Having several different regulators use several different approaches to oversee an insurer may help detect problems early.
Therese Vaughan, chief executive officer of the National Association of Insurance Commissioners, Kansas City, Mo., makes that argument in a policy brief released by the Networks Financial Institute at Indiana State University.
In the brief, Vaughan discusses the implications of the new Solvency II European insurance regulation reforms for U.S. insurance regulation.
Vaughan will be presenting the brief June 15 in Minneapolis, during the summer meeting of the NAIC, at a session organized by the NAIC’s Solvency Modernization Initiative Task Force.
Vaughan emphasizes in a note that the views expressed in the brief are hers and do not necessarily reflect official positions of the NAIC or of NAIC members.
“Much of the recent work in supervision, both in banking and in insurance, has been characterized as a movement from a rules-based approach to a principles-based approach to supervision and regulation,” Vaughan writes.
Vaughan says regulators and others have assumed that:
- Companies had an incentive to properly manage their risk.
- Regulators could distinguish between firms that effectively managed risk and those that did not, and that the results generated by an insurer’s own internal risk-assessment models were an effective measure of risk differentiation.
- Regulators would take action when they had identified a firm that did not effectively manage its risk.
“All three assumptions are being questioned in light of the recent market turmoil,” Vaughan writes.
One lesson of the turmoil is that “a regulatory structure that includes a system of checks and balances can help control the negative effects of errors,” Vaughan writes.
Another lesson is that insurance supervision should reflect a careful balance of rules-based and principles-based approaches to supervision, Vaugh writes.
“A rules-based approach is one way to address the potential for regulatory errors, the problem of regulatory forbearance,” she writes. “Internal models will continue to serve a role, but they must be used with a proper appreciation for their limitations. Companies will undoubtedly find internal models useful as they plan for the future. But for regulatory capital purposes, they are best used on a targeted basis, aimed at those risks that require the use of internal models, and used with proper safeguards.”
The Solvency Modernization Initiative Task Force also will consider draft recommendations from the International Solvency and Accounting Working Group, according to a task force session agenda.
“The NAIC should discuss the need for a company to have written risk management policies adopted by the board as well as a common format for risk-focused financial reporting,” the working group suggests in the draft, which is posted on the task force section on the NAIC website. “A common format could improve the risk-focused surveillance process, could provide for an actual to expected analysis, and could be used for desired regulatory data collection at times of newly emerging or unusual risk events.”
The NAIC also should address topics such as the proper use of internal models, regulation of corporate groups, and systemic risk oversight, the working group suggests.