Regulation: government
intervention and harmonization
How do governments intervene?
Why do governments intervene?
Why do we need harmonization?
Harmonization
• Why is it important?
• Liberalization, harmonization and
deregulation
• Arguments for
• Arguments against
• Recent experiences of harmonization
Why harmonize?
• Cross border trade has grown much faster
than the growth of GDP (and trade growth
causes GDP growth)
• Cross border borrowing and lending has
grown even faster
• Thus, regulatory harmonization has become
a necessity
• Unilateral changes causes turmoil
Underlying causes
• Economic convergence taking place across
borders
– Convergence is taking place at times with the
blessings of the respective governments but at
other times against government wishes
• Governments are actively pursuing policies
of harmonization
– This has been more out of necessity than out of
foresight
Implication
• Capital mobility implies that much of
borrowing and lending can be accomplished
without any regard to national boundariesborrowing in California can be financed in
Hong Kong
• Technology has made communication
cheaper across the world which has
enhanced the process of internationalization
Lowering fences
• GATT rounds have done much to lower
fences on cross border movement of goods
and capital (however, it has not done so for
cross border movement of labor)
• Some countries have unilaterally reduced
tariffs, followed prudent macroeconomic
policies and had success in stimulating
economic growth and reducing inflation
Political trends
• More and more independent nations are
joining world organizations such as the UN
and the IMF (for example, China)
• US economic and political power has been
diminishing since the end of World War II
• Centrally planned economies are falling
apart and they have all adopted capitalist
systems
International versus domestic
• If fences are high, we can distinguish
between domestic and foreign policies
• Domestic: competition, product standard,
worker’s safety, regulation and supervision
of financial institutions, environment etc.
• Foreign: tariffs and quotas and other cross
border issues
• With integration new issues: behind border
Examples
• Talks between Mexico and US next month
include the following
• Drug issues in the US
• Illegal immigration to US
• Democracy in Mexico
• Pollution in Mexico
• Behind the border policies are discussed
between countries!
Why?
• There are externalities
• Externality: When the action of one party
affects another outside markets
• Example: Severe recession in Mexico due
to a macroeconomic downturn may increase
illegal immigration to the US
• Example: Default of international loans in
Mexico may trigger bank failure in US
Environmental issues
• Should developing countries be forced to
adopt environmental standards of developed
countries?
• Problem: Now developed countries while
developing had bad environmental record
• Problem: Difficult to force any country to
adopt a particular environmental standard
• Problem: Cheap production possible with
pollution and competitive issues
Diminishing national autonomy
• Setting domestic monetary and fiscal
policies have international impact
• Example: German reunification had costs
throughout Europe
• Bad economic policies lead to movement of
capital out of country
• Example: Best known Swedish/Japanese
companies produce more outside!
New issues
• Good externality: research and development
• Bad externality: pollution
• Both kinds of externalities flow across
national boundaries
• Without coordination between countries,
there will be too few good externalities and
too many bad externalities
Conflicting values
• Human rights issues in China or Peru
affects their discussions with US
• US talks with Japan about the use of timber
products imported into Japan from
Indonesia or Brazil
• Environmentalist proposals to ban tuna
import from countries that use driftnets
Liberalization
• Types of liberalization
• Most favored nation (MFN) means trade
concessions extended to one country are
extended to all trading partners
• Reciprocity: Give and take between
countries
Harmonization
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Making laws identical
de jure: mirror image laws
de facto: laws are similar in substance
complete harmonization
minimum harmonization
Deregulation and liberalization
• Deregulation: reduction in national
regulation
• Liberalization: market opening
• Typically they go together
• It is possible to have domestic deregulation
without allowing for foreign entry
Why harmonize?
• Regulatory diversity magnifies market
failure or impede liberalization
• Harmonization reduces transaction costs
• If financial services are insulated then
diverging rules do not pose problems
• If financial services are global, then they
they will suffer from domestic regulations
Arguments against harmonization
• Differing regulatory philosophies would
bring in more innovation and competition
• Risk of getting it wrong
• There is more risk of fraud when national
boundaries are removed
• Insurance is about security, therefore less
regulation may not be attractive
Harmonization: wrong level
• Government driven harmonization can
create problems of harmonization at the
wrong level: example qwerty keyboard
• Create barriers: example setting capital
requirement too high/low
• Consumer protection
• Definitional issues: all countries do not
have identical accounting procedures
Harmonization in insurance
versus harmonization in banks
• Cross border harmonization rules are much
more common in banks than in insurance
companies. Why?
• Banks “create” money, therefore, banking
crisis has a contagion effect
• Systematic risk is much higher in banks
than in insurance companies
Recent experiences
• The only body that deals with some
insurance harmonization issues is the
International Association of Insurance
Supervisors (IAIA)
• Formed in 1993 with 50 governments
• Most are developed countries
European Union
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Reinsurance Directive: 1964
First Non-life Directive: 1973
First Life Directive: 1979
EC White Paper: 1985 minimum
harmonization principle
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prudential standards
technical reserve calculations
asset valuation
sovlency
EU experience
• Third Directive (Life and Non-life) 1992
– intended for complete freedom and single
market in insurance
• Objective: Create a single integrated market
for all financial services
• Has it succeeded?
• Emerging trends
OECD
• Code of Liberalization of Capital
Movements
• Code of Liberalization of Current Invisible
Operations
• Production by foreign companies is
typically forbidden
• Distribution may or may not be allowed
• Subsidiary, foreign equity are favored
Government role: regulation
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Why regulate?
Quality
Affordability
Availability
Reliability
Development: promoting domestic
insurance industry
Types of regulation
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Liberal: UK, Chile, Hong Kong
Regulated: Germany, Japan, Korea
Mostly in between
Evolution:
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Socialized (no private)
National (no foreign)
Protected/transitional
Liberal
Mechanism of regulation
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Licensing of insurer/reinsurer
licensing of agents and brokers
filing and approving insurance rates
filling and approving materials and forms
financial reporting requirements
liquidity of insurers
guaranty funds
product and company taxation
Types of regulation
• EU: through directives
• Japan: through the Ministry of Finance
– Department of Banking Bureau
– Convoy principle (price competition
prohibited)
– Insolvency prevented
– Volatility minimized
– Excessive competition is discouraged
Types of regulation
• US: 1945 McCarran Ferguson Act
– Each state determines admittance, forms and
reserve requirements
– regulatory rates
– Rules vary
• Nation-wide body: National Association of
Insurance Commissioners (NAIC)
coordinates regulatory matters across states
India and China
• India
– Started in 1818 by Oriental Life
– Indian Life Assurance Company Act 1912 was
the first statutory measure to regulate life
insurance business in India
– Insurance Act 1938 was the first comprehensive
Act to regulate insurance
– Amendment of 1950 imposed stricter control
India
• 1956: 156 Indian insurers, 16 foreign and
75 mutual societies were selling life
insurance in India
• Life Insurance Corporation Act of 1956,
nationalized all of them and formed a
monopoly
• To date, it is still a monopoly
India
• Thus, it is not always the case that over time
we have all countries are moving to
deregulation
• Note also that non-life business was not
nationalized at the same time
• In 1973, General Insurance Corporation
(GIC) Act was passed and non-life business
was also nationalized
China
• Before 1949, there were 205 insurance
companies operating in China
• After the revolution, life insurance was
banned
• In early 1980s, People’s Insurance
Company of China (PICC) was formed
• Rates were not actuarially set by PICC
China
• Banking system is non-existent in rural area
• Life insurance provides an avenue for
saving
• PICC is forming global alliance through
Hong Kong
• New competition but they need to reinsure
at least 30% with PICC
China
• Only foreign company allowed to write
domestic policies is AIG
• It started as a joint venture between PICC
and AIG, China American Insurance
Company, with the intention to write
China’s exposure outside of China itself in
1980.
• Then, in April 1991, PICC formed another
joint venture with AIG.
AIG
– AIG received a license to operate a life and a
non-life business in Shanghai
– It has a license to underwrite property and
casualty risks in the Shanghai area.
– It could also offer life and savings products,
effectively throughout China
– It currently writes comprehensive business
insurance coverages ranging from Property to
Marine, from Casualty to Financial Services for
both Joint-Venture and foreign-funded comp
AIG
– The Life operations sells life,personal accident
and employee benefits insurance to the
population of Shanghai
– Operation has been profitable
– It could use old ties
– It had the first mover advantages
– Competition from PICC
– Repatriation is a problem