MASTER IN FORENSIC ACCOUNTING & FINANCIAL CRIMINOLOGY

MAF 721 - RISK MANAGEMENT

Insurance and Risk in Malaysia: A perspective from Money Laundering activities

For:Dr Sharifah Khadijah Syed Agil

CONTENTProject synopsis3Introduction3-4Types of Insurance5-6Risk associated with Insurance Products6-8Impact of Non-Compliance9-10Summary of Case10-11Recommendations11-12Conclusion12Reference13

INSURANCE AND RISK IN MALAYSIA:A PERSPECTIVE FROM MONEY LAUNDERING ACTIVITIES

Synopsis

Insurance in general is an economic device whereby an individual substitutes a small certain cost (or known as premium) for a large uncertain financial loss (the contingency insured against), which would exist if it were not for the insurance. Some sees insurance as an economic device in reducing and eliminating risk through the process of combining a sufficient number of homogenous exposures to make the losses predictable for the group as a whole. The insurance industry in general provides risk transfer, savings and investment products to a variety of consumers, from individuals to multi-national corporations and governments. FATF through their report on Money Laundering typologies report in 2003 stated that, experts viewed the insurance industry as potentially vulnerable to money laundering activities because of the size of the industry, the easy availability and diversity of its products and the structure of its business. This study adopts conceptual approach through analysis of previous studies on money laundering risk and the impact to the APG (Asian Pacific Group) assessment, Malaysian economy and enforcement to anti money laundering, anti-corruption and bribery. This study in particular, is structured in a way, which it will first discuss on the different types of insurance products, ie from general insurance to investment link products. It will then discuss on the risk that is associated to the insurance industry, focusing on money laundering activities in particular and will later look into the consequences if an organization does not comply with the spelled out regulations. The second part would discuss on actual case studies and to identify its typologies being adopted. The final part of this study is a conclusion of what has been presented on the earlier part, which would be the presenters recommendation in fighting money laundering activities that the insurance industry should adopt.

Introduction

This research is conducted with the objective of assessing the risk of money laundering that involves a multi-factor analysis. Factor influencing the level of money-laundering risk associated with a business relationship include country or geographic risk, distribution risk, customer risk, product risk and financial sanction risk. Malaysia, even though does not rated as high risk countries by any international bodies, have been rated medium risk under Basel AML Index and Corruption Perceptions index.

It is important to understand what money laundering is, both in general terms and it is defined in the law. The term money laundering is in fact misleading and precise, for a number of reasons. The term money laundering suggests that criminal property starts out in one form then goes through some sort of laundering process and comes out in a different form. In other words, the term implies that it involves some form of relatively complex transformation process. This encourages the view that the clients who pose a money laundering threat know how to launder money and set out consciously to cleanse it in some way. This view is encouraged by the traditional staged interpretation of money laundering. The objective of money laundering is to be able to benefit from the crime and not get caught. This will require disguising the source of the property and altering it into something else. It is important to the criminal not to leave a trail leading back to the crime, or to the property derived from it.

Due to money laundering, the development is distorted as products are supplied at a price lower than production cost, making it difficult for others to stay alive in the competition. The overall productivity of the economy of a country can be decreased. The demand for money in our country will unpredictably fluctuate and the international exchange rates and cash flow will also become unstable. Studies from The BASEL AML Index, Country Risk Ranking shows that Malaysia AML Risk is moderate where Malaysia was ranked 102 out 162 countries and our risk score is 5.41 which is classified as moderate. Assessment from BASEL and APG is very important in order to have the confidence level of foreign investor to invest in Malaysia which would however affect our economy as a whole. Weak law enforcement to anti-corruption and bribery, heighten the risk of money laundering in the country. It was mentioned that the amount of worldwide money laundering is problematic, the International Monetary Fund has estimated that between 2% and 5% of global GDP per year is generated annually as the proceeds of crime (in US funds that is an amount in the trillions of dollars), the largest sources of which are illicit drug manufacturing and trafficking, arms and people smuggling, corruption, fraud, extortion, kidnapping and theft.Based from the assessment from BASEL and APG, the study shows several areas need to be improved. The areas are:

1) weak law enforcement to anti-corruption and bribery hamper the effectiveness of operations of competence authorities to counter crime;2) weak and immature countrys awareness on Money Laundering offences, 3) present of terrorist groups that support violent extremism exposed the risk of fundraising from criminal or apparently lawful activities; and4) Influx of (illegal) foreign workers from neighbouring countries and the Malaysia My Second Home (MM2H) programme, may carry forged IDs and provide fabricated documentation to circumvent controls.

The objective of this study is to:1) To explore the risk of non-compliance of anti-money laundering in the financial institution focusing in insurance company in Malaysia2) To explore the risk of money laundering towards the Malaysian economy3) To identify whether money laundering risk in insurance company (financial institution) could impact the society as a whole.

In order to assess the risk in the insurance sector in a structured form, discussion will be based on:1) The different types of insurance products, ie from general insurance to investment link products;2) The risk that is associated to the insurance industry, focusing on money laundering activities in particular and will later look into the consequences if an organization does not comply with the spelled out regulations; 3) The second part would discuss on actual case studies and to identify its typologies being adopted.

Types of Insurance Product

Common modus operandi to launder money using insurance policies premium is paid up front lump sum rather than in annual installment. Launderers purchase them and then redeem at a discount (including paying for the fees and penalties). The launderer will receive a clean cheque from the insurance company.

In the modern insurance industry, competitiveness amongst the insurance companies worldwide is becoming more vicious. Therefore, attractiveness of the insurance product is one of the factors that would attract sales towards customer compared to the olden insurance product that only offers solely in life insurance. Below are the list groups of type of insurance products:

1) Investment linked product a) Product features allow for high liquidity which could be relied upon to draw out deposited funds with relatively ease (at minimal cost)b) Characteristics include larger cash and premium payments, surrender value, accumulation of funds with top-up/ withdrawal facilityc) Free-look provision allowing for immediate policy cancellation (with full premium refund)

2) General Insurancea) Non-life insurance, including automobile and homeowners policies, provide the payments depending on the loss from a particular financial eventb) Low exposure to money laundering

3) Life Insurancea) Pays out a certain amount of money to the insured or their specified beneficiaries upon a certain event such as death of the individual who is insured. b) The coverage period for life insurance is usually more than a year. So this requires periodic premium payments, either monthly, quarterly or annually.

High Risk Products a) Single premium linked policy and high value policyb) Regular premium plans with annual premium on per policy more than RM 5,000

Low Risk Productsa) Group insurance b) General insurancec) Telemarketing insurance products

Investment linked product, one of the most active selling insurance product in the insurance industry, features high liquidity which could be relied upon to draw out deposited funds with relative ease, and thus significantly increase its risk exposure toward money laundering. According to 2013 statistics, about 76% of the policies were investment-linked plan. However, majority of the plan was medically related and 20 odd percent were still having unit linked features. Product characteristics such as large premium payment, cashing in of the policy through redemption (surrender value) and free-look period provision allowing for immediate premium cancellation with full refund are considered high risk. Only 2% of the total business was single premium, which met all the high risk characteristics and the remaining 98% of the business are regular premium basis.Most significant laundering and terrorist financing risks in the insurance industry are found in life insurance and annuities products. While many life insurance policies are generally structured to pay a certain sum upon the death of the insured, others have an investment value which can create a cash value if the policyholder wishes to cancel the policy. Life insurance policies that have an investment feature, which can increase the death benefit as well as the cash value of the policy, are often referred to as whole life or permanent life. Vulnerabilities in the insurance sector include:

1) Lack of oversight/controls over intermediariesInsurance brokers have a great deal of control and freedom regarding policies.

2) Decentralized oversight over aspects of the sales force Insurance companies may have employees (captive agents) who are subject to the full control of the insurance company. Non-captive agents, those who offer an insurance companys products, but are not employed by an insurance company (i.e., the non-captive agent will often work with several insurance companies to find the best mix of products for their clients) may fall between the cracks of multiple insurance companies or may work to find the company with the weakest AML oversight if they are complicit with the money launderer.

3) Sales-driven objectives The focus of brokers is on selling the insurance products and, thus, they often overlook signs of money laundering, such as a lack of explanation for wealth or unusual methods for paying insurance premiums.

Risk associated with the Insurance Products

Reputational risk is described as the potential that adverse publicity regarding an organizations business practices and associations, whether accurate or not, will cause a loss of public confidence in the integrity of the organization.

Legal risk is the potential for lawsuits, adverse judgments, unenforceable contracts, fines and penalties generating losses, increased expenses for an organization, or even the closure of the organization. For instance, legitimate customers may become victims of a financial crime, lose money and sue the organization for reimbursement. There may be investigations conducted by regulators and/or law enforcement authorities, resulting in increased costs, as well as fines and other penalties. Also, certain contracts may be unenforceable due to fraud on the part of the criminal customer.

Concentration risk is the potential for loss resulting from too much credit or loan exposure to one borrower or group of borrowers. This is particularly a concern where there are related counter-parties, connected borrowers, and a common source of income or assets for repayment. Loan losses can also result, of course, from unenforceable contracts and contracts made with fictitious persons.

Understanding of money laundering and terrorist financing risks in a bigger scope can be seen three levels which are:1) Countrys level a. Results of NRAb. Reports by reputable sourcesc. FIs own analysis on the countrys ML/TF risks

2) Financial Institutions Inherent Vulnerabilities (Factors influencing FIs vulnerabilities)a. FIs size, structure and geographical locations of branches/operationsb. Variety of channels of deliveries available for products and servicesc. Extent of exposures to cash-based transactions or cash-intensive customersd. Level of skills and experience of resources in AML/CFT including front liners

3) Customers Level (Factors influencing ML/TF risks of the customers)a. Type of customersb. Type of transactions

There are three types of risks involved in mapping out anti-money laundering procedures depending on the capacity of a company to map its risks. The risk types are:

a) Risk linked to the product itself;b) Risk inherent in client relationship; andc) Risk linked to distribution networks

Therefore, based on FATF recommendations that recommends to the Risk-Based Approach as the central for AML/CFT measures. The purpose of Risk-Based Approach is life insurance companies and intermediaries are able to ensure that measures to prevent or mitigate money laundering (ML) and terrorist financing (TF) are commensurate to the risks identified. This will allow resources to be allocated in the most efficient ways. The principle is that resources should be directed in accordance with priorities so that the greatest risks receive the highest attention. The alternative approaches are that resources are either applied evenly, so that all life insurance companies and intermediaries, customers, products could receive equal attention, or that resources are targeted, but on the basis of factors other than the risk assessed.

FATFs new assessment methodology focuses on:

CONSEQUENCESSMATERIALITYRISK

INFLUENCED BYCountry situation(economic and financial)

Structural elements(geographical location)

Other contextual factors(maturity of financial sectors

THREATS

VULNERABILITIES

This would also closely relate to the Malaysias National Risk Assessment. National Risk Assessment is an assessment of the countrys exposure to prevail crimes (domestic and foreign) and vulnerabilities of various sectors to ML / TF risk. This is an initiative by National Coordination Committee to Counter ML (NCC). National Coordination Committee is a combination several law enforcement which are Malaysian Anti-Corruption Commission, Attorney-Generals Chamber, Companies Commission of Malaysia, Inland Revenue Board, Labuan Offshore Financial Services Authority, Ministry of Domestic Trade and Consumer Affairs, Ministry of Finance, Ministry of Foreign Affairs, Ministry of Internal Security, Royal Malaysian Customs, Royal Malaysia Police, Securities Commission and Bank Negara Malaysia.

The risk-based approach places the responsibility to identify and assess the money laundering and terrorist financing risks and to take appropriate measures to identify, manage and monitor those risks.

Risk-based approach to money laundering covers:

1) Risk identification and assessment identifying the money laundering risks facing a firm (including related legal, regulatory and reputational risks) given its customers, product and services profile and having regard to available information including published typologies and assessing the potential scale and impact of the risks if they were to crystallize.

2) Risk mitigation identifying and applying measures effectively to mitigate the material risks emerging from the assessment.

3) Risk monitoring putting in place management information systems and keeping up to date with changes to the risk profile through changes to the business or to the threats.

4) Documentation having policies and procedures that cover the above and deliver effective accountability from the board and senior management down. Documenting the risk assessments undertaken to provide the rationale for decisions made.

Financial institutions that rely on the proceeds of crime have additional challenges in adequately managing their assets, liabilities and operations. The adverse consequences of money laundering are generally described as reputational, operational, legal and concentration risks. They are interrelated, and each has financial consequences, such as:

1. Loss of profitable business2. Liquidity problems through withdrawal of funds3. Termination of correspondent banking facilities4. Investigation costs and fines5. Asset seizures6. Loan losses7. Reduced stock value of financial institutions

Impact of Non-Compliance

Loss of control of, or mistakes in, decisions regarding economic policyDue to the large amounts of money involved in the money laundering process, in some emerging market countries these illicit proceeds may dwarf government budgets, resulting in a loss of control of economic policy by governments or policy mistakes due to measurement errors in macroeconomic statistics arising from money laundering. Money laundering can adversely affect currencies and interest rates as launderers reinvest funds where their schemes are less likely to be detected, rather than where rates of return are higher. Volatility in exchange and interest rates due to unanticipated cross-border transfers of funds can also be seen. To the extent that money demand appears to shift from one country to another because of money laundering resulting in misleading monetary data it will have adverse consequences for interest and exchange rate volatility, particularly in economies based, as the tracking of monetary aggregates becomes more uncertain. Last, money laundering can increase the threat of monetary instability due to the misallocation of resources from artificial distortions in asset and commodity prices.

Economic Distortion and InstabilityMoney launderers are not primarily interested in profit generation from their investments, but, rather, in protecting their proceeds and hiding the illegal origin of the funds. Thus, they invest their money in activities that are not necessarily economically beneficial to the country where the funds are located. Furthermore, to the extent that money laundering and financial crime redirect funds from sound investments to low-quality investments that hide their origin, economic growth can suffer. In some countries, entire industries, such as construction and hotels, have been financed not because of actual demand, but because of the short-term interests of money launderers. When these industries no longer suit the needs of the money launderers, they abandon them, causing a collapse of these sectors and immense damage to economies that could ill-afford these losses.

Loss of Tax RevenueOf the underlying forms of illegal activity, tax evasion is, perhaps, the one with the most obvious macroeconomic impact. Money laundering diminishes government tax revenue and, therefore, indirectly harms honest taxpayers. It also makes government tax collection more difficult. This loss of revenue generally means higher tax rates than would normally be the case. A government revenue deficit is at the center of economic difficulties in many countries, and correcting it is the primary focus of most economic stabilization programs.

Risks to Privatization EffortsMoney laundering threatens the efforts of many states trying to introduce reforms into their economies through privatization. Criminal organizations can outbid legitimate purchasers for formerly state-owned enterprises. Furthermore, while privatization initiatives are often economically beneficial, they can also serve as a vehicle to launder funds. In the past, criminals have been able to purchase marinas, resorts, casinos and other businesses to hide their illicit proceeds and to further their criminal activities.

Reputation Risk for the CountryA reputation as a money laundering or terrorist financing haven could cause negative effects for development and economic growth in a country. It diminishes legitimate global opportunities because foreign financial institutions may decide to limit their transactions with institutions located in money laundering havens because the necessary extra scrutiny will make them more expensive. Legitimate businesses located in money laundering havens may suffer from reduced access to world markets (or may have to pay more to have access) due to extra scrutiny of ownership and control systems. Once a countrys financial reputation is damaged, reviving it is very difficult and requires significant resources to rectify a problem that could have been prevented with proper anti-money laundering controls. Other effects include specific counter-measures that can be taken by international organizations and other countries, and reduced eligibility for governmental assistance.

Social CostsSignificant social costs and risks are associated with money laundering. Money laundering is integral to maintaining the profitability of crime. It also enables drug traffickers, smugglers and other criminals to expand their operations. This drives up the cost of government expenses and budgets due to the need for increased law enforcement and other expenditures (for example, increased health care costs for treating drug addicts) to combat the serious consequences that result.

Summary of Case

MALAYSIA

Offence : S.4(1)(a) AMLATFA 2001& S. 25(1) of BAFIAAccused : Datuk Adzhar Sulaiman, Noradzma Adzhar and Noradzrin Adzhar Director Noradz TravelFact of the case :They were alleged to have used the money to buy several properties in Perak and Pahang, buy insurance and investment products and also transfer part of the money into a subsidiary of the company.

Actions :1) Two (2) years imprisonment against Noradzma bt. Dato Adzhar2) Three (3) years imprisonment against Dato Adzhar b. Sulaiman 3) One (1) year imprisonment against Noradzrin bt. Dato Adzhar 4) Travel & Services Sdn Bhd was fined RM5 million; 5) Noradzma bt. Dato Adzhar (1st accused) was sentenced to one (1) year imprisonment and fined RM 500,000.00 (in default - 6 months imprisonment); and 6) Dato Adzhar b. Sulaiman (2nd accused) was sentenced to two (2) years imprisonment and fined RM 1 million (in default - 10 months imprisonment).

Offence : S.4(1)(a) AMLATFA 2001Accused : T. GauthamanFact of the case :He was also convicted on charges of engaging in money laundering and using money from illegal activities to pay deposit to buy a car and bought life insurance policy.Actions :1) T.Gauthaman was sentenced to nine (9) year imprisonment and fined RM 1,800,000.00OVERSEA

Accused : Gao Ailing Wife of Linkwell ownerFact of the case :Evidence showed she had spent some of the money on insurance and investment funds. She also transferred HK$3 million to her personal account in Singapore.

FRAUD OPENING ACCOUNT

Accused : Randall Petersen Insurance Agent of Equity Leadership Insurance Agency Inc.Fact of the case :Florida - Petersen advertised job opportunities on the internet for College Consultants of the Gulf Coast, and induced hundreds of applicants to provide information for life insurance that he and his associates described as free job benefits. College Consultants was not a real company and Petersen merely used the information from the job applicants to complete life insurance applications that he submitted to the insurance companies (American National Insurance Company and Liberty National Insurance Company).

Actions :1) Petersen faces a maximum of 60 years state prison.

RecommendationsThe Money Laundering Compliance Officer (MLCO) who is appointed by BNM are authorized and have access to FINS to report STR and CTR. The STR will be submitted by the MLCO via FINS to report directly to BNM. However the information were escalated only one way direction where only RI such as insurance company report to BNM but the information collected didnt available for review. Therefore it will be useful if BNM can perform live update such as summary of the STR reported. BNM should communicate the latest modus operandi and current status money laundering activities to the insurance company and communicated to the other Reporting Institutions for risk assessment and mitigation action purposes. This information will assist who deal with heavy daily cash transactions to identify the indicator and trends of any suspicious transaction which relevant to current trends of money laundering activities.Looking at the perspective of financial institutions that are involved in dealing with the anti-money laundering, they need to provide continuous education for their members of staff at all levels. For example at an entry level, every new member of staff joining in, has to undergo a compulsory course on money laundering, to start with and perhaps later on, they need to keep a record on how many hours they have spent on attending the update courses on the subject. Everything is aimed so that their level of knowledge is keep up to date with the current environment.

On the other hand, the STRs and CTRs will be more effective if proper legal frameworks are included and introduced to all members of staff. Be it for people working in financial institutions or elsewhere, they need to be able to understand a comprehensive explanation of suspicious transactions, and need well organized supervision and aware of the penalties in the cases of failure to comply with regulations. Then again, the financial institutions and Financial Intelligence and Enforcement Department (FIED) have to ensure that Anti Money Laundering policies are respected and followed by all employees, so that it can deter and prevent the money laundering activities from occurring in their organizations.

Government with the co-operation of the financial institutions and FIED should advise the private sectors on the importance of their role in combating money laundering activities. Wolfberg principles mentioned that the responsibility to combat money laundering is not only borne by the government but also with the help of the private sectors, by giving the information on suspicious transaction activities. Through decentralization of the law in Malaysia, the laws should be strengthen at all levels of the Government as because money launders in this era are always eager and could still find ways or loopholes that will give them those illegal benefits.

In addition, FINS system introduced by BNM can be updated such as automatically block funds movement of the suspected account which STR reported by the MLCO and able directly generates significant amount to be frozen for further investigation. Nevertheless, law requirement might need to review in order to add and implement as we recommend. In addition, law enforcement agencies and regulators should maintain an exchange of ideas medium to develop the use of harmonized data recording practices for the key variables of policy importance.ConclusionMoney laundering activities consist of 3 main activities such as placing, integration and layering. The ultimate goals for money launder was not motivated to gain profit, however their focus is to covert illicit proceed to legitimate fund and use as clean money in daily economy business cycle. Nevertheless, as a result of containing high effort in combating criminal such as corruption, transnational crime and terrorism financing by international and local community, reporting institutions such as commercial bank are mandatory to practice anti money laundering activities with serious approach. Therefore there are law as a regulation and guidelines for the reporting institutions such as insurance company to follow and obliged and responsible to monitor on their customer accounts activities and reported promptly to the authorities. Other than, the laws had set a guideline for the insurance sector to have a good practice how to monitor and techniques in order to face the AMLA related issue. Adequate and continuous training needs to provide to the compliance officer in order to increase awareness to identify any suspicious transactions and report it to relevant authorised appointed MLCO. Supports from top management are crucial in order to implement the guidelines set up by BNM in order to fight and detect money laundering activities. The top management need to identify the risk involved and implement relevant and necessary control to minimize and mitigate money laundering transaction performed and able to detect if any. In addition, continuous monitoring such as annual review by Internal Audit are important in order to ensure appropriate controls had implemented in order to fight against money laundering activities.

Reference1) http://www.themalaysianinsider.com/malaysia/article/money-laundering-man-and-two-daughters-ordered-to-enter-defence#sthash.WQlHOs9K.dpbs2) http://www.bnm.gov.my/microsites/fraudalert/0301_status.htm3) http://www.thesundaily.my/news/10828344) http://www.sprm.gov.my/name-and-shame.html5) http://www.scmp.com/news/hong-kong/article/1679702/mainland-chinese-housewife-jailed-hk240m-hong-kong-laundering-case6) http://www.insurancejournal.com/news/southeast/2015/04/14/364171.htm7) AML/CFT Compliance Conference 2014 FIED, Bank Negara Malaysia

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