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24' Regulation and taxation in Insurance Markets

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Title: 24' Regulation and taxation in Insurance Markets


1
24. Regulation and taxation in Insurance Markets
  • Dr. Jan-Juy Li
  • Dept. of Risk Management and Insurance
  • ETP course, CNCCU

2
Introduction
  • Insurance regulation
  • Taxation in insurance

3
  • Insurance Regulation

4
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 worlds largest 50
    insurance markets are more liberal today.

6
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

7
Mechanisms of Insurance Regulation
  • Legislative
  • Insurer financial reporting, examination and
    other financial requirements
  • Rehabilitation and liquidation of insurers
  • Guaranty funds
  • Insurance product and company taxation

8
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.

9
Mechanisms of Insurance Regulation
  • Executive
  • Policymakers commonly delegate this authority to
    a ministerial department of the government.
  • 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.

10
Mechanisms of Insurance Regulation
  • 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

11
Approaches to Regulation
  • Ex-ante regulation
  • To prevent any offensive activity from occurring
    before the fact
  • Ex. Licensing
  • In some countries, premium rates and policy
    wordings are subject to regulatory approval
    before insurers use them.

12
Approaches to Regulation
  • Ex-post regulation
  • Government intervention into the market only
    after an offensive activity
  • Ex. Insurers may set their own rates, and are
    subject to regulatory review only if theyre
    deemed excessive

13
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

14
Areas of Regulation (Figure 24.2)
15
Regulation -- Controlling Access to the Market
  • The role of government as a supplier of insurance
  • Government should serve as a supplier of
    insurance only where the market has failed to
    respond adequately
  • Privatization the process of allowing the
    private sector to provide services formerly
    provided by government or of converting a
    government-owned asset to private ownership

16
Regulation -- Controlling Access to the Market
  • Licensing requirement
  • Admitted vs. nonadmitted insurers
  • Nondiscrimination no countrys firms obtain
    better market access than any other countrys
    firms.
  • National treatment foreign entrants into a
    market are accorded treatment no less favorable
    than that accorded domestic companies.

17
Regulation -- Controlling Access to the Market
  • Permitted organizational forms
  • Simplicity no artificial distinctions among
    otherwise similar firms
  • Economic neutrality treating organizationally
    different insurers in a way that does not
    advantage one from over others.
  • Ownership restrictions
  • No restriction on insurance ownership

18
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
  • An applicant denied an insurance business license
    has a right to appeal the denial

19
Regulation Balancing Competition
  • Rate and product regulation
  • Financial regulation
  • Intermediary regulation
  • Competition policy regulation

20
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

21
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.

22
Regulation Balancing Competition
  • Areas
  • Ongoing capital regulation
  • Asset limitations and valuation
  • Liability regulation
  • Accounting standards

23
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

24
Asset Limitations and Valuation
  • Authorized (admitted) investments
  • The typical classes of investment permitted to
    back policyholder liabilities
  • Government-backed securities, corporate bonds,
    mortgage and other loans, common and preferred
    stock, deposits and real estate.
  • Diversification
  • Prohibit insurers from excessive investments in a
    single asset category

25
Asset Limitations and Valuation
  • Currency matching (congruence)
  • Match their liabilities denominated in one
    currency with assets denominated in the same
    currency
  • Localization
  • Assets are located in the insurers domiciliary
    jurisdiction

26
(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

27
(Accounting) Liability Regulation
  • 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.

28
Accounting Standards
  • Statutory accounting principle (SAP)
  • Detailed accounting conventions
  • Generally accepted accounting principle (GAAP)
  • Less detailed than the former
  • International Accounting Standard Board (IASB)
  • For standardization of accounting principles
    internationally

29
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.

30
Intermediary Regulation
  • Minimum qualification requirements in most
    countries
  • U.S. ES (Excess and Surplus) broker license as
    an example of a special case
  • The importance of intermediary regulation as
    financial services sectors converge.

31
Competition Policy (Antitrust) Regulation
  • Typical elements of competition law
  • Collusive practices
  • Horizontal collusion
  • Vertical collusion
  • Conglomerate collusion
  • Mergers and acquisitions determining whether a
    proposed merger or acquisition tends to create
    market power
  • Abuses of dominant position national laws
    discourage major market suppliers from using
    their dominant positions to restrain competition

32
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

33
  • International legal norms
  • Two principles
  • The principle of prohibition
  • Enumerated behavior is deemed anti-competitive
    and automatically illegal
  • Like ex-ante regulation
  • The principle of abuse
  • An inquiry into the economic effects of the
    alleged offensive behavior is required
  • Like ex-post regulation

34
Regulation Detecting Financial Difficulty
  • Solvency surveillance
  • Reporting requirements
  • Most countries require all licensed insurers
    yearly to file detailed financial statement
  • Financial examination
  • On-site examination
  • Oversight by professions
  • Regulators rely on the accounting and actuarial
    professions

35
Regulation Responding to Insurers in Difficulty
  • Four options
  • Informal actions
  • The regulator may attempt to work with company
    management to identify and deal with the sources
    of difficulty
  • Formal actions
  • Obtain state approval infuse capital
  • Limit its new business writing
  • Infuse capital
  • Cease certain business practice

36
Regulation Responding to Insurers in Difficulty
  • Rehabilitation
  • Return the insurer to the marketplace as a fully
    functioning insurer
  • Liquidation
  • The winding up of the companys entire business

37
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

38
Regulation Policyholder Protection
  • Guaranty funds diminish market discipline to some
    degree by creating moral hazard.
  • If consumers are aware that they will be made
    whole if there were an insolvency, they have less
    incentive to monitor solvency.
  • Researchers have proposed alternatives to the
    flat-assessment approach.

39
  • Taxation in Insurance

40
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

41
Principles of Taxation
  • Systems of taxation
  • Tax bases
  • The broader the tax bases, the better.
  • Tax exemptions, deductions and credits
  • Modifying a tax system to accomplish social and
    economic goal
  • Tax rates
  • Determining the relative tax on taxpayers

42
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.

43
Life Insurance Taxation
  • 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).

44
Tax Relief on Life Insurance Premium (Table 24.2)
45
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.

46
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.

47
Nonlife Insurance Taxation
  • Consumers
  • 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.

48
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

49
Other Premium-based Taxes on Nonlife (Table 24.3)
50
Nonlife Insurance Taxation
  • Nonlife insurance companies
  • Premium-based taxation is to be paid irrespective
    of insurer profitability.
  • Governments usually tax nonlife insurance
    companies as other corporations.

51
Nonlife Insurance Taxation
  • Nonlife insurance companies
  • 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.

52
  • Discussion Questions

53
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. On the other hand, high
    interest rates also mean high current income from
    investments.
  • Discuss which of these two effects you believe
    would be the more important. Why?

54
Discussion Question 2
  • In the U.K. and Germany, no more than 10 of the
    earnings attributable to a stock life insurers
    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?

55
Discussion Question 3
  • Signatory countries to the GATS bind themselves
    to the fair-trade principles of market access,
    nondiscrimination, national treatment and
    transparency. A provision within the agreement
    reads as followsmember 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.

56
Discussion Question 3
  • What is your interpretation of this provision?
  • Do you believe that this provision is justifiable
    in view of a competitive insurance market
    internationally?
  • Could insurance be the cause of a countrys
    financial system loosing its integrity and
    stability? If so, how?

57
Discussion Question 4
  • Explain why insurance need to be regulated.
  • Address particular lines of business subject to
    less stringent regulation, why?
  • What is the major areas of insurance regulation?
  • Who is the insurance regulators in your country?
    Who regulates the insurance regulators?
  • Describe the concept of prudential regulation.
  • Explain the core principle and mechanism of the
    Risk Based Capital (RBC), and Solvency System
    in EU.

58
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?

59
Discussion Question 6
  • In your opinion, is an insurance market a perfect
    market? Why and why not?
  • If an insurance company fails in your country,
    what measures or action shall be taken by the
    regulators?
  • How to balance the insurance market competition
    and government intervention for consumer
    protection?

60
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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