All the world’s a stage – a perspective on the global implications of proposed federal backstop

And one man in his time plays many part.
All the world’s a stage,
And all the men and women merely players;
They have their exits and their entrances,

Edward Liddy is a player who made made his exit as CEO of Allstate in December 2006 and his entrance as CEO of AIG  this past September.

One of the many parts he will play in his time is the role of  advocate for a federal backstop to the property/casualty insurance insurance industry – a role he played at a December 2005 industry conference.

… catastrophic storms can impact geographies beyond traditional coastal areas, is precisely why the industry needs a federal backstop.

Liddy said the approach is two-pronged: states should have a pool funded with a portion of premiums paid by policyholders — modeled after the reinsurance-like Florida Hurricane Catastrophe Fund as well as a federal backstop that would be broadly funded and would grow on a tax-free basis…

In December 2005, I was too busy finding coats for families that had lost theirs and more to Katrina to give insurance much thought. However, the idea of a federal backstop is about as appealing to me as spending another night in a travel trailer with no heat.

Having given insurance a great deal of thought since joining Sop on Slabbed, I see a clear connection between a federal backstop and the world stage that is the place where the men and women of the insurance industry will increasingly make their exits and entrances.  In that regard, I found Liddy’s comments recorded in a  transcipt of the PBS program, CEO Exchange, particularly interesting.

… I made a decision, oh six years ago or so, not to pursue the international arena. Insurance is different. It’s not as global as some other industries are. I think that was a good decision at the time. I question it… as I look at where the growth is, around the globe right now, and it’s many of the evolving or emerging countries, and we are not there, I wonder if that is a shortcoming in our strategy… Making a decision that’s good for the next 2-3 years, and making a decision that’s good for the next 20-30 years, sometimes are at odds with each other, and being able to balance those two, can sometimes be difficult.

Others made a different decision.  One was Deloitt Touche.  A recent reader comment brought the company to mind as well as a related post I wrote on cat bonds and Solvency II this past July.

Deloitt Touche traces its history from England in the late 1800’s and began focusing on a global future during a period that began in 1990.  Their leadership in Solvency II is understandable from that perspective.

The European Commission has proposed a ground-breaking revision of EU insurance law designed to improve consumer protection, modernise supervision, deepen market integration and increase the international competitiveness of European insurers. Under the new system, known as ‘Solvency II’, insurers would be required to take account of all types of risk to which they are exposed and to manage those risks more effectively...(emphasis added)

The new system would introduce more sophisticated solvency requirements for insurers, in order to guarantee that they have sufficient capital to withstand adverse events, such as floods, storms or big car accidents. This will help to increase their financial soundness. Currently, EU solvency requirements only cover insurance risks, whereas in future insurers would be required to hold capital also against market risk (e.g. a fall in the value of an insurer’s investments), credit risk (e.g. when debt obligations are not met) and operational risk (e.g. malpractice or system failure). All these risk types pose material threats to insurers’ solvency but are not covered by the current EU system.

Insurers would also be required to focus on the active identification, measurement and management of risks, and to consider any future developments, such as new business plans or the possibility of catastrophic events, that might affect their financial standing. Under the new system, insurers would need to assess their capital needs in light of all risks…[supervision]would shift [from a focus] on compliance monitoring and capital to evaluating insurers’ risk profiles and the quality of their risk management and governance systems. (emphasis added)

Solvency II is modeled after the European Union’s banking reform, Basil I and Basil II and reflects the same three pillar design with each pillar governing a different aspect of the Solvency II requirements and approach.uk_fs_solvency_pillars

An interactive version of the graphic is found on the Deloitt Touche website. As these three questions suggest, the FAQ publication of the European Union is also insightful (note the spelling is correct albeit by European standards).

32. What will the proposal mean for insurers that are headquartered outside the EU (‘third-country insurers’)?

The proposal includes specific rules for branches of direct insurers headquartered outside the EU which are similar to those applied to branches of insurers headquartered within the EU. Conversely, the treatment of cross-border provision of insurance services and reinsurance activities conducted by third-country insurers and reinsurers essentially remains a matter for Member States as long as they respect their EU and international obligations.

However, in order to promote greater harmonisation with respect to the treatment of third-country insurers and reinsurers and to take account of the international nature of insurance markets today, the proposal includes a number of provisions that enable the equivalence of a third-country solvency regime to be assessed.(emphasis added)

The proposal also allows for the conclusion of mutual recognition agreements with third countries concerning the supervision of reinsurance entities that conduct business in the territory of each contracting party.

20. Will the new framework allow for securitisation?

The new solvency framework will recognise the economic substance of insurance activity and will focus on risk and the management of risk. Securitisations, as well as other risk mitigation techniques such as reinsurance and derivatives, can be a very useful tool for insurers in managing their risk exposures. The new solvency regime allows insurers to use such techniques and to get commensurate solvency capital relief arising from such a use, provided that insurers can demonstrate that they understand the nature and limitations of such techniques, and provided that there is a real transfer of risk.

39. Is the proposal a ‘Lamfalussy’-style Directive? What are implementing measures?

Yes, this is a ‘Lamfalussy’-style proposal for a Framework Directive. This means that the Framework Directive (‘Level 1’) focuses mainly on elaborating the basic enduring principles, or political choices, underpinning the solvency system. The more detailed, technical rules will then be put in place by the Commission in the form of implementing measures (‘Level 2’), which will be subject to scrutiny by the European Parliament and the Council of Ministers. (See Annex A.3 of the Impact Assessment for an explanation of the Lamfalussy Process).

Congress is currently being encouraged to pass legislation establishing a federal role in insurance regulation and provide a federal backstop – a proposal that has much in common with Solvency II.

The similarities are not coincidental.

The publication of draft framework Directive for Solvency II will also be closely monitored by non EU countries and there are expectations that US and Asian regulators will move towards a Solvency II type regime over time.

“The prospect of global solvency standards based on the EU standard should provide an early mover advantage to EU insurers in the same way that UK insurers are well positioned for the Solvency II…

Neither is the global use of technology.

A key component of CSC’s Office of Innovation, the Global Alliances Program works across CSC divisions worldwide to identify and bring innovative niche, business and technology companies into CSC’s Global Alliances Program portfolio. The program then leverages these partnerships to support the strategic business goals of CSC and our clients— geographically, horizontally by technology initiatives and vertically by industry… Through the Global Alliances Program, every one of our clients can benefit from the power and reach of CSC’s global IT leadership — and our unique partnerships with business and technology leaders worldwide.

Nor is it a coincidence the financial crisis is global.

Convergence between the insurance industry and the capital markets is now a reality.  Insurance linked securities are dramatically changing the landscape of the European insurance and reinsurance market.

What’s more, the European Union Commission has now released the first draft directive of Solvency II – the most far-reaching change to the framework governing insurance companies in the EU for over 20 years. This will encourage more risks to be securitised by allowing you to reduce your capital requirements.

Even Lamfalussy sounds a lot like proposals for a federal-state system.

The Lamfalussy Process is an approach to the development of financial service industry regulations used by the European Union. Originally developed in March of 2001…It is composed of four “levels,” each focusing on a specific stage of the implementation of legislation.

At the first level, the European Parliament and Council of the European Union adopt a piece of legislation, establishing the core values of a law and building guidelines on its implementation. The law then progresses to the second level, where sector-specific committees and regulators advise on technical details, then bring it to a vote in front of member-state representatives. At the third level, national regulators work on coordinating new regulations with other nations. The fourth level involves compliance and enforcement of the new rules and laws.

Change we need or a case of change we need to survive that we first have to survive to change?  Was the scheme a test run?

11 thoughts on “All the world’s a stage – a perspective on the global implications of proposed federal backstop”

  1. “All the world’s indeed a stage
    and we are merely players,
    performers and portrayers,
    each another’s audience
    outside the gilded cage.”

    Beat you to the punch Steve because you have to know that one. That’s even in Doug’s range.

  2. What the industry wants is a federal backstop of the status quo without federal oversight and with the added bonus of federal preemption of state rate regulation.

    During 2006, I spent a lot of time meeting with think tank types and lobbyists while trying to draft a proposal that would make a federal reinsurance concept work with Congressman Taylor’s objectives.
    We suggested a federal natural catastrophe reinsurance program for policies that would cover all perils, with federal oversight to protect consumers and taxpayers, and prohibitions on companies cherry-picking lower risks and dumping the rest into state insurance pools. No one was willing to consider it.

    1. In that context, no one would be willing to consider any offer other than the one they wanted. What makes it so frustrating is that you can bet that once your meeting was over, those attending found a willing ear for complaints. Sometimes it’s just not worth the trouble.

  3. Mr. Martin: what exactly would the feds use to pre-empt state regulation if there is no federal oversight? Your first sentence makes no sense to me. If no oversight, where does the pre-emption come from?

    If a federal backstop is so repugnant, why do so many like social security, welfare, etc? OR, is it purely the concept that it is ONLY ok as long as the feds have ALL the control and can pay or not pay whomever they wish with nobody to answer to? As I have said before, socialism is a mental disease propagated by those with governmental power onto the powerless who wont or cant act for themselves. Our country was NOT founded that way.

    1. Our country certainly wasn’t founded to ignore the needs of the elderly and children. Where’s the middle ground, Proximo?

  4. Insurers say they would write more policies in Florida and other high-risk places if the feds would make rate regulation go away. That is the purpose of Optional Federal Charter. Its premise is very weak federal oversight.
    Social Security is a federal insurance program. It is nothing like a federal backstop of private insurance.
    The correct analogy to a federal reinsurance program would be the Pension Benefit Guaranty Corporation, which will soon spend billions of taxpayer dollars to bail out underfunded private pensions.

  5. If all the world’s a stage
    am I even in the program
    smeared across the bottom
    by a finger on the page?

    And where’s that fucking play’write,
    do they hide behind the curtain
    a’twitterin uncertain
    like a boid wit’out their cage?

    Perchance we are all only agents
    or actors without the range
    to find ourselves another line
    or time for costume change.

  6. Editilla, I had a long hard end to my day and then here you were to brighten it with thoughts of twit wits in cages.

    Be sure and read water, water – just don’t do it while drinking or you may spew!

  7. “What the industry wants is a federal backstop of the status quo without federal oversight and with the added bonus of federal preemption of state rate regulation”
    That is the entire problem in a nutshell. How do you get federal money without federal regulations. The industry protected themselves via a concurrent clause but would not allow consumers to protect themselves via federal legislation. Basically the position of the industry is consumers and tax payers will have to suffer till we get our federal money without strings. What they really want is a state by state pool of money without federal supervision managed by themselves but paid for by a third party. Well guess what I want one of those as well. The money flowing out the backdoor would be great.

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