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Background

The problems in the insurance industry stemmed mainly from the introduction in the early 1990's of new insurance products which offered customers not only life insurance products but investment opportunities.

The new products, popularly known as investment or lump-sum policies, allowed the insurance companies to take in deposits under the guise of insurance premiums. A small amount of the premiums would go towards life insurance, with the majority being used mainly to invest in real estate, stocks, bonds and securities.

Policyholders, who were in effect investors, received a variable return on their investment on a monthly basis and if they did not touch their policies for three years, did not have to pay tax on the interest.

Prudent management required that insurance companies keep liquid assets to meet withdrawal demands of their clients, should policyholders decide to surrender their policies. However this was not the reality. Policyholders funds were tied up in long term investments and poorly performing funds.

As such, when policyholders surrendered their investment policies or made withdrawals the companies had liquidity problems. In simple terms, they had no cash with which to meet demands. Increasingly, they turned to two strategies to ease their cash crunch both of which began to deepen the problem they faced.

Loans

In several cases, insurance companies owned or controlled banks or banks owned or controlled insurance companies. In either case, the parent/child relationship led to banks providing loans to the insurance companies, a fact which later contributed significantly to the problems that surfaced in the banking sector.

In taking this approach, individuals in both the banking and the insurance sectors ignored traditional business principles which mandated arms length transactions as a basic tenet of good business practice.

Since then the banking regulations have been overhauled and several loopholes which allowed this kind of behaviour to escape the scrutiny of the Bank of Jamaica have been plugged.

More Lump-Sum Interest-sensitive Policies

The second strategy used by the insurance companies was to write even more lump-sum policies to get quick funds to meet policyholders' withdrawals from existing policies. And so the problem grew. The lose/lose scenario of short term funds being invested in long-term projects which surfaced in the banking sector was also echoed in the Insurance Industry.

The affected companies then went to the government for help. The first companies to receive FINSAC assistance were Life of Jamaica and Island Life. Mutual Life, Crown Eagle Life and Dyoll Life were swift on their heels in their bid for help.

Diagnostic Review

A diagnostic review by FINSAC of the troubled insurance companies identified the following common characteristics:

  • Over-investment in real estate
  • Extremely low overall returns on investment
  • High surrender rates due to the deposit like nature of the new insurance products
  • Guaranteed rates of return on interest sensitive policies of between 12%-24%
  • High levels of commission for new business
  • Little or no incentives for renewal business
  • High levels of expenses significantly above international industry norms
  • Highly leveraged operations
  • Difficulty in meeting solvency requirements.

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