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A Life actuary’s view - BAI: The Shame of our financial sector

14 avril 2015, 11:38

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As I am writing this piece, the investigation into the BAI scandal is still ongoing, many financial leaders of the country have been interviewed and the policyholders still have no clue whether they will get their money back. 

 

The main reason behind this article is to give some comfort to the policyholders. They have done nothing wrong and they shouldn’t let themselves be led astray with what is being reported in the media and some of the views of the insurance “experts”. People now seem to have realised that the statements made in the wake of the scandal by the government concerning the Single Premium endowment products were seriously misplaced and I will not stretch on that further.

 

Ponzi and Related Parties

These two terms have been used extensively in the media recently. I can only say that at the time the whistle was first blown around BAI’s operations, I seriously doubt that it was a Ponzi scheme. It could have become a Ponzi later on as now information is being released that BAI Dawood and his family were scamming millions out of the Group on a monthly basis. At the end of the day, it doesn’t matter whether it is a Ponzi or not, what really matters is that policyholders are now facing the prospect of losing their lifetime savings. This is a real tragedy.

 

I listened to the ex Minister of Finance interview and he was on and on about the Related Parties. Yes there was excessive investment in the related parties in 2012 (84%) and it had reduced to 58% in 2014. Even, if it had reduced to the famous 10%, it still wouldn’t have solved the problem.  

 

The main underlying problem

The main factor which has lead to the collapse of BAI, is that the assets backing the liabilities were not suitable at all. This should have been picked up ages ago.

 

Section 16.3 of the Insurance Act stipulates that:

 

“The assets covering the technical provisions shall take account of the insurance business and the classes or part of classes of business carried on by the insurer in such a way as to secure the safety, yield and marketability of its investments, which the insurer shall ensure are diversified and adequately spread in accordance with solvency rules.”

 

I will give a quick example how I would have expected the assets backing the Single Premium Endowment to have been invested. To refresh some people’s memories, under one variation of this policy, the policyholder will pay in a single premium and at the end of the term (eg. 5 years), BAI will pay back the lump sum alongside a guaranteed return of 9% per annum, provided the policyholder is still alive. If the policyholder dies within the term, BAI will pay a death benefit, normally equal to the lump sum paid it. 

 

Here, the insurance company has a fixed term liability (5 years) and under good practice and governance as per the insurance act, an acceptable simple investment strategy could have been as follows:

 

  • 60% in Bonds (sovereign or corporate fixed interest assets with the majority having a 5 year term)
  • 35% in equity
  • 5% cash

 

The Bonds have a higher security than the equity and as such have a lower return. The equity investment will be much riskier and one could expect that the high returns from the equity could then pay up the 9% guarantee offered to policyholders. The investment market offers so many more products, with funds, derivatives and so on, and the 9% is an achievable return if assets invested appropriately.

 

So we know that BAI assets were invested very aggressively and very far from a responsible and adequate portfolio as described above. It is shocking that this hadn’t been acted upon earlier, as BAI couldn’t have reached 84% investment in related companies overnight.

 

The Related Parties factor

 

The analysts seem to be obsessed about the reduction in the related parties. As I mentioned earlier, this is not THE solution. Related parties are normally legal entities and as such, if they go bankrupt, the exposure of the holding company, will be limited to the assets they hold in them. This reduces the domino effect that if one company goes down, it brings down all others.

 

The problem is that the assets which BAI held in these related companies were not suitable for the profile and nature of the insurance liabilities. It is hard to know whether the BAI money were loans or shares in these other companies, as the information is not publicly available. I simply cannot understand how investment in IFRAMAC or COURTS can ever be a good asset to back insurance liabilities. IFRAMAC and COURTS products have no characteristics which will make them a good match for insurance products. I find this shocking and am really disappointed that this has not been highlighted yet. 

 

I will give an example to back my point, I apologise if it is a bit technical. Let us say Life Insurance Company X was selling an annuity product. Under such product, the policyholder pays a lump sum and Com X guarantees to pay the policyholder a regular income for the rest of the life. So now Com X has a big lump sum and needs to invest that asset accordingly. Ignoring the market risks (eg,interest rate), the other major risk facing Com X is that the policyholders live longer than expected.

 

Now Com X might have a related party, Com Y, which sells a product called equity release. This product is for old people who have a house but not much money. The Com Y will give the policyholder a loan and on death the money will be claimed back following the sale of the house. Here the longer the people live, the more interest Com Y will get. 

 

Here if Com X invests the annuity lump sums as loans to Com Y, it will be a very good investment. If people live longer, the liabilities in the form of annuity payments will be higher but also the loans to equity release policyholders will grow in size. Com X will get a very good return on its money as the interest rate is expected to be higher than many bonds, and the asset is very suitable.

 

What I am trying to get at is that it doesn’t matter how much you have invested in Related Companies as long as the assets are suitable for your liabilities.

 

The guilty parties

Policyholders?

Certainly not the policyholders, certainly not! If certain stakeholders continue on putting the blame on policyholders, this is the end of our booming insurance sector. People need to understand that policyholders are not shareholders. There are not owners of a company but are the customers and in the Insurance Industry, customers are at the centre of everything. Insurance companies exist because of customers and we try our best to put their needs first.  Please change your attitude to policyholders as soon as possible and try to understand who the policyholders are. If the government continues with this current treatment, it will draw a lot of international criticisms and this will seriously affect our financial sector.

 

BAI execs

 

Well it is obvious that they should have been involved in the insurance industry in the first place. Scammers to say the least and jail sentences to be expected.

 

FSC, Auditors and Government

 

It is time to face the music and stop this “Pas Moi Li Sa” attitude. You have seriously faulted and you can’t hide away from it. I still don’t think you really understand where the problem lies and that is really worrying. You are responsible for having a trustworthy and efficient regulatory framework in place in the industry and that has not been achieved. The policyholders are no experts in Insurance and that’s why you are here, to give them confidence.

 

I have the impression that many of you are out of your depth in the area. Sometimes it is better to admit it and try to make amends rather than deny it. You are only making things worse. It is worth recruiting people who are experts in the insurance industry as it is a very technical area and as we are witnessing at the moment, it can bring the whole country to its knees.

 

Insurance Act

 

The international regulatory framework has changed a lot in recent years with the upcoming Solvency 2 regime. These new rules have been set up exactly to avoid such catastrophes. We need to keep up if Mauritius wants to be a big player. The current Insurance Act mentions about the solvency margin but doesn’t detail how it is calculated. The FSC website describes the IA as being aligned to the IAIS. This surely means that insurance companies have rigorously assessed their risks and have enough reserves to cover their worse scenarios. Somehow I doubt this because, BAI doesn’t even seem to have got the basics right.

 

Compensation fund

 

A compensation fund is mentioned in the Insurance Act. It will be good if we know a bit more about that fund. Nothing has been mentioned in the media about it so far.

 

Actuary

 

BAI hires an actuarial company based in the States, and the actuary is a FIA. Well I would be would very worried if I was in his shoes right now. 

 

Precedent Case – Equitable Life

 

Does this remind you of the Equitable Life scandal? It does for me and it should do if you work in the actuarial field. I do not want to bore you with the details but it was another case where there were serious failings in the regulatory bodies and policyholders lost out. A lengthy legal battle followed and at the end of the saga, the policyholders were compensated. 

Conclusion

I cannot see any other outcome here than the policyholders being compensated. It will probably be best to avoid a legal battle as this will be very costly and extremely strainful for the thousands of families concerned. Please stop differentiating regular premium policies from single premium. It is pathetic. It seems like you are punishing people who have worked hard.

 

There is a need to avoid a social crisis by all means.

 

The auditors should obviously share the blame for utter incompetence and they can expect a big bill coming their way. 

The government will need to act now by reforming the insurance sector as there are serious doubts on the financial health of the other insurance companies. 

 

I will finish with an extract of the insurance act, Section 14. 

 

“Maintenance of financially sound condition 

 

(1) An insurer shall maintain its business in a financially sound condition by generally conducting its affairs so as to be in a position at all times to – 

 

(a) meet its liabilities as they arise; and 

 

(b) keep the solvency margin required under this Part.”

 

Dayalan - Life actuary