International Trends in Insurance Regulation PDF

296 CHAPTER 9 INTERNATIONAL TRENDS IN INSURANCE REGULATION Chapter Introduction All business entities that deal with the public are bound by certain laws of the country in which it operates. While all are bou...

296 CHAPTER 9 INTERNATIONAL TRENDS IN INSURANCE REGULATION Chapter Introduction All business entities that deal with the public are bound by certain laws of the country in which it operates. While all are bound by the common law, there are certain laws that are specific to the type of business and not applicable to others. For instance, in India even though there are laws common to all citizens, there is a specific law covering motor vehicles and its users (Motor Vehicles Act 1988). Similarly, in insurance also, specific laws are made to cover insurance companies, insurance intermediaries and insurance contracts. The Government of India had enacted the Insurance Act, 1938 and modified it many times depending on the regulatory needs of the insurance business. When the market was opened for private sector participation, the Insurance Regulatory and Development (IRDA) Act, 1999 was enacted to incorporate the revised needs of the industry and authorised to make specific regulations for different sections of the market. Insurance laws are thus country specific and market specific aimed at regulating the situations and practices prevailing in that particular market. However, insurance regulations in all countries serve some purposes that are common for all countries. Students of insurance should be aware why insurance is being regulated and what are the purposes served by such regulation. Students of insurance should also have some familiarity about the regulatory systems prevalent in different countries. a) Explain some of the purposes of having regulations for insurance. b) Explain the areas where regulations mainly focus upon. c) Discuss the insurance regulatory systems of a few countries.  297 Look at this scenario The sub-prime financial crisis of 2008 led to the collapse or near collapse of a lot of financial institutions in the US. ! Mortgage institutions like Fannie Mae and Freddie Mac had to be bailed out by the Government ! Investment Banks like Bear Sterns and Lehman Brothers collapsed ! Insurance Companies like AIG had to bailed out by the Government ! Consumer Banks like Citibank had to be bailed out by the Government All these institutions took more risk than they could afford to do. Proper due diligence or credit appraisal was not done before taking investment decisions and lending decisions. Some even bypassed rules and did not follow regulations. The result was a near collapse of the entire financial system. The sub-prime crisis of 2008 lays greater emphasis on the need for stringent rules and regulations and greater control systems to be put in place. Impact on the Indian Insurance Sector AIG had too much of exposure to credit-default swaps (CDS) which almost brought the institution down on its knees. AIG relied too much on unregulated investments that carried enormous risks. The jitters of near collapse of AIG in the US were felt in India also. Tata AIG is a joint venture between the Tatas (74% shareholding) and AIG (26% shareholding). Even though the operations of Tata AIG were smooth and well within the regulations of Indian insurance rules, the policyholders of Tata AIG were worried about their investments. They feared if AIG in the US went bankrupt they will also lose their money in India. The Indian company management, the Indian regulators, the Indian Government had to come out with a number of clarifications to soothe the nerves of the anxious policyholders in India. The wrong doings of AIG US had a sentimental effect on the policyholders of Tata AIG and they had to spend lot of sleepless nights here in India when the US Government was busy trying to douse the fire by averting a collapse of AIG US with bailout after bailout with taxpayers’ money. IRDA has stipulated stringent regulations for insurance business in India so that such a situation does not arise in India. We will study these regulations and the regulations laid down by the insurance regulators of some other countries in this chapter.  298 1. Explain some of the purposes of having regulations for insurance [Learning Outcome a] Though insurance is regulated through different systems and procedures in different countries, there are some common reasons that form the basis of many regulations. One should not forget that insurance serves a great social need of providing financial security. Insurance protects members of the society from financial ruin in various situations. Some of the scenarios where the insurance system comes to the rescue include: ! when someone dies and leaves the family without proper income; ! when fire or flood destroys one’s shop, merchandise or factory depriving him of his livelihood; ! when earthquake or fire destroys a house and its contents causing great financial loss, ! when someone falls sick and the family is forced to part with its life-time savings for treatment Hence the Government is interested in protecting its citizens’ welfare through the system of insurance. The scope of insurance regulation includes orderly growth of long-term businesses like life insurance, annuities and pension products as well as typical short term businesses like automobiles, buildings, household items, travel risks, ships and shipments. The difference of insurance regulation from regulation of other branches of finance or economics is that the insurance contract generally allows general insurers to keep the premium with them if there is no loss. Life insurers have control over the insured’s money for long periods and have to pay their contractual obligations when there is a death. The contract between the insured and the insurer, in essence, is a promise of indemnification (reimbursement for the loss) in the event of a loss. The insurer needs to act as per his promise only if the specific loss making event happens. This situation arises only for a small percent of insured. When a situation comes when the insurer has to fulfil his promise, the policyholder may face problems in multiple ways. Insurers may go bankrupt and may not exist to pay the claim.  299 Insurers may wind up their business in a country and may not be available to settle the claim when it arises. Insurers may give some reason to avoid paying the claim and leave the policy holders in a difficult situation. Insurers may make complicated policy wordings that the insured may not understand, to avoid payment of claims. The regulator creates a proper legal environment to ensure that the policyholder is protected and when he comes to the insurer after a loss, his contractual rights are protected. Regulations are created to protect the policyholder. For insurance to be successful as a social security measure or as a business, public confidence in the insurance mechanism is required to be built. But, if an insurer fails to deliver what he promises, the particular insured loses his trust in the insurer. Many such instances may erode the trust and confidence of the people. Hence, insurance regulators use controls like prescribing a high capital base for issuing licences so that only financially strong companies can enter the insurance market. Question 1 As per the principle of indemnity, for acceptable claims; insurance companies pay ________ A. Compensation only for the loss amount B. The full policy amount irrespective of the loss amount C. Actual loss amount even if the loss amount is more than the policy amount D. 50% of the loss amount irrespective of the loss amount 2. Explain the areas where regulations mainly focus upon [Learning Outcome b] Licensing: The regulatory processes starts from issuance of licences, checking the promoting company’s credentials, analysing their business plan, ensuring that they have sufficient investment in the company, their ability to be in the business after paying a reasonable number of claims, background of people employed at senior levels and the like. As per existing rules the minimum capital requirement for starting life insurance business in India is 100 crores.  300 Management of funds Insurers have large amounts of public funds with them and have to exercise proper control on their investment. Errors of insurers in making prudent investments can affect the financial security of many insured. Regulators try to ensure that owners of insurance companies do not take away the public funds or utilize the money for wrong purposes. Accounting norms, investment norms, audit systems, inspections etc. are created for this purpose. Maintaining financial solvency Insurers are expected to do their business prudently and remain financially healthy and strong. Regulations ensure that insurers do not take undue risks in their business and all employees should do business as per a management philosophy. So, the regulators ask them to have a business plans and create underwriting manuals, claims manuals etc. Actuarial evaluations of long-term liability, internal audit and external audit systems are also insisted upon. Solvency measures whether the insurance company can settle all the claims and still continue to be in business. Standardisation of Insurance Products Customers of consumer items can easily evaluate the products and promises made by sellers. However, customers of insurance do not have the chance for evaluating an insurer’s promises to perform certain obligations under future situations. It is difficult for customers to evaluate an insurance policy at the time of purchasing insurance. Often, many policy conditions are not comprehensible to the common man. Insurance regulators professionally evaluate services to ensure standardisation of insurance products. Pricing of Insurance Products Buyers of insurance are unable to find out whether the policy is over-priced. If products are over-priced, insured feel cheated. Under-pricing of insurance products can make insurers weak and unable to pay claims when the contingency arises. To ensure that insurance products are priced on proper technical and business factors, effective regulation is needed. Creating a Level Playing Field The regulator has to create a level playing ground for all insurers by ensuring that all are abiding by ethical practices and no one gets an unfair edge over another. In addition to standardising insurance products and rationalising the prices, regulators prescribe uniform norms for valuation of assets, actuarial vetting of rates etc. Norms are laid down for ensuring policyholders’ protection and maintaining ethical standards.  301 Monitoring reinsurance Reinsurance contracts run into huge amounts and more importantly, they have to work when an insurer gets a large claim. Regulators ensure that foreign exchange is not unduly lost through reinsurance programmes. Regulations in many countries try to retain maximum premium within the country and in some countries there are norms for placing a particular proportion of the reinsurance with national reinsurer(s). Question 2 How can one assess if an insurance company will be able to meet its claims or not? A. Operating margins of the company B. Profitability of the company C. Solvency ratio D. Share capital of the company 3. Discuss the insurance regulatory systems of a few countries [Learning Outcome c] The challenge of regulating insurance has grown with the growth of the industry. Over the last two decades, a lot of reforms have happened in insurance regulation worldwide. Organisations like World Bank, World Trade Organisation (WTO), Asian Development Bank (ADB), Basel Committee on Banking Supervision (BCBS) and many other international bodies have contributed to insurance reform. International Association of Insurance Supervisors (IAIS) is a full time body working for the better regulation and development of insurance. IAIS has developed core insurance principles relevant to contemporary markets and provided a forum of interaction among the insurance supervisors and professionals all over the world.  302 Insurance regulators like Financial Services Authority (FSA) of UK, National Association of Insurance Commissioners (NAIC) which is the apex body of fifty State level regulators of USA, Australian Prudential Regulatory Authority (APRA), and Financial Services Authority (FSA) of Japan, Bank Negara Malaysia (BNM) and Insurance Regulatory and Development Authority (IRDA) of India are well known insurance regulators. There are different associations of insurers and self-governing bodies that try to create standards in the insurance industry. The International Association for the Study of Insurance Economics, popularly known as "The Geneva Association" is a non-profit world organisation that conducts research on growing importance of worldwide insurance activities in all sectors of the economy. It comprises around 80 chief executive officers from insurance companies from Europe, North America, South America, Asia, Africa and Australia. In addition to the regulators, there are associations of insurers in many countries who try to create discipline in the industry and promote professional ethics in the insurance market. Insurance Association of British Insurers (ABI) is one of the oldest and well respected entities. International Association of Insurance Supervisors (IAIS) is presently reaching out to all insurance regulators and consolidating them under one banner and creating commonly acceptable standards for all regulators and markets across the world. Established in 1994, the IAIS represents insurance regulators and supervisors of some 190 jurisdictions. IAIS has more than 120 representations from industry associations, professional associations, insurers and reinsurers, consultants and international financial institutions. IAIS issues global insurance principles, standards and guidance papers, provides training and support on issues related to insurance supervision, and organises meetings and seminars for insurance supervisors. IAIS works closely with other financial sector standard setting bodies and international organisations to promote financial stability and creates opportunities for insurance supervisors, industry representatives and other professionals to discuss developments in the insurance sector and topics relating to insurance regulation.  303 Question 3 The Financial Services Authority (FSA) is the insurance regulator of which country? A. United States B. United Kingdom C. Pakistan D. France Summary ! Insurance serves a great social need of providing financial security. ! The Government protects its citizens’ welfare through the system of insurance. ! The contract between the insured and the insurer, in essence, is a promise of indemnification (reimbursement for the loss) in the event of a loss. ! The regulator creates a proper legal environment to ensure that the policyholder is protected and when he comes to the insurer after a loss, his contractual rights are protected. Regulations are created to protect the policyholder. ! IRDA has laid down rules and regulation for insurance companies pertaining to licensing, premium investment, solvency margins, standardisation and pricing of insurance products. ! Over the last two decades, a lot of reforms have happened in insurance regulation worldwide and many international bodies have contributed to insurance reform. ! International Association of Insurance Supervisors (IAIS) is a full time body working for the better regulation and development of insurance. ! IAIS issues global insurance principles, standards and guidance papers, provides training and support on issues related to insurance supervision, and organises meetings and seminars for insurance supervisors.  304 Answers to Test Yourself Answer to TY 1 The correct option is A. As per the principle of indemnity, for acceptable claims; insurance companies pay compensation only for the loss amount. Answer to TY 2 The correct option is C. Solvency measures whether the insurance company can settle all the claims and still continue to be in business. Answer to TY 3 The correct option is B. The Financial Services Authority (FSA) is the insurance regulator of the United Kingdom. Self-Examination Questions Question 1 How much is the minimum capital requirement for starting insurance business in India? A. Rs. 25 crores B. Rs. 50 crores C. Rs. 75 crores D. Rs. 100 crores  305 Question 2 The International Association of Insurance Supervisors (IAIS) was established in which year? A. 1854 B. 1994 C. 1894 D. 1954 Answers to SEQ Answer to SEQ 1 The correct option is D. The minimum capital requirement for starting insurance business in India is Rs. 100 crores. Answer to SEQ 2 The correct option is B. The International Association of Insurance Supervisors (IAIS) was established in 1994.