1. b 2. a 3. d 4. b 5. d 6. c 7. a 8. c 9. b 10. c
Exercises
1. How might a supervisory authority determine whether unlicensed insurers are op-erating in the jurisdiction?
The existence of unlicensed insurers might be identified by considering consum-ers’ inquiries and complaints, monitoring advertisements, maintaining regular communication with licensed insurers and intermediaries, sharing information with other supervisory authorities within the jurisdiction and the region, and surfing the Internet to identify insurance offered to those in your jurisdiction.
2. What steps might be taken if an insurer is discovered operating without the neces-sary license? Have such situations arisen in your jurisdiction? If so, what actions were taken?
Actions that might be taken if an unlicensed insurer is identified include re-questing in writing that it cease operation in the jurisdiction, issuing a formal cease-and-desist order, seeking a court injunction, publishing a notice to warn the public, and contacting the home supervisor of an unauthorized foreign in-surer. Consult with senior officials in your jurisdiction regarding such situations that may have arisen in the past and how they were dealt with.
3. Does the insurance law (or another law) in your jurisdiction define “insurance”? If so, how is it defined?
Review the insurance law in your jurisdiction. If insurance is not defined in the law, discuss with colleagues how this term is interpreted in practice.
4. Provide several examples of insurance activities, or business activities in the nature of insurance, that are sometimes exempted from licensing or supervisory registra-tion. Do any of these exist in your jurisdiction? If so, is licensing or supervisory registration required?
Exemptions from licensing or supervisory registration are sometimes provided for manufacturers’ warranties, social insurance programs, motor vehicle assis-tance services, fraternal insurers, government-owned insurers, insurance pools, and insurance or reinsurance underwritten through the cross-border provision of services. Consult with colleagues regarding the existence of any of these in your jurisdiction. Review the insurance law to identify which must be licensed or registered.
5. Explain why some jurisdictions do not permit foreign insurers to operate through branches and describe the types of licensing requirements sometimes imposed on branches by those jurisdictions that do permit them. How does your jurisdiction deal with this issue?
Jurisdictions may prohibit foreign branches because a branch is not a legal entity. It thereby lacks a full corporate governance structure and cannot inde-pendently raise capital. Operational control of a branch may reside outside the host jurisdiction, making it more difficult to inspect the operation and correct deficiencies. Some reliance would have to be placed on the home supervisory authority, and there may be a reluctance to do so. Requirements sometimes put on branches include the need to make a financial deposit with the supervisory authority and to maintain assets locally to cover obligations to policyholders residing in the jurisdiction. Local assets must sometimes include a solvency margin and may need to be placed in trust. Consult with colleagues or review the insurance law to determine how the issue of foreign branches is dealt with in your jurisdiction.
6. Describe three types of specialization requirements that may be used to limit the scope of insurers’ operations. What is the rationale for requiring specialization?
Specialization requirements include the prohibition of composite insurers, the need to obtain a license for each class of business that will be underwritten, and
the restriction or prohibition of non-insurance activities. Such requirements ex-ist to limit exposure of policyholders to the different types of risks that may arise from business activities that differ significantly from those relevant to insurance they have purchased. These risks are heightened when the insurer lacks the spe-cialized expertise needed to carry on the other activities, whether directly or through its investment in a subsidiary.
7. Is the suitability of key functionaries and significant owners assessed as part of the licensing process in your jurisdiction? If so, which key functionaries are subject to assessment? How is “significant owner” defined in your jurisdiction?
Review the insurance law and licensing requirements in your jurisdiction to de-termine whether the suitability of key functionaries is assessed and, if so, which ones. Review the insurance law to determine the definition of “significant own-er” or the equivalent term used in your jurisdiction.
8. Describe the types of information that can be used to assess the suitability of key functionaries and significant owners. Which of these typically are used in your jurisdiction?
Sources of information on suitability could include a standardized background questionnaire, financial statements, checks of police records, contacts with for-mer employers, and consultation with other relevant supervisory authorities, both local and foreign. Consult with colleagues to determine which sources of information are commonly used in your jurisdiction.
9. A foreign insurer intends to establish a branch in your jurisdiction and has applied for a license. The application indicates that computer services and claims process-ing will be handled by the head office of the insurer under a service agreement, at a cost of 15 percent of premiums. What concerns might you have about this ar-rangement? What information could you use to evaluate the issues of concern, and where might you obtain this information?
Concerns about this arrangement could include the adequacy of controls over the quality of service and compliance with local legislation, the ability of the su-pervisor to access the records and inspect the activities, the ability of the branch to maintain service in the event of difficulties at the head office, and whether the interests of branch policyholders are being compromised by excessive fees for the services provided. Information that could be reviewed includes the service contract, the proposed program of internal controls, the contingency plan, a comparison of costs with those incurred by other local insurers for the same
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services, and input from the home supervisor regarding the capabilities of the insurer.
10. A newly formed non-life insurer has applied for a license, and you are responsible for analyzing its business plan and preparing a report for the head of the supervi-sory authority. Review the following information, identify any significant concerns that you will comment on in your report, and state your recommendations.
The non-life insurance market in your jurisdiction has consisted largely of com-pulsory motor vehicle third-party liability insurance (gross written premiums of 50,000, compared to total non-life premiums of 60,000). Several leading insurance agents believe there is an opportunity to develop the property insurance market rapidly. These agents have pooled their resources to form an insurance company.
Using the Internet, the owners have conducted research regarding the financial re-sults of property insurers in other markets. They have used this information as the basis for the claims and expense assumptions underlying the financial projections included in the business plan.
The owners have raised 2,500 initial capital, which is more than required to meet the 2,000 minimum amount specified under the Insurance Act. Insurers are re-quired to maintain at least this much equity on an ongoing basis or, if higher, a solvency margin calculated as the sum of 20 percent of net written premiums, 15 percent of claims provisions, and 15 percent of assets (other than cash, bank ac-counts, and government bonds). The supervisory authority has established (for internal use) a solvency control level of 150 percent of the minimum solvency mar-gin; if an insurer’s available solvency falls below this level, supervisory action is taken. The following table presents the company’s financial projections.
Item Initial Year Year Year
Main assumptions
Gross written premiums — 1,000 3,000 6,000
Paid claims ratio — 0.65 0.60 0.55
Expense ratio — 0.40 0.30 0.30
Return on invested assets — 0.06 0.08 0.10
Income statement
Gross written premiums — 1,000 3,000 6,000
Net written premiums — 900 2,700 5,400
Net earned premiums — 320 1,730 4,000
Net claims incurred — 260 1,250 2,490
Expenses — 360 810 1,620
Underwriting result — −300 −330 −110
You might begin your analysis by preparing a spreadsheet that contains the fi-nancial projections provided by the insurer. You could use this spreadsheet to check the mathematical accuracy of the projections, calculate the ratios ordinar-ily used by your supervisory authority in the financial analysis of non-life insur-ers, and test alternative assumptions.
The business plan calls for rapid growth in premiums in a class of business for which the market demand is unproven. After three years, the new company seems projected to control a potentially large share of the non-motor vehicle in-surance market. The applicant could be asked to explain how the demand for the product was estimated and how it expects to capture such a large market share.
The financial results should be tested assuming alternative growth scenarios.
The expense and claims assumptions are projected to improve rapidly and pro-duce an underwriting profit in the third year. This may be unrealistic for a new insurer. Comparisons with the expense levels of insurers of similar size in the jurisdiction and in less developed markets should be made. The financial results should be tested assuming alternative expense and claims ratios.
Item Initial Year Year Year
Investment income — 160 220 370
Net income, before tax — −140 −110 260
Net income, after tax — −110 −90 210
Shareholder dividends — — — 110
Balance sheet Assets
Cash and bank accounts 2,500 600 620 590
Government bonds — 910 1,030 1,180
Common shares — 760 1,230 2,070
Non-invested assets — 750 1,230 2,060
Total assets 2,500 3,020 4,110 5,900
Liabilities
Unearned premiums — 580 1,550 2,950
Claims provisions — 50 260 550
Other liabilities — — — —
Total liabilities — 630 1,810 3,500
Total equity 2,500 2,390 2,300 2,400
Requirements
Minimum capital 2,000 2,000 2,000 2,000
Minimum solvency — 410 950 1,780
The insurer intends to retain 90 percent of its premiums, which may be quite high for a new, small non-life insurer. The nature of the property risks that the insurer intends to underwrite should be determined and the adequacy of its reinsurance program assessed closely.
The rate of return on invested assets is assumed to increase steadily during the projection period. The assumptions should be evaluated in light of local market conditions. The likelihood that the projected returns can be achieved should be questioned, along with the appropriateness of the asset mix. The projected level of liquidity is fairly low, especially if the government bond market in the jurisdiction is inactive. The applicant should explain the large increase in “other assets”; perhaps it includes the planned purchase of a lavish head office.
The total equity of the insurer is projected to remain above both the minimum capital and minimum solvency margin requirements throughout the three-year period. However, the rapid growth in business means that the insurer would breach the solvency control level in the third year (150 percent of 1,780 equals 2,670, while total equity is 2,400). The adoption of alternative assumptions for the projections might make this situation even worse. You might recommend that the applicant (and other insurers) be informed of the solvency control level used by the supervisory authority. The applicant will need to be advised that the payment of shareholder dividends in the third year is inappropriate and that, unless credible sources of additional capital can be identified, the growth pro-jections will need to be scaled back.
11. Identify the parties involved in the licensing process in your jurisdiction. Do writ-ten agreements exist among them regarding their respective responsibilities?
Review the insurance law and the written licensing procedures and then consult with colleagues to identify which parties are involved in the licensing process in your jurisdiction. Consult with colleagues to determine whether any written agreements exist among these parties and what the agreements cover.
12. Prepare a flowchart, such as those shown in figures 1 and 2, to illustrate the licens-ing process in your jurisdiction.
Review the insurance law and the written licensing procedures and then consult with colleagues to identify the steps in the licensing process in your jurisdic-tion.
13. Based on your report, the applicant described in exercise 10 amended its business plan and was issued a license. The amended business plan reflects a doubling of the
liquidity and reinsurance cession ratios, a reduction of “other assets” to 10 percent of the total, and a reduction of gross written premiums to 2,000 and 4,000 in the second and third years, respectively. The applicant has agreed not to declare share-holder dividends without prior supervisory approval. Develop a plan for monitor-ing this insurer durmonitor-ing its first three years of operation.
The insurer is newly formed, so close monitoring is appropriate during its ear-ly years of operation. Your plan should probabear-ly require limited financial re-porting on a quarterly, or more frequent, basis. Start-up expenses should be monitored carefully in comparison with the insurer’s budget. Given the lack of historical data, both on this insurer and on the property insurance business in your market, regular and detailed analysis of the adequacy of the unearned pre-mium and claims provisions is required. Conformity of the insurer’s operations with its business plans should be monitored, through both financial analysis and regular discussions with senior management. Onsite inspections should be conducted to verify the adequacy of internal controls and the implementation of any changes that may be required. In the case of adverse experience, additional capital may have to be raised, in which case the insurer should be required to prepare a realistic plan and implement it without delay.