Bigness

There is a serious difference in opinion between the Department of Finance (DOF) and the insurance industry. The matter was brought to court — probably the least desirable forum for settling an issue amenable to intelligent compromise.

The DOF, however is not inclined to dialogue with an industry it regulates. The insurance industry believes it faces an existential threat from a wrong-headed policy and its final resort is to seek judicial intervention by way of a temporary restraining order (TRO).

At issue is DOF Order 27-2006 which implements a schedule for raising the minimum capital requirements for insurance companies to continue operating. The 2006 policy began to be implemented in 2009 because of strong opposition from the smaller insurance companies.

At present, the minimum capital requirement is P125 million. The DOF intends to raise that to P175 million shortly. By 2016, the Finance Secretary wants that minimum requirement raised to P1 billion.

The regulator clearly thinks bigger is better. The bigger the company, the better it is able to service its clients, the less it is likely to experience corporate failure. At the back of the regulator’s mind is the failure of several pre-need companies (a very different business entirely from insurance) over the past few years.

The insurance companies, for their part, think the industry rests on the adept management of risks and not on the size of capitalization. Bigness is not a guarantee of success. A company with large capitalization but mediocre risk management is more likely to fail than a smaller, well-managed company.

The DOF wants the companies doing insurance business to grow bigger. The insurers think the DOF should instead focus on enforcing the highest standard of risk management. There are companies that prefer to remain small and safe. Besides, large capitalization, considering the small size of our domestic economy, could in fact represent inefficient use of capital. It may precisely produce the business failures the regulator wants to avert.

The move to raise minimum capitalization requirements is being resisted by the Philippine Insurers and Reinsurers Association (PIRA).

PIRA maintains the DOF order will only “kill a very healthy industry.” Ten of the smaller insurance companies are now seeking a temporary restraining order against the DOF policy saying this constitutes an “unjust takeover of business.” The policy, they say, will effectively force the closure of the smaller companies without any legal basis or just compensation.

If the DOF policy is enforced, many of the smaller domestic insurance companies, most of them conducting sound business for decades, will be forced to shut down in the near term. Many more medium-sized companies will eventually be forced to close as the minimum capitalization requirement is drastically raised in an unreasonably short period.

The DOF surely has the means to enforce even a most irrational policy. When an insurance company does not meet the minimum capital requirement, it is not issued a certificate enabling it to continue operations. The beleaguered company is forced to shut down or sell out to a larger competitor.

At the moment, 8 insurance companies could not meet the standing minimum capital requirement. Two more companies will be unable to meet requirements. By insisting on its arbitrary schedule for raising the capital bar, the DOF is effectively exterminating existing companies.

What happens if a good number of these companies are forced to cease doing business? Will the business demand for insurance services be quickly filled by the bigger players?

By PIRA’s computation, the aggregate capitalization of our domestic insurance industry would most likely decline instead of increase as smaller firms shut down. There will be lesser players in a highly competitive business, of course. Even the bigger players will eventually find it necessary to merge with foreign companies in order to make the minimum capitalization requirement financially feasible.

Over the longer term, in PIRA’s analysis, the local insurance industry will fall under the control of big international players repatriating their profits. Fewer players will likewise create cartel-like conditions, making it even more difficult for the authorities to regulate. This unintended consequence is surely not the outcome our regulators want to see.

Besides, PIRA spokesman Michael Rellosa points out, many companies are comfortable remaining small. They are in their comfort zone keeping at their present volumes. Their business models work. The DOF’s demand for them to be suddenly bigger could upset businesses that are otherwise performing well.

Our economy is littered with the carcasses of corporations forced to extinction by unenlightened shifts in policy.

For instance, the once-robust educational pre-need companies so controversially collapsed when government abruptly decided to deregulate tuition fees. That burst the existing business model and forced bankruptcy. Thousands of middle-income families that invested in educational plans were left to grief.

The same story happened to our once-robust textile industry. When government abruptly liberalized textile imports, local manufacturers went bankrupt and tens of thousands of workers were left unemployed.

All PIRA wants is dialogue and compromise so that policies do not run afoul of business realities. The Finance Secretary, they report, is not too keen on doing that. Consequently, the insurers now seek protection from legal technicalities to avert annihilation.

The DOF, for its part, thinks our insurance companies must quickly grow bigger to survive the onset of liberalization under the terms of the Asean Free Trade Area (AFTA). Liberalization happens in 2015. The Finance Secretary believes that “small companies have no place in the insurance business” which he sees as a “business of scale.”

Perhaps. Although he still has to offer some technical justification for why the minimum capital requirement should be P1 billion.