Anthony Hilton: Relax the rules to give our insurers a chance

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The season of goodwill has been characterised this year by a distinct lack of goodwill between the insurance industry and those who regulate it.

Ever since the Treasury Select Committee decided to investigate how Brexit might affect the industry and how it is regulated, the insurers have closed ranks to complain. 

The regulatory problem has recently become more pressing because of developments in the US.

If President-elect Trump fulfils his promise to scale back the Dodd-Frank Act, the centrepiece of US post-crisis banking regulation, it will free up the investment banks to become active traders again on their own account.

Such a liberalisation in the US regime would give New York a huge competitive advantage over London as a location for investment banking and securities and hedge-fund business. 

It is easy to foresee liquidity being sucked out of London’s markets as if by a giant vacuum cleaner, and New York propelled to a position of unrivalled global dominance.

If London lets this happen, it is hard to see how it will ever get its position back. 

Over here, individual insurers such as Nigel Wilson at Legal & General, Mark Wilson at Aviva and Mike Wells at the Prudential have sought to highlight the perverse consequences of overzealous regulation.

Now they have been joined by the British Insurance Brokers’ Association, which has made an official request that the burden be lifted a bit, and the Association of British Insurers, which in evidence to the Treasury Select Committee accused the Prudential Regulation Authority of gold-plating the rules far more than is necessary for financial stability.

This is something which should concern us all. The insurance industry controls a massive amount of capital, and Government is hoping a significant slice of it will be channelled into investment in infrastructure renewal. The insurers are generally willing because the returns from equities and bonds are unlikely to be sufficient for their needs and they want to be more imaginative in their investment policies. 

L&G’s Wilson wants to build new towns, with massive amounts of housing for rent. As a sign of seriousness of purpose, his company has already funded a factory in Lancashire that makes prefrabricated parts of houses to help tackle building costs and the shortage of skilled labour. 

Meanwhile, in a recent article in the Financial Times, Aviva’s Wilson argued that the way regulation is imposed in this county makes infrastructure investment far more costly than it should be, meaning Britain is missing a great opportunity.

All Europe’s insurers are now regulated in accordance with Solvency II, a set of rules developed at the truly astronomical cost of about £3 billion. This specifies how much capital they need to allocate to different classes of investments to cover the perceived but different levels of risk. 

Unfortunately, Solvency II is one of those brilliant ideas in theory that has become a giant train smash in practice by insisting (as with pension schemes) that assets and liabilities with a life running for decades should be measured for risk on a 12-month basis.

Of course, having spent all that money, it becomes like the emperor’s new clothes, and no one will face up to the reality and scrap it. This is a pity because, among many other things, it puts Europe’s insurers at a major competitive disadvantage. Mark Wilson pointed out in his article that a Canadian insurance company wanting to make a $200 million investment to finance a wind farm would be required by its regulator to allocate $3 million of capital to cover the risk. 

Under Solvency II, a British insurer making an identical investment would have to put up more than $10 million — over three times as much. That is why when assets like City Airport or the high-speed rail link from London to  the Channel Tunnel come up for sale, the Canadians can always outbid the British.

Meanwhile, the British  are incentivised by Solvency II to  invest instead in the safe debt of the Greek government.

Wilson says that if the British Government is serious about encouraging infrastructure investment, it needs to stop these heavy-handed formulaic approaches to regulation and change the rules towards a principles-based system. Insurers ought to be permitted to use their judgment again and to be encouraged to take sensible, well-thought-through risks so they can fulfil their economic purpose.

But powerful forces are also pushing the other way. In a speech in America last week, International Accounting Standards Board chairman Hans Hoogervorst pointed out that accounting rules currently allow insurance companies to come up with all sorts of different numbers for their profit — often in the same set of accounts. 

Figures can easily vary by 50% while at the same time the accounts fail to show the devastating effect of the low interest rate environment. Hoogervorst has big changes in mind that will come as a huge shock to the industry.

At the heart of this lies the debate about what a company is for. Is it there for its investors alone, its customers alone or society as a whole? Accounting is not the same as regulation, of course, but it does play to the same theme. It is all very well for the regulator to insist that customers must be totally protected, just as it is sensible for accountants to believe that investors should be totally protected. 

But these things come at a cost, and that cost can easily become excessive. The more prescriptive and intrusive the accounting and regulatory requirements are,  the more society suffers because  they prevent the insurance industry deploying its investment funds to maximum effect. 

Do we really believe the national interest is best served by piling on regulation in the vain hope that investors and customers will never lose money? Or would we prefer to accept a bit more risk and in return see these oceans of capital deployed more effectively throughout the economy?

If we are to have any hope of remaining competitive in the world, there can only really be one answer.

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December 15, 2016 |
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