Insurance: A heavy hand looming / Poor cover for a rainy day

Date: 08/03/03

Europe's troubled insurers need more sensible regulation

MIGHT Europe's insurers go the way of Japan's? Japanese insurance companies have been in near-perpetual crisis, with many bankruptcies, for over a decade. Their main error was to promise too much to life-insurance policyholders. The state of European insurers is eerily similar to the Japanese in the early 1990s. Indeed, those who wonder if any big bank might go bust in today's lacklustre global economy are looking in the wrong place: it is more likely to be an insurer that goes under. Life insurers in particular, notably in Germany, Britain and Switzerland, are at risk, because their investments have been badly hit by falling stockmarkets. Regulators have offered some relief by relaxing rules on pay-outs and solvency - but not enough to avert the danger of following Japan.

Don't blame the sheriff

European insurers argue that one cause of their problems is the messy patchwork of European regulation and inappropriate domestic supervision. Despite a series of directives to harmonise the rules, they still diverge considerably. Brussels determines minimum requirements for the solvency of both life and non-life insurers, but each country adds its own rules on top. Britain's regulator has a resilience measure that stress-tests investment portfolios for falls in equity markets. The French have their own Gallic version of such a test.

Yet it is too easy to blame regulators for insurers' problems. European insurers are themselves at fault for their biggest failings: mispricing of underwriting risks and the poor performance of their investments. The purpose of regulation should not be to make insurers choose risks more carefully or invest more prudently. Rather, the case for regulating insurers is to protect policyholders, who are not well placed to judge the security of a life insurer, say, and who may also be obliged by law to buy certain types of cover.

When American insurers got into trouble two decades ago, regulators imposed rules that circumscribed their investment unnecessarily. They discouraged investment in equities, for example, by forcing insurers to put up more capital against their risks. As a result insurers park most assets in “safe” investments, largely bonds. That has helped recently; but in the longer run safety implies lower returns, so policyholders end up paying more for their insurance.

The Europeans, who are reconsidering their own regulations, should avoid copying America by interfering too much in the day-to-day decisions of insurance companies. They certainly need to rethink rules on solvency, possibly adding a component that better reflects long-term investment risk. But their most important role should be to create a safety-net for insurers that get into trouble. Regulators should be ready to intervene sooner in the management of a troubled company to restore its finances. And in extremis a “policyholder guarantee fund” should be able to take control. The German life-insurance industry has such a system; others should copy.

New regulation cannot and should not shield insurers from all troubles. Regulators could not have prevented the collapse of Independent Insurance in Britain, say; nor are they to blame for the tribulations of Gerling, Swiss Life, Zurich Financial Services, Royal & Sun Alliance and Scor. But if chronic sickness can be avoided for the entire industry, some European insurers will thrive, many will merge and a few will die. And all will have learned a useful, albeit painful lesson.

Europe's troubled insurers need more sensible regulation.

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