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Governance Structure

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Corporate Governance

Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers … and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.1

Articles and Bylaws

States require corporate business entities to have certain organizing documents in order to do business. Articles set out the basic framework and structure of the organization, identifying the bodies or entities that will provide governance, the offices that comprise the basic management of the organization, the provisions regarding membership or ownership, the provisions for required meetings, etc. Bylaws are the “contract” of existence between the business entity and the owners or members of the organization. The additional detail in bylaws usually addresses the following subjects – the rights of members or owners, the basic roles or duties of the board and officer positions, the timing and notice of meetings, the method of board nominations and elections, the removal of directors, and any board indemnity provisions.

An important part of a mutual company’s governance practice is to review and maintain an effective set of articles and bylaws. In states where certain article or bylaw provisions are mandated by state law, such provisions must be identified and preserved. In other areas however, the directors are free to update and modernize as circumstances may suggest or demand.

Board Size

Like other governance practices, board size will vary from industry to industry and from company to company. Boards will want to be sensitive to the influence of board size on director participation, the depth or quality of board discussions and the time needed for good decision-making by the board. The factors that farm mutual boards should consider when addressing the issue of board size include:

  • The role and philosophy of the board regarding its governance function.
  • The number of board committees needed to be staffed.
  • The desire for increased diversity or representation (is a strong community presence desired?).
  • The size of the company itself.
  • The complexity of the company.
  • The stage of the company’s development.
  • The coordination and logistics issues involved with board size.

Board Leadership

The choice of chairman can significantly impact the effectiveness of these groups and the satisfaction of serving as a member. For these reasons, thoughtful consideration should be given to the selection of a chairman. The use of well-established criteria can enhance the selection process for a Chairman and is a worthwhile board governance exercise.

A chairman’s function within a board or committee will include some or all of the following tasks and responsibilities (some of these functions will depend on whether the position is separate from that of the CEO):

  • Prepares agenda and conducts meetings.
  • Collaborates closely with the CEO on board matters (if not the CEO already).
  • Attends committee meetings as ex-officio member.
  • Exercises powers and duties of the CEO in his or her absence (if not addressed in other succession planning policies).
  • Participates in external activities to promote the company.
  • Investigates and recommends ways to improve corporate governance.
  • Presides at all policyholder meetings (this may be a CEO function in some companies).
  • Recommends nominees to the board (or to the nominating committee).
  • Advises the CEO on major operational issues (mentor role).
  • Communicates the board’s evaluation of the CEO’s performance.2

Some companies have kept the CEO and Chairman position separate as a way of promoting greater independent management oversight by the board and allowing the Chairman to be more focused on important board tasks – e.g., management succession planning. In the alternative, some companies combine the roles of Chairman and CEO to provide a significant organizational link between management and the board of directors. Other companies, in situations where the CEO is the chairman, have chosen to create the position of “lead director”. The lead director position attempts to the benefits of a combined CEO/chairman and the benefits of a recognized and formal independent leadership position on the board. Many of the same functions of an independent board chairman would be contained in the position description for a lead director.

Board Committees

The advantages of a board committee structure are apparent – committees can apply more extensive experience and abilities or more focused attention to significant areas of company activity.

Some of the factors that help to decide whether a board should establish a committee include:

  • The specific skill or experience required to understand the activity or issue and to propose recommendations or make decisions.
  • The time commitment required to oversee the particular issue or activity.
  • The importance of the issue or activity that is the subject of the committee’s responsibilities.

It can be a good practice to periodically review or evaluate the overall committee structure of the board to consider the following issues:

Committee Purpose:

  • Is special knowledge or effort still required for this issue/activity?
  • Can the work of any committees be combined?
  • Should the work of the committee be expanded?

Committee responsibilities (as established by written charter):

  • Is the authority granted consistent with the responsibilities delegated?
  • Are the specific functions and tasks still relevant?

Committee size:

  • Does size impact positively the level of discussion/review we desire?
  • Does size allow the level of representation or expertise we desire?

Committee structure:

  • Should the Chairperson have special expertise?
  • Should an officer of the board serve on the committee?

Committee charters are an excellent idea and a well written committee charter addresses such matters as the purpose of the committee, the specific functions and tasks assigned to the committee, the delegated authority of the committee (decision-making or recommendations only), and meeting and reporting time frames.

Financial/Audit Committee

Financial information and management practices are critical to any business organization since all companies must fairly and accurately report financial information. A financial/audit committee can assist the board greatly in meeting its obligations in this important function. The specific tasks or functions of the audit committee generally include the following:

  • Recommend or select the firm that is to serve as independent auditor.
  • Understand the critical accounting policies, judgments and estimates being applied.
  • Review and discuss the audit plan with the auditor.
  • Review the qualifications, independence, and work product of the auditor;
  • Review with the auditors their proposed audit report and management letter, if any;
  • Meet privately with the independent auditor from time to time to review the adequacy of management’s internal controls and recommend corrective action as needed.3

The financial literacy of members of a company’s financial/audit committee has become increasingly important to boards. Committee members are expected to be able to read and understand insurance company financial statements as well as important financial ratios and terms.4 The chairman of the committee may be expected to be knowledgeable and experienced in financial management, perhaps with a specific insurance accounting or financial management background.5 Boards will also want to carefully consider the independence of the committee and its chairperson, since an inside director (and especially the CEO) faces the potential for clear conflicts as a result of the committee’s audit responsibilities and role.

Nominations/Governance Committee

A nominating committee is generally tasked with finding, qualifying and recommending nominees for election to the board and/or its committees. Some nominating committees however, have a broader scope of responsibilities that include overseeing the company’s corporate governance practices. Factors that a board will want to take into account in the decision to create a nominating/governance committee include:

  • The importance attached to recruiting qualified board members in the future.
  • The importance and advantages of a regular review of the company’s governance practices.
  • The relative need for a change in governance.
  • The desire to create a focus on change and a process for overseeing corporate governance improvement activity.

General responsibilities for an expanded nominations/governance committee could include:

  • Establish criteria for board nominations and committee appointments and recommend same.
  • Oversee policyholder governance relations and any policyholder participation issues and activity.
  • Oversee the board-meeting process, including information reporting and meeting management.
  • Develop governance principles, policies or guidelines for adoption by the board.
  • Oversee board and/or board member evaluations.

Compensation Committee

Since management compensation is both important and increasingly scrutinized, the justifications for a compensation committee seem more compelling than ever. The functions or tasks typically assigned to compensation committees include:

  • Oversight of the company’s overall compensation/benefits program.
  • Setting the compensation/benefits of the CEO (or senior management).
  • Ensuring linkage between compensation and long-term goals.
  • Conducting or managing the process of the CEO’s evaluation.

The compensation committee benefits if its members, or the chairman, have knowledge or experience in compensation/benefits or human resources. Governance advocates also recommend that only independent directors serve as members of the compensation committee as this reinforces the idea that the committee is not controlled or unduly influenced by management.

Executive Committee

Executive committees have traditionally been the most common of any board committees. Executive committees can fulfill a number of functions, including conducting the CEO evaluation (as an alternative to a compensation committee), initial development or review of important policies for the full board to consider and approve, and/or initial review or formulation of long-range plans.

The executive committee also serves as an emergency decision-making body on behalf of the board where expediency does not allow for a full board meeting. Executive committees generally possess the authority of the full board, unless the issue under consideration is a fundamental company matter (merger, sale of substantial assets, director dismissal, etc.). For some companies the executive committee has become unnecessary due to the presence of other more specialized committees or because the full board has been restructured to a more manageable size.

Investment Committee

Boards are ultimately accountable for the investment function of the mutual company. However, the board does not always possess the required skill, experience, or time to oversee a portfolio of any size and the responsibility is often too great for a single person to handle. A committee composed of knowledgeable and competent directors can be a reasonable approach to this important function. Generally, the committee is responsible to:

  • Establish and maintain investment policies and guidelines for investments.
  • Determine and monitor asset allocation for investments.
  • Set expectations for diversification and security selection and asset performance.
  • Monitor returns and review asset performance.
  • Approve any investment transactions that exceed management limits of authority.
  • Interview, hire and review any investment managers that may be needed.
  • Review the overall effectiveness and appropriateness of the investment policies and management practices and recommend any changes.

Conclusion

There is tremendous opportunity in the insurance industry. Perhaps more than ever before the critical capability of the insurance industry to manage risk and enable a robust economy is understood by a number of consumers and policymakers. Just as in the past, the mutual insurance industry is more than capable of meeting these challenges and exceeding all expectations, and improved corporate governance can be a significant enabler in that effort.


Footnotes

1 OECD, Principles of Corporate Governance, April 1999.

2 J. E. Richard, Board of Director Compensation Guide, J. Richard & Co., (Montara, CA 1995), p. V-4.

3 Audit Committees: Providing Oversight in Challenging Times, Ernst & Young, 2002, p. 37.

4 There are a number of sources for a definition of financial literacy. One of the Better Sources is found in the Report of the NACD Blue Ribbon Commission on Director Professionalism, 2001 Edition, National Association of corporate Directors, (Washington, D.C. 2001),Appendix C. 5Audit Committees: Providing Oversight in Challenging Times, Ernst & Young, 2002, p.30.

Posted: Monday, March 29, 2004 12:00:00 AM. Modified: Friday, September 23, 2005 4:03:38 PM.

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