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Insurer policyholder security

We are consulting on policyholder security (Options Paper 2), as part of our review of the Insurance (Prudential Supervision) Act 2010 — the IPSA review. The paper raises issues relating to insurers' financial strength disclosures, solvency requirements, termination values, statutory funds and a potential policyholder guarantee scheme.

Issues discussed in this consultation

This consultation looks at the parts of the IPSA that are particularly focused on improving policyholder security — making it more likely that insurers will be in a financial position to make claims payments that they owe to policyholders.

The issues are set out in the table below.

Rules Benefits for policy security Cost
Financial strength disclosure Rules about publishing information on an insurer’s financial position. Helps customers assess an insurer’s financial soundness when deciding which insurer to use. Insurers pay for ratings and may pass costs on to policyholders.
Solvency standards Rules about how insurers calculate the minimum level of assets they must hold in order to meet future claims, even under adversity. Reduces the chance that insurers will fail because they can’t afford to pay claims. More capital generally makes cover more expensive.
Minimum termination values Rules governing what the policyholder should receive when policies that store value terminate early.
Setting out how to calculate minimum termination values would clarify policyholder’s rights when contracts aren’t completed as planned.
This measure should clarify fair treatment, rather than imposing costs.
Statutory funds Rules that particularly protect life insurance policyholders by ‘ring- fencing’ life insurance funds.
Ring-fencing limits what insurance companies can do with life insurance assets in ways that benefit policyholders. (There are rules about removing any assets from the statutory find. Directors have to put policyholder interests first when managing the assets; and policyholders have a prior claim on those assets if the insurer fails, so it is more likely their claims will be paid).
Statutory funds add administrative costs to insurers and may reduce flexibility.
Policyholder guarantee scheme A requirement for insurers to pay into a policyholder guarantee scheme, which could pay claims if an insurer fails.
Would guarantee to pay policyholders’ claims even if their insurer failed. To keep costs down, the guarantee might only cover some kinds of policy and/or offer partial payment
Direct financial cost to insurers, which they are likely to pass on to policyholders. Cost depends on scheme design.

Proposed changes

The consultation discusses possible problems with the ways the rules currently work and how they might be changed.

For further details of options and the reasons for them, see the full consultation paper.

1. Financial disclosure statements

At the moment, insurers must publish a ‘rating’ from a ‘ratings agency’, which is a company that researches companies’ financial strength, giving them a grade for how financially secure they are. They must also publish some information about their ‘solvency’ (which we discuss in more detail in the next section). Insurers have to pay rating agencies to research the insurer’s financial position and decide on a rating, which is expensive.

The consultation asks whether:

  • rating agency ratings are useful to potential policyholders
  • we could ask insurers to publish ratings in more useful ways (for example, some sort of traffic light system)
  • more small insurers should be allowed not to obtain ratings to reduce their costs
  • there is other information that insurers could publish to help potential policyholders assess their financial strength.

 2. Solvency standards

The IPSA gives us the power to set solvency standards, which explain how insurers should calculate the assets they need to hold to make sure they can pay claims, even in adverse circumstances (economic problems affecting their investments or higher than usual claims perhaps because of some sort of disaster).

In this consultation, we look at how we currently measure and describe an insurer’s ‘solvency position’. In our consultation we ask:

  • Could we develop different measures or different ways of explaining measures to make it easier for outsiders to interpret what solvency numbers tell us about insurers’ financial strength?

At the moment, the rules are organised around a single test for whether an insurer has enough assets or not. They either meet their solvency requirements or they do not. The consultation asks whether it would be more helpful to have two different control levels, one which starts to indicate problems and another lower level that shows an insurer is in serious trouble and likely to need restructuring or resolution. Between the two levels there could be a ‘ladder of intervention’, where we would take increasingly significant action to help the insurer improve its financial position. In our consultation we ask:

  • Would it be a good idea to introduce a ladder of intervention approach in New Zealand?

3. Minimum termination values

Many insurance contracts are funded annually, so the premium collected in a particular year is used to pay that year’s claims. However, some kinds of insurance build up a store of value, used to pay benefits in the future. For example, some traditional life insurance products include a savings element and some life annuities start with a lump sum payment, which funds regular income for life.

If either the insurer or policyholder want to terminate these policies early, it may not be obvious how much compensation a policyholder should be entitled to. They may not have made a claim yet (or their policy may not have ‘matured’) but they have contributed funds that are being held by the insurer to provide them with protection or benefits for the future.

In our consultation we ask:

  • Should the legislation contain rules for working out what policyholders are owed if contracts are cut short for some reason?

4. Statutory funds

Statutory funds are a way of ring-fencing assets for life insurance but they do not apply to other types of insurance business (such as health insurance, property insurance, professional indemnity etc.).

The rules were set up that way because life insurance can involve a very long-term relationship with an insurer and has often had a savings element incorporated. Since policyholders build up funds over a long period of time, it is particularly important that their funds are protected.

The consultation asks whether the life insurance / non-life insurance distinction is the right way to decide which policyholders benefit from statutory fund protection.

One reason for asking the question is that most new life insurance business is structured differently from traditional policies. Rather than building up savings over time, policyholders pay for their life cover year-by-year (although insurers have to keep allowing them to renew their policies, even if their health deteriorates in the meantime). In our consultation we ask:

  • Does this kind of policy (known as a ‘yearly renewable term’ or YRT policy) still need ring- fencing protection?

The other reason is that some kinds of ‘non-life’ insurance policies, which aren’t currently protected by statutory funds, have a longer-term element. Health and disability insurance are, in many ways, similar to YRT life policies. Some other general insurance products, such as warranties, professional indemnity cover, or those with slow-to-settle claims can also operate  over a long time horizon. In our consultation we ask: 

  • Should these non-life long-term policies also be protected by statutory funds?

Doing so would provide greater security but would also increase administrative costs for insurers (and so, probably, the cost of insurance).

Finally, one of the benefits of statutory funds is that, if an insurer gets into difficulties and can’t get enough money to pay everything it owes, the assets in the statutory fund get used to pay policyholders’ claims before most of the insurer’s other debt. We call this ‘policyholder preference in insolvency’. In our consultation we ask:

  • Should the benefit of preference in insolvency be extended to all policyholders, not just those included in statutory funds?

That would benefit policyholders but at the expense of other people the insurer owed money to (‘general creditors’, possibly including employees).

5. Policyholder security and a policyholder guarantee scheme

In our consultation we ask: 

  • Overall, are our proposals enough to provide the level of security that policyholders need, bearing in mind the cost of additional protection?

We also ask whether it is worth considering a policyholder guarantee scheme for New Zealand. Designing such a scheme is complex, and we have not yet assessed the costs. As such at this stage we’re only asking whether the idea merits further research and consideration.

Policyholder guarantee schemes are designed to cover some or all of a policyholder’s claims if their insurer fails. There are several ways a scheme could be funded but the most common approach is to charge insurers a levy, which builds up into a fund over time.

These schemes are reasonably common overseas but the kinds of policies they cover and the amount of a claim they will pay varies considerably. Some cover all policies, while others just cover compulsory insurance (for example, third party motor insurance in countries where there is no ACC). Some cover a wider range of insurance policies but limit payouts to a maximum sum or a certain percentage of claims.

The costs of a scheme are difficult to estimate because they depend on how often insurers fail and on how generous the scheme coverage is. We believe that insurers would pass on at least some of the cost to policyholders and the scheme may approximately increase insurance premiums by around 1% to 2% for policies that were covered.

In our consultation we ask:

  • Understanding the likely cost, do you think it is worth considering introducing a policyholder guarantee scheme for New Zealand?