Chapter 2: Taxation and supervision

Question 1

Legislation governing the taxation of short-term insurance in SA

Answer 1

Short-term insurance companies are taxed in accordance with
section 28 of the Income Tax Act No. 58 of 1962,
read together with subsequent amendments made thereto from time to time.

Question 2

Short-term insurers are taxed on …..

Answer 2

their operating profits.

Taxation in SA is RESIDENT BASED.

Question 3

Resident based taxation

Answer 3

Insurance companies resident in SA are subject to tax on income received from local and foreign sources.

Question 4

3 expenses deducted from premium income accrued to determine taxable income

Answer 4

1. reinsurance premiums incurred
2. actual claims incurred net of claims recovered or recoverable under any contract of insurance, guarantee, security or indemnity
3. any other expenses incurred in the running of the business as are admissible in terms of the Income Tax Act.

Question 5

Technical reserves deductible to determine taxable income

Answer 5

In addition to deductible expenses, the following technical reserves referred to in Section 32(1) (a) and (b) of the Short-term Insurance Act No. 53 of 1998, namely:

a. the amount which the short-term insurer estimates will become payable in respect of claims incurred under short-term insurance policies –
1. and reported but not yet paid, reduced by the amount which it estimates will be paid in respect of those claims under approved reinsurance policies;
2. not yet reported, reduced by the amount which it estimates will be paid in respect of those claims under approved reinsurance policies, being an amount not less than the amount calculated in accordance with Part II of Schedule 2 of the Short-Term Insurance Act.

b. an unearned premium provision being an amount not less than the amount calculated in accordance with Part II of Schedule 2.

Question 6

Investment income comprises (3)

Answer 6

• net interest received
• dividends received
• profit or loss on realisation of investments are subject to Capital Gains Tax (CGT)

Question 7

Dividend tax

Answer 7

A tax on shareholders at a rate of 15% on receipt of dividends.

Withholding tax.

Question 8

Secondary Tax on companies (STC)

Answer 8

imposed on companies (at a rate of 10%) on the declaration of dividends.

Question 9

Taxation within the Lloyd’s Market

Answer 9

Tax is levied on individual Names and is subject to the delay arising from the 3 year basis of accounting.

All Names are taxed in the UK on their Lloyd’s income regardless of their country of origin and the country in which their syndicates’ business is written.

Tax at the basic rate is deducted from a Name’s overall profits and paid directly to the Inland Revenue by the Name’s Members’ Agent. The Name is responsible for paying any additional tax due.

Any Lloyd’s business arising locally is subject to VAT which is paid to SARS before the net premium is remitted to the United Kingdom.

Question 10

Supervision of Short-term insurance companies

Answer 10

• regulated by the Short-term Insurance Act of 1998
• the Registrar of Short-Term Insurance monitors adherence to the Act.

The executive officer of the Financial Services Board is the Registrar of Short-Term Insurance.

Short-term insurance companies have to be registered under the Companies Act 1973 and so are also regulated by this Act.

Question 11

8 Classes of insurance in the Short-term Insurance Act No. 53 of 1998

Answer 11

• accident and health
• engineering
• guarantee
• liability
• miscellaneous
• motor
• property
• transportation

Question 12

Define “Approved reinsurance”

Answer 12

Approved reinsurance is defined to be

a) all proportional reinsurance; and
b) non-proportional reinsurance only if the policy “remains in force until the liabilities under short-term policies have expired”,

where the reinsurance must be placed with

a) any RSA insurer (registered reinsurer or direct writer); or
b) Lloyd’s

Question 13

Reinsurance placed with a foreign reinsurer will only be approved if (3)

Answer 13

• the reinsurer holds a deposit in South Africa (the insurer can only reduce its liabilities by the amount of this deposit)
• an irrevocable guarantee is in place (the FSB has a prescribed form for this guarantee)
• the reinsurer issues a letter of credit (the insurer can only reduce its liabilities by the amount stated in this letter)

Question 14

10 Parts of the Short-term insurance act

Answer 14

I: Administration of the Act
II: Registration of Short-term Insurers
III: Business and Administration of Short-term Insurers
IV: Financial Arrangements
V: Compromise, Arrangement, Amalgamation and Transfer
VI: Judicial Management and Winding up of Short-term Insurers
VII: Business Practice, Policies and Policy Holder Protection
VIII: Provisions relating to Lloyds
IX: Offences and Penalties
X: Transitional and General Provisions

Question 15

Short-term insurance act

Part I: Administration of the Act

Answer 15

• formalises communications between the Registrar and other persons
• stipulates the general and specific provisions concerning the Registrar

Question 16

6 Requirements for registration under the Short-term insurance Act

Answer 16

• entity must be a public company or corporation
• adequate management, financial and organisational resources
• directors and managing executive to be fit and proper
• control to be in the public interest
• the applicant must be able to comply with the Short-term Insurance Act
• business must in general be in the public interest

Further conditions may be included by the Registrar, such as limitation on the kinds of policies, minimum reinsurance requirements and certain provisions in the Memorandum and Articles of Association of the company.

The Registrar may vary a registration condition or terminate registration after giving notice to the insurer.,

Question 17

Meaning of a “Pay as paid” clause

Answer 17

The insurer will only pay the insured if the reinsurer paid the insurer.

Question 18

Short-term Insurance Act Part III:

Business and Administration of Short-term Insurers

Answer 18

This section states the limitations on business that the Registrar may impose when actin in the interest of policyholders.

In particular, short-term insurers are prohibited from carrying on any other business.

Insurers are to notify the Registrar of all appointments or terminations of directors or managing executives. The Registrar may require the termination or appointment of a director, managing executive, public officer, statutory actuary or auditor if it is believed that they are not fit and proper.

The Registrar’s approval is needed to issue debentures and some forms of preference shares.
Authorisation is also needed if more than 25% of the shareholding of the company is to be transferred to another shareholder.

The section also regulates the appointment of an auditor and stipulates that the auditor must notify the Registrar of anything which could prejudice the financial soundness of the insurance company. The appointment of an audit committee is compulsory.

Section 19A of the Act provides for the appointment of a Statutory Actuary.

Question 19

The role of the Statutory Actuary in a short-term insurer

Answer 19

A professional whose duty it is to protect the policyholders and to report on the financial health of the insurer.

The actuary is granted powers under this section to help him or her discharge his/her professional duties.

Question 20

Short-term insurance Act: Part IV: Financial Arrangements

A short-term insurer may not without approval of the Registrar: (4)

Answer 20

• encumber any of its assets
• allow its assets to be held by another person on its behalf;
• directly or indirectly borrow an asset, sign surety-ship or give personal security
• include in its assets shares directly or indirectly held in its holding company

Question 21

Short-term insurance Act: Part IV: Financial Arrangements

A short-term insurer may also not invest in derivatives unless: (3)

Answer 21

• it is acquired out of surplus assets;
• it is acquired for efficient portfolio management and to reduce investment risk;
• the insurer has the underlying asset available for settlement purposes.

Question 22

Short-term insurance Act: Part IV: Financial Arrangements

4 Technical provisions that an insurer must hold

Answer 22

• outstanding claims - calculated as case estimates;
• IBNR
• unearned premium provision
• unexpired risk provision

Question 23

Short-term insurance Act: Part IV: Financial Arrangements

Calculation of Unearned Premium Provision (excluding reinsurance policies)

Answer 23

Minimum amount of the Unearned Premium Provision
= (A - B) x (z - C/D) + E

A - gross premium (excl VAT)

B = refunded premiums (cancellations / changes)
+ reinsurance premiums
+ net commission payable

C - number of days from commencement of incidence of risk, until day of calculation.

D - total number of days for the whole period of risk

E - total reserve for any cash-back bonus

Question 24

Short-term insurance Act: Part IV: Financial Arrangements

Calculation of Unearned Premium Provision (reinsurance policies)

Answer 24

Minimum amount of the Unearned Premium Provision
= (A - B) / 2

A - gross premium (excl VAT)
…. as stipulated in the policy document
…. for the full term of the policy
…. irrespective of the frequency of the premium payment
…. under all of the policies concerned for the whole of the preiod
…. for which each of those policies is operative.

B - Sum of the following under all policies concerned for the whole of the period for which each of those policies is operative:

• — refunded premiums (cancellation/variation)
• — retrocession premiums payable by the reinsurer
• — net commissions payable by the reinsurer

Question 25

Short-term insurance Act: Part IV: Financial Arrangements

Outstanding Claims Reserve (OCR)

Answer 25

Based on case estimates in respect of claims incurred which
…. are reported
…. but not yet fully paid.

Can be reduced by expected approved reinsurance recoveries.

Question 26

Short-term insurance Act: Part IV: Financial Arrangements

Unexpired Risk Provision (URP)

Answer 26

A URP is necessary if the insurer has incurred an underwriting loss and in consultation with the auditor (and statutory actuary if applicable) the provision is deemed necessary.

The insurer, in consultation with its auditor (and statutory actuary if applicable), shall determine the amount of such a provision.

Question 27

Short-term insurance Act: Part IV: Financial Arrangements

Solvency

Answer 27

Insurance companies have to ensure that the assets as valued and admissible in accordance with the Act exceed the sum of liabilities as valued in accordance with the Act plus the capital requirement.

The amount by which the assets exceed the liabilities is the surplus assets.

Question 28

Operational risk capital

Answer 28

The Operational Risk Capital (OP) take into account the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.

Question 29

Section 35 of the short-term insurance Act provides for returns to the Registrar.

3 required returns

Answer 29

• audited short-term insurance annual return (STAR), which needs to be submitted within four months of the insurer’s year-end.
• quarterly returns (based on unaudited data) which needs to be submitted within a month of each quarter-end.
• a copy of the insurer’s audited financial accounts within a period of six months after the year-end.

Question 30

Short-term insurance Act: Part VII: Business Practice, Policies and Policy Holder Protection

In terms of the Act, commission may not exceed ___% of the premium on motor policies,

and _____% of the premium on any other short term products.

Answer 30

12.5%

20%

In terms of the Act, commission may not exceed 12.5% of the premium on motor policies,
and 20% of the premium on any other short term products.

Question 31

Short-term insurance Act: Part VII: Business Practice, Policies and Policy Holder Protection

Policyholder protection rules

Answer 31

• introduced by the FSB in 1991, with subsequent amendments.

Relate to various DISCLOSURES THAT NEED TO BE MET
… to ensure that a consumer is provided with SUFFICIENT INFORMATION
… to make an informed choice about products
… before the purchase is made.

Also aims to provide for certain measures to ensure consumer protection by ensuring that parties involved conduct business fairly and with due care. Through effective disclosure, consumer education and protection is provided.

Question 32

Short-term insurance Act: Part VII: Business Practice, Policies and Policy Holder Protection

7 General principles of disclosure

Answer 32

• The intermediary or insurer (as applicable) must be able to prove that disclosure was made;
• Disclosure must be in plain, easy to read language;
• Disclosure must be made at the appropriate time, using appropriate medium (e.g. system generated);
• If a disclosure is made orally, it must be followed up in writing within 30 days;
• If an intermediary has made disclosure, it need not be repeated by insurer, unless changes to premiums, fees, excesses and the like occur;
• Standard forms or format may be used for disclosure;
• Records which are to be kept in terms of the Rules, may be kept in writing or an appropriate electronic means.

Question 33

Short-term insurance Act: Part VII: Business Practice, Policies and Policy Holder Protection

Obligatory disclosure by an intermediary
(6)

Answer 33

• provide client with STATUTORY NOTICE (this document is specified in the legislation);
• FULL DETAILS of the intermediary;
• LEGAL STATUS of the intermediary, contractual relationship with insurer;
• whether the intermediary holds professional indemnity insurance;
• details of required claims notification procedures;
• AMOUNT OF COMMISSION and any fees earned by the intermediary.

All of the above must be made at the COMMENCEMENT OF DEALINGS with the policyholder in respect of an insurance transaction.

Question 34

Short-term insurance Act: Part VII: Business Practice, Policies and Policy Holder Protection

Obligatory disclosure by an insurer
(6)

Answer 34

• STATUTORY NOTICE (as defined in the Rules)
• FULL DETAILS of the insurer head office
• details of the COMPLIANCE DEPARTMENT or officer
• details of CLAIMS NOTIFICATION PROCEDURES
• name / class / type of policy
• MONETARY obligations,
• DUE DATES of premium,
• CONSEQUENCES of non-payment, etc.

Question 35

Short-term insurance Act: Part IX:
Offences and Penalties
(8)

Answer 35

In terms of the Act, serious offences are punishable with a R1 MILLION FINE and/or a 10-YEAR PRISON SENTENCE.

The following constitutes a serious offence:

• unregistered business;
• unauthorised control of insurer;
• undesirable business practices;
• failure to comply with legislation conditions;
• carrying on of other business not approved by the Registrar
• failure to appoint an auditor;
• unauthorised issue of loan capital, and
• the failure of a statutory actuary to perform his/her reporting duties.

Less serious offences are subject to a fine of R100 000 and/or a 1-year prison sentence.
The penalty for the late submission of a statutory return is R1 000 per day.

Question 36

Purposes of Solvency capital requirements (4)

Answer 36

• reducing the risk that an insurer will be unable to meet claims
• REDUCING LOSSES that policyholders will incur in the event that an insurer is unable to fully meet all claims
• providing supervisors with EARLY WARNING of impending problems so they will be able to intervene promptly if capital falls below the required level
• PROMOTING CONFIDENCE in the financial stability of the insurance sector.

Question 37

Index or factor-based solvency model

Answer 37

Applies factors to accounting positions in order to arrive at the amount of capital required.

It is usually determined as a proportion of the business written based either on premiums received, claims incurred or reserves brought forward.

Question 38

2 Advantages of an

Index or factor-based solvency model

Answer 38

• it takes into account each company’s individual experience

- it is simple to administer

Question 39

4 Disadvantages of an

Index or factor-based solvency model

Answer 39

• it penalises companies that hold adequate reserves and/or those that charge adequate premiums compared with those that do not
• it does not distinguish between companies that write similar volumes but different mixes of business
• it does not distinguish, other than in a broad way, between high risk and low risk companies
• it can be significantly circumvented by reinsuring outstanding claims portfolios.

Question 40

Risk-based capital (RBC) approach

Answer 40

Minimum Capital Requirement is calculated on the basis of such components as
…. the volatility of past profits,
…. the growth of the business,
…. the direction and volatility of past reserve development and
…. the quality and diversification of asset holding.

Question 41

3 Advantages of the Risk-based capital (RBC) approach

Answer 41

• it recognises the volatility inherent in the business
• it will penalise companies that hold inadequate reserves or that write business on inadequate rates
• it can recognise asset and credit risk.

Question 42

5 Disadvantages of the Risk-based capital (RBC) approach

Answer 42

The disadvantages are the practical difficulties of deciding:

• the definition of profit
• the definition of volatility (does it refer to observed variation in experience from the company own average or the variation about the industry average?)
• the period over which volatility is measured
• how to allow for reinsurance and the security of the reinsurers used
• whether the same proportion should be applied to the volatility for all companies.

Question 43

Solvency Assessment and Management (SAM)

Answer 43

SAM is a holistic approach to risk management, encompassing the measurement of assets, liabilities and capital, the supervisory review process and disclosure requirements.

The SAM project covers both short-term and long-term insurance as there is considerable overlap in a number of areas.

The basis of the SAM regime are the principles of the Solvency II Directive.

Question 44

3 Pillars of Solvency II

Answer 44

Pillar 1: QUANTITATIVE REQUIREMENTS

• — valuation of assets and liabilities
• — setting of capital requirements
• — based on either a standard model / approved internal model

Pillar 2: QUALITATIVE REQUIREMENTS

• — standards and guidance on governance
• — internal controls
• — risk management
• — supervisory process

Pillar 3: REPORTING AND DISCLOSURE

Question 45

FAIS Legislation

Answer 45

The Financial Advisory and Intermediary Services Act No. 37 of 2002 (“FAIS Act”)
was introduced to regulate the business of all Financial Service Providers (FSPs) who give advice or provide intermediary services to clients, regarding a wide range of financial products.

As a result of this, aggrieved consumers will be able to seek redress when they have been misled or misrepresented by a Financial Services Provider or its representatives.

Question 46

The FAIS Act aims to achieve (3)

Answer 46

• professional conduct
• better informed clients
• a professional, responsible sector

Question 47

FAIS aims to achieve effective regulation through 3 mechanisms:

Answer 47

• FSP’s have to be authorised under the FAIS Act and they have to comply with certain prescribed fit and proper criteria.
• The FSP’s are responsible for their representatives who also have to comply with fit and proper requirements.
• The FAIS Act lays down standards for the market conduct of both FSP’s and representatives. Again, the focus is on the consumer to receive fair treatment and to have full disclosure made to the consumer. Professional conduct is controlled through Codes of Conduct and enforcement measures.

Question 48

FAIS Legislation:

Define “Advice”

Answer 48

Any 
- recommendation, 
- guidance or
- proposal 
of a financial nature 

furnished, by any means or medium, to a client or group of clients in respect of:

• the purchase / investment in any financial product,
• the conclusion of any other transaction aimed at incurring any right or benefit or liability in respect of any financial product, or
• the variation, replacement or termination of any financial product.

Question 49

FAIS Legislation:

The definition of “Advice” does not include (4)

Answer 49

• factual advice
• an analysis or report on a financial product without any express or implied recommendation, guidance or proposal that any particular transaction in respect of the product is appropriate to the particular investment objective, financial situation or particular needs of a client; and
• advice given by the board of management, or any board member, of any pension fund organisation or friendly society to the members of the organisation or society on benefits enjoyed or to be enjoyed by such members; or
• the board of trustee of any medical scheme to the members of the medical scheme, on health care benefits enjoyed or to be enjoyed by such members.

Question 50

FAIS Legislation:

Define “Intermediary Service”

Answer 50

Any activity other than advice performed by a person for or on behalf of a product supplier or client

a) the result of which is that a client may enter into, offers to enter into or enters into any transaction in respect of a financial product with a product supplier;
b) with a view to-
i) buying, selling or otherwise dealing in, managing, administering, keeping in safe custody, maintaining or servicing a financial product purchased by a client from a product supplier or in which the client has invested;
ii) collecting or accounting for premiums or other moneys payable by the client to a product supplier in respect of a financial product; or receiving, submitting or processing the claims of a client against a product supplier. In addition, in each instance, the “advice” or “intermediary service” must be rendered in respect of a “financial product” which is defined in section 1(1) of the FAIS Act.

Question 51

FAIS Legislation:

Define FSP

Answer 51

A Financial Services Provider is any person, other than a representative, who as a regular feature of the business of such person furnishes advice, or renders any intermediary service, or both.

In terms of Section 7(1) of the FAIS Act, no person will be able to act as an FSP, unless such person has been authorised by the Registrar.

Question 52

FAIS Legislation:

Define Key Individuals

Answer 52

These are natural persons within the FSP who are either managing or overseeing the activities of the FSP relating to financial services.

Question 53

FAIS Legislation:

Define Representatives

Answer 53

These are the persons who render a financial service to clients for or on behalf of an FSP, in terms of an employment contract or any other mandate.

Question 54

5 Categories of FSPs

Answer 54

Category I FSPs
can provide advice and render intermediary services in respect of
… 20 SUB-CATEGORIES OF PRODUCTS,
… have to ACT ON THE DIRECT INSTRUCTION of their client.

Category II FSPs
can provide services in respect of
… 15 SUB-CATEGORIES OF PRODUCTS,
… in terms of a DISCRETIONARY MANDATE.

Category IIA FSPs
HEDGE FUND MANAGERS

Category III FSPs
LINKED INVESTMENT service providers, providing sophisticated administrative platforms.

Category IV FSPs
provide ADMINISTRATIVE SERVICES in respect of assistance business policies only.

Question 55

The Aim of the NCA

Answer 55

The National Credit Act (NCA) was intended to repeal the Usury and Credit Agreement Acts as well as subordinate legislation.

The aim of the NCA is, inter alia, to introduce a single, functional system of regulation that will apply to all credit activities, thereby ensuring that all credit providers and credit consumers are treated equally.

Question 56

4 Reasons for the NCA

Answer 56

• the Usury and Credit Agreement Acts were outdated
• Access to credit was a problem to a large portion of the population.
• There was generally reckless lending by certain credit providers.
• Credit consumers were being exploited by the credit industry.

Question 57

5 Objectives of the NCA

Answer 57

• Create a framework where competition and transparency will be promoted because all credit transactions will be treated the same within the identified market sectors.
• All consumers will have equal rights and those rights will be protected.
• Measures are introduced to manage over-indebtedness of consumers and to avoid reckless lending practices
• A regulatory framework is establish to regulate credit bureaux, credit providers and debt counsellors.
• The complaints mechanisms are formalised and regulated to ensure maximum protection and compensation for consumers.

Question 58

The purpose of the NCA can be summarised as:

6

Answer 58

• improved accessibility of the credit market to previously disadvantaged consumers
• enhanced consumer rights and education
• better regulation of credit
• consistent treatment of all consumers and credit providers
• responsible borrowing and elimination of reckless lending
• redressing the balance of power between the consumer and the credit providers.

Question 59

The impact of the NCA on short-term insurers

Answer 59

The NCA mainly impacts on short-term insurers writing credit life insurance, especially through partners (like furniture stores or banks).

Some of the main requirements of the Act that may impact short-term insurers include:

• If a single premium is charged, it may not be included in the principle debt. Premiums need to be collected as a separate transaction unrelated to the credit transaction.
• No interest may be charged on the insurance premium charged.
• In the case where the credit provider collects the premium on behalf of the credit received and then pays it over the to short-term insurer, the credit provider must have a Section 45 guarantee in place.