Lee Hsien Loong: Best practices in insurance regulation
Keynote address by Mr Lee Hsien Loong, Deputy Prime Minister of Singapore and Chairman of the
Monetary Authority of Singapore, at the International Insurance Society's 38th Annual Seminar,
Singapore, 15 July 2002.
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Introduction
Mr Douglas Leatherdale, Chairman of the International Insurance Society, distinguished guests, ladies
and gentlemen,
I am pleased to address this seminar organised by the International Insurance Society. It is an honour
for Singapore to be hosting this prestigious event again.
These are trying times for the insurance world. Insurers are coping with extraordinary losses arising
from the Sep 11 tragedy. High profile corporate scandals involving household names such as Enron
and Worldcom are depressing market sentiment. Sustained declines in asset values mean that
insurers can no longer rely on investment returns to offset poor underwriting results.
New risks facing insurers
Over the past decade, insurers have forayed deeper into financial markets in pursuit of higher
profitability - both as investors and as intermediaries.
As investors, they are exposed to the vagaries of volatile capital markets. As intermediaries, they are
taking on new financial risks. Insurers investing in credit derivatives effectively take on bank credit
risks. Insurers who underwrite professional indemnity policies for bank directors and officers,
effectively assume banks' operational risks.
Insurance company managers must keep abreast of these developments. They must understand how
their companies' risk profiles have changed, and how new activities can have opposing effects on both
sides of the balance sheet. All insurance industry professionals need to become more astute at
assessing risks, and competency needs to be upgraded at all levels in the company.
Regulators must also keep pace. In supervising individual insurers, regulators need to look beyond
insurance risks and protecting policy-holders. From a broader systemic perspective, greater
engagement of insurers in financial markets raises important questions concerning their impact on
financial stability. How well are insurers managing this new portfolio of risks? What are the spillover
effects of an insurance company failure in this environment of inter-linkages?
Traditionally, regulators associate systemic risk with the failure of large banks. The events of Sep 11
have turned the spotlight onto the importance of the insurance industry as a whole, and even of
individual insurance players. A number of recent failures and near failures of insurance companies
have revealed just how wide an economic impact insurers have. The high-profile collapse of a few
major insurers such as HIH and Independent, left businesses without essential insurance cover, and
critical services without professional indemnity coverage. Economic activity in these sectors might
have ground to a halt, had the government not stepped in. But by stepping in, the governments
created a new source of moral hazard.
These issues have been extensively debated. The IMF has concluded that the insurance industry,
while not systemically critical, has taken up a definite systemic relevance. We need to understand
better the nature of insurance companies' financial activities and their possible impact on global
financial stability.
In Singapore, the supervisors of banks, insurance companies and securities houses are housed under
one roof in MAS. This has given us a head-start in dealing with current industry trends, with financial
product boundaries blurring and insurance companies crossing over into banking and capital market
territory. The pressure is on to bring integrated supervision to an even deeper level.
Singapore's response
In today's new risk landscape, MAS aims to develop sound and efficient markets where risk can be
effectively spread and mitigated. We need to make sure that best practices prevail in the management
as well as regulation of insurance companies. Strong players will make for a resilient industry.
Two years ago, Singapore opened up completely the direct life and general insurance market. The
earlier closed-door policy had insulated both local and foreign incumbents from competition and
engendered complacency. Creating an open and competitive environment was the first step to raising
standards and strengthening resilience.
Since we opened up the industry, insurers in Singapore have taken various measures to enhance their
competitiveness. They have sharpened their business focus, moved into higher-value added and
higher-growth areas and improved professional standards. This will stand our insurers in good stead to
meet new challenges and opportunities.
Meeting new challenges and opportunities
Entering new growth areas
Globalisation of markets, advances in technology, changing demographics and socio-economic
patterns are some trends that will result in new or changing needs for insurance protection and
financial planning. Insurers should hone their skills in these new areas and take advantage of
emerging opportunities.
One important opportunity is in health insurance, especially financing the health care needs of the
aged. This is a challenge that is facing governments around the world. It is no different in Singapore
where the population is aging rapidly. Health insurance can play a greater role in financing old age
medical care than it now does. MAS plans to introduce in 2003, a regulatory framework for this
specialized area of insurance. We will be seeking feedback from local industry on this.
The government recently announced the launch of Eldershield, a national long-term care insurance
scheme to be underwritten by private insurance companies. Eldershield provides a basic level of
benefits, which many Singaporeans will wish to supplement. This will create opportunities for insurers
to structure and market appropriate Long-Term Care policies.
Credit insurance and political risk insurance are two other promising areas. Globalisation and lower
barriers to cross-border trade will spur continued internationalization of trade and support strong
demand for credit and political risk insurance.
Being located in Asia, a region that has traditionally witnessed strong trade flows, Singapore is
wellplaced to develop further as a hub for such activity. Several new specialist insurers and brokers have
in recent months set up a presence in Singapore, including financial guarantee insurers and trade
credit insurers and brokers.
Another growing area of business is bancassurance activity. Life insurance products sold through the
bancassurance channel now account for 25% of new life insurance business. Two new specialist
bancassurance players have established operations in Singapore, and contributed significantly to this
trend.
Increasing resilience
Amidst these new opportunities, more than ever, we now need to strengthen the resilience of the
insurance industry. The MAS has for some time, been working with the insurance and reinsurance
industry to raise standards of corporate governance, internal controls and professionalism. Many of
our companies are already at international best practice standards. However, as in all countries,
practices vary, and we aim to have all our insurers to attain best practice standards by 2005 if not
earlier.
Risk-based supervision
In 1998, MAS embarked on a strategic change in our regulatory philosophy. We moved from a
bottomup, audit-based inspection approach to a top-down, risk-based supervisory approach. This approach,
being prospective in nature, is well suited to today's world of new and increased risks.
Risk-based supervision evaluates the major risks faced by an institution and assesses how well these
risks are being mitigated. This will help both regulators and companies to identify and, importantly, to
pre-empt problems. Well-managed institutions will be given greater flexibility, while less well-managed
ones will be subject to closer scrutiny.
Singapore's risk-based supervisory framework for insurers
The basic framework for risk-based supervision of insurers in Singapore has been set up.
MAS is now developing risk profiles for each Singapore-based insurer. We have devised a five-step
"supervisory ladder of intervention", and will use it to classify insurers according to their risk rating. The
five steps range from "Normal" to "Viability at Risk" and terminally, "Winding Up or Closure".
Insurers assessed to be on the more critical steps will receive more stringent and intrusive supervisory
actions. MAS draws the analogy between the risk classification of an insurance firm and the medical
assessment of a patient's health. If an insurer is classified as being on the "Viability at Risk" step, it will
probably be admitted to MAS' Intensive Care Unit.
However, MAS is not regulating for a no-failure regime. We encourage industry consolidation. In
today's competitive environment, size brings financial strength and facilitates diversification on both
sides of the balance sheet. But it is not possible, and also not desirable, to operate on the basis that
we will never, under any circumstances, allow a financial institution to fail. That way lies moral hazard.
Improving corporate governance and internal controls
A risk-based supervisory approach relies heavily on the strength of company leadership and
management. Corporate governance is thus critical. MAS expects the Board of Directors to provide
clear strategic leadership and set consistent corporate values. Management teams must
operationalise these strategies while upholding the spirit of the corporate values.
Given the nature of the insurance business, corporate values need to be guided by risk management
concerns. What is the company's risk appetite? What should be its risk tolerance limits? What is the
level of risk management skills in the company? How profitable is the underwriting of various classes
of risks? Apart from answering to shareholder interests, the board of directors and management also
have a fiduciary duty to their policy-holders. Sound internal risk management and controls are needed
to protect policy-holders' interests.
Currently, our regulations oblige the Appointed Actuary to take responsibility for monitoring the
financial soundness of life insurance companies. But the Board and management cannot just sit back
and rely on the actuaries. Board and management themselves must acquire a better awareness and
understanding of actuarial assessment.
We need to set clear expectations of the role that the Board and management play, in ensuring the
financial soundness of their companies. MAS will work with industry and professional associations to
set out guidelines for this important area.
In Singapore, we established the Corporate Governance Code for listed companies last year. MAS
has tightened corporate governance standards for local banks. We recently required auditor rotation
for local banks, a policy which we had been considering for some time, even before the latest wave of
accounting scandals.
For insurance companies, we are currently working on a draft corporate governance framework. MAS
is consulting the industry and will issue guidelines for internal governance for local boards of directors,
as well as guidelines for the roles and responsibilities of Principal Officers of insurance companies.
The guidelines for internal governance will deal with the main responsibilities for the Board, stress the
importance of transparent and performance-linked compensation; emphasise the need for the integrity
of financial information; encourage fair dealings with the members of the public who are policy-holders
and urge insurers to engage in regular communications with policy-holders.
Life insurance companies are entrusted with the management of long term funds. We are considering
more rigorous corporate governance requirements for life insurers. We intend to formally introduce
and enforce the corporate governance framework for the insurance industry later this year.
Imposing risk-based capital requirements
In a world of new and increased risks, appropriate levels of capitalization are necessary. Insurers face
mounting complexities, given the increased volatility of asset risks and the diversity of liability risks.
In Singapore, as in many other countries, the existing statutory framework of solvency and capital
adequacy for insurers is essentially a "one-size-fits-all" approach. This is clearly no longer appropriate,
since different insurers have acquired different levels of exposures to financial risks and developed
different underwriting specialties.
In banking, a risk-based capital approach is well-established. There are clear guidelines from the Bank
for International Settlements, and a new standard is undergoing extensive worldwide consultation.
For the insurance industry, the same level of regulatory consensus does not as yet exist. MAS has
formed two work groups comprising industry practitioners, representatives of professional associations
and regulators to develop risk-based capital models for life and non-life insurance.
Besides refining the treatment of liability risk, we will also look at capital charges for asset risks. This
will help to level the playing field between banks and insurance companies, and minimise opportunities
for capital arbitrage. The new capital requirements should also provide an early indicator of financial
weaknesses, and thus facilitate progressive intervention by regulators. These risk-based capital
requirements will be introduced by end-2003.
Raising professional standards in insurance
To improve corporate governance and internal governance, it is critical to raise insurance professional
standards. All insurance professionals should constantly upgrade both their technical and
management skills.
In 2000, MAS appointed a private sector committee, the Committee for Efficient Distribution of Life
Insurance Products (CEDLI) to recommend minimum standards of transparency, competition and
efficiency in the distribution of life insurance products. MAS accepted CEDLI's recommendations to
enhance the sales advisory process and professional training.
To date, industry practitioners have adopted these minimum standards enthusiastically. Many have
gone further, and set their own requirements that exceed the prescribed standards, because they
realised that this makes them more competitive in the market. This has improved the level of
professionalism among life insurance agents and greatly enhanced the reputation of the industry,
which in turn, is helping the industry to attract higher-calibre talent.
Training and competency requirements should apply across-the-board to all insurance professionals,
and not just to life insurance intermediaries. MAS is currently reviewing the manpower capabilities of
the insurance industry and will identify the main competency gaps and areas of weakness. Apart from
upgrading professional competency, consideration will also be given to the technical competency of
company directors and other staff involved in the insurance business. We will work with industry to
formulate an insurance manpower development strategy. We envisage industry players, training
providers and tertiary institutions co-operating to develop programmes that will enhance
professionalism in the insurance industry.
Conclusion
MAS will continue to work together with the insurance industry to achieve international best practices
and standards. Over the past two years, MAS has worked hard to build a closer partnership with the
financial sector. We will continue to promote an open environment and consult actively with the private
sector for its views. The relationship between the regulator and the regulated should be arms length
but not adversarial. The regulator has to be firm, but also friendly. Market practitioners can help
regulators generate ideas, keep abreast of market developments, anticipate global trends and review
our financial sector strategies. Candid, thoughtful feedback, including dissenting views, go a long way
to ensure that policies are pragmatic and remain relevant.
We hope that such a regulatory environment will help to develop well-managed insurers in Singapore,
who will take up new challenges, and play a more active and productive role in upgrading our
insurance industry, and thus our financial sector as a whole.
I wish you fruitful deliberations.