Life Insurer Must Perform

Excess management expense as per cent of allowable management expense of the same set of life insurance companies declined to 8.20 in 2015 from 16.70 in 2011. Management expense as per cent of total premium income declined from 43.62 in 2011 to 33. 76 in 2015. Performances of the companies in respect of controlling their management expenses vary widely. Some companies, though not fully compliant with the regulatory requirement but performing well in other areas, have been able to meet the reasonable expectation of policyholders as well as shareholders. But there is no scope for complacency for them; rather they should strive hard to reduce management expenses further in view of the reduced rate of return on their investment.

With the increase in capital in future to meet the solvency margin requirement, the rates of dividend to the shareholders and bonus rates to the policyholders are likely to go down unless substantial improvement in monitoring and controlling expenses is made. It will not be out of place to mention that the commission ratio, defined as the ratio of commission to the premium underwritten, was in India 5.52 per cent in 2015-16. Operating expense ratio, defined as the ratio of operating expenses to the premium underwritten, was 10.57 per cent in 2015-16. Sum of these two ratios was 16.09 per cent in 2015-16.

Some companies have not been performing well both in controlling expenses and investment of life fund, while a few others have been doing badly in almost all areas of their business operations. A few companies have not been able to go for initial public offering (IPO) even after 16 years' of their operations because of their dismal financial performances.

There are a few companies which have shown reasonable performances in the earlier years and were able to get their shares listed in the stock exchange but with the passage of time, their financial performances have declined significantly, in terms of growth of business, return on investment and management of expenses. If these trends continue, the long term financial viability of these companies will be at stake.

In some jurisdictions there are provisions for imposing heavy penalty for not complying with regulatory requirement in respect of expenses of management. For example, in India as per the regulations relating to expenses of management of insurers transacting life insurance business, any violation of the limits on overall basis or the directions issued by Insurance Regulatory and Development Authority of India (IRDAI) with regard to management expenses entails one or more of the following actions:


(i) Excess to be charged to Shareholders' Account;

(ii) Restriction on performance incentive to Managing Director/Chief Executive Officer/Whole Time Directors and Key Management Persons;

(iii) Restriction on opening of new places of business;

(iv) Graded penal action under the Insurance Act;

(v) Removal of Managerial Personnel and/or appointment of Administrator;

(vi) Any other action as specified in the Act.

The IRDAI, apart from taking above action, may also direct the insurer not to underwrite new business in case of repeated violation of the regulations.

Rules 39 of Insurance Rules 1958, prescribing the limit on expenses of management expenses, are still in force in Bangladesh. Neither these rules have any provision with regard to imposition of penalty for violation of the limit nor does the draft regulation prepared by Insurance Development and Regulatory Authority (IDRA), Bangladesh (IDRA,B) which is under consideration of the government, have any such provision. In this respect, the IDRA,B is lenient to a certain extent because in its view very stringent actions against the companies whose business operations were not monitored properly in the absence of relevant rules or regulations would not be appropriate. Any severe action all on a sudden against the insurers which were outside the regulatory radar for many years will have serious deleterious effect on their business operations.
However, IDRA,B has taken punitive action against the violators as per the relevant provision of the Insurance Act 2010 but at the same time used moral suasion to reduce expenses of management. The results are positive but not very encouraging. At the moment, no punitive action other than that provided in the Act is under consideration of IDRA,B. But if the insurers fail to show continual improvement, IDRA,B will, in the absence of separation of shareholders' fund and policyholders' fund, be constrained to cause them to charge excess expenses from the surplus available to the shareholders and other punitive measures to protect the interests of the policyholders.

The Chief Executive Officers (CEOs) and other senior executives of the companies are responsible for carrying out their duties in accordance with the Insurance Act and rules and regulations made thereunder and also as per policies of the companies formulated by the respective Boards not being inconsistent with the provisions of the Act and rules and regulations. They should bring all aspects of managing the company in a profitable manner to the notice of the Board of Directors without any fear and hesitation.

The Insurance Act, 2010 has provided protection to the CEOs in the sense that no person can be appointed as the CEO without the approval of IDRA,B and that no CEO can be removed, terminated or dismissed by the insurer without the prior approval of IDRA,B. It expects that the CEOs and other senior executives would be proactive and take more and more responsibilities in the affairs of the companies.

The directors of the Board should be well aware of the regulatory requirements of insurance business. They should direct the management to transact insurance business within the regulatory framework. The Board is equally responsible for transacting insurance business violating the provisions of the Act and other regulatory requirements. It should extend full-fledged cooperation to the management enabling the latter to run the affairs of the company in prudent and transparent manner.
The management should not, in any way, make any collaborative arrangement with the Board which may be harmful to the company and may affect the interests of the policyholders whose share of surplus is 90%, the share of surplus to the shareholders being 10% only. One of the objectives of IDRA,B, as per preamble of the IDRA Act, 2010 is to protect the interests of the policyholders and their beneficiaries, and therefore IDRA,B will not hesitate to take any punitive action against those whose activities are detrimental to the interests of the policyholders. The Board, which has greater responsibilities, would also be responsible for any kind mismanagement in the affairs of the company.

Special Audit and periodic investigation, carried out by IDRA,B through the renowned chartered accounting firms and also investigation made by its own Onsite Inspection Team, revealed that the Board did not take any interest in the matters related to regulatory compliance of various aspects of the company's business operation including controlling management expenses. Most board members showed keen interest in the amount of fees payable to them for attending meetings of the Board and the meetings of various committees of the Board rather than taking measures for improvement of the financial performances of their companies.

There has been ongoing debate in Bangladesh whether there is any necessity of having both capping of expenses of management and minimum solvency margin as regulatory requirements. It is often argued that while calculating available solvency margin, actual expenses of life insurers is taken into account, and therefore if the insurers are required to comply with the solvency margin requirement, there is no need of having separate regulatory requirement for expenses of management. Solvency margin is defined as the difference between the value of assets and the expected value of policy liabilities.

This definition would not be a suitable measure of financial health of an insurance company, if either the assets or the liabilities or both are not valued in a proper manner. Capital, which represents the excess of an insurer's assets over its liabilities, is thus a measure of solvency of an insurer. The amount of capital available depends on how assets and liabilities are valued. For an example, an asset having zero value will have hundred percentage charge on the capital and an assets such as government securities and bonds, having hundred per cent value, will not have any charge on the capital. The extent of risks associated with adequacy of pricing, underwriting and reserving will also have charges on the capital.
Profit (surplus) of a life insurer is calculated as the excess of assets constituting life fund over the insurer's liabilities to the policyholders, termed simply as policy liabilities, and in the context of current regulation in force in Bangladesh, it is called net liability. Net liability is calculated as the present value of sum assured and vested bonuses minus the present value of net premium (modified with Zillmer adjustment). The higher the actual management expenses, the lower will be the accretion of life fund that a life insurer holds at a given date.

If net liability, which is normally termed in the insurance literature as mathematical or actuarial reserves, falls below the life fund there will be a deficit and the insurer will not be in a position to declare dividend for the shareholders and bonuses for the policyholders. Actual management expenses do not come into the picture for calculation of required solvency margin. Required solvency margin in its simplest form is the sum of risk-weighted liabilities of different segments of life insurance business and sum at risk. Many countries including our neighbouring ones have included the provisions of both solvency margin and maximum limit of management expenses in the insurance laws and also the rules and regulations under those laws.
Countries that have no provision of ceiling on expenses of management in the relevant laws have a very high quality of qualified and experienced persons in the insurance sector who are well aware of the consequences of excess management. These professionally qualified people with high levels of expertise and skills in management of insurance business are aware of the maximum levels of management expenses that the insurers can spend to maintain long- term financial solvency of the insurers and to meet the reasonable expectation of both the shareholders and policyholders. The insurers in those cases ensure through self-governance that actual level of expenses do not exceed the expenses as provided in the premium rates.

In the cases where the insurers fail to contain the levels of expenses within the required levels as per provision made in the premium rates, they would eventually fail to meet the contractual obligations to the policyholders and in the long run, the claim-paying ability of the insurers will be seriously affected. IDRA,B by exercise of its power and responsibilities under the Act and Rules and Regulations intend to make sure that the insurers contain the management expenses within the regulatory limit with a view to promoting viable insurance sector in the country.

Some of the insurers in Bangladesh argue that since scheduled banks in Bangladesh are not required to pay license fees to the central bank before starting their business operations and thereafter yearly renewal fees for carrying on their banking business, the licensing fees imposed on the insurers should be dispensed with. The central bank has several sources of income. First, scheduled banks are required to keep a certain percentage of their deposit liabilities in the form of balances with the central bank. This ratio is called cash reserve ratio (CRR). These balances with the central bank do not earn any interest, but if the central bank lends to the scheduled banks and the government out of these balances, it earns interest on the amount of such outstanding loans. The central bank is the custodian of foreign exchange reserves and whatever the amount of reserves it holds, it is invested abroad and a significant amount of income is earned on such investment.
The central bank has the power to create reserve money, sometimes called high powered money. Reserve money is the monetary liabilities of the central bank, and therefore an increase in reserve money gives rise to an increase in the assets of the central bank. If such increase in assets takes the form of increase in lending by the central bank, its income goes up. Therefore, there are many sources from which central bank can earn income if it wishes to do so.

However, the central bank does not use CRR or any other monetary policy instruments to maximize its income; rather it undertakes monetary measures to control money supply consistent with the maximum allowable rate of inflation and expected growth of real gross domestic product (GDP). In the case of insurance regulator, there is no scope for asking the insurers to maintain a percentage of their premium income as cash balance with the regulator. Income of the regulator is derived from licensing fees and penalties. This practice is followed in many countries including our neighbouring countries.
The provision of payment of fees for obtaining licenses and yearly renewal fees thereafter is included in the Insurance Act 2010 and details of such payment have been made in the Rules. The regulatory requirement has allowed the insurance regulator to manage the affairs of IDRA,B with their own resources without having to depend on the budgetary allocations from the government. This practice should continue to provide the insurance regulator with operational independence and enable IDRA to exercise strict surveillance and monitoring on the business operations of insurers.