While cynics would say that regulators are closing the barn door long after the horses have bolted, the idea of recognizing beforehand that a bank or investment house or insurance company is too big to fail -- that is, too big for us to allow it to fail -- offers the rest of us some comfort. Had standards been in place in 2008, perhaps the financial meltdown would be only a worst-case scenario and not a painful memory.
As we said in our last post, the International Association of Insurance Supervisors has drawn up criteria that, if met, would signal that an insurance company is so interconnected with other businesses and the government that its failure would have far-reaching consequences. For their part, insurance companies, represented by an industry think-tank and lobbying group, says the criteria are just too much.
The IAIS came up with five factors: size, global activity, interconnectedness, non-traditional activities and sustainability. Insurers apparently object to all of them. They argue that size is good: A large, well-diversified insurance company that serves a large geographical area is a company that knows how to reduce risk.
"The insurance business is based on the law of large numbers," a think-tank representative explained, "[and] the larger number of units that you insure, the lower the volatility of the portfolio." Also, insurance companies are fundamentally different from banks because insurers do not lend money.
If the factors remain intact, the next step would be to evaluate 48 large insurance companies against each factor. Financial regulators from the G20 group of nations are devising measures that would reduce the risk to the economy posed by too big to fail insurers. One option would be to require the insurance company to maintain additional capital.
Companies being considered for the group of 48? Allianz S.E., AXA S.A., Prudential P.L.C. -- and American International Group Inc., one of the companies that brought "to big to fail" back into the lexicon.
Source: Reuters, "Insurers seek softening of 'too big to fail' criteria," July 31, 2012