Will Innovation Withstand Regulators’ Microscope

Regulatory investigations into “non-traditional” insurance products may discourage insurers from offering innovative insurance products, senior brokers told a PLUS Canada luncheon audience in Toronto last month. The “strain on resources” required to maintain disclosure and transparency could displace efforts necessary for product and service innovation, some fear. Nonetheless, when it comes to implementing proper risk management practices, insurance companies are ethically – if not legally – obligated to “figure it out.”

Innovative insurance products and services such as finite reinsurance may become the first casualty of North American regulators’ ongoing investigations into contingent commissions and “non-traditional insurance products,” a panel of speakers told a PLUS Canada Chapter luncheon in Toronto this October.

In a discussion entitled ‘Under the Microscope, Eh?’ four panelists presented their views on how the U.S. and Canadian regulators’ recent activities could ultimately shape the North American insurance industry.

“I think there’s an issue at stake here in terms of how will this affect initiatives of innovation in our business,” John Chippindale, the managing director of Integro (Canada) Ltd., told his audience. “If we can now look at things with the lenses of today and go back five-plus years and call certain things ‘illegal,’ and have criminal and civil charges, one might argue people may not be as courageous in the future relative to innovation. Does that mean the industry is in a stage of ‘back to basics?'”

New York state attorney general Eliot Spitzer indicted eight now-former executives from Marsh & McLennan Cos. in September 2005 on allegations of fraud and engaging in anti-competitive practices. The investigations that led to the indictments – which followed a 2004 legal settlement of a civil suit against Marsh – were part of a much broader probe by other US states and the Securities Exchange Commission (SEC) into contingent commissions and “nontraditional insurance products” such as finite insurance.

A finite insurance contract is one in which an insurance company pays money to a reinsurer as a premium to finance a specific, limited short-term risk. If the risk does not materialize, the reinsurer pays back the insured’s money after a defined, short-term period – usually between three to five years – as stated in a written contract.

A September 2005 report by Guy Carpenter summarizes the controversy currently surrounding finite insurance. “The regulators’ primary concern is that insurers are using finite reinsurance as a method of concealing their true financial results from regulators or other stakeholders,” the report notes. Debate often turns on whether, as the report notes, “the risk transferred [to the reinsurer] is sufficient and of the right character to allow the contract to be accounted for as reinsurance or whether the contract should be more accurately accounted for as a financing instrument.”

Regulators can cite Brightpoint as a prime example of their concern. In September 2003, the SEC settled civil fraud charges against mobile phone distributor Brightpoint and the American International Group (AIG). In a release announcing the settlement, the SEC reported that AIG issued a “purported insurance policy to Brightpoint for the purpose of assisting Brightpoint to conceal $11.9 million in losses that Brightpoint sustained in 1998.” As part of the settlement, AIG agreed to pay a $10-million civil penalty and Brightpoint agreed to pay a $450,000 civil penalty.

PLUS panelist Susan Meltzer, Sun Life Financial’s assistant vice president of risk management, said Spitzer’s investigations have changed the regulatory environment for the insurance industry. “He took it from a rules-based environment to a principles-based environment,” she noted.

As a result, because brokerage firms and insurance companiesare publicly-traded firms that hold a position of trust and fiduciary responsibility, they have incurred an obligation to incorporate sound business practices and demonstrate greater transparency about those internal processes, she said. To those businesses that haven’t yet implemented appropriate, transparent risk management practices, she said simply: “Figure it out.”

Meltzer acknowledged that the “strain on resources” required to alleviate regulators’ concerns may make it difficult for some companies to spend much time designing new products or services. “I, too, am worried about innovation,” she said. “I am worried about the strain on resources. I am worried about the stacks of submissions that are on your desks. And we are at a time when we do need innovation.”

Lynn Olsen, vice president of corporate marketing at AIG, agreed that all of the regulatory attention has come at a time when the post-9/11 marketplace is just transitioning out of a hard market. In turn, she is worried about the impact that will have on innovation.

“If you are an underwriter, I would suggest to you that in the last 12 months, your desk has changed and your desk has changed quite a bit,” she said. “Corporate governance, internal audits, additional processes, additional responsiveness to the transparency and disclosure that’s being required of us hits every single one of us on a day-to-day basis.”

However, while Olsen said the concerns of U.S. regulators are shaping global debate around finite insurance, “I have to believe that with all of the controversy surrounding finite risk right now, innovation and product development is not dead. I can tell you we are having lots of very robust discussions with clients who are very, very interested in continuing to dialogue on cutting-edge development…”

PLUS panelist Grant Swanson is the executive director of the licensing and market conduct division of the Financial Services Commission of Ontario (FSCO). He noted regulators in the Canadian context have preferred to ask questions first before acting. “People have asked us: ‘Why aren’t you recommending anything yet?'” Swanson said, answering a question from the audience. “I keep reminding them that right now we are fact-finding. We’re asking questions. We’re giving the industry an opportunity to find its own solutions.”

Swanson said during his presentation “laws are not necessarily the answer, but maybe part of the answer.” He noted FSCO was poised to publicize a report outlining the results of consultations with the public and the industry, although he would not say when. “Stay tuned,” he said.