Regulatory Impact Statement
Statement of the Problem and the Need for Action
Consumers of insurance products are particularly vulnerable to an insurer's insolvency. Assessment of an insurer's financial position is technical which makes it difficult for ordinary consumers to make a reasonable and informed choice regarding the financial strength and viability of their insurance provider. Insurers themselves are vulnerable to the risk of unusual or unpredicted liabilities and require rigorous records and a considerable level of technical competence to accurately assess their future risk and liabilities and calculate premiums.
The failure of an insurer can have disastrous consequences for policyholders, for people who have claims against policyholders and for the economy as a whole. These include: policyholders face potential financial losses as their claims may not be fully met; loss of confidence in the insurance market; and increased pressures on social welfare systems and government reserves. The collapse of HIH in Australia was a reminder of how real those risks are and of how serious the consequences of an insurer's failure can be.
The existing Ratings Act and the Deposits Act both attempted, in different ways, to protect consumers against the insolvency of an insurer. There are however issues with the current application of both these statutes. The Deposits Act no longer fulfils its original purpose of providing a realistic pool of funds to compensate policyholders in the event of an insurer's insolvency and the financial reporting requirements it imposes are outdated and inadequate. The Ratings Act, which requires insurers to obtain and publicise annual ratings of their financial positions, generally works well but does not apply to all types of insurance products. A rating, given by an approved ratings agency, provides a professional, expert and independent assessment of an insurer's financial strength and allows policyholders to compare insurance companies that provide the same or similar products and services.
Statement of the Public Policy Objective
The objective of the proposal is to promote good business practice in the insurance industry by requiring all insurers to get an annual rating and file standardised financial returns. This will ensure that consumers get better information about their insurers and their ability to meet future obligations. These measures will go some way to improving consumer protection and will enable consumers to make an informed choice of their insurance provider.
Statement of Feasible Options to Achieve the Desired Objective
The following five options were considered:
- The level of deposits required for unrated insurers could be increased.
- The Deposits Act could be repealed and no new requirements imposed.
- An annual rating could be required from all insurers and deposits could be refunded (preferred option).
- A rating could be required for any insurer that has not yet lodged a deposit.
- The existing deposit requirements for unrated insurers could be continued.
In addition, all insurers (except captive insurers1 and overseas reinsurers2) will be required to file statements complying with the relevant New Zealand financial reporting standard ("FRS") instead of the current requirements in the Deposits Act. These will be audited and filed for public inspection at the Companies Office.
Net Benefits of the Proposal
The advantages and disadvantages of the five options are summarised below:
| | Option 1 | Option 2 | Option 3
Preferred option | Option 43
existing / future | Option 5 |
|---|
| Encourages good practice | No effect | No effect | Strong effect | No effect | Strong effect | No effect |
| Discourages weak insurers from entering the market | Strong effect | No effect | Strong effect | Strong effect | Weak effect |
| Discourages weak insurers from staying in the market | Strong effect | No effect | Strong effect | No effect | No effect |
| Allows existing sound insurers to continue | Weak effect | Strong effect | Weak effect | Strong effect | Strong effect |
| Low compliance costs | No effect | Strong effect | Weak effect | Strong effect | Weak effect | Strong effect |
| Competitive market | Weak effect | Strong effect | Weak effect | Weak effect | Strong effect |
| Protection on liquidation | Strong effect | No effect | No effect | Weak effect | No effect | Weak effect |
| Equal treatment of similar insurers | Weak effect | Weak effect | Strong effect | No effect | Weak effect |
Preferred Option
Option 3: that all insurers should be required to have ratings and deposits should be refunded would:
- promote good business practice by increasing the rigour that both ratings and an improved financial reporting requirement would impose on insurers' financial systems;
- discourage unsound insurers from entering the market by requiring them to first meet certain standards and requirements;
- remove some at-risk insurers from the market who would be unable to comply with the new regime; and
- provide a logically consistent system for rating non-life insurers which would allow consumers to compare like insurance companies.
Further benefits include:
- standardised financial reports would require insurers to adopt good accounting practices which would demonstrate to them whether they are conducting sound business and are capable of meeting potential claims. This would enable insurers to identify and deal promptly with potential problems;
- ratings would give consumers the benefit of an external, independent and professional assessment of an insurer's financial status;
- consumers would be better able to assess insurer's financial positions and to compare different insurers;
- all insurers who have lodged deposits would get their money back (over $50 million is currently held), allowing them to put the money to more efficient use and offsetting the increased compliance costs;
- costs for insurers who already have ratings would be reduced since they would no longer be required to lodge a deposit;
- at-risk insurers unable to meet the increased costs and comply with the new regime are likely to be a high-risk business and, therefore, their removal from the market will reduce risks to policy holders;
- unnecessary compliance costs associated with specially preparing financial returns under the Deposits Act would be removed; and
- the Registrar of Companies will keep a register of insurers and will have an enforcement function under the new regime.
There may be some minimal costs associated with establishing a register. Further there may also be enforcement costs relating to potential prosecutions of insurers who carry on business without a current rating. These are also likely to be low as there may be only 1 to 2 cases a year for potential prosecution.
Consultation
Between December 2000 and December 2001, two rounds of consultation were conducted. These targeted key stakeholders and all unrated insurers. The second round, which was in the form of a discussion paper, focused on the specific proposals set out in this paper.
In addition to the public consultation, the following parties have also been consulted: Department of Prime Minister and Cabinet, Treasury, Ministry of Consumer Affairs, Te Puni Kokiri, Ministry of Justice, Public Trustee and the Insurance and Savings Ombudsman.
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