The new world

They said it could never happen. The world’s largest insurance company teetered on the edge of ruin, Wall Street institutions were brought to their knees ... and a black man was elected president of the USA. Two days ago, Barack Obama started work, pledging to turn around the economy.

Implementing his promise of change will not be easy, but regulating the financial services industry – including insurance companies – is set to be a priority for the new administration. Here, as with every other issue on his desk, Obama has to get the balance right. He must ensure that stability is restored but he also needs the co-operation of the financial services industry. If the rules are too tight, they won’t let business thrive; if they are too relaxed, there is a danger of a similar catastrophe in the future.

“The issue will be achieving some of the campaign goals, without driving the industry into complete revolt,” says Craig Weber, senior vice-president of the insurance practice at consultant Celent.

Insurance Times looks at the decisions Obama might make – and how they will affect insurance in the USA and the UK.

Regulation

The American public and the financial services industry expect Obama to make sweeping regulatory changes

to ensure that the credit crisis will not be repeated. Under the current framework for insurance, 50 state regulators oversee the business. Politicians and industry have criticised the inefficiency of this system and urged Washington to introduce a single federal regulator. Commentators believe such a regulator could be introduced over the next 18 months. It is not yet clear whether it would replace state regulators or simply have the power to overrule them.

There is a danger, however, that the federal regulator will just be another layer of bureaucracy. It could leave the industry confused over who is in charge and raise costs.

“Some chairman of key committees here in Congress have indicated that they are not interested in regulating the cost of auto or homeowners’ insurance and that this would be left to the individual states,” says Dr Robert Hartwig, president of the Insurance Information Institute in New York.

“Congress is not interested in complete regulation, but they are interested in being involved in solvency, risk issues and regulation of holding company structures.”

For British and European insurers trying to work in America, the lack of a “one-stop shop” is frustrating. “Insurers want to be regulated by a federal agency, rather than have to deal with 50 state regulators on a piecemeal basis when they want to issue a new type of policy or change rates,” says Charles Gordon, partner in the insurance practice at City law firm DLA Piper.

“The current system is cumbersome and time-consuming for the insurance industry – an inefficiency that ultimately impacts on front-line client services.”

A single regulator will speed up product launches for international insurers operating in the USA.

“If products can be approved by one regulator and simultaneously rolled out in 50 states, new products would reach consumers quicker and insurers will be able to respond to changing market conditions, which will also be good for consumers,” says Hartwig.

He adds: “Agents or brokers could also get a federal licence, which means a broker who sold insurance in New York could sell it in California. A foreign broker could potentially obtain such a licence if the language were written in the appropriate way, and a broker in the USA would be able to place business with a European insurer.”

Risk and investments

Insurance firms will undoubtedly face more scrutiny of their investments. “That [reviewing investment] will be the national insurance regulator’s job,” says Gene Ludwig, chief executive of Promontory Financial Group, who has advised members of the Obama team.

Tighter rules will not hit insurers as hard as banks, though. “Insurers are traditionally conservative when it comes to investing money and will primarily be left alone as an industry,” says Celent’s Weber.

If another insurer runs into serious difficulties, it is unlikely to be simply handed a cheque.

“If another major insurer were to suffer, it will be given a loan or the government will take a stake in it, as it did with AIG,” says Weber.

America would do well to learn from the European Union, which is introducing Solvency II, a risk-based approach to assessing capital adequacy (see page 16). If a federal regulator were introduced, it would probably use Solvency II as the basis for its approach. Indeed, talks have been held between Peter Skinner, the MEP in charge of steering Solvency II through the European parliament, and US regulators about how an American version might look.

The new administration also has to decide how it will help insurers affected by claims linked to investment fraud. Bernard Madoff’s alleged $50bn (£34.4bn) Ponzi scheme has caught out several investors.

Fraud will affect the UK as well. Lloyd’s has indicated that claims will be made against financial firms and that they will, in turn, claim on directors’ and officers’ (D&O) and errors and omissions (E&O) policies. D&O and E&O losses could reach $2.5bn.

“Many of these claims will fall into the lap of the insurance industry,” says Gordon. “This is a cost the industry can ill afford; having itself suffered significant investment losses.”

Tax

While on the campaign trail, Obama criticised corporations that “hide” their profits offshore (see box, right). Now he is in the Oval Office, he is likely to introduce a tax on companies that have offshore operations in order to pay for his commitment to provide tax relief to middle-class Americans.

“Some tax issues may arise in terms of the tax treatments of certain insurance transactions when the insurer is foreign domiciled,” says Hartwig. “The impact there has more to do with places like Bermuda. US tax policy is likely to be examined because of the financial needs of the US government going forward.”

But tax on offshore business is likely to be met by resistance from insurers. “In general, I don’t think it’s a good idea,” says Alessandro Iuppa, senior vice-president at Zurich. “To penalise a company that has the global reach and the ability to disperse and diversify risk is a mistake. It means there will be less capital available to the employer marketplace.”

The UK could follow suit on this offshore policy. Gordon Brown has promised “very large and radical changes” in financial regulation while Alistair Darling, the chancellor, has spoken of “potential problems with overseas territories and crown dependencies.” Insurers based in Jersey, Guernsey and the Isle of Man could be affected. Other jurisdictions that could be taxed include the Cayman Islands, British Virgin Islands, Gibraltar, Turks and Caicos Islands and Anguilla.

Health insurance

Obama’s campaign goals included making healthcare more affordable for Americans, providing cover for people who don’t have it and making products portable. Currently, consumers cannot stay with their healthcare provider if they change employer.

Earlier this month, Congress voted for a large expansion in healthcare coverage for children. Democratic politicians said this would bring the US closer to providing insurance to the 47 million people who do not have it.

The idea that Obama will introduce some kind of UK-style national health service has been dismissed, however, because there would be too much opposition from health insurers.

“It turns out the health industry has a lot more clout than they realised and is much more unwieldy and hard to move,” says Weber. “But over time I expect there to be some compromise. It will result in coverage of more people and will be conducted through a private company mechanism and health insurers will be allocated for that role. This is the halfway solution that makes the most sense,” says Weber.

No large UK or European health insurers currently operate in the USA, but such a halfway solution could provide an opportunity for non-US insurers. They would still need an American licence and would be subject to US insurance regulation, but a federal regulator could make it easier to access the market.

“You could have UK companies sell directly in the United States without having an admitted US subsidiary,” says Peter Lefkin, head of governmental affairs for Allianz.Obama’s campaign goals included making healthcare more affordable for Americans, providing cover for people who don’t have it and making products portable. Currently, consumers cannot stay with their healthcare provider if they change employer.

Earlier this month, Congress voted for a large expansion in healthcare coverage for children. Democratic politicians said this would bring the US closer to providing insurance to the 47 million people who do not have it.

The idea that Obama will introduce some kind of UK-style national health service has been dismissed, however, because there would be too much opposition from health insurers.

“It turns out the health industry has a lot more clout than they realised and is much more unwieldy and hard to move,” says Weber. “But over time I expect there to be some compromise. It will result in coverage of more people and will be conducted through a private company mechanism and health insurers will be allocated for that role. This is the halfway solution that makes the most sense,” says Weber.

No large UK or European health insurers currently operate in the USA, but such a halfway solution could provide an opportunity for non-US insurers. They would still need an American licence and would be subject to US insurance regulation, but a federal regulator could make it easier to access the market.

“You could have UK companies sell directly in the United States without having an admitted US subsidiary,” says Peter Lefkin, head of governmental affairs for Allianz.

What UK insurance wants from Obama

• Don’t tax companies and subsidiaries that are located offshore
• The federal government should take on some catastrophe risk and cover areas such as Florida
• Make plans for AIG to return as a commercial entity
• Create a federal regulator that will provide a cross-border licence for international insurers and brokers keen to expand their business in the USA
• Monitor the insurance sector closely and aid insurers exposed to financial fraud
• Don’t nationalise the healthcare system. A deal should be reached between the government and insurers to provide universal healthcare
• Help restore and stabilise the financial services sector, particularly the banks.