Sorting Through the Wall Street Mess for Insurers

Had it not been for the insurer AIG, the insurance industry might have escaped some of the ugliness of the recent financial crisis that hit the entire financial services industry.

“AIG was the king of credit default swaps,” says Jonathon Steiman, analyst, financial services technology for Datamonitor. “It flew high on them and crashed hard on them.”

However, what bothers insurers is–whether there had been federal regulation of the insurance industry or the current state regulation–insurance regulations as we know them would not have been able to prevent this. “[The AIG mess] was outside of traditional insurance regulation,” he says.

AIG's insurance business remains strong, but it's getting weakened because market participants see a tainted name and are moving away from it. “AIG is a financial services conglomerate that is unique,” says Steiman. “There's not another insurer like it in the United States market. It was one small unit that precipitated [AIG's] fall.”

The financial crisis has spurred more debate over the federal insurance charter, Steiman asserts. Supporters of a federal charter believe the crisis is why the insurance industry needs federal regulation, while the NAIC responds the crisis and AIG's involvement in it had nothing to do with the way the industry currently is regulated.

As the debate continues, Steiman anticipates it will open an enormous opportunity for other insurers to gain market share. “Agents and brokers have noticed the flight out of AIG because of the tainted name,” he says. “Every single insurer has an opportunity to gain market share.”

The other issue affecting insurers during the financial crisis is the soft premium market. Soft markets are not the worst thing in the world for insurers when the investment market is working well, but Steiman calls the current state of affairs “a double whammy. The competition has driven down premium prices and simultaneously there has been weakening of investment income. I think, across the board, insurers are going to begin to raise premiums because they need to focus on underwriting profitability in the current economic state.”

Raising premiums in a weakened economy is not easy, though, adds Steiman. “People aren't as willing to get that extra coverage on their automobile, and businesses are weakened and not expanding and therefore not needing extra coverage or are just going under-covered,” he says.

The financial crisis will bring regulatory changes to the industry, Steiman predicts, and those changes are going to require different compliance rules and different risk profiles. “It encompasses everything–people, processes, and technology,” he says. “Certainly, technology is a massive part of that. There is going to be change driven by more transparency, better reporting, and better audit trails.”

Steiman supports federal regulations for insurance. His rationale is the U.S. market is costly and slow to develop new products and bring them to market. Other countries such as the United Kingdom have one national insurance oversight commission, and things move quicker there, he notes.

“Here, if you want to launch a new product, you have to get it approved by one to 51 agencies, depending on whether you want it to go across the country, and that slows everything down,” he says. “I certainly would like to see a nationwide insurance program that ensures all the regulations are there–the two major pillars being solvency and consumer protection.”

Steiman is unsure whether the financial crisis is going to make a federal charter come quickly or not. “It's tough to say because the insurance space is still safe,” he says, pointing out the major problems involve bank oversight, leveraging within banks, and deciding there needs to be some balance sheet restrictions. “I think due to the events happening in the capital markets and the banks, the push for insurance into a national oversight probably is going to get lost in the shuffle,” he says.

An interesting commentary on the Wall Street mess, indicates Steiman, is because of the lack of federal regulations in the financial sector, investment firms actually became very innovative. “No one can argue credit debt obligations are innovative and valuable products,” he says. “They just got abused.”

Insurance, with its state regulators, has better oversight, but Steiman contends insurance is an industry where innovation has been dampened. What the financial services industry needs is a balance between innovation and regulation, he suggests.

Technology vendors will play a huge role in helping the financial services dig out of this mess, according to Steiman. “What vendors need to realize as they are developing their products is the siloed way of looking at the different types of risk as well as organization [divisions] not talking to each other can't happen again,” he says. “We need to build models and strategies that solve that problem. The models need to be able to meet new regulations quickly, so if something changes, it doesn't take nine months of reprogramming and retooling of the business process to achieve compliance.”