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Insurance regulation prepares for 1992.

Christopher Columbus convinced the Spanish throne to underwrite his daring adventure 200 years before patrons of Edward Lloyd's coffee-house even started thinking about marine coverage. Today, just shy of 500 years since those three small ships set sail from the lberian coast in 1492, Americans are looking east, over the vast Atlantic Ocean, to the unchartered terrain of an emerging united European Community. The prospects of many U.S. insurers successfully tackling this frontier are uncertain and opportunities are being met with caution. Some have even expressed skepticism at this latest variation of an oft-repeated experiment.

For insurance overseers and regulators, the creation of a unified European market by 1992 and the course of recent world events have opened once-forbidden markets in Eastern Europe, posing interesting new challenges. However, despite advances in computer and satellite communications technology, most insurers in the United States have chosen to stay home. Indeed, barely a handful of them have engaged in any credible efforts in the international market. After all, many insurers believe that dealing with 50 distinct jurisdictions and the challenges of the American market present sufficient business opportunities and concerns. At the same time, U.S. insurance companies have not played host to a teeming array of foreign explorers, unlike the banking, manufacturing and high technology sectors of the U.S. economy. Thus, among those who still believe the insurance world is flat, it is perceived that American corporate ships, attempting to sail without adequate navigational equipment, may drop off the edge never to be heard from again.

There are several reasons why U.S. insurers are not testing international waters. First, a large segment of the American insurance industry is geared exclusively to the domestic marketplace. The $6 billion in premiums generated by American firms in foreign countries represents only 3 percent of the total $250 billion in annual premiums earned by those companies. Thus, notwithstanding widespread interest in EC 1992, and the attention it has received in the trade press, expansion into the European market will probably be limited to only the largest insurers and brokerages. Furthermore, market share will most likely be limited to firms which have already established a presence in some community countries or which service clientele with extensive foreign holdings. Interestingly, some Continental observers of the European business scene note that Britain appears to be in a position similar to that of the United States regarding EC 1992. Many of its property/casualty insurers have until now focused on their own domestic markets and those within the Commonwealth.

The second reason U.S. insurers are hesitant to set up businesses overseas is because they recognize the fact that the enthusiasm that accompanies international opportunities is usually more vibrant than actual economic benefits from such adventures. In China, for example, Beijing and, to a lesser extent, Shanghai became hotbeds of American entrepreneurial activity. But the wave of economic integration and democratic reform, in a country that until then had been a 20th century anachronism, came only after its foundation had been established by President Nixon and developed by the American higher education establishment. Yet, that country's borders have been largely closed again and the rich prospects of economic expansion have soured in the face of governmental restrictions on economic ties to the West. This leads to the final reason why U.S. insurers are not rushing to open branch offices in Warsaw, Prague or Budapest. They know the opening of Eastern bloc nations to Western entrepreneurs can reinstate the closed society that has separated Europe for more than 40 years.

However, if progress in Eastern Europe is maintained, and markets truly open up, such events will influence, and possibly detract from, the continued development of an orderly EC 1992 program. The countries within the European market could become preoccupied with regulating their own companies which seek to capitalize on the business potential in the East. In addition, a focus on Western companies as a corporate priority could be supplanted by a rush to Eastern countries where there is currently little, if any, private insurance presence. Western Europe's future is also uncertain and as prone to political and social influences as its sister states in the East, or the provinces of China for that matter.

It remains to be seen if European executives can overcome these problems through the mutual goal of acquiring more financial power. However, without political consolidation as the United States has under federalism, Europeans will have to adopt the notion of individual countries being responsible for regulating companies incorporated within its boundaries-even for actions taken beyond its borders. Suffice to say, there is great uncertainty in America over whether a federalization of Europe can be achieved without widespread integration at the core of the country's political and social existence.

Insurers as Political Scientists

It is critical for the insurance industry to carefully gauge unfolding events in Europe. This may require insurers to act as political scientists, sociologists and cartographers. Their perspectives will have to widen to properly set priorities, formulate strategies and act as leaders on the cutting edge of emerging markets.

As with most insurers, state legislatures and insurance departments have until now focused almost exclusively on the domestic market. The attention given to regulating foreign insurers has been limited mostly to American insurers doing business in Canada. In terms of those insurers which enter the European market, legislators and regulators have focused only on insurers in their own states.

In addition, when advocating international market development in the United States, American regulators have been too conservative. This lack of initiative on the international stage is evident in our disappointing record in starting insurance exchange experiments. During the 1980s, for example, two companies experienced unsuccessful projects: New York Insurance Exchange, which aimed for the European market, and Miami's Insurance Exchange of the Americas, which targeted the Caribbean. In addition, only a handful of states have welcomed alternative mechanisms, such as captives, that have long been accepted in international insurance circles. This policy also applies to American companies that may be acquired by large European insurers and financial services companies.

Some would say that the globalization of insurance is inevitable, and that the American market must learn to respond and adapt more quickly to global trends. Others contend that the federal government, which addresses issues of international trade and foreign relations, should regulate insurance. I disagree with such a rejection of the traditional primacy of state regulation of insurance. To be sure, the federal government should play a significant role, but it should be in assuring that the international playing field remains neutral. For example, the government should protect American insurers against unfair trade barriers imposed by other nations through GATT proceedings on service-sector trade.

Maintain U.S. Regulation

The actions of the European market, and the trends that develop, should not drastically alter the way insurance is regulated in the United States. There is still significant justification for retaining insurance regulation by the states. To replace this system in favor of a model reflecting the trends of Western Europe or the global market would ignore the fact that the U.S. market is still largely contained within its borders. Remember that states are often able to compete in international markets. In fact, insurance regulation in many states already reflects this reality, at least to some degree. Use of the terms 'foreign insurer' and 'alien insurer' in state insurance laws, for example, connotes the soverign character of states in relation to one another and the federal government. Also, remember that the ultimate concern of all insurance regulation is maintaining the ability of insurers to pay claims within the states in which they operate.

Whether companies remain largely affiliated with the United States or if they expand into other markets, it is still the responsibility of state regulators to assure solvency. Solvency assurance is already a prime component of many regulators' operations, and protecting local constituencies has been a priority whether the company under review is a global insurer or a local farm mutual. A difficult task is to assure the solvency of European parent companies that decide to merge or acquire other companies. In many states, statutes and regulations already segregate foreign insurers in terms of reporting requirements and minimum adherence standards.

The solvency of insurers who choose to do business in the United States, as well as the provision of adequate service and fair treatment in claims processing, do not constitute impermissible barriers to trade in this country. Some suggest that 50 distinct jurisdictions encourage a prevailing mood of protectionism. Although certain protections stem from strict state regulation, they are not arbitrary or unreasonable trade restrictions that unfairly dampen an insurer's entry into the domestic market. Such restrictions already exist for companies operating between states. Quite frankly, it is up to those companies to choose whether to domicile and obtain licensure within a particular state or operate under a distinctly different set of rules within that state as part of the surplus, non-admitted marketplace. The state and federal governments, along with the National Association of Insurance Commissioners, the International Insurance Council and other organizations, should establish a domestic working alliance that addresses trade barriers issues with European and Asian nations, tax treatment of alien insurers and domestic activities of alien insurers which may frustrate solvency.

A Cautious Approach

Insurance industry trade groups, lately embroiled in legal skirmishes from Proposition 103 to the attorneys' general antitrust suits, must closely watch events in the international markets and be ready to assist their member companies and the regulatory community in determining what serves the best interest of individual clients and the entire American insurance industry. This cautious tone is not intended to ignore international insurance trends that could be harbingers of opportunity. However, American business and government should be alerted to the fact that European companies engage in more mergers and acquisitions-not leveraged buyouts-than U.S. companies, and resort to natural consolidation as a method of capital development and solvency assurance. For example, it is customary in the United States to allow weak companies to become impaired or insolvent. However, European firms in similar condition usually find themselves the subject of merger negotiations. In fact, although the overall number of mergers and acquisitions in the United States has been increasing, only 40 property/casualty companies went through that process between 1987 and 1989, and less than half of those transactions involved insurers on both sides.

The pace of mergers and acquisitions in Europe (45 transactions in the past three years) is quickening as the July 1 implementation of the Second Non-Life Directive, which allows cross-border coverage on large risks, approaches. The stepped-up pace indicates that the market will experience a significant shakeout of players in the early running of EC 1992, with the remaining players being large and probably diversified entities exerting firm control over key insurance cities. This could make it difficult, and perhaps unwise, for American insurers not previously involved in international trade to try their hand at it over the next several years.

Indeed, it may be best to play the spectator as European companies consolidate and compete. European experts expect significant price crunching to occur in the first years of EC 1992, which could lead to the same results which affected the American market in the 1980s, namely, record insolvencies, dropping capacity and the foreboding sense that small players may have become ambulatory if things had gone much further. In the 1970s, astute observers cautioned that 'innocent capacity' was entering the reinsurance market without any appreciation for the perils which surfaced a decade later. In the 1990s, there will be some inadequately priced risks which will be rejected by large, established insurers and which, in turn, will seem attractive to anxious players seeking a foothold in an unknown land.

These large European insurers could become the merger-minded companies landing on our shores to invest in American companies. Recent indications show an active interest from Europe's largest carriers, as well as those from Japan and Australia, to integrate into the American market. This integration would come primarily through existing outlets already acclimated to state regulatory environments, the American tort system and an activist public ready to vote its heart, but not necessarily its mind, on insurance issues. In fact, until now, more than 25 percent of the mergers involving insurers in the United States were transactions with foreign companies on the buying end.

The much-debated integration of insurance with financial services is another popular concept in Western Europe. Since the onset of EC 1992, banks and insurers have been on shopping sprees for each other, which will result in a number of large financial services conglomerates. This trend is contrary to policies and practices in the United States, where efforts have been made to retain the separateness of insurance and banking. Indeed, it could be the European influence which finally breaks the congressional logjam which has kept the Bank Powers, Glass-Steagall and McCarranFerguson acts in place. In fact, American commercial bankers' aggressive style could capitalize here at home on such European trends.

American insurance regulators may not see all their constituents head for foreign shores or a dramatic influx of alien insurers seeking entry into the non-admitted market, but they must understand that the global insurance arena will get smaller as insurance giants are created by the anticipated shakeouts. Thus, it is inevitable that new pressures will mount to allow further integration of services, a wider variety of risk to be covered and a general nationalization of the scope of insurance practice and regulation. The world is smaller than it was in the days of Columbus, and as the global marketplace adjusts over the next several years, so too will the insurance industry. But these changes cannot come at the expense of effective solvency regulation and the policyholder, who will still look to the insurance industry for the same service and security that has been its hallmark.
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Title Annotation:European Community
Author:Dunne, John R.
Publication:Risk Management
Date:Apr 1, 1990
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