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Global Scale by Coletta Kemper The British Invasion

If New York’s Dinallo follows the Brit example, insurance regulation will never be the same.

By  Coletta Kemper

Brace yourself for another British invasion. No, it’s not Spice Girl Posh and hubby David Beckham, but a theory of regulating—so-called principles-based regulation. The approach, introduced by UK’s Financial Services Authority (FSA) in its market in 2001, has crossed the pond and landed on the desk of New York’s new insurance superintendent, Eric Dinallo.

This summer, Dinallo unveiled a draft regulation for insurance titled “Principles Applicable to Insurers and Other Entities Subject to the Insurance Law.” The draft represents a first stab at raising the idea for discussion in the colonies.

Briefly, principles-based regulation means setting high-level principles and letting businesses decide how best to meet those goals—within reason, that is. The approach shifts away from prescriptive rules imposed by the regulator and places more responsibility on the business to act appropriately as a corporate citizen. The goal is to make both regulation and the market more efficient.

This is not a new idea as anyone who took a college economics course knows. In his book The Wealth of Nations, Adam Smith argued that markets are most efficient if left to their own designs. The less government intervention into private economic decisions, the more efficient the market will be in delivering the goods and services people want and need at a competitive price.

Classic economics argues that government should only get involved if the market fails. Market efficiency also depends heavily on transparency, which is why the FSA emphasizes the importance of “treating customers fairly” and providing the information they need to make informed decisions.

The cost of unnecessary and inefficient regulation to the economy is significant. By some estimates, complying with federal and state government regulations costs as much as $1.4 trillion. Americans for Tax Reform reports that the average American has to work 192 days in 2007 to pay the cost of federal, state and local taxes and regulations. The cost of government consumes 52.6% of national income. Small businesses pay 45% more per employee than large companies to comply with federal regulation.

The FSA acknowledges that it won’t get away entirely from detailed rules, but it sees real benefits for business, markets and consumers as well as for regulators.

The FSA says it will carefully consider whether there is a market failure that needs to be addressed by regulation. If it does, it will assess the potential costs and benefits of regulatory intervention and whether there is a better way to accomplish the same goal.

Earlier this year, N.Y. Gov. Eliot Spitzer named Dinallo to head a commission to consider how to modernize the state’s financial services regulatory system and possibly bring insurance, banking and securities under the same roof. Principles-based regulation may be a part of that plan.

In an interview with the Leader’s Edge early this year, Dinallo said when it comes to regulation, “I think it’s fair game to ask, ‘What’s the wrong the rule sought to prevent?’” If it is outdated or ineffective, then it should be changed or eliminated.

Dinallo’s 10 proposed principles for insurance mirror the FSA’s. A licensee shall:

  1. Conduct its business with integrity, due skill and diligence
  2. Take reasonable care to organize and control its affairs responsibility and effectively, with adequate risk management systems
  3. Maintain adequate financial resources
  4. Observe proper standards of market conduct
  5. Pay due regard to the interests of its clients and treat them fairly
  6. Pay due regard to the information needs of its clients and communicate information to them in a way that is clear, fair and not misleading
  7. Manage conflicts of interest fairly, both between the licensee and its clients and between clients
  8. Take reasonable care to ensure the appropriateness or suitability of its advice and discretionary decisions for any person or other entity that is entitled to rely upon such
  9. Ensure that the assets of any client for which the licensee is responsible are adequately protected
  10. Interact with the superintendent and other regulators in an open and cooperative way, and disclose to the superintendent any information relating to the licensee of which the superintendent would reasonably expect notice.

For an industry that doesn’t like uncertainty, these inspirational principles are likely to put the fear of Spitzer in them…and put their lawyers on high alert. After all, the insurance sector experienced Spitzer’s “interpretation” of laws and regulations firsthand.

These non-specific principles are open to wide interpretation without guidance from the regulator.
The FSA model envisions a strong partnership and ongoing consultation with the regulated industry. Regulators have to underpin the principles with rules and guidance on what constitutes compliance. And the industry has to be a partner in those discussions if the approach is to succeed.

I applaud Dinallo for this experiment. The Council has long advocated eliminating unnecessary, burdensome and costly regulations that add no value to consumers or oversight. If successful, the initiative could encourage more innovation and efficiency for our industry.

But ironically, the devil is in the details.

Kemper is The Council’s vice president of Industry Affairs.

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