Risk-Based Capital on top of IFRS 17: what it does to a small insurer's capital

Saudi Arabia's Insurance Authority (IA) is moving the market to a Risk-Based Capital (RBC) regime: a pilot through 2026, where firms calculate solvency under both the existing model and the new framework, and a mandatory effective date of 1 January 2027. The framework is broadly aligned with Solvency II and adapted for the Saudi market, with four Quantitative Impact Studies completed and a fifth on year-end 2025 data.

For an insurer already three years into IFRS 17, this lands as a second, separate layer of discipline. IFRS 17 governs how the balance sheet is measured and reported. RBC governs how much capital must sit behind the risks that balance sheet carries, and it does so on its own solvency valuation basis — a different set of asset and liability rules from IFRS 17. For a small, focused insurer the binding pressure comes from the capital requirement: the SCR rises sharply because a single-line book earns almost no diversification credit. This post works through the mechanics in the order an actuary assembles the RBC number, with a fictitious motor-only takaful operator, Al-Mizan Takaful, carrying the worked figures. The figures are illustrative and aligned to Solvency II calibration rather than the official Saudi QIS factors, but the direction of each step is structural.

1. Separate the two layers before anything else

The first task is to be precise about what each framework does, because the easiest error is to count the same risk twice.

IFRS 17 is the financial-reporting layer. It measures a group of insurance contracts on initial recognition at the total of the fulfilment cash flows — the best-estimate future cash flows, discounted for the time value of money and financial risk, plus a risk adjustment for non-financial risk — and the contractual service margin, the unearned profit (paragraph 32). It governs what the balance sheet and income statement show, and the timing of profit emergence as the CSM releases over the coverage period.

RBC is the solvency layer. It sets the amount of capital the insurer must hold so it can absorb a severe but plausible stress — in Solvency II-aligned regimes, calibrated to a one-in-200-year event over one year — and remain able to meet policyholder obligations.

The interpretation that matters: the risk adjustment inside IFRS 17 and the Solvency Capital Requirement under RBC are answering different questions. The risk adjustment is the compensation the insurer requires for bearing non-financial uncertainty, embedded in the measurement of the liability. The SCR is capital held against a tail stress across all risk types. They sit on different parts of the same balance sheet, and conflating them either double-counts risk or leaves a gap.

2. Define the object you are computing: the solvency ratio

Every mechanic below either lifts a numerator or a denominator, so it helps to write the target down first.

Solvency ratio = Eligible Own Funds ÷ Solvency Capital Requirement (SCR).

Eligible own funds are the excess of the insurer's admissible assets over its liabilities, both measured on the solvency basis — a different valuation from IFRS 17 equity, because the two frameworks apply different rules to what counts as an asset and how the liabilities are valued. Qualifying subordinated debt also counts, subject to tiering. The SCR is the aggregate risk capital produced by the standard formula. In Solvency II-aligned regimes the regulatory minimum is a solvency ratio of at least 100% of the SCR, with a comfortable operating buffer typically set higher; a minimum capital requirement (MCR) sits below the SCR as a harder floor, and the IA frames the test as actual company capital against minimum required capital.

The standard formula is the default. A company may apply to the IA to use a full or partial internal model, subject to approval. Most smaller insurers will run the standard formula, which is where the structural penalty below is hardest to avoid.

3. Build the SCR from the risk modules

The SCR is assembled from individual risk charges, each computed on its own first.

• Underwriting risk stresses the net loss ratio above expected. It varies by line of business and by reinsurance structure, and the charge is heaviest for thin, high-frequency books. A single-product motor writer draws a large premium-risk factor.
• Market risk covers interest rate, equity, property, spread and currency exposure on the invested assets.
• Credit risk captures counterparty default, including the credit quality of reinsurers — the stress factor is tied to the counterparty's external rating.
• Concentration risk applies asset-threshold surcharges: exceeding limits on equities, lower-rated bonds and similar holdings triggers an additional charge.

For Al-Mizan, writing only motor in Saudi Arabia on SAR 200m net premium, the underwriting module dominates. Under the old fixed-margin rules its required capital was roughly 15% of net premium, around SAR 30m. The standalone risk charges under the standard formula are several times that before any aggregation.

4. Aggregate with the correlation matrix — where diversification appears, or does not

The modules do not simply add. They combine through a correlation matrix, the same logic Solvency II uses, so the total SCR is less than the sum of the standalone charges. The size of that reduction is the diversification credit, and it is the single most important mechanic for a small insurer.

Diversification credit is largest for a book spread across multiple lines and geographies, where the modules are imperfectly correlated and partially offset. A single-line, single-geography writer captures almost none of it. The charges aggregate with little relief, so the SCR per unit of premium is structurally higher than for a diversified group writing the same volume.

For Al-Mizan, the aggregated SCR lands near SAR 90m — roughly three times the SAR 30m the old regime required — with no earned diversification benefit to bring it down. The standard-formula correlation matrix applied to a one-line book produces this directly — the elevated SCR is a structural feature of the method, not a modelling judgement that can be argued away.

5. Read the result for the small insurer

For Al-Mizan, solvency-basis own funds of around SAR 80m against an SCR of around SAR 90m give a solvency ratio near 89% — below the 100% SCR coverage threshold. On these illustrative figures the insurer must raise capital, rebalance the portfolio, or merge; falling below the SCR minimum triggers a regulatory recovery plan.

The return-on-capital arithmetic makes the pressure concrete. Return on capital is underwriting profit over required capital. RBC raises the denominator fastest for the least-diversified writers, and the numerator is already thin — aggregate Saudi sector profit reportedly fell 46.5% year on year in the second quarter of 2025 on intense price competition. Required capital up and underwriting profit down together collapse the return on capital for a focused writer, well before investment returns are considered.

6. The levers available before go-live

Three levers change the ratio, and each is a modelling exercise, not a simple switch.

Reinsurance. A quota share cedes part of the premium and reserve base, which lowers the underwriting charge and, where it covers the concentrated line, the concentration charge. It introduces a credit charge against the reinsurer, mitigated by using highly-rated counterparties. For Al-Mizan, a 40% quota share to an AA-rated global reinsurer pulls the SCR from around SAR 90m toward SAR 59m and the ratio back above 130%, at the cost of ceded profit. One caveat specific to the market: a 2025 mandate gives local reinsurers a right of first refusal on 30% of placements, which can limit access to the most highly-rated international capacity for some treaties.

Subordinated debt. The RBC framework permits subordinated debt to count toward eligible capital — a structural addition to the previous fixed-capital regime, and one that opens the bond market as a capital-raising channel instead of relying on equity alone.

Portfolio focus and capital planning off the pilot. The 2026 parallel run is the rehearsal. Running the standard formula on the real book during the pilot is where the binding charge is found, and where the 2027 capital position can be planned, rather than discovered after the mandatory date.

The net effect of any lever depends on the counterparty rating and the treaty structure — numbers that have to be modelled for the specific deal.

7. Why it accelerates consolidation

The diversification mechanic makes merger economically rational, not merely a regulatory response. Combine two single-line books and the correlation matrix grants genuine SCR relief outright. For Al-Mizan (motor) merging with a health book of similar size, the combined SCR lands near SAR 140m against roughly SAR 175m standalone — about SAR 35m of capital freed by diversification alone — lifting a combined entity to a viable ratio where each was individually under pressure. Shared overhead and common actuarial and IT functions then improve the numerator as well.

The market is already moving in this direction. Fitch expects Saudi insurance consolidation to accelerate over 2025 to 2027, driven by the new capital requirements and weak underwriting profitability. The top two insurers already hold around 52% of gross written premiums, several mergers are under IA review, and 28 insurance agent and broker licences were revoked in May 2025 as part of the Authority's corrective measures. The same dynamic Solvency II produced among smaller European insurers — capital efficiency rewarding scale and diversification — is now playing out in Saudi Arabia.

What it is for

RBC adds a solvency layer on top of IFRS 17's measurement discipline — a separate framework, measured on its own basis. For a small, focused insurer the pressure lands on the capital requirement: the standard formula concentrates charges on a single-line book and grants it almost no diversification credit, so the SCR climbs and the solvency ratio compresses. Diversification is the cheapest source of that capital relief, which is why reinsurance, subordinated debt, portfolio focus and, ultimately, consolidation all resolve the same constraint.

The work through 2026 is to compute the binding charge early on the real book, decide which lever to pull, and plan the 2027 capital position off the pilot — rather than letting the mandatory date settle it.

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This is the first in a short series on the Saudi insurance market's RBC transition. Later posts pick up parametric risk transfer and the reinsurance-as-capital lever in more depth.