ICP 6:
Licensing
Basic-level Module
All rights reserved.
The material in this module is copyrighted. It may be used for training by competent organizations with permission. Please contact the IAIS to seek permission.
This module was prepared by Michael Hafeman. Mr. Hafeman is an actuary and independent consultant on financial sector supervision and related issues. He has held senior positions in both private and public sector organizations in the financial services industry in the United States and Canada. Most recently, he was assistant superintendent of the Specialist Support Sector at the Office of the Superintendent of Financial Institutions Canada (OSFI), during which time he also served as a member of the Executive and Technical Committees of the IAIS and chair of its Solvency Subcommittee. Mr. Hafeman is a member of the Public Interest Oversight Board, charged with overseeing the auditing and assurance, ethics, and education standard-setting activities, and the Member Body Compliance Program, of the International Federation of Accountants. He also serves on the Insurance Program Advisory Committee of the Toronto International Leadership Centre for Financial Sector Supervision.
The module was reviewed by Giovanni Manghetti and John Thompson. Mr. Manghetti is president of Casa di Risparmo di Vollera S.p.A (a regional bank in Italy). Prior to this, he worked for 19 years with the Italian Insurance Supervisory Authority (ISVAP), holding titles of president and board member. Mr. Thompson is a private consultant based in Toronto, Canada who provides advice and functional support to financial sector regulators, the financial services industry, and educational organizations. He is the chairman of the Insurance Advisory Group for the Toronto International Leadership Cen-tre (which is based in Toronto, Canada, and provides leadership development training for financial sector regulators). He is an actuary with more than 24 years of experience in senior positions within a life insurance company, both in Canada and the United Kingdom. Prior to becoming a consultant, he was deputy superintendent at the Office of the Superintendent of Financial Institutions in Canada. He also has broad experience at the international level as the former chairman of the Executive Com-mittee of the International Association of Insurance Supervisors and member of the Basel Commit-tee for Banking Supervision.
Contents
About the Core Curriculum . . . v
Note to learner . . . vii
Pretest . . . .ix A. Introduction . . . 1 B. Scope of licensing. . . 7 C. Licensing criteria . . . 15 D. Licensing process . . . 27 E. References . . . 36 Appendix I: ICP 6 . . . 37
Appendix II: Cross-references . . . 40
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Figures
Figure 1. Licensing Process in Jurisdiction A . . . 29 Figure 2. Licensing Process in Jurisdiction B . . . 30
About the
Core Curriculum
A financially sound insurance sector contributes to economic growth and well-being by supporting the management of risk, allocation of resources, and mobilization of long-term savings. The insurance core principles (ICPs), developed by the International As-sociation of Insurance Supervisors (IAIS), are key international standards relevant for sound financial systems.
Effective implementation of the ICPs requires skilled and knowledgeable insurance supervisors. Recognizing this need, the World Bank and the IAIS partnered in 2002 to develop a “core curriculum” for insurance supervisors. The Core Curriculum Project, funded and supported by various sources, accelerates the learning process of both new and experienced supervisors. The ICPs provide the structure for the core curriculum, which consists of a set of modules that summarize the most relevant aspects of each topic, focus on the practical application of supervisory concepts, and cross-reference existing literature.
The core curriculum is designed to help those studying it to: • Recognize the risks that arise from insurance operations
• Know the techniques and tools used by private and public sector professionals to identify, measure, and manage these risks
• Operate effectively within a supervisory organization
• Understand the ICPs and other IAIS principles, standards, and guidance
• Recommend techniques and tools to help a particular jurisdiction observe the ICPs and other IAIS principles, standards, and guidance
• Identify the constraints and identify and prioritize supervisory techniques and tools to best manage the existing risks in light of these constraints.
Note to learner
Welcome to ICP 6: Licensing module. This is a basic-level module on licensing that does not require specific prior knowledge of this topic. The module should be useful to either new insurance supervisors or experienced supervisors who have not dealt exten-sively with the topic or are simply seeking to refresh and update their knowledge.
Start by reviewing the objectives, which will give you an idea of what a person will learn as a result of studying the module, and answer the questions in the pretest to help gauge your prior knowledge of the topic. Then proceed to study the module either on an independent, self-study basis or in the context of a seminar or workshop. The amount of time required to study the module on a self-study basis will vary, but it is best addressed over a short period of time, broken into sessions on sections if desired.
To help you engage and involve yourself in the topic, we have interspersed the module with a number of hands-on activities for you to complete. These exercises are intended to provide a checkpoint from time to time so that you can absorb and under-stand the material more readily and can apply the material to your local circumstances. You are encouraged to complete each of these activities before proceeding with the next section of the module. If you are working with others on this module, develop the an-swers through discussion and cooperative work methods. An answer key in appendix III sets out some of the points that you might consider when tackling the exercises and suggests where you might look for the answers.
As a result of studying the material in this module, you will be able to do the fol-lowing:
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2. Describe the following bases for conducting insurance operations and the li-censing appropriate to each:
a. Domestic insurer
b. Subsidiary of a foreign insurer c. Branch of a foreign insurer
d. Foreign insurer operating on a services basis
3. Explain the disadvantages of composite insurers and describe the additional controls required of them for prudential reasons
4. Provide examples of circumstances when it may be acceptable for insurance business to be conducted without a license
5. Enumerate the criteria that should be considered before a license is granted and explain the importance of each, including:
a. Suitability of key functionaries b. Suitability of significant owners c. Availability of required capital
d. Adequacy of risk management, controls, policies, and procedures e. Viability of the business plan
f. Products to be offered
g. Contracts with affiliates and providers of outsourced services h. Management and supervisory reporting arrangements
i. Input from the home supervisory authority of an insurer with foreign con-nections
6. Describe the information that should be sought from the home supervisory au-thority before a foreign insurer is allowed to carry on business in the jurisdic-tion
7. Assess the adequacy of the business plan of a particular applicant for an insur-ance license
8. Enumerate the typical steps in the licensing process
9. Illustrate additional requirements, conditions, or restrictions that might be im-posed on an applicant by a supervisory authority and explain why they would be appropriate
10. Prepare a plan for supervisory monitoring during the three years after a particu-lar insurer has been granted a license
Pretest
Before studying this module on licensing, answer the following questions. The ques-tions are designed to help you gauge your existing knowledge of this topic. An answer key is presented in appendix III at the end of the module.
For each of the following questions, circle the response that is correct or most relevant. 1. The most important reason for licensing insurers is to: a. Generate licensing fee revenues for the supervisory authority b. Help to ensure that only insurers able to meet their obligations to policyholders are allowed to operate c. Protect established insurers from new competitors d. Keep insurers from carrying on banking business. 2. An insurer may be able to operate outside its home jurisdiction in various ways, except by: a. Purchasing the shares of a foreign mutual company b. Establishing a branch c. Forming a stock company subsidiary d. Providing cross-border services.
x 3. A composite insurer is one that: a. Insures both property and liability risks under the same policies b. Was formed through the merger of two or more companies c. Is partly owned by the government d. Insures both life and non-life risks. 4. It may be acceptable for an insurer to conduct insurance business without a license if: a. The supervisory authority has a backlog of license applications b. The insurer is a small fraternal organization operating in a limited geographic area c. The insurer is part of a very large, highly rated international group d. The significant owner of the insurer is a former insurance supervisor. 5. Licensing criteria should be clear, objective, and public in order to: a. Make it easier for the licensing authority to process applications b. Help insurers to understand what is required to enter the market c. Make it more difficult for undesirable insurers to enter the market d. Accomplish all of the above. 6. If a foreign insurer applies for a license, the licensing authority should contact the home supervisor: a. Unless the insurer will be setting up a subsidiary b. Only if it needs more information on the financial situation of the insurer c. To obtain input on the suitability of key functionaries and significant owners d. Only if a memorandum of understanding is in place to govern such contact. 7. When evaluating the business plan of an applicant, the licensing authority should consider that: a. Although the applicant’s plan may seem reasonable, prudence dictates that the impact of potentially adverse developments be assessed b. The applicant knows its business best, so its assumptions should usually be accepted without question c. An applicant with a financially strong owner can always obtain more capital, whenever it may be needed d. Business plans can change from year to year, so the proposed business plan is probably of limited value.
8. In some jurisdictions, parties other than the insurance supervisor play a role in the licensing process. This situation: a. Is inconsistent with the approach required by ICP 6 b. Can provide an appropriate control on supervisory power, as long as the other parties form their views without being influenced by those of the supervisor c. Can provide for consideration of a range of views in arriving at the important licensing decision, but the views of the supervisory authority should normally prevail d. Can be an excellent way to advance the government’s market development goals without subjecting existing insurers to excessive loss of market share. 9. An insurer that has been a consistently profitable underwriter of motor vehicle and property insurance applies to extend its license to cover marine and aviation insurance. The most appropriate response may be to: a. Reject the application, since the insurer has no track record in marine and aviation insurance b. Grant the license but restrict the maximum per-event risk that the insurer may retain within the marine and aviation portfolio c. Grant the license but restrict its term to a period of six months d. Grant the license without restriction, since the insurer has adequately demonstrated its capabilities already. 10. Once a license has been issued to a new insurer, the supervisory authority should monitor its progress: a. After two years have passed, to give the insurer time to get its systems and procedures fully in place b. In accordance with the supervisory processes generally applied to all insurers c. Frequently, to ensure that the insurer is operating in accordance with its business plan and supervisory requirements d. Continuously, to facilitate ongoing supervisory advice to management on strategic and operational issues.
ICP 6:
Licensing
Basic-level Module
A. Introduction
The Insurance Core Principles and Methodology (see IAIS 2003b) includes five principles under the heading of “the supervised entity.” First among these is ICP 6 on licensing:
This placement is appropriate. A license formally authorizes an insurer to carry on insurance business in a jurisdiction. In the absence of a license, an insurer should not be operating and there would be no entity to supervise.
However, the granting of a license should not be a mere formality. Licensing re-quirements should help to ensure that only entities that are financially strong, owned and operated by suitable persons, and operated in an appropriate manner are given ac-cess to the market. Licensing should help to protect consumers from insurers that are either likely to be unable to meet their obligations or not prepared to follow appropri-ate market conduct practices. Without licensing, it would be very difficult to control market access and to supervise insurers that are operating in the market. This would place consumers at considerable risk. Therefore, effective licensing is essential to the protection of consumers. It forms the first line of defense against future supervisory problems.
An insurer must be licensed before it can operate within a jurisdiction. The requirements for licensing are clear, objective, and public.
Licensing requirements have been developed based on the experiences of super-visors in dealing with troubled, weak, and failed companies. Analysis of the lessons learned from these experiences has helped to identify ways to avoid repeating the situ-ation. The failure of a company that was managed by people intending to steal from the public may have led to the requirement that people who operate insurers must be ethical and experienced in the business. The failure of an insurer that was owned by someone who invested all of his savings in setting up the company may have led to the requirement that the insurer must have sufficient start-up capital to keep the company solvent until it begins to make a profit and the requirement that owners must be a source of strength for the company. Licensing requirements can be expected to con-tinue to evolve, as supervisors gain additional experience in dealing with challenges in their market.
One type of problem that licensing can help to combat is the operation of “insur-ers” that are not really insurers at all. As Savage (1998) notes in a paper on insurance supervision,
Unfortunately there are fraudulent insurers who specialize in coming into a coun-try, selling products which will never provide any benefits, and then disappearing along with the premium income. Of course the premiums charged by such “insur-ers” can be very low, given that they will not be paying any claims.
Unsuspecting consumers may be sold these fictitious policies, and when a claim occurs the results can be disastrous. The business owner who insures his plant and equipment, experiences a serious fire, and then discovers that his insurer does not actually exist is in a terrible situation.
Fortunately, such situations do not occur very often. However, licensing can also help to protect consumers from potential losses due to the market misconduct or fail-ure of a legitimately constituted insfail-urer. Although many circumstances can cause an insurer to fail, a comprehensive study by the Committee of the Conference of Insurance Supervisory Services of the Member States of the European Union (2002) has shown that the most obvious causes of solvency problems were “the inappropriate risk deci-sion, the external ‘trigger event,’ or the resulting adverse financial outcomes. However, further analysis showed that these causal chains began in each case with underlying internal causes, being problems with management or shareholders or other external controllers.”
Licensing criteria
These findings reinforce the need for comprehensive licensing criteria, as described in ICP 6, essential criterion b. These criteria help to distinguish between applicants that
are likely to meet their obligations and should be granted licenses and those that have an unacceptable probability of failure and should be refused licenses.
ICP 6, essential criterion c, requires all domestic or foreign insurance establish-ments to be supervised. This criterion can be met through licensing since, typically, most provisions of insurance law apply to licensed insurers. Licensing is therefore the point of entry for an insurer to the application of legal and regulatory requirements and the ongoing supervisory processes of a jurisdiction.
A license to operate is a valuable privilege provided to an insurer. Conversely, its withdrawal can cause significant difficulties for the insurer, its owners, and its policy-holders, not to mention the supervisor. Neither the granting nor the withdrawal of a license should be entered into lightly. It is better to deny a license to an insurer that seems likely to create difficulties than to grant the license and cope with the subsequent problems! However, once a license has been granted, the threat of its withdrawal can be a powerful supervisory tool (see ICP 15).
Licensing criteria are important minimum criteria for assessing the probability that an insurer will meet its obligations. As such, similar criteria are used in assessing the suitability of owners and management when a change in control takes place and in carrying out regular inspections of insurers’ operations.
As mentioned in the explanatory notes to ICP 6, licensing should remain focused on supervisory purposes, and licensing procedures and conditions “should not in them-selves act as a barrier to market access.” Furthermore, “When the licensing procedure meets internationally accepted standards and is effective and impartial, confidence in the supervisory system will grow and may facilitate mutual recognition of supervisory systems and thus the further liberalization of market access for foreign insurers.” These points have been reinforced by various international agreements, such as those of the European Union, and by negotiations, such as those relating to the General Agreement on Trade in Services (GATS; see Ishii 1999).
It is no surprise, therefore, that the IAIS recognized the need to provide guidance on licensing by adopting a Supervisory Standard on Licensing and publishing a Licensing
Textbook that builds on the standard (see IAIS 1998, 2000b). It is not the intent of this
module to repeat their content, but to help you to understand the reasons underlying their main points. Appendix II cross-references these documents with the learning ob-jectives and the various criteria of ICP 6 to help you to study a particular issue further. For an overview of the licensing requirements of various jurisdictions, you are encour-aged to consult the IAIS Insurance Laws Database.1 More detailed information on such
requirements is available on the websites of many supervisory authorities (for example, see OSFI 2004).
Finally, this module deals with the licensing of insurers rather than intermediaries. The definition of insurer refers to “underwriting” insurance. This is to distinguish in-surers (which are responsible for meeting the benefit obligations arising from insurance
1. The IAIS Insurance Laws Database can be accessed via the IAIS website, at www.iaisweb.org. The user identification and password differ from those used to access the members’ section of the website; ask the principal IAIS contact in your organiza-tion for the access informaorganiza-tion.
contracts) from intermediaries (which are involved in the distribution and servicing of insurance). Although intermediaries should also be licensed or registered, and their conduct supervised, these matters are dealt with in ICP 24 on intermediaries and the related module.
Commonly used terms
Before delving further into the topic of licensing, it is important to define some com-monly used terms. Most of the definitions are taken from the IAIS Glossary of Terms (see IAIS 2005), although some clarifications and additions have been made. As noted in the Supervisory Standard on Licensing (see IAIS 1998), some of these terms, such as “branch,” “cross-border provision of services,” and “domestic/foreign,” do not always apply in the sense given here to jurisdictions within countries that have a federal struc-ture. In such cases, cross-border refers to crossing the borders surrounding the jurisdic-tions of the federal structure, but not inside it.
• Authorized insurer: An insurer that is authorized to operate in a jurisdiction. Authorization is typically achieved through licensing or supervisory registra-tion.
• Available solvency: Surplus of assets over liabilities, both evaluated in
accor-dance with domestic regulation (either in accoraccor-dance with rules of public ac-counting or with special supervisory rules) and taking into account domestic requirements regarding eligible capital elements, that is, the amount of capital appropriate to cover the required solvency margin in accordance with domestic law or supervisory regulations (see IAIS Glossary of Terms for a mathematical formula for calculating available solvency).
• Branch: Part of a company, not a separate legal entity, established in a
jurisdic-tion other than the company’s home jurisdicjurisdic-tion. Other forms of permanent presence (for example, an agency) may exist in some jurisdictions.
• Captive insurer: An insurance company established by a parent firm for the
pur-pose of insuring the exposures of the parent or its affiliates.
• Composite (insurance company): An insurance company that concurrently
oper-ates both life and non-life insurance business.
• Cross-border provision of services: Provision of insurance on a services basis
(without local establishment) in a jurisdiction other than the company’s home jurisdiction.
• Domestic/foreign: Inside/outside the jurisdiction. In connection with an insurer,
domestic or foreign refers to the place where the company concerned is incor-porated, irrespective of the place of incorporation of its parent company. • Fraternal insurance: Life or disability insurance that certain fraternal
• Home jurisdiction: Jurisdiction in which an insurer has its head office or, in the context of a group, in which an insurer’s parent is incorporated. Due to the hier-archical corporate structures of many groups, both immediate and higher-level home jurisdictions may exist.
• Host jurisdiction: Jurisdiction in which a foreign insurer operates by way of a
lo-cal branch. In the case of the cross-border provision of services, the jurisdiction in which the service is provided or, in the context of a group, in which an insurer that is a subsidiary or joint venture of a foreign parent is incorporated.
• Home/host supervisor: Supervisor of the home/host jurisdiction.
• Insurer/insurance company: A legal entity that underwrites insurance.
• Jurisdiction: A territory with local insurance laws that relate to the
incorpora-tion or operaincorpora-tion of insurance companies. This territory, as a rule, is the naincorpora-tional territory and, at the same time, the territory of the insurance supervisor’s com-petence. In certain cases, this may be the territory inside a nation with a federal structure, for example, the states making up the United States.
• License: The authority to operate business in the domestic market, which
un-der domestic law (a) is defined as insurance business, (b) is based on contracts between the company offering the business and the policyholders, and (c) is subject to supervision by the competent authorities. License refers only to the formal authority to operate business in the meaning of the domestic supervision law; it does not refer to approvals in the meaning of the general trade or com-pany law.
• Licensing: The granting of approval to a company to underwrite insurance in
the jurisdiction. The IAIS Glossary of Terms defines licensing as including the incorporation of a company in the jurisdiction. However, the glossary notes that incorporation is a separate approval from the approval to underwrite insurance and that these approvals may be made in separate jurisdictions. In this module, as in the Supervisory Standard on Licensing, such approval is referred to as “registration.” Note that the insurance laws of some jurisdictions use the term “registration” in the sense that “licensing” is defined here.
• Mutual insurance company: A nonprofit insurance company, without capital
stock, that is owned by the policyholders. It may be incorporated or unincorpo-rated.
• Qualifying participation: A participation held directly, or indirectly through one
or several subsidiaries, by a natural or legal person, of at least X percent in the company or—in the case of a lower percentage—a participation enabling the shareholder to substantially influence the company’s management. X is defined in accordance with domestic law (10 percent or 20 percent are common thresh-old values).
• Registration: The granting of approval to a company under the general trade or
company law of a jurisdiction, sometimes formalized through entry of the com-pany in a register of commerce.
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• Stock insurance company: An insurance company owned by stockholders (share-holders), usually for the purpose of making a profit.
• Supervisory registration: The listing of an insurer in a register maintained by the
insurance supervisory authority of a jurisdiction. In some circumstances—for example, for the cross-border provision of services in certain jurisdictions—an insurer may not be subject to a formal licensing procedure but may, neverthe-less, be required to register with the supervisory authority before carrying on business in the jurisdiction.
Exercises
Answer the following questions considering, where indicated, the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods.
1. How might a supervisory authority determine whether unlicensed insurers are operating in the jurisdiction?
2. What steps might be taken if an insurer is discovered operating without the necessary license? Have such situations arisen in your jurisdiction? If so, what actions were taken?
B. Scope of licensing
Although the statement “an insurer must be licensed before it can operate within a ju-risdiction” seems fairly simple and straightforward, fundamental and sometimes com-plex issues must be decided when establishing the scope of licensing. Decisions must be made regarding what is insurance and what is not, what types of legal entities should be permitted to act as insurers, how much freedom should each insurer have to under-write different classes of insurance, and what it means to operate within a jurisdiction. In making such determinations, the potential for exceptions arises, and policymakers should consider carefully the implications of each possible exception.
Insurance
Since an “insurer” has been defined as a legal entity that underwrites insurance, this seems to call for a definition of “insurance.” Unfortunately, it has proven impossible to define “insurance” in a manner that is clear, unambiguous, and universally accepted. The IAIS Glossary of Terms does not define insurance, the International Accounting Standards Board (IASB) has struggled to define insurance contracts (as distinct from other financial instruments), and the definition of license indicates that the insurance business is whatever the domestic law says it is.
Why is this so difficult? In part, it is because the boundaries between insurance and other financial services, such as banking and securities, are unclear. For example, a short-term fixed-rate annuity contract shares many characteristics with the guaranteed investment certificates offered by banks, while a variable annuity contract may look and perform much like a pooled investment fund. Another factor is the similarity of some commercial services to insurance contracts. For example, a manufacturer’s warranty provides protection against the malfunctioning of its product, and an automobile asso-ciation may provide both reimbursement of expenses and services in kind in the event of motor vehicle problems.
Whether or not it explicitly defines “insurance,” the insurance law of a jurisdic-tion must make it clear which activities and entities are subject to regulajurisdic-tion under the insurance law and which are not. This may be done by defining various classes of insur-ance business in the insurinsur-ance law and stating that only authorized insurers may under-write such business. Supervisors could then take action against unauthorized persons carrying on insurance business (see ICP 15 on enforcement or sanctions).
Many classification schemes have evolved over time in response to differences in the nature of the insurance market in various jurisdictions. Some types of business com-monly exempted from insurance regulation are manufacturers’ warranties and obliga-tory social insurance schemes. However, other types of business may be regulated as insurance in one jurisdiction but not in another, such as motor vehicle assistance
ser-
vices. Such differences can pose difficulties, particularly where an insurer operates in more than one jurisdiction.
Modes of operation
There are various ways in which an insurer might operate in a jurisdiction, and the acceptability of each needs to be considered when developing licensing requirements. The most easily understood situation is that of a locally owned domestic insurer—that is, one with its head office in the jurisdiction. The licensing requirements of the home jurisdiction thus govern the basis on which the insurer will be authorized to operate there. The insurance law of the home jurisdiction may also set out the conditions under which a domestic insurer can operate in foreign jurisdictions, subject, of course, to the licensing requirements of those jurisdictions.
A foreign insurer or group may wish to operate outside of its home jurisdiction by forming a subsidiary insurance company in another jurisdiction. In some jurisdictions, this is the only manner in which a foreign insurer is permitted to operate. The subsid-iary is a legal entity in its own right. It is subject to local company law and has its own board of directors and capital. For licensing and supervisory purposes, therefore, a sub-sidiary is often treated much like a locally owned domestic insurer. However, since the operation and financial situation of the subsidiary may be affected by its membership in the group (see ICP 17 on group-wide supervision), the relevant authorities in the home jurisdiction of the group should be consulted before the subsidiary is licensed.
Most jurisdictions allow foreign insurers to establish branches. A branch is an oper-ating unit of the foreign insurer, not a separate legal entity. Branches may have staff and, in some cases, perform many of the activities typical of an insurer’s head office. They are generally required to submit financial reports on local operations to the host supervisor. However, the policies they issue are legally those of the foreign insurer, whose capital, board of directors, and senior management are typically elsewhere.
An insurer may prefer to establish a branch rather than a subsidiary for a variety of reasons. A branch may involve lower initial and ongoing costs, which is particularly important if the insurer does not expect to write a large volume of business in the juris-diction. It can also provide greater flexibility in the use of capital and staff resources and facilitate easier exit from the market if business expectations are not met.
When licensing a branch, it is even more important than in the case of a subsidiary to consider the overall situation of the insurer and consult with its home supervisor. The solvency and governance of the insurer as a legal entity are being supervised by another authority, and the insurer could fail in spite of the best efforts of the branch manage-ment and the host supervisor. Some jurisdictions seek to protect local policyholders in such a situation by requiring branches to deposit funds with the supervisor and keep assets within the jurisdiction to cover liabilities to local policyholders—perhaps even with an additional solvency margin. Sometimes, the assets are required to be held in
trust within the jurisdiction. Such requirements help to protect local policyholders from problems of the insurer that may have their source elsewhere, but the protection can never be complete. The insurer may become insolvent due to problems in the host jurisdiction or elsewhere, unexpectedly large claims could deplete the local assets, or assets could be removed from the jurisdiction in spite of requirements to the contrary. The growing use of electronic registration, trading, and transfer of assets makes it in-creasingly difficult to control their movement. This incomplete protection is one reason that some jurisdictions do not permit foreign branches.
However, it cannot be stated categorically that a subsidiary provides more protec-tion to policyholders in the host jurisdicprotec-tion than does a branch. Legally, the liabilities of a branch are supported by the full capital of an insurer, while the obligation of a par-ent company to its subsidiary is limited to its invested capital. If a subsidiary gets into significant difficulties, its owners may simply choose to abandon it, while the failure of an insurer to meet the obligations incurred by a branch will create problems for the company as a whole.
Some jurisdictions allow foreign insurers to operate without having any local es-tablishment at all. This is referred to as operating on a services basis. The cross-border provision of services, where allowed, is usually subject to either licensing or supervisory registration. This enables the supervisory authority at least to know which insurers are operating in its jurisdiction. Especially when only supervisory registration is required, it is important for the home and host supervisors to communicate with each other about the insurer. Both need to understand their respective supervisory responsibilities and ensure that there are no gaps in supervision.
Sometimes, such as in the European Union, a formal agreement exists to govern the cross-border provision of services (see Ishii 1999). Such agreements facilitate the access of insurers to a wider geographic territory, while providing consumers in the various jurisdictions with more choice in their purchase of insurance products and ser-vices. The jurisdictions participating in the agreement know in advance how the super-visory responsibilities are allocated. Typically, prudential oversight is left to the home supervisor, with the host supervisor overseeing the conduct of the insurer in the local jurisdiction.
Cross-border provision of services may also be allowed under other circumstances, for example, where a consumer in a jurisdiction needs an insurance product that is not available from any insurer licensed in the jurisdiction. Jurisdictions that allow this sometimes impose controls on the activity, such as requiring that the business be placed through a specially authorized intermediary and that the policyholder sign a document acknowledging awareness that the insurer is not subject to local supervision.
Reinsurance is commonly provided on a services basis, and most of the jurisdic-tions that allow this do not require that the reinsurer be licensed in the jurisdiction. The rationale for this limited regulation of reinsurers is that their customers are insurers, who are presumed to be capable of looking out for their own interests (the supervisory authority should also assess insurers’ reinsurance programs in accordance with the
Su-0
pervisory Standard on the Evaluation of Reinsurance Cover; see IAIS 2002).
Neverthe-less, some jurisdictions that allow cross-border reinsurance impose limitations, such as prohibiting an insurer from taking credit in calculating available solvency for amounts owed by an unlicensed reinsurer.
Insurers can operate across borders using the Internet. Unfortunately, this tech-nology is also available to fraudulent and unlicensed insurers. Therefore, in order to protect consumers, insurers operating over the Internet should meet the same licensing requirements applicable to insurers operating through more traditional means. How-ever, detecting the existence of unlicensed insurers who are offering insurance over the Internet can be a significant challenge for supervisors (see IAIS 2000c).
Captive insurers are permitted in many jurisdictions. A captive insurer is a compa-ny established by a parent firm for the purpose of insuring the exposures of the parent or its affiliates. Since captive insurers do not deal with the general public, they may be subjected to less stringent licensing requirements. For tax and other business reasons, captive insurers are sometimes established in jurisdictions other than the one in which the exposures it insures are located. Relatively few jurisdictions, for example, those “off-shore,” are prepared to license an insurer that will not underwrite local risks.
Insurance pools operate in some jurisdictions; examples include a marine insur-ance pool in Singapore and a pool providing liability insurinsur-ance to universities in Can-ada. Pools are formed and owned by the companies whose insured losses are shared through the pool. They may be subject to less stringent capital and other requirements than apply to regular insurers, in recognition of the lower risk that they present to the general public.
Exemptions from licensing
ICP 6, essential criterion c, states, “The supervisory authority requires that no domestic or foreign insurance establishment escape supervision.” While this statement is quite clear, the Supervisory Standard on Licensing (see IAIS 1998) does allow for exceptions. Beyond the exceptions for cross-border business noted above, certain domestic enti-ties may be exempt from licensing in some jurisdictions, even if their activienti-ties might be considered underwriting insurance. Exemptions are sometimes granted because the nature of the insurer itself is believed to adequately protect policyholders or because the number of policyholders or the amount of insurance involved are so small that the costs of supervision outweigh the benefits.
Any exemptions from licensing should be clearly identified in the legislation, along with any requirements to which such entities may be subject. Legislation should clearly describe the powers and obligations, if any, that the supervisory authority has with re-spect to the exempt entities. For example, entities that are exempt from licensing may nevertheless be required to register with the supervisory authority and to submit and publish financial statements periodically.
Fraternal organizations sometimes provide life or disability insurance to their members, consistent with their principles of social solidarity. In some jurisdictions, fraternal insurance is exempted from regulation. This exemption may be justified on the premise that the members are committed to looking out for each other’s interests and will govern their affairs prudently. It may also be justified because many fraternal organizations are quite small and offer only low amounts of coverage. Furthermore, they would be difficult to supervise in a cost-effective manner, they place relatively few consumers at risk, and their failure would have little overall impact on the mar-ket. However, small fraternal insurers may lack professional insurance expertise within their board and management, making them prone to difficulties. Larger fraternal insur-ers may operate much like commercial insurinsur-ers, with little social solidarity among their policyholders. In either case, such an exemption may place consumers at higher risk, an issue that policymakers should consider.
In some jurisdictions, certain types of insurance may be provided by a govern-ment-owned entity, either exclusively or in competition or collaboration with other insurers. Examples include compulsory third-party motor vehicle liability insurance, crop damage insurance, and terrorism coverage. Government-owned entities are often formed under special legislation, which exempts them from the insurance law and pro-vides for their oversight through an alternative mechanism. Where government-owned insurers are exempt from licensing, the insurance supervisory authority seldom has direct responsibility for overseeing their affairs. Nevertheless, as market participants, these insurers can have an impact on those insurers that are supervised, for example, by influencing the prevailing level of premium rates. Therefore, supervisors cannot ignore them completely.
The alternative approach of licensing and supervising government-owned insurers comes with its own set of challenges. For example, consider the pressure that a supervi-sor might face in attempting to restrict or withdraw the license of a government-owned insurer that is engaging in inappropriate market conduct. A “technical failure” of a gov-ernment-owned insurer could occur when it fails the required capital test, which may itself be less stringent than the test that other insurers must satisfy. This situation has arisen, and, in some cases, the supervisory authority has been unable to enforce the law when the government, as owner, has refused to inject additional capital. In order to minimize the potential for political interference, it is important for the supervisory au-thority to have the autonomous power to intervene (see ICP 3 on supervisory auau-thority and ICP 15 on enforcement or sanctions).
Even in situations where some insurers are exempt from licensing and supervision, the supervisory authority might take steps to protect their current and prospective poli-cyholders. For example, the supervisory authority could publish a list of licensed insur-ers as well as information to assist consuminsur-ers in selecting their insurer, which could describe the potential disadvantages of dealing with an unlicensed insurer. The super-visory authority might also contribute to the prudent management of exempt insurers
by including them in the distribution of relevant supervisory guidance, for example, regarding risk management practices.
Permissible legal forms
Consumers pay money to insurers in exchange for the promise of future benefits under the terms of an insurance contract. Some of these contracts may span decades. It is es-sential that an insurer be constituted under the law in a form that will enable it to fulfill these obligations. As noted in ICP 6, essential criterion a, legislation should specify the legal forms permitted in a jurisdiction.
Most insurers are stock companies; that is, they are owned by stockholders (share-holders), usually for the purpose of making a profit. Most, if not all, jurisdictions permit stock companies that are public limited companies, and many permit private limited companies. While the liability of stockholders is limited to the amount they have in-vested in shares of the company, the company has flexibility in raising additional capital if needed, for example, through the sale of additional shares. This makes the legal form well suited to meeting long-term obligations.
Many jurisdictions permit mutual insurance companies, which do not have stock-holders but are instead owned by some or all of their policystock-holders. Mutual insurers operate on a nonprofit basis, sharing the results of favorable experience with partici-pating policyholders through dividends or bonuses. Although some mutual insurance companies are quite large and successful, few new insurance companies take this legal form, because they have difficulty raising capital.
Other legal forms are permitted in some jurisdictions but are much less common than stock or mutual companies. They include fraternal insurers, which may be orga-nized as cooperative associations, insurance or reinsurance pools, and government-owned entities constituted under special laws.
Most jurisdictions require a foreign insurer applying for a license to have a legal form that is either the same as, or comparable to, one of the forms permitted for domes-tic insurers. The module addressing ICP 9 on corporate governance provides more in-formation about the different legal forms and governance structures used by insurers.
Specialization
Some jurisdictions permit an insurer to underwrite both life insurance business and non-life insurance business. Such insurers are referred to as composites. ICP 6, essential criterion g, indicates that composites should not be licensed unless each of these types of risk is handled separately on both a going concern and a winding-up basis.
The reason for requiring such separation lies in the nature of life insurance and non-life insurance. The risks insured under a life insurance or annuity contract can
often be reliably estimated, and the amount to be paid on occurrence of an insured event—for example, death—is often certain. This contrasts with non-life insurance, where both the frequency and the amount of claims are typically less predictable. Life insurance products are often purchased to provide for persons’ long-term financial sup-port, which could be placed at greater risk if the insurer is also underwriting the more volatile non-life business. In recognition of the fact that accident and sickness insur-ance has some of the characteristics of both life insurinsur-ance and non-life insurinsur-ance, some jurisdictions permit both life insurers and non-life insurers to underwrite this class of business.
Although many jurisdictions (about three-quarters, according to the Insurance Laws Database) at one time permitted composites, only about half currently grant new licenses to composites. Some jurisdictions have changed their laws on this matter to require existing composites to separate into two legal entities, while others have allowed them to continue as composites.
Steps can be taken to help deal with the risk to policyholders created by compos-ites. At a minimum, the two types of business should be separately accounted for and reported in the financial statements, and the assets required to support life insurance liabilities should not be used to pay non-life insurance claims or expenses. Some juris-dictions require that the assets be separated through the use of trust funds. The insur-ance law would need to be drafted carefully to provide for an appropriate allocation of assets in the event of insolvency. The minimum capital required of a composite, both initially and in terms of available solvency, may be the sum of the amounts required of a life insurer and a non-life insurer. Insurers may even be required to maintain separate head office staff to operate each type of business, although such a requirement tends to defeat the cost-saving rationale for operating a composite.
Some jurisdictions extend the specialization requirement further and license each insurer to operate specific classes of life insurance or non-life insurance. For example, a non-life insurer may be licensed to underwrite the classes of motor vehicle insur-ance, property insurinsur-ance, and general liability insurinsur-ance, but not other classes, such as marine, aviation, and transport insurance. A licensed insurer that wants to extend its operations into different classes of insurance would have to apply to have its license modified. Licensing by class of insurance helps to ensure that insurers have the capabil-ity and financial resources to handle each class of business they underwrite, without placing the policyholders within either the new class or existing classes at undue risk. However, it places more regulatory burden on both the insurers and the licensing au-thority than is the case when insurers are licensed to operate all classes of either life insurance or non-life insurance.
Insurers are typically severely restricted, if not prohibited, from carrying on non-insurance business activities. Again, the reason for such restriction or prohibition is the specialization concept, since difficulties arising in the non-insurance activities could put policyholders at risk. Mixing insurance and other business activities within the same company makes supervision more difficult, for example, in determining the total
capital that should be required. However, some jurisdictions permit insurers to carry on non-insurance activities that are ancillary to the insurance business. Limitations applicable to all insurers are commonly set out in the insurance law or regulations, but further limitations may be imposed as a condition of licensing. If policyholders do not have priority over other creditors in the event of an insurer’s insolvency, then the existence of non-insurance activities could further increase the potential losses of poli-cyholders in such a situation.
Exercises
Answer the following questions considering, where indicated, the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods.
3. Does the insurance law (or another law) in your jurisdiction define “insurance”? If so, how is it defined? 4. Provide several examples of insurance activities, or business activities in the nature of insurance, that are sometimes exempted from licensing or supervisory registration. Do any of these exist in your jurisdiction? If so, is licensing or supervisory registration required? 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? 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?
C. Licensing criteria
Section B discussed the types of insurance activity that should be licensed and the types of entities that might appropriately carry on these activities. This section deals with the criteria used when deciding whether or not a particular entity should be granted a license. ICP 6 requires that “the requirements for licensing are clear, objective, and pub-lic.” Licensing requirements that possess these characteristics are better for consumers, insurers, the insurance supervisor, and the authority or authorities responsible for li-censing. These characteristics make it easier for insurers to understand what is required to enter the market and more difficult for undesirable insurers to obtain a license. Clear and objective requirements facilitate a smooth licensing process (see section D) and should reduce the potential for inappropriate political or industry influence over licens-ing decisions. Similar, if not identical, criteria should be applied when assesslicens-ing changes in the control of an insurer (see ICP 8 on changes in control and portfolio transfers).
Licensing criteria may differ somewhat depending on the nature of an insurer’s business or the classes of insurance it intends to underwrite. For example, the criteria for licensing an insurer that will be operating in the local retail insurance market may differ from those for licensing an offshore captive insurer that will be insuring only risks arising from the activities of its non-insurance parent company.
Government policy can have an impact in determining which applicants for a li-cense might be considered. In some emerging and developing markets, government policy may restrict access of new insurers to the market in order to allow existing com-panies time to prepare for a more competitive environment and provide stability to the market. In such cases, it is appropriate for the licensing criteria to change as the market matures in order to facilitate competition and the benefits it can bring to insurance consumers and the economy as a whole.
ICP 6, essential criterion b, states that licensing criteria should require the follow-ing:
• The applicant’s board members, senior management, auditor, and actuary, both individually and collectively, to be suitable, as specified in ICP 7 on suitability of persons
• The applicant’s significant owners (refer to ICP 8, essential criterion a) to be suitable, as specified in ICP 7
• The applicant to hold the required capital
• The applicant’s risk management systems, including reinsurance arrangements, internal control systems, information technology systems, policies, and proce-dures, to be adequate for the nature and scale of the business in question • Information on the applicant’s business plan to be projected out for a minimum
of three years. The business plan must reflect the business lines and risk profile and give details of projected setting-up costs, capital requirements, development of business, solvency margins, and reinsurance arrangements. The business plan
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must present information regarding primary insurance and inward reinsurance separately
• Information on the products to be offered by the insurer
• Information on contracts with affiliates and outsourcing arrangements
• Information on the applicant’s reporting arrangements, both internally to its own management and externally to the supervisory authority
• Input from the applicant’s home supervisory authority when the insurer or its owners are not domestic and a home supervisory authority exists (refer to ICP 5 on supervisory cooperation and information sharing).
Each of these criteria will be considered in turn, with an explanation of why it is important and a brief description of how an applicant might be assessed against it. Specific information that may be required of a foreign insurer is discussed at the end of this section.
Suitability of key functionaries
The persons involved in performing key functions for an insurer, such as its directors, senior managers, auditors, and actuaries, must be suitable to fulfill their roles (see ICP 7 on suitability of persons). In the case of a branch, insurance law may require that an in-dividual be appointed by an insurer as its principal legal representative (or chief agent) in the jurisdiction. This person should also be suitable.
Suitability means that these persons have not only the appropriate competency, experience, and qualifications needed to perform the duties of their position but also the integrity to do so in a manner that will not jeopardize the interests of policyhold-ers. As mentioned in the introduction, problems with key functionaries are a common reason why insurers get into difficulty. Thus an insurer should not be licensed if there are significant concerns about the suitability of one or more of its key functionaries and the applicant does not put forward a satisfactory replacement.
Qualifications can be assessed by considering a person’s education, membership in professional organizations, and career history. The qualifications should be relevant to the particular position. For example, an individual may be qualified to be an insurer’s auditor but not qualified to be its chief executive officer, or vice versa. If a person has held a position of significant responsibility, such as a member of the board of direc-tors or senior management, in an insurer or other type of company that has failed, this should raise serious concerns about the person’s qualifications (and, perhaps, charac-ter).
It is more difficult to assess a person’s character objectively. Insurance laws typi-cally include character-related criteria that would disqualify a person from serving as a key functionary, such as having been convicted of a criminal offense or having been bankrupt. It is common for licensing authorities to check police records for evidence of
past illegal behavior. However, some persons may have a “bad reputation.” It may be dif-ficult to disqualify a person simply based on reputation, so the underlying facts should be ascertained before a decision is made. Every effort should be made to keep criminals out of the industry. Legal protection for the persons making these decisions is essential, so that appropriate decisions can be made in the interest of protecting policyholders. Independence from political influence is also important in such situations.
It is common to require specific information on each key functionary to be provid-ed in a standard format as part of a licensing application. Further information should be sought by the authority, where needed to complete the assessment of suitability. The failure of an applicant to cooperate willingly with such requests should itself serve as a warning signal. The module on ICP 7 on suitability of persons and the Guidance Paper
on Fit and Proper Principles and Their Application (see IAIS 2000a) should be consulted
for more information on this subject.
Suitability of owners
Those with significant holdings are often in a position to influence the operation of the insurer. They should, therefore, be suitable to exercise this influence in an appropriate manner.
The stock in an insurance company may be widely held, although it is not un-common for there to be a single owner or one or more stockholders with a significant ownership position. Owners may vary considerably in nature. For example, they may be widely held companies, intermediate holding companies, or natural persons. When assessing a license application, it is important to consider the suitability of not only the immediate owners of the applicant but also those who may exercise ultimate control over the applicant.
The company law or insurance law of a jurisdiction typically defines the level of ownership, for example, 10 percent or 20 percent of any class of shares, at which super-visory approval of the right to hold the shares is required. This level of control is called a qualifying participation. If the holder of a qualifying participation is a natural person, his or her suitability should be assessed using criteria similar to those applied to key functionaries. If the holder is a legal entity, then the personal suitability criteria should be applied to its key functionaries.
However, there is more to assessing the suitability of an owner than merely evaluat-ing the qualifications and integrity of the individuals. The funds used to purchase the shares must have a legitimate source. If the person has been involved in illegal transac-tions, the funds may be proceeds of crime, and there is a possibility that the owner may seek to involve the insurer in such transactions, for example, money laundering (see ICP 27 on fraud and ICP 28 on anti-money laundering and combating the financing of terrorism). Obviously, such persons should be refused permission to hold a qualifying participation.
Beyond this, an evaluation should be made about whether the owner is likely to be a source of strength or a source of weakness for the insurer. ICP 6, essential criterion j, indicates that a license application should be refused “where it considers the applicant not to have sufficient resources to maintain the insurer’s solvency on an ongoing basis.” An owner with significant financial resources could be a future source of capital, should the insurer expand rapidly or encounter difficulty. However, an owner who has pur-chased shares using borrowed funds may pressure the insurer to pay dividends, even during periods when earnings are low or losses occur, in order to meet debt-servicing requirements. The owner’s financial statements—personal or corporate, as the case may be—should be reviewed as part of this evaluation.
It is important that the owner, or the manner in which the owner’s holdings have been structured, not be a hindrance to supervision. Essential criterion j indicates that a license should not be issued “where the organizational (or group) structure hinders effective supervision.” This could occur, for example, if the owner is another company within a group structure that includes cross-shareholdings or other commercial link-ages. In some jurisdictions, mixed conglomerates, including both financial and nonfi-nancial companies, are permitted. If an insurer is part of a mixed conglomerate, it may be particularly difficult to assess the possible impact of the nonfinancial activities on the insurer.
Required capital
Capital serves as an essential margin of safety, helping an insurer to cope with adverse situations while continuing to meet its obligations. Insurance law typically specifies the permissible forms and minimum amount of capital required of an insurer. It may also require insurers and branches to deposit specified amounts of assets with the super-visory authority or in trust. These minimum requirements help to ensure that only insurers of a viable size and with adequate resources are allowed to operate. In many jurisdictions, additional capital is required based on the size and nature of an insurer’s operations (see ICP 23 on capital adequacy and solvency). An insurer’s available solven-cy must cover at least the required solvensolven-cy margin determined in accordance with the insurance law or regulations. Some jurisdictions also establish solvency control levels, expecting insurers to maintain further margins.
It is important that an insurer be able to meet all relevant capital requirements both at the time of licensing and on an ongoing basis. The determination of capital adequacy at the time of licensing should be based on the factual situation, not on promises that additional funds will be raised once a license is granted. Therefore, proof should be re-quired that the minimum capital has been paid up.
In order to assess the likelihood that available solvency will be equal to or exceed the solvency margin on an ongoing basis, a careful review of the insurer’s business plan is required. In its initial years of operation, an insurer may be particularly subject to the
risk of insolvency. For example, setting-up expenses may be higher than anticipated, ac-quisition expenses may be high in relation to the flow of profits from a small portfolio of business, and the small size of the portfolio may make fluctuations in experience more likely. Accordingly, some jurisdictions require new insurers to have a separate “setting-up fund” or additional solvency margins.
Risk management systems
Insurers face many kinds of risks and use a variety of tools to manage these risks. When evaluating a licensing application, a determination must be made about whether the specific risk management systems that an insurer has put in place (or, in the case of a newly formed insurer, intends to put in place) are adequate for the nature and scale of its business. For example, a new domestic insurer proposing to underwrite only simple products in two classes of business needs to have much less sophisticated risk manage-ment systems than does a large multinational insurer.
In terms of overall business risks, an insurer’s corporate governance practices, op-erational policies and procedures, and internal controls are essential elements of its risk management framework (see ICP 9 on corporate governance and ICP 10 on internal control; see also Basel Committee on Banking Supervision 1998). Risks related more explicitly to insurance operations call for risk management tools such as pricing poli-cies, investment polipoli-cies, asset liability management, claims management processes, a reinsurance program, and stress testing (see ICPs 18–28).
These elements may be assessed, for example, by requiring the insurer to submit a questionnaire regarding its practices, reviewing relevant documents (for example, or-ganizational charts, risk management policies, procedure manuals, audit reports, rein-surance contracts), requesting information from other supervisors, or conducting an onsite inspection. If the applicant is a newly formed insurer, reliance will necessarily be placed on the policies and procedures it intends to follow and the capabilities of key functionaries, since it is impossible to evaluate actual practices.
Business plan
An applicant should provide information on its business plan for at least the next three years. Information should be both qualitative and quantitative and in sufficient detail so that the viability of the business plan can be evaluated. Any business must take risks to succeed, and it is unrealistic to expect any applicant to devise a commercially practical business plan that eliminates all risk of failure. Nevertheless, a business plan that is in-coherent, incomplete, or excessively optimistic in the context of local market conditions indicates that the insurer may not be capable of succeeding in its business and meeting long-term obligations to policyholders. The business plan must demonstrate knowledge
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of the insurance business and the local market. Even if the plan was prepared largely by an independent consultant, management must adopt it as their own, be capable of explaining it, and be prepared to implement it once the license is granted.
Qualitative information should describe the business lines the insurer intends to underwrite, the distribution systems it will employ, and the market segments it will target. The nature, size, and location of the proposed head office or branch operation should be described. The reinsurance program should be outlined, and it should be ap-propriate to the nature and size of the business that is proposed to be underwritten. If the applicant will be underwriting reinsurance, the business plan should separate infor-mation on that activity from inforinfor-mation on the primary (direct) business. Of course, whether senior management has the competency, skills, and experience necessary to manage the risks involved in underwriting reinsurance should be considered when evaluating their suitability.
Quantitative information should include details of the projected costs of setting up the business. The applicant should provide projected financial statements, starting with a projection of the development of premium revenues from year to year, by business segment. An income statement and a balance sheet should be presented for each year of the projection period, along with the assumptions underlying each of the elements, such as investment income, operating expenses, commissions, and taxes. The assump-tions should be compared against the actual experience of existing companies in the market, and any major variances should be questioned. For example, an applicant that is projecting an expense ratio of 20 percent and a claims ratio of 70 percent for motor vehicle insurance business in a market where the combined ratio of existing insurers range from 98 to 115 percent must be prepared to explain how it proposes to achieve such favorable results. The applicant might be required to revise the projections using alternative assumptions.
Along with the balance sheet projections, the applicant should project both the required solvency margin (and control levels) and the available solvency each year. If the projection shows a potential shortfall in available solvency, the applicant should ex-plain how it would deal with such a situation. For example, the insurer might be able to raise additional capital from its parent, reinsure some of its portfolio, or reduce its new business production. Even if the results of the initial projections appear satisfactory, it may be useful to require the applicant to prepare alternative projections using adverse assumptions, in order to assess the level of risk inherent in the business plan. Alterna-tively, if the insurer has prepared stress tests for its own use, these could be reviewed (see IAIS 2003a).
Products
As noted in the Supervisory Standard on Licensing (see IAIS 1998), “Insurance com-panies should not be regulated more than strictly necessary regarding the design of
their products.” To do otherwise could impede product innovations that would benefit consumers and contribute to the success of the insurers. Nevertheless, it is important that insurers underwrite products that are prudently designed and priced and have the capability to administer the business that they have underwritten. It is also essential that products meet the requirements of the jurisdiction regarding general policy condi-tions.
To facilitate an assessment of the prudential aspects of the products, applicants could be required to provide information on the technical bases used to calculate pre-mium rates and technical provisions (liabilities). The capabilities of an applicant to un-derwrite and administer its products properly should, at least in part, be dealt with by its business plan. The acceptability of policy conditions could be assessed by reviewing the policy forms; some jurisdictions conduct such reviews after a license has been is-sued.
Contracts with affiliates and outsourcing arrangements
An insurer’s contracts with its affiliates or its outsourcing arrangements can have a sig-nificant impact on the operations and financial situation of the insurer. They can also affect the ability of the authority to supervise the insurer. Therefore, it is important to review such arrangements during the licensing process.
An affiliation contract may subject an insurer to control by a holding company or another company in its group. It may also commit the insurer to transfer a share of its profits to such a company. Such contracts should be reviewed to ensure that they do not interfere with the supervisor’s ability to conduct ongoing supervision or to intervene if difficulties arise. Neither should they commit the insurer to making transfer payments that might impair its solvency.
It has become increasingly prevalent for businesses to transfer various functions to other companies under outsourcing arrangements. Successful outsourcing arrange-ments can enable a business to reduce its expenses and improve quality by engaging a specialized company to perform certain functions. However, inappropriate outsourcing arrangements can cause a company to lose control over the quality of the outsourced function.
Such loss of control is of particular concern where a key business function has been outsourced. For example, while outsourcing the processing of an insurer’s payroll may pose a negligible risk to policyholders, the same cannot be said about outsourc-ing the processoutsourc-ing of claims. Insurers should have adequate controls in place regardoutsourc-ing their outsourced activities, such as the ability to conduct audits of the service provider. The operations of an insurer must be conducted prudently, and consumer protection requirements must be met, even if services have been outsourced.
If the outsourcing is done to an affiliate of the insurer, the terms of the arrangement may have been dictated by others and be financially disadvantageous to the insurer; this
