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Former NAIC CEO Vaughan: Heavy-Handed Regulation Creates Its Own Risks

Source: A.M. Best - Lee McDonald

Posted on 04 Apr 2013 by Neilson

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RegulationsAfter a series of roles regulating insurance, Therese M. Vaughan believes one of her biggest lessons was learning that regulation has its limits, and respecting those limits makes for a stronger, more diverse and vibrant financial environment.

In a speech to insurers at A.M. Best's recent Review/Preview conference, Vaughan compared the insurance industry to a biological ecosystem. Diversity, competition and creativity help spur improvements. Rigid rules and inflexible models enforce conformity, making the overall sector more vulnerable to financial shocks and catastrophes. "Diversity is important. If you create a global standard, chances are it can't keep up with the market." Vaughan said. "Markets are dynamic. Regulatory capital can only be one tool. It's not a panacea. It's one of many tools that a regulator needs to use."

Vaughan served as the first Washington, D.C.-based chief executive officer of the National Association of Insurance Commissioners and is a former state insurance commissioner in Iowa. She's also served as a professor at Drake University and held a variety of industry posts. She's currently updating an insurance text originally authored by her father.

Vaughan wondered when Europe's Solvency II regulatory regime will be fully implemented, and questioned whether it can deliver the simplicity and confidence it's supporters originally sought. She described recent proposals by international regulators as an "inexorable push" toward developing a global metric that will hamper the ability of regulators to respond to local market issues and possibly benefit large global insurers to the detriment of smaller insurers.

As international pressures increase, U.S. state and federal regulators will need to aggressively provide a U.S. perspective or risk hampering the vibrancy of the U.S. domestic market. Vaughan said she believes the U.S. system has demonstrated it's strengths and will further improve as Own Risk and Solvency Assessment deploys. "What we are seeing in the U.S. is the expectation that firms have systems in place, they have a view on risk and have ways of assessing that risk. That's the U.S. perspective."

Vaughan credited the American International Group Inc. crisis in 2008 for introducing the issue of systemic risk to the insurance industry. "Granted, this was not insurance activity, but AIG was viewed as a large insurance global insurance organization," Vaughan said. Our sector has been branded as one that can have systemic risk. The question is what to do with it.

The Dodd-Frank Act enables regulators to designate some financial organizations as systemically important, which in turn skews financial markets in favor of select organizations, Vaughan warned. "This implicit government guarantee has affected the biggest banks' cost of funding. They may have a 1% advantage in the cost of funding."

Vaughan said she believes that "too big to fail" has no place among organizations in the business of risk management. Let's not let this problem become a problem in insurance," Vaughan said. Once you've got the problem of too big to fail in your sector you can't get rid of it. There's no known cure for this disease. The answer to the AIG problem is to reduce systemic activities to non-systemic levels, she said. "If it is too big to fail, it is too big to exist in the insurance sector."

Vaughan shared three observations on the Federal Insurance Office from her recent vantage overseeing NAIC's Washington, D.C. activities:

Turf matters. "I didn't appreciate how much it was going to be an issue. Turf battles are chronic in D.C. Treasury and other agencies have battles. FIO was complicated by the fact it was brand new. There was a feeling that too much cooperation would diminish the importance of FIO."

Some supporters of federal regulation of the insurance industry saw FIO as a way to further their aim. "They were pushing for FIO to take a more expansive role." FIO has been relatively low-profile but is expected to release several long-overdue reports in coming months.

The success of the state-and-federal system of insurance regulation takes collaboration. "With (former Nebraska Senator) Ben Nelson coming to the NAIC, there is an opportunity to better clarify the roles of the FIO and the NAIC. If they can get those roles straight, things can work out."