Expert Identifies "Worrisome Trends" in Solvency Regulation of Insurance Groups

Robert E. Litan, a nonresident senior fellow in the Economic Studies Program at the Brookings Institution, suggests that global trends of insurance solvency regulation focused on a "creditor-centric" approach, as opposed to the traditional "customer-centric" approach used in the United States, may ultimately have negative impacts on individual policyholders.

In Source of Weakness: Worrisome Trends in Solvency Regulation of Insurance Groups in a Post-Crisis World, Litan discusses some key differences, as well as some similarities, between the banking industry and the insurance industry that insurance regulators should recognize when drafting and implementing insurance regulatory policy. The essay also discusses the Dodd-Frank Act and "post-crisis" regulation of banks and insurance in the U.S.

From the abstract to Litan's essay:
The regulation of insurer financial strength in the United States historically has focused on a fundamental principle: that the premiums and capital of any insurer are meant to pay the claims of that insurer’s policyholders and not to be drawn on to rescue a failing affiliate within the same group. This is a customer-centric approach, based on the individual insurance contract that is issued by a separately capitalized insurer for a specific period of time, in which the premiums charged are regulated based on that issuer’s solvency position and the risk assumed under that contract.

Since the financial crisis, however, international financial bodies, including the EU, have been pressing U.S. policy makers to adopt the EU’s very different approach toward insurance regulation for globally and systemically important insurers, and potentially for all insurers, borrowing from the banking industry the notion of “group capital” regulation. This latter approach ignores the legal separateness of the different entities belonging to the same group and makes all parts of a banking group financially responsible for each other, through the so-called “source of strength” doctrine for holding companies and “cross-guarantee” requirements for bank subsidiaries. In effect, group capital regulation is creditor-centric, and potentially ignores the specifics of individual insurance contracts.
Litan suggests that, while group capital regulation many be appropriate for banks, it is not generally appropriate for insurance, and U.S. policy makers should remain cognizant of this distinction when considering European-style insurance solvency regulation in the United States.

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