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2. Insurance


Review of Financial Products and Providers: Insurance

[ Last Updated 1 November 2006 ]


Within this section …

2.1 New Zealand Insurance Market

17. The New Zealand insurance market is best described as diverse and unique. This is a result of features such as the products offered and how they are delivered, the legal form of players, the domicile of the insurer's parent, composition of consumer consumption and the provision of public insurance through vehicles such as ACC and EQC.

18. With the current regulatory environment for insurance being extremely light-handed the market has invested significantly in developing a model of self-regulation that has led to a stable and well-managed market over time. Industry bodies such as the New Zealand Insurance Council ("ICNZ"), Health Funds Association of New Zealand (HFANZ), Investment Savings and Insurance Association ("ISI"), New Zealand Society of Actuaries (NZSA) and the Insurance and Saving Ombudsman (ISO) have been important players in promoting and facilitating this self-regulatory environment for their members and the insurance sector.

19. At a broad level there is low market penetration of some insurance products in New Zealand. Recent data implies that almost 50 percent of New Zealanders have no cover on their life or health.1 When probing the data further it becomes apparent that this figure may not accurately reflect the depth of coverage as the data also identifies a strong correlation between those who hold one policy and those who own a number of insurance policies. Therefore, the total number of people holding insurance coverage may in fact be substantially less.

20. This is consistent with general public discussion, not only around the level of under-insurance in New Zealand, but around the wider issues of high levels of personal borrowing and spending, and failure to prioritise the need to self-insure or obtain insurance to mitigate exposure to financial hardship due to unforeseen events. It has been reported that the level of under-insurance could in fact be NZ$1.8 to $2.8 billion2 meaning that roughly 40 percent of New Zealanders would not be able to financially withstand three months without income. Currently only approximately 32 percent of the New Zealand population have private health insurance. New Zealand-specific research suggests there is a public expectation that ACC3, work, friends, sickness benefits, credit cards, revolving mortgages and overdrafts would somehow enable them to "get by".4

21. The life insurance component of the sector has a total of 37 entities.5 However, the traditional life assurance market (relating to whole of life and endowment policies) is in decline, with total annual premiums in force for this area continuing to fall as the popularity of whole of life and endowment insurance wanes.6 In March 2003 total annual premiums in force for traditional life policies were roughly $274 million.7 By the end of March 2006 the total annual premiums in force were around $234 million.8 However, there has been a growth in the risk and group market of the life sector as demonstrated through the continued expansion of annual earned premiums in what is a relatively contestable market.9 The growth in risk products in the life insurance market has resulted in total life insurance premiums growing from $1.037 billion in March 2003 to $1.273 billion in March 2006.

22. General insurers provide a range of risk products and this diversity is promoted by a competitive market comprised of 104 entities.10 Total net written premiums have grown from approximately $1.65 billion in 2001 to $2.53 billion in 2005 with the largest area of growth being in the motor vehicle (commercial and private) market.11

23. The private health insurance sector is characterised by a strong interface with the public provision of health services. There are 11 insurers in a highly concentrated market where most players (almost 75 percent by number) are not-for-profit organisations that write a small number of premiums annually. These small insurers provide 23.5 percent of New Zealand's health cover (some totalling only $1 million in premiums annually).

24. The total number of New Zealanders with private health coverage tends to fluctuate more sharply than with other types of insurance products. Currently, there are approximately 1.354 million New Zealanders with private health insurance, representing approximately 32 percent of the total population.12 In comparison with insurance consumption trends generally in New Zealand, this is below the global average. These figures are in part due to the supplementary and complementary relationship private health insurance has with the public provision of health services in New Zealand.

2.2 Purpose of Insurance

25. The insurance sector is important not only to individuals, but to the financial sector, contributing significantly to the sustainable economic development of the New Zealand community. Specifically, there are six main areas where insurance contributes to sustainable economic development and Government's focus on economic transformation.

2.2.1 Reduces Risk Volatility among Households and Firms

26. Insurance enables households and firms who are least able to withstand unforeseen events carrying weighty financial consequences to transfer those risks to parties who are more able to manage the risks and withstand the events.13 This overcomes the need for a household or firm to self-insure by holding sums of capital to weather such events and enables them to stabilise their financial position over the long term. It also promotes efficient allocation of capital.

2.2.2 Facilitates Economic Activity

27. Innovation and entrepreneurship, fundamental building blocks of economic activity, are typically accompanied by higher levels of risk. Therefore, new business ventures are often dependent on the ability to avoid or minimise risk outside their control. As Arrow (1970) has described it,14

…insurance in the broadest sense, permits individuals to engage in risk activities that they would not otherwise undertake.

28. Take for example, the case of goods being transported distances for reasons such as firm production or to connect a buyer and seller. By covering the potential loss in transit, insurance facilitates exchange. Insurance may be a precondition for commercial activity (e.g. for borrowing/lending). It can also reduce the risk of costly interruption and even fend off liquidation altogether, smoothing the progress of trade and commerce for activities that may have previously been viewed as uneconomical. Hence, commercial access to insurance facilitates improved resource allocation within the economy.15

2.2.3 Provides the Capacity for Communities to Mitigate Risk

29. Insurers enable community risk to be managed more efficiently through risk pricing, transformation of the individual's risk profile, risk pooling and risk reduction. The greater the potential for loss the higher the premium charged (the price of that risk). In pricing risk, consumers adjust their behaviour to attain an optimal economic position. Hence, insurance products create an incentive structure for policyholders to undertake loss management activities or risk mitigation strategies, which can benefit the community at large.

2.2.4 Reduces Pressure on Government Welfare Programmes

30. Insurance can act as a substitute for or complement to Government welfare programmes and safety nets. Higher levels of private consumption of insurance products have been associated with, and some would argue correlated to, lower Government expenditure on Government welfare programmes.16 It lessens the pressure or dependence on Government to "rescue" communities following natural disasters. In addition, the need for insurance is more pertinent today given the current demographic transitions in New Zealand which will impact upon the provision of public goods and services, such as health care, in the future.

2.2.5 Provides a Capacity to Mobilise Savings

31. Life insurance products were some of the first vehicles to enable low income individuals to more effectively engage in saving and investing for the long term (e.g. insurance consumption can mitigate the risk that a consumer will need to call on their superannuation funds for financial hardship). This was due to the ability of individuals to purchase life insurance and savings contracts in small amounts on a regular basis over time, rather than to hold stores of capital (either liquid or illiquid) to overcome financially debilitating events.17 Through the pooling of funds and risks, an insurer becomes a part of the group of institutional investors.

2.2.6 Enables a More Efficient Allocation of Capital

32. At a high level, premiums collected from policyholders are mobilised and invested in capital markets. This has broader benefits for the economy as this stimulates growth of the capital market.

33. Insurance prices risk at two levels. First, by placing a price on the potential for loss, (which is done through premiums), and second, through the pursuit of particular rates of return through the insurer's investment activities. An insurer has a vested interest in information collection to evaluate individuals and firms in deciding whether they will offer insurance and at what price. This results in an efficient allocation of insurance risk-bearing capacity.18

34. The insurer has an advantage over individuals and firms (as do other intermediaries) in allocating capital efficiently as the insurer is able to better allocate funds to the most sound and efficient firms and investments.19 It is important that regulatory requirements do not interrupt and consequently stifle this valuable process.

2.3 Outcomes Sought

35. Given the benefits the consumption of insurance products provides to the economy, 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.

2.4 Reasons for Regulatory Intervention

36. Market imperfections impacting on the above outcomes, which may compromise the benefits that can derived from the consumption of insurance products are:

  • Information asymmetries and complexity;
  • Issues of transferability;
  • Unfair or fraudulent conduct;
  • Expectations and confidence; and
  • Externalities.

37. It is not reasonable to expect the insurance sector to overcome these market imperfections on its own to achieve the desired outcomes of the Review of Financial Products and Providers ("RFPP"). Government intervention is necessary:

  • To complement market forces in increasing the capacity for the New Zealand economy to derive benefits from the consumption of insurance products, while attaining the desired Government outcomes from the insurance industry; and
  • For New Zealand to meet international guidelines and principles under, for instance, International Association of Insurance Supervisors ("IAIS") and Financial Action Task Force ("FATF").20

38. These market imperfections provide rationale for regulatory intervention in the insurance sector through prudential regulation and market conduct requirements.

2.4.1 Information Asymmetries and Complexity

39. By way of standard definition, asymmetric information is a situation in which one party to an economic relationship is better informed than the other. At different times in the ongoing association between the policyholder and the insurer, this can involve either party. Consequently, a number of adverse selection issues arise. This means that due to the incomplete or inaccurate information held by one party, the transaction may be biased in favour of the other party.21 Hence, economic efficiency and its benefits may be compromised.

40. Government can assist the market through regulatory intervention directed at these asymmetries. Specifically, the proposed regulatory tools are focused on overcoming information asymmetries in relation to the product, the insurer as an entity, and disclosure by the policyholder.

2.4.1.1 The Product

41. For an individual to make an informed choice about whether an insurance policy is appropriate for their personal financial needs, it is important the consumer is aware of the features of the product they may purchase. Well-informed consumers can, in addition to determining the appropriateness of the insurance product to their needs, undertake comparisons between similar products being offered by other insurers.

42. Some of the primary details a consumer needs about the product before entering into a contract of insurance relate to, for example, the terms (including any exclusions), total sum insured, what costs the policyholder must bear, price of the policy, data which allows comparison between products, and the level of insurance they require. The reasons a consumer may not have the information to determine which product is most appropriate for them may include:

  • How often people take out an insurance product and the ease of understanding of the product;
  • The longevity of some products making it difficult for a policyholder to adequately assess their individual needs at a point in time a number of decades away;
  • Lack of knowledge of the costs involved in self-insurance. For example, the cost of cardiac surgery in a private hospital or angiography services vs the cost of private health insurance;
  • Lack of consistent information making it difficult for consumers to compare products;
  • Lack of desire or resources to interpret or internalise the information available; and
  • Lack of incentives for insurers to provide information beyond a certain point.

43. Due to the information asymmetries relating to insurance products, some of the regulatory tools needed to overcome information asymmetries involve improved product disclosure. The types of product disclosure are discussed in the Market Conduct section.

44. Financial intermediaries can play a role in informing policyholders about the appropriateness of a product for their needs. This can assist in overcoming some of the problems associated with asymmetric information and consumers' ability to determine the optimal product on offer. Research shows that consumers regularly seek the assistance of insurance intermediaries to obtain advice on the appropriateness of insurance products for their personal needs.22 This is due to the experience and expertise held by many intermediaries.

45. However, at times, intermediaries can suffer from unaligned incentives to provide policyholders with optimal information. For instance, where an intermediary's remuneration is commission-based there may be incentives to offer products based on commissions received rather than a product which will best meet the consumer's needs. In addition, due to the irregularity of purchasing an insurance policy or it being unlikely that consumers will make repeat purchases, some intermediaries may not have strong reputation incentives to adjust behaviour.

46. The Financial Intermediaries discussion paper sets out the generic discussion on how the skills and competencies of intermediaries can be enhanced. Hence, the Market Conduct section focuses more on insurance specific regulatory tools that are proposed in relation to intermediaries providing advice on insurance products and providers.

2.4.1.2 The Insurer as an Entity

47. The stability of an insurer is important to the policyholder as it will impact on whether the insurer has the adequate longevity to provide cover when an insured event arises. Without appropriate insurer longevity, the policyholder will have to bear the costs of the insured event. In some circumstances, this can be financially debilitating, and potentially contribute to the financial ruin of the policyholder.

48. An insurance promise can be complex for the insurer to determine in relation to the probability of the event arising and the ability to assess the size of that promise. Even if information about associated risks to the insurer's stability were provided in a timely manner some consumers may lack the necessary skill set to usefully interpret it to achieve the optimal individual benefit. In that regard, it is appropriate to consider what form this disclosure should take. Sometimes the problem cannot be fixed by disclosure alone. This is where licensing and prudential requirements become important, since they encourage insurers to focus on stability issues. Discussion of regulatory tools to facilitate insurer stability are set out in the Licensing and Prudential Requirements section and the Monitoring and Supervision section.

49. As is the case with product disclosure, insurance intermediaries play a role in disseminating information to consumers about the longevity of the insurer. The role of an intermediary in informing consumers about the stability of the insurer is discussed in the Market Conduct section.

2.4.1.3 Disclosure by the Policyholder

50. To appropriately underwrite the risks of an individual, the insurer is reliant on the consumer disclosing all material circumstances relevant to the contract. Failure to do so results in a scenario where not all risks attached to the policy are underwritten, and therefore, risks in a policy are not correctly priced by the insurer. At the same time, it is difficult for the insurer to identify all potential risks of a policyholder, but the policyholder may be unaware of what is material to a prudent insurer. This creates an adverse selection issue which may result in a contract that is inadvertently biased in favour of one party over the other.23 The consumer may unknowingly be left without cover, or the insurer exposed to unidentified risk.

51. From a market conduct perspective, a further regulatory tool available to help resolve some of the issues relating to imperfect or asymmetric information is improvements in the level of public education around insurance products and financial knowledge generally. Issues regarding materiality, non-disclosure and mis-statement, and remedies are discussed in the Market Conduct section.

2.4.2 Issues of Transferability (Lock-In)

52. Some insurance products exhibit characteristics of lock-in due to the inability of a policyholder to transfer between providers. This is because material circumstances of the policyholder can change over the duration of the contract. If the consumer were to transfer between providers, material circumstances that have developed would require re-underwriting. These risks may be subject to exclusions, and higher excesses or increased premiums may apply. Consequently, the policyholder will either be in an inferior position, or in some circumstances, unable to obtain cover at all.24 The significant impacts of change for the policyholder highlights the importance of an insurer's longevity.

53. For example, at the time a consumer enters into an insurance contract, they may have received all the necessary information to make an optimal decision regarding the appropriateness of the product and provider for their needs. Some time later, during the term of the contract, the consumer receives information about detrimental changes to the product or stability of the insurer. In the same time period there may have been significant changes in the personal circumstances of the policyholder (such as deterioration of their health). Therefore, even with the existence of simplified information about either the product or the insurer's stability, the policyholder may be unable to act on the information due to the prohibitive cost of transferability noted above. Hence, the policyholder has no choice but to bear the cost of changes outside their control.

54. Regulatory intervention can be utilised to limit the negative effects of lock-in experienced by consumers of certain insurance products. For instance, prudential regulation can constrain excessively risky behaviour or poor risk management by the insurer through encouraging more effective corporate governance and risk management. 25 Also, the Regulator may focus on applying more of the intervention powers to insurance products that exhibit problems of lock-in and where an insurer is experiencing financial distress. Regulatory tools to help overcome transferability issues are discussed further in the Licensing and Prudential Requirements section and the Monitoring and Supervision section.

2.4.3 Unfair and Fraudulent Conduct

55. There is scope for some insurers, policyholders and intermediaries to partake in practices that unfairly disadvantage or commit fraud against another party to the insurance arrangement. For instance, an insurer or its directors may misrepresent the stability of the entity, or provide disclosure which is misleading about a product. The policyholder may misrepresent or withhold information crucial to the underwriting of a policy. An intermediary may not disclose information that enables a policyholder to determine whether they are acting in the policyholder's best interests, for instance, whether they are tied or independent.

56. How regulation can minimise the incentives for parties to partake in unfair or fraudulent conduct is discussed in the Licensing and Prudential Requirements section, Monitoring and Supervision section, Market Conduct section and the Financial Intermediaries discussion document.

2.4.4 Expectations and Confidence

57. There is an expectation that New Zealand should be meeting international guidelines and principles relating to the supervision of insurance, where it is currently not doing so. Non-compliance presents reputation risks for the New Zealand insurance sector. Hence, the proposed insurance regulatory framework should address this issue.

58. The existence of ACC and EQC has created uninformed (and perhaps unrealistic) expectations about the support provided by these forms of public insurance. Public pressure on Government to assist communities when natural disasters occur may also contribute to a blurred understanding of where individual responsibility lies. In addition, research has identified that consumers have an expectation that work, friends, sickness benefits, credit cards, revolving mortgages and overdrafts would somehow manage them to ‘get by'.26 While this expectation continues it is unlikely that consumer participation in the insurance sector will improve.

59. With any Government regulatory intervention there is an inherent risk that consumers develop an expectation that the regulation provides them with a Government guarantee. To overcome this moral hazard27 issue, it is important Government reinforces that financial decision-making responsibility is still the responsibility of the individual.

60. Failure to identify and account for factors such as expectations and confidence, which impact on consumption, affects the appropriateness of regulatory tools used to resolve market imperfection issues. Tools designed to mitigate moral hazard risks are looked at further in the Licensing and Prudential Requirements section, Monitoring and Supervision section, and the Market Conduct section.

2.4.5 Externalities

61. We consider there are limited externalities to justify regulatory intervention in the case of insurance. Distress or failure in the insurance sector is not likely to pose a risk to the soundness of the financial system. This reflects several factors, including that insurance is not a significant source of intermediation or payment system functions, and that there are only limited inter-connections and exposures between insurance and other parts of the financial system.

62. However, we believe large-scale distress or failure in the insurance sector could have potentially significant adverse impacts on the wider economy. For instance, through business interruptions due to the unavailability of insurance cover; especially, where parts of the economy are dependent on a small number of dominant insurers.

63. There is also an externality in terms of the impact of insurance failure on the international reputation of the New Zealand financial system. A significant spate of distress or failure in the insurance sector could be damaging to the reputation of the financial system as a whole, with potential flow-on effects to the financial system and markets.

64. Conduct of an insurer regulated under New Zealand insurance law can also created implications for the New Zealand insurance sectors international reputation. It is important the regime does not provide incentives for entities to arbitrage into the New Zealand market and compromise the sector's reputation through its conduct overseas.

2.5 Objectives

2.5.1 Prudential Regulation28

65. The objectives for prudential regulation are:

  • 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.

2.5.1.1 Promote Policyholder Confidence in the Soundness of the Insurance Sector

66. Promoting policyholder confidence in the soundness of the insurance sector is closely linked to the other objectives of the regulatory framework. Soundly governed insurers who have good financial disciplines and manage risks effectively, policyholders who are well informed, and a competitive market are all factors that will contribute to this objective.

2.5.1.2 Encourage Soundly Governed Insurers

67. The core business of an insurer is the management of pools of risk. An insurer needs to be soundly governed to facilitate a well-run business, and to minimise the risk that the insurer will not be able to meet its liabilities as they fall due.

68. Encouraging sound governance that is integrated into the insurer's business supports the Government's objective of providing policyholders with confidence in the insurance sector. It further facilitates effective risk management both in the insurance sector and, depending on consumption of insurance products, the broader economy.

2.5.1.3 Ensure Timely and Orderly Resolution of Distressed Insurers

69. To provide confidence in the sector that encourages participation by consumers, it is important that the Regulator exert a proactive stance in the performance of its role. For instance, in relation to the potential for a consumer to be locked in to their long-tail insurance product (e.g. life insurance) the Regulator may focus on a timely and orderly approach to resolving problems that put the insurer at risk of failure. In relation to short-tail insurance (e.g. property insurance) without issues of transferability or lock-in the focus may be more on orderly exit from the market. On the basis that different classes of insurance pose different risks there may be more reason for the Regulator to intervene in one class of insurance than another. It is also important that insurers are encouraged to resolve their own problems, which could be achieved through providing the Regulator with a wider range of intervention tools that allow a more granulated approach to the issues faced by financially distressed insurers.

2.5.2 Market Conduct Regulation

70. The objectives for market conduct regulation are:

  • 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.

2.5.2.1 Promotion of Well-informed Insurance Policyholders

71. A key component of the regulatory regime is fostering policyholders who are well informed about both the products they are purchasing and the providers of these products. This will facilitate an environment in which the policyholder can assess the appropriateness of the product and provider to their individual needs. That is, they can determine whether the policy terms, price of the risk and characteristics of the insurer are compatible with their individual needs.

2.5.2.2 Promote the Effective Use of an Intermediaries Market

72. Insurance intermediaries play a valuable role in connecting consumers and insurers. The expertise and experience of an intermediary can overcome some of the information issues that face a consumer in determining the appropriateness of a policy and insurer for their personal needs. In addition to this an intermediary can help mitigate adverse selection issues which face insurers. This function of the intermediary facilitates an efficient allocation of resources in the sector.

2.5.2.3 Deter, Detect and Minimise Fraudulent Conduct

73. The objective to detect, deter and minimise fraudulent conduct is applicable to the insurance framework on a number of levels. Regulation that detects and minimises the incentives for participants to partake in such behaviour may range from simply informing participants to placing prohibitions on certain actions. It will also involve meeting the recommendations outlined by the Financial Action Task Force (FATF).29

Questions for Submission

Q1. Are the outcomes being sought from the insurance sector appropriate? If no, are there additional outcomes that should be sought?

Q2. Are the reasons for regulatory intervention correctly identified? Are there other reasons for regulatory intervention that also require identification?

Q3. Are the objectives for insurance legislation appropriate? Are there any other objectives which should be included?

2.6 Current Regulatory Framework

74. Historically, New Zealand insurance legislation has focused on protecting the interests of policyholders driven by the fact that insurance contracts are based on utmost good faith. A policyholder, depending upon the class of insurance, will be reliant on a promise that may not eventuate for potentially 30 or 40 years. In addition, it is difficult for a policyholder to determine the long-term viability of their chosen provider. The regulatory framework was driven by disclosure, based on the premise that appropriate disclosure would enable consumers to make informed decisions and bear the risk of these decisions themselves.

75. The main tools used in the regulation of the New Zealand insurance sector are outlined below.

2.6.1 Deposit Requirement

76. A de facto registration system operates by virtue of the Insurance Companies Deposits Act 195330, Life Insurance Act 190831, and Mutual Insurance Act 195532, which require insurers carrying on insurance business in New Zealand to lodge a specified monetary deposit with the Public Trustee. The entry deposit was established to provide protection to policyholders in the event of the insurer's failure, where the funds could then be distributed amongst policyholders of that provider.

2.6.2 Ratings

77. Insurers offering disaster and property insurance33 in New Zealand are required under the Insurance Companies (Ratings and Inspections) Act 1994 to obtain a rating from one of the approved rating agencies.34 Each rating must be registered with the Registrar within five days of receipt, and disclosed to consumers prior to entering into or renewing a contract of insurance. Any downgrade to the insurer's rating must be disclosed to the Registrar and to the public, within 10 days of that downgrading. Those insurers failing to comply with the requirements will be subjected to monetary fines, as will its directors. Consumers have the right to avoid the contract if there is a failure to disclose a mandatory rating.

2.6.3 Insurance Contracts

78. There are a number of statutes that specifically govern the contractual relationship between the insurer and policyholder, including the Life Insurance Act 1908, Marine Insurance Act 1908, Insurance Law Reform Act 1977 and Insurance Law Reform Act 1985.

2.6.4 Insurance Intermediaries

79. The statutes that govern the insurance intermediary's contractual relationship are the Insurance Intermediaries Act 1994, which relates to insurer liability on the payment to the intermediary of premiums by the policyholder and claims money by the insurer; and the Insurance Law Reform Act 1977 which defines when an intermediary is the agent of the insurer. There are no insurance specific formal conduct requirements.

2.6.5 Financial Reporting

80. Reporting requirements for insurers vary. Insurance products that include the issuing of securities must comply with the Financial Reporting Act 1993 (FRA), including full reporting, auditing, and then lodgement with the Companies Office for public viewing. Those who are not issuers for the purposes the FRA, but take on a company structure must prepare financial reports and obtain an audit. An exemption process exists for small entities that meet prescribed criteria. Insurers that do not take a company structure fall outside the FRA, but have specific reporting requirements in the legislation that relate to their legal form (i.e. Friendly Societies and Credit Unions Act 1982).

81. Other financial reporting requirements are outlined in the schedules to the insurance legislation. For example, a life insurer must produce an annual, audited statement of its revenue account and financial position in accordance with the Life Insurance Act 1908.

2.6.6 Monitoring and Supervision

82. The primary supervisory tool across the industry is the lodgement of returns with the Insurance and Superannuation Unit (ISU) on behalf of the Chief Executive of the Ministry of Economic Development. The Government Actuary receives a copy of life insurance returns for review.35 The insurer is required to complete a number of schedules as included in the Insurance Companies' Deposits Act 1953 and/or the Life Insurance Act 1908.

83. Under the Insurance Companies (Ratings and Inspections) Act 1994, the Registrar of Companies has the power to require insurers to produce documents for the purpose of determining whether the insurer is able to pay its debts as they fall due. An inspector can be appointed for this purpose. The inspector's report becomes admissible in liquidation proceedings. Under that Act, the insurer can be required to stop writing new business either temporarily or permanently. This power is also contained in the Life Insurance Act 1908 in relation to life insurers only.

2.6.7 Exit Management

84. The two primary tools for managing the failure of an insurer are statutory management and judicial management (applying to life insurers only).

  • The Life Insurance Act 1908 makes provisions, upon application, for the court to appoint a judicial manager to a life insurer:

    …where it appears that there is a likelihood that the company is, or will be unable to meet any of its liability to policyholders.36

  • The Corporations (Investigation and Management) Act 1989 (CIMA) applies to any corporation:37
    1. That is or may be operating fraudulently or recklessly; or
    2. To which it is desirable that the Act should apply –
      1. For the purpose of preserving the interests of the corporation's members or creditors; or
      2. For the purpose of protecting any beneficiary under any trust administered by the corporation; or
      3. For any other reason in the public interest.

2.7 Problems Identified

85. The problems identified with the existing insurance regulatory framework that need to be addressed are outlined below.

2.7.1 Lack of Merit Requirements

86. There is no merit licensing procedure for providers of insurance in New Zealand either on entry to the market or an ongoing basis. Lack of a basic minimum qualitative standard is problematic because there is no means of controlling the quality of entrants to the market or continuing vetting to assess whether an insurer should remain.38 Internationally a combination of qualitative and quantitative measures are recommended to more effectively assess an entrant's ability to perform, and for ongoing purposes.39

87. The requirement to lodge a deposit under the Insurance Companies Deposits Act 1953, Life Insurance Act 1908 and Mutual Insurance Act 1955, is a quantitative measure. It was originally intended to provide policyholder protection. However, as a licensing requirement it:

  • Operates as a blunt quantitative tool, merely restricting entry to those who can raise the monetary amount for the deposit. The current amount does not preclude the entry of under-funded insurers, and is low by international standards;
  • Does not specifically address qualitative factors such as governance, risk management and solvency assessment, and has no relationship to an insurer's total policyholder obligations, investment or other risks40; and
  • Is efficient from a process perspective, but compromises economic equity considerations, since it is difficult to find one optimal level that accounts for different types of insurance and for providers of different scale and scope.

88. There is no publicly available centralised register of insurance providers in the financial sector. Consumers are unable to verify whether an insurer is in compliance with New Zealand regulatory requirements. Publicly available information on insurers is limited.

2.7.2 Inconsistent Governance Requirements

89. Registration under different Acts provides different levels of governance and negative assurance requirements for key functionaries in the entity (eg directors, officers, and senior management). This inconsistency means that holders of the same type of policy from different legal entities may not be afforded the same protections. Having inconsistent principles of governance across the sector fails to meet the Government's objective of facilitating contestability and competitiveness. Further, it fails to meet the desired regulatory attribute of reducing regulatory arbitrage.

2.7.3 Inappropriate Governance Requirements

90. Governance requirements for certain expertise to ensure soundly governed entities in the insurance market do not exist. Also, New Zealand has a number of obligations under international treaties and arrangements, with which it is seeking to comply as part of this review. For instance, none of the existing formal requirements in New Zealand meet the fit and proper person tests under FATF recommendations41, OECD guidelines42, and IAIS principles43.

2.7.4 Ratings

91. Ratings are required for disaster and property insurers only. This creates inconsistency across the sector, does not allow competitive neutrality due to the differing models used by the approved ratings agencies, and permits regulatory arbitrage.

92. At the time of the 2001 review of the existing mandatory ratings regime there was a recognised need for improved internal management rigour within each insurer. When this approach was retained there was no capacity for the Ministry of Economic Development ("MED") to consider other regulatory tools such as formalised prudential regulation.44

2.7.5 No Formal Requirement for Separation of Classes of Insurance

93. Unlike some other jurisdictions,45 New Zealand has no formal requirements for an insurer to only offer insurance business (ownership separation),46 to conduct each class of insurance business through separate legal entities (legal separation),47 or to maintain separate book-keeping and funds for each class of insurance business (accounting separation with segregated funds).48 This means there are intra-class contagion risks, difficulties in applying actuarial solvency standards and a limited ability for the Regulator to licence and monitor effectively.

2.7.6 Lack of New Zealand Policyholder Asset Ring-fencing for Foreign Insurers

94. There is no requirement that a foreign insurer's assets in New Zealand be kept separate from its home jurisdiction assets. As such, there is a failure to adequately protect New Zealand policyholder interests at time of insolvency. This is of particular concern where the insurer's home jurisdiction gives statutory priority to policyholders in that home jurisdiction.

2.7.7 Public Reporting

95. Not all insurance providers are required to report financial statements under the Financial Reporting Act 1993 ("FRA"). Requirements for public reporting of financial statements that are audited only apply to certain entities over a specific size. This is not consistent with international recommendations on reporting requirements for insurance entities.

96. Reporting is not a costless exercise. Despite the significant number of insurers in New Zealand that have their parent domiciled in a foreign jurisdiction, the legislative framework does not provide the Regulator with the authority to accept reports provided to home jurisdiction regulators to meet some or all of the reporting requirements in New Zealand.

2.7.8 Insufficient Monitoring and Enforcement Tools

97. Assessment of whether an insurer is responsibly managing the risks its business is exposed to or the underlying financial viability of its book is difficult. This is amplified by the lack of legislative powers afforded to the Insurance and Superannuation Unit49 to call for further information to discharge the assigned supervisory role. 50 The main problems inhibiting assessment are:

  • Time lag in information. Current reporting to the Regulator is nine months following the close of the financial reporting period. This results in the disclosure providing limited meaningful information as problems that have developed may have already reached a point where they cannot be readily resolved.
  • Lack of financial information. The existing schedules in insurance legislation provide limited information for the assessment and understanding of the insurer's solvency position based on the performance of the classes of insurance business an insurer may undertake.
  • Inability to call for information. There are limited circumstances under which the Regulator can call for further information and no ability to change the frequency of reporting by the insurer.

98. Supervisory tools that allow proactive risk management and timely corrective action across the insurance market do not currently exist. There are some standards that must be met (e.g. reporting, deposits, and for disaster and property insurers, ratings), which are subject to fines where breached. However, in terms of enforcement powers there is little else. There is a need for more tools than monetary penalties to provide flexibility of response in supervisory actions and to create appropriate incentive structures.

2.7.9 Managing Distress Limited

99. The powers to manage financially distressed insurers are either non-existent or too strong; for a large part of the insurance market there is little in between. There are limited regulations that can be applied by Government prior to exit under the investigation sections in the Corporations (Investigation and Management) Act 1989 (CIMA) and under the Life Insurance Act 1908. The investigation powers contained in these acts are not granulated sufficiently to provide optimal intervention outcomes.51

2.7.10 Exit Tools Blunt

100. The existing regulatory exit tools applying to insurers are in the nature of a final step and for use in drastic cases. In this sense, statutory management and judicial management are blunt tools. There is also an inability for the Regulator to direct the actions of the manager appointed under the existing tools.

101. The threshold for intervention under CIMA is fairly high.52 The insurer must either be operating fraudulently or recklessly, or any action taken must be to preserve the interests of members, shareholders or creditors (including policyholders) or to act in the public interest, where those parties are not able to be adequately protected under the Companies Act 1993 or any other lawful way. CIMA is designed to deal with corporate collapses of such magnitude that the normal legal procedures available are inadequate.

102. Although the judicial management regime applying to life insurers under the Life Insurance Act 1908 has an emphasis on carrying on the business and preserving assets, it also sets out a process for a scheme of transfer of policies and assets, and for liquidation. The criteria for intervention only relates to the likelihood that the insurer is, or will be unable to, meet its liabilities to policyholders. Therefore, this mechanism only covers performance based on quantitative criteria not qualitative criteria.

103. While judicial and statutory management provide the option of "trading out" of the situation, this is not commonly done. The procedures are more focused on exit than rehabilitation, providing no clear interim tools to assist a financially distressed insurer, but rather relying on the discretion of the manager, once appointed, to decide on the best course of action, without the Regulator having the power to direct the actions of the manager. No other statutory tools for exit are available to the Regulator in the current legislative framework.

2.7.10.1 Inconsistent Treatment of Insurance Categories

104. There is a lack of consistent treatment and prudential oversight of products that present similar risk to consumers. This is due to the different types of requirements adopted by industry associations. From the perspective of an insured, oversight of the insured person's insurer's business activities and solvency is determined by whether the insurer is a member of an industry association or not. Therefore, policyholders of one product class are afforded differing levels of protection depending on the association their provider is a member of.

2.7.11 Limited Regulation of Insurance Intermediaries

105. There is no conduct legislation that governs the practices and quality of insurance intermediaries outside of the Consumer Guarantees Act 1993 and the Fair Trading Act 1986. This may cause differing standards in the insurance market that can inhibit efficient matching of consumers with insurers.

2.7.12 Insurance Contract Legislation

106. There are a number of existing statutes that specifically govern insurance contracts, which causes confusion in the market. Some of the legislation is out-of-date or not consistent with New Zealand conditions, specifically:

  • There are problems relating to non-disclosure and mis-statements, including:
    1. That the duty to disclose is not understood by policyholders,53 is uncertain and can create unfairness;54 there is no obligation on the insurer to ask questions;55 and there is limited understanding by policyholders that there is a duty to disclose matters outside the scope of any questions asked;56
    2. The all or nothing remedy of contract avoidance is disproportionately harsh on policyholders57 (i.e. there is a lack of distinction in the consequences of innocent, negligent and fraudulent non-disclosure,58 there is absence of a need for a causal link between non-disclosure and loss, and a lack of reciprocity in remedies);
    3. A lack of alignment with the law on misrepresentation;59 and
    4. Consumer expectations that underwriting occurs at contract formation rather than at the time of claim are not always being met.

  • The registration system for assignments and mortgages of life policies is out-of-date, is not widely used and is not consistent with New Zealand conditions. For instance, it still requires presentation of paper policy documents to the insurer, placing unnecessary transaction costs on the process.
  • There are no legal requirements relating to the form, content and timing of product disclosure of risk-based insurance products. This is inconsistent with other products in the financial sector. Consequently it is difficult for consumers to compare products from different providers, and to be well informed of the particular details of the contract applying to them prior to the commencement of the insurance policy.
  • There is a greater need for clarity around when an intermediary is the agent of the insurer or agent of the policyholder. Product disclosure obligations on the insurer and intermediary also need to be addressed to balance the incentives for efficient contracting.

2.7.13 No Legislatively Required Enhanced Solvency Regime

107. Although the insurance industry, through its associations and the New Zealand Society of Actuaries, has developed prudential frameworks and created solvency regimes, insurance legislation in New Zealand does not require compliance with formalised prudential or enhanced solvency requirements. 60 This is inconsistent with international practices outlined by the IAIS and OECD which promote risk-based management of organisational risks. Jurisdictions such as Canada, South Africa, United States, Australia and United Kingdom have all adopted risk-based solvency regimes that their insurers must comply with.

108. Although good self-discipline exists, it is difficult for an industry association to take enforcement action following identification of a member in breach of the industry association's or society's guidelines and requirements. Directives can be issued, but if there is non-compliance the primary remedy is expulsion from the association. This provides little benefit to policyholders of the insurer or in ensuring rectification of insurer breaches. More particularly, it places policyholders in a more financially vulnerable position where they experience prohibitive costs to change due to either being in the process of claim or because their policy is underwritten on the basis of their health, which has deteriorated. An insurer that is not a member of any association is not bound to comply at all with self-regulatory disciplines.

109. The financial reporting requirements under New Zealand International Financial Reporting Standards ("NZIFRS") outline requirements for the providers of insurance products to disclose their solvency position under NZIFRS4. Appendix C relates to life insurance and Appendix D relates to non-life insurance. The only requirement the standards specify is that the insurer disclose its solvency position.

Questions for Submission

Q4. Do these problems accurately reflect issues in the current insurance sector? Is the magnitude of these problems correctly identified in the discussion?

Q5. Are there any other problems which have not been identified?

2.8 Research Tools

110. We have considered recommendations from the International Association of Insurance Supervisors,61 Organisation for Economic Co-operation and Development,62 European Union,63 International Actuarial Association and other academic literature.

111. The comparative analysis undertaken covers the jurisdictions of Canada, Singapore, South Africa, United Kingdom, Trinidad and Tobago, and Australia.64

112. The principles of regulatory design for the proposed insurance regulatory framework have been applied in accordance with the Legislation Advisory Committee Guidelines65 and the core regulatory design principles66 of efficiency, effectiveness, transparency, clarity, and equity, under the Code of Good Regulatory Practice, as discussed in the Overview of the Review and Registration of Financial Institutions discussion document.

1 Blackwood King Adpartners, Oct 2005, AIA Life Matters Survey, Commissioned by American International Assurance New Zealand.

2 Weir, J. (2005), Kiwis’ spend-up bypasses insurers, Dominion Post 5 December 2005.

3 A contributing factor to the levels of under-insurance in New Zealand is the assumption by many New Zealanders that ACC and the Government will "take care of things" when times become tough. See Boyes, P. Insurance Competition Heats up in the Insurance Market, New Zealand Herald, 22 May 2006

4 Blackwood King Adpartners, Oct 2005, AIA Life Matters Survey, Commissioned by American International Assurance New Zealand.

5 Source: Insurance and Superannuation Unit, MED.

6 The decline in the popularity of traditional whole of life insurance products has been attributed to the taxation basis for life insurance business.

7 Source: Quarterly Return for Benefits Paid, March 2006 [links to ISI website] last accessed Monday 10 May 2006.

8 Source: Quarterly Return for Traditional and Risk Business, March 2006 [link to ISI website] last accessed Monday 10 May 2006.

9 Source: Investment Savings and Insurance Association Statistics [link to ISI website] last accessed Thursday 11 May 2006.

10 Insurance and Superannuation Unit, Structure of NZ Insurance Sector, Ministry of Economic Development.

11 Source: The Annual Insurance Industry Review 2005-06: Industry statistics [link to ICNZ website] last accessed Monday 8 May 2006

12 Source: Health Funds Association of New Zealand.

13 Carmichael, J., Pomerleano, M., 2002, The Development and Regulation of Non-Bank Financial Institutions, The World Bank.

14 Arrow, K., 1970, Essays in the Theory of Risk-Bearing, North Holland Publishing Co, Amsterdam and London.

15 Webb, I.P., Grace, M.F., Skipper, H.D., March 2002, The Effect of Banking and Insurance on the Growth of Capital and Output, Centre for Risk Management and Insurance Working Paper 02-1, Robinson College of Business, Georgia State University

16 Skipper, Jr., H.D., Starr, C.V., Robinson, J.M., 2000, Liberalisation of Insurance Markets: issues and Concerns, OECD.

17 Dickinson, G. Encouraging a Dynamic Life Insurance Industry: Economic Benefits and Policy Issues, Professor and Director, Centre for Insurance and Investment Studies, City University, Business School, London.

18 Skipper, Jr., H.D., Starr, C.V., Robinson, J.M., 2000, Liberalisation of Insurance Markets: Issues and Concerns, OECD.

19 Centre for International Economics, General Insurance Sector: Big benefits but overburdened, August 2005.

20 See International Association of Insurance Supervisors website and see FATF (Financial Action Taskforce).GAFI (Groupe d’action financiere sur le blanchiment de captaux), The Forty Recommendations, 20 June 2003.

21 See Abelson, P, (2000) Lectures in Public Economics, Published by Applied Economics, Sydney, Australia.

22 See studies referred to in the Market Conduct section.

23 See Rickets, M. (2002) The Economics of Business Enterprise: An introduction to Economic Organisation and the Theory of the Firm, Third Edition, Edward Elgar Publishing, Inc USA.

24 The FSA states, customers who have developed a medical condition (or any material condition) during the life of a policy are effectively ‘trapped’ with their existing provider. See FSA Consultation Paper 160, Insurance Selling and Administration: The FSA’s high-level approach to regulation.

25 J. David Cummins, Scott Harrington and Greg Niehaus, An economic overview of risk based capital requirements for the property-liability insurance industry, Journal of Insurance Regulation, Vol 11, No 4.

26 Blackwood King Adpartners, Oct 2005, AIA Life Matters Survey, Commissioned by American International Assurance New Zealand.

27 Traditionally stated, "moral hazard" is the presence of incentives for individuals to act in ways that incur costs that they do not have to bear. Moral hazard is one of those important market distortions based on imperfect information. It also relates to a dependency culture, incentive compatibility and the principal-agent problem. See Graham Bannock, R.E. Baxter, and Evan Davis, The Penguin Dictionary of Economics, 7th Edition, 2003.

28 Note the IAIS, OECD and other jurisdictions have the protection of policyholder interests as an objective for regulation in the insurance sector. Although not expressly listed, we believe the objectives stated above cover this issue.

29 FATF (Financial Action Taskforce).GAFI (Groupe d’action financiere sur le blanchiment de captaux), The Forty Recommendations, 20 June 2003, see the Licensing and Prudential Requirements section for more detail.

30 Deposit required for general and some other insurers is $500,000. Other amounts apply to entities which paid deposits under the Insurance Companies Act 1940 and Insurance Companies Deposits Amendment Act 1950.

31 Deposit required for life insurers ranges between $100,000 (1975) and $500,000 (1979 onwards) depending on the year the deposit was made.

32 Deposits required for mutual insurance associations relating to agriculture (currently there is only one such entity) vary, depending on the line of business, from $10,000 to $45,000.

33 This includes loss or damage to tangible property, and due to natural disasters and fire caused by those disasters. See section 2 of the act. It does not include life, health or non-property related insurance.

34 Current approved rating agencies are A.M. Best, Standard & Poors and Fitch Ratings.

35 This is in addition to the disclosure required under the Financial Reporting Act 1993.

36 Refer s 40A(2) of the Life Insurance Act 1908.

37 Refer s 4(a) and (b) of the Corporation (Investigations and Management) Act 1989.

38 There are requirements regarding structure and governance in the Companies Act 1993, Industrial and Provident Societies Act 1908, Friendly Societies and Credit Unions Act 1982, and Incorporated Societies Act 1908.

39 IAIS, Supervisory Standard on Licensing, October 1998.

40 Comment in relation to state laws in the United States requiring a fixed monetary deposit, Insurance Committee Secretariat, for OECD, Glossary of Policy Terms, 1999.

41 Recommendation 23, FATF (Financial Action Taskforce).GAFI (Groupe d’action financiere sur le blanchiment de captaux), The Forty Recommendations, 20 June 2003.

42 Jörg Volbrecht, for OECD, Insurance Regulation and Supervision in OECD Countries, 2000.

43 IAIS, Insurance Core Principles and Methodology, October 2003, ICP 7.

44 Ratings and Deposit Review carried out by MED in 2001.

45 Jörg Volbrecht, for OECD, Insurance Regulation and Supervision in OECD Countries, 2000.

46 For instance, the United States where specialisation was originally very strict but has moved to allowing ancillary subsidiaries that do non-insurance business. See Jörg Volbrecht, for OECD as above.

47 For example, South Africa. See Financial Services Board, Republic of South Africa, Guideline Paper for registration as a long or short term insurer, 1 September 2004

48 For example, Singapore. See Monetary Authority of Singapore website , and Canada see Updates to Justice Laws Web Site [link to Department of Justice Canada website]

49 This is part of MED.

52 As stated in the Law Commission’s Report on Life Insurance (2004, Report 87).

53 See for example Neil Campbell Insurance [1999] New Zealand Law Review 191.

54 Note that Australia discarded the prudent insurer test over 20 years ago, see section 21 Insurance Contracts Act 1984 (Cth) ("ICA". Also it appears to be the same position in Scotland, see The Law Commission (UK) and the Scottish Law Commission, Insurance Contract Law: A Joint Scoping Paper, January 2006, page34; Life Association of Scotland v Foster (1873) 11 M 351.

55 See Lambert v Cooperative Insurance Society Limited [1975] 2 Lloyd's Rep 485.

56 Quinby Enterprises supra. Misirlakis v NZ insurance Co Ltd (1985) 3 ANZ Ins Cas 78,893 (CA).

57 This is on the basis that the contract is a nullity and the insurer therefore sacrifices its right to the premium. There is an exception in the case of fraud, in which case the insurer may keep all premiums paid by the policyholder; see Rivaz v Gerussi Bros & Co (1880) 6 QBD 222 (CA) at 229.

58 Fraud in respect of non-disclosure means deliberate concealment or recklessness amounting to indifference about whether this occurs; see NRG Victory Australia Limited v Hudson [2003] WASCA 291.

59 The remedies under the Contractual Remedies Act 1979 apply subject to any provision in the contract that provides a remedy for misrepresentation. Insurance contracts usually provide for avoidance for misrepresentation, hence the contract provision will apply subject to the Insurance Law Reform Act 1977. As material misrepresentation (i.e. material mis-statement or material oral misrepresentation) often also involves material non-disclosure, where a contract does not state a remedy for misrepresentation, insurers generally o proceed on the basis of material non-disclosure rather than material misrepresentation. This reduces the relevance of the Contractual Remedies Act 1979 and the three year limitation applicable to life insurance contracts under section 4(1) of the 1977 Act.

60 This limits the ability of the regime to facilitate targeted effective risk management that reduces the probability, to an acceptable level, that the financial obligations of the insurer will not be met. See Torrance, D. (2001), The Development of Prudential Requirements for Private Health Insurers, Prepared for the IAAust Biennial Convention where this is outlined as one of the key objectives for solvency requirements of the Private Health Industry in Australia.

61 October 2003, see www.iaisweb.org.

62 See www.oecd.org.

63 See www.europa.org.

64 List of insurance regulators globally [Link to St. Johns University webpage].

65 For details see www.justice.govt.nz.

66 For details of each of these see the Code of Good Regulatory Practice


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