Unfortunately, we're all familiar with the phrase, "too big to fail." In fact, we've all gotten a wake-up call about the consequences of mostly unregulated interconnectivity and globalization in the financial markets. It's not just us anymore. It's us and the European Union, Japan, China, South America and on. And it's not just the pesky big banks we have to watch, it's also the global insurance companies.
There are efforts underway to bring standards and monitoring to world financial markets. And, of course, when there are regulations in the offing, there are those that will look for ways to circumvent them. So, regulators can't just make rules for one industry without thinking about the broader effects.
Concerns about bank fiscal imprudence have so scared the financial regulatory community that some aspects of new rules to ensure no insurer is too big to fail are really aimed at banks, a top industry supervisor told Reuters Friday.
While insurance and banking are inherently different business models, international insurance regulators are rightly concerned that banking activity may move into the insurance sector as a way for banks to avoid their own industry regulations and capital surcharges.
There's actually an organization, the Financial Stability Board (FSB), formulating and coordinating financial regulation on behalf of the Group of Twenty (G20) finance ministers and central bank governors from 19 countries and the European Union. Yes, suddenly we've all got an interest in what the Group of 20 is up to and what the consequences of any decisions they make will be. When the G20 got together for their summit in November 2011, they approved mandatory capital surcharges of 1 to 2.5 percent for the world's largest banks - those considered systemically important - banks like Goldman Sachs, HSBC, Deutsche Bank and JPMorgan Chase. The surcharges are intended to make sure that banks have enough capital to withstand market turbulence.
Here comes the next chapter. Insurers are now battling against being saddled with similar regulations to banks, including extra layers of supervision and surcharges. But, as regulators consider rules for the insurance industry, they don't want regulatory differences between industries to push banking activity into the insurance sector or vice versa. Regulators are worried that if they don't make insurers' rules as tough as those the banks must follow, they leave room for banks to find loopholes. And it's certainly a valid concern that banks and insurers could migrate risky activities to less regulated parts of the financial system.
Another organization, the International Association of Insurance Supervisors (IAIS), established in 1994, is trying to set standards to promote effective and consistent supervision of the global insurance industry. Their objective is to maintain fair markets that protect policyholders and foster global financial stability. The organization currently represents insurance regulators in nearly 140 countries, constituting 97% of the world's insurance premiums. And if we think about how difficult it is to write the rules for just one country, think about what it takes for the international community to agree. Yet, some level of standards and supervision are already being implemented. Guess all it takes is a crisis to get countries to the table to talk "regulatory detente."
Just yesterday, Reuters reported that Yoshihiro Kawai, secretary general of the IAIS, said no decision had been made on whether to include capital surcharges in the regulatory framework for systemically important insurers due by the end of this year. Ah, but they are working on making recommendations. And, they're not doing it in a vacuum. They're trying to look at the factors that contributed to the global financial crisis. And, they're clearly aware that it's natural for market forces to take advantage of any "i's" they fail to dot or "t's" they fail to cross. So, they're trying to be more thorough than perhaps they've been in the past.
Kawai indicated the IAIS is helping draw up the framework on behalf of the FSB with the goal of preventing a repeat of the problems at American International Group Inc. (AIG) which was bailed out by the U.S. government during the recent financial crisis. They get it. There are potentially far reaching financial effects, now global, when it comes to the interconnectivity of our financial markets. Think about it - it's almost impossible to unravel the web of international markets. And, even trying to keep the web intact, as the U.S. did with AIG, has consequences - AIG is still majority owned by U.S. taxpayers.
Right now there are three key standards in place for international financial regulation: the BCBS (Basel Committee on Banking Supervision) Core Principles for Effective Banking Supervision, the IAIS Insurance Core Principles, and the IOSCO (International Organization of Securities Commissions) Objectives and Principles of Securities Regulation. Hopefully each brings something important to the table.
Kawai said the FSB would issue recommendations including how to decide which insurance companies would be subject to the rules and how they would be supervised sometime in March. He added that it is still not a foregone conclusion whether any insurer would be judged too big to fail. "We don't know if there are any global systemically important insurers, but if there are any under the judgment of the FSB and national authorities, then they are likely to announce it this November."
According to Reuters, the world's biggest insurers based on market capital include Berkshire Hathaway, China Life Insurance Company, Allianz and Axa SA. Rules to decide whether companies are systemically important and too big to fail are likely to look at how interconnected a company is worldwide rather than just its size. And that makes a whole lot of sense.
The FSB plans to have an international structure for insurers and large systemically important banks finalized for the Group of 20 meeting being held at the end of 2012 in Mexico. We'll keep you posted.
But, while you're thinking insurance, don't forget the importance of insurance company financial strength. Check the Weiss Financial Strength Rating.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.