The Economist (subscription only) had an article in its recent survey of banks on the new and increasingly tight regulation of banks world wide.
“Medieval engineers built many daunting castles with thick walls and redoubts that made them seem impregnable to the armies of the day. But sooner or later they were destroyed or simply by-passed by invaders. In the same way, the big banks that dominate the financial landscape at present may turn out to be less secure than they seem.”
The major argument of the article was that by regulating banks very carefully to require them to hold more capital if they took greater risk, a natural process of regulatory arbitrage means that the risks get transferred elsewhere. And when the regulators of other parts of the financial system do their job properly, a substantial amount of risk gets transferred to the end consumer.
According to a recent IMF study into insurance, “It is likely that such [credit] risk will continue to be passed to less sophisticated participants, namely to policyholders and hence to the household sector.” (IMF commentary in the Financial Times)
In a small way, this is what has happened to the Australian life insurance industry in the past two decades. The regulator forced the life industry to hold sufficient capital against the long term asset liability mismatches that were implicit in their traditional with profits and less traditional investment account contracts. Once that happened, life insurers were increasingly reluctant to sell such contracts, and now policyholders are effectively taking those risks by being invested in unit linked contracts.
Looking at what happened in the UK (where for whatever reason, life insurers were not sufficiently discouraged from their guarantees, and went through a pretty hairy couple of years in the early noughties) suggests that the Australian life industry got it about right. And ultimately, if the life insurer did go bust, the policyholder is wearing the risk anyway.
But right now, householders are the ones wearing the risk that their long term savings are going to be adequate for them to live on, and it’s unlikely that most of them understand the risks that they are exposed to. Those that do understand those risks have decided that they’re not worth taking.