3rd June 2016
The Registrar of Financial Institutions has today issued a notification that Prime Insurance Company Limited (Prime) has been placed under statutory management. The notification advises the public:
I. Not to transact insurance business with any employee, agent or shareholder of Prime Insurance Company
II. During the period if statutory management, no new business or insurance policy renewals will be accepted by the Company
III. However, existing policies issued by the Company will remain valid.
Furthermore all Prime’s branches and agencies have been closed for business.
WHY THE CENTRAL BANK IS INVOLVED
According to law, the Governor of the Reserve Bank, is the Registrar of Financial Services. That is why the two communiques in circulation today have been issued by Charles S R Chuka, the current Governor. So Charles Chuka essentially wears two hats; one of Governor of the central bank and one of Registrar of Financial Institutions. Both roles require of him to do specific duties, the common thread being that they are relate to the financial sector. But they are different roles.
In Malaŵi the overarching law that regulates the financial sector is the Financial Services Act 2012 (FSA). There are several Acts which comprise what is called financial services law, such as The Banking Act, 2010, the Insurance Act 2010 among others. Under the FSA, “a person shall not operate, as a business, a financial institution unless the financial institution is licensed or registered and … complying with the terms of the licence.” The licence is issued by the Registrar. The reason why the Reserve Bank of Malaŵi, as a central bank, is mandated to supervise and regulate the financial sector is to avoid what is called systemic financial risk or contagion. The G-10 has defined systemic financial risk as:
risk that an event will trigger a loss of economic value or confidence in, and attendant increases in uncertainty about, a substantial portion of the financial system that is serious enough to quite probably have significant adverse effects on the real economy… In all but the most highly concentrated financial systems, systemic risk is normally associated with a contagious loss of value or confidence that spreads to parts of the financial system well beyond the original location of the precipitating shock. In a very highly concentrated financial system, on the other hand, the collapse of a single firm or market may be sufficient to qualify as a systemic event.
And the reason why central banks are concerned with systemic risk is because the buck stops with them when there is trouble in the financial system. When a financial institution is in financial problems, or financial distress, it usually looks to the central bank for salvation. The central bank is not only the issuer of currency but also injects money into the financial system to stabilise it when the need arises. The technical term for this is liquidity. So when a financial institution has liquidity problems, the central bank needs to step in and avoid panic spreading within the financial system. Such panic can lead to contagion.
Padoa-Schioppa has provided a good rationale why central banks are involved in ensuring there is financial stability within the financial system:
A financial system may, and usually does, remain segmented to some extent. However, if a liquidity need emerges in a specific segment of it, it is always the central bank that bears ultimate responsibility. Hence, all the answers to why banking is a “system” have to do with the singleness of the currency and the central bank. This also shows that – with or without formal supervisory functions – the central bank is a key part of the financial system and responsible for its smooth functioning.
This means the central bank really has no choice, it has to intervene whenever a financial institution is in problems because ultimately this will affect its liquidity needs. The problems may be corporate in nature including bad management or governance by the board. Just to make sure that we break this down, it is important to reiterate that the terms liquidity means money. Businesses need money to operate, it is as simple as that. And for the financial system, it is the money that oils its engine. The money may be in different forms (a subject outside the scope of this article) but this does not really matter. The money must be there otherwise the system collapses. Money does matter in finance. Under the law, the Registrar has power to act on troubled financial institutions including placing them under statutory management or in the worst case scenario, closure.
In finance law, statutory management is a term of art. It is a technical term that refers to a situation when a regulator or supervisor (usually of the financial services appoints someone to run a business regulated under the financial services law. In Malaŵi, when a prudentially regulated financial institution is placed under statutory management, the Registrar or any other person appointed by him shall be the statutory manager. An insurer is under the law a prudentially regulated financial institution. A discussion of regulation and prudential regulation is outside the scope of this article but the reader may wish to consult the Warwick Commission Report for a brief overview. The law requires that once an institution is placed under statutory management, the public must be immediately informed. This is essentially a safety measure; to safeguard the public from dealing with the troubles institution. Importantly, the statutory manager is in charge of management of affairs of the institution to the exclusion of the company’s directors and other managers. Put simply the board and the management effectively become redundant once a statutory manager is appointed unless retained by the statutory manager. But this is not without prejudice to any claims they may have as employees.
Now why does the law provide for a statutory manager or management? In the first place it must be pointed out that the law is saying the previous managers and directors have failed to run the business according to the requirement of the financial services law and there is need for someone to come in. Placing an institution under statutory management usually means closure is not the only option on the table. The task of the statutory manager is to manage the affairs of the institution with the greatest economy possible compatible with efficiency and as soon as practicable report to the Registrar what steps need to be taken at the institution to correct things up or if not practicable whether to transfer the business or to wind it up. It can therefore be inferred that although the law says the Registrar may be the statutory manager, the law does not really envisage this situation as it would lead to an absurdity, since the Registrar would effectively be reporting to himself. This in my view demonstrates that the drafters of this Act did not fully apply their mind to the functions of a statutory manager. But I digress.
The statutory manager is also not an independent manager in his/her own right as he/she has to comply with written directions from the Registrar in relation to his/her functions. It is submitted that even where there is no express ban on new business as in this case, once a statutory manager has been appointed, the process will actually lead to clientele flight, lack of trust and most likely than not, liquidation or winding up of the business will be the end result. Appointment of a statutory manager usually is synonymous with the end of a business.
It is also important to point out that the statutory manager is paid by the company which has been placed under statutory management. This is an issue that has at times raised question about transparency of the process as well as fairness. After all the statutory manager cannot be paid less than he would normally receive in his daily job. Some financial commentators have argued that this in itself leads to a further squeeze on the company’s liquidity.
SO WHAT CAN WE EXPECT NEXT IN THE CASE OF PRIME?
The Registrar will appoint a statutory manager, most likely a tried and tested manager from within the central bank ranks. This person will run Prime Insurance and make an assessment to the Registrar whether the business can be saved as is, whether it needs to be restructured, broken up, sold or whether it should be wound up.
So far this is the third high profile case where a financial institution has been placed under statutory management. The first was Finance Bank. Although business continued, there was clientele flight and liquidation was the result. The other was Citizen Insurance Company Limited (Citizen). With Citizen the situation was similar to the one at Prime. The company was essentially closed to new business and eventually also wound up. The reason for winding up was failure “to meet the minimum criteria as out in the Capital and Solvency Directive for general insurers.” Furthermore the central bank rationalised that:
[H]aving not diversified or penetrated the other insurance sector products, the effects of closing down Citizen Insurance are localized mainly in the Minibus motor subsectors. However, due to its size, and lack of complexity and systemic interconnectedness, it is envisaged that there will be no contagion effects on the other players in the market.
The winding up of Citizen was a messy affair to all involved. In fact the central bank was even sued by its employees over lack of payment. The employees succeeded in the High court but were reversed in the Malaŵi Supreme Court of Appeal. I for one therefore would be most sceptical about Prime Insurance surviving the present arrangement. I just hope the situation will not be as messy. But I have a feeling of déjà vu. Why do I sound so pessimistic?
First the Registrar has implemented two regulatory tools all at once. He has placed the company under statutory management and also closed all new business. This sounds like a death knell to me. But the reason for doing this must be understood, lest I be misunderstood. The Registrar is under an obligation to protect the financial system as well as protect consumers. With the latter, the idea is that until a proper due diligence can be made about the viability of the business, no new consumers of insurance products should buy such products from the company. With regards to those who already have insurance contracts underwritten by the company, the Registrar has advised that these will remain valid. Now here is where the issue of the buck stopping with the central bank comes in. For a start all financial institutions are required to have some capital adequacy reserves set by the central banks. This is a measure of the “financial soundness” of an institution. In the absence of a consumer insurance scheme administered by the central bank for consumers of financial products, these funds plus any accounts receivables would be available in the case of winding up, to pay creditors (including liquidating any assets). But this may not always be enough and in such a case creditors would be required to receive less, or take a hair-cut as is technically called.
Secondly the situation with Prime is somewhat similar to that of Citizen. At the time Citizen was being wound up, Prime was its competitor in the Minibuses insurance underwriting business. So one would say most of Citizen’s business eventually moved to Prime. I am also aware that for some time now, prime has been having serious liquidity problems. It would seem that the same lack of diversification that Citizen faced applies to Prime. Ultimately when push comes to shove, I see the central bank using the same rationale:
Having not diversified or penetrated the other insurance sector products, the effects of closing down Prime Insurance will be localized mainly in the Minibus motor subsectors. However, due to its size, and lack of complexity and systemic interconnectedness, it is envisaged that there will be no contagion effects on the other players in the market.
LESSONS THAT CAN BE LEARNT FROM THIS
For the consumers of insurance products, this is a further squeeze. Insurance products in Malaŵi are arguably not competitively priced to attract those in the lower echelons of society. Despite the insurance sector lamenting at the low insurance penetration in the country, the simple truth is that most Malaŵians cannot afford the premiums. They simply do not have the money. So this is a blow for those who found solace with insurance companies like Citizen and Prime.
For the insurance sector, it is quite clearly that not properly underwriting insurance liabilities of Minibus operators is suicidal. You can have a healthy stream of revenue but when the claims start pouring in, you will not be able to cope. So what is the alternative? Offer the insurance products at premium premiums. This would not only mean the business is viable, but would also hopefully prompt help to restructure the minibuses operation business. For starters, it would mean it would sieve out those who are not prepared to adequately insure their fares as well as other road users who may come into collision with their buses. The downside is that it may shut out those who are struggling financially.
For the regulator, I would say I hope this is a wake-up call that things ought to be done with speed. Any sensible person who has studied the insurance sector will testify that Citizen took too long to be placed under statutory management and the same goes with Prime. Prime has been struggling for almost a decade. Remedial actions should have been implemented then. Had this been done, there could have been hope of saving the business. I would say the entry of the Registrar at this late juncture is like a doctor coming in just to certify death. This is evidence of regulatory failure. I deliberately use the phrase as I am aware that even within the central bank, the regulator was aware that prime was struggled. Although the latest Financial Stability Report (2014) indicates that the “insurance sector remained stable” the report did warn of the danger of “concentration in motor business for general insurance.” I would add that by this time the central bank was merely postponing the inevitable. However postponing the decision to place it under statutory management until now may ultimately mean Prime is on the way out.
So if you are an economist you will simply argue that Prime should get out of the business because they have demonstrated they cannot cope and that others will fill the void. If you are a financial analyst you may wish to inquire further as to the reasons why Prime and similar sized companies have failed to make it in the insurance sector. If you are a social-activist you may ask what this means for the Malaŵian entrepreneur who attempts to enter the closed word of finance and for the Malaŵian consumer who may not afford the insurance products offered by the other insurers.
 Section 8(2), Financial Services Act, Act No. 26 of 2010, Malaŵi 2010) <https://www.rbm.mw/Home/GetContentFile/?ContentID=3743> accessed 3 June 2016
 Section 2, ibid
 Section 21(1)(a)(b) ibid
 G-10, 'Chapter III: Effects of consolidation on financial risk in Report on Consolidation in the Financial Sector' (Group of 10, 2001), <https://www.imf.org/external/np/g10/2001/01/Eng/pdf/file3.pdf> accessed 1 June 2016, p126.
 Tommaso Padoa-Schioppa, ‘Central Banks and Financial Stability: Exploring the Land in Between’ in Vitor Gaspar, Philipp Hartmann and Olaf Sleijpen (eds), Second ECB Central Banking Conference: The Transformation of the European Financial System (European Central Bank 2003), p274.
 Section 68(3), Financial Services Act, Malaŵi (2010)
 Section 2, ibid
 The Warwick Commission, 'The Warwick Commission on International Financial Reform: In Praise of Unlevel Playing Fields' (University of Warwick, 2009), <https://www2.warwick.ac.uk/research/warwickcommission/financialreform/report/uw_warcomm_intfinreform_09.pdf> accessed 2 June 2016
 Section 68(5), Financial Services Act, Malaŵi (2010)
 Section 69(2)(a), ibid
 Section 69(4), ibid
 Section 69(7), ibid
 Neil Nyirongo (then Deputy General Manager and later Executive Director of Economic Services at the central bank) was appointed Statutory Manager.
 (2011) Statutory Management of Citizen Insurance Company Limited (Reserve Bank of Malaŵi 2011)
 'Financial Stability Report : December 2011 ' (Reserve Bank of Malaŵi, 2011 ), <file:///C:/Users/larmah/Downloads/FSR_DEC_2011_MAIN_EST%20DRAFT%20FEB%20%202012%20March%2013%20Launch%20edition.pdf> accessed 3 June 2016, p20.
 'Financial Stability Report : December 2014' (Reserve Bank of Malaŵi, 2014), <file:///C:/Users/larmah/Downloads/FSR_DEC_2011_MAIN_EST%20DRAFT%20FEB%20%202012%20March%2013%20Launch%20edition.pdf> accessed 3 June 2016, p18.