The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage. By Michael S. McGavick NEW YORK ( TheStreet) -- The desire to avoid the next financial crisis has policymakers and regulators worldwide scrambling to write new rules and expand oversight missions. As is typical of responses to crises, their work is largely uncoordinated and prone to overreaction. Regulators are going well beyond the core actors and causes of the credit crisis to impact other industries -- especially insurance. They run the very real risk of not just unintended consequences, but promoting the very outcomes they are trying to avoid. Today's insurance companies are large, global and among the world's most highly and effectively regulated -- as well they should be. Effective, strong, and efficient regulation and a functioning partnership with government are essential. As everyone in the insurance business understands, regulation of the industry promotes and reinforces trust in the insurance product. Further solidifying the government-industry relationship, entire swaths of the insurance industry, such as terrorism and certain catastrophe policies, are only possible because of the partnership with governments. Naturally, as in any relationship, there is also tension. Policy and regulation can solidify and open insurance markets, but they can also cause stress. As essential as this relationship is, I fear we are at a tipping point. The insurance industry is now seeing a "regulation bubble" -- a sudden flurry of no doubt well-intended standards from state, federal and international agencies. Troublingly, this proliferation of new regulation reflects little to no input from insurers. The new rules emerging are largely in reaction to the recent banking crisis and are therefore modeled on a sector that is barely, if at all, relevant to the insurance industry. Banks and insurers have different business models, capital structures and risk profiles. The financial crisis subjected insurers to an intense stress test and the vast majority -- those in the core business of insurance -- came through with flying colors. At the same time, bank failures soared. Regulators and policy makers should start by answering one very simple, but critically important question: What is the problem we're trying to solve?
In getting to the core of the issues, we must first tackle the almost completely artificial notion that insurance represents a systemic risk to the economy -- the potential for contagion of failure. There cannot be a run on a traditional property and casualty insurer, and, in fact, in just about every developed economy, there is a process for dealing with a failing insurer that spreads the risk back into the insurance market. In short, there is already an answer to the question of failure. During the credit crisis, the few insurers that experienced difficulties did so largely based on non-traditional property and casualty insurance activities. (I should know; XL was one of them.) Regulators have also unwisely proposed to ramp up capital and collateral requirements for insurers and reinsurers. With unnecessary collateral requirements and much higher levels of core capital required, large insurers will have tremendous advantages. The small, innovative players will be driven out of the market. That means the scope of competition will decrease, and creativity will be penalized rather than rewarded. Fortunately, regulators in New York, New Jersey and Florida, realizing this danger, have recently changed their laws to require less than 100% collateral from certain non-U.S. reinsurers. Others should follow their example. Many different international agencies, from the G-20 to the International Monetary Fund, are contemplating new requirements for insurers with much potential for unnecessary overlap. The big promise of many of these frameworks, as it is with Solvency II -- the new pan European standards of solvency through non-life insurance directives -- is to create a level playing field, by streamlining regulatory layers. Clearly, this would simplify the regulatory environment and would be a much hoped for outcome. Though, like with many things, the devil will be in the details of the implementation. Certain regulators are already making it known in industry circles that they will continue to apply their own standards on top of such regulation. Without industry partnership and coordination across jurisdictional lines, duplication and multiplication of efforts -- and escalating associated costs -- will be the unintended consequences.
To fully understand how the industry can move forward as a stronger, well-regulated sector, we must have a partnership with government. Sensible regulation that promotes trust within and between markets is essential. We have it more right than wrong today, but I believe we've forgotten the central problem that is meant to be solved by insurance regulation. At its most fundamental level, we sell, and customers rely upon, promises made by each insurer. Effective regulation promotes trust in and the fulfillment of that promise -- an outcome that benefits everyone. Michael S. McGavick is the CEO of XL Group plc, a global insurance and reinsurance company.