Economic Crisis Challenges Harmonization of U.S. Regulations, EU’s Solvency II

By | June 18, 2012

The EU’s Solvency II regulations get most of the headlines, but there are other regulatory bodies, which are trying to modernize and harmonize the regulations for global insurance companies. Their task has been made even more difficult by the prolonged economic crisis.

As the re/insurance industry is more globalized than ever, there is a need for some kind of uniformity, but what form this will take, and how it could be accomplished remain as issues to be resolved. The International Association of Insurance Supervisors has been working on this aspect of global regulation for some time, and it has had a good deal of success, but globally harmonized insurance regulation is still a long way off.

Any future progress in this area will involve SII. The Director Credit Institutions & Insurance Supervision with the Central Bank of Ireland, Fiona Muldoon, in her keynote speech at the European Insurance Forum called for “a common, agreed approach for insurance supervision.” She described the arrival of SII as “altering the insurance landscape,” as it will address the “volatility” inherent in risk assessment, and will “require better assessment of balance sheet risks; more reality and more transparency.”

James Wrynn, New York’s former Superintendent of Insurance, now a partner with the law firm of Goldberg Segalla, expressed his view at the Forum in Dublin. He agreed that certain aspects of SII would eventually find their way into U.S. law, but, “it will not become a mirror image of Solvency II; some of it will be adopted, and vice versa,” as U.S. provisions will find their way into global insurance regulation.

However, SII’s arrival has been continually pushed back to the point that no one is even sure if all of it will arrive. Colm Fagan, who among his other activities, advises the Irish government on SII, is convinced that most of the Pillar I provisions on capital won’t survive local pressures to make exceptions for smaller companies, mutuals and captives.

Meanwhile the global economy hasn’t stood still. 10 years ago regulators didn’t have to deal with a global recession; they didn’t have to define what companies might be “global systemically important financial institutions – G-SIFI’s;” they were less concerned with regulations in emerging markets, or those, such has China and Brazil, which have in most cases emerged. The entire global picture for the insurance industry has changed, and continues to change.

Muldoon described the ideal situation as finding “a common, agreed approach for supervision.” How such a consensus can be reached when the economic situation changes almost daily poses a real problem. “Regulations evolve much faster in a financial crisis,” Wrynn said. But he also warned of the danger in trying to act under such circumstances. “There are benefits if we get it right,” he said, “but it could make things worse if we get it wrong.”

Speaking about G-SIFI’s, he said regulations “must be geared to systemic reasons, not just capital requirements – size, interconnectedness and liquidity all matter.” Wrynn’s ideal form for regulation is that it should be “as comprehensive as necessary, but as narrow as possible.”

The appearance of SII and the efforts to bring about greater harmony in insurance regulation have had the additional consequence of putting the U.S. system in a new light. Wrynn described it as the “most comprehensive” in the world, adding that it’s also in many ways the most practical, as it focuses on an “outcomes basis.”

Thos outcomes are for the most part based on local needs, risks and concerns. Insurance is in many ways just as local as politics. While everyone needs personal liability coverage and auto and home insurance, on the Gulf coast, Florida and the Carolinas people worry about hurricanes; Midwesterners worry about tornadoes, westerners about wild fires; the northeast about blizzards. Personal and commercial lines cover most of these perils, in addition to excess and surplus lines.

But people who seek coverage for their cars and the family home or a small business, aren’t really concerned about the inner workings of risk management, let alone the pillars of Solvency II. They essentially want the best coverage at the best price and prompt, fair claims services, which is, naturally, the main focus for most state regulatory bodies.

Multinational companies have other concerns, and they are the ones who need to have a more uniform system for the regulations governing their insurance coverage. On that score SII isn’t really a step forward. Wrynn pointed out, and most others who spoke on the topic agreed, that the longer it takes to do something the more complex it becomes. That stems from an overly ambitious plan. SII seeks to be all things to all men, but insurance is proving to be a more complex industry than the regulators anticipated.

The one size fits all formula seeks to regulate giant multinationals, smaller companies, mutuals, captives, the P&C carriers and the life insurers. Due to this complexity and the continuing uncertainty about what will eventually emerge, actual equivalence to SII’s regulations by U.S. insurance regulators would seem to be out of the question, at least in the foreseeable future.

In the U.S. regulations developed gradually over time and in response to specific needs. The 50 plus 1 regulatory authorities in the U.S. by and large have done a good job of protecting the insurance buyer. While the regulations may not be perfect, they do mandate reserve requirements and emergency funds, set premium rates and minimum qualifications for insurance professionals. All of which may make the U.S. regulatory system better than the sum of its parts.

Where changes and improvements are needed the system has shown it’s not inflexible. As an example, passage of the Non-admitted and Reinsurance Reform Act, and its implementation has, at least in principle, simplified the rules for surplus lines and created a more level and harmonized playing field.

SII is an attempt to do something similar for all of the EU’s insurance industry, a far more comprehensive goal than anything the U.S. has tried. There are needed provisions in it, which to some extent, will eventually find their way into U.S. regulations – mainly greater use of risk management on both coverage and enterprise levels, and the need for greater transparency.

Does that mean that the U.S. will seek actual equivalency with SII? No, it won’t, as it would be impossible, even with the full backing of the NAIC, to get all 50 plus one regulatory bodies to reach any meaningful agreement. As Wrynn pointed out, U.S. regulations “aren’t going to become a ‘mirror image’ of Solvency II,” but they will be a source for some regulatory changes over time.

In the end the U.S. and the EU will most likely reach a ‘modus vivendi’ that both entities can accept. Given the overriding issues posed by the parlous state of their respective economies, neither entity wants or needs a distracting and unnecessary fight over insurance regulation.

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