Regulating and Supervising Mutuals and Community-based organisations

The International Association of Insurance Supervisors (IAIS) and the Microinsurance Network released an Issues Paper discussing the Regulation and Supervision of Mutuals, Cooperatives and other Community-based Organisations (MCCOs) in October 2010. The IAIS and the Microinsurance Network have been working together through their Joint Working Group since 2007. This is the second significant Issues Paper as part of the effort to develop regulatory and supervisory approaches consistent with accessible and effective insurance markets.

It is clear that MCCOs play an important role to improve the effective provision of insurance services in some jurisdictions to groups of the population that would otherwise be underserved or not served at all. MCCOs have filled a role in overcoming challenges to market access that can arise for a range of reasons from geography, socio-economic and cultural issues to business model, service and product design, and value challenges. In the Pittsburgh Communiqué (September 2009) the G20 noted that the leaders committed to “improving access to financial services for the poor” including to “support the safe and sound spread of new modes of financial service delivery capable of reaching the poor”. The experience of a number of countries has been that MCCOs can be one way to achieve these objectives as an active part of the market.

The paper is directed at the wide range of forms, names, and functions of organisation. It also acknowledges that some countries currently recognise MCCOs explicitly under their insurance law whereas others may have a separate law or may not specifically identify MCCOs at all. MCCOs may be described using names such as ‘mutuals’, ‘mutual benefit organisations’, ‘cooperatives’, ‘friendly societies’, ‘burial societies’, ‘fraternal societies’, or other types of organisations that are essentially ‘community-based’, serve some purposes of risk pooling, or act as group ‘self-insuring’ schemes. The paper is not restricted to those MCCOs acting as risk carriers but also includes more limited roles, for example, focusing on administrative or distribution services. The focus of the paper is on matters that arise as a result of the mutual nature of organisations and not their size. In many jurisdictions, MCCOs may be small and the issues of proportionate regulation and supervisory burden will be relevant. But it is equally the case that some MCCOs can be quite large. The paper does not specifically address the special case of Takaful insurers.

Key defining characteristics of MCCOs are the fundamental basis of the paper. These characteristics are defined as member ownership, democracy, solidarity, the fact that the organisation is created to serve a defined group and purpose, and the membership’s entitlement to profits (surpluses). These defining characteristics could be considered to represent key differences between MCCOs and other insurance market participants.

The premise is that the defining characteristics should be the basis for any different regulatory or supervisory treatment that might be considered. In general terms, the paper proposes that the regulatory and supervisory treatment of MCCOs should be equivalent to the approach taken to other organisations. However, where there is an adjustment, such adjustments should take account of the defining characteristics. For example, the need to establish adequate technical provisions or invest in assets that are appropriate to the liabilities is not usually impacted by whether or not an organisation is more or less ‘democratic’ or because it serves a particular ‘defined group’ of members. However, there are differences that do arise from these defining characteristics and, in such instances, any regulatory or supervisory approach needs to recognise these differences and their basis in the defining characteristics.

However, there are qualifications to supervisory and regulatory recognition:

• Sometimes “defining characteristics” are not as completely “defining” as first appears. For example, although member ownership may be a feature of an MCCO, it is not always the case that all policyholders, let alone beneficiaries of services, are members. In some MCCOs, democracy is stronger and more effective than others. The defined group and purpose may imply a very close member group in some cases or a very diverse group in others.
• Defining characteristics can exist to a different degree from organisation to organisation and over time. Defining characteristics are not so much a “yes” or “no” proposition, but more of a continuum. For example, as organisations get larger effective democracy, and the sense of common purpose among members, and also their solidarity may be more difficult to sustain and may gradually become less defining. Whilst it is a characteristic that MCCOs are formed for a defined purpose, the provision of insurance type benefits might be a core or primary purpose in some cases and fairly ancillary in others with the consequence that the attention of management and boards can be expected to be different.
• Defining characteristics may be different to other insurers, but can also have both advantages and disadvantages. For example, it is often a requirement that MCCOs serve a defined group and this is not an obligation on other insurers. Coupled with effective democracy, this may have the benefit of strengthening solidarity but may have drawbacks such as limitations on the available expertise on boards.

Many MCCOs invest considerable effort in preserving the credibility and value of their defining characteristics despite the difficulties of an increasing membership base. Regarding ‘democracy’, as organisations get larger, ensuring members have the right to be involved in the selection of the board, to participate in meetings, and make decisions allocated to the general assembly becomes increasingly more complex. For larger or more geographically dispersed groups, MCCOs sometimes adopt extra processes to ensure that the voice of members is represented.

Regulation and supervision can consider the benefits of a characteristic, but should also consider the additional issues. For example, the element of member participation of the nature of ownership does suggest room for difference. When policyholders and the owners are, in effect, one and the same, then it can be argued the existence of conflicts of interest and the need to manage them between the rights and interests of policyholders and those of shareholders in a stock company is not as relevant to a mutual insurer. But a simple exemption from ‘conflict of interest’ rules on the basis of member participation is probably an inappropriate response. The IAIS Core Principles define the interests of policyholders to include those of beneficiaries of policies, a group that is not normally accorded full membership status in a MCCO. Additionally, particularly as organisations get larger, sometimes only a subset of policyholders are members, different categories of membership might exist, or not all members might participate in the same way in the democratic processes. As a result, there may still be some issues of conflict of interests between groups of policyholders that need to be balanced. Policyholders may have different and conflicting interests that need to be managed even when they simply have different products.

As a result, regulatory and supervisory ‘concessions’ might be accompanied by other requirements. It may be possible to recognise the effect of democracy but, at the same time, include some obligations to ensure it is maintained effectively.

Through the review of the Insurance Core Principles (ICPs) against the various defining characteristics and related MCCO issues, the issues paper makes a number of observations that are instructive for policymakers, regulators and supervisors.

• Policymaking, regulation and supervision roles are often shared between a range of government ministries and agencies and can be part of a wide range of social and economic policy areas from agriculture to social welfare, and including financial services. Other agencies may not all be as fully conversant with financial services issues, particularly insurance. Arrangements for effective, complete, and coordinated oversight will probably be more challenging;
• Including MCCOs in the insurance market may require amendments to laws to recognise them as insurers and / or distributors. If this step also implies formalising an informal segment then appropriate transitional arrangements may be needed. Not all MCCOs that are more generally registered or licensed should be automatically licensed with respect to insurance. A separate licensing process to provide insurance services would offer a flexible route and it seems to be practical for an insurance supervisor to be the licensing authority for insurance purposes;
• To deliver the intended prudential objectives with respect to corporate governance, MCCOs may need different detailed requirements on boards, given they are often selected through a broad democratic process but from a defined group. Different approaches may include areas such as conflict of interest of the nature of those that arise between owners and policyholders to some extent, coupled with supervisory oversight of democratic processes. Board diversity, expertise and continuity will also have to be considered differently;
• Although the potential for conflicts of interest between those of shareholders and policyholders may not exist when policyholders and shareholders are the same, there can still be conflicts between the interests of management and staff and the interests or policyholders owners or between groups of policyholders;
• Assessing suitability of owners from a prudential perspective is different in the context of MCCOs as it is not expected that there will be a dominant owner, rather the structure implies a widely diverse and democratic ownership. But this also means that MCCOs do not tend to have access to a suitable significant owner with capacity to contribute capital in the way other insurers might, leading to different considerations;
• A diverse ownership base can also present some unique risks. It is possible that senior management may have a greater effective control over the entity;
• It is feasible that a MCCO may seek a license in more than one jurisdiction. In these cases, the same issues of cross border cooperation would apply but the additional consideration of the effective operation of the policyholder democratic processes is also relevant;
• When MCCOs are part of the market, the demutualisation process should be clear as a prudent measure. Demutualisation should be subject to the specific approval of the supervisor. In such cases, especially as they may be rare, the supervisor will probably need to be able to request special expert reports;
• For supervisors, there is a particularly strong need to pay special attention to such issues as the equitable distribution of surpluses;
• The role of apex organisations can provide opportunities for effective supervision but also can give rise to some group related issues and ICP 17 could be considered as part of the treatment of such arrangements. Although it is not a particular “mutual” issue to operate such organisations, there is a greater tendency for MCCOs to do so in some markets;
• Capital rules may require specific consideration. In particular, it is to be expected that MCCOs cannot adjust and raise capital as flexibly so may need to align capital needs with available resources more carefully. The balance between retaining capital to support business growth and distributing profits to members is particularly important as is fairness and equity between generations of policyholder members and tends to demand strong attention from both boards and supervisors. Also, when making changes to the capital requirements, arrangements for transition need to consider the ability of insurers to generate capital making this a special consideration when MCCOs are affected;
• Some regulatory and supervisory systems recognise guarantees from third parties as part of the capital regime. Reliance on such guarantees tends to have a limited duration during the start up period and is usually replaced with retained surpluses. Some MCCOs may also have access to capital through calls on members. This suggests some recognition may be made of the elements of “membership”, “solidarity” and the fact the membership is drawn together through a “defined group and purpose”. Assessing the strength of a potential call is complex and it would be unusual for insurance regulation and supervision to give considerable reliance to callable but unpaid capital or reserve items when considering the financial security of the institution unless there was a strong demonstration that such calls had been met in practice.

November 2010