The Insurance (Prudential Supervision) Bill (the Bill) is now sitting on the Parliamentary order paper for a first reading this week. It will then be referred to the Select Committee, providing a further opportunity for policy input.
Chapman Tripp was actively involved in the consultation process run on the Bill by the Reserve Bank earlier in the year and will be happy to assist those intending to make submissions to the Select Committee.
In this Brief Counsel we provide a refresher of what the Bill will require insurers to do (with indicative timelines) and identify several areas where we think the Bill could be improved.
The Bill establishes a licensing regime, to be administered by the Reserve Bank, for those “carrying on insurance business in New Zealand”. Those caught will need to be licensed and to comply with a number of ongoing prudential requirements, including:
preparing and registering with the Reserve Bank and the Registrar of Companies audited, NZGAAP-compliant annual and interim financial statements
appointing an actuary to review the actuarial information in those financial statements and preparing an annual financial condition report, and
maintaining prescribed solvency margins.
Who is caught by the Bill?
Broadly speaking, any entity incorporated or required to be registered as a company in New Zealand that has accepted risk under a contract of insurance (in New Zealand or elsewhere) and is liable under a contract of insurance to a New Zealand policyholder will be required to obtain a licence under the Bill. The threshold provisions appear straightforward, but there will inevitably be marginal cases.
The Bill’s drafters have attempted to sharpen the coverage boundaries in response to concerns raised during the consultation round, but some issues remain. One such issue is the treatment of foreign domiciled, niche-market insurers who have limited New Zealand operations (see “The threshold test for overseas insurers” below).
Crown Entities and certain other public bodies (including their subsidiaries – read: captives) are excluded from the regime. However not so for captives used by State Enterprises, unless they are specifically excluded by regulations. The Bill’s treatment of captives generally has drawn comment – both in the media and during the consultation round – and is discussed further in the “Captive insurers” section below.
Insurers covered by the new regime will need to be licensed before the Bill comes fully into force. The Bill is expected to receive the Royal Assent in the fourth quarter of next year and will come into effect 18 months after that – pushing the “go live” date out to the second quarter of 2012. After this date it will be an offence (carrying potentially hefty fines) to carry on, or hold out that you carry on, insurance business in New Zealand, without a licence.
The Bill provides for a two-stepped process, by which insurers can first obtain a provisional licence pending consideration of their application for a full licence.
A suite of transitional provisions has been included in the Bill to help insurers bring themselves into compliance with the prudential regime or manage their exit from the New Zealand market, as the case may be.
The Reserve Bank must issue a provisional licence to an insurer that satisfies various, relatively straightforward, requirements. Essentially, these relate to the ‘fit and proper’ and risk management documentation that the Bill requires insurers to prepare, submit to the Reserve Bank and comply with (although there is also a notice requirement).
We expect the turnaround time for a provisional licence will be short. The Bill provides that the provisional licence will remain in force until a full licence is issued, or until the date that is 18 months after the “go live” date (whichever is the sooner).
The Reserve Bank also has discretion to grant a provisional licence to insurers active in the New Zealand market immediately before the Bill is enacted but planning to exit New Zealand within the 18 month period between enactment and the “go live” date.
Although we expect insurers in this position will need to work with officials to ensure their exit strategies are both commercially sensible and acceptable to the Reserve Bank, some comfort should be taken from the generous three year transition window which the Bill provides.
Criteria for a full licence
Specific actions applicants will need to take to meet the requirements for a full licence are laid out in clause 18 of the Bill, and include:
obtaining a current financial strength rating
developing a Bill-compliant fit and proper policy and risk management programme, and registering under the Financial Service Providers (Registration and Dispute Resolution) Act once it comes into effect (or otherwise complying with sections 13(a) and 13(b) of that Act).
Other criteria will be partly or wholly beyond an insurer’s control (like the requirement for overseas insurers to satisfy the Reserve Bank that the regulatory framework in their home jurisdiction is at least as satisfactory as that in New Zealand).
Once fully licensed, insurers will need to comply with a number of ongoing requirements, as well as any conditions imposed on their licence by the Reserve Bank.
Ongoing compliance requirements
These include the following:
Solvency standards: The Reserve Bank may issue solvency standards for insurers, after consulting with those it considers will be substantially affected. A solvency standard may, among other things, prescribe a minimum margin by which the value of the assets of an insurer (and statutory fund, for a life insurer) must exceed the value of its liabilities (including contingent liabilities). Solvency standards may also prescribe requirements relating to financial condition reports. Insurers will be required to comply with solvency margins as a condition of their licence, and to report a likely breach to the Reserve Bank. Exemptions from compliance with a solvency standard may be granted to overseas insurers (but may be subject to conditions).
Financial strength ratings: Licensed insurers will be required to have a current financial strength rating from an approved rating agency (subject to limited exceptions for small friendly societies and credit unions, reinsurers and captives). Details of the rating must generally be disclosed to policyholders before entering into or renewing a contract of insurance, otherwise the contract may be cancelled by the policyholder. Where written disclosure is not reasonably practicable prior to entry/renewal, oral disclosure will suffice (provided this is followed by written disclosure as soon as it becomes practicable to do so). The rating must also be disclosed on the insurer’s website, and details given where the rating is referred to in an advertisement. If the rating changes (or the insurer is subject to a credit watch warning) the Reserve Bank must be notified within 20 working days.
Statutory funds: Life insurers will be subject to a detailed statutory fund regime. A life insurer must establish at least one statutory fund in respect of its life insurance business, relating solely to its life insurance business or a particular part of that business. All amounts received by the life insurer in respect of the relevant business must be credited to the fund. Assets and liabilities (including policy liabilities) related to the business must be included in the fund. The fund’s assets may be applied only for limited purposes. There are provisions governing the treatment of profits and losses and the investment of the assets of a fund, and special rules dealing with composite policies.
Actuarial review: Insurers must appoint an actuary (who may be a consultant rather than an employee) to review certain information contained in or used in the preparation of the insurer’s financial statements, in accordance with the solvency standards. The actuary’s report must accompany the auditor’s report when it is registered under the Financial Reporting Act and, if the auditor’s report is required to be in the annual report, in the annual report also.
Overseas policyholder preferences: Overseas insurers will be required to disclose the nature and extent of any requirement in their home jurisdiction that relates to the recognition and priorities of creditors’ claims in the event of insolvency and has the effect of giving a material preference to policyholders in the insurer’s home jurisdiction or is otherwise materially disadvantageous to New Zealand policyholders.
Financial reporting: Insurers’ financials will be made publicly available. Copies of their audited financial statements (together with the actuarial report) will need to be lodged with the Registrar of Companies, in accordance with the Financial Reporting Act, as well as with the Reserve Bank. Interim financial statements (and interim group financial statements, if applicable) will also need to be provided to the Reserve Bank, within five months after the insurer’s accounting period end. If required by regulations, these will need to be audited and provided to the Registrar too.
Fit and proper requirements: Insurers will need to take all practicable steps to comply with their fit and proper policy, and provide a fit and proper certificate to the Reserve Bank in respect of new directors or relevant officers within 20 working days of their appointment. Helpfully, group policies are permitted (although to the extent they fall short of the Bill’s requirements, a supplementary document will need to be prepared). If the Reserve Bank has reasonable grounds to believe that a director or relevant officer is not fit and proper, it may (unless the insurer is an overseas insurer) remove that person from their position. Alternatively, the Reserve Bank might simply direct, for example, that the individual not be reappointed until they receive a specified qualification.
Risk management: As with their fit and proper policy, insurers will need to take all practicable steps to comply with their risk management programme. Again, group programmes are permitted (with the same caveat). The programme will need to address a number of risks, and the Reserve Bank may issue guidelines to assist insurers to provide for these appropriately.
Reserve Bank prudential supervision: The Reserve Bank will be able to require insurers (and their associated persons) to supply information, data or forecasts about any matters relating to their business, operation or management – including corporate, financial and prudential matters – for business carried on in New Zealand or elsewhere. Information provided will be subject to confidentiality provisions. The Reserve Bank may require that information, data or forecasts be audited or reviewed by an auditor, actuary or approved person. It may also require reports to be prepared by an approved person, and appoint a person to investigate the affairs of an insurer or associated person.
Transfers and amalgamations: Insurers will need to obtain Reserve Bank consent before giving effect to a transaction that involves transferring all or part of its business (New Zealand business, in the case of overseas insurers) to another person. The same applies to amalgamations. If the Reserve Bank chooses to commission an independent actuary to review the portfolio transfer or amalgamation proposal, the insurer in question is liable to pay the Reserve Bank’s costs in commissioning that report. The Reserve Bank may approve the transaction conditionally or unconditionally.
Distress management: The Reserve Bank will be able to direct an insurer to prepare a recovery plan where: the insurer is failing (or will likely fail) to maintain a solvency margin; the business is not being (or has not been) conducted in a prudent manner; or the insurer is failing (or likely to fail) to comply with any direction, condition or other requirement imposed by or under the Bill or regulations. The plan must address certain matters, be approved by the Reserve Bank, and the insurer must take all practicable steps to comply with it. The Reserve Bank will be able to give directions to an insurer or associated person, and to remove, replace or appoint a person as a director, auditor or actuary.
Liquidation, voluntary administration and statutory management: The Reserve Bank will have the power to apply to the High Court to have an insurer put into liquidation or voluntary administration. The Bill also provides a detailed statutory management regime for insurers and associated persons.
Room for improvement
Our overall impression is that the Bill builds a sensible regulatory framework around a complex industry and that it is better as a result of the consultation round run by the Reserve Bank. However, despite a number of issues having been addressed, there remains scope for further improvement. Below we highlight two areas of particular concern.
The threshold test for overseas insurers
This is an aspect of the Bill on which we have commented in past briefing notes. While the test itself did not change following the consultation round, a consequential amendment to section 332 of the Companies Act – which provides for the “carrying on business” test to which clause 8(1)(a)(ii) of the Bill effectively cross refers – has been included in Schedule 3 of the Bill. The amendment clarifies that an overseas company does not carry on business in New Zealand (and is therefore not required to obtain an insurance licence) merely because in New Zealand it:
(x) enters into a contract of insurance as an insurer with a policyholder in New Zealand (being a contract that is governed by the laws of an overseas country).
This will provide some comfort to foreign insurers that issue only non-New Zealand law governed policies. The Bill as first drafted would more likely have required these insurers – some of which do not solicit business in New Zealand but are sought out by New Zealand customers, often because the insurance they write is highly specialised and not offered by local providers – to obtain a New Zealand insurance licence (assuming they satisfied the other criteria in clause 8). However the “governing law” qualification does not deal with the issue entirely and may have unintended consequences.
Questions we have identified include:
to what extent does the clarification make it less likely that a foreign insurer which issues only non-New Zealand law governed policies to New Zealand policyholders is determined to be carrying on insurance business in New Zealand (ceteris paribus)?
does the clarification create a presumption that a foreign insurer issuing a New Zealand law governed policy is carrying on insurance business in New Zealand, regardless of the level of its activity here? and
is encouraging the use of non-New Zealand law governed insurance contracts in areas where New Zealand companies are seeking specialised international insurance the most appropriate mechanism to address the issue?
Beyond the fact that they will not be required to obtain a financial strength rating, the Bill does not accord captive insurers special treatment. Like everyone else, they will need to apply to the Reserve Bank for a licence, if they are “carrying on insurance business in New Zealand”.
The New Zealand Captive Insurance Association has made it clear that its members are open to – and indeed encourage – (some form of) regulation of the New Zealand captive insurance industry. But the Association perceives the Bill’s extensive requirements as being disproportionately burdensome, and has voiced concern about the ongoing viability of current captive insurance practices if the Bill is passed in its current form.
In particular, questions are raised by the Bill’s treatment of captives that insure only foreign domiciled entities. The requirement that an insurer be “liable as an insurer under a contract of insurance to a New Zealand policyholder” to be “carrying on insurance business in New Zealand” excludes these captives from the Bill’s ambit (and therefore from its compliance requirements). A captive in this position will not be able to hold itself out as being licensed in New Zealand; and this may have implications for the captive’s regulatory obligations in the foreign jurisdiction in which it operates.
Having your say
Although the Bill is yet to have its first reading, the Select Committee is expected to hear submissions in the first or second quarter of next year, providing an opportunity for policy input. Anyone considering making a submission should be working now to develop a strategy for framing their concerns.
A copy of the Bill is available here.
Chapman Tripp will be happy to assist in the preparation of submissions to the Select Committee, and to provide advice on the Bill generally. For further information, please contact the lawyers featured.