Insurance regulation is at a crossroads. Faced with an increasingly globalized and dynamic industry, the painful lessons of the financial crisis, dramatic and disruptive advancements in the use of technology, creeping protectionism and nationalism in many markets, competing regulatory agendas and good faith differences in regulatory approaches, insurance regulators are at an important juncture and have the chance to chart their course for the near to mid-term. The choices they make could lead to greater regulatory effectiveness and efficiencies, or result in further Balkanization of regulation and an ever heavier, costlier and at times conflicting set of regulatory rules for insurers. The potential impacts on the insurance industry and those consumers who rely on it are significant.
This paper reflects on the evolution of insurance regulation over the past decade (2007-2017) and offers thoughts on some of the critical choices regulators and the industry need to make going forward. In doing so, it focuses on developments primarily from the onset of the financial crisis and the regulatory response to the crisis. It looks at the positive developments that have taken place and some of the important lessons learned. It also examines what some consider to be misdirected activities and inevitable overreactions to the crisis. This paper considers certain critical new developments that may present regulators with the opportunity to reexamine and perhaps redirect their limited, finite regulatory resources. It is not intended to be a comprehensive report of all key developments during this period, but it aims to highlight some key initiatives and the critical regulatory policies that we believe deserve attention.
This paper reflects our personal views.* It does not reflect the particular views of any of our clients, although our views have certainly been developed as a result of many decades of advising insurers and other financial services industry players on regulatory matters. We hope this analysis will contribute to the ongoing and much needed discussion over the evolution of insurance regulatory policy globally. Getting that policy right matters.
THE CALM BEFORE THE STORM
On January 1, 2007, insurance regulation was centered largely on legal entity regulation with almost complete deference to the domiciliary regulator of the insurer. A focus on group supervision was emerging, but nascent. Insurance holding company regulation had a long tradition in the US, while Solvency II, which was being developed (work began in 2001) included a more robust and comprehensive approach to group supervision, in addition to many other provisions. Also, enterprise risk management requirements were beginning to take root.
At the same time, the International Association of Insurance Supervisors (IAIS) was working on efforts to improve cooperation and communication among global regulators. They were also beginning to talk about common structures and common standards for assessing capital adequacy and solvency. Corporate governance and risk management practices were also emerging on their agenda, along with finite reinsurance concerns, insurance fraud and related matters. In February 2007, the IMS adopted its Multilateral Memorandum of Understanding, which it hailed as a breakthrough to promote close cooperation and information exchange among insurance supervisors.
Overall, however, it was an era of relative regulatory calm, albeit with increasing activity among global regulators.
By mid-2007, the landscape had changed radically, as global financial markets began to shudder. The early trauma was to the banking sector. It was not until mid-2008 that the crisis hit the insurance industry. Memories are short, but in September/ October 2008 the financial system was close to the precipice in its worst crisis since the Great Depression. In just a six- week period in September/October 2008: (a) the US took control of Fannie Mae and Freddie Mac; (b) Lehman Brothers filed for bankruptcy; (c) Merrill Lynch announced its sale to Bank of America; (d) the Federal Reserve extended a $85 billion credit facility to AIG; (e) the Reserve Primary Money Fund NAV fell to below $1;(f) Goldman Sachs and Morgan Stanley converted to bank holding companies largely to have access to the Federal Reserve Discount Window; (g) WaMu Bank failed and was sold toJP Morgan; and (h) Wachovia Bank was sold to Wells Fargo.
Although it is true that the financial crisis was primarily a banking and capital markets crisis, and not an insurance crisis, the near collapse of AIG made it inevitable that there would be enhanced prudential regulation for insurers, particularly non-bank systemically important financial institutions.
At the 2008 IAIS Annual meeting in Budapest, the IAIS became the de facto coordinating center for the global response to the crisis at AIG. US, UK and other global regulators met extensively, discussing developments, regulatory reactions and concerns. Although driven by external events, global regulators can and should be proud of the level of cooperation and coordination displayed during the crisis.
These events ushered in a decade of unprecedented international and, in many countries, domestic insurance regulatory activity. Some of this was merely an acceleration of developments already under way (eg, group supervision and peer review among regulators), but others, such as systemic risk regulation and a special focus on internationally active insurance groups, emerged directly out of the crisis.
The scale and severity of the crisis in the broader economic system created a sense of urgency and, indeed, fear, as regulators scrambled to keep up with fast moving events. Regulatory responses to the crisis included many positive steps, but as always, regulatory over reaction was a constant danger. In certain jurisdictions, regulators began to evidence something close to a zero risk tolerance. Moreover, because the root cause of the crisis was in the banking sector, banking regulatory issues drove the response and dominated much of the regulatory thinking --even vis-a-vis the insurance sector. Certainly the Federal Reserve Board, the Bank of England and the Financial Stability Board (FSB)--founded, in 2009, as a result of the financial crisis by the G20 leaders--all viewed the world through a banking lens.
As an immediate result of the financial crisis, the IAIS was directed by the FSB to develop a system for identifying globally systemically important insurers (G-Slls) and to establish new capital standards for these insurers (known as the Basic Capital Requirement, BCR, and Higher Loss Absorbency, HLA). Despite much debate--and some persuasive analysis that indicated that no insurer was of a scale and with a level of connectedness to the financial system to pose a systemic risk--the IAIS ultimately identified nine insurers as G-Slls.
In addition, the IAIS began development of a Common Framework for Supervision of Internationally Active Insurance Groups (ComFrame) which was to include a set of international supervisory requirements focusing on the effective group-wide supervision of a newly designated class of insurers called "internationally active insurance groups" (IAIGs). It was to be comprised of a range of quantitative and qualitative requirements specific to IAIGs and to provide requirements and protocols for supervisors of IAIGs.
ComFrame was to build on the IMS Insurance Core Principles (ICPs) which lay out fundamental principles of effective insurance supervision. The ICPs essentially serve as a basic benchmark for insurance supervision in all jurisdictions. The ICPs were first issued in 1997 but were significantly revised in 2011 in response to the global financial crisis (and are currently being revised further).
In the US, there was also a flurry of activity resulting from the financial crisis. In June 2008, the NAIC launched its Solvency Modernization Initiative (SMI). The SMI was focused on reassessing the US solvency framework, revisions to US reinsurance regulation, enhancement of group supervision and corporate governance rules, among other matters. More recently, the NAIC followed up with its Macro Prudential Initiative (MPI) which is a logical continuation of its SMI project. The MPI was intended to promote greater insight into how insurers react to financial stress and how that reaction can impact policyholders, other insurers and financial market participants and the public. In 2011, the NAIC adopted the Own Risk and Solvency Assessment (ORSA) Manual, which provides guidance to insurers on how to conduct an ORSA. This was followed by the ORSA Model Act in 2012. Most importantly, the Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) was passed in 2010. That statute established the Federal Reserve Board as the regulator of systemically important insurers (as well as insurers that were subject to FRB regulation as savings and loan holding companies), the Financial Stability Oversight Council (FSOC) and the Federal Insurance Office (FIO).
Of course, the developments from 2008 on were not all coordinated or harmonized. When one considers the number of regulators (or other institutional actors) and the different demands--the Federal Reserve Board, the US Treasury, the state...