RBNZ says insurance regulation will focus on big insurers and/or those deemed to be at higher risk of failure

By Gareth Vaughan

The Reserve Bank says a key feature of its oversight of insurers is taking a risk based approach with the focus squarely on big insurers and/or those deemed to be at "higher" risk of failure.

In a speech yesterday Richard Dean, the manager of operational policy in the Reserve Bank's prudential supervision department, also emphasised the Reserve Bank wasn't running a "zero failure regime."

"Our legislation does not require us to ensure that there will be no insurer failure or no losses to policyholders. Should insurers get into difficulty, there is no guarantee that government support will be forthcoming," Dean said.

Dean also said the Reserve Bank was likely to ask insurers for additional financial and prudential information through regular information returns to the Reserve Bank. And, he noted, effective governance of insurers means governance that's kept separate from ownership. The Reserve Bank also plans to review the quality of risk governance across the insurance sector.

The Reserve Bank's prudential regulation of insurers has been phased following the 2010 passing of the the Insurance (Prudential Supervision) Act (IPSA). This involved the licensing of insurers by  September 7 last year, with 96 full licences issued, plus three firms in "run-off" under provisional licences.

'Not all insurers are equally important from a risk perspective'

Dean said the Reserve Bank was taking a risk-based supervisory approach recognising not all insurers are equally important from a risk perspective. The Reserve Bank can deliver most value by focussing its resources on insurers that have the most impact on the economy, and on the risks that pose the greatest threat to the soundness and efficiency of the insurance sector, he said.

His comments about high impact insurers comes at a time when Insurance Australia Group, owner of NZI, State and AMI, is looking to buy the Wesfarmers owned Lumley in a move that would give it about 50.5% of the overall insurance market and 66% of the home and contents and vehicle insurance market. The deal requires the approval of the Reserve Bank, Commerce Commission and Overseas Investment Office.

In 2012 the Reserve Bank's first public intervention as insurance regulator saw it unable to convince either the policyholders of insurer ACS (NZ) Ltd, formerly Ansvar, or a High Court judge of shortcomings it saw in ACS's scheme of arrangement to effect a managed withdrawal from New Zealand by the church, heritage building and rest home insurer with its directors remaining in control.

Dean said that to give full effect to the risk-based approach, the Reserve Bank is developing a structured and systematic tool to assess insurer risks.

"This work draws on a framework used by our bank supervisors and on frameworks used by well-established and highly regarded insurance supervisors globally," said Dean. "At their core, these frameworks identify the risks that supervisors need to focus on, by assessing an insurer’s impact and probability of failure."

Impact, he said, is about the degree of damage an insurer might cause to financial stability and the economy if it failed.

"Probability of failure is an indication of the likelihood of an insurer failing, regardless of the damage such a failure might cause. Combining the two assessments allows insurers to be categorised according to the risk that they pose for the system. This, in turn, helps determine where our supervisory effort will be directed."

'RBNZ will proactively and rigorously deal with risks to high-impact insurers, Reactive approach to low impact insurers'

The probable outcome is the Reserve Bank will concentrate on high-impact insurers.

"If there were a failure of a high-impact insurer, it is important for financial stability and the economy that resolution of the failure is not disorderly and does not entail government support. The Reserve Bank will proactively and rigorously deal with risks to high-impact insurers that are assessed as threatening their ongoing viability," Dean said.

"Such action would include the use of distress management powers in IPSA to ensure that failures of these insurers, if unavoidable, are at least managed in an orderly way."

As for insurers deemed low-impact, the Reserve Bank's likely approach will be to supervise more reactively, Dean said, accompanied by strong enforcement where there is non-compliance with licence requirements.

"If a low-impact insurer were to fail, the Reserve Bank is likely to limit its role to ensuring that a liquidator is appointed, and that there is an orderly winding-up in line with insolvency legislation."

Dean said the Reserve Bank was "likely to require" additional reporting of financial and prudential information through a regular information return to the Reserve Bank.

"This is currently being scoped and we anticipate sharing our proposals with the industry sometime around the middle of 2014," said Dean.

"To support our assessment of risk, we are currently developing an engagement programme with insurers. This will be guided by our risk-based approach, with the Reserve Bank’s insurance supervision team having regular and frequent interaction with management of high-impact insurers. Similarly, the boards of high-impact insurers can expect the Bank’s Governors to seek engagement with them reasonably frequently. Low-impact insurers can expect more reactive interaction from us. Details will be provided to the industry in due course."

Review of risk governance pledged

He also said the Reserve Bank was likely to undertake an early "thematic review" of the quality of risk governance across the insurance sector. The regulator was likely to undertake one or two such reviews annually.

"A lesson arising from the global financial crisis is that there were significant shortcomings in risk governance in many financial institutions. In separate analyses of the global financial crisis, both the (Basel, Switzerland based) Financial Stability Board and the Group of Thirty (G30) concluded that the main governance failure leading to the crisis was an inability of many boards to accurately identify and understand the risks inherent in their businesses, and to ensure there were robust structures in place for managing and reporting on these risks," said Dean.

"Our upcoming thematic review of risk governance will likely involve a one-off gathering of new information by interviewing the Chair of the Risk Committee or equivalent, reviewing board and risk committee papers and minutes, and reviewing board self-assessments of performance. We expect to review this information alongside existing documentation and knowledge about the risk management framework, including information obtained from the licensing process."

This review will assess whether a board is providing clear leadership on risk governance through a risk management strategy and risk appetite statement. It will also probe  whether there is effective reporting to the board, showing performance against board policies, and whether the board’s actions and behaviour promote a prudent approach to risk throughout the insurer, Dean added.

"The overall aim of such an exercise is as much about establishing whether the right culture, behaviours and values are in place as it is about processes. Both culture and processes are critical for risk governance to be successful."

'Keep governance separate from ownership'

Dean also talked about the characteristics and qualities the Reserve Bank wants to see in insurers' boards and directors. Strong boards and governance are "critical" to both the success of the industry and to the Reserve Bank's role as prudential supervisor.

"In essence, what we want is for board arrangements and the collective skills of directors to be up to the task of overseeing an insurer’s activities, and the actions it takes to mitigate the risks it faces. We want a board to continuously reflect in its actions and behaviours that it has control over governance, and particularly risk governance of the insurer."

"For there to be effective governance, it is important that governance of an insurer be kept separate from its ownership. Separation is achieved through having independent directors on boards. This assists with bringing objectivity and impartial judgement to board deliberations," said Dean, adding Governance Guidelines have been issued to help insurers understand expectations.

These include that:

At least half of the directors will be independent;
The board chairperson is to be independent;
The audit committee chairperson is to be independent and not the same person as the board chairperson; And
A majority of the audit committee is to be independent.

Meanwhile, Dean noted insurance supervision is the responsibility of the Reserve Bank's insurance oversight team within its prudential supervision department and has 10 full-time staff. External resources will be called on as needed, he said.

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