate framework to govern the implementation of approved models after they have been developed. Implementation of each model must be treated as a project within a suitable project management framework. This framework must include the implementation scope, detailed implementation plan including functional and technical specifications, roles and responsibilities, a roll-back plan and User Acceptance Testing (UAT) with suitable test cases.&nbsp;<h3>Model usage</h3>Models usage must be clearly defined, well-documented, monitored and managed. A model usage framework must consider the identification of model users, the frequency of model usage, the source and nature of model inputs, the destination of outputs within the IT system and operational processes, how output must be interpreted including defining the decisions that they can support, limitations of model output including level of uncertainty, and strict governance on the use of input and output overrides.&nbsp;<h3>Performance Monitoring</h3>Banks must have a process in place to monitor the performance of models in light of changes in market conditions and the economic or business environment. Such changes may impact the stability, performance, assumptions or reliability of models. This process must be well documented and cover roles and responsibilities, frequency of monitoring, appropriate metrics and limits, reporting, and escalation processes.&nbsp;<h3>Independent validation</h3>In addition to performance monitoring, banks must have a robust process to ensure the independent validation of models to ensure that they are performing as intended. These processes must include defined responsibilities, frequency of reviews, appropriate metrics and limits, and reporting. Validation must include both quantitative and qualitative approaches and the outcome must include a clear conclusion of the model’s suitability, and the bank must have a well-defined remediation process in the event that models fail the independent validation.&nbsp;<h2>Model Management Guidance (“MMG”)</h2>As a supplement to the Model Management Standards, The Central Bank of the UAE also published Model Management Guidance (“MMG”) which expands on technical aspects specific to certain model types, based on commonly accepted modelling practices used by practitioners and academics internationally. These models include:<ul><li>rating models,</li><li>PD models,</li><li>LGD models,</li><li>Macro models,</li><li>interest rate risk in the banking book (IRRBB) models,</li><li>net present value models (NPV)</li></ul>&nbsp;Although the provisions in the Guidance are not mandatory, they are recommended and deviations from the MMG must be justified and subject to review by the Central Bank. The Standards and Guidance are available on the&nbsp;<a href="https://www.centralbank.ae/en/regulations/">Central Bank of the UAE’s website</a>. &nbsp;&nbsp;

On 23 December 2022 the Central Bank of the UAE published Model Management Standards and Guidance. The Standards present mandatory modelling practices to be implemented by banks in the UAE and cover general standards applicable to all models as well as specific requirements for the application of these standards. The supplementary Guidance contains recommended principles related to technical aspects specific to certain model types.


Model Management Standards and Guidance for UAE banks

The current global economic and geopolitical turmoil has not been experienced for decades and shows no signs of abating, with the cost-of-living crisis, high inflation, aggressive monetary tightening, the continued conflict in Ukraine, and the lingering COVID-19 pandemic all weighing heavily on the financial outlook. In this blog post we consider the current financial situation in the context of Employee Benefit (“EB”) liabilities, such as End of Service Gratuity Benefits (“EOSGB”), focusing on one of the most fundamental factors that determines EB liabilities: the discount rate.&nbsp;Rising interest rates result in lower EB liabilitiesThe discount rate is one of the key assumptions used to compute the present value of the liabilities (or benefits) on an actuarial basis (as prescribed by IAS 19 and other accounting standards). In accordance with IAS 19, the discount rate should be determined by reference to market yields at the end of the reporting period on high quality Corporate Bonds or, where there is no deep market in such bonds, by reference to market yields on Government Bonds. Government Bond yields are extremely high right now, as a result of rising interest rates. Consequently, discount rates (which serve as an important indicator of the conditions of the credit economy) have also increased.When discount rates increase, the EB liability reduces, if all other assumptions remain unchanged. Whilst this has a positive impact on companies’ bottom lines, Finance Directors will be concerned that the short-term hike in the discount rate will cause the EB liabilities to be underestimated in the long term; in other words, there is a risk of under-provision.So, consideration needs to be given to the preventative measures that can be taken to avoid a shock to the Balance Sheet when the markets start to normalize. Since we do not have any control over how interest rates will fluctuate, we have to look at other aspects that will help to mitigate the variations in the liability caused by changes in the discount rate.&nbsp;Salary esclation rates increasing due to inflationIn order to determine what risk mitigation action should be implemented, it is important to understand the other key actuarial assumptions, in particular the salary escalation rate. As the discount rate is used to discount the expected future outflows of Employee Benefits, so is the salary growth rate used to project the expected salary increases and hence the expected benefit pay-outs. This assumption changes in the same direction as the liability. So, when the salary escalation rate increases, so does the liability and vice versa.Lux has identified that, from the start of this year, there has been a growing trend for companies to increase their employees’ salaries in recognition of the high inflation environment. For example, in Saudi Arabia, we are seeing rates increase, from the previous regional benchmark of around 2 – 3% pa, to escalation rates in excess of 4% pa. If we assume a higher salary escalation rate in 2022, when compared to 2021, then this partly offsets the increase in the discount rate, therefore suppressing the reduction in the EB liabilities.&nbsp;Funding liabilities with matching assetsAnother approach or strategy, to help reduce the impact of higher discount rates, is to match the assets and liabilities.&nbsp;Alternative investment options, which give a good asset-liability match in respect of liability profile and duration, will help to curb the volatility resulting from discount rate variations.For example, if we assume that the assets are invested in instruments which give mark-to-market returns, in rising interest rate scenarios, both EB liabilities and asset values will decrease, thereby offsetting actuarial gains or losses on assets and liabilities, resulting in a smoother Profit &amp; Loss account.So, there is no better time than right now, for companies to seriously consider funding their EB liabilities. As a professional actuarial firm that cares about its clients’ financial stability, we recommend that such mitigation options be considered for this year’s EB actuarial valuation.If you are interested in receiving actuarial support &amp; advice regarding your company’s own EB liabilities, then please <a href="https://www.luxactuaries.com/contact" target="_blank" rel="noopener noreferrer">contact us</a>; Lux would be delighted to assist you.&nbsp;Related Links:<ul><li><a href="https://www.luxactuaries.com/practice-areas/employee-benefits" target="_blank" rel="noopener noreferrer">Lux Actuaries' Employee Benefits practice</a></li><li><a href="https://www.luxactuaries.com/solutions/ias-19-employee-benefits-valuation" target="_blank" rel="noopener noreferrer">IAS 19 Employee Benefits valuation service</a></li></ul>

Rising interest rates lead to a reduction in employee benefit liability valuations in the short term. However, Finance Directors may be concerned that current valuations may underestimate EB liabilities in the long term.

Short term gain, long term pain

Lux Actuaries and Consultants and <a href="https://www.insurancemonitor.ae/#" target="_blank" rel="noopener noreferrer">Insurance Monitor</a> bring you the latest GCC Performance Periodical covering the insurance industry performance for the third quarter of 2022. <a href="https://www.insurancemonitor.ae/publications.php?e=NzE=" target="_blank" rel="noopener noreferrer">This report</a> examines the key metrics for listed insurers in the GCC region and features financial performance along with data tables, stock performance, capital management metrics, an update on mergers and acquisitions and financial strength ratings.&nbsp;<h2>GCC Listed Insurers: Top line soars by 21.7% in the first nine months of the year</h2>While the overall improving economy, growing resident population and new mandatory covers has undoubtedly benefitted the GCC insurance industry as evident from the soaring increase of 21.7% in the combined Gross Written Premium (‘GWP’) of 80 listed insurers reaching USD 23.9bn in the first nine months of the year, growth has been highly concentrated with 73% generated by (8) leading players across the region.The report finds that such growth that has come about as a result of (cross-border) acquisitions, strategic arrangements, inward business and other inorganic growth strategies is driving the next wave of growth for capital-rich insurers in the region.&nbsp;<h2 style="margin-left:0px;">Profitability down</h2>Profitability, however, has dipped by 28.6% during the period due to an increase in the spend on claims, distribution, and administrative expenses as well as lower investment income underpinned by higher domestic inflation, increased mobility, aggressive competition, and volatile capital markets.At least 40 insurers have reported underwriting losses with the Net Combined Ratio for the period reaching 98.8%. This has necessitated some form of restructuring for several insurers that have been in sustained breach of solvency regulations. In the UAE, corrective measures undertaken in Q3 2022 include the provision of bank guarantees in favour of the regulator, the announcement of mergers and a more radical plan in the case of AMAN that has decided to sell its insurance portfolio and transform into an investment firm to preserve shareholder value.<h2 style="margin-left:0px;">Rating downgrades</h2>In Saudi Arabia, underwriting losses continue to erode previously restored capital for several insurers including MEDGULF that has triggered a rating downgrade in September, following a previous upgrade in January 2022.Other significant rating developments in Q3 2022 includes the downgrade of Qatar’s leading insurer - QATI following an overall loss in Q3 2022 and underwriting losses reported in each of the last five years.&nbsp;Download your <a href="https://www.insurancemonitor.ae/publications.php?e=NzE=" target="_blank" rel="noopener noreferrer">free copy of Q3 2022: GCC Performance Periodical here</a>.&nbsp;&nbsp;&nbsp;

Lux Actuaries and Consultants and Insurance Monitor bring you the GCC Performance Periodical for Q3 of 2022. This report examines the key metrics for listed insurers in the GCC region and features financial performance along with data tables, stock performance, capital management metrics, an update on mergers and acquisitions and financial strength ratings.

GCC Insurance Industry Performance - Q3 2022

We are pleased to announce the establishment of Lux Actuaries &amp; Consultants in Kuwait, as a locally based actuarial consultancy, registered by the Kuwait Insurance Regulatory Unit (IRU). The management of Lux would like to extend a huge thank you to the team that has been instrumental in getting us to this point, including our local partners. We look forward to supporting the Kuwaiti market and continuing to promote the growth of the profession within the Gulf region. &nbsp;

We are pleased to announce the registration of Lux Actuaries & Consultants with the Kuwait Insurance Regulatory Unit (IRU).

Lux Actuaries now open for business in Kuwait

Increased demand for actuarial skills&nbsp;The most significant change for the actuarial function in 2023 will be alignment with IFRS 17 from a business as usual (BAU) perspective. This includes the associated development and upskilling of the actuarial function with an increasing level of urgency and importance. There will be an uptick in&nbsp;demand for actuarial students and qualified Fellows and Associates to develop and streamline internal processes, particularly between Actuarial and Finance functions,&nbsp;as these are evolving to suit a new reporting workflow. With a supply that won’t keep pace with demand, we would expect an increase in actuarial costs and likely an enhancement of actuarial packages to include study incentives as a standard offering as the better companies work to secure stronger talent.&nbsp;Outsourcing&nbsp;With many insurance companies in the region currently choosing to outsource the Appointed Actuary function to consultancies, these consulting firms are expected to experience an increase in outsourced responsibilities and will need to adopt an operating model that accommodates a new level of scale. External Auditors, many of which utilise actuarial teams based outside of the region, may also choose to invest in actuarial capabilities based locally as the cost-benefit gradient now tilts more towards benefit.&nbsp; With financials coming under greater scrutiny, the external audit scope will increase to include greater actuarial involvement and expertise. This in turn will have knock on effects on audit costs.&nbsp;&nbsp;Regulators&nbsp;Regulators will likely look to issue guidance or regulation on the increased scope that Appointed Actuaries need to fulfil.&nbsp; The upskilling and expansion of regulatory actuarial departments will be crucial to ensure that the review and monitoring of compliance with the new standard meets the minimum requirements. Regulatory forms will likely undergo change and external actuaries will be critical in the population and signoff of these forms.&nbsp;&nbsp;Stakeholder communication&nbsp;One of the most pivotal parts of BAU will be the development of forecasts and comprehensive business plans on an IFRS 17 basis, with a comparison of the differences with respect to the conventional IFRS 4 basis and associated rationale. Where actuarial involvement may have been relatively lighter historically, this will necessarily increase. Forecasted Statements of Financial Performance and Financial Position will require more detailed calculations that the actuarial function should be required to perform as these are naturally within the actuarial remit. Rules of thumb that may have been employed historically will likely be replaced by explicit liability calculations, particularly for longer term lines of business. This will require sophisticated software and knowledge of use, involving further investment in training and development.&nbsp; Explanation of these figures to Senior Management, Rating Agencies and Boards will push the actuarial and finance functions further into the centre of stakeholder communication.&nbsp;&nbsp;Actuarial education&nbsp;Lastly, the training and development of actuarial students produced by local tertiary institutions, most notably in the KSA and Bahrain, is likely to gather more support. Recent initiatives undertaken by the Bahrain Institute of Banking and Finance (BIBF) together with the Institute and Faculty of Actuaries (IFoA) recognise the importance of locally based graduates meeting the increasing demand for actuarial recruits. The long term success of actuaries in the region will be intrinsically linked to the grassroots coaching and support of universities and training institutes in providing fresh talent prepared to suitably meet the changing requirements of the insurance industry. &nbsp;No doubt the upcoming year brings exciting opportunities for the actuarial graduates, students and qualified Associates and Fellows. Our success in meeting the accompanying challenges depends on a proactive vision of the wider industry in developing and supporting the growth of professionals capable of ensuring the industry is able to successfully navigate around this corner. &nbsp;

Shivash Bhagaloo discusses trends and challenges facing the actuarial profession in the GCC in 2023. 

Outlook of the actuarial profession in the GCC for 2023

&nbsp;Lux Actuaries &amp; Consultants is proud to have sponsored the first in-person meeting of the Gulf Actuarial Society (GAS) since 2019. The event took place in Dubai and was attended by over 70 actuaries and students from across the GCC.&nbsp;&nbsp;There were many familiar faces and some new ones. We are particularly honoured to receive a delegation from the Institute and Faculty of Actuaries (“IFoA”), including the president-elect,&nbsp;Kalpana Shah.&nbsp;&nbsp;The seminar provided insightful presentations on interesting topics, including a discussion on the use of machine learning in Health Insurance by Navarun Jain, an update on the status of IFRS 17 implementation in the GCC by Hatim Maskawala, and an introduction to mortgage insurance by Imran Haider. In our final session, IFoA President-elect Kalpana Shah shared her views on her vision for the actuarial profession.&nbsp;&nbsp;As before the pandemic, this event was a great opportunity for actuaries in the region to engage and network with their colleagues and we are all looking forward to hosting many more such events in the region.&nbsp;

Lux Actuaries and Consultants is proud to have sponsored the Gulf Actuarial Society event held in Dubai on 6 October 2022.

Latest from our blog

Model Management Standards and Guidance for UAE banks

Short term gain, long term pain

GCC Insurance Industry Performance - Q3 2022

Lux Actuaries now open for business in Kuwait

Outlook of the actuarial profession in the GCC for 2023

Full house at the Gulf Actuarial Society event in Dubai