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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:

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:

What will licensing and regulation of insurers involve?

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

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

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.