corporate governance in insurance

INTORDUCTION:

The concept of corporate governance is poorly defined because it covers various economics aspects. As a result of this different people have come up with different definitions on corporate governance. It is hard to point on any one definition as the ultimate definition on corporate governance. So the best way to define the concept is to provide a list of the definitions given by some noteworthy people.

Various definitions of corporate governance:

According to Sir Adrian Cadbury:

The system by which  companies are directed and controlled. Corporate Governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The corporate governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations and society"

According to Mathieson (2002)

“Corporate Governance is a field in economics that investigates how to secure/motivate efficient management of corporations by the use of incentive mechanisms, such as contracts, organizational designs and legislation. This is often limited to the question of improving financial performance, for example, how the corporate owners can secure/motivate that the corporate managers will deliver a competitive rate of return.”

The definition given by Mathies on means that corporate governance is a method which tries to find out the different incentives which would motivate the managers of a corporate to give a good return to the owners of the corporation.

According to the Journal of Finance written by Shellfire and Vishnv (1997)

“Corporate governance deals with the way in which suppliers of finance to corporate assure themselves of getting a return on their investment”

The definition here means that corporate governance is basically a technique where people who give money (lenders of the money) promise themselves or comfort themselves about getting a return on their investment.

According to J. Wolfensohn, president of the World Bank, (in 1999)

“Corporate governance is about promoting corporate fairness, transparency and accountability”

According to OECD (Organization for Economic Co-operation and Development)

“Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance”

The definition given by OECD means that corporate governance is an arrangement which manages the corporations. The configuration of corporate governance defines the duties and obligations of all the members of the corporation, gives the structure of setting the objectives and the method of attaining the set In short all the definitions stated above implies that corporate governance is a mode by which the management is motivated to work for the betterment of the real owners of the corporation i.e. the shareholders. In other words corporate governance can be defined as the relationship of a company to its shareholders or more broadly the relationship of the company to the society. Corporate governance thus refers to the manner in which a company is managed and states the rules, laws and regulation that affect the management of the firm. It also includes laws relating to the formation of the firm, establishment of the firm and the structure of the firm. The most important concern of corporate governance is to ensure that the managers and directors act in the interest of the firm and for the shareholders.

HISTORICAL PERSPECTIVE OF CORPORATE GOVERNANCE.

The seeds of modern corporate governance were probably sown by the Water gates can dal in the United States. The global movement for better corporate governance progressed in fits and starts from the mid-1980s up to 1997. There were the odd country-level initiatives such as the Cadbury Committee Report in the United Kingdom (1992) or the recommendations of the National Association of Corporate Directors of the US (1995). It would be fair to say, however, that such initiatives were few and far between. And while there were the occasional international conferences on the desirability of good corporate governance, most companies – both global and Indian knew little of what the phrase meant, and cared even less for its implications. More recently, the first major stimulus for corporate governance reforms came after the South-East and East Asian crisis of 1997-98. This was no classical Latin American debt crisis. Here were fiscally responsible, healthy, rapidly growing, export-driven economies going into crippling financial crises. Gradually, governments, multilateral institutions, banks as well as companies began to understand that the devil lay in the institutional, microeconomic details – the nitty-gritty of transactions between companies, banks, financial institutions and capital markets; the design of corporate laws, bankruptcy procedures and practices; the structure of ownership and crony capitalism; sharp stock market practices; poor boards of directors showing scanter gard to fiduciary responsibility; poor disclosures and transparency; and inadequate accounting and auditing standards.

Suddenly, ‘corporate governance’ came out of dusty academic closets and moved Centre stage. Barring Japan and possibly Indonesia, countries in Asia recovered remarkably fast. By the year 2001, Thailand, Malaysia and Korea were on the upswing and on course to regain their historical growth rates. With such rapid recovery, corporate governance issues s were in the danger of being relegated to the back stage once again. There were projects to be executed, under-value assets to be bought, and profits to be made. International investors were again showing bullishness. In such a milieu, there seemed no urgent need to impose concepts like better accounting practices, greater disclosure, and independent board oversight. Corporate governance once again settled into a phase of extended inactivity.

India’s experience was somewhat different from this Asian scheme of things. First, unlike South-East and East. Asia, the corporate governance movement did not occur due to a national or region-wide macro – economic and financial collapse. Indeed, the Asian crisis barely touched India .Secondly, unlike other Asian countries, the initial drive for better corporate governance and disclosure, perhaps as a result of the 1992 stock market ‘scam’, and the onset of international competition consequent on the liberalization of economy that began in 1990, came from all-India industry and business associations, and in the Department of Company Affairs. Thirdly, it is fair to say that, since April 2001, listed companies in India are required to follow some of the most stringent guidelines for corporate governance throughout Asia and which rank among some of the best in the world. Even so, there is scope for improvement. For one, while India may have excellent rules and regulations, regulatory authorities are inadequately staffed and lack sufficient number of skilled people. This has led to less than credible enforcement.

Delays in courts compound this problem. For another, India has had its fair share of corporate scams and stock market scandals that has shaken investor confidence. Much can be done to improve the situation.

Just as the global corporate governance movement was going into a bit of hibernation, there came the Enron debacle of 2001, followed by other scandals involving large US companies such as WorldCom, Qwest, Global Crossing and the exposure of lack of auditing that eventually led to the collapse of Andersen. After having shaken the foundations of the business world, that too in the stronghold of capitalism, theses candals have triggered another more vigorous phase of reforms in corporate governance, accounting practices and disclosures – this time more comprehensively than ever before. As a US – based expert recently put it, “Enron and WorldCom have done more to further the cause of corporate transparency and governance in less than one year, than what activists could do in the last twenty.”This is truly so. In June 2002, less than a year from the date when Enron filed for  bankruptcy, the US Congress introduced in record time the Sarbanes-Oxley Bill. This piece of legislation (popularly called SOX) brought with it fundamental changes in virtually every area of corporate governance – and particularly in auditor independence, conflicts of interest, corporate responsibility and enhanced financial disclosures.

The SOX Act was signed into law by the US President on 30 July 2002.While the US Securities and Exchanges Commission (SEC) is yet to formalize most of the rules under various provisions of the Act, and despite there being rumbles of  protest in the corporate world against some of the more draconian measures in the new law, it is fair to predict that the SOX Act will do more to change the contours of board structure, auditing, financial reporting and corporate disclosure than any other  previous law in US history.

Although India has been fortunate in not having to go through the pains of massive corporate failures such as Enron and WorldCom, it has not been found wanting in its desire to further improve corporate governance standards. On 21 August 2002, the Department of Company Affairs (DCA) under the Ministry of Finance and Company Affairs appointed this Committee to examine various corporate governance issues.

CORPORATE GOVERNANCE IN INSURANCE

Good governance in a corporate entity should be a voluntary exercise and managements should not reduce it to a function that is statutorily enforced. While the bottom line undoubtedly is making a point, entities should realize that they are in business to enhance the stockholder’s value. Thus they owe a fiduciary responsibility to each of their shareholders. One can analyses corporate governance as a delicate balance between the twin tasks of performance and compliance. When profit making becomes the solitary objective, managements tend to lose sight of their responsibilities and throw caution to winds. When the auditors and other officials associated with surveillance join the black deeds, the problem assumes humongous proportions. It is exactly in this background that we had the occasion to witness several major corporate debacles; and suddenly corporate governance hogs the limelight like never before. The series of fiascos led to several important legislations being enacted in some of the most developed economies and being followed closely globally. We hear of corporate governance in almost all sections of business, irrespective of their size. Corporate governance has a different dimension as far as the insurance business is concerned. On the one hand, insurers have to be prudent in protecting the policyholders’ interests as regards reasonableness in charging premiums; objectivity in settling the claims and so on. On the other, they also have the responsibility of  profitably investing the policyholders’ funds. This demands that insurers additionally have to be sensitive to the management styles of the organizations where the funds are being lodged. To this extent, they have a dual function to play.

STEPS TAKEN BY THE IRDA:

The multi-disciplinary Working Group on Enhanced Disclosure, appointed by the IRDA, while examining the need for improving the public disclosure practices of financial intermediaries, put forward three broad recommendations:

(i)                a specific set of disclosures that should be provided by financial intermediaries that incur a material level of the relevant risks through periodic reports to their shareholders, creditors and counterparties;

(ii)             identification of other disclosures which could be informative but with respect to which further investigation is necessary of their costs and benefits or precisely how they should be made; and

(iii)           Identification of certain areas where quantitative information will fill the gap in disclosures.

Objectives of disclosure:

The working Group while giving its recommendations reiterated the need for extensive disclosures, stating that these “can increase market discipline and may increase the stability of the financial system and lead to an improved allocation of capital and other resources. Greater transparency can allow participants in the financial system to make more informed judgment about risks and returns and to place new information in proper context. More generally, with greater transparency there may be fewer tendencies for markets to place emphasis on positive or negative new sand in this way; volatility in the financial markets and an important source of fragility can be reduced.”

 The Working Group’s conclusions had three general themes: first, a healthy balance is necessary between quantitative and qualitative disclosures; second, intermediaries’ disclosure should be consistent with how they assess and manage their risks; and third, intra-period information is necessary for a more complete view of an institution’s exposure to risks. The IAIS Task Force on Enhanced Disclosure approved the Guidance Note on Public Disclosures by Insurers in January, 2002.Public disclosure of reliable and timely information facilitates the understanding by prospective and existing policyholders and other market participants of the financial position of insurers and the risks to which they are exposed. Supervisors are concerned with maintaining efficient, safe, fair and stable insurance markets for the benefit and protection of policyholders.

Risk disclosure is critical in the operation of a sound market. When provided with appropriate information that allows them to assess an insurer’s activities and the risks inherent in those activities, markets can respond efficiently, rewarding those companies which manage risk effectively and penalizing those that do not. Corporate Governance (CG) encompasses the processes, structures, information and relationships used for directing and overseeing the management of the institution in the best interest of the institution and the key stakeholders that have a significant interest in the on-going viability of the company.

CG is a complex interweaving of legislation, regulation business practices, institution, cultures and social values. In addition, factors such as business ethics and corporate awareness of the environmental and societal interests of the communities in which a company operate scan also have an impact on its reputation and on its long term success. Two elements of CG which make it an important part of effective insurance supervision are:

(i)effective CG can improve the confidence that investors have in a company and therefore strengthen the access that a company enjoys to capital, and other forms of financing, as and when it might be required; and

(ii)Effective CG strengthens the controls within a company to ensure that the strategies adopted and decisions made by the Board, acting on behalf of the stakeholders, are effectively implemented.

Effective CG allows the supervisor to rely on the work performed by the Board of directors and senior management and in doing so allows the supervisory process to operate more efficiently and effectively than it would in the absence of such a relationship. This reliance relationship, however, needs a review from time to time to ensure that it is well founded. Both the capital market regulators and the insurance supervisors are interested that companies adopt CG practices In respect of insurance supervisors, the interest in good CG practices stems not just from the need to protect the rights and interests of the shareholders. It is the money that the investors have tied up in a company that forms at least a part of its capital base that the supervisors are relying on to protect the rights of the policyholders in the event that the company fails.

Insurance supervisors are interested in having insurance enterprises that are well managed, that treat their customers fairly, that are in compliance with the legislation and other requirements, and are well managed by competent ethical individuals. In many insurance companies, there is more policyholders’ money than the shareholders’ money – the size of the policy and claims liabilities (and provisions or reserves) exceed the amount of assets held in respect of shares and other capital instruments that the company has issued.

The investor while making a decision to invest in the insurance company is aware of the risks. Policyholders, on the other hand, are unaware of the risks – rather they seek the services of the insurance company to relieve their unwanted risk exposure. While, both the shareholders and the policyholders have a common interest in the company being run in a prudential, profitable and sound manner, board decisions which may benefit the shareholders may not necessarily benefit the policyholders, and vice versa.

This is where the role of the supervisor in implementing CG acquires greater complexity. CG forms one of the corner stones of the IAIS (international Association of Insurance Supervisors) core principles (ICPs). While ICP 9 focuses on Corporate Governance, the other ICPs which cover various aspects relating to CG are:1.Suitability of Persons (ICP-7);2.Changes in Controls & Portfolio Transfers (ICP-8)3.Internal Controls (ICP-10)4.Onsite Inspections (ICP-13);5.Risk Assessment & Risk Management (ICP-18); and6.Information, disclosure and transparency towards the market (ICP-26).The principle of CG is linked to the Core Principle on Suitability of Persons (ICP-7).The ICP provides, “The significant owners, board members, senior management, auditors and actuaries of an insurer are fit and proper to fulfill their roles. This requires that they possess the appropriate integrity, competency, experience and qualifications”. ICP-9 defines the CG framework as one which recognizes and protects the rights of all interested parties.

The core principle of CG rests on another premise, which is set out in ICP-10, viz., internal Controls. Internal controls represent a very important tool that boards have to ensure that their decisions are implemented. Once in place, internal controls become a very powerful tool for the supervisor. The ICP-18 embodies the principle of Risk Assessment and Management.

A critical component of CG is the ability of insurers to recognize the range of risks that they face, and to assess and manage those risks effectively. Effective and prudent risk management systems appropriate to the complexity, size and nature of the insurer’s business must exist, and the insurer should establish appropriate tolerance levels to risk. The fundamental of CG is dissemination of information to all the stakeholders, and this finds a cornerstone in ICP-26 pertaining to Information, Disclosure and Transparency towards the market, and ICP-12 on Reporting to Supervisors and Off-site Monitoring. For information to be useful, it must be timely, accurate, complete and relevant. Insurers must disclose relevant information on timely basis in order to give the stakeholders a clear view of their business activities and financial position and to facilitate understanding of the risks to which they are exposed.

THE INDIAN CONTEXT

The focus has shifted to CG time and again on account of repeat emergence of financial crises across the global, as well as frequent instances of financial reporting failures. In competitive markets, CG is a reflection of market disciplines, and forms the cornerstone for efficient allocation of resources. CG enables managements to take decisions, while at the same time being accountable for the decisions taken. Securities& Exchange Board of India (SEBI) appointed the Committee on Corporate Governance in May, 1999 under the Chairmanship of Kumar Mangalam Birla, to promote and raise the standards of Corporate Governance, in the particular context of companies of the Committee included(i)to suggest measures to improve CG in the listed companies, in areas such as continuous disclosure of material information, both financial and non-financial, manner and frequency of such disclosures, and the responsibilities of independent and outside directors;(ii)to draft a code of corporate best practices; and(iii)to suggest safeguards to be instituted to deal with insider information and insider trading.

Based on the recommendations of the Birla Committee, SEBI laid down requirements on CG for listed entities in February, 2000. However, certain entities including public and private sector banks, financial institutions, insurance companies and those incorporated under a separate statute were exempted from the requirements. Subsequently, the requirements of SEBI were forwarded to Reserve Bank of India(RBI) to consider issuing appropriate guidelines to banks and financial institutions so as to ensure that all listed companies followed the same standards of CG.

While a number of recommendations already stood implemented, with a view to further improving the CG standards in banks, additional measures were recommended for implementations by banks. These measures included constitution of a Committee to look into the complaints of shareholders and half yearly disclosure of unaudited results. The RBI also recommended compliance with the requirements of the provisions of clause 49 of the Listing Agreement in June, 2002.

 The Standing Committee on International Financial Standards and Codes, Reserve Bank of India constituted the Advisory Group on Corporate Governance to study the status of applicability and relevance and compliance of international standards and codes of industrialized and emerging countries and suggest measures/recommendations for achieving the best practice in India. The Group while submitting its Report in March,2001, drew attention to the Organization for Economic Cooperation and Development(OECD) principles, the models of corporate governance in various countries – U.S.,U.K., East Asia and Europe, and the status in India.

The Group covered the mechanism in India with reference to ,

(i) the private corporate sector,

(ii) banks and the development financial institutions, and

(iii) Central and State public sector enterprises set up under the Companies Act, 1956. Comparisons were also drawn with Bank for International Settlement (BIS) principles. The report submitted that it was essential to bring reforms quickly so as to make boards of corporates/banks/financial institutions/public sector enterprises.

The first important step to improve governance mechanism in public sector units was to transfer the actual governance functions to the boards from the concerned administrative ministers and also strengthen the boards by streamlining the appointment process of directors. Further there was a need for public sector banks to maintain a high degree of transparency in regard to disclosure of information. The recommendations covered areas of responsibilities of the board of stakeholders/shareholders, selection procedures for appointment of directors of the board, size and composition of the board, committees to be appointed by the board for corporate governance, disclosure and transparency standards, role of shareholders and role of auditors.

In August, 2002, the Department of Company Affairs (DCA) under the Ministry of Finance and Company Affairs appointed the Nares Chandra Committee to examine the various CG issues including appointment of the auditors and his independence; determination of audit fees; measures to ensure that the managements and companies present “true and fair” financial statements and certification of the same by the management and the directors; the necessary to have a transparent system of random scrutiny of the audited accounts; adequacy of regulations for oversight of statutory functionaries; and the role of independent directors.

SEBI appointed the N.R. Narayan Murthy Committee in February, 2003 to evaluate the adequacy of existing CG practices and to further improve upon them. The Committee was in line with the Board’s belief that efforts to improve CG standards in India must continue. The Committee focused on such issues as audit committees and reports, independent directors, related parties, risk management, directors and their compensation, code of conduct and financial disclosure.

The Committee’s recommendations were based on such parameters as fairness, accountability, transparency, ease of implementation, verifiability and enforceability. Prior to these initiatives, in 1996, the CII had taken the first institutional initiative to develop and promote a code of conduct for the India industry. The initiative was in response to concerns regarding promotion of investor interest, particularly, small investor’s interest; promotion of transparency within business and industry; need to move towards international standards in terms of disclosure of information by the corporate sector; and to develop a high level of public confidence in Indian industry. The Companies Act, 1956The requirements relating to corporate governance are enshrined in the Companies

Act, 1956 and the Rules framed there under. The various aspects covered include appointment, remuneration and removal of directors, their duties and responsibilities, liabilities and rights of directors, minimum number of directors, loans to directors, their qualifications and disqualification, disclosure of directors’ interest; provisions relating to directors’ relatives, manner of conduct of the Board meetings, qualifications, powers and duties of auditors, constitution of and the role of the Audit Committee, and disclosures pertaining to related party transactions. Comprehensive provisions relating to disclosure to form part of the Annual Report include the state of affairs of the company, changes in business, particulars of employees and their remuneration, details of sweat equity, buy-back of shares, preferential allotments, audit committees, composition of the Board, disclosures on consolidated accounts and the directors’ responsibilities. Requirements under Clause 49 (Companies Act) of the Listing Agreement All companies listed on the stock exchanges are required to comply with the CG requirements as laid down in Clause 49 of the listing agreement.

CG requirement to be complied with by all insurers All insurer are required to ensure compliance on corporate governance as per the provisions of the Corporate Act, 1956. In addition, the insurers have to comply with the requirements of the Insurance Act, 1938 and the regulations framed there under. The various requirements stipulated by the Authority to ensure good governance in the management of affairs of the insurers and transparency in their operations, cover such aspects as internal controls and processes; constitution of Investment Committee, its duties and responsibilities; appointment of managerial personnel to meet the “fit and proper” criteria subject to prior approval of the Authority; disclosure on payments made to individuals, firm, companies and organizations in which directors are interested; stipulation on appointment of joint auditors, their qualifications and rotation of auditors, Format of the Audit Report; defined role of Appointed Actuary; representation of the policyholders on the Board; provisions against commonality of interest through presence of similar directors in two insurance companies; amongst others.

The various Accounting Standards framed by the Institute of Chartered Accountants of India facilitate conformity with the accounting principles and disclosure of specified information to ensure transparency in operations. A review of the financial statements furnished by the insurers reveals certain aspects of their functioning. There were instances of the auditors drawing attention to such aspects as lack of controls, inadequacies in the functioning of the audit committees, and inadequacy of IT systems. Absence of these effects the risk management systems put in place by the insurers. Higher expenses towards related parties, and contracts being executed through related parties, appointment of managerial personnel and underwriting premium for group companies were also noticed. From the regulatory perspective, there is also a need for disclosures at periodic intervals.

While all regulatory stipulations may be in place, ultimately CG is related to imbibing the culture of transparency and fair play within an organization, which cannot come through any impositions but has to percolate down to the lowest rungs through involvement of all people at all levels. Checks and controls need to be in place to ensure that conflicts of interest and deviations are brought out and rectified. To the extent that such mechanisms are in place, the regulator can rely on the information furnished by the insurers and apply the rule of ‘Management by Exception”. Efficiency needs to be achieved through minimizing regulatory prescriptions and maximizing voluntary codes. While SROs can play a significant role in this regard, the Authority is also contemplating framing regulations to cover various aspects of corporate governance.

ACCOUNTING AND ACTUARIAL STANDARDS:

I. Accounting Standards:

The Authority had issued Regulations for Preparation of Financial Statements and Auditor’s Report of insurance companies in the year 2000. Incorporating various clarifications issued on the same from time to time, the regulations were modified in March, 2002. The regulations broadly conform to the Accounting Standards (AS)issued by the Institute of Chartered Accountants of India (ICAI). Modifications have been made in respect of the accounting standards pertaining to preparation of Cash Flow Statement (AS – 3) which is required to be furnished to the Authority only under the direct method. The requirements under Segment Reporting (AS -17) have been made more stringent for the insurers. The regulations further require that the financial statement shall be accompanied by the Management Report, in a prescribed format, duly certified by the management. The Responsibility Statement, as  required under section 217 (2AA) of the Companies Act, 1956 as part of corporate governance, also forms part of the Management Report. Based on interaction with the insurers and various experts in the field of Accounting and Actuarial aspects, clarifications have been issued by the Authority on disclosures pertaining to related party transactions; maintenance of separate investment accounts for the shareholders and the policyholders, etc. The Authority has also prescribed summary format of financial statement as a part of the annual accounts. The summary is required to be furnished for a period of five years along with the prescribed ratios. Provision for premium deficiency is another aspect on which clarity was required. As a step towards this, an informal Group was constituted to consider various issues pertaining to computation of premium deficiency.

Based on the discussions and consensus reached, clarifications were issued to non-life insurers to make provision for premium deficiency; actuarial valuation of liabilities exceeding four years; and a format of Receipts and Payments Account has been prescribed. With the insurance companies completing over three years of operations and market conditions constantly evolving, it was felt that there was a need to re-visit a number of provisions contained in the Regulation for preparation of financial statements. Accordingly, the Committee, which was formed in May, 1999 was re-constituted as a two member Committee comprising:1. T.S. Vishwanath, FCA, New Delhi; and 2. Asish Bhattacharyya, IIM, Kolkata. The Committee looks issues which arise from time to time on matters pertaining to the regulations on preparation of financial statements. Some of the issues which have been examined/are under active consideration of the Committee include

(i) norms for recognition of income, provisioning and assets classification for insurance companies;

(ii) requirement of quarterly/half yearly reporting by the insurers and the per forma in which such reports are required to be submitted by the insurers;

(iii) investment in derivatives including the accounting aspects; and

(iv) accounting and disclosure issues relating to Alternate Risk Transfer (ART) agreements being entered into by non-life insurers.

Official of the Authority were also associated with the Study Group formed by the ICAI to bring out Guidance Notes on audit of companies carrying on general of life insurance business. During the financial year, the Authority, jointly with the ICAI, considered important issues and shared views and ideas on audit and other related subjects in the insurance industry at the macro level. The Institute of Chartered Accountants of India (ICAI) in consultation with the Authority constituted a study group to examine introduction of Long Form Audit Report (LFAR) for insurance companies. The Group comprises of representatives from the Institute, the insurance industry and the Authority. The Study Group is examining development of LFAR on the pattern of banks to deal with internal control systems and procedures covering different aspects of insurance companies at branch and head office levels. The draft of the LFAR is proposed to be circulated to the insurance companies prior to its finalization. In another initiative, the Committee on Insurance of the ICAI is finalizing the Guidance Note on “Inspection of Investment Functions of Insurance Companies.’ The Institute would issue a “technical guide” in the first instance for comments.

 The Note would be considered for issue as a Guidance Note after incorporating the suggestions. The documentation relating to inspection of the investment functions of insurance companies has been developed with inputs from experts in the insurance sector The regulatory framework provides for standards, disclosures and transparency. The role of the auditors is also becoming more demanding as the custodians to prevent fraud and to comment on the prudential management practices.

 The Council of the ICAI has set up the Peer Review Board to introduce peer review in select industries, insurance being one of them. Peer review aims at checking the accuracy of the audit work, and to examine that the technical issues and the statutory requirements have been complied with, It is proposed that in the first phase, 987 practice units will be reviewed under the peer review process over a period of three years.

The Central Statutory Auditors of insurers are also being covered in Stage –I. The objective behind various initiatives is to ensure that the financial statements reflect the financial health of the insurance company to the investor who wants to invest in it as a shareholder, or the prospective policyholder who expects that the insurer would be in a position to honour the claims when the arise, to make informed decisions. For the regulator, the financial statements facilitate the process of off-site inspection, confirming that the internal controls and processes are in place and the insurer is complying with various regulatory requirements to maintain its solvency at all times.

II (a) Appointed Actuary System:

The Authority introduced the system of Appointed Actuary (AA) in the year 2000.The regulatory framework lays down that no insurer can transact life insurance business in India without an Appointed Actuary. While in the case of life insurers, an AA must be a full time employee, in the case of non-life insurers, AA need not necessarily be an employee of the company, but could be a consultant. Every AA has certain privileges and obligations which have been specified in the regulations. During 2003-04, the Authority notified the “Qualification of Actuary” Regulations, defining an actuary for the purposes of the Insurance Act, 1938. The regulations while laying down the qualification of an actuary, further provide that the Authority may relax the provisions in such circumstances as it deems fit and may permit such a person to sign as an Actuary for specified purposes. The powers and duties of an Appointed Actuary are laid down by the Authority in the regulations pertaining to their appointments which include the right to attend all management and board meetings; right to participate in discussions; rendering actuarial advice to the management particularly on product design and pricing, contract wording, investments and reinsurance; ensure maintenance of required solvency margin of the insurer at all times; certifying the value of assets and liabilities of the insurer; drawing the attention of management towards such matters as may prejudice the interests of policyholders; certifying the “Actuarial Report and Abstract” and other returns under Section 13 of the Insurance Act, 1938; complying with Section 40-B of the Act in regard to the basis of premium; complying with Section 112 of the Act on recommendation of interim bonus/bonuses payable; making available requisite records for conducting the valuation; ensuring that the premium rates of the insurance products are fair; certifying that mathematical reserves are set taking into account the Guidance

      Note (GN) of the Actuarial Society of India; ensuring that the Policyholders Reasonable Expectations (PRE) have been considered in the matter of valuation of liabilities and distribution of surplus to participating policyholders; submit actuarial advice in the interests of the insurance industry and the policyholders; and informing the Authority if the insurer has contravened the provisions of the Act. In case of anon-life insurer, the AA is required to certify the rates for in-house non-tariff products and incurred But Not Reported (IBNR) Reserves which are indicated under “Outstanding Claims” in the financial statements. The growth of the insurance industry coupled with the entry of private insurers in the last four years, has augured will for the actuarial profession. The developments in the profession signal evolution in the system of appointed actuaries seeking their rightful place in the corporate environment. The profession is expected to make significant contribution in terms of actuarial inputs in life and general insurance business and risk management and pensions. Actuaries are concerned with the assessment of financial and other risks relating to various contingent events and for scientific valuation of financial products in insurance, retirement and other benefits, investment and other related areas

II (b) Actuarial Standards

The Actuarial Society of India (ASI) issues Guidance Notes (GN) (actuarial standards)to its members. The GNs issued by the ASI are intended at protecting public interest. GNs emanating from the regulations framed by the Authority require its concurrence prior to issuance by ASI. The Actuarial Society of India issued the first Guidance Note (GN-I) on “Appointed Actuaries and Life insurance”. The Guidance Note is a mandatory professional standard and covers the responsibilities of the Appointed Actuary towards maintaining the solvency of the insurer, meeting reasonable expectations of the policyholders, and to ensure that the new policyholders are not misled with regard to their expectations. ASI issued the Guidance Note (GN-21) for the appointed actuaries of general insurers, GN-21 covers such aspects as nature and responsibility of appointed actuaries, considerations effecting their position, the extent of their responsibility and duties, premium rates and policy conditions for new products and existing products on sale, capital requirements, actuarial investigations, premium and claims reserving, written notes and guidance to actuaries who are directors on the boards of, employees or consultants to a general insurance company. The Authority issues clarifications to the Appointed Actuaries on interpretation of the regulations framed by the Authority.

INSURERS & CORPORATE GOVERNANCE

“There have to be structures and mechanisms to keep the board accountable to shareholders” opines G. V. Rao (retired CMD, Oriental Insurance Company Ltd.) He further adds “there has to be a balance of two distinct powers.”

Current state of governance:

In an industry, like insurance, where the shareholding is still restricted to one or two shareholders in each company, the interests of the unorganized stakeholders, particularly the consumer community, can be well protected by a good corporate governance code. Insurance is a financial safety net to those that can afford to buy it. The entire citizenry of India are its potential consumers. Hence there is a national role envisaged for these commercially minded insurers. How does the authority ensure that the dominant shareholding in the industry is working in the interests of the consumers and not in self interest? Is prudent supervision of solvency of insurers and regulations on protection of consumer interests the only mechanisms available to check corporate behavior? There is a definite need to involve consumers to express their responses through a market mechanism. Shifting business from one insurer to the other or through expression of complaints need not necessarily be the only other alternatives. The Boards of the public sector insurers do not presently consider settlement of claims or any consumer issues relating to them, as their corporate responsibility. It is entirely that of their Managements. How then are they ensuring that the consumers, who are dealing with them, are getting a fair deal from the managements they are supervising? Is it not their primary duty to ensure that their managements are dealing with the interests of their consumers fairly and expeditiously? What aspects of governance do the Boards deal with, if dealing fairly with consumer interests is not one of them? To whom are they accountable and for what? That is the crux of corporate governance.

Pressures on good corporate governance:

       The recent highly publicized corporate debacles of Enron and WorldCom have thrown up an increasing awareness in consumers and the authorities, for good corporate governance. New enactments have sprung up in many countries to improve the standards of corporate governance trends.

What ails good corporate governance in India?

Though corporate governance practices in India have picked up momentum, there are factors that inhibit its rapid growth.

1. High concentration of promoter ownership companies.

2. Weak recruitment processes of Directors.

3. Shortage of experienced Directors willing to serve.

4. Poor focus of Directors on their responsibilities.

5. Inadequate supply of information for analysis of issues byDirectors.

 6. Underdeveloped legal regime that permits continuation of existing inadequate systems of control.

7. Intertwining of business and political circles.

8. Individual performance accountability not encouraged.

9. Conflict of interest situations are too many.

As a result of these deficiencies, corporate performance suffers and the cost of capital increases. Ownership structures and lack of enforcement capabilities have added to the burden of poor governance standards. The ownership infrastructure and cultural attitudes of Indian market are different from those in the developed markets.

The foundation of good corporate governance relies on:

1. Transparency on financial reporting and the details of disclosures.

2. Independence of auditors.

3. Independence and expertise of the “independent directors”

4. Regulatory enforcement and its oversight.

5. Legal systems to resolve disputes early and with a sense of fairness.

Role of the Board;

The Board of Directors is the link between the people who provide capital (shareholders) and those (managers) that use the capital to create value. Its primary role is to monitor management on behalf of the shareholders. There have to be structures and mechanisms to keep managements accountable to the Board. Similarly there have to be structures and mechanisms to keep the Board accountable to the shareholders. There has to be a balance of two distinct powers.

Duties of Directors:

The Directors have two duties: duty of care and duty of loyalty; the rest is business judgment. Duty of loyalty means unyielding loyalty to the shareholders. Duty of care would mean that a director must exercise due diligence in making decisions. He must discover as much information as possible on the question at issue and be able to show that, in reaching a decision, he has considered all reasonable alternatives. In the case of Walt Disney vs. its shareholders, it has been held that when a director has demonstration that he has acted with all due loyalty and exercised all possible care, the courts will not second-guess his decision. In other words, the court will defer to his “business judgment”. Unless a decision made by the directors is clearly self dealing or negligent, the court will not challenge it, whether or not it was a “good” decision in the light of subsequent developments.

A distinction has been made by US courts between a director making a wrong decision with ‘ordinary negligence’ but not acting in bad faith and doing wrong with ill considered and reckless negligence.

The Board has responsibilities for the following:

1. Supervise the performance of the CEO.

2. Review and approve financial objective, major strategies and plans

3. Whether the resources are being managed within the law, within ethical considerations, and for enhancing shareholder value.

4. Review the adequacy of systems of internal control to mitigate risk exposures,

5. Provide advice and counsel to the management.

The Board is expected to ensure that the performance of the corporation is efficient but not to run its day-to-day administration, It is responsible for the overall picture, not the daily business decisions, Its job is all to do with creating momentum, movement, improvement and direction. It has to create tomorrow’s corporation out of today. But who is responsible for the company? The Board or the Management? It is the Board that bears responsibility; but in practice it is the management that has the infrastructure, expertise, time, control and information. Given this management domination how can a Board exercise its responsibility? Who actually wears the crown? The paradox is how to allow both to have dynamic control without diminishing initiative and motivation of either. The tension between them is to enhance creative and productivity. What information should the Board have for that purpose?

1. Financial statements, and plans and reviews.

2. Market intelligence about competitors

3. Newspaper reports; and regulatory circulars and issues.

4. Management Committee meetings’ minutes.

5. Consumer issues.

6. Employee attitudes.

Boards are found to be usually reactive and not proactive. They may exercise negative virtues of compliance. Making sure that things are running in order may be good enough. But its main job is to oversee management is effective and satisfy itself that the management is solving company problems and is risk-taking enough to build improved performance.

Role of CEO:

What one wants from a CEO is that he is able by virtue of ability, expertise, resources, motivation and authority, to keep the company not only just ready for change but ready to benefit from changes, and ideally to lead them. The CEO must be powerful enough to do the job, but accountable enough to do the job correctly. The decisions he makes should be in the long-term interests of the shareholders. Who is the best position to make a decision about the direction of the corporation, and does that person or group have the necessary authority? That is determined by two factors: conflicts of interest and information. Decisions must be made with the fewest of conflicts and most information. Accountability must come from within; and that requires a corporate governance system that is itself accountable. It must be continually reevaluated so that the structure itself can adapt to changing times and needs.

Corporate governance in Public sector units:

The Board comprises of the CMD, two Executive Directors, three nominee Directors and four independent Directors, in all ten Directors. Since these companies are not ‘listed’ companies, the compliance with the provision of appointment of independent directors is voluntary, as it is still not a legal provision under the Companies’ Act. The Boards have set up Audit Committees, Investments committees. The most important aspects of corporate governance to be performed by the Board are the supervision of the performance of Management through proper discharge of its statutory responsibilities; enforcement of effective internal control systems; ensuring operation and monitoring of adequate and proper risk assessment procedures; and putting in place a progressive customer grievance handling mechanism. These issues are basically dealt with based on agendas, minutes of the meeting recording decisions and directives after deliberations at the Board meetings for follow up. It is understood from a study made by a consultancy source on the current standards of corporate governance and other issues in the public sector units that the quality of the corporate governance is inadequate.

•The corporate vision, the mission statement, the long term and short-term goals with specific time frames and the corporate strategies for their realization are absent.

•The budget is not owned by any one and is not monitored at any time during the year for variance analysis, on any parameter other than premium growth, and is never measured except at the end of the year as a statutory obligation. As such, the Board gets no opportunity to make any contribution. As such, the Board gets no opportunity to make any contribution in controlling and directing the management for corrective actions.

Notes on 50% of the topics of the agenda to be deliberated upon are tabled on the day of the Board meeting. Most agenda items are circulated on routine issues for information.

•The Board does not enjoy any independence in decision making and looks to the directives and guidelines to be issued by the owner, i.e. Govt. of India.

• The Boards currently function more as compliance agencies under the Companies Act rather than as important corporate entities that are accountable for superior corporate performance. There is no ownership for the results of performance or the lack of it.

• The internal control systems are poor; and inadequacies noted and highlighted are rarely due to lack of functional accountability.

• The full complement of the Boards is not in place at all times. The final conclusion of the study on the risk analysis of the current corporate governance practices, based on certain self-chosen parameters, was that the elements of the risk factors are “High” in most cases.

The way out—partially?

These deficiencies can be radically changed, if a part of the shareholding is divested and the companies, both in the private and public sector, are market “listed” to fulfill stricter norms of corporate governance that SEBI imposes on them. The corporate performance needs to be subjected to public scrutiny through movement of share prices. India having adopted market based policies to boost economy and with insurance being an industry that potentially covers the entire population, like the banking industry, the sooner it is subjected to a market scrutiny, the better corporate behavior must be passed on to the public through share listing, so that the Boards and the managements are held accountable to the investors and consumers. The current shareholders need to build pressure on managements to cut the unacceptably high transactional costs and to deal with consumers in a much fairer manner. Corporate governance, in normal parlance, deals with improving the shareholder value. In the current situation, which is unlikely to change in the near future, it should deal with giving consumers affordable products by cutting internal costs and providing consumers with a mechanism for fair and expeditious settlement of their grievances. The involvement of the Board is necessary in both these measures.

Corporate Governance and Insurance Industry-Lessons to be learnt:

“We don’t have to accept that the world has become a less ethical place and learn to live with it. Even if it has, we can change it” say Dr. K.C, Mishra (Director National Insurance Academy, Pune) & Dr. Geetanjali Panda(Mgmt Faculty, Finance &Economics, IMIS, Bhubaneswar).Modern society can place individuals in situations where they find themselves at odds with principles of personal ethics and character. Our desire for independence and freedom has left us less community-oriented. Our pursuit of happiness in the form of wealth has made a disturbing degree of socially acceptable greed and selfishness. Our ability to demonstrate integrity is challenged by conflicting values and social imperatives .Seven accepted principles of personal ethics and character encompass:

1. Willing compliance with the law

2. Refusal to take unfair advantage

3. Concern and respect for others

4. Prevention of harm

5. Trustworthiness

6. Benevolence

7. Fairness

Individuals in a monetized society constitute the community of corporate citizens. Corporate Governance is about promoting corporate fairness, transparency and accountability. Functionally, Corporate Governance means doing everything better, to improve relations between companies and their shareholders; to improve the quality of Directors; to encourage people to think long-term, to ensure that information needs to all stakeholders are met and to ensure that executive management is monitored properly in the interest of shareholders. Corporate Governance becomes an organic system when companies are directed and controlled by the management in the best interest of the stakeholders and others ensuring greater transparency and better and timely financial reporting.

Corporate Governance of insurers as corporate entities:

Regulations provide for dilution of ownership holding of Indian insurance entities in due course. The conditions for Indian insurance companies’ share holdings will be changing in several essential aspects in the near future. These changes will also intensify the focus on corporate governance matters. An even larger sense, the rise of the corporate governance mentality is tied to a new enlightenment regarding the nature of capital in world markets. Recently U.S. Securities and Exchange Commission Chairman Arthur Levitt made some observation at an insurance industry forum.“Corporate governance springs from a much deeper well. It’s a by-product of market discipline and the information explosion has redefined the markets. Unless there’s high quality financial information governed by corporate oversight, capital will flow elsewhere. Markets exist by the grace of investors. In an era where investors shift money freely, the challenge for insurance companies is how to reconcile their activities with long-term sustainability. Does a company expect its board to ask tough questions, to challenge management? Every public company should have an independent audit committee and the SEC has adapted rules to strengthen audit committees. Why am I so obsessed about this? There’s no greater way to lose confidence than by those numbers. Corporate accountability is at the heart of what companies must do and insurers should not engineer their numbers as already regulatory opinionated probability has done enough engineering in both sides of the balance sheet.” Directors of insurance companies need a few unique skills due to nature of business they are going to govern. Some of the attributes are common to all business but some are special to insurance as enumerated below.

•Being dynamic and dedicated in all insurer’s activities;

•Having self-confidence to work under non-deterministic situations;

•Enjoying work in the Board and the time they spend with other Board Members;

•Encouraging new ideas and thinking in insurer not arresting them;

•Keeping an open mind, listening and learning from others in the expanding world of insurance;

•Being prepared to share ideas and thoughts with the company management;

•Recognizing and rewarding cooperation and franchise which are the corner stone of insurance business;

•Developing the skills of insurer’s employees;

•Being concerned for delivering on promises;

•Inducing teamwork to deliver the best result;

•Showing trust through allowing delegation;

•Actively standing up for what they believe in;

•Dare to challenge the ways insurer is working;

•Going beyond the comfort zone;

•Setting challenging targets and facilitating hard work to achieve them;

•Ensuring insurer’s performance to always exceed the expectations; and

•Inspiring and encouraging management to give their best.

Corporate Governance should obviously ensure governance but with quality of decision-making, efficiency of benchmarking and in-built flexibility to accommodate the certainty of change. Like any other Board, an insurance Board should have audit committee, nomination committee, compensation committee, risk management committee (of the nature of ALCO), executive committee (as standing committee of the Board) conduct review committee, market operation guideline committee, investment committee and compliance committee.

Corporate Governance by insurers as institutional investors in corporate entities :

Insurers are an important class of institutional investors. According to corporate governance policy, Insurer must be able to cooperate with other major owners on corporate governance matters, mainly regarding the election of directors. This cooperation should be concentrated on those companies in which insurer own a significant share of the capital. The so-called percent rule has in principle prohibited Indian insurance companies from owning shares in a company corresponding to more than a statutory percent of the voting rights. When insurance companies exercise corporate governance in other companies, they must take a broader view of these questions than other owners. Consequently, in addition to the interests of its own shareholders, insurer must observe the following:

·        The policyholders’ interests and the legal restriction on insurance companies’ investments-spread of risk, liquidity, etc.;

•Regulatory and Supervisory Authorities-Insurance companies’ operations are subject to IRDA regulations and supervision buation needs of all stakeholders are ms the conglomerate nature of functions may attract oversight by other regulatory authorities like SEBI for investments, PERDA for  pension business and RBI for Forex and Money Market involvements;

•The public and the media

•The insurance sector is dependent on the public’s trust, and operations are the focus of extensive media coverage.

 In light of the above, Insurer’s Board of Directors have to adopt corporate governance policy for the insurer business. The policy should pertain to the insurer’s share holdings in listed Indian companies (external corporate governance) and, where applicable, for insurer itself as a listed company (internal corporate governance). The institutional activism movement has not lacked for skeptics even internationally. Business leaders and politicians have argued that large insurers lack the expertise and ability to serve as effective monitors in the market for corporate control [e.g. Business Week (1991), Cordtz(1993), and Wohlstetter (1993)]. Others have noted that parastatal insurers are subject to pressures to avoid activism and instead aid the objectives of appropriate incentives and free-rider problems may also hinder institutional activism efforts. [Admati, Pfleiderer and Zachner (1994); Monks (1995) and Murphy and Van Nuys (1994]. One way for institutions to reduce free-rider problems among themselves and to sidestep political pressure is to create an organized third party monitoring organization. Such an organization can serve as a focal point for diffuse investors and can enhance credibility when challenging management. In principle, organized institutional shareholders can exercise significant clout at a fairly low cost because of economies of scale in activism [Black (1990)]. IRDA should facilitate such a formation.

Corporate Governance as a business opportunity for insurers:

Corporate Governance requires fair deal, fair competition and fair information collection. Lack of such practice gives rise to liability consequences most often no-fault liability. Here is a business opportunity for insurers. Fair deal envisages employees not to take unfair advantage of anyone through manipulation, concealment, abuse of privileged information, misrepresentation of material facts or any other unfair-dealing practice. Fair competition always attempts to compete fairly and honestly and prohibits conduct that unethically seeks to reduce or restrain competition. Company will not attempt to collect competitor’s information through misrepresentation or unethical business practices. Company will never ask for confidential or proprietary information or ask a client/ ex-employee of a competitor to violate a non-compete or non-disclosure agreement. There are liabilities at even Board level for such breaches. Insurers can create business products as follows:

•Directors’ & Officers’ Liability Insurance

In the current market, directors may fine they are not as protected by insurance as they thought and there may be ever expanding need for newer coverage and greater premium;

•Enterprise Risk Management -

If companies are going to genuinely govern in the interests of shareholders they need to understand their full risk picture. Any gaps in provision could be seen as corporate governance failing. Such risk identification may give rise to outsourcing of risk management expertise of insurers; and

•Reputation Risk Management-

Whilst management of reputation should b an integral component of good management, often it is left to chance. Corporate Governance ensures adequate insurance coverage against the losses arising out of reputational risks. Insurers comprehensive exposure to another business should be a cause of action for corporate governance. Insurance information Institute illustrates this while analyzing the loss of US$ 3.796 billion to insurance industry on account of failed power major Enron. Of the total loss of insurance industry 64% was on account of investments in Enron, 26% for surety recalled, 7% for miscellaneous claims, 2% financial guarantees and 1% for D&O liability claims. Again corporate governance risk of general insurers is compounded by D&O coverage. Personal Coverage protects directors and officers against liability arising out of “wrongful acts” Corporate Reimbursement Coverage reimburses organization when legally required/permitted to indemnify D&Os for their “wrongful acts and Entity Coverage reimburses for claims made directly against the organization including those that names no individual insured. The aggregate liability of the entity needs corporate control.

Governance Code for the Indian Insurance Industry:

-- An Overview

 In the area of corporate governance in India, the approaches would require to be refined. However, the task of the regulatory bodies would be considerably eased once proper governance standards are in place, observes R. Krishna Murthy (MD, Watson Wyatt Insurance Consulting and former MD & CEO of SBI Life Insurance Co. Ltd.).

Corporate governance simply put is just being honest about in every way an enterprise is run governing relationship with every stakeholder in the company. While honesty is the best policy everywhere and at all times, it needs to be practiced particularly in the case of insurance industry which bears a fiduciary relationship with clients, and where the industry is judged by its long term performance. At a time when financial institutions are increasingly under public scanner; and some of the icons in the insurance industry in mature markets are under attack for breaking laws and their key management personnel charged for personal aggrandizement; the issue of corporate governance acquires new dimension.

Urgency in India

There are four major factors why drawing up a set of governance standards for the Indian insurance industry, covering life as well as general insurance companies, public and private sector, is important at this stage.

Firstly, in life insurance, a well drafted governance code and their adherence would help to shore up the level of public confidence in the new generation insurance companies, which seem to suffer in comparison to LIC due to the absence of a level playing field, with the insurance policies issued by the latter carrying the stamp of sovereign guarantee. While there is reportedly a move by the government to level this field by removing the privilege enjoyed by LIC, it is perhaps quite a long way off. Meanwhile, as an industry which engages with clients on long term contract, the new generation life insurance companies should be keen to have a set of standards against which they could benchmark their own governance to strengthen the public image that the new players can be considered as trustworthy and dependable as their public sector counterparts.

Secondly, the Indian Insurance industry is set to witness a major phase of change, and possibly explosive growth, with the lifting of the foreign equity cap and dilution of domestic promoters’ stake in the foreseeable future, as well as removal of tariff regulations in the non-life sector. There are plans to pave way for the entry of large number of players to open business in specialized insurance fields such as health insurance by relaxing the capital and solvency rules. We would possibly witness more foreign firms entering the country, and key management personnel with limited industry experience representing domestic and foreign partners running the companies. There are plans to pave way for the entry of large number of players to open business in specialized insurance fields such as health insurance by relaxing the capital and solvency rules. At the same time, the existing companies in the life insurance sector, along with facing competition from new players, will probably grapple with greater operating challenges, such as increasing number of maturity, death and other claims on the cumulative business built by them over the last few years. We need good governance standards against which the companies’ conduct and performance would get measured in this backdrop. On the general insurance side, with the industry moving away from the tariff regime, there are going to be plenty of issues concerning fair play, transparency and policyholder servicing.

Thirdly, the need for proper governance standards in the insurance industry assumes importance in the context of the Indian corporate sector getting ready to accept and live up to a set of corporate governance rules, thanks to the initiatives taken by the securities market watchdog during the last two years. Companies that are listed in the stock exchange, and having paid up capital of Rs,3crore or net worth of Rs.25crore or more would now need to abide by the new code. SEBI has boldly introduced a system of disincentive-cum-penalty for defaulting companies: they run the risk of being de-listed from bourses, or the promoters being fined up to Rs.25crore (the highest in the corporate law book) or face imprisonment up to 10 years. Since insurance companies are not likely to get listed in bourses in the near future and would remain closely held companies, they need to conform to a set of governance rules of reassures take-holders about their standards of performance and conduct.

Fourthly, there is increasing evidence of public sector financial institutions evincing interest to enter insurance business in partnership with foreign insurance firms, and in some cases as three-way partnerships with private corporate enterprises. While a few such ventures have recently been licensed, several more are set to take off in the life and non-life sectors. There is ambivalence whether such ‘public-private’ partnerships are subject to the rules normally applicable to PSU enterprises. PSU managements in general have no uniform views in regard to the applicability of corporate governance standards to them. It is important that insurance ventures promoted by PSUs are governed by clear governance principles to send the right signals that they are viable and dependable stand alone entities in their own right. On a wider context, this would reinforce the grounds on which the financial sector convergence is taking place in the Indian market.

Key Principles in the Indian context:

The OECD has defined corporate governance as a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Corporate governance is of course an ongoing process. While the set standards may undergo revision based on experienced and developments in the market, the core principles would remain unchanged. From an insurance company perspective, corporate governance involves the manner in which the business of the company is governed by its board and the senior management relating to four key elements:

i.                   How the company set its corporate objectives, including the expected rate of return on the shareholders’ funds. IRDA requires insurance license applications to describe from the first stage (R-1), the objectives of the company and its vision and mission, as well as details of the financial returns anticipated by promoters from insurance operations. The financial accounting rules in the Indian insurance industry require companies to segregate policyholders’ funds and shareholders’ funds at any given time, and conduct the transactions pertaining to shareholders funds in a manner that is fair to the policyholders.

ii.                 How the day to day affairs of the insurance company are proposed to be run in every functional area in the company, and what kind of internal controls are sought to be established and enforced.

iii.              How the company proposes to align the activities and the behaviour with the expectation that the company would operate in a safe and soundmanner and in accordance with the applicable rules and regulations.

iv.              How the company would protect the interest of policyholders.

Board and its responsibilities:

While the IRDA licensing norms. The most important aspect of governance code is to ensure that the collective expertise is available on the board to meet the competitive challenges of the market place while maintaining soundness of the company, require that the company is run by persons who are ‘fit and proper’ for the respective positions, the regulator has largely left issues concerning the constitution of board and defining its responsibilities to the wisdom of the promoters. The most important aspect of governance code is to ensure that the collective expertise is available on the board to meet the competitive challenges of the market place with maintaining soundness of the company. It is important to ensure that board members, especially those appointed to represent the policyholder interests, are qualified for the position, and they have a clear understanding of their role and are able to exercise sound, independent judgment – duty of loyalty as well as duty of care. There are five key aspects of governance expected of boards in insurance companies:

Setting and enforcing clear lines of responsibility and accounting throughout the organization. In insurance companies where the risk experience emerges over several years, demarcating areas of responsibility, and ensuring that there is an appropriate oversight by the senior management in every functional area are crucial.

•Periodically assess the effectiveness of the company’s own governance practices with due understanding of the regulatory environment, identify areas of weakness and make changes where necessary.

•Regularly assess that the risk management systems and policies in the company are sound; and they are rigorously adhered to.

• Identify, disclose and resolve conflicts between the personal interests of  promoters; as well as senior managers and the company. The conflict resolution issue is particularly important where the insurance operations are part of a large business group of a financial conglomerate.

•Overseas that every type of communication to clients and potential clients is clear, fair and not misleading. It is important that the board consists of persons who have the expertise, as well as ability to commit sufficient time and energies to fulfill their responsibilities. The Board members should regularly meet with the senior management, as well as the internal audit team, to monitor progress towards the corporate objectives. They should however never participate as members of the board with the day to day management of the company. The board as well as the senior management would need to ensure that the corporate objectives and the corporate values are clearly set, and they are clearly communicated throughout the organization. As they say, the tone is always set at the top.

Organizational structure and functioning;

The board should exercise oversight in regard to all policy formulations governing the operations of an insurance company, such as investment policy; underwriting policy; product development and risk management policy; and take responsibility for overseeing the management’s actions to ensure their consistency with the policies approved. Senior managers contribute to an insurance company’s sound corporate governance by exercising proper oversight over line managers in specific business areas in a manner consistent with the policies laid down by the board. The senior management is responsible for proper delegation to the staff, while at the same time being cognizant of the responsibility on their part and accountability to the board to oversee the proper exercise of the delegated responsibility. It is therefore important that senior management ensures an effective system of internal and external auditors in enforcing proper governance is well known. The board and the senior management can enhance the effectiveness of the audit function in insurance companies by recognizing its importance and the internal control processes; and effectively communicating the same throughout the organization. In our current stage of market development where several issues concerning premium accounting and reconciliation are emerging; as the insurance buying is spreading to far flung areas and covering various strata of population, timely audit is an important function. It is an equally important corporate governance principle that the findings of the auditors are utilized in a timely and effective manner to correct the problem areas. Corporate governance standards should address corruption, self-dealing and other illegal or unethical practices in insurance companies. There should The senior management is responsible for proper delegation to the staff, while at the same time being cognizant of the responsibility on their part and accountability to the board to oversee the proper exercise of the delegated responsibility be a policy to encourage whistle blowers, as well as support employees to freely express and point out violations to board or senior management without fear of reprisal, either openly or anonymously.

Compensation policies and ethics:

There are already issues surfacing in the Indian market concerning the appropriateness of compensation policies in insurance companies. Failure to link compensation and incentives to senior management to the long term business goals can result in actions that can run counter to the policyholder interests. In general, the compensation policies should be consistent with the culture of the insurance company, its long term objectives and strategy. It is important that the remuneration policies should not be linked to the short term performance of the company.

PSUs and governance:

Keeping in mind the growing phenomenon of state-owned and government controlled banks and financial institutions promoting insurance ventures in India in partnership with foreign firms, or in equity share relationship with private corporate enterprises; the governance principles should address the conduct and behaviour of such multi- party owned entities. Where such entities are subsidiaries of government owned banks, there are new dimensions to the governance principle to be addressed, since the governance codes would affect both the boards of the PSU parent as well as the hybrid subsidiary. In the discharge of the corporate governance responsibilities, the parent boards should exercise due oversight of the functioning of the subsidiary (and even where the parent’s holding in the insurance venture is below 51%), by duly recognizing the material risks and issues that could impact the insurance entity. The corporate governance structure and enforcement would to a large extent be influenced by the manner in which the parent bank conduct its own governance. It is important that the PSU parent allows the insurance entity to set its own governance standards. In multi-party promoted ventures, it is important to pay attention to the scope of  preferential treatment of related parties and favoured entities within the promoter groups, and lay down governance standards to avoid or minimize conflicting situations. Such group dimensions are already receiving attention at the regulator’s level. The initiative taken by RBI to set up a mechanism to track systemic risks posed by financial conglomerates in India is in the right direction. As a new concept in India, the approaches would require to be refined. However, the task of the regulatory bodies would be considerably eased once proper governance standards are in place.

Transparency as the core of governance:

The important of transparency as the core principle in corporate governance is well known. Weak transparency and inadequate disclosures tend to fuel market skepticism, and in a newly deregulated and long term oriented industry, this could affect the interests of all stakeholders. It is well known that complex ownership structures contribute to opacity. While listed companies are generally more transparent, closely held firms suffer on this account by comparison. The Indian insurance regulations emphasize the importance of transparency in every aspect of company operations. At the current stage, there is quite a way to go for companies to achieve the desired levels of disclosure. Accurate and timely disclosure of information in insurance companies should be in place in every area of operation. Such disclosure are desirable by way of annual reports released by companies, as well as through their websites, covering various areas, more particularly the following:

Compensation policies and ethics:

There are already issues surfacing in the Indian market concerning the appropriateness of compensation policies in insurance companies. Failure to link compensation and incentives to senior management to the long term business goals can result in actions that can run counter to the policyholder interests. In general, the compensation policies should be consistent with the culture of the insurance company, its long term objectives and strategy. It is important that the remuneration policies should not be linked to the short term performance of the company.

PSUs and governance:

Keeping in mind the growing phenomenon of state-owned and government controlled banks and financial institutions promoting insurance ventures in India in partnership with foreign firms, or in equity share relationship with private corporate enterprises; the governance principles should address the conduct and behaviour of such multi- party owned entities. Where such entities are subsidiaries of government owned banks, there are new dimensions to the governance principle to be addressed, since the governance codes would affect both the boards of the PSU parent as well as the hybrid subsidiary. In the discharge of the corporate governance responsibilities, the parent boards should exercise due oversight of the functioning of the subsidiary (and even where the parent’s holding in the insurance venture is below 51%), by duly recognizing the material risks and issues that could impact the insurance entity. The corporate governance structure and enforcement would to a large extent be influenced by the manner in which the parent bank conduct its own governance. It is important that the PSU parent allows the insurance entity to set its own governance standards. In multi-party promoted ventures, it is important to pay attention to the scope of  preferential treatment of related parties and favoured entities within the promoter groups, and lay down governance standards to avoid or minimize conflicting situations. Such group dimensions are already receiving attention at the regulator’s level. The initiative taken by RBI to set up a mechanism to track systemic risks posed by financial conglomerates in India is in the right direction. As a new concept in India, the approaches would require to be refined. However, the task of the regulatory bodies would be considerably eased once proper governance standards are in place.

Transparency as the core of governance:

The important of transparency as the core principle in corporate governance is well known. Weak transparency and inadequate disclosures tend to fuel market skepticism, and in a newly deregulated and long term oriented industry, this could affect the interests of all stakeholders. It is well known that complex ownership structures contribute to opacity. While listed companies are generally more transparent, closely held firms suffer on this account by comparison. The Indian insurance regulations emphasize the importance of transparency in every aspect of company operations. At the current stage, there is quite a way to go for companies to achieve the desired levels of disclosure. Accurate and timely disclosure of information in insurance companies should be in place in every area of operation. Such disclosure are desirable by way of annual reports released by companies, as well as through their websites, covering various areas, more particularly the following:

•Board structure and senior management structure

•The company’s self-determined code of conduct, if any, and the process by which it is implemented, including a self assessment by the board of its performance relative to the code

•The special obligations of the insurance company under the regulations, such as the rural and social sector obligations; and the level of their fulfillment

• Nature and extent of inter-party transactions within the promoter groups; and matters on which the directors and senior managers have material interests on behalf of third parties.

•Important aspects of performance that have a bearing on the safety and solvency, such as claim ratios Weak transparency and inadequate disclosures tend to fuel market skepticism, and in a newly de-regulated and long term oriented industry, this could affect the interests of all stakeholders. Better than industry averages of internally projected levels, unexpected  depletion in the value of assets; and actions or warnings issued by regulators.

•Information on the number of cases of policyholder complaints or disputes; and directives against the company issued by Ombudsman or other consumer   protection bodies. While financial statements may be posted on the website, every policyholder should be entitled to ask for a full set of account statements including notes and the supporting schedules. Existence of sound corporate governance standards lowers the moral risk hazard from the regulatory viewpoint. IRDA should view corporate governance as an important element of policyholder protection. Corporate governance codes and the earnestness of insurance companies to adhere to them would encourage regulation to place more reliance on the internal processes in insurance companies; and thereby becoming less strict or more pragmatic in operational areas, as for example, relaxing the rigours of ‘File and Use’ process for product approval. The level of self-policing by the players is indeed a barometer of maturity of the market, since sound corporate governance serves as bedrock to build public trust and confidence.

CORPORATE GOVERNANCE IN A RISK BASED RATING ENVIRONMENT

In a de-tariffed regime, governance for the insurers would be a different ball –game and various issues would come up in the areas of fair rating, equitable policy conditions etc. feels Mr. P.C. James(Executive Director, Non-Life, IRDA).

Insurance and Corporate Governance

Corporate Governance is a subject of significance for the insurance industry. Insurers manage the funds of the public, i.e. the premium of their customers, as well as capital and other resources on behalf of the shareholders. Companies also have other stakeholders such as employees, partners, intermediaries, the government and the society. There is a growing concern that a company’s accountability and transparency requirements need to be aligned with the expectations of stakeholders concerned. Insurance Core Principles No.9 brought out by the IAIS (International Association of Insurance Supervisors), says that the corporate governance framework recognizes and projects the rights of all interested parties. Corporate governance is thus required as a voluntarist agenda for the Board and the top management on how to oversee the success and sustainability of the organization in the wider context of satisfaction of all the stakeholders concerned. Business organizations work in an environment of increasing risks. Risk is anything that can impede on the negative side or accelerate on the positive side, the achievement of business objectives. Responding to risks involves instituting the necessary tools to discover, analyse and make transparent the potential risks. It also means that while taking steps to minimize or eliminate the downside of risks, the upside that can be generated by managing risks successfully needs to be fully exploited. This linkage between business objectives, risk, controls and their alignment to business outcomes is important for enhancing shareholder and stakeholder value. All successful companies excel because they have the necessary risk management capability, internal control systems and procedures to sustain them. This naturally involves Board level interventions in deciding strategies and policies which can ensure that the entire company becomes risk aware; and has one uniform ‘risk’ language in the organization.

Risks and Insurers

The core of insurance business is the bearing of risks transferred to the insurer by customer either through intermediaries or directly. Based on acceptance of the risks and the premium thereof insurers are subject to various organizational risks which are known as technical risks, investment risks and other operational risks. Technical or underwriting risks include premium deficiency risk, concentration risk, catastrophe risks, frequency/severity risks and so on. Investment risks include credit risk, market risk including interest rate risks, liquidity risks etc. Various types of operational risks also face insurers, just as they do other business organizations. Such risks include global risks; general, economics and political risks; industry risks; and company specific risks. The Board is expected to have a grasp of the strategic issues involved, and set the necessary policies and procedures regarding risk taking and the desirable risk management techniques. This enables the organization’s many layers and operational lines to translate the need for risk management into real and verifiable activities including the following:

1. The approach to risk taking.

2. The structure of limits and guidelines governing risk taking.

3. Internal controls including management information systems. Worldwide ,companies are being encouraged to go beyond legislative and regulatory compulsions to where good governance norms are self generated arising from the basic fiduciary role of the Board and the top management. As the insurance sector grows, there will be a reduction of supervisory resources and its place will need to be replaced by self regulation and betterment through various self-governing mechanisms. This will ensure that the company is operated in accordance with the best standards of business and financial practice. From the point of view of the regulator and others, corporate governance is necessary to promote transparent and efficient markets. It helps to lay a strong and sustainable foundation to the business model the Board wishes to set up so as to exploit market opportunities. Business risks that need to be tackled include demand risks where customers or intended customers do not buy; competitive risks, whereby the initiatives taken by competitors can upset strategies drawn up; and capability risks, where the company’s value proposition does or does not match the requirements of the market. A company’s readiness to be aware and act in these areas to understand, report and be accountable for such risks, make companies face a heightened probability of not meeting the expectations of stakeholders.

Risk Governance

When insurers are see to move from a rule based tariff regime to a risk based pricing environment, risks for such insurers generate both opportunities as well as vulnerabilities. Risk exposures heighten because the deeply held mental models of yesterday which were versed in interpretation of given rules need to move onto divination of an ever changing risk landscape in the many businesses that the company may wish to offer protection. The Board needs to put in place new mental models and systems thinking that can create and nurture the necessary skills of seeing the insurable world in the hard reality of risks and realistic pricing of such risks without the comfort of tariffs. Similarly it is to be ensured that the independence of the risk assuming function is clearly maintained and not subordinated to the compulsions of those departments not familiar with the discipline of insurance risk and pricing characteristics. Guidelines will need to be given for the disciplined application of underwriting powers, with clear reporting lines and accountabilities. The underwriting department must be endowed with stature, experience and authority to carry out it expected functioning. There must be the planned churning and rotation of personnel to garner ever-richer experience and bring in new learning’s, experience and perspectives. New skills and knowledge will have to be built up and must flow through the organization to ensure constant up gradation and benchmarking against the best in the market. Risk specialists need to be encouraged to probe and question till satisfactory answers and solutions are obtained, and there should an openness that is not afraid to challenge the ‘experts’.

Regulatory requirements and Corporate Governance

Sensitivity to regulatory requirements is an important part of corporate governance. Companies need to guard against possible clash between the interests of the policyholders and the owners of companies. It is well accepted that having satisfied and happy consumers is good business, and the Board needs to continuously strengthen the alignment of interests between the company and its consumers through better governance standards. Compliance management is the beginning of corporate wisdom and is an expression of the wiliness to develop the continuum towards developing self-accepted norms of governance based on an inclusive agenda that looks to the betterment of all interests in a holistic manner. Adisdain for regulatory accountability as manifest in non-compliance of laws, regulations, guidelines is indicative of a mindset that may block internalization of the best practice codes that can help to enhance business success. Insurance also involves issues of public good; and the legislative and judicial intent wherever spelt out and point to the development of the business in the best interest of the community, need to be kept in mind while dealing with business practices. This means that insurers are prevented by the intent of law and judicial precedents from acting in a manner that is arbitrary, unfair, untenable or adverse to the interest of the consumer. Thus there cannot be arbitrary freedom for private contracts. Corporate governance would have to internalize the nature of insurance business in the context of the law of the land and should keep in mind the moral and social responsibilities involved while fashioning the templates of corporate success. Various issues thus come up in the areas of fair rating, equitable policy conditions, proper disclosures, acceptable methods of solicitation, terms of renewal, cancellation of policies, loading of premium, denial of insurance, repudiation of claims and so on. These will need to be addressed and homogenized across the company to prevent regulatory or judicial strictures that can have a bearing on the reputation or legitimacy of the insurer. Failing to meet society’s expectations can pose risks to organizations and at the same time a proper understanding and effective management of generally recognized social duties can help to build shareholder value, corporate recognized social duties can help to build shareholder value. Corporate social responsibility is also an area which, if neglected, can pose risks for insurers. Managing community perceptions backed by beneficial action in the area of social good can help to reduce downside risks and also open up opportunities for profitable business as those excluded from the benefits of developmental insurance are far too many. Involvement with social concerns including lack of protection to the vast majority who are excluded owing to poverty or ignorance helps to build up long-lasting intangible assets for the company. It helps not only to capitalize on community resources and reduces regulatory intervention but also helps to obtain competitive advantage from a long-lasting fund of public goodwill. Board’s Concerns for smoothening the Rollover Detariffing involves serious transitional issues especially for the older insurers. Active involvement of the Board and the top management is required along with massive investment of time and money in establishing proper systems through necessary hardware and software, as also in training of underwriters and in creating the necessary data infrastructure and its learning context.

In particular, the following areas would be important in the context of corporate governance.

1. Detariffing must not degenerate into mindless rate cutting and so called ‘cash-flow’ underwriting. Equitable rating and solvency issues are paramount in disciplined underwriting. Hence clear guidelines from the level of Board must be given, drawing up the methodologies of rate making and also wherever possible guide tariffs, so that individual discretion at non-responsible levels is reduced to the minimum.

2. Underwriting must be supported by a strong technical base. Rating factors need to be identified for every sub-class, and every type of risk. The required data needs to be captured in respect of every risk underwritten and every claim lodged. Collection, compilation and analysis of data will form the bedrock of developing underwriting expertise. Similarly pre-acceptance risk inspections and data generated by claim surveys and inspections will also form important part of the knowledge bank for underwriter.

3. Delegation of authority will be based on the knowledge of the person concerned based on experience as well as qualifications. There must be proven ability to evaluate all risk factors. The financial implications of underwriting decisions on factors such as adequacy of pricing, the concentration of risks written, the frequency/severity aspects, etc. will need to be understood by persons who are vested with discretionary authority. Responsibility needs to be fixed so that delegated powers are used only as desired.

4. Determining the basis of rating. Rating can be on the basis of class for which internal tariffs can be developed. Rating can also be on community basis for risks such as group health or PA, where there is an incentive for communities/groups to reduce risks and obtain favourable terms. Finally rates can be fixed on individual basis depending on the uniqueness of the risk and the financial magnitude justifying individual rating. In all these cases a base rate has to be set; and loadings and discounts should apply based on risk perceptions, backed by factual risk features.

5. Ready availability of insurance should be ensured at fair terms for all customers. In the restructuring that may take place on account of detariffing it will be unfortunate if the normal insurance enjoyed by the public prior to detariffing are not available readily under internal tariffs and at fair terms.

6. Underwriting audit programmes must be instituted to check the adequacy of  pricing and other disciplines of underwriting and compliance to internal tariffs. Justification of rates, whether individual or class, needs to be examined by the audit department; and necessary correctives need to be suggested for implementation.

7. Training of underwriters and setting up or R&D for developing underwriting practices is to be institutionalized. New product development based onsound market research and innovation in areas that can capture value for the organization in containing risks for the consumer would be a core task to meet competitive challenges. Detariffing will see the emergence of many new competencies and differentiations which will help market development.

8. In moving from tariff policy wording to more innovatively packaged products, insurers would need to ensure that that there are even moredisclosures to avoid consumer confusions, through transparent and logical presentation of covers and benefits.

9 .Finally customer service and grievance handling need to become a thrust area in the detariffing era for the Board, as there are bound to be dissatisfactions that could arise from the asymmetries perceived in the changeover. Alleviating the difficulties of the average consumer in times of  possible uncertainties will help to win goodwill of the public and the regulator as well as the consumer bodies.

            Customers of an insurer look to the company to meet promises made to protect as per its licensed mandate. Insurance is a complex business built around the promise to cover and pay on the occurrence of the specified event i.e. loss occurring. The customer is not the expert on insurance and hence relies on the integrity and skill of the insurer to meet the obligations as promised. Insurers thus need to consider meeting their obligations not only in the end by paying claims when covered losses occur, but also upfront in their readiness to cover fairly and equitably so as to enable consumers to take on economic risks that are necessary to create dynamism and momentum in the economy. If insurers do not stand in the shoes of the consumer through the guiding hand of voluntary governance codes, the long term well being of the organization would get jeopardized leading to losses for the stakeholders. Corporate governance forms the right platform of internal voluntary empowerment that allows companies to play their due role in the interest of all as per the genuinely developed strategic vision.

CONCLUSION

Corporate Governance has come to occupy a very prominent place on the agenda of business houses, the reasons for which are not far to seek. Although it has always been the endeavor of corporate managements to conduct their business in as fair a manner as possible while keeping in view the ultimate bottom line, a senseless adventurism on the part of some to depict their performance out of proportion to there abilities had led to the focus returning to the deliberations in the Board rooms and the responsibilities of the Board of Directors. Corporate managements would do well to realize that it is not merely the appreciation of  most of the corporate debacles that were observed in the recent past, the common thread that was observed was the larger than life image of the CEO which has reduced the Board to a body providing a stamp of approval without subjecting the proposals to a strict scrutiny. When it comes to insurance companies, the fiduciary responsibility of the managements takes a two- pronged direction. As they deal with the policyholders’ money, insurers have to be cautious not just about their own managements but also the way the companies where the funds are invested, conduct their business. A failure on either side would prove to be detrimental to the interests of the insurance company. Insurance companies are surrounded by a complicated pattern of economic, social ideas and expectations. They have a responsibility to themselves, to one another and to their constituencies to make a reasonable and effective response. An insurance company’s responsibilities include how the whole business is conducted every day. It must be a thoughtful institution, which rises above the bottom line to consider the impact of its actions on all, from shareholders to the society at large. All acts of the company should not only be the right course of action, but also be perceived so.

 The means are as equal, if not more, important than the goals. A common feature of well-managed companies is that they have systems in place, which allow sufficient freedom to the boards and management to take decisions towards the progress of their company and to innovate, while remaining within a frame work of effective accountability. In other words they have a system of good corporate governance. This also calls for insurers to devise an internal procedure for adequate and timely disclosure, reporting requirements and code of conduct. Therefore Corporate Governance becomes a key issue in insurance.

Objective of the Study:

In this report, an attempt has been made to present each and every single count related to Corporate Governance that are enshrined in Companies Act, 1956 and rules frames there under. The objective of the report is to explain in detail the corporate governance requirements to be complied with by all the insurance companies by considering various aspects. A proper regulation & Supervision of the insurance sector will help in smooth and efficient functioning of insurance companies.