Insurance

Insurance needs to be regulated by law and regulations that support the development of the sector and that provide adequate protection to policyholders while containing claims for insurance fraud. The insurance laws should specify the powers and responsibilities of the regulator; the conditions for the formation and registration of companies; disclosure requirements; prudential supervision; management of distressed insurers; and provisions with respect to payment of premiums, events of default, and reserves. Legal aspects of insurance supervision are discussed in detail in chapter 5, in the context of the IAIS Insurance Core Principles.

The development of insurance business has also suffered from repressive regulations by government in many low-income countries. Those regulations have included the creation of state-owned insurance companies, sometimes with a monopoly over all insurance busi­ness or for the benefit of state-owned business of state-owned enterprises. In addition, the regulations have included measures (a) to discourage entry by foreign companies,

Box 9.1 Legal Framework for Securitization

 

purpose of isolating and clearly defining the financial risks of pools of assets held by such vehicles, and ensuring the transparency and accountability of the vehicle

6. Laws and regulations relating to governance of financial institutions and special purpose vehicles, which not only ensure fairness, trans­parency and accountability, but [also] impose appropriate fiduciary standards

7. A comprehensive system of accounting and reporting that permits timely and accurate identification, assessment, measurement, and management of risks involved in the creation of the indebtedness and its transfer of interests in the debt; and the ownership, management, and governance of the special purpose vehicles, as well as a system for assessing and managing the risks of off-balance sheet financial struc­tures from the perspective of commercial finan­cial institutions [that are] originating, holding, or participating in the indebtedness

8. A clear system of regulation and disclosure in the capital markets that permits full and fair assessment of the risks involved in purchasing and holding an undivided interest in a pool of financial assets

9. A system of accounting principles and rules that permit a consistent understanding, assess­ment, and measurement of the prices, values, and risks involved in the transfer and pooling of financial assets for all participants

10. A system of tax and related laws [that] may be necessary to ensure that the economic effects of securitization are consistent with economic or other policy imperatives of the jurisdiction

 

Securitization is achieved through the creation of asset-backed securities, which are capital market instruments that represent debt, equity, or hybrid interests in a pool of financial assets, which most often are loans (secured or unsecured), or other evi­dences of indebtedness (such as receivables). A pool of assets is formed and sold in an economic and legal sense to a special purpose vehicle, which then issues securities backed by the asset pool. Securitization permits the shifting of risk from one category of financial intermediaries (usually banks or commercial financial institutions that originate loans or debt instruments), to other financial intermediaries and investors (usually participants in the public or private capital markets). The development of asset-backed securities requires a sound and vibrant commercial finance sector and effective and efficient laws and institutions in the areas of negotiable instruments, secured transactions, and creditors’ rights generally. In addition to efficient and reliable enforcement of contracts representing commercial indebtedness, the creation of asset-backed securities requires:

1. A sophisticated secured transactions law that clearly defines the rights and responsibilities of the parties with respect to the collateral in the event [that] the underlying debt is not paid in time

2. A system of laws relating to the creation, trans­fer, and enforcement of negotiable instruments by financial intermediaries

3. A reliable and effective system of enforcing commercial indebtedness

4. Laws permitting the transfer of secured and unsecured loans and the transfer and assignment of collateral and rights therein

5. Laws permitting the creation and regulation of special purpose financing vehicles with the

 

9

 

(b) to set premiums, (c) to control the terms and conditions of offered policies, and (d) to require insurance companies to invest their reserves in low-yielding assets or in social projects of various forms. In many cases, the imposition of minimum local retention ratios (thus discouraging reinsurance with international companies or markets) or the mandated use of a state-owned reinsurance company has acted as an additional constraint on the development of insurance.

Furthermore, insurance business in developing countries often suffers from widespread mistrust between insurance companies and their customers. To protect against fictitious claims and insurance fraud, insurance companies frequently include clauses that limit their liability in cases where material information was not provided at the time an insur-

 

ance policy was bought. Insurance policies also have exclusion clauses that stipulate that insurance coverage will not be provided under specified circumstances. However, the exclusion clauses make insurance contracts difficult to understand and give rise to disputes. In some countries, those disputes result in long delays in settling claims, which accentuate the mistrust that clients experience toward the insurance companies.

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