Case Against Credit Derivatives As Insurance

M. Todd Henderson, University of Chicago Law School, makes the case that credit derivatives should not be regulated as an insurance product in his article "Credit Derivatives Are Not ‘Insurance’ " on The Harvard Law School Forum on Corporate Governance and Financial Regulation blog on Saturday October 17, 2009.

The superficial similarity of credit derivatives to typical insurance products, like property or life insurance, has caused some politicians and pundits to argue that credit derivatives are a form of insurance and should be regulated as such. The former director of the Commodities Futures Trading Commission (CFTC), which regulates most derivative products, declared: “A credit default swap . . . is an insurance contract, but [the industry has] been very careful not to call it that because if it were insurance, it would be regulated.” New York State went even further. New York State Insurance Commissioner Eric Dinallo testified before a House Committee investigating credit derivatives: “the insurance regulator for New York is a relevant authority on credit default swaps,” because “[w]e believe . . . [they are] insurance.” Although New York has delayed its regulatory plans pending a federal review of credit derivative regulation, the question of whether credit derivatives are insurance remains an open and much bandied about one that needs to be analyzed.

He also has a July 2009, University of Chicago Law & Economics, Olin Working Paper, No. 476, with the same title, "Credit Derivatives Are Not 'Insurance' ."

From the introduction to the paper(Ungated):

The collapse of the housing bubble and the resulting credit crunch has caused untold harm to the economy and the lives of millions by destroying trillions of dollars in global wealth. The search for causes and remedies has begun in earnest, and chief among these is the largely unregulated credit derivatives market. Regulation of one form or another is the proposed solution in many quarters, and one of the prominent proposals is insurance regulation. At the very least, the analogy between credit derivatives and insurance is often made, and this faulty comparison may lead regulators astray, regardless of the mode of regulation ultimately chosen. This Essay explores the suitability of insurance regulation to the credit derivatives market, concluding that it is a bad fit along many dimensions. Regulation of some sort may indeed be needed to remedy some fairly obvious market failures, but insurance regulation and regulators have little if any role to play in any new regulatory regime.