A Core Curriculum for Insurance Supervisors. ICP 6: Licensing. Basic-level Module

Transcription

1 A Core Curriculum for Insurance Supervisors ICP 6: Licensing 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 module was prepared by Michael Hafeman. Mr. Hafeman is an actuary and independent consultant on financial sector supervision and related issues. He has held senior positions in both private and public sector organizations in the financial services industry in the United States and Canada. Most recently, he was assistant superintendent of the Specialist Support Sector at the Office of the Superintendent of Financial Institutions Canada (OSFI), during which time he also served as a member of the Executive and Technical Committees of the IAIS and chair of its Solvency Subcommittee. Mr. Hafeman is a member of the Public Interest Oversight Board, charged with overseeing the auditing and assurance, ethics, and education standard-setting activities, and the Member Body Compliance Program, of the International Federation of Accountants. He also serves on the Insurance Program Advisory Committee of the Toronto International Leadership Centre for Financial Sector Supervision. The module was reviewed by Giovanni Manghetti and John Thompson. Mr. Manghetti is president of Casa di Risparmo di Vollera S.p.A (a regional bank in Italy). Prior to this, he worked for 19 years with the Italian Insurance Supervisory Authority (ISVAP), holding titles of president and board member. Mr. Thompson is a private consultant based in Toronto, Canada who provides advice and functional support to financial sector regulators, the financial services industry, and educational organizations. He is the chairman of the Insurance Advisory Group for the Toronto International Leadership Centre (which is based in Toronto, Canada, and provides leadership development training for financial sector regulators). He is an actuary with more than 24 years of experience in senior positions within a life insurance company, both in Canada and the United Kingdom. Prior to becoming a consultant, he was deputy superintendent at the Office of the Superintendent of Financial Institutions in Canada. He also has broad experience at the international level as the former chairman of the Executive Committee of the International Association of Insurance Supervisors and member of the Basel Committee for Banking Supervision.

3 Contents About the Core Curriculum v Note to learner vii Pretest ix A. Introduction B. Scope of licensing C. Licensing criteria D. Licensing process E. References Appendix I: ICP Appendix II: Cross-references Appendix III: Answer key iii

4 Insurance Supervision Core Curriculum Figures Figure 1. Licensing Process in Jurisdiction A Figure 2. Licensing Process in Jurisdiction B iv

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 longterm savings. The insurance core principles (ICPs), developed by the International Association of Insurance Supervisors (IAIS), are key international standards relevant for sound financial systems. Effective implementation of the ICPs requires skilled and knowledgeable insurance supervisors. Recognizing this need, the World Bank and the IAIS partnered in 2002 to develop a core curriculum for insurance supervisors. The Core Curriculum Project, funded and supported by various sources, accelerates the learning process of both new and experienced supervisors. The ICPs provide the structure for the core curriculum, which consists of a set of modules that summarize the most relevant aspects of each topic, focus on the practical application of supervisory concepts, and cross-reference existing literature. The core curriculum is designed to help those studying it to: Recognize the risks that arise from insurance operations Know the techniques and tools used by private and public sector professionals to identify, measure, and manage these risks Operate effectively within a supervisory organization Understand the ICPs and other IAIS principles, standards, and guidance Recommend techniques and tools to help a particular jurisdiction observe the ICPs and other IAIS principles, standards, and guidance Identify the constraints and identify and prioritize supervisory techniques and tools to best manage the existing risks in light of these constraints. v

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7 Note to learner Welcome to ICP 6: Licensing module. This is a basic-level module on licensing that does not require specific prior knowledge of this topic. The module should be useful to either new insurance supervisors or experienced supervisors who have not dealt extensively with the topic or are simply seeking to refresh and update their knowledge. Start by reviewing the objectives, which will give you an idea of what a person will learn as a result of studying the module, and answer the questions in the pretest to help gauge your prior knowledge of the topic. Then proceed to study the module either on an independent, self-study basis or in the context of a seminar or workshop. The amount of time required to study the module on a self-study basis will vary, but it is best addressed over a short period of time, broken into sessions on sections if desired. To help you engage and involve yourself in the topic, we have interspersed the module with a number of hands-on activities for you to complete. These exercises are intended to provide a checkpoint from time to time so that you can absorb and understand the material more readily and can apply the material to your local circumstances. You are encouraged to complete each of these activities before proceeding with the next section of the module. If you are working with others on this module, develop the answers through discussion and cooperative work methods. An answer key in appendix III sets out some of the points that you might consider when tackling the exercises and suggests where you might look for the answers. As a result of studying the material in this module, you will be able to do the following: 1. Explain what licensing means and why it is important that insurers be licensed vii

8 Insurance Supervision Core Curriculum 2. Describe the following bases for conducting insurance operations and the licensing appropriate to each: a. Domestic insurer b. Subsidiary of a foreign insurer c. Branch of a foreign insurer d. Foreign insurer operating on a services basis 3. Explain the disadvantages of composite insurers and describe the additional controls required of them for prudential reasons 4. Provide examples of circumstances when it may be acceptable for insurance business to be conducted without a license 5. Enumerate the criteria that should be considered before a license is granted and explain the importance of each, including: a. Suitability of key functionaries b. Suitability of significant owners c. Availability of required capital d. Adequacy of risk management, controls, policies, and procedures e. Viability of the business plan f. Products to be offered g. Contracts with affiliates and providers of outsourced services h. Management and supervisory reporting arrangements i. Input from the home supervisory authority of an insurer with foreign connections 6. Describe the information that should be sought from the home supervisory authority before a foreign insurer is allowed to carry on business in the jurisdiction 7. Assess the adequacy of the business plan of a particular applicant for an insurance license 8. Enumerate the typical steps in the licensing process 9. Illustrate additional requirements, conditions, or restrictions that might be imposed on an applicant by a supervisory authority and explain why they would be appropriate 10. Prepare a plan for supervisory monitoring during the three years after a particular insurer has been granted a license 11. Summarize the requirements of ICP 6. viii

9 Pretest Before studying this module on licensing, answer the following questions. The questions are designed to help you gauge your existing knowledge of this topic. An answer key is presented in appendix III at the end of the module. For each of the following questions, circle the response that is correct or most relevant. 1. The most important reason for licensing insurers is to: a. Generate licensing fee revenues for the supervisory authority b. Help to ensure that only insurers able to meet their obligations to policyholders are allowed to operate c. Protect established insurers from new competitors d. Keep insurers from carrying on banking business. 2. An insurer may be able to operate outside its home jurisdiction in various ways, except by: a. Purchasing the shares of a foreign mutual company b. Establishing a branch c. Forming a stock company subsidiary d. Providing cross-border services. ix

10 Insurance Supervision Core Curriculum 3. A composite insurer is one that: a. Insures both property and liability risks under the same policies b. Was formed through the merger of two or more companies c. Is partly owned by the government d. Insures both life and non-life risks. 4. It may be acceptable for an insurer to conduct insurance business without a license if: a. The supervisory authority has a backlog of license applications b. The insurer is a small fraternal organization operating in a limited geographic area c. The insurer is part of a very large, highly rated international group d. The significant owner of the insurer is a former insurance supervisor. 5. Licensing criteria should be clear, objective, and public in order to: a. Make it easier for the licensing authority to process applications b. Help insurers to understand what is required to enter the market c. Make it more difficult for undesirable insurers to enter the market d. Accomplish all of the above. 6. If a foreign insurer applies for a license, the licensing authority should contact the home supervisor: a. Unless the insurer will be setting up a subsidiary b. Only if it needs more information on the financial situation of the insurer c. To obtain input on the suitability of key functionaries and significant owners d. Only if a memorandum of understanding is in place to govern such contact. 7. When evaluating the business plan of an applicant, the licensing authority should consider that: a. Although the applicant s plan may seem reasonable, prudence dictates that the impact of potentially adverse developments be assessed b. The applicant knows its business best, so its assumptions should usually be accepted without question c. An applicant with a financially strong owner can always obtain more capital, whenever it may be needed d. Business plans can change from year to year, so the proposed business plan is probably of limited value. x

11 ICP 6: Licensing 8. In some jurisdictions, parties other than the insurance supervisor play a role in the licensing process. This situation: a. Is inconsistent with the approach required by ICP 6 b. Can provide an appropriate control on supervisory power, as long as the other parties form their views without being influenced by those of the supervisor c. Can provide for consideration of a range of views in arriving at the important licensing decision, but the views of the supervisory authority should normally prevail d. Can be an excellent way to advance the government s market development goals without subjecting existing insurers to excessive loss of market share. 9. An insurer that has been a consistently profitable underwriter of motor vehicle and property insurance applies to extend its license to cover marine and aviation insurance. The most appropriate response may be to: a. Reject the application, since the insurer has no track record in marine and aviation insurance b. Grant the license but restrict the maximum per-event risk that the insurer may retain within the marine and aviation portfolio c. Grant the license but restrict its term to a period of six months d. Grant the license without restriction, since the insurer has adequately demonstrated its capabilities already. 10. Once a license has been issued to a new insurer, the supervisory authority should monitor its progress: a. After two years have passed, to give the insurer time to get its systems and procedures fully in place b. In accordance with the supervisory processes generally applied to all insurers c. Frequently, to ensure that the insurer is operating in accordance with its business plan and supervisory requirements d. Continuously, to facilitate ongoing supervisory advice to management on strategic and operational issues. xi

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13 ICP 6: Licensing Basic-level Module A. Introduction The Insurance Core Principles and Methodology (see IAIS 2003b) includes five principles under the heading of the supervised entity. First among these is ICP 6 on licensing: An insurer must be licensed before it can operate within a jurisdiction. The requirements for licensing are clear, objective, and public. This placement is appropriate. A license formally authorizes an insurer to carry on insurance business in a jurisdiction. In the absence of a license, an insurer should not be operating and there would be no entity to supervise. However, the granting of a license should not be a mere formality. Licensing requirements should help to ensure that only entities that are financially strong, owned and operated by suitable persons, and operated in an appropriate manner are given access to the market. Licensing should help to protect consumers from insurers that are either likely to be unable to meet their obligations or not prepared to follow appropriate market conduct practices. Without licensing, it would be very difficult to control market access and to supervise insurers that are operating in the market. This would place consumers at considerable risk. Therefore, effective licensing is essential to the protection of consumers. It forms the first line of defense against future supervisory problems.

14 Insurance Supervision Core Curriculum Licensing requirements have been developed based on the experiences of supervisors in dealing with troubled, weak, and failed companies. Analysis of the lessons learned from these experiences has helped to identify ways to avoid repeating the situation. The failure of a company that was managed by people intending to steal from the public may have led to the requirement that people who operate insurers must be ethical and experienced in the business. The failure of an insurer that was owned by someone who invested all of his savings in setting up the company may have led to the requirement that the insurer must have sufficient start-up capital to keep the company solvent until it begins to make a profit and the requirement that owners must be a source of strength for the company. Licensing requirements can be expected to continue to evolve, as supervisors gain additional experience in dealing with challenges in their market. One type of problem that licensing can help to combat is the operation of insurers that are not really insurers at all. As Savage (1998) notes in a paper on insurance supervision, Unfortunately there are fraudulent insurers who specialize in coming into a country, selling products which will never provide any benefits, and then disappearing along with the premium income. Of course the premiums charged by such insurers can be very low, given that they will not be paying any claims. Unsuspecting consumers may be sold these fictitious policies, and when a claim occurs the results can be disastrous. The business owner who insures his plant and equipment, experiences a serious fire, and then discovers that his insurer does not actually exist is in a terrible situation. Fortunately, such situations do not occur very often. However, licensing can also help to protect consumers from potential losses due to the market misconduct or failure of a legitimately constituted insurer. Although many circumstances can cause an insurer to fail, a comprehensive study by the Committee of the Conference of Insurance Supervisory Services of the Member States of the European Union (2002) has shown that the most obvious causes of solvency problems were the inappropriate risk decision, the external trigger event, or the resulting adverse financial outcomes. However, further analysis showed that these causal chains began in each case with underlying internal causes, being problems with management or shareholders or other external controllers. Licensing criteria These findings reinforce the need for comprehensive licensing criteria, as described in ICP 6, essential criterion b. These criteria help to distinguish between applicants that

15 ICP 6: Licensing are likely to meet their obligations and should be granted licenses and those that have an unacceptable probability of failure and should be refused licenses. ICP 6, essential criterion c, requires all domestic or foreign insurance establishments to be supervised. This criterion can be met through licensing since, typically, most provisions of insurance law apply to licensed insurers. Licensing is therefore the point of entry for an insurer to the application of legal and regulatory requirements and the ongoing supervisory processes of a jurisdiction. A license to operate is a valuable privilege provided to an insurer. Conversely, its withdrawal can cause significant difficulties for the insurer, its owners, and its policyholders, not to mention the supervisor. Neither the granting nor the withdrawal of a license should be entered into lightly. It is better to deny a license to an insurer that seems likely to create difficulties than to grant the license and cope with the subsequent problems! However, once a license has been granted, the threat of its withdrawal can be a powerful supervisory tool (see ICP 15). Licensing criteria are important minimum criteria for assessing the probability that an insurer will meet its obligations. As such, similar criteria are used in assessing the suitability of owners and management when a change in control takes place and in carrying out regular inspections of insurers operations. As mentioned in the explanatory notes to ICP 6, licensing should remain focused on supervisory purposes, and licensing procedures and conditions should not in themselves act as a barrier to market access. Furthermore, When the licensing procedure meets internationally accepted standards and is effective and impartial, confidence in the supervisory system will grow and may facilitate mutual recognition of supervisory systems and thus the further liberalization of market access for foreign insurers. These points have been reinforced by various international agreements, such as those of the European Union, and by negotiations, such as those relating to the General Agreement on Trade in Services (GATS; see Ishii 1999). It is no surprise, therefore, that the IAIS recognized the need to provide guidance on licensing by adopting a Supervisory Standard on Licensing and publishing a Licensing Textbook that builds on the standard (see IAIS 1998, 2000b). It is not the intent of this module to repeat their content, but to help you to understand the reasons underlying their main points. Appendix II cross-references these documents with the learning objectives and the various criteria of ICP 6 to help you to study a particular issue further. For an overview of the licensing requirements of various jurisdictions, you are encouraged to consult the IAIS Insurance Laws Database. 1 More detailed information on such requirements is available on the websites of many supervisory authorities (for example, see OSFI 2004). Finally, this module deals with the licensing of insurers rather than intermediaries. The definition of insurer refers to underwriting insurance. This is to distinguish insurers (which are responsible for meeting the benefit obligations arising from insurance 1. The IAIS Insurance Laws Database can be accessed via the IAIS website, at The user identification and password differ from those used to access the members section of the website; ask the principal IAIS contact in your organization for the access information.

16 Insurance Supervision Core Curriculum contracts) from intermediaries (which are involved in the distribution and servicing of insurance). Although intermediaries should also be licensed or registered, and their conduct supervised, these matters are dealt with in ICP 24 on intermediaries and the related module. Commonly used terms Before delving further into the topic of licensing, it is important to define some commonly used terms. Most of the definitions are taken from the IAIS Glossary of Terms (see IAIS 2005), although some clarifications and additions have been made. As noted in the Supervisory Standard on Licensing (see IAIS 1998), some of these terms, such as branch, cross-border provision of services, and domestic/foreign, do not always apply in the sense given here to jurisdictions within countries that have a federal structure. In such cases, cross-border refers to crossing the borders surrounding the jurisdictions of the federal structure, but not inside it. Authorized insurer: An insurer that is authorized to operate in a jurisdiction. Authorization is typically achieved through licensing or supervisory registration. Available solvency: Surplus of assets over liabilities, both evaluated in accordance with domestic regulation (either in accordance with rules of public accounting or with special supervisory rules) and taking into account domestic requirements regarding eligible capital elements, that is, the amount of capital appropriate to cover the required solvency margin in accordance with domestic law or supervisory regulations (see IAIS Glossary of Terms for a mathematical formula for calculating available solvency). Branch: Part of a company, not a separate legal entity, established in a jurisdiction other than the company s home jurisdiction. Other forms of permanent presence (for example, an agency) may exist in some jurisdictions. Captive insurer: An insurance company established by a parent firm for the purpose of insuring the exposures of the parent or its affiliates. Composite (insurance company): An insurance company that concurrently operates both life and non-life insurance business. Cross-border provision of services: Provision of insurance on a services basis (without local establishment) in a jurisdiction other than the company s home jurisdiction. Domestic/foreign: Inside/outside the jurisdiction. In connection with an insurer, domestic or foreign refers to the place where the company concerned is incorporated, irrespective of the place of incorporation of its parent company. Fraternal insurance: Life or disability insurance that certain fraternal organizations underwrite on a cooperative basis and make available to their members.

17 ICP 6: Licensing Home jurisdiction: Jurisdiction in which an insurer has its head office or, in the context of a group, in which an insurer s parent is incorporated. Due to the hierarchical corporate structures of many groups, both immediate and higher-level home jurisdictions may exist. Host jurisdiction: Jurisdiction in which a foreign insurer operates by way of a local branch. In the case of the cross-border provision of services, the jurisdiction in which the service is provided or, in the context of a group, in which an insurer that is a subsidiary or joint venture of a foreign parent is incorporated. Home/host supervisor: Supervisor of the home/host jurisdiction. Insurer/insurance company: A legal entity that underwrites insurance. Jurisdiction: A territory with local insurance laws that relate to the incorporation or operation of insurance companies. This territory, as a rule, is the national territory and, at the same time, the territory of the insurance supervisor s competence. In certain cases, this may be the territory inside a nation with a federal structure, for example, the states making up the United States. License: The authority to operate business in the domestic market, which under domestic law (a) is defined as insurance business, (b) is based on contracts between the company offering the business and the policyholders, and (c) is subject to supervision by the competent authorities. License refers only to the formal authority to operate business in the meaning of the domestic supervision law; it does not refer to approvals in the meaning of the general trade or company law. Licensing: The granting of approval to a company to underwrite insurance in the jurisdiction. The IAIS Glossary of Terms defines licensing as including the incorporation of a company in the jurisdiction. However, the glossary notes that incorporation is a separate approval from the approval to underwrite insurance and that these approvals may be made in separate jurisdictions. In this module, as in the Supervisory Standard on Licensing, such approval is referred to as registration. Note that the insurance laws of some jurisdictions use the term registration in the sense that licensing is defined here. Mutual insurance company: A nonprofit insurance company, without capital stock, that is owned by the policyholders. It may be incorporated or unincorporated. Qualifying participation: A participation held directly, or indirectly through one or several subsidiaries, by a natural or legal person, of at least X percent in the company or in the case of a lower percentage a participation enabling the shareholder to substantially influence the company s management. X is defined in accordance with domestic law (10 percent or 20 percent are common threshold values). Registration: The granting of approval to a company under the general trade or company law of a jurisdiction, sometimes formalized through entry of the company in a register of commerce.

18 Insurance Supervision Core Curriculum Stock insurance company: An insurance company owned by stockholders (shareholders), usually for the purpose of making a profit. Supervisory registration: The listing of an insurer in a register maintained by the insurance supervisory authority of a jurisdiction. In some circumstances for example, for the cross-border provision of services in certain jurisdictions an insurer may not be subject to a formal licensing procedure but may, nevertheless, be required to register with the supervisory authority before carrying on business in the jurisdiction. Exercises Answer the following questions considering, where indicated, the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 1. How might a supervisory authority determine whether unlicensed insurers are operating in the jurisdiction? 2. What steps might be taken if an insurer is discovered operating without the necessary license? Have such situations arisen in your jurisdiction? If so, what actions were taken? 6

19 ICP 6: Licensing B. Scope of licensing Although the statement an insurer must be licensed before it can operate within a jurisdiction seems fairly simple and straightforward, fundamental and sometimes complex issues must be decided when establishing the scope of licensing. Decisions must be made regarding what is insurance and what is not, what types of legal entities should be permitted to act as insurers, how much freedom should each insurer have to underwrite different classes of insurance, and what it means to operate within a jurisdiction. In making such determinations, the potential for exceptions arises, and policymakers should consider carefully the implications of each possible exception. Insurance Since an insurer has been defined as a legal entity that underwrites insurance, this seems to call for a definition of insurance. Unfortunately, it has proven impossible to define insurance in a manner that is clear, unambiguous, and universally accepted. The IAIS Glossary of Terms does not define insurance, the International Accounting Standards Board (IASB) has struggled to define insurance contracts (as distinct from other financial instruments), and the definition of license indicates that the insurance business is whatever the domestic law says it is. Why is this so difficult? In part, it is because the boundaries between insurance and other financial services, such as banking and securities, are unclear. For example, a short-term fixed-rate annuity contract shares many characteristics with the guaranteed investment certificates offered by banks, while a variable annuity contract may look and perform much like a pooled investment fund. Another factor is the similarity of some commercial services to insurance contracts. For example, a manufacturer s warranty provides protection against the malfunctioning of its product, and an automobile association may provide both reimbursement of expenses and services in kind in the event of motor vehicle problems. Whether or not it explicitly defines insurance, the insurance law of a jurisdiction must make it clear which activities and entities are subject to regulation under the insurance law and which are not. This may be done by defining various classes of insurance business in the insurance law and stating that only authorized insurers may underwrite such business. Supervisors could then take action against unauthorized persons carrying on insurance business (see ICP 15 on enforcement or sanctions). Many classification schemes have evolved over time in response to differences in the nature of the insurance market in various jurisdictions. Some types of business commonly exempted from insurance regulation are manufacturers warranties and obligatory social insurance schemes. However, other types of business may be regulated as insurance in one jurisdiction but not in another, such as motor vehicle assistance ser-

20 Insurance Supervision Core Curriculum vices. Such differences can pose difficulties, particularly where an insurer operates in more than one jurisdiction. Modes of operation There are various ways in which an insurer might operate in a jurisdiction, and the acceptability of each needs to be considered when developing licensing requirements. The most easily understood situation is that of a locally owned domestic insurer that is, one with its head office in the jurisdiction. The licensing requirements of the home jurisdiction thus govern the basis on which the insurer will be authorized to operate there. The insurance law of the home jurisdiction may also set out the conditions under which a domestic insurer can operate in foreign jurisdictions, subject, of course, to the licensing requirements of those jurisdictions. A foreign insurer or group may wish to operate outside of its home jurisdiction by forming a subsidiary insurance company in another jurisdiction. In some jurisdictions, this is the only manner in which a foreign insurer is permitted to operate. The subsidiary is a legal entity in its own right. It is subject to local company law and has its own board of directors and capital. For licensing and supervisory purposes, therefore, a subsidiary is often treated much like a locally owned domestic insurer. However, since the operation and financial situation of the subsidiary may be affected by its membership in the group (see ICP 17 on group-wide supervision), the relevant authorities in the home jurisdiction of the group should be consulted before the subsidiary is licensed. Most jurisdictions allow foreign insurers to establish branches. A branch is an operating unit of the foreign insurer, not a separate legal entity. Branches may have staff and, in some cases, perform many of the activities typical of an insurer s head office. They are generally required to submit financial reports on local operations to the host supervisor. However, the policies they issue are legally those of the foreign insurer, whose capital, board of directors, and senior management are typically elsewhere. An insurer may prefer to establish a branch rather than a subsidiary for a variety of reasons. A branch may involve lower initial and ongoing costs, which is particularly important if the insurer does not expect to write a large volume of business in the jurisdiction. It can also provide greater flexibility in the use of capital and staff resources and facilitate easier exit from the market if business expectations are not met. When licensing a branch, it is even more important than in the case of a subsidiary to consider the overall situation of the insurer and consult with its home supervisor. The solvency and governance of the insurer as a legal entity are being supervised by another authority, and the insurer could fail in spite of the best efforts of the branch management and the host supervisor. Some jurisdictions seek to protect local policyholders in such a situation by requiring branches to deposit funds with the supervisor and keep assets within the jurisdiction to cover liabilities to local policyholders perhaps even with an additional solvency margin. Sometimes, the assets are required to be held in

21 ICP 6: Licensing trust within the jurisdiction. Such requirements help to protect local policyholders from problems of the insurer that may have their source elsewhere, but the protection can never be complete. The insurer may become insolvent due to problems in the host jurisdiction or elsewhere, unexpectedly large claims could deplete the local assets, or assets could be removed from the jurisdiction in spite of requirements to the contrary. The growing use of electronic registration, trading, and transfer of assets makes it increasingly difficult to control their movement. This incomplete protection is one reason that some jurisdictions do not permit foreign branches. However, it cannot be stated categorically that a subsidiary provides more protection to policyholders in the host jurisdiction than does a branch. Legally, the liabilities of a branch are supported by the full capital of an insurer, while the obligation of a parent company to its subsidiary is limited to its invested capital. If a subsidiary gets into significant difficulties, its owners may simply choose to abandon it, while the failure of an insurer to meet the obligations incurred by a branch will create problems for the company as a whole. Some jurisdictions allow foreign insurers to operate without having any local establishment at all. This is referred to as operating on a services basis. The cross-border provision of services, where allowed, is usually subject to either licensing or supervisory registration. This enables the supervisory authority at least to know which insurers are operating in its jurisdiction. Especially when only supervisory registration is required, it is important for the home and host supervisors to communicate with each other about the insurer. Both need to understand their respective supervisory responsibilities and ensure that there are no gaps in supervision. Sometimes, such as in the European Union, a formal agreement exists to govern the cross-border provision of services (see Ishii 1999). Such agreements facilitate the access of insurers to a wider geographic territory, while providing consumers in the various jurisdictions with more choice in their purchase of insurance products and services. The jurisdictions participating in the agreement know in advance how the supervisory responsibilities are allocated. Typically, prudential oversight is left to the home supervisor, with the host supervisor overseeing the conduct of the insurer in the local jurisdiction. Cross-border provision of services may also be allowed under other circumstances, for example, where a consumer in a jurisdiction needs an insurance product that is not available from any insurer licensed in the jurisdiction. Jurisdictions that allow this sometimes impose controls on the activity, such as requiring that the business be placed through a specially authorized intermediary and that the policyholder sign a document acknowledging awareness that the insurer is not subject to local supervision. Reinsurance is commonly provided on a services basis, and most of the jurisdictions that allow this do not require that the reinsurer be licensed in the jurisdiction. The rationale for this limited regulation of reinsurers is that their customers are insurers, who are presumed to be capable of looking out for their own interests (the supervisory authority should also assess insurers reinsurance programs in accordance with the Su-

22 Insurance Supervision Core Curriculum pervisory Standard on the Evaluation of Reinsurance Cover; see IAIS 2002). Nevertheless, some jurisdictions that allow cross-border reinsurance impose limitations, such as prohibiting an insurer from taking credit in calculating available solvency for amounts owed by an unlicensed reinsurer. Insurers can operate across borders using the Internet. Unfortunately, this technology is also available to fraudulent and unlicensed insurers. Therefore, in order to protect consumers, insurers operating over the Internet should meet the same licensing requirements applicable to insurers operating through more traditional means. However, detecting the existence of unlicensed insurers who are offering insurance over the Internet can be a significant challenge for supervisors (see IAIS 2000c). Captive insurers are permitted in many jurisdictions. A captive insurer is a company established by a parent firm for the purpose of insuring the exposures of the parent or its affiliates. Since captive insurers do not deal with the general public, they may be subjected to less stringent licensing requirements. For tax and other business reasons, captive insurers are sometimes established in jurisdictions other than the one in which the exposures it insures are located. Relatively few jurisdictions, for example, those offshore, are prepared to license an insurer that will not underwrite local risks. Insurance pools operate in some jurisdictions; examples include a marine insurance pool in Singapore and a pool providing liability insurance to universities in Canada. Pools are formed and owned by the companies whose insured losses are shared through the pool. They may be subject to less stringent capital and other requirements than apply to regular insurers, in recognition of the lower risk that they present to the general public. Exemptions from licensing ICP 6, essential criterion c, states, The supervisory authority requires that no domestic or foreign insurance establishment escape supervision. While this statement is quite clear, the Supervisory Standard on Licensing (see IAIS 1998) does allow for exceptions. Beyond the exceptions for cross-border business noted above, certain domestic entities may be exempt from licensing in some jurisdictions, even if their activities might be considered underwriting insurance. Exemptions are sometimes granted because the nature of the insurer itself is believed to adequately protect policyholders or because the number of policyholders or the amount of insurance involved are so small that the costs of supervision outweigh the benefits. Any exemptions from licensing should be clearly identified in the legislation, along with any requirements to which such entities may be subject. Legislation should clearly describe the powers and obligations, if any, that the supervisory authority has with respect to the exempt entities. For example, entities that are exempt from licensing may nevertheless be required to register with the supervisory authority and to submit and publish financial statements periodically. 10

23 ICP 6: Licensing Fraternal organizations sometimes provide life or disability insurance to their members, consistent with their principles of social solidarity. In some jurisdictions, fraternal insurance is exempted from regulation. This exemption may be justified on the premise that the members are committed to looking out for each other s interests and will govern their affairs prudently. It may also be justified because many fraternal organizations are quite small and offer only low amounts of coverage. Furthermore, they would be difficult to supervise in a cost-effective manner, they place relatively few consumers at risk, and their failure would have little overall impact on the market. However, small fraternal insurers may lack professional insurance expertise within their board and management, making them prone to difficulties. Larger fraternal insurers may operate much like commercial insurers, with little social solidarity among their policyholders. In either case, such an exemption may place consumers at higher risk, an issue that policymakers should consider. In some jurisdictions, certain types of insurance may be provided by a government-owned entity, either exclusively or in competition or collaboration with other insurers. Examples include compulsory third-party motor vehicle liability insurance, crop damage insurance, and terrorism coverage. Government-owned entities are often formed under special legislation, which exempts them from the insurance law and provides for their oversight through an alternative mechanism. Where government-owned insurers are exempt from licensing, the insurance supervisory authority seldom has direct responsibility for overseeing their affairs. Nevertheless, as market participants, these insurers can have an impact on those insurers that are supervised, for example, by influencing the prevailing level of premium rates. Therefore, supervisors cannot ignore them completely. The alternative approach of licensing and supervising government-owned insurers comes with its own set of challenges. For example, consider the pressure that a supervisor might face in attempting to restrict or withdraw the license of a government-owned insurer that is engaging in inappropriate market conduct. A technical failure of a government-owned insurer could occur when it fails the required capital test, which may itself be less stringent than the test that other insurers must satisfy. This situation has arisen, and, in some cases, the supervisory authority has been unable to enforce the law when the government, as owner, has refused to inject additional capital. In order to minimize the potential for political interference, it is important for the supervisory authority to have the autonomous power to intervene (see ICP 3 on supervisory authority and ICP 15 on enforcement or sanctions). Even in situations where some insurers are exempt from licensing and supervision, the supervisory authority might take steps to protect their current and prospective policyholders. For example, the supervisory authority could publish a list of licensed insurers as well as information to assist consumers in selecting their insurer, which could describe the potential disadvantages of dealing with an unlicensed insurer. The supervisory authority might also contribute to the prudent management of exempt insurers 11

24 Insurance Supervision Core Curriculum by including them in the distribution of relevant supervisory guidance, for example, regarding risk management practices. Permissible legal forms Consumers pay money to insurers in exchange for the promise of future benefits under the terms of an insurance contract. Some of these contracts may span decades. It is essential that an insurer be constituted under the law in a form that will enable it to fulfill these obligations. As noted in ICP 6, essential criterion a, legislation should specify the legal forms permitted in a jurisdiction. Most insurers are stock companies; that is, they are owned by stockholders (shareholders), usually for the purpose of making a profit. Most, if not all, jurisdictions permit stock companies that are public limited companies, and many permit private limited companies. While the liability of stockholders is limited to the amount they have invested in shares of the company, the company has flexibility in raising additional capital if needed, for example, through the sale of additional shares. This makes the legal form well suited to meeting long-term obligations. Many jurisdictions permit mutual insurance companies, which do not have stockholders but are instead owned by some or all of their policyholders. Mutual insurers operate on a nonprofit basis, sharing the results of favorable experience with participating policyholders through dividends or bonuses. Although some mutual insurance companies are quite large and successful, few new insurance companies take this legal form, because they have difficulty raising capital. Other legal forms are permitted in some jurisdictions but are much less common than stock or mutual companies. They include fraternal insurers, which may be organized as cooperative associations, insurance or reinsurance pools, and governmentowned entities constituted under special laws. Most jurisdictions require a foreign insurer applying for a license to have a legal form that is either the same as, or comparable to, one of the forms permitted for domestic insurers. The module addressing ICP 9 on corporate governance provides more information about the different legal forms and governance structures used by insurers. Specialization Some jurisdictions permit an insurer to underwrite both life insurance business and non-life insurance business. Such insurers are referred to as composites. ICP 6, essential criterion g, indicates that composites should not be licensed unless each of these types of risk is handled separately on both a going concern and a winding-up basis. The reason for requiring such separation lies in the nature of life insurance and non-life insurance. The risks insured under a life insurance or annuity contract can 12

25 ICP 6: Licensing often be reliably estimated, and the amount to be paid on occurrence of an insured event for example, death is often certain. This contrasts with non-life insurance, where both the frequency and the amount of claims are typically less predictable. Life insurance products are often purchased to provide for persons long-term financial support, which could be placed at greater risk if the insurer is also underwriting the more volatile non-life business. In recognition of the fact that accident and sickness insurance has some of the characteristics of both life insurance and non-life insurance, some jurisdictions permit both life insurers and non-life insurers to underwrite this class of business. Although many jurisdictions (about three-quarters, according to the Insurance Laws Database) at one time permitted composites, only about half currently grant new licenses to composites. Some jurisdictions have changed their laws on this matter to require existing composites to separate into two legal entities, while others have allowed them to continue as composites. Steps can be taken to help deal with the risk to policyholders created by composites. At a minimum, the two types of business should be separately accounted for and reported in the financial statements, and the assets required to support life insurance liabilities should not be used to pay non-life insurance claims or expenses. Some jurisdictions require that the assets be separated through the use of trust funds. The insurance law would need to be drafted carefully to provide for an appropriate allocation of assets in the event of insolvency. The minimum capital required of a composite, both initially and in terms of available solvency, may be the sum of the amounts required of a life insurer and a non-life insurer. Insurers may even be required to maintain separate head office staff to operate each type of business, although such a requirement tends to defeat the cost-saving rationale for operating a composite. Some jurisdictions extend the specialization requirement further and license each insurer to operate specific classes of life insurance or non-life insurance. For example, a non-life insurer may be licensed to underwrite the classes of motor vehicle insurance, property insurance, and general liability insurance, but not other classes, such as marine, aviation, and transport insurance. A licensed insurer that wants to extend its operations into different classes of insurance would have to apply to have its license modified. Licensing by class of insurance helps to ensure that insurers have the capability and financial resources to handle each class of business they underwrite, without placing the policyholders within either the new class or existing classes at undue risk. However, it places more regulatory burden on both the insurers and the licensing authority than is the case when insurers are licensed to operate all classes of either life insurance or non-life insurance. Insurers are typically severely restricted, if not prohibited, from carrying on noninsurance business activities. Again, the reason for such restriction or prohibition is the specialization concept, since difficulties arising in the non-insurance activities could put policyholders at risk. Mixing insurance and other business activities within the same company makes supervision more difficult, for example, in determining the total 13

26 Insurance Supervision Core Curriculum capital that should be required. However, some jurisdictions permit insurers to carry on non-insurance activities that are ancillary to the insurance business. Limitations applicable to all insurers are commonly set out in the insurance law or regulations, but further limitations may be imposed as a condition of licensing. If policyholders do not have priority over other creditors in the event of an insurer s insolvency, then the existence of non-insurance activities could further increase the potential losses of policyholders in such a situation. Exercises Answer the following questions considering, where indicated, the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 3. Does the insurance law (or another law) in your jurisdiction define insurance? If so, how is it defined? 4. Provide several examples of insurance activities, or business activities in the nature of insurance, that are sometimes exempted from licensing or supervisory registration. Do any of these exist in your jurisdiction? If so, is licensing or supervisory registration required? 5. Explain why some jurisdictions do not permit foreign insurers to operate through branches and describe the types of licensing requirements sometimes imposed on branches by those jurisdictions that do permit them. How does your jurisdiction deal with this issue? 6. Describe three types of specialization requirements that may be used to limit the scope of insurers operations. What is the rationale for requiring specialization? 14

27 ICP 6: Licensing C. Licensing criteria Section B discussed the types of insurance activity that should be licensed and the types of entities that might appropriately carry on these activities. This section deals with the criteria used when deciding whether or not a particular entity should be granted a license. ICP 6 requires that the requirements for licensing are clear, objective, and public. Licensing requirements that possess these characteristics are better for consumers, insurers, the insurance supervisor, and the authority or authorities responsible for licensing. These characteristics make it easier for insurers to understand what is required to enter the market and more difficult for undesirable insurers to obtain a license. Clear and objective requirements facilitate a smooth licensing process (see section D) and should reduce the potential for inappropriate political or industry influence over licensing decisions. Similar, if not identical, criteria should be applied when assessing changes in the control of an insurer (see ICP 8 on changes in control and portfolio transfers). Licensing criteria may differ somewhat depending on the nature of an insurer s business or the classes of insurance it intends to underwrite. For example, the criteria for licensing an insurer that will be operating in the local retail insurance market may differ from those for licensing an offshore captive insurer that will be insuring only risks arising from the activities of its non-insurance parent company. Government policy can have an impact in determining which applicants for a license might be considered. In some emerging and developing markets, government policy may restrict access of new insurers to the market in order to allow existing companies time to prepare for a more competitive environment and provide stability to the market. In such cases, it is appropriate for the licensing criteria to change as the market matures in order to facilitate competition and the benefits it can bring to insurance consumers and the economy as a whole. ICP 6, essential criterion b, states that licensing criteria should require the following: The applicant s board members, senior management, auditor, and actuary, both individually and collectively, to be suitable, as specified in ICP 7 on suitability of persons The applicant s significant owners (refer to ICP 8, essential criterion a) to be suitable, as specified in ICP 7 The applicant to hold the required capital The applicant s risk management systems, including reinsurance arrangements, internal control systems, information technology systems, policies, and procedures, to be adequate for the nature and scale of the business in question Information on the applicant s business plan to be projected out for a minimum of three years. The business plan must reflect the business lines and risk profile and give details of projected setting-up costs, capital requirements, development of business, solvency margins, and reinsurance arrangements. The business plan 15

28 Insurance Supervision Core Curriculum must present information regarding primary insurance and inward reinsurance separately Information on the products to be offered by the insurer Information on contracts with affiliates and outsourcing arrangements Information on the applicant s reporting arrangements, both internally to its own management and externally to the supervisory authority Input from the applicant s home supervisory authority when the insurer or its owners are not domestic and a home supervisory authority exists (refer to ICP 5 on supervisory cooperation and information sharing). Each of these criteria will be considered in turn, with an explanation of why it is important and a brief description of how an applicant might be assessed against it. Specific information that may be required of a foreign insurer is discussed at the end of this section. Suitability of key functionaries The persons involved in performing key functions for an insurer, such as its directors, senior managers, auditors, and actuaries, must be suitable to fulfill their roles (see ICP 7 on suitability of persons). In the case of a branch, insurance law may require that an individual be appointed by an insurer as its principal legal representative (or chief agent) in the jurisdiction. This person should also be suitable. Suitability means that these persons have not only the appropriate competency, experience, and qualifications needed to perform the duties of their position but also the integrity to do so in a manner that will not jeopardize the interests of policyholders. As mentioned in the introduction, problems with key functionaries are a common reason why insurers get into difficulty. Thus an insurer should not be licensed if there are significant concerns about the suitability of one or more of its key functionaries and the applicant does not put forward a satisfactory replacement. Qualifications can be assessed by considering a person s education, membership in professional organizations, and career history. The qualifications should be relevant to the particular position. For example, an individual may be qualified to be an insurer s auditor but not qualified to be its chief executive officer, or vice versa. If a person has held a position of significant responsibility, such as a member of the board of directors or senior management, in an insurer or other type of company that has failed, this should raise serious concerns about the person s qualifications (and, perhaps, character). It is more difficult to assess a person s character objectively. Insurance laws typically include character-related criteria that would disqualify a person from serving as a key functionary, such as having been convicted of a criminal offense or having been bankrupt. It is common for licensing authorities to check police records for evidence of 16

29 ICP 6: Licensing past illegal behavior. However, some persons may have a bad reputation. It may be difficult to disqualify a person simply based on reputation, so the underlying facts should be ascertained before a decision is made. Every effort should be made to keep criminals out of the industry. Legal protection for the persons making these decisions is essential, so that appropriate decisions can be made in the interest of protecting policyholders. Independence from political influence is also important in such situations. It is common to require specific information on each key functionary to be provided in a standard format as part of a licensing application. Further information should be sought by the authority, where needed to complete the assessment of suitability. The failure of an applicant to cooperate willingly with such requests should itself serve as a warning signal. The module on ICP 7 on suitability of persons and the Guidance Paper on Fit and Proper Principles and Their Application (see IAIS 2000a) should be consulted for more information on this subject. Suitability of owners Those with significant holdings are often in a position to influence the operation of the insurer. They should, therefore, be suitable to exercise this influence in an appropriate manner. The stock in an insurance company may be widely held, although it is not uncommon for there to be a single owner or one or more stockholders with a significant ownership position. Owners may vary considerably in nature. For example, they may be widely held companies, intermediate holding companies, or natural persons. When assessing a license application, it is important to consider the suitability of not only the immediate owners of the applicant but also those who may exercise ultimate control over the applicant. The company law or insurance law of a jurisdiction typically defines the level of ownership, for example, 10 percent or 20 percent of any class of shares, at which supervisory approval of the right to hold the shares is required. This level of control is called a qualifying participation. If the holder of a qualifying participation is a natural person, his or her suitability should be assessed using criteria similar to those applied to key functionaries. If the holder is a legal entity, then the personal suitability criteria should be applied to its key functionaries. However, there is more to assessing the suitability of an owner than merely evaluating the qualifications and integrity of the individuals. The funds used to purchase the shares must have a legitimate source. If the person has been involved in illegal transactions, the funds may be proceeds of crime, and there is a possibility that the owner may seek to involve the insurer in such transactions, for example, money laundering (see ICP 27 on fraud and ICP 28 on anti-money laundering and combating the financing of terrorism). Obviously, such persons should be refused permission to hold a qualifying participation. 17

30 Insurance Supervision Core Curriculum Beyond this, an evaluation should be made about whether the owner is likely to be a source of strength or a source of weakness for the insurer. ICP 6, essential criterion j, indicates that a license application should be refused where it considers the applicant not to have sufficient resources to maintain the insurer s solvency on an ongoing basis. An owner with significant financial resources could be a future source of capital, should the insurer expand rapidly or encounter difficulty. However, an owner who has purchased shares using borrowed funds may pressure the insurer to pay dividends, even during periods when earnings are low or losses occur, in order to meet debt-servicing requirements. The owner s financial statements personal or corporate, as the case may be should be reviewed as part of this evaluation. It is important that the owner, or the manner in which the owner s holdings have been structured, not be a hindrance to supervision. Essential criterion j indicates that a license should not be issued where the organizational (or group) structure hinders effective supervision. This could occur, for example, if the owner is another company within a group structure that includes cross-shareholdings or other commercial linkages. In some jurisdictions, mixed conglomerates, including both financial and nonfinancial companies, are permitted. If an insurer is part of a mixed conglomerate, it may be particularly difficult to assess the possible impact of the nonfinancial activities on the insurer. Required capital Capital serves as an essential margin of safety, helping an insurer to cope with adverse situations while continuing to meet its obligations. Insurance law typically specifies the permissible forms and minimum amount of capital required of an insurer. It may also require insurers and branches to deposit specified amounts of assets with the supervisory authority or in trust. These minimum requirements help to ensure that only insurers of a viable size and with adequate resources are allowed to operate. In many jurisdictions, additional capital is required based on the size and nature of an insurer s operations (see ICP 23 on capital adequacy and solvency). An insurer s available solvency must cover at least the required solvency margin determined in accordance with the insurance law or regulations. Some jurisdictions also establish solvency control levels, expecting insurers to maintain further margins. It is important that an insurer be able to meet all relevant capital requirements both at the time of licensing and on an ongoing basis. The determination of capital adequacy at the time of licensing should be based on the factual situation, not on promises that additional funds will be raised once a license is granted. Therefore, proof should be required that the minimum capital has been paid up. In order to assess the likelihood that available solvency will be equal to or exceed the solvency margin on an ongoing basis, a careful review of the insurer s business plan is required. In its initial years of operation, an insurer may be particularly subject to the 18

31 ICP 6: Licensing risk of insolvency. For example, setting-up expenses may be higher than anticipated, acquisition expenses may be high in relation to the flow of profits from a small portfolio of business, and the small size of the portfolio may make fluctuations in experience more likely. Accordingly, some jurisdictions require new insurers to have a separate settingup fund or additional solvency margins. Risk management systems Insurers face many kinds of risks and use a variety of tools to manage these risks. When evaluating a licensing application, a determination must be made about whether the specific risk management systems that an insurer has put in place (or, in the case of a newly formed insurer, intends to put in place) are adequate for the nature and scale of its business. For example, a new domestic insurer proposing to underwrite only simple products in two classes of business needs to have much less sophisticated risk management systems than does a large multinational insurer. In terms of overall business risks, an insurer s corporate governance practices, operational policies and procedures, and internal controls are essential elements of its risk management framework (see ICP 9 on corporate governance and ICP 10 on internal control; see also Basel Committee on Banking Supervision 1998). Risks related more explicitly to insurance operations call for risk management tools such as pricing policies, investment policies, asset liability management, claims management processes, a reinsurance program, and stress testing (see ICPs 18 28). These elements may be assessed, for example, by requiring the insurer to submit a questionnaire regarding its practices, reviewing relevant documents (for example, organizational charts, risk management policies, procedure manuals, audit reports, reinsurance contracts), requesting information from other supervisors, or conducting an onsite inspection. If the applicant is a newly formed insurer, reliance will necessarily be placed on the policies and procedures it intends to follow and the capabilities of key functionaries, since it is impossible to evaluate actual practices. Business plan An applicant should provide information on its business plan for at least the next three years. Information should be both qualitative and quantitative and in sufficient detail so that the viability of the business plan can be evaluated. Any business must take risks to succeed, and it is unrealistic to expect any applicant to devise a commercially practical business plan that eliminates all risk of failure. Nevertheless, a business plan that is incoherent, incomplete, or excessively optimistic in the context of local market conditions indicates that the insurer may not be capable of succeeding in its business and meeting long-term obligations to policyholders. The business plan must demonstrate knowledge 19

32 Insurance Supervision Core Curriculum of the insurance business and the local market. Even if the plan was prepared largely by an independent consultant, management must adopt it as their own, be capable of explaining it, and be prepared to implement it once the license is granted. Qualitative information should describe the business lines the insurer intends to underwrite, the distribution systems it will employ, and the market segments it will target. The nature, size, and location of the proposed head office or branch operation should be described. The reinsurance program should be outlined, and it should be appropriate to the nature and size of the business that is proposed to be underwritten. If the applicant will be underwriting reinsurance, the business plan should separate information on that activity from information on the primary (direct) business. Of course, whether senior management has the competency, skills, and experience necessary to manage the risks involved in underwriting reinsurance should be considered when evaluating their suitability. Quantitative information should include details of the projected costs of setting up the business. The applicant should provide projected financial statements, starting with a projection of the development of premium revenues from year to year, by business segment. An income statement and a balance sheet should be presented for each year of the projection period, along with the assumptions underlying each of the elements, such as investment income, operating expenses, commissions, and taxes. The assumptions should be compared against the actual experience of existing companies in the market, and any major variances should be questioned. For example, an applicant that is projecting an expense ratio of 20 percent and a claims ratio of 70 percent for motor vehicle insurance business in a market where the combined ratio of existing insurers range from 98 to 115 percent must be prepared to explain how it proposes to achieve such favorable results. The applicant might be required to revise the projections using alternative assumptions. Along with the balance sheet projections, the applicant should project both the required solvency margin (and control levels) and the available solvency each year. If the projection shows a potential shortfall in available solvency, the applicant should explain how it would deal with such a situation. For example, the insurer might be able to raise additional capital from its parent, reinsure some of its portfolio, or reduce its new business production. Even if the results of the initial projections appear satisfactory, it may be useful to require the applicant to prepare alternative projections using adverse assumptions, in order to assess the level of risk inherent in the business plan. Alternatively, if the insurer has prepared stress tests for its own use, these could be reviewed (see IAIS 2003a). Products As noted in the Supervisory Standard on Licensing (see IAIS 1998), Insurance companies should not be regulated more than strictly necessary regarding the design of 20

33 ICP 6: Licensing their products. To do otherwise could impede product innovations that would benefit consumers and contribute to the success of the insurers. Nevertheless, it is important that insurers underwrite products that are prudently designed and priced and have the capability to administer the business that they have underwritten. It is also essential that products meet the requirements of the jurisdiction regarding general policy conditions. To facilitate an assessment of the prudential aspects of the products, applicants could be required to provide information on the technical bases used to calculate premium rates and technical provisions (liabilities). The capabilities of an applicant to underwrite and administer its products properly should, at least in part, be dealt with by its business plan. The acceptability of policy conditions could be assessed by reviewing the policy forms; some jurisdictions conduct such reviews after a license has been issued. Contracts with affiliates and outsourcing arrangements An insurer s contracts with its affiliates or its outsourcing arrangements can have a significant impact on the operations and financial situation of the insurer. They can also affect the ability of the authority to supervise the insurer. Therefore, it is important to review such arrangements during the licensing process. An affiliation contract may subject an insurer to control by a holding company or another company in its group. It may also commit the insurer to transfer a share of its profits to such a company. Such contracts should be reviewed to ensure that they do not interfere with the supervisor s ability to conduct ongoing supervision or to intervene if difficulties arise. Neither should they commit the insurer to making transfer payments that might impair its solvency. It has become increasingly prevalent for businesses to transfer various functions to other companies under outsourcing arrangements. Successful outsourcing arrangements can enable a business to reduce its expenses and improve quality by engaging a specialized company to perform certain functions. However, inappropriate outsourcing arrangements can cause a company to lose control over the quality of the outsourced function. Such loss of control is of particular concern where a key business function has been outsourced. For example, while outsourcing the processing of an insurer s payroll may pose a negligible risk to policyholders, the same cannot be said about outsourcing the processing of claims. Insurers should have adequate controls in place regarding their outsourced activities, such as the ability to conduct audits of the service provider. The operations of an insurer must be conducted prudently, and consumer protection requirements must be met, even if services have been outsourced. If the outsourcing is done to an affiliate of the insurer, the terms of the arrangement may have been dictated by others and be financially disadvantageous to the insurer; this 21

34 Insurance Supervision Core Curriculum possibility should be considered. An outsourcing agreement should be in place, just as in the case of an independent service provider, and the arrangements should be on commercially reasonable terms. In some jurisdictions, insurers are required to secure the approval of the supervisory authority before entering into material outsourcing arrangements, and criteria have been published for the evaluation of outsourcing arrangements (see OSFI 2003). The criteria may deal with issues such as the adoption of an outsourcing policy by the insurer s board of directors, the terms of the outsourcing contract, the location of the service provider, the provisions made by the insurer for monitoring the quality of service, and the existence of a business continuity plan to cope with failure of the service provider. Such issues are equally relevant when evaluating outsourcing arrangements as part of the licensing process. Supervisors must have the ability to supervise all significant activities of an insurer, including those that are outsourced. This could be done directly, where either the law or the terms of the outsourcing contract permit the supervisor to obtain information from and inspect the service provider. It could also be done indirectly, where the terms of the contract enable the insurer to obtain information from and issue instructions to the service provider. Management and supervisory reporting arrangements An insurer must have the ability to prepare comprehensive, accurate, and timely financial and nonfinancial information. Internal stakeholders, such as senior management, the board of directors, and management of the parent company require such information in order to direct the company effectively. External stakeholders, such as stockholders, policyholders, creditors, and supervisory authorities, also require information. Finally, appropriate information is essential to the work of the supervisor (see ICP 12 on reporting to supervisors and offsite monitoring). During the licensing process, the adequacy of reporting arrangements should be assessed. This could be done by reviewing the significant reports produced by the insurer for internal stakeholders, by considering the nature and frequency of any reports the insurer is already preparing for other supervisory authorities, and by obtaining information about the level of human and technological resources the insurer has devoted to the reporting process. When assessing a license application from a newly formed insurer, there is little to be considered with respect to reporting other than the qualifications and experience of senior management and their plans regarding reporting policies, systems, and procedures. It can be helpful for the supervisor to have detailed discussions with senior management about reporting expectations before a license is issued. After licensing, periodic supervisory follow-up would help to ensure that these expectations are understood and being acted upon. 22

35 ICP 6: Licensing Input from the home supervisor Where the applicant is a foreign insurer or a subsidiary of a regulated foreign company, the home supervisor may be able to provide useful information on many of the issues discussed above. For example, the home supervisor may provide information on its experience in dealing with the insurer or its group and on the suitability of the owners and some, if not all, of the key functionaries responsible for operations in the host jurisdiction. The home supervisor should be able to confirm the company s licensing status and solvency position. The home supervisor may be prepared to discuss the applicant s operational and risk management capabilities. It is much easier to make a positive licensing decision if an applicant is well regarded by its home supervisor, particularly where supervision in the home jurisdiction is itself well regarded, than if the opposite situation exists. An applicant regarded as uncooperative by its home supervisor is likely to be even less cooperative and more difficult to supervise in foreign jurisdictions. If the host supervisor is unfamiliar with how supervision is conducted in the home jurisdiction, the host jurisdiction should inquire about this, in order to consider the extent to which the home supervisor s oversight will protect policyholders in the host jurisdiction. As mentioned previously, both the home and host supervisors must understand their respective roles in supervising an insurer and cooperate with one another, as necessary, in fulfilling their responsibilities. Some jurisdictions have formal arrangements for the exchange of information during the licensing process and as part of ongoing supervision. The protocols in place in the European Union are an excellent example (see European Commission 2000). However, even without a formal agreement, supervisory authorities are expected to cooperate and share information subject to confidentiality requirements (see ICP 5 on supervisory cooperation and information sharing). The licensing process provides an excellent opportunity to develop contacts with another supervisory authority, where an ongoing relationship does not already exist. Unfortunately, in practice, the sharing of information with other supervisors is not always a high priority for very busy supervisors. This may pose a particular challenge in situations where the insurer s operations in the host jurisdiction are expected to be large in the context of that market, but small in relation to the total business of the insurer. In such situations, the host supervisor is vitally interested in obtaining information, but the home supervisor may see little to be gained by providing it. If the home supervisor is unresponsive or reluctant to share information about an applicant, it may be appropriate to give the applicant the responsibility for securing the home supervisor s cooperation. Where a foreign licensing application is being delayed pending information from the home supervisor, the applicant has an important incentive to encourage its home supervisor to cooperate. This discussion is also relevant in a purely domestic context. If the applicant is a member of a group that includes other regulated domestic financial institutions, their supervisors should be contacted for information. 23

36 Insurance Supervision Core Curriculum Information about a foreign insurer ICP 6, essential criterion f, mentions various types of information that should be obtained before a foreign insurer is allowed to carry on business in a jurisdiction. Much of this information has been discussed already. For example, the insurer should provide whatever information would normally be required of a domestic applicant, where relevant. Additionally, the home supervisor should confirm that the insurer is solvent and meets all regulatory requirements. The home supervisor should also confirm whether or not the insurer is authorized to carry on the same types of insurance business in its home jurisdiction as it proposes to underwrite in the host jurisdiction. If an insurer has experience with a type of business in its home jurisdiction, this indicates that the insurer probably has the necessary technical expertise to operate the same type of business elsewhere. However, the applicant may not have sufficient understanding of local market conditions to be successful; reviewing the proposed business plan will be useful in this regard. In some cases, the laws of a host jurisdiction may permit a subsidiary of a foreign company to carry on business activities that its parent would not be allowed to carry on directly in its home jurisdiction. If so, the host licensing authority should confirm the acceptability of this situation with the home supervisor before licensing the subsidiary to carry on such activities. The manner in which group-wide supervision will be accomplished, particularly where the home supervisor does not have expertise in the business activities to be carried out by the foreign subsidiary, should be clearly established. Where the applicant will be operating through a branch, the name and address of the branch should be provided. If insurance will be offered on a services basis, the name and address of the authorized agent in the local jurisdiction should be provided. Exercises Answer the following questions considering, where indicated, the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 7. Is the suitability of key functionaries and significant owners assessed as part of the licensing process in your jurisdiction? If so, which key functionaries are subject to assessment? How is significant owner defined in your jurisdiction? 8. Describe the types of information that can be used to assess the suitability of key functionaries and significant owners. Which of these typically are used in your jurisdiction? 9. A foreign insurer intends to establish a branch in your jurisdiction and has applied for a license. The application indicates that computer services and claims processing will be handled by the head office of the insurer under a service agreement, at a cost of 15 percent of premiums. What concerns might you have about this 24

37 ICP 6: Licensing arrangement? What information could you use to evaluate the issues of concern, and where might you obtain this information? 10. A newly formed non-life insurer has applied for a license, and you are responsible for analyzing its business plan and preparing a report for the head of the supervisory authority. Review the following information, identify any significant concerns that you will comment on in your report, and state your recommendations. The non-life insurance market in your jurisdiction has consisted largely of compulsory motor vehicle third-party liability insurance (gross written premiums of 50,000, compared to total non-life premiums of 60,000). Several leading insurance agents believe there is an opportunity to develop the property insurance market rapidly. These agents have pooled their resources to form an insurance company. Using the Internet, the owners have conducted research regarding the financial results of property insurers in other markets. They have used this information as the basis for the claims and expense assumptions underlying the financial projections included in the business plan. The owners have raised 2,500 initial capital, which is more than required to meet the 2,000 minimum amount specified under the Insurance Act. Insurers are required to maintain at least this much equity on an ongoing basis or, if higher, a solvency margin calculated as the sum of 20 percent of net written premiums, 15 percent of claims provisions, and 15 percent of assets (other than cash, bank accounts, and government bonds). The supervisory authority has established (for internal use) a solvency control level of 150 percent of the minimum solvency margin; if an insurer s available solvency falls below this level, supervisory action is taken. The following table presents the company s financial projections. Item Initial Year 1 Year 2 Year 3 Main assumptions Gross written premiums 1,000 3,000 6,000 Paid claims ratio Expense ratio Return on invested assets Income statement Gross written premiums 1,000 3,000 6,000 Net written premiums 900 2,700 5,400 Net earned premiums 320 1,730 4,000 Net claims incurred 260 1,250 2,490 Expenses ,620 Underwriting result Investment income

38 Insurance Supervision Core Curriculum Item Initial Year 1 Year 2 Year 3 Net income, before tax Net income, after tax Shareholder dividends 110 Balance sheet Assets Cash and bank accounts 2, Government bonds 910 1,030 1,180 Common shares 760 1,230 2,070 Non-invested assets 750 1,230 2,060 Total assets 2,500 3,020 4,110 5,900 Liabilities Unearned premiums 580 1,550 2,950 Claims provisions Other liabilities Total liabilities 630 1,810 3,500 Total equity 2,500 2,390 2,300 2,400 Requirements Minimum capital 2,000 2,000 2,000 2,000 Minimum solvency ,780 26

39 ICP 6: Licensing D. Licensing process Section C discussed the criteria that should be used when deciding whether or not to license an insurer. These criteria will be applied during the licensing process, which should be clearly defined for the immediate benefit of both the applicants and those involved in evaluating the application. An orderly, objective, and timely licensing process ultimately benefits consumers by facilitating the entry of appropriate insurers to the market and laying the groundwork for their supervision. The authorities involved in the licensing process should have clearly defined responsibilities. The steps involved in the process should be clearly described, transparent to both applicants and existing market participants, and completed in a timely manner. The licensing decision should be clearly communicated to the applicant, along with the terms and conditions of the license. Finally, once the license has been issued, it is important that the supervisory authority monitor the progress of an insurer and its compliance with licensing principles and requirements. Based on the results of the monitoring, the supervisory authority should take prompt corrective action, as necessary. Each of these issues is discussed below. Licensing responsibilities The criteria applied in evaluating a licensing applicant parallel the issues considered by a supervisory authority in the ongoing supervision of an insurer. The supervisory authority should, therefore, be well qualified to evaluate licensing applications. The fact that the supervisory authority needs to deal with insurers on an ongoing basis provides an incentive to avoid licensing those that are likely to experience difficulties. Accordingly, some jurisdictions give the supervisory authority responsibility for the licensing decision. Even in such cases, in light of the significance of licensing, legislation may require the board of directors of the supervisory authority to make the final decision. In some jurisdictions, other parties either participate in or are responsible for the licensing decision. For example, a license may be issued by a government ministry on the recommendation of the supervisory authority. In other jurisdictions, the ministry may have sole formal responsibility, without any role for the supervisory authority being specified in the legislation. Sometimes, the ministry may make the final decision after considering both the recommendation of the supervisor and the comments of an advisory committee. Reasons vary for having parties other than the supervisory authority involved in the licensing decision. If a government policy objective is to expand the insurance market, the government may believe that the supervisory authority will be too conservative in its decisions, unduly restricting the ability of entrepreneurs to enter the market. The advice of industry and other stakeholders may be sought in the interest of avoiding excessive disruption of the market by potential new entrants. Alternatively, the government may wish to limit the concentration of power in the supervisory authority. 27

40 Insurance Supervision Core Curriculum Unfortunately, in spite of the possible merits of such policy objectives, involving others in specific licensing decisions also poses potential problems. The objectivity of the decision may be compromised by political pressure. For example, existing market participants may exercise their influence to keep new entrants out of the market and protect their market share and profit margins. Potential new entrants (perhaps friends of the minister or large contributors to causes supported by the political party in power) may exert influence to obtain a license, even if they are not financially strong or otherwise suitable. Accordingly, ICP 6 emphasizes the need for the supervisory authority to play a significant role in the licensing process. ICP 6, essential criterion a, states that legislation should allocate the responsibility for issuing licenses. However, several other criteria assume that the supervisory authority has a measure of control over the licensing process; for example, essential criterion i states that no license should be issued without approval of the supervisory authority. Certainly, when more than one party has responsibilities in the licensing process, the need for clear requirements is heightened and active communication among the parties is essential. Where communication and cooperation are lacking, serious difficulties could arise for the supervisory authority. For example, the authority could be forced to deal with an insurer that should never have been licensed and is unviable from the start, consuming significant supervisory resources. Industry participants could also receive mixed messages about the responsibilities of the supervisory authority and other authorities, making it difficult for the supervisory authority to gain the attention and respect of the industry that it needs to supervise effectively. For example, if a license has been issued in spite of objections by the supervisory authority, the insurer may be especially likely to resist or appeal subsequent supervisory actions. In some jurisdictions, more than one authority is responsible for insurance supervision. For example, one agency may be responsible for prudential supervision and another for market conduct supervision. In such cases, an insurer may need to apply for a separate license from each of these agencies. The agencies should communicate with one another. From the standpoint of the applicants, it would be useful for the authorities to harmonize their application requirements and licensing processes, where possible. It is desirable that the manner in which the agencies will cooperate on both licensing and other issues be documented in writing and, where relevant, disclosed to industry participants (see ICP 4 on supervisory process). Finally, as noted in section B, insurers are business entities that can take various legal forms. When a business entity is being established in a jurisdiction, or when a foreign business seeks to operate in the jurisdiction, approval under the general trade or company law may be required. The granting of such approval, sometimes formalized through entry of the company in a register of commerce, is referred to in this module as registration. Registration is ordinarily the responsibility of someone other than the insurance supervisor, such as the Ministry of Commerce or a local chamber of commerce. 28

41 ICP 6: Licensing In some jurisdictions an insurer must be registered before it can be licensed, while in other jurisdictions the order is reversed. Steps in the process The steps in the licensing process should be identified, documented, and published. The advantages of doing so include promoting a smooth process, facilitating communication between the applicant and the authorities, reducing the risk that important issues will be overlooked, and limiting the scope for abuse. Transparency of the processes and consistency in their application help to build confidence in the insurance sector and in the quality and fairness of its supervision. Many supervisory authorities publish information about the licensing process and criteria on their websites (for example, see OSFI 2004). The steps in the process will vary from one jurisdiction to another, reflecting differences in the parties with responsibilities in the process and the legal requirements for licensing. Examples are provided in figures 1 and 2. While the licensing process generally requires the submission of a formal application, it is often worthwhile for the licensing authority to hold preliminary discussions with the potential applicant. Such discussions help to ensure that the potential applicant understands the process and requirements and enable the licensing authority to identify significant issues of concern. The potential applicant might then take actions to deal with these concerns prior to submitting its formal application. In some jurisdictions, preliminary discussions are followed by a more formal screening process. For example, the suitability of owners and the proposed key functionaries may be assessed. Any concerns about suitability have to be dealt with before a full application is accepted. While preliminary discussions and screening processes may extend the time required to obtain a license, they may reduce the time that both the applicants and the authorities waste on deficient applications. The formal application for a license may need to be made using a particular form, as specified in the insurance law or regulations. It would Figure 1. Licensing Process in Jurisdiction A Preliminary discussions Registration under Companies Act Formal application for license Supervisory review License granted Yes Insurer begins operating No Additional information May appeal to court 29

42 Insurance Supervision Core Curriculum Figure 2. Licensing Process in Jurisdiction B Preliminary discussions Preliminary application Suitability assessment Suitable Formal application for license Supervisory review Recommend license Minister considers supervisory recommendation License granted Yes Insurer begins operating No No No May propose others Additional information May appeal to minister May appeal to court be accompanied by the documents needed to assess compliance with the licensing criteria. In addition to the information mentioned in section C, relevant official documents would be requested, such as articles of incorporation or association, bylaws, and a board of directors resolution authorizing management to apply for a license. Many jurisdictions impose a licensing fee; if so, the fee needs to be paid along with the application. The applicant typically provides a large amount of sometimes complex documentation. Therefore, it would be unusual for an authority to be able to review the documentation and make a licensing decision without having some interaction with the applicant. Required information may be missing, clarifications may be required, and follow-up questions may arise when the materials are reviewed. The licensing authority needs to contact other relevant authorities, such as the applicant s home supervisor, and these contacts may raise further questions. Nevertheless, if the licensing criteria are clearly defined, the process is well managed, and the applicant is competent and cooperative, the review process can be completed without excessive delay. If one or more of these is lacking, the process can become protracted and frustrating for all involved. Interaction between the applicant and the authorities can be a valuable part of the licensing process, even beyond the exchange of factual information. The supervisory authority can take the opportunity, at an early stage, to communicate expectations regarding ongoing operations of the insurer. Dealing with the key functionaries and professional advisors of the applicant can help the supervisory authority to assess their capabilities, the viability of their business plan, and the extent to which they are likely to cooperate in the achievement of supervisory objectives. 30

43 ICP 6: Licensing It is simply good operating practice for authorities to maintain well-organized files documenting their work. This practice is particularly important with respect to the work performed in assessing a license application. This work will almost always lead to a decision by the authority, which must be explained to the applicant and may need to be defended in the courts. Appropriate documentation will help to inform and defend the licensing decision. Once all of the necessary information has been received from the applicant and its home supervisor (where relevant) and evaluated by the responsible authorities, the licensing decision should be made within a reasonable time according to essential criterion i. In many jurisdictions, the insurance law or regulations specify the period of time within which a decision must be made, starting from the point at which all necessary documentation has been received. Typically, this period ranges from three to six months. The reason for specifying such a time constraint is to ensure that an applicant is not unduly delayed from pursuing its business objectives as a result of regulatory inefficiencies or indecision. Nevertheless, the licensing decision is too important for the application to be deemed approved merely because the specified time has passed; an explicit decision should be made. The reasons for delay should be communicated clearly to the applicant. In such circumstances, it is appropriate for the applicant to have the right to appeal to the courts (or elsewhere, such as an appeals board) to force a decision. Licensing decisions If the assessment reveals all aspects of a license application to be favorable, the licensing decision should be simple and straightforward. The application can be approved, the decision communicated to the applicant, and an official license issued. If the assessment raises serious concerns, which the applicant is unable to resolve in a manner satisfactory to the authorities, the appropriate decision is to deny a license. In most jurisdictions, the insurance law mentions the reasons for which a license may be denied. In some cases, the insurance law provides an explicit and exhaustive listing of the reasons; in other cases, some discretionary power is available to the licensing authority. Reasons for denial typically include the following: Key functionaries or owners do not meet suitability requirements Minimum capital or solvency margin requirements are not fulfilled The business plan does not meet legal requirements; one or more other licensing criteria are not satisfied Supervision may be hindered due to the group structure (see essential criterion j). 31

44 Insurance Supervision Core Curriculum Where the licensing criteria are clear and explicit for example, regarding minimum capital the law should make it clear and evident to the applicant that the failure to satisfy such criteria constitutes grounds for denial. However, in some cases, the reason for denial may be less easily demonstrated, for example, the authority does not believe that the interests of the policyholders are adequately safeguarded. In any case, the reasons for denial should be supportable and communicated clearly to the applicant. The licensing authority should also be prepared to demonstrate that it followed the licensing process diligently in arriving at its decision. Particularly in situations where the denial of a license is based on subjective judgment, the applicant can be expected to object to the refusal. Most jurisdictions give applicants the right to appeal a licensing decision to the courts. In some situations, an assessment may raise concerns that are material in nature, but perhaps not serious enough to warrant the outright denial of a license. For example, an applicant may meet all suitability and financial requirements but have a business plan that introduces a new type of product to the local market, for which demand is uncertain. In such situations, the insurance laws of many jurisdictions make an alternative course of action available to the licensing authority: a license may be issued subject to additional requirements, conditions, or restrictions on the applicant. Depending on the nature of the concerns, it may be appropriate to formulate these conditions in consultation with the applicant. Some examples of conditions or restrictions include the following: Providing that no business can be transacted by a newly formed insurer until the supervisory authority is satisfied that staffing, systems, and procedures are in place and have been adequately tested Restricting the types of risk that may be underwritten within a particular class of business Limiting the total premiums that may be written in each of the first three years to the amounts shown in the business plan Requiring that a higher than normal level of available solvency be maintained Limiting the initial duration of the license to one year (in a jurisdiction where licenses are normally of unlimited duration). Such restrictions can protect policyholders by limiting the ability of an insurer to take on risks that it may not be prepared to handle. However, it is important that the restrictions not be so severe that they unduly compromise the ability of the insurer to operate in a commercially viable manner. Furthermore, they should be framed in a manner that facilitates subsequent monitoring by the supervisory authority. 32

45 ICP 6: Licensing Supervisory monitoring Once a license has been granted, an insurer will be subject to regulatory reporting requirements and both offsite analysis and onsite inspection by the supervisory authority. In some cases, it may be adequate and appropriate to include the insurer in the normal supervisory work program. For example, if the insurer is a branch or subsidiary of an international insurer with both a long and solid reputation and a strong home supervisor, it may be unnecessary for the host supervisor to take special measures. In other cases, close monitoring may be essential. Where the licensee is a newly formed insurer, the supervisory authority might pay particular attention to whether start-up costs are in line with the budget, operations are progressing in accordance with the business plan, and available solvency is adequate. Many authorities require more frequent financial reporting by new licensees during their initial years of operation. If the license has been issued subject to conditions or restrictions, the supervisory authority will need to verify that the insurer is complying with these requirements. Once it is satisfied that the insurer is operating appropriately and the factors that caused initial concern are no longer significant problems, the conditions or restrictions on the license might be removed and close monitoring replaced by regular supervisory oversight. Although most jurisdictions issue licenses of unlimited duration, in some jurisdictions licenses must be renewed periodically (usually annually). An advantage of limiting the term of licenses is that the renewal process may both require and facilitate periodic monitoring by the supervisor. However, the renewal process may impose an unnecessary administrative burden on both the insurer and the supervisory authority, in cases where less-formal monitoring would have been adequate. If concerns arise in the course of its monitoring, the supervisor should deal with them promptly (see ICP 14 on preventive and corrective measures). Supervisory forbearance is inadvisable, anyhow, but this is particularly true in the case of a new licensee, which is particularly vulnerable to failure in the early years of operation. In recognition of this factor, the insurance laws in some jurisdictions provide the supervisory authority with greater powers of intervention with respect to new licensees than to longer-established insurers. The supervisory authority should impose appropriate sanctions to deal with its concerns (see ICP 15 on enforcement or sanctions). As noted in ICP 15, essential criterion k, the sanctions could include withdrawing the license of an insurer. The insurance law should specify the reasons for which an insurer s license may be withdrawn. These would usually, if not always, include failure to meet significant obligations under the insurance laws and regulations, failure to fulfill the conditions of licensing, refusal to comply with certain instructions of the supervisory authority, and the withdrawal of a foreign insurer s license by its home supervisor. It is also common that an insurer s license could be withdrawn if it fails to operate as an active business in the jurisdiction. This could include failing to commence operations within a prescribed period of time after the issuance of the license or ceasing to 33

46 Insurance Supervision Core Curriculum transact business for a certain period. It could also occur if the insurer transfers all of its business to another company or otherwise withdraws from the market and requests that its license be withdrawn. The withdrawal of an insurer s license can have significant consequences for the insurer, its policyholders, and other stakeholders. Therefore, the insurance law may include controls to ensure that a decision to do so is considered carefully. For example, the approval of the minister may be required to withdraw a license, even if the minister is not involved in the granting of licenses. Such controls exist primarily to protect the legitimate interests of the insurer and its owners against arbitrary action by the supervisory authority. However, they also hold the potential to interfere with appropriate supervisory actions. For example, the insurer may apply pressure on the minister to veto the supervisor s recommendation that the license be withdrawn. Where others besides the supervisory authority are involved, it is useful if the time frames for reaching decisions are either prescribed by legislation or agreed upon by the parties, because undue delays can increase the potential losses of policyholders. An insurer should have the right to appeal the actual or proposed withdrawal of its license to the courts. In practical terms, it may be very difficult for an insurer to resume its activities if a court reinstates its license, unless the withdrawal was clearly inappropriate. This reinforces the need for a careful decision, based on well-documented analyses and appropriate motivation. In summary, licensing is an essential element of the supervisory process. It helps to ensure that only insurers that are likely to be both willing and able to meet their obligations to policyholders are allowed to enter the market. Clear, objective, and public licensing requirements in terms of both criteria and process facilitate timely and appropriate licensing decisions. Ongoing monitoring by the supervisory authority is required to ensure that an insurer remains worthy of policyholders trust. If the monitoring raises concerns, appropriate supervisory action should be taken. Where the concerns are serious and not remedied by the insurer, the appropriate action may well be withdrawal of the license. Licensing is, therefore, relevant throughout the full life cycle of an insurer. 34

47 ICP 6: Licensing Exercises Answer these questions considering, where indicated, the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods. 11. Identify the parties involved in the licensing process in your jurisdiction. Do written agreements exist among them regarding their respective responsibilities? 12. Prepare a flowchart, such as those shown in figures 1 and 2, to illustrate the licensing process in your jurisdiction. 13. Based on your report, the applicant described in exercise 10 amended its business plan and was issued a license. The amended business plan reflects a doubling of the liquidity and reinsurance cession ratios, a reduction of other assets to 10 percent of the total, and a reduction of gross written premiums to 2,000 and 4,000 in the second and third years, respectively. The applicant has agreed not to declare shareholder dividends without prior supervisory approval. Develop a plan for monitoring this insurer during its first three years of operation. 35

48 Insurance Supervision Core Curriculum E. References Basel Committee on Banking Supervision Framework for Internal Control Systems in Banking Organizations. Basel, September. Available at Committee of the Conference of Insurance Supervisory Services of the Member States of the European Union Prudential Supervision of Insurance Undertakings. Known as the London Group Report or the Sharma Report. London, December. Available at European Commission Commission on Interpretative Communication: Freedom to Provide Services and the General Good in the Insurance Sector. Official Journal C 043. Brussels, February 16. Available at Published in a variety of languages. IAIS (International Association of Insurance Supervisors) Supervisory Standard on Licensing. Basel, October. Available at a. Guidance Paper on Fit and Proper Principles and Their Application. Basel, October. Available at b. Licensing Textbook. Basel, October. Available at c. Principles on the Supervision of Insurance Activities on the Internet. Basel, October. Available at Standard 7: Supervisory Standard on the Evaluation of Reinsurance Cover. Basel, January. Available at a. Guidance Paper on Stress Testing by Insurers. Basel, October. Available at b. Insurance Core Principles and Methodology. Basel, October. Available at Glossary of Terms. Basel, February. Available at Ishii, Hisaya Liberalisation of International Insurance Operations: Cross-border Trade and Establishment of Foreign Branches. Paris: OECD (Organisation for Economic Cooperation and Development) Available at dataoecd/56/51/ pdf. OSFI (Office of the Superintendent of Financial Institutions Canada) Guideline B-10: Outsourcing of Business Activities, Functions, and Processes. Ottawa, December. Available at Also published in French Guide for Incorporating Federally Regulated Insurance Companies. Ottawa, August. Available at Also published in French. Savage, Lawrie Re-Engineering Insurance Supervision. Policy Research Working Paper Washington, D.C.: World Bank and Inter-American Development Bank, December. Available at IBank_Servlet?pcont=details&eid= _

49 ICP 6: Licensing Appendix I: ICP 6 ICP 6: Licensing An insurer must be licensed before it can operate within a jurisdiction. The requirements for licensing are clear, objective, and public. Explanatory notes 6.1. To protect the interest of policyholders a jurisdiction must be able to determine which insurers are allowed to carry out insurance activities within its area. Licensing refers to the formal authority given to an insurer to carry on insurance business under the domestic insurance legislation. It does not refer to any approval granted in terms of the general domestic company or business legislation When the licensing procedure meets internationally accepted standards and is effective and impartial, confidence in the supervisory system will grow and may facilitate mutual recognition of supervisory systems and thus the further liberalization of market access for foreign insurers. Licensing procedures and conditions are in place for supervisory purposes; they should not in themselves act as a barrier to market access. Essential criteria a. The insurance legislation: Includes a definition of insurers Requires licensing of insurers and prohibits unauthorized insurance activities Defines the permissible legal forms of insurers Allocates the responsibility for issuing licenses. b. Clear, objective, and public licensing criteria require: The applicant s board members, senior management, auditor, and actuary, both individually and collectively, to be suitable, as specified in ICP 7 on suitability of persons The applicant s significant owners (refer to ICP 8, essential criterion a) to be suitable, as specified in ICP 7 The applicant to hold the required capital 37

50 Insurance Supervision Core Curriculum The applicant s risk management systems, including reinsurance arrangements, internal control systems, information technology systems, policies, and procedures, to be adequate for the nature and scale of the business in question Information on the applicant s business plan to be projected out for a minimum of three years. The business plan must reflect the business lines and risk profile and give details of projected setting-up costs, capital requirements, projected development of business, solvency margins, and reinsurance arrangements. The business plan must present information regarding primary insurance and inward reinsurance separately Information on the products to be offered by the insurer Information on contracts with affiliates and outsourcing arrangements Information on the applicant s reporting arrangements, both internally to its own management and externally to the supervisory authority Input from the applicant s home supervisory authority when the insurer or its owners are not domestic and a home supervisory authority exists (refer to ICP 5 on supervisory cooperation and information sharing). c. The supervisory authority requires that no domestic or foreign insurance establishment escape supervision. d. All insurance establishments of international insurance groups and international insurers are subject to effective supervision. The creation of a cross-border establishment should be subject to consultation between the host and home supervisor. e. The insurance legislation determines the method by which a foreign insurer can carry on business in the jurisdiction. This may be by way of a local branch or subsidiary that must be licensed or on a services basis only. f. If a foreign insurer is allowed to carry on business in the jurisdiction, the supervisory authority must be provided with the following data: Confirmation from the home supervisory authority that the insurer is authorized to carry on the types of insurance business proposed Information from the home supervisory authority that the insurer is solvent and meets all the regulatory requirements in the home jurisdiction In the case of a branch office, the name and address of the branch The name of the authorized agent in the local jurisdiction in the case of insurance offered on a services basis (that is, where a local branch or subsidiary is not established) The information and documentation normally required to be licensed in the local jurisdiction, when appropriate. 38

51 ICP 6: Licensing These information requirements might be waived if insurance is offered on a services basis only. g. An insurer licensed to underwrite life insurance business must not also be licensed to underwrite non-life insurance business, and vice versa, unless the supervisory authority is satisfied that the insurer has satisfactory processes requiring that risks be handled separately on both a going concern and a windingup basis. h. The supervisory authority imposes additional requirements, conditions, or restrictions on an applicant where the supervisory authority considers this appropriate. This might include restrictions on non-insurance activities. i. The supervisory authority assesses the application and makes a decision within a reasonable time. No license is issued without its approval. The applicant must be informed of the decision without delay and, if the license is denied or conditional, be provided with an explanation. j. The supervisory authority refuses to issue a license where it considers the applicant not to have sufficient resources to maintain the insurer s solvency on an ongoing basis, where the organizational (or group) structure hinders effective supervision, or where the application is not in accordance with the licensing criteria. k. As necessary, after an insurer has been licensed, the supervisory authority evaluates and monitors the degree to which the insurer satisfies the relevant licensing principles and requirements of the jurisdiction. 39

52 Insurance Supervision Core Curriculum Appendix II: Cross-references The table below cross-references the learning objectives with the various criteria of ICP 6, the Supervisory Standard on Licensing (see IAIS 1998) and the Licensing Textbook (see IAIS 2000b), in the order in which the topics are covered in this module. Learning objective ICP 6 Standard Textbook A. Introduction 1. Explain what licensing means and why it is important that insurers be licensed B. Scope of licensing 2. Describe the following bases for conducting insurance operations and the licensing appropriate to each: a. Domestic insurer b. Subsidiary of a foreign insurer c. Branch of a foreign insurer d. Foreign insurer operating on a services basis 3. Explain the disadvantages of composite insurers and describe the additional controls required of them for prudential reasons 4. Provide examples of circumstances when it may be acceptable for insurance business to be conducted without a license An insurer must be licensed before it can operate within a jurisdiction. The requirements for licensing are clear, objective, and public. Explanatory notes 6.1 and 6.2 Essential criteria a, d, and e 1. Background 2. Definitions 3. General licensing principles 3.1 The term license in this paper scope of application 4. Licensing requirements 4.1 Preliminary remark 3.2 Types of company that must be licensed 3.3 Types of business that must be licensed 3.5 Scope of license 4.2 Legal form and head office of the company 4.3 Objective of the company Part H: Why is it necessary to license an insurance company to take up operations? Regarding domestic and foreign insurers (8 9) Regarding foreign insurers (10) Regarding legal form and head office of the company (21) Part H: Which companies must be licensed? Essential criterion g 4.4 Specialization Regarding scope of license (18 19) Regarding objective of the company (23) Regarding specialization (25 27) Part F: OECD common classification of classes of insurance model list Essential criterion c 3.4 Insurance business that may not be licensed Regarding insurance business (13) Regarding distinction between insurance and social security (14) Regarding insurance business that may not be licensed (15) Regarding correspondent insurance (16) Regarding products that are not offered by licensed domestic insurers (17) 40

53 ICP 6: Licensing Learning objective ICP 6 Standard Textbook C. Licensing criteria 5. Enumerate the criteria that should be considered before a license is granted and explain the importance of each, including a. Suitability of key functionaries b. Suitability of significant owners c. Availability of required capital d. Adequacy of risk management, controls, policies, and procedures e. Viability of the business plan f. Products to be offered g. Contracts with affiliates and outsourcing service providers h. Management and supervisory reporting arrangements i. Input from the home supervisory authority of an insurer with foreign connections 6. Describe the information that should be sought from the home supervisory authority before a foreign insurer is allowed to carry on business in the jurisdiction Essential criterion b Essential criterion f 4.5 Minimum capital 4.6 Business plan 4.7 Suitability of directors and/or senior management 4.8 Suitability of owners (control of shareholders) 4.9 Affiliation contracts and outsourcing 4.10 Product control 4.11 Articles of incorporation 4.12 Actuaries and auditors Regarding minimum capital (28 31) Regarding deposit (31) Regarding suitability of directors and/or senior management (37 39) Regarding suitability of owners: control of shareholders (41 44) Regarding affiliation contracts and outsourcing (45 49) Regarding product control (50 54) Regarding policy conditions (51 52) Regarding technical bases for the calculation of premium rates and provisions (53 54) Regarding articles of incorporation (55 56) Regarding auditor (58) Part E: Guidelines regarding the choice of a reinsurer Part H: Which information is to be provided by the company to obtain the license? Part H: What does minimum capital mean? Part H: Why is it necessary for the directors and/or senior managers of an insurance company to be professionally qualified and of good repute? Part I: Guidelines concerning directors and/ or senior managers of insurance companies Part J: Model for articles of incorporation (Joint Stock Company) Part K: Notification concerning the holder of a qualifying participation Part L: Declaration by directors and/or senior managers in respect of any criminal proceedings Part M: Model for outsourcing contract Part H: What is to be taken into account by foreign insurance companies in particular? 41

54 Insurance Supervision Core Curriculum Learning objective ICP 6 Standard Textbook 7. Assess the adequacy of the business plan of a particular applicant for an insurance license D. Licensing process 8. Enumerate the typical steps in the licensing process 9. Illustrate additional requirements, conditions, or restrictions that might be imposed on an applicant by a supervisory authority and explain why they would be appropriate 10. Prepare a plan for supervisory monitoring during the three years after a particular insurer has been granted a license Essential criterion i Essential criteria h and j 5. Licensing procedure 5.1 Application 5.2 Examination procedure 5.3 License and registration in the register of commerce 5.4 Licensing body and supervisor 5.5 Duration of the licensing procedure 5.6 Cooperation Regarding the business plan (32 36) Part C: Estimates of the expected business trend in the first five financial years Part D: Estimates of the expected business trend in the first three financial years Part H: Why is the business plan so important, and what should it include? Regarding preliminary remark (20) Regarding application (59) Regarding examination procedure (60 62) Regarding license and registration (63) Regarding licensing body and supervisor (64) Regarding duration of licensing procedure (65) Part G: Guidelines for jointstock insurance companies applying for the license (non-life insurance) Part H: What is the advantage of a standardized licensing procedure prescribed by law? Part H: Who decides on the granting of the license? Essential criterion k 6. Withdrawal of license Regarding the withdrawal of license (67 69) Part H: Under which conditions should it be possible to withdraw the license? 11. Summarize the requirements of ICP 6 42

55 ICP 6: Licensing Appendix III: Answer key Pretest 1. b 2. a 3. d 4. b 5. d 6. c 7. a 8. c 9. b 10. c Exercises 1. How might a supervisory authority determine whether unlicensed insurers are operating in the jurisdiction? The existence of unlicensed insurers might be identified by considering consumers inquiries and complaints, monitoring advertisements, maintaining regular communication with licensed insurers and intermediaries, sharing information with other supervisory authorities within the jurisdiction and the region, and surfing the Internet to identify insurance offered to those in your jurisdiction. 2. What steps might be taken if an insurer is discovered operating without the necessary license? Have such situations arisen in your jurisdiction? If so, what actions were taken? Actions that might be taken if an unlicensed insurer is identified include requesting in writing that it cease operation in the jurisdiction, issuing a formal cease-and-desist order, seeking a court injunction, publishing a notice to warn the public, and contacting the home supervisor of an unauthorized foreign insurer. Consult with senior officials in your jurisdiction regarding such situations that may have arisen in the past and how they were dealt with. 43

56 Insurance Supervision Core Curriculum 3. Does the insurance law (or another law) in your jurisdiction define insurance? If so, how is it defined? Review the insurance law in your jurisdiction. If insurance is not defined in the law, discuss with colleagues how this term is interpreted in practice. 4. Provide several examples of insurance activities, or business activities in the nature of insurance, that are sometimes exempted from licensing or supervisory registration. Do any of these exist in your jurisdiction? If so, is licensing or supervisory registration required? Exemptions from licensing or supervisory registration are sometimes provided for manufacturers warranties, social insurance programs, motor vehicle assistance services, fraternal insurers, government-owned insurers, insurance pools, and insurance or reinsurance underwritten through the cross-border provision of services. Consult with colleagues regarding the existence of any of these in your jurisdiction. Review the insurance law to identify which must be licensed or registered. 5. Explain why some jurisdictions do not permit foreign insurers to operate through branches and describe the types of licensing requirements sometimes imposed on branches by those jurisdictions that do permit them. How does your jurisdiction deal with this issue? Jurisdictions may prohibit foreign branches because a branch is not a legal entity. It thereby lacks a full corporate governance structure and cannot independently raise capital. Operational control of a branch may reside outside the host jurisdiction, making it more difficult to inspect the operation and correct deficiencies. Some reliance would have to be placed on the home supervisory authority, and there may be a reluctance to do so. Requirements sometimes put on branches include the need to make a financial deposit with the supervisory authority and to maintain assets locally to cover obligations to policyholders residing in the jurisdiction. Local assets must sometimes include a solvency margin and may need to be placed in trust. Consult with colleagues or review the insurance law to determine how the issue of foreign branches is dealt with in your jurisdiction. 6. Describe three types of specialization requirements that may be used to limit the scope of insurers operations. What is the rationale for requiring specialization? Specialization requirements include the prohibition of composite insurers, the need to obtain a license for each class of business that will be underwritten, and 44

57 ICP 6: Licensing the restriction or prohibition of non-insurance activities. Such requirements exist to limit exposure of policyholders to the different types of risks that may arise from business activities that differ significantly from those relevant to insurance they have purchased. These risks are heightened when the insurer lacks the specialized expertise needed to carry on the other activities, whether directly or through its investment in a subsidiary. 7. Is the suitability of key functionaries and significant owners assessed as part of the licensing process in your jurisdiction? If so, which key functionaries are subject to assessment? How is significant owner defined in your jurisdiction? Review the insurance law and licensing requirements in your jurisdiction to determine whether the suitability of key functionaries is assessed and, if so, which ones. Review the insurance law to determine the definition of significant owner or the equivalent term used in your jurisdiction. 8. Describe the types of information that can be used to assess the suitability of key functionaries and significant owners. Which of these typically are used in your jurisdiction? Sources of information on suitability could include a standardized background questionnaire, financial statements, checks of police records, contacts with former employers, and consultation with other relevant supervisory authorities, both local and foreign. Consult with colleagues to determine which sources of information are commonly used in your jurisdiction. 9. A foreign insurer intends to establish a branch in your jurisdiction and has applied for a license. The application indicates that computer services and claims processing will be handled by the head office of the insurer under a service agreement, at a cost of 15 percent of premiums. What concerns might you have about this arrangement? What information could you use to evaluate the issues of concern, and where might you obtain this information? Concerns about this arrangement could include the adequacy of controls over the quality of service and compliance with local legislation, the ability of the supervisor to access the records and inspect the activities, the ability of the branch to maintain service in the event of difficulties at the head office, and whether the interests of branch policyholders are being compromised by excessive fees for the services provided. Information that could be reviewed includes the service contract, the proposed program of internal controls, the contingency plan, a comparison of costs with those incurred by other local insurers for the same 45

58 Insurance Supervision Core Curriculum services, and input from the home supervisor regarding the capabilities of the insurer. 10. A newly formed non-life insurer has applied for a license, and you are responsible for analyzing its business plan and preparing a report for the head of the supervisory authority. Review the following information, identify any significant concerns that you will comment on in your report, and state your recommendations. The non-life insurance market in your jurisdiction has consisted largely of compulsory motor vehicle third-party liability insurance (gross written premiums of 50,000, compared to total non-life premiums of 60,000). Several leading insurance agents believe there is an opportunity to develop the property insurance market rapidly. These agents have pooled their resources to form an insurance company. Using the Internet, the owners have conducted research regarding the financial results of property insurers in other markets. They have used this information as the basis for the claims and expense assumptions underlying the financial projections included in the business plan. The owners have raised 2,500 initial capital, which is more than required to meet the 2,000 minimum amount specified under the Insurance Act. Insurers are required to maintain at least this much equity on an ongoing basis or, if higher, a solvency margin calculated as the sum of 20 percent of net written premiums, 15 percent of claims provisions, and 15 percent of assets (other than cash, bank accounts, and government bonds). The supervisory authority has established (for internal use) a solvency control level of 150 percent of the minimum solvency margin; if an insurer s available solvency falls below this level, supervisory action is taken. The following table presents the company s financial projections. Item Initial Year 1 Year 2 Year 3 Main assumptions Gross written premiums 1,000 3,000 6,000 Paid claims ratio Expense ratio Return on invested assets Income statement Gross written premiums 1,000 3,000 6,000 Net written premiums 900 2,700 5,400 Net earned premiums 320 1,730 4,000 Net claims incurred 260 1,250 2,490 Expenses ,620 Underwriting result

59 ICP 6: Licensing Item Initial Year 1 Year 2 Year 3 Investment income Net income, before tax Net income, after tax Shareholder dividends 110 Balance sheet Assets Cash and bank accounts 2, Government bonds 910 1,030 1,180 Common shares 760 1,230 2,070 Non-invested assets 750 1,230 2,060 Total assets 2,500 3,020 4,110 5,900 Liabilities Unearned premiums 580 1,550 2,950 Claims provisions Other liabilities Total liabilities 630 1,810 3,500 Total equity 2,500 2,390 2,300 2,400 Requirements Minimum capital 2,000 2,000 2,000 2,000 Minimum solvency ,780 You might begin your analysis by preparing a spreadsheet that contains the financial projections provided by the insurer. You could use this spreadsheet to check the mathematical accuracy of the projections, calculate the ratios ordinarily used by your supervisory authority in the financial analysis of non-life insurers, and test alternative assumptions. The business plan calls for rapid growth in premiums in a class of business for which the market demand is unproven. After three years, the new company seems projected to control a potentially large share of the non-motor vehicle insurance market. The applicant could be asked to explain how the demand for the product was estimated and how it expects to capture such a large market share. The financial results should be tested assuming alternative growth scenarios. The expense and claims assumptions are projected to improve rapidly and produce an underwriting profit in the third year. This may be unrealistic for a new insurer. Comparisons with the expense levels of insurers of similar size in the jurisdiction and in less developed markets should be made. The financial results should be tested assuming alternative expense and claims ratios. 47

60 Insurance Supervision Core Curriculum The insurer intends to retain 90 percent of its premiums, which may be quite high for a new, small non-life insurer. The nature of the property risks that the insurer intends to underwrite should be determined and the adequacy of its reinsurance program assessed closely. The rate of return on invested assets is assumed to increase steadily during the projection period. The assumptions should be evaluated in light of local market conditions. The likelihood that the projected returns can be achieved should be questioned, along with the appropriateness of the asset mix. The projected level of liquidity is fairly low, especially if the government bond market in the jurisdiction is inactive. The applicant should explain the large increase in other assets ; perhaps it includes the planned purchase of a lavish head office. The total equity of the insurer is projected to remain above both the minimum capital and minimum solvency margin requirements throughout the three-year period. However, the rapid growth in business means that the insurer would breach the solvency control level in the third year (150 percent of 1,780 equals 2,670, while total equity is 2,400). The adoption of alternative assumptions for the projections might make this situation even worse. You might recommend that the applicant (and other insurers) be informed of the solvency control level used by the supervisory authority. The applicant will need to be advised that the payment of shareholder dividends in the third year is inappropriate and that, unless credible sources of additional capital can be identified, the growth projections will need to be scaled back. 11. Identify the parties involved in the licensing process in your jurisdiction. Do written agreements exist among them regarding their respective responsibilities? Review the insurance law and the written licensing procedures and then consult with colleagues to identify which parties are involved in the licensing process in your jurisdiction. Consult with colleagues to determine whether any written agreements exist among these parties and what the agreements cover. 12. Prepare a flowchart, such as those shown in figures 1 and 2, to illustrate the licensing process in your jurisdiction. Review the insurance law and the written licensing procedures and then consult with colleagues to identify the steps in the licensing process in your jurisdiction. 13. Based on your report, the applicant described in exercise 10 amended its business plan and was issued a license. The amended business plan reflects a doubling of the 48

61 ICP 6: Licensing liquidity and reinsurance cession ratios, a reduction of other assets to 10 percent of the total, and a reduction of gross written premiums to 2,000 and 4,000 in the second and third years, respectively. The applicant has agreed not to declare shareholder dividends without prior supervisory approval. Develop a plan for monitoring this insurer during its first three years of operation. The insurer is newly formed, so close monitoring is appropriate during its early years of operation. Your plan should probably require limited financial reporting on a quarterly, or more frequent, basis. Start-up expenses should be monitored carefully in comparison with the insurer s budget. Given the lack of historical data, both on this insurer and on the property insurance business in your market, regular and detailed analysis of the adequacy of the unearned premium and claims provisions is required. Conformity of the insurer s operations with its business plans should be monitored, through both financial analysis and regular discussions with senior management. Onsite inspections should be conducted to verify the adequacy of internal controls and the implementation of any changes that may be required. In the case of adverse experience, additional capital may have to be raised, in which case the insurer should be required to prepare a realistic plan and implement it without delay. 49