The tsunami of regulation

Friday, 25 April 2014

uring the last month I have spoken to the Chief Executives of many ICMIF organizations and also a number of other financial services leaders and the key topic of conversation is invariably regulation. Or, should I say, the potential tsunami of regulation that appears to be coming our way. Many of these industry leaders view the situation as one of over-regulation, which is not only a burdensome cost, but also a drain on human resources. From the regulation industry side it seems to be a situation of carte-blanche to regulate everything that is slightly risky. The two sides are becoming more and more polarized.

When The Economist runs a lead story on what its author sees as the over-regulation of financial services, as it did on 12 April 2014, entitled Leviathan of last resort, you know there is a problem. The Economist is often seen as being a champion of the free market and the author of this piece is very concerned with the level of current state interference in financial services.

The lead article and the associated in-depth essay, The slumps that shaped modern finance looked at the last five major financial crises of 1792, 1825, 1857, 1097 and 1929 and sought to find the lessons learnt. The article concluded that “the more the state protected the system, the more likely it was that people in it would take risks with impunity”.  In other words, more regulation is not the answer as it leads to financial services businesses being de-risked by the state as the state takes a greater role, through regulation, in running the global financial services sector.  Where states have too much power, protectionism becomes an issue, which means risk management (insurance) becomes political, and therefore inherently relationship driven rather than business driven.

In The Economist’s article the one thing it failed to point out was that in all five of the financial crises mentioned, and I would also argue in the 2007/8 crisis, it was the banking system that was the cause. Not once was the insurance sector mentioned as a cause. This is a point which is increasingly being made by insurance leaders around the world and, in particular, vociferously made by Mike McGaverick, Chairman of the Geneva Association, at their conference last month. However, I feel that the message is falling on deaf ears as far as the regulatory industry is concerned.

Without doubt the regulation industry is in a huge growth stage. Nobody disagrees with the aim of harmonizing regulation on a global basis; it is just the speed at which it is currently being driven that will be damaging to the insurance industry. We all know about Solvency II which started life back in 2002 and may be operational by 2016, a long time yes, but an iterative process worked on with the industry to get the best solution.

The International Association of Insurance Supervisors (IAIS), in contrast, is hoping to have a harmonized global financial regulatory system in place by 2019. Starting by defining the Basic Capital Requirement (BCR) in 2017; then the Higher Loss Absorbency (HLA) by 2018; and, finally, the International Capital Standard (ICS) in 2019.  An ambitious timescale given the Solvency II experience. Now, the IAIS say that they are under instructions from the Financial Stability Board (FSB) to achieve this target by 2019, which they are, and that the rules will only apply to global systemically important insurers (G-SIIs), but is this a little naive? Many will hold the belief that these rules will eventually apply to all insurers.

So, the insurance regulatory system that has been evolving over 200 years is about to be totally renewed in less than five years simply because of another banking crisis!!  It somehow doesn’t feel right or make sense to me.  The really worrying bit for me is the immense drive to make progress that the regulatory industry seems to have already generated with FSB and G20 political support. This is before the insurance sector has even had chance to become involved.  They are empire building without telling the foot soldiers that run the industry, all in the name of protecting the customer.

I wonder does the customer know what the regulatory industry is doing and how much it is costing them to have this new regulatory system. I heard the CFO of a large, global insurer say that the cost to his organization is one percent of total premiums. The proportionate cost to smaller insurers (and most are smaller) will be even greater. And it is the customer that pays in the end.

Apart from the disproportionate increase in costs that will affect mutual insurers, another disturbing rumour circulating is that the regulators only want to see an industry of large players as this is easier for them to manage and understand.  Could it be that regulation is being actively promoted to support consolidation and drive out medium- and small-sized insurers?  For ICMIF, in our role as the voice of the mutual and cooperative insurance sector, this is deeply concerning as many of those medium- and small-sized insurers are mutuals or cooperatives.

There is, therefore, indeed a great challenge ahead for the insurance industry – possibly the greatest yet. For the mutual and cooperative sector in particular we must slow down the tsunami of regulation heading our way and turn it into something eminently more fit for purpose. The stakes are indeed high and we will need to collaborate with the other insurance industry players and utilize all the collective power and political influence we have within the membership of the Federation. The recent creation of the new ICMIF External Relations team, with their remit to focus on influencing the global regulatory arena, could not have been better timed.

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