Insurance legislation and the demise of the industry

Paper presented to The Development Group of Southern Africa - Thursday, November 8, 1999

Introduction:

My purpose today ladies and gentlemen, is to demonstrate how, over little more than 100 years, South African insurance legislation has grown, at each step gaining greater control over the business activities of insurers, at each step further inhibiting their discretionary decision-making abilities and at each step becoming more difficult and expensive to administer. (This trend is strangely contrary to the de-regulation now taking place in numerous other S.A. industries ranging from agriculture to telecommunications.)

The latest insurance enactments which became law in January this year, may be among the most deleterious ever passed, not so much because of their content but because of the lack thereof. The almost total absence of provisions to circumscribe the powers of the administering officials is a matter for grave concern. The wide, largely unrestrained and subjective powers bestowed upon the Registrar of Insurance to control the registration, functioning, spread of assets, ownership, management and winding up of insurers has sent a shiver of startled apprehension down the collective spines of the South African insurance community. (Notwithstanding the question in some quarters as to whether our industry has a spine at all!).

The granting of such subjective, untrammelled and extensive powers to the Registrar who is, after all, merely a ward of the taxpayer, is contrary to the interests of the insuring public, to the principles of modern administrative law and in a number of instances, contrary to the Constitution.

Insurance legislation in South Africa goes back to the last century when what later became the four provinces of the Union of South Africa (i.e. the two British colonies of the Cape and Natal and the two Boer republics of the Free State and the Transvaal) each introduced their own life assurance legislation. Prior to this, the law of insurance was merely part of the general mercantile law of the time with English or Roman-Dutch law being used as appropriate.

The first Life Assurance Act was passed 108 years ago by the 8th Parliament of the Cape of Good Hope in 1891and was drafted with a view to “encouraging persons to insure” and to protecting those who were insured. The Act protected policies from execution in the event of insolvency, allowed women married in community of property to insure their own lives and allowed husbands to cede their policies to their wives. In no way did it seek to inhibit the activities of insurers. Rather it sought to encourage the public to purchase and maintain insurance policies in force.

Similar Acts were passed in the other three provinces between 1892 and 1907. In all cases, the legislation in the four South African provinces prior to 1910 sought variously to obtain deposits and taxes, protect policies, obtain financial disclosures and encourage persons to insure. Nowhere was any attempt made to control the entrepreneurial activities of insurance companies.

<>The Insurance Act of 1923: “Freedom with Publicity”:

The Insurance Act of 1923 was the first insurance legislation passed by the Union Parliament. It was designed “to consolidate and amend the laws in force in the several provinces of the Union relating to insurance”. As this Act was passed a full 13 years after Union, it may safely be assumed that no great urgency had attached to it and that the various provincial laws had proved adequate up to that time.

The 1923 Act was derived from the United Kingdom Assurance Company Act of 1909 and was based on the principle of “freedom with publicity”. This allowed insurers wide discretion in the conduct of their business but required that all their activities and the results thereof be fully disclosed publicly. The Act therefore concerned itself primarily with registration and the form, method and extent of the disclosures required. It also provided protection of policies, including in the case of insolvency and marriage. There were no regulations governing the investment of funds but these were required to be fully disclosed, thereby allowing the market to determine the competence, stability and value of each insurer.

The Views of Arndt

Professor E.H.D. Arndt, then Professor of Banking at the University of Pretoria, claimed in a critique of the 1923 Act that “an insurance contract is a mere piece of paper unless not only the actuarially determined funds are being held but also unless such funds have been wisely and safely invested,/i>.”

In an article he wrote for the 1934 South African Journal of Economics, Arndt questioned the adequacy of the control and supervision of financial institutions. This may not be so surprising when it is remembered that at the time of his writing there was a great movement in Europe and elsewhere towards experimental socialism and State economic intervention.

Arndt was critical of the fact that insurers were allowed to make their own decisions about the investment of their funds and went on to complain that an assurer such as the African Life Assurance Company had investments and inter-locking directorships in no less than 106 South African companies, mines, farms and industries.

Because of this, Arndt believed he had demonstrated how the savings of policyholders could be “abused”. Instead, he had failed to understand the role insurers play in mobilising savings for the creation of capital, infrastructure and employment opportunities. At a time when South Africa was a young country, gravely in need of infra-structural developments through innovative financing, investment and entrepreneurial flair, Arndt publicly cast suspicion on the motives of insurance companies and their directors. Arndt felt that Government intervention and control of the investment of life assurance funds was “an imperative necessity”.

Arndt went so far as to recommend that the Government be burdened with such things as the election of insurance company directors and the establishment of their remuneration! He was also of the persuasion that the State should be burdened with the responsibility of eliminating what he termed “undesirable practices”, as well as possible “unfair privileges” that may be enjoyed by some institutions to the detriment of others.

Now, you ask, what has all of this to do with the new Insurance Acts? Well, allow me to inform you:

Today, these self same sentiments are to be found expressed in the new Insurance Acts. Many of the provisions of the new Acts, which I shall briefly detail in a few moments, were in fact originally espoused by Arndt, a socialist with known Nazi sympathies, more than half a century ago when he was in fact trying to effectively nationalise the S.A. insurance industry.

In the 1941 South African Journal of Economics Professor S.H. Frankel was critical of Arndt’s work. He wrote: “While the object of the author is laudable, it is necessary to remember that too great rigidity in controlling investment policy may have a boomerang effect.” Prophetic words indeed!

The Insurance Act of 1943 - “Control Legislation”:

Fortunately, because of critics like Frankel, not all of Arndt’s recommendations were accepted. Nevertheless, many were and the 1943 Act sought to control the business activities of these enterprises to a far greater extent than ever before and to eliminate what Arndt called the “divergences” in their practices.

The 1943 Act called for the establishment of a “Financial Institutions Office” and the appointment of a Registrar of Insurance who was placed under the control of the Minister of Finance. The very first Registrar of Insurance was an actuary by the name of George Beak who was given early release by the Royal Air Force in order to take up this post. (Ironic, considering it was a Nazi sympathiser who had called for his appointment!)

Among the new provisions of the 1943 Act was the introduction of so-called “prescribed asset” requirements. This compelled insurers to hold fixed proportions of their assets in securities prescribed by the Act. They included various types of deposits as well as bills, bonds and securities issued by the Government or other specified public bodies. Ostensibly this was to provide policyholder security but experience subsequently showed that this very soon became more important to Government as additional State revenue rather than as policyholder protection.

In times of rising interest rates, investments in Prescribed Assets were exposed to capital losses. In addition, yields on Government and semi-Government securities were generally well below market yields, thereby penalising widows, orphans and pensioners, the very persons whom Arndt had alleged he wished to protect. It has been estimated that the cost to such people over the period of these provisions exceeded R10 billion.

It took more than 40 years for the deleterious effects of Prescribed Assets to be acknowledged and for these provisions to be scrapped in 1986 in favour of the less prescriptive yet, may I say equally inappropriate, “Prudential Investment Guidelines” for insurers. (“PIGS” for some – SWINE for others!)


Similarly, It took 20 years to get rid of a 1976 legislative intervention known as the VIth Schedule to the Income Tax Act under which we all laboured at the cost of severe market distortions until that too was shown to have been misguided and costly.

Enquiries into the Industry:

The insurance industry has been the subject of numerous enquiries since the introduction of the 1943 Act. These include the Franzsen Commission, the Louw Commission, the Committee on Financial Soundness and Valuation Matters, the Melamet Commission of Enquiry, the Van der Horst Committee of 1988 and the 1992 Melamet/Norton Committee of Enquiry in to a Super-regulator for all financial services.

In short, the insurance industry has seldom experienced a period since 1923 when it was not under some form of public scrutiny, in most cases leading to further legislative constraints.

The Financial Services Board Act, 1990:

For example, on recommendation by the Van Der Horst Enquiry, a Statutory Regulatory Board was created to supervise all financial institutions formerly under the supervision of the Financial Institutions’ Office. In June, 1990 the Financial Services Board Act became law and a so-called “Executive Officer” was appointed shortly thereafter.

This arrangement effectively created an umbrella body for the supervision of all laws relating to insurance companies, pension funds, financial markets, unit trusts and investment portfolio managers.

As a result of subsequent amendments to the FSB Act, by July, 1992, through direct levies on the Industry, the FSB became financially entirely autonomous and not accountable either to the Industry or the Minister of Finance for either the source or quantum of its income. Important ministerial controls on the level of remuneration of FSB’s executives and staff and the quantum of the FSB’s levies, simply vanished.

Under the Act, the FSB is the principal regulator of the Financial Services Industry. The Act created a body which also acquired significant powers with respect to policy-making, previously the exclusive preserve of the Minister of Finance. This interposition of the FSB between the Minister and the Industry has caused much uncertainty about the role and function of the various participants involved in regulation and has led to serious and costly problems in practice. In fact, they became so serious that an attempt to ameliorate the situation was made in 1993 by Act No. 141 which created the “Policy Board for Financial Services Regulation” comprising of selected representatives of the industry and of members of the FSB but which excludes the Minister of Finance.

Notwithstanding an attempt to resolve these matters through a Committee of Enquiry chaired by Mr. Justice Melamet, the difficulty still remains today that the FSB Act has made the policy-making functions of the Minister and those of the FSB difficult to distinguish between, with the result that ultimate supervision of the Industry is today biased bureaucratically rather than ministerially. This is exacerbated by the new-found fiscal independence of the FSB and its lack of accountability to Parliament in this regard.

What is more, the new Insurance Acts have further cemented this state of affairs. The Registrar and his staff are now yet further beyond the purview of Parliament, having been granted the power to create their own laws without ever again having to approach the legislators for their approval. But more on this in a moment.

The Views of Beak:

As I mentioned earlier, George Beak became the first Registrar of Insurance in terms of the 1943 Act and it fell to him to set up the new Financial Institutions’ Office in Pretoria.

After 9 years as Registrar, Beak was appointed Secretary and Actuary to the Life Offices’ Association in 1952. He retired in 1970 and in a paper to the Actuarial Society in 1973, Beak presented the views of a man who had had 30 years of experience and intense involvement with the 1943 Act on both sides of the fence, so to speak.

He said that “vigour and variety are not readily reconciled with the spirit of restrictive uniformity embodied in this Act, and it therefore seems probable that the Financial Institutions’ Office finds the administration of this Act more onerous now than ever before.

“Legislation of this kind is aimed at improving the security of policyholders but it inevitably destroys the freedom of insurers. It imposes on the industry a degree of uniformity which is likely to be disadvantageous to policyholders.”

Beak’s belief was that absolute safety in insurance legislation was neither attainable nor desirable in view of the prohibitive cost and administrative difficulty that that entails. His view was that the continuing development of the economy was ipso factor complex and accorded ill with the control legislation which “on the one hand restricts the ability of insurers to provide the public with the best possible service and, on the other hand, places a heavy responsibility on the administering authority.” And so, ladies and gentlemen, Beak, after 30 years of experience with this Act, both as Registrar and the LOA representative, in 1973 was pointing the way back to “freedom with publicity” and away from the control provisions of the 1943 Act.

Apart from the “control” implications of the 1990 FSB Act as amended, three further events seem to confirm that the role of the Registrar has changed from that of “shepherd of the industry”, to manager of the entire farm: In May, 1986 it was the Registrar, not the policyholders, who sued for the liquidation of the then second largest short term insurance company in the country, the AA Mutual. As has since emerged, it was not in the best interests of policyholders for that company to have been liquidated in the manner that it was.

The second foreboding event happened less than a year later in January, 1987 when the Registrar circulated the 1987 Draft Insurance Bill. This Draft contained far-reaching divergences from the previous legislation and from the essential components required of an insurance act. It did not reflect the deregulation policies of the Government of the day and included some surprising and novel proposals. These included matters never before seen in South African insurance legislation, such as empowering the Registrar effectively to set insurance company reinsurance arrangements, to alter their Memorandum and Articles of Association, to demand what were called “improved” actuarial valuations and allowing the Minister of Defence to determine certain policy provisions.

The Draft thankfully never got beyond being just that. However, the legislative “control” debate, which had been started by Arndt in 1934 ,was once more to the fore.

It is not surprising then that since 1987 many members of the industry have been calling for a return of the Registrar to the role of custodian of the interests of policyholders, rather than the director of the business activities of insurers. The adoption again of the essential principles of “freedom with publicity” first embodied in the 1923 Act has repeatedly been called for. Less bureaucratic “controls” but greater disclosures are far more likely to better serve the public interest as consumers and competitors alike will quickly ensure that no insurer is long permitted practices which conflict with sound operational bases.

Indeed, such an arrangement would lift from the shoulders of the Registrar and of the Financial Services Board the onerous, expensive and frankly impossible burden of having to be responsible for the business affairs, and therefore the solvency, of all South African insurers.

The 1998 Insurance Acts

The third event which confirms the changed role in which the Registrar now perceives himself has been the passing of two new Insurance Acts – one for each of the Long and Short Term industries.

The new Acts show no indication of acknowledging Beak’s call for a return to “freedom with publicity”. On the contrary, the ghost of Arndt prevails, providing the civil servants with greater discretionary “controls” over the business activities of insurers than ever before. Indeed, these Acts have already been dubbed “Regulation by Inclination”.

I restrict myself to commenting on a small selection of some of the control clauses included in the Long Term Insurance Act. However, almost all of these or similar provisions appear in the Short Term Act and are equally objectionable:

Section 9 of the new Act provides that the Registrar may approve an application for a new insurance licence on such terms and conditions as he in his sole discretion may personally determine. Furthermore, it provides that the Registrar may according to his own disposition and without legislative constraint, determine whether any person is “fit and proper” to hold office as a director or manager of an insurer. Section 10 empowers his office to control different insurers according to different criteria at different times at the inclination of different registrars from time to time. Section 15 provides that at the discretion of the Registrar acting in “the interests of the policyholders” or of insurers in general, he may determine the nature and type of policies which may be sold by different insurers from time to time. Section 22 provides that the Registrar can actually terminate the appointment of any existing company director or manager whom he considers is no longer “fit and proper” to hold office. No objective guidelines are provided to guide the Registrar in the execution of these far-reaching powers. Section 26 provides that the Registrar in his sole and absolute discretion will decide who may or may not own 25% or more of an insurer’s issued shares. Again, he is merely required to make his decision in what is called, “the public interest” or in the “interests of policyholders or persons who may become policyholders.”

Section 49 is a carry-over from the old Regulation 28 to the 1943 Act and controls the amount of commissions which may be paid to intermediaries. Once more, apart from the controls which this imposes on the business affairs of insurers, such bureaucratic interference in the day to day management of business is highly undesirable. It is gratifying to know therefore, that the current incumbent at the FSB acknowledges that attempts at commission control have been misguided and that he is now looking for a way out.

Section 62 is among the most controversial provisions of the new Act in that it is a kind of “catch all” which has the effect of over-riding all of the other provisions of the Act at the proclivity of whomsoever happens to be the Registrar at the time. It empowers him to make rules to ensure that insurance policies are entered into in accordance with what he decides is “in the interests of the parties and the public in general”.

In short, the provisions of the new Acts go far beyond the essential requirements of prudent insurance legislation and would have made Professor Arndt proud. Beak and Frankel have been ignored in their entirety and the lessons of the past have been completely neglected.

Now, before anyone accuses us of not having done anything about this travesty, let me assure you that our Group made comprehensive and needless to say, expensive, submissions to the Parliamentary Portfolio Committee on Finance in this regard (both written and oral.) Not a single submission made by ourselves was accepted by the Portfolio Committee and the Acts have gone through without the slightest attention having been paid to any of our concerns.

Furthermore, even before the industry has had time to adjust to this new legislative environment, no less than 13 new financial services Acts and Amendments are in the pipeline and bearing down upon us as I speak - due for promulgation within a year. Among these are the Financial Markets Control Amendment Bill, the Financial Services Board Amendment Bill, the Participation Bonds Amendment Bill, the Unit Trust Control Amendment Bill, the Financial Institutions (Investment of Funds) Amendment Bill, the Collective Investment Schemes Bill, two Pension Funds Amendment Bills, the Insurance Laws Amendment Bill, the Insider Trading Amendment Bill, the Revised Taxation of Life Assurers Revenue Laws Amendment Bill and the Promotion of Equality Bill which inter alia proposes to compel insurers to insure AIDS sufferers but not necessarily cancer sufferers! Frankly, ladies and gentlemen, our industry cannot cope even with the reading material, let alone any appreciation of the impact of these proposed laws, nor the cost of their implementation.

Among the most controversial of these pending Acts is the so-called “Financial Advisers Bill”. This proposes, inter alia, to license every financial adviser including stockbrokers, bank officials and short term insurance agents, to make their registration subject to their being “fit and proper”, at the discretion of a new “Registrar of Financial Advisers”, to make “unsolicited calls” (the very life blood of the industry) a criminal offence and requiring every intermediary, even an independent one-man business, to appoint a “Compliance Officer”, who twice annually, is to certify that the individual concerned is adhering to a plethora of compliance matters, all of which are to be promulgated by regulations from time to time.

Again, ladies and gentlemen, I could go on all evening telling you about the unpleasant realities of the proposed Financial Advisers’ Bill. A similar Act introduced in the UK in 1984 was referred to last year by the President of the British Actuarial Society when he was quoted as asking the following question:

“Do the British public know that the current regulatory system costs them as much each year as Robert Maxwell did in a lifetime?” Not only has this Act dethroned the British life assurance industry as the world’s leading and most innovative insurance market, it has relegated it to the backwaters of international competition, all in the space of 10 years. Similar damage has been done to the Australian market since 1993 to the extent that it is now almost impossible to purchase a life assurance policy from an Australian agent or broker for less than about A$200 per month (that is R800 per month). This is because the cost of compliance is such that the very segment of the population whom this type of legislation purports to protect can no longer afford to be serviced by the industry. We understand that fully 25% of a UK financial adviser’s income is now consumed by compliance costs.

In fact we wonder why this legislation is necessary at all in S.A. when the FSB’s own independent research shows that less than 3% of all life assurance policies sold are terminated as a result of perceived intermediary mis-selling. This figure has been corroborated by the Life Office Association’s own research and the experience of the Life Assurance Ombudsman.

Sadly, empirical evidence gathered by independent UK actuaries indicates that after 15 years the regulations in the life assurance sector have yet to have any tangible benefits. This is because more information is being given but the more vulnerable prospective purchasers are not reading it, policy values have not improved, complaints have not declined as a proportion of sales made, overall lapses have not declined but the sale of insurance has. In Australia, the number of career financial advisers has fallen from approximately 20 000 to less than 4 500 in three years. Now, almost no companies are recruiting new financial advisers and traditional agency force management skills are all but lost as British and Australian companies have shed their internal field forces and no longer employ traditional agency skills in-house.

Conclusion:

It is difficult to conclude in any way other than to say that contrary to strong trends in other industries, South African insurance legislation as it has developed over the past 100 years seems to be moving inexorably in the direction of greater and greater Government control. The new Acts might have been written by Professor Arndt himself and are perhaps the best proof of the direction being taken. They give the impression of having been drafted without reference to the valuable lessons of the past, both from within the industry and the free enterprise system. Despite its stated claim that the guiding principles used to draft the new legislation attempt to create regulatory flexibility providing the Registrar with what he describes as “circumscribed” discretionary power, his discretion has been very comprehensively widened and can hardly be viewed as “circumscribed”. This situation creates vast scope for arbitrary decision-making and possibly injurious interventions by future administrators in these crucial entrepreneurial ventures . Moreover, as predicted by Beak, Acts of these kinds are very likely to bring with them a considerable increase in costs of administration. Recent information from the International Association of Insurance Supervisors reveals that insurance advisory staff in the UK total over 600. The equivalent number in Japan is 40 and in New Zealand it is just 4. In South Africa it is already well over 150. It is no secret which of these countries today has the most progressive, efficient and growing insurance industry. The UK has seen its previously world-renowned insurance industry devastated by the introduction of this type of “control” legislation. One fears now that South Africa may have been seduced into a similar calamity.

Considering the sound state of the insurance industry in South Africa, it seems difficult to justify the apparently ongoing drive for Government “control” of the business activities of this important industry, critical as it is to the mobilisation of a large part of the nation’s savings, to capital formation and to employment creation.

Regrettably, legislation of the nature now over-shadowing the Financial Services Industry, however praiseworthy its alleged intentions, will do little to enhance the innovation and global competitiveness of the South African industry and may prove yet more deleterious than did some of the provisions of the 1943 Act.

The first Insurance Act after Union in 1910 was dubbed “Freedom with Publicity”. The Second was the 1943 Act which the first Registrar of Insurance himself dubbed “Control Legislation”. In light of what you have heard today, you will understand Ladies and Gentlemen, why the 1998 Act has already been dubbed “Regulation by Inclination” or, “From Shepherd to Farm Manager”.

Whilst I feel certain that it was not the intention of the present incumbents at the FSB, this state of affairs is very likely to lead to a steady deterioration in the quality of the relationship between the industry and the Financial Services Board. The pattern followed in most similar cases, is that among the first things to develop is patronage. One will have to be vigilant indeed if we are to avoid this developing in S.A. Similarly, we shall have to guard against a separate set of norms and rules emerging for each and every member of the industry, with these changing as often as the guard changes at the FSB. Objections to the Registrar’s edicts will effectively take place through appeals to his Appeal Boards, then to the Courts and then to the Constitution. Policyholders will be left wondering just how much “protection” they can actually expect from an FSB preoccupied with attempts at “managing the farm”. It may then be too late to have regard to the words of Adam Smith written with just this kind of thing in mind:

“The Statesman, who would attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with the utmost unnecessary attention, but assume an authority which could safely be trusted, not only to no single person but to no Council or Senate whatever, and which would nowhere be so dangerous as in the hands of a man who had the folly and presumption enough to fancy himself fit to exercise it.”


Source: Dr Brian Benfield is the Founder and Chairman of Clientèle Life Assurance Holdings (Pty) Limited