Déjà Vu (All Over Again)
The NAIC held its 11th Annual International Forum in Washington, D.C. on May 15-16, 2017. The NAIC Press Release issued post-forum states as follows:
“The two-day forum included more than 300 regulators and insurers from 20 jurisdictions representing more than 70 percent of global insurance premium.”
While there were certainly late arrivals, i.e., too late to make it into the official listing, the listing itself indicated 272 attendees (inclusive of the 30 speakers/panellists). Since some jurisdictions and insurers had multiple attendees, the breadth of attendance portrayed by the release is somewhat overstated. Also, a fair number of people in the audience were neither regulators (taken in the broad sense (e.g., the FSOC representative technically not being a “regulator” even though he is a former regulator) nor insurer representatives, but rather people from law firms, accounting firms, and consultants, seeking perhaps a forum to interact and/or pick-up clients (I plead “guilty”). Nevertheless the Forum, in my estimation, could be described as a somewhat positive effort. As opposed to last year’s Forum whereat Daniel Tarullo spoke volumes and made headline news concerning how the U.S. will react to developing international regulatory and capital standards, this year’s Forum’s headline might relate to the FSOC representative putting “it” to the Secretary General of the International Association of Insurance Supervisors (IAIS) as to why he was not previously invited (and in fact, had his specific request denied) to attend a meeting to be held the very next day in Washington relative to systemic risk.
The topics on the agenda were:
Asia-Pacific Regional Focus
Emerging Risk Insights
Transatlantic Regional Focus
International Capital Standards
Systemic Risk
Reinsurance Issues
The comments made by the various panellists were mostly the standard fare and it is not my purpose here to provide a summary (presumably the media, and the press did indeed attend, will provide that type of coverage). What is the standard fare? Uniform group capital standards should be developed, risk should be managed, there is a need for more cost containment in complying with new rules, etc. It seems a wonder as to how the industry, globalized for centuries, ever succeeded to its current level without these efforts. Whether the current level is a level of success is arguable considering, at least in the U.S., the declining share of GDP represented by the insurance industry.
However, there were many things left out. First and foremost is the refusal to address the fundamental issue of why there hasn’t been cost-benefit analysis of each of the various efforts. One of the panellists did touch on the fact that, for instance, ORSA filing requirements have been implemented; however, the question unanswered is: What has been the quantifiable benefit? This is quite curious inasmuch as regulators evaluating insurer risk management systems certainly would look for their charges to employ such a procedure in managing a company. Moreover, the company’s comment noted that it had to file 11 separate and distinct ORSAs to various global regulators! There are various things that sound good, but ultimately are never proved to provide a benefit concomitant with the cost.
A second missing link is an indication of understanding of the very nature of insurance products in that they are not exactly “risk transfer” mechanisms. If you have a home exposed to the risk of fire damage, buying an insurance policy doesn’t “transfer” that risk; it provides an indemnification for a specific loss in a specifically defined calculable amount. The risk of loss of a home cannot be completely transferred or allow for complete indemnification. You may love your home and have memories that cannot be replaced. That’s your loss. Essentially, insurance is a method by which the cost of being exposed to a specific risk is calculated and represented by the premium for the indemnification. Since people are subject to a wide variation of specific risks, there are various products designed to compute the costs of each of such exposures.
This led to a discussion about a third matter, i.e., the simplification of coverage. A half-century or more ago, homeowners’ multiple peril and commercial multiple peril policies were the answer to this concern. The CEOs discussed the need for further effort using losses occurring as a result of water damage when, for instance, floods occur coincident to wind storms. Private flood insurance has recently been on the rise, and indeed many of the catastrophe losses that occur involve disputes as to whether losses were caused by wind or flood, much to the disadvantage of consumers. Another example is coverage for health-related losses when injuries can be caused for various reasons and in various venues which, in turn, can involve workers’ compensation coverage, home-owners’ coverage, auto coverage, regulator accident and health coverage, Medicare, Medicaid, etc. When a person is injured, they need their coverage, as opposed to disputes as to who is primary, secondary, etc.
A fourth matter that seems to escape the ken of regulators and standard setters in particular (but some companies too) is the very nature of the insurance business. Insurers exist to, quite simply, make money. Capital providers invest for one of four reasons, namely to: (i) create the means of production in order to generate profits; (ii) seek a rate of return for loaned capital (e.g., the interest on a bond) in the form of scheduled cash-flows; (iii) seek capital appreciation (i.e., to have the capital generate profits which makes the investment grow in value (e.g., stock price increases; and (iv) some combination of reasons (i)-(iii) (e.g., a preferred stock investment). Of course all investments are, or at least should be, weighted as to the risk of the desired outcome.
In order for insurers to utilize any invested capital, they have to compete in the marketplace. This means they not only manage risk, they take risk (their own, not policyholders’). The actuaries cannot merely go in the back room, analyze the risks of their products and come to a price. They have to consider that competing entities are doing the same thing and if the determined price is too high, they won’t sell any product and there will be no risks to manage (which means no money made). The problem regulators are engendering here, through the plethora of new standards and capital requirements, is that they are ultimately imposing their view of risk into the competitive process by establishing capital parameters based on their view of the various risks that inure to the business of insurance. Well, regulators, capital providers haven’t invested in you, and will not automatically further invest in you; they seek to invest in the actual stewards of capital whose stewardship might be adversely impacted by your standards. It’s nice to desire to protect policyholders, but regulators may actually be shooting themselves in the foot if capital is not attracted to the industry because, in turn, the abilities to create competitive returns on invested capital are too limited. It is noteworthy that regulators have no skin in the game since they are not the holders of capital available to be invested, and they cannot dictate that investments into the insurance industry be made. After all, the industry competes with other industries for the available capital which is not totally elastic in supply. This is why cost/benefit analyses are necessary to ensure that what sound like reasonably prudent regulatory measures are actually providing a return commensurate to policyholders and investors, and not merely raising prices and lowering rates of return.
