ICP 9: Corporate Governance

Transcription

1 A Core Curriculum for Insurance Supervisors ICP 9: Corporate Governance Basic-level Module

2 Copyright 2006 International Association of Insurance Supervisors (IAIS). 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 paper has been prepared by Mr. John Thompson, 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 Centre (The Toronto Centre is based in Toronto, Canada and provides leadership development training for financial sector regulators.). He is an actuary with over 24 years experience in senior positions within a life insurance company both in Canada and the UK. Prior to becoming a private 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 Committee of the International Association of Insurance Supervisors and member of the Basel Committee for Banking Supervision. The paper was reviewed by Mr. Andre Swanepoel, South Africa and Mr. Alvaro Clarke, Chile. Andre Swanepoel is a private consultant, who retired in 2004 after 13 years as head of insurance and retirement funds supervision with the Financial Services Board in South Africa, where he dealt with all aspects of prudential and market conduct supervision. He is a qualified actuary and spent 15 years in the merchant and general banking industries. Prior to this, he worked for 12 years with a life insurer in the actuarial and investment research departments; he was a member of the Executive Committee of the International Association of Insurance Supervisors (IAIS) and chaired the Emerging Markets Committee of the IAIS. He is active in the Toronto International Leadership Centre.Mr. Clarke is the Principal Partner Clarke & Associates and Professor of Law at Universidad de Chile, Faculty of Law and Faculty of Economics. Mr. Clarke also held various senior government positions in Chile, including the Chairman of Superintendencia de Valores Y Seguros (the Insurance and Securities Supervisor) ( ) and as Vice Minister of Finance ( ). Mr. Clarke was the president of ASSAL between

3 Contents About the Core Curriculum v Overview and Learning Objectives vii Pretest ix A. Introduction B. Fundamentals of Corporate Governance C. Understanding the Core Principle D. Supervision and Inspection E. Principles of Corporate Governance to Protect Key Stakeholders F. Issues for Insurance Supervisors Appendix I. ICP 9: Corporate Governance Appendix II. Answer Key iii

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5 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 Association of Insurance Supervisors (IAIS), is one of the 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, supports 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 your 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. v

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7 Overview and Learning Objectives Note to Learner Welcome to ICP 9: Corporate Governance module! This is a basic-level module on Corporate Governance that does not require specific prior knowledge of this topic. The module should be useful to either a new insurance supervisor or an experienced supervisor who has not dealt extensively with the topic or is simply seeking to refresh and update 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. Then answer the questions in the Pretest to help gauge 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 recommended that it be addressed over a short time, broken into six sessions on chapters 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 are intended to provide a checkpoint from time to time so that you can absorb and understand the material more readily. You are encouraged to complete each of these activities before proceeding with the next section of the module. An answer key in Appendix II sets out some of the points that you might consider when responding to the questions in each question set. You will also find question sets dealing with the local situation and related to practices in your jurisdiction. These are intended to help you apply the material in this module to your local circumstances. If you are working with others on this module, develop the answers through discussion and cooperative work methods. Since these vii

8 Insurance Supervision Core Curriculum responses will vary by jurisdiction, the answer key 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 following: 1. Summarize the requirements of insurance core principle (ICP) 9 2. Explain the concept of a corporation, specifically (a) the liability of the owners of the corporation; (b) the duties, rights, and powers of shareholders and directors; (c) the duties of directors to shareholders and other creditors; and (d) the way in which the structure of a corporation compares to other forms of business organization 3. Summarize the role of corporate governance in managing the business and meeting the duties of different parties under corporate law 4. Explain the ultimate responsibility of the board of directors, specifically (a) the information needed and available to the board; (b) the role of independent directors; (c) the role of committees of the board; (d) the setting and enforcement of company policy; and (e) the linkage to, and role of, internal controls 5. Explain why the board of a financial institution should have a higher standard of care than a general-purpose corporation 6. Identify the stakeholders affected by the corporate governance requirements for different forms of business organization 7. Describe the responsibilities of management to the board of directors and how these can be met 8. Explain how corporate governance can be used as a supervisory tool 9. Explain how corporate governance practices can be inspected 10. Summarize the linkages between other supervisors and regulators in setting and enforcing corporate governance practices. viii

9 Pretest Before studying this module on corporate governance, answer the questions on this page. The questions are designed to help you gauge your existing knowledge of this topic. An answer key is presented in appendix B at the end of the module. Q1 For each of the following questions, circle the responses that are correct. 1. Corporate governance refers to: a. The laws with which corporations must comply b. The way in which companies are directed, managed, and controlled for the benefit of key stakeholders c. The bylaws that a corporation has established d. The way in which meetings of the board of directors are managed. 2. Corporate governance requirements respond to the need to balance potential conflicts between the interests of: a. Investors and the board of directors of the corporation b. Investors and senior management of the corporation c. Investors and customers of the corporation d. The board of directors and senior managementcustomers of the corporation. ix

10 Insurance Supervision Core Curriculum Q1 continued 3. Corporate governance is important to insurance supervisors because: a. Well-governed insurers need no onsite inspection b. When it is performed effectively, the supervisor can rely on the work of senior management and the board of directors c. The board will establish conservative reporting standards with hidden reserves, and this will make financial results more predictable d. Shareholder rights are better protected, and this improves the ability of the insurance company to raise money from investorssecurities supervisors rely on them to protect the shareholders of insurers. 4. With respect to widely held insurance companies, the corporate governance requirements that are set by securities regulators or defined in corporate law meet the needs of insurance supervisors. a. True b. False. 5. Boards of directors establish committees in order to: a. Minimize the conflicts of interest among members of the board b. Review specific matters in detail without taking the time of the full board c. Meet the requirements of applicable corporate governance requirementsmore frequently than is practical for full board meetings and thereby keep in closer touch with senior management d. Relieve some of the liability for directors when faced with decisions that fall outside their area of expertise. 6. Delegation of duties to members of senior management should: a. Be done carefully so that the board has protection from legal liability for decisions made by management b. Be extensive complete so that management is fully able to run the company on a day-to-day basis with little inter ference from the board x

11 ICP 9: Corporate Governance Q1 continued c. Incorporate checks and balances to ensure that the board can have full confidence in the work of management d. Be limited to areas of the business that the board has insufficient time to work on effectively. 7. ICP 9 focuses on the role of corporate governance in protecting the rights of policyholders: a. True b. False. 8. Ultimate responsibility for the accuracy of information provided by an insurance company to its key stakeholders rests with: a. The insurance supervisor b. The securities regulator c. The external auditors d. The board of directors e. Senior management of the company. 9. A well-run insurance company should have independent members of the board of directors because: a. If it is widely held, these directors will protect the rights of minority shareholders b. These directors will facilitate business development, and this will increase the company s profitability c. If they have previous insurance experience, these directors will be able to provide market intelligence to the company d. These directors will stimulate discussion at board meetings and question management on the issues. 10. The insurance supervisor is able to assess the effectiveness of corporate governance through: a. Offsite analysis of regulatory filings, public documents, and news releases from the company b. Regular interviews and discussions with senior management and directors c. Onsite inspection of board minutes, internal audit reports, and discussions with senior management xi

12 Insurance Supervision Core Curriculum Q1 continued d. Onsite inspection of the effectiveness of the company s internal controls e. A combination of both onsite and offsite activities If a foreign insurance company is operating in your jurisdiction through a branch, your supervisory agency should: a. Enforce the same corporate governance requirements on the branch as apply to locally incorporated insurance companies b. Rely on the home supervisor where the company is located to enforce its corporate governance requirements on the branch c. Adapt the corporate governance requirements that apply to locally incorporated companies and places d. Require the branch to establish a board of directors in your jurisdiction. 12. For an insurance company that is owned by a single individual, corporate governance: a. Need not be applied b. Should be applied with the exception that members of the board may all be family members c. Should be applied except that strategic planning for the company should be left entirely to the shareholder since shareholder money is at risk d. Should be applied as it would for a widely held company. 13. Internal controls are important for effective corporate governance because: a. Fraud against the company is more easily caught and dealt with b. Management and the board can be more confident that their decisions are implemented c. Management is better able to control the areas of the business that auditors and actuaries are allowed to access d. Management and the board receive reports summarizing the results of implementing company policyon staffing decisions. xii

13 ICP 9: Corporate Governance Basic-level Module A. Introduction Corporate governance is an important topic for insurance supervisors as evidenced by the fact that one of the 28 insurance core principles (ICP 9) is dedicated entirely to this topic and six others make specific references to the role, composition, and function of the board of directors (see IAIS 2003b). This module focuses primarily on what corporate governance is and why financial sector supervisors are interested in this topic. It shows some of the similarities and differences between the objectives of the capital market regulators and insurance supervisors and illustrates why these regulatory authorities should work together cooperatively. Internal controls are an important tool for implementing decisions made by the board of directors and senior management and, as such, are an extension of the discussion on corporate governance. The importance of internal controls to insurance supervisors is evidenced by the fact that ICP 10 is dedicated to this topic (see IAIS 2003b). Other closely related topics covered by the core principles include suitability of persons (ICP 7), changes in control (ICP 8), onsite inspection (ICP 13), risk assessment and risk management (ICP 18), and information, disclosure, and transparency toward the market (ICP 26). As further evidence of the importance of this topic to insurance supervisors, many of the supervisory standards and guidance papers that have been issued by the International Association of Insurance Supervisors (IAIS) make reference to corporate governance issues (see IAIS 1998a, 2000, 2002a).

14 Insurance Supervision Core Curriculum Concept of corporate governance The concept of corporate governance is widely discussed, and the term is used to describe a range of practices and approaches. In this module, the term is defined as the processes, structures, information, and relationships used for directing and overseeing the management of the institution in the best interest of the institution and key stakeholders with a significant interest in the ongoing viability of the company. It is used in a broad sense so that it covers the interests of financial sector supervisors and policyholders as well as investors. If a more narrow interpretation is intended, this is made clear in the text. Corporate governance is most often thought of in terms of corporate entities. A corporation is a special form of business enterprise that is approved under corporate law or company law. This is distinct from a partnership, personal company, and so forth in that the liabilities of the corporation are limited to the value of the Corporate Governance assets of the corporation. The corporation often has the rights and Corporate governance consists of the processes, structures, information, and responsibilities of a person under relationships used for directing and overseeing the management of the institution the law, although it is a corporate entity. It is a legal person as distinct from a natural person. A cor- in the best interest of the institution and the key stakeholders that have a significant interest in the ongoing viability of the poration has a board of directors that provides oversight and advice company. to management on behalf of key stakeholders. The concept of corporate governance as used here applies to legal entities with a board of directors. The concept is not directly applicable to branches of foreign companies. However, the advanced-level corporate governance module develops some ideas on how supervisors can apply the same basic concepts to the supervision both of branches and of companies. This definition is supported by the requirements of the IAIS core principle on corporate governance, which sets out the powers, rules, and requirements that should be in place for the insurance supervisor to be able to use corporate governance as an effective supervisory tool. According to ICP 9, The corporate governance framework recognizes and protects the rights of all interested parties. The supervisory authority requires compliance with all applicable corporate governance standards. Supervisors need to understand what corporate governance means, why it is an important supervisory topic for inclusion in the core principles, what this principle requires, and how these requirements can be implemented.

15 ICP 9: Corporate Governance Context for corporate governance Corporate governance is a complex interweaving of legislation, regulation, business practices, institutions, traditions, culture, and social values. This complexity has produced different definitions and practices in different parts of the world as to what constitutes good corporate governance (see Iskander and Chamlou 2000 for a discussion of the history and range of practices). Corporate governance focuses on knowledge and behavior and so deals with the processes for sharing information, making decisions, and implementing decisions effectively. Corporate governance is not about power and centralizing power in a few people (for a more complete discussion, see the paper by John Pound in Salmon and others 2000). Good governance is the means of ensuring that there is adequate control over objectives, strategies, controls, and operations within the company. A great deal has been written about corporate governance, including the internationally recognized principles developed by the Organisation for Economic Co-operation and Development (see OECD 1999), and the topic is actively evolving. What is considered to be good corporate governance in a country has changed considerably, largely as a result of reviews undertaken after a large corporate failure in which the failure was a surprise or investors suffered significant losses. For example, consider the failure in 2001 of HIH Insurance Group in Australia (see HIH Royal Commission 2003) or the failure of Enron in the United States in 2002, which produced numerous recommendations for changes in corporate governance practices in the United States and other capital markets. This type of historical development of corporate governance is common in most developed countries. The term corporate governance is most often associated with requirements for the composition, structure, and work of the board of directors so that it can meet its obligation to shareholders in general and minority shareholders in particular. With this definition and its focus on investors, it is easy to understand why a capital market regulator is concerned about companies having sound corporate governance practices. Through these processes, the board ensures that the company is directed and managed in a way that is transparent to and protects the interests of shareholders. By extension, corporate governance as used here relates to meeting the needs of all of the key stakeholders through the practices and work of the board and senior management. By using this more comprehensive definition, we consider why an insurance supervisor presses for good corporate governance, as a key stakeholder working on behalf of the government (to bolster public confidence in the financial system) and on behalf of policyholders and claimants (to protect them from undue loss). The basic concept behind corporate governance is that the board should have sufficient influence on, and control of, the major decisions made by and the operations of the company to control its financial destiny as much as possible. Corporate governance defines the mechanisms for achieving this objective, and an important element of these requirements revolves around the business plan and its use in managing the company.

16 Insurance Supervision Core Curriculum This need to develop and implement business plans is an important part of the role of senior management and the board of any company. Relevance to insurance supervision Two elements of the corporate governance concept make it an important part of effective insurance supervision: Effective corporate governance can improve the confidence that investors have in a company and therefore strengthen the access that a company enjoys to capital and other forms of financing, as and when it might be required. Effective corporate governance strengthens the controls within a company to ensure that the strategies adopted and decisions made by the board, acting on behalf of stakeholders, are implemented effectively. Effective corporate governance allows the supervisor to rely on the work performed by the board of directors and senior management and, in so doing, allows the supervisory process to operate more efficiently and effectively than it could in the absence of such reliance. This reliance relationship must be reviewed from time to time to ensure that the reliance is well founded. 1 It is important for the supervisor to review the corporate governance practices in place in each company to ensure that the specific elements adopted by the company are appropriate for its circumstances. Each company should implement all of the corporate governance requirements. However, more complex companies must have more complex structures and procedures to manage the business and the inherent risks to which the company is exposed. As a result, the process that a supervisor might use to inspect corporate governance and internal controls forms a part of this module. Commonly used terms Before delving into the topic, it is important to define some commonly used terms: Board of directors. This term is used to mean the most senior body in the corporate structure. In some countries, senior management reports to a single board of directors. When there is one board, the term applies to the board. In other countries, a two-tiered system applies, so there is a supervisory board and a management board. 1. The term reliance relationship is used here to describe a relationship between people or groups under which one party depends on the other to perform certain work to prescribed and agreed standards. The party that depends on the other to perform the work is involved in setting the standards for performance or agrees to the standards as reasonable. Once the work is performed, the dependent party reviews the work to determine whether or not it was performed to the agreed standards but does not reproduce the work itself. If the work does satisfy the standards, the dependent party uses the results.

17 ICP 9: Corporate Governance In this case, the term board is used to mean the supervisory board, and members of the management board are referred to as senior management. Corporation. A corporation is a special form of company structure permitted under legislation: the company has limited liability but has the duties and responsibilities of an ordinary person. Closely held company. A closely held company is a business that is owned by shareholders who are few in number or closely associated so that control of the enterprise is focused in a few hands. Widely held company. A widely held company is a business that is owned by shareholders, none of whom owns a sufficient number of shares to exercise control of the company or its board. Q2 For each of the following questions, which responses are correct? Circle your choices. More than one may be valid. 1. Corporate governance refers to: a. The way that companies are directed, managed, and controlled for the benefit of all stakeholders and interested parties b. The structures, processes, and relationships used for directing the affairs of the company c. The framework that insurance supervisors have in place to protect the rights of policyholders d. The centralization of power and control in the company s board of directors. 2. In ICP 9, IAIS has defined: a. All of the corporate governance requirements that insurance companies must follow b. The corporate governance framework that insurance supervisors should have in place to support effective supervision c. The concept of corporate governance to include any rules that may be prescribed by securities regulators d. The concept of corporate governance so that supervisors can look to the board of directors to implement remedial action when necessary. 3. Effective corporate governance: a. Strengthens the confidence that the public places in the insurance sector b. Provides the supervisor with more flexibility in designing its supervisory methodology

18 Insurance Supervision Core Curriculum Q2 continued c. Creates a sound reliance relationship so that the insurance supervisor can rely on the work of the board of directors d. Creates complex structures for complex companies and simple structures for simple companies. 4. Corporate governance requirements for insurance companies can be defined in: a. Insurance companies legislation b. Insurance companies regulations c. Corporate law or the companies act d. Securities legislation and rules. Q3 Answer these questions in relation to the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 1. Are insurance companies required to comply with corporate governance requirements in your jurisdiction? What competent body sets these rules? Do these rules apply to all types of insurance companies? 2. What types of insurance enterprises operate in your jurisdiction? a. Locally incorporated companies b. Branches of foreign companies c. Friendly societies or cooperative or mutual insurance companies d. Fraternal benefit societies e. Government-owned companies under special enabling legislation. 3. What types of board structures are permitted in your jurisdiction? a. Single board b. Two-tiered board c. Other. Please describe. 4. What types of insurance corporations are present in your jurisdiction? And how are their boards of directors selected? a. Corporations with exchange-traded shares b. Closely held corporations.

19 ICP 9: Corporate Governance B. Fundamentals of Corporate Governance To understand corporate governance, it is appropriate to start with the role of corporate governance in meeting the needs of investors and securities regulators and then to consider how corporate governance is used by insurance supervisory authorities. Role in investor protection Much of the literature on corporate governance focuses on shareholder protection in general and on the rights of minority shareholders in particular. Providing this type of protection is intended to increase investor confidence and thus foster a more robust capital market. The more confidence that investors have in the marketplace and the companies whose shares are traded in the market, the greater is the likelihood that the market will be an active place for companies to raise capital and investors to buy and sell shares or other securities. Corporate governance emerges out of the need to balance the potential conflict between the investor (the lender of money who is seeking a good return in relation to the risks involved) and the interests of those who control the company (the individuals who decide how that money is used and may be more willing to take risks when using other people s money). When the owner of a company also manages the company, decisions will have to recognize and balance these divergent interests. When more than one shareholder is involved, these relationships become more complex, and a process must be established to oversee the operations of the company and protect the interests of the lenders of capital. The people who run the company are insiders because they have ready access to information about the company and its prospects for the future. 2 The lenders of capital are often outsiders and do not have ready access to this level of information. An important part of corporate governance is disclosure and transparency aimed at balancing the interests of outside investors and the interests of insiders so that the rights of all shareholders are distributed broadly and evenly. Corporate governance is intended to provide this balance so that outside investors are not at a significant disadvantage in relation to insiders. Access to information Investors with a majority shareholder position generally are able to obtain access to information about the performance of the company and its plans for the future. Minority 2. Insiders who also own shares can decide to buy and sell shares using this inside information if no system is in place to balance the interests of insiders and outside investors. Corporate governance is not generally intended to protect outside investors from this risk. However, most securities regulators have rules regarding insider trading. Most corporate governance regimes, however, include elements that minimize the undue influence of insiders on setting strategy and making important decisions that affect the rights of other shareholders.

20 Insurance Supervision Core Curriculum shareholders generally are not treated as insiders because the investment position they hold is small and they may only hold the securities for a short period before trading them. As a result, in the absence of rules protecting the rights of minority shareholders, these investors might not get good-quality information about the company and may be reluctant to make an investment. The possibility of uneven access to information about the company gives rise to many of the requirements and practices which may be defined in corporate law, securities law, or other legally enforceable ways that are fundamental to good corporate governance. Investor confidence One of the objectives of corporate governance is to provide investors Corporate Governance and Investor with the confidence to make informed investment decisions. To Good corporate governance can increase Confidence investor confidence in making investment make an informed decision, investors must have access to infor- decisions. This, in turn, can improve the access of companies to additional working capital, enabling them to improve their mation that allows them to assess the risks to which the investment range of products and services. This can is exposed and the potential for improve company profitability and retained investment gains. This is the basic risk-reward assessment that confidence that the company will meet its earnings, thereby improving policyholder informed investors carry out in promises. matching their own risk tolerance with their desire for a good return on investment. When investor information is distributed more evenly so that majority and minority shareholders have access to the information necessary to make this risk assessment, investor confidence increases, more investors are willing to take a position in the market, and companies have more opportunities to raise capital when needed. Having a wide range of investors making informed decisions contributes to building and maintaining a broad, deep, and diversified market for traded securities. The foundation of deep and broad capital markets is access to investor information: Investors need to have good-quality, reliable information so that they have confidence in making informed decisions. Investors need to understand the financial condition of the company and the impact of planned actions for the future. Investors should have information about the people running the company and how they manage and control the business activities of the company.

21 ICP 9: Corporate Governance Investors need to be confident that they are receiving accurate information in a timely manner. Investors need to be confident that the people who are running the company are doing so in a prudential manner. Internal controls These needs are met through checks and balances at the board level and internal controls at the company level that ensure that the board and senior management are fully aware of what is happening within the company. Having control of the operation of the business is important for the management of all companies and for good corporate governance. If the board or senior management has control of the company, the company is probably using elements of corporate governance. The basic concept is as appropriate for a closely held company as for a Internal Control widely held company. It is as appropriate Internal control is an important tool for a company with only majority shareholders as it is for a company with only used by the board of directors and senior management to ensure that minority shareholders. It is as appropriate for companies that are traded on rec- followed within the company. Know- their decisions are implemented and ognized exchanges as for those that are ing that a company has good internal not publicly traded. The basic need is controls allows the regulator or insurance supervisor to have greater con- for the board and senior management to have control of the company, to have a fidence that the company will be able suitable strategy for directing the operations of the company, to have adequate might be given. to comply with any directives that it information to control the company, and to ensure that appropriate checks and balances are in place so that the board and management have reasonable control of the future potential of the company. The board and senior management control the company through a combination of requirements for how the board operates, for management, and for the flow of information, controls for ensuring the accuracy of information and the implementation of company policy as well as other decisions of the board and management, and practices for managing risks. This range of requirements and processes defines the requirements for corporate governance. It also covers the tools required to make corporate governance effective. These include the individuals who hold senior positions, the size and composition of the board, compensation, the planning processes, and internal controls and audit. 9

22 Insurance Supervision Core Curriculum Figure 1: Checks and Balances in a Well-Run Company Delegation Range of action Authority Limits Tools Company policy Departmental role Job descriptions Business plans Board Senior management Staff Control Monitoring Reporting Review Revision Tools Performance appraisal Audit Variance reports Delegation of duties, with controls The knowledge and experience of members of the board and management are an important part of corporate governance. After all, the board effectively delegates matters to senior management, and senior management carries out the decisions of the board and runs the company on a day-to-day basis. Management, in turn, reports back to the board on its achievements and the progress of the company toward meeting its goals and objectives. The board must have confidence in management for the company to run effectively; for this reason, checks and balances are needed to ensure that the confidence in management is well deserved. 3 Once again, any well-run company would want to have controls in place in order to ensure that the individuals running the company set a direction and strategy and the individuals working for the company do what is expected of them (see figure 1). This process of delegation, review, assessment, and revision is an example of a reliance relationship. Capital market regulators Capital market regulators want to ensure that companies have these controls, checks, and balances in place because they look to the board to protect the interests of investors. Capital market regulators maintain that fair and efficient markets must be transparent. As a result, there are a great deal of rules around what market participants must do in order to keep the investing public informed about the activities and affairs of the company. 3. It is not unusual for the controlling shareholders of a closely held company to have undue influence in selecting senior management, setting strategy, and making important decisions. This influence can work to the disadvantage of other investors. Effective corporate governance minimizes this effect. 10

23 ICP 9: Corporate Governance Shareholder meetings are an important vehicle for providing investors with access to information and exposure to the board and management. This, in turn, contributes to the confidence of investors in how the company is managed. Insurance supervisors Corporate Governance and Confidence of Stakeholders The principles of sound corporate governance contribute to the confidence that all stakeholders place on management and the board to balance their interests with those of other stakeholders. Corporate governance allows the board to provide direction, leadership, and control to the company. Insurance supervisors seek to ensure that companies have good Exemptions from Compliance In many jurisdictions, legal entities are corporate governance practices as active in insurance that are not corporations and are not subject to corporate well. However, that interest is not simply to protect the rights and law. These may be insurance pools or interests of shareholders. After government-owned insurance providers all, the money that investors have established under special legislation. tied up in a company forms at least These entities may be exempted from part of its capital base, 4 and supervisors rely on that base to protect nance or supervisory requirements in the compliance with normal corporate gover- the rights of policyholders in the jurisdiction. event the company fails. Insurance supervisors want to ensure that companies have access to additional capital should that be necessary. They want to have insurance enterprises that are well managed, treat their customers fairly, are in compliance with the legislation and other requirements, and are managed by competent, ethical individuals. In addition, insurance supervisors want to have confidence that any supervisory sanctions, demands, or actions required of the company will be carried out. The principles of sound corporate governance contribute to all of these goals. It is, therefore, not surprising that insurance supervisors expect all companies to practice good corporate governance no matter what the corporate form of the company. Fiduciary duties Many insurance companies have more policyholder money than shareholder money. That is, the size of the policy and claims liabilities (and provisions or reserves) exceeds the amount of assets held as the result of shares and other capital instruments that the company has issued. In deciding to invest in the company, investors are aware 4. Capital is made up of retained earnings and a range of financial instruments that are subordinate to the rights and interests of policyholders and claimants. For a more complete discussion of capital, see IAIS (2002b). 11

24 Insurance Supervision Core Curriculum of the risks and seek information to assess the level of risk and potential rewards. Policyholders rarely recognize the risks involved in dealing with a particular insurance company. Rather, they seek the services of an insurance company to relieve them of unwanted exposure to risk. Since policyholders and shareholders both have money in the company and are at risk in the event of failure, they share a common interest that the company should be run in a prudential, profitable, and sound manner over an extended period. These groups are both interested in corporate governance to protect their interests. However, even though they have some interests in common, board decisions that benefit shareholders may not necessarily benefit customers and vice versa. Within the company, corporate governance must balance the potential conflict between the rights and interests of various stakeholders. 5 For example, a decision by the board may increase the risks to which shareholders are exposed, while reducing the risks to which policyholders are exposed. Investment strategies that seek to meet the long-term commitments to policyholders may not produce attractive short-term results for investors. Corporate governance must recognize, balance, and deal with these potential conflicts. The special relationship between the insurance company and its customers requires an especially high standard of care on the part of company management and the board. In addition, since the business is complex and few customers understand all aspects of the products and services they purchase, the insurance supervisor provides oversight of the industry on behalf of policyholders and the general public. This complex interaction of issues and interested parties makes the topic of corporate governance a challenging one for financial sector supervisors. Given the importance of corporate governance to supervisors, IAIS has prepared clear guidance for insurance supervisors on this topic Balancing the interests of stakeholders is an important function of the board. Some stakeholders have a long-term view, and this may be best met through strategies that focus on prudential, profitable approaches with a focus on the customers, staff, and the expectations of regulators. Other stakeholders have a short-term view, and this may be best met through a strategy that focuses on earnings and shareholder dividends. The need to balance these potentially divergent objectives often requires choices, and in making these choices, the decisionmakers need to understand the business and the issues involved.

25 ICP 9: Corporate Governance Q4 For each of the following questions, which responses are correct? Circle your choices. More than one may be valid. 1. Boards of directors control the flow of information out of the company so that: a. Proprietary information is kept confidential b. The information that is released is accurate c. Key stakeholders will have greater confidence in the company d. The company s profile is kept at a high level to increase sales. 2. Stakeholders need to make informed decisions about the company using information from the company. For example, a. Shareholders need to decide whether to buy, sell, or hold their shares b. Brokers need to decide whether to place business with the company c. Insurance supervisors need to determine if the company is in compliance with legislation and regulations d. Securities regulators need to decide if the company is viable. 3. Internal controls are designed to: a. Help companies identify members of staff who are stealing from the company b. Enforce decisions made by the board c. Ensure that information provided to the board is accurate d. Keep management and the board fully aware of what is happening in the company. 4. When the board of directors delegates duties to senior management: a. The board delegates accountability for the function as well b. The board intends to make it clear that management is fully accountable for decisions made in that area c. The board establishes benchmarks for measuring per formance d. The board intends to test the competence of management. 13

26 Insurance Supervision Core Curriculum Q4 continued 5. A board of directors has a duty to: a. Ensure that all promises made on behalf of the company are met b. Balance the expectations of policyholders and investors c. Invest the assets of the company for the maximum yield d. Ensure that the company is in compliance with all legislation and regulations. Q5 Answer these questions in relation to the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 1. What corporate governance requirements have the capital market regulators in your jurisdiction set that apply to insurance companies? 2. Have any of the locally incorporated insurance companies in your jurisdiction recently used the local capital market to raise additional capital? What type or types of financial instruments did they use? 3. For the largest corporate life insurance company in your jurisdiction, what is the ratio of the value of the liabilities related to policyholder obligations to the value of capital provided by investors and shareholders? 14

27 ICP 9: Corporate Governance C. Understanding the Core Principle The meaning of ICP 9 corporate governance should be considered with reference to the detailed wording of the explanatory notes, the essential criteria, and the advanced criteria. The complete text of this core principle is reproduced as appendix I to this module. The core principle itself focuses on the powers and authority that insurance supervisors must have in order to carry out their duties in an effective manner. The principle does not attempt to define corporate governance or provide a detailed list of every element that is required for the concept to be effective within a company. The focus is on the supervisory needs. The first sentence of the principle indicates that the corporate governance framework should protect the rights of all interested parties. These terms should be understood in the context of why an insurance supervisor should focus on these issues and how the principle can be met. The word protect does not mean that supervision will guarantee that the parties will never lose money. Rather, it means that supervision provides a defense against undue loss losses that are surprisingly large under the circumstances. As with any defensive system, the effectiveness cannot be guaranteed, so the test of the supervisory system is not whether there are failures or losses but whether those losses are unduly large. The term all interested parties refers to persons or entities that have a financial interest in the insurance company or are regulators or supervisors with responsibility for oversight of the insurance company. These are policyholders, claimants, investors or other creditors, securities regulators, and insurance supervisors. The second sentence of the principle deals with the need for the insurance supervisor to recognize and require compliance with all of the corporate governance requirements that apply to insurers, including those that may have been set by other competent regulatory authorities. This highlights the need for supervisors to work cooperatively, since each may have expectations and needs that can best be met through good corporate governance. The overall corporate governance regime only makes sense and is effective if insurers have a coherent, cohesive set of rules with which to comply. The explanatory notes In the explanatory notes, the first two sentences in paragraph 9.2 say, The board is the focal point of the corporate governance system and is ultimately accountable and responsible for the performance and conduct of the insurer. Thus the board has direct responsibility for management and oversight of the company. The board can delegate responsibility to full-time staff and executive officers, but this does not absolve the board from its responsibilities. 15

28 Insurance Supervision Core Curriculum The explanatory notes also indicate (in paragraph 9.3) that even in jurisdictions where corporate governance rules apply to all general-purpose corporations, it is necessary to establish additional requirements. This higher standard of care is required because of the board s fiduciary duty to policyholders and its duties to the insurance supervisor. 6 The essential criteria IAIS defines three essential criteria. The first deals with the possibility that insurance supervisors and others could promulgate corporate governance rules and regulations and that insurance companies would have to comply with all of them. The insurance supervisor must, as a result, have authority to verify and enforce compliance with all of these rules and regulations, whether they are defined under insurance legislation or not. This is necessary because only one set of corporate governance rules should apply to any one company, even if they are developed and promulgated by different empowered bodies in a jurisdiction. Therefore, if existing corporate governance rules apply to insurance companies, the insurance supervisor may expand on those rules to include duties for the board and management to meet its own special needs. However, in so doing, the existing rules and the additional rules must complement each other and work together. The second deals with the power and responsibility that falls to the board of directors. The 11 subcriteria in this section deal with the idea that the board has a duty to see that the company is well managed and has sound practices and procedures in place, including processes for ensuring that the company is in compliance with relevant laws and other requirements and that management is competent and fit for their position. These requirements are similar to what one would expect to be in place to protect the rights of investors. However, due to the special nature of the insurance business, these subcriteria include references to oversight of the company s risk management practices and actuarial practices and the need for the board to communicate and meet with the insurance supervisor, as may be required. The third of the essential criteria deals with the responsibility of management. The three subcriteria in this section focus on setting direction for the company, having control of its operations, and providing full and fair reporting to the board. A sound and open working relationship between the board and management is critical to the effectiveness of corporate governance within a company. The flow of information from management to the board is critical to the board s ability to understand the operations of the company The nature of these duties depends on the fact that a large proportion of the assets of the company should be treated as policyholder or claimant money and not as money that can be used at the complete, unfettered discretion of the company.

29 ICP 9: Corporate Governance The advanced criteria IAIS defines four advanced criteria. The first deals with the establishment of board committees with specific responsibilities, such as compensation, audit, or risk management. The use of board committees is discussed in the section of this module dealing with the structure and functioning of the board. The second notes that remuneration of directors and senior management should give regard to the performance both of the individual and of the company. Remuneration policy should not include incentives that encourage imprudent behavior. The third recommends that one or more officers be given responsibility for ensuring compliance with relevant legislation and required standards of business conduct. The existence of an effective compliance officer, who reports to the board of directors at regular intervals, can be an important part of an insurer s system of internal controls. The last of the advanced criteria indicates that when a responsible actuary is part of the supervisory process, the actuary should have direct access to the board of directors or a committee of the board and report relevant matters to it on a timely basis. IAIS (2003a) contains a full discussion of this topic. Q6 Please answer the following questions: 1. Why would ICP 9 require the insurance supervisor to protect the rights of all interested parties, where these include shareholders? 2. Why should an insurance supervisor have the power to enforce the corporate governance requirements of other competent regulatory bodies? 3. Why might an insurance supervisor prescribe corporate governance requirements for insurance companies in addition to those that apply to other companies? 17

30 Insurance Supervision Core Curriculum Q7 Answer these questions in relation to the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 1. After reviewing the material above and the text of ICP 9 (appendix I), consider the degree to which the insurance supervisory authority in your jurisdiction has the powers to specify and enforce the corporate governance requirements described in ICP Which of the duties described in the second essential criteria are required of a board of directors in your jurisdiction? Whether or not they are legally required, which of these criteria are commonly met? Which require strengthening? 18

31 ICP 9: Corporate Governance D. Supervision and Inspection Supervision of corporate governance involves a combination of offsite analysis and onsite inspection. The measurable elements of the corporate governance requirements can generally be assessed through offsite analysis, while it is generally necessary to inspect the principles-based requirements through a document review and through discussions with senior management. These are generally possible only onsite. Compliance assessment Compliance assessment is an important extension of a company s When a supervisor is satisfied that a Internal Controls and Inspection corporate governance regime because sound corporate governance in place, the supervisor is able to focus company has effective internal controls and internal controls processes are inspection on the internal procedures and needed for the company to ensure internal enforcement actions taken by the that it is in compliance with all of company rather than carry out a detailed the requisite laws and regulations. review of compliance itself. Therefore, supervisors should review the internal controls and compliance assessment procedures. The compliance assessment process should be in place and used effectively to support the information needs of senior management and the board. Board oversight Part of what constitutes good corporate governance relates to what Planned Activities in Onsite and Offsite Inspection the board does to oversee and assess its own work, the work of quires planned activities in both onsite and Inspection of corporate governance re- senior management, and internal control processes. Appraising inspection process can be used effectively offsite inspection. Neither element of the boardroom performance is not an on its own to review the corporate governance and internal control procedures that easy task, and it is best carried out through formal processes that are a company has in place and to determine accepted and understood by the how well they work. board. Increasingly, companies are implementing this aspect of good corporate governance (for a discussion of this topic, see the contribution by Jay Conger in Salmon and others 2000). 19

32 Insurance Supervision Core Curriculum A supervisory review of a company s corporate governance includes both offsite analysis and onsite inspection. Offsite analysis entails the following activities: Review public documents on board structure and membership Review regulatory filings that include information on board members, changes in composition, curriculum vitae of board members, and changes in committees of the board Review documents prepared by the company to disclose its financial position (see IAIS 2002a for the range of information that should be made available to stakeholders) Review news releases to identify the types of issues that are disclosed during the year and the reaction of industry commentators (either analysts or journalists) to this disclosure. Onsite inspection entails the following: Review the minutes of the board Review information provided to the board Review the minutes of board committees Review the reports of external auditors Review the reports of internal auditors and discuss them with audit staff as well as staff in the areas affected. The quality of this type of review is highly dependent on the support and involvement that the inspection team receives from the company. Access to information by inspectors must be unimpaired for this review to be useful. Reliance relationships Inspectors are, in effect, reviewing a reliance relationship that corporate governance creates between the staff of the company and the board of directors. A party determined to hide information from another can always find ways to do so. Recent events involving some very large companies in various parts of the world have demonstrated this. In some cases, the boards of these companies included very knowledgeable and able people, and yet transactions were completed in a way that avoided scrutiny by the board and auditors of the company. However, even though corporate governance is not a perfect mechanism for protecting the rights and interests of key stakeholders, those interests are far better served through the use of corporate governance than would be the case in its absence. 20

33 ICP 9: Corporate Governance A supervisor cannot check every transaction to ensure that every law is followed and that sound accounting and risk management practices are employed. The cost of such a system would be prohibitive. However, relying on the work of the board and the sound corporate governance practices it has adopted allows the supervisor to verify that a company uses the appropriate systems and processes in its day-to-day operations. Internal controls Inspecting the internal controls procedures is also important because doing so allows the inspection team to determine the level of control that the board and senior management have over the operations of the company. Inspecting internal controls involves verifying the following: Policy is set by the board. The board is specific in identifying the person to whom authority is delegated. The delegation includes an accountability framework, which means in most cases that this person reports on the use and effectiveness of the policy. The policy is clearly communicated to everyone who needs to know about it. The application of the policy is monitored regularly. There is an independent review process (probably an internal audit). The effectiveness is assessed regularly, recommendations for strengthening are made, and the recommendations are considered and implemented, where appropriate. The policy is reviewed by the board from time to time and is updated regularly. If these steps are not in place, the inspectors will need to be satisfied that whatever processes are in place are effective in implementing, overseeing, and verifying the decisions of the board. For a more extensive discussion of internal control issues, see the core curriculum module on ICP 10 and Basel Committee on Banking Supervision Influences on supervisory effectiveness In order for the insurance supervisor to be effective in carrying out his or her duties: The supervisor must be able to obtain comprehensive written information about the company and rely on its accuracy and completeness. The supervisor must be able to assess and have confidence in the competency of management. 21

34 Insurance Supervision Core Curriculum Since some board records are only available at company offices, some of this review can only be carried out through the onsite inspection process (for a more extensive discussion, see IAIS 1998b). The supervisor must have access to people in the company and to proprietary information about the company s operations that is timely, reliable, and accurate. The supervisor must have confidence that a commitment for action by the company can be made and met. The supervisor must be able to conduct effective onsite inspections to verify all important facts and to talk to staff and management as appropriate. The supervisor must have confidence that the company is managed in a manner that meets the requirements of the law. The supervisor must have confidence that the company is managed in a prudential manner that recognizes and manages risks inherent in the business. The supervisor must have confidence that policyholders and prospective policyholders are treated fairly. These objectives can be met through sound corporate governance practices and good internal controls procedures. 22

35 ICP 9: Corporate Governance Q8 For each of the following questions, which responses are correct? Circle your choices. More than one may be valid. 1. Effective corporate governance allows the insurance supervisor to look to the board of directors: a. To assure that directives issued by the authority are implemented b. To ensure that information filed with the authority is filed on a timely basis c. To attract and retain a competent senior management team d. To provide inspectors with free access to people and information. 2. The licensing process requires the insurance company to have a board of directors and senior management that are competent and experienced. It is not necessary to review the fitness and propriety of management after the license has been granted. a. True b. False. 3. In carrying out an offsite analysis of a company s corporate governance regime, the supervisory authority will: a. Focus on a review of public documents and regulatory filings b. Consider articles on the company that were published in the newspapers c. Assess the depth of discussion that is reported in board minutes d. Review the effectiveness of the company s internal control procedures. 4. In conducting an onsite inspection of a company s corporate governance process, the supervisory authority will: a. Work through senior management to get copies of the information that was provided to the board to support any important decisions that were made b. Review internal audit reports on control procedures c. Talk to department heads to see what they understand of specific compliance requirements that have been prescribed by the authority d. Review business plans and reports on achievements versus goals. 23

36 Insurance Supervision Core Curriculum Q9 Answer these questions in relation to 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 is compliance with corporate governance requirements done in your jurisdiction? 2. What process would the inspectors follow if they uncovered a violation of one of the requirements set out under corporate law? How would remedial action be enforced, and what body would lead the effort? 24

37 ICP 9: Corporate Governance E. Principles of Corporate Governance to Protect Key Stakeholders This section presents some elements of corporate governance that may practically be applied in less developed economies or insurance sectors. However, it is instructive to understand how some of the best practices are integrated and defined. In the advanced-level corporate governance module, a section discusses some of the issues that supervisors face and how they have implemented or might implement a revised regime to compensate for the gaps. 7 This section discusses best practices that build on those that are often promoted for general-purpose companies with shareholders. Where appropriate, these concepts are expanded for insurance enterprises. As a result, this discussion goes beyond the scope and content of ICP 9. Basic principles Corporate governance regimes are usually based on the basic principles of transparency, fairness, accountability, responsibility, and control (for a more complete discussion, see Iskander and Chamlou 2000). These can be embodied in a few common concepts: Shareholders should have a right of access to information about the company and should be involved in key decisions that affect the fundamental framework of the company. There should be fair and equitable treatment of all shareholders and all key stakeholders so that no group is at either an advantage or a disadvantage in the process. Timely and accurate financial information should be made available. Boards should provide oversight of the operations of the company and balance the interests of all key stakeholders with those of the company. These principles are met by dealing with the following topics and issues: Board membership Structure and functioning of the board Business planning and controls Information provided to the board Information provided to key stakeholders. 7. There are basic differences in how these elements are put into effect in different countries. For countries that use the civil code approach, it is common for the requirements to be defined clearly in legislation or regulations in a prescriptive manner. This could be thought of as a rules-based approach, and the onus is on the supervisor to demonstrate noncompliance. For countries that follow the common law approach, the requirements could be defined in a rules-based way or in a principlesbased approach. The latter approach includes a clear definition of the objective that is to be achieved, and the onus is placed on the company to demonstrate that the regime meets these objectives. The legal system can affect how corporate governance is implemented within a country. 25

38 Insurance Supervision Core Curriculum Each of these areas is considered in turn. Board membership The following issues are relevant to board membership: Independent directors Executive and nonexecutive directors Experience and ability to work as a board member Attendance and level of involvement of board members Terms of appointment Separation of duties Conflict of interest. Best practices in these areas are intended to ensure that individuals on the board of an insurance company have adequate experience and knowledge and few direct links to management. This will improve their ability to achieve the following objectives: Provide insightful direction to management and oversight in balancing the interests of the company with the interests of investors and other stakeholders Question the decisions and results of the company as an investor would in the same circumstances. ICP 9 includes several references Who May Be a Member to these issues. The second essential Who may be a member of the board of an criterion deals with the duties and insurance company is an important part of composition of the board and links determining the ethical and business standards to which the day-to-day operations directly to the core principles on suitability of persons (ICP 7). Some of of the company are held. Board members the best practices noted are included must be not only fit and proper for their in the advanced criteria. Some of role but also willing to dedicate the time these may be more readily applied in and effort required to perform their duties an established mature market than in effectively. a less developed insurance market. However, the insurance supervisor should have the authority to require boards of directors of insurance companies to have in place procedures dealing with these issues. This best practice category is directed at ensuring that the board is able to oversee the company and management in a way that balances the interests of key stakeholders with those of the company. To achieve this objective, the board must be composed of capable individuals who are willing, and have the time, to oversee the operations of the company. 26

39 ICP 9: Corporate Governance One of the functions of the board is to establish the roles and duties of senior management and to select the most senior person to look after the day-to-day operations of the company. In doing this work, it is important to minimize the conflicts of interests that may emerge. Because of this, concentration of power and authority is usually balanced with the need for efficiency, range of responsibility of senior people, and authority to act. Separation of duties is a common way to avoid the concentration of power and provide checks and balances in the management system. The size of the board is also important for its effective operation. The board should be small enough to attract involved, capable, and interested individuals but large enough so that the burden on any one individual is manageable. Structure and functioning of the board The following issues are relevant to the structure and functioning of the board: Setting of the board agenda Provision of information in advance of meetings Frequency and scope of meetings Board committees and composition Setting of board and management compensation Performance of board members. Best practices in these areas are desirable for the following reasons: How a board makes decisions and the matters that are discussed with the board all influence its effectiveness. The person who controls the agenda influences the scope of work of the board and the level of understanding that the board has on issues. Use of board committees can relieve the full board of the detailed review that some issues require by having a few individuals conduct the review on behalf of the full board. Board Effectiveness and Efficiency of the Board The effectiveness and efficiency of the committees can also be structured board are influenced by what matters are to provide more independence in brought to the board and the processes the review process when that is appropriate. the board has in place to consider the issues and make decisions. The base level of compensation and incentive compensation can affect behavior and the degree to which the interests of key stakeholders are met. The role of the board is critical, and the performance of individual board members can affect the performance of the board as a whole. 27

40 Insurance Supervision Core Curriculum ICP 9 discusses these issues in paragraph 9.2, while discussion of committees of the board forms part of the advanced criteria. The practices included in this category are directed at ensuring that the board has the information it needs to make decisions and that this information is available in advance of meetings so that members can study it. It also requires that boards meet often enough to be kept informed about the progress of the company and the industry so that they can make informed decisions. In most jurisdictions, it is common for boards of directors to establish an audit committee to meet with external auditors, 8 to review in detail the financial information that goes to the board, and to oversee the work performed by the internal auditors. The composition of this committee is often relatively small and, in most cases, is made up entirely of independent directors or, at least, is chaired and dominated by independent directors. Independent directors are often required to review related-party transactions between companies within the same corporate group to ensure that such transactions do not unduly provide an advantage to another entity within the group. The requirements affecting the structure and functioning of the board are intended to ensure that the board is sufficiently knowledgeable about the affairs of the company so that it is able to make informed decisions. It is also intended to ensure that the functioning of the board is robust enough to deal with crises. The time to build knowledge and understanding of the industry and the company and to build strong checks and balances in the structure and operation of the board is when operations are going smoothly. These systems and procedures are required and will be tested when operations are not going smoothly. One of the reasons why supervisors are concerned about the structure and functioning of boards is because, in the event of a crisis, they will direct the company (through the board) to take remedial action. The supervisor must be confident that the board can actually do what is required of it to meet that demand. Business planning and control In the area of business planning and control, best practices relate to the following areas: Role in developing a strategic plan Monitoring and reporting of performance Large business transactions Human resource management Succession planning Internal audit Risk management This function is a part of ICP 10, although neither ICP 9 nor ICP 10 requires that an audit committee be established.

41 ICP 9: Corporate Governance These areas are important for a number of reasons: The board should be involved in setting the strategic objectives of the company and in approving its plan for achieving the objectives. An important part of achieving a goal is to assess progress against the objective. Delegation of responsibility is a function of the board, and it is important to identify what issues must be referred to the board. Internal oversight and verification that board decisions and policy are followed are important elements of effective internal controls. Understanding and managing risks affect the predictability and stability of earnings, which affect the confidence that stakeholders have in the company. ICP 9 assigns management the role of developing a strategic plan and submitting recommendations to the board for approval. In practice, strategic planning is carried out in this way. However, even when the board delegates a function to others, responsibility for the function rests with the board. Information provided to the board Best practices must address the information that should be provided to the board, including: Frequency, scope, and level of detail Financial and nonfinancial information. This is important for the following reasons: Information is the foundation on which informed decisions are made. The board must have access to timely, comprehensive, and meaningful information. ICP 9 does not specifically include requirements in this area. However, ICP 10 on internal controls sets out several areas in which management is to provide comprehensive reports to the board on important internal controls and risk management topics (see IAIS 2003b, p. 21). In the area of free access to information, essential criteria require internal auditors to have unfettered access to departments and functions and to report on a regular basis to the board. In this way, the core principles present a model that is consistent with the best practices outlined above. In providing information, a balance is needed between too much and too little detail, between relevant and not so relevant information, between raw data and refined analysis, and between detailed information and summary information. Providing in- 29

42 Insurance Supervision Core Curriculum formation that meets this balance is not always easy. A person who is receiving and using information can have difficulty telling whether complete disclosure has been achieved. Confusion may be the result of not understanding the subject or of reading information that is poorly presented and confusing. An Informed Board In order for a board to be effective, it must be well informed about the operations of the company and able to influence all aspects of the company s business and internal processes. Information provided to key stakeholders Regarding information provided to key stakeholders, best practices relate to the following areas: Audited financial information Disclosure of major events and decisions Timeliness and completeness of disclosure. This is important for the following reasons: Information provided to key stakeholders should be informative and provided in a manner that supports informed decisionmaking. Major events that force the company to alter its direction or plans, involve unplanned large expenditures, or change control of the company are important for most stakeholders because these events alter the risks involved in the company and the value of interest the stakeholder has in the company. ICP 26 (information, disclosure, and transparency toward the market) and ICP 12 (reporting to supervisors and offsite monitoring) require the board of directors to have suitable internal controls to ensure that information provided to the insurance supervisor is accurate and that appropriate audit procedures are in place to support this activity. This requirement is directed at a similar need for the supervisor to be well informed. Both insurance supervisors and all other stakeholders need reliable, meaningful information. This is not coincidental. All key stakeholders need information in order to make informed decisions about the affairs of the company. The board of an insurance company has a duty to manage the company in the best interest of the company, its shareholders, and its policyholders. Information is the foundation on which informed decisionmaking is built, both for the board and for other stakeholders. 30

43 ICP 9: Corporate Governance For information to be useful, it Reliable, Timely Information must be timely, accurate, complete, Reliable, relevant, and timely information and relevant. It should be no more is critical for all stakeholders. The board detailed or comprehensive than should control the scope, quality, accuracy, and timeliness of information that necessary. Therefore, a balance is required between too much information and not enough information. board should have sufficient checks and is released to outside stakeholders. The This is true for all stakeholders. As balances in place to ensure that any information released meets these standards. an example, too much information may overwhelm staff of the supervisory authority and prevent them from understanding the company and its financial condition. Too little information may hide the important trends and indicators of problems. The key challenge is to achieve balance. Q10 Please answer the following questions: 1. Why is it important to have independent directors on the board? 2. Why should an insurance supervisor be interested in who actually sets the agenda for board meetings? 3. Why might an insurance supervisor require insurance companies to establish an audit committee? 4. How can the way in which information is provided to the board influence its decisions? 5. Why should an insurance supervisor be interested in knowing the degree to which individual members of the board are active and involved in decisionmaking? 31

44 Insurance Supervision Core Curriculum Q11 Answer these questions in relation to the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 1. What are the requirements for boards in your jurisdiction regarding: a. Composition, or membership, of the board (including their qualifications) b. Committee structure c. Information that must be provided to key stakeholders. 2. Are there requirements that deal with the quality of information provided to the board? If so, do you feel that they support the board s responsibilities? If not, how satisfied are you that boards receive sufficient information to carry out their responsibilities? 3. What two major concerns do you have about the functioning of boards of directors of insurance companies in your jurisdiction? 32

45 ICP 9: Corporate Governance F. Issues for Insurance Supervisors The policyholders of many insurance companies have more money in the company than the shareholders. It is reasonable that the supervisor, who has a role in working on behalf of the policyholders, should share common interests with the policyholders and work to protect them from undue loss. Since policyholders generally consider that purchasing insurance reduces the financial risks to which they are exposed, they often do not consider that their money is at risk in the insurance company. This is quite different from an investor who recognizes the risks involved in making investments and accepts increases and decreases in the value of the shares acquired as a normal part of the investment process. This is one reason why, in many countries, the rights of policyholders, as customers of insurance companies, are given legal priority over the rights of shareholders and other providers of capital. 9 Defining what processes and systems each company should have in place becomes a challenge for supervisors. In doing so, the supervisor should recognize that what constitutes good corporate governance is a changing and evolving target. The definitions should therefore be reviewed and, where necessary, revised relatively frequently. However, once the definitions are in place and companies have implemented sound practices, the industry will work to a higher standard, and efficient supervisory processes can be adopted. Scope of application Not all insurance companies that are subject to regulation and supervision have their shares traded on an exchange (see figure 2). In order to keep the marketplace fair and consistent among companies and to provide similar protection for all policyholders, the supervisor has Effective Controls and Fair Treatment to ensure that similar rules apply Every effort should be made to have to all companies. This statement equally effective controls in place for all applies to all aspects of supervision, and corporate governance is stakeholders can expect consistent and forms of insurance enterprises so that all fair treatment from all companies operating in the market. no exception. Good corporate governance should apply to all companies under all forms of corporate organization, whether owned by shareholders or not. In many countries, some insurance enterprises are operated for the benefit of policyholders, and some or all policyholders 9. Legal priority applies in the winding up or liquidation of an insurance company and determines the order in which the assets of the company are distributed in resolving claims against the insolvent company. 33

46 Insurance Supervision Core Curriculum Figure 2: The Local Insurance Industry Foreign companies Local insurance industry Companies with exchange-traded shares Branches of foreign companies Locally incorporated closely held companies and subsidiaries Locally incorporated traded insurance companies have the rights of owners. 10 These may by fraternal benefit societies, cooperative insurance companies, friendly societies, mutual insurance companies, or any other similar form. In any of these cases, the board acts on behalf of the policyholders as owners and customers of the enterprise. Since these institutions do not have shareholders and are not traded on capital markets, they often must comply with corporate governance rules defined by the insurance supervisor. Branches of foreign companies are not local legal corporate entities, and they do not have a board of directors of their own. For this reason, the rules of corporate governance cannot be applied directly to a branch without adjustment. The supervisor has to make the requirements for all insurance enterprises that operate in the jurisdiction as consistent as possible so that markets are not distorted and competitive advantage is not granted to one company or form of operation over another. The discussion of corporate governance most frequently relates to companies with shares traded on the local capital market or exchange. However, from the discussion so far, it should be clear that the insurance supervisor is very interested in ensuring that all companies adopt sound corporate governance practices and the associated internal controls. It is common for supervisors to set requirements for all supervised companies, extending to closely held financial institutions the rules that apply to companies whose shares are traded on an exchange. 11 The insurance core principles that have been developed by IAIS and the core principles for banking supervision that have been developed by the Basel Committee on Banking Supervision both include references to corporate governance and internal 10. Although there are no shareholders with money at risk, policyholders, as owners, have money at risk. In the event the enterprise requires additional capital, policyholders may contribute through a reduction in dividends or bonuses, through an assessment, or through a reduction in policy benefits. The range of possible actions available to the board to increase capital or reduce liabilities is usually defined in the company bylaws or in the law under which the institution receives its charter. 11. This can be demonstrated by the behavior of financial sector supervisors in Canada (the Office of the Superintendent of Financial Institutions issued a guideline on corporate governance that applies to all financial institutions) and the United States (the Office of the Comptroller of the Currency issued a notice on application of the Sarbanes Oxley Act to all banks). 34

47 ICP 9: Corporate Governance controls (see IAIS 2003b; Basel Committee on Banking Supervision 1997). These principles do not apply only to financial institutions whose shares are traded on an exchange or to local legal corporate entities. They apply to all financial institutions, and the supervisor should have the authority to strengthen the requirements that may already apply to other commercial enterprises. This is because corporate governance makes such an important contribution to efficient and effective supervision and to the sound management of financial institutions for all stakeholders. Linkage to other regulators and supervisors Because corporate governance is often a part of the rules that securities regulators set for market participants and some features of corporate governance are often included in commercial law, it is necessary for insurance supervisors to coordinate the requirements that they set for insurance enterprises with those of the other supervisory authorities in the jurisdiction. Obviously, the rules set by securities regulators apply to all companies that are market participants, but not all insurance companies have their securities traded on the securities exchange. However, what constitutes good corporate governance is often independent of whether the shares are traded on a securities exchange. While companies whose shares are not traded on an exchange may not have minority shareholders for whom the securities regulator has a concern, the board of directors should be concerned with other key stakeholders. These stakeholders include policyholders and the insurance supervisor. As a result, part of the role of the board should be to ensure that Cooperation information provided to the insurance supervisor is accurate and must cooperate with other regulators and To be effective, insurance supervisors complete and presents fairly the supervisors on many issues; corporate true condition of the company. governance is no exception. In fact, a To ensure that the same rules wide range of regulatory authorities may deal with corporate governance requirements. and regulatory requirements apply to all insurance enterprises, the insurance supervisory authority should be able to set requirements for all insurance enterprises. In doing this, the level of overlap and duplication should be kept to a minimum so that, as the requirements change over time, the insurance supervisor does not have to reissue the requirements with each change that the other regulatory authority makes. The insurance supervisor should set the special requirements made necessary by the nature of the insurance business and cover the bulk of the requirements by reference to the rules already in place. If the rules for corporate governance have been either set by the securities regulator or included in the commercial law, then the insurance supervisor should take a different 35

48 Insurance Supervision Core Curriculum approach to defining the corporate governance requirements than in situations where these rules are not in place. The insurance supervisor must decide whether these additional requirements should be set out in legislation, in regulation, or through guidance to the industry. The manner of putting these into effect has to reflect local practices in putting other elements of corporate governance requirements into effect. If rules for corporate governance are already in place, the insurance supervisor should: Adopt, by reference, the existing corporate governance rules and indicate that they apply to all companies whether or not they are legally bound to comply with the requirements set out by the originator of the rules 12 Identify any special features that may be required because the industry is a regulated and supervised industry, including specific requirements for the board of directors to report to, or accept reports from, the insurance supervisor, specific reference to disclosure requirements to policyholders or potential policyholders, or reference to board composition if some directors are elected by policyholders Identify any special features that may be required for the insurance industry, including reference to special review and oversight that may be required in dealing with estimates of policy and other liabilities, the process for appointing the actuary, the role of the actuary in working with the board or a committee of the board, or special risk management policies or practices. For branches of foreign companies, the reporting requirements should be similar to those that apply to local companies, and the control procedures around the preparation and certification of financial information should be similar. The difference is that the supervisor cannot rely on the board to provide oversight. Rather the supervisor looks to senior local officials in the branch to provide that control. Therefore, the elements of the checks and balances that apply to local companies should apply to the branches as well, whenever possible. This is necessary so the supervisor can rely on the accuracy and completeness of the information submitted and policyholders can have the same level of confidence in business placed with a branch as they have in business placed with a local company. What if there are no rules? If no rules (for some or all of the insurance enterprises) have been prescribed by the securities regulator or set out in commercial law, then the insurance supervisor needs to issue comprehensive rules that cover the rights of shareholders and policyholders as well as the interests of the supervisor. The insurance supervisor needs to ensure that shareholders interests are respected, because they are the source of capital that the su- 36

49 ICP 9: Corporate Governance pervisor will be looking for should it be necessary. However, the supervisor should be ready and able to revise the rules that apply to insurance companies as corporate governance rules are adopted by the securities regulatory authority or through changes in the commercial law. Q12 Please answer the following questions: 1. Why should an insurance supervisor implement a regime under which many of the corporate governance requirements that apply to a publicly traded insurance company apply to the branch operations of a foreign insurance company? 2. Why should an insurance supervisor be interested in protecting shareholder and creditor rights?? 3. Should an insurance supervisor check on the quality of work done by the external auditors? If so, why? If not, why not? 4. Why might an insurance supervisor set corporate governance requirements that override the corporate governance requirements that otherwise apply to publicly traded insurance companies? 5. In what way do policyholders benefit from a corporate governance regime? 6. Under what circumstances might an insurance supervisor define a complete corporate governance regime for insurance companies, branches, or subsidiaries of foreign insurance companies? Q13 Answer these questions in relation to the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 1. In your jurisdiction, which supervisory or regulatory agencies have full or partial responsibility for: a. Setting corporate governance requirements for corporations b. Oversight or inspection of compliance with these requirements c. Enforcement if noncompliance is discovered. 37

50 Insurance Supervision Core Curriculum Q13 continued 2. What are the similarities and differences in the requirements for the following types of insurance enterprises in your jurisdiction? a. Closely held, locally incorporated insurance companies b. Widely held, locally incorporated insurance companies c. Branches of foreign insurance companies. 3. How do the agencies in your jurisdiction coordinate the review and revision of the corporate governance requirements that apply to insurance companies? In your view, how can that process be strengthened? 4. Which of the corporate governance requirements in effect are specifically designed to protect the rights and interests of policyholders? Q14 Considering the material in this module and the text of ICP 9, and relating them to your experience and knowledge of the situation in your country, answer each of the following questions. If you are working in a group, discuss your responses, identify similarities and differences, and then develop a group response. 1. What objectives might an insurance supervisor have in mind when developing a corporate governance regime for insurance companies in the jurisdiction? How can these objectives be met? 2. Why should an insurance supervisor coordinate the features of a corporate governance regime with any requirements that are in place for general-purpose companies in the jurisdiction? How can this be achieved? 3. How might the local corporate governance requirements be inspected and enforced by the insurance supervisor? How should this be coordinated with other local supervisory and regulatory bodies? 4. Would you expect there to be any differences in the corporate governance requirements that apply to a locally incorporated company, a local subsidiary of a foreign insurance company, and a local branch of a foreign insurance company? What might some of these differences be? Why might these differences be necessary? 38

51 ICP 9: Corporate Governance Q14 continued 5. Would you expect there to be any similarities in the corporate governance requirements that apply to a locally incorporated company, a local subsidiary of a foreign insurance company, and a local branch of a foreign insurance company? What might some of these similarities be? Why might these similarities be necessary Q15 These are simulated situations in which you are asked to decide how you would respond in the circumstances outlined. If you are working in a group, reach your decision through discussion and agreement. 1. You are head of the insurance supervisory agency in your jurisdiction. The head of the local securities regulatory authority has informed you that the largest insurance company listed on the local exchange has issued a prospectus to raise additional capital that includes significant errors. You understand from the information that the problem is due to inconsistent financial information reported in the prospectus as compared to the information reported in the most recent annual report released to investors. What actions would you take? 2. You are head of the insurance supervisory authority in your jurisdiction. Your agency has recently released new regulations that require insurance companies to have an audit committee. This committee is to meet regularly with the internal auditor and at least once a year with the external auditor. In addition, it must review the quarterly financial results before they are presented to the board for approval and release. A foreign company has just made an application to operate on a branch basis in your jurisdiction. The home jurisdiction of this company does not require an audit committee. Explain what you would do and why. a. Assuming everything else about this application is acceptable, would you accept the application? b. Would you establish any conditions to be complied with by the branch before accepting the application? If so, what would these be? c. Would you decline the application? 39

52 Insurance Supervision Core Curriculum G. References Basel Committee on Banking Supervision Core Principles for Effective Banking Supervision. Basel, September. Available at Framework for Internal Control Systems in Banking Organizations. Basel, September. Available at HIH Royal Commission The Failure of HIH Insurance, released by the Hon. Justice Owen as commissioner. Canberra: Commonwealth of Australia, April. Available at IAIS (International Association of Insurance Supervisors). 1998a. Supervisory Standards on Licensing. Basel, October. Available at b. Supervisory Standards on On-site Inspection (Standard No 2). Basel, October. Available at Guidance Paper on Fit and Proper Principles and Their Application. Basel, October. Available at a. Guidance Paper on Public Disclosure by Insurers. Basel, January. Available at b. Principles on Capital Adequacy and Solvency. Basel, January. Available at a. Guidance Paper on the Use of Actuaries as Part of the Supervisory Process. Guidance Paper 7. Basel, October. Available at b. Insurance Core Principles and Methodology. Basel, October. Available at Iskander, Magdi R., and Nadereh Chamlou Corporate Governance: A Framework for Implementation. Washington, D.C.: World Bank, May. Available at OECD (Organisation for Economic Co-operation and Development) OECD Principles of Corporate Governance. Paris. Available at Salmon, Walter, and others Harvard Business Review on Corporate Governance. Cambridge, Mass.: Harvard Business School Press, January. 40

53 ICP 9: Corporate Governance Appendix I. ICP 9: Corporate Governance The corporate governance framework recognises and protects rights of all interested parties. The supervisory authority requires compliance with all applicable corporate governance standards. Explanatory note 9.1. Insurers must be managed prudently. Corporate governance refers to the manner in which boards of directors and senior management oversee the insurers business. It encompasses the means by which members of the board and senior management are held accountable and responsible for their actions. Corporate governance includes corporate discipline, transparency, independence, accountability, responsibility, fairness, and social responsibility. Timely and accurate disclosure on all material matters regarding the insurer, including the financial situation, performance, ownership, and governance arrangements, is part of a corporate governance framework. Corporate governance also includes compliance with legal and regulatory requirements The board is the focal point of the corporate governance system. It is ultimately accountable and responsible for the performance and conduct of the insurer. Delegating authority to board committees or management does not in any way mitigate or dissipate the discharge by the board of directors of its duties and responsibilities. In the case of a policy established by the board, the board would need to be satisfied that the policy has been implemented and that compliance has been monitored. Similarly the board needs to be satisfied that applicable laws and regulations have been complied with. The responsibilities of the governing body must be consistent with the rules on governance structure established in the jurisdiction. Where the posts of chairman and chief executive are combined in one person, the supervisory authority will verify that appropriate controls are in place to ensure that management is sufficiently accountable to the board of directors In most jurisdictions, corporate governance rules exist for general-purpose corporations; these likely also apply to insurers. Often, however, it is necessary to establish additional requirements, through the insurance legislation, that deal with the matters of specific concern and importance to insurance supervisors. These matters are described in the criteria below. As the supervisory authority may not have the power to specify the details of general corporate governance rules or to enforce compliance, several criteria under this principle refer to the responsibility of the board of directors rather than requirements from the supervisory authority. 41

54 Insurance Supervision Core Curriculum Essential criteria a. The supervisory authority requires and verifies that the insurer complies with applicable corporate governance principles. b. The board of directors: Sets out its responsibilities in accepting and committing to the specific corporate governance principles for its undertaking. Regulations on corporate governance should be covered in general company law and/or insurance law. These regulations should take account of the size, nature, and complexity of the insurer. Establishes policies and strategies, the means of attaining them, and procedures for monitoring and evaluating the progress toward them. Adherence to the policies and strategies are reviewed regularly, and at least annually. Satisfies itself that the insurer is organised in a way that promotes the effective and prudent management of the institution and the board s oversight of that management. The board of directors has in place and monitors independent risk management functions that monitor the risks related to the type of business undertaken. The board of directors establishes audit functions, actuarial functions, strong internal controls, and applicable checks and balances. Distinguishes between the responsibilities, decision-making, interaction, and cooperation of the board of directors, chairman, chief executive, and senior management. The board of directors delegates its responsibilities and establishes decision-making processes. The insurer establishes a division of responsibilities that will ensure a balance of power and authority, so that no one individual has unfettered powers of decision. Establishes standards of business conduct and ethical behaviour for directors, senior management, and other personnel. These include policies on private transactions, self-dealing, preferential treatment of favoured internal and external entities, covering trading losses and other inordinate trade practices of a non-arm s-length nature. The insurer has an ongoing, appropriate, and effective process of ensuring adherence to those standards. Appoints and dismisses senior management. It establishes a remuneration policy that is reviewed periodically. This policy is made available to the supervisory authority. Collectively ensures that the insurer complies with all relevant laws, regulations, and any established codes of conduct (refer to advanced criterion f). Has thorough knowledge, skills, experience, and commitment to oversee the insurer effectively (refer to ICP 7). Is not subject to undue influence from management or other parties. The board of directors has access to information about the insurer and asks and receives additional information and analyses that the board sees fit. 42

55 ICP 9: Corporate Governance Communicates with the supervisory authority as required and meets with the supervisory authority when requested. Sets out policies that address conflicts of interest, fair treatment of customers, and information sharing with stakeholders and reviews these policies regularly (refer to ICP 25). c. Senior management is responsible for: Overseeing the operations of the insurer and providing direction to it on a dayto-day basis, subject to the objectives and policies set out by the board of directors, as well as to legislation Providing the board of directors with recommendations, for its review and approval, on objectives, strategy, business plans, and major policies that govern the operation of the insurer Providing the board with comprehensive, relevant, and timely information that will enable it to review business objectives, business strategy, and policies and to hold senior management accountable for its performance. Advanced criteria d. The board of directors may establish committees with specific responsibilities like a compensation committee, audit committee, or risk management committee. e. The remuneration policy for directors and senior management has regard to the performance of the person as well as that of the insurer. The remuneration policy should not include incentives that would encourage imprudent behaviour. f. The board of directors identifies an officer or officers with responsibility for ensuring compliance with relevant legislation and required standards of business conduct and who reports to the board of directors at regular intervals (refer to essential criterion b). g. When a responsible actuary is part of the supervisory process, the actuary has direct access to the board of directors or a committee of the board. The actuary reports relevant matters to the board of directors on a timely basis. 43

56 Insurance Supervision Core Curriculum Appendix II. Answer Key Set and question Suggested answer or consideration Q1 1 Response b is correct. The other responses relate to requirements placed on corporations but do not in themselves constitute corporate governance. 2 Response b is correct. Response a is weak, since one of the roles of a board is to act in the interest of stakeholders, including the investors. 3 Response b is correct. 4 Response b is correct. This statement is partially true. However, it ignores the fiduciary duty of the board toward policyholders, which is generally not covered by those bodies. 5 Response b is correct. 6 Response c is correct. 7 Response b is correct. ICP 9 is directed at protecting the rights of all parties with an interest in the ongoing viability of the company. 8 Response d is correct. 9 Response d is correct. 10 Response e is the most correct, as all of a, b, c, and d should be performed to support an adequate assessment. 11 Response c is correct. 12 Response d is correct. 13 Response b is correct. Response a is a possible benefit, but not the motivation for implementing internal controls. 44

57 ICP 9: Corporate Governance Set and question Suggested answer or consideration Q2 1 Responses a, b, and c are correct. 2 Response b is correct. However, responses c and d are acceptable additions to the response. 3 Responses a, b, c, and d are correct. 4 Responses a, b, c, and d are correct. These responses depend on local conditions to determine how the rules are put into effect. Q3 1 Consider the insurance act and regulations. How are insurance rules linked to corporate law and securities regulatory requirements? Discuss the practices that might be in place with senior staff in the insurance agency. 2 Consider the insurance act and the regulations. There may also be guidance notes that set out requirements for applicants. 3 Consider corporate law and the insurance act. Experienced staff in the supervisory authority should be able to provide the answer and explanation. 4 Consider internal records. A comparison of the list of companies approved to operate in the jurisdiction against those listed on the local exchange would also support the response. In addition, consider corporate law and any insurance company requirements. Q4 1 Response b is correct. However, responses a and c are acceptable as supporting responses. 2 Responses a and c are correct. 3 Responses b, c, and d are correct. However, response a could be a byproduct, but it is not the motivation for implementing internal controls. 4 Response c is correct. 5 Response b and d are correct. 45

58 Insurance Supervision Core Curriculum Set and question Suggested answer or consideration Q5 1 Consider the rules for the securities regulatory authority. A discussion with senior supervisory staff should be helpful. 2 Discuss this issue with supervisory staff who analyze or inspect insurance companies listed on an exchange. 3 Consider the financial reports that have been filed with the supervisory authority. Q6 1 Consider the common interests among stakeholders. Corporate governance needs to balance competing needs of different stakeholders, and insurance supervisors need to recognize this pressure. Corporate governance applies while a company is a going concern, and all stakeholders needs must be satisfied. However, in the event of the failure of the company, it is common for policyholders to be given preference over shareholders and creditors. 2 Consider the reduction of duplication. Other bodies may not carry out inspections. Insurance supervisors set additional rules to enhance rules set by other bodies and, in the absence of rules by others, may have to set all of the rules. Not all insurance companies are subject to the rules of others. 3 Consider the fiduciary duties of the board and the special nature of insurance business. Insurance is a regulated business, and boards must deal with regulators. Q7 1 Consider the insurance act and regulations, any self-assessment that might have been completed for your agency, and the documentation of the supervisory methodology for the agency. 2 Discuss this with experienced supervisory staff to find the answer. 46

59 ICP 9: Corporate Governance Set and question Suggested answer or consideration Q8 1 Responses a, b, c, and d are correct. 2 False. The fitness and propriety of management and members of the board should be an ongoing concern of supervisors. 3 Responses a and b are correct. 4 Responses a, b, c, and d are correct. Q9 1 Consider the documentation of supervisory methodology for the agency. Discuss this with experienced inspectors. 2 Discuss this with experienced staff of the agency. Q10 1 Consider that one basic principle requires fair treatment for all stakeholders. Independent directors have few vested interests or conflicts; independent members may be more willing to challenge management. Left to its own decision, the board may prefer to have like-minded people on the board, and independent directors widen the scope of thought brought to issues facing the company. 2 Consider that controlling the agenda can control and limit the range of issues brought to the board. The result could be a less involved and less knowledgeable board with weaker internal controls. Policyholder interests could be compromised, and the ability of the board to take control in a crisis could be reduced. 3 Consider the need for accurate financial information, efficient supervisory processes, efficient board functioning, stronger internal controls and oversight by the board, and reduced ability of management to prepare reports that meet its needs but not those of the board. 4 Consider that information forms the basis of decisionmaking. One-sided information can lead the board to a single conclusion. Complex or voluminous information can cause the board to rely on verbal descriptions. 5 Consider that the role of any one member can affect the performance of the board as a whole. Boards must be well informed and involved to be effective. Boards should provide insight in setting directions and providing oversight, and low involvement reduces effectiveness in these areas. 47

60 Insurance Supervision Core Curriculum Set and question Suggested answer or consideration Q11 1 Consider corporate law, the insurance act, and regulations. Discuss this with experienced staff in the agency. 2 Discuss this with experienced staff in the agency. 3 Discuss this with experienced staff in the agency. Q12 1 Consider that all policyholders should have equal confidence that the company they deal with is equally well managed. Compliance assessment and internal controls should be comparable, independent of business structure. The supervisor should be equally confident that directives given to the company will be effectively implemented. 2 Consider that shareholders provide capital to the company and to the industry. Companies need access to capital to finance growth and respond to an emergency. Supervisors need to be satisfied that companies have adequate access to capital when needed. 3 Consider that reliance on the work of others involves checking to see that the work is done to appropriate standards. Audit standards should be reviewed from time to time to ensure that they are appropriate for the needs of the users, including supervisors. 4 Consider that rules set by the insurance supervisors should not contradict rules set by other competent bodies. Additional requirements are appropriate to reflect the fiduciary nature of the insurance business. Not all insurance enterprises are subject to the rules set by other competent bodies; insurance is a long-term business, which could create the need for expanded rules. 5 Consider that the board should balance the interests of all stakeholders, including policyholders. Disclosure of important matters to policyholders is controlled by the board, and corporate governance influences how transparency works. Special rules relating to the unique features of insurance affect policyholders directly, and these are only effective in a good corporate governance regime. 6 Consider that not all insurance enterprises may be covered by existing corporate governance rules. There may be no effective corporate governance rules in place for any industry, and the insurance supervisor may want to fill a temporary void until another competent body completes comprehensive rules for all industries. 48

61 ICP 9: Corporate Governance Set and question Suggested answer or consideration Q13 1 Consider corporate law, securities regulatory rules, and the insurance act and regulations. Also consider the supervisory methodology of the agency. Discuss this with experienced staff in the agency. 2 Consider the insurance act and regulations. Discuss this with senior staff in the agency. 3 Discuss this with senior staff in the agency. 4 Consider the insurance act and regulations. Q14 1 Consider the efficiency of the supervisory methodology. Objectives may be to rely on and strengthen the company s focus on internal controls, focus the boards of insurance companies on their duties and responsibilities to policyholders and the insurance supervisor, meet international standards for insurance supervision, increase consumer confidence, and strengthen the financial system. 2 Consider the need to reduce duplication, avoid contradictory requirements, maintain the requirements for corporate governance as they develop and change, and maintain consistent expectations for all boards so that the expectations of board members and consumers can be managed. 3 Consider offsite review of aspects of the requirements that can be quantified and onsite review of the aspects of the requirements that are either proprietary or qualitative in nature. Coordinate inspection activities with other regulators and supervisors to reduce duplication, share results, discuss findings, and coordinate regulatory enforcement. 4 Consider that differences result from ownership of the entity, who the home regulator is, the legislation under which the board operates, the supervisor to whom the board has a primary duty, the location of incorporation of the company, and who controls the internal audit function and the location of the books and records of the company. 5 Consider that similarities result from the location of the policyholders, the need to comply with local legislation, and the duties and responsibilities of the local insurance supervisor. Policyholders should expect the same standard of treatment from companies independent of the business organization of the company, and the insurance supervisor should expect the same standard of internal controls to be met independent of the business structure of the company. 49

62 Insurance Supervision Core Curriculum Set and question Suggested answer or consideration Q15 1 Consider whether there is any reason to reexamine the accuracy of the regulatory information that is on file in the supervisory agency. Is there reason to believe that the internal control procedures in the company are weak and that board oversight is weak? When were these last inspected? Should a special onsite inspection be made to review these procedures? What role have the internal audit and the external auditor had in preparing this information? Are their controls and processes sufficient? 2 Consider the insurance act and the licensing requirements under regulations and any guidance notes. What powers do you have to establish a higher duty of care on a branch to bring its controls procedures up to the standards expected of domestic companies? Do you have the power to decline an application if you believe the home jurisdiction has a weak supervisory regime? The answers to this could lead to a decision either to decline the application or to impose special reporting on the local head of the branch. It also could lead to a decision to consider the application only if the foreign company establishes a local subsidiary. 50