RS21828 -- Insurance Regulation: International Developments April 28, 2004 Summary Events and entities outside the United States are affecting or may affect the competitiveposition of U.S. insurers, intwo ways. First, supranational organizations are developing international standards for insurance accounting andfor aspects of supervision, such as reinsurancesupervision. Second, U.S. insurers are operating under a much more fragmented regulatory regime than theircompetitors in other countries, such as the U.K.,that are consolidating and modernizing their supervision. International standards and regulatory competition areimportant parameters on the U.S. industry'saccess to capital and therefore on its ability to provide innovative and traditional risk financing in the United States. This report was written under the researchsupervision of Barbara Miles, Government and Finance Division, and will be updated as events warrant. Economists generally agree that, while capital markets are not perfectly integrated internationally, they are farmore integrated than was true only 20 yearsago. (1) This integration has created pressures forenhancing transparency in the capital markets and for curtailing risks of "contagion." (2) Several supranationalorganizations are addressing these pressures, some specifically with respect to insurance. New internationalaccounting standards may import new definitionsof "insurance," and new transparency standards for reinsurers may help buyers shop for risk financing. At the sametime, many other developed countries aresynthesizing their supervision of financial services, while in the United States insurance regulation remainsfragmented. These trends will likely affect thecompetitive positions of U.S. insurers and reinsurers, though it is not clear presently what the direction and scopeof those changes might be. The International Accounting Standards Board (3) (IASB) has determined to create principles-based accounting for insurance contracts in two stages. Phase Iwas released on March 31, 2004, as International Financial Reporting Standard 4 (IFRS 4). (4) It is scheduled to become effective in the EuropeanUnion (EU)on January 1, 2005. European insurers have objected to Phase I because, among other things, it would require themto measure derivatives at fair or marketvalue and to show their annual gains and losses on them. Derivatives do not appear on European balance sheetscurrently, as they have little or no initial cost. U.S. insurers that are publicly traded already measure their derivatives at fair value. (5) U.S. insurers objected to several other aspects of IFRS 4. (6) Phase II has just begun and will likely be implemented in 2008. (7) The U.S. standard-setter -- the Financial Accounting Standards Board (FASB) -- hasagreed to work with IASB in converging international and U.S. accounting standards. (8) The National Association of Insurance Commissioners (NAIC) hasdecided to work closely with the IASB to incorporate its regulatory perspectives into development of Phase II. (9) Several issues will have significant effect onthe capital positions of U.S. insurers. One will be whether and how to measure insurance liabilities at fair value. Another will be whether and how to unbundlevarious kinds of insurance contracts. Insurers are also concerned about how the IASB will treat reserves for lossesand expected investment income andpremium on long-term contracts, among other issues. They fear that the Phase II rules will lead to greater volatilityin their public disclosures, and thus affecttheir capital positions -- and the market's perception of their capital positions -- unfairly and incorrectly, in theirview. (10) Whether those fears are justified orappropriate is unclear at this stage -- but it is clear that Phase II of the IASB's proposals will greatly affect insurers'competitive position in the financialservices sector. Rightly or wrongly, insurance has been identified as "the weakest link in the finance-industry chain." (11) Reinsurance has been identified as "occupyingaposition of systemic importance to the insurance industry ...." (12) Reinsurers lost about $40 billion on September 11, 2001, and they lost about that much as theequities bubble burst. (13) Financial supervisorsbegan to regard reinsurance -- again, rightly or wrongly -- as a systemic risk. (14) In September 2002, the Financial Stability Forum (FSF) (15) said that though the reinsurance industry had performed well, FSF members were concerned aboutthe opaqueness of the reinsurance market and of individual reinsurers' disclosures. It charged the InternationalAssociation of Insurance Supervisors (IAIS)with producing data on the market and with enhancing reinsurers' disclosures qualitatively and quantitatively. (16) The IAIS's task force -- known as Task ForceRe -- submitted its report to the FSF in March 2004. (17) It described how data on the international reinsurance market will be gathered and published, notedthat the IAIS has drafted a standard on what non-life reinsurers should disclose about their technical performance,and said that IAIS would be preparing globalreinsurance market reports. (18) Data on U.S.reinsurers will be compiled by the NAIC and will likely be available to the Treasury, the Federal Reserve Board,and the SEC. (19) The FSF, in receiving the report,urged that "more work be done in this complex area." (20) In October 2003, the IAIS adopted a new standard on supervising reinsurers. (21) The standard addresses reinsurers' risk management, relations with its cedinginsurers, investments and liquidity, economic capital requirements, and corporate governance. It also imposes onthe home supervisor of an internationallyactive reinsurer the obligation to share information about that reinsurer with other ("host") supervisors. It expresslycontemplates "a global supervisoryframework" based on "a system of accreditation of home supervisors"and this standard. (22) Though IAIS has begun a survey of its members' supervision ofreinsurers, it has not fixed a timetable for creating a global regulatory regime for reinsurers. (23) Some developed nations have unified their own supervisory regimes for financial services. Comprehensiveregulatory reform of financial services began inAustralia in 1996. Since then the U.K., Germany, and Japan have also unified their national supervisory regimesfor all financial services sectors. Each countryhas taken a slightly different approach. Australia formed one agency to craft and administer consistent andcomparable disclosure requirements for a broadrange of products, including deposit accounts, securities, insurance products, and pensions. It formed anotheragency to perform prudential supervision forbank and non-bank financial intermediaries. Germany unified financial supervision of banks, securities, andinsurance into one regulatory agency to achieveconsistent supervision of different sectors and of cross-sectoral issues. Japan's new Financial Services Agency,which reports directly to the Prime Minister'soffice, supervises banks, private insurers, securities, and securities markets. (24) Perhaps of greatest interest -- because it is most accessible -- is the U.K.'s undertaking to unify its supervision of financial services. The unification processbegan in 1997, and the new Financial Services Authority (FSA) acquired its full powers in 2001. It now regulatesbanking, insurance, pensions, and securities,though the process of integrating those functions continues. (25) The FSA's enabling legislation gave it four objectives -- maintaining market confidence,promoting public awareness, protecting consumers, and reducing financial crime. In pursuing those objectives, theFSA is directed to: Use its resources in the most efficient and effective manner; Recognize that a firm's senior management bears ultimate responsibility for its risk management andinternalcontrols; Make sure that burdens imposed on firms and markets are in proportion to the expected benefits forconsumers and theindustry; Facilitate innovation in the financial services markets; Acknowledge the "international character of financial services and markets and the desirability ofmaintaining the competitive position ofthe United Kingdom;" (26) Minimize regulation's adverse effects on competition; and Promote competition among regulated entities. (27) According to the FSA, the "insurance sector is a key part of the UK financial services industry. It is important, both from an economic and social perspective,that the UK has an insurance market that operates effectively [and] remains competitive in European and worldmarkets...." (28) According to the FSA, itscreation "as a single regulator highlighted differences between the regulation of insurance and other sectors inrespect of similar types of risks." (29) Accordingly,it has undertaken a major overhaul of insurance regulation to strengthen it and "to establish a common, risk-basedapproach to regulation across all financialsectors." (30) In revising its insurance regulation, the FSA has cooperated closely with and contributed to both the formulation of EU directives on insurance and reinsuranceas well as IAIS standards. The EU's Financial Services Action Plan (FSAP), due to be completed next year, containsdirectives that will directly affect therelative competitive positions of U.S. and U.K. insurers including Lloyds. (31) In addition, the European Commission (EC) has proposed a directive onreinsurance that would allow a reinsurer domiciled and licensed in an EU country, under the new standards, to dobusiness throughout the EU without furtherregulation or collateral. The directive is intended to, among other things, improve access to foreign markets --particularly the United States. (32) Unified supervision of financial services may not be successful. Certainly neither Australia's nor the U.K.'s financial supervisory authority has been free fromfailures. The efforts are noteworthy, however, for two reasons. One is that their changes may, like the proposedEU directive on reinsurance, directly affect thecompetitive positions of U.S. insurers and reinsurers. The other is their express emphasis on maintaining thecompetitiveness of their domestic insurers in aworldwide market. (33) Representative Oxley, Chairman of the House Financial Service Committee, has outlined a road-map toinsurance regulatory reform. He and RepresentativeBaker, Chairman of the Subcommittee on Capital Markets, Insurance and Government-Sponsored Entities, haveproposed achieving uniformity in some aspectsof state-based insurance regulation by imposing federal standards but not federal regulation. (34) Chairman Oxley, in expressing his support forsuch reforms,said that "(i)nsurers are facing increasing competition from other financial services sectors which have significantlylower regulatory costs.... If insurers cannotraise new capital, this marketplace is at risk for a major collapse. Without change, consumers face a world withfewer options, less competition, and lesscoverage." (35) At the Subcommittee's hearing onMarch 31, 2004, Representative Kanjorski expressed support for those goals and initial doubt about whetherthe proposal as outlined could achieve them. Senator Hollings, Ranking Member of the Senate Committee onCommerce, Science, and Transportation hasintroduced S. 1373 , the Insurance Consumer Protection Act, to mandate federal regulation of insurance. As Congress continues its efforts to modernize insurance regulation, entities in other countries are taking steps that will affect the competitive positions of U.S.insurers. The NAIC is working closely with Congress to assist in its efforts. It is also working closely withinternational entities, particularly the IAIS, todevelop new international standards for insurance regulation. It remains to be seen whether or how all these effortswill coordinate for the benefit of the UnitedStates as a whole. 1. (back) CRS Report RL30514 , GlobalCapital Market Integration: Implications for U.S. Economic Performance , by [author name scrubbed]. 2. (back) Ibid.; CRS Report RL32354 , European Union -- United States: Financial Services Action Plan's Regulatory Reform Issues , by WalterW. Eubanks. 3. (back) Further information and background on the Board and its activities are available at http://www.iasb.org/ , visited April 20, 2004. 4. (back) For a brief discussion of the overall projectand the new guidance, see http://www.iasb.org/news/index.asp?showPageContent=no&xml=10_116_25_31032004_31032005.htm ,visited April 20, 2004. 5. (back) Andrew Parker and Charles Pretzlik, "TakeIt or Leave It," Financial Times , March 30, 2004. 6. (back) The comments letters on Phase I of theproject may be reviewed at http://www.iasb.org/current/comment_letters.asp?showPageContent=no&xml=16_46_79_10122003.htm ,visited April 23, 2004. 7. (back) Sam Gutterman, "International FinancialReporting Standards and Insurance," Society of Actuaries: Reinsurance News, no. 53, March 2004, pp.12-18. 8. (back) Financial Accounting Standards Board,"Convergence with the International Accounting Standards Board," available at http://www.fasb.org/intl/convergence_iasb.shtml , visited April 23, 2004. 9. (back) National Association of InsuranceCommissioners, "The NAIC Team Approach to IASWG Technical Support," International AccountingUpdate , vol. 3,April 9, 2004, available at http://www.naic.org/frs/international_insurance_accounting/newsletters/newsletter.pdf ,visited April 23, 2004. 10. (back) Gutterman, ReinsuranceNews , pp. 17-18; David Pilla, "Global Accounting Accord Eludes Insurers," BestWire , March31, 2004. 11. (back) "Poor Cover for a Rainy Day," The Economist , March 8, 2003, p. 65 (acknowledging, however, that American insurers are in bettercondition than Europeaninsurers). 12. (back) Udaibir S. Das, Nigel Davies, andRichard Podpiera, "Insurance and Issues in Financial Soundness," International Monetary Fund Working PaperNo.WP/03/138, p. 16, available at http://www.imf.org/external/pubs/ft/wp/2003/wp03138.pdf , visited April23, 2004. 13. (back) Swiss Re, "World Insurance in 2001:Turbulent Financial Markets and High Claims Burden Impact Premium Growth," Sigma No. 6/2002 ,Oct. 31, 2002,available at http://www.swissre.com/INTERNET/pwsfilpr.nsf/vwFilebyIDKEYLu/SHOR-5GFJ8G/$FILE/sigma6_2002_e.pdf ,visited April 23, 2004. 14. (back) International Association of InsuranceSupervisors, "Enhancing Transparency and Disclosure in the Reinsurance Sector: Report Presented to the FinancialStability Forum," March 2004, available at http://www.iaisweb.org/143taskforcerereport5april2004.pdf , visitedApril 23, 2004 [hereafter " Task Force ReReport "], p. 7. 15. (back) The FSF, an initiative of the G7Finance Ministers and Central Bank Governors, convened first in 1999, and is charged with strengthening theinternationalfinancial system; see http://www.fsforum.org/about/what_we_do.html , visited April 23, 2004. 16. (back) Eighth Meeting of the FSF (Sept. 3-4,2002), Press Releases 2002, available at http://www.fsforum.org/press/press_releases_44.html , visitedApril 23,2004. 17. (back) Task Force Re Report ,supra note 15. 18. (back) Ibid. See Appendices 3 through 5 (pp.37-50), 9 (pp. 65-68), and 11 (pp. 71-72). 19. (back) Ibid., Appendix 3, pp. 40-41. NAICwill prepare the data with its special insurance accounting. 20. (back) Eleventh Meeting of the FSF (March29-30, 2004), Press Releases 2004, available at http://www.fsforum.org/press/press_releases_64.html ,visited April23, 2004. 21. (back) International Association of InsuranceSupervisors, Supervisory Standard No. 8, Standard on Supervision of Reinsurers, available at http://www.iaisweb.org/184reinsurers03.pdf , visited April 23, 2004. 22. (back) Ibid., p. 3. 23. (back) Edward Ion, "An Idea Whose TimeHas Come?" Insurance Day , Oct. 14, 2003. 24. (back) Heidi Mandanis Schooner and MichaelTaylor, "United Kingdom and United States Responses to the Regulatory Challenges of Modern Financial Markets," Texas International Law Review, vol. 38, spring 2003 [hereafter " Regulatory Challenges ],pp. 317-345. 25. (back) Financial Services Authority, Summary Annual Report 2002/03 , pp. 33-37, available at http://www.fsa.gov.uk/pubs/annual/ar02_03/ar02_03summary.pdf ,visited April 25, 2004. 26. (back) Financial Services and Markets Act,2000, c. 8 (Eng.), Part 1, sec. 1, available at http://www.fsa.gov.uk/fsma/data/fsma/act/act_part_i.htm#2 , visitedApril25, 2004. 27. (back) Ibid.; Financial Services Authority, A New Regulator for the New Millennium , Jan. 2000, available at http://www.fsa.gov.uk/pubs/policy/p29.pdf , visitedApril 25, 2004. 28. (back) Financial Services Authority, TheFuture Regulation of Insurance , Oct. 2002, p. 7, available at http://www.fsa.gov.uk/pubs/policy/bnr_progress3.pdf ,visited April 25, 2004. 29. (back) Ibid., p. 3. 30. (back) Financial Services Authority, Annual Report 2002/03 , p. 85, available at http://www.fsa.gov.uk/pubs/annual/ar02_03/ar02_03sec5.pdf , visited April 25,2004. Appendix 8, pp. 205-210, shows absolute costs of financial sector regulation in different countries. 31. (back) CRS Report RL32354 , EuropeanUnion -- United States: Financial Services Action Plan's Regulatory Reform Issues , by [author name scrubbed]. 32. (back) Commission of the EuropeanCommunities, Proposal for a Directive of the European Parliament and of the Council , SEC(2004)443,April 21, 2004,available at http://europa.eu.int/comm/internal_market/insurance/docs/reinsurance/directive/com-2004_273-final-en.pdf ,visited April 25, 2004. In the U.S.,reinsurers that are not licensed in a state must commit collateral in the U.S. at least equal to the gross amount of theirU.S. liabilities. Non-U.S. reinsurersobject to the requirement as a trade barrier, while many U.S. insurers favor the requirement. See Michael Loney,"The Collateral Battle," Reactions, Nov. 2003. 33. (back) Schooner and Taylor, RegulatoryChallenges , pp. 343-345. See also Kenneth K. Mwenda and Judith M. Mvula, "A Framework for UnifiedFinancialServices Supervision: Lessons from Germany and Other European Countries, Journal of International BankingRegulation, vol. 5, Sept. 2003, pp. 35-56. 34. (back) Chairman Michael G. Oxley, "RoadMap to State-based Insurance Regulatory Reform," speech to the National Association of Insurance Commissioners,March 14, 2004 (released March 15, 2004), available at http://financialservices.house.gov/news.asp , visited April25, 2004. 35. (back) Ibid.

Summary: Events and entities outside the United States are affecting or may affect the competitiveposition of U.S. insurers, intwo ways. First, supranational organizations are developing international standards for insurance accounting andfor aspects of supervision, such as reinsurancesupervision. Second, U.S. insurers are operating under a much more fragmented regulatory regime than theircompetitors in other countries, such as the U.K.,that are consolidating and modernizing their supervision. International standards and regulatory competition areimportant parameters on the U.S. industry'saccess to capital and therefore on its ability to provide innovative and traditional risk financing in the United States. This report was written under the researchsupervision of Barbara Miles, Government and Finance Division, and will be updated as events warrant.