Actuarial Notes

The Economic Crisis and Lessons from (and for) U.S. Insurance Regulation

By Therese M. Vaughan · National Association of Insurance Commissioners · 2009

Study guides: Exam 6U, Exam GI-302

An article by Therese M. Vaughan, then CEO of the NAIC, published in the Journal of Insurance Regulation (Fall 2009). It summarizes the theories often used to explain regulatory failure and examines the structure of U.S. insurance regulation within the context of those theories, in the light of the financial turmoil of 2008 and 2009 and the expected changes to U.S. financial services regulation.

On the syllabus

  • Exam 6U — objectives A2 and A4; pp. 6–13 (Journal of Insurance Regulation, Fall 2009, as the content outline states it)
  • Exam GI-302 — Outcomes 2a-d, 2f; pp. 6-13, ending at "Lessons from State Insurance Regulation" on p. 13 (as the syllabus states it)

Abstract

  • Policymakers and scholars are asking what role regulation played in creating the financial turmoil and how the structure of financial services regulation should change; policymakers argue the U.S. needs more focus on systemic risk and a resolution authority for systemically risky institutions.
  • The article summarizes theories often used to explain regulatory failure and examines the structure of U.S. insurance regulation within the context of those theories.

Introduction

Why Regulation Fails

  • Regulation is fallible because human beings are fallible; scholars have also developed concepts related to regulatory failure, two of which are regulatory forbearance and regulatory capture.
  • Regulatory Forbearance
  • Regulatory Capture

The Structure of Insurance Regulation in the United States

  • Duplication
    • The Martin Frankel fraud of the 1990s, which several state regulators missed and the Mississippi Insurance Department uncovered, is given as an example of the value of duplicative regulatory oversight.
    • The NAIC designated a lead state regulator for every U.S. insurance group, responsible for coordinating the other regulators on examinations, analysis and regulatory action.
  • Peer Review and Peer Pressure
    • The NAIC's Financial Analysis Division performs ongoing financial analysis of all nationally significant insurers and refers unusual findings to the Financial Analysis Working Group, a group of 16 experienced financial regulators that works as a forum for troubled insurers.
    • The NAIC's accreditation program, established in 1990, has each state evaluated on site by an NAIC accreditation team every five years, with annual off-site reviews.
  • Diversity of Perspective and a Search for Compromise
  • Market Discipline and Moral Hazard
    • A state-based system has difficulty accessing federal government funds, which decreases the likelihood of bailouts and the moral hazard that accompanies a market expectation of bailouts.

Lessons from State Insurance Regulation

  • Building an effective system that emphasizes coordination and cooperation requires four elements: supervisors must have confidence in each other, information must be shared freely among supervisors, supervisory action must be coordinated and multilateral, and there must be a credible mechanism for resolving situations where assets are insufficient to fund all claims.

Lessons for State Insurance Regulation

  • U.S. insurance regulators have identified targeted areas for further improvement, including their reliance on rating agencies in the risk-based capital system and the potential impact of unregulated affiliates on insurance companies.

References

Sources