Insurers have spent years planning for Solvency II compliance. Now’s the time to refocus on innovation.
By Van Beach, Principal, Life Technology Solutions, Milliman.
Regulation is often accused of stifling innovation among financial institutions. It is hard to know exactly how regulation affects companies’ products and operations, but competitive pressures ensure a drive for continuous improvement
Financial institutions typically respond to new regulation in phases. Initially the focus is simply about compliance. The more complex the regulation, the longer this phase will last and during it innovation takes a back seat.
Once institutions have met the new bar of compliance, other pressures kick in and stimulate innovation. Some of those pressures are external, others internal.
Regulation often strips away the complexity of product design and even limits the range of products that can be offered. It may start by making all products look the same. But this produces fresh external competitive pressures on firms to distinguish themselves in the market.
If this can’t be done in the product’s design, then it has to be done through service and building consumer confidence in the reputation and strength of the institution.
Often the tighter the regulation, the more creativity is required for companies to gain an advantage and genuinely stand out from the competition.
This creative response to regulation has been seen in the UK over the last few years with the Retail Distribution Review (RDR), a set of rules aimed at making the investment industry more transparent and fair.
The tighter the regulation, the more creativity is required to gain an advantage. As the need for compliance isn’t going to go away, boards start to search for new ways of achieving it in the most cost effective way.
Launched in 2006, with most rules needing to be implemented by the end of 2012, the RDR caused great upheaval among independent financial advisers and the asset managers and life companies whose products they sell.
The focus was initially on compliance, often causing severe disruption to business models and client relationships. Slowly new models for the fee-based advice world emerged and, as they have bedded in, the focus has returned to product innovation.
We are now seeing something similar in the US, where the Department of Labor’s fiduciary rule is causing havoc in the variable annuity market. In the short term there is likely to be a decline in annuity sales while advisors and insurance companies adjust to the changes and focus on compliance. Undoubtedly product innovation will follow as companies shift away from up-front commissions to new structures to compensate agents or entirely new product designs.
At the same time as external competitive pressures build up, requiring a creative consumer-focused response, internal pressures start to act as an additional creative stimulant. Solvency II is one of the most dramatic examples of regulation that has created internal pressure.
The compliance phase for Solvency II has lasted longer than almost any other regulatory change. This has damped innovation during the last four or five years. Now firms want to optimize their response to it and this will entail fresh, innovative thinking.
More generally, the cost of compliance is a constant source of complaint among insurers and financial institutions. As the need for compliance isn’t going to go away, boards start to search for new ways of achieving it in the most cost effective and—if possible—value-enhancing way.
When successful this will feed through to keener pricing of products, more effective risk management, and streamlined operations, again giving a firm a competitive edge in terms of customer service, operational efficiency, and optimizing risk.
The transition from achieving compliance to creatively responding to the challenge is a pattern that has played out repeatedly in the insurance industry. Companies that needed to implement Solvency II are now delicately poised to begin creatively responding to the challenge of this regulation. But the long compliance phase of Solvency II has created a somewhat unique situation. The biggest challenge for many of these insurers will be rekindling creativity after living so long in the shadow of compliance.