Policyholder security: IPSA option paper released

Yesterday the Reserve Bank of New Zealand (Reserve Bank) issued its second options paper as part of the broader review of the Insurance (Prudential Supervision) Act 2010 (IPSA).  The consultation presents options to enhance policyholder protection security in the event of an insurer’s insolvency.  Given the heightened alert levels, the Reserve Bank has extended the consultation window to 15 November 2021.

A link to the options paper is available here.

Who needs to read it?  Why?

Insurers, actuaries, and investors should consider the proposals in the options paper.  The proposals relating to statutory funds and a potential statutory policyholder preference may also be of interest to lenders to insurers.

The proposed options will impact how solvency is calculated, how financial strength and solvency disclosed to the market, and may have implications for product design for certain products.

What does it cover?

The Reserve Bank has indicated in the options paper that further regulation under IPSA is necessary to increase the likelihood that policyholders will receive payments they are entitled to if they make a claim on their insurance policy

The Reserve Bank has proposed the following areas where regulation may provide greater security:

Information Disclosure

The Reserve Bank is considering including new requirements to disclose the financial stability of an insurer.  Insurers currently have an obligation to disclose their financial strength rating to policyholders before entering into, or renewing, a contract of insurance.  Insurers are also required to display their rating on their website.  In addition to financial strength, insurers are required to disclose solvency indicators (including their solvency ratio) in their financial statements and on their websites.

Small insurers are exempt from the requirement to have and disclose a financial strength rating, due to the disproportionate cost of acquiring a rating in relation to premiums earned.  However, the Reserve Bank is considering whether, and to what extent, that exemption should continue.

The Reserve Bank considers there are shortcomings in the disclosure requirements. In particular, the Reserve Bank is concerned about the number of rating agencies, whether insurers are “shopping around” for the best rating, and confusion between the different kinds of ratings across providers. The options paper sets out a number of options to remedy this. These options focus on standardising disclosure (including potential requirements to disclose a “guide to financial strength” or a traffic light system for financial strength rating disclosures), requiring further disclosure of solvency indicators, and requiring insurers to rotate rating agencies.

Enforcement options

IPSA is currently based on a single solvency level: either an insurer is solvent or insolvent.  However, following the solvency standard review, the Reserve Bank decided that an additional control level will be added.  The options paper explores different options for enforcement actions in the new dual solvency level model and asks the market for input on what powers the Reserve Bank should have at each level.

Statutory Funds

IPSA requires life insurers to have at least one statutory fund, as a way of ring-fencing assets for the life insurance business from the rest of the insurer’s business.  In 2016, the International Monetary Fund suggested that further statutory protection be afforded to policyholders of non-life policies, either through a statutory fund or through affording policyholders a preference in insolvency.  The options paper asks whether, and to what extent, general insurance contracts should have assets held in a statutory fund.  The options paper also explores giving a statutory preference to policyholders.  However, the Reserve Bank is unsure whether this preference should extend beyond policy benefits to refunds of unearned premiums.

Mandatory minimum termination values

The options paper discusses whether mandatory minimum termination values should be introduced for insurance products which involve a portion of premiums being accumulated to fund benefits and claims payable in future years.  Examples include conventional life insurance policies where a benefit is paid on death and on survival to an advanced age, funded by regular premiums payable throughout the term, and builder’s warranty insurance where an up-front single premium funds claims that may arise over the medium-long term.

The options paper notes that in some cases, policies such as these that store value for policyholders have contractual provisions that provide for a benefit to be paid to the policyholder on early termination, in order to provide fair value for the premiums that have been remitted.  In other cases, contracts are silent and contain no explicit protection for the policyholder

The options paper is seeking feedback on whether New Zealand should follow some overseas jurisdictions with the result that where a contract does not provide for a benefit to be paid to the policyholder in the event of early termination, IPSA will impose a minimum termination value to be paid to the policyholder.

Our view

As the option paper notes, when considering whether to introduce new regulation, the Reserve Bank must strike a balance between the benefit to policyholders from the increased security of policy benefits and the impact on the cost of insurance.  Any new regulation should be considered in the context of the solvency standards review and interim solvency standards, which are expected to result in higher solvency requirements for insurers, and therefore a likely increase in the cost of insurance for policyholders.

While we support the Reserve Bank’s aim to help policyholder’s assess a prospective insurer’s financial health, we think it is key that any information provided to policyholders is comparable between insurers and, most importantly, easily understandable by consumers.

International solvency standards have shifted to use of multi-level controls for solvency.  One of the key drivers of the review of IPSA and the accompanying solvency standards was to move to a multi-level approach. In the solvency standard review, this received strong support from the market.  However, the Reserve Bank will need to have an appropriate range of enforcement powers with sufficient flexibility to ensure that the required action can be taken before an insurer reaches the “top level” and becomes insolvent.

What next?

If you have any questions in relation to the options paper, IPSA review, or Solvency Standards review or are considering how these changes may affect your business, please contact one of our experts.

Co-authored by Sarah Jones, a Solicitor in our Financial Services team.

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