Regulating insurance

Insurance is a major component of the financial sector. It is a risk transfer mechanism, whereby an insured transfers a risk exposure to an insurer in consideration for the payment of a premium. This is a tool of prime importance in modern economies: it enables the commercial sector as well as individuals to reduce and better manage the uncertainties of the future. In several developed countries the ratio of aggregate insurance premiums (life and non-life premiums) to gross domestic product exceeds 10%, which shows the importance in economic terms of the insurance industry. The basic feature of the non-life insurance contract is that the insured buys a future promise of payment contingent upon the occurrence of specified events. This means that, first, the policy-holder pays and then some time in the future the insurer may be required to reimburse the insured or a third party for a claim. This has several consequences, inter alia: the long-term reliability of an insurer must be beyond doubt; funds are entrusted to insurers which in large part constitute reserves to cover future obligations.

The development of a sound insurance industry is partly in the hands of the legislators and supervisors. They have to establish the framework for the healthy development of the insurance industry and to deal with the incidences of market failure and imperfections. This should benefit not only consumers but also the economy as a whole through better protection of the existing and future wealth of the country, the availability of more funds for investment purposes and the strengthening of state finances through higher tax incomes directly or indirectly deriving from the performance of the insurance sector.

Legislators and supervisors need to ensure that the market develops towards optimal effectiveness and efficiency. This is usually best achieved in a competitive environment based on the principles of a market economy. Applied to insurance markets these principles include: (a) Atomicity: the market should comprise a sufficient number of buyers and sellers to ensure that no individual player is able to acquire a dominant position; (b) Transparency: market conditions should be made fully transparent. The products offered should attain a certain degree of homogeneity so that buyers can make objective comparisons between products on offer; (c) Information: buyers and sellers should be able at any time, and at minimal cost, to inform themselves of prevailing market conditions, to make the best choice in terms of price and quality of service and to respond to changes in competitive conditions.

There are a number of constraints on the adaptation of these principles to insurance markets. To achieve an optimum market structure, ([ie] to have the ideal number and size of companies) may require some trade-offs between security (reliability of insurance concerns), and concerns of competitiveness and diversity of products available. In terms of the products, there might also be trade-offs between product innovation and homogeneity. The interests of consumer protection and market efficiency may sometimes conflict, and the legislator should seek the optimum balance between the two.

The situation is, changing rapidly, however, and to establish or strengthen supervision of insurance has become a necessity for the following reasons:< (a) A clear trend has emerged towards establishment of competitive markets to which the principles of the market economy apply. Supervisory authorities have a primary role in ensuring that these principles are respected and that markets function efficiently;< (b) The democratization process is changing the attitude of politicians towards consumer protection. Because of national economic strategies, until recently laws and regulations in some countries have been producer biased, but they are now being altered to give greater consideration to consumer interests. This general trend is especially noticeable in attitudes regarding the insurance industry's treatment of policy-holders, beneficiaries and third parties. Complaints from the public about insurance operations are treated with greater attention, as is demonstrated by the establishment of public complaints units within supervisory bodies and of ombudsmen's offices, as well as by regulations geared to speed up claims settlement.

(c) World trade liberalization in services includes insurance. The opening up of developing countries' domestic markets to foreign competitors will undoubtedly change prevailing market conditions significantly. In this respect supervisory bodies have an important role to play, They have to ensure that rules flowing from the implementation of the [General Agreement on Trade in Services] (GATS) contained in the Final Act of the [Uruguay Round] in relation to such issues as market access, establishment, national treatment, non-discrimination and transparency are respected, and that no breaches occur in the rules of competition.

In most developing countries there are objective reasons to change the regulatory and supervisory frameworks for insurance. A number of developing countries, especially in Latin America, have already made substantial changes with a view to liberalizing their insurance markets. In this respect supervisory authorities should play a pro-active role by proposing to their governments the new rules that are deemed necessary for adapting markets to changing conditions and for continuously assessing and fine tuning the implementation of these rules. Often liberalization processes are intermingled with deregulation, which is often seen as a reduction in regulatory activity. Certainly "administrative harassment" should be reduced, but the whole process should be directed towards greater autonomy of the management of insurance concerns rather than a reduction in the number of rules and regulations.

The international nature of insurance business requires supervisors to have constant contacts with their counterparts in other countries. The increasing complexity of insurance and its operating structures have rendered an assessment of the security profiles of international players more difficult. Greater dialogue among supervisory authorities is necessary to amass more complete information on transborder operations. In developing countries it is still difficult to obtain satisfactory information on terms and conditions in international markets. In this respect supervisory authorities may play the role of a focal point for improving market information. One of the areas in which international cooperation between supervisory authorities could usefully be developed concerns the harmonization of insurance laws, regulations and practices. In order to have more efficient international and national markets a move towards more standardized practices seems to be essential. Another area where international cooperation could create considerable economies of scale in terms of cost is training. Because of the specialized aspect of insurance supervision and the small number of people involved, formal training in specific areas of insurance supervision is scarce or even non-existent. Many countries have internal training courses for supervisory staff but the USA is the only country in which training for supervisors is available through independent courses where anybody who pays the fee may attend. However, the cost of such training through the National Association of Insurance Commissioners (NAIC) is often out of the reach of most developing countries. There is a need therefore to organize more affordable [ad hoc] training on a regional basis. International organizations, bilateral donors and interested sponsors can play an important role in this respect.