Regulatory Outlook: The Truth About Unintended Consequences

Adapting to upcoming regulatory reform will be a challenge for the industry. But it's the unintended consequences that can be the most costly, says Howard Mills, chief adviser for Deloitte's national insurance group.

In 1936 noted sociologist Robert K. Merton popularized the concept of "unintended consequences" in his paper, "The Unanticipated Consequences of Purposive Social Action." It is interesting to juxtapose Merton's observations with the flurry of financial services regulation reform proposals that have surfaced in Washington over the past 18 months.

"The most obvious limitation to a correct anticipation of consequences of action is provided by the existing state of knowledge," Merton wrote. "The extent of this limitation may be best appreciated by assuming the simplest case where this lack of adequate knowledge is the sole barrier to a correct anticipation."

As we head into 2010, several bills lingering in Congress vary in scope and severity in terms of the extent to which they would, if enacted, change the way insurance is regulated. One bill put forth by Senate Banking Committee Chairman Chris Dodd (D-Conn.) would strip the Federal Reserve of its powers and replace it with three agencies. Then there is a list of bills that seek to create some sort of federal insurance office -- from the more benign Office of Insurance Information to the less defined Office of National Insurance -- that would give the federal government the ability to pre-empt state law, something those in favor of keeping state-based regulation, including the National Association of Insurance Commissioners (NAIC), fear could work to usurp the current state-based system.

The bottom line is that no matter where you stand on how insurance should be regulated, two things on the regulatory front are certain: There will be change, and that change won't be easy.

A Ripple Effect

It's not too far of a stretch to suppose that the vehement and vigorous debate currently on the table is most likely to continue long after bills are passed and signed into law by President Obama. Historically, in the rush to plug sections of the system that suddenly seem to be broken, other, unintended issues may surface as a result of the "repair."

One of the more recent examples is the Sarbanes-Oxley Act of 2002. Put in place in answer to malfeasance seen in the corporate sector, the law is aimed at bolstering internal controls over financial reporting. Supporters of the edict have praised its ability to strengthen corporate accounting controls, while critics have said the cost/benefit does not add up and that the law has hindered international competition. And while Congress is currently weighing whether to grant a reprieve for smaller companies, starting in 2011, non-public companies that meet a certain threshold are required to comply with SOX-like best practices that the NAIC has written into its Model Audit Rule.

Moving forward, victors in the regulatory overhaul debate may indeed seek to deem the new rules a success. Buzz words and phrases that make people feel comfortable, such as "consumer protection," "level global playing field," "putting the reins on 'too big to fail' " will likely rule the day for a while.

But what happens when everyone heads back to the office to try to figure out what it all really means? Will there be added compliance costs leveled at insurance companies and the consumers they serve? Will there be confusion and stresses put on the industry that weren't there before? And will there be overlapping, dual regulation between the state and federal levels, despite promises to the contrary?

There will be consequences, and that may not be a bad thing. It's the unintended ones that we need to watch out for.