Friday, 14 November 2008

The regulation of insurance in the U.S.

The Aleph Blog has a remarkably wrong-headed piece on insurance regulation here, suggesting that federal insurance regulation is a bad thing and that the FED should have let the AIG parent fail.

Some comments. First, the US is the only major economy that does not have a national regulatory framework for insurance. Instead it is regulated at the state level. Some of the states do it well, some less well. Many of them are different. How can it possibly make sense to have over 30 regulatory frameworks for the same product in one country?

Secondly US insurance regulation is a long way behind the curve even in the best states. While the EU is on solvency two, with fairly sophisticated capital modelling, the US framework does not require enough capital for credit risk, which is why the monolines and AIG got into so much trouble in the first place. Their leverage was not effectively constrained by their capital requirements (and in some cases their accounting framework encouraged them to take risks more cheaply than banks would). The U.S. needs to address the arbitrage whereby it is significantly cheaper for some insurance companies to take credit risk than for banks.

Thirdly, letting AIG fail was not a realistic option however much moral hazard its bailout presented. I continue to dislike the bailout. However depriving the banks of hundreds of billions of dollars of protection is simply not sensible at the moment: you would only have to spend the money recapitalising them.

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