View this article online: https://www.insurancejournal.com/magazines/mag-closingquote/2014/12/15/349429.htm
It appears that the insurance industry is having an easier time emerging from the financial crisis than entering the new regulatory environment, particularly as it relates to nonorganic growth. With increasingly healthy balance sheets, insurers face what may historically be the most dramatic changes in regulation and regulatory authorities.
These changes are having a profound impact on the strategic and operational initiatives of the industry. Regulatory changes are widely regarded as the largest uncertainty that overhangs the industry, impacting valuation as well as strategic and operational decisions of insurers.
Verging on Radical Transformation
For nearly 150 years, states essentially regulated the U.S. insurance industry. The status quo was dealt a major blow with the 2010 Dodd-Frank law, which ushered in an unrelenting pace of regulatory changes, including federal and international regulators asserting greater levels of oversight for the industry.
The Dodd-Frank Law created the Financial Stability Oversight Council (FSOC) with authority to identify nonbank financial institutions whose failure “could pose a threat to the financial stability of the U.S.” The International Association of Insurance Supervisors, a voluntary membership organization of insurance supervisors and regulators from more than 200 jurisdictions in nearly 140 countries, is developing a risk-based global Insurance Capital Standard (ICS) to be implemented by 2019.
The FSOC has applied the “systemically important financial institutions” (SIFIs) classification to AIG, Prudential and MetLife. Dodd-Frank also empowers the Fed to regulate certain insurance companies that own savings and loan institutions. Consequentially, the central bank is positioned to become the consolidated regulator of some of the nation’s largest insurers.
There is competition among state and federal regulators vying for hegemony of the regulatory oversight of the insurance industry. As the balance of regulatory powers shift from state to federal and international authorities, and insurance regulations mirror more bank-centric capital requirements, insurers are adjusting to the increased compliance cost and higher levels of required capital.
So what might the oversight battle mean for insurers?
Several themes are emerging from the changing landscape, including a post-crisis aversion climate, low equity market valuations and additional powers for regulators.
Post-Crisis Aversion Climate
Merger and acquisition transactions are generally viewed as one of the more risky strategic initiatives. Consequently, there is a much longer gestation period for transactions as insurers look closely at strategic fit as well as regulatory and integration issues during the due diligence process.
Low Equity Market Valuations
Property/casualty insurers and life insurers are trading at 1.23x and .99x book value, respectively, according to SNL. These low valuation levels, with little catalyst for higher stock price performances, remain a significant obstacle to consolidation activity.
Additional Powers for Regulators
The Dodd-Frank law extends the responsibilities of regulators to include: anti-money laundering, fair lending and the issue of deceptive practices.
The insurance industry emerged from the financial crisis relatively unscathed, yet the aftershocks still reverberate, resulting in increasing regulation and a chilling effect on large-scale M&A activity.