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The dangers of over regulation in the insurance sector are mounting

The dangers of over regulation in the insurance sector Anthony Harrington

With the LIBOR rigging scandal still very fresh in everyone's mind now is not a good time for anyone to point out that there is a real and growing danger in the current massive political appetite for re-regulation of all parts of the financial sector.

If "light touch" regulation lay behind much of the wrong doing leading up to the 2008 global financial crash, then surely what we need is the exact opposite, ie uncompromising regulation to constrain the current generation of reckless investment bankers? The answer you will get from the press, the politicians and the public is a loud "yes". No one will get much of a hearing for pointing out that there will be a tremendous cost to be borne for pushing derivatives, for example, through clearing houses, and that in the final analysis what will be seen to have been achieved will in all probability simply be that we will have moved risk from one point in the system to somewhere else in the system. Market risk is akin to heat in a closed system. You can move it about and you can mitigate some of its negative effects, but you can't make it disappear. It will always turn up somewhere else.

Moreover, when politicians and regulators turn their attention to "the financial sector" they have an understandable inclination to lump all the participants together. As Walter Kielholz, the chairman of Swiss Re argued back in 2010, the inevitable result of this careless mixing up of banks and insurance companies within the same legislative thrust, is the threat of inappropriate regulation. This worries insurance sector players since they came through the crash in vastly better shape than the banks, and did not need to be bailed out with public money, with the exception of AIG, which was always a special, one-off sort of beast, and arguably highly uncharacteristic of the sector as a whole.

Kielholz argues that what is driving regulation of the insurance sector is not any real palpable need, but rather the momentum in favour of regulating everything that moves:

"The world's insurance industry fears many regulators remain under political pressure to designate and consequently penalise, some insurers as potential threats to the financial system. That's despite encouraging signs that key supervisors have in fact taken the view that insurance does not represent systemic risk... ill thought out regulation (could) threaten the fundamentals on which the insurance industry depends in order to operate efficiently."

The theme of what exactly constitutes a "systemically important insurance company", as opposed to a systemically important bank, has, not surprisingly, also been exercising the IAIS (the international association of insurance supervisors). Peter Braumüller, Chair of the IAIS Executive Committee gave a speech on this theme back in 2010. The basic thrust is for the IAIS and the regulators to focus on insurance companies that trade internationally and are large enough to be considered a "systematically important financial institution", or SIFI. Notice that being "systemically important" is not quite the same thing as being a systemic risk. Having identified the universe of SIFIs, the IAIS is proposing that all SIFIs should basically be asked to increase their capital reserves to the point where they can clearly withstand a major shock. It also wants prudential requirements to be laid on SIFIs "commensurate with their systemic importance".

To much of the public and to many politicians this looks no more than sensible. However, what is not thought about as they root for regulators to pile on the pressure, is that there are no free lunches. What the big insurers rack up in costs they pass on as premiums. So ultimately regulation simply increases everyone’s “taxes”. You pay for regulation, only the cost is a hidden proportion of every premium you buy. Insurance is pervasive in modern society. No airplane takes to the air without insurance, no ships sail,  no cars are supposed to drive, no businesses operate. When you crank up insurance costs you crank up the costs of doing business, travelling and relaxing or simply living. So it behoves legislators and regulators to think a few moves beyond the knee jerk response when it comes to devising more smoke and mirror tricks to “take risk out the system”.

Further reading on the insurance sector:

Tags: 2008 financial crisis , AIG , crash , IAIS , insurance , insurance sector , Libor , Peter Braumüller , premiums , regulation , Scandal , Solvency II , systemically important
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