Vaughan Crisis Flashcards
Main test of regulation’s success is its effectiveness in achieving its objectives in these areas
protects-PIED
* protecting Policyholders
* protecting Investors
* protecting Economy, in general
* protecting Depositors
Concepts related to regulatory failure
FFC
* regulatory Fallability
* regulatory Forbearance
* regulatory Capture
Regulatory Fallability
Regulators are human and humans make errors
Regulatory Forbearance
Definition: Failure of a regulator to intervene promptly in a troubled company
Reasons:
* company may recover without intervention (not all troubled companies go bankrupt)
* company may object to intervention
Consequences:
* if company recovers > no consequences
* if company doesn’t recover > impact to policyholders and strain on guaranty funds may be worse than if regulator had intervened earlier
* data shows that troubled companies often take increased risks when trying to recover
* these increased risks could be successful or they could make a bad situation worse
Regulatory Capture
Definition: tendency for a regulator to assume the mindset of an interest group
Reasons:
* the interest group may be good at influencing a regulator
* political interference
Consequences:
* if company recovers > no consequences
* if company doesn’t recover > impact to policyholders and strain on guaranty funds may be worse than if regulator had intervened earlier
Checks & Balances in US insurance regulatory system for limiting failures
D2P2M
* Duplication
* Diversity of perspective
* Peer review
* Peer pressure
* Market discipline
Duplication
- multi-state insurers are subject to regulation in each state of operation
- 1 state may miss warning signs of a troubled company
- but it’s unlikely that all states would miss the warning signs
Diversity of perspective
- different regulators have different perspectives regarding regulation
- some prefer strong regulation (higher costs but protects consumers)
- some prefer weaker regulation (lower costs but can be harmful to consumers)
- competing perspectives encourage centrist solutions (prevents overregulation/deregulation)
Peer review
- NAIC coordinates peer review groups FAD & FAWG
FAD = Financial Analysis Division
* analyzes nationally significant insurers
* refers unusual findings to FAWG
FAWG = Financial Analysis Working Group
* consists of 16 highly experience financial regulators (not the same as regulatory duplication by state regulators)
Peer pressure
- any state can investigate or take action against any insurer operating in their state
- such action by 1 state can pressure other states to do the same
Market discipline
- state-based regulation cannot easily access federal bailout funds (eliminates moral hazard of relying on federal government)
- provides incentive for states to exercise strong regulation
Elements in building an effective global insurance regulatory system
TSAR
1 Trust
* regulators must trust each other
* US: accomplished through NAIC accreditation
* global proposal: IMF Financial Sector Assessment Program and G20 peer review
2 Share
* regulators in different countries must share information (this is the greatest challenge because domestic regulators want to protect domestic industries)
3 Action
* other countries must be able to take action against an insurer (if dissatisfied with actions by other regulators)
4 Resolution
* mechanism of resolution for bankrupticies (must be fair to all countries involved)
Areas that regulators have targeted for improvements to the US insurance regulatory system
- rating agencies: review reliance on rating agencies in the RBC system
- securities lending: new reporting requirements for securities lending
- unregulated affiliates: impact on insurers
NAIC’s 5 principles that any national regulatory structure should possess
STarCH
Standards
* uniform where appropriate but local where necessary
* set & enforce at state level
Taxes & fees
* states should still be able to collect taxes & fees
Collaboration
* encourage: collaboration with international bodies
Holding companies
* state regulators should have equal standing with other regulators regarding holding companies
