The Reserve Bank of New Zealand (RBNZ), in supervising insurance businesses, should adopt a pre-emptive stance of being ready to act on doubts and suspicions of lack of financial soundness, rather than waiting for certainty or advisory confirmation of financial risk, says a report released yesterday following an independent review that it commissioned of its supervision of collapsed insurer CBL Insurance (CBLI).

The review relates to the Bank as regulator and supervisor of licensed insurers, and the RBNZ says it accepts all findings and recommendations for itself and the insurance regulatory regime.

The report says that there are many case studies in many jurisdictions that demonstrate that, for long-tail insurance business, early hints of under-reserving frequently are signs of trouble ahead and need to be ‘nipped in the bud’ by the regulator.

Background

CBLI started out as a New Zealand-based insurer of builders’ warranty business but it began to operate overseas in the 1990s. By the time of licensing in 2013, it was already writing the vast majority of its business as offshore inwards reinsurance from Europe, mainly in France. GWP in the 2013 calendar year were NZ$165m ($111m), less than NZ$2m of which was New Zealand business.

Most of its business was in building and construction-related classes of insurance and was ‘long-tail’, with claims reporting periods of 10 years or more. The company expanded rapidly from 2012 to its interim liquidation in February 2018: premiums increased from NZ$165m in 2013 to NZ$247m in 2016 and NZ$313m in 2017. Expansion came about mainly from a range of acquisitions of managing general agents in Europe.

CBLI is a wholly-owned subsidiary of a subsidiary of CBL Corporation, which listed on the NZX and ASX in October 2015.

Interim liquidation of the insurer came about in February 2018 following a sequence of events beginning in June 2017 when Elite Insurance, a Gibraltar-based ceding company of CBLI, was found by its regulator to be under-reserved. In August 2017, the RBNZ appointed an investigator (McGrathNicol, a specialist advisory and restructuring firm) to examine CBL and also Milliman and Finity, actuarial firms, to assess CBL's claims reserves.

In February 2018, the reserves were found to be seriously understated, leading to a major breach of CBLI's solvency requirement to a level justifying interim liquidation. The Court ordered interim liquidation as a result not of the solvency breach, however, but of a serious breach by CBLI of RBNZ directions regarding corporate transactions. Shares of the parent company CBL Corporation were suspended from trading and, after an interim liquidator was appointed to CBLI, the parent was placed in voluntary administration. Full liquidation occurred in November 2018.

Findings

The review stated the following findings regarding RBNZ:

During pre-licensing and licensing in 2012 and 2013, when the Insurance (Prudential Supervision) Act 2010 was new and being applied for the first time, RBNZ's processes were sound and the Bank made a sound decision in granting CBL a licence despite concerns over some aspects of the company's affairs. These concerns were to be followed up after licensing.

But the Bank had limited resources in both scale and insurance experience arising from the introduction of the licensing regime in 2013: there were some 100 companies to license in a limited timeframe, supervisory staff were unaccustomed to their roles and the demands of the Canterbury earthquakes were a critical industry risk and user of resources in this period;

The Bank had no evidence that its efforts in 2014 to encourage both CBL and the Appointed Actuary to draw on international actuarial experience were taken up;

CBLI deflected the Bank’s concerns on its claims reserves and solvency in 2014, simply referring them to the Appointed Actuary; and

Subsequent interest by RBNZ in dealing with its doubts about CBLI's claims reserving and solvency was not actively pursued by the Bank until 2017 because of a combination of factors including internal legal advice that the Appointed Actuary's opinion on those matters could not be easily circumvented, doubts as to whether its concern about possible under-reserving were a serious problem and competing priorities (the Canterbury earthquakes in particular).

Local media reports say that when CBLI collapsed last year costing shareholders nearly NZ$750m, investors found they had been kept in the dark about the state of the company. When CBLI hit trouble in early 2018 after claims in France began to rise, the company revealed that RBNZ had been investigating it for months and had issued confidentiality orders that prevented the insurer telling the market.

Recommendations

Supervision

The independent report recommends that in supervision, apart from taking a pre-emptive approach on doubts and suspicions, the RBNZ should:

• Act forcefully, making full use of the powers available to it, when in doubt about a company’s financial soundness.

- In the CBL case, the Bank made a number of judgements from 2014 to 2016 that gave the benefit of the doubt to CBL. If it had acted more forcefully, CBL's solvency may well have been found to be inadequate in 2014 or 2015; if that had been the case, the scope and complexity of the CBL liquidation would have been much reduced compared to the position in 2018.

• For insurers with high risk ratings or that are under increased surveillance, rely not only on the written word but interact more extensively with boards, senior management and appointed actuaries, including meetings aimed at identifying any activities or behaviours that are contrary to prudent conduct of the business.

• Strengthen the governance obligations of insurers through greater scrutiny and accountability of boards, management and Appointed Actuaries.

- Revisions to the Solvency Standard (see below) should contribute to stronger financial management, business planning, governance and board accountability.

- For an insurer with a high risk rating, the Bank should monitor and test the outcomes of the insurer’s compliance with the terms of the Governance Guidelines and the Risk Management Guidelines.

• On receiving expert reports, whether by actuaries, auditors, expert consultants or others, examine them in depth for a full understanding of the messages they might contain.

• Ensure that Appointed Actuary engagements work effectively, with unfettered access to any and all of the company chairman, directors and senior executives and also to the Bank. Require full adherence to Solvency Standard requirements, including professional standards.

• Maintain active relationships with international regulators by utilising the Bank’s membership of the International Association of Insurance Supervisors.

• Ensure solvency assessments take full account of business plans and recognise the significance of pricing and future profitability as well as balance sheet integrity.

• In order to deliver on all of the above, allocate additional resources to the supervisory team and the policy team to a level consistent with the Bank’s goals, priorities and risk appetite.

Regulation

On regulatory matters, there is a case for:

• Modifying the Solvency Standard (and, if necessary, the Act) so as to

- operate as a graduated and flexible set of solvency measures and triggers, in the same manner as the Bank has proposed introducing for licensed banks, with a prudential capital buffer and an escalating supervisory response as the buffer reduces. Such an approach would not only strengthen the capital management and solvency framework, but would also oblige active participation by, and responsibility of, the board for capital management and business planning.

- Make it less difficult for the Bank to challenge the Appointed Actuary’s advice in determining an insurer’s solvency margin.

• Introducing, by amendment to the Insurance (Prudential Supervision) Act 2010 (the Act) –

- group supervision for insurance groups using non-operating holding companies and insurance subsidiaries (as in the CBL case), to ensure capital integrity and protection against contagion risk within the group;

- outsourcing requirements for all insurers (especially for underwriting agencies, third-party claims managers and reinsurance);

- a power for the Bank to issue a wider range of prudential standards including governance and risk management standards; and

- correction of some omissions including the inability to stop an insurer renewing existing contracts when the insurer’s solvency is under question.

RBNZ's  response

In a statement, RBNZ deputy governor Mr Geoff Bascand said, “The Reserve Bank’s approach to prudential regulation and supervision is being updated to promote financial stability for future generations.

"We are reviewing key regulatory requirements to boost the resilience of our banking and insurance sectors, and we are intensifying our supervision of financial institutions. In short, we are recalibrating the rules and our enforcement of them.”

In thanking the reviewers, Mr Bascand said: “We are encouraged that our licensing decision and process were found to be sound, and that our actions leading to CBLI being placed into liquidation were assessed to be appropriate. We acknowledge the review’s finding that our supervision was overly-lenient towards CBLI and should have addressed concerns about its reserving and management more urgently.”