why regulation fails Flashcards
reasons regulation fails
- Regulator Fallibility: regulators are human, humans make errors
- Regulatory Forbearance
Failure to take prompt & stringent action in the face of a potentially troubled firm
Chance the insurer will survive
Shutting down an insurer is difficult
- Regulatory Capture (Tendency of regulators to side with an interest group)
- A system that relies on a single regulator that is able to scan the market, see problems, know what to do AND then do that will ultimately fail
Structure of Insurance Regulation in US
- State based system
- Co-ordinated via NAIC
- Oversight of insurance industry; share data & information; develop common solvency tools, reporting requirements and model laws
Uniform regulation due to Accreditation Program
-Checks and balances:
Duplication
Peer Pressure
Diversity of Perspective
There is value to duplication & overlap
Different regulators can perform several of the same regulation activities, to avoid potential errors
peer review & peer pressure
- peer review: Other regulators can request that the regulator to take action; US regulation features multistate oversight and peer review systems like the ones coordinated by the NAIC. When peer reviewing one another’s work, they are more likely to catch errors and issues
- peer pressure: regulators can urge the domiciliary regulator to act; When one state detects a weakness in regulation by a domestic regulator’s analysis, they can question that state, encourage changes, and in the worst case, bring pressure to bear on the regulator to act
Diversity of Perspectives
effective system considers diversified perspectives and strikes to reach compromise; Different vantage points will avoid extreme policies
Overregulation vs insufficient regulation
- Overregulation imposes unnecessary costs
- Insufficient regulation causes unnecessary harm to consumers & taxpayers
4 elements of effective regulatory system
Regulators must have confidence in each other, Free sharing of information among supervisors, Ability for other countries to take action if they are dissatisfied with actions of another supervisor, Must be credible mechanism to resolve situation where assets are insufficient to fund all of the claims
NAIC realizes the need for uniformity & reciprocity. They proposed 5 principles of nationwide regulation to help achieve this:
a. There need to be uniform standards where appropriate, although local standards may apply where necessary
b. States should have the responsibility for setting/ enforcing standards
c. State regulators should have equal standing regarding the regulation of holding company structures
d. Structure should provide mechanisms for collaboration & interaction with international & financial services regulators on matters that impact US insurance
e. The system shouldn’t reduce state’s authority to impose taxes & fees
Measurement Tools
- each tool only provides one piece of evidence, so should not rely only on 1 to make conclusions about financial health of insurer
- tools should not replace audit, do not guarantee that input data is accurate/complete, do not indicate if management has implemented good internal management, systems, and controls, and will not uncover fraud
- results of tool may indicate need for further investigation and when multiple tools are used together over period of several yrs they can provide early warning of high risks insurers
hard to perform detailed exam of filings of each insurer
so need to rely on other tools in conjunction with statements to prioritize which insurers to target
How have tools faired?
- AAA conducted study of insolvencies and issued report
- insolvency is caused by combo of factors but under reserving is factor but not leading cause
- size/experience/diversification had significant impact
- good management & governance is essential
- poor decision = little/no reins, insufficient reins for amount of risk, very rapid prem growth, sign adverse devel, inadeq pricing, serious data problems
- although the SAO did not prevent insolvencies, it did help identify companies that may be in trouble
- Of the insurers that went insolvent, it observed: only 1 SAO was qualified, remaining were “reasonable”, nearly 1/2 concluded that there was a risk of material adverse deviation, materiality stds were unusually based on % of surplus
final message of study
financial impairment is caused by variety of factors and if tools used collectively, can help detect those that are @ risk for impairment
IRIS, RBC, SAO/AOS as measurement tools
IRIS: focuses on BS strength and earnings quality
- no direct link btw results of ratios and regulatory intervention
- NAIC analyst system team will review IRIS results together with other tools to prioritize companies that require attention
RBC: considers BS risk via asset and reserve risk charges and profitability via WP risk charge
-dis=most of factors are based on industry wide experience rather than company’s
SAO & AOS: actuary’s opinion of reserve adequacy which is important since largest single item on BS typically
- regulators may give add scrutiny if actuary opines reserves are anything but reasonable or id additional comments mention sign risks that could result in material adverse deviation
- This only addresses reserve adequacy, not a holistic evaluation of financial impairment AOS -This tool is confidential
statutory financial statements provide 2 views of financial health
balance sheet strength (focus on areas that can impair solvency ie reserve & UEPR adequacy) and earnings potential
Credit Rating Agencies provide & cons
provide financial strength ratings (rating of ability to meet obligations) and debt/issuer ratings (ability to meet debt obligations)
- ratings are based on both qual (corporate gov, product development, capital structure, asset quality, investment strategy, reserve adeq, claims management, contingent assets and liab, level of reins dependency) and quant (capital adequacy models) analysis of insurer’s financials
- ratings established annually but monitoring throughout year to evaluate whether rating needs to change in light of certain developments (statutory financial statement filings, interim management reports, significant public announcements)
- FSRs can be used by PH for change insurer will be able to pay claims, directors of corporate PH may require use of highly rate insurers, insurers to look at reinsurers to decide which companies to use, investors to assist in decision about whether to invest
- Ratings agencies core analysis is once a year and may not be able to identify a troubled insurer in time. -Rating agencies don’t respond quickly to changing conditions -Proprietary formulas
