Martin Grace, James S. Kemper Professor of Risk Management and Insurance, Chair at Georgia State University and Networks Financial Institute Senior Fellow, shared insights from his paper, International Capital Rules: Harmonization, Conflict or Competition with Insurance Public Policy Summit participants.
As the European Union and United States have very different methods of determining insurance capital requirements, discussion has focused on which method is "best." Dr. Grace provided an overview of the principal characteristics of the U.S. Risk-Based Capital (RBC) tool and the European Solvency II model. In summary, the RBC model is regarded as a somewhat "suspect" model based on static statutory financial ratios. In contrast, the EU Solvency II approach is regarded as modern, technical and based on the newest types of financial modeling.
In an ever more global environment where institutions are no longer restricted to conducting business based on their geographic area, the two standards have presented conflict regarding which standard is optimal for the industry and those it serves. Much of the recent debate has focused on consumer protection, however, Dr. Grace cautioned that the goal of effective regulation is not about avoiding every insolvency, but about minimizing the overall social cost of insolvency on society.
While the US model might seem very simple compared to the sophisticated EU model, Grace noted that U.S. insurers hold significant levels of capital, are examined by multiple regulators through a strong surveillance system that alerts regulators to troubled companies, and exists in a market where competitors are motivated to detect companies whose potential insolvency might affect their guaranty costs.
Grace noted that the two systems do not need to be in conflict or competition with one another, based on a recent agreement between the US and European Insurance and Occupational Pensions Authority (EIOPA) that provides a roadmap for harmonizing the two systems. Harmonization addresses the tension that is created between two different philosophies—a European model that is very averse to insolvency and brings with it higher prices; and a U.S. model characterized by lower prices and an environment where insolvency is allowed to occur.
The Way Forward document emerging from the US/EIOPA discussions would make it possible to have two systems with different capital requirements but the same outcome in terms of solvency costs. Thus, regulators on both sides of the Atlantic could set capital requirements that impose similar overall social costs but are responsive to the nature of each market. Dr. Grace’s paper is available in its entirety from our Summit research page.
Our partners for this event, Faegre Baker Daniels, have also published a brief report of the Summit.