Oct 13

Regulators of the World, Unite!

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With apologies to Marx and Engels, this may also sound like the clarion call for those responsible for regulating financial institutions.
We have already seen developed countries discuss how regulations on banking, derivatives, etc, can better be coordinated…all the better to keep the financial players from picking the best domicile for their activity.
And, now, we have the US Government looking to create a national office of insurance. Although the initial and ultimate authority of such a new department is still open for debate…even the insurance industry does not agree on what that should be…the trend is clear. Many regulators believe they must unite to throw off the yolk of the oppressive insurers who look for optimal domiciles or otherwise ‘game the system’. And, in some instances, insurers (some of who support an ‘optional federal charter’) are supportive of this view of the world.
Of course, in the insurance industry, the granddaddy of this approach is the National Association of Insurance Commissioners (NAIC), that trade association or regulatory body (I’m not sure even the NAIC agrees on which it is). The NAIC developed a unification tool called ‘accreditation’ to keep all its ‘members’ on the same page on key ‘model law’ issues. Yet, one of the most prestigious members, New York, takes the approach of a different Marx (Groucho), who said “I don’t care to belong to a club that accepts people like me as members.” New York remains ‘unaccredited’, preferring to buck the system, while still having a large hand in how it operates.
However, this misses something that we all should remember. Whether in banking or insurance, the regulators are ‘captured’ by the largest of those they regulate. In other words, the regulators must bend to the wishes of the largest firms they regulate, especially in difficult times.
If you don’t believe this happens in insurance, we have only to look at the topic of ‘permitted practices’, those actions that are OK for certain companies, but probably not for yours.
For example, the Insurance Underwriter recently reported that the number of life insurers using permitted practices increased from 25 companies in 2007 to 80 in 2008, and that the combined effect on surplus for those companies went from a reduction in surplus of $313 million in 2007 to an increase in surplus of $8 billion in 2008.
Capital out of thin air.
But, wait, there’s more.
The life industry is advocating relaxing capital requirements for many residential mortgage backed securities because using rating agency ratings are inaccurate. Their alternative would revolve around using third party modeling. But, isn’t the incorrect use of models one of the problems encountered by investors (and the rating agencies) in the recent financial crisis? Based upon continuing discussions, this proposal or something like it, may pass.
Regulators of the World Unite!  
Indeed.