PowerPoint Slides for Professors Spring 2010 Version

1. PowerPoint Slidesfor Professors Spring 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 solely 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. Visit the following site for updates: http://facpub.stjohns.edu/~kwonw/Blackwell.html. To change the slide design/background, [View]  [Slide Master] W. Jean Kwon, Ph.D., CPCUSchool of Risk Management, St. John’s University101 Murray StreetNew York, NY 10007, USA Phone: +1 (212) 277-5196E-mail: Kwonw@stjohns.edu

2. Risk Management and Insurance: Perspectives in a Global Economy 24. Regulation and taxation in Insurance Markets Click Here to Add Professor and Course Information

3. Study Points • Insurance regulation • Taxation in insurance

4. Insurance Regulation

5. Evolving International Insurance Markets (Figure 24.1)

6. Insurance Regulation Trends • Countries 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.

7. Mechanisms of Insurance Regulation • Legislative • Formation and licensing of insurers • Licensing of agents and brokers • Filing and approval of insurance rates • Filing and approval of proposal material and policy forms • Unauthorized insurance and unfair-trade practices • Insurer financial reporting, examination and other financial requirements • Rehabilitation and liquidation of insurers • Guaranty funds • Insurance product and company taxation

8. Mechanisms of Insurance Regulation • Judiciary • Resolves disputes between insurers and policyholders • Enforces insurance laws • Insurers and intermediaries occasionally resort to the courts seeking to overturn arbitrary or unconstitutional statutes, administrative regulation and orders promulgated by regulators.

9. Mechanisms of Insurance Regulation • Executive • 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 be • Explicitly for insurance regulation and supervision • Part of a larger institution that also oversees banking • Part of the bigger financial supervisory agency • A formal advisory body may assist the regulatory authority (not in the U.S.) • The regulatory situation in the E.U. is unique.

10. Approaches to Regulation • Ex-ante regulation • Ex-post regulation

11. Areas of Regulation • Access to the Market • Balancing competition against consumer protection • Detecting insurer financial difficulty • Responding to insurers in financial difficulty • Protecting insureds of an insolvent insurer

12. Areas of Regulation (Figure 24.2)

13. Regulation – Controlling Access to the Market See also Chapter 20. • The role of government as a supplier of insurance • Privatization • Licensing requirement • Admitted vs. nonadmitted insurers • Nondiscrimination and national treatment • Permitted organizational forms • Ownership restrictions

14. Regulation – Controlling Access to the Market • Restriction on business scope • Restriction to the conduct of insurance business • Separation of classes of insurance business • Right of appeal

15. Regulation – Balancing Competition • Rate and product regulation • Financial regulation • Intermediary regulation • Competition policy regulation

16. Regulation – Balancing Competition • Rate and product regulation • Rates are not excessive, unfairly discriminatory or inadequate. • Types • Tariff markets • Prior approval system • Flexi-rate system • File-and-use (use-and-file) system • Open competition

17. Regulation – Balancing Competition • Financial (prudential) regulation • More 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. • Areas • Ongoing capital regulation • Asset limitations and valuation • Liability regulation • Accounting standards

18. Ongoing Capital (Solvency) Regulation Insight 24.1 (U.S. RBC regulation) • Solvency margins • Within the E.U. (and many other countries), minimum ongoing capital and surplus requirements are set out. • Solvency I • Solvency II • Risk-based capital • As in the U.S. and several other countries, minimum acceptable capital for business continuation of an insurer

19. Asset Limitations and Valuation • Authorized (admitted) investments • Diversification • Currency matching (congruence) • Localization

20. (Accounting) Liability Regulation • Life insurance • In some countries, the regulator prescribes in detail the methods and assumptions used to derive life insurer technical (mathematical) reserves • In other, the regulator relies on an actuarial valuation. • Nonlife insurance • National laws are more general for nonlife insurers • Appropriate 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.

21. Accounting Standards • Statutory accounting principle (SAP) • Generally accepted accounting principle (GAAP) • International Accounting Standard Board (IASB) • For standardization of accounting principles internationally

22. Intermediary Regulation • The 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 intermediaries • Minimum qualification requirements • Imposed in most countries • U.S. Excess and Surplus (E&S) broker license as an example of a special case • The growing importance of intermediary regulation as financial services sectors converge

23. Competition Policy (Antitrust) Regulation • Typical elements of competition law • Collusive practices • Horizontal collusion • Vertical collusion • Conglomerate collusion • Mergers and acquisitions • Abuses of dominant position

24. Competition Policy (Antitrust) Regulation • International 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 doctrine • Two principles • The principle of prohibition • The principle of abuse

25. Regulation – Detecting Financial Difficulty • Solvency surveillance • Reporting requirements • Financial examination • On-site examination • Oversight by professions

26. Regulation – Responding to Insurers in Difficulty • Four options • Informal actions • Formal actions • Rehabilitation • Liquidation

27. Regulation – Policyholder Protection • Two philosophies • No protection based on true laissez-faire economics • Guaranty fund benefits • Guaranty funds • Pre-insolvency assessment to all licensed insurers in the line(s) of business • Post-insolvency assessment • Guaranty funds diminish market discipline to some degree by creating moral hazard. • Researchers have proposed alternatives to the flat-assessment approach.

28. Taxation in Insurance

29. Principles of Taxation • General purposes of taxation • To raise revenue • To promote economic goals • To promote social goals • Desirable traits of tax policy • Equity • Economic neutrality (also called horizontal equity) • Simplicity • Systems of taxation • Tax bases • Tax exemptions, deductions and credits • Tax rates

30. Life Insurance Taxation • Consumers (policyholders) • Tax relief for premiums paid for qualifying policies in many countries Table 24.2 • Dividends not considered as taxable income • Generally no direct taxation on interest credited on cash values • When taxed, the build-up is considered as part of benefits. • Same tax treatment for the inside interest build-up of annuities during accumulation period • Most 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).

31. Tax Relief on Life Insurance Premium (Table 24.2)

32. Life Insurance Taxation • Life insurance companies • Commonly taxes levied on insurers’ premium revenues • Premium taxes being the most common • Governments 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.

33. Nonlife Insurance Taxation • Consumers • Premiums paid by individuals for personal policies not deductible from income for tax purposes • Exceptions exist. • Premium payments by businesses to purchase compulsory insurance and other business-related insurance commonly tax deductible • Benefits received under personal policies are tax free. • Exceptions exist. • Benefits received by businesses are tax free in many countries.

34. Nonlife Insurance Taxation • Nonlife insurance companies • Commonly more cases of premium taxation in nonlife than in life • Tax rates with nonlife insurance are generally higher. • Other premium-based taxes can increase the effective tax in nonlife Table 24.3 • Premium-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

35. Other Premium-based Taxes on Nonlife (Table 24.3)

36. Discussion Questions

37. 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?

38. Discussion Question 2 • In 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?

39. Discussion Question 3 • Signatory 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?

40. Discussion Question 4 Explain why insurance is regulated.

41. Discussion Question 5 • Examine 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?

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

43. Discussion Question 7 • Economies 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?