European insurance companies are busy preparing the implementation of the European Solvency 2 Directive. This law increases the degree of governmental control of the already strongly regulated industry.
State interference at present
Britain has one of the least regulated insurance markets in Europe but, despite this and even before Solvency 2, the state is heavily involved in running insurance businesses. Firstly of all, to set up an insurance company, an authorisation from the Financial Services Authority (FSA) is needed. From this moment on, the insurer must use government-approved accounting, reporting and actuarial standards. This means that basic tools of processing financial information are imposed by the political process.
The FSA also decides who can do the most important jobs in an insurance company. It is not the owner or the shareholders who have the final say on who will be the sales, risk or finance director, but a government agency approves individuals to perform such functions.
On top of that, all important meetings in an insurance organisation must be minuted and the FSA can review the minutes, check who said what and question them about it. This stifles internal discussions and challenge process because people are less willing to say what they really think when an FSA auditor can later be questioning them about this.
The regulator also approves every insurer’s principles of customer service. Under the “Treating Customers Fairly” regulation, insurance companies cannot freely change their claims handling processes, call centre procedures or complaints handling. Significant changes to those may require FSA approval.
Pricing of insurance services is at least partly regulated too. The recent decision of the Office of Fair Trading limits the use of some market information for pricing and underwriting. Similarly, the European Court of Justice prohibits (PDF) the use of an important risk factor – gender – in pricing. The Transport Committee Enquiry may well result in additional government interventions.
The FSA also decides how insurance should be distributed. The FSA’s Retail Distribution Review will be a massive change to the way life insurance is distributed in the UK.
As if this was not already too much, in the near future, the FSA wants to regulate the terms and conditions of insurance contracts and be directly involved in product design and development.
State interference under Solvency 2
Solvency 2 comes into force in 2013, but it is already affecting insurance companies today. It introduces new requirements for management data collection and reporting. Even today, although the implementation of Solvency 2 is still in progress, large insurance companies send every day half a dozen e-mails to the FSA with data and information on the strategy, risks, governance and financial results.
Solvency 2 introduces new ”controlled functions” in insurance businesses. Those include (PDF): the actuary, chief risk officer, and a new audit function. As a result the government is increasing its control over the senior management and governance of insurers.
Under Solvency 2 the FSA approves individual insurers’ internal risk management models. These models must then be used in all strategic decisions such as mergers, spin-offs, entering a new market, distribution strategies or investment and reinsurance programs. By deciding which internal models to approve and which to reject, the FSA gains additional influence over all strategic decisions of insurance enterprises.
Private ownership, mixed control
Watching the European insurance regulatory expansion feels like reading Schumpeter’s “Capitalism, Socialism and Democracy” again. The ownership of insurance enterprises remains in private hands but their decision making processes and operations are to a significant extent controlled by the state. With Solvency 2, Europe and the UK take another step towards statism.