Discussion Paper on Life Insurance Law and Practices [1997] NZSecCom 4 (8 December 1997)

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Introduction
1.1	The life insurance industry is an important repository of savings in New Zealand with aggregate assets (including managed funds and superannuation) at 30 June 1997 of some $20.68 billion.1 ¹
1.2	The Commission has been statutorily involved with the life insurance industry since our establishment in 1979. However our relationship with the industry has changed over the years as the status of life insurance policies under the Securities Act 1978 ("the Securities Act") has changed.
1.3	We have prepared this paper with the benefit of our experience of the administration of securities law, particularly as that law has related to the life insurance industry since 1989.
Our statutory authority
1.4	We are publishing this paper in terms of one of our primary statutory functions, that of (section 10(c) of the Securities Act) "[keeping] under review practices relating to securities, and [commenting] thereon to any appropriate body."
1.5	The quorum of Members responsible for this paper comprised: Mr E.H. Abernethy, Chairman Ms E.M. Hickey Mr D.J. Stock Mr M.R.H. Webb.
The purpose and structure of this paper *Purpose*
1.6	On the basis of our experience we believe there are important issues concerning the life insurance industry which need to be discussed more widely and more fully in the community, particularly having regard to the current attention which is being given to the desirability and responsibility of individuals to save for their retirement.
1.7	The purpose of this paper is to identify these issues, and to raise questions concerning the life insurance industry which we believe need to be addressed by the Government, the industry, the accounting profession, the actuarial profession and the investing public. We identify actual or potential issues arising from the current business practices of, and regulatory and financial reporting regimes relating to, the life insurance industry.
1.8	It is not our purpose to provide answers to the questions we identify in this paper, nor does this paper attempt to identify and address all issues relating to life insurance regulation and operations. We think a comprehensive review of the Life Insurance Act 1908 is called for. We believe responses received to the issues identified in this paper will provide a valuable input into such a review.
1.9	We are aware that financial reporting by life insurance companies is already under detailed review with a draft financial reporting standard for life insurance companies2 currently on issue.
*Structure*
1.10	In Part I of our paper, after an overview of the New Zealand life insurance industry and of the application of the Securities Act to life insurance contracts, we look at the nature of life insurance contracts and the regulatory environment for the selling of life insurance policies.
1.11	In Part II of our paper we review and discuss a number of key areas of life company operations and structure. For each of these subject areas we discuss our experience of the New Zealand life insurance industry, we refer to the existing legislative environment affecting that aspect of life company operations and we summarise the legislative approaches in Australia and the United Kingdom. We make a number of comments concerning each issue.
1.12	We illustrate some of our comments by use of examples drawn from our experience with the "authorisation" of life insurance companies. The examples are drawn from companies both large and small, both New Zealand and overseas owned. In using these examples in relation to particular topics in this paper the Commission is expressing no view as to the appropriateness or merits of those transactions themselves or on the parties involved. In a number of cases those examples are also parts of wider transactions and views as to those transactions may not be able to be based on the examples alone.
1.13	We have chosen to analyse the approaches taken by overseas regulatory regimes, particularly those in Australia and the United Kingdom, to the issues discussed. We have done this because the New Zealand life insurance industry has been dominated, with a few exceptions, by life insurance companies incorporated in, founded in, or directed from, Australia and the United Kingdom. We do not have a view as to whether the approaches followed by the United Kingdom and Australia (or any other jurisdiction) are the models on which future New Zealand life insurance regulation should be based.
1.14	In Part III we discuss various elements of public policy in relation to the regulation of the New Zealand life insurance industry. We raise various questions for consideration about the issues discussed in Part II.
1.15	We are inviting comments on the questions raised in this paper. When these have been considered we will report to the Minister of Commerce.
Brief overview of the New Zealand life insurance industry
1.16	The life insurance industry has been a feature of New Zealand commercial life for well over a century. Life insurance business in this country was originally undertaken by United Kingdom companies, but in the late 1800s the major Australian mutual companies established branches in New Zealand. The Government established its own life insurance office in 1869 to augment the "very inadequate"3 life insurance facilities existing at the time.
1.17	The retail life insurance industry now comprises around 30 companies. The three large Australian mutuals have already converted to, or are in the process of converting to, widely-held proprietary4 companies, with their newly formed parent companies becoming or intended to become listed public companies. With some exceptions New Zealand owned life insurance companies have tended to be fairly small proprietary companies.
1.18	United Kingdom life insurance companies have always had a significant presence in New Zealand, with two of the companies having recently "domesticated" what were formerly branch operations into locally incorporated subsidiaries. More recently life insurance companies from the United States of America and Sweden have commenced operations in New Zealand.
1.19	In addition to aggregate assets under their control of around $20.0 billion (see para 1.1) the life companies operating in New Zealand had "in-force" New Zealand business at 30 June 1997 (including life insurance and superannuation) with annual premiums of $1.565 billion5. This is a measure of the companies' expected annual cash flow from premiums on existing policies without regard to new business or policy surrenders and cancellations. At the same date the companies were obligated to pay annuities in New Zealand at a rate of $28.8 million per annum.
A brief summary of the regulation of the New Zealand life insurance industry prior to 1989
1.20	The first New Zealand legislation directly related to the life insurance industry was the Life Insurance Companies Act 1873.
1.21	The Life Insurance Act 1908 ("the Life Act"), which consolidated the 1873 Act and other life insurance legislation then in force, has been the principal source of statutory authority governing the operation and oversight of the life insurance industry in New Zealand since its enactment.
1.22	Under section 10 of the Life Act the Registrar of Companies may not issue a certificate of incorporation to any company that proposes to carry on the business of insurance upon human life unless that company, before commencing to carry on that business, deposits with the Public Trustee approved securities of an aggregate value of not less than $500,000. There are no other barriers to entry into the New Zealand life insurance industry apart from (for overseas companies) compliance with overseas investment legislation.
1.23	The Life Act includes requirements for the depositing of various annual returns with the Secretary of Commerce (formerly with the Secretary of Justice) and for the undertaking by an actuary of an annual investigation of the financial condition of each company (see para 4.8 onwards). The returns filed with the Secretary are all passed to the Government Actuary for his review.
1.24	When the Securities Act was originally enacted on 20 October 1978 contracts of life or endowment assurance, although "securities", were exempted, by section 5(1)(a), from the provisions of Part II of that Act. This meant that life insurance contracts were exempted from the prospectus, trustee, statutory supervisor and advertising requirements of the Securities Act. This situation changed in 19896

The enactment of sections 7A and 7B of the Securities Act 1978
1.25	With effect from 1 July 19897 section 5(1)(a) of the Securities Act was revoked and sections 7A and 7B inserted. The text of sections 7A and 7B is set out in Appendix One to this paper.
1.26	The effect of the new sections was that life insurance contracts became subject to the normal rules of law relating to the offering of securities to the public, but the Commission was empowered by section 7A(2) to "authorise" life insurance companies, that is, to exempt them from the prospectus and trustee/statutory supervisor provisions, but not the advertising provisions, of the Securities Act. The Commission was also empowered to set terms and conditions of authorisation.
Background to the enactment of sections 7A and 7B
1.27	Enactment of sections 7A and 7B followed closely on the Court of Appeal decision in the Marac case (see para 2.2) which ruled that Marac's life insurance bonds, basically term deposits with an insurance element (covering early repayment in the event of the death of the investor), were life insurance contracts for the purposes of the Securities Act. A particular concern was that in the absence of legislative amendment unsatisfactory business practices would affect the debt security type market of the life companies as well as the more traditional life insurance market.
1.28	The Hon Philip Woollaston, Associate Minister of Justice, in introducing a Supplementary Order Paper to the Securities Law Reform Bill into the House of Representatives on 18 October 1988 said (Hansard p. 7409): ... The Securities Act 1978 exempts life insurance policies from Part II of the Act. In recent times, however, the distinction between investments to which the Act applies and life insurance policies has become blurred and provides a means of avoiding the requirements of the Act. As a result of the Court of Appeal decision in the Marac Life Assurance Ltd case the exemption applies not only to traditional life insurance products but to life insurance products that in legal form are life assurance but in economic substance are ordinary investments. In that case, which also involved taxation matters, the life bonds - as they were called - were indistinguishable from ordinary investment except that they were described in life insurance terms and the investor's death accelerated the repayment of the investment. In recent times a trend has emerged circumventing the Securities Act requirements by using the life insurance exemption for what would otherwise be ordinary investment. That position is not desirable, and should be stopped. To that end the supplementary order paper repeals the exemption for life insurance policies, and empowers the Securities Commission to grant an exemption from the Act's prospectus requirements by way of designating life insurance companies as authorised life insurance companies issuing policies in accordance with the authorisation. That approach has been taken because of the difficulty, if not the impossibility, of defining in advance the life insurance policies that are regarded as life insurance proper policies and the life insurance policies that are regarded as an investment in substance. ...
1.29	It was recognised by the industry, the Commission and the Government that much needed to be done to improve the business practices of the life insurance industry. Of particular relevance to the Commission was improving the disclosure obligations of life insurance companies.
1.30	It was accepted that the industry was not ready at that time to move to a full prospectus-based issuing regime. Improvement was needed in the procedures for selling life insurance contracts and in the information provided at the time of sale. Financial reporting by life insurance companies, based as it was on the schedules to the Life Act, was inconsistent between companies and generally unsatisfactory. There was no accounting standard applicable to life insurance business at that time.
The general conditions of authorisation under sections 7A and 7B
1.31	Authorisations were subject to a number of general conditions imposed by the Commission under sections 7A(3) and 7B. One of the principal conditions of authorisation, applying throughout the period the two sections were in force, was a limitation of 12 months on each company's period of authorisation. This meant that each company had to apply for renewed authorisation each year.
1.32	The second main condition of authorisation was that life insurance companies agreed to abide by the Code of Business Practices for Life Insurance Companies ("the Code")8. The Code, which was formulated by the industry and approved by the Commission, regulated many aspects of life company selling practice, including information, such as financial statements and policy details, required to be disclosed to policyholders and prospective policyholders.
1.33	A third condition of authorisation, introduced in 1995, related to a "directors' statement". It contained a declaration as to the directors' knowledge of any adverse circumstances which had arisen between the date of the company's last financial statements and the date of signature of the statement. It effectively imposed an obligation on the directors of life insurance companies to affirm in a document provided to investors that they had addressed the financial condition of their companies mid-way through the year. (Life insurers, unlike other continuous issuers of securities at the time, were not required to prepare half-yearly financial statements.)
The Commission's approach to the authorisation of individual life insurance companies under section 7A
1.34	The Commission's approach to the "authorisation" of life insurance companies was to approve authorisation for a period of twelve months where Commission Members were satisfied, on the basis of staff review of each life insurance company's: latest audited financial statements; Sixth Schedule statutory return, prepared by the company's actuary, which indicated the applicant's "actuarial" profit (solvency basis) and any surplus or deficit in the "life insurance fund"; Twentieth Schedule statutory return, which indicated the business being written by the company; that the affairs of the company were reported in an orderly manner in accordance with the law and that there were not aspects of the company's activities or operations which should be drawn to the attention of prospective investors either through requiring the company to issue a prospectus or by some supplementary means of disclosure.
1.35	We required the financial and other information to be supplied to us within four and a half months of balance date (as compared to the nine months allowed under the Life Act for the returns and the five months allowed for the auditing and registration of the financial statements under the Financial Reporting Act 1993 ("the FRA")) in order to ensure that (1) we would be making our authorisation decision on the basis of timely information, (2) prospective policyholders who exercised their rights to request them would be given financial statements which were reasonably current and (3) we could establish an orderly and predictable annual procedure for the authorisation of companies.
1.36	In reviewing the information available to us we paid attention to various factors including: the amount of profit as disclosed in the Sixth Schedule return (and also disclosed sometimes, but not often, in the financial statements); the level of the company's reported shareholders funds and reserves (or, in the case of mutual companies, their reserves); any surplus in the valuation balance sheet between the actuarially computed amount of the company's liabilities to its policyholders and the stated amount of its "policyholders' funds" as disclosed in the company's financial statements; the nature and spread of the company's assets, including exposures to related parties; and any external debt, guarantees or other contingent obligations.
1.37	Where the Sixth Schedule abstract indicated that there were matters about which the company's actuary was concerned we sought the actuary's full Financial Condition Report9.
1.38	We routinely discussed individual cases with the Government Actuary. In one case the Commission retained an international firm of consulting actuaries to give an expert analysis of an applicant's solvency.
1.39	Where review of a company's financial statements and actuarial reports indicated there could be something about the company's performance, structure or assets which should be brought to the attention of prospective investors we sought further information and invited comment from the company. These indications sometimes lead to the imposition of pre-conditions on the authorisation, generally although not always about the disclosure of additional information, or to an application being declined. Sometimes approval was granted on a short term basis, say three months, to allow a particular situation to be remedied before an application was granted in full.
1.40	In a few instances we believe our interest in requiring a company to disclose information on its financial position may have encouraged that company to increase its level of paid up share capital. However it has not been the Commission's role to prescribe minimum or appropriate levels of capital or solvency.
1.41	The Commission also had the power under section 7A(4) to vary or revoke existing authorisations. For this purpose we reviewed existing authorisations in circumstances where: There appeared to be matters about the company's financial position which should be drawn to the attention of prospective investors and which had come to light since the most recent application for authorisation was approved by the Commission; or The company's current financial statements appeared to be misleading as a result of factors which had come to light or events which had occurred since the most recent application for authorisation was approved; or Some other factor or factors material to the company's status as an authorised life insurance company had come to the attention of the Commission.
An overview of the authorisation process
1.42	In the first year of operation of section 7A (year ended 30 June 1990) the Commission declared 40 companies to be authorised life insurance companies, of which 39 remained authorised at year end. In the year ended 30 June 1991 38 companies were authorised, of which 36 remained in force at year end. The number of authorisations then remained at 35 for several years but dropped to 34 by June 1997.
1.43	All but one authorisation was in respect of all the life insurance policies sold by the authorised company. One company was authorised for several years in respect of life insurance policies other than those policies secured by mortgage securities given over company property and issued in terms of a registered prospectus.
1.44	Since 1990 we have reviewed the existing authorisations of several life companies outside of the routine reauthorisation procedures. These reviews were prompted by a variety of factors, including concerns expressed by the Government Actuary, identification of potential difficulties arising from relationships with related parties, financial statements which did not comply with the FRA, and the pledging of a life company's assets to an external financier. In one case we revoked the authorisation of the company concerned.
Comment on our authorisation role
1.45	Life insurance authorisation was a difficult area for us because it involved our taking a view about the adequacy of information available to prospective investors in individual life insurance companies in the absence of the company being obliged to issue a registered prospectus which would have had to be provided to each prospective investor.
1.46	Our main emphasis was on promoting adequate disclosure of product and institutional information, including financial information, to prospective life insurance policyholders. We believe our approach to authorisation reflected the underlying policy of sections 7A and 7B.
1.47	We did not supplant the important statutory role of the Government Actuary. However he considered that his role in relation to life companies was limited in practice to that of last-resort intervention.
1.48	The Commission had concerns at some of the inherent difficulties of any "authorisation" process. Because of these concerns the Commission advocated the removal of the authorisation process with the advent of the now current investment adviser and product disclosure regime.
The effect of the revocation of sections 7A and 7B
1.49	The position of life insurance policies under securities legislation changed again from 1 October 1997 with the revocation of sections 7A and 7B. Issuers of life insurance policies are now, subject to certain transitional arrangements10, required to comply with the full prospectus, investment statement11 and advertising provisions of the Securities Act, although the trustee/statutory supervisor and trust deed/deed of participation provisions of the Act do not apply. Moreover the Investment Advisers (Disclosure) Act 1996 (which also came into force on 1 October 1997) generally applies to investment advisers promoting life insurance policies.
Comment on the structure of the life insurance industry
1.50	The life insurance companies currently operating in New Zealand include companies incorporated in, or subsidiaries of companies incorporated in, a number of different countries, including New Zealand, Australia, the United Kingdom, the United States of America, Sweden, and Bermuda.
1.51	The operations of the companies incorporated in New Zealand are regulated primarily by the statutory requirements of New Zealand. However the locally incorporated subsidiaries of overseas life companies, could, we understand, also follow regulatory standards imposed in the home jurisdictions if those standards were imposed by direction of the parent company. Branches of overseas life companies operating in New Zealand are regulated primarily by the statutory requirements of their home countries, although they are also subject to New Zealand law.
1.52	These regulatory differences may have implications for New Zealand resident policyholders as well as for the efficacy or otherwise of New Zealand life insurance regulation

What is life insurance?
2.1	The Life Act defines a policy of "life insurance" as: ... any contract, so long as such contract remains in force, heretofore or hereafter lawfully entered into by a company, the terms of which are dependent upon the contingencies of human life:
2.2	In the Court of Appeal case Marac Life Assurance Limited v Commissioner of Inland Revenue [1986] 1 NZLR (694) Cooke J cited the definition contained in the opening words of Bunyon on Life Assurance (5th ed, 1914) p. 1: The contract of insurance has been defined by Tindal CJ to be that in which a sum of money "as a premium is paid in consideration of the insurer's incurring the risk of paying a larger sum upon a given contingency" ... The contract of life insurance may be further defined to be that in which one party agrees to pay a given sum upon the happening of a particular event contingent upon the duration of human life, in consideration of the immediate payment of a smaller sum or certain equivalent periodical payments by another. This consideration in money is termed the premium or premiums, and is paid either in one sum, when it is termed a single premium, or by a succession of periodical instalments.
2.3	In the same case McMullin J noted that the above definition had been cited by Windeyer J in National Mutual Life Association of Australasia Ltd v Federal Commissioner of Taxation (1959) 102 CLR at p 43, who had added: This description covers the three forms which, historically, life insurance has taken, and which, singly or in combination, are the essence of a life insurance policy. All such policies are basically either term policies, whole of life policies, or endowment policies.
2.4	The essential elements of an insurance policy are risk and uncertainty. In the case of a life insurance policy, the uncertainty element is generally a contingency of human life.
Different types of life insurance contract
2.5	Life insurance companies offer a wide variety of contracts, some of which involve savings or investment elements along with some risk cover and others of which involve only risk cover.
2.6	The industry classifies life insurance policies as either "conventional" policies, subdivided into "whole of life", "endowment" and "term" assurance, or "unbundled" life policies, subdivided into "capital stable" and "equity linked".12
2.7	The "whole of life" contracts include both insurance cover and a savings element. Many are "with-profits" policies. These contracts could involve payment of premiums for 30 - 40 years with payment of an accumulated capital sum on death or (as an industry practice) on reaching an advanced age.
2.8	"Endowment" policies usually involve payment of regular premiums by the policyholder and then payment by the company of an accumulated sum plus bonuses at a specified age, say 65 or on earlier death. In the event of early death there would be payment of a specified sum, plus accumulated bonuses at that time.
2.9	The conventional contracts are sometimes called "bundled" because the savings and risk components of the contract and the expenses charged to them are not separately identified.
2.10	The "unbundled" policies include fixed-term fixed-interest investments, often called insurance "bonds". The Marac case (see para 2.2) related to insurance bonds. The only insurance element in these contracts may be the provision for early repayment in the event of death during the investment period. Other unbundled policies are similar in nature to unit trusts, with a fixed investment (or single premium) being invested (at the investor's option) into a particular group of assets (for example, property, equities, fixed interest securities, or a mixture) and with the return to the investor being determined by the return on the particular group of assets
2.11	Term or "pure" life insurance contracts provide for a payment during the period of the contract only if the specified contingency occurs during that period. There is no saving or investment element. Such policies are not covered by the Securities Act and Regulations.
2.12	A common feature of the more traditional life insurance contracts is that they are long- or very-long-term contracts frequently with uncertainties as to both the timing and amount of payments to be made to the policyholders. Some life insurance policies are for fixed and generally shorter terms. We are aware that some life policies may be for periods as short as 90 days. In the past some companies have issued call life bonds. These securities differ little from debt securities
Termination of life insurance contracts
2.13	Generally speaking a policyholder is unable to sell his or her interest in a life insurance policy, although we have been aware of a small secondary market being developed in New Zealand for the buying and selling of interests in life policies.
2.14	Where a policyholder wishes to realise an interest in a policy before its termination date the main option available is to surrender the policy back to the company.
2.15	Most life insurance policies have a surrender value, defined in clause 1.9(g) of the Code to mean: ... a policy having a cash sum which may be available to the policyholder in the event the policy is surrendered earlier than expected maturity, or prior to death (but shall exclude the return of any unexpired premium in relation to a pure risk policy).
2.16	Because of the high front-end selling costs of life insurance policies (see para 3.2 onwards for further discussion on this point) the surrender values of most regular premium policies are low or non-existent in the initial years of life of the policy.
2.17	Policy surrender values for each type of policy are determined by the company. We understand the values can depend on a variety of factors including investment performance, claims experience, the level of expenses incurred in the sale and ongoing administration of a policy, the likely pattern of policy discontinuances, and, in the case of proprietary companies, the dividend aspirations of the company's shareholders .
2.18	Surrender values may or may not be expressed as being "assured" by the company, depending on the terms of the contract. The so-called "capital stable" policies generally include a commitment by the company to maintain a minimum surrender value related to the amount of the policyholder's accumulated premium payments.
2.19	Mr James Richardson-Hay, Assistant General Manager (Finance) and chief actuary of Guardian Assurance Limited (incorporated in New Zealand)13 , in a paper "Solvency Issues for Life Offices" prepared for an address given to the New Zealand Society of Actuaries ("the Society") on 3 June 1997, said: There are a number of ways life offices can protect themselves from insolvency. They can use cop out or weasel clauses. These in effect are actions which adversely affect policyholder expectations. Main examples include: Expenses can be deducted from policies as and when required. Higher charges levied on existing products i.e management charges. Reduction in bonus declarations and/or removal of terminal bonuses. Reduction in surrender terms. Payments under provisions included in policy documents are deferred until conditions improve. Unit prices determined by life office. Methods can be both vague and unclear with wide parameters for calculation. Unilateral introduction and imposition of withdrawal penalties. [Original emphasis]
2.20	These observations are equally applicable whether the life company is a proprietary company, with shareholders' funds, or a mutual company, with reserves, as protection against insolvency.
2.21	In future, now that life insurance companies are required to issue investment statements for their products, we expect to see greater transparency in the disclosures to prospective investors at the point of sale of the companies' fees and charges, including those which would apply on ultimate surrender or maturity of the policy.
2.22	The protection afforded to policyholders seeking to surrender their insurance policies in New Zealand differs profoundly from the position in Australia. We discuss this issue in a later section of the paper (see para 8.24 onwards).

Life insurance policies are generally unsecured
2.23	In almost all cases the obligations arising under life insurance policies in New Zealand are unsecured obligations of the companies concerned. In a few cases policyholders have the benefit of a guarantee from a third party.
2.24	The question of security becomes relevant where a life company has borrowed funds and/or given security over its assets to a third party in competition with or in priority to the claims of its policyholders. The giving of such security can affect the position and prospects of both existing and prospective policyholders.
2.25	From the point of view of the prospective investor we think that the disclosure of such borrowings, of the giving of any prior security, and of the company's ability to undertake such borrowing and to give such security are important.
2.26	Issues may also arise with respect to the position of existing policyholders at the time a life company gives security over its assets to a third party. Relevant factors include whether existing policyholders were aware of the company's ability to pledge its assets to outside parties, whether existing policyholders were informed of the giving of the security, and the costs of terminating the policy if the policyholder wishes to surrender it back to the company.
2.27	We have observed that life companies in New Zealand can and do borrow from external parties on security which ranks ahead of or in competition with the claims of policyholders (see para 6.1 onwards). They may do so without the prior knowledge of policyholders.

3. THE SELLING OF LIFE INSURANCE CONTRACTS
3.1	Life insurance contracts have traditionally been sold on a commission basis. Companies use both "tied" agents i.e. those who are contracted to sell the products of only one company, and brokers or investment advisers, who might sell products offered by a number of companies. The amount of commission paid to agents varies between companies and products but has been in the range of 60% - 100% of the first year's premium for regular premium contracts14 .
3.2	One of the consequences of commission selling is the strong incentive for the aggressive marketing of life insurance contracts. Another consequence of this form of selling is that there tend to be high front-end costs for most policies sold (sometimes referred to as "new business strain"). This cost pattern has implications for the policyholder who terminates the life insurance contract in its early years.
3.3	We note that life companies have changed their selling practices in recent years to try and reduce selling costs and to give greater rewards to their agents for selling good business ("persistence") as opposed to just any business. Where a policy lapses in its early years a proportion of the commission which had been paid to the agent is "clawed back" by the company15. Alternatively, payments of commission are structured such that initial payments are relatively lower, with further payments spread out over the early years of the policy so long as the policy is maintained by the policyholder. Either way, there are now incentives for the agent to ensure that policies sold meet the needs of the client and are affordable.
3.4	3.4 Some life companies, particularly but not only those operated by banks, also undertake direct selling through the mail. While these policies have low or no commission costs, we are informed that, because of low take-up rates, distribution costs of policies sold by mail can be just as high (proportionately) as the costs for policies sold on commission.
The Code of Business Practices for Life Insurance Companies
3.5	The Code was developed by the Life Office Association of the New Zealand ("the LOA") in the period leading up to and following the enactment of the Securities Amendment Act 1988. The LOA had agreed to develop a suitable code of selling practice for life insurance companies to coincide with the introduction of the section 7A authorisation procedures. Compliance with the Code was to be a condition of authorisation.
3.6	The Code was approved by the Commission in June 1989 and came into force on 1 January 1990. Several amendments have been made to the Code since 1990, with significant changes covering collateral business, benefit projection procedures and establishment of the Insurance and Savings Ombudsman Scheme. The Code no longer has the backing of the authorisation procedure. Its future coverage is uncertain.
3.7	The Code set out the types of information which were to be disclosed to prospective policyholders, either on request (e.g. the company's latest audited financial statements, a specimen of the appropriate life policy, and a copy of the completed life policy) or as of right (a statement of policyholder rights).
3.8	The Code provided for a "free look" period of seven days for single premium policies and fourteen days for policies with periodic premiums. During the free look period the new policyholder was entitled to withdraw from the investment and to receive a full refund of the premium paid without penalty.
3.9	The Code also covered companies' use of benefit projections in the selling process. Life companies would frequently provide a prospective policyholder with a projection of the future benefits likely to arise for a given level of investment and on various yield assumptions. The Code included provisions designed to ensure realism in the projection rates used. Benefit illustrations were to be provided to the client in writing and were not to be misleading nor give unrealistic expectations.
3.10	Where a life insurance company, as a lender, required a borrower to take out life insurance cover in order to comply with a condition of the loan or to provide security for the loan the Code provided that the borrower must be informed that the life policy (a collateral policy) could be taken out with any company of the borrower's choice. It was also a Code requirement that the amount of the policy be no more than was reasonably necessary to protect the prospective interests of the lender and the borrower.
3.11	The Code included a complaints procedure. When the Code was introduced in 1990 the complaints procedure involved referral to the LOA's Business Practices Committee16 if the complainant could not resolve the matter directly with the company. If either party considered that the matter was not satisfactorily dealt with by the Committee there was a right of appeal to the Review Authority, who was retired chief district court judge, Mr Peter Trapski CBE.
3.12	The Review Authority had the power to refer serious or persistent breaches of the Code to us. Mr Trapski reported annually to us on the exercise of his responsibilities. He considered very few cases. He did not refer a case of serious or persistent breaches of the Code to the Commission during his tenure, which ended on the establishment of the Insurance and Savings Ombudsman scheme in early 1995.
3.13	The Code was amended in 1995 so that the primary person handling complaints about life company practices was the Insurance and Savings Ombudsman (or, if the company chose to submit to that jurisdiction, the Banking Ombudsman).
3.14	Generally all complaints relating to life insurance companies, and the administration of the Code more generally, have been undertaken without reference to us, but in the knowledge that we could review the authorised status of any life insurance company if circumstances warranted this. Where complaints were made directly to the Commission we referred them to the company concerned, to the LOA or to the Insurance and Savings Ombudsman for resolution. We undertook detailed analysis of particular circumstances in a very few cases, where there appeared to be evidence of a wider market practice on which we might wish to comment.
3.15	The commitment of life insurance companies to abide by the Code no longer has its present force as a result of the revocation of sections 7A and 7B. Compliance with good selling practices, subject to compliance with the law, is a matter of company policy, agreement between life companies and the Insurance Savings and Investment Association ("the ISI")17 if the Code or something similar continues to apply, and the determinations of the Insurance and Savings Ombudsman. The future of the Code could be influenced by what we understand is some dissatisfaction among life insurers with some of the provisions of the present Code, particularly those relating to benefit projections.
3.16	Under the newly-amended securities law18 where an advertisement for securities includes prospective financial information (including benefit projections) the principal assumptions and methods of calculation for those benefit projections must either be included in the registered prospectus for the product being offered or, if there is no prospectus, in the document containing the benefit projection.
3.17	The new investment statements17 will be required to provide details of the fees and charges imposed on life insurance policies.
3.18	We understand that most if not all life companies will remain members of one or the other of the available ombudsman schemes.
Other Securities Act provisions related to life insurance selling processes
3.19	The Commission's interest in the selling of life insurance products has not been limited to transactions covered by the Code.
3.20	Life insurance advertisements, brochures and other selling material are classified as "advertisements" for the purposes of the Securities Regulations 1983. As such the advertisement is not permitted (regulation 8) to: ... contain any information, sound, image, or other matter that is likely to deceive, mislead, or confuse with regard to any particular that is material to the offer of securities contained or referred to in the advertisement.
3.21	We have powers, under section 38B(1) of the Securities Act20, where, at any time, we : ... [are] of the opinion that an advertisement-- (a) Is likely to deceive, mislead, or confuse with regard to any particular that is material to the offer of securities to which it relates; or (b) Is inconsistent with any registered prospectus referred to in it; or (c) Does not comply with [the] Act and regulations made under [the] Act-- to make an order prohibiting the distribution of that advertisement or any advertisement which relates to the offer of securities.
3.22	Since July 1989 we have, on several occasions, exercised our powers under former section 44A to prohibit the advertisements of life insurance companies. We did not find it necessary to publicise those prohibitions or to issue public warnings concerning investment with any particular life insurance company. Companies have immediately withdrawn or amended advertisements where there was a problem of compliance with the Securities Act or Regulations.
3.23	We have not, however, as a matter of practice, routinely scrutinised life insurance company advertisements. Where matters arise we prefer that they are dealt with in the first instance by the Advertising Standards Complaints Board21 where it has jurisdiction. Most of our formal interventions have related to promotional material other than that appearing in the media.
3.24	In the process of selling life insurance products companies have also been obliged to comply with other statutory provisions including those in the Fair Trading Act 1986 and the Consumer Guarantees Act 1993.
3.25	In addition the Investment Advisers (Disclosure) Act 1996 applies in respect of the offer of life insurance policies to the public.

Our experience of New Zealand life insurance company practice
5.1	Life insurance companies, by their nature, accumulate large sums of money for investment on behalf of their policyholders. These moneys, together with shareholders' funds, are invested in a wide range of investments in accordance with the decisions of the directors of each company (as expressed through investment policies and strategies as well as discrete decisions).
5.2	Some of the investments undertaken by life insurers operating in New Zealand which we have observed32 have included: some four-fifths of a life company's total assets being advanced to a related party. The auditor's report on the company's financial statements said the auditor was unable to determine whether the related party loan was collectable in full. The life insurer had also guaranteed a bank overdraft obligation of its parent; investment of over 50% of a company's total assets in a business which was: situated on land owned by the insurance company; managed by the life insurance company; owned by a trust which was heavily indebted and incurring ongoing trading losses; investment of some 94% of a company's funds with its parent (a financial institution); concentration of a company's total investment assets (over 60% of total assets) in commercial property (some of which was probably held to back policies linked to property investment); a long-term investment of more than 10% of a company's total assets in a single advance to the company's own parent company secured by a second mortgage over certain overseas assets at a bank-bill interest rate, with the value of the security influenced to a significant degree by the company's parent's own financial performance; an investment of just under 10% of total assets in a minority but controlling holding in a listed commercial property trust; a long-term fixed interest loan by a life insurance company to the owner of a commercial building, representing nearly 4% of the life company's total assets with the property being leased-back (and occupied) by the insurance company; a long-term investment in forestry futures; two instances of ownership of what might be termed "lifestyle" assets which may be regarded as being a disproportionately significant part of the companies' assets.
Legal provisions relating to the investment of life insurance company assets
5.3	In New Zealand there are no prescribed rules or guidelines for the investment of the policyholders' funds of a life insurance company. Current New Zealand law does not constrain related party exposures by life insurers. As noted earlier (see para 4.25) in some circumstances the law would seem to facilitate related party exposures. We have seen examples of material related party lending by New Zealand life insurance companies. We are aware that the constitutions of some life companies allow them to act in the best interests of their holding companies even if this is not in their own best interests.
5.4	Current law does not prevent the accumulation by life insurance companies of large asset concentrations, whether in single investments or in sectors. Disclosure of such exposures, if any, is usually limited to a company's audited financial statements. However if the life insurer were a listed public company, or the subsidiary of a listed public company, the New Zealand Stock Exchange's Listing Rules (Rule 9.1) would oblige the company to obtain the approval of the members of the company by Ordinary Resolution33 to enter into any transaction where the gross value was in excess of 50% of the value of the shareholders' funds of the listed company. In addition, section 129 of the Companies Act 1993 provides that, where an acquisition (or disposition) of property is valued at more than 50% of the value of the company's total assets before the transaction, the transaction has to be approved by a special resolution of the company34.
5.5	In some cases the types of investment held by a life company may reflect choices made by the investors themselves. Companies offer policies ("investment-linked") which allow the policyholders to nominate the types of investment into which their money is to be invested. The choices available can include fixed interest securities, New Zealand equities, overseas equities, cash and other liquid assets, emerging market securities, etc. The life company, either directly or through contracted managers, decides on the particular assets to be acquired in each asset class. These investments may be said to be divided into units, with a market price per unit available at all times to measure their performance. Under New Zealand law, however, the allocation of assets to units will generally be notional, as there will be no statutory fund or separate trust for the assets, and the allocation will not be effective against competing claims of creditors in the event of financial difficulty.
5.6	The investment-linked types of policies may raise different issues from the traditional participating policies. The investor has made the choice of the type or types of assets into which the funds are to be invested. Managers' performance may be, and sometimes are, measured by prices which are published and are available to potential investors. The exit price will be determined by reference to the market price of the assets allocated to particular securities after taking into account a price spread between buying and selling unit prices to allow for costs and charges.
The approach in Australia and the United Kingdom to regulation of the quality of life insurance company investments
5.7	As discussed earlier Australian life insurance companies are required to fulfil a number of statutory requirements related to solvency and capital adequacy (see para 4.29 onwards). While these requirements do not include specific prohibitions on life companies making certain types of investment, nor limit the companies' ability to accumulate large concentrations of risk, they effectively achieve these outcomes by the manner in which the statutory requirements are structured.
5.8	To illustrate, the "Solvency Standard" requires the company to create an "Inadmissible Assets Reserve" in relation to related party exposures, investments in companies already subject to prudential ratio requirements, and for various large exposures35. The effect of the reserve is to negate some or all of the value of the company's assets for the purposes of the solvency requirement calculation.
5.9	In the United Kingdom, under the ICA(UK), the solvency requirements have the effect, as in Australia, of imposing de facto constraints on life insurers' investments in particular types of asset.
5.10	Life insurers are able to include within their "admissible" or qualifying assets only those assets which come within the classes of assets prescribed in regulations. Apart from investments in cash and gilt edged securities, which are unrestricted, the admissible level of other assets ranges from around 0.1% of the "long term business amount"36 for debenture options and share options in any one company to 5% of that "amount" for land, mortgages over land and listed shares and debentures. There are prescriptions for valuing the various types of assets.
5.11	The general scheme limits a life insurer's exposure to any particular asset, other than gilt edged securities, to 5% of the long term business amount.
5.12	In addition to the de facto constraints described in the preceding paragraphs, the ICA(UK) also imposes a de jure restriction on transactions with connected persons. In general terms insurance companies (or their subsidiaries) cannot enter into transactions with connected persons (being controllers or directors of the insurance company) if the aggregate of the assets and liabilities attributable to existing transactions with the person concerned exceeds 5% of the amount of the long-term fund, or the proposed transaction would take the aggregate over the 5% limit.
Comment
5.13	It is generally accepted that the riskiness of a financial institution's investment portfolio is likely to be increased37 to the extent the institution has: large exposure concentrations i.e. single exposures to individual counter-parties, or single or multiple exposures to a single industry or geographical sector; related party exposures i.e. investments with parties related to the institution
5.14	We have observed that some New Zealand life insurance companies have amassed relatively large single exposures, relatively large related party exposures, and relatively large sector exposures.
5.15	There are currently no direct constraints on the size or nature of exposures which may be undertaken by New Zealand life companies. However exposures which are material in the accounting sense should be disclosed in a life company's audited financial statements. The Companies Act, also the New Zealand Stock Exchange Listing Rules, where applicable, provide for shareholder approval for some very large transactions. There is no requirement for approval by policyholders for such transactions.
5.16	We think there are a number of questions which need to be addressed concerning the capacity of life insurance companies to undertake large and related party exposures. We raise these questions in the final section of the paper.

Our experience of life insurance industry practice
6.1	We have seen instances where life companies' policyholder funded assets have been pledged as security to financiers with claims either ranking ahead of, or in competition with, those of the policyholders themselves. In many cases it was not apparent that the policyholders had gained from the pledging of the assets to third parties.
6.2	These instances included: a case where a life insurer had guaranteed the obligations of its parent entity to a bank under a mortgage advance by the bank to the parent. The amount of the advance was nearly equal to the life insurer's total assets. The ability of the bank to call on the guarantee would have been of serious concern to policyholders if it had been brought to their attention; a case where a life insurer had guaranteed the obligations of its overseas parent to the parent's bankers; a case where a life insurer had co-guaranteed certain obligations of a subsidiary company to its customers. These guarantees were long-term in nature and the life insurer could not readily be released from them; a case where a life insurer borrowed funds from a bank to help finance a significant acquisition, with the bank taking a debenture security over the assets of the acquiring life insurance company that ranked in priority to the claims of the company's policyholders. The life insurance policies of the acquiring (borrowing) life insurance company were non-participating and primarily investment- linked.
The legal provisions relating to the pledging of life insurance assets
6.3	There are no specific provisions in the Life Act dealing with the giving of security over policyholder-funded assets. The principal section of relevance is section 15 which states: LIFE FUNDS SEPARATE-- (1) In the case of a company established before or after the coming into operation of this Act transacting other business besides that of life insurance, a separate account shall be kept of all receipts in respect of the life insurance and annuity contracts of the company, and the said receipts shall be carried to and form a separate fund (to be called the Life Insurance Fund of the company); and such fund shall be as absolutely the security of the life policy and annuity holders as though it belonged to a company carrying on no other business than that of life insurance, and shall not be liable for any contracts of the company for which it would not have been liable had the business of the company been only that of life insurance. (2) ....
6.4	Section 15 refers only to those life insurance companies which carry on business other than that of life insurance, and provides that in such cases the company should keep separate account of all moneys received in respect of its life insurance business and these moneys will form a separate Life Insurance Fund which will be "as absolutely the security of the life policy and annuity holders as though it belonged to a company carrying on no other business than that of life insurance...".
6.5	Section 15 does not expressly deal with the giving of security over life fund assets. However there is relevant case law on the subject. Barker J, in ACL Insurance Limited v ACL Insurance Limited (In Liquidation) HC, Auckland M2121/89 6 March 1995, a case involving a company which carried on both life and general business, said: Section 15 does require the formation of a separate Life Insurance Fund into which premiums from life insurance and annuity contracts and other receipts from that class of business are paid. The section also requires that those receipts "shall be carried to and form a separate fund to be called the Life Insurance Fund of the company". The formation of the separate fund and the requirement that the Fund be the security of the life policyholders also implies that the assets of the fund (including any investments deriving from those assets) be retained in separately identifiable form. The Fund is available only to meet the proper liabilities of a company carrying on no other business than that of life insurance. In other words, to the extent that liability is incurred to outside creditors in connection with the business of life assurance, those creditors may property [sic] claim against the Fund. However, to the extent that the creditors relate to business other than that of a life assurance company, they may not claim against the assets of the Fund. To the extent that a separate fund is required to be formed and provide security, a trust in favour of the policyholders arises but on terms as outlined in the previous sub-paragraph. In other words, the Life Insurance Fund is not to be applied exclusively to the claims of the life insurance policyholders. Creditors relating to the life insurance business of the company are also to be recognised. If secured, then depending on the terms of the security, they may have priority over the life policyholders. In effect, a statutory preference in relation to the life insurance business is created. This is to be recognised both during the existence of the company and in a winding-up by exonerating the Life Insurance Fund from liability in connection with debts not connected with the life insurance business. Thus, if a Bank lends money to the company for some purpose other than the life insurance business, the assets representing the Life Insurance Fund would not be liable for that debt (or such part as did not relate to the life insurance business). The opening words of section 15(2) give further support to this analysis.
6.6	In the particular case the company had not maintained a separate fund of assets for the life insurance policyholders, despite carrying on other business. Barker J declined to make an order giving any priority to the life insurance policyholders. They would rank as unsecured creditors along with the company's other creditors (other than a bank, which had security over a property owned by ACL). Barker J commented: That seems a somewhat contrary result to what the legislature tried to achieve on [the policyholders] behalf. There does not seem to have been any effective policing of these statutory requirements. I was informed from the Bar that there were auditors of the company and that the company was required to provide an actuarial report annually when filing its annual statement. The company did show in its statement filed in terms of the Act, that it had at 31 March 1989 (9 months before it was placed in judicial management) a Life Insurance Fund of some $12.5 million. Anyone reading the published balance sheet might have thought that that sum was being kept separate for life insurance creditors. However, that apparently was not the case because of the intermingling of accounts. It is still not clear that the legislation requires a separate bank account for the life insurance fund. I should hope that in any revision of the Life Insurance Act there will be a number of reforms to which attention should be given. Some have been demonstrated in this case. I list them as follows - The legislation should make it clear whether there should be a separate bank account for the Life Insurance Fund. There should be something in the statute akin to s.29 of the current English legislation which states in effect that the assets represented in the fund should be applicable only for the purposes of the life insurance business and not available for other purposes of the company. The archaic wording and format of the Schedules to the Act (which included reference to Indian and Colonial securities and other unlikely forms of security) should be overhauled; far more accountable information should be provided for the public and policyholders; S.28(1) which deals with non compliance reads as follows - "Every company which makes default in complying with any of the requirements of this part of this Act, where no other penalties are expressly provided, is liable to a fine not exceeding £100 for every day during which the default continues; and in the case of a foreign company the general agent shall be liable as to such fine as well as the company." There should be a much greater maximum penalty fixed than £100 a day as an indication to those responsible for running life insurance companies that they have serious obligations to those from whom they take premium income.
6.7	Two issues arise from the application of section 15 of the Life Act and Barker J's judgment: the extent to which assets of a life insurance company are available to satisfy the debts incurred by the company in business other than that of life insurance; and whether a life insurance company is free to pledge its policyholders' assets to financiers in priority to the claims of policyholders to support borrowings regardless of the purpose for the which the proceeds of the borrowings are used.
6.8	The ACL case was concerned primarily with the claims of policyholders versus the claims of other unsecured creditors, not those of secured creditors. In the absence of a separate "Life Fund" the policyholders lost any protection they might have otherwise had. The question of the purpose of other borrowings did not arise.
6.9	Requirements for the segregation of policyholders' funds, and the security position of policyholders more generally, are not clearly stated in the legislation.
The pledging of policyholder assets in Australia and the United Kingdom
6.10	Australian life insurance legislation provides that all life insurance business must be conducted by life insurance companies within separate "statutory funds". Section 30 of the LIA(Aust) states: The principal requirements of this Part in relation to statutory funds may be summarised as follows: all amounts received by a life company in respect of the business of a fund must be credited to the fund; all assets and investments related to the business of a fund must be included in the fund; all liabilities (including policy liabilities) of the company arising out of the conduct of the business of a fund must be treated as liabilities of the fund; the assets of a fund are only available for expenditure related to the conduct of the business of the fund; statutory funds may not be divided or amalgamated without the approval of the [Insurance and Superannuation] Commissioner; profits and losses of a statutory fund may only be dealt with in accordance with Divisions 5 and 6 (the object of those Divisions being to ensure that such profits and losses are dealt with in a manner that protects the interests of policy owners and is consistent with prudent management of the fund).
6.11	Every Australian life insurance company is required to have at least one statutory fund, but may have more than one fund.
6.12	Under the LIA (Aust) it is not permissible for a life insurer to mortgage or charge any asset of a statutory fund except to secure a bank overdraft or else with the approval of the Insurance and Superannuation Commissioner ("the Commissioner").
6.13	In the United Kingdom the ICA (UK) requires the separation of the "long-term business" (life insurance) assets from the "general business" assets of any company which carries on both life and general insurance. Separate "funds" must be maintained for each type of business. All receipts relating to the respective types of business are paid into the respective funds. In addition, life offices must separate the assets and liabilities relating to their insurance business and their shareholders' funds. We understand that many life offices have at least two long-term funds, one for their with-profit (participating) business and one for their non-profit (linked) business while others have a single fund covering both with-profit and non-profit business.
6.14	The ICA(UK) restricts the uses to which the long-term assets of a company may be put. In general terms they may only be used for the purposes of the long-term business. An exception is provided for the "free reserves" i.e. the extent to which the long-term assets exceed the long-term liabilities as disclosed by an actuarial valuation, which may be used for the purposes of the company's business generally. In addition, long-term assets of the company may be exchanged for other assets of the company provided the exchange is at fair market value. As a further protection no dividend may be declared by any company authorised to conduct long-term business unless it has established, by a valuation, that its long-term assets are at least equal to its long-term liabilities.
6.15	There appear to be no express constraints on the ability of an United Kingdom life office to mortgage or charge its assets. However the requirements in the ICA(UK) for the segregation of business appear to mean that a life company's assets can only be pledged where it is for the purpose of the life business. It would not seem possible for life (long-term) assets to be secured for the benefit of the shareholders. Barker J drew attention to the United Kingdom provisions in the ACL case (see para 6.6).
Comment
6.16	Some New Zealand life insurance companies have pledged their assets as security to third parties in priority to or in competition with the claims of policyholders. There are currently no constraints on life companies acting in this manner, except to the extent that section 15 of the Life Act may apply.
6.17	Australia has direct controls over external borrowing by life companies and achieves separation of life company business through the use of statutory funds. The United Kingdom requires segregation of long-term (life insurance) business.
6.18	We think there are a number of questions to be addressed concerning the segregation of policyholders' funds and the capacity of life insurance companies to pledge their assets to third parties in priority to, or in competition with, the claims of policyholders, including the relevance of any perceived direct benefits to policyholders. We identify these questions in the final section of the paper.

Our experience of New Zealand life industry practice
7.1	Over recent years there have been a number of instances in New Zealand where ownership, or effective ownership, of a portfolio of life insurance contracts has changed. Such changes have been effected in a number of different ways with a range of direct and indirect consequences for policyholders.
Acquisition by reinsurance
7.2	A fairly common technique for changing the risks and rewards of an insurance portfolio, without actually changing the legal ownership of the portfolio, is through use of reinsurance. In this method the acquiring company assumes all the risk under a portfolio of policies without any change of obligor. The selling company pays the reinsurer (acquirer) a reinsurance premium by transferring an appropriate amount of the seller's assets to the acquirer. The selling company remains legally liable under each contract but the acquirer takes all or a major part of that risk, and the associated reward, under a reinsurance contract.
7.3	The policyholders' contractual arrangements are undisturbed. Their consent to the reinsurance arrangement is not required even though the strength of their future claims may rest rather more on the viability and business philosophy of the acquiring company than on that of the selling company. Provided the bonus determination processes are not changed by the acquiring company there may be no change in participating policyholders' benefit expectations. However the policyholder's security cover may be improved or worsened depending on the capital position of the company assuming the risks under the reinsurance contract compared with that of the company ceding those risks.
Acquisition by takeover
7.4	We have also observed a few instances in recent years of change of ownership of New Zealand life insurance companies, and thus of their life insurance portfolio of business, effected by acquisition or takeover.
7.5	In such cases the equity participants would be subject to the normal rules of law concerning changes of company ownership. For example: The provisions of the Companies Amendment Act 1963 may apply if the offer is made in writing, is made to more than six members of the target company, and the target company has more than 25 shareholders; If a listed company is involved compliance with the Listing Rules of the New Zealand Stock Exchange may be required; If an overseas owned company is involved the consent of the Overseas Investment Commission may be required; Depending on the size of the transaction the provisions of the 1993 Companies Act concerning "major transactions" may have to be followed38 . Note, however, that the company's policyholders (as creditors) have no standing in the shareholders' consideration of major transactions; If the target company was providing financial assistance for the purchase of its own shares (or those of its holding company) the transaction may be subject to the "financial assistance" provisions of the 1993 Companies Act39 .
7.6	There are no special provisions of the Life Act, the Companies Act, the Securities Act or any other New Zealand legislation applying to life insurance companies, whether as target companies or acquiring companies. There is, for example, no requirement that policyholders should be consulted, or their consent obtained, before an acquisition or sale transaction can proceed. There is also no specific requirement that the directors of either an acquiring or of a selling company obtain independent actuarial advice on the effect of any prospective takeover transaction on the policyholders of either company before the transaction is proceeded with.
7.7	With respect to the interests of the policyholders of an acquired life insurance company: Under the Companies Act an acquiring life insurance company may use the assets of an acquired life insurance company to assist the purchase of that company's shares. The directors of the acquired company can assent to various of the resolutions required under the "financial assistance" provisions of the Companies Act provided the requirements of that Act are met, including the requirement to satisfy the solvency test40 ; Where the giving of financial assistance is assented to under the "unanimous consent" provisions (sections 107/108) of the Companies Act, as could occur when a life company becomes a wholly owned subsidiary of another company, there is no requirement (unlike under section 76) for the directors of the acquired company to resolve either that the giving of the financial assistance is in the best interests of the (acquired) company giving the assistance or that the terms and conditions under which the assistance is given are fair and reasonable to the company. However, the requirements for satisfaction of the solvency test are more rigorous under the "unanimous consent" provisions than under the more general provisions41; The policyholders of the acquired company are, nevertheless, creditors of that company and are owed duties as creditors42 by the directors of the acquired company (although in many cases the companies have considerable discretion to determine the amounts owed to them as creditors).
7.8	With respect to the interests of the policyholders of an acquiring life insurance company the provisions of existing law appear to mean that such a company is generally free to use its own assets, or indeed the assets of a wholly owned subsidiary, either directly or as security to support borrowings used to finance the purchase of another company, including a life company. Where any such acquisition is made it needs to be questioned whether that acquisition is for the purposes of the "life insurance business" of the acquiring company and if there should be a separation of the life insurance policyholders' funds as provided for in section 15 of the Life Act.
7.9	Examples in the area include where one life insurance company acquired another life insurance company and: the acquisition was partly funded by bank finance, with the assets of the acquiring company pledged to the bank, with the bank having a charge over the assets of the acquiring company which ranked in priority to the claims of the policyholders. All the acquiring company's policies were non-participating i.e. the policyholders were not entitled to share in the company's profits; the acquired life insurance company gave extensive financial assistance43for the purchase of its parent's and thus its own shares. This financial assistance included: a long term advance, representing around 10% of the acquired company's total assets, given to the acquiring company's parent and secured by the assignment of a second mortgage security over certain offshore assets which had been sold by the acquired company to its parent as part of the transaction; the distribution, to the acquiring company, post acquisition, of more than half of the acquired company's pre-acquisition shareholders' funds; the pledging of the rights to ownership of the acquired company's life insurance portfolio to a group of reinsurance companies as security for an advance to the acquiring company against future profits arising from that portfolio.
7.10	With respect to any consultation with policyholders we observed that in various instances, including that outlined in the preceding paragraph, the directors of the acquiring company did not seek the views of the policyholders or of any representative on the proposed acquisition.
Instances of changes of obligor
7.11	There were two recent instances where the New Zealand branches of United Kingdom life insurance companies were "domesticated", with the policyholders of the New Zealand branches of the United Kingdom companies becoming policyholders of New Zealand subsidiaries of those companies. These changes were effected through court approved Schemes of Arrangement under section 205 of the Companies Act 1955.
7.12	In both cases the companies requesting court approval to the transfers obtained independent actuarial advice, which was made available to the policyholders and the court, as to the fairness of the arrangements to the policyholders and the effect they would have on the financial security and future prospects of those policyholders.
7.13	These cases involved a change in the entity liable under the life insurance policies from a global United Kingdom-based company to a New Zealand incorporated company. These were arguably rather more fundamental changes to the position of policyholders than would occur with the takeover of one New Zealand life insurance company by another, because of the change in obligor.
7.14	One of the insurance groups involved in the domestication process sought to preserve for its New Zealand policyholders some of the regulatory benefits they were giving up by becoming members of a New Zealand incorporated life company. They achieved this by use of a "Policyholders Protection Guidance Note" which was protected by a Deed of Covenant.
7.15	The Independent Actuary, in an affidavit filed in the Court in support of the application for domestication by the company, said: 4.2 The disadvantages [of domestication] are: a perceived loss of policyholder security through the loss of membership of the world wide life fund. a perceived loss of future earnings caused by the narrower range of investments available in New Zealand. loss of United Kingdom legislative controls including: The fit and proper person legislation which controls senior management and directors, Appointed Actuary regime, Controls on the transfer of surplus to shareholders, Department of Trade and Industry reporting and other public reporting requirements, European Community Solvency Standards, Transactions between shareholders and policyholders should be no less than fair and equitable. change in the Articles of Association under which shareholders share in the surplus lack of any New Zealand bonus distribution protection for policyholders.
7.16	The Policyholders' Protection Guidance Note was designed to address these issues by prescribing the allocation of profits between participating policyholders and shareholders, by obliging the directors of the company to take actuarial advice on a range of matters, and, through the covering Deed of Covenant, to require that the company obtain policyholder approval for any change in profit distribution policy in favour of the shareholders. The Note could only be varied at the request of the directors of the company after taking the advice of the company's actuary and of an independent actuary. The distribution policy in favour of shareholders could not be improved without the approval of 75% of the policyholders.
Changes of ownership of life insurance companies and policies in Australia and the United Kingdom
7.17	Australia has legislative controls relating to changes of ownership of life insurance business, changes in the risks and rewards under life insurance contracts effected through reinsurance and takeovers or acquisitions of insurance (including life) companies.
7.18	Part 9 of the LIA (Aust) covers "Transfers and Amalgamations of Life Insurance Business". This Part (section 189 onwards) provides that no part of the life insurance business of a life insurance company can be transferred to, or amalgamated with the business of, another life insurance company without the approval of the Court44. A copy of the scheme of transfer or amalgamation, and any actuarial report thereon, must be provided to the Commissioner. Appropriate public notification of the intention to seek approval to the scheme must be given. Every affected policy owner must be given a copy of an approved summary of the scheme.
7.19	The Commissioner may arrange for an independent actuary to prepare a report on the scheme and is entitled to be heard in the court proceedings dealing with the application45.
7.20	Any change in the incidence of risks or rewards under life insurance contracts effected through reinsurance requires the approval of the Commissioner.46 Thus changes in the effective ownership of portfolios of life insurance policies cannot take place without consent.
7.21	The "Insurance Acquisitions and Takeovers Act 1991" ("the IAT") covers changes of ownership of both general and life insurance companies in Australia. The objects of the IAT are expressed to be to protect the public interest in a number of ways, including: by ensuring that the affairs of Australian-registered insurance companies are carried out in a prudential manner; by preventing unsuitable persons from being in a position of influence over Australian-registered life insurance companies47; and by preventing the undue concentration of economic power in the Australian general insurance industry, the Australian life insurance industry, or in the Australian financial system48.
7.22	For this purpose any takeover proposal must be notified to the relevant Minister and the proposal is stopped if the Minister makes either a temporary or a permanent restraining order. If a proposal proceeds without the necessary procedures having been followed the Minister may make a divestment order.
7.23	Part 7 of the IAT provides that the Minister may formulate "decision-making principles" to be complied with by him in exercising his powers under that Act. Principles were published in April 1992 and included, among the elements the Minister had to have regard to in considering whether a proposal was "contrary to the public interest": 6 (b) whether the proposal could adversely affect the interests of policy holders of an Australian-registered insurance company;
7.24	In the United Kingdom the ICA (UK) covers transfers of portfolios of life insurance business from one company to another. Sections 49 and 50 enable such transfers to be made with the approval of the High Court. It is necessary for various notices to be published, for the scheme of transfer to be available for prior inspection by policy holders, and for a report on the effects of the scheme to be made by an independent actuary.
7.25	"Controllers", defined as anyone (person or company) entitled to exercise 15% or more of the voting power of an insurance company, as well as the chief executive or managing director of the insurer, are required to satisfy the Secretary of State that they are "fit and proper" persons to control an insurance company.
7.26	Changes of life insurance company ownership are also controlled. Section 61 of the ICA (UK) requires any person seeking to become a controller of an insurance company through acquisition of 15% or more of the shareholding to obtain the approval of the Department of Trade and Industry before the change can become effective. The Department has three months in which to consider the merits and implications of the change in control. If it objects to a proposed change in controller it must give advance notice of this and allow the applicant to appeal.
Comment
7.27	In New Zealand there are no special constraints on either the change of ownership of a life insurance company or the change of effective ownership of the risks and rewards of a portfolio of life insurance business through reinsurance.
7.28	The "major transactions" provisions of the Companies Act and Stock Exchange Listing rules may apply, but these are for the benefit and protection of shareholders not policyholders. There is no requirement for a takeover of a life company or its portfolio of policies to be referred to a representative of policyholders. A life company can give financial assistance for the purchase of its own shares, and where the unanimous consent provisions are available and are used there is no requirement that this assistance be in the best interests of the life company concerned.
7.29	In Australia and the United Kingdom rules of law require court or regulator approval for changes of ownership of a life insurance company or of the risks and rewards under a portfolio of life insurance business.
7.30	Changes of company or portfolio ownership could have implications for policyholders in a number of ways, including in relation to the relative security and yield of their investments and (for participating policyholders) their share of the company's profits (see para 8.11 onwards for further discussion).
7.31	We think there are a number of questions which need to be addressed concerning the takeover of life insurance companies and life insurance business. We set out these questions in the final section of our paper.

DETERMINING THE RETURNS TO POLICYHOLDERS
8.1	There are a number of factors which bear on the returns policyholders are likely to receive from their investments in life insurance policies. These factors include: the returns received by the life insurance company on its asset portfolio; the company's level of expenses and the mechanisms used (fees, charges, pricing spreads) used to apply these costs to policyholders; in the case of with-profits policies, the division of profits between shareholders and policyholders; and the form of contractual arrangement between the company and the policyholder (with-profits, non-participating, capital stable, investment linked).
8.2	In this section of the paper we will look at life companies' practices for the allocation of profits between shareholders and participating policyholders, and at the extent to which minimum surrender values are protected for the benefit of policyholders.
The allocation of profits between policyholders and shareholders Our experience of New Zealand life industry practice
8.3	From our observations the practices followed by life insurance companies in determining the allocation of profits between their current policyholders, reserves and (for proprietary companies) shareholders, vary widely.
8.4	As we noted earlier (see para 4.8) the company's actuary is required to state in the Sixth Schedule abstract the principles used to determine the split of profits between shareholders and policyholders, and the source of those principles.
8.5	We have reviewed many Sixth Schedule abstracts. These are usually expressed in the form of a recommendation by the actuary as to the amount of bonus or profit which should be applied to various classes of policy.
8.6	We have seen instances where, in the face of what appeared to be very small profit allocations to policyholders compared to the profit attributed to shareholders, the actuary indicated he would support a higher allocation of profits to policyholders should the company feel disposed to make such an allocation (which it did not).
8.7	In one instance a proprietary company reported a significant profit arising from the public flotation of one of its long-held investments. The company subsequently paid a substantial dividend to its parent. In the same year no reversionary bonuses were allocated to with-profit whole of life and endowment policies.
8.8	The particular investment giving rise to the profit was shown in the company's financial statements as an investment of the company without qualification and certain contingent liabilities (guarantees given by the life insurer covering obligations of the floated company) were also shown in the company's financial statements without qualification.
8.9	In effect life insurance companies have the capacity to select after the event which particular profits arising from their business will be for the benefit of policyholders and which profits will be attributed to the shareholders. This is clearly so when the company has not disclosed the "ownership" attribution of the company's assets.
8.10	We are also aware that companies can allocate benefits to policies even though the underlying assets did not earn positive yields. Such allocations may be at the "cost" of other policyholders and/or of the shareholders.
Factors in determining the allocation of profits between policyholders and shareholders
8.11	There are no effective rules of law in New Zealand governing the splitting of profits between current policyholders, shareholders and reserves in a life insurance company with participating policies.
8.12	In mutual companies the issue is one of how much profit to transfer to or from reserves and how much to allocate to policyholders in any given year. In the case of proprietary companies it is also necessary to allocate profits between participating policyholders and shareholders.
8.13	We expect profit allocation decisions are based on a variety of factors including current and expected profitability of the asset portfolio, indications given to policyholders at the time policies were sold, comparable market performance, the interests of the shareholders of the company, and the need to service shareholders' funds.
8.14	The role of the actuary in the profit allocation process is unclear. As we noted earlier (see para 4.8) the actuary is required to prepare a report on the financial condition of the company each year. That report is required to state the principles on which the distribution of profits was made. However the actuary is not required to state, for example, if the distribution appears fair or equitable as between classes of policyholders or as between shareholders and policyholders (although the actuary may choose to do so).
8.15	The actuary is appointed by the company and owes a duty of care to the company. There is not an explicit duty of care towards, or mandate to act for, or in the interests of, a company's policyholders. Many actuaries are employees of the life insurance companies they are reporting on. Some actuaries are directors of the companies they are reporting on. In other instances consulting actuaries are appointed by the directors of the company to report on the company's financial position. There would appear to be important conflict of interest questions for actuaries who undertake section 18 investigations, questions which, as far as we know, are not addressed by formal industry guidance.
8.16	There is no existing opportunity, either in the law or in the conventional policies offered to the general public, for the policyholders themselves to have a say in the distribution of a company's profits between shareholders and policyholders and as between different classes of policyholders.
8.17	Mr Richardson-Hay in his paper (see para 2.19) observed: Life offices in New Zealand have no restrictions in the following areas: ... ... Profit sharing for with profits policyholders The basis on which profits are shared is totally at the discretion of the life office. Policyholders are not informed of this issue. Nor [are policyholders informed] in the case of branch operations if a reduction in New Zealand funds will be required to support another part of the global fund
8.18	Until recently disclosure of the company's approach to profit allocation was a matter for promotional and contractual documentation. However life insurance companies are now49 required to prepare investment statements.These documents have to be provided to all prospective investors andare required to include: a brief description of the key factors that determine the returns to the policyholders; a statement whether or not an amount of returns, quantifiable at the date of the investment statement and enforceable by subscribers, has been promised and, if so, the amount or how it is to be calculated; and with respect to the consequences of policy termination: a brief description of the policyholders' rights to terminate or surrender the policy; a statement of the types of charges which may be incurred in relation to the early termination of the investment; a statement of the amount of any charges (dollar amount or percentage) which may be incurred in relation to early termination, or, if the amount or percentage cannot be described at the time the investment is made, a statement describing how the charges will be calculated.
The approach to the allocation of profits between shareholders and policyholders in Australia and the United Kingdom
8.19	As noted earlier, in Australia life insurance legislation requires life insurance business to be conducted within separate "statutory funds"(see para 6.10 onwards).
8.20	The LIA (Aust) contains detailed provisions about many facets of the operation of the statutory funds. With respect to the allocation of operating profit section 60 states that, for a statutory fund representing Australian participating business, at least 80% of the profit (or such higher percentage as may be specified in the company's articles of association) must be added to policy owners' retained profits of the statutory fund. The balance of operating profit must be treated as, or added to, shareholders' retained profits.
8.21	The Australian legislation allows for different treatment for overseas participating business. For example, there is no 80% minimum profit allocation rule. Instead, overseas participating policyholders can have any proportion of the funds' operating profit added to, or treated as, their retained profits provided the allocation would not be inconsistent with the company's articles of association. If a company's articles of association require any part of a profit representing overseas participating business to be treated as overseas policyholders' retained profits then that part of the profits must be treated as, or added to, overseas policyholders' retained profits.
8.22	With respect to the distribution of retained profits, the LIA(Aust) provides that Australian policy owners' retained profits may only be distributed to owners of Australian participating policies. However a similar provision applying to the distribution of the retained profits of overseas participating policyholders is qualified by a further provision which allows overseas policy owners' retained profits, with the approval of the Commissioner, to be transferred to owners of Australian participating policies or to shareholders' funds.
8.23	In the United Kingdom the ICA(UK) (section 30) limits the options available to a company to dispose of profits when the company has with-profits policyholders. The section appears designed to ensure an element of stability in the proportion of profits which can be distributed to policyholders from year to year. Based on the premise that with-profits policies are usually sold by the illustration of the future effects of past bonus declarations, the rule of law means that companies cannot lower the proportion of profits allocated to policyholders from one year to the next by more than 0.5 percentage points without invoking a formal procedure involving notification to the Department of Trade and Industry, publication of the intention in the London, Belfast and Edinburgh Gazettes and in specified newspapers, and delaying the allocation by almost two months from the giving of the public notice.50
Minimum surrender values for life insurance contracts
8.24	The effect of the practices followed in the allocation of profits to participating policies is particularly evident on policy termination.
8.25	Earlier in our paper (see para 2.13 onwards) we discussed the vulnerability of New Zealand life insurance policyholders to the very wide discretion of life insurance companies to determine the surrender value of life insurance contracts. The current position in New Zealand is different from that prevailing in Australia.
Policy termination in Australia
8.26	Under sections 207 and 209 of the LIA(Aust) the LIASB is required to develop an actuarial standard related to Minimum Surrender Values and Paid Up values for life insurance policies.
8.27	In May 1997 the LIASB issued for comment draft standard 4.01 "Minimum Surrender Values and Paid-up Values". It is proposed that the standard, when formally promulgated, will apply to transactions occurring on or after 30 June 1998.
8.28	The purpose of the standard is described in the "Overview" section as being twofold: To prescribe, for the relevant policies, the minimum amount which must be paid (provided for) by the life company when the policy owner requests that the policy be surrendered (made paid-up). To prescribe the amount which is appropriate as the base value for the Minimum Termination Value from which the Solvency Requirement of a statutory fund is determined
8.29	The objectives in prescribing these amounts were described in the "Introduction" to the standard as: in protecting the interests of surrendering policyholders in the situation of terminating (or making paid-up) life insurance policies prior to their full term, by providing for a minimum amount; and in protecting the interests of remaining policyholders, by both: - ensuring that the costs of termination are being appropriately borne by the surrendering policy owners; and - providing a base to the value of policy liabilities which is used as a component in the determination of the Solvency Requirement for the statutory fund.
8.30	In outlining the principles underlying the standard the "Overview" included: During the development of the Standard it was recognised that there are three broad categories of charges levied against life policies by the life company to meet its expenses and provide for its profits. This categorisation - according to the timing of application of the charges - has been adopted throughout the Standard, as: front end charges; ongoing charges; and back end charges. The most important (and variable) factors affecting the surrender value of the policy are considered [to be] the charges in respect of the establishment and termination of the policy - or the front end and back end charges. Further, while regular product information disclosure reinforces to the policy owner the impact of ongoing charges on the in force value of their policy - the effectiveness of disclosure requirements in respect of these other charges (front end and back end charges) is arguably less. The Standard therefore seeks to limit the adverse effects on the policy owner of excessive charges on the establishment of a policy and significant reductions in the in force value of the policy due to charges levied on termination.
8.31	The first part of the standard says: 1.1 The Minimum Surrender Value of a policy must provide a basic level of protection to the owner of the policy being surrendered, while not disadvantaging the interests of the owners of other policies within the statutory fund or those of the shareholders
8.32	The draft standard is quite detailed. It prescribes the methodology to be applied to determine the surrender values of the four major policy types. It requires that Minimum Surrender Values be provided for all policies issued after 1 July 1995 with some exceptions.51
8.33	The standard prevents ongoing charges being levied at a level exceeding that actually applied to the policy. It also provides that charges cannot exceed the level prescribed in the standard. For example, the standard prescribes a maximum administration or transaction charge in respect of a surrendered policy of A$50 (for 1998).
8.34	While the draft standard itself does not prescribe the minimum returns policyholders can expect from their policy, since these returns will obviously vary widely among different types of policy and will depend on the performance of the assets supporting those policies, the standard will require that most policies prescribe a minimum surrender value which includes all returns credited to the policyholder in relation to that policy.
8.35	The minimum surrender values become part of each company's solvency calculation.
Comment
8.36	The processes used by proprietary companies for determining the division of profits between policyholders and shareholders, and between different classes of policyholder, are generally unclear to the outside observer.
8.37	With the significant shift, as a result of demutualisation, towards life insurance business being conducted by proprietary rather than mutual life insurance companies, the issue of profit allocation between shareholders and policyholders is likely to assume greater importance in future years.
8.38	As already noted (see para 2.19), there appear to be a number of ways that a New Zealand life insurance company can adjust the return provided to policyholders, including the levying of expenses against policies, describing the procedures for determining bonuses in imprecise and obscure language in the policy documents to allow flexibility in bonus calculation, adjusting bonus declarations already made and removing expected terminal bonuses.
8.39	Where the ownership of life insurance companies or portfolios change policyholders could be adversely affected if new owners have a different investment philosophy or approach towards benefit allocation.
8.40	The introduction of the new investment statements should go some way to improving the quality of disclosures to prospective policyholders but does not affect the ability of life insurance companies to allocate benefits at their discretion.
8.41	Australia has specific rules of law concerning the allocation of life insurance profits between participating policyholders and shareholders. The United Kingdom has requirements which ensure some stability in profit allocations from year to year. There are no such rules in New Zealand.
8.42	Some New Zealand life insurance policies, generally the "capital stable" policies, have what is akin to a minimum surrender value. Under those policies there could be a promise by the life insurer to pay the policyholder a minimum amount related to the original investment or premiums paid by the policyholder. Otherwise, however, the policyholder may have no assurance as to the value of the investment at any given time.
8.43	We think there are a number of questions which need to be addressed concerning the allocation of profits between policyholders and shareholders and the possible provision of minimum surrender values for life policies. We set out these questions in the final section of the paper.

Our experience of New Zealand life insurance industry practice
9.1	Life insurance companies are "issuers" for the purposes of the FRA. As such they are required to deliver to the Registrar of Companies for registration financial statements which comply with the requirements of that Act, including compliance with applicable financial reporting standards and generally accepted accounting practice. However, as noted earlier (see para 4.17), there is no applicable financial reporting standard for life insurance business and there are number of approaches to life insurance accounting which may be regarded as generally accepted accounting practice. Life companies are also, by Release No 4 issued by the ASRB in August 1994, excused from the application of six SSAPs to their financial statements (see para 4.18).
9.2	We have reviewed each year the financial statements of nearly every life insurance company operating in New Zealand. In our view these financial statements have had many shortcomings. The enactment of the FRA did not significantly remedy these shortcomings because there has been no approved financial reporting standard for life insurance companies available to deal with the peculiarities of life insurance business.
9.3	Among the matters we noted were: many financial statements of life insurers did not show a "profit" figure in the conventional sense. In these cases it was impossible to determine the outcome of the company's trading for the year from its published financial statements. Companies which reported on the basis of the schedules to the Life Act provided only a "revenue account" and a balance sheet. The "income" or "surplus" figure in the revenue statement took no account of the change in the company's liabilities over the period.52 Some Life Act "revenue statements" did not include comparative figures for the previous year; where financial statements showed something akin to a profit figure it was sometimes not possible to tell the extent to which this profit had been derived from the year's trading and the extent it had been increased or reduced by transfers to or from reserves; there was inconsistent treatment of unrealised profits and losses on revaluation of investments. Some companies put these changes through the profit and loss or revenue account while others took them directly to reserves; it was generally not possible to ascertain the level of a company's capital or solvency "buffer" i.e. its shareholders' funds plus the difference between the company's liability to its policyholders and its disclosed level of life insurance funds, because generally a company's actuarially computed liability to its policyholders was not disclosed. This liability was usually not the same as the "life insurance fund" disclosed as a source of funds in the company's financial statements because: the actual liability to policyholders was less than the stated amount of the life insurance fund; and/or the liability to policyholders in the valuation (sixth schedule) balance sheet included contingency and other reserves not disclosed in the financial statements; and/or sometimes investment revaluation reserves disclosed in the company's statement of financial position (separately from what was described as the "Life Fund", but among "Life Assurance Funds") were actually required to cover the company's liability to its policyholders; a few financial statements disclosed the actuarial liability to policyholders as a memorandum item so that the extent of any "hidden reserve" could be calculated; there was no distinction in the financial statements between assets attributed to policyholders and those attributed to shareholders; there was no disclosure of the basis upon which profits had been divided between shareholders and with-profits policyholders, where this had occurred; there was often no disclosure of the basis on which the company's liabilities to policyholders had been determined; there was no analysis of the risk concentration of the company's investment exposures broken down, for example, by percentage of total assets; there was no breakdown of the life insurer's policy liabilities by maturity so that it was not possible to ascertain either the extent to which the life insurer was using the issue of short-term life policies as a means of financing its day to day operations or the extent of any matching or mis-matching of the maturity of its assets and liabilities; there was generally no statement attributed to the company's actuary as to his or her responsibility for measuring the value of the company's liabilities, his or her assessment of the company's ability to meet its liabilities as they fall due, or his or her assessment of the fairness of the procedures used for setting the distribution of profits as between shareholders and policyholders.
A financial reporting standard for life insurance business
9.4	It has been partly as a result of our awareness of life insurance industry accounting practices that we have been encouraging the Institute of Chartered Accountants of New Zealand ("the Institute") (formerly the New Zealand Society of Accountants ("the NZSA")) to introduce a financial reporting standard for life insurance companies.
9.5	We have been conscious that, with the obligation from October 1997 onwards for life insurance companies to issue prospectuses and investment statements, there should be a satisfactory financial reporting standard for life insurance in place in New Zealand.
9.6	We welcomed the publication of ED-79, Financial Reporting of Life Insurance Business, by the NZSA in July 1996 and we look forward to the exposure draft becoming an approved financial reporting standard as soon as possible.
9.7	It follows from our earlier comments that in our view the new financial reporting standard needs to provide for: a consistent approach to the valuation of liabilities and the calculation of profit taken by all companies; a conceptually sound "profit attributable to shareholders" figure reported for all proprietary life insurers; disclosure of actuarially computed solvency reserves, with an explanation of the meaning and status of those reserves; disclosure of any difference between the reported level of "life insurance funds" and the calculated actuarial liability to policyholders ; some analysis of the exposure concentrations, along the lines incorporated in the financial reporting standard for financial institutions (in bands related to percentages of total assets); appropriate disaggregation of the life insurer's policy liabilities by broad order of liquidity; disclosure of the basis on which profits have been divided between with-profits policyholders and shareholders; description of those assets assigned to shareholders and those assigned to policyholders and a description of the principles of segregation, where allocation of assets is asserted; a statement from the company's actuary as to his or her responsibility for the calculation of the company's liabilities to its policyholders, assessment of the company's ability to meet its obligations as they fall due, and procedures for ensuring the fairness of the distribution of profits between shareholders and with-profits policyholders.
9.8	The ED already addresses a number, but not all, of these issues.
9.9	The Institute has a process underway for considering submissions on the exposure draft, ED-79. It can be expected that the form of the standard will change as a result of the Institute's normal consultation process. Moreover the Institute has committed itself to moving forward with its counterpart organisations in Australia. It is our expectation from discussions in Australia that progress achieved on this joint basis is likely to be slow.
Life insurance financial reporting in Australia and the United Kingdom
9.10	ED-79 is an exposure draft of what is intended to be a joint Australia-New Zealand financial reporting standard for life insurance business. However in Australia the Commissioner, through his rule-making powers, has prescribed financial reporting obligations for life companies, including use of the "margin on services" method of accounting for determining life insurance policy obligations and thus profits. This method is, with some variations, the same as that included in the current draft Australia/New Zealand financial reporting standard. Australian life insurance companies are currently publishing their financial statements on the basis of the Commissioner's rules.
9.11	In the United Kingdom there is no approved financial reporting standard for life insurance business. Companies generally report on a solvency basis. However some life insurers have used, as a supplementary basis of financial reporting, the "achieved profits" method. This is a method put forward by the Association of British Insurers but is one which does not, we understand, have wide acceptance in the UK. (Several companies have used the achieved profits method to report their results in New Zealand.)
Comment
9.12	In general terms we have supported the approach taken in the exposure draft, including its adoption of the "margin on services" method of measuring life insurance company liabilities.
9.13	We do not propose to discuss the various alternative methods of profit determination for life insurance companies in this paper in any detail.53
9.14	We are aware that there are criticisms of the margin on services method of accounting for life insurance profits, particularly as to the predictive value of its reported profit. Mr Richardson-Hay, for example, with respect to the "margin on services" method, said in his paper, "It has a number of fundamental flaws, which make it unusable for any other purpose except as an accounting tool. It will generate a profit figure that may be considered meaningless and misleading. ... If adopted in New Zealand will it replace the current unacceptable system with a meaningless system? ...".
9.15	We think this criticism is too harsh. We understand that the method, despite its shortcomings, is generally accepted by the actuarial profession in Australia, where there is now some experience with using it. Moreover the policy of the FRA is to provide harmonisation of financial reporting standards with Australia and this should be an important consideration particularly as it will facilitate comparisons of the results of companies in the Australasian region.
9.16	The solvency method is generally regarded as too conservative to give a fair recognition of the profitability of a portfolio of life insurance policies. This view is supported by recent experience where the prices paid for life insurance businesses being acquired greatly exceeded the book value of the shareholders' and policyholders' funds.
9.17	We consider there is an urgent need for the adoption of a new financial reporting standard for life insurance business in New Zealand. The regulatory environment under which life companies operate in Australia is fundamentally different from that in place in New Zealand. Because Australian life insurance companies are now reporting publicly under financial reporting rules imposed by the Commissioner there is less urgency in Australia for the introduction of a new financial reporting standard. The basic philosophy in New Zealand is disclosure of information and market scrutiny. That process of scrutiny is hamstrung at present by a lack of coherent financial information.

10.1	In this paper we have set out some of our experiences during the administration of the provisions of section 7A of the Securities Act.
10.2	We have observed that: there are no specific statutory duties imposed on the directors of life insurance companies other than those imposed on directors in favour of creditors generally; there are general disclosure obligations in the Life Act, the FRA and the Securities Act designed to provide financial information about the issuers of life insurance policies to prospective policyholders, but these are dependent for their effectiveness on the approval of the proposed new financial reporting standard; the new prospectus and investment statement requirements will oblige life insurance companies to disclose such matters as product risk, details of the fees and charges and methods of determining returns and surrender values for each type of policy; there is limited official monitoring of the activities of life insurance companies through review of statutory returns carried out be the Ministry of Commerce and the Government Actuary; there are minimal barriers to entry into the New Zealand life insurance market; there is no requirement that the board or management of a life insurance company have to be "fit and proper" persons to be engaged in life insurance business; there are no prescribed standards for solvency or capital adequacy; there is no actuarial standard relating to solvency developed by the actuarial profession; there are no constraints of related party exposures or concentration of risks which can be undertaken by New Zealand life insurance companies: related party exposures appear to be facilitated by the provisions of the Companies Act 1993 which allow subsidiary companies to act in the best interests of their parent companies in certain circumstances; the existing statutory rules about the segregation of policyholders' funds from other assets of life insurers are unclear; there are no effective rules of law as to the division of profits between shareholders and with-profits policyholders; life insurance companies are able to pledge, and some have pledged, their life insurance assets to third parties with claims which rank in priority to, or in competition with, the claims of policyholders; there are no effective rules of law as to minimum surrender values of life insurance policies; there are no minimum qualification or experience criteria for actuaries who make financial condition reports on companies; there is no requirement which would prevent an actuary with demonstrable conflicts of interest (managing director of the company) from giving the statutory report to the company on its financial condition and there is no explicit requirement for disclosure of details about any conflicts of interest the actuary may have; there is no requirement in the law for policyholders to be consulted on major transactions, including changes of business ownership, which could materially affect them; life insurance companies do not have to appoint trustees or statutory supervisors pursuant to trust deeds or participation deeds; there has been no financial reporting standard for life insurance financial reporting, although this problem is being addressed through a draft new financial reporting standard, but the evaluation of that standard has been seriously delayed.
10.3	We have noted that Australia and the United Kingdom are examples of regulatory regimes for life insurance which are considerably more extensive than that existing in New Zealand. This is not an argument that such regulatory approaches should necessarily be followed in New Zealand. They are examples, however, of how the various issues have been addressed elsewhere.
10.4	We believe on the basis of our experience that there are a number of questions relating to the operation of life insurance companies, and the laws which govern those operations, which need to be addressed. We believe there is an urgent need to review the provisions of the Life Act.
10.5	In the final Part of our paper we provide further analysis and comment and we set out questions which we believe are relevant. We welcome responses to the questions we have identified. Once these responses have been analysed we will report as appropriate to the Minister of Commerce.

ISSUES IN THE REGULATION OF LIFE INSURANCE COMPANIES
11.1	In this Part of our paper we discuss some of the issues relating to possible forms of regulation of the life insurance industry. We do this to assist readers to respond to the questions set out in section 12. We are not promoting any particular regulatory approach. The Commission at this stage does not have a view as to the appropriate form of regulation, if any, of the life insurance industry.
11.2	A fundamental question in any regulatory review is whether there should be any form of regulation of the subject industry or activity at all. The paper does not address that question. We believe the most useful way to consider life insurance regulatory issues at this time is in the context of already-regulated markets. This brings into consideration some "level playing field" arguments as well as questions of the appropriate degree of regulatory input, if any, into various facets of companies' operations.
11.3	We are aware there is extensive academic literature on the economics of regulation. We would expect any comprehensive review of the Life Act to have proper regard to the literature.
11.4	The existing "regulation" of the life insurance industry is a mix of various inter-dependent components. We discuss the existing components of life insurance regulation, and some possible additional or alternative elements, including the possibility of appointing a trustee or statutory supervisor for life companies, introducing an appointed actuary regime, or introducing a requirement for compulsory rating of life insurance companies' obligations, in the remainder of this section.
The duties of the directors of life insurance companies
11.5	Issues which arise when considering the possible weight to give to reliance on directors' statutory and other duties as means of "regulating" the life insurance industry include: the influence of directors' duties is pervasive i.e. it affects all aspects of a company's operation without the need for specific regulation of various components; 2 action against directors for breach of their duties is generally a civil matter taken by shareholders or creditors; enforcement action may be too expensive, or too impractical, for individual policyholders, or shareholders, to undertake; policyholders are owed duties as creditors of life companies but may be contractually vulnerable to the ability of companies to vary the amounts owed to them as creditors; different rules of law apply to directors of companies incorporated in New Zealand and those incorporated overseas but carrying on business in New Zealand; the penalties provided in the legislation may not be adequate as a means of ensuring directors are diligent in carrying out their obligations; broadly expressed duties and obligations may be difficult to apply in specific circumstances and ultimately require interpretation by the Courts; directors of New Zealand life insurance companies have no obligation to give priority to the interests of policyholders; policies tend to be for a long period of time and the policy of directors on conduct of the company's business generally, including investment philosophy and the allocation of benefits to policyholders, may change significantly over the contract period.
The role of market scrutiny in the regulation of the industry
11.6	Matters which arise in relation to the possible weight which should be given to market scrutiny as a means of "regulating" the life insurance industry include: the adequacy of disclosures to be made in the prospectuses and investment statements of life companies; the limitations inherent in any prescribed disclosure regime, including the cost of compliance, the risk of over- or under-prescribing the amount of information to be provided, and the difficulties of keeping abreast with market developments; the responsibility for investment decisions rests with the investor; life insurance companies are complex and it is not possible for the prudent but non-expert investor to adequately comprehend their financial and actuarial information; the nature of investors in or beneficiaries of life insurance policies, being generally private individuals, often purchasing life insurance at a young age or when family circumstances may dictate the need for some life insurance cover; disclosures to prospective investors of a life company's investment mix may be of limited usefulness when a life insurance contract may run as long as 70-80 years; knowledge of a company's deteriorating financial performance or position may be of little benefit to an existing policyholder because of the generally high cost to the policyholder of surrendering a policy.
Direct role of the Government and its agencies
11.7	Issues which arise in relation to the possible weight which should be given to the role of the central government in the "regulation" of the life insurance industry include: Government intervention involves direct costs for the taxpayer, compliance costs for life companies, and resource allocation costs; the effectiveness of the respective present roles of the Secretary for Commerce, the Government Actuary and the Securities Commission in monitoring and last-resort intervention is dependent on provision of appropriate resources; if the Government contemplated some form of prudential supervision for the life insurance industry, the matters for consideration might include the levels of solvency and capital adequacy, the quality of investments, major transactions such as the pledging of assets and acquisition or sale of businesses. Factors bearing on the costs and benefits of such an approach might include: similar factors to those which may limit the effectiveness of market scrutiny of the industry (see para 11.6 above); investors in life insurance products may gain a more reasoned expectation that life insurance companies will remain solvent in the longer term regardless of future changes to management or ownership; the moral hazard costs arising from the perceived moving of responsibility for monitoring company performance to the supervisor and the associated reduced diligence of investors.
11.8	Australia and the United Kingdom have rules of law relating to life companies' processes of profit allocation, setting of fees and charges, and determination of policy surrender values. Issues arising as to whether such rules of law should be introduced in this country include: while a minimum surrender value standard along Australian lines may give policyholders greater assurance as to the value of their investments it could arguably also put a life insurer's solvency at increased risk because the company would have a reduced capacity to lower the value of its obligations to policyholders in certain circumstances; if a significant share of the risk of investment decisions is passed to the policyholders this would give the directors of life insurance companies incentives to engage in somewhat more risky investment or other activities than might otherwise be the case; effective disclosure of profit allocation policies and of fees and charges should diminish or offset factors such as the weak bargaining position of individual investors and the difficulty of monitoring companies' compliance with commitments made to investors in earlier years.
The segregation of policyholders' funds
11.9	Issues which arise in relation to the segregation of policyholders' funds include: the adequacy and clarity of the present provisions of section 15 of the Life Act regarding the separation of the life insurance assets of a life insurance company; the risks and benefits to policyholders which can arise from the pledging of life insurance assets to third parties in priority to, or competition with, the claims of policyholders; the creation of separate "statutory funds" for the receipt of policyholders' premium and other payments and the holding of the corresponding assets should help to clarify: the status of policyholders' funds in the event of the winding up of the company; whether the assets of such funds could be pledged as security to third parties, and, if so, whether the circumstances in which this is done need to be constrained; the terms on which moneys could be transferred out of such funds other than by way of distribution to policyholders i.e to other funds or to shareholders.
The change of ownership of life insurance companies and portfolios of life insurance business
11.10	Issues which arise in relation to changes of ownership of life insurance companies and portfolios of life insurance business include: the adequacy or otherwise of the existing provisions of the Companies Act and the Listing Rules of the New Zealand Stock Exchange in relation to changes of company ownership and other major transactions; the adequacy or otherwise of the 'financial assistance" provisions of the Companies Act in relation to use of the resources of a life insurance company to finance its own acquisition; the favourable and adverse affects for policyholders which could follow from changes of company or portfolio ownership; the status of policyholders as creditors of life insurance companies; the desirability or otherwise of giving policyholders some input into changes of company or portfolio ownership; whether directors of life companies should be required to obtain independent actuarial advice in relation to major transactions including changes of company or portfolio ownership.
The appointment of a trustee or statutory supervisor for life insurance companies
11.11	Issues which arise in relation to a possible requirement to appoint a trustee or statutory supervisor to a life insurance company include: the similarity of some life company policies, particularly short-term fixed interest bonds, with debt securities, for which a trustee is required to be appointed; the similarity of some life company policies to interests in a unit trust under the Unit Trusts Act 1960 or in a contributory scheme under the Securities Act, which have a trustee or a statutory supervisor; the actuary does not appear have a clear role in relation to policyholders; although the Government Actuary has power to report to the Minister on the basis of his analysis of a company's statutory returns, this power has, in practice, been one of last-resort used where the solvency of a life insurance company appeared to be at risk; a trust deed could provide a mechanism to overview life insurance company capital adequacy, solvency and investment practices, major transactions, profit allocation policies and the giving of security over company assets, in the interests of the policyholders; a trustee would be in a position to initiate winding up action on behalf of policyholders; difficulties may arise with any proposal to introduce a trustee requirement because of the number of New Zealand insurance companies which are incorporated overseas and, potentially, subject to comprehensive regulation in their primary place of business.
An appointed actuary for life insurance companies
11.12	Issues which arise in regard to possible introduction of an appointed actuary regime in New Zealand include: the Life Act does not currently define "actuary" nor set minimum standards of education, experience or competence; actuaries currently have no guaranteed rights of access to company records, speaking rights at board meetings, nor protection for "whistle-blowing"; actuaries currently have no reporting obligations to policyholders; restricting participation in a statutory office to those persons who meet certain academic and other qualifications may restrict competition among those wishing to provide actuarial advice to life companies; whether an appointed actuary regime needs to have statutory backing or whether, alternatively, it could be established and managed by the actuarial profession in consultation with the life companies.
A requirement for compulsory rating of life insurance obligations
11.13	Issues which arise concerning possible introduction of a compulsory rating requirement for life insurance companies include: requiring disclosure of a rating could be an effective way of communicating a professional assessment of a company's long-term claims paying ability to prospective investors; a rating requirement could be seen as a substitute for, or addition to, a more broadly-based scheme of regulation for life insurance companies; life insurance companies would be put in a similar position to general insurance companies, which already have a legislative requirement to obtain a rating of their claims-paying ability; it may be necessary to distinguish for this purpose companies offering term life insurance policies only, which are no longer subject to the Securities Act, and companies offering investment linked policies. The term life policy is likely to be renewed annually. The investment linked policy will tend to be of a much longer duration, and have a surrender value during the life of the policy; should the policyholder have any rights in the event that a company's rating deteriorates, e.g. a right to terminate a policy, or to alter the terms of investment; the quality of rating agencies for the purposes of any compulsory requirement


12.1	Life insurance is an important and complex industry. Contracts of life insurance range from the equivalent of short-term debt securities to whole of life policies which could last for 70 - 80 years. Many life insurance contracts lack portability, and can only be realised prior to maturity at considerable cost to the policyholder. Some life insurance policies give rise to benefits which are in the nature of annuities, on which beneficiaries may be dependent for their livelihood.
12.2	All life insurance contracts are subject to the Life Act. Many life insurance policies are subject to securities law. Some aspects of life insurance companies' business are monitored by government agencies. There are special provisions which provide for the judicial management of failed life insurance companies.
12.3	We think it most likely there will continue to be Government or Crown Agency involvement in the regulation of the life insurance industry, including of the disclosures to be made to policyholders and prospective policyholders, for the foreseeable future. Similarly, the life insurance industry, the actuarial profession, the accounting profession and securities market practitioners generally, all have and will continue to have important roles to play.
12.4	Responses to the questions we set out in this section of the paper should aid the process of deciding what these respective roles should be.
The questions
1.	Do you consider changes should be made to the existing regulatory regime for life insurance companies or products? Why?
2.	Do the particular characteristics of the life insurance industry warrant or justify any different treatment for securities issued by companies operating in that industry compared to other issuers of securities? If so, what are the characteristics which give rise to the need for differential treatment?
3.	What are your views on the relevance and weighting (if any) which should be given to each of the following elements in an overall scheme of regulation of the life insurance industry: Company law containing provisions about the duties and responsibilities of directors of life companies, the rights of shareholders and the rights of policyholders and other creditors; Provisions in the law for adequate and timely disclosure of relevant information to prospective and existing policyholders concerning a company's financial position, performance, cash flows and solvency and of the practices it will follow in relation to the allocation of profits and the imposition of fees and charges; Some form of prudential supervision of life insurance companies, which might include a statutory framework for prescribing levels of capital adequacy and solvency for life insurers and for constraining large and related party exposures; A trust deed entered into between a trustee corporation and the life company which might include negative pledge provisions monitored by the trustee and relating to maintenance of adequate capital and solvency, constraints on large and related party exposures and clauses requiring consultation with the trustee in certain events such as takeovers or other major transactions? What other options exist and what are your views on them? Additional comments on reasons for the relative emphasis given to each element would be helpful.
4.	With respect to the statutory duties of directors of life companies: Should the directors of life companies be subject to an additional specific duty to recognise or give priority to the interests of policyholders? In what respects? Should life companies which are wholly owned subsidiaries of other companies be permitted to include in their constitutions clauses which enable them to act in the best interests of the parent company even if it is not in the best interests of the life company? Should the existence of such clauses be disclosed in prospectuses or investment statements for life insurance policies? Should the inclusion of such clauses in a life company's constitution require the approval of policyholders before they can be made?
5.	With respect to takeovers of life insurance companies, or changes of ownership of portfolios of life insurance business: Are the existing provisions of the Companies Act and the Listing Rules of the New Zealand Stock Exchange in relation to changes of life insurance company or portfolio ownership adequate in relation to the interests of policyholders? If not, if what way should these provisions be changed? Are the existing "financial assistance" provisions of the Companies Act adequate in relation to the interests of policyholders where a life company is acquired by another company? Should policyholders have the right to be consulted by the life company concerning major transactions undertaken which might affect them, either directly or through reference to a trustee or statutory supervisor or otherwise? Should the directors of life insurance companies be required to obtain independent actuarial advice on the effect on policyholders of prospective change of ownership or other major transactions?
6.	With respect to the rules of law regulating disclosure of information to prospective and existing policyholders: Is the existing disclosure framework adequate? If not, in what respects is it deficient? Are the disclosures of a life company's financial position and performance adequate without the promulgation of a New Zealand financial reporting standard for life insurance business? Does the proposed financial reporting standard as set out in ED-79 provide for the appropriate amount of information including information about a life company's exposure concentrations, liquidity, risk profile and solvency?
7.	With respect to the role of the Government or Crown Agency in the regulation of the life insurance industry: Should the Government sector's direct role be limited to that of review and last-resort intervention; or Should the Government establish a form of prudential supervision of the industry, including a framework for the monitoring and/or constraint of significant risk factors of life company operations such as capital adequacy, solvency, large and related party exposures; or Should the Government encourage greater self-regulation of the industry; or Should the Government's current role be reduced?
8.	With respect to the determination of returns on policies: What freedom do life companies currently have to determine policy returns? How does the position differ for various classes of policy? Is this position satisfactory? Should rules of law be introduced to provide for minimum surrender values for any policies? Should rules of law be introduced which regulate the manner of distribution of annual profits between shareholders and participating policyholders? If so, what form might such regulation take? Are there adequate requirements for disclosure of the basis on which returns to policyholders are calculated?
9.	Should life insurance companies be required to appoint a trustee under a trust deed to represent the interests of policyholders and to monitor the activities of the life companies on policyholders' behalf?
10.	With respect to the separation of life insurance assets: Are the current provisions of the Life Act covering the separation of life insurance business adequate? Do they require clarification? Should life companies be free to pledge their life insurance assets to external parties in priority to, or in competition with, the claims of policyholders? In what circumstances, if any, should such pledging of assets be constrained? If there are some circumstances where the pledging of life insurance assets to third parties should be constrained how should such constraint be achieved? Should New Zealand introduce a form of statutory fund for the conduct of life insurance business along the lines of the current provisions in Australia? Should there be restrictions placed on the types of business which can be undertaken by companies conducting life insurance business?
11.	With respect to the position and role of actuaries: Should actuaries have explicit responsibilities towards the policyholders? If so, what should those responsibilities be? Should New Zealand introduce an appointed actuary scheme along the lines of those already in place in Australia and the United Kingdom, with defined responsibilities, qualifications, access to information, and protection in relation to disclosures made to the authorities? Are there adequate disclosures in a company's prospectus and financial statements concerning the relationship between the company and the actuary responsible for preparing the valuation of the company's assets and liabilities, including disclosure of any pecuniary interest the actuary may have in the company? If actuaries are required to assume greater responsibilities should their liabilities be restricted in any way? If so, how?
12.	Should a compulsory rating requirement for life insurance company's claims paying ability be introduced? Should policyholders have any specific rights in the event that a company's rating deteriorated? Would such a rating requirement be an alternative to, or a supplement to, existing or more extensive regulation of the life insurance industry in New Zealand?
Invitation
12.5	The Commission welcomes observations on the questions raised in this paper. We also welcome comment on any other matters covered in the paper. All comments should be forwarded to the Commission by 31 March 1998 at the addresses below.
	E H Abernethy Chairman Securities Commission 12th Floor Reserve Bank Building 2 The Terrace WELLINGTON 8 December 1997 Addresses for comments Postal: P O Box 1179, Wellington Telephone: (04) 472 9830 Facsimile: (04) 472 8076 Email: seccom@seccom.govt.nz

APPENDIX ONE

THE TEXT OF SECTIONS 7A AND 7B OF THE SECURITIES ACT 1978

SECT. 7A. EXEMPTION FOR AUTHORISED LIFE INSURANCE COMPANIES--

(1) Nothing in sections 33 (2), 33 (3), 35, 37, 37A, 39 to 44, and 44B to 54 of this Act shall apply in respect of any life insurance policy issued by an authorised life insurance company in accordance with its authorisation.

(2) The Commission may, by notice in the Gazette, declare a life insurance company to be an authorised life insurance company for the purposes of this Act.

(3) An authorisation may be for--
(a) Specified life insurance policies:
(b) A specified class or specified classes of life insurance policy:
(c) Life insurance policies generally:
(d) Life insurance policies generally other than--

Specified life insurance policies:
A specified class or specified classes of life insurance policy--

and may be on such terms and conditions as the Commission thinks fit.

(4) The Commission may, by notice in the Gazette, vary or revoke any authorisation.

(5) Before issuing any notice the Commission shall do everything reasonably possible on its part to advise all persons and organisations, who in its opinion will be affected by the proposed notice, of the proposed terms of it; and give such persons and organisations a reasonable opportunity to make submissions to the Commission.

(6) Subsection (5) of this section shall not apply in respect of any particular notice if the Commission considers that it is desirable in the public interest that the notice be made urgently.

(7) Failure to comply with subsection (5) of this section shall in no way affect the validity of any notice made under this section.

SECT. 7B. TERMS AND CONDITIONS OF AUTHORISATION--
The terms and conditions of authorisation of a life insurance company may include terms and conditions--

(a) Requiring the company to observe standards for the carrying on of life insurance business prescribed or approved by the Commission:

(b) Requiring the company to publish in such manner and at such times as may be specified by the Commission financial statements, which the Commission may require to be audited, containing such information as the Commission may specify.

APPENDIX TWO

THE REQUIREMENTS OF THE SIXTH SCHEDULE TO THE LIFE INSURANCE ACT 1908

STATEMENT RESPECTING THE VALUATION OF THE LIABILITIES UNDER LIFE POLICIES AND ANNUITIES OF THE, TO BE MADE BY THE ACTUARY

...

1. The date up to which the valuation is made.

2. The principles upon which the valuation and distribution of profits among the policyholders are made, and whether these principles were determined by the instrument constituting the company, or by its regulations or bylaws, or otherwise.

3. The table or tables of mortality used in the valuation.

4. The rate or rates of interest assumed in the calculations.

5. The proportion of the annual premium income (if any) reserved as a provision for future expenses and profits. (If none, state how this provision is made.)

6. The Consolidated Revenue Account since the last valuation, or, in case of a company which has made no valuation, since the commencement of the business. (...)

7. The liabilities of the company under life policies and annuities at the date of the valuation, showing the number of policies, the amount assured, and the amount of premiums payable annually under each class of policies, both with and without participation in profits, and also the net liabilities and assets of the company, with the amount of surplus or deficiency. ( ...)

8. The time during which a policy must be in force in order to entitle it to share in the profits.

9. The results of the valuation, showing-

The total amount of profit made by the company.
The amount of profit divided among the policyholders, and the number and amount of the policies which participated.
Specimens of bonuses allotted to policies for [$200] effected at the respective ages of 20, 30, 40, and 50, and having been respectively in force for 5 years, 10 years, and upwards, at intervals of 5 years respectively, together with the amounts apportioned under the various modes in which the bonus might be received.

...

	GLOSSARY OF TERMS USED IN THE PAPER
	the ACL case	ACL Insurance Limited v ACL Insurance Limited (In Liquidation) HC, Auckland M2121/89 6 March 1995
	the ASRB	the Accounting Standards Review Board, a statutory body established under the Financial Reporting Act to approve financial reporting standards
	authorisation	declaration concerning a life insurance company made by the Commission under section 7A of the Securities Act 1978
	bundled policies	life insurance policies where the savings and risk components of the contract, and the expenses charged to it, are not separately identified
	the Code	the Code of Business Practices for Life Insurance Companies, a document issued by the LOA and approved by the Commission
	the Commission	the Securities Commission
	the Commissioner	the Insurance and Superannuation Commissioner (head of the Insurance and Superannuation Commission, the Australian regulatory body responsible for oversight of the life insurance and superannuation industries)
	the Companies Act	the Companies Act 1993 (New Zealand legislation)
	ED-79	Exposure Draft 79 Financial Reporting of Life Insurance Business issued by the New Zealand Society of Accountants in July 1996
	the FRA	the Financial Reporting Act 1993 (New Zealand legislation)
	FRS	Financial Reporting Standard, issued or adopted by the Institute of Chartered Accountants of New Zealand
	the IAT	the Insurance Acquisitions and Takeovers Act 1991 (Australian Federal legislation)
	the ICA (UK)	the Insurance Companies Act 1982 (United Kingdom legislation)
	the Institute	the Institute of Chartered Accountants of New Zealand
	investment statement	offer document required for all offerings of securities after 1 October 1997 designed (section 38D Securities Act) to provide key financial information for the prudent but non-expert investor
	the ISI	the Investment Savings & Insurance Association of NZ Inc, formed following the merger of the Life Office Association of New Zealand and the Unit Trust Association of New Zealand
	the LIA (Aust)	the Life Insurance Act 1995 (Australian Federal legislation)
	the LIASB	the Life Insurance Actuarial Standards Board (Australian authority established by section 100 of the Life Insurance Act 1995 with responsibility for making actuarial standards under that Act)
	the Life Act	the Life Insurance Act 1908 (New Zealand legislation)
	the LOA	the Life Office Association of New Zealand Inc
	the Marac case	Marac Life Insurance Limited v Commissioner of Inland Revenue [1986] 1 NZLR (694)
	mutual company	life insurance company owned by the policyholders i.e. with no separate shareholders
	the NZSA	the New Zealand Society of Accountants
	persistence	the maintenance of policies in full force from year to year
	proprietary company	life insurance company owned by shareholders
	reassurance	a contract of indemnification providing for a third party to accept part or all of the mortality or morbidity risk associated with a particular life assurance or disability policy respectively
	the Secretary	the Secretary of Commerce (the chief executive of the Ministry of Commerce)
	section 7A	section 7A of the Securities Act 1978
	section 7B	section 7B of the Securities Act 1978
	the Securities Act	the Securities Act 1978 (New Zealand legislation)
	Sixth Schedule return	return required by the Sixth Schedule to the Life Insurance Act 1908, being an abstract from the actuary's annual investigation of a company's financial position
	the Society	the New Zealand Society of Actuaries
	solvency	the ability of life assurance companies to meet the claims of policyholders as they fall due
	SSAP	Statement of Standard Accounting Practice issued by the New Zealand Society of Accountants. Forerunner to Financial Reporting Standards.
	statutory fund	term currently used in Australia to define a fund that is established in the records of a life company and relates solely to the life insurance business of the company or a particular part of that business
	surrender value	a cash sum available to a policyholder in the event the policy is surrendered earlier than its expected maturity, or prior to death
	Twentieth Schedule return	return required by the Twentieth Schedule to the Life Insurance Act 1908, being statistical information of the number, value and types of policies sold by the company during the last twelve month reporting period, and of the policies still in force at balance date.
	unbundled policies	those life insurance policies where the cost of life cover and expenses are explicitly separated on an individual policy basis from the amount available for investment

New Zealand Securities Commission

Discussion Paper on Life Insurance Law and Practices [1997] NZSecCom 4 (8 December 1997)