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Risk Management and Insurance: Perspectives in a Global Economy
24. Regulation and taxation in
Insurance Markets
Click Here to Add Professor and Course
Information
Points to Ponder
Insurance regulation
Taxation in insurance
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Insurance Regulation
Evolving International Insurance Markets (Figure 24.1)
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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
It resolves disputes between insurers and policyholders.
It enforces insurance laws through orders supporting the insurance
supervisor and by assessing civil and sometimes criminal penalties
against those who violate insurance law.
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.
In most countries, a special department or subordinate institution of
the relevant ministry carries out insurance regulatory oversight. The
department 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 assists regulatory authorities in most countries
(but not typically 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
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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
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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 services of knowledgeable intermediaries are important
in highly competitive than in more restrictive markets.
Because individuals and businesses rely on the advice as
well as risk management and insurance services of such
intermediaries, they should be knowledgeable, trustworthy
advisors.
Minimum qualification requirements in most countries
U.S. E&S broker license as an example of a special case
The 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
Many countries provide tax relief to policyholders for premiums paid
for qualifying life insurance policies.  Table 24.2
Dividends are not considered as taxable income, as they are chiefly a
return to the policyholder of his or her own funds.
Countries generally do not directly tax interest credited on policy cash
values.
When taxed, the build-up is considered as part of benefits.
The inside interest build-up of annuities during their accumulation
period usually receives the same tax treatment as that of other life
insurance products.
Most countries seem to tax annuity payouts to some degree.
Most countries exempt death proceeds paid under qualifying life
insurance policies from income taxation.
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
Several OECD countries and perhaps most developing countries levy
taxes on insurers’ premium revenues.
Premium taxes are 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 nonlife insurance policies
are not deductible from income for tax purposes.
Exceptions exist.
Premium payments by businesses to purchase compulsory insurance
and other business-related insurance are commonly tax deductible.
Benefits received under personal nonlife insurance policies are tax
free.
Exceptions exist.
For benefits received by a business, such benefits are tax free in
many countries.
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Nonlife Insurance Taxation
Nonlife insurance companies
Countries are less reluctant to impose premium taxation in nonlife
insurance than in life insurance.
Moreover, tax rates with nonlife insurance are generally higher.
Some governments levy other premium-based taxes that can greatly
increase the effective tax in nonlife insurance.
Table 24.3
Premium-based taxation is to be paid irrespective of insurer
profitability.
Governments usually tax nonlife insurance companies as other
corporations.
The great majority of countries seem to allow deductions for claims
reported but unpaid and certain other reserves.
The tax rates in most countries are the same as those applicable to
other corporations and as for life insurers.
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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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