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Faculty Insights

The Financial Hazards of Failure to Act

By Wisconsin School of Business

March 26, 2018

Tyler Leverty
Tyler Leverty, associate professor of risk and insurance. PHOTO: PAUL L. NEWBY II

Insurance regulators delay interventions on failing firms to save political face
Insurers are regulated at the state level. The state in which the insurer is domiciled serves as the primary solvency regulator. Thus, it is the job of the domiciliary regulator to identify failing firms and take them over to protect the policyholders. The domiciliary state reaps the lion’s share of economic benefits from an insurer, but the cost of the failure is dispersed across all of the states in which the insurer does business.
Given these facts, it’s conceivable that regulators might hesitate to take over failing firms prior to an election in case it might impact their career goals or cast them in a negative light by having to declare failure on their watch. My co-author, Martin Grace of Temple University, and I questioned: Are regulators less likely to take over a failing firm before an election?
Our study looked at U.S. property-liability insurance companies for the period of 1990 to 2011, examining more than 37,830 firm-year observations across 3,261 insurers. Of these, regulators intervened upon 260 firms.
The results were significant: In election years, both elected and appointed regulators delayed closing failing insurance firms, causing the probability of failure to fall by a whopping 78 percent. Additionally, we found that the magnitude of the delay is greater for elected regulators than for appointed and that in competitive races, such as when appointing governors or insurance commissioners are in a tight election, there was an even greater impact.
The high price of failure
A second part of our study investigates the cost of regulators not acting before elections. Quantifying loss in this case is challenging because we are trying to identify the effect of inaction. Forbearance is the technical term; it essentially means holding back from exercising a legal right—it’s the watching and waiting. With insurance firms, estimates can be particularly tricky because the cost of doing business is not known until the passage of time, as claims are paid. The timing of insurance losses makes it difficult to ascertain what a firm’s true liabilities are and subsequently, whether the firm is actually failing or not.
Our data suggests that when regulators drag their feet on intervening prior to elections, these delays compound the ultimate cost of failure because during that lull, a firm’s assets are diminishing and its liabilities are growing. When we did a rough calculation over the course of our study period, we estimated that nearly $500 million and very likely more were wasted due to delays prior to elections.
A bigger picture
The implications of our findings go beyond the insurance industry. We find evidence of politicians subverting public interest in order to get themselves elected, wasting millions of dollars in the process—and its likely happening everywhere.
If regulators cared about the cost to the public, firm failures would be decided based on a firm’s economic health and market conditions, not political considerations. Instead, we find that regulators, particularly ones that are elected by popular vote, are protecting their own futures by ensuring that firms do not fail on their watch—at least until after the election.
Almost $500 million just to get a handful of self-interested officials elected?
That’s a high price to pay.
Read the paper “Do Elections Delay Regulatory Action?” forthcoming in the Journal of Financial Economics.
Ty Leverty is an associate professor in the Department of Risk and Insurance and the Gerald D. Stephens CPCU Distinguished Chair in Risk Management and Insurance at the Wisconsin School of Business.