Insurancedigest Sharing insights on key industry issues*
Americas edition • July 2005 The Americas Insurance digest is published three times a year, to address the key issues driving the insurance industry. If you would like to discuss any of the issues raised in more detail, please contact the individual authors or the Editor-in-chief, whose details are listed at the end of each article. We would also welcome your feedback and comments on Insurance digest, and as such, we enclose a Feedback Fax Reply form. Your feedback will help us to ensure that our publications are addressing the issues that you feel most strongly about. Contents
Americas edition • July 2005
Editor’s Comment 2 John S. Scheid
The evolving definition of ‘compliance’ 4 Stephen Koslow There are several significant drivers behind the increased attention being paid to the governance of compliance operations. This article examines new perspectives on compliance functions and structure and their impact on the governance of a company’s compliance operation.
European regulatory change – Threats or opportunities? 10 Tim Harris The regulatory and reporting environment for insurers in Europe has begun a process of radical change, and there is little sign of the pace of change relenting. This presents threats but also opportunities to insurers and reinsurers doing business with Europe.
Record retention compliance in a changing regulatory environment 14 Jin J. Lee, James Santangelo and Rosalind Conway Record retention compliance in a changing regulatory environment examines the regulatory impact on the insurance industry, the approach to mitigating the risk of non-compliance and the approach to an effective records management program. The CFO Forum’s European Embedded Value – A superior financial reporting framework for life insurers 20 Sheryl A. Battit and David C. Scheinerman As European Embedded Value support among analysts in the European market increases, the concept is likely to spill over into the U.S. insurance market. U.S. adoption of EEV principles could provide an opportunity for improved communication to stakeholders and present an opportunity for U.S. insurers to enhance their internal performance measurement.
China and India – Opportunities too big to ignore? 26 Robert Fok and Khushroo Panthaky Our authors examine the current state of affairs and future trends in these two markets, and discuss the life insurance market entry considerations from the perspective of an overseas insurer. Editor’s Comment
JOHN S. SCHEID: CHAIRMAN, AMERICAS INSURANCE GROUP
As this edition The first article looks at some of the more Welcome to the is released, significant conditions leading to increased companies are attention being paid to governance and July 2005 edition completing their compliance by many within the industry. second quarter Effective compliance functions aligned with of Americas or half-year company business goals and board/CEO results, the strategies are increasingly challenging Insurance digest. financial markets organizations and their chief compliance are heading officers. Where is this evolution headed? into the slower This will be examined carefully. days of summer and yet the Insurance industry remains increasingly challenged While most regulatory discussions over the by its regulators. past two years have centered on Sarbanes- Oxley requirements in the US, European Generally, the content of Insurance digest insurers have been focusing on increasing is based upon reader feedback and input regulations and changing reporting standards. from our clients about the issues that are Our second article provides a look at changes of most importance to them. Consequently, that will redefine the reporting and regulatory it is no surprise that given the ongoing landscape for European insurance companies. developments affecting companies and the concerns expressed by many insurance As a result of all the increasing regulation, executives, regulation and compliance are there are numerous tactical challenges that two subjects weighing heavily on your all businesses are facing. One of these agendas. As a result we have a few articles challenges is records retention. Our third addressing these subjects. article presents some thoughts on effective records management, together with mitigating compliance risk.
2 Insurance digest • PricewaterhouseCoopers A perennial topic of interest is capital think tank to the industry and the MOF I hope you find this range of articles of management. Today, regulators are increasingly (Ministry of Finance) and also as a bridge interest. Please do continue to provide us interested in solvency and capital adequacy. between the Government and the Industry. with feedback on the topics you would like to Embedded Value (EV) is an important tool China and India also made up the agenda at see addressed in future issues. Online copies in life insurer evaluations and in certain PricewaterhouseCoopers’ first Asia Insurance of both this publication and the sister European markets EV is increasingly utilized Forum, held in October 2004, aimed at European and Asia Pacific editions are in insurer financial reporting. The launch, providing an informal discussion forum for available from our website, therefore, of the European Embedded Value senior executives. The insights from these www.pwc.com/insurance. guidelines by the European Insurance programs regarding the dynamic markets CFO Forum is a major step forward for in China and India are well worth your read. transparency and comparability in insurance company disclosure. The development is a Finally, PricewaterhouseCoopers just rare example of industry-sponsored reporting completed a white paper focusing on the guidelines and should enable companies to future of the financial services industry over achieve a degree of consistency of reporting the next three years. Piecing the Jigsaw throughout a period of considerable change considers the drivers, risks and opportunities, John S. Scheid brought about by the move to IFRS. Like as well as the impact and responses for Editor-in-chief IFRS, these new principles are likely to have existing and potential players in the industry. an impact in North America, as well as in Asia The study identifies five principal drivers that Tel: 1-646-772-3061 and Europe. will affect all financial institutions: Politics, [email protected] Demographics, The Economic Cycle, Our last article on China and India grew out Regulation and Reporting, and Technology. of a seminar organized and sponsored by the Insurance Institute of the Republic of China Soft copies of this and all of our other FS (IIROC), which plays a very important and and sector surveys and reports are available, active role in the insurance industry in Taiwan. free of charge from our web site, The IIROC has traditionally served as the www.pwc.com/financialservices.
Insurance digest • PricewaterhouseCoopers 3 The evolving definition of ‘compliance’
AUTHOR: STEPHEN KOSLOW
4 Insurance digest • PricewaterhouseCoopers New perspectives on compliance functions and structure and their impact on the governance of a company’s compliance operation.
THE EVOLVING DEFINITION OF ‘COMPLIANCE’
Chief compliance officers are Exchange Commission (SEC) and Ultimately, through this structure often asked to identify the current the National Association of of relationships and connections, issues occupying a significant Securities Dealers (NASD) have the company is able to maintain amount of their time and energy. enacted rules requiring the governance framework for Over the years, responses to this compliance-related certifications meaningful oversight. question have closely tracked by senior management.2 matters being played out in the In addition, the highly publicized Compliance functions – core, media and boardrooms across the investigations and enforcement supporting and monitoring country. In the early to mid-90s, actions by New York Attorney- In a broad sense, virtually compliance officers of life General Eliot Spitzer, and the all functions occurring in insurance companies questioned related inquiries by state the business environment relate There are several whether their company had departments of insurance into to compliance. Essentially, all significant drivers adequate controls over sales and the world of brokers and employees are directed to perform advertising materials to meet contingent commissions, activities in compliance with behind the new standards of fairness and has focused attention on the company policies, procedures disclosure. Just a few years ago, governance and oversight of and objectives. Unfortunately, increased attention compliance officers worried about compliance operations at both such a broad definition becomes being paid to the how well their compliance property and casualty, as well meaningless for purposes of program compared to that of as life insurance companies. analysis and discussion. governance of peer companies and industry standards. Today, facing stiff Effective governance of a Today’s environment requires compliance compliance operation occurs inquiry by boards of directors that the word ‘compliance’ operations. and senior management teams, when a company establishes an be expanded into a term which compliance officers are intensely appropriate structure to facilitate more clearly articulates the focused on whether there is meaningful oversight over the contextual meaning of the sufficient governance and myriad compliance functions concept being conveyed. At the oversight over their company’s being implemented throughout the most expansive level, the term compliance operation. company. To build an effective ‘compliance operation’ can be compliance structure, a company used to define the universe of There are several significant first needs to identify the universe compliance functions and drivers behind the increased of these compliance functions and activities being implemented by attention being paid to the the individuals and business units individuals and business units governance of compliance throughout the company who throughout a company, and the operations. The Sarbanes-Oxley have been charged with their organizational structure Act of 2002 requires companies implementation. With this established to link these to formalize and strengthen the information, the company is individuals and business units governance structure surrounding prepared to establish and formalize to each other, as well as to the company’s financial reporting the relationships which serve to stakeholders inside and outside 1 and operating structure. More connect and link together these the company. recently, the Securities and individuals and business units.
1 The Sarbanes-Oxley Act of 2002 (Pub. L. 107-204, 116 Stat. 745 (2002)). 2 Securities and Exchange Commission (‘SEC’) rule 38a-1 under the Investment Company Act of 1940 and rule 206(4)-7 under the Investment Advisors Act of 1940 and the National Association of Securities Dealers (‘NASD’) Rule 3013.
Insurance digest • PricewaterhouseCoopers 5 THE EVOLVING DEFINITION OF ‘COMPLIANCE’ continued
It is helpful to further divide procedures, the completion and compliance functions into at use of risk assessments, analysis FIGURE 1 Core, supporting and monitoring functions least three groups which exhibit and communication of emerging generally accepted distinctions: regulations, and the application compliance itoring functio ‘core compliance functions’, of a formalized metrics-based Mon ns ‘supporting compliance supervisory system. Attention to Con functions’ and ‘monitoring supporting compliance functions assessmenttinuou compliance functions’. Core increased when regulators began Periodic s g compliance testing rtin func compliance functions refer to drafting laws with an embedded ppo tio Su Emerging ns those activities necessary to ‘reasonableness’ standard as the regulations meet specific and defined qualitative measure. For example, regulatory and company NASD Rule 30103 and the lianc procedur t mp e fu Pol requirements. Traditionally, core regulations implementing the co n k c icies/ men e t is i s r o 4 R o n compliance functions include USA PATRIOT Act, Section 352 , C e s activities such as rate and form utilize a reasonableness standard asses filing, complaint handling, as the basis for compliance. licensing and registration, where In effect, ‘reasonableness’ Cert regulations enumerate specific regulations prescribe a desired ificat
ion Metric activities that can be objectively outcome and leave it to the Auditing supervision-ba sed tested during an examination to company to tailor specific Training determine whether a company controls to achieve the outcome. is successfully complying with As a result, companies have the requirement. In certain needed to look beyond the realm circumstances, companies of technical compliance with Advice/ mandate activities that, while not specific regulations and focus on consulting imposed by regulation, become those compliance-related activities a compliance requirement. necessary to support the For example, certain companies successful implementation of the Source: PricewaterhouseCoopers require that replacement related core compliance function. disclosure forms be provided to customers in all states, including In addition, companies with those states which have not leading edge compliance activities, periodic testing and Emerging core compliance regulated this disclosure. operations formally monitor the formal, independent audits. functions implementation of both core and In addition, it is often within the Supporting compliance functions supporting compliance functions scope of those performing Recent regulatory actions refer to those activities that are to evaluate and verify that these monitoring functions to provide indicate that lawmakers are now performed to help ensure all functions are reasonably advice and counsel on the taking a hybrid approach to core compliance functions are designed and being effectively design of core and supporting enacting relevant legislation. being implemented as required. implemented. This assessment compliance controls. Figure 1 While generally maintaining These functions might include takes many forms, and often illustrates the relationship reasonableness standards, activities such as training, the includes continual monitoring between core, supporting and these new regulations address documentation of policies and and analysis of compliance monitoring compliance functions. activities previously performed in voluntary support of core
3 ‘Each member shall establish and maintain a system to supervise the activities of each registered representative and associated person that is reasonably designed to achieve compliance with applicable laws and regulations, and with the Rules of the Association.’ NASD Rule 3010 (emphasis added). 4 ‘…[E]ach member shall develop and implement a written anti-money laundering program reasonably designed to achieve and monitor the member’s compliance with the requirements of the Bank Secrecy Act (31 U.S.C. 5311 et. seq.) and the implementing regulations promulgated thereunder by the Department of the Treasury. …The anti-money laundering program required by this Rule shall, at a minimum, *** (b) Establish and implement policies, procedures and internal controls that can be reasonably expected to detect and cause the reporting of transactions required under 31 U.S.C. 5318(g) and the implementing regulations thereunder.’ NASD Rule 3011 (emphasis added).
6 Insurance digest • PricewaterhouseCoopers THE EVOLVING DEFINITION OF ‘COMPLIANCE’ continued
functions. For example, organization, and requires that product development to have Having a compliance function certification requirements under management seek answers to responsibility for rate and form implemented by an organizational Sarbanes-Oxley5, NASD Rule the following: Which operational filing. In addition, legal unit other than the compliance 30136 and the SEC Rule 38a-17 business unit or units should be departments often retain department does not address the have made voluntary monitoring charged with responsibility for responsibility for the initial question of whether the by company officers a regulatory implementing specific identification and analysis of implementation should be handled requirement. Other examples compliance functions? What is emerging regulations, and many in a centralized or decentralized include the training and testing the appropriate role for the companies charge customer manner. Centralization of certain required under anti-money compliance department and the service departments with compliance functions has laundering regulations.8 As such, chief compliance officer in responsibility for handling distinct advantages over broad companies must address these developing and managing the complaints. Of course, this is decentralization of these functions from two different structure established to support a simplified delineation and no functions. There are clear perspectives. In this circumstance, the implementation of these company has pure separation economic efficiencies and control training and testing are now core compliance functions? of responsibility. benefits to the centralization compliance functions, as well as remaining vital supporting and Organizational alignment Open communication between all individuals for the implementation monitoring compliance functions. FIGURE 2 performing related compliance functions is key to As a supporting function, training of compliance functions maintaining an effective compliance operation will still be an essential element The establishment of formal for ensuring compliance with compliance departments came Example of functional alignment activities such as reporting large into vogue after the market cash transactions and the conduct scandals of the mid-90s, identification and reporting of when life insurance companies Board of Directors & Exec. Mgmt suspicious activities. However, pulled the implementation of in addition, the company will certain core compliance functions need to support this training (e.g. sales material review) out of activity with documented policies line business units and centralized Audit department CCO/Compliance department LOB officer and procedures, training of the these functions into the compliance • Auditing • Periodic testing • Certification trainers, formal supervision and department. However, companies • Assessment • Advice/consultation appropriate monitoring to ensure that built large, centralized the training program is reasonably compliance departments for these designed and being effectively purposes have started to move implemented (see Figure 2). these functions back out to line business units in an effort to better Legal department Business unit management Training department Compliance structure – roles, • Emerging regulations • Risk management • Training manage risk. Many companies • Policies/procedures responsibilities and reporting strongly believe that line business • Metric-based supervision The broad array and increasing units should retain responsibility complexity of compliance for the implementation of those functions being implemented core compliance functions which throughout an organization are central to the line business Key – Compliance functions Business unit staff Governance and oversight • Complaint handling places new demands on unit’s general operation. Today, Monitoring company management to assess it is not unusual for marketing or Enabling and determine the appropriate distribution to have responsibility Core compliance structure for their for sales material review, or for Source: PricewaterhouseCoopers
5 The Sarbanes-Oxley Act of 2002 (Pub. L. 107-204, 116 Stat. 745 (2002)) (Section 302). 6 ‘Each member shall have its chief executive officer (or equivalent officer) certify annually, as set forth in IM-3013, that the member has in place processes to establish, maintain, review, test and modify written compliance policies and written supervisory procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations…’ NASD Rule 3013(b). 7 Under SEC rules 38-a-1 and 205(4)-7 investment companies are required to appoint a chief compliance officer who is responsible for certifying to the adequacy and effectiveness of the company’s compliance policies and procedures. 8 USA PATRIOT Act, Section 352 (c) and (e).
Insurance digest • PricewaterhouseCoopers 7 THE EVOLVING DEFINITION OF ‘COMPLIANCE’ continued
of functions such as licensing, Role of the chief compliance well-defined and communicated performing related monitoring complaint handling and analysis officer and compliance in a manner that leaves no functions requires a degree of of emerging regulations. department questions as to what behaviors independence that supersedes However, the complexity of some are expected. Well-articulated direct line, or even dotted-line, organizations requires the Discussions around which responsibilities lead to clear reporting relationships. However, decentralization of even these business units should be charged expectations that can be the absence of reporting does functions. The primary challenge with the implementation of specific measured and evaluated (e.g. not diminish the need for a associated with decentralization compliance functions leads to metric-based supervision, testing). formal relationship to exist is managing consistency in questions surrounding the role between these individuals. In fact, implementation and in allocating of the chief compliance officer Second, it is essential that monitoring relationships often sufficient resources to handle all and compliance department individuals implementing call for a high degree of formality necessary support and monitoring in designing, developing and compliance functions are with specified forms of functions. It should be noted that maintaining a compliance organizationally linked in a communication (e.g. reports) and assigning responsibility for the structure that is sufficiently manner that makes sense for direct oversight. Ultimately, what implementation of a compliance structured to facilitate the effective the company’s general operating matters is that individuals who function to an individual aligned oversight and governance of all style and culture. It is not unusual perform related compliance with the compliance department compliance activities. for multiple business units to play functions remain connected to does not, necessarily, avoid the key roles in the support and each other in a meaningful While there are many identifiable consistency or resource issue. monitoring of a specific core manner, and each company elements evident in the structure Compliance departments with function. For example, where needs to find the appropriate of a robust compliance operation, staff physically embedded into a core compliance function is level of formality and structure to two stand out as being essential: the business units are also being implemented by individuals facilitate these connections. the quality of the individuals challenged by consistency and in a specific business unit assigned responsibility for resource issues. (e.g. complaints being handled Based on the above, chief implementing the compliance by the customer service compliance officers must There are no universal answers functions and the manner in department), the activities of possess skill sets that are, for which compliance functions which these individuals are these individuals may be directly in many respects, quite different should be implemented by connected to each other. supported and monitored by from the skills that may have individuals aligned with the Today, a primary role of the individuals from the legal, served them well just a few years company’s compliance chief compliance officer is to training, auditing and compliance ago. It is now incumbent on the department and by which make certain these elements are departments (see Figure 2). chief compliance officer and individuals assigned to one of the successfully addressed. individuals organizationally company’s other business units. Consequently, in a robust assigned to the compliance Individuals assigned a role in Similarly, each company needs compliance operation, the department to facilitate the the performance of a specific to decide whether compliance compliance department must linkage between individuals compliance function must possess functions should be implemented ensure that individuals are performing compliance functions the requisite skills, experience and from a centralized operation connected in a formal manner across the enterprise. Today’s authority to effectively implement (compliance department or that goes well beyond traditional effective chief compliance officer the function. The chief otherwise) or performed by direct or dotted-line matrix must be a fully integrated compliance officer is responsible multiple individuals located in reporting relationships. For member of the executive for ensuring that business units decentralized business units example, where similar management team with full assign compliance responsibility across the enterprise. For a compliance functions are being access to all business leaders to appropriate individuals and compliance operation to find implemented in a decentralized and the board of directors. that resource levels are sufficient success, the location of environment, consistency In addition, the chief compliance to meet the compliance needs individuals responsible for the requirements dictate the need for officer must complement broad of the company. In addition, implementation of compliance formal communication on a technical expertise with a compliance departments are functions must be aligned with consistent basis. In addition, the mastery of organizational skills now responsible for making the company’s overall culture relationship between individuals and the ability to present certain that compliance-related and operational needs. performing core or supporting complex compliance concepts roles and responsibilities are functions and individuals to all stakeholders.
8 Insurance digest • PricewaterhouseCoopers THE EVOLVING DEFINITION OF ‘COMPLIANCE’ continued
effective, essential confirming the occurrence of Governance and oversight compliance functions provide an information will flow expected compliance activity. FIGURE 3 overlay to the core, enabling and monitoring functions being implemented across the company from those Risks of non-compliance are performing core identified and escalated to senior and supporting management and the board for nd oversight complian ance a ce fun vern ction compliance functions evaluation and direction before Go Program s review to those charged they result in an adverse with monitoring these regulatory action or lawsuit. compliance functions. In turn, With this type of information, itoring functio Mon ns this information will senior management and the be presented to board of directors have the Con assessmenttinuou members of senior tools necessary to provide Periodic s compliance f management and the meaningful oversight over the testing ling unct nab ion E Emerging s board of directors compliance operation.
s t Str planning ou regulations who are charged with ategic nu men ti s providing oversight There is no question that federal Con and state lawmakers, regulators, asses of the compliance t lianc pro mp e fu Pol co n k c cedur icies/ e t operation. The chief and those charged with enforcing is i smen r o R o n es C these laws and regulations, expect e compliance officer is s ass generally responsible meaningful governance of the for providing timely compliance operation from a Cert
g reports summarizing company’s leadership team. ificat risks, issues and With continually emerging ion Metric Auditin supervision-ba operational regulations and new corporate sed ining Tra effectiveness. demands, building the compliance infrastructure Importantly, where necessary to facilitate this the company’s expected governance is no simple Advice/ compliance structure undertaking. Chief compliance Pol consulting approvalicy k effectively links all of officers must structure and Ris the individuals who manage a compliance operation management are implementing that successfully connects related core, individuals from across the supporting and enterprise having the responsibility Source: PricewaterhouseCoopers monitoring for implementing multiple layers Compliance governance – compliance leadership, and the compliance functions across the of compliance functions. senior management and continual assessment of whether enterprise, these reports provide Understanding that the simple board oversight compliance functions are being much more than a retrospective term ‘compliance’ now requires effectively implemented in communication focused solely on an expansive definition helps in In today’s environment, it is accordance with the company’s the number of complaints, results beginning to frame the issues expected, and in certain risk management philosophy of regulatory inquiries or the cost and questions that will lead to circumstances required, that (see Figure 3). of litigation. These reports have the development of a successful senior management and the board the potential of providing valuable compliance operation. of directors (directly or through For this oversight to be prospective analytical information a committee) actively provide meaningful, sufficient and oversight over the company’s significant information relating to AUTHOR compliance operation. The the effective implementation of all compliance oversight functions compliance functions must be Stephen Koslow performed include the review and provided to senior management Director, Financial Services Compliance approval of significant compliance and the board. If the structure of Advisory Practice policies and programs, the the compliance operation is Tel: 1 312 298 3829 provision of strategic direction to [email protected]
Insurance digest • PricewaterhouseCoopers 9 European regulatory change – Threats or opportunities?
AUTHOR: TIM HARRIS
10 Insurance digest • PricewaterhouseCoopers Current and future change will redefine the reporting and regulatory landscape for Europe’s insurers. This article explores these changes and the threats and opportunities they present, and asks the question whether reinsurance arrangements could be developed to help European insurers manage their risks and capital more effectively as the new regimes evolve.
EUROPEAN REGULATORY CHANGE – THREATS OR OPPORTUNITIES?
Radical change in reporting financial position of an insurer. The most significant and regulation New ways of measuring these developments are still to come attributes are emerging, both The regulatory and reporting Changes experienced in Europe by voluntary initiative and environment for insurers in Europe over the last two years are only regulatory compulsion. has begun to change. Radically. the start. Following the initial And there is little sign of the pace implementation of IFRS, insurers, The initiative taken by Europe’s of change relenting, at least for regulators and standards-setters largest life insurers to develop the next several years. are now turning their minds to the a way of presenting their bigger prize of a long-term solution performance in a more comparable Take International Financial addressing the accounting and and coherent way illustrates this. Reporting Standards (IFRS) for regulation of the industry. These Stakeholders are European insurers responded to example. Listed insurance changes will arise from the the concerns of stock analysts demanding a more companies, along with around implementation of a ‘Phase II’ that their supplementary reporting 7,000 other companies listed on standard from the International of life business performance holistic view of European stock exchanges, are Accounting Standards Board lacked consistency and credibility. required to convert to IFRS for (IASB) on accounting for the performance In May 2004, a group of the CFOs their main ‘generally accepted insurance contracts and the of 20 leading insurance groups and funding of accounting principles’ (GAAP) introduction of ‘Solvency II’ – in Europe (the ‘CFO Forum’) financial reporting this year. a new basis for the prudential insurance published voluntary guidance to For the insurers, this means regulation of insurance. These align their reporting, known as implementing new or revised two initiatives are inter-related, businesses. ‘European Embedded Value’. accounting standards for their because the regulators would assets and liabilities, including Changes in regulation have also like to use IFRS ‘Phase II’ as the the International Accounting driven changes in reporting. In the underlying measurement basis for Standards Boards ‘interim’ UK, for example, the Financial the ‘Solvency II’ framework. standard for insurance contracts, Services Authority (FSA) has IFRS4. Because GAAP can impact IASB ‘Phase II’ – required life insurers to measure regulatory and tax reporting, this current status their ‘with-profits’ liabilities on a means consequential effects on new ‘realistic’ basis, and The IASB relaunched its the ways companies manage their companies have started deliberations on insurance regulatory capital and tax positions. submitting their own ‘internal contract accounting in 2004 by establishing a working party to Stakeholders want the whole capital assessment’, a precursor consider the way forward. picture…and the European to full risk-based capital Following the controversy insurance industry is methodologies, for regulatory surrounding some of the earlier responding review. The regulator expects these disciplines to be in place, proposals, including the ‘Draft Stakeholders are demanding and for companies to refine and Statement of Principles’ published a more holistic view of the improve their underlying models under the supervision of the performance and funding of of the business over time. predecessor of the IASB, the insurance businesses. Capital Reinsurers aren’t immune either, International Accounting adequacy, performance, cash with the recent introduction of the Standards Committee, the IASB generation and risk management reinsurance directive by the has promised to look at the are fundamental to assessing the European Commission (EC). issues anew.
Insurance digest • PricewaterhouseCoopers 11 EUROPEAN REGULATORY CHANGE – THREATS OR OPPORTUNITIES? continued
Unlike ‘Phase I’ (the interim The EC’s desire to issue the capital assessment. Often this Companies looking for standard which became IFRS4) directive in 2006 for 2008 diversification capital benefit innovative ways to manage risks there are wider international implementation clearly doesn’t is highly material in the context These changes in regulation and issues to consider. Phase II is a work with the IASB timetable. of the overall capital required. reporting, especially unresolved ‘modified joint project’ on the It remains to be seen how the This is a key element of issues like diversification, make IASB’s convergence program EC will respond to this dilemma – companies’ own calculations. Europe’s insurers more willing with the US Financial Accounting the fear is that they may create The regulators want companies than ever to consider innovative Standards Board (FASB). So in a new regulatory measurement to prove that the diversification ways of increasing the flexibility time, the standard arising from basis (as has been seen in the is real and that capital is truly of their capital. Emerging capital ‘Phase II’ could replace US UK with ‘with-profits’ life ‘fungible’ – i.e. it can be assessment disciplines enable GAAP for insurance. Accordingly, business), further adding to the mobilised between operations insurers to measure and be more US companies have started reporting burden of insurers. (which may be different legal aware of the underlying risks in taking notice, are represented entities in different territories). their business. on the IASB working group, Regulatory change – prizes as While diversification of insurance well as burdens and have presented to the IASB risk at the portfolio level is the An opportunity for reinsurers? in session. The prize of consistent and essence of insurance, in the This represents a significant comparable regulation regulators’ eyes broader The IASB has not given a firm opportunity for the reinsurance throughout Europe is real, and diversification of insurance, timetable for Phase II, but has markets, which are expert in one the insurance industry operational, liquidity, investment indicated that there will be no the diversification of risk. eagerly anticipates. Unlike the and other risks at the group level standard until at least 2008, Interestingly, however, Europe’s U.S., the prudential regulation of is more difficult to demonstrate. which suggests implementation insurers appear increasingly insurers in the European Union And it isn’t just the regulators not before 2010. The first step drawn towards solutions from differs significantly between who are taking notice – the rating will be a high-level discussion the capital markets, perceiving member states, and there is no agencies are increasingly paper that the IASB is expected structured products such as common framework similar to interested in companies’ own to publish later this year. innovative debt and securitisations that established by the NAIC. capital assessments, and capital a potentially more cost-effective The hope is that consistent adequacy has been a recurring ‘Solvency II’ – what is the means of meeting their capital regulation will lead to competition theme of the stock analysts for current status? needs. Reinsurance can be and ultimately sales across several years. perceived as expensive Despite the apparent dependency borders between member states. financing. Investment banks and on IFRS Phase II, it is clear the Diversification is key to whether capital houses are investing Solvency II timetable is not Europe’s insurers would like the the promised benefits of heavily in the skills and expertise aligned. Solvency II will be regulation to be based on their ‘Solvency II’ come with a bitter to exploit this new market. implemented through a directive own assessment of their capital aftertaste for the insurers. issued by the EC. The EC has requirements, and are busy Without regulatory credit for The challenge and opportunity prioritised creating a directive that developing their own risk-based diversification, insurers may for reinsurers is to create or will define Solvency II, and intends capital frameworks. It is likely need to look hard at their capital reinvent risk transfer to follow a fast-track procedure that this will be a feature of the position. At one extreme, the arrangements that help insurers to expedite its development. framework, although the regulators potential consequences of this manage their capital positions in may be more prescriptive about are obvious – more capital a cost-effective way, comparable The EC has asked the body the models used. required to support the business. with the costs associated with that represents the prudential Even if additional capital isn’t capital markets products. regulators across Europe Diversification is key, but the needed, it is possible that capital (CEIOPS) to begin work on regulators need convincing constraints on insurers could One way of doing this might be technical aspects of the directive. limit their ability to exploit the One of the areas likely to to take a long hard look at whether Initial consultations identified growth opportunities arising be highly contentious is the reinsurance arrangements could strong support for an approach from the advent of a common degree to which the regulators be used as a way of enabling based broadly on the ‘Basel II’ regulatory framework. allow groups to recognize insurers to take regulatory credit regulatory framework for banks, diversification benefits between for the diversification within their using IFRS Phase II as the their operations in the risk-based operations. If a cost-effective underlying measurement basis.
12 Insurance digest • PricewaterhouseCoopers EUROPEAN REGULATORY CHANGE – THREATS OR OPPORTUNITIES? continued
means of crystallizing the theoretical and practical basis for regulation is anything to go by, diversification benefit through a diversification – a debate which, the prospects are good, but it’s combination of internal (mixer or at the end of the day, the going to be tough. captive-type arrangements) and regulators have the casting vote. external reinsurance could be found, this might provide a more It remains to be seen whether the AUTHOR tangible way of demonstrating reinsurers and their clients in the the value of diversification to European insurance markets are Tim Harris equal to the challenge. If the recent regulators and other stakeholders. Partner, Global Capital Markets Group, London This might help avoid the positive and proactive response Tel: 44 20 7213 1366 prospect of a lengthy academic of the insurers to the first wave of [email protected] debate to seek to prove the radical change in reporting and
Insurance digest • PricewaterhouseCoopers 13 Record retention compliance in a changing regulatory environment
AUTHORS: JIN J. LEE, JAMES SANTANGELO AND ROSALIND CONWAY
14 Insurance digest • PricewaterhouseCoopers Evolving regulations require compliance with a staggering variety of retention periods, storage methods, and other specifics corresponding to the many types of company records generated in the course of doing business. With the market’s focus on corporate accountability, the government agencies that put forth these regulations have been increasing their scrutiny in the record retention area, especially electronic records, elevating the risk of non-compliance and ultimately litigation.
RECORD RETENTION COMPLIANCE IN A CHANGING REGULATORY ENVIRONMENT
Introduction 3. SEC Rule 17a-4 for broker- records to electronic discovery; dealers states the types of or 3) more significantly, Insurance companies are now records that brokers and inadvertently destroying records faced with the arduous task of dealers are required to create, that the company is legally promptly updating and modifying how long they must be stored, obligated to retain. Record their current records management and under what media retention becomes even more of programs to reflect recent requirements.3 a major issue for companies when regulatory requirements for record they find themselves immersed in retention. United States regulators 4. NASD 3010 and 3110 require electronic discovery during litigation from the Securities and Exchange that brokers and dealers and undergo the enormous effort Commission (SEC) to the Health monitor and supervise the and resource allocation necessary and Human Services and the Insurance external transactions and to produce electronic records, National Association of Securities communications of registered which creates a tremendous companies are Dealers (NASD) have implemented representatives, including burden for the organization. and are rigorously enforcing the monitoring, archiving, now faced with the books and records regulatory and retrieval of instant In 2004, the financial services requirements, including: arduous task of message traffic required industry was put on notice about by SEC Rule 17a-4.4 the importance of a robust record promptly updating 1. The Sarbanes-Oxley Act 2002 retention program through (SOX), Section 802 (Criminal and modifying their Given the number of new regulatory enforcement and Penalties for Altering regulations, the emphasis on court action: Documents) of SOX imposes current records… compliance and enforcement, penalties and/or fines for and the potential financial • The SEC brought a ‘documents altering, destroying, mutilating, and reputational impact on case’ against the Banc of concealing, falsifying records, non-compliance, insurance America Securities in March documents, or tangible objects companies have started to review 2004. The SEC’s extraordinary with the intent to obstruct, their current record retention enforcement action against impede or influence a legal policies, procedures, and Banc of America Securities investigation.1 compliance. Subsequently, they (BAS) resulted in BAS being have often found themselves with censured and ordered to pay 2. The Health Insurance outdated policies and procedures a civil penalty of $10,000,000. Portability and Accountability and potential exposure to non- During the investigation, the Act of 1996 (HIPAA) 45 CFR compliance. Companies also SEC stated that BAS Parts 160 and 164 under found that they are: 1) not repeatedly failed promptly to HIPAA requires healthcare retaining records as required; furnish documents that had institutions to implement a 2) retaining records longer than been requested by the staff. comprehensive information necessary, subjecting their Specifically, BAS failed in a security plan.2
1 Sarbanes-Oxley Act of 2002, Section 802, §1519. 2 Federal Register, Volume 68, No. 34, 45 CFR Parts 160 and 164, February 20, 2003. 3 Elizabeth Clark, ‘Data Retention Regulations: Keep It Legal.’ Network Magazine. March 3, 2004, p.1. 4 NASD Notice to Members 03-33 (Clarification for Members Regarding Supervisory Obligations and Recordkeeping Requirements for Instant Messaging), p. 345, July 2003.
Insurance digest • PricewaterhouseCoopers 15 RECORD RETENTION COMPLIANCE IN A CHANGING REGULATORY ENVIRONMENT continued
timely manner: (i) to produce documents were damaging to • In a legal blow to Wall Street Federal and state electronic mail, including a the defendant in light of the giant Morgan Stanley, a Florida regulatory concerns particular e-mail exchange defendant’s failure to fulfill its jury awarded billionaire Considering the imposition of relating to matters that BAS duty to preserve and produce financier Ronald Perelman record retention compliance knew were under those documents;7 $604.3 million on his claims responsibilities dictated by investigation; (ii) to produce that the investment bank federal and state regulations, certain compliance reviews • The SEC announced on defrauded him when he sold it is incumbent upon the after the staff had requested August 23, 2004 that it fined camping-gear maker Coleman insurance industry to look them; and (iii) to produce four firms (Adams Harkness, Inc. to Sunbeam Corp. in beyond the NAIC Market compliance and supervision Inc., Needham & Company, 1998. The nine jurors found Conduct Record Retention and records concerning the Inc., Janney Montgomery that Mr. Perelman, chairman Production Model Regulation11 personal trading activities of a Scott LLC, and Morgan of cosmetics giant Revlon and state insurance statutes for former senior employee of the Keegan & Co., Inc.) for Inc., relied on statements guidance on complying with the firm. When BAS ultimately did violating the record-keeping made by Morgan Stanley myriad of complex government respond to the staff’s requirements of Section 17(a) when he sold his stake in record-keeping requirements. requests, its responses were and Rule 17a-4 of the Coleman to the investment For example, SEC Rule 17a-4 often incomplete, inaccurate Exchange Act concerning bank’s client, Sunbeam, for has become a rightly placed or unreliable.5 business-related internal $1.5 billion in stock and cash. focal point of concern for e-mail communications during Not long after the deal, insurance companies and other • In Zubulake v. UBS Warburg the period July 1999 through accounting shenanigans at players in the financial services (UBS), the U.S. District Court June 2001. Each of the four Sunbeam were exposed and industry because of increased for the Southern District of firms consented, without the value of Mr. Perelman’s regulator enforcement action and New York entered a motion admitting or denying the investment plummeted. the resulting financial and legal to sanction UBS on July 20, findings, to a cease-and-desist Sunbeam sought bankruptcy- consequences that come from 2004 for destroying e-mails order and to undertakings to court protection in 2001. non-compliance. Although the sent or received by UBS ensure that they are in Florida State Judge Elizabeth record retention requirements of personnel relevant to the compliance with the record- Maass, angered by what she federal regulations such as SOX litigation.6 On April 6, 2005, keeping requirements of called Morgan Stanley’s bad- are targeted at public companies, a federal jury in New York Section 17(a) and Rule 17a-4 faith actions in turning over privately owned companies returned a verdict in the of the Exchange Act;8 documents relevant to the should also assess their wrongful termination case of case, entered a so-called information and records Zubulake vs. UBS Warburg • The New York Attorney- default judgment against the management practices in the LLC, awarding $29.3 million to General Eliot Spitzer, on firm, making Mr. Perelman’s spirit of enterprise-wide risk the plaintiff where the plaintiff October 14, 2004, announced case decidedly easier than management. In the post- established that the defendant his office’s filing of both establishing that he had been SOX era, all organizations failed to preserve potentially criminal and civil lawsuits defrauded. In most fraud (public companies as well as relevant e-mails after learning against Marsh & McLennan, cases, plaintiffs have to prove private companies not subject that Zubulake was pursuing a the largest U.S. insurance they actually were defrauded.10 to SOX) should revisit their claim. The Court granted an brokerage firm, a probe partly In this unusual trial, the judge records management programs ‘adverse inference’ instruction, based on a trail of internal told jurors to accept as fact to ensure they appropriately noting that the jury could e-mails;9 and that Morgan Stanley helped address their business, legal, assume that the missing Sunbeam defraud investors. and compliance needs.12
5 Securities Litigation Watch. March 2004. ‘Banc of America Hit With $10 Million Penalty For Impeding SEC Investigation’. March 11, 2004. 6 Zubulake v. UBS Warburg LLC, et al. 2004 U.S. Dist. LEXIS (SDNY, 20 July 2004). 7 David Cohen. ‘Record Retention & E-Discovery: Zubulake Jury Returns E-Discovery: ‘Wake-up Call’.’ K&LNG Alert, April 2005. Accessed June 9, 2005.
16 Insurance digest • PricewaterhouseCoopers RECORD RETENTION COMPLIANCE IN A CHANGING REGULATORY ENVIRONMENT continued
Adding to the complexity of the 2. Missouri – The Missouri Code record retention, an example expose many companies not only myriad of federal statutory of State Regulations (Rules of of the lack of consistency to negative publicity, but also to regulatory requirements, record the Missouri Department of among the state statutory the possibility of monetary retention standards for the Insurance, Division 300, requirements for the same sanctions. For a company’s insurance industry vary greatly Chapter 2-Record Retention type of record.15 management to navigate the from state to state, as noted, for for Market Conduct multitude of record retention example, by the differences in the Examinations) require that a Mitigating the risk variables in today’s highly insurance statutes/regulations of Missouri policy record file be of non-compliance regulated insurance industry New York, Missouri, and Florida: maintained for each Missouri Evolving regulations require and reduce its risk of policy issued, and be compliance with a staggering non-compliance, it must 1. New York – Part 243.2(b)(1) maintained for the duration variety of retention periods, understand the implications of Title 11 of the Official of the current policy term storage methods, and other of the changing business, Compilation of Codes, Rules plus two calendar years.14 specifics corresponding to the technological innovation, and and Regulations of the State many types of company records legal requirements, and how of New York (Regulation No. 3. Florida – Florida’s insurance generated in the course of doing those changes affect record 152) requires that a policy record retention standards are business. With the market’s focus retention criteria. Well record for each insurance detailed in the Florida on corporate accountability, the documented and organized contract or policy, except statutory and administrative government agencies that put records help form a basis of as otherwise required by codes, specifying the record forth these regulations have been evidence needed to defend the law or regulation, must be retention standards that apply increasing their scrutiny in the company’s position on maintained for six calendar to recordkeeping for insurance record retention area, especially compliance-related matters. years after the date the policy companies. The Florida electronic records, elevating the is no longer in force or until Then how is it possible to Administrative code, however, risk of non-compliance and after the filing of the report implement an enterprise-wide does not specify the record ultimately litigation. Such on examination in which the records management program retention period for policy aggressive investigation of record was subject to review, in order to mitigate the risk issued records as do the New corporate wrongdoing and the whichever is longer.13 of non-compliance when the York and Missouri statutes for related document requests,
13 Part 243.2(b) (1) of Title 11 of the Official Compilation of Codes, Rules and Regulations of the State of New York (Regulation No. 152). 14 Rules of the Missouri Department of Insurance, Division 300, Chapter 2-Record Retention for Market Conduct Examinations. 15 Florida Administrative Code, Chapter 4 (Department of Insurance), Section 4-184.004.
Insurance digest • PricewaterhouseCoopers 17 RECORD RETENTION COMPLIANCE IN A CHANGING REGULATORY ENVIRONMENT continued
requirements are evolving are modified and appropriate recovery and record retention • The technological on a number of fronts? If the resources and processes are not utilizing the appropriate infrastructure and systems appropriate policies and in place to keep up. Therefore, technology to support this used to store, secure and procedures are in place today, the policy may become integrated strategy. Also, one of provide business continuity – what can be done to ensure insufficient, the technology the biggest challenges in evaluate the technical that they are current and that inadequate, or program implementing a records capability and the ability to employees comply with those administration ineffective, but management program is the utilize technology to facilitate policies and procedures on a most importantly, the company employees’ compliance with the record retention to the fullest daily basis? The answer must may generate new information policies and procedures as they extent reasonably possible; include a periodic analysis of: outside of the current policy due perform their work. Integrating to additions or changes in compliance requirements into the • The records management • The understanding of the business processes (e.g., through business processes and periodic organizational structure – current businesses and the an acquisition of another audits for their enforcement will ensure that it is effective and regulations affecting them; company or the creation of new make the records management that people continue to products or services) and the program effective. comply with its policies and • The business processes information that needs to be procedures; and and the types of information stored for record retention Additionally, periodic they generate; purposes is not being retained. assessments and audits that • Communications and training This results in an ineffective provide regular ‘snapshots’ of the to ensure both are conducted • The record retention program that translates into a effectiveness of the compliance periodically and regularly. policies governing high exposure to sanctions and program are essential to ensure information management; penalties for the company. the program’s success. Periodic Conclusion Essential to reducing the risks is assessments and audits should The insurance industry faces • How the information is to establish a record retention be completed to assist in many challenges to keep pace used and stored as records, methodology that integrates evaluating and monitoring the with the complex changes in the including the related record retention compliance into following areas: business, legal, and technical technological infrastructure an organization’s corporate components of the current and systems used to secure governance and risk • Company functions and regulatory environment with and archive it; and management structure, which business processes and the respect to record retention. In provides for periodic program information they generate – today’s regulatory environment, • The records management assessments and audits. assess areas of the company companies must re-examine their organizational structure and that are considered high risk enterprise-wide information and its effectiveness in execution. What is the most to validate the information document retention policies and effective approach? they produce; The general approach to the practices to ensure their A key driver of an effective adequacy. New and extensive effective records management • Regulations affecting the records management approach document retention regulatory program is to deploy enterprise- company functions and their is the integration of a compliance requirements, together with wide policies and procedures, record retention requirements program into the company’s greater regulatory scrutiny and apply technology to capture, – review and determine business processes. For enforcement, have significantly archive, and retain the applicable laws and specific example, an organization that increased the risks and costs of information, organize a network actions needed to comply; of compliance coordinators to has the conflicting goals of an not retaining documentation and information as statutorily facilitate the program, and, of e-mail archiving strategy needed • The company record retention required. A records management course, include general counsel for disaster recovery, but which policies, procedures and program that incorporates its in any decisions that are made. also finds itself attempting to retention schedules – ensure compliance requirement into But over a short period of time, create an e-mail retention they are updated in the business processes, there are revisions to the strategy to comply with federal accordance with the current and a periodic assessment regulations, the technology and state regulatory requirements. laws and regulations, changes and audit, reduces the risk of changes, some of the people These archiving and retention in business environment, and non-compliance and drives its with program knowledge are strategies should be integrated to technology innovation; redeployed, business processes satisfy the objectives of disaster overall success.
18 Insurance digest • PricewaterhouseCoopers RECORD RETENTION COMPLIANCE IN A CHANGING REGULATORY ENVIRONMENT continued
AUTHORS Jin J. Lee James Santangelo Partner, Information and Document Director, Information and Document Retention Services Retention Services Tel: 1 312 298 4367 Tel: 1 203 881 0722 [email protected] [email protected] Rosalind Conway Manager, Insurance Regulatory Compliance Advisory Services Tel: 1 646 471 2781 [email protected]
Insurance digest • PricewaterhouseCoopers 19 The CFO Forum’s European Embedded Value – A superior financial reporting framework for life insurers
AUTHORS: SHERYL A. BATTIT AND DAVID C. SCHEINERMAN
20 Insurance digest • PricewaterhouseCoopers European Embedded Value (EEV) seeks to address certain limitations associated with most existing embedded value reporting, and provides a framework for financial measurement and disclosure that can be of significant value to all life insurers, including U.S. insurers who have not embraced embedded value reporting before.
THE CFO FORUM’S EUROPEAN EMBEDDED VALUE – A SUPERIOR FINANCIAL REPORTING FRAMEWORK FOR LIFE INSURERS
Introduction What is embedded value? EV measures bridge a gap between statutory surplus Transparency, consistency and Mathematically, EV equals the (often reflecting conservative comparability: key goals of most present value of future assumptions that embed expected financial reporting systems, ‘distributable’ shareholder cash future profit in reserves) and GAAP but not yet available across flows from ‘in-force’ (existing) equity (which, although it reflects international borders. International business (PVIF) and the value of a ‘going-concern’ perspective, Financial Reporting Standards capital supporting the business. allows most assets to be reported (IFRS) are evolving to address this The value of capital supporting at their fair value, while liabilities gap, but in the near term, most the business includes required are generally reported at book insurance contract accounting will capital (e.g. risk-based capital) value). EV earnings may provide remain primarily based on local and excess surplus (‘free surplus’) EEV provides a clearer view of current-year accounting standards. Although over required capital. The valuation financial and management a framework many European companies have of this capital recognizes the performance than either GAAP or adopted IFRS this year, it will economic cost of holding the for financial statutory earnings. EV estimates require significant experience and required surplus to support existing are designed to reflect the effect time for the benefits of this new business. Present values are measurement of more realistic expectations set of standards to be fully determined using a risk-adjusted about future performance and and disclosure… realized. This gap served as a discount rate, generally disclosed experience, including investment prime motivator for the European to the stakeholders. risks/rewards, customer behavior Insurance Chief Financial Officers and other factors that influence (CFO) Forum to develop an EV measurement incorporates future profitability. alternative financial reporting and discloses the value of new framework: European Embedded business (the present value of How is EV used? Value Principles (EEV). distributable shareholder cash flows from the current year’s EV provides an economic This article describes embedded sales). EV earnings may also be valuation of existing business value reporting, how EEV seeks determined as the change in EV through a forward-looking to address certain limitations during the year plus dividends projection of expected profit, associated with most existing minus capital contributions. EV and is used in both external and EV reporting, and how EEV can earnings may be analyzed by internal reporting. In both Europe assist internal and external components, including the value and Canada, it has generally been stakeholders in evaluating added by the current year’s sales, included as disclosure a company’s performance, the earnings from existing accompanying life insurers’ the value of shareholders’ business, and the investment financial statements. When interests and a company’s overall return on capital supporting the available, shareholders, rating financial position. EEV provides business. In addition, each of agencies and financial analysts a framework for financial these components may be further have used EV to evaluate an measurement and disclosure that analyzed in order to identify the insurer’s financial performance the authors believe can be of source of the earnings, which can and position, as well as to provide significant value to all life insurers, provide further insight from EV as a a more realistic view of current including U.S. insurers who have performance measurement basis. and likely future return on capital. not embraced EV reporting before. When viewed over time,
Insurance digest • PricewaterhouseCoopers 21 THE CFO FORUM’S EUROPEAN EMBEDDED VALUE – A SUPERIOR FINANCIAL REPORTING FRAMEWORK FOR LIFE INSURERS continued
comparability in financial reporting. EEV is a set of 12 principles that aim to build on the strengths of existing embedded value methodologies, while addressing the key concerns of users of the resulting information.
What are the key elements of EEV? The 12 principles of EEV, as put together by the CFO Forum, are summarized in Figure 1. The application of these principles is expected to provide more reliable and risk-responsive information as well as enhanced financial disclosure, with a much greater degree of consistency and reliability in the approach.
The EEV principles are designed to account for all significant risks in the covered business. They incorporate allowances for it provides an indication of the disclosure of EV reporting, which and raised questions concerning financial options and guarantees, value added by management in has resulted in difficulties in the reliability of the risk the prudence of the liability running the business. making valid comparisons assumptions that underpin the valuations, the cost of holding between companies. As usage EV projections. As a result, in the capital needed to support EV can be used internally as of EV increases within the Europe, analysts have sometimes any mismatching of assets and a basis for establishing and investment community, it is applied their own, sometimes liabilities, and a risk discount evaluating business strategies, important that these measures significant, risk discount to rate to determine the present and it has been effectively used be consistent and comparable published EV numbers. value of future cash flows. for performance measurement among peer group companies. In their calculations, companies and incentive compensation To address these concerns, in are required to use stochastic programs. EV is also used by Another criticism of conventional May 2004, the European Chief methods to estimate the future insurers as a predictive basis for EV techniques is that they fail Financial Officers (CFO) Forum cost of options and guarantees. judging pricing, capital allocation to take proper account of launched what they referred to Such projections need to reflect and risk management strategies. changes in asset mix and the as European Embedded Value the likelihood of a range of potential cost of financial options Principles (EEV). The CFO Forum scenarios and outcomes, Why did the CFO Forum (e.g., guaranteed minimum brings together CFOs from including probable variations in develop ‘European EV’? death benefits) and guarantees Europe’s leading life insurers long-term economic assumptions Although current industry EV (e.g., minimum interest rates). to discuss issues relating to and possible changes in practice is gaining increased Such concerns have been accounting standards and management/customer behavior. acceptance internationally, it has heightened in recent years as developments and how to EEV’s extensive new disclosure had its detractors and some volatile equity markets and low enhance transparency of their requirements include an analysis inherent limitations. Among them interest rates have triggered financial accounts. The Forum of the return on capital, along has been a diversity in practices increasing expected costs has sought ways to promote with sensitivity analyses to relating to the calculation and associated with these obligations stability, credibility and
22 Insurance digest • PricewaterhouseCoopers THE CFO FORUM’S EUROPEAN EMBEDDED VALUE – A SUPERIOR FINANCIAL REPORTING FRAMEWORK FOR LIFE INSURERS continued
FIGURE 1 The 12 principles of European Embedded Value
Principle 1: Embedded value is a measure of the consolidated value of shareholders’ interests in the covered business.
Principle 2: The business covered by the embedded value methodology should be clearly identified and disclosed.
Principle 3: Embedded value is the present value of shareholders’ interests in the earnings distributable from assets allocated to covered business after sufficient allowance for the aggregate risks in the covered business. The embedded value consists of the free surplus, the required capital and the value of future cash flows.
Principle 4: The free surplus is the market value of any capital and surplus allocated to, but not required to support, covered business at the valuation date.
Principle 5: Required capital should include any amount of assets attributed to the covered business over and above that required to back the liabilities for covered business whose distribution to shareholders is restricted. The embedded value should allow for the cost of holding the required capital.
Principle 6: The value of future cash flows from in-force covered business is the present value of future shareholder cash flows projected to emerge from the assets backing liabilities of the in-force covered business. This value is reduced by the value of financial options and guarantees as defined in Principle 7.
Principle 7: Allowance must be made in the embedded value for the potential impact of future shareholder cash flows of all financial options and guarantees within the in-force covered business. This allowance must include the time value of financial options and guarantees based on stochastic techniques consistent with the methodology and assumptions used in the underlying embedded value.
Principle 8: New business is defined as that arising from the sale of new contracts during the reporting period. The value of new business includes the value of expected renewals on those new contracts and expected future contractual alterations to those new contracts. The embedded value should only reflect in-force business, which excludes future new business.
Principle 9: The assessment of appropriate assumptions for future experience should have regard to past, current and expected future experience and to any other relevant data. Changes in future experience should be allowed for in the value of in-force when sufficient evidence exists and the changes are reasonably certain. The assumptions should be actively reviewed.
Principle 10: Economic assumptions must be internally consistent with observable, reliable market data. No smoothing of market or account balance values, unrealized gains or investment return is permitted.
Principle 11: For participating business the method must make assumptions about future bonus rates and the determination of future profit allocation between policyholders and shareholders. These assumptions should be made on a basis consistent with the projection assumptions, established company practice and local market practice.
Principle 12: Embedded value results should be disclosed at consolidated group level using a business classification consistent with the primary statements.
Supporting guidance and more details about the thinking behind EEV are available on the CFO Forum website www.cfoforum.nl
Source: PricewaterhouseCoopers
Insurance digest • PricewaterhouseCoopers 23 THE CFO FORUM’S EUROPEAN EMBEDDED VALUE – A SUPERIOR FINANCIAL REPORTING FRAMEWORK FOR LIFE INSURERS continued
enable users of accounts to own assessments about how calculations, and in the amount the U.S. could provide an assess the sustainability of the companies should be compared. of capital designated as being opportunity for improved reported EEV results. Among the Validation of the approach taken necessary to back the business. communication to stakeholders. other disclosure principles is and the assumptions applied assurance that segment reporting by an external review will also A key practical issue that remains The use of EEV also presents is consistent with the company’s prove useful in increasing the is how to set risk discount rates an opportunity for U.S. insurers primary financial statement, credibility of the resulting to reflect the aggregate risks to enhance their internal which for the larger European measures to stakeholders. not reflected elsewhere. performance measurement. listed groups would normally Other practical challenges As public companies seek to be the segments determined While life insurance is the key include satisfying the detailed measure their performance in accordance with the new focus of EEV, the principles documentation and disclosure relative to their peers, a standard IFRS requirements. are designed to expand the requirements involved, approach to measurement and possible scope of embedded developing these values in disclosure of embedded values Companies will also need to valuation to other long-term a timely fashion, given all of the using the EEV principles should provide information on the business and could be extended other reporting requirements prove to be valuable. amount and cost of required to non-life business. that insurers are subject to, capital and the nature and and developing the data retrieval Given the lack of sensitivity of techniques used to value options What are the perceived and scenario modeling systems statutory accounting measures to and guarantees. In keeping with limitations of EEV? capable of generating, calibrating realistic current expectations, and the sensitivity of GAAP earnings the latest regulation on senior While adherence to the EEV and validating the necessary patterns to product classification management ‘ownership’ of principles should improve the risk projections. and its mixed book/market value financial disclosure, executives consistency and transparency Finally, firms must consider the approach, the authors believe will be expected to certify of EV calculations, certain governance implications of EEV. that EEV provides a superior personally that the values limitations remain. For example, Not only do they have to ensure financial reporting framework. produced and the disclosures the principles do not require that senior management EEV provides financial information provided have been prepared in a fully ‘market consistent’ EV understands and endorses the consistent with the way insurance accordance with EEV principles. calculation and therefore could new measures, but they also products and strategies are Where this is not the case, they continue to allow insurers have to effectively embed them priced and valued, and EEV will need to identify any discretion over their allowance in the operations of the company provides for standardized departures and clearly explain for market risk and asset/liability and explain them effectively to disclosures that allow for more why they have been used. mismatch risks. Although the the markets. meaningful analysis within and EEV principles aim to address Greater consistency in EV among companies. The authors the concern that EV can be reporting will be achieved in two Conclusion: what does this believe that EEV provides a inflated by using a riskier asset ways. First, companies adopting mean to U.S. insurers? significant opportunity to achieve mix with higher anticipated EEV need to use the principles in improved transparency, returns, it is not yet clear how As EEV support among analysts their entirety. Secondly, the consistency, and comparability this concern is addressed by the in the European market increases, principles require the disclosure among insurance companies new methodology. Variation the concept is likely to spill over of key assumptions and within local markets and across could still exist, relative to the into the U.S. insurance market. sensitivities, which will better international borders. level of risk assumed in the Adoption of EEV principles within enable the markets to make their
AUTHORS Sheryl A. Battit David C. Scheinerman Manager, Actuarial and Insurance Director, Actuarial and Insurance Management Solutions Management Solutions Tel: 1 617 530 7078 Tel: 1 860 240 2046 [email protected] [email protected]
24 Insurance digest • PricewaterhouseCoopers THE CFO FORUM’S EUROPEAN EMBEDDED VALUE – A SUPERIOR FINANCIAL REPORTING FRAMEWORK FOR LIFE INSURERS continued
Insurance digest • PricewaterhouseCoopers 25 China and India – Opportunities too big to ignore?
AUTHORS: ROBERT FOK AND KHUSHROO PANTHAKY
26 Insurance digest • PricewaterhouseCoopers To enter China and India successfully, an overseas insurer must know the markets and carefully consider the options.
CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE?
Without doubt China and India However, while the rules on Penetration levels are similar at offer some of the very largest ownership may be unattractive, around 2.3% of GDP. However, opportunities for insurers the foreign insurer has, in many there are sharp differences in the worldwide today. However, cases, effective control of key make-up of national savings. In they are very different both in management positions and India, the proportion of household regulatory environment and in hence of company strategy savings accounted for by life the potential approaches an and operation. assurance is about 15%, with interested investor might take. pension and provident funds A comparison of the two is Looking at the reality of doing taking up a further 19%. This is instructive in deciding on business rather than the in sharp contrast to China, where possible market entry strategies. regulatory situation, the position life and pension savings make Both markets is rather different. While the up only around 5% of retail savings Where they are similar is in percentage foreign holding in assets, despite the greater size of have seen population size. Currently, China India is half that of China – the market. It is therefore clear that impressive is the most populous country in 26% rather than 50% – product there is a considerably greater the world, with a total population innovation and less restrictive potential for transfers of funds from growth in the of 1.27 billion, followed by India regulation have enabled foreign- bank deposits to life assurance with 1.06 billion (mid-1999 invested life companies to achieve policies in China than in India last few years. figures). By 2045, it is projected a market share of 13%. In contrast, (see Figure 2 overleaf). that the Indian population will the tight regulatory environment outstrip that of China – 1.501 in China, with restrictions on Both markets have seen billion as against 1.496 billion. where foreign-owned companies impressive growth in the last can do business and their few years. In 2003, the Chinese Significantly for international exclusion from the group market life assurance market grew by insurers, both markets are soon (recently relaxed), combined with over 30% and in India growth to enter a new phase. This year vigorous competition from local was 18% (2002-03). In the China will remove some of the companies, has led to foreign medium term, life assurance regulatory restrictions which companies winning only 1.9% of premium growth in both have held back foreign-invested life business in 2003 countries will increase faster companies in the past. In India, (see Figure 1 overleaf). than GDP. In fact, high GDP new rules on ownership are likely growth rates, combined with to give multinational insurers Before considering market penetration moving towards greater scope to expand their entry strategies, it is helpful mature market levels of 4% or level of ownership in future. to take a bird’s eye view of more, will ensure double digit the two markets. premium growth. In the immediate While non-life companies in China future, growth drivers in China may be wholly foreign-owned, Market background – may be stronger, since the foreign-invested life companies are life assurance population is aging much faster required to take the form of joint In 2003, the Chinese life insurance than in India and recent pension venture operations. India restricts market totalled US $36bn in reforms lay heavy emphasis on the maximum foreign holding, premiums – two and a half times the insurance sector. However, in companies writing any the size of the Indian market. much of the growth of the class of insurance, to 26%.
Insurance digest • PricewaterhouseCoopers 27 CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
FIGURE 1 Life market share of year 2003 in China Life market share of year 2003 in India
20% 13% 55% 55% 10.5 55% 13% 10.5
11% 87%
1.2% 0.8%
Foreign companies Ping’An CPIC Other domestic companies Life insurance Corporation of India AIA Other foreign companies China Life
Source: China Insurance Yearbook 2004 Source: IRDA Annual Report 2002-03
FIGURE 2 Growth of life premium income in China Growth of life premium income in India
40 15 32.4% 18% 35 10.3% 12 30 59.8% 43.5%
25 9 28.2% 20 42.8% US $ billion US $ billion 6 15 14.4%
10 10.5 12.1 17.2 27.5 36.4 3 5.7 7.3 10.4 11.5 13.6 5
0 0 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003
Source: China Insurance Yearbook (2001-2003) Source: IRDA Annual Report 2002-03
28 Insurance digest • PricewaterhouseCoopers CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
Chinese bancassurance market Market background: has been occasioned by the non-life assurance FIGURE 3 Profit margins of life insurance products in China switching of savings from bank In 2003, China’s overall non-life deposits to life assurance; a premiums came to US $10.5 process likely to be dampened billion, dwarfing the Indian by the recent interest rate rise. Bancassurance 3% market’s rather smaller total 14.8%7.2 24.4% of US $3.6 billion. The relative While business growth rates sizes of the respective non-life Group 4% have been attractive, margins on markets are explained by the bancassurance business in China 73.2% 23.8% Chinese economy’s greater have been poor. Significantly, Individual regular premium 8% urbanisation and emphasis on management of business mix manufacturing. Growth rates has been a key factor in the are similar – nearly 12% in Individual single premium 6% profit performance of the players China and 13% in India – and in this market. Foreign joint they are likely to run a little ahead 0 12345678 ventures have generally of GDP growth as penetration had a lower proportion of levels rise from 1% in China Source: PricewaterhouseCoopers Estimates bancassurance business and and 0.6% in India towards no group business, resulting mature market levels of in better gross margins around 2% (see Figure 4). (see Figure 3).
FIGURE 4 Growth of non-life premium income in China Growth of non-life premium income in India
12 4.0 11.7% 12.5% 3.5 10 13.6% 12.9% 14.5% 3.0 25.9% 8 14.8% 2.5 5.9%
6 2.0 US $ billion US $ billion 1.5 4 6.3 7.2 8.3 9.4 10.5 1.0 2.1 2.2 2.8 3.2 3.6 2 0.5
0 0.0 1999 2000 2001 2002 2003 1999 2000 2001 2002 2003
Source: China Insurance Yearbook 2004 Source: IRDA Annual Report 2002-03
Insurance digest • PricewaterhouseCoopers 29 CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
According to published Regulation has significantly China has around 11 domestic While entry to either market results for the last three affected market make-up in non-life insurers and 11 foreign is not without challenges and years, the Chinese non-life both countries. The Indian companies but, currently, foreign risks for a foreign company, market has been profitable. non-life market is divided companies’ market share is small. the opportunities are large. Although some market between five public sector Past geographical and product With restrictions set to segments have relatively low companies and a larger number restrictions, not applied to loosen in the life sector in rates, at market level there has of new, private sector domestic companies, have played China and ownership rules been an underwriting profit. companies, some of which a significant part in holding down likely to become more In contrast, recent years have are joint ventures with foreign the foreigners’ share. As these attractive in India next year, seen most Indian non-life insurers. These new companies restrictions are about to be lifted, more foreign insurers are companies make underwriting currently have a combined the market may now be more actively considering these losses – turned into modest market share of 14% and, attractive to foreign companies. two exciting markets. profits only by substantial in response to recent poor Importantly, though, 60% of the Over the next few pages, investment returns (see Figure 5). underwriting conditions, have China market is motor business, we look at life market entry been more selective as to which is effectively closed to considerations from the point which risks they will accept. foreign insurers and is expected of view of overseas insurers. to remain so (see Figure 6).
30 Insurance digest • PricewaterhouseCoopers CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
Overall profitability of a leading non-life Overall profitability of non-life FIGURE 5 insurer in China insurers in India
100
3.7% 0
2003 14.8%71.9%7.2 24.4% 2% -100 3% -200 2002 -0.3% 73.2% 23.8%
6.4% -300
2001 68.5% 25.1% 1.6% -400
-20%0% 20% 40% 60% 80% 100% 120% -500 (% of net premiums earned)
-600 Loss ratio Expense ratio 1998-99 1999-00 2000-01 2001-02 2002-03
Underwriting profit Investment return National New India Oriental United Royal Sundaram Reliance IFFCO-Tokyo Tata-AID Bajaj Allianz ICICI Lombard Cholamnadalam HDFC-Chubb
Source: PricewaterhouseCoopers research Source: IRDA Annual Report 2002-03
FIGURE 6 Market share of non-life insurer 2004 March in China Market share of non-life insurer 2004 March in India
3%
13% 11% 14% 18%
55% 15% 55%
10.5 10.5 1% 25% 19%
60% 21%
Ping An Other domestic Others New India National
Foreign companies PICC CPIC United India Oriental ECGC
Source: China Insurance Yearbook 2004 Source: IRDA Annual Report 2002-03
Insurance digest • PricewaterhouseCoopers 31 CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
32 Insurance digest • PricewaterhouseCoopers CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
Entering the Chinese • The first is to develop brand hold strategic investments in the Secondly, you need to develop life insurance market recognition and an adequate two medium-sized life companies a set of selection criteria suitable distribution infrastructure in – Xinhua and Taikang. Buying for the Chinese market. These Entry strategies the face of fierce domestic into an existing operational might include the usual items Foreign companies cannot competition; and structure and business strategy such as financial strength, brand operate wholly owned subsidiaries offers opportunities, but it also position and strength (in China), or branches, therefore they must • The second is to keep the holds risks which are not always distribution capability and either form a joint venture (JV) Chinese JV partner, whose easy to identify. synergies. These are questions or become a strategic investor familiarity with life insurance of fact. in a domestic company (with business is likely to be very JV partner selection limited, comfortable with the Three further criteria are material. a maximum stake of 24.9%). Some foreign companies who growth and capital investment The first is the potential JV There are effectively three have formed life JVs have strategy being pursued. partner’s attitude towards a types of opportunity: experienced conflicts with their potential overseas industry Chinese partners. Many complain At the moment, strategic investor. In addition, the reputation • A joint venture with that their Chinese partner has not investment in one of the smaller, of the company and its key a Chinese partner; delivered operational advantages. recently-licensed, domestic management personnel is Others have found that the new companies amounts to little more absolutely fundamental. Last, • A strategic investment in partner’s management team than buying a stake in a license. but by no means least, potential a small or start up domestic lacks the necessary understanding None of these companies has investors need to pay close insurer; and of the long-term perspective yet achieved scale and there are attention to any possible partner’s needed to write life business and several who are still in the set-up relationship with the government. • A strategic investment in that, as a consequence, financial phase. Of course, being in at the a large domestic insurer. objectives are not aligned. The start of a business offers more Only at this stage should the partner selection process needs To date, most foreign entrants opportunity to influence direction search for a partner begin. to consider issues such as this have favoured the joint venture than would normally be Careful screening against the very carefully indeed. It is also route. A lack of enthusiasm for associated with a minority stake. criteria, using published important not to be dazzled by joint ventures back in head office information but also informal the names of potential partners has generally been offset by the It should also offer a faster conversations with the potential but to consider carefully what all limited alternatives available and track to getting into business or partners, regulators and others, potential partners might bring to the scale of the opportunity. gaining regulatory approval for should be carried out. This will the joint venture. For various reasons, there have expansion plans. Additionally, yield a short list with whom more this year’s recent tranche of new detailed negotiations may be been marked differences in the In our view, there are several domestic licenses also means conducted. It is unusual to select success of joint ventures. key steps. Implementation is key. that the supply of potential a preferred partner until a relatively investments has increased, which Firstly, it’s prudent to eliminate late stage in the discussions. may exert some downward Most of the restrictions to which industry groups which are pressure on the prices being joint ventures were subject are generally unattractive to foreign Business locations sought for minority stakes. in the process of being relaxed. insurers sensitive about their With the restrictions on business Subject to gaining a license, there reputations, such as military- locations having been lifted at Making a strategic investment is now no practical limitation on related industries or tobacco the end of 2004, the selection in one of the larger domestic the locations in which a joint companies. Secondly, many now needs to be a more insurers poses stiff challenges. venture can operate. The inability foreign companies are adverse to structured process than before. The three major life insurance to transact group business was stakes in banks or securities companies have already either lifted in December 2004. companies, and obviously those completed deals or are in However, the JV model poses which already have an insurance discussions with potential two critical challenges: JV with a foreign company are investors. Global insurers already ruled out.
Insurance digest • PricewaterhouseCoopers 33 CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
For the next five years at least, both foreign brands than are their and the supply of suitable market cap of RMB 4,246 billion. growth and market opportunity counterparts elsewhere. For investments. Investments in The Chinese government look likely to remain concentrated example, there is a big difference securities funds, which typically owns the non-tradable portion in the eastern coastal provinces. in the values with which Shanghai hold 70% in equities, are limited of the market capitalisation, The factors below are material to consumers imbue foreign brands to a maximum of 15% of which is about 70%. The most the successful ranking of and those of other cities. invested funds. Direct investment recent bear market started in possible locations. in equities is limited to 5% of mid-2001. After two years of Profitability total assets. Direct investment in disappointing performance, Growth potential – much of the There is significant variation in property is prohibited. At the time the domestic stock market available data on individual city profitability between market of writing, overseas investment is finally ended up in positive and provincial markets requires players. Some of those heavily also prohibited, except to match territory in 2003 (see Figure 7). informed analysis. focussed on bancassurance foreign currency policy liabilities have seen declining margins or in other limited circumstances. Bond market Target market – foreign insurers as the banks have exploited Compared with more mature who target the affluent market In addition, no more than their control over the distribution capital markets, China’s bond may favour Shanghai and Beijing, 20% of assets can be invested channel to demand a greater market is underdeveloped. whereas those who target the in corporate bonds. These share of the cake. At the same As at the end of 2002 it was mass market may lean towards must be AA rated and relate time, the growth in participating RMB 2.67 trillion, only about Tianjin, Jiangsu, Zhejiang and to Government-sponsored business means that, overall, a third of the size of the stock Guangdong. Accurately infrastructure projects. newer business has been market. Current bond types estimating the size of the target (Investment-linked contracts inherently less profitable for include treasury bonds, market in each potential business may be wholly backed by bonds shareholders than the non- corporate bonds, convertible location is crucial. or equities.) participating business sold in corporate bonds and policy the recent past. bonds. These are bonds Competition – levels of The remaining funds effectively issued by the China competition vary considerably have to be invested in Interestingly, careful management Development and China between cities and the most Government bonds, bonds of business mix has enabled Import and Export Banks attractive places to new entrants issued by financial institutions some companies, both foreign for purposes of generating now will not tend to be the or bank deposits. joint ventures and domestic funds for infrastructure existing hot spots of Beijing, companies, to do considerably development and international Shanghai and Guangzhou. Stock market better than the market generally. trade. Treasury and policy Those new companies who China’s stock market has a bonds make up 98% of total have blazed a trail in what were Investment environment short 13-year history. At the bond balances. There are no seen as secondary cities have end of 2003, there were 1,287 mortgage or asset-backed been rewarded with significant The investment options for life companies listed domestically securities (see Figure 8). success, having found the insurers remain limited, both in (A & B shares) with a total competition for distribution and terms of regulatory requirements customers much less intense. FIGURE 7 Stock exchange data 2003 Branding – the level of competition in many areas is such that branding is critical. Shanghai Shenzhen Total While, in most developed Stock Exchange Stock Exchange insurance markets, branding is a national issue, in China, Number of companies 783 504 1,287 it is local perception of foreign brands which counts and which Market cap (RMB billion) 3,011 1,235 4,246 should play an important part in the selection of business Tradable market cap (RMB billion) 835 485 1,320 locations. Consumers in some Source: www.research.lipper.wallst.com cities are more receptive to
34 Insurance digest • PricewaterhouseCoopers CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
FIGURE 8 Chinese bond market
2002 balance 2003 issues Issue increase (RMB billion) (RMB billion)
Treasury bonds 1,600.00 628.30 10%
Policy bonds 1,000.00 442.00 44%
Corporate bonds 60.00 40.80 10%
Corporate convertible bonds 8.17 18.10 336%
Total 2,668.17 1,129.20 20%
Source: www.research.lipper.wallst.com
Money market business, with-profits business, FIGURE 9 Composition of China’s money market unit-linked and universal Current money market business) is prescribed by the instruments include inter-bank China Insurance Regulatory loans, government bond Commission (CIRC). 12% repurchase agreements, accounts receivable, central 27% The table below summarises bank bills, policy bills and short- the key requirements for long- 55% term bonds, of which interbank term life and health products loans and repos are the biggest 10.5 (see Figure 11 overleaf). proportion. As at September 2003, their total trading volume Dividend distribution was RMB 14.22 trillion (see 61% Figure 9). Dividend distribution must comply with the CIRC’s guidance: Funds Interbank loan Interbank repo Exchange repo The Chinese mutual fund market • The contribution method must be used to calculate Source: People’s Bank of China as of September 2003 saw a spectacular increase in 2003 with the launch of 43 new the dividend; funds bringing the total to 114. As at the end of 2002, the great • The dividend may be paid as FIGURE 10 Chinese mutual fund data 2003 majority of funds were closed- either a cash or reversionary end but all 43 new funds were bonus; and open-end – the norm elsewhere. 2002 2003 Total The first five money market funds • No less than 70% of profit Number Newly launched were successfully launched in must be distributed to December 2003 (see Figure 10). policyholders as dividends. Closed-end funds 54 – 54 Regulatory requirements Most companies limit distributions Open-end funds 17 43 60 to policyholders to the minimum The reserving treatment to be of 70% and only distribute Total 71 43 114 used for each class of long-term investment and mortality profits. business (annuities, non-annuity Source: www.research.lipper.wallst.com
Insurance digest • PricewaterhouseCoopers 35 CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
FIGURE 11 Actuarial basis
Pricing Reserving
Interest rate No more than an equivalent yearly No more than the lower of compound rate of 2.5% • Valuation interest rate announced by CIRC each year (7.5% currently) • Corresponding pricing interest rate
Mortality/morbidity – • China life insurance experience • Same as pricing basis non-annuity non-annuity mortality table
Mortality/morbidity – • China life insurance experience • For whole life annuity, the policy reserve is the larger non-annuity annuity mortality table of that resulting from using the following two loadings: • 80% of CL annuity mortality table • 120% of CL annuity mortality table
Source: www.research.lipper.wallst.com
FIGURE 12 Life business solvency margin
Long-term products Reserve component Net amount at risk component
Insurance products 4% of reserves
Investment-related products 1% of reserves • Coverage period: 0.10% of NAR less than three years • Coverage period: 0.15% of NAR three-five years • Coverage period: 0.30% of NAR over five years
Short-term business The following reserves must be established: • An Outstanding Claims Reserve (in respect of claims reported but not paid) is deemed equal to the estimated losses on claims outstanding as at the balance sheet date; • IBNR is accrued at 4% of claims expenses incurred in the period; and • An Unearned Premium Reserve, i.e. a reserve equal to an amount of net premium written in any year but not yet earned.
Source: www.research.lipper.wallst.com
36 Insurance digest • PricewaterhouseCoopers CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
Solvency margin eligible for business tax exemption Taxation, the following items New life companies must pay (subject to the approval of the are exempted from business a deposit of 1% of forecast The minimum solvency margin State Administration of Taxation). tax – with-profits policies gross premiums – subject to requirement is calculated by A major review of insurance tax with terms of one year or a minimum of INR 1 million applying a percentage to a is scheduled for 2006, although no more, annuity business, (equiv. US $22,000) – and have proxy for exposure to risk details of its likely scope are yet health insurance policies with at least INR 1 billion (equiv. (see Figure 12). available. terms of one year or more, US $22 million) share capital In addition, there is an Insurance agricultural insurance and (after deducting preliminary Key income tax provisions include: Security Fund which is accrued at export credit business. expenses incurred towards 1% of retained premium income incorporation). Companies must • Domestic insurers pay national for those policies with terms of Entering the Indian usually start writing business income tax on taxable income one year to a maximum of 6% within 12 months of being at 30%. In addition, they also life insurance market of total assets. While currently granted a certificate of approval. pay local income tax at 3%; As in China, foreign insurers held as part of the insurer’s Business licenses are renewable doing business in India cannot assets, we understand that the annually and must be applied for, • Foreign Invested Enterprises operate wholly-owned subsidiaries regulators are considering setting and the necessary fees paid, (FIEs) which have registered or branches. In order to be up a formal centralised insolvency before December 31. or operational capital of more granted a licence to write life fund (see Figure 12). than US $10 million and a ten- business, a foreign company A license to issue policies usually year-plus business plan, pay Financial reporting cannot hold (either directly or allows the company to write all income tax at a rate of 15%. and taxation indirectly) more than 26% of classes of life business and to In addition: the paid-up capital. operate across the country. Financial reporting New insurance companies must – No tax is payable in the Insurers doing business in Until 1999, all the life business adhere to rural and social sector first year of profit; China must prepare financial had been written by a public obligations by ensuring that statements in accordance with sector company called Life a certain amount of policies – For the second and third PRC GAAP. This specifies the Insurance Corporation of India are sold in, and a certain level profitable years of operation, accounting treatment for the (LIC). Currently, there are 13 of premium generated from tax is payable at 7.5%; recognition and disclosure of private companies which hold rural and socially backward premium income, claims and around 15% of the life insurance areas. This part of business is – If the profit is used to benefits as well as for the market share. A joint venture, mostly unprofitable. increase the registered capital, determination of reserves. green field operation is the only or for other investment The statements must be realistic entry strategy. Investment policy purposes, and the company filed with CIRC. They also The IRDA (Investments) has been in operation for The general issues which need have to report specifically on Regulations 2000, as amended more than five years, 40% of consideration in selecting a joint participating insurance business, from time to time, specify the tax paid can be refunded; and venture partner and developing solvency position, other type and amount of permitted business strategy are similar to regulatory indicators and other investments and also the – The tax rates and rules those encountered in China. operational and actuarial issues. for FIEs above are only reporting formats. Approved applicable if they have investments are government Taxation Regulatory requirements more than 25% overseas securities, approved securities, Insurance companies doing Insurance companies operating investment. and approved investments in China are subject to both business in India are primarily (usually infrastructure or corporate income tax and Key Business Tax provisions regulated by the ‘Insurance social investments). business tax. An insurer’s include: Development and Regulatory eligibility for taxes and the rates Authority’ (IRDA). There are paid varies by type of company • Business tax is payable at 5%. separate regulators for other and also by the economic zone industries in the financial in which it is licensed to operate. • Subject to approval by services sector. Certain insurance products are the State Administration of
Insurance digest • PricewaterhouseCoopers 37 CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
Stock market by policy conditions). Liabilities justify its retention policy and 8% to 10%. In addition, service must be valued on a policy by demonstrate that it is not fronting tax has just been levied on the Around 800 companies from policy basis. for a foreign insurer. risk element of life policies. all sectors are listed on the Education cess (a levy towards National Stock Exchange (NSE). In the case of any policy where At present, the only reinsurer in ensuring development of Current market capitalisation is the mathematical reserves are the country is General Insurance education in the country) of 2% US $220 billion but significant negative, the company actuary Corporation of India, to whom on all taxes is levied, which implies growth – at a rate of 15.4% per must set the value of any reserve 20% of the non-life reinsurance that the services on insurance annum – is expected until 2009, to nil for the purpose of calculating premiums are mandatorily ceded. would attract an additional 2% which is likely to see the market the solvency margin and also for on the tax amount. A flat rate of top US $450 billion. NSE lists computing the surplus available for Financial reporting and 10.2% is levied on premium securities in both its Capital dividend distribution (Section 49). taxation received for non-life policies. Market (Equities) and Wholesale Furthermore, the life insurance Debt Market segments. Financial reporting Actuarial assumptions are premiums are also subject to the based on the insurer’s own The rules on financial accounting Smaller, but still significant, is the levy of service tax on the portion experience and generally and reporting are prescribed Mumbai exchange, called the which can be fully attributed include an appropriate Margin under the IRDA (Preparation ‘Bombay Stock Exchange’ (BSE). towards insuring mortality risks. for Adverse Deviation. of Financial Statements and Auditor’s Report on Insurance Solvency requirements The Life Insurance Corporation The Solvency regulations require Companies) Regulations, 2002, of India (LIC) is the only life The rules for the valuation of all insurers to maintain assets and Section 11 of the Insurance company actually declaring assets, norms for the valuation of at least US $11 million Act, 1938. profits and therefore currently of liabilities and the methodology (US $22 million for reinsurers) paying corporate tax. for the calculation of solvency in excess of liabilities or an Separate records are required margins are primarily contained equivalent sum calculated using in respect of life, pensions and Until now, there are no insurance in the IRDA (Assets, Liabilities a formula given in the regulations. unit-linked business. Similarly, company-specific taxation and Solvency Margins of Insurers are required to maintain separate records must be arrangements, although Insurers) Regulations, 2000. a solvency ratio of 1.5 times held on policyholders’ and recommendations by a review Separate formats (as defined in the statutory requirement. shareholders’ funds and business committee on this issue have the Regulations) need to be written inside and outside India. been given to the Government. prepared and submitted for Reinsurance New rules are expected in the Section 11 of the above Act assets, liabilities and solvency Government policy on reinsurance near future. margins in respect of the requires insurers to submit a aims to maximise retention within balance sheet, profit and loss insurer’s total business and the the country, develop adequate Conclusion business in India. All the formats account and revenue account domestic capacity, secure best The Chinese and Indian life need to be signed and verified by for each year of business. possible protection for the costs insurance markets are expected the insurer’s appointed actuary. The Regulations specify the incurred and simplify the required format. The financial to see double digit rates of administration required, and so growth in the medium term. The Gross Premium Method is statements must be signed by the there are specific rules on recommended for calculating Chairman (if any), by two directors retention of risk, cession, To capitalise on this, potential mathematical reserves. In respect and by the Principal Officer. reinsurance and retrocession. entrants need to consider their of linked business, the regulations Audited accounts must be submitted to IRDA within six entry strategy very carefully. provide for the separate valuation Every insurer is required to submit months of the end of the period to They need to: of unit and general fund reserves. its reinsurance program for the which they relate. Whatever the method used, forthcoming financial year to • Aim for a corporate structure it must take into account all IRDA at least 45 days in advance Taxation that aligns with their business prospective contingencies (under of the start of that year. Subject philosophy. Areas that need which premiums are paid by the to prudent practice, insurers Insurers are liable to both Service particular attention are policyholders and any benefits must maximise their retention. and Corporate Tax. Service Tax management control and the payable to them, as determined IRDA can require an insurer to rates have recently increased from ability to use their relative
38 Insurance digest • PricewaterhouseCoopers CHINA AND INDIA – OPPORTUNITIES TOO BIG TO IGNORE? continued
advantages such as underwriting expertise and ease of exit;
• Adopt a thorough and structured approach to identifying a short list of eligible potential JV partners, taking specific market conditions into account. Preliminary due diligence is essential before any memorandum of understanding is signed;
• Understand the implications of the financial reporting and taxation requirements;
• Thoroughly understand the investment environment in which life companies must operate and take this into account in their business planning;
• Select potential business locations very carefully, taking into consideration overall growth potential, size of target market and especially national and local brand perceptions; and
• Consciously seek to differentiate themselves from local companies (who have a dominant market share) The preceding article was originally printed in PricewaterhouseCoopers Asia Pacific Insurance digest by using focussed distribution (February 2005), and is reprinted here by permission from our sister publication. methods and differentiated product designs.
AUTHORS Robert Fok Khushroo Panthaky Director, Actuarial Services, Asia Associate Director, Insurance Industry Tel: 852 2289 2960 Practice, India [email protected] Tel: 91 22 2267 7942 [email protected]
Insurance digest • PricewaterhouseCoopers 39 Further information
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