project on corporate governance in insurance sector

1. Executive Summary
Corporate Governance has come to occupy a very prominent place on the agenda of
business houses, the reasons for which are not far to seek. Although it has always
been the endeavor of corporate managements to conduct their business in as fair a
manner as possible while keeping in view the ultimate bottom line, a senseless
adventurism on the part of some to depict their performance out of proportion to the
realities had led to the focus returning to the deliberations in the Board rooms and the
responsibilities of the Board of Directors. Corporate managements would do well to
realize that it is not merely the appreciation of shareholders’ value which is the
ultimate objective but the way it is achieved. In most of the corporate debacles that
were observed in the recent past, the common thread that was observed was the larger
than life image of the CEO which has reduced the Board to a body providing a stamp
of approval without subjecting the proposals to a strict scrutiny. When it comes to
insurance companies, the fiduciary responsibility of the managements takes a two-
pronged direction. As they deal with the policyholders’ money, insurers have to be
cautious not just about their own managements but also the way the companies where
the funds are invested, conduct their business. A failure on either side would prove to
be detrimental to the interests of the insurance company.
Insurance companies are surrounded by a complicated pattern of economic, social
ideas and expectations. They have a responsibility to themselves, to one another and
to their constituencies to make a reasonable and effective response. An insurance
company’s responsibilities include how the whole business is conducted every day. It
must be a thoughtful institution, which rises above the bottom line to consider the
impact of its actions on all, from shareholders to the society at large. All acts of the
company should not only be the right course of action, but also be perceived so. The
means 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 decisions
towards the progress of their company and to innovate, while remaining within a
framework of effective accountability. In other words they have a system of good
corporate governance. This also calls for insurers to devise an internal procedure for
adequate and timely disclosure, reporting requirements and code of conduct.
Therefore Corporate Governance becomes a key issue in insurance.
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2. Objective of the Study
In this report, an attempt has been made to present each and every single count related
to Corporate Governance that are enshrined in Companies Act, 1956 and rules frames
there under.
The objective of the report is to explain in detail the corporate governance
requirements to be complied with by all the insurance companies by considering
various aspects. A proper regulation & Supervision of the insurance sector will help
in smooth and efficient functioning of insurance companies.
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3. Corporate governance
The concept of corporate governance is poorly defined because it covers various
economics aspects. As a result of this different people have come up with different
definitions on corporate governance. It is hard to point on any one definition as the
ultimate definition on corporate governance. So the best way to define the concept is
to 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
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4. Corporate Governance is concerned with holding the balance between economic and
social goals and between individual and communal goals. The corporate governance
framework is there to encourage the efficient use of resources and equally to require
accountability for the stewardship of those resources. The aim is to align as nearly as
possible the interests of individuals, corporations and society"
According to Mathiesen (2002)
“Corporate Governance is a field in economics that investigates how to
secure/motivate efficient management of corporations by the use of incentive
mechanisms, such as contracts, organizational designs and legislation. This is often
limited to the question of improving financial performance, for example, how the
corporate owners can secure/motivate that the corporate managers will deliver a
competitive rate of return.”
The definition given by Mathiesen means that corporate governance is a method
which tries to find out the different incentives which would motivate the managers of
a 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 corporate
assure themselves of getting a return on their investment”
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5. The definition here means that corporate governance is basically a technique where
people who give money (lenders of the money) promise themselves or comfort
themselves 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 and
accountability”
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6. According to OECD (Organisation for Economic Co-operation and
Development)
“Corporate governance is the system by which business corporations are directed and
controlled. The corporate governance structure specifies the distribution of rights and
responsibilities among different participants in the corporation, such as, the board,
managers, shareholders and other stakeholders, and spells out the rules and procedures
for making decisions on corporate affairs. By doing this, it also provides the structure
through which the company objectives are set, and the means of attaining those
objectives and monitoring performance.”
The definition given by OECD means that corporate governance is an arrangement
which manages the corporations. The configuration of corporate governance defines
the duties and obligations of all the members of the corporation, gives the structure of
setting the objectives and the method of attaining the set
In short all the definitions stated above implies that corporate governance is a mode by
which the management is motivated to work for the betterment of the real owners of
the corporation i.e. the shareholders.
In other words corporate governance can be defined as the relationship of a company
to its shareholders or more broadly the relationship of the company to the society.
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7. Corporate governance thus refers to the manner in which a company is managed and
states the rules, laws and regulation that affect the management of the firm. It also
includes laws relating to the formation of the firm, establishment of the firm and the
structure of the firm. The most important concern of corporate governance is to
ensure that the managers and directors act in the interest of the firm and for the
shareholders.
Historical Perspective of Corporate Governance
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8. The seeds of modern corporate governance were probably sown by the Watergate
scandal in the United States. The global movement for better corporate governance
progressed in fits and starts from the mid-1980s up to 1997. There were the odd
country-level initiatives such as the Cadbury Committee Report in the United
Kingdom (1992) or the recommendations of the National Association of Corporate
Directors of the US (1995). It would be fair to say, however, that such initiatives were
few and far between. And while there were the occasional international conferences
on the desirability of good corporate governance, most companies – both global and
Indian 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 after
the South-East and East Asian crisis of 1997-98. This was no classical Latin
American 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 understand
that the devil lay in the institutional, microeconomic details – the nitty-gritty of
transactions between companies, banks, financial institutions and capital markets; the
design of corporate laws, bankruptcy procedures and practices; the structure of
ownership and crony capitalism; sharp stock market practices; poor boards of directors
showing scant regard to fiduciary responsibility; poor disclosures and transparency;
and inadequate accounting and auditing standards.
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9. Suddenly, ‘corporate governance’ came out of dusty academic closets and moved
centre stage. Barring Japan and possibly Indonesia, countries in Asia recovered
remarkably fast. By the year 2001, Thailand, Malaysia and Korea were on the
upswing and on course to regain their historical growth rates. With such rapid
recovery, corporate governance issues s were in the danger of being relegated to the
back stage once again. There were projects to be executed, under-value assets to be
bought, and profits to be made. International investors were again showing
bullishness. In such a milieu, there seemed no urgent need to impose concepts like
better accounting practices, greater disclosure, and independent board oversight.
Corporate governance once again settled into a phase of extended inactivity.
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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 occur
due to a national or region-wide macro – economic and financial collapse. Indeed, the
Asian crisis barely touched India.
Secondly, unlike other Asian countries, the initial drive for better corporate
governance and disclosure, perhaps as a result of the 1992 stock market ‘scam’, and
the onset of international competition consequent on the liberalization of economy that
began in 1990, came from all-India industry and business associations, and in the
Department of Company Affairs.
Thirdly, it is fair to say that, since April 2001, listed companies in India are required to
follow some of the most stringent guidelines for corporate governance throughout
Asia and which rank among some of the best in the world.
Even so, there is scope for improvement. For one, while India may have excellent
rules and regulations, regulatory authorities are inadequately staffed and lack
sufficient 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 of
corporate scams and stock market scandals that has shaken investor confidence. Much
can be done to improve the situation.
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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 US
companies such as WorldCom, Qwest, Global Crossing and the exposure of lack of
auditing that eventually led to the collapse of Andersen. After having shaken the
foundations of the business world, that too in the stronghold of capitalism, these
scandals have triggered another more vigorous phase of reforms in corporate
governance, accounting practices and disclosures – this time more comprehensively
than ever before.
As a US – based expert recently put it, “Enron and WorldCom have done more to
further the cause of corporate transparency and governance in less than one year, than
what activists could do in the last twenty.”
This is truly so. In June 2002, less than a year from the date when Enron filed for
bankruptcy, the US Congress introduced in record time the Sarbanes-Oxley Bill. This
piece of legislation (popularly called SOX) brought with it fundamental changes in
virtually every area of corporate governance – and particularly in auditor
independence, conflicts of interest, corporate responsibility and enhanced financial
disclosures. 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 of
the rules under various provisions of the Act, and despite there being rumbles of
protest in the corporate world against some of the more draconian measures in the new
law, it is fair to predict that the SOX Act will do more to change the contours of board
structure, auditing, financial reporting and corporate disclosure than any other
previous law in US history.
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12. Although India has been fortunate in not having to go through the pains of massive
corporate failures such as Enron and WorldCom, it has not been found wanting in its
desire to further improve corporate governance standards. On 21 August 2002, the
Department of Company Affairs (DCA) under the Ministry of Finance and Company
Affairs appointed this Committee to examine various corporate governance issues.
CORPORATE GOVERNANCE IN INSURANCE
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13. Good governance in a corporate entity should be a voluntary exercise and
managements should not reduce it to a function that is statutorily enforced. While the
bottom line undoubtedly is making a point, entities should realize that they are in
business to enhance the stockholder’s value. Thus they owe a fiduciary responsibility
to each of their shareholders. One can analyse corporate governance as a delicate
balance between the twin tasks of performance and compliance. When profit making
becomes the solitary objective, managements tend to lose sight of their responsibilities
and throw caution to winds. When the auditors and other officials associated with
surveillance join the black deeds, the problem assumes humongous proportions. It is
exactly in this background that we had the occasion to witness several major corporate
debacles; and suddenly corporate governance hogs the limelight like never before.
The series of fiascos led to several important legislations being enacted in some of the
most developed economies and being followed closely globally. We hear of
corporate governance in almost all sections of business, irrespective of their size.
Corporate governance has a different dimension as far as the insurance business is
concerned. On the one hand, insurers have to be prudent in protecting the
policyholders’ interests as regards reasonableness in charging premiums; objectivity in
settling the claims and so on. On the other, they also have the responsibility of
profitably investing the policyholders’ funds. This demands that insurers additionally
have to be sensitive to the management styles of
the organizations where the funds are being lodged. To this extent, they have a dual
function to play.
STEPS TAKEN BY THE IRDA
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14. The multi-disciplinary Working Group on Enhanced Disclosure, appointed by the
IRDA, while examining the need for improving the public disclosure practices of
financial 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
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15. The working Group while giving its recommendations reiterated the need for
extensive disclosures, stating that these “can increase market discipline and may
increase the stability of the financial system and lead to an improved allocation of
capital and other resources. Greater transparency can allow participants in the
financial system to make more informed judgment about risks and returns and to place
new information in proper context. More generally, with greater transparency there
may be fewer tendencies for markets to place emphasis on positive or negative news
and in this way; volatility in the financial markets and an important source of fragility
can be reduced.” The Working Group’s conclusions had three general themes: first, a
healthy balance is necessary between quantitative and qualitative disclosures; second,
intermediaries’ disclosure should be consistent with how they assess and manage their
risks; and third, intra-period information is necessary for a more complete view of an
institution’s exposure to risks. The IAIS Task Force on Enhanced Disclosure
approved the Guidance Note on Public Disclosures by Insurers in January, 2002.
Public disclosure of reliable and timely information facilitates the understanding by
prospective and existing policyholders and other market participants of the financial
position of insurers and the risks to which they are exposed. Supervisors are
concerned with maintaining efficient, safe, fair and stable insurance markets for the
benefit and protection of policyholders. Risk disclosure is critical in the operation of a
sound market. When provided with appropriate information that allows them to assess
an insurer’s activities and the risks inherent in those activities, markets can respond
efficiently, rewarding those companies which manage risk effectively and penalizing
those that do not. This is often referred to as Market Discipline, and it acts as an
adjunct to supervision. Corporate Governance (CG) encompasses the processes,
structures, information and relationships used for directing and overseeing the
management of the institution in the best interest of the institution and the key
stakeholders that have a significant interest in the on-going viability of the company.
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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 is
adequate control over objectives, strategies, controls and operations within the
company. In addition, factors such as business ethics and corporate awareness of the
environmental and societal interests of the communities in which a company operates
can also have an impact on its reputation and on its long term success. Two elements
of 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.
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17. Effective CG allows the supervisor to rely on the work performed by the Board of
directors and senior management and in doing so allows the supervisory process to
operate more efficiently and effectively than it would in the absence of such a
relationship. This reliance relationship, however, needs a review from time to time to
ensure that it is well founded. Both the capital market regulators and the insurance
supervisors are interested that companies adopt CG practices. In case of the capital
market regulators it is to ensure that the interests of the investors are protected. In
respect of insurance supervisors, the interest in good CG practices stems not just from
the need to protect the rights and interests of the shareholders. It is the money that the
investors have tied up in a company that forms at least a part of its capital base that the
supervisors are relying on to protect the rights of the policyholders in the event that the
company fails. Insurance supervisors are interested in having insurance enterprises
that are well managed, that treat their customers fairly, that are in compliance with the
legislation and other requirements, and are well managed by competent ethical
individuals. In many insurance companies, there is more policyholders’ money than
the shareholders’ money – the size of the policy and claims liabilities (and provisions
or reserves) exceed the amount of assets held in respect of shares and other capital
instruments that the company has issued. The investor while making a decision to
invest in the insurance company is aware of the risks. Policyholders, on the other
hand, are unaware of the risks – rather they seek the services of the insurance
company to relieve their unwanted risk exposure. While, both the shareholders and
the policyholders have a common interest in the company being run in a prudential,
profitable and sound manner, board decisions which may benefit the shareholders may
not necessarily benefit the policyholders, and vice versa.
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18. This is where the role of the supervisor in implementing CG acquires greater
complexity. CG forms one of the corner stones of the IAIS (international Association
of Insurance Supervisors) core principles (ICPs). While ICP 9 focuses on Corporate
Governance, 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. This
requires that they possess the appropriate integrity, competency, experience and
qualifications”. ICP-9 defines the CG framework as one which recognizes and
protects the rights of all interested parties. The supervisory authority requires
compliance with all applicable corporate governance standards. The core principle of
CG 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 their
decisions are implemented. Once in place, internal controls become a very powerful
tool for
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19. the supervisor. The ICP-18 embodies the principle of Risk Assessment and
Management. A critical component of CG is the ability of insurers to recognize the
range of risks that they face, and to assess and manage those risks effectively.
Effective and prudent risk management systems appropriate to the complexity, size
and nature of the insurer’s business must exist, and the insurer should establish
appropriate tolerance levels to risk. The fundamental of CG is dissemination of
information to all the stakeholders, and this finds a cornerstone in ICP-26 pertaining to
Information, Disclosure and Transparency towards the market, and ICP-12 on
Reporting to Supervisors and Off-site Monitoring. For information to be useful, it
must be timely, accurate, complete and relevant. Insurers must disclose relevant
information on timely basis in order to give the stakeholders a clear view of their
business activities and financial position and to facilitate understanding of the risks to
which they are exposed.
The Indian context
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20. The focus has shifted to CG time and again on account of repeat emergence of
financial crises across the global, as well as frequent instances of financial reporting
failures. In competitive markets, CG is a reflection of market disciplines, and forms
the cornerstone for efficient allocation of resources. CG enables managements to take
decisions, while at the same time being accountable for the decisions taken. Securities
& Exchange Board of India (SEBI) appointed the Committee on Corporate
Governance in May, 1999 under the Chairmanship of Kumar Mangalam Birla, to
promote and raise the standards of Corporate Governance, in the particular context of
companies 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.
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21. Based on the recommendations of the Birla Committee, SEBI laid down requirements
on CG for listed entities in February, 2000. However, certain entities including public
and private sector banks, financial institutions, insurance companies and those
incorporated 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 so
as to ensure that all listed companies followed the same standards of CG. While a
number of recommendations already stood implemented, with a view to further
improving the CG standards in banks, additional measures were recommended for
implementations by banks. These measures included constitution of a Committee to
look into the complaints of shareholders and half yearly disclosure of unaudited
results. The RBI also recommended compliance with the requirements of the
provisions of clause 49 of the Listing Agreement in June, 2002. The Standing
Committee on International Financial Standards and Codes, Reserve Bank of India
constituted the Advisory Group on Corporate Governance to study the status of
applicability and relevance and compliance of international standards and codes of
industrialized and emerging countries and suggest measures/recommendations for
achieving 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 the
mechanism in India with reference to (i) the private corporate sector, (ii) banks and the
development financial institutions, and (iii) Central and State public sector enterprises
set up under the Companies Act, 1956. Comparisons were also drawn with Bank for
International Settlement (BIS) principles. The report submitted that it was essential to
bring reforms quickly so as to make boards of corporates/banks/financial
institutions/public sector enterprises
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22. more professional and truly autonomous. The first important step to improve
governance mechanism in public sector units was to transfer the actual governance
functions to the boards from the concerned administrative ministers and also
strengthen the boards by streamlining the appointment process of directors. Further
there was a need for public sector banks to maintain a high degree of transparency in
regard to disclosure of information. The recommendations covered areas of
responsibilities of the board of stakeholders/shareholders, selection procedures for
appointment of directors of the board, size and composition of the board, committees
to be appointed by the board for corporate governance, disclosure and transparency
standards, role of shareholders and role of auditors. In August, 2002, the Department
of Company Affairs (DCA) under the Ministry of Finance and Company Affairs
appointed the Naresh Chandra Committee to examine the various CG issues including
appointment 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 the
directors; the necessary to have a transparent system of random scrutiny of the audited
accounts; adequacy of regulations for oversight of statutory functionaries; and the role
of independent directors. SEBI appointed the N.R. Narayana Murthy Committee in
February, 2003 to evaluate the adequacy of existing CG practices and to further
improve upon them. The Committee was in line with the Board’s belief that efforts to
improve CG standards in India must continue. The Committee focused on such issues
as audit committees and reports, independent directors, related parties, risk
management, directors and their compensation, code of conduct and financial
disclosure. The Committee’s recommendations were based on such parameters as
fairness, accountability, transparency, ease of implementation, verifiability and
enforceability. Prior to these initiatives, in 1996, the CII had taken the first
institutional initiative to develop and promote a code of conduct for the Indian
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23. industry. The initiative was in response to concerns regarding promotion of investor
interest, particularly, small investor’s interest; promotion of transparency within
business and industry; need to move towards international standards in terms of
disclosure of information by the corporate sector; and to develop a high level of public
confidence in Indian industry.
The Companies Act, 1956
The requirements relating to corporate governance are enshrined in the Companies
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24. Act, 1956 and the Rules framed there under. The various aspects covered include
appointment, 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; provisions
relating to directors’ relatives, manner of conduct of the Board meetings,
qualifications, powers and duties of auditors, constitution of and the role of the Audit
Committee, and disclosures pertaining to related party transactions. Comprehensive
provisions relating to disclosure to form part of the Annual Report include the state of
affairs of the company, changes in business, particulars of employees and their
remuneration, details of sweat equity, buy-back of shares, preferential allotments,
audit committees, composition of the Board, disclosures on consolidated accounts and
the directors’ responsibilities.
Requirements under Clause 49 (Companies Act) of the Listing Agreement
All companies listed on the stock exchanges are required to comply with the CG
requirements as laid down in Clause 49 of the listing agreement. The Clause provides
for the composition of the board of directors, meetings of the board, remuneration of
the directors, composition of the Audit Committee, its responsibilities and the manner
of conduct of its meetings; disclosure of interests of the management; and
Management Discussion & Analysis Report (MDAR); Report on CG to form part of
the Annual Report – covering both mandatory and non-mandatory aspects; and
Compliance Certificate from the statutory auditors on compliance with Clause 49 to
form part of the Directors’ Report.
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25. CG requirement to be complied with by all insurers
All insurer are required to ensure compliance on corporate governance as per the
provisions of the Corporate Act, 1956. In addition, the insurers have to comply with
the requirements of the Insurance Act, 1938 and the regulations framed there under.
The various requirements stipulated by the Authority to ensure good governance in the
management of affairs of the insurers and transparency in their operations, cover such
aspects as internal controls and processes; constitution of Investment Committee, its
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26. duties and responsibilities; appointment of managerial personnel to meet the “fit and
proper” criteria subject to prior approval of the Authority; disclosure on payments
made to individuals, firm, companies and organizations in which directors are
interested; stipulation on appointment of joint auditors, their qualifications and
rotation of auditors, Format of the Audit Report; defined role of Appointed Actuary;
representation of the policyholders on the Board; provisions against commonality of
interest through presence of similar directors in two insurance companies; amongst
others. The various Accounting Standards framed by the Institute of Chartered
Accountants of India facilitate conformity with the accounting principles and
disclosure of specified information to ensure transparency in operations. A review of
the financial statements furnished by the insurers reveals certain aspects of their
functioning. There were instances of the auditors drawing attention to such aspects as
lack of controls, inadequacies in the functioning of the audit committees, and
inadequacy of IT systems. Absence of these effects the risk management systems put
in place by the insurers. Higher expenses towards related parties, and contracts being
executed through related parties, appointment of managerial personnel and
underwriting premium for group companies were also noticed. From the regulatory
perspective, there is also a need for disclosures at periodic intervals. While all
regulatory stipulations may be in place, ultimately CG is related to imbibing the
culture of transparency and fair play within an organization, which cannot come
through any impositions but has to percolate down to the lowest rungs through
involvement of all people at all levels. Checks and controls need to be in place to
ensure that conflicts of interest and deviations are brought out and rectified. To the
extent that such mechanisms are in place, the regulator can rely on the information
furnished by the insurers and apply the rule of ‘Management by Exception”.
Efficiency needs to be achieved through minimizing regulatory prescriptions and
maximizing voluntary codes. While SROs can play a significant role in this regard,
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27. the Authority is also contemplating framing regulations to cover various aspects of
corporate governance.
Accounting and Actuarial Standards
I Accounting Standards
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28. The Authority had issued Regulations for Preparation of Financial Statements and
Auditor’s Report of insurance companies in the year 2000. Incorporating various
clarifications issued on the same from time to time, the regulations were modified in
March, 2002. The regulations broadly conform to the Accounting Standards (AS)
issued by the Institute of Chartered Accountants of India (ICAI). Modifications have
been made in respect of the accounting standards pertaining to preparation of Cash
Flow Statement (AS – 3) which is required to be furnished to the Authority only under
the direct method. The requirements under Segment Reporting (AS -17) have been
made more stringent for the insurers. The regulations further require that the financial
statement shall be accompanied by the Management Report, in a prescribed format,
duly certified by the management. The Responsibility Statement, as required under
section 217 (2AA) of the Companies Act, 1956 as part of corporate governance, also
forms part of the Management Report. The Authority has also prescribed a format for
the 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 panel
maintained at the Authority. The insurers have, from time to time, raised issues for
clarification on the preparation of financial statements. Based on interaction with the
insurers and various experts in the field of Accounting and Actuarial aspects,
clarifications have been issued by the Authority on disclosures pertaining to related
party transactions; maintenance of separate investment accounts for the shareholders
and the policyholders, etc. The Authority has also prescribed summary format of
financial statement as a part of the annual accounts. The summary is required to be
furnished for a period of five years along with the prescribed ratios. Provision for
premium deficiency is another aspect on which clarity was required. As a step
towards this, an informal Group was constituted to consider various issues pertaining
to computation of premium deficiency. The regulations stipulate that premium
deficiency shall be recognized if the sum of expected claim costs, related expenses and
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29. maintenance costs exceeds the related Reserve for Unexpired Risks. The other issues
examined were actuarial valuation of liabilities exceeding four years; and the format
of 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-life
insurers to make provision for premium deficiency; actuarial valuation of liabilities
exceeding four years; and a format of Receipts and Payments Account has been
prescribed. With the insurance companies completing over three years of operations
and market conditions constantly evolving, it was felt that there was a need to re-visit
a number of provisions contained in the Regulation for preparation of financial
statements. 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
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30. insurers and the proforma in which such reports are
required 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 the
ICAI to bring out Guidance Notes on audit of companies carrying on general of life
insurance business. During the financial year, the Authority, jointly with the ICAI,
considered important issues and shared views and ideas on audit and other related
subjects in the insurance industry at the macro level. The Institute of Chartered
Accountants of India (ICAI) inconsultation with the Authority constituted a study
group to examine introduction of Long Form Audit Report (LFAR) for insurance
companies. The Group comprises of representatives from the Institute, the insurance
industry and the Authority. The Study Group is examining development of LFAR on
the pattern of banks to deal with internal control systems and procedures covering
different aspects of insurance companies at branch and head office levels. The draft of
the LFAR is proposed to be circulated to the insurance companies prior to its
finalization. In another initiative, the Committee on Insurance of the ICAI is
finalizing the Guidance Note on “Inspection of Investment Functions of Insurance
Companies.’ The Institute would issue a “technical guide” in the first instance for
comments. The Note would be considered for issue as a Guidance Note after
incorporating the suggestions. The documentation relating to inspection of the
investment functions of insurance companies has been developed with inputs from
experts in the insurance sector. The exercise has been initiated with a view to
ensuring that the Guidance Note serves as a ready reckoner for Inspection/Audit
teams, while carrying on Investment Audits. With the requirements for disclosure in
the financial statements becoming more stringent across the globe, the Indian industry
should also prepare for higher level of disclosure. The regulatory framework provides
for standards, disclosures and transparency. The role of the auditors is also becoming
more demanding as the custodians to prevent fraud and to comment on the prudential
management practices. The Council of the ICAI has set up the Peer Review Board to
introduce 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 technical
issues and the statutory requirements have been complied with, It is proposed that in
the fist phase, 987 practice units will be reviewed under the peer review process over a
period of three years. The Central Statutory Auditors of insurers are also being
covered in Stage –I. The objective behind various initiatives is to ensure that the
financial statements reflect the financial health of the insurance company to the
investor who wants to invest in it as a shareholder, or the prospective policyholder
who expects that the insurer would be in a position to honour the claims when the
arise, to make informed decisions. For the regulator, the financial statements facilitate
the process of off-site inspection, confirming that the internal controls and processes
are in place and the insurer is complying with various regulatory requirements to
maintain 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 insurance
business in India without an Appointed Actuary. While in the case of life insurers, an
AA must be a full time employee, in the case of non-life insurers, AA need not
necessarily be an employee of the company, but could be a consultant. Every AA has
certain 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 while
laying down the qualification of an actuary, further provide that the Authority may
relax the provisions in such circumstances as it deems fit and may permit such a
person to sign as an Actuary for specified purposes. The powers and duties of an
Appointed Actuary are laid down by the Authority in the regulations pertaining to
their appointments which include the right to attend all management and board
meetings; right to participate in discussions; rendering actuarial advice to the
management particularly on product design and pricing, contract wording, investments
and reinsurance; ensure maintenance of required solvency margin of the insurer at all
times; certifying the value of assets and liabilities of the insurer; drawing the attention
of management towards such matters as may prejudice the interests of policyholders;
certifying the “Actuarial Report and Abstract” and other returns under Section 13 of
the Insurance Act, 1938; complying with Section 40-B of the Act in regard to the basis
of premium; complying with Section 112 of the Act on recommendation of interim
bonus/bonuses payable; making available requisite records for conducting the
valuation; ensuring that the premium rates of the insurance products are fair; certifying
that mathematical reserves are set taking into account the Guidance
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34. Note (GN) of the Actuarial Society of India; ensuring that the Policyholders’
Reasonable Expectations (PRE) have been considered in the matter of valuation of
liabilities and distribution of surplus to participating policyholders; submit actuarial
advice in the interests of the insurance industry and the policyholders; and informing
the Authority if the insurer has contravened the provisions of the Act. In case of a
non-life insurer, the AA is required to certify the rates for in-house non-tariff products
and incurred But Not Reported (IBNR) Reserves which are indicated under
“Outstanding Claims” in the financial statements. The growth of the insurance
industry coupled with the entry of private insurers in the last four years, has augured
will for the actuarial profession. The developments in the profession signal evolution
in the system of appointed actuaries seeking their rightful place in the corporate
environment. The profession is expected to make significant contribution in terms of
actuarial inputs in life and general insurance business and risk management and
pensions. Actuaries are concerned with the assessment of financial and other risks
relating to various contingent events and for scientific valuation of financial products
in insurance, retirement and other benefits, investment and other related areas.
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35. II (b) Actuarial Standards
The 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 concurrence
prior to issuance by ASI. The Actuarial Society of India issued the first Guidance
Note (GN-I) on “Appointed Actuaries and Life insurance”.
The Guidance Note is a mandatory professional standard and covers the
responsibilities of the Appointed Actuary towards maintaining the solvency of the
insurer, meeting reasonable expectations of the policyholders, and to ensure that the
new policyholders are not misled with regard to their expectations. ASI issued the
Guidance Note (GN-21) for the appointed actuaries of general insurers, GN-21 covers
such aspects as nature and responsibility of appointed actuaries, considerations
effecting their position, the extent of their responsibility and duties, premium rates and
policy conditions for new products and existing products on sale, capital requirements,
actuarial investigations, premium and claims reserving, written notes and guidance to
actuaries who are directors on the boards of, employees or consultants to a general
insurance company. The Authority issues clarifications to the Appointed Actuaries on
interpretation of the regulations framed by the Authority.
35

36. INSURERS & CORPORATE GOVERNANCE
“There have to be structures and mechanisms to keep the board accountable to
shareholders” opines G. V. Rao (retired CMD, Oriental Insurance Company Ltd.) He
further 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 two
shareholders in each company, the interests of the unorganized stakeholders,
particularly the consumer community, can be well protected by a good corporate
governance 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 role
envisaged for these commercially minded insurers. How does the authority ensure
that the dominant shareholding in the industry is working in the interests of the
consumers and not in self interest? Is prudent supervision of solvency of insurers and
regulations on protection of consumer interests the only mechanisms available to
check corporate behavior? There is a definite need to involve consumers to express
their responses through a market mechanism. Shifting business from one insurer to
the other or through expression of complaints need not necessarily be the only other
alternatives. The Boards of the public sector insurers do not presently consider
settlement of claims or any consumer issues relating to them, as their corporate
responsibility. It is entirely that of their Managements. How then are they ensuring
that the consumers, who are dealing with them, are getting a fair deal from the
managements they are supervising? Is it not their primary duty to ensure that their
managements are dealing with the interests of their consumers fairly and
expeditiously? What aspects of governance do the Boards deal with, if dealing fairly
with consumer interests is not one of them? To whom are they accountable and for
what? 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 thrown
up an increasing awareness in consumers and the authorities, for good corporate
governance. New enactments have sprung up in many countries to improve the
standards of corporate governance trends.
What ails good corporate governance in India?
Though corporate governance practices in India have picked up momentum, there are
factors 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 capital
increases. Ownership structures and lack of enforcement capabilities have added to
the burden of poor governance standards. The ownership infrastructure and cultural
attitudes 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 primary
role is to monitor management on behalf of the shareholders. There have to b
structures and mechanisms to keep managements accountable to the Board. Similarly
there have to be structures and mechanisms to keep the Board accountable to the
shareholders. 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 business
judgment. Duty of loyalty means unyielding loyalty to the shareholders. Duty of care
would mean that a director must exercise due diligence in making decisions. He must
discover as much information as possible on the question at issue and be able to show
that, in reaching a decision, he has considered all reasonable alternatives. In the case
of Walt Disney vs. its shareholders, it has been held that when a director has
demonstration that he has acted with all due loyalty and exercised all possible care, the
courts 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 or
negligent, the court will not challenge it, whether or not it was a “good” decision in
the light of subsequent developments.
A distinction has been made by US courts between a director making a wrong decision
with ‘ordinary negligence’ but not acting in bad faith
and 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 efficient
but 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 of
today. But who is responsible for the company? The Board or the Management? It is
the Board that bears responsibility; but in practice it is the management that has the
infrastructure, expertise, time, control and information. Given this management
domination how can a Board exercise its responsibility? Who actually wears the
crown? The paradox is how to allow both to have dynamic control without
diminishing initiative and motivation of either. The tension between them is to
enhance creative and productivity. What information should the Board have for that
purpose?
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 negative
virtues of compliance. Making sure that things are running in order may be good
enough. But its main job is to oversee management is effective and satisfy itself that
the management is solving company problems and is risk-taking enough to build
improved 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 but
ready to benefit from changes, and ideally to lead them. The CEO must be powerful
enough to do the job, but accountable enough to do the job correctly. The decisions he
makes should be in the long-term interests of the shareholders. Who is the best
position to make a decision about the direction of the corporation, and does that person
or group have the necessary authority? That is determined by two factors: conflicts of
interest and information. Decisions must be made with the fewest of conflicts and
most information. Accountability must come from within; and that requires a
corporate governance system that is itself accountable. It must be continually
reevaluated 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 Directors
and four independent Directors, in all ten Directors. Since these companies are not
‘listed’ companies, the compliance with the provision of appointment of independent
directors is voluntary, as it is still not a legal provision under the Companies’ Act.
The Boards have set up Audit Committees, Investments committees. The most
important aspects of corporate governance to be performed by the Board are the
supervision of the performance of Management through proper discharge of its
statutory responsibilities; enforcement of effective internal control systems; ensuring
operation and monitoring of adequate and proper risk assessment procedures; and
putting in place a progressive customer grievance handling mechanism. These issues
are basically dealt with based on agendas, minutes of the meeting recording decisions
and directives after deliberations at the Board meetings for follow up. It is understood
from a study made by a consultancy source on the current standards of corporate
governance and other issues in the public sector units that the quality of the corporate
governance 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.
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46. The way out—partially?
These deficiencies can be radically changed, if a part of the shareholding is divested
and the companies, both in the private and public sector, are market “listed” to fulfill
stricter norms of corporate governance that SEBI imposes on them. The corporate
performance needs to be subjected to public scrutiny through movement of share
prices. India having adopted market based policies to boost economy and with
insurance being an industry that potentially covers the entire population, like the
banking industry, the sooner it is subjected to a market scrutiny, the better corporate
behavior must be passed on to the public through share listing, so that the Boards and
the managements are held accountable to the investors and consumers. The current
shareholders need to build pressure on managements to cut the unacceptably high
transactional costs and to deal with consumers in a much fairer manner. Corporate
governance, in normal parlance, deals with improving the shareholder value. In the
current situation, which is unlikely to change in the near future, it should deal with
giving consumers affordable products by cutting internal costs and providing
consumers 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 to
live with it. Even if it has, we can change it” say Dr. K.C, Mishra(Director National
Insurance Academy, Pune) & Dr. Geetanjali Panda(Mgmt Faculty, Finance &
Economics, IMIS, Bhubaneswar).
Modern society can place individuals in situations where they find themselves at odds
with principles of personal ethics and character. Our desire for independence and
freedom has left us less community-oriented. Our pursuit of happiness in the form of
wealth has made a disturbing degree of socially acceptable greed and selfishness. Our
ability to demonstrate integrity is challenged by conflicting values and social
imperatives .
Seven accepted principles of personal ethics and character encompass:
1. Willing compliance with the law
2. Refusal to take unfair advantage
3. Concern and respect for others
4. Prevention of harm
5. Trustworthiness
6. Benevolence
7. Fairness
47

48. Individuals in a monetized society constitute the community of corporate citizens.
Corporate Governance is about promoting corporate fairness, transparency and
accountability. Functionally, Corporate Governance means doing everything better, to
improve relations between companies and their shareholders; to improve the quality of
Directors; to encourage people to think long-term, to ensure that information needs to
all stakeholders are met and to ensure that executive management is monitored
properly in the interest of shareholders. Corporate Governance becomes an organic
system when companies are directed and controlled by the management in the best
interest of the stakeholders and others ensuring greater transparency and better and
timely financial reporting.
Corporate Governance of insurers as corporate entities
48

49. Regulations provide for dilution of ownership holding of Indian insurance entities in
due course. The conditions for Indian insurance companies’ share holdings will be
changing in several essential aspects in the near future. These changes will also
intensify the focus on corporate governance matters. An even larger sense, the rise of
the corporate governance mentality is tied to a new enlightenment regarding the nature
of capital in world markets. Recently U.S. Securities and Exchange Commission
Chairman Arthur Levitt made some observation at an insurance industry forum.
“Corporate governance springs from a much deeper well. It’s a by-product of market
discipline and the information explosion has redefined the markets. Unless there’s
high quality financial information governed by corporate oversight, capital will flow
elsewhere. Markets exist by the grace of investors. In an era where investors shift
money freely, the challenge for insurance companies is how to reconcile their
activities with long-term sustainability. Does a company expect its board to ask tough
questions, to challenge management? Every public company should have an
independent audit committee and the SEC has adapted rules to strengthen audit
committees. Why am I so obsessed about this? There’s no greater way to lose
confidence than by those numbers. Corporate accountability is at the heart of what
companies must do and insurers should not engineer their numbers as already
regulatory opinionated probability has done enough engineering in both sides of the
balance sheet.” Directors of insurance companies need a few unique skills due to
nature of business they are going to govern. Some of the attributes are common to all
business 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 of
decision-making, efficiency of benchmarking and in-built flexibility to accommodate
the certainty of change. Like any other Board, an insurance Board should have audit
committee, nomination committee, compensation committee, risk management
committee (of the nature of ALCO), executive committee (as standing committee of
the Board) conduct review committee, market operation guideline committee,
investment committee and compliance committee.
50

51. Corporate Governance by insurers as institutional investors in corporate entities
Insurers are an important class of institutional investors. According to corporate
governance policy, Insurer must be able to cooperate with other major owners on
corporate governance matters, mainly regarding the election of directors. This
cooperation should be concentrated on those companies in which insurer own a
significant share of the capital. The so-called percent rule has in principle
prohibited Indian insurance companies from owning shares in a company
corresponding to more than a statutory percent of the voting rights. When insurance
companies exercise corporate governance in other companies, they must take a
broader view of these questions than other owners. Consequently, in addition to the
interests 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 adopt
corporate governance policy for the insurer business. The
policy should pertain to the insurer’s share holdings in listed
Indian companies (external corporate governance) and, where
applicable, for insurer itself as a listed company (internal
corporate governance). The institutional activism movement
has not lacked for skeptics even internationally. Business
leaders and politicians have argued that large insurers lack the
expertise and ability to serve as effective monitors in the market
for corporate control [e.g. Business Week (1991), Cordtz
52

53. (1993), and Wohlstetter (1993)]. Others have noted that
parastatal insurers are subject to pressures to avoid activism
and instead aid the objectives of appropriate incentives and
free-rider problems may also hinder institutional activism
efforts. [Admati, Pfleiderer and Zachner (1994); Monks (1995)
and Murphy and Van Nuys (1994]. One way for institutions to
reduce free-rider problems among themselves and to sidestep
political pressure is to create an organized third party
monitoring organization. Such an organization can serve as a
focal point for diffuse investors and can enhance credibility
when challenging management. In principle, organized
institutional shareholders can exercise significant clout at a
fairly low cost because of economies of scale in activism [Black
(1990)]. IRDA should facilitate such a formation.
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54. Corporate Governance as a business opportunity for insurers
Corporate Governance requires fair deal, fair competition and fair information
collection. Lack of such practice gives rise to liability consequences most often no-
fault liability. Here is a business opportunity for insurers. Fair deal envisages
employees not to take unfair advantage of anyone through manipulation, concealment,
abuse of privileged information, misrepresentation of material facts or any other
unfair-dealing practice. Fair competition always attempts to compete fairly and
honestly and prohibits conduct that unethically seeks to reduce or restrain competition.
Company will not attempt to collect competitor’s information through
misrepresentation or unethical business practices. Company will never ask for
confidential or proprietary information or ask a client/ ex-employee of a competitor to
violate a non-compete or non-disclosure agreement. There are liabilities at even
Board 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.
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55. Corporate Governance ensures adequate insurance coverage against the losses arising
out of reputational risks. Insurers comprehensive exposure to another business should
be a cause of action for corporate governance. Insurance information Institute
illustrates this while analyzing the loss of US$ 3.796 billion to insurance industry on
account of failed power major Enron. Of the total loss of insurance industry 64% was
on account of investments in Enron, 26% for surety recalled, 7% for miscellaneous
claims, 2% financial guarantees and 1% for D&O liability claims. Again corporate
governance risk of general insurers is compounded by D&O coverage. Personal
Coverage protects directors and officers against liability arising out of “wrongful acts”
Corporate Reimbursement Coverage reimburses organization when legally
required/permitted to indemnify D&Os for their “wrongful acts and Entity Coverage
reimburses for claims made directly against the organization including those that
names no individual insureds. The aggregate liability of the entity needs corporate
control.
Governance Code for the Indian Insurany ce Industry
-- An Overview
In the area of corporate governance in India, the approaches would require to be
refined. However, the task of the regulatory bodies would be considerably eased once
proper governance
55

56. standards are in place, observes R. Krishna Murthy (MD, Watson Wyatt Insurance
Consulting and former MD & CEO of SBI Life Insurance Co. Ltd.).
Corporate governance simply put is just being honest about in every way an enterprise
is run governing relationship with every stakeholder in the company. While honesty
is the best policy everywhere and at all times, it needs to be practiced particularly in
the case of insurance industry which bears a fiduciary relationship with clients, and
where the industry is judged by its long term performance. At a time when financial
institutions are increasingly under public scanner; and some of the icons in the
insurance industry in mature markets are under attack for breaking laws and their key
management personnel charged for personal aggrandizement; the issue of corporate
governance acquires new dimension.
Urgency in India
There are four major factors why drawing up a set of governance standards for the
Indian insurance industry, covering life as well as general insurance companies, public
and private sector, is important at this stage.
Firstly, in life insurance, a well drafted governance code and their adherence would
help to shore up the level of public confidence in the new generation insurance
companies, which seem to suffer in comparison to LIC due to the absence of a level
playing field, with the insurance policies issued by the latter carrying the stamp of
sovereign guarantee. While there is reportedly a move by the government to level this
field 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 new
generation life insurance companies should be keen to have a set of standards against
which they could benchmark their own governance to strengthen the public image that
the new players can be considered as trustworthy and dependable as their public sector
counterparts.
56

57. Secondly, the Indian Insurance industry is set to witness a major phase of change, and
possibly explosive growth, with the lifting of the foreign equity cap and dilution of
domestic promoters’ stake in the foreseeable future, as well as removal of tariff
regulations in the non-life sector. There are plans to pave way for the entry of large
number of players to open business in specialized insurance fields such as health
insurance by relaxing the capital and solvency rules. We would possibly witness more
foreign firms entering the country, and key management personnel with limited
industry experience representing domestic and foreign partners running the
companies. There are plans to pave way for the entry of large number of players to
open business in specialized insurance fields such as health insurance by relaxing the
capital and solvency rules. At the same time, the existing companies in the life
insurance sector, along with facing competition from new players, will probably
grapple with greater operating challenges, such as increasing number of maturity,
death and other claims on the cumulative business built by them over the last few
years. We need good governance standards against which the companies’ conduct and
performance 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 of
issues concerning fair play, transparency and policyholder servicing.
Thirdly, the need for proper governance standards in the insurance industry assumes
importance in the context of the Indian corporate sector getting ready to accept and
live up to a set of corporate governance rules, thanks to the initiatives taken by the
securities market watchdog during the last two years. Companies that are listed in the
stock exchange, and having paid up capital of Rs,3crore or net worth of Rs.25crore or
more would now need to abide by the new code. SEBI has boldly introduced a system
of 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 the
corporate law book) or face imprisonment up to 10 years. Since insurance companies
are not likely to get listed in bourses in the near future and would remain closely held
companies, they need to conform to a set of governance rules of reassures take-holders
about their standards of performance and conduct.
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58. Fourthly, there is increasing evidence of public sector financial institutions evincing
interest to enter insurance business in partnership with foreign insurance firms, and in
some cases as three-way partnerships with private corporate enterprises. While a few
such ventures have recently been licensed, several more are set to take off in the life
and non-life sectors. There is ambivalence whether such ‘public-private’ partnerships
are subject to the rules normally applicable to PSU enterprises. PSU managements in
general have no uniform views in regard to the applicability of corporate governance
standards to them. It is important that insurance ventures promoted by PSUs are
governed by clear governance principles to send the right signals that they are viable
and dependable stand alone entities in their own right. On a wider context, this would
reinforce the grounds on which the financial sector convergence is taking place in the
Indian market.
Key Principles in the Indian context:
The OECD has defined corporate governance as a set of relationships between a
company’s management, its board, its shareholders and other stakeholders. Corporate
governance provides the structure through which the objectives of the company are
set, and the means of attaining those objectives and monitoring performance are
determined. Corporate governance is of course an ongoing process. While the set
standards may undergo revision based on experienced and developments in the
market, the core principles would remain unchanged. From an insurance company
perspective, corporate governance involves the manner in which the business of the
company is governed by its board and the senior management relating to four key
elements:
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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.
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60. Board and its responsibilities:
While the IRDA licensing norms. The most important aspect of governance code is to
ensure that the collective expertise is available on the board to meet the competitive
challenges of the market place while maintaining soundness of the company, require
that the company is run by persons who are ‘fit and proper’ for the respective
positions, the regulator has largely left issues concerning the constitution of board and
defining its responsibilities to the wisdom of the promoters. The most important
aspect of governance code is to ensure that the collective expertise is available on the
board to meet the competitive challenges of the market place with maintaining
soundness of the company. It is important to ensure that board members, especially
those 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.
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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 as
ability to commit sufficient time and energies to fulfill their responsibilities. The
Board members should regularly meet with the senior management, as well as the
internal audit team, to monitor progress towards the corporate objectives. They should
however never participate as members of the board with the day to day management
of the company. The board as well as the senior management would need to ensure
that the corporate objectives and the corporate values are clearly set, and they are
clearly communicated throughout the organization. As they say, the tone is always set
at the top.
Organizational structure and functioning;
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62. The board should exercise oversight in regard to all policy formulations governing the
operations of an insurance company, such as investment policy; underwriting policy;
product development and risk management policy; and take responsibility for
overseeing the management’s actions to ensure their consistency with the policies
approved. Senior managers contribute to an insurance company’s sound corporate
governance by exercising proper oversight over line managers in specific business
areas in a manner consistent with the policies laid down by the board. The senior
management is responsible for proper delegation to the staff, while at the same time
being cognizant of the responsibility on their part and accountability to the board to
oversee the proper exercise of the delegated responsibility. It is therefore important
that senior management ensures an effective system of internal and external auditors
in enforcing proper governance is well known. The board and the senior management
can enhance the effectiveness of the audit function in insurance companies by
recognizing its importance and the internal control processes; and effectively
communicating the same throughout the organization. In our current stage of market
development where several issues concerning premium accounting and reconciliation
are emerging; as the insurance buying is spreading to far flung areas and covering
various strata of population, timely audit is an important function. It is an equally
important corporate governance principle that the findings of the auditors are utilized
in a timely and effective manner to correct the problem areas. Corporate governance
standards should address corruption, self-dealing and other illegal or unethical
practices in insurance companies. There should The senior management is
responsible for proper delegation to the staff, while at the same time being cognizant
of the responsibility on their part and accountability to the board to oversee the proper
exercise of the delegated responsibility be a policy to encourage whistle blowers, as
well as support employees to freely express and point out violations to board or senior
management without fear of reprisal, either openly or anonymously.
Compensation policies and ethics:
There are already issues surfacing in the Indian market concerning the appropriateness
of compensation policies in insurance companies. Failure to link compensation and
incentives to senior management to the long term business goals can result in actions
that can run counter to the policyholder interests. In general, the compensation
policies should be consistent with the culture of the insurance company, its long term
objectives and strategy. It is important that the remuneration policies should not be
linked to the short term performance of the company.
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63. PSUs and governance:
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64. Keeping in mind the growing phenomenon of state-owned and government controlled
banks and financial institutions promoting insurance ventures in India in partnership
with 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 owned
banks, there are new dimensions to the governance principle to be addressed, since the
governance codes would affect both the boards of the PSU parent as well as the hybrid
subsidiary. In the discharge of the corporate governance responsibilities, the parent
boards should exercise due oversight of the functioning of the subsidiary (and even
where the parent’s holding in the insurance venture is below 51%), by duly
recognizing the material risks and issues that could impact the insurance entity. The
corporate governance structure and enforcement would to a large extent be influenced
by the manner in which the parent bank conduct its own governance. It is important
that the PSU parent allows the insurance entity to set its own governance standards. In
multi-party promoted ventures, it is important to pay attention to the scope of
preferential treatment of related parties and favoured entities within the promoter
groups, and lay down governance standards to avoid or minimize conflicting
situations. Such group dimensions are already receiving attention at the regulator’s
level. The initiative taken by RBI to set up a mechanism to track systemic risks posed
by financial conglomerates in India is in the right direction. As a new concept in
India, the approaches would require to be refined. However, the task of the regulatory
bodies 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 well
known. Weak transparency and inadequate disclosures tend to fuel market skepticism,
and in a newly deregulated and long term oriented industry, this could affect the
interests of all stakeholders. It is well known that complex ownership structures
contribute to opacity. While listed companies are generally more transparent, closely
held firms suffer on this account by comparison. The Indian insurance regulations
emphasize the importance of transparency in every aspect of company operations. At
the current stage, there is quite a way to go for companies to achieve the desired levels
of disclosure. Accurate and timely disclosure of information in insurance companies
should be in place in every area of operation.
Such disclosure are desirable by way of annual reports released by companies, as well
as through their websites, covering various areas, more particularly the following:
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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 from
the regulatory viewpoint. IRDA should view corporate governance as an important
element of policyholder protection. Corporate governance codes and the earnestness
of insurance companies to adhere to them would encourage regulation to place more
reliance on the internal processes in insurance companies; and thereby becoming less
strict 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 players
is indeed a barometer of maturity of the market, since sound corporate governance
serves as bedrock to build public trust and confidence.
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66. CORPORATE GOVERNANCE
- In A Risk Based Rating Environment
In a de-tariffed regime, governance for the insurers would be a different ball –game
and various issues would come up in the areas of fair rating, equitable policy
conditions etc. feels Mr. P.C. James(Executive Director, Non-Life, IRDA).
Insurance and Corporate Governance
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67. Corporate Governance is a subject of significance for the insurance industry. Insurers
manage the funds of the public, i.e. the premium of their customers, as well as capital
and other resources on behalf of the shareholders. Companies also have other
stakeholders such as employees, partners, intermediaries, the government and the
society. There is a growing concern that a company’s accountability and transparency
requirements need to be aligned with the expectations of stakeholders concerned.
Insurance Core Principles No.9 brought out by the IAIS (International Association of
Insurance Supervisors), says that the corporate governance framework recognizes and
projects the rights of all interested parties. Corporate governance is thus required as a
voluntarist agenda for the Board and the top management on how to oversee the
success and sustainability of the organization in the wider context of satisfaction of all
the stakeholders concerned. Business organizations work in an environment of
increasing risks. Risk is anything that can impede on the negative side or accelerate
on the positive side, the achievement of business objectives. Responding to risks
involves instituting the necessary tools to discover, analyse and make transparent the
potential risks. It also means that while taking steps to minimize or eliminate the
downside of risks, the upside that can be generated by managing risks successfully
needs to be fully exploited. This linkage between business objectives, risk, controls
and their alignment to business outcomes is important for enhancing shareholder and
stakeholder value. All successful companies excel because they have the necessary
risk management capability, internal control systems and procedures to sustain them.
This naturally involves Board level interventions in deciding strategies and policies
which can ensure that the entire company becomes risk aware; and has one uniform
‘risk’ language in the organization.
Risks and Insurers
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68. The core of insurance business is the bearing of risks transferred to the insurer by
customer either through intermediaries or directly. Based on acceptance of the risks
and the premium thereof insurers are subject to various organizational risks which are
known as technical risks, investment risks and other operational risks. Technical or
underwriting risks include premium deficiency risk, concentration risk, catastrophe
risks, frequency/severity risks and so on. Investment risks include credit risk, market
risk including interest rate risks, liquidity risks etc. Various types of operational risks
also face insurers, just as they do other business organizations. Such risks include
global risks; general, economics and political risks; industry risks; and company
specific 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 desirable
risk management techniques.
This enables the organization’s many layers and operational lines to translate the need
for 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.
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