The future of insurance regulation.

Current corporate governance initiatives are focusing on public corporations. However, the distinct nature of insurance companies as regulated financial institutions is emerging as an issue for regulators worldwide.

Rather than being transparent, insurers often are considered "opaque" because some of their activities are not publicly disclosed or disclosed only with significant time lags. Insurance accounting rules don't always help to make the business more understandable to investors. Moreover, policyholders are a class of unsecured financial stakeholders unique to insurance business, and life insurance creates an even greater conflict-of-interest potential. Prudent rules and state supervision traditionally have been used instead of market mechanisms to protect policyholders from most of the major agency problems.

Nevertheless, supervision also may give rise to additional problems. For example, when the role of monitoring management is transferred to the supervisor, the incentives of shareholders, policyholders and market participants to assume a respective role are diminished.

The governance of mutual insurers is also an area of growing concern. Policyholder ownership originally was seen as a way to protect policyholders against governance problems posed by investor-owned insurance companies. Now, mutuals are lagging behind in good corporate governance practice. Although nominally run on a policyholder democracy basis, for example, mutuals may be managed by professional managers holding voting proxies and operating under little control or accountability.

It is not easy to address the agency problems among managers, policyholders and shareholders in a regulated environment. The European Commission's Action Plan does not contain any such initiatives, nor is there any indication that the commission is considering any in the immediate future. But there is a host of jurisdictions contemplating the introduction of related legislation. Both Canada and Singapore consulted in early 2003 on whether corporate governance rules should be reflected in the legislative framework of financial institutions. Since 2001, Illinois has had in place legislation on the corporate governance of insurance companies. Several countries whose legislation is being overhauled by western experts or that are under pressure from international development banks and organizations have included specific governance rules for insurance companies.

However, insurance company objectives and the allocation of responsibilities between board and actuary can be difficult to define. At the moment, nonbinding guidelines remain the rule. The International Association of Insurance Supervisors has already issued corporate governance guidelines for insurance companies, and the Organization for Economic Cooperation and Development is currently working on a similar initiative in the framework of its project on financial governance. Only last year it issued its guidelines on Pension Fund Governance. The OECD 1999 original corporate governance principles were the blueprint for countless national codes of conduct.

There have been several claims that lax corporate governance mechanisms have contributed to the failure of some insurance companies (the financial collapse of Australia's HIH Insurance Group or the United Kingdom's Independent Insurance, for example). Litigation over the United Kingdom's Equitable Life with-profits scandal is bringing under the spotlight the duties and responsibilities of nonexecutive insurance directors. Although many believe that corporate governance fears have been milked dry, insurers should take care not to become the next case study. They should identify any governance issue that might be of concern for a zealous legislator or regulator and take steps to address it in a both adequate and preemptive way.