Regulators around the world have been shaken by the downfall of American International Group (AIG), once seen as the pinnacle of well-managed international insurance groups.
The harshest aspect of AIG's difficulties is that its problems originated not within its far-flung collection of insurance operations, but in a securities trading wing. Like other groups that have run into trouble -- Aegon, ING, Swiss Re -- AIG's top-rate insurance subsidiaries were fine (or could have been fine) on their own. But problems within banking, trading and capital markets operations posed what, in the current fashionable parlance, amounted to enterprise-wide risk.
For years, international insurance groups had been operating on the theory that diversification into various insurance and capital markets businesses would act as a check against the vagaries of the insurance cycle (for nonlife lines) or interest-rate and other financial risks (for life insurance). It appears now that diversification for some, at least, led to unforeseen pitfalls.
So, now that many complex international insurance organizations are struggling, what's a regulator to do?
Group vs. Solo
When the European Parliament gave its recent blessing to the proposed Solvency II directive governing insurer solvency standard, the legislation left out a key provision on supervision of insurance groups. European Union official and industry representatives couldn't work out a compromise on accounting for group support for individual entities, so the provision was kicked down the road for the sake of getting Solvency II on the books as quickly as possible.
But this is an issue that won't go away. In the United States, the National Association of Insurance Commissioners is poised to assert regulatory authority over noninsurance business entities owned by insurance holding companies. The NAIC said that, working through a recently created Solvency Modernization Initiative Task Force, it will review international accounting and group solvency issues.
The NAIC said group supervision includes regulation of areas not previously regulated or not regulated well, such as AIG's Financial Products division, which was behind AIG's credit default swap problems.
On the other side of the world, the Australian Prudential Regulation Authority it also focused on the group supervision issue. APRA executive member John Trowbridge gave a speech to the NAIC's recent forum on international insurance regulation calling for a comprehensive approach to the regulation of insurance groups.
Trowbridge defined the "single biggest issue" in insurance regulation today as "how to continue to maintain the integrity of solo supervision of insurers while also carrying out effective group supervision that protects the integrity of the group, including all regulated and unregulated subsidiaries."
For Trowbridge, the AIG debacle demonstrated "the extraordinary strength of solo supervision" in that policyholders of AIG's more than 150 subsidiaries worldwide were protected from the parent company's problems. Since the assets of AIG insurers were "quarantined" by regulation from the parent, policyholders were protected.
The bad news was that the absence of effective group supervision meant an unregulated subsidiary's actions severely damaged AIG as a group.
Trowbridge said the AIG debacle, along with the problems of ING, Fortis and others, will lead to a range of regulatory initiatives. Among them, either there will be more effective regulation of specialist insurance groups or cross-sector financial groups, or there will be restrictions on what such groups can do. There will also be a greater interest in the development of accounting and audit standards.
Regulators and supervisors also will take a greater interest in the remuneration practices of groups, and will pay closer attention to their governance and risk management practices.
Trowbridge said Australia is already on the path to comprehensive regulation and supervision. After all, the country had its own AIG moment, when HIH Ltd., once Australia's largest nonlife insurer, collapsed in 2001.