The importance of the regulatory environment

Regulation is vital to ensure that policyholders can feel confident buying insurance products. Inappropriate regulation, however, can have a significant impact on the ability of insurers to function effectively and sustainable and to supply the insurance products that individuals and businesses wish to purchase.

Against the background of growing public debt and ageing populations in developed economies, with the resulting strains on state social welfare and taxation systems, it is increasingly important to ensure that the regulatory environment supports a well functioning private insurance sector.

The product development and pricing strategies of companies are often driven by the regulatory environment in which they operate. Individual companies can be affected by regulation that is unsuitable for their business. International groups can be affected by inconsistencies in regulatory environments that can even lead to corporate restructurings.

Below are just four examples of areas in which regulation can affect the optimal functioning of the insurance market. They show how important it is that all the possible implications are considered when regulations are developed or revised.

Enough capital, but not too much
Insurers need to be able to provide cost-effective insurance to policyholders while also holding sufficient capital to pay claims. It is vital that the capital that insurers are required to hold is proportionate to the risks they are taking; the regulatory requirements should inspire consumer confidence but should not be overly prudent. Should companies be forced to hold excessive capital, there is the risk that the additional costs could be passed on to policyholders through higher premiums, that products could be redesigned to offer fewer guarantees and benefits to policyholders, or that products could be withdrawn altogether. This could potentially result in individuals and companies buying less insurance and therefore retaining more risk themselves, with detrimental consequences for society and the economy (see p13).