The Architecture of Insurance Supervision Before and after the Financial Crisis

Abstract

Which is the current state of the insurance supervision architectures? The recent financial crisis has forcefully demonstrated that the financial services markets are deeply integrated, requiring an integrated supervisory approach. How is insurance supervision integrated into the overall regulatory setting? This work wishes to answer this question by proposing an index of sectoral integration - the Integration in Insurance Supervision Index - which is applied based on a large and updated database of the national supervisory settings (102 countries for the period 1998-2009). Furthermore the results are used to evaluate the proposed reforms in the European Union (EU) and the US. Although the financial crisis hit the insurance industry in a less dramatic way than the banking industry, the turmoil suggested the need of reconsidering the overall picture of supervision. The primary goal of insurance supervision is to monitor both the financial risk profile of each company and the systemic risk profile of the insurance markets. In the last decade-and-a-half risk distribution in the financial sector was deeply influenced by the blurring of boundaries among individual sectors, with to an increasing integration of the banking, securities and insurance markets, as well as their respective products and instruments (Group of Ten, 2001). The consequences of the blurring effect on both the supervisory setting and its effectiveness are relevant. In this context, separate supervision for banking, insurance and other financial businesses increases the risk of regulatory arbitrage, which was one of the roots of the crisis: the shortcomings of fragmented supervisory settings were particularly evident in the US (Coffee 1995 and 2007, Brown 2005, Leijonhufvud 2009, Flamee and Windels 2009). The lack of integration is particularly acute in the insurance sector, given the US tradition of state – based supervision. Proposals to establish a new federal insurance regulator were discussed to improve the national regime (Harrington 2006, Scott 2007, Tennyson 2008), as well as to contribute to the development of international insurance standards (Brown 2009). However the federal regulator option has also been criticized by some (Kwon 2007, Grace 2009). During the recent crisis the failure of the US insurance setting is represented by the $ 160 billion bailout of the insurance giant American International Group (AIG) (Sjostrom, 2009). AIG was able to conduct regulatory arbitrage among different jurisdictions in US and in Europe, and the federal agency which failed in AIG oversight was the Office of Thrift Supervision (OTS). Why was AIG – a insurance company which conducted business in 130 countries - controlled by a minor US regulator? Because among its several holdings, AIG had a savings and loans firm – since 1999