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Questions and Answers on prudential requirements for insurance supervision

December 2007

What will be the role of the Reserve Bank of New Zealand?

As announced in June 2007, the Reserve Bank will become the single prudential regulator for New Zealand. This will widen the scope of the Reserve Bank’s prudential functions to include the prudential regulation of registered deposit takers (RDTs) and the regulation and supervision of insurance companies.

This Q and A covers insurance regulation and supervision only, and in areas where policy decisions have been taken by Cabinet.

There is still detail to be worked through, some of which will be covered in a report back to Cabinet by 31 July 2008.

What is an insurance business?

An “insurance business” (also referred to in this document as “insurer”) will be defined in legislation. The intention is that the definition of an insurance business will capture all providers of insurance services including general, life and health insurance.

The Reserve Bank will have the power to exempt insurance businesses, or classes of business, from the prudential requirements in appropriate circumstances.

It will be unlawful to act as an insurer without being licensed by the Reserve Bank as a registered insurer.

What are the outcomes and objectives of regulation?

Outcomes sought

The three outcomes sought from the improved regime for the prudential regulation and supervision of the insurance sector are:

  • A sound and efficient insurance sector;
  • Confidence in the insurance sector; and
  • Not to unduly compromise or constrain contestability, competitiveness and innovation.

The outcomes create a balance between the need for effective regulation and regulatory requirements that are not unnecessarily onerous and which are therefore suitable for the New Zealand insurance sector.

Objective of regulation

The objective of prudential regulation is to encourage the maintenance of a sound and efficient insurance sector that promotes policyholder confidence.

The objective is closely related to and supports the fulfilment of the outcomes sought.

What does the objective not include?

The objective does not include:

  • promoting a uniform level of risk across the insurance sector;
  • preventing insurance failures; or
  • insulating policyholders from loss in the event that an insurer fails.

What will licensing and regulation of insurers involve?

The key elements of the proposed licensing and other prudential requirements are as follows:

  • All insurers are required to be licensed by the Bank and only entities that meet the required standards would be licensed. Licensing decisions will be made on the basis of requirements in relation to minimum capital, fit and proper persons, sufficient financial strength, the insurer having a financial strength rating and other matters. Further details regarding some of these requirements are provided below. Minimum requirements would apply to all insurers at the time of licensing and on an ongoing basis.

  • A minimum capital requirement, anticipated at $2 million, is proposed to demonstrate financial commitment to the insurance sector. In addition to this, there will be solvency and capital adequacy (“financial strength”) requirements, based on actuarial standards, which will be developed in liaison with the insurance industry.

  • All insurers will be required to maintain policies and processes to validate the suitability and integrity of prospective directors and certain senior managers – usually known as “fit and proper” requirements. The Reserve Bank will perform its own checks in this area and have the power to dis-approve proposed appointees and remove incumbents. The purpose of these requirements is to ensure that insurers are controlled and managed by persons with appropriate integrity and experience.

  • A requirement for all insurance providers to obtain and disclose a financial strength rating from a rating agency approved by the Reserve Bank, subject to an exemption for small insurers (except for disaster and property insurers, who are already required to have a rating). The threshold for this exemption will be set in regulations and is likely to be initially available to insurers with annual gross premiums of less than $5 million.

  • All insurers will be required to publish annual financial statements (and reduced form financials on a six monthly basis) including attestations from directors. The Reserve Bank will also require additional information to monitor the financial condition of each insurer.

  • A requirement that each insurer uses a qualified actuary to arrive at the valuation of insurance liabilities.

  • For insurers who are in run-off and not writing new business, a different class of licence which prohibits the writing of new business will be granted.

  • A requirement for an insurer to prepare and give to the Reserve Bank any information needed for prudential purposes.

  • The Reserve Bank will have the ability to perform on-site reviews and initiate third party reviews, but these powers are not expected to be used routinely.

  • A requirement for auditors of insurers to report to the Reserve Bank any major concerns they may have about an insurer they audit.

  • In circumstances where the insurer is in actual or potential distress, the Reserve Bank will have the ability to take action appropriate to the circumstances of the distress. An insurer is considered to be in distress if it is in actual or potential breach of its prudential requirements and is not able to satisfy the Reserve Bank that it will be able to return to compliance within a reasonable period of time.

  • It will be an offence (and penalties will apply) if an insurer fails to comply with regulatory requirements, including the failure to comply with fit and proper requirements or to provide information requested by the Reserve Bank.

  • International co-operation will be a feature of the regime. For example, foreign-owned insurers will be able to use the financial strength calculations prepared for their home regulator, if the Reserve Bank is satisfied with these calculations.

Will the insurance regime be included under the current Reserve Bank of New Zealand Act?

  • An Insurance Prudential Supervision Act will be created for the prudential regulation of insurance, distinct from the current Reserve Bank of New Zealand Act. This is because the objective of regulating the insurance sector is sufficiently different from that for banking.

  • The new Act will set out, amongst other matters: the definition of insurance and insurer and the scope for exemptions, the requirement for all providers of insurance to be licensed and supervised, the powers of the prudential regulator and supervisor of insurers and the purposes for which those powers may be exercised and insolvency and distress arrangements that apply distinctly to insurers.

  • Certain aspects of the framework will be enacted by secondary legislation in the form of regulations, including the amount of minimum capital, the financial strength requirements and limits on the nature and extent of connected lending and non-insurance activities.

Why is a mandatory financial strength rating being proposed?

The requirement to obtain and disclose a financial strength rating (“rating”) from a rating agency approved by the Reserve Bank will bring a number of important benefits to policyholders and to the insurance sector as a whole.

Ratings provide a relatively simple metric summarising, in one measure, the risk of an insurer defaulting on its obligation to pay claims. A rating therefore reduces the need for the public to try to understand more complex and voluminous published financial information about insurers. Ratings provide a means of enabling brokers and the public to distinguish between higher and lower risk insurers and thereby make better-informed decisions in choosing their insurer. This is particularly so if ratings are disclosed prominently in ways that can be readily understood by the general public, backed by greater initiatives to promote financial literacy.

Ratings will also strengthen market disciplines on insurers and reduce the need for a more intrusive form of regulation and supervision.

Will ratings be understood by all policyholders?

Currently, there appears to be quite limited public understanding of financial strength ratings. However, as more insurers acquire ratings and as public awareness of ratings grows, the understanding and use of ratings by ordinary insurance policyholders are likely to increase.

Will ratings be costly for insurers?

Requiring insurers to obtain and disclose a rating will involve costs for insurers – both in terms of the direct cost of the rating and the indirect cost of management time. However, the costs of mandatory ratings are expected to be modest for most insurers relative to their size.

As the costs could be more significant for very small insurers, it has been agreed by Cabinet that small insurers will be exempt from the credit rating requirement. The threshold for this exemption is likely to be initially available to insurers with annual gross premiums of less than $5 million. These exempt entities will be required to prominently disclose that they do not have a rating.

When will the new arrangements come into force?

It is intended that legislation to give effect to the insurance prudential regulatory framework will be introduced in 2008, with the legislation being brought into force in 2010. There will be a transition period during which all insurers must apply for a licence, which will only be granted once the Bank is satisfied that an insurer meets the prescribed licensing requirements. At the end of the transition period, insurers will be prohibited from operating without a licence, unless they have been specifically exempted from licensing requirements.

Will stakeholders be consulted on the details of the regulatory requirements?

Yes. Stakeholders will be consulted during the development of the proposed prudential requirements. Once legislation has been introduced into Parliament, it will be subject to the standard select committee process, therefore enabling any parties to express views on the proposed requirements. Any regulations prepared pursuant to the legislation will also be subject to the standard consultation process. The Reserve Bank intends to work closely with stakeholders on these matters.

How will the cost of prudential supervision be funded?

To minimise the cost to industry of these requirements, the cost will be met through the Reserve Bank’s funding agreement and not financed through a licensing fee or other levy imposed on insurers.