icp 9: corporate governance

ICP 9: Corporate Governance

Basic-level Module

A Core Curriculum for Insurance Supervisors

Copyright © 2006 International Association of Insurance Supervisors (IAIS).All rights reserved.

The material in this module is copyrighted. It may be used for training by competent organizations with permission. Please contact the IAIS to seek permission.

This paper has been prepared by Mr. John Thompson, a private consultant based in Toronto, Canada who provides advice and functional support to financial sector regulators, the financial services industry and ed-ucational organizations. He is the Chairman of the Insurance Advisory Group for the Toronto International Leadership Centre (The Toronto Centre is based in Toronto, Canada and provides leadership development training for financial sector regulators.). He is an actuary with over 24 years experience in senior positions within a life insurance company both in Canada and the UK. Prior to becoming a private consultant, he was Deputy Superintendent at the Office of the Superintendent of Financial Institutions in Canada. He also has broad experience at the international level as the former Chairman of the Executive Committee of the International Association of Insurance Supervisors and member of the Basel Committee for Banking Supervision.

The paper was reviewed by Mr. Andre Swanepoel, South Africa and Mr. Alvaro Clarke, Chile. Andre Swane-poel is a private consultant, who retired in 2004 after 13 years as head of insurance and retirement funds supervision with the Financial Services Board in South Africa, where he dealt with all aspects of prudential and market conduct supervision. He is a qualified actuary and spent 15 years in the merchant and general banking industries. Prior to this, he worked for 12 years with a life insurer in the actuarial and investment research departments; he was a member of the Executive Committee of the International Association of Insurance Supervisors (IAIS) and chaired the Emerging Markets Committee of the IAIS. He is active in the Toronto International Leadership Centre.Mr. Clarke is the Principal Partner Clarke & Associates and Professor of Law at Universidad de Chile, Faculty of Law and Faculty of Economics. Mr. Clarke also held various senior government positions in Chile, including the Chairman of Superintendencia de Valores Y Seguros (the Insurance and Securities Supervisor) (2000–2003) and as Vice Minister of Finance (1999–2000). Mr. Clarke was the president of ASSAL between 2001–2003.

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Contents

About the Core Curriculum . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Overview and Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

Pretest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .ix

A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

B. Fundamentals of Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

C. Understanding the Core Principle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

D. Supervision and Inspection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

E. Principles of Corporate Governance to Protect Key Stakeholders . . . . . . . . . . . . . . 25

F. Issues for Insurance Supervisors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Appendix I. ICP 9: Corporate Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Appendix II. Answer Key . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44

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About the Core Curriculum

A financially-sound insurance sector contributes to economic growth and well-be-ing by supporting the management of risk, allocation of resources and mobilization of long-term savings. The Insurance Core Principles (ICPs), developed by the Inter-national Association of Insurance Supervisors (IAIS), is one of the key international standards relevant for sound financial systems. Effective implementation of the ICPs requires skilled and knowledgeable insurance supervisors.

Recognizing this need, the World Bank and the IAIS partnered in 2002 to develop a “Core Curriculum” for insurance supervisors. The Core Curriculum project, funded and supported by various sources, supports the learning process of both new and ex-perienced supervisors. The ICPs provide the structure for the Core Curriculum, which consists of a set of modules that summarize the most relevant aspects of each topic, focus on the practical application of supervisory concepts and cross-reference existing literature.

The Core Curriculum is designed to help those studying it to:

• Recognize the risks that arise from insurance operations• Know the techniques and tools used by private and public sector professionals

to identify, measure, and manage these risks• Operate effectively within a supervisory organization• Understand the ICPs and other IAIS principles, standards and guidance• Recommend techniques and tools to help your jurisdiction observe the ICPs

and other IAIS principles, standards and guidance• Identify the constraints and identify and prioritize supervisory techniques and

tools to best manage the existing risks in light of these constraints.

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Note to Learner

Welcome to ICP 9: Corporate Governance module!This is a basic-level module on Corporate Governance that does not require spe-

cific prior knowledge of this topic. The module should be useful to either a new insur-ance supervisor or an experienced supervisor who has not dealt extensively with the topic—or is simply seeking to refresh and update knowledge.

Start by reviewing the objectives which will give you an idea of what a person will learn as a result of studying the module. Then answer the questions in the Pretest to help gauge prior knowledge of the topic. Then proceed to study the module either on an independent, self-study basis or in the context of a seminar or workshop. The amount of time required to study the module on a self-study basis will vary but it is recommended that it be addressed over a short time, broken into six sessions on chapters if desired.

To help you engage and involve yourself in the topic, we have interspersed the module with a number of hands-on activities for you to complete. These are intended to provide a checkpoint from time to time so that you can absorb and understand the material more readily. You are encouraged to complete each of these activities before proceeding with the next section of the module. An answer key in Appendix II sets out some of the points that you might consider when responding to the questions in each question set. You will also find question sets dealing with the local situation and related to practices in your jurisdiction. These are intended to help you apply the material in this module to your local circumstances. If you are working with others on this module, develop the answers through discussion and cooperative work methods. Since these

Overview andLearning Objectives

Insurance Supervision Core Curriculum

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responses will vary by jurisdiction, the answer key suggests where you might look for the answers.

As a result of studying the material in this module, you will be able to do the fol-lowing:

1. Summarize the requirements of insurance core principle (ICP) 92. Explain the concept of a corporation, specifically (a) the liability of the owners

of the corporation; (b) the duties, rights, and powers of shareholders and direc-tors; (c) the duties of directors to shareholders and other creditors; and (d) the way in which the structure of a corporation compares to other forms of business organization

3. Summarize the role of corporate governance in managing the business and meeting the duties of different parties under corporate law

4. Explain the ultimate responsibility of the board of directors, specifically (a) the information needed and available to the board; (b) the role of independent di-rectors; (c) the role of committees of the board; (d) the setting and enforcement of company policy; and (e) the linkage to, and role of, internal controls

5. Explain why the board of a financial institution should have a higher standard of care than a general-purpose corporation

6. Identify the stakeholders affected by the corporate governance requirements for different forms of business organization

7. Describe the responsibilities of management to the board of directors and how these can be met

8. Explain how corporate governance can be used as a supervisory tool9. Explain how corporate governance practices can be inspected10. Summarize the linkages between other supervisors and regulators in setting and

enforcing corporate governance practices.

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Pretest

Before studying this module on corporate governance, answer the questions on this page. The questions are designed to help you gauge your existing knowledge of this topic. An answer key is presented in appendix B at the end of the module.

For each of the following questions, circle the responses that are correct.

1. Corporategovernancerefersto:

a. Thelawswithwhichcorporationsmustcomply

b.Thewayinwhichcompaniesaredirected,managed,andcontrolledforthebenefitofkeystakeholders

c. Thebylawsthatacorporationhasestablished

d.Thewayinwhichmeetingsoftheboardofdirectorsaremanaged.

2. Corporategovernancerequirementsrespondtotheneedtobalancepotentialconflictsbetweentheinterestsof:

a. Investorsandtheboardofdirectorsofthecorporation

b. Investorsandseniormanagementofthecorporation

c. Investorsandcustomersofthecorporation

d.Theboardofdirectorsandseniormanagementcustomersofthecorporation.

Q1


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3. Corporategovernanceisimportanttoinsurancesupervisorsbecause:

a. Well-governedinsurersneednoonsiteinspection

b.Whenitisperformedeffectively,thesupervisorcanrelyontheworkofseniormanagementandtheboardofdirectors

c. Theboardwillestablishconservativereportingstandardswithhiddenreserves,andthiswillmakefinancialresultsmorepredictable

d.Shareholderrightsarebetterprotected,andthisimprovestheabilityoftheinsurancecompanytoraisemoneyfrominvestorsSecuritiessupervisorsrelyonthemtoprotecttheshareholdersofinsurers.

4. Withrespecttowidelyheldinsurancecompanies,thecorporategovernancerequirementsthataresetbysecuritiesregulatorsordefinedincorporatelawmeettheneedsofinsurancesupervisors.

a. True

b.False.

5. Boardsofdirectorsestablishcommitteesinorderto:

a. Minimizetheconflictsofinterestamongmembersoftheboard

b.Reviewspecificmattersindetailwithouttakingthetimeofthefullboard

c. Meettherequirementsofapplicablecorporategovernancerequirementsmorefrequentlythanispracticalforfullboardmeetingsandtherebykeepinclosertouchwithseniormanagement

d.Relievesomeoftheliabilityfordirectorswhenfacedwithdecisionsthatfalloutsidetheirareaofexpertise.

6. Delegationofdutiestomembersofseniormanagementshould:

a. Bedonecarefullysothattheboardhasprotectionfromlegalliabilityfordecisionsmadebymanagement

b.Beextensivecompletesothatmanagementisfullyabletorunthecompanyonaday-to-daybasiswithlittleinterferencefromtheboard

Q1continued


xi

c. Incorporatechecksandbalancestoensurethattheboardcanhavefullconfidenceintheworkofmanagement

d.Belimitedtoareasofthebusinessthattheboardhasinsufficienttimetoworkoneffectively.

7. ICP9focusesontheroleofcorporategovernanceinprotectingtherightsofpolicyholders:

a. True

b.False.

8. Ultimateresponsibilityfortheaccuracyofinformationprovidedbyaninsurancecompanytoitskeystakeholdersrestswith:

a. Theinsurancesupervisor

b.Thesecuritiesregulator

c. Theexternalauditors

d.Theboardofdirectors

e.Seniormanagementofthecompany.

9. Awell-runinsurancecompanyshouldhaveindependentmembersoftheboardofdirectorsbecause:

a. Ifitiswidelyheld,thesedirectorswillprotecttherightsofminorityshareholders

b.Thesedirectorswillfacilitatebusinessdevelopment,andthiswillincreasethecompany’sprofitability

c. Iftheyhavepreviousinsuranceexperience,thesedirectorswillbeabletoprovidemarketintelligencetothecompany

d.Thesedirectorswillstimulatediscussionatboardmeetingsandquestionmanagementontheissues.

10.Theinsurancesupervisorisabletoassesstheeffectivenessofcorporategovernancethrough:

a. Offsiteanalysisofregulatoryfilings,publicdocuments,andnewsreleasesfromthecompany

b.Regularinterviewsanddiscussionswithseniormanagementanddirectors

c. Onsiteinspectionofboardminutes,internalauditreports,anddiscussionswithseniormanagement

Q1continued


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d.Onsiteinspectionoftheeffectivenessofthecompany’sinternalcontrols

e.Acombinationofbothonsiteandoffsiteactivities..

11.Ifaforeigninsurancecompanyisoperatinginyourjurisdictionthroughabranch,yoursupervisoryagencyshould:

a. Enforcethesamecorporategovernancerequirementsonthebranchasapplytolocallyincorporatedinsurancecompanies

b.Relyonthehomesupervisorwherethecompanyislocatedtoenforceitscorporategovernancerequirementsonthebranch

c. Adaptthecorporategovernancerequirementsthatapplytolocallyincorporatedcompaniesandplaces

d.Requirethebranchtoestablishaboardofdirectorsinyourjurisdiction.

12.Foraninsurancecompanythatisownedbyasingleindividual,corporategovernance:

a. Neednotbeapplied

b.Shouldbeappliedwiththeexceptionthatmembersoftheboardmayallbefamilymembers

c. Shouldbeappliedexceptthatstrategicplanningforthecompanyshouldbeleftentirelytotheshareholdersinceshareholdermoneyisatrisk

d.Shouldbeappliedasitwouldforawidelyheldcompany.

13.Internalcontrolsareimportantforeffectivecorporategovernancebecause:

a. Fraudagainstthecompanyismoreeasilycaughtanddealtwith

b.Managementandtheboardcanbemoreconfidentthattheirdecisionsareimplemented

c. Managementisbetterabletocontroltheareasofthebusinessthatauditorsandactuariesareallowedtoaccess

d.Managementandtheboardreceivereportssummarizingtheresultsofimplementingcompanypolicyonstaffingdecisions.

Q1continued

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Basic-level Module

A. Introduction

Corporate governance is an important topic for insurance supervisors as evidenced by the fact that one of the 28 insurance core principles (ICP 9) is dedicated entirely to this topic and six others make specific references to the role, composition, and function of the board of directors (see IAIS 2003b). This module focuses primarily on what cor-porate governance is and why financial sector supervisors are interested in this topic. It shows some of the similarities and differences between the objectives of the capital market regulators and insurance supervisors and illustrates why these regulatory au-thorities should work together cooperatively.

Internal controls are an important tool for implementing decisions made by the board of directors and senior management and, as such, are an extension of the discus-sion on corporate governance. The importance of internal controls to insurance super-visors is evidenced by the fact that ICP 10 is dedicated to this topic (see IAIS 2003b). Other closely related topics covered by the core principles include suitability of persons (ICP 7), changes in control (ICP 8), onsite inspection (ICP 13), risk assessment and risk management (ICP 18), and information, disclosure, and transparency toward the market (ICP 26). As further evidence of the importance of this topic to insurance su-pervisors, many of the supervisory standards and guidance papers that have been is-sued by the International Association of Insurance Supervisors (IAIS) make reference to corporate governance issues (see IAIS 1998a, 2000, 2002a).


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Concept of corporate governance

The concept of corporate governance is widely discussed, and the term is used to de-scribe a range of practices and approaches. In this module, the term is defined as the processes, structures, information, and relationships used for directing and overseeing the management of the institution in the best interest of the institution and key stake-holders with a significant interest in the ongoing viability of the company. It is used in a broad sense so that it covers the interests of financial sector supervisors and policyhold-ers as well as investors. If a more narrow interpretation is intended, this is made clear in the text.

Corporate governance is most often thought of in terms of corporate entities. A corporation is a special form of business enterprise that is approved under corporate law or company law. This is distinct from a partnership, personal company, and so forth in that the liabilities of the corpora-tion are limited to the value of the assets of the corporation. The cor-poration often has the rights and responsibilities of a person under the law, although it is a corporate entity. It is a legal person as dis-tinct from a natural person. A cor-poration has a board of directors that provides oversight and advice to management on behalf of key stakeholders.

The concept of corporate governance as used here applies to legal entities with a board of directors. The concept is not directly applicable to branches of foreign com-panies. However, the advanced-level corporate governance module develops some ideas on how supervisors can apply the same basic concepts to the supervision both of branches and of companies.

This definition is supported by the requirements of the IAIS core principle on cor-porate governance, which sets out the powers, rules, and requirements that should be in place for the insurance supervisor to be able to use corporate governance as an effective supervisory tool. According to ICP 9,

The corporate governance framework recognizes and protects the rights of all in-terested parties. The supervisory authority requires compliance with all applicable corporate governance standards.

Supervisors need to understand what corporate governance means, why it is an important supervisory topic for inclusion in the core principles, what this principle requires, and how these requirements can be implemented.

Corporate Governance

Corporategovernanceconsistsofthe

processes,structures,information,and

relationshipsusedfordirectingandover-

seeingthemanagementoftheinstitution

inthebestinterestoftheinstitutionand

thekeystakeholdersthathaveasignifi-

cantinterestintheongoingviabilityofthe

company.


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Context for corporate governance

Corporate governance is a complex interweaving of legislation, regulation, business practices, institutions, traditions, culture, and social values. This complexity has pro-duced different definitions and practices in different parts of the world as to what con-stitutes good corporate governance (see Iskander and Chamlou 2000 for a discussion of the history and range of practices). Corporate governance focuses on knowledge and behavior and so deals with the processes for sharing information, making decisions, and implementing decisions effectively. Corporate governance is not about power and centralizing power in a few people (for a more complete discussion, see the paper by John Pound in Salmon and others 2000). Good governance is the means of ensuring that there is adequate control over objectives, strategies, controls, and operations within the company.

A great deal has been written about corporate governance, including the interna-tionally recognized principles developed by the Organisation for Economic Co-opera-tion and Development (see OECD 1999), and the topic is actively evolving. What is considered to be good corporate governance in a country has changed considerably, largely as a result of reviews undertaken after a large corporate failure in which the failure was a surprise or investors suffered significant losses. For example, consider the failure in 2001 of HIH Insurance Group in Australia (see HIH Royal Commission 2003) or the failure of Enron in the United States in 2002, which produced numerous recommendations for changes in corporate governance practices in the United States and other capital markets. This type of historical development of corporate gover-nance is common in most developed countries.

The term corporate governance is most often associated with requirements for the composition, structure, and work of the board of directors so that it can meet its obliga-tion to shareholders in general and minority shareholders in particular. With this defini-tion and its focus on investors, it is easy to understand why a capital market regulator is concerned about companies having sound corporate governance practices. Through these processes, the board ensures that the company is directed and managed in a way that is transparent to and protects the interests of shareholders.

By extension, corporate governance as used here relates to meeting the needs of all of the key stakeholders through the practices and work of the board and senior manage-ment. By using this more comprehensive definition, we consider why an insurance su-pervisor presses for good corporate governance, as a key stakeholder working on behalf of the government (to bolster public confidence in the financial system) and on behalf of policyholders and claimants (to protect them from undue loss).

The basic concept behind corporate governance is that the board should have suf-ficient influence on, and control of, the major decisions made by and the operations of the company to control its financial destiny as much as possible. Corporate governance defines the mechanisms for achieving this objective, and an important element of these requirements revolves around the business plan and its use in managing the company.


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This need to develop and implement business plans is an important part of the role of senior management and the board of any company.

Relevance to insurance supervision

Two elements of the corporate governance concept make it an important part of effec-tive insurance supervision:

• Effective corporate governance can improve the confidence that investors have in a company and therefore strengthen the access that a company enjoys to capi-tal and other forms of financing, as and when it might be required.

• Effective corporate governance strengthens the controls within a company to ensure that the strategies adopted and decisions made by the board, acting on behalf of stakeholders, are implemented effectively.

Effective corporate governance allows the supervisor to rely on the work performed by the board of directors and senior management and, in so doing, allows the supervi-sory process to operate more efficiently and effectively than it could in the absence of such reliance. This reliance relationship must be reviewed from time to time to ensure that the reliance is well founded.1

It is important for the supervisor to review the corporate governance practices in place in each company to ensure that the specific elements adopted by the company are appropriate for its circumstances. Each company should implement all of the corporate governance requirements. However, more complex companies must have more com-plex structures and procedures to manage the business and the inherent risks to which the company is exposed. As a result, the process that a supervisor might use to inspect corporate governance and internal controls forms a part of this module.

Commonly used terms

Before delving into the topic, it is important to define some commonly used terms:

• Board of directors. This term is used to mean the most senior body in the corporate structure. In some countries, senior management reports to a single board of direc-tors. When there is one board, the term applies to the board. In other countries, a two-tiered system applies, so there is a supervisory board and a management board.

1. The term reliance relationship is used here to describe a relationship between people or groups under which one party depends on the other to perform certain work to prescribed and agreed standards. The party that depends on the other to perform the work is involved in setting the standards for performance or agrees to the standards as reasonable. Once the work is performed, the dependent party reviews the work to determine whether or not it was performed to the agreed standards but does not reproduce the work itself. If the work does satisfy the standards, the dependent party uses the results.


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In this case, the term board is used to mean the supervisory board, and members of the management board are referred to as senior management.

• Corporation. A corporation is a special form of company structure permitted under legislation: the company has limited liability but has the duties and re-sponsibilities of an ordinary person.

• Closely held company. A closely held company is a business that is owned by shareholders who are few in number or closely associated so that control of the enterprise is focused in a few hands.

• Widely held company. A widely held company is a business that is owned by shareholders, none of whom owns a sufficient number of shares to exercise con-trol of the company or its board.

For each of the following questions, which responses are correct? Circle your choices. More than one may be valid.

1. Corporategovernancerefersto:

a. Thewaythatcompaniesaredirected,managed,andcontrolledforthebenefitofallstakeholdersandinterestedparties

b.Thestructures,processes,andrelationshipsusedfordirectingtheaffairsofthecompany

c. Theframeworkthatinsurancesupervisorshaveinplacetoprotecttherightsofpolicyholders

d.Thecentralizationofpowerandcontrolinthecompany’sboardofdirectors.

2. InICP9,IAIShasdefined:

a. Allofthecorporategovernancerequirementsthatinsurancecompaniesmustfollow

b.Thecorporategovernanceframeworkthatinsurancesupervisorsshouldhaveinplacetosupporteffectivesupervision

c. Theconceptofcorporategovernancetoincludeanyrulesthatmaybeprescribedbysecuritiesregulators

d.Theconceptofcorporategovernancesothatsupervisorscanlooktotheboardofdirectorstoimplementremedialactionwhennecessary.

3. Effectivecorporategovernance:

a. Strengthenstheconfidencethatthepublicplacesintheinsurancesector

b.Providesthesupervisorwithmoreflexibilityindesigningitssupervisorymethodology

Q2


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Answer these questions in relation to the practices in your jurisdiction. If you are working with others on this module, develop the answers through discussion and cooperative work methods.

1. Areinsurancecompaniesrequiredtocomplywithcorporategovernancerequirementsinyourjurisdiction?Whatcompetentbodysetstheserules?Dotheserulesapplytoalltypesofinsurancecompanies?

2. Whattypesofinsuranceenterprisesoperateinyourjurisdiction?a.Locallyincorporatedcompanies

b.Branchesofforeigncompanies

c. Friendlysocietiesorcooperativeormutualinsurancecompanies

d.Fraternalbenefitsocieties

e.Government-ownedcompaniesunderspecialenablinglegislation.

3. Whattypesofboardstructuresarepermittedinyourjurisdiction?a.Singleboard

b.Two-tieredboard

c. Other.Pleasedescribe.

4. Whattypesofinsurancecorporationsarepresentinyourjurisdiction?Andhowaretheirboardsofdirectorsselected?a.Corporationswithexchange-tradedshares

b.Closelyheldcorporations.

Q3

c. Createsasoundreliancerelationshipsothattheinsurancesupervisorcanrelyontheworkoftheboardofdirectors

d.Createscomplexstructuresforcomplexcompaniesandsimplestructuresforsimplecompanies.

4. Corporategovernancerequirementsforinsurancecompaniescanbedefinedin:

a. Insurancecompanieslegislation

b. Insurancecompaniesregulations

c. Corporatelaworthecompaniesact

d.Securitieslegislationandrules.

Q2continued


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B. Fundamentals of Corporate Governance

To understand corporate governance, it is appropriate to start with the role of corporate governance in meeting the needs of investors and securities regulators and then to con-sider how corporate governance is used by insurance supervisory authorities.

Role in investor protection

Much of the literature on corporate governance focuses on shareholder protection in general and on the rights of minority shareholders in particular. Providing this type of protection is intended to increase investor confidence and thus foster a more robust capital market. The more confidence that investors have in the marketplace and the companies whose shares are traded in the market, the greater is the likelihood that the market will be an active place for companies to raise capital and investors to buy and sell shares or other securities.

Corporate governance emerges out of the need to balance the potential conflict between the investor (the lender of money who is seeking a good return in relation to the risks involved) and the interests of those who control the company (the individuals who decide how that money is used and may be more willing to take risks when using other people’s money). When the owner of a company also manages the company, deci-sions will have to recognize and balance these divergent interests. When more than one shareholder is involved, these relationships become more complex, and a process must be established to oversee the operations of the company and protect the interests of the lenders of capital.

The people who run the company are insiders because they have ready access to information about the company and its prospects for the future.2 The lenders of capital are often outsiders and do not have ready access to this level of information. An impor-tant part of corporate governance is disclosure and transparency aimed at balancing the interests of outside investors and the interests of insiders so that the rights of all shareholders are distributed broadly and evenly.

Corporate governance is intended to provide this balance so that outside investors are not at a significant disadvantage in relation to insiders.

Access to information

Investors with a majority shareholder position generally are able to obtain access to in-formation about the performance of the company and its plans for the future. Minority

2. Insiders who also own shares can decide to buy and sell shares using this inside information if no system is in place to balance the interests of insiders and outside investors. Corporate governance is not generally intended to protect outside investors from this risk. However, most securities regulators have rules regarding insider trading. Most corporate governance regimes, however, include elements that minimize the undue influence of insiders on setting strategy and making important decisions that affect the rights of other shareholders.


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shareholders generally are not treated as insiders because the investment position they hold is small and they may only hold the securities for a short period before trading them. As a result, in the absence of rules protecting the rights of minority shareholders, these investors might not get good-quality information about the company and may be reluctant to make an investment. The possibility of uneven access to information about the company gives rise to many of the requirements and practices—which may be defined in corporate law, securities law, or other legally enforceable ways—that are fundamental to good corporate governance.

Investor confidence

One of the objectives of corporate governance is to provide investors with the confidence to make in-formed investment decisions. To make an informed decision, in-vestors must have access to infor-mation that allows them to assess the risks to which the investment is exposed and the potential for investment gains. This is the ba-sic risk-reward assessment that informed investors carry out in matching their own risk tolerance with their desire for a good return on investment. When investor in-formation is distributed more evenly so that majority and minority shareholders have access to the information necessary to make this risk assessment, investor confidence increases, more investors are willing to take a position in the market, and companies have more opportunities to raise capital when needed. Having a wide range of investors making informed decisions contributes to building and maintaining a broad, deep, and diversified market for traded securities.

The foundation of deep and broad capital markets is access to investor informa-tion:

• Investors need to have good-quality, reliable information so that they have con-fidence in making informed decisions.

• Investors need to understand the financial condition of the company and the impact of planned actions for the future.

• Investors should have information about the people running the company and how they manage and control the business activities of the company.

Corporate Governance and Investor

Confidence

Goodcorporategovernancecanincrease

investorconfidenceinmakinginvestment

decisions.This,inturn,canimprovethe

accessofcompaniestoadditionalwork-

ingcapital,enablingthemtoimprovetheir

rangeofproductsandservices.Thiscan

improvecompanyprofitabilityandretained

earnings,therebyimprovingpolicyholder

confidencethatthecompanywillmeetits

promises.


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• Investors need to be confident that they are receiving accurate information in a timely manner.

• Investors need to be confident that the people who are running the company are doing so in a prudential manner.

Internal controls

These needs are met through checks and balances at the board level and internal con-trols at the company level that ensure that the board and senior management are fully aware of what is happening within the company.

Having control of the operation of the business is important for the management of all companies and for good corporate governance. If the board or senior management has control of the company, the company is probably using elements of corporate gov-ernance. The basic concept is as appro-priate for a closely held company as for a widely held company. It is as appropriate for a company with only majority share-holders as it is for a company with only minority shareholders. It is as appropri-ate for companies that are traded on rec-ognized exchanges as for those that are not publicly traded. The basic need is for the board and senior management to have control of the company, to have a suitable strategy for directing the opera-tions of the company, to have adequate information to control the company, and to ensure that appropriate checks and balances are in place so that the board and management have reasonable control of the future potential of the company.

The board and senior management control the company through a combination of requirements for how the board operates, for management, and for the flow of infor-mation, controls for ensuring the accuracy of information and the implementation of company policy as well as other decisions of the board and management, and practices for managing risks. This range of requirements and processes defines the requirements for corporate governance. It also covers the tools required to make corporate gover-nance effective. These include the individuals who hold senior positions, the size and composition of the board, compensation, the planning processes, and internal controls and audit.

Internal Control

Internalcontrolisanimportanttool

usedbytheboardofdirectorsand

seniormanagementtoensurethat

theirdecisionsareimplementedand

followedwithinthecompany.Know-

ingthatacompanyhasgoodinternal

controlsallowstheregulatororinsur-

ancesupervisortohavegreatercon-

fidencethatthecompanywillbeable

tocomplywithanydirectivesthatit

mightbegiven.


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Delegation of duties, with controls

The knowledge and experience of members of the board and management are an im-portant part of corporate governance. After all, the board effectively delegates matters to senior management, and senior management carries out the decisions of the board and runs the company on a day-to-day basis. Management, in turn, reports back to the board on its achievements and the progress of the company toward meeting its goals and objectives. The board must have confidence in management for the company to run effectively; for this reason, checks and balances are needed to ensure that the confidence in management is well deserved.3

Once again, any well-run company would want to have controls in place in order to ensure that the individuals running the company set a direction and strategy and the individuals working for the company do what is expected of them (see figure 1). This process of delegation, review, assessment, and revision is an example of a reliance relationship.

Capital market regulators

Capital market regulators want to ensure that companies have these controls, checks, and balances in place because they look to the board to protect the interests of investors. Capital market regulators maintain that fair and efficient markets must be transparent. As a result, there are a great deal of rules around what market participants must do in order to keep the investing public informed about the activities and affairs of the com-pany.

3. It is not unusual for the controlling shareholders of a closely held company to have undue influence in selecting senior management, setting strategy, and making important decisions. This influence can work to the disadvantage of other inves-tors. Effective corporate governance minimizes this effect.

Figure 1: Checks and Balances in a Well-Run Company

Delegation

• Range of action• Authority• Limits

Tools

• Company policy• Departmental role• Job descriptions• Business plans

Control

• Monitoring• Reporting• Review• Revision

Tools

• Performance appraisal• Audit• Variance reports

Board

Senior management

Staff


��

Shareholder meetings are an important vehicle for providing investors with access to informa-tion and exposure to the board and management. This, in turn, contrib-utes to the confidence of investors in how the company is managed.

Insurance supervisors

Insurance supervisors seek to en-sure that companies have good corporate governance practices as well. However, that interest is not simply to protect the rights and interests of shareholders. After all, the money that investors have tied up in a company forms at least part of its capital base,4 and super-visors rely on that base to protect the rights of policyholders in the event the company fails.

Insurance supervisors want to ensure that companies have access to additional capital should that be necessary. They want to have insurance enterprises that are well managed, treat their customers fairly, are in compliance with the legislation and other requirements, and are managed by competent, ethical individuals. In addition, insurance supervisors want to have confi-dence that any supervisory sanctions, demands, or actions required of the company will be carried out.

The principles of sound corporate governance contribute to all of these goals. It is, therefore, not surprising that insurance supervisors expect all companies to practice good corporate governance no matter what the corporate form of the company.

Fiduciary duties

Many insurance companies have more policyholder money than shareholder money. That is, the size of the policy and claims liabilities (and provisions or reserves) ex-ceeds the amount of assets held as the result of shares and other capital instruments that the company has issued. In deciding to invest in the company, investors are aware

4. Capital is made up of retained earnings and a range of financial instruments that are subordinate to the rights and interests of policyholders and claimants. For a more complete discussion of capital, see IAIS (2002b).

Corporate Governance and Confidence

of Stakeholders

Theprinciplesofsoundcorporategover-

nancecontributetotheconfidencethatall

stakeholdersplaceonmanagementand

theboardtobalancetheirinterestswith

thoseofotherstakeholders.Corporate

governanceallowstheboardtoprovide

direction,leadership,andcontroltothe

company.

Exemptions from Compliance

Inmanyjurisdictions,legalentitiesare

activeininsurancethatarenotcorpora-

tionsandarenotsubjecttocorporate

law.Thesemaybeinsurancepoolsor

government-ownedinsuranceproviders

establishedunderspeciallegislation.

Theseentitiesmaybeexemptedfrom

compliancewithnormalcorporategover-

nanceorsupervisoryrequirementsinthe

jurisdiction.


��

of the risks and seek information to assess the level of risk and potential rewards. Policyholders rarely recognize the risks involved in dealing with a particular insur-ance company. Rather, they seek the services of an insurance company to relieve them of unwanted exposure to risk.

Since policyholders and shareholders both have money in the company and are at risk in the event of failure, they share a common interest that the company should be run in a prudential, profitable, and sound manner over an extended period. These groups are both interested in corporate governance to protect their interests. However, even though they have some interests in common, board decisions that benefit share-holders may not necessarily benefit customers and vice versa.

Within the company, corporate governance must balance the potential conflict be-tween the rights and interests of various stakeholders.5 For example, a decision by the board may increase the risks to which shareholders are exposed, while reducing the risks to which policyholders are exposed. Investment strategies that seek to meet the long-term commitments to policyholders may not produce attractive short-term re-sults for investors. Corporate governance must recognize, balance, and deal with these potential conflicts.

The special relationship between the insurance company and its customers requires an especially high standard of care on the part of company management and the board. In addition, since the business is complex and few customers understand all aspects of the products and services they purchase, the insurance supervisor provides oversight of the industry on behalf of policyholders and the general public.

This complex interaction of issues and interested parties makes the topic of cor-porate governance a challenging one for financial sector supervisors. Given the im-portance of corporate governance to supervisors, IAIS has prepared clear guidance for insurance supervisors on this topic.

5. Balancing the interests of stakeholders is an important function of the board. Some stakeholders have a long-term view, and this may be best met through strategies that focus on prudential, profitable approaches with a focus on the customers, staff, and the expectations of regulators. Other stakeholders have a short-term view, and this may be best met through a strategy that focuses on earnings and shareholder dividends. The need to balance these potentially divergent objectives often requires choices, and in making these choices, the decisionmakers need to understand the business and the issues involved.


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1. Boardsofdirectorscontroltheflowofinformationoutofthecompanysothat:

a. Proprietaryinformationiskeptconfidential

b.Theinformationthatisreleasedisaccurate

c. Keystakeholderswillhavegreaterconfidenceinthecompany

d.Thecompany’sprofileiskeptatahighleveltoincreasesales.

2. Stakeholdersneedtomakeinformeddecisionsaboutthecompanyusinginformationfromthecompany.Forexample,

a. Shareholdersneedtodecidewhethertobuy,sell,orholdtheirshares

b.Brokersneedtodecidewhethertoplacebusinesswiththecompany

c. Insurancesupervisorsneedtodetermineifthecompanyisincompliancewithlegislationandregulations

d.Securitiesregulatorsneedtodecideifthecompanyisviable.

3. Internalcontrolsaredesignedto:

a. Helpcompaniesidentifymembersofstaffwhoarestealingfromthecompany

b.Enforcedecisionsmadebytheboard

c. Ensurethatinformationprovidedtotheboardisaccurate

d.Keepmanagementandtheboardfullyawareofwhatishappeninginthecompany.

4. Whentheboardofdirectorsdelegatesdutiestoseniormanagement:

a.Theboarddelegatesaccountabilityforthefunctionaswell

b.Theboardintendstomakeitclearthatmanagementisfullyaccountablefordecisionsmadeinthatarea

c. Theboardestablishesbenchmarksformeasuringperformance

d.Theboardintendstotestthecompetenceofmanagement.

Q4


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Q4continued

5. Aboardofdirectorshasadutyto:

a. Ensurethatallpromisesmadeonbehalfofthecompanyaremet

b.Balancetheexpectationsofpolicyholdersandinvestors

c. Investtheassetsofthecompanyforthemaximumyield

d.Ensurethatthecompanyisincompliancewithalllegislationandregulations.


1. Whatcorporategovernancerequirementshavethecapitalmarketregulatorsinyourjurisdictionsetthatapplytoinsurancecompanies?

2.Haveanyofthelocallyincorporatedinsurancecompaniesinyourjurisdictionrecentlyusedthelocalcapitalmarkettoraiseadditionalcapital?Whattypeortypesoffinancialinstrumentsdidtheyuse?

3.Forthelargestcorporatelifeinsurancecompanyinyourjurisdiction,whatistheratioofthevalueoftheliabilitiesrelatedtopolicyholderobligationstothevalueofcapitalprovidedbyinvestorsandshareholders?

Q5


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C. Understanding the Core Principle

The meaning of ICP 9—corporate governance—should be considered with reference to the detailed wording of the explanatory notes, the essential criteria, and the advanced criteria. The complete text of this core principle is reproduced as appendix I to this module.

The core principle itself focuses on the powers and authority that insurance super-visors must have in order to carry out their duties in an effective manner. The principle does not attempt to define corporate governance or provide a detailed list of every ele-ment that is required for the concept to be effective within a company. The focus is on the supervisory needs.

The first sentence of the principle indicates that the corporate governance frame-work should “protect” the rights of “all interested parties.” These terms should be un-derstood in the context of why an insurance supervisor should focus on these issues and how the principle can be met.

The word “protect” does not mean that supervision will guarantee that the parties will never lose money. Rather, it means that supervision provides a defense against un-due loss—losses that are surprisingly large under the circumstances. As with any defen-sive system, the effectiveness cannot be guaranteed, so the test of the supervisory system is not whether there are failures or losses but whether those losses are unduly large.

The term “all interested parties” refers to persons or entities that have a financial interest in the insurance company or are regulators or supervisors with responsibility for oversight of the insurance company. These are policyholders, claimants, investors or other creditors, securities regulators, and insurance supervisors.

The second sentence of the principle deals with the need for the insurance supervi-sor to recognize and require compliance with all of the corporate governance require-ments that apply to insurers, including those that may have been set by other competent regulatory authorities. This highlights the need for supervisors to work cooperatively, since each may have expectations and needs that can best be met through good cor-porate governance. The overall corporate governance regime only makes sense and is effective if insurers have a coherent, cohesive set of rules with which to comply.

The explanatory notes

In the explanatory notes, the first two sentences in paragraph 9.2 say, “The board is the focal point of the corporate governance system” and “is ultimately accountable and responsible for the performance and conduct of the insurer.” Thus the board has di-rect responsibility for management and oversight of the company. The board can del-egate responsibility to full-time staff and executive officers, but this does not absolve the board from its responsibilities.


��

The explanatory notes also indicate (in paragraph 9.3) that even in jurisdictions where corporate governance rules apply to all general-purpose corporations, “it is nec-essary to establish additional requirements.” This higher standard of care is required because of the board’s fiduciary duty to policyholders and its duties to the insurance supervisor.6

The essential criteria

IAIS defines three essential criteria. The first deals with the possibility that insurance supervisors and others could

promulgate corporate governance rules and regulations and that insurance companies would have to comply with all of them. The insurance supervisor must, as a result, have authority to verify and enforce compliance with all of these rules and regulations, whether they are defined under insurance legislation or not. This is necessary because only one set of corporate governance rules should apply to any one company, even if they are developed and promulgated by different empowered bodies in a jurisdiction. Therefore, if existing corporate governance rules apply to insurance companies, the in-surance supervisor may expand on those rules to include duties for the board and man-agement to meet its own special needs. However, in so doing, the existing rules and the additional rules must complement each other and work together.

The second deals with the power and responsibility that falls to the board of direc-tors. The 11 subcriteria in this section deal with the idea that the board has a duty to see that the company is well managed and has sound practices and procedures in place, including processes for ensuring that the company is in compliance with relevant laws and other requirements and that management is competent and fit for their position. These requirements are similar to what one would expect to be in place to protect the rights of investors. However, due to the special nature of the insurance business, these subcriteria include references to oversight of the company’s risk management practices and actuarial practices and the need for the board to communicate and meet with the insurance supervisor, as may be required.

The third of the essential criteria deals with the responsibility of management. The three subcriteria in this section focus on setting direction for the company, having con-trol of its operations, and providing full and fair reporting to the board. A sound and open working relationship between the board and management is critical to the ef-fectiveness of corporate governance within a company. The flow of information from management to the board is critical to the board’s ability to understand the operations of the company.

6. The nature of these duties depends on the fact that a large proportion of the assets of the company should be treated as policyholder or claimant money and not as money that can be used at the complete, unfettered discretion of the company.


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The advanced criteria

IAIS defines four advanced criteria. The first deals with the establishment of board committees with specific responsi-

bilities, such as compensation, audit, or risk management. The use of board committees is discussed in the section of this module dealing with the structure and functioning of the board.

The second notes that remuneration of directors and senior management should give regard to the performance both of the individual and of the company. Remunera-tion policy should not include incentives that encourage imprudent behavior.

The third recommends that one or more officers be given responsibility for ensur-ing compliance with relevant legislation and required standards of business conduct. The existence of an effective compliance officer, who reports to the board of directors at regular intervals, can be an important part of an insurer’s system of internal controls.

The last of the advanced criteria indicates that when a “responsible actuary” is part of the supervisory process, the actuary should have direct access to the board of direc-tors or a committee of the board and report relevant matters to it on a timely basis. IAIS (2003a) contains a full discussion of this topic.

Please answer the following questions:

1. WhywouldICP9requiretheinsurancesupervisortoprotecttherightsofallinterestedparties,wheretheseincludeshareholders?

2. Whyshouldaninsurancesupervisorhavethepowertoenforcethecorporategovernancerequirementsofothercompetentregulatorybodies?

3. Whymightaninsurancesupervisorprescribecorporategovernancerequirementsforinsurancecompaniesinadditiontothosethatapplytoothercompanies?

Q6


��

Answer these questions in relation to the practices in your jurisdiction. If you are working with others on this module, develop the answers through discus-sion and cooperative work methods.

1. AfterreviewingthematerialaboveandthetextofICP9(appendixI),considerthedegreetowhichtheinsurancesupervisoryauthorityinyourjurisdictionhasthepowerstospecifyandenforcethecorporategovernancerequirementsdescribedinICP9.

2. Whichofthedutiesdescribedinthesecondessentialcriteriaarerequiredofaboardofdirectorsinyourjurisdiction?Whetherornottheyarelegallyrequired,whichofthesecriteriaarecommonlymet?Whichrequirestrengthening?

Q7


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D. Supervision and Inspection

Supervision of corporate governance involves a combination of offsite analysis and on-site inspection. The measurable elements of the corporate governance requirements can generally be assessed through offsite analysis, while it is generally necessary to inspect the principles-based requirements through a document review and through discussions with senior management. These are generally possible only onsite.

Compliance assessment

Compliance assessment is an im-portant extension of a company’s corporate governance regime be-cause sound corporate governance and internal controls processes are needed for the company to ensure that it is in compliance with all of the requisite laws and regulations.

Therefore, supervisors should review the internal controls and compliance assessment procedures. The compliance assessment process should be in place and used effectively to support the information needs of senior management and the board.

Board oversight

Part of what constitutes good cor-porate governance relates to what the board does to oversee and as-sess its own work, the work of senior management, and inter-nal control processes. Appraising boardroom performance is not an easy task, and it is best carried out through formal processes that are accepted and understood by the board. Increasingly, companies are implementing this aspect of good corporate governance (for a discussion of this topic, see the contribution by Jay Conger in Salmon and others 2000).

Internal Controls and Inspection

Whenasupervisorissatisfiedthata

companyhaseffectiveinternalcontrols

inplace,thesupervisorisabletofocus

inspectionontheinternalproceduresand

internalenforcementactionstakenbythe

companyratherthancarryoutadetailed

reviewofcomplianceitself.

Planned Activities in Onsite and

Offsite Inspection

Inspectionofcorporategovernancere-

quiresplannedactivitiesinbothonsiteand

offsiteinspection.Neitherelementofthe

inspectionprocesscanbeusedeffectively

onitsowntoreviewthecorporategover-

nanceandinternalcontrolproceduresthat

acompanyhasinplaceandtodetermine

howwelltheywork.


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A supervisory review of a company’s corporate governance includes both offsite analysis and onsite inspection.

Offsite analysis entails the following activities:

• Review public documents on board structure and membership• Review regulatory filings that include information on board members, changes

in composition, curriculum vitae of board members, and changes in commit-tees of the board

• Review documents prepared by the company to disclose its financial position (see IAIS 2002a for the range of information that should be made available to stakeholders)

• Review news releases to identify the types of issues that are disclosed during the year and the reaction of industry commentators (either analysts or journalists) to this disclosure.

Onsite inspection entails the following:

• Review the minutes of the board• Review information provided to the board• Review the minutes of board committees• Review the reports of external auditors • Review the reports of internal auditors and discuss them with audit staff as well

as staff in the areas affected.

The quality of this type of review is highly dependent on the support and involve-ment that the inspection team receives from the company. Access to information by inspectors must be unimpaired for this review to be useful.

Reliance relationships

Inspectors are, in effect, reviewing a reliance relationship that corporate governance creates between the staff of the company and the board of directors. A party deter-mined to hide information from another can always find ways to do so. Recent events involving some very large companies in various parts of the world have demonstrated this. In some cases, the boards of these companies included very knowledgeable and able people, and yet transactions were completed in a way that avoided scrutiny by the board and auditors of the company. However, even though corporate governance is not a perfect mechanism for protecting the rights and interests of key stakeholders, those interests are far better served through the use of corporate governance than would be the case in its absence.


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A supervisor cannot check every transaction to ensure that every law is followed and that sound accounting and risk management practices are employed. The cost of such a system would be prohibitive. However, relying on the work of the board and the sound corporate governance practices it has adopted allows the supervisor to verify that a company uses the appropriate systems and processes in its day-to-day operations.

Internal controls

Inspecting the internal controls procedures is also important because doing so allows the inspection team to determine the level of control that the board and senior manage-ment have over the operations of the company. Inspecting internal controls involves verifying the following:

• Policy is set by the board.• The board is specific in identifying the person to whom authority is delegated.• The delegation includes an accountability framework, which means in most

cases that this person reports on the use and effectiveness of the policy.• The policy is clearly communicated to everyone who needs to know about it.• The application of the policy is monitored regularly. • There is an independent review process (probably an internal audit).• The effectiveness is assessed regularly, recommendations for strengthening are

made, and the recommendations are considered and implemented, where ap-propriate.

• The policy is reviewed by the board from time to time and is updated regularly.

If these steps are not in place, the inspectors will need to be satisfied that what-ever processes are in place are effective in implementing, overseeing, and verifying the decisions of the board. For a more extensive discussion of internal control issues, see the core curriculum module on ICP 10 and Basel Committee on Banking Supervision 1998.

Influences on supervisory effectiveness

In order for the insurance supervisor to be effective in carrying out his or her duties:

• The supervisor must be able to obtain comprehensive written information about the company and rely on its accuracy and completeness.

• The supervisor must be able to assess and have confidence in the competency of management.


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• Since some board records are only available at company offices, some of this review can only be carried out through the onsite inspection process (for a more extensive discussion, see IAIS 1998b).

• The supervisor must have access to people in the company and to proprietary in-formation about the company’s operations that is timely, reliable, and accurate.

• The supervisor must have confidence that a commitment for action by the com-pany can be made and met.

• The supervisor must be able to conduct effective onsite inspections to verify all important facts and to talk to staff and management as appropriate.

• The supervisor must have confidence that the company is managed in a manner that meets the requirements of the law.

• The supervisor must have confidence that the company is managed in a pruden-tial manner that recognizes and manages risks inherent in the business.

• The supervisor must have confidence that policyholders and prospective policy-holders are treated fairly.

These objectives can be met through sound corporate governance practices and good internal controls procedures.


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1. Effectivecorporategovernanceallowstheinsurancesu-pervisortolooktotheboardofdirectors:

a. Toassurethatdirectivesissuedbytheauthorityareimplemented

b.Toensurethatinformationfiledwiththeauthorityisfiledonatimelybasis

c. Toattractandretainacompetentseniormanagementteam

d.Toprovideinspectorswithfreeaccesstopeopleandin-formation.

2. Thelicensingprocessrequirestheinsurancecompanytohaveaboardofdirectorsandseniormanagementthatarecompetentandexperienced.Itisnotnecessarytoreviewthefitnessandproprietyofmanagementafterthelicensehasbeengranted.

a. True

b.False.

3. Incarryingoutanoffsiteanalysisofacompany’scorpo-rategovernanceregime,thesupervisoryauthoritywill:

a. Focusonareviewofpublicdocumentsandregulatoryfil-ings

b.Considerarticlesonthecompanythatwerepublishedinthenewspapers

c. Assessthedepthofdiscussionthatisreportedinboardminutes

d.Reviewtheeffectivenessofthecompany’sinternalcon-trolprocedures.

4. Inconductinganonsiteinspectionofacompany’scorpo-rategovernanceprocess,thesupervisoryauthoritywill:

a. Workthroughseniormanagementtogetcopiesofthein-formationthatwasprovidedtotheboardtosupportanyimportantdecisionsthatweremade

b.Reviewinternalauditreportsoncontrolprocedures

c. Talktodepartmentheadstoseewhattheyunderstandofspecificcompliancerequirementsthathavebeenpre-scribedbytheauthority

d.Reviewbusinessplansandreportsonachievementsver-susgoals.

Q8


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1. Howiscompliancewithcorporategovernancerequirementsdoneinyourjurisdiction?

2. Whatprocesswouldtheinspectorsfollowiftheyuncoveredaviolationofoneoftherequirementssetoutundercorporatelaw?Howwouldremedialactionbeenforced,andwhatbodywouldleadtheeffort?

Q9


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E. Principles of Corporate Governance to Protect Key Stakeholders

This section presents some elements of corporate governance that may practically be applied in less developed economies or insurance sectors. However, it is instructive to understand how some of the best practices are integrated and defined. In the ad-vanced-level corporate governance module, a section discusses some of the issues that supervisors face and how they have implemented or might implement a revised regime to compensate for the gaps.7

This section discusses best practices that build on those that are often promoted for general-purpose companies with shareholders. Where appropriate, these concepts are expanded for insurance enterprises. As a result, this discussion goes beyond the scope and content of ICP 9.

Basic principles

Corporate governance regimes are usually based on the basic principles of transparen-cy, fairness, accountability, responsibility, and control (for a more complete discussion, see Iskander and Chamlou 2000). These can be embodied in a few common concepts:

• Shareholders should have a right of access to information about the company and should be involved in key decisions that affect the fundamental framework of the company.

• There should be fair and equitable treatment of all shareholders and all key stakeholders so that no group is at either an advantage or a disadvantage in the process.

• Timely and accurate financial information should be made available.• Boards should provide oversight of the operations of the company and balance

the interests of all key stakeholders with those of the company.

These principles are met by dealing with the following topics and issues:

• Board membership• Structure and functioning of the board• Business planning and controls• Information provided to the board• Information provided to key stakeholders.

7. There are basic differences in how these elements are put into effect in different countries. For countries that use the civil code approach, it is common for the requirements to be defined clearly in legislation or regulations in a prescriptive manner. This could be thought of as a rules-based approach, and the onus is on the supervisor to demonstrate noncompliance. For countries that follow the common law approach, the requirements could be defined in a rules-based way or in a principles-based approach. The latter approach includes a clear definition of the objective that is to be achieved, and the onus is placed on the company to demonstrate that the regime meets these objectives. The legal system can affect how corporate governance is implemented within a country.


��

Each of these areas is considered in turn.

Board membership

The following issues are relevant to board membership:

• Independent directors • Executive and nonexecutive directors • Experience and ability to work as a board member• Attendance and level of involvement of board members• Terms of appointment• Separation of duties• Conflict of interest.

Best practices in these areas are intended to ensure that individuals on the board of an insurance company have adequate experience and knowledge and few direct links to management. This will improve their ability to achieve the following objectives:

• Provide insightful direction to management and oversight in balancing the in-terests of the company with the interests of investors and other stakeholders

• Question the decisions and results of the company as an investor would in the same circumstances.

ICP 9 includes several references to these issues. The second essential criterion deals with the duties and composition of the board and links directly to the core principles on suit-ability of persons (ICP 7). Some of the best practices noted are included in the advanced criteria. Some of these may be more readily applied in an established mature market than in a less developed insurance market. However, the insurance supervisor should have the authority to require boards of directors of insurance companies to have in place procedures dealing with these issues. This best practice category is directed at ensur-ing that the board is able to oversee the company and management in a way that balances the interests of key stakeholders with those of the company. To achieve this objective, the board must be composed of capable individuals who are willing, and have the time, to oversee the operations of the company.

Who May Be a Member

Whomaybeamemberoftheboardofan

insurancecompanyisanimportantpartof

determiningtheethicalandbusinessstan-

dardstowhichtheday-to-dayoperations

ofthecompanyareheld.Boardmembers

mustbenotonlyfitandproperfortheir

rolebutalsowillingtodedicatethetime

andeffortrequiredtoperformtheirduties

effectively.


��

One of the functions of the board is to establish the roles and duties of senior man-agement and to select the most senior person to look after the day-to-day operations of the company. In doing this work, it is important to minimize the conflicts of interests that may emerge. Because of this, concentration of power and authority is usually bal-anced with the need for efficiency, range of responsibility of senior people, and author-ity to act. Separation of duties is a common way to avoid the concentration of power and provide checks and balances in the management system.

The size of the board is also important for its effective operation. The board should be small enough to attract involved, capable, and interested individuals but large enough so that the burden on any one individual is manageable.

Structure and functioning of the board

The following issues are relevant to the structure and functioning of the board:

• Setting of the board agenda• Provision of information in advance of meetings• Frequency and scope of meetings• Board committees and composition• Setting of board and management compensation• Performance of board members.

Best practices in these areas are desirable for the following reasons:

• How a board makes decisions and the matters that are discussed with the board all influence its effectiveness.

• The person who controls the agenda influences the scope of work of the board and the level of understanding that the board has on issues.

• Use of board committees can relieve the full board of the detailed review that some issues require by having a few individuals conduct the review on behalf of the full board. Board committees can also be structured to provide more independence in the review process when that is ap-propriate.

• The base level of compensation and incentive compensation can affect behavior and the degree to which the interests of key stakeholders are met.

• The role of the board is critical, and the performance of individual board mem-bers can affect the performance of the board as a whole.

Effectiveness and Efficiency of the Board

Theeffectivenessandefficiencyofthe

boardareinfluencedbywhatmattersare

broughttotheboardandtheprocesses

theboardhasinplacetoconsidertheis-

suesandmakedecisions.


��

ICP 9 discusses these issues in paragraph 9.2, while discussion of committees of the board forms part of the advanced criteria.

The practices included in this category are directed at ensuring that the board has the information it needs to make decisions and that this information is available in ad-vance of meetings so that members can study it. It also requires that boards meet often enough to be kept informed about the progress of the company and the industry so that they can make informed decisions.

In most jurisdictions, it is common for boards of directors to establish an audit committee to meet with external auditors,8 to review in detail the financial information that goes to the board, and to oversee the work performed by the internal auditors. The composition of this committee is often relatively small and, in most cases, is made up entirely of independent directors or, at least, is chaired and dominated by independent directors. Independent directors are often required to review related-party transactions between companies within the same corporate group to ensure that such transactions do not unduly provide an advantage to another entity within the group.

The requirements affecting the structure and functioning of the board are intended to ensure that the board is sufficiently knowledgeable about the affairs of the company so that it is able to make informed decisions. It is also intended to ensure that the func-tioning of the board is robust enough to deal with crises.

The time to build knowledge and understanding of the industry and the company and to build strong checks and balances in the structure and operation of the board is when operations are going smoothly. These systems and procedures are required and will be tested when operations are not going smoothly. One of the reasons why super-visors are concerned about the structure and functioning of boards is because, in the event of a crisis, they will direct the company (through the board) to take remedial ac-tion. The supervisor must be confident that the board can actually do what is required of it to meet that demand.

Business planning and control

In the area of business planning and control, best practices relate to the following areas:

• Role in developing a strategic plan• Monitoring and reporting of performance• Large business transactions• Human resource management• Succession planning• Internal audit• Risk management.

8. This function is a part of ICP 10, although neither ICP 9 nor ICP 10 requires that an audit committee be established.


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These areas are important for a number of reasons:

• The board should be involved in setting the strategic objectives of the company and in approving its plan for achieving the objectives.

• An important part of achieving a goal is to assess progress against the objec-tive.

• Delegation of responsibility is a function of the board, and it is important to identify what issues must be referred to the board.

• Internal oversight and verification that board decisions and policy are followed are important elements of effective internal controls.

• Understanding and managing risks affect the predictability and stability of earn-ings, which affect the confidence that stakeholders have in the company.

ICP 9 assigns management the role of developing a strategic plan and submitting recommendations to the board for approval. In practice, strategic planning is carried out in this way. However, even when the board delegates a function to others, responsi-bility for the function rests with the board.

Information provided to the board

Best practices must address the information that should be provided to the board, in-cluding:

• Frequency, scope, and level of detail• Financial and nonfinancial information.

This is important for the following reasons:

• Information is the foundation on which informed decisions are made.• The board must have access to timely, comprehensive, and meaningful informa-

tion.

ICP 9 does not specifically include requirements in this area. However, ICP 10 on internal controls sets out several areas in which management is to provide comprehen-sive reports to the board on important internal controls and risk management topics (see IAIS 2003b, p. 21). In the area of free access to information, essential criteria re-quire internal auditors to have unfettered access to departments and functions and to report on a regular basis to the board. In this way, the core principles present a model that is consistent with the best practices outlined above.

In providing information, a balance is needed between too much and too little detail, between relevant and not so relevant information, between raw data and refined analysis, and between detailed information and summary information. Providing in-


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formation that meets this balance is not always easy. A person who is receiving and using informa-tion can have difficulty telling whether complete disclosure has been achieved. Confusion may be the result of not understanding the subject or of reading information that is poorly presented and con-fusing.

Information provided to key stakeholders

Regarding information provided to key stakeholders, best practices relate to the follow-ing areas:

• Audited financial information• Disclosure of major events and decisions• Timeliness and completeness of disclosure.

This is important for the following reasons:

• Information provided to key stakeholders should be informative and provided in a manner that supports informed decisionmaking.

• Major events that force the company to alter its direction or plans, involve un-planned large expenditures, or change control of the company are important for most stakeholders because these events alter the risks involved in the company and the value of interest the stakeholder has in the company.

ICP 26 (information, disclosure, and transparency toward the market) and ICP 12 (reporting to supervisors and offsite monitoring) require the board of directors to have suitable internal controls to ensure that information provided to the insurance supervisor is accurate and that appropriate audit procedures are in place to support this activity. This requirement is directed at a similar need for the supervisor to be well informed. Both insurance supervisors and all other stakeholders need reliable, mean-ingful information. This is not coincidental. All key stakeholders need information in order to make informed decisions about the affairs of the company.

The board of an insurance company has a duty to manage the company in the best in-terest of the company, its shareholders, and its policyholders. Information is the foundation on which informed decisionmaking is built, both for the board and for other stakeholders.

An Informed Board

Inorderforaboardtobeeffective,itmust

bewellinformedabouttheoperations

ofthecompanyandabletoinfluenceall

aspectsofthecompany’sbusinessand

internalprocesses.


��

For information to be useful, it must be timely, accurate, complete, and relevant. It should be no more detailed or comprehensive than necessary. Therefore, a balance is re-quired between too much informa-tion and not enough information. This is true for all stakeholders. As an example, too much information may overwhelm staff of the super-visory authority and prevent them from understanding the company and its financial condition. Too little information may hide the important trends and indicators of problems. The key challenge is to achieve bal-ance.


1. Whyisitimportanttohaveindependentdirectorsontheboard?

2. Whyshouldaninsurancesupervisorbeinterestedinwhoactuallysetstheagendaforboardmeetings?

3. Whymightaninsurancesupervisorrequireinsurancecompaniestoestablishanauditcommittee?

4. Howcanthewayinwhichinformationisprovidedtotheboardinfluenceitsdecisions?

5. Whyshouldaninsurancesupervisorbeinterestedinknowingthedegreetowhichindividualmembersoftheboardareactiveandinvolvedindecisionmaking?

Q10

Reliable, Timely Information

Reliable,relevant,andtimelyinformation

iscriticalforallstakeholders.Theboard

shouldcontrolthescope,quality,accu-

racy,andtimelinessofinformationthat

isreleasedtooutsidestakeholders.The

boardshouldhavesufficientchecksand

balancesinplacetoensurethatanyinfor-

mationreleasedmeetsthesestandards.


��

Answer these questions in relation to the practices in your jurisdiction. If you are working with others on this module, develop the answers through discus-sion and cooperative work methods.

1. Whataretherequirementsforboardsinyourjurisdictionregarding:

a. Composition,ormembership,oftheboard(includingtheirqualifications)

b.Committeestructure

c. Informationthatmustbeprovidedtokeystakeholders.

2. Arethererequirementsthatdealwiththequalityofinformationprovidedtotheboard?Ifso,doyoufeelthattheysupporttheboard’sresponsibilities?Ifnot,howsatisfiedareyouthatboardsreceivesufficientinformationtocarryouttheirresponsibilities?

3. Whattwomajorconcernsdoyouhaveaboutthefunctioningofboardsofdirectorsofinsurancecompaniesinyourjurisdiction?

Q11


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F. Issues for Insurance Supervisors

The policyholders of many insurance companies have more money in the company than the shareholders. It is reasonable that the supervisor, who has a role in working on behalf of the policyholders, should share common interests with the policyholders and work to protect them from undue loss. Since policyholders generally consider that purchasing insurance reduces the financial risks to which they are exposed, they often do not consider that their money is at risk in the insurance company. This is quite dif-ferent from an investor who recognizes the risks involved in making investments and accepts increases and decreases in the value of the shares acquired as a normal part of the investment process.

This is one reason why, in many countries, the rights of policyholders, as custom-ers of insurance companies, are given legal priority over the rights of shareholders and other providers of capital.9

Defining what processes and systems each company should have in place becomes a challenge for supervisors. In doing so, the supervisor should recognize that what con-stitutes good corporate governance is a changing and evolving target. The definitions should therefore be reviewed and, where necessary, revised relatively frequently. How-ever, once the definitions are in place and companies have implemented sound prac-tices, the industry will work to a higher standard, and efficient supervisory processes can be adopted.

Scope of application

Not all insurance companies that are subject to regulation and supervision have their shares traded on an exchange (see figure 2). In order to keep the marketplace fair and consistent among companies and to provide similar protection for all policyholders, the supervisor has to ensure that similar rules apply to all companies. This statement applies to all aspects of supervi-sion, and corporate governance is no exception.

Good corporate governance should apply to all companies un-der all forms of corporate orga-nization, whether owned by shareholders or not. In many countries, some insurance enterprises are operated for the benefit of policyholders, and some or all policyholders

9. Legal priority applies in the winding up or liquidation of an insurance company and determines the order in which the assets of the company are distributed in resolving claims against the insolvent company.

Effective Controls and Fair Treatment

Everyeffortshouldbemadetohave

equallyeffectivecontrolsinplaceforall

formsofinsuranceenterprisessothatall

stakeholderscanexpectconsistentand

fairtreatmentfromallcompaniesoperat-

inginthemarket.


��

have the rights of owners.10 These may by fraternal benefit societies, cooperative insur-ance companies, friendly societies, mutual insurance companies, or any other similar form. In any of these cases, the board acts on behalf of the policyholders as owners and customers of the enterprise. Since these institutions do not have shareholders and are not traded on capital markets, they often must comply with corporate governance rules defined by the insurance supervisor.

Branches of foreign companies are not local legal corporate entities, and they do not have a board of directors of their own. For this reason, the rules of corporate gover-nance cannot be applied directly to a branch without adjustment.

The supervisor has to make the requirements for all insurance enterprises that op-erate in the jurisdiction as consistent as possible so that markets are not distorted and competitive advantage is not granted to one company or form of operation over an-other.

The discussion of corporate governance most frequently relates to companies with shares traded on the local capital market or exchange. However, from the dis-cussion so far, it should be clear that the insurance supervisor is very interested in ensuring that all companies adopt sound corporate governance practices and the as-sociated internal controls. It is common for supervisors to set requirements for all supervised companies, extending to closely held financial institutions the rules that apply to companies whose shares are traded on an exchange.11

The insurance core principles that have been developed by IAIS and the core prin-ciples for banking supervision that have been developed by the Basel Committee on Banking Supervision both include references to corporate governance and internal

10. Although there are no shareholders with money at risk, policyholders, as owners, have money at risk. In the event the enterprise requires additional capital, policyholders may contribute through a reduction in dividends or bonuses, through an assessment, or through a reduction in policy benefits. The range of possible actions available to the board to increase capital or reduce liabilities is usually defined in the company bylaws or in the law under which the institution receives its charter.11. This can be demonstrated by the behavior of financial sector supervisors in Canada (the Office of the Superintendent of Financial Institutions issued a guideline on corporate governance that applies to all financial institutions) and the United States (the Office of the Comptroller of the Currency issued a notice on application of the Sarbanes Oxley Act to all banks).

Figure 2: The Local Insurance Industry

Locallyincorporated

closely held companiesand subsidiaries

Locallyincorporated traded

insurance companies

Foreign companiesLocal

insuranceindustry

Companies withexchange-traded shares

Branches offoreign companies


��

controls (see IAIS 2003b; Basel Committee on Banking Supervision 1997). These prin-ciples do not apply only to financial institutions whose shares are traded on an exchange or to local legal corporate entities. They apply to all financial institutions, and the super-visor should have the authority to strengthen the requirements that may already apply to other commercial enterprises. This is because corporate governance makes such an important contribution to efficient and effective supervision and to the sound manage-ment of financial institutions for all stakeholders.

Linkage to other regulators and supervisors

Because corporate governance is often a part of the rules that securities regulators set for market participants and some features of corporate governance are often included in commercial law, it is necessary for insurance supervisors to coordinate the requirements that they set for insurance enterprises with those of the other supervisory authorities in the jurisdiction. Obviously, the rules set by securities regulators apply to all companies that are market participants, but not all insurance companies have their securities trad-ed on the securities exchange. However, what constitutes good corporate governance is often independent of whether the shares are traded on a securities exchange.

While companies whose shares are not traded on an exchange may not have minor-ity shareholders for whom the securities regulator has a concern, the board of directors should be concerned with other key stakeholders. These stakeholders include policy-holders and the insurance supervi-sor. As a result, part of the role of the board should be to ensure that information provided to the insur-ance supervisor is accurate and complete and presents fairly the true condition of the company.

To ensure that the same rules and regulatory requirements ap-ply to all insurance enterprises, the insurance supervisory authority should be able to set requirements for all insurance enterprises. In doing this, the level of overlap and duplication should be kept to a minimum so that, as the requirements change over time, the insurance supervisor does not have to reissue the requirements with each change that the other regulatory authority makes. The insurance supervisor should set the special require-ments made necessary by the nature of the insurance business and cover the bulk of the requirements by reference to the rules already in place.

If the rules for corporate governance have been either set by the securities regulator or included in the commercial law, then the insurance supervisor should take a different

Cooperation

Tobeeffective,insurancesupervisors

mustcooperatewithotherregulatorsand

supervisorsonmanyissues;corporate

governanceisnoexception.Infact,a

widerangeofregulatoryauthoritiesmay

dealwithcorporategovernancerequire-

ments.


��

approach to defining the corporate governance requirements than in situations where these rules are not in place. The insurance supervisor must decide whether these addi-tional requirements should be set out in legislation, in regulation, or through guidance to the industry. The manner of putting these into effect has to reflect local practices in putting other elements of corporate governance requirements into effect.

If rules for corporate governance are already in place, the insurance supervisor should:

• Adopt, by reference, the existing corporate governance rules and indicate that they apply to all companies whether or not they are legally bound to comply with the requirements set out by the originator of the rules12

• Identify any special features that may be required because the industry is a regu-lated and supervised industry, including specific requirements for the board of directors to report to, or accept reports from, the insurance supervisor, specific reference to disclosure requirements to policyholders or potential policyhold-ers, or reference to board composition if some directors are elected by policy-holders

• Identify any special features that may be required for the insurance industry, including reference to special review and oversight that may be required in deal-ing with estimates of policy and other liabilities, the process for appointing the actuary, the role of the actuary in working with the board or a committee of the board, or special risk management policies or practices.

For branches of foreign companies, the reporting requirements should be similar to those that apply to local companies, and the control procedures around the prepara-tion and certification of financial information should be similar. The difference is that the supervisor cannot rely on the board to provide oversight. Rather the supervisor looks to senior local officials in the branch to provide that control. Therefore, the ele-ments of the checks and balances that apply to local companies should apply to the branches as well, whenever possible. This is necessary so the supervisor can rely on the accuracy and completeness of the information submitted and policyholders can have the same level of confidence in business placed with a branch as they have in business placed with a local company.

What if there are no rules?

If no rules (for some or all of the insurance enterprises) have been prescribed by the securities regulator or set out in commercial law, then the insurance supervisor needs to issue comprehensive rules that cover the rights of shareholders and policyholders as well as the interests of the supervisor. The insurance supervisor needs to ensure that shareholders’ interests are respected, because they are the source of capital that the su-


��

pervisor will be looking for should it be necessary. However, the supervisor should be ready and able to revise the rules that apply to insurance companies as corporate gov-ernance rules are adopted by the securities regulatory authority or through changes in the commercial law.


1. Whyshouldaninsurancesupervisorimplementaregimeunderwhichmanyofthecorporategovernancerequirementsthatapplytoapubliclytradedinsurancecompanyapplytothebranchoperationsofaforeigninsurancecompany?

2. Whyshouldaninsurancesupervisorbeinterestedinprotectingshareholderandcreditorrights??

3. Shouldaninsurancesupervisorcheckonthequalityofworkdonebytheexternalauditors?Ifso,why?Ifnot,whynot?

4. Whymightaninsurancesupervisorsetcorporategovernancerequirementsthatoverridethecorporategovernancerequirementsthatotherwiseapplytopubliclytradedinsurancecompanies?

5. Inwhatwaydopolicyholdersbenefitfromacorporategovernanceregime?

6. Underwhatcircumstancesmightaninsurancesupervisordefineacompletecorporategovernanceregimeforinsurancecompanies,branches,orsubsidiariesofforeigninsurancecompanies?

Q12


1. Inyourjurisdiction,whichsupervisoryorregulatoryagencieshavefullorpartialresponsibilityfor:

a. Settingcorporategovernancerequirementsforcorporations

b.Oversightorinspectionofcompliancewiththeserequirements

c. Enforcementifnoncomplianceisdiscovered.

Q13


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2. Whatarethesimilaritiesanddifferencesintherequirementsforthefollowingtypesofinsuranceenterprisesinyourjurisdiction?

a. Closelyheld,locallyincorporatedinsurancecompanies

b.Widelyheld,locallyincorporatedinsurancecompanies

c. Branchesofforeigninsurancecompanies.

3. Howdotheagenciesinyourjurisdictioncoordinatethereviewandrevisionofthecorporategovernancerequirementsthatapplytoinsurancecompanies?Inyourview,howcanthatprocessbestrengthened?

4. Whichofthecorporategovernancerequirementsineffectarespecificallydesignedtoprotecttherightsandinterestsofpolicyholders?

Q13continued

Considering the material in this module and the text of ICP 9, and relating them to your experience and knowledge of the situation in your country, an-swer each of the following questions. If you are working in a group, discuss your responses, identify similarities and differences, and then develop a group response.

1. Whatobjectivesmightaninsurancesupervisorhaveinmindwhendevelopingacorporategovernanceregimeforinsurancecompaniesinthejurisdiction?Howcantheseobjectivesbemet?

2. Whyshouldaninsurancesupervisorcoordinatethefeaturesofacorporategovernanceregimewithanyrequirementsthatareinplaceforgeneral-purposecompaniesinthejurisdiction?Howcanthisbeachieved?

3. Howmightthelocalcorporategovernancerequirementsbeinspectedandenforcedbytheinsurancesupervisor?Howshouldthisbecoordinatedwithotherlocalsupervisoryandregulatorybodies?

4. Wouldyouexpecttheretobeanydifferencesinthecorporategovernancerequirementsthatapplytoalocallyincorporatedcompany,alocalsubsidiaryofaforeigninsurancecompany,andalocalbranchofaforeigninsurancecompany?Whatmightsomeofthesedifferencesbe?Whymightthesedifferencesbenecessary?

Q14


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5. Wouldyouexpecttheretobeanysimilaritiesinthecorporategovernancerequirementsthatapplytoalocallyincorporatedcompany,alocalsubsidiaryofaforeigninsurancecompany,andalocalbranchofaforeigninsurancecompany?Whatmightsomeofthesesimilaritiesbe?Whymightthesesimilaritiesbenecessary

Q14continued

These are simulated situations in which you are asked to decide how you would respond in the circumstances outlined. If you are working in a group, reach your decision through discussion and agreement.

1. Youareheadoftheinsurancesupervisoryagencyinyourjurisdiction.Theheadofthelocalsecuritiesregulatoryauthorityhasinformedyouthatthelargestinsurancecompanylistedonthelocalexchangehasissuedaprospectustoraiseadditionalcapitalthatincludessignificanterrors.Youunderstandfromtheinformationthattheproblemisduetoinconsistentfinancialinformationreportedintheprospectusascomparedtotheinformationreportedinthemostrecentannualreportreleasedtoinvestors.Whatactionswouldyoutake?

2. Youareheadoftheinsurancesupervisoryauthorityinyourjurisdiction.Youragencyhasrecentlyreleasednewregulationsthatrequireinsurancecompaniestohaveanauditcommittee.Thiscommitteeistomeetregularlywiththeinternalauditorandatleastonceayearwiththeexternalauditor.Inaddition,itmustreviewthequarterlyfinancialresultsbeforetheyarepresentedtotheboardforapprovalandrelease.Aforeigncompanyhasjustmadeanapplicationtooperateonabranchbasisinyourjurisdiction.Thehomejurisdictionofthiscompanydoesnotrequireanauditcommittee.Explainwhatyouwoulddoandwhy.

a. Assumingeverythingelseaboutthisapplicationisacceptable,wouldyouaccepttheapplication?

b.Wouldyouestablishanyconditionstobecompliedwithbythebranchbeforeacceptingtheapplication?Ifso,whatwouldthesebe?

c. Wouldyoudeclinetheapplication?

Q15


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G. References

Basel Committee on Banking Supervision. 1997. Core Principles for Effective Banking Supervision. Basel, September. Available at www.bis.org.

———. 1998. Framework for Internal Control Systems in Banking Organizations. Basel, September. Available at www.bis.org.

HIH Royal Commission. 2003. The Failure of HIH Insurance, released by the Hon. Jus-tice Owen as commissioner. Canberra: Commonwealth of Australia, April. Avail-able at www.hihroyalcom.gov.au/finalreport/.

IAIS (International Association of Insurance Supervisors). 1998a. Supervisory Stan-dards on Licensing. Basel, October. Available at www.iaisweb.org.

———. 1998b. Supervisory Standards on On-site Inspection (Standard No 2). Basel, Oc-tober. Available at www.iaisweb.org.

———. 2000. Guidance Paper on Fit and Proper Principles and Their Application. Basel, October. Available at www.iaisweb.org.

———. 2002a. Guidance Paper on Public Disclosure by Insurers. Basel, January. Avail-able at www.iaisweb.org.

———. 2002b. Principles on Capital Adequacy and Solvency. Basel, January. Available at www.iaisweb.org.

———. 2003a. Guidance Paper on the Use of Actuaries as Part of the Supervisory Process. Guidance Paper 7. Basel, October. Available at www.iaisweb.org.

———. 2003b. Insurance Core Principles and Methodology. Basel, October. Available at www.iaisweb.org.

Iskander, Magdi R., and Nadereh Chamlou. 2000. Corporate Governance: A Framework for Implementation. Washington, D.C.: World Bank, May. Available at www.world-bank.org.

OECD (Organisation for Economic Co-operation and Development). 1999. OECD Principles of Corporate Governance. Paris. Available at www.oecd.org.

Salmon, Walter, and others. 2000. Harvard Business Review on Corporate Governance. Cambridge, Mass.: Harvard Business School Press, January.


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Appendix I. ICP 9: Corporate Governance

The corporate governance framework recognises and protects rights of all interested parties. The supervisory authority requires compliance with all applicable corporate governance standards.

Explanatory note

9.1. Insurers must be managed prudently. Corporate governance refers to the manner in which boards of directors and senior management oversee the insurers’ business. It en-compasses the means by which members of the board and senior management are held accountable and responsible for their actions. Corporate governance includes corpo-rate discipline, transparency, independence, accountability, responsibility, fairness, and social responsibility. Timely and accurate disclosure on all material matters regarding the insurer, including the financial situation, performance, ownership, and governance arrangements, is part of a corporate governance framework. Corporate governance also includes compliance with legal and regulatory requirements.

9.2. The board is the focal point of the corporate governance system. It is ultimately ac-countable and responsible for the performance and conduct of the insurer. Delegating authority to board committees or management does not in any way mitigate or dissi-pate the discharge by the board of directors of its duties and responsibilities. In the case of a policy established by the board, the board would need to be satisfied that the policy has been implemented and that compliance has been monitored. Similarly the board needs to be satisfied that applicable laws and regulations have been complied with. The responsibilities of the governing body must be consistent with the rules on governance structure established in the jurisdiction. Where the posts of chairman and chief execu-tive are combined in one person, the supervisory authority will verify that appropriate controls are in place to ensure that management is sufficiently accountable to the board of directors.

9.3. In most jurisdictions, corporate governance rules exist for general-purpose corpo-rations; these likely also apply to insurers. Often, however, it is necessary to establish additional requirements, through the insurance legislation, that deal with the matters of specific concern and importance to insurance supervisors. These matters are described in the criteria below. As the supervisory authority may not have the power to specify the details of general corporate governance rules or to enforce compliance, several criteria under this principle refer to the responsibility of the board of directors rather than re-quirements from the supervisory authority.


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Essential criteria

a. The supervisory authority requires and verifies that the insurer complies with appli-cable corporate governance principles.

b. The board of directors:

• Sets out its responsibilities in accepting and committing to the specific corporate governance principles for its undertaking. Regulations on corporate governance should be covered in general company law and/or insurance law. These regula-tions should take account of the size, nature, and complexity of the insurer.

• Establishes policies and strategies, the means of attaining them, and proce-dures for monitoring and evaluating the progress toward them. Adherence to the policies and strategies are reviewed regularly, and at least annually.

• Satisfies itself that the insurer is organised in a way that promotes the effective and prudent management of the institution and the board’s oversight of that management. The board of directors has in place and monitors independent risk management functions that monitor the risks related to the type of business undertaken. The board of directors establishes audit functions, actuarial func-tions, strong internal controls, and applicable checks and balances.

• Distinguishes between the responsibilities, decision-making, interaction, and cooperation of the board of directors, chairman, chief executive, and senior management. The board of directors delegates its responsibilities and establishes decision-making processes. The insurer establishes a division of responsibilities that will ensure a balance of power and authority, so that no one individual has unfettered powers of decision.

• Establishes standards of business conduct and ethical behaviour for directors, senior management, and other personnel. These include policies on private transactions, self-dealing, preferential treatment of favoured internal and ex-ternal entities, covering trading losses and other inordinate trade practices of a non-arm’s-length nature. The insurer has an ongoing, appropriate, and effective process of ensuring adherence to those standards.

• Appoints and dismisses senior management. It establishes a remuneration poli-cy that is reviewed periodically. This policy is made available to the supervisory authority.

• Collectively ensures that the insurer complies with all relevant laws, regulations, and any established codes of conduct (refer to advanced criterion f).

• Has thorough knowledge, skills, experience, and commitment to oversee the insurer effectively (refer to ICP 7).

• Is not subject to undue influence from management or other parties. The board of directors has access to information about the insurer and asks and receives ad-ditional information and analyses that the board sees fit.


��

• Communicates with the supervisory authority as required and meets with the supervisory authority when requested.

• Sets out policies that address conflicts of interest, fair treatment of customers, and information sharing with stakeholders and reviews these policies regularly (refer to ICP 25).

c. Senior management is responsible for:

• Overseeing the operations of the insurer and providing direction to it on a day-to-day basis, subject to the objectives and policies set out by the board of direc-tors, as well as to legislation

• Providing the board of directors with recommendations, for its review and ap-proval, on objectives, strategy, business plans, and major policies that govern the operation of the insurer

• Providing the board with comprehensive, relevant, and timely information that will enable it to review business objectives, business strategy, and policies and to hold senior management accountable for its performance.

Advanced criteria

d. The board of directors may establish committees with specific responsibilities like a compensation committee, audit committee, or risk management committee.e. The remuneration policy for directors and senior management has regard to the per-formance of the person as well as that of the insurer. The remuneration policy should not include incentives that would encourage imprudent behaviour.

f. The board of directors identifies an officer or officers with responsibility for ensuring compliance with relevant legislation and required standards of business conduct and who reports to the board of directors at regular intervals (refer to essential criterion b).

g. When a “responsible actuary” is part of the supervisory process, the actuary has di-rect access to the board of directors or a committee of the board. The actuary reports relevant matters to the board of directors on a timely basis.


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Appendix II. Answer Key

Set and question Suggested answer or consideration

Q1

� Responsebiscorrect.Theotherresponsesrelatetorequirementsplacedoncorporationsbutdonotinthemselvesconstitutecorporategovernance.

� Responsebiscorrect.Responseaisweak,sinceoneoftherolesofaboardistoactintheinterestofstakeholders,includingtheinvestors.

� Responsebiscorrect.

� Responsebiscorrect.Thisstatementispartiallytrue.However,itig-noresthefiduciarydutyoftheboardtowardpolicyholders,whichisgener-allynotcoveredbythosebodies.

� Responsebiscorrect.

� Responseciscorrect.

� Responsebiscorrect.ICP9isdirectedatprotectingtherightsofallpar-tieswithaninterestintheongoingviabilityofthecompany.

� Responsediscorrect.

9 Responsediscorrect.

�0 Responseeisthemostcorrect,asallofa,b,c,anddshouldbeper-formedtosupportanadequateassessment.

�� Responseciscorrect.

�� Responsediscorrect.

�� Responsebiscorrect.Responseaisapossiblebenefit,butnotthemotivationforimplementinginternalcontrols.


��


Q2

� Responsesa,b,andcarecorrect.

� Responsebiscorrect.However,responsescanddareacceptableaddi-tionstotheresponse.

� Responsesa,b,c,anddarecorrect.

� Responsesa,b,c,anddarecorrect.Theseresponsesdependonlocalconditionstodeterminehowtherulesareputintoeffect.

Q3

� Considertheinsuranceactandregulations.Howareinsuranceruleslinkedtocorporatelawandsecuritiesregulatoryrequirements?Discussthepracticesthatmightbeinplacewithseniorstaffintheinsuranceagency.

� Considertheinsuranceactandtheregulations.Theremayalsobeguid-ancenotesthatsetoutrequirementsforapplicants.

� Considercorporatelawandtheinsuranceact.Experiencedstaffinthesupervisoryauthorityshouldbeabletoprovidetheanswerandexplana-tion.

� Considerinternalrecords.Acomparisonofthelistofcompaniesap-provedtooperateinthejurisdictionagainstthoselistedonthelocalex-changewouldalsosupporttheresponse.Inaddition,considercorporatelawandanyinsurancecompanyrequirements.

Q4

� Responsebiscorrect.However,responsesaandcareacceptableassupportingresponses.

� Responsesaandcarecorrect.

� Responsesb,c,anddarecorrect.However,responseacouldbeaby-product,butitisnotthemotivationforimplementinginternalcontrols.

� Responseciscorrect.

� Responsebanddarecorrect.


��


Q5

� Considertherulesforthesecuritiesregulatoryauthority.Adiscussionwithseniorsupervisorystaffshouldbehelpful.

� Discussthisissuewithsupervisorystaffwhoanalyzeorinspectinsur-ancecompanieslistedonanexchange.

� Considerthefinancialreportsthathavebeenfiledwiththesupervisoryauthority.

Q6

1 Considerthecommoninterestsamongstakeholders.Corporategov-ernanceneedstobalancecompetingneedsofdifferentstakeholders,andinsurancesupervisorsneedtorecognizethispressure.Corporategovernanceapplieswhileacompanyisagoingconcern,andallstake-holders’needsmustbesatisfied.However,intheeventofthefailureofthecompany,itiscommonforpolicyholderstobegivenpreferenceovershareholdersandcreditors.

2 Considerthereductionofduplication.Otherbodiesmaynotcarryoutinspections.Insurancesupervisorssetadditionalrulestoenhancerulessetbyotherbodiesand,intheabsenceofrulesbyothers,mayhavetosetalloftherules.Notallinsurancecompaniesaresubjecttotherulesofothers.

3 Considerthefiduciarydutiesoftheboardandthespecialnatureofinsur-ancebusiness.Insuranceisaregulatedbusiness,andboardsmustdealwithregulators.

Q7

� Considertheinsuranceactandregulations,anyself-assessmentthatmighthavebeencompletedforyouragency,andthedocumentationofthesupervisorymethodologyfortheagency.

� Discussthiswithexperiencedsupervisorystafftofindtheanswer.


��


Q8


� False.Thefitnessandproprietyofmanagementandmembersoftheboardshouldbeanongoingconcernofsupervisors.

� Responsesaandbarecorrect.


Q9

� Considerthedocumentationofsupervisorymethodologyfortheagency.Discussthiswithexperiencedinspectors.

� Discussthiswithexperiencedstaffoftheagency.

Q10

� Considerthatonebasicprinciplerequiresfairtreatmentforallstakehold-ers.Independentdirectorshavefewvestedinterestsorconflicts;inde-pendentmembersmaybemorewillingtochallengemanagement.Lefttoitsowndecision,theboardmayprefertohavelike-mindedpeopleontheboard,andindependentdirectorswidenthescopeofthoughtbroughttoissuesfacingthecompany.

� Considerthatcontrollingtheagendacancontrolandlimittherangeofissuesbroughttotheboard.Theresultcouldbealessinvolvedandlessknowledgeableboardwithweakerinternalcontrols.Policyholderinterestscouldbecompromised,andtheabilityoftheboardtotakecontrolinacrisiscouldbereduced.

� Considertheneedforaccuratefinancialinformation,efficientsupervisoryprocesses,efficientboardfunctioning,strongerinternalcontrolsandoversightbytheboard,andreducedabilityofmanagementtopreparereportsthatmeetitsneedsbutnotthoseoftheboard.

� Considerthatinformationformsthebasisofdecisionmaking.One-sidedinformationcanleadtheboardtoasingleconclusion.Complexorvolumi-nousinformationcancausetheboardtorelyonverbaldescriptions.

� Considerthattheroleofanyonemembercanaffecttheperformanceoftheboardasawhole.Boardsmustbewellinformedandinvolvedtobeeffective.Boardsshouldprovideinsightinsettingdirectionsandprovid-ingoversight,andlowinvolvementreduceseffectivenessintheseareas.


��


Q11

� Considercorporatelaw,theinsuranceact,andregulations.Discussthiswithexperiencedstaffintheagency.

� Discussthiswithexperiencedstaffintheagency.

� Discussthiswithexperiencedstaffintheagency.

Q12

� Considerthatallpolicyholdersshouldhaveequalconfidencethatthecompanytheydealwithisequallywellmanaged.Complianceassess-mentandinternalcontrolsshouldbecomparable,independentofbusi-nessstructure.Thesupervisorshouldbeequallyconfidentthatdirectivesgiventothecompanywillbeeffectivelyimplemented.

� Considerthatshareholdersprovidecapitaltothecompanyandtothein-dustry.Companiesneedaccesstocapitaltofinancegrowthandrespondtoanemergency.Supervisorsneedtobesatisfiedthatcompanieshaveadequateaccesstocapitalwhenneeded.

� Considerthatrelianceontheworkofothersinvolvescheckingtoseethattheworkisdonetoappropriatestandards.Auditstandardsshouldbereviewedfromtimetotimetoensurethattheyareappropriatefortheneedsoftheusers,includingsupervisors.

� Considerthatrulessetbytheinsurancesupervisorsshouldnotcontra-dictrulessetbyothercompetentbodies.Additionalrequirementsareappropriatetoreflectthefiduciarynatureoftheinsurancebusiness.Notallinsuranceenterprisesaresubjecttotherulessetbyothercompetentbodies;insuranceisalong-termbusiness,whichcouldcreatetheneedforexpandedrules.

� Considerthattheboardshouldbalancetheinterestsofallstakeholders,includingpolicyholders.Disclosureofimportantmatterstopolicyhold-ersiscontrolledbytheboard,andcorporategovernanceinfluenceshowtransparencyworks.Specialrulesrelatingtotheuniquefeaturesofinsur-anceaffectpolicyholdersdirectly,andtheseareonlyeffectiveinagoodcorporategovernanceregime.

� Considerthatnotallinsuranceenterprisesmaybecoveredbyexistingcorporategovernancerules.Theremaybenoeffectivecorporategover-nancerulesinplaceforanyindustry,andtheinsurancesupervisormaywanttofillatemporaryvoiduntilanothercompetentbodycompletescomprehensiverulesforallindustries.


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Q13

� Considercorporatelaw,securitiesregulatoryrules,andtheinsuranceactandregulations.Alsoconsiderthesupervisorymethodologyoftheagency.Discussthiswithexperiencedstaffintheagency.

� Considertheinsuranceactandregulations.Discussthiswithseniorstaffintheagency.

� Discussthiswithseniorstaffintheagency.

� Considertheinsuranceactandregulations.

Q14

� Considertheefficiencyofthesupervisorymethodology.Objectivesmaybetorelyonandstrengthenthecompany’sfocusoninternalcontrols,focustheboardsofinsurancecompaniesontheirdutiesandresponsi-bilitiestopolicyholdersandtheinsurancesupervisor,meetinternationalstandardsforinsurancesupervision,increaseconsumerconfidence,andstrengthenthefinancialsystem.

� Considertheneedtoreduceduplication,avoidcontradictoryrequire-ments,maintaintherequirementsforcorporategovernanceastheydevelopandchange,andmaintainconsistentexpectationsforallboardssothattheexpectationsofboardmembersandconsumerscanbeman-aged.

� Consideroffsitereviewofaspectsoftherequirementsthatcanbequan-tifiedandonsitereviewoftheaspectsoftherequirementsthatareeitherproprietaryorqualitativeinnature.Coordinateinspectionactivitieswithotherregulatorsandsupervisorstoreduceduplication,shareresults,discussfindings,andcoordinateregulatoryenforcement.

� Considerthatdifferencesresultfromownershipoftheentity,whothe“home”regulatoris,thelegislationunderwhichtheboardoperates,thesupervisortowhomtheboardhasaprimaryduty,thelocationofincor-porationofthecompany,andwhocontrolstheinternalauditfunctionandthelocationofthebooksandrecordsofthecompany.

� Considerthatsimilaritiesresultfromthelocationofthepolicyholders,theneedtocomplywithlocallegislation,andthedutiesandresponsibili-tiesofthelocalinsurancesupervisor.Policyholdersshouldexpectthesamestandardoftreatmentfromcompaniesindependentofthebusi-nessorganizationofthecompany,andtheinsurancesupervisorshouldexpectthesamestandardofinternalcontrolstobemetindependentofthebusinessstructureofthecompany.


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Q15

� Considerwhetherthereisanyreasontoreexaminetheaccuracyoftheregulatoryinformationthatisonfileinthesupervisoryagency.Istherereasontobelievethattheinternalcontrolproceduresinthecompanyareweakandthatboardoversightisweak?Whenweretheselastinspected?Shouldaspecialonsiteinspectionbemadetoreviewtheseprocedures?Whatrolehavetheinternalauditandtheexternalauditorhadinprepar-ingthisinformation?Aretheircontrolsandprocessessufficient?

� Considertheinsuranceactandthelicensingrequirementsunderregula-tionsandanyguidancenotes.Whatpowersdoyouhavetoestablishahigherdutyofcareonabranchtobringitscontrolsproceduresuptothestandardsexpectedofdomesticcompanies?Doyouhavethepowertodeclineanapplicationifyoubelievethehomejurisdictionhasaweaksu-pervisoryregime?Theanswerstothiscouldleadtoadecisioneithertodeclinetheapplicationortoimposespecialreportingonthelocalheadofthebranch.Italsocouldleadtoadecisiontoconsidertheapplicationonlyiftheforeigncompanyestablishesalocalsubsidiary.

icp 9: corporate governance

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