Lecture 12: Government Regulation of

Insurance
The need for Regulation
• Like other businesses, insurance industry is
subjected to regulations due to :
• To protect the consumers, as insurance only
sells promises which will only be fulfilled in
the occurrence of the insured events and
depends on the insurers’ integrity and
financial stability
• The inability of policyholder to interpret and
understand the contract
• To protect the well being of the public and the
economy
The Importance
The basic consumer rights :
1)Right to satisfaction
2)Right to information
3)Right to choose
4)Right to basic goods and services Right
to be heard
5)Right to redress
6)Right to consumer education
7)Right to a safe and clean environment
Consumer Criticisms and Complaints

• Unreasonable delay in settlement of claims

• Unfair claims settlement
• Operating at high marketing costs
• Collusion and price fixing
• Poor service
• Providing incomplete and false information
• Resorting to pressure selling
• Lack of professionalism
Self Regulation

Its purposes:

To instill and promote healthy competition in

the industry

To provide some element of protection to

insurance consumers
Advantages

• Helps to instill self-discipline among

insurance companies
• Avoids the need to introduce legislation to
regulate the industry
• When laws are passed, bureaucratic back-up
will be required to enforce them
• Measures can respond to changing needs
faster than legislation
Disadvantages

• Voluntary codes of practice do not have the

power of law

• The statement of practice viewed

consumers’ needs from the insurers’
perspective

• Unlike laws, statements are interpreted by

the insurers
Purpose of Regulation
• To protect the public interest
• Insurer is financially solvent and able to fulfill
its obligations
• To promote fairness and equity
• insurers, brokers and adjusters fair and
equitable in their dealings
• To foster competency
• Insist high level of professional competence
and integrity
• To play developmental role
• Encourage the industry to take active part in
the economic development of the country
Licensing of Insurer and Insurance Brokers
(1) For the purposes of this Act, insurance
business shall be divided into two classes:

a) life business, which in addition to all

insurance business concerned with life
policies shall include any type of insurance
business carried on as incidental only to the
life insurer’s business;

b) general business, which means all insurance

business which is not life business
Except with the prior written approval of the
Bank and subject to such conditions as it may
specify, no licensed insurer shall carry on—

• annuity certain business; or

• investment-linked insurance business.

• “annuity certain” means an annuity contract
where the duration of periodic payments is
predetermined and does not depend on the death
or survival of the policy owner;

• “investment-linked insurance business” means the

effecting and carrying out of a contract of
insurance on human life or annuity where the
benefits are, wholly or partly, to be determined by
reference to the value of, or the income from,
property of any description or by reference to
fluctuations in, or in an index of, the value of
property of any description.
(1)For the purposes of this Act, a reference to
carrying on insurance business includes all or
any of the following:

(a)receiving proposals for insurance;

(b)negotiating on proposals for insurance on
behalf of an insurer;
(c)issuing of policies;
(d)collection or receipt of premiums on
policies; or
(e)settlement or recovery of claims on policies.
• No person shall hold himself out to be an
insurer, insurance broker, adjuster or financial
adviser unless he is licensed under this Act.

• (1) A licensed insurer, other than a licensed

professional reinsurer, shall not carry on both
life business and general business.
No licensee shall carry on its licensed business
unless it is a member of an association of:

(a)life insurers for life insurance business;

(b)general insurers for general insurance

business;

(c)insurance brokers; or

(d)adjusters,
The Role and Challenges of
Insurance regulators
Insurance Regulators

The role of an actuary in a regulator's office is

two- fold - protecting the policyholders by
ensuring the insurer's solvency, and equitably
treating all policyholders,
 Role of Regulators

Protect the interest of holders of insurance

policies.
Register insurance companies and also cancel their
registration.
Monitor and certify the soundness of the terms of
insurance business.
Make regulation relating to the conduct of business
of insurance.
Inspect documents of insurers.
Appoint additional directors.
Issue directions
Take over the mgmt. of insurer and
appoint administration.
Adjudicate on disputes between insurer
and intermediaries.
To regulate, promote and ensure orderly
growth of the insurance business in the country.
Control and regulation of the rates, advantage,
terms and conditions that may be offered by
insurers.
To report and maintain liaison with the
Ministry of Finance.

Giving proper direction and control to the

insurance sector.

Resolve complaints.
 Challenges of regulators

Development of insurance sector.

Confidence of general public.
Insurance policy regulation (establishing
market discipline).
Granting of license to new Insurers.
Foreign direct Investment (FDI).
Solvency Regulations
Market Practices-
• Uniform system and Procedures ,
• To ensure transparency ,
• Deliberate hype about the returns.
Detariffication of General Insurance Product.
In the non-life area the
availability of actuarial expertise itself is
a challenge.
Insurance Sector
Services in Insurance Sector

Term Life
Insurance
Life Insurance
Permanent
Life Insurance

Fire
Insurance Insurance

Marine
Insurance

General
Mediclaim
Insurance

Accidental

Motor
Vehicle
 Life Insurance
• It is a written contract between the insured and
the insurer.

• Term Life: the insured is covered while the

policy is in effect usually 10–20 years.

• Whole Life: similar to term life, but allows the

policyholder to borrow against the policies
cash value.

• When the term of policy expires, the insured

can get the cash value of the policy.
 General Insurance

• It is a non life insurance policies, including

automobile and homeowners policies, provides
payments depending on the loss from a particular
financial events.

• General insurance typically comprises any

insurance that is not determined to be life
insurance.
Types of General Insurance

Health insurance: Just like one looks to safeguard

ones wealth, these policies ensure guarding the
insurer's health against any calamities that may
cause long term harm to ones life and even hamper
ones earning ability for a lifetime.

Business insurance: Risks of loss of

profits/business, goods, plant and machinery
are most profound in case of business.
Automobile insurance: Auto Policy is
required to be taken to cover the risks that
arise to the owner, vehicle and third party.

Fire insurance: This policy is required to be

taken to prevent any loss of profits /
property from incidental fire.
 Private Sector v/s Public Sector
• State-owned enterprises
• Public owned corporation • Main motive of providing
• Main objective of earning service to public
profit • Formed in short time just
• Formation involves a long by government decision
process • Capital contributed
• Capital contributed by owner by government
and investor • Less freedom of
• More freedom of operations
operations • Managed and control by
• Managed and control by board board of directors selected
of by government
directors selected by • Accountable to general public
shareholders on performance discus in
• Not directly accountable to parliament
general public • Performance evolution on
• Performance evolution on basis basis of economic and non-
of economic gains economic gain
Contribution to Kenyan Economy
• Life Insurance is the only sector which
garners long term savings
• Spread of financial services in rural areas and
amongst socially less privileged
• Long term funds for infrastructure
• Strong positive correlation between development
of capital markets and insurance /pension sector
• Employment generation
 The role of insurance from an economic
perspective

Individu Consumption Level/

Coporate Comfortability Production Activity

Financial
Risk Transfer

Bank
Long term investment
Insurance Funding
Company Stability

Capital
Market
 Definition of Insurance from Business
Perspective
• By the presence of insurance products, business
risks such as business

• interruptions, worker compensation, fire and floods,

malpractice and liabilities, crops and shipments,
and errors might be risk mitigated.

• Hence, the firm managers do not need to set aside

funds against exogenous events. Insurance
integrates into their risk management operations
and allows them to concentrate on core activities
Factors affecting Business and Business Risks

Customer Legal

M OPERATION MARKETING M
Competitor Economi
I TECHNOLOGY CULTURE A
BUSINESS
C RISKS C
OBJECTIVES FINANCE

R Collaborator Politic R
SKILL &
KNOWLEDGE PEOPLE
O O

Social &
Creditor
Culture
Internal
Eksternal
Business risks are risks that can cause a company to
earn a profit lower than expected or lose.

EXP ECTE
D
RISK/LOSS

FAC
T
 A. RISK
CLASSIFICATION
Financial Risk Strategic Risk Other Risk
Operational
Risk

= Corp. Govern = Econ. Risk

= Competitive Risk = Tehnology
= Technology = Prod.failure Risk = Tax Risk
= Bankruptcy; = Prod. Liability Risk = Market Risk
= People;
= Curr. Fluctuation = Op. quality risk & Selling Risk
= Business
= Securities Rel. = Logisticts Risk = HR Risk
= Fraud
= Financial Lost = Procurement Risk = Nature Risk
B. How to Overcome Business Risk

1. To reduce the risk;

2. To transfer the risk;
 3. To bear the risk;
 4. To plan emergency measures &
 5. To avoid the risk
 1. To reduce the risk

1. To design layout to reduce the possibility of risk

or fire;

2. To educate on how to safely use the work tool

3. To perform regular maintenance of safety

equipment;

4. To measure the limits of business products

 2. To transfer the Risk

 Physical insurance: which guarantees the loss of

physical material (cash, inventory, vehicles and
buildings);
 Property Insurance: buildings, land and
equipment;
 Individual Goods: Vehicles, clothing, furniture
and jewelry; and
 Business interruption insurance: Protects income
loss if business is suddenly closed due to repair of
the building.
 Casualty insurance: Protects the business from
lawsuits;
 Errors-and-omissions insurance: Protects
business from lawsuits as a result of mistakes;
 Product liability insurance: Protects the
manufacturer from claim of protection for
accidents by using manufactured products;
 Fidelity bonds: Protects companies from theft;
 Performance bonds: Protect business if work is
not on time &
 Life insurance: Protect business if the object
passed away.
 3. To bear the risk

 Self-insurance if business losses occur;

 Businesses are required to allocate a certain

amount of funds at any time to help overcome
the cost of recovery in the event of a loss..
4. To plan emergency measure

 Businesses must have procedures to

resolve the crisis before a crisis occurs;

 Businesses are required to respond

quickly to an emergency measure
 5. To avoid the risk

 To stay away from sources that can drive risk;

 Do not offer specific products;

 To ensure that something has not

happened yet, thus eliminating the possibility
of a risk.
Intermediaries and Actuaries of Insurance
Intermediaries of Insurance
Who Is Intermediary?

A person who acts as a link between people in order

to try and bring about an agreement; a mediator.

Insurance Intermediary :
• Brokers or agents who represents consumers in
insurance transactions.
• Insurance intermediaries are contracted with
multiple insurance companies so they can focus
on matching their clients needs with the most
suitable insurance products.
 Supervisory Authority sets requirements, directly
or through the Supervision of the Insurers, for the
conduct of Intermediaries

 Intermediaries for this purpose include Insurance

Agents, Corporate Agents, Insurance Brokers,
Insurance Surveyors and Loss Assessors and
Third Party Administrators in Health Insurance

 Intermediaries are an essential area of supervision

in the insurance sector and may have a reputation
risk or a prudential impact on Insurers.
 Intermediaries serve as an important
distribution channels of insurance

 They provide interface between Consumers and

Insurers

 Their good conduct is essential to protect

consumers and promote confidence in the
insurance markets.

 Therefore there is a need for supervision of

intermediaries
• Insurance intermediaries facilitate the placement
and purchase of insurance, and provide services
to insurance companies and consumers that
complement the insurance placement process.

• Traditionally, insurance intermediaries have been

categorized as either insurance agents or
insurance brokers.

• The distinction between the two relates to the

manner in which they function in the
marketplace.
The Role of Insurance Intermediaries

• As players with both broad knowledge of the

insurance marketplace, including products,
prices and providers, and an acute sense of the
needs of insurance purchasers, intermediaries
have a unique role to play in the insurance
markets and, more generally, in the functioning
of national and international economies.

• Intermediary activity benefits the overall

economy at both the national and international
levels
• The role of insurance in the overall health of the
economy is well-understood.
• Without the protection from risk that insurance
provides, commercial activities would slow,
perhaps grinding to a halt, thus stunting or
eliminating economic growth and the financial
benefits to businesses and individuals that such
growth provides.
• The role of insurance intermediaries in the overall
economy is, essentially, one of making insurance
thereby increasing the positive effects of insurance
– risk-taking, investment, provision of basic
societal needs and economic growth.
There are several factors that intermediaries
bring to the insurance marketplace that help to
increase the availability of insurance generally:
Innovative marketing

• Insurance intermediaries bring innovative

marketing practices to the insurance
marketplace.

• This deepens and broadens insurance markets

by increasing consumers’ awareness of the
protections offered by insurance, their
awareness of the multitude of insurance
options, and their understanding as to how to
purchase the insurance they need.
Dissemination of information to consumers

• Intermediaries provide customers with the

necessary information required to make
educated purchases/ informed decisions.
• Intermediaries can explain what a consumer
needs, and what the options are in terms of
insurers, policies and prices.
• Faced with a knowledgeable client base that has
multiple choices, insurers will offer policies that
fit their customers’ needs at competitive prices.
Dissemination of information to the marketplace
• Intermediaries gather and evaluate information
regarding placements, premiums and claims
experience.
• When such knowledge is combined with an
intermediary’s understanding of the needs of its
clients, the intermediary is well-positioned to
encourage and assist in the development of new
and innovative insurance products and to create
markets where none have existed.
• Dissemination of knowledge and expansion of
markets within a country and internationally can
help to attract more direct investment for the
insurance sector and related industries.
Sound competition

• Increased consumer knowledge ultimately

helps increase the demand for insurance and
improve insurance take-up rates.

• Increased utilization of insurance allows

producers of goods and services to make the
most of their risk management budgets and
take advantage of a more competitive financial
climate, boosting economic growth.
Spread insurers’ risks

• Quality of business is important to all insurers for

a number of reasons including profitability,
regulatory compliance, and, ultimately, financial
survival.

• Insurance companies need to make sure the risks

they cover are insurable – and spread these risks
appropriately – so they are not susceptible to
catastrophic losses.
• Intermediaries help insurers in the difficult task of
spreading the risks in their portfolio.
Intermediaries work with multiple insurers, a
variety of clients, and, in many cases, in a broad
geographical spread.

• They help carriers spread the risks in their

portfolios according to industry, geography,
volume, line of insurance and other factors.

• This helps insurers from becoming over-exposed

in a particular region or a particular type of risk,
thus freeing precious resources for use elsewhere.
Reducing costs

• Broker services also reduce the insurance costs of

all undertakings in a country or economy.

• Because insurance is an essential expense for all

businesses, a reduction in prices can have a large
impact on the general economy, improving the
overall competitive position of the particular
market.
• The insurance cycle of “hard” and “soft” markets
can have a significant impact on the benefits –
both good and bad – of increased availability.
Increased availability benefits the consumer by
leading to product competition, price competition,
and improved services.

• By reducing insurance costs across markets,

intermediaries make an important contribution to
improving the economic conditions in a country.
Role of Insurance Intermediary :

Innovating
marketing

Disseminating
Reducing costs of
information
of consumer

Dissemination
Spread of
insurers risks information
to the
marketplace

Sound
competition
Qualities of a Insurance Intermediary?

Adverse Role of
compensatio
intermediar
n
selectio y
n
The Regulation of Intermediaries :

Agent
s

Brokers

Insurance
intermediaries act
Insurance Agents

• Insurance agents are licensed to conduct business on

behalf of insurance companies.
• Agents represent the insurer in the insurance
process and usually operate under the terms of an
agency agreement with the insurer.
• The insurer-agent relationship can take a number of
different forms.
• In some markets, agents are “independent” and
work with more than one insurance company
(usually a small number of companies);
• in others, agents operate exclusively – either
representing a single insurance company in one
geographic area or selling a single line of business
for each of several companies.

• Agents can operate in many different forms –

independent, exclusive, insurer-employed and
self-employed.
Insurance Brokers
• Insurance brokers typically work for the policyholder
in the insurance process and act independently in
relation to insurers.
• Brokers assist clients in the choice of their insurance
by presenting them with alternatives in terms of
insurers and products.
• Acting as “agent” for the buyer, brokers usually work
with multiple companies to place coverage for their
clients.
• Brokers obtain quotes from various insurers and
guide clients in determining the adequate policy from
a range of products.
• In some markets, there are distinctions among
brokers depending upon the types of insurance
they are authorized (licensed) to intermediate –
all lines of insurance, property and casualty or
life/health coverage.
• While most, if not all, brokers are active in
commercial lines, some also intermediate
personal lines policies.
• There are also distinctions between “retail
brokers,” who negotiate insurance contracts
directly with consumers, and “wholesale
brokers,” who negotiate insurance contracts with
retail brokers and agents, but not directly with
consumers.
Actuaries of Insurance
 Who is an Actuary ?
• Actuaries are experts who perform actuarial
analysis of insurance rates, rating procedures,
rating plans, and schedules of insurance
companies.

• These are professionals who are experienced in

reviewing and analyzing insurance operations,
reserves and underwriting procedures and
provide technical assistance regarding actuarial
matters to policy examiners and other technical
staff.
 Their main activities :

pricing Financial Corporate

managemen planning
t
Role of Actuaries in Insurance
Evaluating the likelihood of future events
Designing creative ways to reduce the
likelihood of undesirable events

Decreasing the impact of undesirable events

that do occur.

undesirable events can be both:

a. Emotional
b.Financial.
 Techniques to Control Risk :

Offsettin
Risk is a Focus on
g one
matter of catastrophi
risk with
perspectiv c risks
another
e
 List of Typical Actuaries Project :
Analyzing insurance rates, such as for cars,
homes or life insurance.
Estimating the money to be set-aside for
claims that have not yet been paid.
Participating in corporate planning, such as
mergers and acquisitions.
Calculating a fair price for a new insurance
product.
Forecasting the potential impact of
catastrophes.
Analyzing investment programs.
 Policy Support:

 Tax incentives

 Insurance Bill Provides Insurance Regulatory

Authority (IRA) with the flexibility to
formulate regulations

 Attempts to make sector lucrative for foreign

participants
 Competitive Challenges:

1.Multi-channel distribution footprint:

• Understanding the science of multi- distribution
channel management and developing a robust field
footprint will remain the most distinctive
competitive challenges for the new age insurers.
•
• Managing the expectations of channel partners, viz.,
banks, corporate agents, brokers, and advisory force,
and keeping the acquisition costs at manageable
proportions at the same time will help the new
players reach break-even relatively sooner.
2. Technological advancement:

• A key driver of growth in a long-term business

like life insurance, technological advancement
will be critical to functions like data
management, underwriting, fund management,
actuarial efficiency, and the end- to-end service
delivery process.

• Technology will provide the cutting edge in

terms of improved disclosure to the policy
holder as well as the regulator in due course of
time.
3.Quality of manpower:

• Insurance is an intensively people-oriented

business and human resources will be the
undoubted differentiator like in any other retail
industry.

• The quality of manpower attracted and retained

by insurers and how their abilities and ambitions
are harnessed would be the litmus test for the
industry.
4.Investment strategy and fund
management:
• Expertise in fund management is the value
proposition that any insurance company offers and
the quality of asset-liability management (ALM) in
a falling or stable interest rate regime will thus be a
key challenge.

• The regulator is progressively in favor of insurance

companies setting up their own investment
research and dealing cells and against knowledge
sharing with group asset management companies.
5. Acquisition costs:
• Acquisition costs which is a sum total of
technological, operational, and distribution
costs, will be the key differentiating factor in the
initial years.
• While the initial hits on the technology and
process costs have already been absorbed by a
majority of the new insurers, intermediary costs
of distribution is a critical variable.
• Further, the intermediary costs to distribution
channel partners are also lower due to the
bargaining power that the strong brand possesses
in life insurance.
 Reasons for Insurance Regulation

• Maintain insurer solvency

• Compensate for inadequate consumer

knowledge

• Ensure reasonable rates

• Make insurance available Methods of

Regulating Insurers
• The three principal methods of regulating insurers
are:
• Legislation, through both state and federal
laws
• Court decisions, e.g., interpreting policy
provisions
• Every Country has an insurance
commissioner, who administers state
insurance laws
• The National Association of Insurance
Commissioners meets periodically to discuss
industry problems and draft model laws
What areas are Regulated?

• All states have requirements for the formation

and licensing of insurers
• Licensing includes minimum capital and
surplus requirements
• A domestic insurer is domiciled in the state
• A foreign insurer is an out-of-state insurer
that is chartered by another state, but
licensed to operate in the state
• An foreign insurer is an insurer that is
chartered by a foreign country, but is
licensed to operate in the state
• Insurers are subject to financial regulations
designed to maintain solvency

• Assets must be sufficient to offset liabilities

• Admitted assets are assets that an insurer
can show on its statutory balance sheet in
determining its financial condition

An insurer’s surplus position is carefully monitored

by state regulators
• Life and health insurers must meet certain risk-based
capital standards.
• A risk-based capital (RBC) standard means that
insurers must have a certain amount of capital,
depending on the riskiness of their investments and
insurance operations
• An insurer’s RBC depends on:
• Asset risk
• Underwriting risk
• Interest rate risk
• Business risk
• A comparison of the company’s total adjusted capital
to the amount of required risk-based capital
determines whether company or regulatory action is
required
• The purpose of investment regulations is to
prevent insurers from making unsound
investments that could threaten the company’s
solvency and harm the policy owners
• Laws generally place a limit on the proportion
of assets in a specific asset category, such as
real estate
• Many states limit the amount of surplus a
participating life insurer can accumulate, rather
than pay as dividends
• Each insurer must file an annual report with the
state insurance department in the states where
it does business
The insurance department assumes control of
insurance companies that they determine to be
financially impaired
• All Countries have guaranty funds that provide for
the payment of unpaid claims of insolvent
property and casualty insurers
• They have guaranty laws and guaranty
associations that pay the claims of policy owners
of insolvent life and health insurers
• The assessment method is the major method used
to raise the necessary funds to pay unpaid claims
• Forms of rate regulation for property and casualty
insurance include:
• Prior approval law
• Modified prior approval law
• File-and-Use law
• Use-and-File law
• Flex Rating law
• State made rates
• Open Competition
• Many Countries exempt insurers from filing
rates for large commercial accounts
• Life insurance rates are not directly regulated by
the Countries.
• Country insurance commissioners have the
authority to approve or disapprove new policy
forms before the contracts are sold to the
public
• Sales practices are regulated by the laws
concerning the licensing of agents and brokers
• All Countries require agents and brokers to be
licensed
• Insurance laws prohibit a variety of unfair
trade practices, such as misrepresentation,
twisting, and rebating
• Twisting is the inducement of a policy owner to
drop an existing policy and replace it with a new
one that provides little or no economic benefit to
the client

• Rebating is the practice of giving an individual a

premium reduction or some other financial
advantage not stated in the policy as an
inducement to purchase the policy
• Advantages of Insurance regulation include:

• Greater responsiveness to local needs

• Promotion of uniform laws

• Greater opportunity for innovation

• Decentralization of political power

• Shortcomings of regulation include:

• Inadequate protection against insolvency

• Inadequate protection of consumers
• Improvements needed in handling
complaints
• Inadequate market conduct examinations
• Insurance availability
• Regulators may be overly responsive to the
insurance industry
 Current Problems and Issues in
Insurance Regulation
• Insolvency of insurers continues to be an
important regulatory concern
– Reasons for insolvencies include:
• Inadequate rates
• Inadequate reserves for claims
• Rapid growth and inadequate surplus
• Problems with affiliates
• Overstatement of assets
• Alleged fraud
• Failure of reinsurers to pay claims
• Mismanagement
• Catastrophic losses
• An increasing number of insurers are using a
credit-based insurance score for underwriting
• Proponents argue:
• There is a high correlation between an
applicant’s credit record and future claims
experience
• Underwriting and rating can be more objective
and consistent
• Critics argue:
• The use of credit data in underwriting or
rating discriminates against certain groups
• Credit reports often contain errors that can
harm insurance applicants
• Credit-based scoring is socially unacceptable
THANK YOU!