April 2009 | Volume 1, Issue 2
Reinsurers Need a New Paradigm
2009 Roundtable Co-Chair Discuss the Issues Facing the Industry in Light of the Financial Crisis
An interview with Debra Hall
by Teresa Zink
Asked to describe the most critical issues facing the reinsurance industry, Debra Hall has one answer that tops her list: regulation. Specifically, regulatory modernization in the United States that would allow global insurance and reinsurance companies to be regulated by a single federal regulator. One of the primary reasons she believes that a single regulator should be at the federal level is “to ensure a national and international level of policy development and implementation and a regulator who can sit at the table with other U.S. financial sector regulators as well as insurance regulators from other countries,” she says. “Not all companies should or need to be federally regulated,” Hall adds. “Indeed, federal regulation need not necessarily extend to all issues. Similarly, the states are ill-equipped for regulating certain areas, including issues involving global commerce.”
This is not a particularly surprising answer from an executive who has spent nearly 20 years of her career developing and implementing regulatory policy for the reinsurance industry as a whole and Swiss Re in particular. “We have been pursuing federal regulation of reinsurers for a long time,” Hall admits. In fact, she recently proposed the creation of the Global Risk Coalition. The purpose behind forming the Coalition was to “focus global companies on consistent international regulatory modernization.” She explains that large primary and reinsurance companies in the United States have been mostly focused on the issue of a single regulator versus multiple state regulators, however, modernization of the substance of reinsurance regulation is equally important.
In the wake of the financial crisis, plans for the Coalition have been scaled back or even placed on hold because of the difficulty in getting companies to commit to funding, but the issues remain, Hall says While this might not be the best time for the creation of the Coalition, Hall and her former colleagues have formed Global Regulatory and Risk Consultants (GRRC), to provide regulatory assistance to companies in meeting new modernization challenges, including regulatory monitoring and advocacy on single issues, as well as consulting on strategic risk and capital management issues such as market access, enterprise risk management and corporate governance.
“We face many of the same issues that we were facing before the financial crisis, but the crisis will serve to underscore the need for change. One major example is the need for some form of group supervision and stronger and more effective supervision of financial conglomerates,” she says. “There needs to be far greater emphasis on effective risk management, something that some have been advocating for several years.”
Global Industry Faces Global Issues
What are those issues? “Reinsurance has been an international industry for a long time but has become increasingly more global,” says Hall. “Nearly all major reinsurance groups are now headquartered outside the U.S. Having 50 U.S. state regulators overseeing the contracts and solvency of global companies no longer makes any sense. This has become increasingly clear, even to state regulators who have recently proposed a framework that would provide for a single state regulator to oversee reinsurers,” she explains.
She says that when people become engaged in discussion on an international level, for example through the International Association of Insurance Supervisors, “you will find that issues such as group supervision are very important in Europe and are issues that we haven’t really begun to focus on, in any meaningful way, in the United States.”
Bottom line, she says “Post financial crisis it should be clear to everyone that regulatory modernization needs to be a priority. Of course, TARP, issues of capital adequacy and asset quality are occupying the field for the moment, but once we move beyond those immediate issues, industry and policymakers are going to have to be prepared to face the broader questions of how to bring our financial services regulation into a more modern, cohesive and rational framework.”
So what does that mean? “Number one, we need to have the availability of a single regulator. From a reinsurance standpoint, and also from a large primary company standpoint, a more streamlined approach is necessary to address the realities of the current marketplace, both in terms of the manner in which business is done as well as the complexity of products and services offered,” says Hall.
“Number two,” she says, industry needs to evaluate issues related to group supervision for internationally active groups. “There needs to be recognition and an understanding about what a group does worldwide. One model of group supervision of multinational companies calls for the formation of ‘colleges’ of national supervisors to coordinate the supervision of groups operating in several countries, with the regulator from a single country having a mandate over the other national regulators. This is exemplified in the situation of AIG. As the crisis unfolded in the fall of 2008, there were concerns in numerous parts of the world about what action was necessary to address AIG’s situation. Fortunately, regulators acted in what appears to be a concerted manner (including the involvement of their financial conglomerate regulator, the OTS) but it could have just as easily gone the opposite direction. There needs to be a framework for dealing with companies that operate in multiple jurisdictions – one that creates a relationship and systematic way of approaching problems in times of relative calm so that the familiarity, structure and trust exists between the regulatory entities in times of crisis. Without suggesting anything one way or another about the quality of OTS regulation, it is instructive that OTS uses the ‘college of supervisors’ approach and this, no doubt, helped to contribute to the fact that precipitous action was not taken by individual regulators around the globe.”
The third component, according to Hall “is the actual substantive regulation.” Looking at the three components, she notes that “the first two are more structural, and the third one is more content oriented. In the U.S. we, in the (re)insurance industry, have been very focused on the structural part – who will regulate us – rather than on the substantive content of what the regulation ought to be,” Hall observes. “Of course, in the wake of the financial crisis affecting retail banks, investment banks, hedge funds and other financial services industry players and multiple regulators – this focus on structure is more important than ever. But content will be equally as important going forward.”
The substantive issues that should be looked at include improvements in risk-based capital structures, improvements in risk modeling and improvements in risk management, according to Hall. “In some of these areas, the U.S. is lagging behind Europe. For example, the U.S. was among the first countries to introduce a risk-based capital system in the early 1990s. At the same time, the European single market was strengthened by the adoption of the insurance directive in 1992, and the reinsurance directive, in 2005, both of which laid the groundwork for the European Commission to launch Solvency II. Because of the timing, Europe was able to benefit from strides in risk management and technology made in recent years. The U.S. now needs to revisit their prior work and, hopefully, design a system that is the best of both worlds. Overall, we need to have solvency systems that provide incentives to regulated entities to measure and properly manage their risks,” says Hall.
What would an ideal regulatory environment look like in the United States? “I think that we are nowhere near a conclusion on that point yet,” says Hall. Looking at what has been done in other countries and sectors, she says, “I don’t think that U.S. regulators and policymakers will or should simply take everything that Europe has done in Solvency II and incorporate that into the United States. There will need to be some changes and alterations,” to the system adopted by the European Union “that would be necessary for our market and our regulatory approach.”
Similarly, she said “I don’t think that we are going to wholesale adopt everything the banks have done in banking regulation either. This was true before the crisis and is especially true post-crisis.”
Post-crisis, she says, it is important to ask how effective some of these regulatory schemes really are and how they would work if applied to the U.S. insurance and reinsurance market. “That will be a subject for the panel that we do at the April conference, because we are going to have regulators from Europe and the U.S. who will engage in precisely that discussion.”
Right now, says Hall, “state regulators are touting state regulation as superior, or at least sufficient, because insurance companies weren’t hit as hard as banks.” However, she points out “we haven’t seen the last of the problems. There is potentially more to come in the insurance area, particularly in the life sector and the mortgage insurance arena. Additionally, there are potentially severe consequences, as in the case of AIG, for insurance companies that were involved in other activities that have gone unregulated. This demonstrates a broad problem to which insurance regulation and insurance companies have not been immune.” There are gaps in the current system, she says and those gaps illustrate the need for a different type of regulation.
Looking at some of the proposals that have already been considered, she noted that there have been a number of different federal regulatory proposals over the last few years. Following the publication of the U.S. Department of Treasury Blueprint for a Modernized Financial Regulatory Structure, legislation was created that would create the Office of Insurance Information (OII). Hall characterizes the legislation as “a very good first step, depending on how it holds up as it makes its way through Congress.”
“But in order for the OII to be a good first step,” Hall clarifies, “the federal government needs to be given the authority and tools to be an effective policy setter for international matters.”
“Stepping back, I think it is obvious to some of us that the federal government should set international policy, and setting international policy includes issues like under what conditions non-U.S. companies can do business in this country,” says Hall.
“The requirements for and the implementation of entering into mutual recognition agreements between foreign countries and the United States is something that the federal government ought to be doing, not individual states.” She said she applauds the efforts of New York and other states that have stepped forward and tried to enter into mutual recognition agreements to share information and foster cooperation between regulators. “Given the fact that we have a state system of regulation that is the best that can be done at the moment,” according to Hall.
However, she explains, “they are entering into mutual recognition agreements for limited purposes, as opposed to the more substantive determination governing the basis upon which companies can conduct business here. For that broader more substantive mutual recognition you need to have international policy carried out at the federal level.”
In order for that to work, she explains, “it is critical that the federal government have the authority to preempt states that act contrary to that policy. It is that very issue where the rubber meets the road with respect to the OII legislation – the power of preemption is one that state regulators and some in the industry who tend to favor state regulation don’t like. But in my view, it’s fundamental or all you have is an emperor with no clothes.”
All Options are on the Table
So what does she predict for the future? “I think it is still unclear what we are going to wind up with from a Federal standpoint, but I think it is clear that we are going to wind up with something,” Hall says. Looking back at the Treasury Blueprint, she says it “had been pretty positive about the optional federal charter (OFC) concept. Treasury had viewed the OFC as more of an intermediate type of step, but that the sort of ‘nirvana’ of regulation was more of a long term overhaul of the system.”
However, she says, “post-crisis a lot of folks are wondering if maybe we are looking at a system that leapfrogs the OFC and takes us more immediately into that financial sector overhaul, that brings us closer to the supposed ideal than what Treasury initially contemplated at the time they issued the report. In any event, many are suggesting that the OFC might look more like the NOFC – the ‘Non-Optional Federal Charter’ for some systemically important entities.”
“We can expect that policymakers will take a critical look at what the so-called ‘nirvana’ was per the previous Treasury Department,” she predicts, “ and, most importantly, we can expect that all possibilities are on the table in terms of a far more comprehensive approach than we ever thought possible before.”
Debra Hall is a Principal and founder of The Global Regulatory and Risk Consultants and reinsurance arbitrator (email@example.com). She served as Senior Vice President and Senior Regulatory Counsel of Swiss Re America Holding Corp. and Swiss Re America from June 2005 to Oct. 2008, and before that she was Senior Vice President and General Counsel for the Reinsurance Association of America (RAA) for more than 13 years. She is a co-chair of HB Litigation Conferences 16th Annual Insurance Insolvency & Reinsurance Roundtable to be held April 22 to 25 at the Fairmont Scottsdale Princess in Scottsdale, Arizona.