1. Suitability of Person and Sound Corporate Governance Practices
Regional Seminar on Capital Adequacy and Risk-based Supervision
for Supervisors in Latin America
Rio de Janeiro, Brazil, May 2007
Gunilla Borer
Senior Financial Sector Specialist

2. ICP 7 Suitability of persons
The significant owners, board members, senior management, auditors and actuaries of an insurer are fit and proper to fulfil their roles. This requires that they possess the appropriate integrity, competency, experience and qualifications

3. ICP 9 Corporate Governance
The corporate governance framework should recognise and protect the rights of all interested parties. The supervisory authority should require compliance with all applicable corporate governance standards*
* Applies to all insurers irrespective of organisational form

4. Other relevant Insurance Core Principles
Internal control (10)
Risk assessment and management (18)
Information disclosure (26)

5. Suitability of key employees
Whose suitability do we want to assess?
Why?
How can suitability be demonstrated or documented?
Whose task is it to assess the suitability - ultimate responsibility?

6. Suitability of significant owners
Defined as a person (legal or natural) that directly or indirectly, alone or with an associate, exercises control over the insurer
Significance of control (and change in control) in ICP 8 (common target level is 10%)
Fit and proper relates to the persons and their financial soundness (if legal, also look at the key functionaries)
Responsibility for the fitness and propriety of key functionaries lies with the company itself

7. Suitability (fit and proper)
Knowledge (theory)
Professional experience - not necessarily insurance related (practice)
Holistic approach
Ethics and morals
Integrity
Individual approach - a lack cannot be compensated by another person’s qualities

8. Definition of Corporate Governance
The manner in which boards of directors and senior management oversee the business and affairs of insurers. It encompasses the means by which they are held accountable and responsible for their actions. It includes corporate discipline, transparency, independence, accountability, responsibility, fairness and social responsibility. Timely and accurate disclosure on all material matters regarding the insurer, including the financial situation, performance, ownership and governance arrangements, is part of such a framework. Corporate governance also includes compliance with legal and regulatory requirements.

9. Why is corporate governance important?
Financial institutions have a critical role and are exposed to risk
Decreases the risk of unexpected losses (increasing complexity)
Efficiency creates value and core competencies
Competitive environment
Ensure that the goals and objectives are met
Decrease the risk of damage to the insurers’ reputation (and others’)
Clients have claims on the institution for future payment
Create confidence in the ability to meet the obligations
Facilitate compliance with rules, policies and plans – if oversight framework does not work, more detailed requirements will not be effective
Supports supervisory objectives of sound, safe, stable and efficient markets

10. Why do companies fail?* Poor management
Lack of skills or integrity (non-suitability)
Lack of clear objectives and how to measure the results
Poor risk management
Interactions and correlations of different risks not anticipated or assessed
Complex corporate structures
Groups (conflicting or irrelevant objectives)
Mergers and acquisitions (poor overview and control)
Outsourced key functions (poor instructions and control)
* London Report

11. Poor corporate governance: cause or symptoms of larger problems
Internal risks (management related)
External risks (business related)
Inadequate or failed internal processes. people or systems
Inappropriate risk decisions
Financial outcome
Policyholder harm
Incorrect evaluation of financial outcomes
Risk appetite decisions

12. Clear lines of responsibility and accountability
Define the authorities and key responsibilities for board of directors and senior management
Create an accountability hierarchy for the staff*
Different responsibilities require different persons being responsible, otherwise no accountability (conflicts of interest)
Take into consideration that the ultimate responsibility stays with the board
* Several models are available, e.g. two-tier system and committees

13. Separation of duties and checks and balances
Delegation: Authority and duty (range of actions, limits)
Control: Monitoring, reporting, review and revision
Reporting line

14. Strategic objectives and corporate values
The board should
Define a well articulated corporate strategy
Create a corporate climate that prevents corruption and fraud (start from the top - suitability)
Safeguard the interests of key stakeholders
Create a system to avoid conflict of interests
Put systems in place to control lending and other forms of self-dealing
Ban preferential treatment also to related parties and other favoured parties

15. Quality, awareness and independence of board members
Understand oversight role and duty of loyalty
Understand the fiduciary duty to policyholders
Avoid conflicts of interest
Not participate in day-to-day management (sufficient number of non-executives)
Provide objective advice and recommend sound practices based on experience (suitability)
Have power and structure to question management (information, size, frequency, standing, evaluation etc.)
Robust enough to deal with crisis situations – supervisors will require the board to take remedial action
Meet regularly with senior management and internal audit
Assess own and others’ performance and take corrective actions

16. Appropriate oversight by senior management
Oversight consistent with board policy
Key decisions should never be made by a single person – however not be too involved in business-line decisions
Exercise control over key employees
Have the necessary prerequisite skills (suitability)

17. Proper use of internal auditors
Recognise the importance of the audit process and communicate it throughout the company
Take measures to enhance their independence
Provide access to business and support areas
Utilise findings effectively and in a timely manner
Have external audit verify internal controls
Correct problems identified by auditors
Use auditors as independent check of information from management – direct reporting

18. Controlled risk management (RM)
Find the right balance between the opportunity to take risk and create value for the company and the threat risk poses to the survival of the firm through:
Qualitative RM
Sound valuation and risk measurement
Quantitative risk limit monitoring system
Reliable capital adequacy framework
Risk governance
Clearly defined responsibilities for risk taking and RM
Sound and well documented RM policies and guidelines; and operating, reporting, limit monitoring and control procedures
Regulatory compliance
Internal and external audit of processes and figures
Transparency
Risk, objectives, issues, performance etc.
Financial and risk disclosure
Company culture demonstrating disciplined and controlled risk taking

19. Special control functions (not exhaustive)
Appointed or responsible actuary
Compliance officer
Proactive (information and education)
Reactive (complaints)
Know-Your-Customer procedures
Committees, e.g. Audit Committee:
Review financial reporting and internal control systems
Independence and financial, accounting or auditing knowledge
Direct access to the Board

20. The role of the compensation policy
Smart people who are doing stupid things are often being paid for it
It is never good to have a system of incentives that you have to resist in order to avoid going in the wrong direction (suitability is not a guarantee)
Short-term incentives can be contrary to long-term interests
Should create the right incentives and be consistent with
Ethical values
Long-term objectives and strategy
Control environment (should only risk be rewarded, not control?)
Should be approved by the board

21. Shareholders’ interests and responsibilities
Corporate governance practices are in general designed to protect shareholders’ interests, i.e. balance potential conflicts of investors (outsiders) and those who control the company (insiders) - Supervisors need to take an interest (capital base is solvency buffer) but should focus on the interests of the policyholders (does not have to be contradictory)
Do shareholders also have responsibilities?
Majority shareholders
Too influential/insufficient independence?
Minority shareholders
Too passive/insufficient focus on accountability?

22. Know-your-structure
Board and senior management should understand the operational structure of the company/group
Also when operating in jurisdictions and through structures that impede transparency (impose better structures?)
Ensure that risks are assessed and managed appropriately

23. Foreign companies’ operations
Subsidiaries of foreign companies are locally incorporated and follow national rules
Branches are not legal entities and need to follow the corporate governance rules of the foreign company
Potential conflict between the need for uniform rules applicable to all operations within a jurisdictions and the need for consistent rules in a company or group
International standards and best practice, as well as some flexibility in the application

24. Supervisory focus
Prevent and identify problems at the earliest possible stage
Preventive tools
Off- and on-site supervision
Access to information must be unimpaired
Look at individual companies and group structure
Take action when necessary (early)

25. Preventive tools
Check fitness and propriety of significant owners and key functionaries
Initially through licensing
Continuously through notification of change
Pose relevant questions and require certified answers (liability promotes true information)
Soundness should be demonstrated by the company at any time (awareness of relevant circumstances)
Require policies and procedures related to good corporate governance and internal control to be in place

26. Market and off-site analysis
Board structure and membership
Regulatory filings on board related issues (suitability etc.)
Company documents on financial position (regulatory and public)
Individual and group structure
Reactions to public disclosure (news etc.)

27. On-site inspection Boardroom performance: Minutes of board
Information provided to the board
Minutes of board committees, where relevant
Quality of audit and control functions: Reports of internal auditors – to be discussed with audit staff and staff in areas affected
Reports of external auditors
Policies and procedures: Assess if effective and implemented
Effects of group structures

28. Enforcement
Enforcement mechanisms promote adherence to rules and principles
Take supervisory action when the requirements are not fulfilled (lack of soundness needs to be demonstrated by the supervisor)
Supervisory action may also be needed in cases of conflicts of interest
Alert board and senior management to problems and take actions as necessary and appropriate

29. The role of market discipline
Market discipline provides an important incentive when it comes to adherence to rules and principles
Market forces can raise the cost or restrict the volume of funding - deters excessive risk taking and inappropriate behaviour (rewards good behaviour and punishes bad behaviour)
Markets are vulnerable to reputational risk - discipline promotes financial stability
Financial markets should be sound, stable and effective

30. ICP 26 Information, disclosure and transparency towards the market
Insurers need to disclose relevant information on a timely basis in order to give stakeholders a clear view of:
Business activities
Financial position
Risks to which they are exposed
Quantitative (e.g. audited financial information) and qualitative information
Periodical and ad hoc

31. Information related to suitability and corporate governance
Board and senior management
Basic organisational structure
Incentive structure
Nature and extent of transactions with affiliates and related parties
Major events and decisions (possibilities of altered risks)
Significant risk exposures, their effects and how they are being managed and controlled
Off-balance sheet transactions (e.g. guaranties)
Compliance

32. Internal transparency
External transparency requires internal transparency
Visible operations, activities, risk exposures
Clearly defined responsibilities, processes
Risk disclosure and dialogue among people, business/corporate areas, board and senior management
Market discipline can promote good corporate governance structures, risk management practices and internal control

33. Accountability and liability
CEOs and CFOs should be aware of all operational information that is material to the financial results of their companies and should therefore take all the necessary steps in order to get this information
Requiring CEOs and CFOs to certify the information disclosed promotes better internal control and due diligence
Combining this with liability and criminal sanctions could promote enhanced analysis and transparency

34. Conclusions
Sum up by identifying the key words and notions (suggestions by the participants)