Regulation: government intervention and harmonization

1
Regulation government intervention and
harmonization

• How do governments intervene?
• Why do governments intervene?
• Why do we need harmonization?

2
Harmonization

• Why is it important?
• Liberalization, harmonization and deregulation
• Arguments for
• Arguments against
• Recent experiences of harmonization

3
Why harmonize?

• Cross border trade has grown much faster than the
  growth of GDP (and trade growth causes GDP
  growth)
• Cross border borrowing and lending has grown even
  faster
• Thus, regulatory harmonization has become a
  necessity
• Unilateral changes causes turmoil

4
Underlying causes

• Economic convergence taking place across borders
• Convergence is taking place at times with the
  blessings of the respective governments but at
  other times against government wishes
• Governments are actively pursuing policies of
  harmonization
• This has been more out of necessity than out of
  foresight

5
Implication

• Capital mobility implies that much of borrowing
  and lending can be accomplished without any
  regard to national boundaries-borrowing in
  California can be financed in Hong Kong
• Technology has made communication cheaper across
  the world which has enhanced the process of
  internationalization

6
Lowering fences

• GATT rounds have done much to lower fences on
  cross border movement of goods and capital
  (however, it has not done so for cross border
  movement of labor)
• Some countries have unilaterally reduced tariffs,
  followed prudent macroeconomic policies and had
  success in stimulating economic growth and
  reducing inflation

7
Political trends

• More and more independent nations are joining
  world organizations such as the UN and the IMF
  (for example, China)
• US economic and political power has been
  diminishing since the end of World War II
• Centrally planned economies are falling apart and
  they have all adopted capitalist systems

8
International versus domestic

• If fences are high, we can distinguish between
  domestic and foreign policies
• Domestic competition, product standard, workers
  safety, regulation and supervision of financial
  institutions, environment etc.
• Foreign tariffs and quotas and other cross
  border issues
• With integration new issues behind border

9
Examples

• Talks between Mexico and US next month include
  the following
• Drug issues in the US
• Illegal immigration to US
• Democracy in Mexico
• Pollution in Mexico
• Behind the border policies are discussed between
  countries!

10
Why?

• There are externalities
• Externality When the action of one party affects
  another outside markets
• Example Severe recession in Mexico due to a
  macroeconomic downturn may increase illegal
  immigration to the US
• Example Default of international loans in Mexico
  may trigger bank failure in US

11
Environmental issues

• Should developing countries be forced to adopt
  environmental standards of developed countries?
• Problem Now developed countries while developing
  had bad environmental record
• Problem Difficult to force any country to adopt
  a particular environmental standard
• Problem Cheap production possible with pollution
  and competitive issues

12
Diminishing national autonomy

• Setting domestic monetary and fiscal policies
  have international impact
• Example German reunification had costs
  throughout Europe
• Bad economic policies lead to movement of capital
  out of country
• Example Best known Swedish/Japanese companies
  produce more outside!

13
New issues

• Good externality research and development
• Bad externality pollution
• Both kinds of externalities flow across national
  boundaries
• Without coordination between countries, there
  will be too few good externalities and too many
  bad externalities

14
Conflicting values

• Human rights issues in China or Peru affects
  their discussions with US
• US talks with Japan about the use of timber
  products imported into Japan from Indonesia or
  Brazil
• Environmentalist proposals to ban tuna import
  from countries that use driftnets

15
Liberalization

• Types of liberalization
• Most favored nation (MFN) means trade concessions
  extended to one country are extended to all
  trading partners
• Reciprocity Give and take between countries

16
Harmonization

• Making laws identical
• de jure mirror image laws
• de facto laws are similar in substance
• complete harmonization
• minimum harmonization

17
Deregulation and liberalization

• Deregulation reduction in national regulation
• Liberalization market opening
• Typically they go together
• It is possible to have domestic deregulation
  without allowing for foreign entry

18
Why harmonize?

• Regulatory diversity magnifies market failure or
  impede liberalization
• Harmonization reduces transaction costs
• If financial services are insulated then
  diverging rules do not pose problems
• If financial services are global, then they they
  will suffer from domestic regulations

19
Arguments against harmonization

• Differing regulatory philosophies would bring in
  more innovation and competition
• Risk of getting it wrong
• There is more risk of fraud when national
  boundaries are removed
• Insurance is about security, therefore less
  regulation may not be attractive

20
Harmonization wrong level

• Government driven harmonization can create
  problems of harmonization at the wrong level
  example qwerty keyboard
• Create barriers example setting capital
  requirement too high/low
• Consumer protection
• Definitional issues all countries do not have
  identical accounting procedures

21
Harmonization in insurance versus harmonization
in banks

• Cross border harmonization rules are much more
  common in banks than in insurance companies.
  Why?
• Banks create money, therefore, banking crisis
  has a contagion effect
• Systematic risk is much higher in banks than in
  insurance companies

22
Recent experiences

• The only body that deals with some insurance
  harmonization issues is the International
  Association of Insurance Supervisors (IAIA)
• Formed in 1993 with 50 governments
• Most are developed countries

23
European Union

• Reinsurance Directive 1964
• First Non-life Directive 1973
• First Life Directive 1979
• EC White Paper 1985 minimum harmonization
  principle
• prudential standards
• technical reserve calculations
• asset valuation
• sovlency

24
EU experience

• Third Directive (Life and Non-life) 1992
• intended for complete freedom and single market
  in insurance
• Objective Create a single integrated market for
  all financial services
• Has it succeeded?
• Emerging trends

25
OECD

• Code of Liberalization of Capital Movements
• Code of Liberalization of Current Invisible
  Operations
• Production by foreign companies is typically
  forbidden
• Distribution may or may not be allowed
• Subsidiary, foreign equity are favored

26
Government role regulation

• Why regulate?
• Quality
• Affordability
• Availability
• Reliability
• Development promoting domestic insurance industry

27
Types of regulation

• Liberal UK, Chile, Hong Kong
• Regulated Germany, Japan, Korea
• Mostly in between
• Evolution
• Socialized (no private)
• National (no foreign)
• Protected/transitional
• Liberal

28
Mechanism of regulation

• Licensing of insurer/reinsurer
• licensing of agents and brokers
• filing and approving insurance rates
• filling and approving materials and forms
• financial reporting requirements
• liquidity of insurers
• guaranty funds
• product and company taxation

29
Types of regulation

• EU through directives
• Japan through the Ministry of Finance
• Department of Banking Bureau
• Convoy principle (price competition prohibited)
• Insolvency prevented
• Volatility minimized
• Excessive competition is discouraged

30
Types of regulation

• US 1945 McCarran Ferguson Act
• Each state determines admittance, forms and
  reserve requirements
• regulatory rates
• Rules vary
• Nation-wide body National Association of
  Insurance Commissioners (NAIC) coordinates
  regulatory matters across states

31
India and China

• India
• Started in 1818 by Oriental Life
• Indian Life Assurance Company Act 1912 was the
  first statutory measure to regulate life
  insurance business in India
• Insurance Act 1938 was the first comprehensive
  Act to regulate insurance
• Amendment of 1950 imposed stricter control

32
India

• 1956 156 Indian insurers, 16 foreign and 75
  mutual societies were selling life insurance in
  India
• Life Insurance Corporation Act of 1956,
  nationalized all of them and formed a monopoly
• To date, it is still a monopoly

33
India

• Thus, it is not always the case that over time we
  have all countries are moving to deregulation
• Note also that non-life business was not
  nationalized at the same time
• In 1973, General Insurance Corporation (GIC) Act
  was passed and non-life business was also
  nationalized

34
China

• Before 1949, there were 205 insurance companies
  operating in China
• After the revolution, life insurance was banned
• In early 1980s, Peoples Insurance Company of
  China (PICC) was formed
• Rates were not actuarially set by PICC

35
China

• Banking system is non-existent in rural area
• Life insurance provides an avenue for saving
• PICC is forming global alliance through Hong Kong
• New competition but they need to reinsure at
  least 30 with PICC

36
China

• Only foreign company allowed to write domestic
  policies is AIG
• It started as a joint venture between PICC and
  AIG, China American Insurance Company, with the
  intention to write Chinas exposure outside of
  China itself in 1980.
• Then, in April 1991, PICC formed another joint
  venture with AIG.

37
AIG

• AIG received a license to operate a life and a
  non-life business in Shanghai
• It has a license to underwrite property and
  casualty risks in the Shanghai area.
• It could also offer life and savings products,
  effectively throughout China
• It currently writes comprehensive business
  insurance coverages ranging from Property to
  Marine, from Casualty to Financial Services for
  both Joint-Venture and foreign-funded comp

38
AIG

• The Life operations sells life,personal accident
  and employee benefits insurance to the population
  of Shanghai
• Operation has been profitable
• It could use old ties
• It had the first mover advantages
• Competition from PICC
• Repatriation is a problem