metadata: authors: 0: author: Vittas,Dimitri
count: Mauritius
docna: 0: docna: The insurance industry in Mauritius
docty: Policy Research Working Paper
subtopic: Urban Housing and Land Settlements,Social Funds and Pensions,Urban Governance and Management,Urban Housing,Insurance & Risk Mitigation,Capital Markets and Capital Flows,Non Bank Financial Institutions,Capital Flows,Municipal Management and Reform,Transport Services,Financial Sector Policy
teratopic: Finance and Financial Sector Development
abstracts: cdata!: The insurance industry is relatively
            well developed. It makes extensive use of reinsurance
            facilities and is free from the pervasive premium, product,
            investment, and reinsurance controls that have bedeviled the
            insurance markets of so many developing countries around the
            world. Total premiums amounted in 2001 to 4.1 percent of
            GDP, while insurance company assets were equivalent to 18
            percent of GDP. Life insurance, which has been favored by
            generous tax incentives and has also benefited from the
            growth of pension business and housing finance, represents
            61 percent of total premiums. Nonlife business is also well
            organized. Large industrial and commercial risks are
            reinsured with top international companies, while motor
            insurance, which is the largest class of business with 45
            percent of total nonlife premiums, does not suffer from high
            loss ratios or unduly long delays in settlement. Investment
            limits are generally sound and, with some small but
            important exceptions, effectively nonbinding. There is no
            minimum requirement for investment in government securities.
            Investment in overseas assets is limited to 25 percent of
            total assets, except for foreign life companies and general
            insurance business which are not allowed to invest in
            overseas assets. The insurance sector is highly
            concentrated. The three largest groups have 76 percent of
            total assets. Despite the high level of concentration, the
            insurance industry appears to be competitive, operating with
            high efficiency and re Despite the high level of
            concentration, the insurance industry appears to be
            competitive, operating with high efficiency and reasonable
            profitability. Large and medium-size companies have strong
            reserves, appropriate reinsurance arrangements, and good
            profitability. However, several of the smaller companies
            have weak financial ratios and suffer from long delays in
            settling claims. Insurance regulation and supervision is
            entrusted to the Financial Services Commission (FSC). The
            current regulatory framework has many strong elements,
            including reliance on solvency monitoring, prudent asset
            diversification, international accounting standards, and
            actuarial methods. But there are some important gaps in
            corporate governance, internal controls, and risk
            management. In addition, solvency ratios are below
            international standards and do not include modern risk-based
            capital requirements. These gaps are already being addressed
            in two new draft insurance bills which contain many highly
            modern provisions. Implementing regulations on solvency and
            actuarial standards need to be developed. Insurance
            supervision has been invigorated since the creation of the
            FSC, but further strengthening is required. It needs to
            emphasize risk management and internal controls, to develop
            an early warning system, and to establish clear procedures
            for early and effective intervention. The FSC should require
            actuaries to report on the reinvestment risk faced by
            insurance companies and their exposure to a large and
            persistent fall in interest rates.
geo_reg_key: 517191
repnme: repnme: The insurance industry in Mauritius
display_title: The insurance industry in Mauritius
listing_relative_url: /research/2003/04/2329627/insurance-industry-mauritius
topicv3: Pension Funds m1326066 611,Transport m1326661 135,Land and Housing m1327648 817,Financial Sector Development m1327681 1920,Life Insurance m1505058 3837
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Finance and Financial Sector Development
origu: FSD
no_of_pages: 28
author_keys: 0: author_key: 92949
model_extractions: POLICY RESEARCH WORKING PAPER 3034

# Abstract

The insurance industry is relatively well developed. It makes extensive use of reinsurance facilities and is free from the pervasive premium, product, investment, and reinsurance controls that have bedeviled the insurance markets of so many developing countries around the world.

Total premiums amounted in 2001 to 4.1 percent of GDP, while insurance company assets were equivalent to 18 percent of GDP.

Life insurance, which has been favored by generous tax incentives and has also benefited from the growth of pension business and housing finance, represents 61 percent of total premiums.

Nonhfe business is also well organized. Large industrial and commercial risks are reinsured with top international companies, while motor insurance, which is the largest class of business with 45 percent of total nonlife premiums, does not suffer from hligh loss ratios or unduly long delays in settlement.

Investment limits are generally sound and, with some small but important exceptions, effectively nonbinding. There is no minimum requirement for investment **in** government securities. Investment in overseas assets is limited to _25_ percent of total assets, except for foreign life companies and general insurance business which are not allowed to invest in overseas assets.

The insurance sector is highly concentrated. The three largest groups have 76 percent of total assets. Despite the high level of concentration, the insurance industry appears to be competitive, operating with high efficiency and reasonable profitability.

Large and medium-size companies have strong reserves, appropriate reinsurance arrangements, and good profitability. However, several of the smaller companies have weak financial ratios and suffer from long delays **in** settling claims.

Insurance regulation and supervision is entrusted to the Financial Services Commission (FSC). The current regulatory framework has many strong elements, including reliance on solvency monitoring, prudent asset diversification, international accounting standards, and actuarial methods.

But there are some important gaps in corporate governance, internal controls, and risk management. In addition, solvency ratios are below international standards and do not include modern risk-based capital requirements. These gaps are already being addressed **in** two new draft insurance bills which contain many highly modern provisions. Implementing regulations on solvency and actuarial standards need to be developed.

Insurance supervision has been invigorated since the creation of the FSC, but further strengthening is required. It needs to emphasize risk management and internal controls, to develop an early warning system, and to establish clear procedures for early and effective intervention.

The FSC should require actuaries to report on the reinvestment risk faced by insurance companies and their exposure to a large and persistent fall in interest rates.

This paper-a product of the Financial Sector Operations and Policy Department-is part of a larger effort in the department to study insurance companies and contractual savings. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washingtoni, DC 20433. Please contact Priscilla Infante, room MC9-904, telephone 202-4737642, fax 202-522-7105, email address pinfante@worldbank.org. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at dvittas@worldbank.org. April 2003. (19 pages) _The Policy Research Working Paper Series disseminates the findings of work_ **_in_** _progress to encourage the exchange of ideas about development issues An objective of the series_ **_is_** _to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the auithors anid should be cited accordingly. The findizgs. interpretatiois, and conclusions expressed_ **_in this_** _paper are entirely those of the authors 7hey do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent_ Produced by the Research Advisory Staff
### Financial Sector Development World Bank

# The Insurance Industry in Mauritius

## Dimitri Vittas
# Table of Contents*

|I.|Introduction|1|
|---|---|---|
|II.|InsuranceMarketDevelopment|1|
|III.|InstitutionalStructureandPerformance|4|
|IV.|Long-Term(Life)Insurance|6|
|V.|GeneralInsurance|9|
|VI.|Motor Insurance|13|
|VII.|RegulationandSupervision|14|
|VIII.|FutureProspectsandPolicyIssues|16|
||References|19|

* The paper has benefited from comments and insights provided by officials of the<sup>Financial</sup> Services Commission of Mauritius, the Insurers Association, representatives of Mauritian insurers, brokers and consulting firms and colleagues at the World Bank. Special thanks are due to Rehana Kasenally and Maheswar Beefeya of the Financial Services Commission for their help in obtaining the relevant data.
Gossary

- FSC Financial Services Commission IBNR Incurred But Not Reported NEP Net Earned Premiums NIC Net Incurred Claims NPF National Pensions Fund NSF National Savings Fund ROA Return on Assets ROE Return on Equity SICOM State Insurance Corporation of Mauritius
# I. Introduction

Mauritius, a small island economy in<sup>the IndianOceanoff the coast of Africa, has</sup> been remarkably successful in achieving<sup>rapideconomicgrowthinthecontextof</sup> financial and political stability. This<sup>successisinsharpcontrasttothepooreconomic</sup> performance of most neighboring<sup>countries intheAfricancontinentandhasbeen</sup> attributed to the pursuit of stable macroeconomic<sup>policiesand thecreationof a regulatory</sup> framework that encourages private sector<sup>development.Theimportanceof efficientand</sup> well functioning institutions in explaining<sup>the stronggrowthperformanceof Mauritiusis</sup> highlighted in Subramanian and Roy (2001).

These policies have benefited many<sup>sectorsoftheeconomy,includingthe</sup> financial sector. They have stimulated<sup>thegrowthofbanksaswellasinsurance</sup> companies and pension funds. The<sup>authoritieshaveavoidedusingpriceandproduct</sup> controls and imposing prescribed<sup>investmentrequirementsonfinancialinstitutions.</sup> Instead of relying on direct controls,<sup>theyhaveplacedgreateremphasisonapplying</sup> sound prudential regulations to ensure<sup>thatfinancialinstitutionsareable tocompeteand</sup> innovate without undermining the security<sup>of the financialsavingsof the public.</sup> This paper examines the structure and performance<sup>of theinsuranceindustryin</sup> Mauritius.' The Mauritian insurance<sup>industryisrelativelywelldeveloped, makes</sup> extensive use of reinsurance facilities,<sup>andisfreefromthepervasivepremium,product,</sup> investment and reinsurance controls<sup>thathavebedeviledtheinsurancemarketsofso</sup> many developing countries around the<sup>world.The paperaims todocumentthe successof</sup> the insurance sector, but also to highlight<sup>someimportantareaswhere problemsarise.In</sup> particular, the need for a more effective<sup>supervisionof insurancecompaniesis stressed.</sup><sup>**2**</sup> The paper is organized as follows. Section<sup>IIreviewstheextentofinsurance</sup> market development in comparison to<sup>othercountries. Sectionmfocusesonits</sup> institutional structure and overall performance.<sup>The followingthreesectionsofferin turn</sup> brief reviews of the state of development,<sup>structureand performanceof long-term(life),</sup> general and motor insurance. Section<sup>VIIexaminestheregulatoryandsupervisory</sup> framnework, drawing attention to its<sup>strengths andweaknesses.The paperconcludeswith</sup> a section on future prospects and policy issues.

# **II.** Insurance Market Development

Mauritius has a much higher insurance<sup>penetration(premiumsasa percentageof</sup> GDP) than India, Lebanon, Morocco<sup>andSriLankaand isonthesamelevelasChile,</sup> Cyprus and Singapore (Sigma 2002).<sup>Total annualpremiumsamountedto5.3billion</sup> rupees in 2001, corresponding to 4.1<sup>percentofGDP(Table1).Lifepremiums</sup>

> 1 Similar analyses have been undertaken<sup>for the US insuranceindustry by Wright(1992) andGrace and</sup> Barth (1993) and for Tunisia by Vittas (1995).

> 2 The paper does not cover the operations of<sup>the captive insurance companiesor the Sugar InsuranceFund</sup> that offers specialized coverage to sugar planters<sup>and millers.</sup>
represented 61 percent of the total, providing a further indication of the development of the sector. The level of per capita premiums amounted to USD 156 in 2001. This compared with USD 12 in India, 10 in Sri Lanka and 113 in Mexico.

Table 1: l[nsurance Premiums, 2001

|percentofGDP|Total|Non-Life|Life|%Life|
|---|---|---|---|---|
|Mauritius|4.06|1.59|2.47|61|
|Chile|4.23|1.30|2.93|69|
|Cyprus|4.46|2.00|2.46|_55_|
|India|2.71|0.56|2.15|79|
|HongKong|6.34|1.21|5.13|81|
|Lebanon|2.70|2.22|0.48|18|
|Malaysia|5.18|1.80|3.38|65|
|Malta|4.26|2.28|1.99|47|
|Mexico|1.81|0.95|0.86|48|
|Morocco|2.82|2.01|0.81|29|
|Singapore|4.58|1.17|3.40|74|
|SouthAfrica<br>|17.97<br>|2.78<br>|15.19<br>|85<br>|
|SriLanka|1.20|0.67|0.53|44|

Source: FSC and Sigma.

Life business has been favored by generous tax incentives and has also benefited from the high level of development of pension funds on the one hand and housing finance on the other (Vittas 2003). In recent years, life insurance business and the total assets of insurance companies, which are linked to life policies, have grown faster or, at least, as fast as GDP (Table 2). The share of life premiums in total insurance premiums has been rising steadily.

The breadth of tax incentives cannot be exaggerated. Life premiums are deductible from income tax up to MUR 80,000 per family per year (about 80 percent of per capita income), while investment income is treated favorably and policy payouts are free from tax. In addition, both pension saving and housing loans enjoy considerable tax advantages. Pension contributions are exempt from tax without any ceiling, while interest on housing loans is deductible up to MUR 250,000 per family per year. Interest relief is available on all secured loans used for primary housing or education purposes, even those secured by life insurance policies - thus, providing a further incentive for purchasing life insurance to middle and high income people.

Table 2: Evolution of lInsurance lBusiness, 1997-2001

||1997|1998<br>(perce|1999<br>ntofGD|2000<br>P)|2001|
|---|---|---|---|---|---|
|Total Assets|16.0|16.7|17.9|17.8|18.2|
|LifePremiums|2.15|2.16|2.21|2.34|2.47|
|GeneralInsurancePremiums|2.07|1.81|1.68|1.66|1.59|
|TotalGrossPremiums|4.22|3.97|3.89|4.00|4.06|
|ShareofLife Business(%)|51<br>Source:FS|54<br>C|57|58|61|

2
Internationally, South Africa and Ireland<sup>haveverylargelifeinsurancesectors</sup> and in both countries, tax incentives<sup>playa majorpart that is fuelled by the high marginal</sup> tax rates applying in these countries.<sup>In Mauritius,therelatively lowpersonalincome tax</sup> rates and the availability of a large<sup>varietyof deductionsweakenthetaxadvantagesof</sup> individual life insurance policies.

In the nonlife sector, motor insurance<sup>isthelargestcomponent.It doesnot suffer</sup> from very high loss ratios as is the<sup>caseinmostotherdevelopingcountries.The useof</sup> high deductibles has helped to keep<sup>lossratios lowandhasallowedmanysmallinsurers</sup> to survive despite their operating inefficiencies.<sup>General insurancebusinessissubject to</sup> high volatility of premiums, claims<sup>andearningslinkedtocyclicalfluctuationsin</sup> economic activity and the adverse<sup>impactof largelossescaused by low frequencyevents,</sup> such as devastating cyclones and<sup>firesaffectinglargetextilefactoriesandhotels.</sup> Insurance companies use international<sup>reinsurancefacilitiesfortheirlargeindustrial and</sup> commercial risks. Most companies<sup>arewellcapitalizedandreserved,although some</sup> small companies have long faced financial<sup>difficulties.</sup> Insurance companies are majorparticipants<sup>in the contractualsavingsmarket.As</sup> noted in Vittas (2003), Mauritius belongs<sup>toa select group of developing countrieswhere</sup> contractual savings (i.e., savings with<sup>insurancecompaniesand pensionfunds)exceed 40</sup> percent of GDP and represent a major<sup>potential force inthe localfinancialsystem.</sup> Other developing countries with large<sup>contractualsavingssectorsincludeSouth</sup> Africa, Malaysia and Chile alongside<sup>mosthighincomecountriesandsomeisland</sup> economies like Cyprus and Malta. The<sup>vastmajorityof developingcountriesinAfrica,</sup> Asia and Latin America as well as<sup>mosttransitioncountriesof EasternEuropearewell</sup> below this level.

The total assets of insurance companies<sup>from boththeirpensionandnon-pension</sup> business amounted in 2001 to MUR<sup>24billion, equivalentto18.2percentof GDP.This</sup> represented 45 percent of net contractual<sup>savings.Nearly40percentofinsurance</sup> company assets are linked to pension<sup>schemesthatareinsuredand/oradministeredby</sup> insurance companies.

The other major participants in the<sup>contractual savingsmarketaretheNational</sup> Pensions Fund (NPF) and National<sup>SavingsFund(NSF), 'whichhaveacombined45-</sup> percent of the market, and the self-administered<sup>funded, pension,schemescreatedby</sup> statutory bodies and private companies,<sup>whichaccountfortheremaining10percent.</sup> Public sector institutions, including<sup>the NPF,NSF and theState InsuranceCorporationof</sup> Mauritius (SICOM) are responsible<sup>formanaging57percentof thetotal,althoughthe</sup> operations of SICOM are no different<sup>fromthose of any privatesector manager.</sup> As a group, contractual savings<sup>institutions investheavilyingovernment</sup> securities (mostly two-year treasury<sup>bills)andhousing loans. But sincethey benefitfrom</sup> positive cash flows and their total<sup>assetsarelikelytocontinuetogrowrelativeto GDP,</sup> they represent a major source of<sup>demandforlong-durationassets.Theycantherefore</sup> stimulate the development of the<sup>marketfor long-termgovernmentbonds(bothinflation-</sup> 3
linked and zero-coupon), corporate debentures, mortgage bonds and mortgage-backed securities, corporate equities, and venture capital.

# f1111 EnsfitudonaR Structure and Pirformance

> There are 22 insurance companies operating in Mauritius.<sup>3</sup> This is a large number for the size of the local market, although some of the smaller companies appear to serve

> segments of the market that are unattractive to the larger companies. 19 of these

> companies are locally incorporated by Mauritian interests, 2 are local branches of Indian

> companies (present in Mauritius since the early 1960s), and the last is the South African

> subsidiary of Munich Re, which specializes in reinsurance.

11 of the 19 local companies operate as composites, engaging in both life and nonlife business, while 2 specialize in long-term (life) business and 6 in short-term (general) insurance. Two groups operate separate insurance subsidiaries in both segments of the market. One of the Indian companies is a long-term insurer, while the other specializes in short-term business.

> The insurance industry experienced considerable new entry over the past two

> decades. 5 new companies were established in the 1990s and another 5 in the 1980s.

> Several of these companies face financial difficulties, including 3 that were intervened over the past couple of years. The authorities have raised the minimum capital

> requirement (now standing at MUR 25 million, close to USD 1 million) in an attempt to

> strengthen the financial soundness of all companies and encourage a consolidation of the

> sector through mergers, but so far there has been very limited exit through merger or liquidation.

> Some of the smaller companies incurred large losses over several years. In one

> case, accumulated losses exceeded the paid up capital of the company, resulting in the

> company operating with negative equity. Another 2 companies had equity capital

> significantly below the minimum capital requirement. All these companies received

> capital injections during 2002.

Foreign companies may operate with branches or subsidiaries. Apart from the two Indian companies, and the recent arrival of a Sri Lankan company, there are no other foreign companies. None of the large multinationals has a local presence in Mauritius, perhaps because of the small size of the market and the strong performance of local companies. However, one multinational company has a small stake in a medium size local company.<sup>4</sup> Despite the presence of a large number of companies, the sector is characterized by a highly oligopolistic structure with a few companies holding the lion's share of the market. However, the market is deemed to be contestable with keen competition in several segments. The largest three groups (SICOM, Swan/Anglo Mauritius, and British American Insurance) control 76 percent of total assets. The largest company is effectively

> 3 Another 2 companies are registered but are not active.

> 4 Eagle Star of South Africa of the Zurich Group has a participation in Mauritian Eagle.

4
owned by the state, either directly or through other state entities.<sup>Nevertheless,it appears</sup> to operate at arm's length from the govemment and to be highly<sup>efficientand profitable.</sup> It has a 36 percent share of total insurance company assets, but<sup>thisincludes theassets of</sup> pension funds, mostly of statutory bodies, that it administers<sup>butdoesnotinsure.</sup> Excluding this business, its share of total assets falls to 11 percent.

Dividing the 21 insurance companies by size reveals some<sup>interestingpatterns</sup> (Table 3)5. The four largest companies account for 76 percent<sup>oftotal assets,but 84</sup> percent of retained profits, while small companies account<sup>foronly3percent ofthe</sup> market. The 8 small companies as a group have negative<sup>accumulated (retained)profits,</sup> but they report as a group high solvency ratios. However, some of the small<sup>companies</sup> have strong balance sheets and sound operations.

**Table 3: Structure and Performance of Total Insurance Market, 2001**

|(percent)|4Large<br>Companies|9Medium<br>Companies|8Small<br>Companies|1Reinsurer|All<br>Companies|
|---|---|---|---|---|---|
|TotalAssets|75.7|20.7|2.9|0.6|100.0|
|EquityCapital|61.8|31.1|7.1||100.0|
|<br>RetainedProfits|83.8|21.2|-7.9|2.9|100.0|
|GrossPremiums|59.7|31.9|8.3|0.1|100.0|
|Equity/TotalAssets|7.86|14.44|23.47||9.69|
|<br>Equity/TotalPremiums|44.8|42.1|37.5||43.3|
|<br>ReturnOnAverageEquity|21.5|20.9|13.3||20.7|
|<br>ReturnonAverageAssets|1.73|2.93|2.94||2.00|
|<br>Profits/GrossPremiums|9.18|8.16|4.62||8.48|

ROE and ROA are equal to profits before taxes divided respectively by average<sup>equity andaverage assets.</sup> Source: Estimated on the basis of data collected by the FSC..

Profitability of the insurance sector is healthy, but not excessive,<sup>despitethehigh</sup> level of concentration of the industry. This supports the argument that the<sup>marketis</sup> contestable. The return on average equity (ROE) amounted to 21<sup>percentforall</sup> companies taken together in 2001, but was significantly lower for the<sup>groupofsmall</sup> companies. The return on average assets (ROA) amounted to 2 percent. It<sup>waslowerfor</sup> the large companies, because of their lower equity ratios and reached nearly<sup>3</sup> percent for the other groups of companies. A couple of individual companies report<sup>very high ROAs</sup> of well over 4 percent. These companies operate with very high equity ratios. In<sup>one case,</sup> equity capital exceeds 40 percent of total assets.

The insurance industry suffers from considerable cyclicality<sup>(Table4).In</sup> Mauritius this is linked to the impact of cyclones and other causes of large but<sup>infrequent</sup> losses. Judicious use of reinsurance facilities has, however,<sup>shieldedlocalcompanies</sup> from the full effects of such events. Cyclicality is also linked<sup>totheconditionsthat</sup> prevail in financial markets. While the level of interest<sup>rates inMauritiushasnot</sup> experienced the wide fluctuations that are seen in other countries, financial<sup>resultshave</sup> suffered from the volatility of local and intemational equity markets. Insurance

> 5 The reported data aggregate statistics of individual companies. Most companies have<sup>financialyears</sup> ending in December but several report at the end of June and some use other<sup>months.</sup>

5
> profitability was low, though still satisfactory, in- 1999 as a result of the effects of

> protracted drought.

Table 4: Cyclicality of Finmcial results, 1997-2001

||1997|1998|1999|2000|2001|
|---|---|---|---|---|---|
|OwnFunds/TotalLiabilities%|10.7|10.4|10.0|9.5|9.7|
|LTInsurFund/TotalLiabilities%|72.3|73.3|75.7|_e_76.9|77.6|
|GeneralInsurReserves/TotalLiabilities%|<br>7.6|6.8|6.1|5.7|5.2|
|ROA|2.19|2.02|1.54|1.61|2.00|
|ROE|20.6|19.4|15.4|17.0|20.7|
|Profits/GrossPremiums(%)|8.33<br>Source:FSC|8.50|6.87|7.18|8.48|

Insurance companies have adequate asset diversification. According to FSC statistics, government securities represented 8 percent of total assets and corporate securities (both equities and debentures) 35 percent (Table **5)6** Housing loans account for 23 percent of assets. They used to be the largest type of asset but have declined in recent years, reflecting the growing presence of banks in this important market. Although the long-term insurance fund, representing the assets of life business, can be invested overseas up to a limit of 25 percent and despite the presence of several large privately owned companies, foreign securities absorb less than 10 percent of total assets. In fact, SICOM, the state-owned company, invests more in foreign assets than even the large private companies. Other assets absorb 11 percent of total assets. They include loans to shareholders, which in the case of some small companies, are large relative to capital (see below).

Table 5: Asset Allocation of Insurance Companies, 1997-2001

|(percentoftotal)|1997|1998|1999|2000|2001|
|---|---|---|---|---|---|
|MortgageLoans|30|26|25|25|23|
|OtherLoans|8|5|_5_|_5_|4|
|Government Securities|7|9|6|7|8|
|Shares&Debentures|22|26|30|35|35|
|Land&Property|6|7|6|_5_|_5_|
|Deposits&Securities|16|16|17|13|14|
|OtherAssets|11|11|11|10|11|
|Total|100|100|100|100|100|
|TotalAssets(MURmnillion)|14130|16672|19200|21123*|23971|

Source: FSC

# KY0 Long-Term (LTe) nsuraimce

14 companies operate in the life sector. 11 of these are composites and only 3 specialize in life insurance -(2 Mauritian companies plus the local branch of the Life Insurance Corporation of India). Concentration in the sector is very high. The largest 3

> **6** As noted above, official statistics probably understate the share of government securities in the portfolios of insurance companies.

6
> companies accounted for 79 percent of premiums in 2001, while the Herfindahl. concentration index stood at 2168. Concentration is even higher with regard to the long term insurance fund. The share of the long term fund held bt the largest 3 companies was

> 83 percent, while the Herfidanhl index was as high as 2872.

Despite the high level of concentration, it is claimed by local experts that competition for new business is very keen. The largest 3 companies specialize in particular segments of the market-that they dominate. SICOM obtains a very large part of its business from the pension funds of statutory bodies, while Anglo-Mauritius has a dominant share of insured company pension schemes. British American specializes in what looks like "industrial life" insurance: low-premium, low-value insurance sold to low-income households. In fact, British American has 60 percent of premiums generated by new business, although it probably experiences much higher lapse and surrender rates than the other large companies. Allowing for these differences, competition for new business in other market segments is much keener than may be implied by the overall concentration indices.

Long-term insurance business operates on the whole with sound financial ratios (Table 6). A small part of premiums is ceded to reinsurers (4 percent), while net claims (payments for all kinds of benefits, including surrenders) amount on average to 52 percent of net premiums. Administration costs absorb about 17 percent of net premiums and net commission paid to agents add another 4 percent, resulting in a total'charge of 21 percent of net premiums. -

|**Table6:FinancialRatios**<br>t|**ofLong**<br>1997|**-Term **<br>18|**Insuran**<br>|**ce,1997**<br>|**-2001**<br>|
|---|---|---|---|---|---|
|(percen)||99|1999|2000|2001|
|CededPremiums/Gross Premiums<br>|5.3<br>|4.1<br>|4.1<br>|4.2<br>|3.8<br>|
|NetClaims/NetPremiums<br>|48.2<br>|54.6<br>|54.2<br>|52.8<br>|52.5<br>|
|NetCommissions/NetPremiums<br>|6.1<br>|5.4<br>|4.6<br>|4.3<br>|4.0<br>|
|AdminCosts/NetPremiums<br>|15.3<br>|16.1<br>|15.9<br>|16.6<br>|16.8<br>|
|Investment Income/Net Premiums<br>|56.9<br>|72.5<br>|63.2<br>|58.4<br>|52.7<br>|
|AnnualSurplus/NetPremiums<br>|90.0<br>|96.4<br>|88.5<br>|84.7<br>|79.4<br>|
|Changein LifeFund/NetPrem<br>|91.4<br>|93.2<br>|86.0<br>|80.8<br>|75.2<br>|
|Profit/NetPreniums<br>|-1.4<br>|3.2<br>|2.5<br>|3.9<br>|4.2<br>|
|Profit/AnnualSurplus<br>|-1.6<br>|3.4<br>|2.8<br>|4.5<br>|5.3<br>|
|ReturnonAverageLifeFund|10.9|13.4|10.9|10.2|_9.5_|

> Source: Estimated on the basis of data collected by the FSC.

> Investment income on the life fund has fluctuated significantly over the years reflecting market returns on the underlying assets. On average it amounted to around 60

> percent of net income, leaving an annual surplus in excess of between 80 and 95 percent of net premiums. Over 95 percent of the annual surplus has been credited to the life fund. The rate of return on the life insurance fund has fluctuated between 9.5 and 13.4 percent between 1997 and 2000. This is at'the same level as that achieved by the National

> 7 In the US, a Herfindahl index of 1800 is used as a threshold value for defining a market as concentrated

> and meriting the attention of competition policy authorities.

7
Pensions Fund and compares favorably with the performance of self-administered private pension funds (Vittas 2003).

Reserving policies are deemed by local actuaries to be adequate, at least for the large and medium companies. Actuaries use mortality tables from the<sup>UnitedKingdom,</sup> while future actuarial liabilities are discounted at nominal rates that are close<sup>to</sup> prevailing market interest rates.

The typical life policies are participating policies where 90 percent of profits must be distributed to policy holders. Unit-linked business is not well-developed.<sup>Housing</sup> loans are tied to endowment insurance, though borrowers may opt for<sup>lifecoverona</sup> declining balance basis.

The more advanced companies adopt modem asset/liability management techniques in detennining the allocation of assets. However, the absence of<sup>zerocoupon</sup> bonds and other sophisticated instruments and the general underdevelopment of the local financial markets limit the applicability of such techniques.

The life insurance companies face considerable reinvestment risk arising from the current duration mismatch of their assets and liabilities. This is caused by<sup>thedearthof</sup> long-term assets in the local financial system on the one hand and the prevalence of long duration liabilities on the other. Some insurance companies offer minimum<sup>guaranteed</sup> rates of return on their policies, but these are subject to periodic review, thus<sup>limitingthe</sup> exposure of insurers to a large and persistent fall in the level of interest rates. Guaranteed rates of return are low compared to the current level of interest<sup>ratesandinsurance</sup> companies typically retain considerable discretion over terms and conditions. Nevertheless, insurance companies in several European countries have<sup>beenhit by the</sup> offer of guaranteed returns and caution is advisable.

Endowment insurance policies are linked to housing loans and thus are nominally well hedged. But they raise the possibility of even greater mismatch exposure<sup>if housing</sup> loans were prepaid in the event of a large fall in interest rates, but endowment policies were not surrendered. Admittedly, companies have built in various protective features<sup>in</sup> their operations but could still be exposed to large losses. Similarly,<sup>grouppension</sup> business that is linked to defined benefit plans involves the offer of guaranteed<sup>annuity</sup> options that could expose insurance companies to significant losses in the<sup>eventof a large</sup> and persistent fall in interest rates.

Operating and investment performance varies considerably among individual companies by size. In general, the 3 largest companies operate with<sup>muchlower</sup> administration and acquisition costs of 21 percent of net premiums<sup>againsta hefty41</sup> percent for small companies (Table 7). Large companies earned in<sup>2001(aswellasin</sup> some earlier years) a lower return on their life insurance fund than the smaller<sup>companies.</sup> However, the difference in returns was small and was completely offset by the higher administration and acquisition costs of smaller companies. The higher level of claims of small companies, probably reflecting a greater occurrence of policy surrenders,<sup>andtheir</sup> 8
higher expense ratios resulted in a much lower annual surplus and a slower build-up of the life fund.

**Table 7: Structure of Long-Term Insurance, 2001**

|(percent)|3Large<br>Companies|5Medium<br>Companies|6Small<br>Companies|All<br>Companies|
|---|---|---|---|---|
|GrossPremiums|79.0|17.7|3.3|100.0|
|CededPremiums/GrossPremiums|3.2|5.7|8.8|3.8|
|NetClaims/NetPremiums|53.1|48.2|60.2|_52.5_|
|NetCommissions/NetPremiums|3.2|6.9|8.4|4.0|
|AdminCosts/NetPremiums|14.4|20.6|32.7|16.8|
|InvestmentIncome/NetPremiums|53.4|49.8|51.8|52.7|
|AnnualSurplus/NetPremiums|82.7|74.1|50.6|79.4|
|<br>ChangeinLifeFund/NetPremiums|82.5|69.2|42.6|75.2|
|<br>ReturnonLifeFund|10.2|10.4|11.1|9.5|
|MultipleofAssetsoverPremiums|6.2|4.8|4.0|5.9|

* percent of gross premiums Source: Estimated on the basis of data collected by the FSC.

# V. General Insurance

18 companies operate in the general insurance market, 11 are composites and 7 specialize in nonlife business. However, one of the composites (British American) is predominantly a life insurer with a very small and selective participation in nonlife insurance. The general insurance market comprises five classes of business, viz. fire, motor, personal accident, transport and miscellaneous. Except for the last named, concentration is much smaller in these classes than in life insurance. For general insurance as a whole, the four largest companies accounted in 2001 for 56 percent of gross premiums, while the Herfindahl index ainounted to 1090 (compared with 2168 for life insurance).

Motor insurance is the largest class of general insurance, accounting for 45 percent of total nonlife premiums in 2001 (Table 8). Its share has been rising, reflecting the growing number of cars in circulation. But the fire and miscellaneous insurance classes are also relatively large, each with about 20 percent of total premiums. These two lines cover large industrial and commercial risks and tend to rely heavily on reinsurance.

Most large industrial and commercial risks are reinsured with nonproportional treaties. This is a very sound policy, because their gross claims ratios show considerable variability, connected to the volatility of large losses caused by low frequency events. Outside motor insurance, where only 13 percent of premiums are ceded to reinsurers, the other four classes operate with an average reinsurance ratio of 75 percent. In line with most developing countries around the world, product liability and malpractice insurance are not developed.

9
Table 8: General Insurance by Line of 1Busmess, 1997-2001

||1997|1998|1999|2000|2001|
|---|---|---|---|---|---|
|GrossPremiums||(percentof|totalprem|iums)||
|FirePremiums|26.2|22.8|22.6|20.2|20.4|
|Motor|37.9|41.4|41.9|43.6|44.5|
|PersonalAccident|8.8|7.6|7.9|7.5|7.8|
|Transport|9.4|9.4|8.3|7.8|9.3|
|Miscellaneous|17.7|18.8|19.5|20.8|18.0|
|Total|100.0|100.0|100.0|100.0|100.0|
|ReinsuranceRatio||(percentof|grossprem|iums)||
|Fire|79|80|84|85|85|
|Motor|15|13|14|14|13|
|PersonalAccident|57|65|68|68|70|
|Transport|62|61|61|60|62|
|Miscellaneous|65|68|67|76|70|
|Total|49|47|48|49|47|
|Gross ClaimsRatio||(percentof|grossprem|iums)||
|Fire|33|33|242|30|24|
|Motor|64|78|81|86|74|
|PersonalAccident|41|42|39|32|32|
|Transport|20|36|38|21|24|
|Miscellaneous|47|55|94|79|62|
|Total|47|57|113|59|53|
|Net ClaimsRatio||(percentof|netpremiu|ms)||
|Fire|29|41|100|36|34|
|Motor|66|71|77|74|65|
|Personal Accident|49|38|48|32|43|
|Transport|28|39|34|23|31|
|Miscellaneous|45|58|75|68|62|
|Total|56|63|75|66|59|

This table follows the classification used by the FSC. Reinsurance treaties are placed according to fire (including flood and cyclone); engineering (including contractors all risk and machinery breakdown); marine (including cargo, hull and pleasure crafts); miscellaneous accident (including personal accident); motor; and liabilities.

# Source: FSC

10
The claims experience of the past five years demonstrates the large volatility of losses. In fire insurance, the gross claims ratio fluctuates around 30<sup>percent ofgross</sup> premiums. However, in 1999 as a result of the protracted drought it<sup>jumpedto242</sup> percent. Yet, because of the use of nonproportional reinsurance treaties,<sup>thenetclaims</sup> ratio did not exceed 100 percent of net premiums. Fluctuations<sup>in the net claimsratioare</sup> thus much smaller than in gross claims.

Like long-term business, general insurance also exhibits sound financial ratios (Table 9). Net claims ratios are low by intemational standards. Acquisition<sup>costsbenefit</sup> from the high commissions received from reinsurers. These exceed the commissions<sup>paid</sup> to local agents and thus cover some of the overhead expenses<sup>of localcompanies.Asa</sup> result, net administration and acquisition costs amount to about 15 percent<sup>ofgross</sup> premiums, although they represent 30 percent of net earned premiums.<sup>Investment</sup> income amounts to 25 percent of net earned premiums.<sup>Asalreadynoted,</sup> the profitability of general insurance business is affected by the volatility<sup>of claimsandthe</sup> need to build adequate reserves

**Table 9: Financial Ratios of General Insurance, 1997-2001**

|(percent)|1997|1998|1999|2000|2001*|
|---|---|---|---|---|---|
|CededPremiums/GrossPremiums|48.8|47.0|48.0|49.1|47.3|
|NEP/GrossPremiums|50.2|53.4|52.7|49.3|51.3|
|NetClaims/Net Prenuums|55.8<br>|62.9<br>|74.6<br>|65.7<br>|62.5<br>|
|NIC/NEP|59.2|69.2|74.1|73.3|68.9|
|NetCommissions/NEP|-3.8|-4.4|-5.2<br>|-6.5<br>|-5.4<br>|
|AdminCosts/NEP|29.6|31.0|32.4|34.5|35.1<br>|
|CombinedRatio/NEP|84.9|95.8|101.4|101.2|98.6|
|UnderwritingResult/NEP|15.1|4.2|-1.4<br>|-1.2<br>|1.4<br>|
|InvestmentIncome/NEP|21.1<br>|23.8<br>|26.0<br>|25.8<br>|25.8<br>|
|Profit/NEP|36.1|28.0|24.6|24.6|27.2|

NEP: Net Earned Premiums; NIC: Net Incurred Claims

* excluding Secura

Source: Estimated on the basis of data collected by the FSC.

Measuring the profitability and solvency of different classes of general insurance business depends not only on their claims and expense ratios<sup>butalsoontheadequacy</sup> and appropriateness of their of reserving policies. General insurance<sup>companiesin</sup> Mauritius are required to establish reserves for unearned premiums, for<sup>outstanding</sup> claims, and for claims incurred but not reported (IBNR).

On the whole, reserve levels seem both adequate and appropriate (Table<sup>10).</sup> The unearned premium reserve ranged between 48 and 53 percent of net earned<sup>premiums,</sup> while the reserve for outstanding claims fluctuated between 94 and<sup>110percentofnet</sup> incurred claims. This implied that claims were settled with an average delay of<sup>one year</sup> during this period.
However, the adequacy and appropriateness of reserve levels cannot be ascertained without direct knowledge of the business of each insurer. A low level of reserves, especially for outstanding claims, may reflect short delays in settling claims or it may be caused by inadequate reserving in the face of protracted disputes. Similarly, a high level of reserves may reflect conservative reserving in the face of such delays or it may be caused by excessive reserving in order to understate profits and lower tax liability.

Table 10: Reserve Levels of General Insurance, 997-2001

|(percent)|1997|1998|1999|2000|2001*|
|---|---|---|---|---|---|
|UnearnedPremiumReserve/NEP<br>|53.0<br>|49.5<br>|49.1<br>|51.4<br>|47.8<br>|
|OutstandingClaimsRes/NIC<br>Tl|109.6<br>|98.7<br>|94.2<br>|100.7<br>|99.0<br>|
|otaReserves/NEP<br>NEP:NetEarnedPremi<br>*excl<br>Source:Estimatedontheb|117.8<br>ums;NIC:<br>udingSecu<br>asisofdat|117.8<br>NetIncu<br>ra<br>acollecte|118.8<br>rredClai<br>dbythe|125.2<br>ms<br> FSC.|116.0|

Reserve levels in Mauritius vary considerably across companies and across classes of business as well as over time, even within the same companies. In the absence of either a rigorous inspection program or a requirement on companies to employ experienced and qualified auditors and actuaries for ascertaining reserve levels, it is not possible to judge their adequacy and appropriateness.

> As in long-term insurance, there is considerable variation in the performance of

> general insurance companies by size (Table 11). Small companies are preponderantly involved in motor insurance where they generate 76 percent of their premium income against 34 percent for large companies.

Table 11: Performance and Company Size of Gemeral Isurance, 2001

|(percent)|4Large<br>Companies|7Medium<br>Companies|6Small<br>Companies*|All<br>Companies|
|---|---|---|---|---|
|TotalPremiums<br>|56.1<br>|35.1<br>|6.9<br>|100.0<br>|
|TotalMotor Premiums<br>|43.0<br>|41.4<br>|11.9<br>|100.0<br>|
|MotorPrem/GrossPremiums<br>|34.2<br>|52.6<br>|76.0<br>|44.5<br>|
|Reinsurance/GrossPremuums<br>|53.9<br>|38.2<br>|36.8<br>|46.8<br>|
|GrossClaims/GrossPremiums|49.9|53.1|66.5|53.1|
|NIC/NEP<br>|67.9<br>|71.1<br>|64.2<br>|68.9<br>|
|NetComm/NEP<br>|-9.6<br>|-1.1<br>|-1.3<br>|-5.4<br>|
|Admin Costs/NEP<br>|28.7<br>|41.5<br>|40.5<br>|35.1<br>|
|NetCosts/NEP<br>|19.1<br>|40.4<br>|39.2<br>|29.7<br>|
|Combined Ratio/NEP<br>|87.0<br>|111.5<br>|103.4<br>|98.6<br>|
|UnderwritingResult/NEP<br>|13.0<br>|_-11.5_<br>|-3.4<br>|1.4<br>|
|Invest. IncomefNEP<br>|20.7<br>|29.3<br>|37.7<br>|25.8<br>|
|Profit/NEP|33.7|17.8|34.4|27.2|

NEP: Net Earned Premiums; NIC: Net Incurred Claims

> * excluding Secura

> Source: Estimated on the basis of data collected by the FSC.

12
Small companies also report a lower reinsurance ratio<sup>thanlargecompanies(37</sup> against 54 percent). However, the aggregate data conceal<sup>thefactthat, becauseof their</sup> smaller capital and risk retention capacity, small companies<sup>tendtorelymoreon</sup> reinsurance in each class of business. This is hidden<sup>inthereportedoverallreinsurance</sup> ratios because motor insurance, in which small companies<sup>specialize more,isa linethat</sup> relies less on reinsurance.

Large companies receive much more on commissions from their<sup>reinsurersthan</sup> what they pay out to their agents. Their administration<sup>costsarealso muchlower than for</sup> medium and small companies. As a result, their net costs<sup>absorb19 percentof net earned</sup> premiums against 40 in the case of medium and small<sup>companies.</sup> Large companies report a significant positive underwriting<sup>resultin2001against</sup> losses suffered by medium and small companies. This<sup>was partlyor fullyoffset by higher</sup> investment returns earned by medium and small<sup>companiesrespectively. Theoverall</sup> profit margin is quite healthy, although no firm conclusions<sup>can be derivedwithout more</sup> precise knowledge of the adequacy and appropriateness<sup>of reservingpolicies.</sup> VI. Motor Insurance Motor insurance is the largest class of general insurance,<sup>accountingfor45</sup> percent of total nonlife premiums in 2001. It<sup>representsthemainlongtailclassof</sup> business, but generally reports low levels of claims ratios,<sup>particularlyby the standardsof</sup> most developing countries.

Motor claims, especially those that involve only material<sup>damage,tendtobe</sup> settled quickly. However, claims arising from accidents<sup>involvingbodilyinjuriesare</sup> sometimes protracted by disputes between some small<sup>companiesand claimants.</sup> Motor insurance, even the compulsory part, is not subject<sup>topremiumcontrol.</sup> However, bodily injury liability is unlimited and<sup>thiscreatesproblemswithreinsurers</sup> who press for a cap on liability.

The market for motor insurance is much less concentrated<sup>thanthatforother</sup> classes of business. The largest 4 companies accounted<sup>for43percentoftotalmotor</sup> premiums in 2001, while the smallest 7 had 15 percent of<sup>premiums.Thelatter compared</sup> with less than 6 percent in each of the other classes.<sup>TheHerfindahlindexamountedto</sup> 866 in 2001. Not surprisingly, small companies had 22<sup>percentof thenumberof motor</sup> policies in force.

As in most other countries, and despite the absence of tariff<sup>controlsand</sup> prevalence of low loss ratios, motor insurance faces<sup>some pressingpolicyissues.Atone</sup> level, there are the problems created by the companies<sup>that havebeen putinliquidation</sup> and the need for the creation of a viable compensation<sup>fund.Then,thereisaneedto</sup> establish an insurance information bureau to collect<sup>market-widestatisticson</sup> underwriting practices, loss experience, and incidents of<sup>fraudulentclaims.</sup> 13
> A further issue concems the introduction of a system that would allow statements of fact to be jointly completed by all parties to an accident and filed with their respective insurers for processing ("constat a 1'amiable"), doing away with the need for police presence. This will lower the administrative burden of motor accident on the police but

> some small insurers express concem about the shift of the administrative burden to them. They also fear that less sophisticated drivers could be intimidated by more aggressive drivers.

Another point of contention is the high registration fee of 11 percent on the value of cars that is assessed every time there is a change of ownership. It is argued that to avoid the registration fee ownership changes go unreported and cars are insured in the names of previous owners. Small insurers are also afraid that the proposal to eliminate the requirement for a road license for motorcycles may encourage some motorcyclists to drive uninsured.

The absence of any provisions to cover uninsured as well as bad drivers probably explains the presence of small companies that specialize in motor insurance. Organizing a bad risk pool, like the setting up of a compensation fund, faces difficult problems of its own, but relying on under-capitalized and under-reserved companies to serve this market does not seem to solve the problem. Most of these issues are inter-related and require a global approach after detailed consideration of available options and extensive consultation with all parties concerned.

# VIL I Regufllation and SupeirvMon

Insurance regulation and supervision is entrusted to the Financial Services Commission (FSC). Since its creation, the FSC has taken steps to improve the regulatory framework and strengthen supervision. The current regulatory framework contains many positive features. These include the absence of tariff and product controls, the reliance on solvency monitoring, the extensive use of international reinsurance facilities and the use of intemational accounting standards and internationally acceptable actuarial methods.

However, there are also some important shortcomings. Solvency margins deviate from prevailing international practice, while regulations on corporate governance, internal controls and risk management need to be brought in line with emerging international norms. Moreover, no "whistle blowing" responsibilities are imposed on actuaries and auditors.<sup>8</sup> A minimum capital of MUR 25 million is required for setting up an insurance company. The proposed new rule that will impose the creation of separate companies for long-term and general insurance business will effectively double the minimum capital requirement. However, given the large number of insurance companies, a further increase in the minimum capital may be advisable.

> 8 The importance of these aspects of the regulatory and supervisory framework are stressed in Savage (1998) and Thompson (2001).

14
There is at present no risk-based capital requirement. For general insurance, the required solvency margin is related to annual premium income and is equal to 20 percent of net premiums up to MUR. 30 million, falling to 10 percent for higher volumes. No minimum retention ratio is used in calculating the solvency margin. Despite the risk of encouraging the practice of "fronting", whereby local insurance companies act effectively as brokers of foreign reinsurers, the lack of a minimum retention ratio in calculating the solvency margin is consistent with the high volatility of insurance claims and losses in Mauritius and the limited local capacity to retain large risks.

There is no solvency margin that is set in relation to claims, a provision that is used in the European Union and has been widely adopted around the world. A claimsbased solvency margin prevents companies that charge unreasonably low premiums from operating with low levels of capital in relation to their claims.

For long-term business, the amount of admitted liabilities must not exceed the amount of the long-term insurance fund, but there is no requirement for the maintenance of a positive solvency margin or for risk-based capital.

Admitted assets exclude loans and claims on related parties (directors, agents and affiliated companies), premiums receivable that are outstanding for more than 12 months, intangible assets, and assets held outside Mauritius, including claims on reinsurers that are outstanding for more than 6 months. Housing loans secured by a mortgage in favor of the insurer are included in the definition of admitted assets.

A prescribed investment ratio is applied whereby 30 percent of admitted assets must be invested in prescribed assets. However, the latter are defined very broadly and include government bonds, corporate securities, unit trusts, or bank deposits. The only exception is the exclusion of housing loans and mortgages. Given that housing loans do not suffer from high delinquency rates, they would seem ideal for matching the long-term liabilities of life insurance and thus for inclusion in any minimum prescribed ratio. The rationale of having a minimum prescribed ratio of such broad scope needs to be reconsidered with a view to eliminating it. Reliance on the "prudent expert" principle would be more in line with best international practice.

The most binding restrictions on investments are the limits on overseas assets. Insurers carrying on general insurance business are not allowed to invest in overseas assets any part of their technical reserves and share capital. Mauritian companies engaging in long-term business may invest up to 25 percent of the long term insurance fund in overseas assets. However, foreign companies engaging in long-term business suffer from unfair discrimination since they are subject to a 100 percent localization requirement and are not allowed to diversify their assets by investing overseas.

The setting of technical reserves is subject to a general requirement whereby all insurance reserves and provisions must be calculated in accordance with internationally approved methods. The methods used, and any changes in them, must be disclosed to the FSC, . Most companies maintain strong reserves and provisions, even though the regulator is not authorized to vet the assumptions used by actuaries regarding loss 15
experience, interest rates, and mortality, nor to control the amount of credit taken for amounts recoverable from reinsurers. Only long-term business requires an actuarial valuation of liabilities. However, the regulatory authority has considerable power to influence actuarial calculations since it may revoke a license if it is not satisfied that an insurance company operates in accordance with sound insurance principles.

Reinsurance arrangements are reviewed by the regulatory authority, which has the right to require any changes that it deems necessary. There is a requirement for compulsory cession of 5 percent of premiums risks to the Statutory Reinsurer, which is Africa Re, but otherwise companies are free to make their own reinsurance arrangements.

One problem is the absence of a strong and effective supervision, although considerable progress has been made over the past couple of years. Filings of audited accounts and financial statements must be made eight months after the end of each company's financial year. Submission of extensive statistical forms is required, but improperly completed forms are often filed by some companies and no corrections seem to be demanded.

Prior to 2001, no on-site inspections had been conducted for almost a decade. The audited accounts of one company showed that it had accumulated large losses that exceeded its paid-up capital and was thus operating with negative equity. Despite a qualified report by the auditor, no action had been taken. Another company had outstanding loans to directors that exceeded its net worth. (Both of these companies took corrective action in 2002.) Insurance supervision has been invigorated since April 2001 and especially following the creation of the FSC. On-site inspections have been resumed. Three weak companies were put on the "watch" list in 2002. One is now under administration and will probably be liquidated, joining another company that was intervened in 2000. A second company has been restructured with an injection of new capital from a Sri Lankan company. The third company has reportedly been able to strengthen its financial condition and will probably be removed from the watch list.

# VIHUL IF'ture irospects and IoUcy lsstues

The future growth of the insurance industry depends on continuing macroeconomic stability, sound regulation and avoidance of company failures and scandals that would mar the good reputation of the industry. The leading companies have a strong record of innovation and efficiency and have been responsive to the changing needs of their customers. The main challenge lies in strengthening the effectiveness of supervision and modernizing the legal and regulatory framework. A consolidation of the industry by encouraging weak firms to merge or exit the market would also contribute to sounder competition and greater safety.

Two new draft insurance bills are under consideration. These aim to modernize the legal framework and address most of the current gaps in regulation and supervision. They introduce new rules on corporate governance and the responsibilities of directors, 16
on internal control and risk<sup>management systems, andonthedutiesofactuariesand</sup> auditors. They also require<sup>the creationof separatesubsidiariesfor engagingin long-term</sup> and general insurance.

As part of the new framework,<sup>detailedstandardsshouldbeissuedcoveringthe</sup> constitution and methods of<sup>calculationofreservesand provisionsandtheamountof</sup> credit for amounts recoverable<sup>underreinsurancearrangementstoensurethatall</sup> companies follow sound policies.<sup>Whileaccountingand actuarialpracticesused bymost</sup> companies are in line with<sup>bestinternationalpractice,theFSCshouldbeableto</sup> challenge all assumptions<sup>usedby actuariesinthevaluationoftechnicalprovisions,</sup> especially in the case of smaller<sup>companies.</sup> Capital adequacy standards should<sup>bebroughtinline withbestinternational</sup> practice. The EU standards on<sup>solvencymarginsarewidely usedandarenothardto</sup> administer. A solvency margin<sup>basedonaveragenetclaimsoveraspecifiedperiod</sup> (between 3 and 7 years depending<sup>on thevolatilityoflosses)shouldbeintroducedto</sup> complement the solvency<sup>marginthatisbasedon netpremiums.Apositivesolvency</sup> margin requirement for long-term<sup>business should alsobeapplied.Theapplicationof</sup> EU-type solvency standards<sup>couldbeseenas a transitionalsteptoward theintroduction</sup> of risk-based capital requirements,<sup>i.e.requirements that take into accountthe volatilityin</sup> the market values of assets<sup>and liabilities.</sup> Consolidation of the insurance<sup>industryneeds tobepromotedtoensuresounder</sup> competition and greater safety.<sup>Thiscanbeachievedbyraisingthelevelofminimum</sup> capital and introducing risk-based<sup>capitalrequirementsaswellasbyencouragingweak</sup> firms to merge with other<sup>firms orexitthemarket.Theneed tocoverthehigh-risk</sup> segments of the motor<sup>insurancemarket couldbeaddressedmoreeffectivelyby</sup> supporting the creation of<sup>a nationalpoolingarrangement bythe InsurersAssociation.</sup> An insurance information bureau<sup>shouldbecreatedwithdataonunderwriting</sup> policies, loss claims and incidents<sup>of insurancefraud. The bureau should facilitatesharing</sup> of these data by all licensed<sup>companiesand shouldcontributetowardhigherunderwriting</sup> standards. Competition policy<sup>shouldban thepracticeof tied saleswherebycustomersof</sup> large companies are forced<sup>tobuy severalservicesfromthesame group.Thesepractices</sup> discriminate against smaller firms.

Consideration needs to be given<sup>to thecreationofacompensationfundto cover</sup> the unpaid claims of failing<sup>companiesandprotect policyholders,especiallyin</sup> connection with life and<sup>annuity policies.Specialprovisionswouldberequiredto</sup> expedite the liquidation process,<sup>requirethesubmissionofreorganizationplans,and</sup> facilitate the reinsurance and/or<sup>transferof policies.Thesemeasureswouldprotectthe</sup> assets of the failed companies<sup>fromtheexpensesofprotractedliquidationandthus</sup> maximize the amounts available<sup>fordistributiontopolicyholdersandotherclaimants.</sup> However, as in the case of<sup>depositinsurance schemesfor banks, effectivesupervisionand</sup> risk-based capital requirements<sup>would provide a better safeguardagainstsuchlosses.</sup> 17
Although the likelihood of a large and persistent fall in the level of interest rates seems remote at this juncture, the FSC would be well advised to require company actuaries to report on the sensitivity of company balance sheets to such an event. The undertaking of dynamic solvency tests would be motivated by the current duration mismatch of assets and liabilities that is caused by the dearth of long-term assets in the local financial system on the one hand and the prevalence of endowment insurance policies and group pension business on the other.

Regular reporting of the exposure of insurance companies to reinvestment risk would encourage early action to avoid the recent experience of several European countries. It would also reinforce the case for the issuance by the government of longterm bonds (inflation-linked, zero-coupon or other) that would provide a better match to the liabilities of insurance companies.

> To strengthen the effectiveness of supervision, the FSC has plans to develop a

> sophisticated early warning system that would enhance the quality of off-site surveillance

> and would help identify companies in difficulty. On-site inspections would need to be

> better organized, to be focused on weak companies and to emphasize the importance of

> good corporate governance and adequate internal controls and risk management systems.

> The adequacy and soundness of reinsurance arrangements should to be regularly reviewed.

There is considerable need for hiring experienced and high caliber professionals and for training to upgrade supervisory skills. Increasing contact and cooperation with actuaries and auditors would help alleviate the workload of insurance supervisors and would address the current skills deficit.

18