Regulatium Arcadium
The Economist thinks ‘America should ditch its outdated system of insurance regulation’:
Although the sophistication of insurers’ underwriting and risk management has advanced by leaps and bounds in recent times, the regulation of the American market—by far the world’s largest, with more than $1.1 trillion of direct premiums in 2005—has stayed rooted in a 19th-century system of state-based oversight. Because all 50 states and the District of Columbia have their own regulators, insurers, whether domestic or foreign, that want to operate nationally must traipse from Albany to Sacramento seeking permission.
This absurdly complicated system is inevitably supported by local insurers (as most of America’s 4,500 or so underwriters are): they gain from chummy relationships with the regulators. Some consumer groups like state-based regulation because it helps hold down insurance rates in some places, notably where insurance commissioners are elected. In places facing above-average risks from natural disasters, like Florida, commissioners work closely with state legislatures to combat spiralling premiums and capacity shortages, sometimes through state-supported insurance funds. And, given the state-by-state variation in rules on everything from workers’ compensation to corporate liability, state officials are held to be well placed to understand the nuances of local business.
Surely a more efficient market in insurance risks would also help ‘sell’ (from a political point of view) appropriately risk-adjusted prices to the general public. The transparency implicit in traded markets often lends the resultant prices greater legitimacy. (Although this is not always the case, as populist responses to higher energy prices has recently shown…)
In any event, this is yet another example of anachronistic and entrenched regulatory and legal environments deleteriously holding back the benefits afforded by a modern approach to finance. A clear example of why AmazonBay is far from a (metaphorical) foregone conclusion:
My point is that while there have been very important and very real improvements in productivity in financial services due to this investment in ICT, the underlying business models have changed very little – if at all – and there has been no ‘disruptive’ newcomers to the party. This is not completely surprising as the barriers to entry in financial services are very high: highly regulated, powerful (financially and politically) incumbents, extremely high customer inertia and a natural embedded conservatism given that we are dealing with people’s money. So if I am an eBay or an Amazon or Google or the next great WebCo, it is natural that I aim my innovation at softer targets like media or retailing (or even sports betting!) first. Main Street before Wall Street.
Now don’t get me wrong. The fact that financial services are robustly regulated is and has been much to their advantage – for consumers and providers alike – but given the rapid and especially the accelerating pace of change and innovation in products and delivery channels, one has to think that an analogous rethinking of the regulatory infrastructure is needed if we are not to suffer from an ever increasing gulf between the needs of the industry and the means available to regulators. I mean imagine if air traffic control used roadsigns suspended in mid-air…wouldn’t inspire alot of confidence (although the roadsign makers might be quite pleased.)
I don’t pretend to know how a modern financial regulatory body should be built, but it would seem to me that in should lean heavily on principles (as opposed to specific rules that are often obsolete by the time they are agreed and almost always subject to the law of unintended consequences.) But I do wonder where the political capital would / could come from to drive this kind of change. Who is the natural constituency who will ‘vote for Christmas’ against all the turkeys voting against?
On another note, I was impressed / interested by the statistics regarding the percentage of insurance premiums paid as a percentage of GDP in the industrialized economies (via The Economist):
It would seem that in aggregate and on average, we pay 10% of our income away to mitigate the impact of bad things happenning. Made me think of tithes… Coincidence?
