The theory of principles-based regulation sounds promising, but actual application of the concept may fall short, warned one Bermuda representative, drawing parallels to the development of risk-transfer rules for finite insurance deals.
Bradley Kading, president and executive director of the Association of Bermuda Insurers and Reinsurers, made his assessment in response to a question during a recent joint luncheon of the Association of Professional Insurance Women and the Insurance Brokers Association of the State of New York.
A principles-based regulation system for insurance was spotlighted recently in New York when Insurance Superintendent Eric Dinallo proposed rules in his state. Mr. Kading pointed out that "if you look at the pronouncements 10 years ago on finite risk," those were principles-based.
"What happened? People tried to develop guidelines to define what the principles were," he said.
However, Mr. Kading related, "after companies adhered to them for a number of years, the authors of the guidelines backed away from them when people thought there were problems in the business."
He referred to 2004 and 2005 investigations by the Securities and Exchange Commission, as well as by state attorneys general and others into accounting of finite insurance deals, which also prompted internal investigations and restatements by Bermuda reinsurers.
Generally, finite insurance is distinguished from traditional reinsurance in that the reinsurer's risk is more limited than it is in traditional contracts. (Finite deals can include profit-sharing features and loss caps, as well as the possibility of refunding some portion of investment income to cedents.)
Over time, accounting rules of thumb developed allowing such deals to be accounted for as reinsurance if they had a certain amount of risk transfer.
The principle was that a deal had the appropriate amount of risk transfer "if it was reasonably possible that a reinsurer would realize a significant loss" on the contract, explained Mr. Kading.
Insurance accounting professionals over time settled on a practical rule to interpret the principle–agreeing that a reinsurer would clear the risk-transfer hurdle if there was at least a 10 percent probability of a 10 percent loss of premium.
While Mr. Kading did not detail the "10 percent rule" for the APIW audience, he offered the development of practical finite rules as "an example to keep in your mind about what in the future this means with principle-based [insurance] regulation."
Mr. Kading also mentioned that U.K. regulators, who are moving ahead with principles-based regulation, talk about the principles being the guiding interpretative documents that allow you to figure out how to apply the underlying regulation–but the underlying regulation stays in place.
"It's clear this is not an either-or proposition," he said. "Regulation is not being replaced by principles."
"It's…not an either-or proposition. Regulation is not being replaced by principles."
Bradley Kading, President
Association of Bermuda Insurers & Reinsurers
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