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Preconditions for effective insurance supervision

Preconditions for effective insurance supervision

An effective system of insurance supervision needs a number of external elements, or preconditions, on which to rely as they can have a direct impact on supervision in practice.

The preconditions include:

• sound and sustainable macroeconomic and financial sector policies;

• a well developed public infrastructure;

• effective market discipline in financial markets;

• mechanisms for providing an appropriate level of protection (or public safety net); and

• efficient financial markets.

As these preconditions are normally outside the control or influence of the supervisor, the supervisor should not be assessed against these preconditions. However, the preconditions can have a direct impact on the effectiveness of supervision in practice. Therefore, where shortcomings exist, the supervisor should make the government aware of these and their actual or potential negative repercussions for the supervisory objectives and should seek to mitigate the effects of such shortcomings on the effectiveness of supervision.

The supervisor should have the necessary powers to make rules and establish procedures to address shortcomings. Where the preconditions for effective insurance supervision are not yet met, the supervisor should have additional powers or adopt other measures to address the weaknesses.

Sound macroeconomic policies must be the foundation of a stable financial system. This is not within the mandate of supervisors, although they will need to react if they perceive that existing policies are undermining the safety and soundness of the financial system. In addition, financial sector supervision needs to be undertaken within a transparent government policy framework aimed at ensuring financial stability, including effective supervision of the insurance and other financial sectors.

Insurance
[Post Image Courtesy of Naypong at FreeDigitalPhotos.net]

A well developed public infrastructure needs to comprise the following elements, which if not adequately provided, can contribute to the weakening of financial systems and markets or frustrate their improvement:

• a system of business laws, including corporate, insolvency, contract, consumer protection and private property laws, which is consistently enforced and provides a mechanism for the fair resolution of disputes;

• an efficient and independent judiciary;

• comprehensive and well defined accounting principles and rules that command wide international acceptance;

• a system of independent audits for companies, to ensure that users of financial statements, including insurers, have independent assurance that the accounts provide a true and fair view of the financial position of the company and are prepared according to established accounting principles, with auditors held accountable for their work;

• the availability of skilled, competent, independent and experienced actuaries, accountants and auditors, whose work complies with transparent technical and ethical standards set and enforced by official or professional bodies in line with international standards and is subject to appropriate oversight;

• well defined rules governing, and adequate supervision of, other financial sectors and, where appropriate, their participants;

• a secure payment and clearing system for the settlement of financial transactions where counterparty risks are controlled; and

• the availability (to the supervisor, financial services and public) of basic economic, financial and social statistics.

Effective market discipline depends, in part, on adequate flows of information to market participants, appropriate financial incentives to reward well managed institutions, and arrangements that ensure that investors are not insulated from the consequences of their decisions. Among the issues to be addressed are the existence of appropriate corporate governance frameworks and ensuring that accurate, meaningful, transparent and timely information is provided by borrowers to investors and creditors.

In general, deciding on the appropriate level of policyholder protection is a policy question to be addressed by the relevant authorities, particularly if it may result in a commitment of public funds. Supervisors will normally have a role to play because of their in-depth knowledge of the entities involved. They should be prepared, as far as possible, and equipped to manage crises involving insurers. Such mechanisms of protection could include a system of policyholder compensation in the event of insolvency of an insurer. Provided such a system is carefully designed to limit moral hazard, it can contribute to public confidence in the system.

Efficient financial markets are important to provide for both long-term and short-term investment opportunities for insurers. They facilitate the assessment of the financial and risk position of insurers and execution of their investment and risk management strategies.

When the financial market loses its efficiency, assessment of financial and risk positions can be more challenging for both insurers and supervisors.

Therefore, supervisors will need to give due consideration to the impact of financial market efficiency on the effectiveness of their supervisory measures.

A Primary legislation clearly defines the authority (or authorities) responsible for insurance Regulation and the mandate and responsibilities of the regulator. Primary legislation gives the regulator adequate powers to conduct insurance supervision, including powers to issue and enforce rules by administrative means and take immediate action.

In India, the Insurance Act, 1938 and IRDA Act, 1999, gives powers to Insurance Regulatory and Development Authority to regulate the insurance sector.

Insurance Law And Practice - ICSI

About Author Mohamed Abu 'l-Gharaniq

when an unknown printer took a galley of type and scrambled it to make a type specimen book. It has survived not only five centuries.

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