In Regulation, 'tis a Gift to Be Simple
Since 2008, the debate over regulatory regimes, solvency, equivalency, group status, local requirements and just exactly which regulator will be supreme has been – to say the least – extensive. Solvency II, ORSA, the FIO, SIFI and GSIs, the EOIPA, the FSB and the FSOC - it is an alphabet soup of acronyms, frameworks, promulgations and bodies who have and want a say over the future of the (re)insurance sector. Accomplishments of each body, so far, are few, aside from keeping company government affairs, finance and legal teams busy. We remain lost in the woods.
Regulators across the financial services and insurance sectors perform valuable and important work. For (re)insurance in particular, the regulator is integral to the fulfillment of the underlying claims-paying promise at the heart of the industry. But the fundamental flaw in the renewed emphasis on the role of the regulator is that it is still largely a reaction to the problems then in the banking sector that led to the last crisis. In aiming to fix what went wrong we are not looking at what is now working right. And, the attempts to fix the past may indeed jeopardize the future productivity of the sector. We cannot let (re)insurance – particularly the property and casualty sector – follow the same fate of the banks.
The recent history of the banking sector demonstrates the power of unintended consequences. Increasing compliance costs and capital requirements have helped drive consolidation and more “too big to fail” banks. The U.S., for example, is increasingly dependent on fewer, larger banks.
From 1984 to 2011, the number of U.S. banks with assets less than $25 million declined by 96%, while the largest banks with assets greater than $10 billion grew eleven-fold, raising their share of industry assets from 27% to 80%. At the end of 2011 the five largest banks in the U.S. held assets equal to 56% of the total U.S. economy, up from 43% just five years earlier. None of the regulatory impulses in the banking system were intended to make our world more aligned on fewer, larger banks, but that is exactly what we face.
The degree of the current debate doesn't trouble me. These are complex and fundamental issues to get right. And it gives my fellow CEOs plenty to do. But, in the well intentioned effort to ‘get it right’ – at least as to the viewpoint of each individual regulator, each delayed, discussed, and reformulated systems from Solvency II, ComFrame and others, and the very real potential that each creates additional and conflicting rather than simple and complementary layers of regulation is detrimental to the sector and leads to negative spillover effects for our clients. Each additional regulatory layer drives up compliance costs, taps more man-hours, hampers innovation and leads to a commoditization of practices and products – all of which hurt our companies and our ability to serve clients. And it is time spent directed away from the core problem that should be solved – how do regulators and the sector continue to work together to ensure the fundamental delivery of the core insurance promise. Amazingly, one might say, I remain optimistic that we can and will get it right. Unlike their regulatory banking siblings, in our sector there is a successful record of putting complex systems, built largely on trust and mutual agreement between regulators, like the U.S. state-based system, into practice. But, future success might be in spite of ourselves if we continue to lose sight of common sense guidance:
Be precise in the problem we are trying to solve.
Precisely define the problem we are trying to tackle and match the solution to it. For instance, I am always told that the reason there needs to be enhanced regulation of non-bank financials is because of AIG’s (and to some extent, XL’s experience) history and I am told that the solution for such a company would be a higher loss absorbency and now, the listing of the company as systemically significant. While this premise for the future soundness of our industry is indeed appreciated, the idea of having AIG on the list when the company is no longer involved in the products that give rise to contagion seems to miss the mark. This is true particularly when there is good academic work being done by the Geneva Association and others showing the actual contagion risk of our industry is minute. We must focus precisely on the problem we are trying to solve and design the solution to the problem.
Ambition here can be dangerous.
We are working on transition rules to Solvency II; we have ORSA in the U.S., ComFrame, and now we’re talking about the ComFrame allocation balance sheet. Each of these on their own is a massive effort. If we are to take them together on a permanent basis, it will be too much. My fear is all of these regulations will saddle the industry with huge costs of complying with unclear, conflicting rules.
But, I think we could come to a more natural state of agreement. While the existing system is not perfect, it works relatively well, and in fact performed relatively well in the last financial crisis. A more focused, evolutionary approach would create a more stable and realistic system, without such a great risk of over-complexity. Here, trust between regulatory bodies is essential. Rather than competing standards of solvency, there should be mutual agreement to principles and local application of regulation to meet very real market and regional differences. In looking for a uniform, one size fits all system; we will miss the opportunity for wider application of the solution that does in fact work now.
Mind the gaps.
Multiple, overlapping regulatory regimes can result in gaps, which can have tragic consequences. The 2008 crises was a clarion call to the industry and regulators, and a terrible reminder of the potential dire consequences of regulatory gaps. We all have a responsibility to imagine the gaps that could appear and to flag them to regulators.
There is a great benefit to the sharing of information and ideas across the world and across industries. This is true in all fields, including regulation. Regulators must work together to share knowledge of the industry and it is incumbent on the companies to honestly and adamantly share.
Trying to mash together some of these new systems will guarantee failure and strip our industry of innovation and creativity. Regulators should focus on broad standards, learning from each other and from (re)insurers as to where gaps exist and potential issues lay.
At the end of the day, I think all of us – (re)insurers, regulators, brokers, clients, etc. – have the same goal in mind: a healthy and vibrant insurance industry. Insurance regulators should be proud of the role they played in the last financial crisis, and that they will continue to play in safeguarding our industry long into the future.
Reprinted with permission from Reactions Magazine, 2013.