Securities Commission - Discussion on Life Insurance and Law Practices


	PART II - LIFE INDUSTRY LAW AND PRACTICES Main Contents Glossary Part I - Background Part II - Life Industry Law and Practices Part III - Public Policy Discussion Appendices	THE QUALITY, SIZE AND SPREAD OF INVESTMENTS BY LIFE INSURANCE COMPANIES Our experience of New Zealand life insurance company practice Legal provisions relating to the investment of life insurance company assets The approach in Australia and the United Kingdom to regulation of the quality of life insurance company investments Comment

Our experience of New Zealand life insurance company practice

5.1
Life insurance companies, by their nature, accumulate large sums of money for investment on behalf of their policyholders. These moneys, together with shareholders' funds, are invested in a wide range of investments in accordance with the decisions of the directors of each company (as expressed through investment policies and strategies as well as discrete decisions).

5.2
Some of the investments undertaken by life insurers operating in New Zealand which we have observed³² have included:

some four-fifths of a life company's total assets being advanced to a related party. The auditor's report on the company's financial statements said the auditor was unable to determine whether the related party loan was collectable in full. The life insurer had also guaranteed a bank overdraft obligation of its parent;

investment of over 50% of a company's total assets in a business which was:

situated on land owned by the insurance company;

managed by the life insurance company;

owned by a trust which was heavily indebted and incurring ongoing trading losses;

investment of some 94% of a company's funds with its parent (a financial institution);

concentration of a company's total investment assets (over 60% of total assets) in commercial property (some of which was probably held to back policies linked to property investment);

a long-term investment of more than 10% of a company's total assets in a single advance to the company's own parent company secured by a second mortgage over certain overseas assets at a bank-bill interest rate, with the value of the security influenced to a significant degree by the company's parent's own financial performance;

an investment of just under 10% of total assets in a minority but controlling holding in a listed commercial property trust;

a long-term fixed interest loan by a life insurance company to the owner of a commercial building, representing nearly 4% of the life company's total assets with the property being leased-back (and occupied) by the insurance company;

a long-term investment in forestry futures;

two instances of ownership of what might be termed "lifestyle" assets which may be regarded as being a disproportionately significant part of the companies' assets.

Legal provisions relating to the investment of life insurance company assets

5.3 In New Zealand there are no prescribed rules or guidelines for the investment of the policyholders' funds of a life insurance company. Current New Zealand law does not constrain related party exposures by life insurers. As noted earlier (see para 4.25) in some circumstances the law would seem to facilitate related party exposures. We have seen examples of material related party lending by New Zealand life insurance companies. We are aware that the constitutions of some life companies allow them to act in the best interests of their holding companies even if this is not in their own best interests.

5.4 Current law does not prevent the accumulation by life insurance companies of large asset concentrations, whether in single investments or in sectors. Disclosure of such exposures, if any, is usually limited to a company's audited financial statements. However if the life insurer were a listed public company, or the subsidiary of a listed public company, the New Zealand Stock Exchange's Listing Rules (Rule 9.1) would oblige the company to obtain the approval of the members of the company by Ordinary Resolution³³ to enter into any transaction where the gross value was in excess of 50% of the value of the shareholders' funds of the listed company. In addition, section 129 of the Companies Act 1993 provides that, where an acquisition (or disposition) of property is valued at more than 50% of the value of the company's total assets before the transaction, the transaction has to be approved by a special resolution of the company³⁴.

5.5 In some cases the types of investment held by a life company may reflect choices made by the investors themselves. Companies offer policies ("investment-linked") which allow the policyholders to nominate the types of investment into which their money is to be invested. The choices available can include fixed interest securities, New Zealand equities, overseas equities, cash and other liquid assets, emerging market securities, etc. The life company, either directly or through contracted managers, decides on the particular assets to be acquired in each asset class. These investments may be said to be divided into units, with a market price per unit available at all times to measure their performance. Under New Zealand law, however, the allocation of assets to units will generally be notional, as there will be no statutory fund or separate trust for the assets, and the allocation will not be effective against competing claims of creditors in the event of financial difficulty.

5.6 The investment-linked types of policies may raise different issues from the traditional participating policies. The investor has made the choice of the type or types of assets into which the funds are to be invested. Managers' performance may be, and sometimes are, measured by prices which are published and are available to potential investors. The exit price will be determined by reference to the market price of the assets allocated to particular securities after taking into account a price spread between buying and selling unit prices to allow for costs and charges.

The approach in Australia and the United Kingdom to regulation of the quality of life insurance company investments

5.7 As discussed earlier Australian life insurance companies are required to fulfil a number of statutory requirements related to solvency and capital adequacy (see para 4.29 onwards). While these requirements do not include specific prohibitions on life companies making certain types of investment, nor limit the companies' ability to accumulate large concentrations of risk, they effectively achieve these outcomes by the manner in which the statutory requirements are structured.

5.8 To illustrate, the "Solvency Standard" requires the company to create an "Inadmissible Assets Reserve" in relation to related party exposures, investments in companies already subject to prudential ratio requirements, and for various large exposures³⁵. The effect of the reserve is to negate some or all of the value of the company's assets for the purposes of the solvency requirement calculation.

5.9 In the United Kingdom, under the ICA(UK), the solvency requirements have the effect, as in Australia, of imposing de facto constraints on life insurers' investments in particular types of asset.

5.10 Life insurers are able to include within their "admissible" or qualifying assets only those assets which come within the classes of assets prescribed in regulations. Apart from investments in cash and gilt edged securities, which are unrestricted, the admissible level of other assets ranges from around 0.1% of the "long term business amount"³⁶ for debenture options and share options in any one company to 5% of that "amount" for land, mortgages over land and listed shares and debentures. There are prescriptions for valuing the various types of assets.

5.11 The general scheme limits a life insurer's exposure to any particular asset, other than gilt edged securities, to 5% of the long term business amount.

5.12 In addition to the de facto constraints described in the preceding paragraphs, the ICA(UK) also imposes a de jure restriction on transactions with connected persons. In general terms insurance companies (or their subsidiaries) cannot enter into transactions with connected persons (being controllers or directors of the insurance company) if the aggregate of the assets and liabilities attributable to existing transactions with the person concerned exceeds 5% of the amount of the long-term fund, or the proposed transaction would take the aggregate over the 5% limit.

Comment

5.13
It is generally accepted that the riskiness of a financial institution's investment portfolio is likely to be increased³⁷ to the extent the institution has:

large exposure concentrations i.e. single exposures to individual counter-parties, or single or multiple exposures to a single industry or geographical sector;

related party exposures i.e. investments with parties related to the institution

5.14 We have observed that some New Zealand life insurance companies have amassed relatively large single exposures, relatively large related party exposures, and relatively large sector exposures.

5.15 There are currently no direct constraints on the size or nature of exposures which may be undertaken by New Zealand life companies. However exposures which are material in the accounting sense should be disclosed in a life company's audited financial statements. The Companies Act, also the New Zealand Stock Exchange Listing Rules, where applicable, provide for shareholder approval for some very large transactions. There is no requirement for approval by policyholders for such transactions.

5.16 We think there are a number of questions which need to be addressed concerning the capacity of life insurance companies to undertake large and related party exposures. We raise these questions in the final section of the paper.

Footnotes

Not all these investments would be considered material to the financial condition of the investing life office.
An Ordinary Resolution requires a simple majority of the voting securities of the company.
A special resolution requires the approval of 75% of the voting power of the company (unless the company's constitution provides for a higher percentage requirement).
For example, for those investments in first mortgages which do not exceed 70% of the market capitalisation of the property a reserve has to be created for any amount exceeding 5% of the value of the statutory fund. For investments secured by mortgages other than first mortgages, or where the percentage of market capitalisation exceeds 70%, any amount exceeding 1% of the statutory fund has to be reserved.
The long term business amount is calculated by formula which comprises the amount of the company's long-term business liabilities plus one-sixth of the company's UK solvency requirement and is reduced by the amount of any loans to dependant companies, reinsurance recoveries and any liabilities in respect of property linked benefits.
This would not be the case if the life insurer was fully invested in Government securities or similar gilt-edged securities. As paragraph 6.9 of FRS-31 Disclosure of Information about Financial Instruments says "Disclosure of information about concentrations of credit risk permits users of financial reports to make their own assessments of the relative risk associated with an entity's portfolio of financial assets. Whether a particular concentration of credit risk is viewed favourably or unfavourably will depend on the particular risks associated with an individual counterparty or group of counterparties."

Main Contents
Glossary
Part I - Background
Part II - Life Industry Law and Practices
Part III - Public Policy Discussion
Appendices
INDEX || BACK || FORWARD

Our experience of New Zealand life insurance company practice
5.1	Life insurance companies, by their nature, accumulate large sums of money for investment on behalf of their policyholders. These moneys, together with shareholders' funds, are invested in a wide range of investments in accordance with the decisions of the directors of each company (as expressed through investment policies and strategies as well as discrete decisions).
5.2	Some of the investments undertaken by life insurers operating in New Zealand which we have observed³² have included: some four-fifths of a life company's total assets being advanced to a related party. The auditor's report on the company's financial statements said the auditor was unable to determine whether the related party loan was collectable in full. The life insurer had also guaranteed a bank overdraft obligation of its parent; investment of over 50% of a company's total assets in a business which was: situated on land owned by the insurance company; managed by the life insurance company; owned by a trust which was heavily indebted and incurring ongoing trading losses; investment of some 94% of a company's funds with its parent (a financial institution); concentration of a company's total investment assets (over 60% of total assets) in commercial property (some of which was probably held to back policies linked to property investment); a long-term investment of more than 10% of a company's total assets in a single advance to the company's own parent company secured by a second mortgage over certain overseas assets at a bank-bill interest rate, with the value of the security influenced to a significant degree by the company's parent's own financial performance; an investment of just under 10% of total assets in a minority but controlling holding in a listed commercial property trust; a long-term fixed interest loan by a life insurance company to the owner of a commercial building, representing nearly 4% of the life company's total assets with the property being leased-back (and occupied) by the insurance company; a long-term investment in forestry futures; two instances of ownership of what might be termed "lifestyle" assets which may be regarded as being a disproportionately significant part of the companies' assets.
Legal provisions relating to the investment of life insurance company assets
5.3	In New Zealand there are no prescribed rules or guidelines for the investment of the policyholders' funds of a life insurance company. Current New Zealand law does not constrain related party exposures by life insurers. As noted earlier (see para 4.25) in some circumstances the law would seem to facilitate related party exposures. We have seen examples of material related party lending by New Zealand life insurance companies. We are aware that the constitutions of some life companies allow them to act in the best interests of their holding companies even if this is not in their own best interests.
5.4	Current law does not prevent the accumulation by life insurance companies of large asset concentrations, whether in single investments or in sectors. Disclosure of such exposures, if any, is usually limited to a company's audited financial statements. However if the life insurer were a listed public company, or the subsidiary of a listed public company, the New Zealand Stock Exchange's Listing Rules (Rule 9.1) would oblige the company to obtain the approval of the members of the company by Ordinary Resolution³³ to enter into any transaction where the gross value was in excess of 50% of the value of the shareholders' funds of the listed company. In addition, section 129 of the Companies Act 1993 provides that, where an acquisition (or disposition) of property is valued at more than 50% of the value of the company's total assets before the transaction, the transaction has to be approved by a special resolution of the company³⁴.
5.5	In some cases the types of investment held by a life company may reflect choices made by the investors themselves. Companies offer policies ("investment-linked") which allow the policyholders to nominate the types of investment into which their money is to be invested. The choices available can include fixed interest securities, New Zealand equities, overseas equities, cash and other liquid assets, emerging market securities, etc. The life company, either directly or through contracted managers, decides on the particular assets to be acquired in each asset class. These investments may be said to be divided into units, with a market price per unit available at all times to measure their performance. Under New Zealand law, however, the allocation of assets to units will generally be notional, as there will be no statutory fund or separate trust for the assets, and the allocation will not be effective against competing claims of creditors in the event of financial difficulty.
5.6	The investment-linked types of policies may raise different issues from the traditional participating policies. The investor has made the choice of the type or types of assets into which the funds are to be invested. Managers' performance may be, and sometimes are, measured by prices which are published and are available to potential investors. The exit price will be determined by reference to the market price of the assets allocated to particular securities after taking into account a price spread between buying and selling unit prices to allow for costs and charges.
The approach in Australia and the United Kingdom to regulation of the quality of life insurance company investments
5.7	As discussed earlier Australian life insurance companies are required to fulfil a number of statutory requirements related to solvency and capital adequacy (see para 4.29 onwards). While these requirements do not include specific prohibitions on life companies making certain types of investment, nor limit the companies' ability to accumulate large concentrations of risk, they effectively achieve these outcomes by the manner in which the statutory requirements are structured.
5.8	To illustrate, the "Solvency Standard" requires the company to create an "Inadmissible Assets Reserve" in relation to related party exposures, investments in companies already subject to prudential ratio requirements, and for various large exposures³⁵. The effect of the reserve is to negate some or all of the value of the company's assets for the purposes of the solvency requirement calculation.
5.9	In the United Kingdom, under the ICA(UK), the solvency requirements have the effect, as in Australia, of imposing de facto constraints on life insurers' investments in particular types of asset.
5.10	Life insurers are able to include within their "admissible" or qualifying assets only those assets which come within the classes of assets prescribed in regulations. Apart from investments in cash and gilt edged securities, which are unrestricted, the admissible level of other assets ranges from around 0.1% of the "long term business amount"³⁶ for debenture options and share options in any one company to 5% of that "amount" for land, mortgages over land and listed shares and debentures. There are prescriptions for valuing the various types of assets.
5.11	The general scheme limits a life insurer's exposure to any particular asset, other than gilt edged securities, to 5% of the long term business amount.
5.12	In addition to the de facto constraints described in the preceding paragraphs, the ICA(UK) also imposes a de jure restriction on transactions with connected persons. In general terms insurance companies (or their subsidiaries) cannot enter into transactions with connected persons (being controllers or directors of the insurance company) if the aggregate of the assets and liabilities attributable to existing transactions with the person concerned exceeds 5% of the amount of the long-term fund, or the proposed transaction would take the aggregate over the 5% limit.
Comment
5.13	It is generally accepted that the riskiness of a financial institution's investment portfolio is likely to be increased³⁷ to the extent the institution has: large exposure concentrations i.e. single exposures to individual counter-parties, or single or multiple exposures to a single industry or geographical sector; related party exposures i.e. investments with parties related to the institution
5.14	We have observed that some New Zealand life insurance companies have amassed relatively large single exposures, relatively large related party exposures, and relatively large sector exposures.
5.15	There are currently no direct constraints on the size or nature of exposures which may be undertaken by New Zealand life companies. However exposures which are material in the accounting sense should be disclosed in a life company's audited financial statements. The Companies Act, also the New Zealand Stock Exchange Listing Rules, where applicable, provide for shareholder approval for some very large transactions. There is no requirement for approval by policyholders for such transactions.
5.16	We think there are a number of questions which need to be addressed concerning the capacity of life insurance companies to undertake large and related party exposures. We raise these questions in the final section of the paper.