REGULATIONS as solutions to real problems

01 April 2015 Robert W Vivian, Agata MacGregor & Justine van Vuuren, University of the Witwatersrand

It is clear that financial markets do from time to time exhibit real problems and the costs of these problems are borne by the public. Consequently, it can be argued that aspects of the market should be regulated in the belief that regulation is in the public’s best interest. For example, if a short-term insurer becomes insolvent, hundreds of thousands of people who purchased insurance from this company could face serious problems. Accordingly, it can be argued that the solvency of short-term insurers should be regulated, which gives rise to prudential regulation. Specific regulations can then be seen as solutions to real problems. But, on what basis nowadays is it decided what regulations should be passed?

A trail of misfortunes

There are a couple of ways in which this issue can be addressed. One method is the method of jolly good ideas. This requires that individuals be rounded up to collect all their good ideas and collate this feedback into a collection of jolly good ideas, and the best of these are then selected and implemented.

A second method is the knee-jerk reaction method. For example, if a crisis takes place governments do not want to be accused of doing nothing, but rather of doing something, therefore knee jerk decisions are implemented. The textbook example of this is Herbert Clark Hoover, the 31st President of the United States.

He was elected shortly before the Great Stock Market Crash of 1929 - the event many believe was the start of the Great Depression. He was accused of not doing enough in the face of the Depression and was defeated in the next election by Franklin Delano Roosevelt, who promised America the New Deal. The point is to do anything rather than nothing. Doing anything may well produce the wrong outcomes as enough time is not taken to fully understand the causes for the crisis taking place and then to design the appropriate course of action.

The third method, which we favour, is the academic process method. This process comes from Sir Isaac Newton who remarked that, “if I have seen further, it is by standing on the shoulders of giants”. This method requires a clear understanding of what happened in the past, what was learnt from the past so that future actions can be taken to incrementally improve the system. This is similar to Winston Churchill’s expression that, “the further back you look, the further forward you are likely to see”.

Historical overview

In the early 1900s, for example, in the UK it was decided to have a single insurance Act rather than several Acts. Thus, the British Assuruance Companies Act of 1909 was passed and several Acts such as the Short-term Act, Long-term Act, Marine Insurance Act, Motor Insurance Act and so on were not. South Africa then followed suit in 1923 passing a single Act. But strangely in 1998 two Acts were passed; the Long-term and Short-term Acts.

It now appears that South Africa may go back to one Act, but why were two Acts passed in 1998 in the first place? The likely answer is that in 1998 no one remembered the debate about one Act versus two Acts, and so two Acts were passed. There is of course nothing wrong with changing a previous course of action, but it should be done as the consequence of an informed debate and not simply because someone thinks it is a jolly good idea.

Those who made the decision in the period leading up to the passing of the two Acts in 1998 cannot really be blamed because the history of the South African insurance legislation has not been recorded. So even if the drafters of the legislation wanted to read up about the history of the legislation, they could not because there was no record of the history.

Therefore, in order to set out the history of insurance regulation, including the South African insurance legislation, a series of articles will be published. This is the first article of the series. As the articles are read, certain characteristics will become clear.

The law of unintended consequences

It will become clear that until 1986 the UK legislation was passed as a solution to real manifested problems in the insurance market. When something went wrong an analysis was conducted to identify the source of the problem and then legislation was passed in an attempt to better regulate the market. Regulations were passed as solutions to identified problems. Sometimes problems were anticipated and legislation was passed in anticipation of a problem. This was not always successful. Passing legislation to deal with a possible perceived problem can have side effects; the so-called law of unintended consequences. In this case, instead of solving problems, new problems were created.

A second characteristic was the explosion in the volume of legislation. The 1923 South African Insurance Act was twelve pages excluding the annexures. The Act was bilingual; English and Dutch, so essentially the Act consisted of six pages. The 1986 UK Act had expanded to 289 pages. The recently released Solvency II draft, released by the European Commission, is 312 pages. The solvency provisions in the existing insurance legislation are a mere few paragraphs.

If prudential and market conduct are combined into one document it can be expected that the legislation will exceed a 1 000 pages excluding other documents. In total, it can be expected that the documentation will run into multiples of thousands of pages. This is obviously more than any human being can comprehend. This expansion is of recent origin.

Solving transparent issues

A further characteristic is that legislation is no longer directed at a specifically identified problem. References are vaguely made about these problems, but the specific source of the problem is no longer identified. Therefore, it is by no means clear how the new legislation is supposed to solve the problem which was not correctly identified in the first place.

It has been an interesting exercise to unearth the history of insurance regulation. Wits University has introduced an honours course on insurance regulation and the course now includes several papers on the history of South African legislation.

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