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Insurers face risk management challenge

The Reserve Bank of New Zealand (RBNZ) is getting ready to launch a series of measures that would enhance its supervisory role of the insurance sector.

The Bank’s Insurance Oversight Manager Peter Brady said in a speech to the delegates attending the ‘Finity Consulting Directors Forum’ held in Auckland on February 19 that risk management would come under sharper focus as these measures are implemented.

He said that that the Reserve Bank’s evolving approach to insurance was risk-based and that closer supervision would fall on large insurance companies and those that face a higher risk of failure.

Christchurch fallout

The insurance sector worldwide took the brunt of the Global Financial Crisis leading to failure of large companies. This was exacerbated by the reluctance of reinsurers to take more risks and/or reduce their existing exposure to the insurance market. In the case of New Zealand, insurance companies were forced with increasing pressure on claims orchestrated by the earthquakes and aftershocks at Christchurch and other disasters around the country over the past three years.

The New Zealand Government announced a $500 million support package to AMI in the wake of the Christchurch tremors three years ago but there is not guarantee that it would do so in the case of future failures of other insurance companies.

The high risks to which insurers are exposed would therefore compel RBNZ to impose a tighter regime on insurance companies operating in the country. The insurance sector, which has largely been self-regulated for several decades, now faces a more stringent compliance environment.

Better Governance

The Bank will also insist on stronger boards of directors with more robust governance mechanisms in place. As the prudential supervisor, it would be obliged to keep a closer watch on the functioning of insurance companies, the policies they underwrite, their retention rate and their exposure to market movements and risks.

As Mr Brady said, the Reserve Bank will concentrate its resources on high-impact insurers. If there were a failure of a high-impact insurer, it is important for financial stability and the economy that resolution of the failure is not disorderly and does not entail government support.

“The Reserve Bank will proactively and rigorously deal with risks to high-impact insurers that are assessed as threatening their ongoing viability. Such action would include the use of distress management powers in the ‘Insurance Prudential Supervision Act’ 2010, to ensure that failures of these insurers, if unavoidable, are at least managed in an orderly way,” he said.

Prudential powers

For low-impact insurers, the Bank’s likely approach will be to supervise more reactively, accompanied by strong enforcement where there is non-compliance with license requirements. If a low-impact insurer were to fail, the Reserve Bank is likely to limit its role to ensuring that a liquidator is appointed, and that there is an orderly winding-up in line with insolvency legislation.

The Reserve Bank has a broad responsibility for financial stability, without the separation between prudential supervision and financial stability that is seen in some other countries.

“As a full-service central bank, RBNZ has access to information and policy thinking that can inform its executives of system-wide threats to the soundness of the insurance sector.”

Insurers can expect the Bank to deal with such threats across the sector, or the part of the sector concerned. This might include thematic reviews that would involve investigating the same concern across a number of insurers.

RBNZ has issued a Governance Guideline to help insurers understand the Bank’s minimum expectation around independence.

They include (a) at least half of the directors will be independent (b) the board chair is to be independent (c) the audit committee chair is to be independent and not the same person as the board chair; and (d) a majority of the audit committee should be independent.

The minimum expectations are reasonable. The Guidelines will ensure the good health of the insurance sector.

As the country returns to the promised surplus, it cannot afford large bailouts.

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