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The Role of Governments in the Insurance Industry Royal Institute for International Affairs London, U. K. 2 December 2002 If you would like a copy of this presentation, please give me your business card with e-mail address Download at http: //www. iii. org Robert P. Hartwig, Ph. D. , CPCU, Senior Vice President & Chief Economist Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346 -5520 Fax: (212) 732 -1916 [email protected] org www. iii. org
Presentation Outline Changing Role of Government in Insurance • Historical/Traditional Role of Government • Is Role of Government Expanding/Contracting? • Role & Rule of Government Beyond Direct Regulation • Is ‘Insurance Regulation’ Obsolete or Marginalized? • Summary & Conclusions • Q & A
HISTORICAL ROLE OF GOVERNMENT IN INSURANCE Fundamentals of Insurance Regulation
Expanded View of Insurance Regulation Traditional Ancillary Fiscal Political Solvency Pools Taxes/Fees & Assessments Public Policy Rate/Form Guarantee Funds Stimulative Political Agenda Consumer Protection (Re)insurer of Last Resort Income Redistribution Mitigation/ Safety Source: Insurance Information Institute
Rationale for Insurance Regulation Why Should Insurance be Regulated? • Contrary to public belief, there is no “right” to insurance Ø Therefore need justification for existence of regulation • Frequently cited reasons are market imperfections (e. g. , ruinous competition), consumer protection (licensing), systematic risks (e. g. , investment risk) • Regulation has probably extended well-beyond these bounds in some jurisdictions
IS ROLE OF GOVERNMENT IN INSURANCE EXPANDING OR CONTRACTING? Evidence of Expansion Evidence of Contraction
Expansionary Influence of Government on Insurance Government Expansion & Defense of the Status Quo • Terrorism • Health Care • Social Insurance (Elderly, Disabled, etc. ) • Recent Institution of Strict Regulation (e. g. , Texas? ) • Defense of Local Control over Federal Regulation Ø US: State vs. Federal Regulation Debate Ø EU: Member states slow to adopt regulations/harmonize
Governments Insuring Terror Risk Government Backed Terrorism Insurance Programs Terrorism Risk Insurance Country Provider United Kingdom Pool Re Spain Consorcio South Africa SASRIA Israel PTCF France GAREAT Germany Extremos Australia XXX Source: Swiss Re Focus Report: Terrorism Details Created in 1990’s due to IRA terrorism losses. Covers “Extraordinary Risks” such as Earthquake, Volcanic Eruption, Flood, Storm, Terrorism and Civil Commotion Created in 1929 due to political climate in South Africa - still in existence today. Covers losses triggered by politically motivated violence (including terrorism). Created post September 11, pool with state guarantee for terrorism coverage Proposed in November 2002
Industry Losses Under Proposed Federal Backstop Using 9/11 Scenario (as proposed/interpreted from Act signed Nov. 26, 2002) Total Ind. Loss: $10. 875 B $2. 0 B Industry Co-Share $14. 25 B $1. 75 B Industry Co-Share $19. 675 B $0. 925 B Industry Co-Share $0. 125 B Industry Co-Share Assumes $30 B Commercial Prop & WC Loss, $125 B “At Risk” Commercial DPW Source: Insurance Information Institute.
US Health Care Expenditures by Source (2000) US health care expenditures totaled $1. 3 trillion in 2000. Nearly half (45%) of expenditures are from govt. sources Source: U. S. Dept. of Health and Human Services, Health Care Financing Administration, III.
Source: Bureau of Economic Analysis, Insurance Information Institute. Expenditures as a % of GDP Expenditures ($ Billions) US Health Care Expenditures as a % of GDP
Government Share of Health Care Costs is Increasing Govt. share= 24. 9% Govt. share= 46. 8% Source: Bureau of Economic Analysis, Insurance Information Institute.
US Public Health Expenditures as Percentage of Total Government’s share of health expenditures has nearly doubled from 24. 9% in 1965 to 46. 8% in 2003 (est. ) Source: U. S. Dept. of Health and Human Services, Health Care Financing Administration, III.
US Old-Age, Survivors & Disability Insurance Expenditures as % GDP (“Social Security” Program) Government outlays for social security as a % of GDP will increase by 52% by 2035 Bush plan to “privatize” social security on indefinite hold. Time is “not ripe. ” Source: Social Security Administration
The Texas Takeover & Maryland Maneuver Dramatic Examples of Expansion of State Control • Texas: Dysfunctional homeowners insurance market Ø 3. 5 million HO policyholders Ø Historically most expensive state to insure home (severe windstorm, hail, tornado threat; high freq. of water claims) Ø 95% homes insured via “county mutuals”: not rate regulated Ø ‘Toxic’ mold problems crisis of availability/affordability Ø Became major issue in campaign for governor Ø Proposals to ban county mutual/implement rate regulation • Maryland Ø State forced struggling insurer to provide terror coverage on state property
Contractionary Influence of Government on Insurance Govt. Contraction/Liberalization/Harmonization • EU Directives • Japanese “Big Bang” (1996) • Harmonization efforts in US after Gramm-Leach-Bliley • Opening of Chinese market (esp. post-WTO) • Support of ART (generally), esp. captives Ø Strong interest in some states in domestic captives (e. g. , Vermont)
ROLE/RULE OF GOVERNMENT BEYOND DIRECT REGULATION Monetary/Fiscal Policy Regulation of Securities Industry Judicial System Taxation Trade Policy National Security & Defense
(US$) Billions U. S. Net Investment Income Investment income is directly affected by monetary policy, but insurance regulators are powerless to affect. Facts 1997 Peak = $41. 5 B 2000= $40. 7 B 2001 = $37. 7 B 2002 E = $35. 8 B Source: A. M. Best, Insurance Information Institute
U. S. Interest Rates: Lower Than They’ve Been in Decades 1. 2. Historically low interest rates are the primary driver behind lower investment yields. There is little insurers can do about this. 66% of the industry’s invested assets are in bonds *Average for week ending November 1, 2002. Source: Board of Governors, Federal Reserve System; Insurance Information Institute
Falling Interest Rates Mean Lower Bond Yields for Years to Come Interest rates are down globally. More room to fall in Europe than in US or Japan Source: Blue Chip Economic Indicators, October 2002.
Insurance Industry Stock and Bond Holdings, 2001 In Billions Total Industry Holdings = $3. 3 Trillion Total $1531 P/C $194 Life $1, 337 Total $1120 P/C $185 Life $935 Total $438 Total $209 P/C $188 Life $21 Source: Federal Reserve Flow of Funds Report as of Dec. 31, 2001. P/C $131 Life $307
% GDP Employment (Millions) U. S. Federal Budget Deficit/Surplus FY 1990 -2010* Budgetary policy affects insurers directly, but insurer/ins. regulators have no influence. *FY 1990 -2001 actual values; FY 2002 -2010 are CBO forecasts. Source: Congressional Budget Office, Insurance Information Institute.
Economic Outlook for Major Economies (Real GDP Growth, %) Economic outlook for 2003 is mixed/weakening for major economies, esp. US, W. Europe, Japan Source: Blue Chip Economic Indicators, October 2002.
U. S. Real GDP Growth Fiscal & Monetary policy have direct impact on pace of economic activity. (first recession since 1990/91) Source: US Department of Commerce, Blue Economic Indicators 10/02, Insurance Information Institute.
The Tragedy of Corporate Governance: Insurers Held Hostage • Enron was tip of an iceberg • Major implications for insurers (p/c and life)
Corporate Governance: Expensive and Hard-Learned Lessons • Crisis of Confidence—skepticism is on the rise Ø Ratings agencies Analysts Ø Investors/Creditors Employees Regulators Lawmakers • Regulatory/Legislative Fallout Unclear Ø SEC is “rudderless” Ø Enormous number of investigations under way SEC, State Attorneys General, IRS, Do. J, etc. Most new SEC cases are against large companies Ø Many competing reforms from Congress, SEC, A. G. ’s. , NYSE, NASDAQ, etc. Ø Collectively are likely to help, at least somewhat • SEC, Administration & Congressional proposals vary • Surge in shareholder suits well underway
Financial Restatements Filed The number of financial restatements is rising even thought the number of publicly traded companies is falling. *Approximate Sources: Huron Consulting Group
Serious Implications for Insurers • Insurers exposed to a wide variety of risks: Ø Investment risk (as institutional investors) Ø Insurance risk (surety, D&O, E&O, etc. ) Ø Litigation risk (as both plaintiff & defendant) Ø Accounting Risk Ø Regulatory risk • Outcome of corporate governance issue hinges most critically on regulatory reform and enforcement in the securities industry: Ø Insurers have little, if any, say in this debate
Enron-Related Losses for Insurers Total Exposure (Life & Non-Life): $3. 796 Billion Enron is the biggest bankruptcy in US history ($31 B+) Equity/debt widely -held as S&P 500 company Biggest impact in institutional investors/creditors 11 Congressional investigations 56 suits against officers & directors Will spark similar suits Source: Loss estimates from Morgan Stanley as Feb. 8, 2002; Insurance Information Institute.
Average U. S. Jury Awards 1994 vs. 2000 Source: Jury Verdict Research; Insurance Information Institute.
Cost of U. S. Tort System ($ Billions) Tort costs consumed 2. 0% of GDP annually on average since 1990, expected to rise to 2. 4% of GDP by 2005! Tort costs equaled $636 person in 2000! Expected to rise to $1, 000 by 2005 Source: Tillinghast-Towers Perrin; Insurance Information Institute estimates for 2001/2002 assume tort costs equal to 2% of GDP. 2005 forecasts from Tillinghast.
Who Will Pay for the US Asbestos Mess? Estimated Total US Settlements & Expenses = $200 billion $78 billion $60 billion $62 billion Source: Tillinghast-Towers Perrin; Insurance Information Institute
Non-Malignant Asbestos Claimants File Most Claims, Get Most $$$ DISTRIBUTION OF CLAIMS ALLOCATION OF COMPENSATION 1991 -2000 Source: RAND, Tillinghast-Towers Perrin
National Security & Defense Issues More Important in Post 9/11 Era Terrorists & Terrorism Insurers forced to cover losses over which War on Terrorism they have no control, little knowledge and that properly rest with public sector Expansion of War Is Iraq No regulatory “compass” for this issue. Next?
THE ROLE OF GOVERNMENTS IN IN INSURANCE IN THE 21 ST CENTURY Is Traditional’ Regulation is Archaic? Focus on Convergence of Sectors Conclusions
Is Insurance Regulation Becoming Marginalized • • Are Insurance Regulators Overshadowed? Efforts to modernize insurance regulation progressing more slowly than world in which insurance operates Approaching time when non-insurance regulators have more influence over insurance industry than noninsurance regulators Impact of non-insurance policy (war on terror, Iraq) & non-insurance regulatory decisions (e. g. , SEC) on industry becoming more pronounced (corp. governance) Monetary/fiscal policy decisions are more critical than ever to insurers (esp. life) in convergent world
Core Principals of Insurance Regulation (IAIS) • • • System of insurer licensing Standards for corporate governance Standards for capital adequacy/solvency Rules governing assumption of risk by insurers Authority to monitor/conduct on-site inspections “Principles” applicable to intl. /cross border nature of global insurers • Power to take remedial action at problem insurers Source: Holfeld, Knut, “Comments of Global Regulation, ” Geneva Paper on Risk and Insurance, January 2002.
Focus on Regulatory Convergence is Insufficient Are Insurance Regulators Overshadowed? • Much of the focus on modernization of insurance regulation in recent years has focused on convergence • While convergence proceeds (domestically and internationally) there is no push for a global “super regulatory authority” ØPractical/political impossibility even within US/EU for now • Regulatory modernization is a necessary but not sufficient condition for regulatory relevance
Conclusions • • Maintaining Relevance in the 21 st Century Cross-sectoral efforts are underway (acknowledges realities of convergence), and work with groups like Basel Committee, IMF and World Bank are important, but… Sphere of insurer regulatory influence is under siege by outside forces—often beyond regulator control Regulators must achieve a delicate balance of achieving effective regulation without stifling innovation in insurance Many government policymakers/lawmakers and noninsurance regulators know very little about the insurance industry—must be educated.
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