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PowerPoint Slides

for ProfessorsSpring 2010 Version

This file as well as all other PowerPoint files for the book, “

Risk Management and Insurance: Perspectives in a Global Economy

” authored by Skipper and Kwon and published by Blackwell (2007), has been created

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for classes where the book is used as a text. Use or reproduction of the file for any other purposes, known or to be known, is prohibited without prior written permission by the authors.

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 [Slide Master]

W. Jean Kwon, Ph.D., CPCU

School of Risk Management, St. John’s University

101 Murray Street

New York, NY 10007, USA

Phone: +1 (212) 277-5196

E-mail:

Kwonw@stjohns.edu

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Risk Management and Insurance: Perspectives in a Global Economy 24. Regulation and taxation in Insurance Markets

Click Here to Add Professor and Course InformationSlide3

Study PointsInsurance regulation

Taxation in insurance3Slide4

Insurance Regulation

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Evolving International Insurance Markets (Figure 24.1)

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Insurance Regulation TrendsCountries worldwide began moving toward more liberal (i.e., freer) markets and away from more circumscribed markets.

Countries have moved from more to less restrictive insurance markets.They have increasingly embraced competition and eschewed special interest regulation.The great majority of the world’s largest 50 insurance markets are more liberal today.6Slide7

Mechanisms of Insurance RegulationLegislativeFormation and licensing of insurers

Licensing of agents and brokersFiling and approval of insurance ratesFiling and approval of proposal material and policy formsUnauthorized insurance and unfair-trade practicesInsurer financial reporting, examination and other financial requirementsRehabilitation and liquidation of insurersGuaranty fundsInsurance product and company taxation7Slide8

Mechanisms of Insurance RegulationJudiciaryResolves disputes between insurers and policyholders

Enforces insurance lawsInsurers and intermediaries occasionally resort to the courts seeking to overturn arbitrary or unconstitutional statutes, administrative regulation and orders promulgated by regulators.8Slide9

Mechanisms of Insurance RegulationExecutive

Governments commonly delegate this authority to a ministerial department.A subordinate section of the ministry or a special agency carries out the regulatory oversight. The section/agency can beExplicitly for insurance regulation and supervisionPart of a larger institution that also oversees bankingPart of the bigger financial supervisory agencyA formal advisory body may assist the regulatory authority (not in the U.S.)The regulatory situation in the E.U. is unique.

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Approaches to RegulationEx-ante regulation

Ex-post regulation10Slide11

Areas of RegulationAccess to the Market

Balancing competition against consumer protectionDetecting insurer financial difficultyResponding to insurers in financial difficultyProtecting insureds of an insolvent insurer11Slide12

Areas of Regulation (Figure 24.2)

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Regulation – Controlling Access to the Market

The role of government as a supplier of insurancePrivatizationLicensing requirementAdmitted vs. nonadmitted insurersNondiscrimination and national treatmentPermitted organizational formsOwnership restrictions13

See also Chapter 20.Slide14

Regulation – Controlling Access to the Market

Restriction on business scopeRestriction to the conduct of insurance businessSeparation of classes of insurance businessRight of appeal14Slide15

Regulation – Balancing CompetitionRate and product regulation

Financial regulationIntermediary regulationCompetition policy regulation15Slide16

Regulation – Balancing CompetitionRate and product regulationRates are not excessive, unfairly discriminatory or inadequate.

TypesTariff marketsPrior approval systemFlexi-rate systemFile-and-use (use-and-file) systemOpen competition16Slide17

Regulation – Balancing CompetitionFinancial (prudential) regulationMore restrictive financial regulation is associated with more secure insurers.

Nevertheless, extensive restrictions stifle competition and innovation and, thereby, can lower consumer value and choice.The more competitive a market, the more important is prudential regulation.AreasOngoing capital regulationAsset limitations and valuationLiability regulationAccounting standards17Slide18

Ongoing Capital (Solvency) RegulationSolvency marginsWithin the E.U. (and many other countries), minimum ongoing capital and surplus requirements are set out.

Solvency ISolvency IIRisk-based capitalAs in the U.S. and several other countries, minimum acceptable capital for business continuation of an insurer18

Insight 24.1 (U.S. RBC regulation)Slide19

Asset Limitations and ValuationAuthorized (admitted) investments

DiversificationCurrency matching (congruence)Localization19Slide20

(Accounting) Liability RegulationLife insurance

In some countries, the regulator prescribes in detail the methods and assumptions used to derive life insurer technical (mathematical) reservesIn other, the regulator relies on an actuarial valuation.Nonlife insuranceNational laws are more general for nonlife insurersAppropriate loss reserve establishment has been a regulatory challenge.The discounting of loss reserves is not, in general, practiced.

Some countries make no provisions for claims incurred but not reported (IBNR) losses.

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Accounting StandardsStatutory accounting principle (SAP)

Generally accepted accounting principle (GAAP)International Accounting Standard Board (IASB)For standardization of accounting principles internationally21Slide22

Intermediary RegulationThe importance of the services of knowledgeable intermediaries in competitive markets

Individuals and businesses rely on the advice as well as risk management and insurance services of such intermediariesMinimum qualification requirementsImposed in most countriesU.S. Excess and Surplus (E&S) broker license as an example of a special caseThe growing importance of intermediary regulation as financial services sectors converge22Slide23

Competition Policy (Antitrust) RegulationTypical elements of competition law

Collusive practicesHorizontal collusionVertical collusionConglomerate collusionMergers and acquisitionsAbuses of dominant position23Slide24

Competition Policy (Antitrust) RegulationInternational legal norms

Countries usually take a pragmatic position to enforcement.The effectiveness of competition regulation depends on both the law itself and the stringency of its enforcement.Competition law in the E.U. and the U.S. cannot be evaded by initiating the anti-competitive behavior outside the relevant territories.Effects doctrineTwo principlesThe principle of prohibitionThe principle of abuse24Slide25

Regulation – Detecting Financial DifficultySolvency surveillance

Reporting requirementsFinancial examinationOn-site examinationOversight by professions25Slide26

Regulation – Responding to Insurers in DifficultyFour options

Informal actionsFormal actionsRehabilitationLiquidation26Slide27

Regulation – Policyholder ProtectionTwo philosophiesNo protection based on true

laissez-faire economicsGuaranty fund benefitsGuaranty fundsPre-insolvency assessment to all licensed insurers in the line(s) of businessPost-insolvency assessment Guaranty funds diminish market discipline to some degree by creating moral hazard.Researchers have proposed alternatives to the flat-assessment approach.

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Taxation in Insurance

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Principles of TaxationGeneral purposes of taxation

To raise revenueTo promote economic goalsTo promote social goalsDesirable traits of tax policyEquityEconomic neutrality (also called horizontal equity)Simplicity

Systems of taxation

Tax bases

Tax exemptions, deductions and credits

Tax rates

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Life Insurance TaxationConsumers (policyholders)Tax

relief for premiums paid for qualifying policies in many countries Table 24.2Dividends not considered as taxable incomeGenerally no direct taxation on interest credited on cash valuesWhen taxed, the build-up is considered as part of benefits.Same tax treatment for the inside interest build-up of annuities during accumulation periodMost countries tax annuity payouts to some degree.Exempt death proceeds paid under qualifying policies from income taxation in most countries

Governments commonly levy estate duties (taxes).

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Tax Relief on Life Insurance Premium (Table 24.2)

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Life Insurance TaxationLife insurance companies

Commonly taxes levied on insurers’ premium revenuesPremium taxes being the most commonGovernments tax life insurers on some variation of net income or value added and sometimes both.When using total income, governments permit several deductions in deriving taxable income.32Slide33

Nonlife Insurance TaxationConsumers

Premiums paid by individuals for personal policies not deductible from income for tax purposesExceptions exist.Premium payments by businesses to purchase compulsory insurance and other business-related insurance commonly tax deductibleBenefits received under personal policies are tax free.Exceptions exist.

Benefits received by

businesses

are tax free in many countries.

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Nonlife Insurance TaxationNonlife insurance companies

Commonly more cases of premium taxation in nonlife than in lifeTax rates with nonlife insurance are generally higher.Other premium-based taxes can increase the effective tax in nonlife Table 24.3Premium-based taxation is to be paid irrespective of insurer profitability.Also, taxation on nonlife insurance companies for income from operations (e.g., profit and interest income)Deductions for claims reported but unpaid and certain other reserves in many countries

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Other Premium-based Taxes on Nonlife (Table 24.3)

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Discussion Questions36Slide37

Discussion Question 1“The influence of interest rates on the trend in insolvency is not clear

a priori, however, as two opposite effects exist. On the one hand, assets lose value when interest rates rise, which means that solvency is reduced. If a company in this situation is forced to dispose of assets in order to pay claims, it can get into payment difficulties. On the other hand, high interest rates also mean high current income from investments. High interest rates when a contact is arranged make it possible to reduce prices (this is known as “cash flow underwriting”). If interest rates fall and current investment income declines, the overall result deteriorates and the risk of insolvency increases.” Discuss which of these two effects you believe would be the more important. Why?37Slide38

Discussion Question 2In the U.K. and Germany, no more than 10% of the earnings attributable to a stock life insurer’s participating (with bonuses) business may be distributed to shareholders. France limits such distributions to 15% of investment gains and 10% of all other gains. Italy limits distributions to 20% of investment gains. By contrast, the Netherlands and most states in the U.S. have no similar restrictions:

What public policy arguments support limitations on such distributions?Why do believe that the Netherlands and many other countries have not such limitations?38Slide39

Discussion Question 3Signatory countries to the GATS bind themselves to the fair-trade principles of market access, nondiscrimination, national treatment and transparency. GATS’s purpose is to create a more liberal market in trade in services in general and in financial services, including insurance, in particular. A provision within the agreement reads as follows:

[member countries] shall not be prevented from taking measures for prudential reasons, including for the protection of policyholders . . . or to ensure the integrity and stability of the financial system.What is your interpretation of this provision?Do you believe that this provision is justifiable in view of a competitive insurance market internationally?The provision is quite general. Could you imagine that some countries might try to place a conservative interpretation of this provision and, if so, what measures might they take that you would believe to be inconsistent with the spirit of the provision?

Could insurance be the cause of a country’s financial system loosing its integrity and stability? If so, how?

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Discussion Question 4Explain why insurance is regulated.

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Discussion Question 5Examine the insurance act in your country to answer the following:

What is the relationship between the insurance regulator and the government?Summarize the key provisions related to licensing insurers, reinsurers and insurance intermediaries. Does the act include a “fit-and-proper person” provision or equivalent?What information are insurance companies required to submit to the regulator?Do you find any sections relating to anti-competitive practices in the insurance industry?What are the steps that the regulator is empowered to take against insurance companies experiencing extreme financial or operational difficulty?

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Discussion Question 6Analyze the premium tax using the desirable traits of tax systems.

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Discussion Question 7Economies in transition have expressed interest in the possibility of stimulating the purchase of life insurance through tax concessions to its purchase.

Why might such countries want to promote the purchase of life insurance?Would you expect such tax concessions to lead to increased sales of life insurance?What effect might such tax concessions have on savings through other financial intermediaries and through government?43