Having carefully written insurer solvency rules is important, but good regulations are no substitute for vigilant supervision of insurers and other financial services companies.

Therese Vaughan, chief executive officer of the National Association of Insurance Commissioners (NAIC), Kansas City, Mo., made that argument earlier this week in Austin, Texas, during a session organized by the NAIC’s Solvency Modernization Initiative Task Force.

Vaughan talked about efforts by the International Association of Insurance Supervisors, Basel, Switzerland, to develop a “Common Framework for the Supervision of Internationally Active,”Earth or “ComFrame.”

ComFrame is still in an embryonic stage, and its exact nature is still under discussion, but the intent is to define how regulators will work together to supervise internationally active groups, Vaughan said.

The NAIC is devoting significant resources to ComFrame, and the United States is in a unique position, because it has many years of experience with supervising insurance groups across state lines, Vaughan said.

Vaughan argued that insurance regulators should try to make sure that they are clear about what problem they are trying to solve.

Insurance regulators should deal with issues that actually affect insurance and insurers, not simply adopt standards because banks are adopting standards, Vaughan said.

Vaughan said problems that may affect the insurance industry include “regulatory arbitrage,” or

the risk that companies will do business with the weakest regulations and weakest supervision; the risk the companies will concentrate risk in unregulated or poorly regulated entities; and the inefficiency that plagues insurers doing business in many different jurisdictions with many different regulatory requirements.

“Companies are being asked to provide various reports to supervisors in a variety of countries,” Vaughan said. “Our information requests, formats, and focus are different, and, from what I can tell from some companies, this lack of supervisory coordination is creating frustration and unnecessary administrative costs.”

Vaughan said efforts to improve group supervision are more about supervision than regulation.”

“Rules have a place, but the real magic in what financial regulators do is to use the knowledge and intuition they have gained over the years about how companies operate — and the various ways they can get into trouble — to try to identify developing problems before they get serious, and to take action,” Vaughan said. “We should not place excessive reliance on regulatory capital requirements as the solution. Companies can take risk in many ways, and it’s not possible for regulatory capital systems to capture all of those.”

The regulatory structure in place also has to make a group’s lead supervisor accountable to supervisors in other jurisdictions, and give the supervisors in “host” jurisdictions the freedom to act if they feel the lead supervisor has fallen down on the job, Vaughan said.

“The incentives of the home and host jurisdictions are not necessarily aligned, and in many cases, it is the host jurisdictions that have more to lose,” Vaughan said. “It is essential that a global system of regulation empower host jurisdictions to halt behaviors that are potentially harmful to their markets.”

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