Obama team abdicates leadership on insurance regulation

Exclusive analysis for FinReg21 by Darrell Delamaide

The Obama administration’s blueprint for financial regulatory reform by and large left any initiative on reform of insurance regulation to Congress.

Big insurers with diversified operations that include banking or “shadow banking” could well qualify as the newly defined “Tier 1 financial holding companies” – systemically important institutions that will come under the supervision of the Federal Reserve on a consolidated basis, if Congress goes along with the government plan.

And the administration proposals call for an “Office of National Insurance” to collect information on the industry and to serve as a repository of expertise for the federal government and an interlocutor in international meetings on insurance. One of the tasks for the ONI would be to recommend to the Fed which insurers should be supervised as systemically important.

But the administration’s plans stop short of calling for a federal insurance charter or federal regulation of insurance, which currently is regulated at the state level. The 89-page document instead sets out six principles for “modernization” of insurance regulation, which stress the need for consistency and harmonization of regulation nationwide.

Congress, in the person of House Capital Markets subcommittee chairman Paul Kanjorski, at least, is willing to take the initiative offered by the White House.

But even a congressman with Kanjorski’s pull will have trouble overcoming the entrenched opposition of the states, who cherish their current prerogative as exclusive regulators of insurance.

Kanjorski, who has already introduced legislation for an Office of Insurance Information that is similar to the administration’s proposed ONI, held a hearing this week on “Systemic Risk and Insurance.”

The lawmaker stopped short of urging federal regulation of insurance in general, saying instead that “the federal government should actively regulate some specific insurance lines, especially those that pose systemic risk or which have a national significance.”

In Kanjorski’s view, these would include bond insurers, mortgage insurers, and reinsurers. Even without a federal regulator for the industry as a whole, he said, the government should look for ways to promote greater uniformity in regulation.

The administration’s action plan echoes this sentiment. One of the six principles to guide any reform of insurance regulation was “Increased national uniformity through either a federal charter or effective action by the states.”

The current system, the government’s white paper says, “is highly fragmented, inconsistent, and inefficient.” Measures taken so far to harmonize regulation across the states have been insufficient, the paper says.

But the paper does not call for any concrete measures, saying only, “Treasury will support proposals to modernize and improve our system of insurance regulation.”

State insurance regulators oppose any federal regulation of insurance. Michael McRaith, Illinois director of insurance regulation, spoke on behalf of the National Association of Insurance Commissioners at the Kanjorski hearing and said that insurers were victims in a financial crisis but do not constitute a source of systemic risk themselves.

“Even a major insurer failure…will generally not impose systemic risk,” he said in his testimony, citing the safety nets in place to protect policyholders.

The more specialized lines listed by Kanjorski as possible subjects of federal regulation – such as bond or mortgage insurers – were indeed hit in the current crisis, but only because of the proliferation of bad mortgages and bonds in sectors that may need tougher regulation, McRaith said.

“While isolated lines of insurance may be susceptible to systemic risk, and while insurers are exposed to market risk as are other investors, the current insurance regulatory system closely supervises and manages any purported insurance sector risk to the economy,” he concluded.

The affiliate of American International Group that so famously forced a federal bailout of the company with its unfettered issuance of credit default swaps was not regulated as an insurance unit, but as a savings association by a federal agency, the Office of Thrift Supervision.

Insurers did not generate “the toxic financial products,” McRaith said, because NAIC rules require that insurers be capable of paying any losses in full on any derivative written by the insurer. “Needless to say, the non-insurance originators of the faulty derivatives were not subject to similar reserving or collateral requirements,” he said.

The administration white paper does see a gap here, however, and recommends more robust supervision of insurers on a consolidated basis to identify activities that increase risk for the company as a whole.

“As we saw with respect to AIG, the problems of associated affiliates outside of a consolidated insurance company’s traditional insurance business can grow to threaten the solvency of the underlying insurance company and the economy,” the white paper said. “Any new regulatory regime must address the current gaps in insurance holding company regulation.”

Many insurers that operate nationwide would welcome a federal regulator to streamline the regulatory process.

Kenneth Spence, general counsel at The Travelers Companies, delivered this message at this week’s hearing. “Recent problems have revealed gaps in insurance regulation that demonstrate that the current insurance regulatory structure is unable to adequately oversee the diverse industry that insurance has become,” he said in testimony before the Kanjorski subcommittee.

Spence said an information office would be a step in the right direction but that reform should go further. “We believe that a comprehensive approach to federal financial services modernization will not be complete unless it includes a broader federal insurance presence that encompasses federal chartering for insurers,” he said.

The debate is likely to rage on for some time in Congress. The states will vociferously defend their role as exclusive regulators for insurance. After all, the fact that a prosperous Travelers was selected to replace the troubled Citigroup in the Dow Jones Industrial Average earlier this month, would suggest that state regulation of insurance has been more effective that federal regulation of bank holding companies.

This point was underscored by Teresa Bryce, president of Radian Guaranty, representing the Mortgage Insurance Companies of America at the hearing. She noted that mortgage insurers have been able to pay their claims even in this time of “unprecedented stress” and that has helped stabilize the market.

Federal regulators were in many ways less prepared with their capital standards and other requirements than the state insurance regulators who applied the existing rules for [mortgage insurance],” she told the panel.

Insurance regulation is an important power base at the state level and has launched numerous political careers. Kathleen Sebelius, the new secretary of Health and Human Services in the Obama cabinet, used her tenure as state insurance commissioner as a springboard to become the Democratic governor of heavily Republican Kansas. Eric Dinallo, a former aide to Eliot Spitzer when he was New York attorney general, spent an energetic two years as state insurance superintendent before resigning last month to reportedly prepare his campaign for the AG office next year.

In addition to the state opposition, the very amplitude of the initiatives the administration is proposing may prevent Kanjorski or other congressional leaders from getting any traction on the insurance issue. Congress will have enough to do considering the main recommendations of the white paper while dealing with healthcare reform and global warming.