Combating the Teleological Drift of Life Insurance Solvency Regulation: The Case for a Meta-Risk Management Approach to Principles-Based Reserving

This Article presents the recent U.S. “principles-based reserving” (PBR) reform of life insurance solvency regulation as a case study of how regulatory systems can “drift” from their putative objectives when the complexity of the regulated market outpaces the capabilities of traditional regulatory tools to effectuate those objectives. As the life insurance industry developed new products and investment strategies to confront interest rate volatility and the competitive effects of deregulation, regulators perceived the traditional, rigid formula-based methodologies of statutory accounting for reserves – which comprise by good measure insurers’ largest set of liabilities – as increasingly out of touch with market realities. Under the PBR reform, the statutory accounting system will allow firms to account for their reserves based on their own probabilistic estimates of the future economic value of those liabilities, taking into account past experience and predictive statistical models used in the firms’ internal risk management systems. The statutory reserving regime is a linchpin of life insurance solvency regulation, so regulators should only change it so drastically if they are certain the new approach will promote solvency. The Article considers the PBR reform in this context.The Article begins by explaining the purpose of solvency regulation in the insurance industry (of which statutory accounting is a central pillar) as a public administrative intervention into the insurance market to remedy corporate governance gaps due to insurers’ unique capital structures. It then distinguishes statutory accounting system from GAAP accounting by elaborating the former’s traditional conservatism and emphasis on long-term viability and solvency over short-term optimization metrics such as share price and earnings. The Article then draws on “new governance” and “reliability” theories to analyze the PBR reform as an attempt to restore meaning to the statutory accounting system in the face of the new market complexities and dynamism by tapping into regulated firms’ proprietary risk management systems. The Article considers, and finds unlikely, the possibility that firms will themselves adopt a conservative, reliability-focused outlook that privileges long-term solvency over short-term optimization metrics. Under such circumstances, the central task for regulators should be to create a system of “meta-risk management” that aims to encourage the institutionalization of social responsibility and reliability on the part of industry actors. The Article explains how the PBR reform is unlikely to embed conservative reliability-focused principles into insurers’ corporate governance structure, and recommends several modifications that might increase PBR’s effectiveness. Whether statutory accounting can in fact recoup its conservative underpinning is but a single manifestation of a larger problematic concerning the viability of public regulatory control in light of the immanent instability of financial capitalism.