THE BUSINESS OF INSURANCE

A REPORT ON CHAPTER III OF THE INSURANCE CODE OF THE PHILIPPINES INTRODUCTION The insurance industry is one of the most heavily regulated industries because it is impressed with public interest. Insurance companies hold funds paid by the public so that they can maintain a pool of funds to answer for unfortunate events. However, the purpose of the funds received by insurers is not limited to claim settlement. Insurance companies are also financial intermediaries that help channel funds from the public to productive endeavors. Economic development will be directly affected if the insurance industry is weak. These considerations justify the intervention by the State in the operation of insurance companies.

ORGANIZATION (Section 414 415) The Insurance Commissioner regulates insurance companies and pre-need companies in the Philippines. The Insurance Commissioner shall have the duty to see that all laws relating to insurance, insurance companies and other insurance matters, mutual benefit associations, and trusts for charitable uses are faithfully executed and to perform the duties imposed upon him by the Insurance Code (IC) of the Philippines. In addition, the Insurance Commissioner has the sole and exclusive authority to regulate the insurance and sale of variable contracts, and to issue such reasonable rules and regulations governing the same. The Commissioner may issue rulings, instructions, circulars, orders and decision as he may deem necessary to secure the enforcement of the provisions of the IC, subject to the approval of the Finance Secretary. He may also impose administrative sanctions in accordance with Sec. 415 of the IC. He has limited quasi-judicial functions. He has jurisdiction over insurance claims if any single claim does not exceed Php100M. His quasi-judicial power does not cover the relationship affecting the insurance company, its agents but it is limited to claims filed by the insured against the insurance company. Thus, the issue of legality of an agency agreement falls within the jurisdictions of regular courts and not the Insurance Commissioner. The jurisdiction is concurrent with regular courts (Sec. 416).

CAPITALIZATION (Section 188) Capitalization for New Insurance Company. The minimum capitalization requirement prescribed by the Insurance Commission and the Department of Finance for new insurance companies effective 1 July 2006 are as follows: 1. No new life or non-life insurance company shall be allowed to do business in the Philippines unless it has a capitalization of Php1B paid in cash, of which at least 50% consists of paid-up capital and the remaining portion thereof as contributed surplus, which in no case shall be less than php200M. 2. No new reinsurance company shall be allowed to do business in the Philippines unless it has a capitalization of Php2B, paid in cash, of which at least 50% consists of paid-up capital and the remaining portion thereof as contributed surplus, which in no case shall be less than Php400M. Capitalization for Existing Insurance Company. The Insurance Commission also increased the minimum capitalization requirements of existing companies because the current requirements are inadequate relative to:

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1. The needed business infrastructures and quality management team that will ensure better service to all stakeholders and expand its market penetration; and 2. The adequate allowance for increased business volatility and for mitigating market imperfections. The insurance Commission also observed that the capital bases must be rebuilt because low capitalization levels have resulted in low retention ratios and heavy reliance on reinsurance and that the solvency positions of insurers must be secured and stable capital bases reduce insolvency risk and afford better protection for the insuring public.

AUTHORIZATION The Insurance Commissioner may refuse to issue a Certificate of Authority in any of the following cases: 1. If such refusal will best promote the interest of the people; 2. If the Commissioner has not satisfied himself upon examination that such company is qualified by the laws of the Philippines to transact business therein; 3. If the Commissioner is not satisfied that the grant of such authority appears to be justified in the light of economic requirements; 4. If the Commissioner is not satisfied that the direction and administration, as well as the integrity and responsibility of the organizers and administrators, the financial organization and the amount of capital, reasonably assure the safety of the interests of the policyholders and the public; and 5. If the Commissioner is not satisfied that the name of the company is not that of any other known company transacting a similar business in the Philippines, or a name so similar as to be calculated to mislead the public.

INSURANCE LICENSING REQUIREMENTS There are two basic requirements for the formation of an insurance corporation, to wit: 1. It must possess that capital and assets required of an insurance corporation doing the same kind of business in the Philippines and invested in the same manner and the Insurance Commissioner had granted a certificate to that effect; and 2. It must have obtained a certificate of authority to transact business from the Insurance Commissioner.

CAPITAL REQUIREMENT The minimum capitalization requirements prescribed by the Insurance Commission and the Department of Finance for new insurance companies effective 1 July 2006 are as follows: 1. No new life or non-life insurance company shall be allowed to do business in the Philippines unless it has a capitalization of Php1B paid in cash, of which at least 50% consists of paid-up capital and the remaining portion thereof as contributed surplus, which in no case shall be less than Php200M. 2. No new reinsurance company shall be allowed to do business in the Philippines unless it has a capitalization of Php2B, paid in cash, of which at least 50% consists of paid-up capital and the remaining portion thereof as contributed surplus, which in no case shall be less than Php400M. The Insurance Commission likewise increased the minimum capitalization requirements of existing companies because the current requirements are inadequate relative to: 1. The needed business infrastructures and quality management team that will ensure better service to all stakeholders and expand its market penetration; and 2. The adequate allowance for increased business volatility and for mitigating market imperfections. The IC also observed that the capital bases must be rebuilt because low capitalization levels have
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resulted in low retention ratios and heavy reliance on reinsurance and that the solvency positions of insurers must be secured and stable capital bases reduce insolvency risk and afford better protection for the insuring public.

MARGIN OF SOLVENCY (Section 194) This margin of insolvency of insurance corporations shall be excess of the value of its admitted assets exclusive of its paid-up capital, in the case of a domestic company, or an excess of the value of its admitted assets in the Philippines.

ASSETS (Section 196 197) Admitted assets are assets that are allowed by law to be part of assets that will be part of the bases in determining the financial conditions of the insurance company. Non-admitted assets are the assets that will not be allowed to be carried on the balance sheet of the insurance company. They are believed to be of marginal quality or of little liquidity for policyholders if the insurer should get into financial difficulty.

INVESTMENTS (Section 198 213) The type, nature and amounts of investments of insurance companies are also regulated. The IC provides for limitations on (1) loans and the security therefor, (2) purchase or ownership of assets, and (3) purchase or ownership of securities including bonds. Sec. 209 provides that it shall be the duty of the officers of the insurance company to report within the first 15 days of every month all such investments as may be made by them during the preceding month, and the Commissioner may, if such investments or any of them seem injudicious to him, require the sale or disposal of the same. The report shall also include a list of investments sold or disposed of by the company during the same period.

RESERVES (Sections 210 214) Legal reserves are provided for under the IC for both life and non-life insurance companies. In Insurance Law, reserve is not equivalent to surplus but is in fact obligations to the insured. a. In life insurance, reserve is the amount that, together with future premiums, interests and benefit of survivorship, will be sufficient, according to valuation assumptions, to pay future claims. Under the IC, all valuations of policies are made upon net premium basis. The aggregate net value so ascertained of the policies of the company shall be deemed its reserve liability which shall be provided for by holding funds in secure investments equal to such net value. b. In non-life insurance, the IC provides hat every non-life insurance company must maintain a reserve for unearned premiums on its policies that are in force which shall be charged as a liability for the determination of its financial condition. Reserves refer to a fund maintained by insurers to assure the payment of losses covered by their policies and the return of unearned premiums. This means a sum of money variously computed or estimated, which, with accretions from interest, is set aside, reserved, as a fund with which to mature or liquidate either by payment or reinsurance with other companies, future un-accrued and contingent claims and claims accrued but contingent and indefinite as to amount or time payment. As a precaution against their assets falling below the amount necessary to their reserve in the event of losses far in excess of those predicted, insurance companies set aside, out of income, a fund in addition

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to the reserve fund the surplus fund, contingent fund or special reserve. In this way, an insurance company can weather a massive disaster without risking insolvency.

LIMIT OF SINGLE RISK (Sec. 215) No insurance company other than life, whether foreign or domestic, shall retain any risk on any one subject of insurance in an amount exceeding 20% of its net worth. Retention Limit of the Insurer refers to the maximum amount of insurance which an insurer will carry on a policy at its own risk without reinsurance protection. It is set so as to avoid inconvenient fluctuations in earnings because of claims involving large amounts. Although determination of a retention limit is in part an actuarial problem, it also involves considerations not subject to precise quantitative analysis. Factors in setting retention limit in life insurance: - amount of the insurers surplus - expected mortality - distribution of insurance in-force per life - distribution of new issues of insurance by size - distribution of in-force insurance and new issues by age at issue and underwriting classification underwriting skill - degree of earning stability desired - cost of the reinsurance ceded Reinsurance agreements provide that the ceding company may increase its limit of retention on new business and also specify the conditions under which amounts of existing reinsurance may be reduced because of the increased limit of retention. Amounts of reinsurance so reduced are said to be recaptured. Maximum retention Allowed. Under Sec. 215 (par. 1) of the IC, if the net worth of a non-life insurance company is Php20M, and it insures a building for Php4.5M it must reinsure the Php500K, the amount exceeding 20% of its net worth. RATIONALE: Without the retention capacity requirement, an insurance company could easily become insolvent if hit by a series of big losses. As to surety risks, the amount assumed by any other company authorized to transact surety business and the value of any security mortgaged, etc., for the suretys protection shall be deducted in determining the risk retained (par. 2). In actual practice, insurance companies seldom, if ever, utilize their maximum retention limit but would adopt a self-imposed schedule of limits based on their estimate of the insured risk.

REINSURANCE (Sections 216 222) Rules and regulations on reinsurance 1. Non-life a. Insurance companies whose treaty limits and premium cessions as of 31 Dec. of the preceding year on the following lines of business do not exceed the corresponding limits hereunder shown: Line of Business Treaty Limit Premium Cession
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Fire Marine Other Lines (except motor car) 2,000,000.00 1,000,000.00 300,000.00 1,500,000.00 750,000.00 200,000.00

shall not enter into outward treaties with companies not authorized to transact business in the Philippines, unless the authorized ceding companies can first show to the satisfaction of the Commission that they will receive from such unauthorized companies, by way of reciprocity, inward business of comparable profitability, in which case, the above treaty limits and premium cessions may be reduced by an amount not exceeding 20% thereof, or that they cannot secure locally the cover sought under the best terms and conditions consistent with sound underwriting practices. b. Reinsurance abroad of motor car business shall not be allowed except on an excess of loss basis, where such coverage could not be availed of locally. 2. Life a. The retention of a life insurance company on any one standard life insured shall not be less than the amount equal to of 1% of the stockholders equity as of 31 Dec. of the preceding year. The stockholders equity shall be the sum total of the paid -up capital, contributed surplus and retained earnings, but not including the sum total of its appraisal and reevaluation surplus, less assets not admitted. b. The minimum retention on substandard lives shall be graded downwards from standard in accordance with sound underwriting practice. The schedules of retention limits shall be submitted to the insurance Commissioner prior to its adoption in any reinsurance agreement. c. No reinsurance shall be placed abroad where the amount of the risk shall be placed abroad where the amount of the risk of Php2M or less, per life standard risk, graded down for substandard lives.

d. No reinsurance shall likewise be placed abroad on accident riders where the accident risk does not exceed Php1M per standard risk. e. Reinsurance treaties placed abroad shall be on the yearly renewable term plan (amount of risk) only. Renewal of existing treaties shall be on a year-to-year basis and shall contain a provision for recapture of previously ceded business. To protect the company against unusual number of claims as a result of jumbo policies issued, the company may avail itself of the catastrophe or stop loss cover abroad. f. Reinsurance abroad on other life insurance riders, group insurance and all other life insurance business may be only after it has been shown by the ceding company that such risk cannot be absorbed by the Philippine market.

3. Facultative Placements. No insurance company doing business in the Philippines shall cede all or part of any risk situated in the Philippines by way of facultative placements directly to any foreign reinsurer not authorized to do business in the Philippines or indirectly to such unauthorized foreign reinsurer thru the services of a non-resident broker unless the ceding company shall first show to the satisfaction of the Commission, proofs that the Philippine market cannot provide the facilities being sought abroad. However, in highly meritorious cases, and subject to the prior approval of the Commission, facultative placements may be made if the ceding company shall withhold and set up in its books the full amount of the reserve fund equivalent to at least 40% of the gross premiums ceded and shall invest such fund in accordance with Sec. 219, par. 2 of the IC.
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In all cases, before any insurance company enters into any kind of reinsurance treaty or agreement involving remittances of foreign exchange with any other insurance company or insurance broker, the prior approval of the treaty or agreement by the Insurance Commission shall first be obtained.

ANNUAL STATEMENTS (Sections 223 225) Insurance companies shall end its fiscal period on 31 Dec. of every year, and annually on or before 30 April of each year render to the commissioner a statement signed and sworn to by the chief officer of such company. The States power to require insurance companies to make this periodical statements and reports concerning their business, reserves, and financial conditions is well recognized, and a statute requiring insurance companies to make annual statements of their business and financial condition, enacted under the police power, does not impair the obligation of the contract evidenced by the charter of a company previously incorporated. It is immaterial in this respect whether the company is solvent or insolvent. The requirement to file annual statements is the primary means of alerting the Insurance Commission to any danger of threatened insolvency (with resulting inability to honor obligations to insured persons) on the part of any insurance company.

POLICY FORMS (Sections 226 - 229) Standardization of Insurance Contracts. Insurance contracts are highly standardized (in terms of provisions not form) through statutory or administrative regulations, voluntary agreement, or customary practice. 1. Standardization makes it easier for consumers to study insurance contracts and to compare contracts issued by different insurers. 2. Both insurers and insured persons gain from greater meaning they can attach to court interpretations of earlier contracts and from the reduction of policy conflicts in adjusting claims. Standardization, on the other hand, may reduce or delay the advantages of experimentations and competition. 3. Even when there is no statutory or voluntary standardization, competition and tradition favor some standardization. There are advantages to selling a contract that does not differ too much from that of a competitor and from the use of language that has been tested in practice.

The Insurance Commission requires that no policy, certificate, or contract of insurance shall be issued in the Philippines unless the Omnibus Clause is incorporated therein as an integral part thereof providing as follows: all applicable provisions of PD 1460 (IC of 1978), as amended, as of the date of effectivity, latest renewal or reinstatement of this policy/certificate/contract of insurance, as the case may be, and all existing laws obligatory upon insurance companies aas may be pertinent are deemed incorporated in this policy/certificate/contract of insurance and will supersede any agreement/contract inconsistent therewith. Basic required provisions: - Incontestable provision (Sections 48 and 227) - Grace period provision - Entire contract provision - Misstatement of age provision
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Reinstatement provision

Optional provisions: - Suicide provision - Assignment provision - Ownership provision - War clauses - Payor clause - Policy change provision

VARIABLE CONTRACTS (Sections 232 240) Variable Life Insurance has been defined as that form of life insurance contract under which the benefits, payable upon death or surrender, and/or the premiums vary with the investment performance of the assets derived from the sale of those contracts. As defined, such insurance must be distinguished from life insurance contracts with benefits dependent on some index as, for example, the Consumer Price Index (CPI). Variable Life Insurance is new product being developed in the insurance business, designed to combine the traditional protection and savings functions of life insurance with the growth potential associated with equities, particularly common stock. The traditional idea is to change the traditional fixed-value-life insurance, where the insurer pays a stated face value. The problem is that the specified face value does not attempt to guarantee any particular purchasing power for the consumer. In an era of continuing inflation, this is a real disadvantage to the life insurance beneficiary. To offset this disadvantage, the variable life contract bases its reserves and policy amount payable on investments primarily devoted to common stocks. The theory is that as inflation raises common stock values and dividends, the values paid under the contract will also increase hopefully as much as purchasing power has decreased. The death payments are usually guaranteed not to fall below a minimum face value, but could increase if the equity values increased.

CLAIMS SETTLEMENT (Sections 241 244) Claims settlement is the indemnification of the loss suffered by the insured. The claimant may be insured or reinsured, the insurer who is entitled to subrogation, or a third party who has a claim against the insured. Sec. 241 enumerates the grounds which shall be considered as sufficient cause of the suspension or revocation of an insurance companys certificate of authority. It is des igned to eliminate unfair claim settlement practices.

EXAMINATION OF COMPANIES (Sections 245 246) Objective of the examinationthe examination of every insurance company doing business in the Philippines is an important task of the insurance Commissioner. Continued solvency of insurance companies or financial ability to meet their commitments is the major objective of such detailed examinations (245) which shall be conducted according to law at least once a year and whenever the Commissioner considers the public interest so demands. Powers of Commissioner The checking of assets, liabilities and reserves is part of this procedure as well as a review of almost all underwriting, investment, and claim practices of the insurer.
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SUSPENSION OR REVOCATION OF AUTHORITY (Section 247) The Insurance Commissioner is given the power to revoke or withdraw the license or the renewal of the license of an insurance company. The decision made by the Commissioner shall be appealable to the Finance Secretary (Sec. 414). The action taken by the Finance Secretary may be judicially reviewed to determine whether the charges upon which his action is based are supported by the evidence. However, his decision will not be disturbed unless there has been an abuse of discretion. The Insurance Commissioner is authorized to suspend or revoke all certificates of authority granted to an insurance company for any of the grounds enumerated in Sec. 247.

APPOINTMENT OF CONSERVATOR (Section 248) As a protection against insolvency and unfair treatment of claimants, policyholders and creditors, insurance regulation continues after the formation and licensing of an insurer. The Commissioner exercises some control over many phases of the operations of insurance companies. Under Sec. 248, the Commissioner, before or after suspension or revocation of the certificate of authority of an insurance company, may appoint a conservator to take charge of the management of such company if he finds that it is in a state of continuing inability or unwillingness to maintain a condition of solvency or liquidity deemed adequate to protect the interest of policyholders and creditors. The conservator shall exercise all powers necessary to preserve the assets of the said company, reorganize the management thereof, and restore its viability. The appointment of a conservator is only a temporary situation to enforce changes in the insurance companys operations, or it may be a prelude to liquidation proceedings under the provisions of Title 15 if it cannot be restored to financial stability through reorganization.

PROCEEDINGS UPON INSOLVENCY (Sections 249 251) The Insurance Commissioner not only officiates at the birth and growth of an insurance company but also at its demise if necessary. An insurer may be liquidated for a number of reasons including financial insolvency. Some liquidation may be voluntary in nature in order to effect a corporate reorganization or merger.

CONSOLIDATION AND MERGER OF INSURANCE COMPANIES (Sections 252 261) MERGER means the union of two companies which results in continuation of the corporate existence and survival of one constituent company and dissolution of the other. CONSOLIDATION is the combination or union of two or more companies which results in the termination and dissolution of the corporate existence of all constituent companies and the formation of a new company. ABSORBING OR ACQUIRING COMPNAY means the surviving company, in case of merger, or the newly formed company, in case of consolidation. Absorbed company means the constituent company whose corporate existence is dissolved as a result of the merger or consolidation. COMPANY OR COMPANIES refers only to domestic insurance company or companies.

WITHDRAWAL OF FOREIGN INSURANCE COMPANIES (Sections 273 279)

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PROCEDURE Sections 273 277 prescribe the procedure to be followed upon cessation of business of a foreign insurance company. The foreign insurer must apply. Its application must be published in two newspapers. It must discharge its liabilities to policy holders and creditors in this country, and cause its policies insuring Philippine residents to be taken up by other qualified insurers. Then the Insurance Commissioner shall make an examination of the books and records of the withdrawing company and if upon such examination he finds the insurer has no outstanding liabilities to residents of the Philippines, he shall permit the insurer to withdraw. WHEN PERMIT TO WITHDRAW MAY BE GIVEN. Under Sec. 276, the Insurance Commissioner may permit the foreign insurer to withdraw (and get back the securities it has deposited for the benefit of policyholders) only when he finds that such foreign insurer has no outstanding liabilities to residents of the Philippines. If the Commissioner is fully aware of pending cases against the foreign insurer, he may not declare that the insurer has no outstanding liabilities to residents of the Philippines. JUDICIAL REVIEW OF DISCRETION OF COMMISSIONER When the Insurance commissioner approves the withdrawal of a foreign insurance company from business in the Philippines, the courts may review the discretion exercised by him and substitute their own judgment therefor, where the insurer has accrued liabilities which the law requires it to discharge before withdrawal. The law should not be interpreted as to permit foreign insurers to escape the results of pending actions against them by withdrawing from the Philippines with all the securities they have deposited, provided they get the sanction of the Commissioner. That would be giving the Commissioner discretion to frustrate orders of courts in litigations against foreign insurers and to liberate the latter from claims of local policyholders, whose interest it is his principal duty to protect, and for whose benefit he is given broad powers of supervision over insurance companies as are seldom conferred upon parallel agencies. Sec. 278 states when a foreign life insurance company that withdraws from the Philippines shall be considered a servicing insurance company. Before it can act as a servicing company, it must obtain a special certificate of authority to act as such from the Insurance Commissioner (Sec. 279).

PROFESSIONAL REINUSURES (Sections 280 281) BASIC TYPES There are two basic types of reinsurers, namely: 1. PROFESSIONAL REINSURERS or reinsurers that do reinsurance business only (Sec. 280). 2. NON-PROFESSIONAL REINSURERS or insurers that do not specialize in reinsurance only. They are primary insurers which maintain reinsurance departments. They may accept reinsurance regularly or only occasionally. SPECIAL TYPE REINSURANCE POOL is an association for the exchange of reinsurance among two or more insurers according to an automatic agreement. (Many of these pools are technically associations of insurers rather than reinsurers; thus, they are insurance pools instead of reinsurance pools, but the purposes of each are similar.) Each reinsurer receives a certain amount or proportion of the risks or losses of the other reinsurer or reinsurers, and each cedes or gives to all the others for spreading infrequent catastrophic types of risks among insurers of a company group or fleet.

HOLDING COMPANIES (Sections 282 298) A holding company means any person who directly or indirectly controls any authorized insurer; while control means the possession directly or indirectly of the power to direct or cause the direction of the management and policies of an authorized insurer or other person or corporation within the holding company system (Sec. 282).

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Under the IC, no insurance company may be acquired by a holding company without prior review by the Insurance Commissioner (Sec. 294); all insurance companies controlled by a holding company are required to register with the Commissioner, furnish the Commissioner with the required information concerning the holding company (Sec. 286), and file such reports concerning operations which may materially affect the operations, management or financial condition of the controlled insurer (Sec. 287); and all holding companies are subject to examination on matters affecting an insurance company which is held or on such insurance companys treatment of its policyholders (Sec. 288). Conflicts of interest in transactions between an insurance company and its parent holding company or its affiliates are prohibited (Sections 290 293).

References: Aquino, Timoteo B. Essentials of Insurance Law Rex Printing Company, Inc., Quezon City, 2009 De Leon, Hector S. The Insurance Code of the Philippines Annotated Rex Printing Company, Inc., Quezon City, 2002

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