1. Executive Summary

1.1 Introduction

1. The current legislative framework for the regulation of insurance products and providers is light-handed, in many cases extremely out-dated and not consistent with internationally recommended practices. Given the existing regulatory environment, industry has developed a strong self-regulatory environment that instils a number of disciplines on the market. Proposals and options contained in the discussion paper are intended to address problems that have arisen with the existing regime and to continue a non-intrusive regulatory environment reinforcing existing market- and self-disciplines.

2. A number of factors have contributed to the need for Government to comprehensively review the regulatory framework for the insurance market and there is general consensus within the insurance industry that change is needed.

3. While most of the insurance sector is operating responsibly there are providers at the fringes who are not adhering to acceptable standards. The existing regulatory framework provides the opportunity for some providers to adopt practices considered by industry (and internationally) to be imprudent when providing insurance products to the public. In addition, a few providers register entities in New Zealand, but only provide products outside New Zealand, in order to hold out that they are supervised under New Zealand insurance law when they are not. These fringe providers are causing reputation problems for the New Zealand insurance market, which may impact on responsible providers.

4. Consultation has identified that some finance companies providing insurance are failing to comply with insurance regulation. This unduly exposes consumers, unjustly provides competitive advantages to the non-compliant providers and compromises the efficacy of regulation. The Ministry of Economic Development has also received a number of queries regarding whether a specific product or provider is or should be complying with insurance law. Without a centralised register of insurance providers the market is unable to ascertain this for itself.

5. The limited monitoring and enforcement powers under the current regime make it difficult for the Regulator to identify troubled insurers or to do anything to assist in their rehabilitation where they are identified. If a financially distressed insurer collapses there is little that can be done to limit the impact on consumers. This is especially the case where New Zealand policyholder assets are not ring-fenced from those of a foreign parent or where policyholders are trapped in products without the ability to obtain replacement cover on the same terms due to materially changed circumstances (e.g. health conditions). This puts policyholders in a vulnerable position. It also creates moral hazard for Government because we have an insurance Regulator (the Insurance and Superannuation Unit) that lacks enforcement powers. It therefore appears as if Government should be able to do something where insurers are financially distressed but in fact this is not the case.

6. Some insurance legislation is nearly a century old so does not reflect the insurance market today. Other insurance legislation has been developed in a piecemeal way, causing inconsistencies and differing levels of protections for consumers, and making it difficult for consumers to compare providers of similar products. The problems with the current legislation are is imposing unnecessary cost and impeding innovation. Hence, aligning the regulatory framework with current practices in a consistent manner across the sector and developing a flexible framework which accounts for future market changes is the desired approach.

7. Feedback from the insurance industry is that they are eager for the reform of the legislation and keen to resolve the above issues along with others discussed in this paper. In developing the proposals and options for a new regulatory framework for insurance products and providers, we have considered and accounted for the existing market disciplines and best practices. Much of what is set out below may be considered as giving regulatory backing to these. Our research and consultation has highlighted that most of the insurance market is or will be able to meet most of these requirements. Where insurers are not in compliance, we believe it is unlikely the cost of change will exceed the benefits derived.

1.2 Outcomes Sought

8. The overall outcomes Government is specifically seeking from the insurance sector are:

• A sound and efficient insurance sector;
• Facilitation of effective risk management;
• Confidence in the insurance sector that encourages participation by consumers, firms and providers; and
• Not to compromise or constrain contestability, competitiveness and innovation in the insurance sector.

1.3 Reasons for Regulatory Intervention

9. There are five main areas that give rise to the need for regulatory intervention in the insurance market.

• Asymmetries of information and complexity. Consumers need to be well informed about insurance products and providers through accessible, timely, and easily understood information in order to assess which product and provider will best meet their financial needs. Due to the complexity and long term nature of some insurance products insurers may not have sufficient incentives to ensure the consumer is provided with the information they need and in a readily understandable form.
• Issues of transferability. Consumers of some insurance products are unable to act upon information that alerts them to the vulnerability of an insurer's financial position. This is because they may be unable to obtain replacement cover from another insurer on similar terms, or at all, due to material changes in their insurable circumstances. As these policyholders have become effectively locked in to their policies they will be exposed to financially debilitating events, without the ability to take any meaningful mitigating action, if their insurer becomes insolvent.
• Unfair or fraudulent conduct. This is not a major feature of the insurance market, but potentially relates to all participants (insurers, intermediaries and policyholders). Practices which may be misleading, unfair, or fraudulent may arise because of unaligned incentives between the participants and the difficulties faced by individuals in monitoring the conduct or behaviour of others, especially since insurance products can be complex and of a long term nature.
• Expectations and confidence. Currently some entities operating in the market are taking advantage of the regulatory environment. This relates to feedback regarding some finance companies offering insurance products without complying with insurance legislation and a few New Zealand domiciled insurance companies only providing products overseas but holding out they are regulated under New Zealand insurance law when they are not. This is causing reputation issues for the New Zealand market both domestically and internationally. Also, consumers have uninformed expectations about the role of the Accident Compensation Corporation ("ACC"), the Earthquake Commission ("EQC") and Government in relation to the provision of cover, contributing to a lack of clarity about where individual responsibilities lie. Non-compliance with international best practice also has the potential to reduce confidence in, and damage the reputation of, the New Zealand insurance market.
• Externalities. Distress or failure in the insurance industry is unlikely to pose a risk to the soundness of the financial system, but potentially has international reputation impacts. Large scale events, like a natural disaster, may have some implications for the economy in terms of business interruption.

1.4 Objectives

10. The Government's objectives regarding the regulation of the New Zealand insurance sector are as follows.

1.4.1 Prudential Regulation

• To promote policyholder confidence in the soundness of the insurance sector.
• To encourage soundly governed insurers.
• To ensure timely and orderly resolution of distressed insurers.

1.4.2 Market Conduct Regulation

• To promote well-informed insurance policyholders.
• To promote effective use of an intermediaries market.
• To deter, detect and minimise the risk of unfair or fraudulent conduct.

1.5 Proposals and Options for Regulation

11. The proposals and options for the insurance regulatory framework are summarised below.

1.5.1 Proposal - Regulatory Boundaries

12. The proposal is that the insurance regulatory regime will be applied to all insurance products and providers who provide cover for any New Zealand or foreign risks, i.e. to all types of general insurance, life insurance, disability insurance, professional indemnity insurance, public liability insurance and health insurance.

1.5.2 Proposal - Licensing and Prudential

13. The proposals relating to licensing and prudential requirements are noted below. Most of these requirements are already being met by industry and complement the existing self-regulatory disciplines developed through insurance industry associations.

1.5.3 Options - Licensing and Prudential

14. The areas where further discussion and feedback is sought in relation to licensing and prudential requirements are set out below. In considering these requirements and providing submissions it is important to consider what problems the options will overcome and their consistency with the outcomes and objectives of the regulatory framework.

1.5.4 Proposals - Monitoring and Supervision

15. The proposals for monitoring and supervision requirements are set out below. These requirements are standard to any regime to enable effective monitoring and enforcement. Currently the Regulator does not have the necessary regulatory powers to effectively monitor the insurance market, and the insurance industry has recognised the need for improved tools for the purposes of supervision. While some insurers will be complying with some of the reporting requirements, many of the monitoring powers of the Regulator will be new. Therefore, we are keen to receive feedback on the appropriateness of these proposals and the potential impacts of change.

1.5.5 Proposals - Market Conduct

16. The proposals for insurance regulation relating to market conduct are noted below. They are intended to cover aspects of the conduct of providers in the insurance market. The requirements focus on clarifying who is responsible for disclosure of information about insurance products (plus what, how, and when) in order to deter unfair or fraudulent conduct. They also review the registration system for assignments and mortgages of life policies, and propose an approach for dealing with the contractual relationship between the insured and the insurer regarding the duty of disclosure and the insurer's remedies for non-disclosure and mis-statement.

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