Reconstruction Of The Insurance Industry In Jamaica

1
Reconstruction Of The Insurance Industry In
Jamaica

• An Enhanced Role For The Jamaican Actuary
• John Robinson FSA MAAA

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WARNING If the numbers of J overwhelm you,
divide by 60 to get US!!
3
LAWD MI MONEY GAWN!!!!!!!

• Translation
• Oh My God, my life insurance contract is down
  the drain!!!
  

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Jamaica Mutual Life Assurance Society

• Mutual Life policyholders awoke on the morning of
  August 2, 1999 to find the company closed for
  business.
  
• Founded 1855 by George William Gordon (a National
  Hero) et al
  
• One of the most stable insurance companies in the
  English-speaking Caribbean.

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Jamaica Mutual Life Assurance Society

• What factors led to the failure?
• How did the Govt of Jamaica respond?
• How has the industry changed?
• How has the role of the actuary changed?

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I. CAUSES OF THE FAILURE

• Mutual Lifes failure was part of a general
  failure of the financial services sector.
  
• All locally-owned banks and insurance companies
  were seriously affected.
  

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THE CRISIS UNFOLDSGOVERNMENT POLICY

• In the early 1990s, Govt pursued policy of
  liberalization of banking sector.
  
• Relaxed controls over entry into the sector.
• Eliminated foreign exchange controls.
• Exchange rate determined by demand and supply.
• Interest rates on savings deregulated.
• Govt strengthened regulatory framework for
  monitoring and enforcing new banking rules.
  
• BUT no changes to supervision of insurance.

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THE CRISIS UNFOLDSCONSUMERISM

• With liberalization came a major expansion of
  credit. However, loans and investments were made
  without proper risk assessment.
  
• Loans were mainly for consumption, rather than
  economic production.
  
• ME WANT A LEXUS AN A VIDEO!!!
• Translation
• I must buy a Lexus and a VCR, even if I cant pay
  back the loan!!!
  

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THE CRISIS UNFOLDSECONOMIC DOWNTURN

• Under liberalization, Jamaican residents could
  hold US accounts.
  
• They could also borrow in US.
• Rapid depreciation of the foreign exchange rate
  (156 in one year) seriously impacted ability to
  repay US-denominated loans.

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THE CRISIS UNFOLDSECONOMIC DOWNTURN,Continued

• Interest rates on loans increased, in some cases
  to over 50.
  
• No, not BY 50.
• Inflation reduced consumers disposable income.

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THE CRISIS UNFOLDSTHE INSURANCE COMPANY
PERSPECTIVE

• Corporate Structure
• During the late 1980s, financial sector groups
  emerged.
  
• Group life insurance company
• commercial bank
• building society
• general (property-casualty) insurance
  company
  
• other

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1. Corporate Structure, Continued

• Groups were designed to take advantage of (i.e.
  minimize impact of) regulation, supervision and
  taxation.
  
• Interlocking boards of directors.
• Extensive inter-group transactions.

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THE CRISIS UNFOLDSTHE INSURANCE COMPANY
PERSPECTIVE, Continued

• Investment Policy
• For LICs, real estate was the only asset class in
  abundant supply.
  
• In addition, tourism-related real estate was a
  major potential earner of US.

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Investment Policy, Continued

• LICs invested heavily in tourism-related real
  estate, agricultural ventures and office
  buildings.
  
• State the obvious real estate is highly
  illiquid and valuation is an art.
  

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D. THE CRISIS UNFOLDS THE INSURANCE COMPANY
PERSPECTIVE, Continued

• Hyperinflation
• Inflation caused significant increases in wages
  and other internal expenses.
  
• LICs and banks both needed cash flow to finance
  their operations.
  
• Banks attracted funds in the form of CDs,
  offering high credited rates.

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3. Hyperinflation, Continued

• LICs competed by offering CD-like contracts, with
  high credited rates, liberal withdrawal options
  and high commissions.
  
• Many of these contracts were equity-linked
  i.e. variable tied to the stock market.
  

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D. THE CRISIS UNFOLDS THE INSURANCE COMPANY
PERSPECTIVE, Continued

• Run on the bank
• In 1993, the stock market plummeted, and
  equity-linked policyholders exercised their
  withdrawal rights.
  
• ME A MOVE MI MONEY A SCOTIA BANK!!
• Translation
• I am moving my money to the Bank of Nova Scotia
  right away!!

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4. Run on the bank, continued

• To cover excessive demand for cash, LICs turned
  to their bank affiliates for loans.
  
• Commercial banks non-performing loans (NPLs)
  grew from 7.4 in 1994 to 28.9 in 1997, mainly
  due to loans to affiliated LICs.
  
• Investment returns fell below interest credited.
• LICs continued to report profits by including
  unrealized gains on real estate in earnings!
  
• Slowing economy caused businesses to close and
  offices to be left vacant.
  
• THEN, real estate values began to decline.

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4. Run on the bank, continued

• A severe asset-liability mismatch, combined with
  a decline in asset values, led to the demise of
  the LICs, and spread to further cause the demise
  of their affiliated banks.
• Ironically, foreign-owned banks, such as the Bank
  of Nova Scotia, became favored. They avoided a
  similar fate.
  
• Better internal controls.

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D. THE CRISIS UNFOLDS THE INSURANCE COMPANY
PERSPECTIVE, Continued

• The following other contributing factors have
  been identified by economists
  
• Entrepreneurs too bullish in risking customers
  savings, too eager to build large offices and too
  prone to bend prudential norms and regulations.
  
• Lack of a credit-reporting entity.
• No sharing of consumers credit histories.

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D. THE CRISIS UNFOLDS THE INSURANCE COMPANY
PERSPECTIVE, Continued

• 3. Deficient regulatory environment,
  particularly for insurance.
  
• Inadequately staffed.
• No full-time actuary.
• Lacked stature in eyes of insurance community.
• 4. Liberalization led to increased risk-taking
  and reduced managerial prudence.
  
• 5. Interconnections among financial institutions
  meant that transparency of relations and accuracy
  of information could not be guaranteed.
  

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II. THE GOVERNMENTS RESPONSE

• SO MISTA PJ, IS WHAT YUH GWINE DO BOUT DIS?
• Translation
• Mr. Prime Minister, how does your Govt propose
  to overcome this catastrophe?
  

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FINANCIAL RESPONSE

• In 1994, problems with Blaise Group uncovered.
• Govt provided full protection to depositors,
  seized Blaises assets, closed the group and sued
  the owners.
  
• In 1995, Century National Bank had problems.
• Govt took the same steps.

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FINANCIAL RESPONSE

• In 1994, problems with Blaise Group uncovered.
• Govt provided full protection to depositors,
  seized Blaises assets, closed the group and sued
  the owners.
  
• In 1995, Century National Bank had problems.
• Govt took the same steps.
• Govts approach maintained public confidence in
  the financial sector.
  
• In Indonesia, failure to protect depositors
  caused severe erosion of confidence.
  
• However, Govts guarantee led to greater
  risk-taking and imprudence by both savers and
  lenders.
  

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A. FINANCIAL RESPONSE, Continued

• In mid-1996, CEOs of LICs approached Govt for
  assistance. What appeared to be liquidity
  problems were also revealed to be solvency
  problems.
• Because the problems were sector-wide, closing
  troubled institutions was not an option.
  
• In early 1997, following a study by local and
  international experts, Govt formed the Financial
  Sector Adjustment Company (FINSAC) and announced
  that it would again guarantee depositors funds.
• FINSACs mission
• Phase 1 Intervention
• Phase 2 Rehabilitation
• Phase 3 Divestment
• To be completed in 5 to 7 years.

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A. FINANCIAL RESPONSE, Continued

• FINSACs accomplishments to date
• Consolidated 13 LICs into 2, both foreign-owned.
• Provided J65-70 billion of financing in the form
  of Govt-guaranteed bonds.
  
• In effect, Govt created money. Impact will be
  felt for many years.
  

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B. LEGAL / REGULATORY RESPONSE

• BE IT ENACTED BY THE QUEENS MOST
• EXCELLENT MAJESTY, BY AND WITH
• THE ADVICE AND CONSENT OF THE
• SENATE AND HOUSE OF
• REPRESENTATIVES OF JAMAICA.

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B. LEGAL / REGULATORY RESPONSE, Continued

• The Insurance Act of 2001 replaces the Insurance
  Act of 1971.
  
• The new law (94 pages) is accompanied by a
  substantial set of regulations (1,038 pages) and
  a separate set of actuarial regulations (57
  pages).
• Major Considerations in creating the new law
• Regulatory convergence.
• Must be aligned with overall financial sector
  regulation.
  
• Insurance Act was just one of 5 pieces of
  legislation.
  
• The Insurance Core Principles developed by the
  International Association of Insurance
  Supervisors (IAIS).
  

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IAIS Core Principles

• As of October 2003, there were 28 of them, with
  more to come.
  
• I will now mention 9 of these principles.

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IAIS Core Principles

• ICP 1 Conditions for effective insurance
  supervision
  
• Insurance supervision relies upon
• a policy, institutional and legal framework for
  financial sector supervision
  
• a well developed and effective financial market
  infrastructure
  
• efficient financial markets.
• ICP 3 Supervisory authority
• The supervisory authority
• has adequate powers, legal protection and
  financial resources to exercise its functions and
  powers
  
• is operationally independent and accountable in
  the exercise of its functions and powers
  
• hires, trains and maintains sufficient staff with
  high professional standards.
  

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IAIS Core Principles

• ICP 5 Supervisory cooperation and information
  sharing
  
• The supervisory authority cooperates and shares
  information with other relevant supervisors
  subject to confidentiality requirements.
  
• ICP 7 Suitability of persons
• The significant owners, board members, senior
  management, auditors and actuaries of an insurer
  are fit and proper to fulfill their roles. This
  requires that they possess the appropriate
  integrity, competency, experience and
  qualifications.

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IAIS Core Principles

• ICP 9 Corporate governance
• The supervisory authority requires compliance
  with all corporate governance standards.
  
• ICP 10 Internal control
• The supervisory authority requires insurers
• to have in place internal controls that are
• adequate for the nature and scale of the
• business. The oversight and reporting systems
• allow the board and management to monitor and
• control the operations.

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IAIS Core Principles

• ICP 18 Risk assessment and management
• The supervisory authority requires insurers to
  recognize the range of risks that they face and
  to assess and manage them effectively.
  
• ICP 21 Investments
• The supervisory authority requires insurers to
  comply with standards on investment activities.
  

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IAIS Core Principles

• ICP 26 Information, disclosure and
  transparency towards the market
  
• The supervisory authority requires insurers to
• disclose relevant information on a timely basis
  in
  
• order to give stakeholders a clear view of their
  
  
• business activities and financial position and
  to
  
• facilitate the understanding of the risks to
  which
  
• they are exposed.

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III. SOME PROVISIONS OF THE NEW LAW, AND
RESULTING CHANGES

• INVESTMENT REGULATIONS
• To be eligible for purchase by an insurance
  company, a security must be
  
• Interest-bearing or
• Interest-accruing or
• Dividend-paying
• AND
• Not in default.

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A. INVESTMENT REGULATIONS, Continued

• Real estate is admitted
• for the head office and branch offices,
• AND
• only up to 10 of assets.
• Not more than 5 of assets in any one security.
• Bonds issued by Govt of Jamaica, municipalities
  and Govt agencies are admitted.
  
• Obligations of certain (named) regional financial
  institutions are admitted.
  
• Preferred or guaranteed stocks are admitted, up
  to 15 of assets.
  

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A. INVESTMENT REGULATIONS, Continued

• Ordinary shares (common stock) are not admitted.
• First mortgages are admitted,
• 80 LTV for residential mortgages up to 30
  years
  
• 75 LTV otherwise.
• Every investment must have approval of the
  Investment and Loan Committee.
  

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The following charts compare the portfolio of
Life of Jamaica at year-ends 1990 and 2003.
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The following charts compare the portfolio of
Life of Jamaica at year-ends 1990 and 2003.
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SOME PROVISIONS OF THE NEW LAW, AND RESULTING
CHANGES, Continued

• Solvency Requirements, Life Insurance
• Minimum continuing capital and surplus
  requirements (MCCSR)
  
• Minimum capital the sum of components for
• Asset default risk
• Changes in interest rate environment risk
• Foreign exchange risk
• Interest margin pricing risk
• Mortality / morbidity / lapse risk.

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B. Solvency Requirements, Life Insurance,
Continued

• MCCSR percentage Available capital
• Minimum capital
• Must exceed a prescribed level.

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III. SOME PROVISIONS OF THE NEW LAW, AND
RESULTING CHANGES, Continued

• Solvency Requirements, General Insurance
• Admitted Assets Required Assets.
• Required Assets Total Liabilities
• Reserves for reinsurance ceded to
  unlicensed reinsurers
  
• Margins for unearned premiums and
  claims

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III. SOME PROVISIONS OF THE NEW LAW, AND
RESULTING CHANGES, Continued

• Corporate Governance
• A 1988 study of bank failures in the US found the
  following primary causes
  
• Uninformed or inattentive board of directors
• CEO lacked capability, experience and / or
  integrity
  
• Inappropriate transactions with affiliates.

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D. Corporate Governance, Continued

• Risk based supervision requires strong
  corporate governance and less emphasis on
  compliance.
  
• The new regulatory approach stresses sound
  business and financial management.
  
• Requirements include
• Board of directors must appoint
• Audit Committee
• Investment and Loan Committee and
• Conduct Review Committee.
• Board of directors must have a written policy
  for each of the risks faced by the company.
  

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III. SOME PROVISIONS OF THE NEW LAW, AND
RESULTING CHANGES, Continued

• Appointed Actuary
• Prior to the new law,
• the life insurance actuarys formal
  responsibility was limited to
  
• calculation of reserves and
• pricing of insurance products
• general insurance companies had no actuaries.

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E. Appointed Actuary, Continued

• The new law provides that every insurance company
  must appoint an actuary.
  
• The actuary shall
• Value reserves and other policy liabilities
• Submit report at the AGM of shareholders and
  policyholders
  
• At least once a year, meet with the board of
  directors to report on the companys financial
  position
  
• The actuary shall, continued
• Submit a written report to the CEO and CFO on
  matters adversely affecting the company, with a
  copy to the regulator
  
• If management fails to act, the actuary must
  notify the board of directors and the regulator.
  

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E. Appointed Actuary, Continued

• Upon termination, the actuary must communicate in
  writing the reasons, to the regulator, the board
  of directors and his/her successor.
  
• CEO, COO or CFO may not normally also be the
  appointed actuary.
  
• Appointed actuary must annually carry out Dynamic
  Capital Adequacy Testing (DCAT).
  
• Objective identify threats to future solvency
  and recommend ways to mitigate those threats.
  
• Step 1 Define solvency criteria.
• Step 2 Project results 5 years into the
  future, under several scenarios. Include new
  sales.
  
• Step 3 For each scenario, analyze results
  relative to the solvency criteria.
  

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E. Appointed Actuary, Continued

• Finally, the actuary is expected to play a key
  role in risk management.

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IV. CONCLUSIONS

• Jamaica provides a prime example to the Third
  World of how to handle a financial crisis without
  IMF assistance. However, the impact will evolve
  over many years.
• In Jamaica, the appointed actuary, and the
  actuarial profession in general, now has a much
  more demanding, more respected and more public
  role, and the independence needed to act as a
  quasi-regulator.

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REFERENCES

• Storm In A Teacup Crisis in Jamaicas
  Financial Sector Dr. Gladstone Bonnick
  
• Jamaicas Life Insurance and Financial Sector
  Crisis Janet Sharp FSA
  
• Responding to Financial Crisis The Case of
  Jamaica Colin Kirkpatrick and David Tennant
  
• Adjusting Jamaicas Financial Sector to Meet the
  Challenge of The 21st Century Dr. Gladstone
  Bonnick
  
• A New Regulatory Framework in Jamaica The
  Legislative Challenge Brian Wynter
  
• The Importance of Strong Corporate Governance
  A Regulators Perspective Brian Wynter
  
• Regulatory Convergence A Must For Financial
  Sector Safety Gayon Hosin
  
• The Financial Services Commission and the Role
  of Actuaries in the New Regulatory Framework
  Brian Wynter and Catherine Allen FSA
  
• Critical Issues Arising From World Bank Report
  Dennis Morrison
  
• THE INSURANCE ACT, 2001 and THE INSURANCE
  REGULATIONS, 2001
  

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Acknowledgements

• The following persons contributed information,
  ideas and/or encouragement
  
• Acheampong Boamah ASA
• Neil Dingwall FFA
• Astor Duggan FIA
• Fray Ellis ASA
• Andrew Gooden FCIA
• Geoffrey Melbourne ASA
• Janet Sharp FSA
• W. St. Elmo Whyte FIA
• Michele Robinson
• Vicki French
• Illustration Laura Vulpio
• Audio clips Garrett Shafer
• Inspiration Use of dialect inspired by Louise
  Bennett, poet, actor, cousin.