Corporate Governance and the So-Called ‘Four-Eyes Principle’

Abstract

This chapter aims to analyse the current role played by insurance undertakings and their senior managers—with a specific reference to the Italian, French, Spanish and British insurance industry, taking into consideration the important changes introduced by the Solvency II framework.

In doing so, the study identifies features of the international regulation of insurance development based on the recommendations of the International Association of Insurance Supervisory (IAIS) and the Directives of the European Union (EU).

The board delegates the running of the business to the senior managers, expecting them to operate on behalf of the company’s interests.

The literature has identified several problems resulting from this relationship.

We intend to consider the internal behaviour affected by the board-senior managers’ relationship, by looking for direct connection between the elements of senior managers behaviours’ and the organisational and operational structure of the enterprise.

Inside the theoretical framework and given the existing related literature, our work aims to answer the above research question.

According to our statements, it will be demonstrated that, with specific focus on the management sector, there are still wide possibilities for improvement and more studies concerning board-senior managers relationship.

The Authors have shared all ‘significant decisions’ in actual application of the so-called ‘Four-Eyes Principle’. Nonetheless, Paragraphs 1, 2 and 4 are attributed to Armando Catania, and Paragraph 3 to Niccolò Abriani.

1 The Corporate Governance Structure

In the Solvency II framework,¹ an effective system of governance² is considered essential for the proper management of insurance undertakings, as well as for the resulting regulatory system.³

Governance is the system through which the insurance company is internally regulated.⁴ It incorporates many aspects of the business of an insurance company, such as corporate structure.⁵

Solvency II identifies an effective system of governance in an adequate organisational and operational corporate structure⁶—aimed at supporting the undertaking’s strategic objectives and operations—clearly distributed, transparent and equipped with an effective system to ensure the transmission of information internally.

The organisational and operational structure plays a decisive role to guarantee the sound and prudent management of the insurance undertaking.⁷ It is the duty of the board of directors⁸ to arrange an appropriate organisational and operational structure, to be adapted periodically to the changing conditions on an international, national and corporate level. The organisational structure determines the tasks and assignments, while the operational structure settles the way of performing the tasks; in any case, it is ultimately the administrative, management or supervisory body⁹ that has the responsibility for the execution.

The four key functions (Risk Management, Compliance, Internal Audit and Actuarial) must have an appropriate standing in the undertaking’s organisational structure, even though it is not required any mandatory organisational structure, as the insurers¹⁰ have the freedom to decide how to organise any function,¹¹ unless otherwise specified by the law.¹²

2 The Board-Senior Managers Relationship

Corporate governance involves making decisions and taking actions related to the corporate culture, environment and structural framework, policies and controls. It is not indeed a once-established system, but a continuous process that needs to be constantly upgraded.¹³ This is why an effective corporate governance structure requires appropriate standards to recognise, protect and promote the rights, relationships and interests of the administrative, management and supervisory bodies.

This chapter aims to explore only the different ways in which the governance of insurance undertakings is involved with the board-senior managers relationship.¹⁴

The day-to-day business of the firm, and so the state of affairs that might lead to any key decision the board is asked to make, is largely determined by the work of the company’s senior managers.¹⁵

Senior managers work with various parties in the interest to manage the firm’s relationships with the outside world,¹⁶ so they have often more intimate knowledge of the deals than the board and may have to explain the interactions of the different relationships to the board.¹⁷

When the board is asked to make significant decisions¹⁸ that involve mediating among various interests, it is supposed to be challenging and reviewing critically the information it needs to fully perform its function by a correct interaction with the senior management¹⁹ and key functions holders (Risk Management, Compliance, Internal Audit and Actuarial).

The board may perform in such effective style if senior managers maintain industrial development, business decisions and internal policies consistent with company’s strategies and risk appetite.

The ability of senior managers to perform this role is to a large extent dependent upon the flow of information—coming across control functions, among internal functions and within the business units—to determine whether, based on each individual senior’s manager experience, knowledge and expertise, any strategic decision is advisable for such company.

Consequently, the collection of credible information provides the foundation for effective decision making by the board.

Senior managers serve, therefore, such as a backstop, or a final quality check, before a major decision is formalised.

Thus, a relational environment throughout the company that fosters open communication between senior managers and the board encourages a critical review of the company’s site and scope of operations.

A relevant mediation function among the board and senior managers is now performed by the in-house counsels of the firm, such as a person, who, over time, has acquired an increasingly distinctive role, i.e. the Secretary of the Board of Directors.

The Codice di Corporate Governance (Corporate Governance Code)²⁰ of listed Italian companies (and the major national insurance companies fall into this category), for instance, assigns to the Secretary of the Board of Directors the task of ensuring, together with the Chairman of the Board of Directors, that the preliminary information and the information provided during board meetings is suitable to empowering the directors to act in an informed manner, also by way of attendance at board meetings by the officers of the company (as well as those of the group companies it heads) who occupy the role of heads of the various company functions.

For listed companies, the UK Corporate Governance Code²¹ provides that the board, supported by the company secretary, should ensure that it has the policies, processes, information, time and resources it needs to function effectively and efficiently, and all directors should have access to the advice of the company secretary, who is responsible for advising the board on all governance matters.²²

According to the Spanish Código de buen gobierno de las sociedades cotizadas (Listed Companies Corporate Governance Code),²³ the company’s secretary is the one who has the key task of facilitating the efficient functioning of the board through a strict control exercised on the performance of the board itself in any matter relating to corporate governance.

An adequate knowledge of the company reality on the part of those who, for various reasons, contribute to the organisation of the enterprise structure, is nourished through effective professional cooperation between them.

In the French legal system, Article 2.5 of the Notice ‘Solvabilité II - Système de gouvernance’ (Notice ‘Solvency II’ - System of governance)²⁴ encourages cooperation between members of the top management of insurance undertakings as a means of preventing unnecessary overlapping of tasks between them, with a view to achieving a balanced distribution, in accordance with the corporate strategy pursued.²⁵

3 The So-Called ‘Four-Eyes Principle’

Under Solvency II the insurance undertakings must implement the Own Risk Self-Assessment (ORSA) and make it an integral part of their business strategy, which must be considered on an ongoing basis in the strategic decisions of the undertakings.²⁶

Through the ORSA process it is expected that senior managers update²⁷ the board regularly at board and committee meetings in light of the progress of the ORSA and of any material findings that may influence the undertaking’s strategy before the making of any key decisions.²⁸

In this regard, it has to be investigated whether it is possible to infer from Solvency II the principle that, prior to the implementation of any significant decision concerning the undertaking, at least ‘two persons’ must review such decision (so called ‘Four-Eyes Principle’);²⁹ that it must necessarily be referred to directors, or that at least one of these ‘two persons’ could be a senior manager.³⁰

A very relevant consequence could arise from the first or the latter of these two working hypotheses.

In the first scenario, it will be confirmed that the ownership of any significant decision concerning the undertaking rests with the board, as the directors are part of it; in the second, it could be demonstrated that, even if it is still true the ownership of this particular kind of decisions rests with the board, some significant decision could be taken by the senior management too.

To find it out, we could assume that, according to Section 1.29 of the EIOPA Guidelines on System of Governance 2016,³¹ the two persons to be involved in any significant decision, before it is implemented, are those who effectively run the undertaking.

For the aforementioned Guidelines, the persons who effectively run the undertaking cover members of the administrative, management or supervisory body taking into account national law, as well as members of the senior management. The latter includes persons employed by the undertaking who are responsible for high level decision making and for implementing the strategies devised and the policies approved by the administrative, management or supervisory body.

So, the governance of insurance undertakings is composed, like that of any other undertaking, of two distinct interdependent spheres, namely management and administration.³²

It appears that this can be deduced from the consideration that, while the governance system as a whole is essential for the management of the entire enterprise, the functions—even those defined as ‘key’—are parts of the governance system and indeed are fundamental for the administration of the various phases of the enterprise.

Between the phases of administration of insurance undertakings, there should be a further distinction between the performance of executive activities, on the one hand, and non-executive activities, on the other.

A precise indication of this impression seems to be found in Recital 35 of Solvency II, which differentiates between the persons who ‘effectively run the undertaking’ and those who ‘have other key functions’.

It seems that the use of the adjective ‘other’, modifying the noun ‘functions’, should relate to a term that is missing in the first part of the same sentence (that is ‘key functions’), which should also apply to those who actually run the business.

In other words, it seems that the European legislator may have wanted to differentiate between those who direct the functions through which executive activities of the companies are performed, and those who direct functions through which non-executive activities are carried out.

True confirmation of the opinion just expressed seems to be found in the Guidelines published by EIOPA regarding the articulation of the corporate governance system, which aim to limit the possibility that the exercise of the four key functions taken into account by Solvency II (Risk management, Compliance, Internal Audit and Actuarial) may be combined with the performance of roles of administration, management and control, or, in any case, with the performance of operational activities.³³

To achieve the desired result, the EIOPA Guidelines aim to prevent a situation where the holder of a key function may be in a subordinate position compared to the head of an operational function,³⁴ unless—in addition to creating no other filter in the direct reporting of the holder of the key function to those with roles of administration, management and control—adequate risk mitigation criteria are also adopted to ensure that the owner of a key function does not find himself, even if only on a purely formal level, in a non-autonomous position in relation to the head of an operational function.³⁵

Thus, according to EIOPA Guidelines, any further reflection on the persons intended to effectively run the undertaking could be developed when we turn to analyse the equivalent regulatory framework shaped by each national law.

4 The Persons Who Effectively Run the Undertaking

4.1 In Italy and in France

In the Italian legal system, according to Article 30, paragraph Codice delle Assicurazioni Private (Private Insurance Code),³⁶ the board of directors has both the power to set up operational functions—by assigning tasks and responsibilities—whereas, according to Article 26, paragraph II, I.V.ASS. Regulation No. 38/2018, has the duty to formalise the establishment of fundamental functions.³⁷

This seems such a natural consequence arising from the content of the previous Article 29-bis which, in accordance with Article 40 Solvency II, provides that the board has the ultimate responsibility for the compliance, by the insurance undertakings, with the laws, regulations and provisions, both at a national and a supranational level.

The nature of the verbs used by the Italian legislator (‘attribute’ and ‘formalise’) does not seem accidental: one can only attribute to someone something that one already possesses; on the other hand, one can only formally acknowledge the fact that someone else already possesses something.

It seems that this may be the reason the board of directors is able to attribute tasks and responsibilities to operational functions, whereas, in relation to fundamental functions, the same body may merely formalise the institution thereof.

The tasks and responsibilities are, therefore, attributed by the board of directors to the heads of the operational functions, so that they can contribute, through their activity, to the sound and prudent management of the company; the tasks and responsibilities, on the contrary, are conferred by the board on the heads of the fundamental functions, because they ensure, through their activity, the sound and prudent management of the company.³⁸

So, while the division of the organisational structure of the company into operational functions is freely left to the board of directors, the division into fundamental functions is provided for by the legislator as an obligation, both of which are instrumental to ensuring the sound and prudent management of the company.

The idea that it is within the board of directors’ power to configure, in compliance with the law, not only the organisational structure of the operational functions, but also the fundamental functions, could be a valid indication of the equivalence of the levels occupied by both functions in the structure of the insurance undertakings, which would also signify an equivalent hierarchical level between the heads of the operational functions and those of the fundamental functions (or, it is the same, no hierarchical level is inserted between the heads of the fundamental functions and those of the operational ones³⁹), even though the latter contribute to the performance of the company’s administrative acts from a position that ensures compliance with the principle of separation from the operational functions, so as to preserve their autonomy, independence and objectivity of judgement.

It would seem, therefore, that the heads of fundamental functions would be part of the management category of the insurance undertakings, even though they carry out non-operational administrative activities.

The heads of the fundamental functions would therefore be at the same level as the heads of the operational functions, with whom they collaborate on a horizontal level, given their autonomy and independence, but unlike the latter, they would not remain subject to the vertical hierarchical line which extends all the way up to the General Manager, precisely in order to preserve their autonomy and independence.

Ultimately, this could be the reason for the choice made by the Italian legislator to coin the notion of ‘personale rilevante’ (‘relevant personnel’) in Article 2, paragraph I, letter m), of I.V.ASS. Regulation No. 38/2018 to bring together under this common definition both those who perform operational functions and those who perform non-operational functions.

Therefore, the notion of ‘relevant personnel’ includes ‘the general managers, managers with strategic tasks, the owners and the highest level staff of the fundamental functions and the other categories of personnel whose activity may have a significant impact on the company’s risk profile, chosen by the company on the basis of motivated and adequately formalised choices’ (‘i direttori generali, i dirigenti con compiti strategici, i titolari e il personale di livello più elevato delle funzioni fondamentali e le altre categorie del personale la cui attività può avere un impatto significativo sul profilo di rischio dell’impresa, identificato dall’impresa, in base a scelte motivate ed adeguatamente formalizzate’).

French legislation explicitly distinguishes the ‘administration’ of a company from its ‘management’. The first, if the company is set up as a joint-stock company, is the job of the board of directors; the second, on the contrary, that of one or more managers,⁴⁰ and indeed the verb used to refer to management activity is ‘diriger’.⁴¹

The French Code de commerce (Commercial Code) seems to end its use of the lexicon to identify the senior managers of the company at the alternation of ‘directeur général’ (general manager)—but also ‘directeur général délégué’ (deputy general manager), since French company law expressly regulates the possibility of appointments up to a maximum of five—and ‘dirigeants’ (managers).⁴²

The Code des assurances (Insurance Code) provides that the dirigeants can take on the additional status of ‘dirigeants effectifs’ (effective managers).

The term dirigeants effectifs seems to pair the adjective and the noun based on the will expressed by the legislator—in Article R 322-168 Insurance Code—which determines that the effective management of the insurance undertaking⁴³—conferred, at the discretion of the board of directors, or of the supervisory board, to the general manager, or to the deputy general manager, or to the members of the board, may also be conferred to one or more officers, having the experience, skills and honourability necessary to ensure the necessary diversity of knowledge, experience and qualifications which are essential to being able to manage the undertaking in a professional manner, and having also sufficiently broad powers over the activities and risks of the company to being involved in decisions with a significant impact, particularly in strategic, budgetary or financial matters (Article L322-2, paragraph VII, Insurance Code, supplemented by Article 4.1 Notice 2015)—who thus assume the profile of dirigeants effectifs.⁴⁴

The Notice 2015 in Article 2.3 determines that it is the responsibility of the companies carrying out insurance activities listed in Articles L 310-3-1 Insurance Code, L 211-10 Code de la mutualité (Mutual Insurance Code) and L 931-6 Code de la sécurité sociale (Social Security Code), to ensure that at least two people effectively manage the company and intervene in all significant decisions before they are taken (‘L’enterprise veille à ce qu’au moins deux personnes dirigent effectivement l’enterprise et interviennent dans toute décision significative avant que celle-ci ne soit mise en oeuvre’).⁴⁵

The syntactic construction used by the Notice 2015 (‘The company shall ensure that at least two persons (…) intervene in all significant decisions before they are taken’), without prejudice to the particular—and certainly far from negligible—reference to the requirement that the persons whose duty it is to intervene in all significant decisions of insurance companies, before they are taken, are the same persons who actually direct them (at least two, therefore, chosen from among the general manager, deputy general managers, members of the board of directors or officers), does not appear to be a mere semantic variation of the definition of ‘effective managers’ (‘dirigeants effectifs’), since the duties incumbent on those who effectively direct insurance undertakings—therefore, also the related powers granted to implement them—are enriched by a further feature, consisting of intervention in any significant decision before it is taken, generally not granted to ‘effective managers’ (‘dirigeants effectifs’).

The Notice 2015 do not seem to provide any indication as to whether such a duty is actually being performed neither with reference to the recipients on the possible power of intervention, nor in relation to the possible effects thereof, nor, finally, in relation to the presumed responsibilities that may arise from the failure to exercise this duty.

Nor does the Insurance Code seem to offer any insight into the scope of the power to intervene in any significant decision given by the Notice 2015 to at least two of the persons who effectively direct insurance companies.

Nor does the Commercial Code seem to provide for what appears to be a kind of veto power that could be vested in those who actually run insurance undertakings, given that, from time to time, they should be allowed to intervene in any significant decision before it is taken, as it should be possible—as a result of the power of intervention—to prevent the decision from being taken, or from being taken in the same form conceived prior to the exercise of the power of intervention itself.⁴⁶

Yet, in the absence of any clue in the regulatory act regarding the possibility of reconstructing the existence of a veto power on the part of those who actually direct insurance undertakings, instrumental to the previous duty to intervene in any significant decision, there seems to be no alternative for the interpreter except to change the hermeneutical approach.

To this end, it seems that the duty/power to intervene in relation to the taking of any significant decision by those who actually direct insurance undertakings—mentioned in the Notice 2015—can only be preceded by a power/duty to act in an informed manner.⁴⁷

It is the same Notice 2015—in Article 2, entitled ‘Exigences générales en matière de gouvernance’ (‘General governance requirements’)—that place the duty to act in an informed manner at the top of the list of elements that contribute to shaping the system of corporate governance of insurance undertakings, to the extent that the following Article 2.1 is specifically entitled ‘L’organe d’administration, de gestion ou de contrôle’ (‘The administration, management or control body’), as if to highlight the fact that the administration, management and control bodies base their functioning on the exchange of information not only between themselves but also with the members of the key functions of the companies.

The regulatory measure, however, fulfils the legislator’s intention set out in Article 354-1 of the Insurance Code, in accordance with Article 41 of Solvency II, to provide insurance undertakings with a system of corporate governance that includes an effective system for the transmission of information.

From this reconstructive point of view, therefore, the idea that the power to intervene in the taking of any significant decision established in favour of those who actually direct insurance undertakings, from Article 2.3 of the Notice 2015, seems to be best interpreted as their duty to intervene (after all, the verb used in the French language ‘intervenir’ can be translated as both ‘to intervene’ and ‘to become involved’).

Whoever becomes involved in a decision merely contributes—whether in a favourable or contrary way to the party or parties responsible for making that decision.

However, a person who intervenes in a decision can influence the outcome.

Assuming that those who actually manage insurance undertakings are burdened with ‘becoming involved’ in any significant decision, rather than being required to ‘intervene’ therein, seems, on the one hand, to be a way of providing them with an exegesis of the regulatory measure that could protect certain subjects from the probable failure that a differently-oriented reading of the provision in question could cause during a conflict of powers between those who, for various reasons, are called upon to make a significant decision for insurance undertakings; on the other hand, it could be an adequate response to the spirit shown by the Regulator through the continuous call for collaboration between the top management of the company, which is instrumental to achieving an effective system of corporate governance. At the end, it could be argued that the basic requirement for being appointed as ‘effective manager’ (‘dirigeant effectif’) in French insurance undertakings is to be involved in strategic decisions.

This could confirm the working hypothesis on the basis of which the idea was put forward that not only the directors, but also the senior managers, could be considered as parties included in the scope of operations of the so called ‘two eyes principle’.

4.2 In Spain and the United Kingdom

The contrast between company administration, on the one hand, and management, on the other, seems to be found intact in the provisions⁴⁸ that the Spanish legislator dedicates to the system of government of insurance undertakings.⁴⁹

Article 2 LOSSEAR—intended to delimit the perimeter of the law—in letter c) begins by declaring that it is addressed to natural or legal persons who, for any reason,⁵⁰ perform administrative or management functions for insurance companies.

An unexpected clarification regarding the persons regarded as holders of administrative and management powers, respectively, appears to be found in a sentence in the second paragraph of Article 24, which is devoted to a quite different aspect, i.e. the absence of any required administrative authorisation to carry on insurance undertakings.

It does not seem essential for the moment to transcribe the entire paragraph, nor to provide an illustration of the premise of the legal precept that is understood as subject to common interpretation.

It seems sufficient to transpose here the only sentence of the above-mentioned regulation that seems to provide a regulatory foothold to the uncertain assumptions made so far.

This refers to the subordinate sentence ‘… como los mencionados administradores o directores’ (‘such as the aforementioned administrators or directors’) placed in relation to the main sentence ‘Esta obligación será solidaria entre la entidad y quienes, desempeñando en la misma cargos de administración o dirección …’ (‘This obligation will be jointly and severally between the company and those who, holding the same administration or management positions …’).

The legislator, according to the sentence under review—which, now, for ease of understanding, is transcribed in the correct order ‘Esta obligación será solidaria entre la entidad y quienes, desempeñando en la misma cargos de administración o dirección, hubieren autorizado o permitido la celebración de tales contratos u operaciones, todo ello sin perjuicio de la infracción administrativa en la que hubieran podido incurrir tanto la entidad como los mencionados administradores o directores’—in making the directors and officers of insurance companies aware of the liability they may incur if they were to conduct insurance business in the absence of administrative authorisation, refers to them as cited above (‘… como los mencionados administradores o directores’).

Article 24 LOSSEAR, on the other hand, mentions for the first time the directors and officers of insurance undertakings,⁵¹ since it previously made a different reference to those who perform administrative or management functions (‘quienes desempeñando cargos de administración o dirección’).

If those who exercise functions of administration and management of insurance undertakings are the ‘mentioned’ directors and officers, it would seem that the structure of relations between holders of administrative and management powers was officially established (up to now this relation could only be unofficially based on a series of conjectures).

The conceptual framework thus formulated seems to receive a decisive endorsement from the following Article 38 LOSSEAR.

This article—which dictates the requirements that must be met by those who exercise the effective management of insurance companies, i.e. perform functions that constitute an integral part of the system of corporate governance (both concepts on which it is not considered useful to dwell, as their content derives directly from Solvency II)—in providing, in the second paragraph, an indication of those who exercise effective management, mentions ‘those who hold positions of administration or management’ (‘quienes desempeñando cargos de administración o dirección’), to clarify immediately thereafter—in letters a) and b), respectively—that such positions are considered to be (i) ‘directors or members of the board of directors’ (‘los administradores o miembros de los órganos colegiados de administración’); (ii) ‘general managers and persons regarded as such’ (‘los directores generales y asimilados’), considering as general managers ‘all those who perform senior management functions under the direct supervision of the Board of Directors, executive committees or managing directors’ (‘entendiendo por tales todas aquellas personas que ejerzan en la entidad la alta dirección bajo la dependencia directa de su órgano de administración, de comisiones ejecutivas o de consejeros delegados de aquel’).⁵²

It seems, therefore, that we can conclude that in insurance undertakings under Spanish law, administration is the responsibility of the ‘administradores’ (directors), while management is the responsibility of the ‘directores’ (senior managers).⁵³

Support for this idea could also be found in Article 540, paragraph IV, letter c) of the Ley de Sociedades de Capital (Companies Act), which, although referring only to listed companies, requires an annual report to be made public providing information on the corporate governance structure adopted, with a distinction to be made between holders of directorships and management positions.

A significant contribution to understanding the powers of administration conferred on ‘senior managers’ could have been found in the Financial Services and Markets Act 2000⁵⁴ (hereinafter, for the sake of brevity, referred to only as FSMA in accordance with the indications of the British legislator), which, together with the Financial Services and Markets Statutory Instrument 2015 No. 575 (better known as ‘The Solvency 2 Regulations 2015’), formed—until 31 December 2020⁵⁵—the reference regulatory framework for the application of the precepts of Solvency in the United Kingdom.

The functions of ‘senior management’,⁵⁶ in the case of companies subject to the application of the FSMA 2000, are characterised, under Section 59ZA, by profiles of daily management, which require the taking of decisions, or even mere participation in the taking of decisions.⁵⁷ These decisions may have serious consequences on the performance of the company itself, if not indeed on the functioning of the economic market in the whole of Great Britain.⁵⁸

Ultimately, it does not seem to be the membership to the board of directors that distinguishes the ‘two persons’ ensuring to take every significant decision, but rather it is the nature of the functions performed, in relation to the type of activities carried out, to allow the senior managers to be involved in some aspects of the firm strategy, such as viability and sustainability of the business model and the establishment, maintenance and use of the risk appetite.