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14340490 C O R P


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project on corporate governance in insurance sector

project on corporate governance in insurance sector

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  • 1. Executive SummaryCorporate Governance has come to occupy a very prominent place on the agenda ofbusiness houses, the reasons for which are not far to seek. Although it has alwaysbeen the endeavor of corporate managements to conduct their business in as fair amanner as possible while keeping in view the ultimate bottom line, a senselessadventurism on the part of some to depict their performance out of proportion to therealities had led to the focus returning to the deliberations in the Board rooms and theresponsibilities of the Board of Directors. Corporate managements would do well torealize that it is not merely the appreciation of shareholders’ value which is theultimate objective but the way it is achieved. In most of the corporate debacles thatwere observed in the recent past, the common thread that was observed was the largerthan life image of the CEO which has reduced the Board to a body providing a stampof approval without subjecting the proposals to a strict scrutiny. When it comes toinsurance companies, the fiduciary responsibility of the managements takes a two-pronged direction. As they deal with the policyholders’ money, insurers have to becautious not just about their own managements but also the way the companies wherethe funds are invested, conduct their business. A failure on either side would prove tobe detrimental to the interests of the insurance company.Insurance companies are surrounded by a complicated pattern of economic, socialideas and expectations. They have a responsibility to themselves, to one another andto their constituencies to make a reasonable and effective response. An insurancecompany’s responsibilities include how the whole business is conducted every day. Itmust be a thoughtful institution, which rises above the bottom line to consider theimpact of its actions on all, from shareholders to the society at large. All acts of thecompany should not only be the right course of action, but also be perceived so. Themeans are as equal, if not more, important than the goals.A common feature of well-managed companies is that they have systems in place,which allow sufficient freedom to the boards and management to take decisionstowards the progress of their company and to innovate, while remaining within aframework of effective accountability. In other words they have a system of goodcorporate governance. This also calls for insurers to devise an internal procedure foradequate and timely disclosure, reporting requirements and code of conduct.Therefore Corporate Governance becomes a key issue in insurance. 1
  • 2. Objective of the StudyIn this report, an attempt has been made to present each and every single count relatedto Corporate Governance that are enshrined in Companies Act, 1956 and rules framesthere under.The objective of the report is to explain in detail the corporate governancerequirements to be complied with by all the insurance companies by consideringvarious aspects. A proper regulation & Supervision of the insurance sector will helpin smooth and efficient functioning of insurance companies. 2
  • 3. Corporate governanceThe concept of corporate governance is poorly defined because it covers variouseconomics aspects. As a result of this different people have come up with differentdefinitions on corporate governance. It is hard to point on any one definition as theultimate definition on corporate governance. So the best way to define the concept isto provide a list of the definitions given by some noteworthy people.Various definitions of corporate governance:According to Sir Adrian Cadbury.The system by which companies are directed and controlled 3
  • 4. Corporate Governance is concerned with holding the balance between economic andsocial goals and between individual and communal goals. The corporate governanceframework is there to encourage the efficient use of resources and equally to requireaccountability for the stewardship of those resources. The aim is to align as nearly aspossible the interests of individuals, corporations and society"According to Mathiesen (2002)“Corporate Governance is a field in economics that investigates how tosecure/motivate efficient management of corporations by the use of incentivemechanisms, such as contracts, organizational designs and legislation. This is oftenlimited to the question of improving financial performance, for example, how thecorporate owners can secure/motivate that the corporate managers will deliver acompetitive rate of return.”The definition given by Mathiesen means that corporate governance is a methodwhich tries to find out the different incentives which would motivate the managers ofa corporate to give a good return to the owners of the corporation.According to the Journal of Finance written by Shleifer and Vishnv (1997),“Corporate governance deals with the way in which suppliers of finance to corporateassure themselves of getting a return on their investment” 4
  • 5. The definition here means that corporate governance is basically a technique wherepeople who give money (lenders of the money) promise themselves or comfortthemselves about getting a return on their investment.According to J. Wolfensohn, president of the World Bank, (in 1999)“Corporate governance is about promoting corporate fairness, transparency andaccountability” 5
  • 6. According to OECD (Organisation for Economic Co-operation andDevelopment)“Corporate governance is the system by which business corporations are directed andcontrolled. The corporate governance structure specifies the distribution of rights andresponsibilities among different participants in the corporation, such as, the board,managers, shareholders and other stakeholders, and spells out the rules and proceduresfor making decisions on corporate affairs. By doing this, it also provides the structurethrough which the company objectives are set, and the means of attaining thoseobjectives and monitoring performance.”The definition given by OECD means that corporate governance is an arrangementwhich manages the corporations. The configuration of corporate governance definesthe duties and obligations of all the members of the corporation, gives the structure ofsetting the objectives and the method of attaining the setIn short all the definitions stated above implies that corporate governance is a mode bywhich the management is motivated to work for the betterment of the real owners ofthe corporation i.e. the shareholders.In other words corporate governance can be defined as the relationship of a companyto its shareholders or more broadly the relationship of the company to the society. 6
  • 7. Corporate governance thus refers to the manner in which a company is managed andstates the rules, laws and regulation that affect the management of the firm. It alsoincludes laws relating to the formation of the firm, establishment of the firm and thestructure of the firm. The most important concern of corporate governance is toensure that the managers and directors act in the interest of the firm and for theshareholders.Historical Perspective of Corporate Governance 7
  • 8. The seeds of modern corporate governance were probably sown by the Watergatescandal in the United States. The global movement for better corporate governanceprogressed in fits and starts from the mid-1980s up to 1997. There were the oddcountry-level initiatives such as the Cadbury Committee Report in the UnitedKingdom (1992) or the recommendations of the National Association of CorporateDirectors of the US (1995). It would be fair to say, however, that such initiatives werefew and far between. And while there were the occasional international conferenceson the desirability of good corporate governance, most companies – both global andIndian knew little of what the phrase meant, and cared even less for its implications.More recently, the first major stimulus for corporate governance reforms came afterthe South-East and East Asian crisis of 1997-98. This was no classical LatinAmerican debt crisis. Here were fiscally responsible, healthy, rapidly growing,export-driven economies going into crippling financial crises. Gradually,governments, multilateral institutions, banks as well as companies began to understandthat the devil lay in the institutional, microeconomic details – the nitty-gritty oftransactions between companies, banks, financial institutions and capital markets; thedesign of corporate laws, bankruptcy procedures and practices; the structure ofownership and crony capitalism; sharp stock market practices; poor boards of directorsshowing scant regard to fiduciary responsibility; poor disclosures and transparency;and inadequate accounting and auditing standards. 8
  • 9. Suddenly, ‘corporate governance’ came out of dusty academic closets and movedcentre stage. Barring Japan and possibly Indonesia, countries in Asia recoveredremarkably fast. By the year 2001, Thailand, Malaysia and Korea were on theupswing and on course to regain their historical growth rates. With such rapidrecovery, corporate governance issues s were in the danger of being relegated to theback stage once again. There were projects to be executed, under-value assets to bebought, and profits to be made. International investors were again showingbullishness. In such a milieu, there seemed no urgent need to impose concepts likebetter accounting practices, greater disclosure, and independent board oversight.Corporate governance once again settled into a phase of extended inactivity. 9
  • 10. India’s experience was somewhat different from this Asian scheme of things. First,unlike South-East and East. Asia, the corporate governance movement did not occurdue to a national or region-wide macro – economic and financial collapse. Indeed, theAsian crisis barely touched India.Secondly, unlike other Asian countries, the initial drive for better corporategovernance and disclosure, perhaps as a result of the 1992 stock market ‘scam’, andthe onset of international competition consequent on the liberalization of economy thatbegan in 1990, came from all-India industry and business associations, and in theDepartment of Company Affairs.Thirdly, it is fair to say that, since April 2001, listed companies in India are required tofollow some of the most stringent guidelines for corporate governance throughoutAsia and which rank among some of the best in the world.Even so, there is scope for improvement. For one, while India may have excellentrules and regulations, regulatory authorities are inadequately staffed and lacksufficient number of skilled people. This has led to less than credible enforcement.Delays in courts compound this problem. For another, India has had its fair share ofcorporate scams and stock market scandals that has shaken investor confidence. Muchcan be done to improve the situation. 10
  • 11. Just as the global corporate governance movement was going into a bit of hibernation,there came the Enron debacle of 2001, followed by other scandals involving large UScompanies such as WorldCom, Qwest, Global Crossing and the exposure of lack ofauditing that eventually led to the collapse of Andersen. After having shaken thefoundations of the business world, that too in the stronghold of capitalism, thesescandals have triggered another more vigorous phase of reforms in corporategovernance, accounting practices and disclosures – this time more comprehensivelythan ever before.As a US – based expert recently put it, “Enron and WorldCom have done more tofurther the cause of corporate transparency and governance in less than one year, thanwhat activists could do in the last twenty.”This is truly so. In June 2002, less than a year from the date when Enron filed forbankruptcy, the US Congress introduced in record time the Sarbanes-Oxley Bill. Thispiece of legislation (popularly called SOX) brought with it fundamental changes invirtually every area of corporate governance – and particularly in auditorindependence, conflicts of interest, corporate responsibility and enhanced financialdisclosures. The SOX Act was signed into law by the US President on 30 July 2002.While the US Securities and Exchanges Commission (SEC) is yet to formalize most ofthe rules under various provisions of the Act, and despite there being rumbles ofprotest in the corporate world against some of the more draconian measures in the newlaw, it is fair to predict that the SOX Act will do more to change the contours of boardstructure, auditing, financial reporting and corporate disclosure than any otherprevious law in US history. 11
  • 12. Although India has been fortunate in not having to go through the pains of massivecorporate failures such as Enron and WorldCom, it has not been found wanting in itsdesire to further improve corporate governance standards. On 21 August 2002, theDepartment of Company Affairs (DCA) under the Ministry of Finance and CompanyAffairs appointed this Committee to examine various corporate governance issues.CORPORATE GOVERNANCE IN INSURANCE 12
  • 13. Good governance in a corporate entity should be a voluntary exercise andmanagements should not reduce it to a function that is statutorily enforced. While thebottom line undoubtedly is making a point, entities should realize that they are inbusiness to enhance the stockholder’s value. Thus they owe a fiduciary responsibilityto each of their shareholders. One can analyse corporate governance as a delicatebalance between the twin tasks of performance and compliance. When profit makingbecomes the solitary objective, managements tend to lose sight of their responsibilitiesand throw caution to winds. When the auditors and other officials associated withsurveillance join the black deeds, the problem assumes humongous proportions. It isexactly in this background that we had the occasion to witness several major corporatedebacles; and suddenly corporate governance hogs the limelight like never before.The series of fiascos led to several important legislations being enacted in some of themost developed economies and being followed closely globally. We hear ofcorporate governance in almost all sections of business, irrespective of their size.Corporate governance has a different dimension as far as the insurance business isconcerned. On the one hand, insurers have to be prudent in protecting thepolicyholders’ interests as regards reasonableness in charging premiums; objectivity insettling the claims and so on. On the other, they also have the responsibility ofprofitably investing the policyholders’ funds. This demands that insurers additionallyhave to be sensitive to the management styles ofthe organizations where the funds are being lodged. To this extent, they have a dualfunction to play.STEPS TAKEN BY THE IRDA 13
  • 14. The multi-disciplinary Working Group on Enhanced Disclosure, appointed by theIRDA, while examining the need for improving the public disclosure practices offinancial intermediaries, put forward three broad recommendations:(i) a specific set of disclosures that should be provided by financial intermediaries that incur a material level of the relevant risks through periodic reports to their shareholders, creditors and counterparties;(ii) identification of other disclosures which could be informative but with respect to which further investigation is necessary of their costs and benefits or precisely how they should be made; and(iii) Identification of certain areas where quantitative information will fill the gap in disclosures.Objectives of disclosure 14
  • 15. The working Group while giving its recommendations reiterated the need forextensive disclosures, stating that these “can increase market discipline and mayincrease the stability of the financial system and lead to an improved allocation ofcapital and other resources. Greater transparency can allow participants in thefinancial system to make more informed judgment about risks and returns and to placenew information in proper context. More generally, with greater transparency theremay be fewer tendencies for markets to place emphasis on positive or negative newsand in this way; volatility in the financial markets and an important source of fragilitycan be reduced.” The Working Group’s conclusions had three general themes: first, ahealthy balance is necessary between quantitative and qualitative disclosures; second,intermediaries’ disclosure should be consistent with how they assess and manage theirrisks; and third, intra-period information is necessary for a more complete view of aninstitution’s exposure to risks. The IAIS Task Force on Enhanced Disclosureapproved the Guidance Note on Public Disclosures by Insurers in January, 2002.Public disclosure of reliable and timely information facilitates the understanding byprospective and existing policyholders and other market participants of the financialposition of insurers and the risks to which they are exposed. Supervisors areconcerned with maintaining efficient, safe, fair and stable insurance markets for thebenefit and protection of policyholders. Risk disclosure is critical in the operation of asound market. When provided with appropriate information that allows them to assessan insurer’s activities and the risks inherent in those activities, markets can respondefficiently, rewarding those companies which manage risk effectively and penalizingthose that do not. This is often referred to as Market Discipline, and it acts as anadjunct to supervision. Corporate Governance (CG) encompasses the processes,structures, information and relationships used for directing and overseeing themanagement of the institution in the best interest of the institution and the keystakeholders that have a significant interest in the on-going viability of the company. 15
  • 16. CG is a complex interweaving of legislation, regulation business practices, institution,cultures and social values. Good governance is the means of ensuring that there isadequate control over objectives, strategies, controls and operations within thecompany. In addition, factors such as business ethics and corporate awareness of theenvironmental and societal interests of the communities in which a company operatescan also have an impact on its reputation and on its long term success. Two elementsof CG which make it an important part of effective insurance supervision are: (i) effective CG can improve the confidence that investors have in a company and therefore strengthen the access that a company enjoys to capital, and other forms of financing, as and when it might be required; and (ii) Effective CG strengthens the controls within a company to ensure that the strategies adopted and decisions made by the Board, acting on behalf of the stakeholders, are effectively implemented. 16
  • 17. Effective CG allows the supervisor to rely on the work performed by the Board ofdirectors and senior management and in doing so allows the supervisory process tooperate more efficiently and effectively than it would in the absence of such arelationship. This reliance relationship, however, needs a review from time to time toensure that it is well founded. Both the capital market regulators and the insurancesupervisors are interested that companies adopt CG practices. In case of the capitalmarket regulators it is to ensure that the interests of the investors are protected. Inrespect of insurance supervisors, the interest in good CG practices stems not just fromthe need to protect the rights and interests of the shareholders. It is the money that theinvestors have tied up in a company that forms at least a part of its capital base that thesupervisors are relying on to protect the rights of the policyholders in the event that thecompany fails. Insurance supervisors are interested in having insurance enterprisesthat are well managed, that treat their customers fairly, that are in compliance with thelegislation and other requirements, and are well managed by competent ethicalindividuals. In many insurance companies, there is more policyholders’ money thanthe shareholders’ money – the size of the policy and claims liabilities (and provisionsor reserves) exceed the amount of assets held in respect of shares and other capitalinstruments that the company has issued. The investor while making a decision toinvest in the insurance company is aware of the risks. Policyholders, on the otherhand, are unaware of the risks – rather they seek the services of the insurancecompany to relieve their unwanted risk exposure. While, both the shareholders andthe policyholders have a common interest in the company being run in a prudential,profitable and sound manner, board decisions which may benefit the shareholders maynot necessarily benefit the policyholders, and vice versa. 17
  • 18. This is where the role of the supervisor in implementing CG acquires greatercomplexity. CG forms one of the corner stones of the IAIS (international Associationof Insurance Supervisors) core principles (ICPs). While ICP 9 focuses on CorporateGovernance, the other ICPs which cover various aspects relating to CG are: 1. Suitability of Persons (ICP-7); 2. Changes in Controls & Portfolio Transfers (ICP-8) 3. Internal Controls (ICP-10) 4. On site Inspections (ICP-13); 5. Risk Assessment & Risk Management (ICP-18); and 6. Information, disclosure and transparency towards the market (ICP-26).The principle of CG is linked to the Core Principle on Suitability of Persons (ICP-7).The ICP provides, “The significant owners, board members, senior management,auditors and actuaries of an insurer are fit and proper to fulfill their roles. Thisrequires that they possess the appropriate integrity, competency, experience andqualifications”. ICP-9 defines the CG framework as one which recognizes andprotects the rights of all interested parties. The supervisory authority requirescompliance with all applicable corporate governance standards. The core principle ofCG rests on another premise, which is set out in ICP-10, viz., internal Controls.Internal controls represent a very important tool that boards have to ensure that theirdecisions are implemented. Once in place, internal controls become a very powerfultool for 18
  • 19. the supervisor. The ICP-18 embodies the principle of Risk Assessment andManagement. A critical component of CG is the ability of insurers to recognize therange of risks that they face, and to assess and manage those risks effectively.Effective and prudent risk management systems appropriate to the complexity, sizeand nature of the insurer’s business must exist, and the insurer should establishappropriate tolerance levels to risk. The fundamental of CG is dissemination ofinformation to all the stakeholders, and this finds a cornerstone in ICP-26 pertaining toInformation, Disclosure and Transparency towards the market, and ICP-12 onReporting to Supervisors and Off-site Monitoring. For information to be useful, itmust be timely, accurate, complete and relevant. Insurers must disclose relevantinformation on timely basis in order to give the stakeholders a clear view of theirbusiness activities and financial position and to facilitate understanding of the risks towhich they are exposed.The Indian context 19
  • 20. The focus has shifted to CG time and again on account of repeat emergence offinancial crises across the global, as well as frequent instances of financial reportingfailures. In competitive markets, CG is a reflection of market disciplines, and formsthe cornerstone for efficient allocation of resources. CG enables managements to takedecisions, while at the same time being accountable for the decisions taken. Securities& Exchange Board of India (SEBI) appointed the Committee on CorporateGovernance in May, 1999 under the Chairmanship of Kumar Mangalam Birla, topromote and raise the standards of Corporate Governance, in the particular context ofcompanies of the Committee included (i) to suggest measures to improve CG in the listed companies, in areas such as continuous disclosure of material information, both financial and non financial, manner and frequency of such disclosures, and the responsibilities of independent and outside directors; (ii) to draft a code of corporate best practices; and (iii) to suggest safeguards to be instituted to deal with insider information and insider trading. 20
  • 21. Based on the recommendations of the Birla Committee, SEBI laid down requirementson CG for listed entities in February, 2000. However, certain entities including publicand private sector banks, financial institutions, insurance companies and thoseincorporated under a separate statute were exempted from the requirements.Subsequently, the requirements of SEBI were forwarded to Reserve Bank of India(RBI) to consider issuing appropriate guidelines to banks and financial institutions soas to ensure that all listed companies followed the same standards of CG. While anumber of recommendations already stood implemented, with a view to furtherimproving the CG standards in banks, additional measures were recommended forimplementations by banks. These measures included constitution of a Committee tolook into the complaints of shareholders and half yearly disclosure of unauditedresults. The RBI also recommended compliance with the requirements of theprovisions of clause 49 of the Listing Agreement in June, 2002. The StandingCommittee on International Financial Standards and Codes, Reserve Bank of Indiaconstituted the Advisory Group on Corporate Governance to study the status ofapplicability and relevance and compliance of international standards and codes ofindustrialized and emerging countries and suggest measures/recommendations forachieving the best practice in India. The Group while submitting its Report in March,2001, drew attention to the Organization for Economic Cooperation and Development(OECD) principles, the models of corporate governance in various countries – U.S.,U.K., East Asia and Europe, and the status in India. The Group covered themechanism in India with reference to (i) the private corporate sector, (ii) banks and thedevelopment financial institutions, and (iii) Central and State public sector enterprisesset up under the Companies Act, 1956. Comparisons were also drawn with Bank forInternational Settlement (BIS) principles. The report submitted that it was essential tobring reforms quickly so as to make boards of corporates/banks/financialinstitutions/public sector enterprises 21
  • 22. more professional and truly autonomous. The first important step to improvegovernance mechanism in public sector units was to transfer the actual governancefunctions to the boards from the concerned administrative ministers and alsostrengthen the boards by streamlining the appointment process of directors. Furtherthere was a need for public sector banks to maintain a high degree of transparency inregard to disclosure of information. The recommendations covered areas ofresponsibilities of the board of stakeholders/shareholders, selection procedures forappointment of directors of the board, size and composition of the board, committeesto be appointed by the board for corporate governance, disclosure and transparencystandards, role of shareholders and role of auditors. In August, 2002, the Departmentof Company Affairs (DCA) under the Ministry of Finance and Company Affairsappointed the Naresh Chandra Committee to examine the various CG issues includingappointment of the auditors and his independence; determination of audit fees;measures to ensure that the managements and companies present “true and fair”financial statements and certification of the same by the management and thedirectors; the necessary to have a transparent system of random scrutiny of the auditedaccounts; adequacy of regulations for oversight of statutory functionaries; and the roleof independent directors. SEBI appointed the N.R. Narayana Murthy Committee inFebruary, 2003 to evaluate the adequacy of existing CG practices and to furtherimprove upon them. The Committee was in line with the Board’s belief that efforts toimprove CG standards in India must continue. The Committee focused on such issuesas audit committees and reports, independent directors, related parties, riskmanagement, directors and their compensation, code of conduct and financialdisclosure. The Committee’s recommendations were based on such parameters asfairness, accountability, transparency, ease of implementation, verifiability andenforceability. Prior to these initiatives, in 1996, the CII had taken the firstinstitutional initiative to develop and promote a code of conduct for the Indian 22
  • 23. industry. The initiative was in response to concerns regarding promotion of investorinterest, particularly, small investor’s interest; promotion of transparency withinbusiness and industry; need to move towards international standards in terms ofdisclosure of information by the corporate sector; and to develop a high level of publicconfidence in Indian industry.The Companies Act, 1956The requirements relating to corporate governance are enshrined in the Companies 23
  • 24. Act, 1956 and the Rules framed there under. The various aspects covered includeappointment, remuneration and removal of directors, their duties and responsibilities,liabilities and rights of directors, minimum number of directors, loans to directors,their qualifications and disqualification, disclosure of directors’ interest; provisionsrelating to directors’ relatives, manner of conduct of the Board meetings,qualifications, powers and duties of auditors, constitution of and the role of the AuditCommittee, and disclosures pertaining to related party transactions. Comprehensiveprovisions relating to disclosure to form part of the Annual Report include the state ofaffairs of the company, changes in business, particulars of employees and theirremuneration, details of sweat equity, buy-back of shares, preferential allotments,audit committees, composition of the Board, disclosures on consolidated accounts andthe directors’ responsibilities.Requirements under Clause 49 (Companies Act) of the Listing AgreementAll companies listed on the stock exchanges are required to comply with the CGrequirements as laid down in Clause 49 of the listing agreement. The Clause providesfor the composition of the board of directors, meetings of the board, remuneration ofthe directors, composition of the Audit Committee, its responsibilities and the mannerof conduct of its meetings; disclosure of interests of the management; andManagement Discussion & Analysis Report (MDAR); Report on CG to form part ofthe Annual Report – covering both mandatory and non-mandatory aspects; andCompliance Certificate from the statutory auditors on compliance with Clause 49 toform part of the Directors’ Report. 24
  • 25. CG requirement to be complied with by all insurersAll insurer are required to ensure compliance on corporate governance as per theprovisions of the Corporate Act, 1956. In addition, the insurers have to comply withthe requirements of the Insurance Act, 1938 and the regulations framed there under.The various requirements stipulated by the Authority to ensure good governance in themanagement of affairs of the insurers and transparency in their operations, cover suchaspects as internal controls and processes; constitution of Investment Committee, its 25
  • 26. duties and responsibilities; appointment of managerial personnel to meet the “fit andproper” criteria subject to prior approval of the Authority; disclosure on paymentsmade to individuals, firm, companies and organizations in which directors areinterested; stipulation on appointment of joint auditors, their qualifications androtation of auditors, Format of the Audit Report; defined role of Appointed Actuary;representation of the policyholders on the Board; provisions against commonality ofinterest through presence of similar directors in two insurance companies; amongstothers. The various Accounting Standards framed by the Institute of CharteredAccountants of India facilitate conformity with the accounting principles anddisclosure of specified information to ensure transparency in operations. A review ofthe financial statements furnished by the insurers reveals certain aspects of theirfunctioning. There were instances of the auditors drawing attention to such aspects aslack of controls, inadequacies in the functioning of the audit committees, andinadequacy of IT systems. Absence of these effects the risk management systems putin place by the insurers. Higher expenses towards related parties, and contracts beingexecuted through related parties, appointment of managerial personnel andunderwriting premium for group companies were also noticed. From the regulatoryperspective, there is also a need for disclosures at periodic intervals. While allregulatory stipulations may be in place, ultimately CG is related to imbibing theculture of transparency and fair play within an organization, which cannot comethrough any impositions but has to percolate down to the lowest rungs throughinvolvement of all people at all levels. Checks and controls need to be in place toensure that conflicts of interest and deviations are brought out and rectified. To theextent that such mechanisms are in place, the regulator can rely on the informationfurnished by the insurers and apply the rule of ‘Management by Exception”.Efficiency needs to be achieved through minimizing regulatory prescriptions andmaximizing voluntary codes. While SROs can play a significant role in this regard, 26
  • 27. the Authority is also contemplating framing regulations to cover various aspects ofcorporate governance.Accounting and Actuarial StandardsI Accounting Standards 27
  • 28. The Authority had issued Regulations for Preparation of Financial Statements andAuditor’s Report of insurance companies in the year 2000. Incorporating variousclarifications issued on the same from time to time, the regulations were modified inMarch, 2002. The regulations broadly conform to the Accounting Standards (AS)issued by the Institute of Chartered Accountants of India (ICAI). Modifications havebeen made in respect of the accounting standards pertaining to preparation of CashFlow Statement (AS – 3) which is required to be furnished to the Authority only underthe direct method. The requirements under Segment Reporting (AS -17) have beenmade more stringent for the insurers. The regulations further require that the financialstatement shall be accompanied by the Management Report, in a prescribed format,duly certified by the management. The Responsibility Statement, as required undersection 217 (2AA) of the Companies Act, 1956 as part of corporate governance, alsoforms part of the Management Report. The Authority has also prescribed a format forthe Auditors’ Report, and requires accounts to be jointly audited by two auditors.Further, the auditors appointed by the insurers have to be drawn from the panelmaintained at the Authority. The insurers have, from time to time, raised issues forclarification on the preparation of financial statements. Based on interaction with theinsurers and various experts in the field of Accounting and Actuarial aspects,clarifications have been issued by the Authority on disclosures pertaining to relatedparty transactions; maintenance of separate investment accounts for the shareholdersand the policyholders, etc. The Authority has also prescribed summary format offinancial statement as a part of the annual accounts. The summary is required to befurnished for a period of five years along with the prescribed ratios. Provision forpremium deficiency is another aspect on which clarity was required. As a steptowards this, an informal Group was constituted to consider various issues pertainingto computation of premium deficiency. The regulations stipulate that premiumdeficiency shall be recognized if the sum of expected claim costs, related expenses and 28
  • 29. maintenance costs exceeds the related Reserve for Unexpired Risks. The other issuesexamined were actuarial valuation of liabilities exceeding four years; and the formatof Receipts and Payments Account required to be furnished by the non-life insurers.Based on the discussions and consensus reached, clarifications were issued to non-lifeinsurers to make provision for premium deficiency; actuarial valuation of liabilitiesexceeding four years; and a format of Receipts and Payments Account has beenprescribed. With the insurance companies completing over three years of operationsand market conditions constantly evolving, it was felt that there was a need to re-visita number of provisions contained in the Regulation for preparation of financialstatements. Accordingly, the Committee, which was formed in May, 1999 was re-constituted as a two member Committee comprising: 1. T.S. Vishwanath, FCA, New Delhi; and 2. Asish Bhattacharyya, IIM, Kolkata. The Committee looks issues which arise from time to time on matters pertaining to the regulations on preparation of financial statements. Some of the issues which have been examined/are under active consideration of the Committee include (i) norms for recognition of income, provisioning and assets classification for insurance companies; (ii) requirement of quarterly/half yearly reporting by the 29
  • 30. insurers and the proforma in which such reports arerequired to be submitted by the insurers;(iii) investment in derivatives including the accounting aspects; and(iv) accounting and disclosure issues relating to Alternate Risk Transfer (ART) agreements being entered into by non-life insurers. 30
  • 31. Official of the Authority were also associated with the Study Group formed by theICAI to bring out Guidance Notes on audit of companies carrying on general of lifeinsurance business. During the financial year, the Authority, jointly with the ICAI,considered important issues and shared views and ideas on audit and other relatedsubjects in the insurance industry at the macro level. The Institute of CharteredAccountants of India (ICAI) inconsultation with the Authority constituted a studygroup to examine introduction of Long Form Audit Report (LFAR) for insurancecompanies. The Group comprises of representatives from the Institute, the insuranceindustry and the Authority. The Study Group is examining development of LFAR onthe pattern of banks to deal with internal control systems and procedures coveringdifferent aspects of insurance companies at branch and head office levels. The draft ofthe LFAR is proposed to be circulated to the insurance companies prior to itsfinalization. In another initiative, the Committee on Insurance of the ICAI isfinalizing the Guidance Note on “Inspection of Investment Functions of InsuranceCompanies.’ The Institute would issue a “technical guide” in the first instance forcomments. The Note would be considered for issue as a Guidance Note afterincorporating the suggestions. The documentation relating to inspection of theinvestment functions of insurance companies has been developed with inputs fromexperts in the insurance sector. The exercise has been initiated with a view toensuring that the Guidance Note serves as a ready reckoner for Inspection/Auditteams, while carrying on Investment Audits. With the requirements for disclosure inthe financial statements becoming more stringent across the globe, the Indian industryshould also prepare for higher level of disclosure. The regulatory framework providesfor standards, disclosures and transparency. The role of the auditors is also becomingmore demanding as the custodians to prevent fraud and to comment on the prudentialmanagement practices. The Council of the ICAI has set up the Peer Review Board tointroduce peer review in select industries, insurance being one of them. Peer review 31
  • 32. aims at checking the accuracy of the audit work, and to examine that the technicalissues and the statutory requirements have been complied with, It is proposed that inthe fist phase, 987 practice units will be reviewed under the peer review process over aperiod of three years. The Central Statutory Auditors of insurers are also beingcovered in Stage –I. The objective behind various initiatives is to ensure that thefinancial statements reflect the financial health of the insurance company to theinvestor who wants to invest in it as a shareholder, or the prospective policyholderwho expects that the insurer would be in a position to honour the claims when thearise, to make informed decisions. For the regulator, the financial statements facilitatethe process of off-site inspection, confirming that the internal controls and processesare in place and the insurer is complying with various regulatory requirements tomaintain its solvency at all times.II (a) Appointed Actuary System 32
  • 33. The Authority introduced the system of Appointed Actuary (AA) in the year 2000.The regulatory framework lays down that no insurer can transact life insurancebusiness in India without an Appointed Actuary. While in the case of life insurers, anAA must be a full time employee, in the case of non-life insurers, AA need notnecessarily be an employee of the company, but could be a consultant. Every AA hascertain privileges and obligations which have been specified in the regulations.During 2003-04, the Authority notified the “Qualification of Actuary” Regulations,defining an actuary for the purposes of the Insurance Act, 1938. The regulations whilelaying down the qualification of an actuary, further provide that the Authority mayrelax the provisions in such circumstances as it deems fit and may permit such aperson to sign as an Actuary for specified purposes. The powers and duties of anAppointed Actuary are laid down by the Authority in the regulations pertaining totheir appointments which include the right to attend all management and boardmeetings; right to participate in discussions; rendering actuarial advice to themanagement particularly on product design and pricing, contract wording, investmentsand reinsurance; ensure maintenance of required solvency margin of the insurer at alltimes; certifying the value of assets and liabilities of the insurer; drawing the attentionof management towards such matters as may prejudice the interests of policyholders;certifying the “Actuarial Report and Abstract” and other returns under Section 13 ofthe Insurance Act, 1938; complying with Section 40-B of the Act in regard to the basisof premium; complying with Section 112 of the Act on recommendation of interimbonus/bonuses payable; making available requisite records for conducting thevaluation; ensuring that the premium rates of the insurance products are fair; certifyingthat mathematical reserves are set taking into account the Guidance 33
  • 34. Note (GN) of the Actuarial Society of India; ensuring that the Policyholders’Reasonable Expectations (PRE) have been considered in the matter of valuation ofliabilities and distribution of surplus to participating policyholders; submit actuarialadvice in the interests of the insurance industry and the policyholders; and informingthe Authority if the insurer has contravened the provisions of the Act. In case of anon-life insurer, the AA is required to certify the rates for in-house non-tariff productsand incurred But Not Reported (IBNR) Reserves which are indicated under“Outstanding Claims” in the financial statements. The growth of the insuranceindustry coupled with the entry of private insurers in the last four years, has auguredwill for the actuarial profession. The developments in the profession signal evolutionin the system of appointed actuaries seeking their rightful place in the corporateenvironment. The profession is expected to make significant contribution in terms ofactuarial inputs in life and general insurance business and risk management andpensions. Actuaries are concerned with the assessment of financial and other risksrelating to various contingent events and for scientific valuation of financial productsin insurance, retirement and other benefits, investment and other related areas. 34
  • 35. II (b) Actuarial StandardsThe Actuarial Society of India (ASI) issues Guidance Notes (GN) (actuarial standards)to its members. The GNs issued by the ASI are intended at protecting public interest.GNs emanating from the regulations framed by the Authority require its concurrenceprior to issuance by ASI. The Actuarial Society of India issued the first GuidanceNote (GN-I) on “Appointed Actuaries and Life insurance”.The Guidance Note is a mandatory professional standard and covers theresponsibilities of the Appointed Actuary towards maintaining the solvency of theinsurer, meeting reasonable expectations of the policyholders, and to ensure that thenew policyholders are not misled with regard to their expectations. ASI issued theGuidance Note (GN-21) for the appointed actuaries of general insurers, GN-21 coverssuch aspects as nature and responsibility of appointed actuaries, considerationseffecting their position, the extent of their responsibility and duties, premium rates andpolicy conditions for new products and existing products on sale, capital requirements,actuarial investigations, premium and claims reserving, written notes and guidance toactuaries who are directors on the boards of, employees or consultants to a generalinsurance company. The Authority issues clarifications to the Appointed Actuaries oninterpretation of the regulations framed by the Authority. 35
  • 36. INSURERS & CORPORATE GOVERNANCE“There have to be structures and mechanisms to keep the board accountable toshareholders” opines G. V. Rao (retired CMD, Oriental Insurance Company Ltd.) Hefurther adds “there has to be a balance of two distinct powers.”Current state of governance: 36
  • 37. In an industry, like insurance, where the shareholding is still restricted to one or twoshareholders in each company, the interests of the unorganized stakeholders,particularly the consumer community, can be well protected by a good corporategovernance code. Insurance is a financial safety net to those that can afford to buy it.The entire citizenry of India are its potential consumers. Hence there is a national roleenvisaged for these commercially minded insurers. How does the authority ensurethat the dominant shareholding in the industry is working in the interests of theconsumers and not in self interest? Is prudent supervision of solvency of insurers andregulations on protection of consumer interests the only mechanisms available tocheck corporate behavior? There is a definite need to involve consumers to expresstheir responses through a market mechanism. Shifting business from one insurer tothe other or through expression of complaints need not necessarily be the only otheralternatives. The Boards of the public sector insurers do not presently considersettlement of claims or any consumer issues relating to them, as their corporateresponsibility. It is entirely that of their Managements. How then are they ensuringthat the consumers, who are dealing with them, are getting a fair deal from themanagements they are supervising? Is it not their primary duty to ensure that theirmanagements are dealing with the interests of their consumers fairly andexpeditiously? What aspects of governance do the Boards deal with, if dealing fairlywith consumer interests is not one of them? To whom are they accountable and forwhat? That is the crux of corporate governance.Pressures on good corporate governance: 37
  • 38. The recent highly publicized corporate debacles of Enron and WorldCom have thrownup an increasing awareness in consumers and the authorities, for good corporategovernance. New enactments have sprung up in many countries to improve thestandards of corporate governance trends.What ails good corporate governance in India?Though corporate governance practices in India have picked up momentum, there arefactors that inhibit its rapid growth. 1. High concentration of promoter ownership companies. 2. Weak recruitment processes of Directors. 3. Shortage of experienced Directors willing to serve. 4. Poor focus of Directors on their responsibilities. 5. Inadequate supply of information for analysis of issues by Directors. 38
  • 39. 6. Underdeveloped legal regime that permits continuation of existing inadequate systems of control. 7. Intertwining of business and political circles. 8. Individual performance accountability not encouraged. 9. Conflict of interest situations are too many.As a result of these deficiencies, corporate performance suffers and the cost of capitalincreases. Ownership structures and lack of enforcement capabilities have added tothe burden of poor governance standards. The ownership infrastructure and culturalattitudes of Indian market are different from those in the developed markets.The foundation of good corporate governance relies on: 1. Transparency on financial reporting and the details of disclosures. 2. Independence of auditors. 39
  • 40. 3. Independence and expertise of the “independent directors” 4. Regulatory enforcement and its oversight. 5. Legal systems to resolve disputes early and with a sense of fairness.Role of the Board;The Board of Directors is the link between the people who provide capital(shareholders) and those (managers) that use the capital to create value. Its primaryrole is to monitor management on behalf of the shareholders. There have to bstructures and mechanisms to keep managements accountable to the Board. Similarlythere have to be structures and mechanisms to keep the Board accountable to theshareholders. There has to be a balance of two distinct powers.Duties of Directors: 40
  • 41. The Directors have two duties: duty of care and duty of loyalty; the rest is businessjudgment. Duty of loyalty means unyielding loyalty to the shareholders. Duty of carewould mean that a director must exercise due diligence in making decisions. He mustdiscover as much information as possible on the question at issue and be able to showthat, in reaching a decision, he has considered all reasonable alternatives. In the caseof Walt Disney vs. its shareholders, it has been held that when a director hasdemonstration that he has acted with all due loyalty and exercised all possible care, thecourts will not second-guess his decision. In other words, the court will defer to his“business judgment”. Unless a decision made by the directors is clearly self dealing ornegligent, the court will not challenge it, whether or not it was a “good” decision inthe light of subsequent developments.A distinction has been made by US courts between a director making a wrong decisionwith ‘ordinary negligence’ but not acting in bad faithand doing wrong with ill considered and reckless negligence.The Board has responsibilities for the following: 1. Supervise the performance of the CEO 2. Review and approve financial objective, major strategies and plans 3. Whether the resources are being managed within the law, within ethical considerations, and for enhancing shareholder value. 4. Review the adequacy of systems of internal control to mitigate risk exposures, 5. Provide advice and counsel to the management. 41
  • 42. The Board is expected to ensure that the performance of the corporation is efficientbut not to run its day-to-day administration, It is responsible for the overall picture,not the daily business decisions, Its job is all to do with creating momentum,movement, improvement and direction. It has to create tomorrow’s corporation out oftoday. But who is responsible for the company? The Board or the Management? It isthe Board that bears responsibility; but in practice it is the management that has theinfrastructure, expertise, time, control and information. Given this managementdomination how can a Board exercise its responsibility? Who actually wears thecrown? The paradox is how to allow both to have dynamic control withoutdiminishing initiative and motivation of either. The tension between them is toenhance creative and productivity. What information should the Board have for thatpurpose? 1. Financial statements, and plans and reviews. 2. Market intelligence about competitors 3. Newspaper reports; and regulatory circulars and issues. 4. Management Committee meetings’ minutes. 5. Consumer issues. 6. Employee attitudes.Boards are found to be usually reactive and not proactive. They may exercise negativevirtues of compliance. Making sure that things are running in order may be goodenough. But its main job is to oversee management is effective and satisfy itself thatthe management is solving company problems and is risk-taking enough to buildimproved performance. 42
  • 43. Role of CEO:What one wants from a CEO is that he is able by virtue of ability, expertise, resources,motivation and authority, to keep the company not only just ready for change butready to benefit from changes, and ideally to lead them. The CEO must be powerfulenough to do the job, but accountable enough to do the job correctly. The decisions hemakes should be in the long-term interests of the shareholders. Who is the bestposition to make a decision about the direction of the corporation, and does that personor group have the necessary authority? That is determined by two factors: conflicts ofinterest and information. Decisions must be made with the fewest of conflicts andmost information. Accountability must come from within; and that requires acorporate governance system that is itself accountable. It must be continuallyreevaluated so that the structure itself can adapt to changing times and needs.Corporate governance in Public sector units: 43
  • 44. The Board comprises of the CMD, two Executive Directors, three nominee Directorsand four independent Directors, in all ten Directors. Since these companies are not‘listed’ companies, the compliance with the provision of appointment of independentdirectors is voluntary, as it is still not a legal provision under the Companies’ Act.The Boards have set up Audit Committees, Investments committees. The mostimportant aspects of corporate governance to be performed by the Board are thesupervision of the performance of Management through proper discharge of itsstatutory responsibilities; enforcement of effective internal control systems; ensuringoperation and monitoring of adequate and proper risk assessment procedures; andputting in place a progressive customer grievance handling mechanism. These issuesare basically dealt with based on agendas, minutes of the meeting recording decisionsand directives after deliberations at the Board meetings for follow up. It is understoodfrom a study made by a consultancy source on the current standards of corporategovernance and other issues in the public sector units that the quality of the corporategovernance is inadequate. • The corporate vision, the mission statement, the long term and short- term goals with specific time frames and the corporate strategies for their realization are absent. • The budget is not owned by any one and is not monitored at any time during the year for variance analysis, on any parameter other than premium growth, and is never measured except at the end of the year as a statutory obligation. As such, the Board gets no opportunity to make any contribution. As such, the Board gets no opportunity to make any contribution in controlling and directing the management for corrective actions. 44
  • 45. • Notes on 50% of the topics of the agenda to be deliberated upon are tabled on the day of the Board meeting. Most agenda items are circulated on routine issues for information.• The Board does not enjoy any independence in decision making and looks to the directives and guidelines to be issued by the owner, i.e. Govt. of India.• The Boards currently function more as compliance agencies under the Companies Act rather than as important corporate entities that are accountable for superior corporate performance. There is no ownership for the results of performance or the lack of it.• The internal control systems are poor; and inadequacies noted and highlighted are rarely due to lack of functional accountability.• The full complement of the Boards is not in place at all times. The final conclusion of the study on the risk analysis of the current corporate governance practices, based on certain self-chosen parameters, was that the elements of the risk factors are “High” in most cases. 45
  • 46. The way out—partially?These deficiencies can be radically changed, if a part of the shareholding is divestedand the companies, both in the private and public sector, are market “listed” to fulfillstricter norms of corporate governance that SEBI imposes on them. The corporateperformance needs to be subjected to public scrutiny through movement of shareprices. India having adopted market based policies to boost economy and withinsurance being an industry that potentially covers the entire population, like thebanking industry, the sooner it is subjected to a market scrutiny, the better corporatebehavior must be passed on to the public through share listing, so that the Boards andthe managements are held accountable to the investors and consumers. The currentshareholders need to build pressure on managements to cut the unacceptably hightransactional costs and to deal with consumers in a much fairer manner. Corporategovernance, in normal parlance, deals with improving the shareholder value. In thecurrent situation, which is unlikely to change in the near future, it should deal withgiving consumers affordable products by cutting internal costs and providingconsumers with a mechanism for fair and expeditious settlement of their grievances.The involvement of the Board is necessary in both these measures. 46
  • 47. Corporate Governance and Insurance Industry-Lessons to be learnt“We don’t have to accept that the world has become a less ethical place and learn tolive with it. Even if it has, we can change it” say Dr. K.C, Mishra(Director NationalInsurance Academy, Pune) & Dr. Geetanjali Panda(Mgmt Faculty, Finance &Economics, IMIS, Bhubaneswar).Modern society can place individuals in situations where they find themselves at oddswith principles of personal ethics and character. Our desire for independence andfreedom has left us less community-oriented. Our pursuit of happiness in the form ofwealth has made a disturbing degree of socially acceptable greed and selfishness. Ourability to demonstrate integrity is challenged by conflicting values and socialimperatives .Seven accepted principles of personal ethics and character encompass:1. Willing compliance with the law2. Refusal to take unfair advantage3. Concern and respect for others4. Prevention of harm5. Trustworthiness6. Benevolence7. Fairness 47
  • 48. Individuals in a monetized society constitute the community of corporate citizens.Corporate Governance is about promoting corporate fairness, transparency andaccountability. Functionally, Corporate Governance means doing everything better, toimprove relations between companies and their shareholders; to improve the quality ofDirectors; to encourage people to think long-term, to ensure that information needs toall stakeholders are met and to ensure that executive management is monitoredproperly in the interest of shareholders. Corporate Governance becomes an organicsystem when companies are directed and controlled by the management in the bestinterest of the stakeholders and others ensuring greater transparency and better andtimely financial reporting.Corporate Governance of insurers as corporate entities 48
  • 49. Regulations provide for dilution of ownership holding of Indian insurance entities indue course. The conditions for Indian insurance companies’ share holdings will bechanging in several essential aspects in the near future. These changes will alsointensify the focus on corporate governance matters. An even larger sense, the rise ofthe corporate governance mentality is tied to a new enlightenment regarding the natureof capital in world markets. Recently U.S. Securities and Exchange CommissionChairman Arthur Levitt made some observation at an insurance industry forum.“Corporate governance springs from a much deeper well. It’s a by-product of marketdiscipline and the information explosion has redefined the markets. Unless there’shigh quality financial information governed by corporate oversight, capital will flowelsewhere. Markets exist by the grace of investors. In an era where investors shiftmoney freely, the challenge for insurance companies is how to reconcile theiractivities with long-term sustainability. Does a company expect its board to ask toughquestions, to challenge management? Every public company should have anindependent audit committee and the SEC has adapted rules to strengthen auditcommittees. Why am I so obsessed about this? There’s no greater way to loseconfidence than by those numbers. Corporate accountability is at the heart of whatcompanies must do and insurers should not engineer their numbers as alreadyregulatory opinionated probability has done enough engineering in both sides of thebalance sheet.” Directors of insurance companies need a few unique skills due tonature of business they are going to govern. Some of the attributes are common to allbusiness but some are special to insurance as enumerated below. • Being dynamic and dedicated in all insurer’s activities; • Having self-confidence to work under non-deterministic situations; • Enjoying work in the Board and the time they spend with other Board Members; 49
  • 50. • Encouraging new ideas and thinking in insurer not arresting them; • Keeping an open mind, listening and learning from others in the expanding world of insurance; • Being prepared to share ideas and thoughts with the company management; • Recognizing and rewarding cooperation and franchise which are the corner stone of insurance business; • Developing the skills of insurer’s employees; • Being concerned for delivering on promises; • Inducing teamwork to deliver the best result; • Showing trust through allowing delegation; • Actively standing up for what they believe in; • Dare to challenge the ways insurer is working; • Going beyond the comfort zone; • Setting challenging targets and facilitating hard work to achieve them; • Ensuring insurer’s performance to always exceed the expectations; and • Inspiring and encouraging management to give their best.Corporate Governance should obviously ensure governance but with quality ofdecision-making, efficiency of benchmarking and in-built flexibility to accommodatethe certainty of change. Like any other Board, an insurance Board should have auditcommittee, nomination committee, compensation committee, risk managementcommittee (of the nature of ALCO), executive committee (as standing committee ofthe Board) conduct review committee, market operation guideline committee,investment committee and compliance committee. 50
  • 51. Corporate Governance by insurers as institutional investors in corporate entitiesInsurers are an important class of institutional investors. According to corporategovernance policy, Insurer must be able to cooperate with other major owners oncorporate governance matters, mainly regarding the election of directors. Thiscooperation should be concentrated on those companies in which insurer own asignificant share of the capital. The so-called percent rule has in principleprohibited Indian insurance companies from owning shares in a companycorresponding to more than a statutory percent of the voting rights. When insurancecompanies exercise corporate governance in other companies, they must take abroader view of these questions than other owners. Consequently, in addition to theinterests of its own shareholders, insurer must observe the following: • The policyholders’ interests and the legal restriction on insurance companies’ investments-spread of risk, liquidity, etc.; • Regulatory and Supervisory Authorities- Insurance companies’ operations are subject to IRDA regulations and supervision buation needs of 51
  • 52. all stakeholders are ms the conglomerate nature of functions may attract oversight by other regulatory authorities like SEBI for investments, PERDA for pension business and RBI for Forex and Money Market involvements; • The public and the media • The insurance sector is dependent on the public’s trust, and operations are the focus of extensive media coverage.In light of the above, Insurer’s Board of Directors have to adoptcorporate governance policy for the insurer business. Thepolicy should pertain to the insurer’s share holdings in listedIndian companies (external corporate governance) and, whereapplicable, for insurer itself as a listed company (internalcorporate governance). The institutional activism movementhas not lacked for skeptics even internationally. Businessleaders and politicians have argued that large insurers lack theexpertise and ability to serve as effective monitors in the marketfor corporate control [e.g. Business Week (1991), Cordtz 52
  • 53. (1993), and Wohlstetter (1993)]. Others have noted thatparastatal insurers are subject to pressures to avoid activismand instead aid the objectives of appropriate incentives andfree-rider problems may also hinder institutional activismefforts. [Admati, Pfleiderer and Zachner (1994); Monks (1995)and Murphy and Van Nuys (1994]. One way for institutions toreduce free-rider problems among themselves and to sidesteppolitical pressure is to create an organized third partymonitoring organization. Such an organization can serve as afocal point for diffuse investors and can enhance credibilitywhen challenging management. In principle, organizedinstitutional shareholders can exercise significant clout at afairly low cost because of economies of scale in activism [Black(1990)]. IRDA should facilitate such a formation. 53
  • 54. Corporate Governance as a business opportunity for insurersCorporate Governance requires fair deal, fair competition and fair informationcollection. Lack of such practice gives rise to liability consequences most often no-fault liability. Here is a business opportunity for insurers. Fair deal envisagesemployees not to take unfair advantage of anyone through manipulation, concealment,abuse of privileged information, misrepresentation of material facts or any otherunfair-dealing practice. Fair competition always attempts to compete fairly andhonestly and prohibits conduct that unethically seeks to reduce or restrain competition.Company will not attempt to collect competitor’s information throughmisrepresentation or unethical business practices. Company will never ask forconfidential or proprietary information or ask a client/ ex-employee of a competitor toviolate a non-compete or non-disclosure agreement. There are liabilities at evenBoard level for such breaches. Insurers can create business products as follows: • Directors’ & Officers’ Liability Insurance In the current market, directors may fin they are not as protected by insurance as they thought and there may be ever expanding need for newer coverage and greater premium; • Enterprise Risk Management - If companies are going to genuinely govern in the interests of shareholders they need to understand their full risk picture. Any gaps in provision could be seen as corporate governance failing. Such risk identification may give rise to outsourcing of risk management expertise of insurers; and • Reputation Risk Management - Whilst management of reputation should b an integral component of good management, often it is left to chance. 54
  • 55. Corporate Governance ensures adequate insurance coverage against the losses arisingout of reputational risks. Insurers comprehensive exposure to another business shouldbe a cause of action for corporate governance. Insurance information Instituteillustrates this while analyzing the loss of US$ 3.796 billion to insurance industry onaccount of failed power major Enron. Of the total loss of insurance industry 64% wason account of investments in Enron, 26% for surety recalled, 7% for miscellaneousclaims, 2% financial guarantees and 1% for D&O liability claims. Again corporategovernance risk of general insurers is compounded by D&O coverage. PersonalCoverage protects directors and officers against liability arising out of “wrongful acts”Corporate Reimbursement Coverage reimburses organization when legallyrequired/permitted to indemnify D&Os for their “wrongful acts and Entity Coveragereimburses for claims made directly against the organization including those thatnames no individual insureds. The aggregate liability of the entity needs corporatecontrol.Governance Code for the Indian Insurany ce Industry -- An OverviewIn the area of corporate governance in India, the approaches would require to berefined. However, the task of the regulatory bodies would be considerably eased onceproper governance 55
  • 56. standards are in place, observes R. Krishna Murthy (MD, Watson Wyatt InsuranceConsulting and former MD & CEO of SBI Life Insurance Co. Ltd.).Corporate governance simply put is just being honest about in every way an enterpriseis run governing relationship with every stakeholder in the company. While honestyis the best policy everywhere and at all times, it needs to be practiced particularly inthe case of insurance industry which bears a fiduciary relationship with clients, andwhere the industry is judged by its long term performance. At a time when financialinstitutions are increasingly under public scanner; and some of the icons in theinsurance industry in mature markets are under attack for breaking laws and their keymanagement personnel charged for personal aggrandizement; the issue of corporategovernance acquires new dimension.Urgency in IndiaThere are four major factors why drawing up a set of governance standards for theIndian insurance industry, covering life as well as general insurance companies, publicand private sector, is important at this stage.Firstly, in life insurance, a well drafted governance code and their adherence wouldhelp to shore up the level of public confidence in the new generation insurancecompanies, which seem to suffer in comparison to LIC due to the absence of a levelplaying field, with the insurance policies issued by the latter carrying the stamp ofsovereign guarantee. While there is reportedly a move by the government to level thisfield by removing the privilege enjoyed by LIC, it is perhaps quite a long way off.Meanwhile, as an industry which engages with clients on long term contract, the newgeneration life insurance companies should be keen to have a set of standards againstwhich they could benchmark their own governance to strengthen the public image thatthe new players can be considered as trustworthy and dependable as their public sectorcounterparts. 56
  • 57. Secondly, the Indian Insurance industry is set to witness a major phase of change, andpossibly explosive growth, with the lifting of the foreign equity cap and dilution ofdomestic promoters’ stake in the foreseeable future, as well as removal of tariffregulations in the non-life sector. There are plans to pave way for the entry of largenumber of players to open business in specialized insurance fields such as healthinsurance by relaxing the capital and solvency rules. We would possibly witness moreforeign firms entering the country, and key management personnel with limitedindustry experience representing domestic and foreign partners running thecompanies. There are plans to pave way for the entry of large number of players toopen business in specialized insurance fields such as health insurance by relaxing thecapital and solvency rules. At the same time, the existing companies in the lifeinsurance sector, along with facing competition from new players, will probablygrapple with greater operating challenges, such as increasing number of maturity,death and other claims on the cumulative business built by them over the last fewyears. We need good governance standards against which the companies’ conduct andperformance would get measured in this backdrop. On the general insurance side,with the industry moving away from the tariff regime, there are going to be plenty ofissues concerning fair play, transparency and policyholder servicing.Thirdly, the need for proper governance standards in the insurance industry assumesimportance in the context of the Indian corporate sector getting ready to accept andlive up to a set of corporate governance rules, thanks to the initiatives taken by thesecurities market watchdog during the last two years. Companies that are listed in thestock exchange, and having paid up capital of Rs,3crore or net worth of Rs.25crore ormore would now need to abide by the new code. SEBI has boldly introduced a systemof disincentive-cum-penalty for defaulting companies: they run the risk of being de-listed from bourses, or the promoters being fined up to Rs.25crore (the highest in thecorporate law book) or face imprisonment up to 10 years. Since insurance companiesare not likely to get listed in bourses in the near future and would remain closely heldcompanies, they need to conform to a set of governance rules of reassures take-holdersabout their standards of performance and conduct. 57
  • 58. Fourthly, there is increasing evidence of public sector financial institutions evincinginterest to enter insurance business in partnership with foreign insurance firms, and insome cases as three-way partnerships with private corporate enterprises. While a fewsuch ventures have recently been licensed, several more are set to take off in the lifeand non-life sectors. There is ambivalence whether such ‘public-private’ partnershipsare subject to the rules normally applicable to PSU enterprises. PSU managements ingeneral have no uniform views in regard to the applicability of corporate governancestandards to them. It is important that insurance ventures promoted by PSUs aregoverned by clear governance principles to send the right signals that they are viableand dependable stand alone entities in their own right. On a wider context, this wouldreinforce the grounds on which the financial sector convergence is taking place in theIndian market.Key Principles in the Indian context:The OECD has defined corporate governance as a set of relationships between acompany’s management, its board, its shareholders and other stakeholders. Corporategovernance provides the structure through which the objectives of the company areset, and the means of attaining those objectives and monitoring performance aredetermined. Corporate governance is of course an ongoing process. While the setstandards may undergo revision based on experienced and developments in themarket, the core principles would remain unchanged. From an insurance companyperspective, corporate governance involves the manner in which the business of thecompany is governed by its board and the senior management relating to four keyelements: 58
  • 59. i. How the company set its corporate objectives, including the expected rate of return on the shareholders’ funds. IRDA requires insurance license applications to describe from the first stage (R-1), the objectives of the company and its vision and mission, as well as details of the financial returns anticipated by promoters from insurance operations. The financial accounting rules in the Indian insurance industry require companies to segregate policyholders’ funds and shareholders’ funds at any given time, and conduct the transactions pertaining to shareholders’ funds in a manner that is fair to the policyholders.ii. How the day to day affairs of the insurance company are proposed to be run in every functional area in the company, and what kind of internal controls are sought to be established and enforced.iii. How the company proposes to align the activities and the behaviour with the expectation that the company would operate in a safe and sound manner and in accordance with the applicable rules and regulations.iv. How the company would protect the interest of policyholders. 59
  • 60. Board and its responsibilities:While the IRDA licensing norms. The most important aspect of governance code is toensure that the collective expertise is available on the board to meet the competitivechallenges of the market place while maintaining soundness of the company, requirethat the company is run by persons who are ‘fit and proper’ for the respectivepositions, the regulator has largely left issues concerning the constitution of board anddefining its responsibilities to the wisdom of the promoters. The most importantaspect of governance code is to ensure that the collective expertise is available on theboard to meet the competitive challenges of the market place with maintainingsoundness of the company. It is important to ensure that board members, especiallythose appointed to represent the policyholder interests, are qualified for the position,and they have a clear understanding of their role and are able to exercise sound,independent judgment – duty of loyalty as well as duty of care.There are five key aspects of governance expected of boards in insurance companies: Setting and enforcing clear lines of responsibility and accounting throughout the organization. In insurance companies where the risk experience emerges over several years, demarcating areas of responsibility, and ensuring that there is an appropriate oversight by the senior management in every functional area are crucial. • Periodically assess the effectiveness of the company’s own governance practices with due understanding of the regulatory environment, identify areas of weakness and make changes where necessary. • Regularly assess that the risk management systems and policies in the company are sound; and they are rigorously adhered to. 60
  • 61. • Identify, disclose and resolve conflicts between the personal interests of promoters; as well as senior managers and the company. The conflict resolution issue is particularly important where the insurance operations are part of a large business group of a financial conglomerate. • Overseas that every type of communication to clients and potential clients is clear, fair and not misleading.It is important that the board consists of persons who have the expertise, as well asability to commit sufficient time and energies to fulfill their responsibilities. TheBoard members should regularly meet with the senior management, as well as theinternal audit team, to monitor progress towards the corporate objectives. They shouldhowever never participate as members of the board with the day to day managementof the company. The board as well as the senior management would need to ensurethat the corporate objectives and the corporate values are clearly set, and they areclearly communicated throughout the organization. As they say, the tone is always setat the top.Organizational structure and functioning; 61
  • 62. The board should exercise oversight in regard to all policy formulations governing theoperations of an insurance company, such as investment policy; underwriting policy;product development and risk management policy; and take responsibility foroverseeing the management’s actions to ensure their consistency with the policiesapproved. Senior managers contribute to an insurance company’s sound corporategovernance by exercising proper oversight over line managers in specific businessareas in a manner consistent with the policies laid down by the board. The seniormanagement is responsible for proper delegation to the staff, while at the same timebeing cognizant of the responsibility on their part and accountability to the board tooversee the proper exercise of the delegated responsibility. It is therefore importantthat senior management ensures an effective system of internal and external auditorsin enforcing proper governance is well known. The board and the senior managementcan enhance the effectiveness of the audit function in insurance companies byrecognizing its importance and the internal control processes; and effectivelycommunicating the same throughout the organization. In our current stage of marketdevelopment where several issues concerning premium accounting and reconciliationare emerging; as the insurance buying is spreading to far flung areas and coveringvarious strata of population, timely audit is an important function. It is an equallyimportant corporate governance principle that the findings of the auditors are utilizedin a timely and effective manner to correct the problem areas. Corporate governancestandards should address corruption, self-dealing and other illegal or unethicalpractices in insurance companies. There should The senior management isresponsible for proper delegation to the staff, while at the same time being cognizantof the responsibility on their part and accountability to the board to oversee the properexercise of the delegated responsibility be a policy to encourage whistle blowers, aswell as support employees to freely express and point out violations to board or seniormanagement without fear of reprisal, either openly or anonymously.Compensation policies and ethics:There are already issues surfacing in the Indian market concerning the appropriatenessof compensation policies in insurance companies. Failure to link compensation andincentives to senior management to the long term business goals can result in actionsthat can run counter to the policyholder interests. In general, the compensationpolicies should be consistent with the culture of the insurance company, its long termobjectives and strategy. It is important that the remuneration policies should not belinked to the short term performance of the company. 62
  • 63. PSUs and governance: 63
  • 64. Keeping in mind the growing phenomenon of state-owned and government controlledbanks and financial institutions promoting insurance ventures in India in partnershipwith foreign firms, or in equity share relationship with private corporate enterprises;the governance principles should address the conduct and behaviour of such multi-party owned entities. Where such entities are subsidiaries of government ownedbanks, there are new dimensions to the governance principle to be addressed, since thegovernance codes would affect both the boards of the PSU parent as well as the hybridsubsidiary. In the discharge of the corporate governance responsibilities, the parentboards should exercise due oversight of the functioning of the subsidiary (and evenwhere the parent’s holding in the insurance venture is below 51%), by dulyrecognizing the material risks and issues that could impact the insurance entity. Thecorporate governance structure and enforcement would to a large extent be influencedby the manner in which the parent bank conduct its own governance. It is importantthat the PSU parent allows the insurance entity to set its own governance standards. Inmulti-party promoted ventures, it is important to pay attention to the scope ofpreferential treatment of related parties and favoured entities within the promotergroups, and lay down governance standards to avoid or minimize conflictingsituations. Such group dimensions are already receiving attention at the regulator’slevel. The initiative taken by RBI to set up a mechanism to track systemic risks posedby financial conglomerates in India is in the right direction. As a new concept inIndia, the approaches would require to be refined. However, the task of the regulatorybodies would be considerably eased once proper governance standards are in place.Transparency as the core of governance:The important of transparency as the core principle in corporate governance is wellknown. Weak transparency and inadequate disclosures tend to fuel market skepticism,and in a newly deregulated and long term oriented industry, this could affect theinterests of all stakeholders. It is well known that complex ownership structurescontribute to opacity. While listed companies are generally more transparent, closelyheld firms suffer on this account by comparison. The Indian insurance regulationsemphasize the importance of transparency in every aspect of company operations. Atthe current stage, there is quite a way to go for companies to achieve the desired levelsof disclosure. Accurate and timely disclosure of information in insurance companiesshould be in place in every area of operation.Such disclosure are desirable by way of annual reports released by companies, as wellas through their websites, covering various areas, more particularly the following: 64
  • 65. • Board structure and senior management structure • The company’s self-determined code of conduct, if any, and the process by which it is implemented, including a self assessment by the board of its performance relative to the code • The special obligations of the insurance company under the regulations, such as the rural and social sector obligations; and the level of their fulfillment • Nature and extent of inter-party transactions within the promoter groups; and matters on which the directors and senior managers have material interests on behalf of third parties. • Important aspects of performance that have a bearing on the safety and solvency, such as claim ratios Weak transparency and inadequate disclosures tend to fuel market skepticism, and in a newly de-regulated and long term oriented industry, this could affect the interests of all stakeholders. Better than industry averages of internally projected levels, unexpected depletion in the value of assets; and actions or warnings issued by regulators. • Information on the number of cases of policyholder complaints or disputes; and directives against the company issued by Ombudsman or other consumer protection bodies. While financial statements may be posted on the website, every policyholder should be entitled to ask for a full set of account statements including notes and the supporting schedules.Existence of sound corporate governance standards lowers the moral risk hazard fromthe regulatory viewpoint. IRDA should view corporate governance as an importantelement of policyholder protection. Corporate governance codes and the earnestnessof insurance companies to adhere to them would encourage regulation to place morereliance on the internal processes in insurance companies; and thereby becoming lessstrict or more pragmatic in operational areas, as for example, relaxing the rigours of‘File and Use’ process for product approval. The level of self-policing by the playersis indeed a barometer of maturity of the market, since sound corporate governanceserves as bedrock to build public trust and confidence. 65
  • 66. CORPORATE GOVERNANCE - In A Risk Based Rating EnvironmentIn a de-tariffed regime, governance for the insurers would be a different ball –gameand various issues would come up in the areas of fair rating, equitable policyconditions etc. feels Mr. P.C. James(Executive Director, Non-Life, IRDA).Insurance and Corporate Governance 66
  • 67. Corporate Governance is a subject of significance for the insurance industry. Insurersmanage the funds of the public, i.e. the premium of their customers, as well as capitaland other resources on behalf of the shareholders. Companies also have otherstakeholders such as employees, partners, intermediaries, the government and thesociety. There is a growing concern that a company’s accountability and transparencyrequirements need to be aligned with the expectations of stakeholders concerned.Insurance Core Principles No.9 brought out by the IAIS (International Association ofInsurance Supervisors), says that the corporate governance framework recognizes andprojects the rights of all interested parties. Corporate governance is thus required as avoluntarist agenda for the Board and the top management on how to oversee thesuccess and sustainability of the organization in the wider context of satisfaction of allthe stakeholders concerned. Business organizations work in an environment ofincreasing risks. Risk is anything that can impede on the negative side or accelerateon the positive side, the achievement of business objectives. Responding to risksinvolves instituting the necessary tools to discover, analyse and make transparent thepotential risks. It also means that while taking steps to minimize or eliminate thedownside of risks, the upside that can be generated by managing risks successfullyneeds to be fully exploited. This linkage between business objectives, risk, controlsand their alignment to business outcomes is important for enhancing shareholder andstakeholder value. All successful companies excel because they have the necessaryrisk management capability, internal control systems and procedures to sustain them.This naturally involves Board level interventions in deciding strategies and policieswhich can ensure that the entire company becomes risk aware; and has one uniform‘risk’ language in the organization.Risks and Insurers 67
  • 68. The core of insurance business is the bearing of risks transferred to the insurer bycustomer either through intermediaries or directly. Based on acceptance of the risksand the premium thereof insurers are subject to various organizational risks which areknown as technical risks, investment risks and other operational risks. Technical orunderwriting risks include premium deficiency risk, concentration risk, catastropherisks, frequency/severity risks and so on. Investment risks include credit risk, marketrisk including interest rate risks, liquidity risks etc. Various types of operational risksalso face insurers, just as they do other business organizations. Such risks includeglobal risks; general, economics and political risks; industry risks; and companyspecific risks. The Board is expected to have a grasp of the strategic issues involved,and set the necessary policies and procedures regarding risk taking and the desirablerisk management techniques.This enables the organization’s many layers and operational lines to translate the needfor risk management into real and verifiable activities including the following: 1. The approach to risk taking. 2. The structure of limits and guidelines governing risk taking. 3. Internal controls including management information systems. Worldwide, companies are being encouraged to go beyond legislative and regulatory compulsions to where good governance norms are self generated arising from the basic fiduciary role of the Board and the top management. As the insurance sector grows, there will be a reduction of supervisory resources and its place will need to be replaced by self regulation and betterment through various self- governing mechanisms. This will ensure that the company is operated in accordance with the best standards of business and financial practice. From the point of view of the regulator and others, corporate governance is necessary to promote transparent and efficient markets. It helps to lay a strong and sustainable foundation to the business model the Board wishes to set up so as to exploit market opportunities. Business risks that need to be tackled include demand risks where customers or intended customers do not buy; competitive risks, whereby the initiatives taken by competitors can upset strategies drawn up; and capability risks, where the company’s value proposition does or does not match the requirements of the market. A company’s readiness to be aware and act in these areas to understand, report and be accountable for such risks, make companies face a heightened probability of not meeting the expectations of stakeholders. 68
  • 69. Risk GovernanceWhen insurers are se to move from a rule based tariff regime to a risk based pricingenvironment, risks for such insurers generate both opportunities as well asvulnerabilities. Risk exposures heighten because the deeply held mental models ofyesterday which were versed in interpretation of given rules need to move ontodivination of an ever changing risk landscape in the many businesses that thecompany may wish to offer protection. The Board needs to put in place newmental models and systems thinking that can create and nurture the necessary skillsof seeing the insurable world in the hard reality of risks and realistic pricing ofsuch risks without the comfort of tariffs. Similarly it is to be ensured that theindependence of the risk assuming function is clearly maintained and notsubordinated to the compulsions of those departments not familiar with thediscipline of insurance risk and pricing characteristics. Guidelines will need to begiven for the disciplined application of underwriting powers, with clear reportinglines and accountabilities. The underwriting department must be endowed withstature, experience and authority to carry out it expected functioning. There mustbe the planned churning and rotation of personnel to garner ever-richer experienceand bring in new learning’s, experience and perspectives. New skills andknowledge will have to be built up and must flow through the organization toensure constant up gradation and benchmarking against the best in the market.Risk specialists need to be encouraged to probe and question till satisfactoryanswers and solutions are obtained, and there should an openness that is not afraidto challenge the ‘experts’.Regulatory requirements and Corporate GovernanceSensitivity to regulatory requirements is an important part of corporate governance.Companies need to guard against possible clash between the interests of thepolicyholders and the owners of companies. It is well accepted that havingsatisfied and happy consumers is good business, and the Board needs tocontinuously strengthen the alignment of interests between the company and itsconsumers through better governance standards. Compliance management is thebeginning of corporate wisdom and is an expression of the wiliness to develop thecontinuum towards developing self-accepted norms of governance based on aninclusive agenda that looks to the betterment of all interests in a holistic manner. A 69
  • 70. disdain for regulatory accountability as manifest in non-compliance of laws,regulations, guidelines is indicative of a mindset that may block internalization ofthe best practice codes that can help to enhance business success. Insurance alsoinvolves issues of public good; and the legislative and judicial intent wherever speltout and point to the development of the business in the best interest of thecommunity, need to be kept in mind while dealing with business practices. Thismeans that insurers are prevented by the intent of law and judicial precedents fromacting in a manner that is arbitrary, unfair, untenable or adverse to the interest ofthe consumer. Thus there cannot be arbitrary freedom for private contracts.Corporate governance would have to internalize the nature of insurance business inthe context of the law of the land and should keep in mind the moral and socialresponsibilities involved while fashioning the templates of corporate success.Various issues thus come up in the areas of fair rating, equitable policy conditions,proper disclosures, acceptable methods of solicitation, terms of renewal,cancellation of policies, loading of premium, denial of insurance, repudiation ofclaims and so on. These will need to be addressed and homogenized across thecompany to prevent regulatory or judicial strictures that can have a bearing on thereputation or legitimacy of the insurer. Failing to meet society’s expectations canpose risks to organizations and at the same time a proper understanding andeffective management of generally recognized social duties can help to buildshareholder value, corporate recognized social duties can help to build shareholdervalue. Corporate social responsibility is also an area which, if neglected, can poserisks for insurers. Managing community perceptions backed by beneficial action inthe area of social good can help to reduce downside risks and also open upopportunities for profitable business as those excluded from the benefits ofdevelopmental insurance are far too many. Involvement with social concernsincluding lack of protection to the vast majority who are excluded owing to povertyor ignorance helps to build up long-lasting intangible assets for the company. Ithelps not only to capitalize on community resources and reduces regulatoryintervention but also helps to obtain competitive advantage from a long-lastingfund of public goodwill. Board’s Concerns for smoothening the RolloverDetariffing involves serious transitional issues especially for the older insurers.Active involvement of the Board and the top management is required along withmassive investment of time and money in establishing proper systems throughnecessary hardware and software, as also in training of underwriters and in creatingthe necessary data infrastructure and its learning context.In particular, the following areas would be important in the context of corporategovernance. 70
  • 71. 1. Detariffing must not degenerate into mindless rate cutting and so called ‘cash-flow’ underwriting. Equitable rating and solvency issues are paramount in disciplined underwriting. Hence clear guidelines from the level of Board must be given, drawing up the methodologies of ratemaking and also wherever possible guide tariffs, so that individual discretion at non- responsible levels is reduced to the minimum.2. Underwriting must be supported by a strong technical base. Rating factors need to be identified for every sub-class, and every type of risk. The required data needs to be captured in respect of every risk underwritten and every claim lodged. Collection, compilation and analysis of data will form the bedrock of developing underwriting expertise. Similarly pre-acceptance risk inspections and data generated by claim surveys and inspections will also form important part of the knowledge bank for underwriter.3. Delegation of authority will be based on the knowledge of the person concerned based on experience as well as qualifications. There must be proven ability to evaluate all risk factors. The financial implications of underwriting decisions on factors such as adequacy of pricing, the concentration of risks written, the frequency/severity aspects, etc. will need to be understood by persons who are vested with discretionary authority. Responsibility needs to be fixed so that delegated powers are used only as desired.4. Determining the basis of rating. Rating can be on the basis of class for which internal tariffs can be developed. Rating can also be on community basis for risks such as group health or PA, where there is an incentive for communities/groups to reduce risks and obtain favourable terms. Finally rates can be fixed on individual basis depending on the uniqueness of the risk and the financial magnitude justifying individual rating. In all these cases a base rate has to be set; and loadings and discounts should apply based on risk perceptions, backed by factual risk features.5. Ready availability of insurance should be ensured at fair terms for all customers. In the restructuring that may take place on account of detariffing it will be unfortunate if the normal insurance enjoyed by the public prior to detariffing are not available readily under internal tariffs and at fair terms. 71
  • 72. 6. Underwriting audit programmes must be instituted to check the adequacy of pricing and other disciplines of underwriting and compliance to internal tariffs. Justification of rates, whether individual or class, needs to be examined by the audit department; and necessary correctives need to be suggested for implementation.7. Training of underwriters and setting up or R&D for developing underwriting practices is to be institutionalized. New product development based on sound market research and innovation in areas that can capture value for the organization in containing risks for the consumer would be a core task to meet competitive challenges. Detariffing will see the emergence of many new competencies and differentiations which will help market development.8. In moving from tariff policy wording to more innovatively packaged products, insurers would need to ensure that that there are even more disclosures to avoid consumer confusions, through transparent and logical presentation of covers and benefits.9. Finally customer service and grievance handling need to become a thrust area in the detariffing era for the Board, as there are bound to be dissatisfactions that could arise from the asymmetries perceived in the changeover. Alleviating the difficulties of the average consumer in times of possible uncertainties will help to win goodwill of the public and the regulator as well as the consumer bodies. 72
  • 73. Customers of an insurer look to the company to meet promises made to protectas per its licensed mandate. Insurance is a complex business built around thepromise to cover and pay on the occurrence of the specified event i.e. lossoccurring. The customer is not the expert on insurance and hence relies on theintegrity and skill of the insurer to meet the obligations as promised. Insurersthus need to consider meeting their obligations not only in the end by payingclaims when covered losses occur, but also upfront in their readiness to coverfairly and equitably so as to enable consumers to take on economic risks that arenecessary to create dynamism and momentum in the economy. If insurers donot stand in the shoes of the consumer through the guiding hand of voluntarygovernance codes, the long term well being of the organization would getjeopardized leading to losses for the stakeholders. Corporate governance formsthe right platform of internal voluntary empowerment that allows companies toplay their due role in the interest of all as per the genuinely developed strategicvision. 73
  • 74. CORPORATE BEST PRACTICES-RECOMMENDATIONS FOR DIRECTORSFor ensuring good corporate governance, the importance of overseeing the variousaspects of the corporate functioning needs to be properly understood, appreciated andimplemented avers Vepa Kamesam (Former Deputy Governor of RBI, Former MD ofSBI and presently MD, institute of Insurance and Risk Management, Hyderabad).Historically attention was paid to the subject following the collapse of Savings andLoan companies in USA in the mid 1980’s and the SEC of USA taking a tough standon the same. It is ironical that once again it was the US which brought in SarbanesOxley Act and along with it very stringent measures of Corporate Governance. Inpassing, we may add that there is no corresponding legislation in India. Later, AdrianCadbury report was an important milestone, which spelt out 19 best practices calledthe “Code of Best Practices”, which the companies listed on the London StockExchange, began to comply with. Some of those guidelines applicable to theDirectors, Non-executive Directors, Executive Directors, an d others responsible forreporting and control are as follows:- 74
  • 75. Relating to the Directors the recommendations are:- The Board should meet regularly, retain full and effective control over the company and monitor the executive management.- There should be a clearly accepted division of responsibilities at the head of a company, which will ensure balance of power and authority, such that no individual has unfettered powers of decision. In companies where the Chairman is also the Chief Executive, it is essential that there should be a strong and independent element of the Board, with a recognized senior member.- The Board should include nonexecutive Directors of sufficient caliber and number for their views to carry significant weight in the Board’s decisions.- The Board should have a formal schedule of matters specifically reserved to it for decisions to ensure that the direction and control of the company is firmly in its hands.- There should be an agreed procedure for Directors in the furtherance of their duties to take independent professional advice if necessary, at the company’s expense. 75
  • 76. - All Directors should have access to the advice and services of the Company Secretary, who is responsible to the Board for ensuring that Board procedures are followed and that applicable rules and regulations are complied with. Any question of the removal of Company Secretary should be a matter for the Board as a whole.Relating to the Non-executive Directors the recommendations are: - Non-executive Directors should bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct. - The majority should be independent of the management and free from any business or other relationship, which could materially interfere with the exercise of their independent judgement, apart from their fees and shareholding. Their fees should reflect the time, which they commit to the company. - Non-executive Directors should be appointed for specified terms and reappointment should not be automatic. 76
  • 77. - Non-executive Directors should be selected through a formal process and both, this process and their appointment, should be a matter for the Board as a whole.For the Executive Directors the recommendations in the Cadbury Code ofBest Practices are: - Directors’ service contracts should not exceed three years without shareholders’ approval. - There should be full and clear disclosure of their total emoluments and those of the Chairman and the highest-paid Directors, including pension contributions and stock options. Separate figures should be given for salary and performance-related elements and the basis on which performance is measured should be explained. - Executive Directors pay should be subject to the recommendations of a Remuneration Committee made up wholly or mainly of Non-Executive Directors. 77
  • 78. And on Reporting and Controls the Cadbury Code of Best Practices stipulatethat: - It is the Board’s duty to present a balanced and understandable assessment of the company’s position. - The Board should establish an Audit Committee of at least three Non- Executive Directors with written terms of reference, which deal clearly with its authority and duties. - The Directors should explain their responsibility for preparing the accounts next to a statement by the Auditors about their reporting responsibilities. - The Directors should report on the effectiveness of the company’s system of internal control. - The Directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary. 78
  • 79. The report created mixed feelings and with some more frauds emerging in UK,Governance came to mean the extension of Directors’ responsibility to all relevantcontrol objectives including business risk assessment and minimizing the risk offraud. The shareholders are surely entitled to ask, if all the significant risks hadbeen reviewed and appropriate actions taken to mitigate them and why a wealthdestroying event could not be anticipated and acted upon.The one common denominator behind the corporate failures and frauds was thelack of effective risk management and the role of the Board of Directors. When itbecame clear that merely reviewing the internal processes of control were notenough and, therefore, risk management had to be embodied throughout theorganization, an easy solution was found by passing on this responsibility to theinternal audit. 79
  • 80. In India, the CII came out with its own views, but SEBI, as the custodian ofmillions of investors came out with its guidelines and Kumar MangalamCommittee recommendations became mandatory and, therefore, all the listedcompanies were obliged to comply in accordance with the listing agreement withthese Stock Exchanges. The clean up of most companies has begun in a big wayand the Section 49 of the SEBI Act has now almost become the hallmark ofcompliance in this country.The mandatory recommendations of the Kumar Mangalam Committee include theconstitution of Audit Committee and Remuneration Committee in all listedcompanies; appointment of one or more independent Directors; recognition of theleadership role of the Chairman of a company; enforcement of accountingstandards; the obligation to make more disclosures in annual financial reports;effective use of the power and influence of institutional shareholders; and so on.The Committee also recommended a few provisions, which are non-mandatory.Some of the mandatory recommendations are: 80
  • 81. - The Board of a company should have an optimum combination of executive and non-executive Directors with not less than 50% of the Board comprising the nonexecutive Directors.- The Board of a company should set up a qualified and an independent Audit Committee. The Audit Committee should have minimum three members, all being nonexecutive Directors, with the majority being independent, and with at least one Director having financial and accounting knowledge. The Chairman of the Audit Committee should be an independent Director. They are responsible for balance sheet compilation and clarificatory notes appearing thereto; and to ensure that sensitive information is not tucked away in small print. 81
  • 82. The Chairman of the Audit Committee should be present at Annual GeneralMeeting to answer shareholder-queries. • The Company Secretary should act as the secretary to the Audit Committee. • The Audit Committee should meet at least thrice a year. The quorum should be either two members or one-third of the members of the Audit Committee. • The Audit Committee should have powers to investigate any activity within its terms of reference, to seek information from any employee; to obtain outside legal or professional advice, and to secure attendance of outsiders if necessary. • The Audit Committee should discharge various roles such as, reviewing any change in accounting policies and practices; compliance with accounting standards; compliance with Stock Exchange and legal requirements concerning financial statements; the adequacy of internal control systems; the company’s financial and risk management policies etc. • The Board of Directors should decide the remuneration of the non-executive Directors. • Full disclosure should be made to the shareholders regarding the remuneration package of all the Directors. • The Board meetings should be held at least four times a year. 82
  • 83. • A Director should not be a member in more than ten committees or act as the Chairman of more than five committees across all companies in which he is a Director. This is done to ensure that the members of the Board give due importance and commitment of the meetings of the Board and its committees.• The management must make disclosure to the Board relating to all material, financial and commercial transactions, where they have personal interest.• In case of the appointment of a new Director or re-appointment of a Director, the shareholders must be provided with a brief resume of the Director, his expertise and the names of companies in which the person also hold Directorship and the membership of committees of the Board.• A Board committee should be formed to look into the redressal of shareholders’ complaints like transfer of shares, non-receipt of balance sheet, dividend etc.• There should be a separate section on Corporate Governance in the annual reports of the companies with a detailed compliance report.Apart from these, the Kumar Mangalam Committee also made somerecommendations that are nonmandatory in nature. Some of are: 83
  • 84. • The Board should set up a Remuneration Committee to determine the company’s policy on specific remuneration packages for Executive Directors.• Half-yearly declaration of financial performance including summary of the significant events in the last six months should be sent to each shareholder.• Non-executive chairman should be entitled to maintain a chairman’s office at the company’s expense. This will enable him to discharge the responsibilities effectively. 84
  • 85. It will be interesting to note that Kumar Mangalam Committee while drafting itsrecommendations was faced with the dilemma of statutory v/s voluntarycompliance. One may also be aware that the desirable code of CorporateGovernance, which was drafted by CII was voluntary in nature and did notproduce the expected improvement in Corporate Governance. It is in thiscontext that the Kumar Mangalam Committee felt that under the Indianconditions a statutory rather than a voluntary code would be far more purposiveand meaningful. This led the Committee to decide between mandatory and non-mandatory provisions. The Committee felt that some of the recommendationsare absolutely essential for the framework of Corporate Governance andvirtually from its code, while others could be considered as desirable. Besides,some of the recommendations needed change of statute, such as the CompaniesAct for their enforcement. Faced with this difficulty, the Committee settled fortwo classes of recommendations.SEBI has given effect to the Kumar Managlam Committee’s recommendationsby a direction to all the Stock Exchanges to amend their listing agreement withvarious companies in accordance with the ‘mandatory part of therecommendations. 85
  • 86. For ensuring good corporate governance in a banking organization theimportance of overseeing the various aspects of the corporate functioning needsto be properly understood, appreciated and implemented. There are fourimportant forms of oversight that should be included in the organizationalstructure of any bank in order to ensure the appropriate checks and balances:(1) oversight by the board of directors or supervisory board;(2) oversight by individuals not involved in the day-today running of the various business areas;(3) direct line supervision of different business areas; and(4) independent risk management and audit functions. In addition to these, it is important that the key personnel are fit and proper for their jobs (this criterion also extends to selection of Directors). 86
  • 87. RECENT DEVELOVMENTSThe Department of Company Affairs, in May 2000, invited a group of leadingindustrialists, professionals and academics to study and recommend measures toenhance corporate excellence in India. The Study Group in turn set up a Task Force,which examined the subject of Corporate Excellence through sound corporategovernance and submitted its report in Nov. 2000. The task force in itsrecommendations identified two classifications namely essential and desirable with theformer to be introduced immediately by legislation and the latter to be left to thediscretion of companies and their shareholders. Some of the recommendations of thetask force include: • Greater role and influence for nonexecutive independent directors • Stringent punishment for executive directors for failing to comply with listing and other requirements • Limitation on the nature and number of directorship of managing and whole- time directors • Proper disclosure to the shareholders and investing community • Interested shareholders to abstain from voting on specified matters • More meaningful and transparent accounting and reporting 87
  • 88. • Tougher listing and compliance regimen through a centralized national listing authority • Highest and toughest standards of Corporate Governance for listed companies • A code of public behaviour for public sector units • Setting up of a centre for Corporate ExcellenceRecently, the Government has announced the proposal for setting up the Centre forCorporate Excellence under the aegis of the Department of Company Affairs as anindependent and autonomous body as recommended by the study group. The centrewould undertake research on Corporate Governance; provide a scheme by whichcompanies could rate themselves in terms of their corporate governance performance;promote corporate governance through certifying companies who practice acceptablestandards of corporate governance and by instituting annual award for outstandingperformance in this area. Government’s initiative in promoting corporate excellencein the country by setting up such a center is indeed a very important step in the rightdirection. It is likely to spread greater awareness among the corporate sectorregarding matters relating to good corporate governance motivating them to seekaccreditation from this body. Cumulative effect of the companies achieving levels ofcorporate excellence would undoubtedly be visible in the form of much enhancedcompetitive strength of our country in the global market for goods and services. 88
  • 89. A large number of public sector companies both in the banking industry and financialsector have on their Boards representative of the Government / Reserve Bank of India.It is for debate whether functionaries of the Government should sit on their boards.While there is no easy or straightforward answer to this question, at some distantfuture it is hoped, all the Directors would be truly independent. The subject is nodoubt complex and can be looked upon from various angles. Frauds in the bankingsystem are also increasing but computer Management Information Systems should beable to detect them early and the Board must have the will to deal with suchmischiefmakers in an exemplary manner. Zero tolerance should be the goal for fraudsin the banking system. It is the leader at the helm of affairs who makes a difference.A close coordination exists through High Level Co-ordination Committee (HLCC)between RBI, SEBI, IRDA and the Secretary Finance, Government of India who has aformal structure for reviewing the affairs which impact the whole financial system.Although the US and UK models are different, this model has served us well and weseem to be comfortable to continue with the same for some more time to come. 89
  • 90. It would be appropriate to dwell upon the Corporate Governance standards asapplicable to the insurance industry. Capital markets, banks, insurers and otherfinancial institutions are all closely linked and international benchmarks have beenestablished and adopted by the regulators under the aegis of IAIS at Basle. The basicprinciples are no doubt adopted from the OECD model. Unlike active regulation andsupervision in the banking sector, insurance regulations are still under evolution asfundamentally the contract of insurance is basically a promise to pay at some time inthe future. Events like Enron, Sumitomo, 9/11 or even natural calamities like theTsunami or Katrina can all change the risk comprehension and call for superiorunderwriting and actuarial skills. The problem of opacity arises due to the underlyingcontracts whose risk-return profiles keep changing. Therefore, the asset liabilitymanagement in insurance companies must be very dynamic and strategies need to befine tuned on a continuous and daily basis depending upon the markets in which thesecompanies operate and the risks get covered. 90
  • 91. Insurance industry is also confronted with intensified agency problems frominformational asymmetries and complex structures of the principal agent relationshipand often times, conflicts of interest arise amongst the insurance companies and withother players in the financial markets. Therefore, there is a clear need for maintainingexcellent Corporate Governance standards in this industry. The IAIS principle ICP 9is the anchor principle which gives the entire criteria of the responsibilities of theBoard of Directors and the senior management, and the oversight responsibilities.Simultaneously it also covers the relationship between the responsible actuary and theboard of the insurance company. All the other insurance core principles are cohesivelyconnected to ICP 9 and it is worth referring to ICP 7, 8, 10, 13, 18 and lastly to 26,which deal on the suitability of persons; controls measures and portfolio changes;internal controls; inspections; risk management and assessment; and lastly informationand disclosure requirments. 91
  • 92. There is no escape from the governance structure and the guideline functions; andresponsibilities of the board covers inter-alia, ‘Reviewing and guiding the strategy ofthe insurance entity, including reinsurance strategies; major plans of action, risk policyrelated to the main insurance risks and annual budgets; approving the pricing strategy;setting performance objectives; overseeing auditing and actuarial function/otheroversight structures; and monitoring the administration of the insurance entity in orderto ensure that the objectives set out in the by-laws, statues or contracts, or indocuments associated with any of these, are attained (e.g. diversified asset allocation,cost effectiveness of administration, etc.”) The guideline further state “BoardMembers are accountable to the entity’s shareholders and / or policy holders, orparticipating policy holders and / or to the competent authorities.” The aboveguidelines got modified in April 2005 by OECD relating to the actuaries andboundaries between life and non-life insurers and the responsibility of the external andinternal auditor. Thus, although the process of evolution is still taking place in view ofthe peculiar situations faced, there is a much greater need, so that the highest ethicsand corporate governance are followed in the insurance industry, so that men at thehelm of these Boards set exemplary standards. 92
  • 93. Finally, the four aspects of oversight that should be included in the organizationalstructure of any financial institution to ensure appropriate check and balances are: (i) Oversight by the board of directors or supervisory board; (ii) Oversight by individuals not involved in the day-to-day running of the various business areas; (iii) Direct line supervision of different business areas; and (iv) Independent risk management and audit functions. 93
  • 94. There is an entire subject called “whistle blowing” and there is enormous literature onthis subject – when to blow the whistle, who should blow the whistle and where thewhistle should be heard. These are the questions for which one needs to find theanswers between spate of anonymous letters to which any one working in publicsector is used to and honest officials are harassed sometimes on one side and thedamaging investigative audit reports and doctored balance sheets on the other side.Somewhere in between lies the governance and ethics; and standards expected to beset up by the virtuous men appointed for heading these institutions. In suchorganizations the shareholders and the other stakeholders derive full value. It ismyopic, bordering on foolishness, to look for astronomical return by the shareholders,who would allow the boards to indulge in unethical practices like market rigging,insider trading, speculation and host of other irregular practices for the sole purpose ofmaking huge profits. One cannot argue that the shareholder’s value is enhanced byhigher profits and dividends are distributed by the board acting merely as an agent ofthe shareholder who becomes the principal. Here lies the test of governance of theboard of directors walking the well defined, honest and straight path in conducting theaffairs in the required atmosphere of transparency seen and perceived by all thestakeholders, the markets and the regulators. Then only one can confidently state thatcorporate governance has taken firm roots in this country. 94
  • 95. 95