The Role of Governments in the
Insurance Industry
Royal Institute for International Affairs
London, U.K.
2 December 2002
If you would like a copy of this presentation, please
give me your business card with e-mail address
Download at http://www.iii.org
Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist
Insurance Information Institute  110 William Street  New York, NY 10038
Tel: (212) 346-5520  Fax: (212) 732-1916  bobh@iii.org  www.iii.org
Presentation Outline
Changing Role of Government in Insurance
• Historical/Traditional Role of Government
• Is Role of Government Expanding/Contracting?
• Role & Rule of Government Beyond Direct Regulation
• Is ‘Insurance Regulation’ Obsolete or Marginalized?
• Summary & Conclusions
• Q & A
HISTORICAL ROLE OF
GOVERNMENT IN
INSURANCE
Fundamentals of Insurance Regulation
Expanded View of
Insurance Regulation
Traditional
Ancillary
Fiscal
Political
Solvency
Pools
Taxes/Fees &
Assessments
Public
Policy
Rate/Form
Guarantee
Funds
Stimulative
Political
Agenda
Consumer
Protection
(Re)insurer of
Last Resort
Income
Redistribution
Mitigation/
Safety
Source: Insurance Information Institute
Rationale for
Insurance Regulation
Why Should Insurance be Regulated?
• Contrary to public belief, there is no “right” to insurance
 Therefore need justification for existence of regulation
• Frequently cited reasons are market imperfections (e.g.,
ruinous competition), consumer protection (licensing),
systematic risks (e.g., investment risk)
• Regulation has probably extended well-beyond these
bounds in some jurisdictions
IS ROLE OF
GOVERNMENT IN
INSURANCE EXPANDING
OR CONTRACTING?
Evidence of Expansion
Evidence of Contraction
Expansionary Influence of
Government on Insurance
Government Expansion & Defense of the Status Quo
• Terrorism
• Health Care
• Social Insurance (Elderly, Disabled, etc.)
• Recent Institution of Strict Regulation (e.g., Texas?)
• Defense of Local Control over Federal Regulation
 US: State vs. Federal Regulation Debate
 EU: Member states slow to adopt regulations/harmonize
Governments Insuring
Terror Risk
Government Backed Terrorism Insurance Programs
Terrorism Risk
Insurance
Country
Provider
United Kingdom Pool Re
Spain
Consorcio
South Africa
SASRIA
Israel
PTCF
France
GAREAT
Germany
Extremos
Australia
XXX
Source: Swiss Re Focus Report: Terrorism
Details
Created in 1990’s due to IRA terrorism losses.
Covers “Extraordinary Risks” such as Earthquake,
Volcanic Eruption, Flood, Storm, Terrorism and
Civil Commotion
Created in 1929 due to political climate in South
Africa - still in existence today.
Covers losses triggered by politically motivated
violence (including terrorism).
Created post September 11, pool with state
guarantee for terrorism coverage.
Created post September 11, pool with state
guarantee for terrorism coverage
Proposed in November 2002
Industry Losses Under Proposed Federal
Backstop Using 9/11 Scenario
(as proposed/interpreted from Act signed Nov. 26, 2002)
$1.75B
Industry
Co-Share
$19.675B
$0.925B
Industry
Co-Share
$10.575
$20
$2.0B
Industry
Co-Share
$18.00
($ Billions)
$25
$15.75
$14.25B
Total Ind. Loss: $10.875B
$30
$15
$10
$5
$0.125B
Industry
Co-Share
$18.75
$1.125
$8.75
$12.50
$0
Year 1
Industry Retention
Year 2
Surcharge Layer
Year 3
Co-Reinsurance Layer
Assumes $30B Commercial Prop & WC Loss, $125B “At Risk” Commercial DPW
Source: Insurance Information Institute.
US Health Care Expenditures
by Source (2000)
US health care
expenditures
totaled $1.3
trillion in 2000.
Nearly half
(45%) of
expenditures
are from govt.
sources
Private Health Ins
34%
Medicare
17%
Other Private
6%
Medicaid
16%
Out-of-Pocket
15%
Other Govt.
12%
Source: U.S. Dept. of Health and Human Services, Health Care Financing Administration, III.
US Health Care Expenditures
as a % of GDP
HC Exp. as % GDP
Health Care Expenditures
$1,800
14.0%
$1,200
$1,429
$1,300
$1,216
$1,150
$1,091
$1,040
$990
$888
$827
$762
$696
$427
$246
$73
$300
$130
$600
$937
$900
$1,601
10.0%
$41
Expenditures ($ Billions)
12.0%
8.0%
6.0%
4.0%
$0
65
70
75
80
85
90
91
92
93
94
95
96
97
Source: Bureau of Economic Analysis, Insurance Information Institute.
98
99
00
01 02*
Expenditures as a % of GDP
$1,500
Government Share of Health
Care Costs is Increasing
$852.0
$712.3
$534.1
Govt. share= 46.8%
Govt. share= 24.9%
50%
$413.5
Private Funds*
$252.2
60%
$140.9
70%
$30.8
90%
80%
$45.4
100%
$74.8
Public Funds
$55.0
$104.8
$174.6
$282.5
$456.2
$587.2
$749.0
20%
10%
$10.2
30%
$27.6
40%
70
75
80
85
90
95
00
02*
0%
65
Source: Bureau of Economic Analysis, Insurance Information Institute.
40%
46.8%
45.2%
45.2%
45.3%
46.0%
46.3%
46.1%
44.0%
43.4%
42.1%
40.6%
40.4%
40.6%
41.9%
41.6%
41.2%
41.7%
41.8%
42.5%
40.9%
37.8%
45%
42.7%
42.4%
50%
45.6%
US Public Health Expenditures
as Percentage of Total
35%
25%
24.9%
30%
Government’s share of health expenditures
has nearly doubled from 24.9% in 1965 to
46.8% in 2003 (est.)
20%
65 75 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
Source: U.S. Dept. of Health and Human Services, Health Care Financing Administration, III.
US Old-Age, Survivors & Disability
Insurance Expenditures as % GDP
(“Social Security” Program)
6.65%
6.72%
6.78%
6.64%
6.66%
4.90%
4.48%
4.41%
4.34%
4.29%
4.25%
4.25%
4.25%
4.27%
4.46%
4.32%
6%
5.59%
Government outlays for social
security as a % of GDP will
increase by 52% by 2035
6.23%
8%
45
2050
4%
Bush plan to “privatize” social security on
indefinite hold. Time is “not ripe.”
2%
2002
03
04
05
06
07
Source: Social Security Administration
08
09
10
11
15
20
25
30
35
40
The Texas Takeover &
Maryland Maneuver
Dramatic Examples of Expansion of State Control
• Texas: Dysfunctional homeowners insurance market
 3.5 million HO policyholders
 Historically most expensive state to insure home (severe
windstorm, hail, tornado threat; high freq. of water claims)
 95% homes insured via “county mutuals”: not rate regulated
 ‘Toxic’ mold problems crisis of availability/affordability
 Became major issue in campaign for governor
 Proposals to ban county mutual/implement rate regulation
• Maryland
 State forced struggling insurer to provide terror coverage on
state property
Contractionary Influence of
Government on Insurance
Govt. Contraction/Liberalization/Harmonization
• EU Directives
• Japanese “Big Bang” (1996)
• Harmonization efforts in US after Gramm-Leach-Bliley
• Opening of Chinese market (esp. post-WTO)
• Support of ART (generally), esp. captives
 Strong interest in some states in domestic captives (e.g.,
Vermont)
ROLE/RULE OF GOVERNMENT
BEYOND DIRECT REGULATION
Monetary/Fiscal Policy
Regulation of Securities Industry
Judicial System
Taxation
Trade Policy
National Security & Defense
U.S. Net Investment Income
$45
Billions
(US$)
$36
$27
Investment income is
directly affected by
monetary policy
policy, but insurance
regulators are
powerless to affect.
Facts
1997 Peak = $41.5B
$18
2000= $40.7B
2001 = $37.7B
$9
2002E = $35.8B
$0
75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
Source: A.M. Best, Insurance Information Institute
U.S. Interest Rates: Lower Than
They’ve Been in Decades
16%
1.
Historically low interest rates are the primary driver
behind lower investment yields. There is little insurers
can do about this.
66% of the industry’s invested assets are in bonds
14%
2.
12%
10%
8%
6%
4%
2%
3-Month T-Bill
1-Yr. T-Bill
10-Year T-Note
2002
*
*Average for week ending November 1, 2002.
Source: Board of Governors, Federal Reserve System; Insurance Information Institute
2000
2001
1998
1999
1996
1997
1994
1995
1992
1993
1990
1991
1988
1989
1986
1987
1984
1985
1982
1983
1980
1981
0%
Falling Interest Rates Mean Lower
Bond Yields for Years to Come
3-Month Yields
5.0%
Most Recent 2002
Year Ago
4.0%
4.44%
3.91%
3.29%
3.06%
3.0%
3.65%
3.65%
3.29%
3.65%
3.29%
2.83%
2.0%
Interest rates are down globally.
More room to fall in Europe than
in US or Japan
1.0%
0.10% 0.10%
0.0%
Canada
Japan
U.K.
Source: Blue Chip Economic Indicators, October 2002.
Germany
France
Euroland
In Billions
Insurance Industry Stock
and Bond Holdings, 2001
Total Industry Holdings = $3.3 Trillion
$1,800
$1,600
Total $1531
Life
P/C $194
Life $1,337
$1,400
P/C
Total $1120
$1,200
P/C $185
Life $935
$1,000
$800
$600
Total $438
$400
Total $209
P/C $188
Life $21
$200
P/C $131
Life $307
$0
Corporate
Bonds
Corporate
Stocks
Source: Federal Reserve Flow of Funds Report as of Dec. 31, 2001.
State/Local
Bonds
U.S. Gov't
Bonds
52
100
15
50
177
126
69
150
-350
-255
-290
-300
-269
-250
-111
-145
-164
-222
-200
-203
-150
-157
-100
-108
-50
-39
-22
0
Budgetary policy affects insurers directly, but
insurer/ins. regulators have no influence.
90 91 92 93 95 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
*FY1990-2001 actual values; FY2002-2010 are CBO forecasts.
Source: Congressional Budget Office, Insurance Information Institute.
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%
-1.0%
-1.5%
-2.0%
-2.5%
-3.0%
-3.5%
-4.0%
-4.5%
-5.0%
% GDP
Employment (Millions)
% GDP
88
Deficit/Surplus
200
127
250
133
236
U.S. Federal Budget Deficit/Surplus
FY1990-2010*
2001
2002E
Economic outlook for 2003 is
mixed/weakening for major economies,
esp. US, W. Europe, Japan
2003F
1.5
1.1
2.6
3.3
3.8
-1.9
3.0
2.2
1.6
2.7
Source: Blue Chip Economic Indicators, October 2002.
Br
azi
l
Ch
ina
iw
an
Ta
nd
Eu
rol
a
a
S.
Ko
re
.
U.K
n
pa
Ja
Ca
na
d
a
-2
Me
xic
o
-0.3
0
-0.2
-0.7
0.9
1.8
3.0
3.4
1.5
4
2
4.0
6
1.5
0.9
2.2
5.9
5.5
Real GDP Growth (%)
8
7.3
7.5
7.3
Economic Outlook for Major
Economies (Real GDP Growth, %)
U.S. Real GDP Growth
Fiscal & Monetary policy have
direct impact on pace of
economic activity.
10%
8.3%
9%
8%
(first recession since 1990/91)
7%
6%
5.7%
4.4%
3.5%
4%
2.5%
3%
5%
2%
5.6%
4.8%
5.0%
2.7%
2.2%
1.0%
3.0%
2.4%
1.1%
1%
0%
-1%
19
98
19
99
19 :I
99
19 :II
99
19 :III
99
:IV
20
00
20 :I
00
20 :II
00
20 :III
00
:I
20 V
01
20 :I
01
20 :II
01
20 :III
01
:IV
20
02
20 :I
02
:
20 II
02
E
20
03
F
-2%
-0.6% -0.3%
-1.6%
Source: US Department of Commerce, Blue Economic Indicators 10/02, Insurance Information Institute.
The Tragedy of Corporate Governance:
Insurers Held Hostage
•Enron was tip of an iceberg
•Major implications for insurers (p/c and life)
Corporate Governance: Expensive
and Hard-Learned Lessons
• Crisis of Confidence—skepticism is on the rise
 Ratings agencies
Analysts
 Investors/Creditors Employees
Regulators
Lawmakers
• Regulatory/Legislative Fallout Unclear
 SEC is “rudderless”
 Enormous number of investigations under way
 SEC, State Attorneys General, IRS, DoJ, etc.
 Most new SEC cases are against large companies
 Many competing reforms from Congress, SEC, A.G.’s., NYSE, NASDAQ, etc.
 Collectively are likely to help, at least somewhat
• SEC, Administration & Congressional proposals vary
• Surge in shareholder suits well underway
Financial Restatements Filed
300
250
200
The number of financial
restatements is rising
even thought the number
of publicly traded
companies is falling.
270
233
215
160
150
116
100
50
0
1997
1998*
*Approximate
Sources: Huron Consulting Group
1999*
2000
2001
Serious Implications for Insurers
• Insurers exposed to a wide variety of risks:
 Investment risk (as institutional investors)
 Insurance risk (surety, D&O, E&O, etc.)
 Litigation risk (as both plaintiff & defendant)
 Accounting Risk
 Regulatory risk
• Outcome of corporate governance issue hinges most
critically on regulatory reform and enforcement in the
securities industry:
 Insurers have little, if any, say in this debate
Enron-Related Losses
for Insurers
Total Exposure (Life & Non-Life): $3.796 Billion
Multiple
7%
Enron is the biggest
bankruptcy in US
history ($31B+)
Equity/debt
widely-held as S&P
500 company
Surety
26%
Biggest impact in
institutional
investors/creditors
11 Congressional
investigations
56 suits against
officers & directors
Fin.
Guarantee
D&O
2%
1%
Will spark similar
suits
Investment
64%
Source: Loss estimates from Morgan Stanley as Feb. 8, 2002; Insurance Information Institute.
Average U.S. Jury Awards
1994 vs. 2000
6,817
2000
1994
$7,000
$6,000
($000)
$5,000
$4,000
3,482
3,566
$3,000
1,744
1,727
$2,000
1,168
$1,000
419
1,140
759
1,185
698
187 269
333
Vehicular
Liability*
Premises
Liability
$0
Overall
Business
Negligence
Source: Jury Verdict Research; Insurance Information Institute.
Medical
Malpractice
Wrongful
Death
Products
Liability
Cost of U.S. Tort System
($ Billions)
Tort costs consumed 2.0% of GDP annually on average since 1990,
$350 expected to rise to 2.4% of GDP by 2005!
$298
$300
Tort costs equaled $636 per person in 2000!
$250
Expected to rise to $1,000 by 2005
$198 $204
$200
$150
$129 $130
$141 $144 $148
$159 $156 $156
$179
$167 $169
$100
$50
$0
90
91
92
93
94
95
96
97
98
99
Source: Tillinghast-Towers Perrin; Insurance Information Institute estimates for
2001/2002 assume tort costs equal to 2% of GDP. 2005 forecasts from Tillinghast.
00
01* 02E* 05F
Who Will Pay for the
US Asbestos Mess?
Estimated Total US Settlements & Expenses = $200 billion
Asbestos
Defendants
39%
US Insurers
30%
$78 billion
$60 billion
$62 billion
Source: Tillinghast-Towers Perrin; Insurance Information Institute
Foreign
Insurers
31%
Non-Malignant Asbestos Claimants
File Most Claims, Get Most $$$
DISTRIBUTION OF CLAIMS
ALLOCATION OF COMPENSATION
1991-2000
1991-2000
Lung &
Other
Cancers
7%
Mesothelioma
3%
Nonmalignant
90%
Source: RAND, Tillinghast-Towers Perrin
Lung &
Other
Cancers
18%
Mesothelioma
17%
Nonmalignant
65%
National Security & Defense Issues
More Important in Post 9/11 Era
Terrorists &
Terrorism
Insurers forced to cover losses over which
War on Terrorism
they have no control, little knowledge and
that properly rest with public sector
Expansion
War
Is for
Iraq
Noofregulatory
“compass”
this issue.
Next?
THE ROLE OF GOVERNMENTS IN
IN INSURANCE IN THE
21ST CENTURY
Is Traditional’ Regulation is Archaic?
Focus on Convergence of Sectors
Conclusions
Is Insurance Regulation
Becoming Marginalized
•
•
•
•
Are Insurance Regulators Overshadowed?
Efforts to modernize insurance regulation progressing
more slowly than world in which insurance operates
Approaching time when non-insurance regulators have
more influence over insurance industry than noninsurance regulators
Impact of non-insurance policy (war on terror, Iraq) &
non-insurance regulatory decisions (e.g., SEC) on
industry becoming more pronounced (corp. governance)
Monetary/fiscal policy decisions are more critical than
ever to insurers (esp. life) in convergent world
Core Principals of
Insurance Regulation (IAIS)
•
•
•
•
•
•
System of insurer licensing
Standards for corporate governance
Standards for capital adequacy/solvency
Rules governing assumption of risk by insurers
Authority to monitor/conduct on-site inspections
“Principles” applicable to intl./cross border nature
of global insurers
• Power to take remedial action at problem insurers
Source: Holfeld, Knut, “Comments of Global Regulation,” Geneva Paper on Risk and Insurance,
January 2002.
Focus on Regulatory
Convergence is Insufficient
Are Insurance Regulators Overshadowed?
• Much of the focus on modernization of insurance
regulation in recent years has focused on
convergence
• While convergence proceeds (domestically and
internationally) there is no push for a global
“super regulatory authority”
Practical/political impossibility even within US/EU
for now
• Regulatory modernization is a necessary but not
sufficient condition for regulatory relevance
Conclusions
•
•
•
•
Maintaining Relevance in the 21st Century
Cross-sectoral efforts are underway (acknowledges
realities of convergence), and work with groups like
Basel Committee, IMF and World Bank are important,
but…
Sphere of insurer regulatory influence is under siege by
outside forces—often beyond regulator control
Regulators must achieve a delicate balance of achieving
effective regulation without stifling innovation in
insurance
Many government policymakers/lawmakers and noninsurance regulators know very little about the
insurance industry—must be educated.
Insurance Information
Institute On-Line
Download or view this presentation at:
http://www.iii.org