A firm hand

Company failures have prompted wide-ranging corporate governance documents to pile up on insurers' desks. Ian Mathers and Maria Mathew clarify the current situation and warn of what is to come

Recent insurance company failures - or near failures - including HIH Insurance, Equitable Life and Independent Insurance, have emphasised the need for improved corporate governance in the insurance sector, on both a domestic and international level.

The Owen Report commissioned for HIH in Australia and published in April 2003; the Penrose Report into the Equitable Life inquiry published in March 2004; and the Sharma Report on the Prudential Supervision of Insurance Undertakings published in December 2002, which looked at a variety of failures and near failures of insurance companies within the European Union, all pointed to deep-seated problems at board level. The Penrose Report in particular pointed to an imbalance of knowledge at board level, a lack of independence of the appointed actuary and an inadequate level of knowledge among the board in detecting reporting discrepancies as important factors in worsening the solvency position of the company.

The public nature of such management scandals has led to an increased demand for accountability from the insurance sector, with a particular emphasis on mutual insurers. The aim is to provide clear information to customers, greater transparency of accounting procedures and internal controls, and for senior management to be selected on a more stringent basis. The result is an extensive list of guidance relevant to the UK (see box).

Current guidance

In addition, publication by the Association of Mutual Insurers and the Association of Friendly Societies of a new annotated combined code of corporate governance for mutual insurers (PM, 21 July, p40), which is set to come into effect next year, only substantiates the current understanding that either insurers comply and set the standard - or they will have it set for them.

Although it may seem overwhelming, the amount of guidance available, compared to 10 years ago, is a reflection of the current challenge that the sector faces to improve its systems.

Many of the proposals are focused on trying to prevent company collapses from occurring again, or at least minimising the damage caused and raising alert signals earlier. The guidance currently available focuses on the need for improved internal accounting controls, independence of the actuarial roles and the skills and experience of board members to fit within the framework goals of the relevant institution. In reality, a large amount of it is not legally binding. Nevertheless, it seeks to provide a benchmark to which insurers should aim, in order to improve market transparency and increase consumer confidence.

The Financial Services Authority is able to enforce its powers and companies will be expected to provide an explanation for their failure to adhere to FSA guidelines.

Equitable Life highlighted the need for closer interaction between regulatory authorities and insurers in obtaining information to assess risk, analyse solvency levels and protect customers. One of the main findings in both the Equitable Life and HIH inquiries was the lack of involvement by the relevant regulatory bodies in analysing risk management procedures and holding the companies to account. Since Equitable Life, the FSA now has its own increased powers under the Financial Services and Markets Act 2000 and has improved capacity to undertake insurance risk analysis both within the sector and for individual corporations.

HIH was unable to adapt its corporate governance model to changing circumstances in the insurance industry. Its regulator, the Australian Prudential Regulatory Authority, did not question the information it was receiving in time.

The Owen Report recommended that the regulatory role of APRA be revamped.

In October 2003, an IAIS report laid out the need for improved supervision as well as compliance by insurers. The report emphasised the need for the supervisory procedures to be more transparent, supervisors to be more consultable and the need for the supervisor to establish greater credibility within the sector and with the public at large.

Insurers have come a long way since the Penrose Report and the Owen Report in their attempts to be more proactive in assessing their board structure, solvency and interaction with the FSA. Then again, they have little choice, either they show willingness to comply with the current board management and solvency requirements or they face further state intervention.

The EU's Solvency II proposals, which are currently at the consultation stage and look unlikely to be implemented until 2008 at the earliest, should set the solvency standard for insurers. However, after the abundance of guidance following Equitable Life's demise it seems doubtful that Solvency II can have much more to add.

What lies ahead?

The Financial Reporting Council announced a review of the 2003 implementation of the Combined Code on Corporate Governance on 14 July, and has requested feedback from listed companies, directors, investors, and other interested parties on their implementation experiences. The FRC findings will be published at the end of 2005 and any amendments to the Combined Code will be subject to public consultation in 2006. This form of monitoring appears to be an area for future development.

So what should insurance companies be doing? Internal risk management has to evolve with the company's goals and strategies. The reality - as proved by HIH, where a governance structure was in place - is that corporate governance is only as good as the people in power implementing it. The Owen Report described the corporate culture of HIH as: "blind faith in a leadership that was ill-equipped for the task. There was insufficient ability and independence of mind in, and associated with, the organisation to see what had to be done and what had to be stopped or avoided. Risks were not properly identified and managed. Unpleasant information was hidden, filtered or sanitised. There was a lack of sceptical questioning and analysis when and where it mattered."

One concern mentioned in the Owen Report, and substantiated by other guidance, is that the wide usage of the term 'corporate governance' may render it meaningless - a public-relations box-ticking exercise aimed at the assumption, perhaps incorrectly, that there are no problems in a corporation. In order for corporate governance to be truly effective, as the Owen Report states, this expression should embrace "not only the models or systems themselves but also the practices by which that exercise and control of authority is, in fact, effected".

No matter what the future holds for corporate governance among insurers, a board is only as good as the information it receives and acts on. Corporate governance values can not just stay at board level, they must be embedded in a firm's culture. Doing this, and ensuring that everyone within the corporation is singing from the same songsheet, may be the best assurance that individuals of appropriate calibre will emerge to strengthen the boards of insurance companies in the years ahead.


- The Penrose Report analysed the issues arising under Equitable Life and made recommendations on how to prevent future scandals from occurring in the insurance sector.

- The review by Paul Myners in 2004 provided recommendations for the corporate governance of mutual life insurers.

- The Baird Report produced in 2001 reviewed the regulation of Equitable Life by the Financial Services Authority.

- Guidelines include the Combined Code on Corporate Governance (July 2003) and the International Association of Insurance Supervisors' Insurance Core Principles and Methodology (October 2003).

- The Organisation for Economic Co-operation and Development issued guidelines in April 2005 that were directed to member states, including the UK, relating to the corporate governance of insurers.

- The Financial Services Authority has also provided guidance on operational risk, systems and controls and requires approval of the appointment of directors and key employees through its handbook.

Ian Mathers and Maria Mathew are members of Allen and Overy's insurance group.

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