The difficult relation between regulation and innovation in insurance

By Antonio Cano, CEO AG Insurance

The insurance industry has always and will always be subject to various kinds of regulation. This has not hindered innovation in the past. Nevertheless, in its Annual Global CEO 2014 Survey, PwC writes as a key finding that “86% of insurance CEOs see over-regulation as an organisational threat. This is a higher percentage than in any other sector, and is far ahead of other perceived threats.” There seems therefore to be an issue with regulation.

In this article I will not dwell upon regulation related to prudential control, since a lot has already been written and discussed on this topic, in particular on the forthcoming Solvency II regime. This does not mean that prudential regulation has not impact on innovation. Changes in prudential control lead, unfortunately, all too often to the wrong kind of innovation aimed at finding ways, via e.g. regulatory arbitrage, to reduce required capital.

My focus will be on how the room to innovate is influenced by conduct regulation which is meant to protect consumer interests. As my main current frame of reference is the Belgian market, my arguments and examples will often refer to Belgian insurance regulation. I am aware that this regulation is today in some aspects probably ahead of (or at least different from) many other countries, so for the non-Belgian reader my examples and references can also serve for comparative purposes.    


It is impossible to argue against regulation that promotes “rightselling” and punishes “misseling” of insurance products. We will all agree that customers should be offered the insurance solution that fits their needs, and risk profile. But I am of the opinion that we need to make a distinction between non-life insurance and life insurance. Life insurance contracts with a strong long-term savings component deserve a stricter conduct regulatory framework than non-life insurance. It is not that life insurance is intrinsically more complex and susceptible to “misselling” practices, but it is their long contractual duration that justifies special attention. If a customer has made an ill-advised wrong decision concerning such products, the consequences might only surface in the future when the financial damage is already done. Ex-ante regulatory prevention measures have a higher expected “net present value” for life insurance products than for non-life insurance which concerns basically one-year contracts.

There is also another reason why I am inclined to advice caution before launching innovate life insurance solutions. As already said, these are long-term contracts and as innovation is by definition a trial-and-error and sometimes messy process, not all innovations will be a success. Failed innovative long-term life insurance products will remain on the books of insurers for many years leading to high administrative expenses if volumes did not meet initial expectations or can generate significant losses if the risks of the product where not adequately priced. The mixed success that in the not so distant past many life insurers have had with products of the Variable Annuity type is a clear example.

Currently in Belgium the Markets in Financial Instruments Directive (MiFID) regulation is being applied also to life insurance products. Although MiFID has been designed for investment products, there are sufficient similarities with most long-term life insurance products that justify the choice of the Belgian regulator to “Mifidize” life insurance. Also the European Commission intends to apply the customer protection provisions of MiFID to so-called Insurance Based Investment (IBI) products, although they have stated that “their different market structures and product characteristics make it more appropriate that detailed requirements are set out in Insurance Mediation Directive 2 (IMD 2) rather than in MiFID 2”.

Although initial steps in applying the MiFID regulation within the banking sector might have been too much a “tick-the-box” exercise, things are evolving towards a real “know your customer” based approach. Distributors of life insurance have benefitted from the early lessons learned and I do not see today any major conduct regulatory constraints on innovation in these kinds of products.

In this context, there is even a piece of (self)regulation that has had a positive influence on the nature of innovation. On 20 June 2011, the Belgian conduct Supervisor, the Financial Services and Market Authority (FSMA) called upon the financial sector to voluntarily adhere to a moratorium on the distribution of "needlessly complex" structured products, to which practically the entire insurance sector positively responded. This is an example of the right kind of regulation that does not stifle real value added innovation.

Whereas a applying a certain degree of restrain when innovating in life insurance is advisable and including life insurance in the scope of MiFID makes sense, when it comes to non-life insurance I have a different opinion. Non-life insurance has practically nothing in common with investment products for which MiFID was designed and deserves a different regulatory approach. The European Commission has excluded non-life insurance from the MiFID scope and only relevant customer protection provisions will be part of IMD2. Non-life insurance concerns furthermore one year contracts, so the customer is not tied for a long period and can try out different insurance solutions. Regulatory prevention efforts have a limited expected “net present value” for non-life insurance.

In non-life insurance we need a minimally intrusive regulation allowing product diversity and different business models to compete, which fosters innovation. There are many examples of good innovation in non-life insurance: various types of no-claims bonus, variable deductibles, extra covers and services like offering a replacement vehicle, assistance services, repair in kind claims services, telematics based solutions, KM-based insurance, etc. Many of these innovations point also the way towards solutions to societal issues concerning difficult to insure risks.

The Belgian consumer enjoys probably the richest non-life insurance offering in Europe, not only in terms of product diversity but also in distribution models. A MiFID inspired straightjacket that is currently being tailored for the non-life insurance sector in Belgium could put this diversity, and therefore innovation, at risk.

There is the tendency to make non-life products comparable which has a logic from the supervisor’s point of view. The desire for regulatory simplicity and efficiency is arguably best served when insurance products are standard or at least when product diversity is limited. Standardization can increase transparency and lowers information gathering costs. But clearly this stands in the way of many forms of innovation and, more importantly, it deprives the consumer of choice. Standardization leads also to price-based competition allowing dominant market players to reap the benefits of economies of scale and market dominance. Also, it not only kills the incentive to innovate, it impacts the development of value added post-sales and claims services. The wrong perception can be created that non-life insurance concerns standard products, a commodity, where it is only about price.

In this sense it is illustrative, and ironic, to read the recent report of the British conduct regulator, the Financial Conduct Authority (FCA), on aggregators (sometimes also called price comparison sites). They have made it their core business to compare insurance offers pretending they are similar, still the FCA said that they “had not always taken reasonable steps to provide sufficient, clear and consistent information on the level of cover, key features, exclusions and limitations to enable consumers to compare the available options and make an informed decision".

It seems to me that regulation for non-life insurance products can only be based on general principles and policies of proper conduct and that detailed rules and checklists will have no real added value and will only choke innovation. Furthermore the cost of compliance can become disproportionally high for the many smaller players in this market, thus leading to market concentration and effectively blocking innovative small new entrants.

Today in Belgium new entrants enjoy relatively low barriers to entry, also thanks to a large number of independent insurance brokers which brings us to the impact of regulation on insurance distribution.  

Concerning distribution, there are many possible models: direct channels, aggregators, bancassurance, tied agents and independent brokers being the most important ones. Each model has a place and appeals to different kinds of customers and a “level playing field” should be maintained on which they all can compete. Here also the simple translation of MiFID principles can be dangerous as, in its current form, it does not treat all distribution models equally imposing stricter rules and regulatory burden on independent intermediaries. This is dangerous for innovation as this channel, characterized by its independent and entrepreneurial spirit, is the natural ground to test new ideas from established insurers but also from new entrants that lack their own captive distribution capacity. Fortunately forthcoming EU legislation on insurance mediation (Insurance Mediation Directive 2) would (re)introduce a more level regulatory playing field.

Affordable insurance

I will end this article with a reflection on regulation and legislation aimed to allow affordable access to insurance coverage to a maximum number of consumers. This type of regulation can have a significant impact on the possibility, and even incentive, to innovate.

In theory all risks are insurable, provided they can be identified as a homogenous group and that their frequency and severity can be quantified. The quantified expected claims costs for a group are the basis for the premium to be paid by each individual member. This is the essence of insurance; redistribution of risk within a common homogenous pool. But the resulting premium for a given group of risks can be such that it is practically unaffordable to its members. The typical example to illustrate this is the difficult insurability of – compulsory – third party motor liability of unexperienced, mostly young, drivers. 

To solve such, and similar, issues various solutions can be found. Typically such solutions allow members in the pool of high risks (the unexperienced drivers in our example) to pay a lower than the actuarially required premium and the resulting gap is funded by someone else. In Belgium for example, this has been solved via the so called ‘Tarification Bureau’. Basically, this is an industry sponsored pool that provides third party motor liability insurance with a capped price to those that have been refused by insurers or that have received prohibitively high quotes. The deficit generated by this pool is spread out amongst all other insured drivers.

The critical issue here is the – political – decision on what an affordable maximum premium level should be. Striking the right balance is important. Defining affordable rates too high could effectively close the access to insurance to a large part of the population. Setting rates, via legislation, too low makes prevention efforts less rewarding and takes away the incentive for insurers to find innovative solutions for these risks. This has clearly a cost to society.      

As insurance sector we should be self-critical here. Maybe we have been unable to explain and defend valid innovative solutions we had found. But we have also been only half-willing to look beyond technical and actuarial arguments in our search for innovative solutions to these and other societal issues where insurance can and should play a role. Flexibility and innovation along the edges of (un)insurability is increasingly needed, not only to avoid unnecessary sometimes counterproductive regulation, but more importantly to improve the perception that the society has of the value added by insurance innovation.

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