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THE LANDSCAPE OF INSURANCE REGULATION: A EUROPEAN VIEW Professor Chris Parsons Cass Business School, City of London

THE LANDSCAPE OF INSURANCE REGULATION: A EUROPEAN VIEW Professor Chris Parsons Cass Business School, City of London. TOPICS. A look backwards … 1 Origins of insurance and its evolution in Europe 2 Different insurance models – ‘Alpine’ and ‘Maritime’

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THE LANDSCAPE OF INSURANCE REGULATION: A EUROPEAN VIEW Professor Chris Parsons Cass Business School, City of London

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  1. THE LANDSCAPE OF INSURANCE REGULATION: A EUROPEAN VIEW Professor Chris Parsons Cass Business School, City of London

  2. TOPICS A look backwards … 1 Origins of insurance and its evolution in Europe 2 Different insurance models – ‘Alpine’ and ‘Maritime’ 3 Harmonisation of regulation in Europe A look forwards … 1 Regulation after the financial crisis 2 The interplay of social insurance and private insurance 3 New sources of regulation and control

  3. A LOOK BACKWARDS …. 3

  4. EARLY DEVELOPMENT OF INSURANCE Risk sharing by Chinese merchants (2,500 B.C.) Early (marine) ‘bottomry’ contracts (Babylon, Mesopotamia, 2,500 B.C.) Roman burial societies

  5. EVOLUTION OF INSURANCE IN EUROPE Two ‘cradles’ (birthplaces) of insurance 1 The Alpine Mountains Early mutual fire and livestock insurance schemes 2 The sea Marine insurance in Italian sea ports then, increasingly, in London

  6. EVOLUTION OF INSURANCE IN EUROPE Two ‘models’ of insurance* 1 The ‘Alpine’ model Mutuality, community solidarity, risk spreading without fine segmentation ‘Spiritual home’: Munich, Zurich, Trieste 2 The ‘Maritime’ model Entrepreneurial, competitive, profit-oriented, with maximum segmentation of risk ‘Spiritual home’: Lloyd’s of London * Michel Albert, ‘Capitalism against capitalism’ 6

  7. EVOLUTION OF INSURANCE European insurers ‘exported’ these two models through colonialism and the influence of their overseas trading companies In the late 19th century a third model emerged with the first social insurance systems (beginning in Germany, 1880s) 7 7

  8. THE SINGLE EUROPEAN INSURANCE MARKET The aim was to allow insurance to be bought and sold freely in Europe, and not affected by differences in national laws and regulatory systems But there were two different models of regulation …

  9. THE ‘ALPINE’ MODEL (e.g. FRANCE , GERMANY) Tight regulation. The approach was more compulsory than discretionary, for example State control of premium levels or guidelines for the calculation of premiums Compulsory notification of changes in premiums Prior approval needed for the wording of insurance contracts, and/or standardisation of clauses Some insurance monopolies Some compulsory specialisation of insurers

  10. THE 'MARITIME’ MODEL (e.g. UK, IRELAND, NETHERLANDS) Lighter regulation. And preference for self – regulation. No price control, provided insurers have set up the necessary actuarial reserves against their liabilities No specific restriction on policy wordings No prior approval required - no standardisation of insurance contracts or clauses No monopolies or compulsory specialisation Supervisory authorities have wide discretionary powers and self-regulation was often preferred

  11. THE EUROPEAN COMPROMISE Stronger prudential regulation – leading eventually to Solvency II (unified European regime for capital adequacy and risk management standards, coming into force in 2013) Abandonment of all (state) regulatory controls over insurance prices and policy terms Market regulation (consumer protection rules) set at national level 11

  12. A LOOK FORWARDS …. 12 12

  13. INSURANCE AFTER THE FINANCIAL CRISIS The 2007-9 financial crisis in Europe and the US has intensified the debate on a number of issues, e.g. 1 The benefits, or otherwise, of convergence in financial services 2 The adequacy, or otherwise, of systems of prudential regulation for insurance 3 Indirectly, the wider social role of insurers 13 13

  14. CONVERGENCE IN FINANCIAL SERVICES INSURANCE INDUSTRY BANKING INDUSTRY SECURITIES INDUSTRY Regulators once kept these circles apart .....

  15. THE CIRCLES HAVE CONVERGED ..... Bancassurer INSURANCE BANKING • Asset Manager • + • Risk Manager • (ART structures) SECURITIES Investment bank Gerry Dickinson Cass Business School Financial conglomerate 15

  16. CONVERGENCE IN FINANCIAL SERVICES The literature on convergence presents a mixed picture, claiming: Benefits: e.g. economies of scale and scope, diversification benefits, enhanced innovation, better consumer choice and convenience But also: Drawbacks: e.g. increase in risk (especially systemic risk), consumer harm through monopoly power, management problems, lack of transparency, additional complexity of regulation 16 16 16

  17. WHICH INSURERS SUFFERED MOST IN THE FINANCIAL CRISIS? 1 Companies which dabbled in risky areas of structured finance (e.g. AIG, Swiss Re) 2 ‘Bancassurers’ – integrated financial services providers and insurers having close affiliations with banks 3 Specialist financial guarantee insurers (e.g. US monolines) 4 Firms writing various forms of credit insurance 5 Insurance firms holding a high proportion of risky assets (some US life insurers especially) 17

  18. REGULATORY AND MARKET ISSUES  Will the circles ‘move apart’ again – and will regulators push them apart?: - restrict convergence within financial services?  To what extent is insurance activity compatible with banking – what models of bancassurance are most viable?  Is there a case for stronger regulation of ‘quasi- insurance’ products such as credit default swaps (CDS)?  How should financial conglomerates be regulated – what form should the regulator take? 18

  19. SOLVENCY II  New, unified European system for capital adequacy and risk management standards, coming into force in 2013)  Three ‘pillars’ (Capital adequacy, Risk management and corporate governance, Transparency and reporting standards)  Solvency II is principle-based rather than rules-based  Solvency II is dynamic and model-based, not static and volume/factor based  Emphasis on risk management and corporate governance not found in many other systems (e.g. US RBC regime)

  20. IMPACT OF SOLVENCY II IN EUROPE  Heavy short-term compliance and development costs, especially for small insurers  Longer-term benefits include better policyholder protection, lower cost of compliance (especially for pan-European firms), more competition?  Solvency II may bring about some changes in market structure and also in the relative cost of some lines of insurance  Possible knock-on effects on other financial markets (e.g. further shift of insurers’ investments away from equities, less liquid assets and banks generally) 20

  21. IMPACT OF SOLVENCY II BEYOND EUROPE  Size of European insurance market (about 40% of world market) will make Solvency II influential  Solvency II may ‘export’ its principles because insurers wishing to enter the EU will undergo mutual recognition assessment  A number of major markets (e.g. US, China) are re- evaluating their own systems and observing Europe  Academic approval for Solvency II (generally)

  22. SOCIAL INSURANCE AND PRIVATE INSURANCE Europe has developed extensive (and expensive) social insurance systems over the last 130 years Historically, many risks have been shared with private insurers For some risks there has been the option to insure privately or through a state system For other risks has been provided through a combination of private and public insurance 22

  23. SOCIAL INSURANCE AND OTHER PUBLIC PROGRAMMES PRIVATE INSURANCE Shared risks: e.g. accidents, sickness, disability, unemployment, pension provision Risks wholly or mainly insured under social insurance or other State programmes Risks wholly or mainly insured under private insurance programmes

  24. SOCIAL INSURANCE AND PRIVATE INSURANCE Social insurance systems in Europe are under extreme pressure Main source of pressure is demographic – e.g. ageing populations, increased longevity The financial crisis has increased this pressure (need to cut public spending and reduce budget deficits) Result is a shift away from social insurance towards private insurance (especially pensions, health insurance, work accident insurance) 24 24

  25. SOCIAL INSURANCE AND OTHER PUBLIC PROGRAMMES PRIVATE INSURANCE Shared risks Risks wholly or mainly insured under social insurance or other State programmes Risks wholly or mainly insured under private insurance programmes 25

  26. SOCIAL INSURANCE AND PRIVATE INSURANCE The shift to private insurance presents opportunities for insurers and potential benefits to consumers (more competition, greater efficiency?) It also presents challenges …. Because social insurance schemes are normally ‘open access’ (no right to decline applicants) …. And social insurance schemes are normally not ‘underwritten’ (no right to vary premiums according to risk) 26 26 26

  27. SOCIAL INSURANCE AND PRIVATE INSURANCE Private insurers that assume previously ‘socialised’ risks will have to accept stricter control of pricing, policy terms and risk selection Regulators will have to find the right balance …. Consumers must be protected, but insurers must be allowed to use their skills and given incentives to participate 27 27 27 27

  28. THE EFFECT OF EQUALITY LAWS Europe is extending the scope of its equality laws Basic proposition: people should not be treated differently because of things which they did not choose and cannot change This includes factors such as race, gender, age and health condition Originally equality laws applied mainly to areas such as employment – they are now being extended to financial services, including insurance 28 28 28 28

  29. CASE STUDY – THE EU GENDER DIRECTIVE Gender may be a relevant risk factor in many forms of insurance – e.g. life insurance, pensions and annuities, health insurance, motor insurance The EU Gender Directive (law) forbids sex discrimination in financial services, but originally had a limited exception which Member States could apply… ‘Member States may … permit proportionate differences in individuals' premiums and benefits where the use of sex is a determining factor in the assessment of risk based on relevant and accurate actuarial and statistical data’ 29 29 29 29 29

  30. CASE STUDY – THE EU GENDER DIRECTIVE The limited exception allowing ’proportional differences in premium based on accurate statistical data’ was difficult to apply Some European states did not adopt the exclusion (so had ‘unisex’ premiums, for at least some lines), some European states adopted it, allowing insurers to charge different rates for men and women The European Court has now declared the exception illegal …. So Europe will have ‘unisex’ premiums for all lines of insurance – including, life, pensions/annuities, health insurance, motor insurance etc. 30 30 30 30 30 30

  31. THE EFFECT OF EQUALITY LAWS The next battle-ground in Europe may be other forms of discrimination (e.g. age or disability) 31 31 31 31 31 31 31

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