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• Insurance
• 3. Requirements

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3.1 Principles of Regulatory Design for Licensing and Prudential Requirements

113. The International Association of Insurance Supervisors has remarked that it:

…firmly holds the view that it is first of all the responsibility of the insurer to manage its risks under both normal and adverse circumstances, so that policyholder interests are protected during ongoing operations and in the event of run-off or insolvency. The role of the regulatory regime and supervisory authority is to see to it that this responsibility is met. The regulatory regime and supervisory authority should thus give insurers the opportunity to manage their business and provide incentives for sound risk management appropriate to the size and nature of their business. ⁶⁷

114. Consistent with this, the Government is of the view that the core function of an insurance business is the prudent and effective management of the risks it underwrites and the subsequent risks its business is exposed to in both normal and adverse circumstances. The following proposals and options for prudential regulation, to be achieved through licensing and ongoing prudential requirements, are to establish a framework that will provide the insurer with the appropriate behavioural incentives to effectively manage its risks and solvency position. The licensing and prudential requirements are focused on maximising the insurer's responsibility to manage its business whilst also enabling the Regulator to assess whether insurers are prudently doing so.

115. The primary outcome sought from licensing requirements is prudent and honest management of an insurer by fit and proper persons with appropriate skills and experience. This is crucial to the capacity of the insurer's managers to appropriately identify and quantify risk. A secondary outcome sought is an appropriate level of funding for the business the insurer intends to undertake. Given there is no historical operational data at start-up it can be difficult to assess the probability of survival in the initial years of operation.

116. Establishing common licensing and prudential requirements that account for good governance and appropriate funding will institute consistent minimum access standards across providers of all classes of insurance business. Consequently, consumers will be afforded uniform levels of protection which can facilitate the confidence to participate in the insurance sector.

117. Ongoing licensing and prudential requirements regarding governance and solvency are key features of an insurance regulatory framework. The primary outcome sought from an enhanced solvency regime is the creation of the appropriate incentives for the insurer, in conjunction with risk management, to reserve in a manner that will maximise the probability of portfolio and entity survival under both normal and adverse conditions.

118. The regime seeks to provide for sufficient flows of information to give confidence to the market and the Regulator that the insurer's responsibilities are being met. This will facilitate sound risk management within each insurer, contributing to a sector that is resilient in the face of economic and financial shocks.

119. Additionally, requiring insurers to be licensed and supervised is an appropriate way of facilitating consolidated group supervision of insurers that provide a wide range of insurance products enabling the supervisor to adequately evaluate and address intra-group contagion issues, while also facilitating effective home/host supervision.

3.2 Background

120. An effective prudential regime places formal obligations on insurers relating to governance, merit licensing and solvency assessment, among other matters.

121. Governance and merit licensing are distinct from registration in that registration is a procedural system that identifies and records entity structures, sometimes with rules relating to the constitutional documents, management and legal form of an entity. It can also operate as a central register of the providers of insurance products in the market and one location for obtaining publicly available information filed by a provider. Registration is addressed in the Overview of the Review and Registration of Financial Institutions discussion document. Licensing is a system that authorises an insurer on the basis of merit to offer identified products within the insurance sector. Generally, these requirements must be continually fulfilled.

122. The international view is that a licensing regime provides two main benefits. First, licensing of insurers plays an important role in ensuring efficiency and stability in the insurance market;⁶⁸ second, licensing protects the public, and more particularly, uninformed insurance purchasers.⁶⁹

123. A licensing procedure is intended to operate as a de minimus benchmark, which will act as an initial vetting process to assess the likelihood of a new insurer keeping future promises. When applied on an ongoing basis it promotes a stable sector in which consumers can have the confidence to participate. However, there is no settled best practice model. Internationally, licensing requirements cover a variety of tools. The IAIS principles⁷⁰ set out that an insurer must be licensed before it can operate within a jurisdiction and that the requirements for licensing are clear, objective and public.⁷¹

124. Licensing procedures and ongoing supervision consistent with internationally accepted general standards, promote domestic and international confidence in the supervisory system,⁷² and create ease of access for insurers operating internationally (subject to meeting local requirements). In relation to prudential requirements, the IAIS core principles recommend that the supervisory authority require insurers to recognise the range of risks that they face and to access and manage them effectively. ⁷³

125. In the absence of a legislated solvency regime the New Zealand insurance industry, through its associations and societies, has invested significantly in developing the skill and expertise to ensure there is prudent management of the risks the industry participants underwrite and the insurance sector is exposed to. The discipline the industry has achieved regarding the management of solvency has meant the levels of self-regulation have contributed to a stable insurance sector over a number of decades. However, there are reputation risks to New Zealand in not meeting international guidelines and principles (for instance, under FATF and IAIS⁷⁴) regarding the monitoring of compliance and enforcement of these and other recommendations.

126. The licensing and supervision proposals for insurers will reinforce existing self and market discipline in the insurance sector by building on existing standards for insurers, enhanced monitoring by an independent government agency, and the capacity for effective legal enforcement where there are breaches of requirements or an insurer is in financial distress.

3.3 Criteria

127. The criteria the Regulator must have regard to in carrying out its functions and powers, and in setting standards are:

• The owners and operators have the expertise to undertake the business of insurance and can be held accountable;
• The entity has the capacity and capability to undertake insurance;
• No unnecessary barriers to entry and recognition of different legal forms;
• Sound management of the risks that are underwritten by the insurer and business practices that will prudently manage external risks the business is exposed to;
• Sensitivity to the diversity of the insurance market so that requirements do not adversely impact on the contestability and competitiveness of the insurance sector, beyond that which is required to promote a sound insurance sector, and can therefore facilitate innovation; and
• International principles and guidelines relating to licensing and prudential requirements.

3.4 Regulation Boundaries

128. Three main options for setting licensing and supervisory boundaries were considered in this review:

• Requiring only insurers that use protected words (such as "insurance" "assurance" or "insurer") to be licensed and supervised;
• Requiring only insurers of a "high impact" nature to be licensed and supervised – such as insurers providing long-tailed insurance policies (where the failure of the insurer would inflict potentially severe costs on policyholders) or insurers whose size or dominant market position could cause difficulties were they to fail; and
• Requiring all insurers, regardless of the types of insurance products they provide, or their size, to be licensed and supervised.

129. The proposal is that the insurance regulatory regime to be developed for New Zealand be applied to all insurance products and providers – i.e. to all types of general insurance, life insurance, disability insurance, professional indemnity insurance, public liability insurance and health insurance. The options for partial or targeted regulation have been considered, with the assistance of the Advisory Groups, but were discarded as they did not meet the Government's objectives for the insurance regulatory regime.

130. Specifically, the proposal is as follows.

3.4.1 Proposal - Supervision of All Insurance Business

131. Under this proposal, an entity wishing to provide insurance products or conduct the business of insurance will be required to be licensed and supervised by the Regulator.⁷⁵ This will apply to the provision of insurance to any persons (whether in New Zealand or offshore) where the insurer has a presence in New Zealand. It is not practicable to licence and supervise insurers that market their products in New Zealand via remote means, such as the internet; however, requirements regarding agents acting on behalf of an insurer will apply.

132. Although licensing and supervision will apply to all insurers, the requirements may vary, depending on the nature of the insurance products provided and the risks inherent in these products. Specifically, this will relate to the class of insurance business licensed and the short-tail or long-tail nature of the products concerned, which will mean there are differing solvency standards, reporting, and monitoring and intervention powers applied by the Regulator.

3.5 Licensing and Prudential Proposals

3.5.1 Governance Proposals

133. Sound governance principles, through the appropriate mix of incentives, can facilitate an environment where fit and proper persons with appropriate experience are held accountable for the management of risk and competing interests within the insurer. ⁷⁶ This has positive externalities of an effectively managed pool of risk in the insurance sector and broader economy.

3.5.1.1 Proposal - Registration of Legal Form

134. The ability to register in different legal forms will be retained. Insurers currently register their corporate form under the Companies Act 1993, Industrial and Provident Societies Act 1908, Friendly Societies and Credit Unions Act 1982, or Mutual Insurance Act 1955. These acts provide certain governance requirements already, which will assist with vetting. For mutuals, see the Mutuals' Governance discussion document.

3.5.1.2 Proposal - Registration as a Financial Service Provider

135. The proposal is that insurers must register as a financial services provider of insurance on a centralised register. This would be a procedural aspect performed by the Registrar of Companies and done in conjunction with the merit licensing process, which would be dealt with by the insurance Regulator. The registration process will include negative assurance checks on shareholders, directors and senior management (see the Overview of the Review and Registration of Financial Institutions discussion document). Positive assurance fit and proper person requirements will be applied by the insurance Regulator, as part of the merit licensing process and are set out directly below.

3.5.1.3 Proposal - Board Structure and Director / Senior Management Capability

136. The primary responsibility for fit and proper vetting of boards and senior managers lies with those responsible for making appointments, that is, the shareholders/members in the case of boards and the board and/or chief executive in the case of senior managers. While the Regulator will review shareholder, board and chief executive appointment decisions in line with FATF and IAIS requirements, the expectation will be that in almost all cases such a review will be light-handed because those making the appointment will have themselves already made appropriate checks.

137. Bearing this in mind, it is proposed that the Regulator will have the power to set requirements with which the insurer must comply in relation to:

• Composition. The number of directors, the mix and number of independent (or non-executive) directors and numbers of executive directors Different considerations will apply for mutuals where directors must also be members of the mutual entity or association (see Mutuals' Governance discussion document).
• Suitability of shareholders with control or significant influence, directors and senior management. The Regulator will have the power to apply a fit and proper persons test to directors and senior management. The fit and proper requirements will be designed to ensure that these parties meet appropriate expertise and experience requirements.⁷⁷ The suitability of shareholders with control of or significant influence over the insurer will also be vetted by the Regulator. This will include factors such as identification of the natural persons holding a direct or indirect qualifying participation in the applicant, negative assurance (e.g. no criminal convictions for money laundering), and whether there is connected shareholding with the applicant that would render effective supervision impossible. This needs to be done to meet the positive assurance principles and guidelines under FATF and IAIS.⁷⁸
• Functions and responsibility. Board sign-off of overall strategy, major action plans, internal risk management policy, pricing, performance objectives, auditing and actuarial functions, and legal compliance.
• External auditors. The supervisor would have the ability to dis-approve the appointment of an auditor to an insurer, so as to ensure that auditors have the appropriate skills and experience to perform the audit tasks in question.

138. The Regulator's review may involve the consideration of the following types of matters:

• Assess the competency of the board as a whole to ensure that there was a range of skills, experience and competencies needed to manage and supervise the insurer;
• Perform a qualitative assurance check to ascertain whether the senior managers and directors would have the skills, experience, integrity and competencies needed for their positions;
• Check with other relevant regulators, both domestic and foreign, to ensure that there were no adverse findings against potential appointees;
• Have the power to accept an assessment already done on the persons for fit and proper purposes in another jurisdiction; and
• Assess whether prospective appointees to senior management and board roles have conflicts of interest which will make them unsuitable for their proposed role. For example, in some cases a person who is a major customer of an insurer as well as a director of the insurer might have a conflict of interest.

3.5.1.4 Approval of Changes in Control Proposal

139. The proposal is that changes in control (significant owners, directors, senior managers) must be notified to, and approved by, the Regulator pursuant to the above criteria.⁷⁹

3.5.2 Categorisation Proposals

3.5.2.1 Proposal - Categorisation by Licence

140. The proposal is that an insurer must obtain a separate licence to offer or carry on the business of life, health and general insurance. These classes of insurance will be defined using both a purposive definition and an example product list, so that the categorisation gives the features (i.e. a description) of a class and then product examples for clarity and transparency when applying for a licence. It will also afford flexibility to the categorisation, allowing for innovation and products to change over time with a focus on substance over form. The Regulator will have the final approval of which class an insurer's application falls within.

141. Separation into classes of insurance business for the purposes of licensing and prudential supervision is important in order to:

• Limit intra-class contamination and contagion, i.e. the effects of unexpected losses or shocks for one class of insurance can be relatively contained so as not to detrimentally expose other classes of insurance business undertaken by the same entity;
• Enable the enhanced solvency standard for each class of insurance business to be effectively applied; and
• Recognise that each class of insurance business entails different risk and requires differing experience and expertise to manage the business effectively.

142. The sector currently provides products along these class categories, and once further consultation with industry as to the appropriate wording for the definitions has been completed, it is thought to be the optimal approach.⁸⁰

3.5.3 Proposal - Provide Products in New Zealand

143. The proposal is that in order to obtain a licence to operate as an insurer in New Zealand the entity must have a physical presence and provide products in New Zealand.

3.5.4 Proposal - Agent of the Insurer

144. It is proposed that agents will be able to apply for a licence to supply insurance products in the New Zealand market on behalf of overseas entities which do not have a New Zealand presence. Criteria will be set against which approvals are made by the Regulator, in line with the process of licensing on terms and conditions. This is a complex issue which will require further consultation once the rest of the framework is agreed on.

3.5.5 Solvency and Capital Proposals

145. In summary, it is proposed that there will be three requirements in relation to solvency and capital which an insurer will have to meet to obtain and then hold a licence.

• Solvency Support Plan (a start-up requirement).
• Flexible start-up capital requirement (a start-up requirement).
• On-going enhanced solvency requirements (a continuing requirement).

146. Start-up requirements (two in total), will be as follows.

• Produce a solvency support plan. The insurer will be required to present a solvency support plan to the Regulator outlining its proposed business and how in the future the insurer will meet the ongoing enhanced solvency requirement. The plan will have a three-year focus; and
• Meet a start-up capital requirement. The Regulator will approve the level of start-up capital, by assessing the solvency support plan and determining the appropriate level of capital required which is commensurate to that business.

147. Ongoing requirement (one in total).

• Enhanced solvency requirement. The insurer will have to comply with an enhanced solvency regime which relates to the class of insurance the insurer is licensed to operate (general, health and/or life). The enhanced solvency framework will determine the insurers appropriate level of reserving which will enable both:
1. Book survival (i.e. the level of capital will allow the insurer to meet the obligations of its insurance book); and
2. Entity survival (i.e. the level of capital will facilitate growth of the business, write new business etc).
• Because the enhanced solvency regime will determine the appropriate level of reserving, based on the obligations and risks of the insurer, the start-up capital requirement becomes redundant. Therefore, at the end of year one, because the first fully audited reports will be provided to the Regulator, the insurer will need only to comply with the enhanced solvency framework relevant to the class or classes of business the insurer is licensed to undertake. This is because the enhanced solvency regime will require reserving which will meet the insurer's actual obligations in accordance with the international approach as set out by the International Actuarial Association and the IAIS.

148. The solvency position of an insurer is an important component of effective prudential regulation. An insurer with a sound financial position is able to meet its obligations as they fall due in foreseeable and unforeseeable, normal and adverse conditions.⁸¹ Operating in a competitive and dynamic market, which is exposed to volatility in economic conditions, may impact differently on the insurer's balance sheet and in some instances on both sides of the balance sheet. This can have adverse implications for the sufficiency of reserves, commensurate to the insurer's risks, as well as the liquidity position of the business. It is important the insurer have an affirmative plan on how to manage these risks so existing conditions do not compromise the insurer's solvency position and capacity to meet obligations as they fall due.

149. We consider that mandatory requirements on solvency and capital are fundamental to the insurance regulatory framework for the purposes of promoting insurers to internally manage their financial strength while also achieving the Government's regulatory objectives. For this purpose, the IAIS is clear that solvency reserving requirements are an important element in the supervisory framework for insurance companies. This principle is adhered to by insurance regulators internationally.

150. In the past, the main international regulatory focus has been on insurer's base level capital needs alone, i.e. that the insurer should hold sufficient assets to ensure solvency while also acting as a buffer to absorb losses from other unexpected events. However, the current trend is for solvency and capital requirements to be set in conjunction with risk management requirements. Hence, because of the inter-related relationship between risk management and reserving, we note that this section on solvency and capital cannot be read in isolation of the risk management option discussed later.

151. The proposals for each of the solvency and capital requirements (discussed above) are set out separately in detail below.

3.5.5.1 Proposal - Solvency Support Plan

152. It is proposed that, at the time of licensing, all new insurers must provide to the Regulator for approval a solvency support plan, which will have prior approval by an independent actuary, and be certified by the directors of the insurer. The solvency support plan will set out how the insurer expects to meet enhanced solvency requirements on an ongoing basis, including:

• Intended type of insurance business to be written (general/health/life);
• Size of business to be undertaken (size of book with projections);
• Access to capital;
• Information on risk management strategy;
• Claims-paying policy and systems;
• Reinsurance arrangements;
• Outsourcing;
• Start-up capital; and
• Technical provisions and reserves.

153. This proposal is intended to deliver some certainty, based on the plan presented to the Regulator, that the insurer will be able to meet its obligations over the first three years of operation. The solvency support plan is flexible, taking into account different legal structures, classes of insurance business, and scale and scope of operations. It is intended to provide a holistic assessment of the business the insurer proposes to undertake, accounting for both quantitative and qualitative factors relating to solvency and ability to meet obligations as they fall due. Hence, the Regulator is afforded a more granulated approach to vetting entrants.

3.5.5.2 Proposal - Flexible Start-Up Capital Requirement

154. It is proposed that the Regulator approve the level of capital required for a new entrant to the insurance market to obtain a licence by vetting the insurer's solvency support plan. This will enable the Regulator to determine the adequacy of start-up capital in reference to the insurance business the insurer is applying to undertake, having regard to the proposed nature of business of the insurer, underwriting policy, nature of reinsurance arrangements, risk management capacity and quality of assets.

155. The start-up capital requirement will be approved on the basis of the above criteria with regard to factors such as:

• Is there sufficient capital to pay for the infrastructure and operations planned?
• How does the insurer plan to meet the requirements of an enhanced solvency regime for the proposed book size?
• Are there sufficient reinsurance arrangements, which satisfy the capital needs for the underwritten business?
• Does the level of capital demonstrate commitment to policyholders and other stakeholders?

156. The start-up capital requirement will not be applied on an ongoing basis. The requirement will cease to apply at the end of year one because the insurer will be required to comply with an enhanced solvency framework (discussed below), which will determine the necessary level of capital, based on actual obligations, through an actuarial framework consistent with IAIS principles.

157. Adopting a flexible approach to determining start-up capital requirements means the capital requirement will be commensurate to the risks of the business while accounting for equity considerations. Thus, the start-up capital requirement will not operate as a barrier to entry. In addition, a flexible approach to start-up capital will become redundant at the end of year one, which means it should help mitigate policyholder expectations that there is some form of guarantee or "special fund" for the obligations in the possible event of an insurer's failure. Therefore, it will also reduce moral hazard incentives for policyholders.

158. With a risk-based focus there will be no need to provide an exemption process, but this brings the disadvantage of no pre-defined figure as a signal to potential entrants to the insurance sector. A further limitation is greater complexity for the process the Regulator must undertake.

3.5.5.3 Proposal - Ongoing Enhanced Solvency Requirements

159. It is proposed that, as an ongoing requirement, all insurers must comply with enhanced solvency requirements applicable to the class of business or classes of business the insurer is licensed to carry out.⁸²

160. Given the diversity of risks an insurance business is exposed to and the unique risk profile of each insurer, it is proposed that the solvency requirements be risk-based, taking into account the specific nature of an insurer's risk profile. This flexibility will ensure that the insurer's reserving is proportionate to its risk and is achieved in a transparent and equitable manner.

161. The purpose of a risk-based enhanced solvency regime is to ensure that all insurers have sufficient assets, at all times, to meet their expected liabilities while also absorbing unexpected economic and financial shocks (which can affect both the assets and liabilities of the insurer). The prescribed model will, in accounting for the current risks the business faces:

• Allow an insurer to assess the appropriate level of reserving so when the fund is closed to new members and in run-off, the insurer can be reasonably expected to meet existing obligations to the members and other creditors of the fund; and
• Enable the insurer to calculate the level of assets that will enable the insurer, with a reasonable degree of confidence, to continue to meet its obligations to both existing and new policyholders into the future.

162. In short, the enhanced solvency regime will provide a model that will enable the insurer to assess the overall financial position of its business, accounting for the relevant risks, and for the Regulator to have a clear understanding of this position. The two primary focuses in achieving this, as outlined by the IAIS and as included in the standards developed by the NZSA, are technical provisions (which focus on portfolio survival) and reserving (which focuses on an entity's survival).

163. As the enhanced solvency regime is risk-based, accounting for each insurer's risk profile, and sensitive to the class of business, it is not intended that an exemption process exist. Every insurer will need to ensure it reserves in a manner that will enable it to meet its obligations under a diversity of conditions.

164. As the calculations used to assess the solvency position and determine the necessary levels of reserving are highly technical, actuarial input and independent review in this area are essential. The development of a proposed co-regulatory model for enhanced solvency standards setting (discussed later in this section) will need to consider and have regard to the existing actuarial standards and guidance notes prepared by the New Zealand Society of Actuaries ("NZSA") and those standards developed by the Health Funds Association of New Zealand ("HFANZ") in concert with the NZSA. Further standards will be required to be developed for classes of insurance business where there are gaps.

165. Adopting an internationally consistent enhanced solvency regime enables ease of access to the New Zealand insurance market for multinational insurers and benefits domestic insurers as their operating environment enables them to remain contestable with multinational firms, and provides them greater ease of access to international markets.

166. The enhanced solvency requirements will be based on the following:⁸³

167. Total Balance Sheet Approach. The financial position of an insurer is subject to a diversity of interdependent variables and factors such as assets, technical provisions, reserving requirements, resources and the need to assess the overall financial position of an insurer.⁸⁴ Therefore, we believe it important to adopt a total balance sheet approach so that the prudential requirements do not create hidden deficits or surpluses.⁸⁵ This "whole of book" approach is generally represented by the following diagram.

Source: IAIS, Towards a common structure and common standards for the assessment of insurer solvency: cornerstones for the formulation of regulatory financial requirements. October 2005

168. Common Valuation and Market Consistency. The enhanced solvency framework will be supported by having a common valuation process consistent with generally accepted accounting and actuarial practice, and market valuations. This is important to the undertaking of comparative analysis and will enable more informed decision-making by both the market and Regulator.

169. Categorisation of risk. The primary categories of risk outlined by the International Actuarial Association (IAA) and IAIS are:

• Underwriting risk - incorporates the risk of loss due to factors such as pricing, product design and claims risks.
• Credit risk - relates to the risks of default, concentration risks and counterparty risks through say reinsurance and derivatives contracts.
• Market risk - arise from economic and market volatility. For example, changes in asset prices, exchange rate movements, interest rate risks, equity risks and concentration risks.
• Operational risk - involves reputation and strategic risks that the insurer is exposed to as well as risks that arise from process failure or system failure. This also includes risks relating to being a member of a financial group.
• Liquidity risk - the insurer has need for cash flows to meet obligations as they arise. Liquidity problems may arise because of a number of factors such as difficulties in asset conversion or drops in the stock market.

170. All of these risk categories can impact differently on the balance sheet of the insurer and not all are easily quantifiable. In modelling these risks there are three key components that need to be considered to better enable an insurer to determine the appropriate action to deal with these characteristics. These are⁸⁶:

• Volatility risk - risk of random fluctuation in either the frequency or severity of an event;
• Uncertainty risk-- risk that the models used are mis-specified or parameters are mis-estimated; and
• Extreme events - these are generally high impact and low frequency events.

171. Analysis of these key characteristics assists in informing how the different risks can be managed and play an integral role in informing the insurer of the appropriate level of reserving.

172. Longevity focus. Risk margins and reserves need to be calculated on the basis of how best estimates will be affected by future deviations. This requires an approach where an insurer's financial obligations, both today and in the future, should be factored into assessments through financial modelling and stress testing so that reserving requirements are calibrated in a manner that enable assets to exceed technical provisions at the end of the defined period with a degree of certainty. The approach will also focus on what financial provisioning will be necessary to maximise the probability of the company's survival.

3.5.6 Proposal - Enhanced Solvency Standard Setting

3.5.6.1 The Role of the New Zealand Society of Actuaries (NZSA) in Solvency Standards Setting

173. Currently, the NZSA performs a pivotal role in developing standards and guidance notes such as PS3 and GN5 for life insurance, and PS4 for general insurance. However, insurers are not legally bound to comply with these standards.

174. There are no corresponding standards for health insurance. Although, since 2001 the NZSA in conjunction with HFANZ (Health Funds Association of New Zealand) has been developing a solvency regime which will apply to the Association's members, and non-members where they choose to be accredited under the regime. This is a risk-based regime that is consistent with the Australian two-step test equivalent. Although this new regime has not yet been made publicly available we have been informed by HFANZ that the regime has focused on five main areas: liability risk, inadmissible asset revenue, resilience, expense risk, and management of capital.

175. The standards development by the NZSA involves consultation with a number of stakeholders and considers factors such as the interplay between actuarial and accounting standards, and the need for consistency internationally. Standards developed by the NZSA to assist an actuary to assess the solvency position of an insurer are risk-based, take a prospective approach, involve stress testing of calculation, and prescribe levels of conservatism in calculations and assumptions. ⁸⁷

176. The standards are designed to be viewed as a financial safety net within a framework that includes qualitative factors such as prudent and honest management by fit and proper persons.⁸⁸ This is in recognition of the importance of governance and integrated internal risk management to facilitate an insurer identifying and managing risks which may impact upon the financial stability of their portfolio(s), therefore limiting the probability an insurer will need the safety net provided by prudential reserving.

177. Approaches developed by the NZSA are consistent with the current international position on insurance solvency assessment as outlined by the IAIS, OECD, World Bank and IMF, and are closely aligned to the Australian equivalents. The profession relies on academic research and analysis of failures elsewhere to calibrate the various prudential factors. It is involved in the ongoing development of standards internationally. The NZSA already has a standards-setting model which is consistent with the co-regulatory framework set out in this section.⁸⁹

178. Against this background the proposal for standard setting for enhanced solvency assessment is as follows.

3.5.6.2 Co-Regulatory Model

179. It is proposed that a co-regulatory model be adopted as shown diagrammatically below. The standards covered by this model will relate to matters that have an actuarial element and do not include standards the Regulator has the power to set under the legislation, for example, governance and licensing conditions.

Co-Regulatory Framework

180. The co-regulatory model⁹⁰ will involve:

• Establishment of a new entity, the Enhanced Solvency Standards Board (ESSB) made up of actuaries, industry, the Regulator and other relevant professionals;
• The Regulator will have the power to instruct the ESSB to undertake work on existing standards or to produce new standards if there is a belief the standards are deficient or do not meet current market conditions;
• The ESSB/NZSA will have the ability to initiate the standards development process and seek approval from the Regulator;
• The ESSB will instruct the New Zealand Society of Actuaries ("NZSA") to enhance or develop standards consistent with gaps in the existing standards and market developments;
• The NZSA will invoke their standards-setting process, which involves consultation with their members and fellows;
• The proposed standards will be put back up to the ESSB for assessment of adequacy and for broader public consultation;
• Once the members of the ESSB have reached agreement, the ESSB will seek approval of the standards from the Regulator;
• The Regulator will have the power to approve the standards developed by the NZSA and agreed by the ESSB, on the following criteria:
  
  1. They take into account international best practice and New Zealand's international obligations;
  2. They have been consulted on with the appropriate stakeholders; and
  3. They meet the objectives of the insurance legislation.
• If the Regulator considers that the proposed standards fail to meet the criteria, the Regulator will have the power to veto the standard, returning it to the ESSB for further review through the above process.
• Where the Regulator has vetoed the proposed standards twice, the Regulator will have the power to set the standard itself. In setting the standard the Regulator must:
  
  1. Have regard to the standard proposed by the ESSB, and the consultation done under the previous reviews; and
  2. Meet the criteria above for Regulator approval in the same manner as applied to standards proposed by the ESSB.
• The Regulator will monitor the insurer's compliance with the standards, which will be legally binding (see the Monitoring and Supervision section);
• The Regulator will have enforcement powers where there is a breach of the standards by an insurer (see the Monitoring and Supervision section).

181. Members of the ESSB will be appointed on the basis of expertise, and will include:

• Membership by the Regulator, which is important to provide checks and balances to the standards development process and to ensure the Regulator's perspectives are taken into account;
• Expert actuarial skills, which are crucial;
• A member versed in accounting standards development, which is key to ensuring the actuarial standards are consistent with financial reporting standards. This may involve membership from the Accounting Standards Review Board; and
• Industry expertise from the relevant classes of insurance business (general, health and life), which is important to consistent development and sound standards. This expertise may come from the current industry associations.

3.5.7 Proposal - Financial Condition Report

182. The financial condition report is an important tool to an insurance entity. It contains detailed and commercially sensitive information about the insurance business. The insurer's actuary provides significant input in to this document and outlines performance of the business and future direction. Despite some jurisdictions requiring this document to be provided to the Regulator as part of standard reporting, such a requirement may create the wrong incentives structures for sound risk management.

183. The proposal is to require an insurer to prepare this document annually, but with only director attestation to the Regulator that it has been prepared. The Regulator will have the power to call on the document if justified for the purposes and objectives of the legislation.

3.5.8 Operational Proposals

3.5.8.1 Proposal - Licensing Subject to Conditions

184. The proposal is that the Regulator will have the power to issue a licence subject to conditions.⁹¹ The Regulator may amend, add to or revoke the conditions at any time, subject to the purposes and objectives of the legislation.

185. The conditions will allow an insurer to comply with the licensing and prudential requirements to different degrees or impose different requirements at the discretion of the Regulator to give flexibility to the regime. The conditions may be applied to an insurer's licence by the Regulator where, for instance, the Regulator considers it necessary to cover situations relevant to the New Zealand insurance market. For example, where:

• An insurer is small, or a mutual whose activities are limited to a certain geographical area, and/or limited to a certain number of policyholders, and/or who offers special types of cover.
• Insurance contracts concluded with an insurer in another jurisdiction on a services basis (without local establishment), where they are entered into without the initiative of the insurer.
• There is an "insurance shortage" in the domestic market that can only be met by a foreign insurer that cannot meet the licensing or prudential requirements.
• Some of the licensing and prudential requirements can be reduced because an insurer meets comparable requirements in an overseas jurisdiction. This may be most relevant to reinsurers.
• There are other factors which the Regulator considers appropriate to meet the Government's regulatory objectives.

3.5.8.2 Proposal - Licensing Fees

186. Potentially, fees will be charged to obtain a licence. If they are, they will be determined following Government fee guidelines, and will be consulted on.

3.5.8.3 Proposal - Insurer Appeal Rights for Prudential Requirements

187. It is proposed that the insurer have the right of appeal to the courts, under judicial review, for decisions made by the Regulator in relation to prudential requirements. ⁹²

188. Judicial review is considered more appropriate for prudential requirements because merit appeal rights may interfere with the timeliness and consistency of their application, which is key to their success as a prudential tool. Internationally it is common for entities to have a right of appeal to an appellate authority (in most countries this is the courts).⁹³ The right of appeal operates as an appropriate check and balance providing transparency and accountability for the regulatory decisions made. The IAIS principles state as an essential criteria that administrative decisions of the supervisory authority must be subject at least to substantive judicial review.

3.6 Licensing and Prudential Options

189. The areas where further discussion is required in order to seek feedback on remaining issues are set out as follows.

3.6.1 Option - Risk Management Strategy

190. An option for the insurance regulatory regime, for the purpose of complementing the enhanced solvency requirements, is the requirement that each insurer have an integrated risk management strategy to proactively identify, quantify and resolve risk that may arise or has arisen. Rather than prescribing a framework, directors would be required to attest on an annual basis to the Regulator that they have implemented an integrated risk management strategy and process which is consistent with a fitness for purpose framework. The fitness for purpose framework may include key areas such as:⁹⁴

• Does the framework identify relevant standards, policies and legal requirements?
• Does the framework enable proactive identification, quantification and management of existing or potential risks?
• Is there capacity to distinguish between risk types (i.e. strategic risk, market risk, operational risk)?
• Are the stated management of risk objectives, constraints and concerns agreed (or validated)?
• Has the framework established how a successful outcome is to be judged?
• Does the framework identify the tools and techniques to be adopted, and the scale for evaluation of risk?
• Will the risk management framework instil the appropriate incentives and behaviours?

191. Under this option, the Regulator would have the power to call for details of the risk management strategy and practices if justified for the purposes and objectives of the legislation.

192. A risk management strategy option has been considered on the basis that the core business of an insurer is risk management. This is reflected in the enhanced solvency framework which requires the insurer to turn its mind to a number of risks. Therefore, the insurer should be able to prudently and proactively manage the risks its business is exposed to under a diversity of conditions to reduce the probability it will not be able to meet its obligations.⁹⁵ Hence, the regulatory framework for insurance may need to be designed so the Regulator is provided with flows of information to assess whether an insurer is managing its risks appropriately with an acceptable degree of clarity.

193. This supports the approach promoted by the IAIS and IAA where they state regulatory capital is an important component of an insurance Regulator's toolbox, but is not the entire answer.⁹⁶ There is a strong interdependency between sound governance, good risk management and an effective solvency regime. Hence, risk management requirements may be viewed as being on a continuum with the tools that address governance and solvency matters.

194. Implementing a "one size fits all" approach to integrated risk management is inherently problematic given insurance entities are exposed to a diversity of risks with magnitudes unique to each insurer. Therefore, under this option it is suggested that the requirements are sufficiently flexible to achieve proactive risk identification and quantification. Such an approach is consistent with international models⁹⁷, which have highlighted that rather than presenting solutions, the risk management models should provide guidance. This is due to the interdependent factors involved in effective risk management including the internal identification of appropriate tradeoffs, and is represented by the following diagram.

Source: IAA Actuarial Control Cycle

195. Following implementation of an integrated risk management framework in conjunction with sound governance, an insurer should be better able to proactively identify and quantify potential risks. Therefore, the insurer should have less dependency on solvency reserving as proactive risk management can facilitate behaviours that will assist in overcoming potentially financially debilitating events, or at the very least, improve the ability of the insurer to mitigate the impact certain events may have on their solvency position.⁹⁸

3.6.2 Option - Separation of Classes Life / General / Health

196. The IAIS has stated that separation of classes of insurance business is a commonly accepted practice across a diversity of jurisdictions.⁹⁹ An IAIS survey of member jurisdictions in 2005 reported that in 75 percent of the jurisdictions insurance companies are allowed to transact life and non-life business simultaneously. All OECD member countries require life and non-life business to be separated in some way, so that one activity cannot be used to support the other. Especially reserves in life insurance.¹⁰⁰ In most member countries, separate licences are issued for each class of insurance business or for several classes of business grouped under a common denomination.¹⁰¹ See the Categorisation Proposals section for discussion on the rationale for separate licences.

197. The issue licensing requirements are seeking to address is the separation of life, health and general insurance business where more than one is undertaken by the insurer. This is to ensure one class of insurance business does not support another class, and limits cross-contagion of funds and cross-subsidisation of products.

198. The option for addressing this issue is:

• All insurers will be required to comply with the accounting separation (with segregated funds) requirement for the class or classes of insurance business they are licensed to carry out. This will also be required for the New Zealand operations of a foreign insurer; plus
• The option of the Regulator having the power to require incorporation for each class of insurance business under the Companies Act 1993, plus conditions, which will be determined against criteria.

3.6.2.1 Accounting Separation (With Segregated Funds)

199. All insurers will have to comply with the accounting separation¹⁰² (with segregated funds) requirement. The Regulator will have the power to set rules and monitor compliance with requirements that an insurance business is licensed to carry on or offer life, health and general insurance business in one entity, that these classes be separated under accounting and segregated funds rules, such as:

• Separate accounts. An entity authorised to provide life insurance and another class of insurance business (i.e. health and/or general) must maintain separate accounts for each.
• Separate reporting and auditing. Account and statement rules requiring an entity to prepare and report separate revenue accounts, balance sheets, and profit and loss accounts for each class of insurance business they undertake, and a requirement to have those accounts audited. The Regulator would have the power to grant de minimus exemptions where a risk category that falls within another class is too small to separate.
• Allocation rules. Allocation rules relating to premiums, costs and profits for products covering more than one class of insurance business.
• Segregated funds. In addition to the separate accounts requirement above, a further requirement in relation to policies for each of life, health and general insurance:
  
  1. To establish and maintain funds that are segregated from the other assets of the entity; and
  2. There are specified assets, the market value of which are relied on to meet the liabilities of the entity in relation to those policies.
  A claim against a segregated fund under a policy for which the fund is maintained would have priority over any other claim against the assets of that fund. Only where the assets of that fund are insufficient to meet its claims would a claim against other assets of the entity arise.
  
• Connected lending. A prohibition on connected lending/security or intermingling of funds within the group or with related parties.
• Winding-up rules.¹⁰³ Applying statutory management to one class of insurance business without doing so for others undertaken by the entity.

200. Note the new legislation will apply standard governance requirements for all insurers. See the Governance Proposals in this section.

3.6.2.2 Incorporation under the Companies Act 1993

201. In addition to the accounting separation (with segregated funds) requirement, the option is that the Regulator be able to require incorporation under the Companies Act 1993. This would occur when the Regulator considers that the accounting separation (with segregated funds) requirements do not provide satisfactory separation in relation to a particular insurer. The Regulator will have the power to require the insurer to:

• Incorporate each class of insurance business (health, life and general) into separate companies under the Companies Act 1993; and
• Comply with accounting separation (with segregated funds) requirements; and
• Comply with further conditions such as acting in its own best interest, having a separate board of directors, and/or other separation requirements determined to be appropriate by the Regulator.

202. The criteria the Regulator would need to have regard to in determining whether incorporation plus conditions is required are:

• Whether it is in the best interests of policyholders;
• Whether each licensed insurance business is operated using a corporate form that meets the purposes and objectives of the legislation in a way which imposes the least costs on business;
• The size of the insurer and whether it presents risks to the stability of the New Zealand insurance market;
• The current structure of the insurer's business and the transition costs of change; and
• The relative size of each insurance business class undertaken.

203. A benefit of this option is that it gives flexibility to the regime, leaving the Regulator to adopt the most advantageous form for the New Zealand regulatory environment having regard to a particular insurer's business. The limitation is that the Regulator may tend towards a risk-averse stance if they are criticised for taking a light-handed approach.

3.6.3 Option - Legal Form of Foreign Insurers

204. The IAIS core principles require that foreign insurers be licensed before operating in a jurisdiction or operating on a services-basis only, but they do not set out recommendations for legal form.¹⁰⁴ Some OECD member countries allow branches of foreign insurers to operate in their market without requiring separate legal incorporation.¹⁰⁵ However, the branches are required to have their own capital resources controlled through accounting separation and segregated funds rules.

205. The main issue for licensing requirements relating to foreign insurers operating in New Zealand that the regulation is seeking to address is the ring-fencing of assets for New Zealand policyholders. The option for addressing this issue is that the Regulator will have the power to determine whether the foreign insurer may operate as a branch or a subsidiary, against criteria, such as, whether:

• It is in the bests interest of policyholders;
• The insurance business is operated using a corporate form that meets the purposes and objectives of the legislation;
• The insurer is small or does not present risks to the stability of the New Zealand insurance market;
• New Zealand policyholders and other creditors would not be disadvantaged by financial losses within a part of an insurance group in another country, for instance, there are no policyholder preference arrangements in legislation in the insurer's home jurisdiction;
• The New Zealand management/board is to operate using adequate governance arrangements, including having all the powers to manage, direct and supervise the affairs of the business in the best interests of New Zealand policyholders and other stakeholders;
• The legal, accounting and governance requirements of the parent company are satisfactory to the Regulator, and are being met by the parent; and
• Any other factor the Regulator considers appropriate to meet the purposes and objectives of the legislation.

206. The foreign insurer, whether a branch or a subsidiary, would have to comply with the accounting separation (with segregated funds) rules above for classes of insurance business, as well as separation from its parent in the home jurisdiction and group internationally.

207. The Regulator would also have the power to impose conditions on the foreign insurer regarding matters such as:

• Connected lending. A prohibition on connected lending/security or intermingling of funds within the group or with related parties.
• Act in own best interests. If a subsidiary company, it must act in the best interest of itself rather than its parent.
• Winding-up rules.¹⁰⁶ Where operating in New Zealand as a branch, the Regulator would have the power to apply statutory management to the property, rights, assets and liabilities relating to its New Zealand business.
• Separate board. For a subsidiary, a board of directors would be required for the New Zealand company (the Companies Act only requires one director).
• NZ chief executive. Whether operating either as a branch or a subsidiary, to appoint and maintain a chief executive in New Zealand who is responsible for the conduct of the New Zealand operations (the Companies Act does not require directors to reside in NZ).

208. The main advantage of requiring legal separation relates to situations where the Regulator needs to take intervention action urgently. It provides a better mechanism for winding-up situations since the Regulator can directly deal with outsourcing, derivatives and other contracts.

3.6.4 Option - Ratings

209. One option being considered in the changes to the insurance regulation relates to the role played by a financial strength rating for insurers.

210. The three options being considered are:

• Option 1: Mandatory ratings for all insurers as a licensing requirement and as an ongoing prudential requirement. Under this option, insurers would be required to:
  • Maintain a financial strength rating from a rating agency approved by the Regulator; and
  • Publicly disclose the rating to policyholders in disclosure statements and on insurance renewal notices including any recent negative changes to the rating.
    
  In the case of very small insurers, where a rating could be impracticable or prohibitively expensive, an exemption could be considered, on the basis that the absence of a rating would have to be disclosed.
  
• Option 2: No mandatory ratings, where no insurers would be required to obtain a rating, but if they did have a rating, it would have to be disclosed to policyholders.
• Option 3: Retain mandatory ratings for disaster and property insurers under licensing and prudential requirements, and to extend to all general insurers, subject to scope for a de minimus exemption for very small insurers. The rating would have to be obtained from a rating agency approved by the Regulator. Where the insurer has been authorised not to obtain a rating, this would have to be disclosed to policyholders. If ratings are obtained voluntarily (by insurers not required to obtain one), from a rating agency approved by the Regulator, the rating would have to be disclosed to policyholders.

211. The three options are discussed below in terms of their ability to meet Government objectives, and the benefits and limitations of them being mandatory.

212. In particular, the ratings proposal is assessed on the basis of ratings' ability to:

• Provide policyholders and others with a relatively simple means of assessing the financial soundness of an insurer and comparing one insurer with another;
• Strengthen market discipline on insurers and increase the incentives for sound governance and risk management; and
• Provide a tool to supplement and complement prudential supervision of insurance.

3.6.4.1 Possible Benefits of Financial Strength Ratings

• A rating can provide a relatively simple grading system to enable policyholders and their advisors to identify and compare an insurer's financial strength, reducing the need for them to obtain and interpret complex information about an insurer's financial strength. Given the inherent complexity of financial and actuarial disclosures issued by insurers, and the extent of expertise required to understand these disclosures, a rating can assist considerably in the assessment of an insurer's financial strength. It can readily alert policyholders and their advisors to an insurer's relative position on the risk scale, particularly if the rating is disclosed by reference to the full rating scale. It can also reveal any recent changes to the rating, including downgrades or credit watch status.
• There is also scope to reduce possible confusion with the meaning of ratings through education of policyholders and their agents, such as by web-based publication of comparisons of the different rating scales. Confusion would be avoided if just one rating agency were approved for use by insurers for disclosure purposes.
• Ratings are also used for commercial purposes such as by independent financial advisors, insurance brokers, corporate buyers of insurance, and investors and banks in assessing credit risk, and for reinsurance security assessment by cedants.¹⁰⁷
• Ratings may assist in encouraging consumers to take responsibility for their decision-making and reduce reliance on the prudential supervisor. Ratings are therefore an important means of reducing moral hazard risks.
• Ratings may be an important source of market discipline on insurers, encouraging them to maintain robust governance and risk management systems and controls. Regular scrutiny by an international rating agency can add to the effectiveness of market disciplines, given that the rating is likely to be used by many market participants as a key indicator of insurer financial strength. Insurers may have strong incentives to manage their affairs in ways that avoid the likelihood of a rating downgrade or a rating lower than their competitors.
• The rating process may also provide an important source of internal self-discipline on insurers, given that it requires the board and senior management of an insurer to prepare for the annual rating assessment, while also sharpening the focus on risk management issues and respond to concerns or questions raised by the rating agency.
• A rating may be able to be used as a supplement to other prudential tools to assist in the supervision process. It can be used as a trigger to determine when monitoring should be escalated. By enhancing market and self discipline, ratings can assist in reducing the extent of supervision required to attain the desired outcomes for the insurance sector, with lower supervisory costs.
• Supervisors have a mixed track record in anticipating distress and failure, and reacting quickly. Moreover, public disclosures are inevitably dated and do not provide a reliable means of anticipating incipient distress. Therefore, though by no means perfect, rating agencies nonetheless may provide additional information to policyholders.
• A de minimus exemption for very small or mutual insurers, where it is not practicable to produce a meaningful rating, may address any issues of whether ratings fairly rate small and mutual insurers or that they are cost prohibitive.

3.6.4.2 Possible Limitations of Mandatory Ratings

• Although there are close similarities between the rating scales of the different international rating agencies, there are some differences. For instance, a weak rating from Standard and Poors is BB whilst the same weak rating from AM Best is B.¹⁰⁸ Consultation has revealed this as one reason ratings may not be clearly understood by consumers. Due to the overall complexity arising from different scales and methodologies rating may not be the most optimal signalling tool for consumers.¹⁰⁹
• A mandatory ratings requirement is internationally inconsistent with other jurisdictions and frameworks recommended by the IAIS and OECD. Internationally the more common tool is a formal prudential regime with appropriate disclosure. ¹¹⁰
• Research on New Zealand's consumption of insurance products¹¹¹ shows ratings do not feature in the decision-making process of consumers for determining which insurance product to purchase. This is consistent with literature on ratings as a tool for informing consumers.¹¹²
• For policyholders in the process of a claim, or with policies underwritten on the basis of their health or life, ratings provide no benefit because the policyholders are effectively locked in to their policy. The prohibitive cost of change, due to material changes in their personal circumstances, means the policyholder is unable to find replacement cover on similar terms. Therefore, in the event of a rating downgrade the policyholder is unable to act upon the information and is exposed to the insurer's failure.
• Previous reviews of the Insurance Companies (Ratings and Inspections) Act 1994 by MED¹¹³ identified that claims-paying capacity only provides short term solvency information, rather than making comment on the long term ongoing viability of the insurer. In that regard, it could be argued that ratings is not an appropriate signal of quality to potential long-tail policyholders, since they are not predictive of the longevity of an insurer, which is key to policies that may not be met until 30-40 years time.
• Rating agencies are not always able to accurately assess the true risk profile of an insurer. The experience with Reliance Insurance in the USA and HIH in Australia has demonstrated that rating agencies do not always move sufficiently quickly to adjust ratings when insurers are in financial difficulty.
• It has been argued that ratings from international rating agencies are inherently biased against small and mutual insurers, because the rating process is geared to large, international institutions.¹¹⁴ This is an arguable point, with little evidence either way. However, to the extent that small and mutual insurers do tend to get lower ratings on average than larger insurers, this probably reflects several factors which, taken together, may justify lower ratings for small and mutual insurers. These factors include:
  
  1. Small and mutual insurers may not have the risk diversification benefits of having a large balance sheet – they generally have larger exposure concentrations to individual or related counterparties, or to particular sectors of the economy;
  2. Operational risk tends to be larger with small and mutual insurers due to increased key person risk, less capacity for diversification of operational risk shocks, and fewer resources devoted to operational risk management;
  3. Corporate governance and risk management systems may be weaker in small and mutual insurers than in larger insurers; and
  4. Shareholder support may be weaker in small insurers compared to many large insurers. Raising capital can be much harder for a small or mutual insurer than a large one with institutional investors and high standing. Moreover, small and mutual insurers may be prone to connected exposure risks to a greater extent than in the case of large insurers.
• Using an exemption power for some insurers may send conflicting signals to the market. It may also create an "uneven playing field" for participants in the industry; it is not a competitively neutral requirement.
• Ratings can potentially be quite costly to obtain. Feedback from the Advisory Groups is that ratings can cost around NZ$40,000¹¹⁵ plus NZ$5,000 to $10,000 per subsidiary in direct rating agency fees. Management time involved in preparing for the rating adds to these costs. Feedback from industry is that to support the cost of a rating of $100,000 (fee plus management costs), the amount of annual premiums written would have to be in the vicinity of: life insurance $1 million; health insurance $3 million to $5 million; and general insurance $1 million to $2 million. These figures relate to a period of medium to high profitability; in a period of low profitability they will be significantly higher.

213. We are keen to receive feedback on whether the prudential regime and market conduct framework alone are sufficient to meet Government objectives for the insurance regulatory framework or whether ratings are also required. Particularly, from a regulatory policy design perspective, whether they meet the central elements of user embeddedness. User embeddedness describes the degree to which information that is mandated in a disclosure system is integrated into the decision-making process of a policy's intended users.¹¹⁶ While ratings currently do not appear to be integrated into consumer's decision-making process, it is possible that other disclosure systems proposed will exhibit the same concerns.

3.6.5 Option - Transition of Existing Insurers

214. The two options identified for dealing with the new legislation applying to existing insurers are:

• Option 1: Set transition period. This option involves setting a defined period within which existing insurers must comply with the new regulatory regime.
• Option 2: Regulator approve transition period. This option involves providing existing insurers with a more flexible approach to transition into the new regulatory framework. On application to the Regulator for approval, the Regulator may approve the terms and conditions of an insurer's licence or licenses. This will mean the Regulator will be able to determine an appropriate transition period for the insurer. This approach gives recognition to the fact that some insurance businesses may not need a significant time period to meet a licensing term or condition. However, other insurers may have different considerations in transitioning to compliance with the proposals and options for the new regulatory regime. The time period approved by the Regulator would need to be consistent with the purposes and objectives of the Act.

215. The benefits of Option 1 are that it is transparent, certain and consistent. The limitation is that it may be blunt; for some it may be too long and for others too short. The benefits of Option 2 are that it takes account of the diversity of insurers in the market, and it is likely that many of the existing insurers in the market will already comply with the licensing requirements, so for much of the market application of a transition period will not be necessary. A limitation of this approach is a lack of clarity about who is currently complying with the regime and confusion for consumers as to which insurers are yet to comply with terms and conditions of their licence. This also may lead to concern that some insurers will be given a competitive advantage over others.

3.6.6 Option - Insurer Appeal Rights for Licensing and De-licensing

216. The two options for the insurer's right of appeal to the courts for decisions made by the Regulator relating to licensing requirements and de-licensing are:¹¹⁷

• Merit review; or
• Judicial review.

217. Internationally it is common for entities that are denied a licence or de-licenced to have a right of appeal to an appellate authority (in most countries this is the courts).¹¹⁸ The IAIS principles state as an essential criteria that administrative decisions of the supervisory authority must be subject at least to substantive judicial review. Given that licensing decisions affect property rights and entering into commercial activity, it may be appropriate that merit review apply. However, it may be that since the licensing requirements were subjected to a significant consultation process all that is required is that the Regulator follows, for instance, due process in their application.

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