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Regulation by yaosaigeng

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									Fall 2008 Version




 Professor Dan C. Jones
             FINA 4355
Risk Management and Insurance: Perspectives in a Global Economy

    24. Regulation and taxation in
               Insurance Markets




                               Professor Dan C. Jones
                                           FINA 4355
Study Points

 Insurance regulation

 Taxation in insurance




                         3
Insurance Regulation
Evolving International Insurance Markets (Figure 24.1)




                                                    5
Insurance Regulation Trends

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

 Countries have moved from more to less restrictive
 insurance markets.
    They have increasingly embraced competition and eschewed special
    interest regulation.


 The great majority of the world’s largest 50 insurance
 markets are more liberal today.




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Mechanisms of Insurance Regulation

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




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Mechanisms of Insurance Regulation

 Judiciary
    Resolves disputes between insurers and policyholders

    Enforces insurance laws

    Insurers and intermediaries occasionally resort to the courts seeking
    to overturn arbitrary or unconstitutional statutes, administrative
    regulation and orders promulgated by regulators.




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Mechanisms of Insurance Regulation

 Executive

    Policymakers commonly delegate this authority to a ministerial department of
    the government.

    Then, a subordinate section of the ministry or a special agency carries out the
    regulatory oversight. The section/agency can be

        Explicitly for insurance regulation and supervision
        Part of a larger institution that also oversees banking
        Part of the bigger financial supervisory agency

    A formal advisory body may assist the regulatory authority (not in the U.S.)

    The regulatory situation in the E.U. is unique.

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Approaches to Regulation

 Ex-ante regulation




 Ex-post regulation




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Areas of Regulation

 Access to the Market

 Balancing competition against consumer protection

 Detecting insurer financial difficulty

 Responding to insurers in financial difficulty

 Protecting insureds of an insolvent insurer




                                                     11
Areas of Regulation (Figure 24.2)




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Regulation -- Controlling Access to the Market

  The role of government as a supplier of insurance
    Privatization


  Licensing requirement
    Admitted vs. nonadmitted insurers
    Nondiscrimination and national treatment


  Permitted organizational forms               See also Chapter
                                                      20.

  Ownership restrictions




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Regulation -- Controlling Access to the Market

  Restriction on business scope
    Restriction to the conduct of insurance business
    Separation of classes of insurance business


  Right of appeal




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Regulation – Balancing Competition

 Rate and product regulation

 Financial regulation

 Intermediary regulation

 Competition policy regulation




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Regulation – Balancing Competition

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




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Regulation – Balancing Competition

 Financial (prudential) regulation
    More restrictive financial regulation is associated with more secure
    insurers.
        Nevertheless, extensive restrictions stifle competition and
        innovation and, thereby, can lower consumer value and choice.
    The more competitive a market, the more important is prudential
    regulation.


 Areas
    Ongoing capital regulation
    Asset limitations and valuation
    Liability regulation
    Accounting standards


                                                                           17
Ongoing Capital (Solvency) Regulation

 Solvency margins
    Within the E.U. (and many other countries), minimum ongoing capital
    and surplus requirements are set out.
       Solvency I
       Solvency II


 Risk-based capital
    As in the U.S. and several other countries, minimum acceptable
    capital for business continuation of an insurer


                                               Insight 24.1 (U.S.
                                                RBC regulation)



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Asset Limitations and Valuation

 Authorized (admitted) investments

 Diversification

 Currency matching (congruence)

 Localization




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(Accounting) Liability Regulation

  Life insurance
    In some countries, the regulator prescribes in detail the methods and
    assumptions used to derive life insurer technical (mathematical)
    reserves
    In other, the regulator relies on an actuarial valuation.

  Nonlife insurance
    National laws are more general for nonlife insurers

  Appropriate loss reserve establishment has been a
  regulatory challenge.
    The discounting of loss reserves is not, in general, practiced.
    Some countries make no provisions for claims incurred but not
    reported (IBNR) losses.


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Accounting Standards

 Statutory accounting principle (SAP)

 Generally accepted accounting principle (GAAP)

 International Accounting Standard Board (IASB)
   For standardization of accounting principles internationally




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Intermediary Regulation

 The importance of the services of knowledgeable
 intermediaries in competitive markets
    Individuals and businesses rely on the advice as well as risk
    management and insurance services of such intermediaries


 Minimum qualification requirements
    Imposed in most countries
    U.S. Excess and Surplus (E&S) broker license as an example of a
    special case


 The growing importance of intermediary regulation as
 financial services sectors converge


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Competition Policy (Antitrust) Regulation

  Typical elements of competition law

    Collusive practices
       Horizontal collusion
       Vertical collusion
       Conglomerate collusion

    Mergers and acquisitions

    Abuses of dominant position




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Competition Policy (Antitrust) Regulation

  International legal norms

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

     Two principles
       The principle of prohibition
       The principle of abuse



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Regulation – Detecting Financial Difficulty

  Solvency surveillance

    Reporting requirements

    Financial examination
       On-site examination

    Oversight by professions




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Regulation – Responding to Insurers in Difficulty

  Four options

    Informal actions

    Formal actions

    Rehabilitation

    Liquidation




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Regulation – Policyholder Protection

 Two philosophies
    No protection based on true laissez-faire economics
    Guaranty fund benefits


 Guaranty funds
    Pre-insolvency assessment to all licensed insurers in the line(s) of
    business
    Post-insolvency assessment


 Guaranty funds diminish market discipline to some degree by
 creating moral hazard.
    Researchers have proposed alternatives to the flat-assessment
    approach.

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Taxation in Insurance
Principles of Taxation

  General purposes of taxation
     To raise revenue
     To promote economic goals
     To promote social goals

  Desirable traits of tax policy
     Equity
     (Economic) neutrality – also called horizontal equity
     Simplicity

  Systems of taxation
     Tax bases
     Tax exemptions, deductions and credits
     Tax rates

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Life Insurance Taxation

 Consumers (policyholders)

    Tax relief for premiums paid for qualifying policies in many countries
     Table 24.2
    Dividends not considered as taxable income
    Generally no direct taxation on interest credited on cash values
        When taxed, the build-up is considered as part of benefits.
    Same tax treatment for the inside interest build-up of annuities during
    accumulation period
        Most countries tax annuity payouts to some degree.
    Exempt death proceeds paid under qualifying policies from income
    taxation in most countries
        Governments commonly levy estate duties (taxes).


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Tax Relief on Life Insurance Premium (Table 24.2)




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Life Insurance Taxation

 Life insurance companies

    Commonly taxes levied on insurers’ premium revenues
      Premium taxes being the most common

    Governments tax life insurers on some variation of net income or
    value added and sometimes both.
        When using total income, governments permit several deductions
        in deriving taxable income.




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Nonlife Insurance Taxation

 Consumers

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

    Benefits received under personal policies are tax free.
       Exceptions exist.
    Benefits received by businesses are tax free in many countries.




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Nonlife Insurance Taxation

 Nonlife insurance companies

    Commonly more cases of premium taxation in nonlife than in life
       Tax rates with nonlife insurance are generally higher.
    Other premium-based taxes can increase the effective tax in nonlife
     Table 24.3
    Premium-based taxation is to be paid irrespective of insurer
    profitability.

    Also, taxation on nonlife insurance companies for income from
    operations (e.g., profit and interest income)
       Deductions for claims reported but unpaid and certain other
       reserves in many countries


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Other Premium-based Taxes on Nonlife (Table 24.3)




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Discussion Questions
Discussion Question 1

 “The influence of interest rates on the trend in insolvency is
 not clear a priori, however, as two opposite effects exist. On
 the one hand, assets lose value when interest rates rise,
 which means that solvency is reduced. If a company in this
 situation is forced to dispose of assets in order to pay claims,
 it can get into payment difficulties. On the other hand, high
 interest rates also mean high current income from
 investments. High interest rates when a contact is arranged
 make it possible to reduce prices (this is known as “cash flow
 underwriting”). If interest rates fall and current investment
 income declines, the overall result deteriorates and the risk
 of insolvency increases.” Discuss which of these two effects
 you believe would be the more important. Why?

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Discussion Question 2

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

    What public policy arguments support limitations on such
    distributions?

    Why do believe that the Netherlands and many other countries have
    not such limitations?


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Discussion Question 3

 Signatory countries to the GATS bind themselves to the fair-trade
 principles of market access, nondiscrimination, national treatment and
 transparency. GATS’s purpose is to create a more liberal market in trade
 in services in general and in financial services, including insurance, in
 particular. A provision within the agreement reads as follows:
 [member countries] shall not be prevented from taking measures for prudential
 reasons, including for the protection of policyholders . . . or to ensure the integrity
 and stability of the financial system.

     What is your interpretation of this provision?
     Do you believe that this provision is justifiable in view of a competitive
     insurance market internationally?
     The provision is quite general. Could you imagine that some countries might
     try to place a conservative interpretation of this provision and, if so, what
     measures might they take that you would believe to be inconsistent with the
     spirit of the provision?
     Could insurance be the cause of a country’s financial system loosing its
     integrity and stability? If so, how?


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Discussion Question 4

 Explain why insurance is regulated.




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Discussion Question 5

 Examine the insurance act in your country to answer the
 following:

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


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Discussion Question 6

 Analyze the premium tax using the desirable traits of tax
 systems.




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Discussion Question 7

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

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




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