[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]



 
                   HOW SHOULD THE FEDERAL GOVERNMENT
                           OVERSEE INSURANCE?

=======================================================================

                                HEARING

                               BEFORE THE

                    SUBCOMMITTEE ON CAPITAL MARKETS,

                       INSURANCE, AND GOVERNMENT

                         SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                              MAY 14, 2009

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-32


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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
 Subcommittee on Capital Markets, Insurance, and Government Sponsored 
                              Enterprises

               PAUL E. KANJORSKI, Pennsylvania, Chairman

GARY L. ACKERMAN, New York           SCOTT GARRETT, New Jersey
BRAD SHERMAN, California             TOM PRICE, Georgia
MICHAEL E. CAPUANO, Massachusetts    MICHAEL N. CASTLE, Delaware
RUBEN HINOJOSA, Texas                PETER T. KING, New York
CAROLYN McCARTHY, New York           FRANK D. LUCAS, Oklahoma
JOE BACA, California                 DONALD A. MANZULLO, Illinois
STEPHEN F. LYNCH, Massachusetts      EDWARD R. ROYCE, California
BRAD MILLER, North Carolina          JUDY BIGGERT, Illinois
DAVID SCOTT, Georgia                 SHELLEY MOORE CAPITO, West 
NYDIA M. VELAZQUEZ, New York             Virginia
CAROLYN B. MALONEY, New York         JEB HENSARLING, Texas
MELISSA L. BEAN, Illinois            ADAM PUTNAM, Florida
GWEN MOORE, Wisconsin                J. GRESHAM BARRETT, South Carolina
PAUL W. HODES, New Hampshire         JIM GERLACH, Pennsylvania
RON KLEIN, Florida                   JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                THADDEUS G. McCOTTER, Michigan
ANDRE CARSON, Indiana                RANDY NEUGEBAUER, Texas
JACKIE SPEIER, California            KEVIN McCARTHY, California
TRAVIS CHILDERS, Mississippi         BILL POSEY, Florida
CHARLES A. WILSON, Ohio              LYNN JENKINS, Kansas
BILL FOSTER, Illinois
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 14, 2009.................................................     1
Appendix:
    May 14, 2009.................................................    41

                               WITNESSES
                         Thursday, May 14, 2009

Grace, Martin F., James S. Kemper Professor of Risk Management; 
  and Director, Center for Risk Management and Insurance 
  Research, J. Mack Robison College of Business, Georgia State 
  University.....................................................    17
Guinn, Patricia L., Managing Director, Risk and Financial 
  Services, Towers Perrin........................................    13
Harrington, Scott E., Alan B. Miller Professor, The Wharton 
  School, University of Pennsylvania.............................    19
Hunter, J. Robert, Director of Insurance, Consumer Federation of 
  America (CFA)..................................................    15
Webel, Baird, Specialist in Financial Economics, Congressional 
  Research Service (CRS).........................................    12

                                APPENDIX

Prepared statements:
    Kanjorski, Hon. Paul E.......................................    42
    Garrett, Hon. Scott..........................................    44
    Grace, Martin F..............................................    46
    Guinn, Patricia L............................................    79
    Harrington, Scott E..........................................    85
    Hunter, J. Robert............................................    90
    Webel, Baird.................................................   143

              Additional Material Submitted for the Record

Kanjorski, Hon. Paul E.:
    Statement of the American Academy of Actuaries...............   155
    Statement of Eric D. Gerst, Esq..............................   167


                   HOW SHOULD THE FEDERAL GOVERNMENT
                           OVERSEE INSURANCE?

                              ----------                              


                         Thursday, May 14, 2009

             U.S. House of Representatives,
                   Subcommittee on Capital Markets,
                          Insurance, and Government
                             Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 10:06 a.m., in 
room 2128, Rayburn House Office Building, Hon. Paul E. 
Kanjorski [chairman of the subcommittee] presiding.
    Members present: Representatives Kanjorski, Sherman, 
Hinojosa, Miller of North Carolina, Scott, Bean, Speier, 
Wilson, Foster, Minnick, Grayson; Garrett, Manzullo, Royce, 
Biggert, Hensarling, Neugebauer, Posey, and Jenkins.
    Chairman Kanjorski. We meet today to continue the review by 
the Capital Markets Subcommittee of insurance regulation. Our 
panel has taken the lead in Congress during the last few years 
in debating insurance matters and finding consensus reforms to 
modernize our national insurance laws.
    Unlike other financial sectors that have evolved over time 
to include some degree of Federal and State regulation, States 
alone continue to have the primary authority to regulate 
insurance today. For that reason, Congress has historically 
only passed insurance legislation to respond to a crisis, 
address a market failure, or adopt narrowly focused insurance 
reforms.
    For example, after September 11th, Congress ultimately 
passed the Terrorism Risk Insurance Act so that construction 
could continue after the terrorist attack and businesses could 
obtain coverage to protect the viability.
    After a series of hearings debating the insurance reform 
last Congress, this subcommittee considered and approved four 
narrow insurance bills. One of those bills, the Insurance 
Information Act, could help the Federal Government build a 
knowledge base on insurance matters so that the Federal 
Government could see the complete picture of the insurance 
industry rather than intermittently seeing the brush strokes of 
a particular problem in the industry or at a particular 
company.
    We are very fortunate that this committee has a long 
history of working in a bipartisan fashion. I hope we continue 
in that vein and find common ground on these matters. 
Thoughtful, broadly supported legislative forms are usually the 
most successful.
    We must, however, also move swiftly yet deliberately in 
developing a new game plan to involve the Federal Government in 
more direct oversight of the insurance industry. Today, we are 
both responding to a crisis of sizeable proportions and seeing 
the big picture of an interconnected modern financial services 
system for the first time.
    After the turmoil in the bond insurance marketplace, the 
decisions to provide substantial taxpayer support to American 
International Group and the requests of numerous insurers to 
get capital investments from the Treasury Department, we can no 
longer continue to ask the question about whether the Federal 
Government should oversee insurance. The answer here is clearly 
yes.
    The events of the last year have demonstrated that 
insurance is an important part of our financial markets. The 
Federal Government therefore should have a role in regulating 
the industry. As such, we now must ask how the Federal 
Government should oversee insurance going forward. This 
question is the topic of today's hearing.
    The answer to this question is difficult. The bond 
insurance crisis showed that even small segments of the 
industry can have a large economic impact. AIG taught us that 
the business of insurance has become complex and no longer 
always fits nicely into the State regulatory box.
    Moreover, some companies operate unlike traditional 
insurers in today's markets. Instead of insuring assets, these 
companies insure financial transactions and use substantial 
leverage.
    My assessments should not be taken as criticism of the 
present State regulatory system. By and large, State regulators 
have performed well despite the growing complexity of the 
financial services system.
    That said, I am also not suggesting that we expand the 
mission of State insurance departments beyond insurance. At the 
very least, this Congress must address the insurance activities 
as it creates a new legislative regime to monitor systemic 
risks and unwind failing nondepository institutions.
    The Administration's proposal to create a resolution 
authority properly includes insurance holding companies. 
Oversight of any financial activity, insurance or otherwise, as 
it relates to the safety and soundness of our economic system 
must also be mandatory.
    Insurance is complex, and it is time for the Federal 
Government to appreciate its importance. Equally important to 
me is that Congress not limit itself to simply responding to 
this latest crisis. Many insurance products are either of 
national importance or uniform in nature. We must therefore 
consider whether to regulate these elements of the industry 
nationally.
    In sum, we have asked our witnesses to help us to examine 
these issues. Their fresh perspectives can point us in the 
right direction as we think about these matters in a new light.
    Now I would like to recognize Ranking Member Garrett for 5 
minutes for his opening statement.
    Mr. Garrett. Thank you, Mr. Chairman. And I look forward to 
an interesting discussion today on the appropriate role of the 
Federal Government to regulate insurance going forward, 
particularly in the context of proposals for risk regulators 
and resolutionary authority for these large non-bank financial 
institutions.
    You know, as I have outlined in my previous hearings, I 
have concerns with some of these proposals and the unintended 
consequences if they are to be implemented. As for a systemic 
risk regulator, we have been told throughout history that more 
regulation will solve our problems. You know, the Federal 
Reserve itself was created to ensure that these asset bubbles 
and panics would never happen again.
    It was back in 1914 that the then-Comptroller of the 
Currency had high expectations when speaking about the law that 
created the Fed. He said, ``Under the operation of this law, 
such financial and commercial crises or panics that the company 
experienced in 1873 and 1893 and 1907 seem to be mathematically 
impossible.'' Clearly, he was mistaken, and he has had a lot of 
company since then.
    A certain level of regulation is appropriate, but many of 
the reforms being talked about now will reduce market 
discipline and increase moral hazard. With the resolution 
authority being proposed by Secretary Geithner and others, for 
instance, I have real doubts that this can be implemented 
without institutionalizing an entire segment of too-big-to-fail 
companies.
    So I have concerns in general about systemic risk 
regulation and resolution authority, but they seem particularly 
inappropriate for the insurance industry. Insurance companies, 
especially those dealing primarily with retail customers, are 
different in nature from banks, for example. They are not 
nearly as interconnected with the rest of the financial 
services sector and the economy as a whole.
    Additionally, we already have the State guarantee funds to 
deal with insolvent insurance companies. And quite frankly, 
these funds have historically worked very well. Bond insurance, 
as you mentioned, of course is a bit of an outlier here, and 
the committee, I think, will address some of the unique 
challenges facing that sector on a different track.
    Also of concern in this current environment, and with the 
makeup of the present Administration and the congressional 
leadership are proposals calling for significant regulatory 
changes. To supporters of these proposals, I would say: Be very 
careful what you wish for.
    And when you think about it, it is not too far of a stretch 
to see a tri-layered or even a quadruple-layered regulatory 
structure for insurance when all the dust settles. You could 
have State regulation, Federal regulation, systemic risk 
regulation, and resolution authority regulation on top of that.
    So while the topic of Federal versus State regulation of 
insurance fosters intense debate, I believe we all can agree 
that a multi-layered regulatory structure for the insurance 
industry would not provide the best model for a competitive and 
a robust marketplace.
    Finally, in one other piece of the regulatory puzzle, I 
have been working with Congressman Dennis Moore, and we have 
been directly involved in the Nonadmitted and Reinsurance 
Reform Act. As you may know, this is a piece of legislation 
that passed the House overwhelmingly in the past two 
Congresses. What it would do is update and streamline State 
regulation in the nonadmitted or surplus lines and reinsurance 
market.
    So the surplus lines bill is an area of insurance 
regulatory reform where there is broad consensus. I look 
forward to working with my colleagues on the other side of the 
aisle to make sure that we get that piece of legislation done 
during this term in Congress.
    And with that, I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Garrett.
    I will now recognize the gentleman from California, Mr. 
Sherman, for 2 minutes.
    Mr. Sherman. Thank you, Mr. Chairman.
    When we first started talking about a Federal role in 
insurance, we were dealing with the problem that certain life 
and annuity products were being approved too slowly through the 
multi-State regulatory process. And I dream of those old days 
when the biggest issue facing this subcommittee might be that 
consumers were being denied creative annuity products on a 
timely basis. Such problems seem almost quaint.
    We should try to achieve faster approval of new products 
through the multi-State process or through some Federal 
involvement. But we should recognize that traditional insurance 
was well-regulated, and while all the other houses on the block 
blew down, the State-regulated insurance policies and annuity 
contracts are still standing.
    In analyzing this issue, we have to ask, what is insurance? 
The President today has talked about an open, transparent 
market for derivatives. I think we have to look at many of 
these derivatives, particularly credit default swaps, as 
insurance. And we don't allow people to sell insurance without 
regulation and without reserves.
    And finally, I think, Mr. Chairman, we have to avoid an 
issue of forum-shopping, where we create a circumstance where 
you get to pick your regulator. Not only will some insurance 
companies pick the easiest regulator, but you will also see 
what we saw to some extent among bank regulators: competition 
to be the friendliest regulator.
    Now, I am all for friendliness. But that should not be the 
basis on which regulators are selected and evaluated.
    I yield back.
    Chairman Kanjorski. Thank you, Mr. Sherman.
    Now we will recognize the gentleman from California, Mr. 
Royce, for 3 minutes. Mr. Royce is the author with Ms. Bean of 
one of the important pieces of legislation pending before the 
committee, so maybe we can get some insight into that bill as 
we have this hearing today.
    Mr. Royce, for 3 minutes.
    Mr. Royce. Thank you, Mr. Chairman. Thank you for your 
continued leadership on this and for the hearings that you held 
last year and now on this issue of insurance regulation.
    I think that a consensus was formed that modernization of 
our regulatory structure was necessary. And I think part of 
that consensus is that there is a Federal role here in 
insurance. I think the events of last year really changed the 
debate on insurance regulatory reform.
    I think prior to last year, the regulatory structure of 50-
plus separate regulators was criticized as being inefficient, 
as being duplicate, as being anti-competitive, and certainly 
costly for consumers.
    But in early 2008, we had another issue surface, and we saw 
many of the top bond insurers suffer significant losses and 
subsequent rating downgrades resulting from their exposure to 
the U.S. mortgage market. Their rating downgrades contributed 
to the freezing of credit markets, and that fed, of course, 
into the larger economic crisis and turmoil that we have had in 
this country.
    And then came the fall of AIG. And the bets that brought 
down AIG were made through the firm's securities lending 
division as well as the financial products unit. As we consider 
the events of the past as they relate to regulatory reform, it 
is worth noting that the securities lending division was 
facilitated and funded by AIG's insurance subsidiaries as a 
vehicle to make unwise bets on the U.S. housing market. At 
least, that is the way I would put it, since they were 
leveraged 170 to 1.
    Using capital from their insurance subsidiaries with the 
approval of the various State insurance regulators, the 
securities lending division, in tandem with the financial 
products unit, put at risk the entire company and, to some 
degree, the broader financial system.
    The AIG debacle has also reminded us of exactly how global 
in scope the insurance market really is. AIG had subsidiaries 
operating in 130 countries and jurisdictions. The now-notorious 
financial products unit had a significant presence in London.
    In order to adequately understand the threats within our 
own financial system, our regulators must be able to look at 
the entire picture, which often means relying to a certain 
extent upon equivalent regulators overseas.
    The European Union continues to move closer to phasing the 
Solvency II directive in, and that is probably going to pass 
this year. Solvency II will create one market for insurance 
throughout all of Europe while we have 50-plus separate markets 
here in the United States.
    Another aspect of Solvency II is meant to increase the 
global cooperation effort by bringing equivalent regulators 
from around the world into closer consultation with each other.
    Now, unfortunately, we have not held up our end of the 
bargain. The various State insurance regulators simply do not 
have the authority to negotiate with foreign regulatory bodies 
on behalf of the U.S. market, and as a result of our fragmented 
State-based system, we will not have that regulatory presence 
capable of understanding risks from around the globe.
    I have co-authored the National Insurance Consumer 
Protection Act with Representative Melissa Bean to establish a 
Federal insurance regulator that would have the capacity and 
the legal authority to address these issues and the many others 
that have surfaced over the years.
    In closing, I believe any regulatory forum effort will be 
incomplete without the inclusion of a world-class Federal 
insurance regulator. I look forward to hearing from our panel 
of witnesses on this topic. And again, I thank you, Mr. 
Chairman, for your leadership on this issue.
    Chairman Kanjorski. Thank you very much, Mr. Royce.
    And now we will hear from the gentleman from Georgia, Mr. 
Scott, for 2 minutes.
    Mr. Scott. Thank you very much, Mr. Chairman. I want to 
congratulate you and the ranking member for holding this very 
important hearing regarding insurance regulation reform.
    I think it is very important that as we move forward, we 
realize and learn from the experiences we have just gone 
through, especially with AIG, as we move forward to deal with 
this issue. Most experts would agree that the problems with AIG 
stem from their excessive trading and credit default swaps out 
of their financial products unit in both London and in 
Connecticut that was not regulated by the State commissioners, 
but was regulated at the Federal level with the Federal Office 
of Thrift Supervision.
    And also, the majority of insurance companies are indeed 
solvent. They are functioning well. So the fundamental question 
as we go forward is this: Does this not only suggest that a 
radical overhaul of insurance regulation at the Federal level 
might not only be unnecessary but it could also be potentially 
dangerous?
    I think it is very important that we take into account as 
we move forward the actual operations of these businesses, take 
into account the complexities of them, the areas in which they 
must be free to compete. We have to make sure we understand how 
to ensure that whatever actions we take, that it does not deter 
competition, that it does not lessen efficiency or increase 
costs of operating.
    From the development of global markets to the various and 
detailed policy rationales toward pursuing regulatory reform, 
we must take all of these into account. We must listen to both 
sides of the issue before taking further action. This is an 
extraordinarily important facet of our financial regulatory 
reforms.
    I will soon be introducing or reintroducing legislation 
which is called the National Association of Registered Agents 
and Brokers Reform Act, or NARAB, which I believe is a start to 
reforming one part of the insurance industry in ensuring 
adequate agent and broker licensing, which is extraordinarily 
important.
    The legislation is straightforward. Insurance agents and 
brokers who are licensed in good standing in their home States 
can apply for membership in NARAB, which would allow them to 
operate in multiple States. Last Congress, this bill garnered 
52 bipartisan, Democratic, and Republican cosponsors, and I 
believe that with continued strong support and interest, this 
provision will be included in our insurance regulatory reform 
package as we move forward.
    Again, I congratulate you, Mr. Chairman, and our ranking 
member, and I look forward to the testimony of our 
distinguished visitors.
    Chairman Kanjorski. Thank you very much, Mr. Scott.
    We will now hear from the gentlelady from Illinois, Mrs. 
Biggert, for 3 minutes.
    Mrs. Biggert. Thank you, Mr. Chairman. And I would like to 
thank you and Ranking Member Garrett for holding today's 
hearing. It is important that insurance be a part of the 
conversation at the Federal level on how to monitor 
institutions that could pose a systemic risk to the financial 
system.
    Should an insurance representative be a part of a Federal 
systemic risk council? Who would that representative be? Should 
Treasury have an office of insurance information? What 
regulator could or should unwind or dismantle a failed company 
like AIG?
    Whatever the solution, I am interested in hearing from 
today's witnesses about how insurance regulators and the 
insurance industry will have a voice at the Federal level 
without dismantling the State insurance regulatory structure, a 
structure that has not failed.
    Notwithstanding AIG, the U.S. insurance industry is alive 
and well, and State regulators, especially in my home State of 
Illinois, are doing a good job. In recent memory, the industry 
has survived terrorist attacks, the 2005 Gulf Coast hurricanes, 
and many other disasters that caused significant harm to our 
country and citizens.
    We as Federal lawmakers should be careful not to throw out 
a regulatory system that seems to be functioning properly as we 
consider broader proposals to establish a Federal systemic risk 
overseer.
    With that, I thank you, and I yield back.
    Chairman Kanjorski. Thank you very much, Mrs. Biggert.
    And now we will hear from the gentlelady from Illinois who 
is the co-author with Mr. Royce of a pending piece of 
legislation before the full committee. The gentlelady, Ms. 
Bean, for 3 minutes.
    Ms. Bean. Thank you, Mr. Chairman, and Ranking Member 
Garrett, for today's hearing and for yielding me time.
    The topic of today's hearing, how the Federal Government 
should oversee insurance, is a subject that Congressman Royce 
and I have worked on tirelessly for years to address the lack 
of Federal regulatory authority over the insurance industry. 
Our predominant focus has been on increasing consumer choice 
and protections, providing advantages to agents, and improving 
industry efficiency.
    Consumers tell us that they want product and pricing 
options, innovative new products available to them, the 
benefits of market pricing, consistency of products across 
State lines, and the peace of mind of knowing that they can 
preserve the trusted relationships with the agents that they 
have worked with even if they do move their families and their 
businesses, whether they be military, seniors, families, 
students, or small businesses.
    Agents are frustrated with the need to spend hours learning 
and training duplicative rules and regulations across State 
lines. Nationwide licensing, provided in our legislation, would 
allow them to eliminate that.
    They won't have to fight too hard to keep and grow their 
customer base, or have the unnecessary costs of those 
duplicative training efforts. And the $8- to $13 billion that 
the industry spends across those multiple bureaucracies would 
be saved and could be passed on to consumers in savings.
    Since we started working on this issue, much has changed in 
our system. After committing nearly $200 billion of taxpayer 
dollars to AIG, with more money expected to be granted to 
several other insurance companies, the need for Federal 
regulatory oversight has never been greater.
    In April, Congressman Royce and I introduced H.R. 1880, the 
National Insurance Consumer Protection Act, to create a 
national insurance regulator with the resources and authority 
to regulate insurance companies whose breadth and complexity 
far exceed the capabilities of the State-based system.
    H.R. 1880 is very different from past bills to create a 
national insurance regulator. This bill includes best-in-class 
nationwide investor and consumer protections exceeding the 
scope and resources of the current State system and any Federal 
legislation previously introduced on the subject.
    It establishes a national insurance commissioner to 
regulate national insurance companies, reinsurance, property 
and casualty, and life insurance, agencies, agents, and 
brokers, similarly as the Comptroller of the Currency regulates 
national banks. It will not only monitor insurance 
subsidiaries, but also the activities of the holding company in 
non-insurance affiliates, such as AIG's well-known financial 
products unit.
    Unlike national bank regulation, this bill includes strong 
protections against regulatory arbitrage by prohibiting 
nationally chartered insurers from switching to a State charter 
without the approval from the national insurance commissioner.
    Unlike past legislation, our bill deals with systemic risk. 
It recognizes that Congress will create a systemic risk 
regulator, which will subject all insurance companies, national 
or State-chartered, to a systemic risk review.
    In instances when an insurance company is deemed to be 
systematically significant, the systemic risk regulator and the 
national insurance commissioner can require an insurer to be 
regulated at the Federal level.
    The robust consumer protections of this bill provide best-
in-class, uniform national consumer protections starting with 
the model market conduct laws of the NAIC, and localizes the 
office of national insurance by requiring each State to have a 
physical office of their division of consumer affairs.
    H.R. 1880 was recently introduced and intended to serve as 
a new starting point for the discussion of national insurance 
regulation. I believe the subcommittee should move a 
comprehensive bill that establishes Federal regulation of all 
lines of insurance, property and casualty, reinsurance, and 
life. Insurance rates should be actuarially sound not subject 
to arbitrary rate caps. And we should include strong, uniform 
consumer protections.
    I look forward to working with the chairman, our ranking 
member, and my colleagues toward that end. And I yield back.
    Chairman Kanjorski. Thank you very much, Ms. Bean.
    Now we will hear from the gentleman from Texas, Mr. 
Hensarling, for 3 minutes.
    Mr. Hensarling. Thank you, Mr. Chairman. Knowing that votes 
are in, I will attempt to be brief here.
    Clearly, the issue of an optional Federal charter has been 
before this committee for some time. I have listened closely to 
the arguments. Frankly, I think it is appealing on a number of 
different fronts. I think potentially it has the ability to 
make our markets more competitive. I think it could provide 
consumers with more choices at reduced cost.
    Having said that, I haven't quite signed onto the final 
product because I think there are some downsides as well. 
Clearly, there is a gap in expertise in insurance in 
Washington, D.C. We know that on March 18th, at a full 
committee hearing on AIG, that the head of the OTS in an open 
hearing told us that they had the resources, they had the 
power, they had the authority, they had the expertise to 
prevent the debacle that became AIG. They just missed it. They 
just didn't do it, which is a lesson to all of us that again, 
Federal regulation is not necessarily a panacea.
    It would be interesting to know also exactly how this would 
intersect with the Administration's intent to give some type of 
resolution authority to some Federal body for large insurance 
companies. Many of us fear that will become a self-fulfilling 
prophecy to designate certain firms as systematically risky and 
create all kinds of little Fannie Maes and Freddie Macs, or 
perhaps a better way of phrasing it might be large Fannies and 
Freddies throughout our economy, ticking fiscal time bombs for 
the American taxpayer.
    So clearly, Federal regulation has not proven to be a 
panacea. Witness Fannie and Freddie and Wachovia and WaMu and 
the problems at Citi and Bank of America, and we have already 
mentioned AIG.
    So I believe that at the end, Mr. Chairman, we need to 
clearly move to smarter regulation, which is not necessarily 
more regulation. We need to figure out some way to end the too-
big-to-fail phenomenon. And our goal should be to ensure that 
taxpayers have market competition, market discipline, and 
ensure that they are ultimately protected.
    With that, I yield back the balance of my time.
    Chairman Kanjorski. Thank you very much, Mr. Hensarling.
    We will now hear from the gentlelady from California, Ms. 
Speier, for 2 minutes.
    Ms. Speier. Thank you, Mr. Chairman, and Ranking Member 
Garrett.
    The subject of today's hearing is how should the Federal 
Government regulate insurance? I think at first we really need 
to answer the question, should the Federal Government regulate 
insurance?
    Here in Washington, the common perception seems to be that 
Federal regulation is always preferable to State regulation. In 
this case, however, I believe the move towards replacing State 
regulatory authority with Federal, particularly if it creates a 
dual optional Federal structure, is seriously misplaced and 
misguided.
    AIG, the world's largest insurance company, is often cited 
as the poster child for the need for Federal regulation of 
insurance. The case of AIG proves just the opposite. AIG's 
insurance operations, and the fact that they were regulated by 
the States and required to hold risk-based reserves, is the 
only reason AIG was salvageable, even if it took $150 billion 
in taxpayer money to bail out the federally regulated holding 
company.
    If the State regulators hadn't prevented the holding 
company from raiding State-based reserves, even the insurance 
subsidiaries would have gone down, jeopardizing consumers and 
State-guaranteed funds all across our country.
    In my opinion, AIG makes the argument not for Federal 
regulation of insurance, but for the reintroduction of Glass-
Steagall. In the words of AIG CEO Liddy before this committee, 
and just yesterday before the Government Oversight Committee, 
``AIG needs to return to doing what it does best, insurance.''
    If it had stuck to insurance and hadn't been able to buy a 
small savings and loan so that it could choose OTS as its 
regulator, we likely wouldn't be facing the crisis we are 
facing today. Instead, it launched into the high-risk and 
supposedly high-reward world of derivatives, where Federal 
regulators were largely asleep at the switch.
    OTS has admitted to this committee that they really had no 
idea what was going on. I think we can all agree that the 
regulator-shopping among financial institutions has been a 
disaster, and we should not now be considering giving that 
opportunity to insurance companies.
    The insurance industry chafes under State regulation not 
because of the onerous regulatory burden, but because States 
impose stringent capital reserve requirements, and because of 
the ability in some States like California to pass tough 
consumer protection laws and rate regulation. Let me be blunt. 
I think the discussion is all about life insurance companies 
being further able to leverage their positions.
    I served as chair of the California State Senate Banking, 
Finance, and Insurance Committee for 8 years. The insurance 
industry lobbyists were always looking to weaken consumer 
protections. I think one of the frequent refrains, that they 
needed to be free of State restrictions so they could be able 
to speed creative and innovative products to market so that 
they could compete with Wall Street, has been shown to be the 
fallacy that it was and is.
    Insurance is an essential part of our economy. It needs to 
be strong and robust. The protections for the consumers and 
taxpayers must be equally strong and robust.
    I yield back.
    Chairman Kanjorski. Thank you very much, Ms. Speier.
    Now we will hear from Mr. Neugebauer for 3 minutes.
    Mr. Neugebauer. Thank you, Mr. Chairman, and Mr. Ranking 
Member, for having this hearing.
    One of the problems of being kind of last in the queue here 
is that a lot of the things that I wanted to say have already 
been said. But I think as we go down this road of regulatory 
reform, one of the things we need to make sure is we understand 
what happened.
    I think there is always a rush, when something unexpected 
happens or something bad happens, that somehow they blow the 
whistle and ask the government to come in and fix it. And quite 
honestly, the record of government fixing things is not all 
that good.
    And so as we go down this road, I think we need to make 
sure we understand what happened. Where were the holes in the 
system? And in some cases, I think we are going to find that it 
wasn't--it is not necessarily we need more regulation as we 
need better regulators or regulators that are actually doing 
their jobs. And so what we don't need to do is to try to pass a 
bunch of regulation because regulators weren't necessarily 
doing their jobs.
    When it comes to the insurance industry, for example, AIG 
was a little bit different entity than a typical insurance 
company. And so is there a need to separate the activities of 
some of these organizations?
    I think what we are going to find in our large banks and we 
are going to find in our larger institutions that got into 
trouble is that the regulators who were primarily responsible 
for them were looking at a core set of their business instead 
of some of the unrelated businesses that those entities were 
in. And maybe those regulators didn't actually understand those 
businesses that they are in.
    And so maybe a more appropriate regulatory structure is to 
make sure that you have regulators that have the expertise 
within the new organization to make sure that they are 
analyzing all of the risks that are being taken. Particularly 
when we look at some of our life insurance companies and our 
insurance companies that are State-regulated, as several of my 
colleagues have said before, is we don't want to be throwing 
another blanket over it.
    In other words, if the other blanket has failed, then I 
think the larger question there is what happened and why 
weren't those regulators able to ascertain what happened to 
those entities rather than adding another layer? There are some 
that are calling for quick regulatory reform, to do this very 
quickly. I think the more important thing is to do it right and 
to do it smart.
    And so I would hope as we go down this road, Mr. Chairman, 
that we take a role of, first, doing what people do in the 
medical community. Somebody gets sick or something happens 
unexpectedly and they die, they do an autopsy. I think what is 
in order here is a major autopsy of the areas where we had 
fallacies and failures, determine what happened, and then look 
at what the appropriate steps are going to be necessary to keep 
those from happening again.
    But I think that the underlying thing that the American 
people and investors and everybody needs to understand is that 
the Federal Government cannot always keep bad things from 
happening. People take risks and they look like a reasonable 
risk at the time, but not every business plan and not every 
business investment pans out like it is purported to do.
    And to think that regulation will fix that, I think, sends 
a poor signal not only to the investors, to policyholders, but 
to everyone else, is that the government is not responsible for 
making things go up and down. It is responsible to make sure 
that there is integrity and transparency in the marketplace and 
in the regulatory scheme, making sure that people are following 
generally good business practices.
    And with that, I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Neugebauer.
    As everyone is aware, we have a series of votes now. We 
have estimated it to be at least an hour and 10 minutes. So the 
committee will stand in recess for at least an hour and 10 
minutes, and then we will return immediately after the last 
vote.
    [recess]
    Chairman Kanjorski. The subcommittee will reconvene.
    I will now introduce the panel. First of all, thank you for 
waiting for an hour-and-a-half, no less thank you for appearing 
before the subcommittee today. Without objection, your written 
statements will be made a part of the record. And you will each 
be recognized for a 5-minute summary so we can move through 
your direct testimony and get to some of the examination by the 
committee members.
    First, we have Mr. Baird Webel, Specialist in Financial 
Economics with the Congressional Research Service. Mr. Webel, 
you are recognized for 5 minutes.

 STATEMENT OF BAIRD WEBEL, SPECIALIST IN FINANCIAL ECONOMICS, 
              CONGRESSIONAL RESEARCH SERVICE (CRS)

    Mr. Webel. Chairman Kanjorski, Ranking Member Garrett, and 
members of the subcommittee, thank you very much for your 
invitation to testify at today's hearing.
    First, just a formality to get out of the way. I just want 
to clarify that CRS's role is to provide objective, nonpartisan 
research and analysis to Congress. CRS takes no position on the 
desirability of a specific policy, and the arguments that I 
have presented in my testimony are for the purpose of informing 
Congress.
    My written testimony provides a range of options for 
Congress to consider as it approaches revamping the insurance 
regulatory system. And I would like to highlight a couple of 
aspects of it right now.
    The first is that the options that I present are not 
mutually exclusive. You can see that in the Bean-Royce bill 
that was mentioned by the members before. It combines both an 
optional Federal charter and a systemic risk regulator.
    Insurance is a wide-ranging business. There are a variety 
of different regulatory approaches that you could consider and 
a variety of different ways that you could split up the 
business if so desired. For example, the option of splitting 
the regulation of life insurance and property/casualty 
insurance has been mentioned frequently. There is also a 
reinsurance component that could be considered.
    One, there is currently existing regulation that is very 
different at the State level between commercial lines insurance 
for large insurers and personal lines insurance that are bought 
by individual consumers. There is a vast difference between the 
scope and reach of large insurers versus small insurers.
    There are aspects of market conduct or consumer protection 
that could be regulated differently than solvency, so that 
there are a lot of different options and different ways, and it 
is not necessarily the case that one size needs to fit all.
    The second thing I would like to talk about is the newest 
concept that has really come out of the couple of--the last 
year or so of a systemic--specifically of a systemic risk 
regulator.
    As the newest idea that is really out there, it is also, I 
think, the least fleshed out of the concepts that we have. And 
as with so many things, the devil truly is in the details. Who 
would be the systemic risk regulator? What would a systemic 
risk regulator do? What would we want it to do? And starting 
just at the definition, even just at the definition of systemic 
risk, one finds frequently differing concepts.
    One of my colleagues, when we started into this discussion 
a few months ago, came around to the people who do this at CRS 
and said, ``So is an asteroid about to hit the United States to 
be considered a systemic risk to the financial services 
industry?'' And after the sort of initial amusement at the idea 
and when people started thinking about it, you know, you start 
to take it a little more seriously.
    What is a financial systemic risk regulator to do about 
this? You know, is it regulating how people would respond to an 
asteroid strike? Is it supposed to be stopping the asteroid 
strike from the beginning?
    If you replace asterisk strike with, say, global warming or 
a pandemic flu or the destruction of the financial 
infrastructure in New York, suddenly it is not--you know, it 
brings up questions that are really a little more serious than 
when you first--when you first thought about it.
    The powers that a systemic risk regulator could have: Does 
it have day-to-day oversight of financial firms, or does it sit 
at 20,000 feet and identify the problems and then expect the 
other regulators to do something about it? If so, does it have 
preemption powers if it identifies a systemic problem but the 
other regulators don't act on it?
    When you apply it to insurance, you get even more 
complicated because of the existing State regulatory system--
questions of how you balance Federal power versus State power, 
of 50 different regulators that would have to be interacting 
with the systemic risk regulator.
    There has been a suggestion of a council with the heads of 
the various Federal regulatory bodies. Well, who sits on that 
council for insurance? I mean, presumably you would want to 
have someone there, but who?
    And when you get down into the very weeds of insurance, I 
think that there is a particular flash point with rate 
regulation. Many of the States consider rate regulation to be a 
bedrock consumer protection.
    But of course, suppression of rates beneath what is 
appropriate for the risk entailed is a definite solvency 
concern, which feeds into a definite systemic risk concern if 
it is a large insurance company. And how that could be managed 
within the system or within whatever the Federal systemic risk 
regulator will be will certainly be a challenge.
    I am happy to be here and happy to answer any other 
questions that you might have. Thank you.
    [The prepared statement of Mr. Webel can be found on page 
143 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Webel.
    We will now hear from Ms. Patricia Guinn, managing director 
of global risk and financial services business for Towers 
Perrin.
    Ms. Guinn, 5 minutes, please.

  STATEMENT OF PATRICIA L. GUINN, MANAGING DIRECTOR, RISK AND 
               FINANCIAL SERVICES, TOWERS PERRIN

    Ms. Guinn. Thank you. Chairman Kanjorski, Ranking Member 
Garrett, and members of the subcommittee, it is an honor to 
testify today on behalf of Towers Perrin.
    Towers Perrin is a global professional services firm that 
helps organizations improve their performance through effective 
people, risk, and financial management. The insurance industry 
is a particular focus of our firm, and I appreciate this 
opportunity to offer our perspective on the important issue of 
insurance industry oversight.
    Without a doubt, the financial crisis has had a significant 
adverse impact on the balance sheets and profitability of 
insurance companies. However, with the obvious exception of 
AIG, the insurance industry as a whole has not been as severely 
impacted by the crisis as has the banking industry.
    Insurers have benefitted from strong risk management 
practices, particularly in the property/casualty sector. In 
addition, the focus of the current State regulatory framework 
on solvency and policyholder protection has served the industry 
well.
    That said, the financial crisis has exposed a number of 
issues that raise valid questions about the adequacy of the 
current regulatory system. And while it is a relatively small 
part of the overall financial services industry, insurance has 
a far-reaching impact on our economy as a whole.
    Think of your own experience. The businesses you rely on 
can't open their doors each day without liability insurance, 
workers compensation, and various other coverages. And as 
individuals, we can't register our automobiles or get a 
mortgage without appropriate insurance.
    Furthermore, insurance companies are major investors in the 
U.S. financial markets, with trillions of dollars of invested 
assets. Finally, the insurance industry fills a less-well-known 
role as the provider of financial guarantee insurance to 
enhance the credit quality of a wide range of municipal bonds 
and structured securities. The importance of this role has been 
highlighted in the current financial crisis.
    These are sufficient reasons for the insurance industry to 
warrant Federal attention. Yet, in our opinion, there is no 
need to start from scratch. Any new Federal role in insurance 
regulation should build on the industry's very positive risk 
management characteristics and the current regulatory 
structure.
    Federal oversight also should address the challenges 
presented by systemic risk, regulatory arbitrage, and an 
increasingly complex landscape that blurs the lines between 
insurers and other financial services players.
    We have made a number of suggestions in our written 
testimony that I will briefly summarize.
    First, we recommend a more holistic regulatory framework 
for the financial services industry that is underpinned by 
economic capital requirements based on enterprise-wide stress 
testing. This would improve transparency into an organization's 
ability to withstand extreme loss scenarios on a consolidated 
basis.
    To be effective, Federal oversight of the insurance 
industry needs to recognize the industry's unique 
characteristics. We recommend that the Federal Government avoid 
a one-size-fits-all approach derived from the larger banking 
industry, and one way to do that is to build an insurance 
industry knowledge base with contributions from State 
regulators along with industry and professional associations.
    Next, the Federal Government should avoid direct 
participation in insurance markets. Except in the most dire of 
circumstances, the private insurance and reinsurance markets 
have continued to function well and are able to finance a wide 
variety of risks.
    While the State insurance guarantee associations have also 
performed well, we believe a Federal resolution authority for 
multi-jurisdictional and multi-entity conglomerates should be 
considered.
    Finally, risk management professionals with appropriate 
training, credentials, and professional standards can play an 
important role in the Federal oversight of financial services. 
The current State regulatory framework for insurance requires 
actuaries to give a professional opinion on the adequacy of an 
insurance company's reserves to meet its future obligations to 
policyholders. We can easily envision expanding this role to 
the evaluation of other financial obligations and hard-to-value 
assets.
    Thank you for the opportunity to express our views.
    [The prepared statement of Ms. Guinn can be found on page 
79 of the appendix.]
    Chairman Kanjorski. Thank you very much, Ms. Guinn.
    And next, we will hear from Mr. J. Robert Hunter, director 
of insurance for the Consumer Federation of America. Mr. 
Hunter?

STATEMENT OF J. ROBERT HUNTER, DIRECTOR OF INSURANCE, CONSUMER 
                  FEDERATION OF AMERICA (CFA)

    Mr. Hunter. Good afternoon, Mr. Chairman, and Ranking 
Member Garrett. I am Bob Hunter, and I formerly served as 
Federal Insurance Administrator under Presidents Carter and 
Ford, and also as Texas Insurance Commissioner.
    CFA has undertaken a major and extensive study of insurance 
regulation in America, given all the developments in recent 
times, and we are nearing an end to that. So I am going to give 
you today our current thinking, which is expressed in some 
detail in my written testimony. And I have also answered your 
questions in that testimony that you raised in your letter of 
invitation.
    The tentative conclusions we are reaching right now are 
these. First, let me discuss what we think Congress should 
consider. I have gone through all the pros and cons of 
different approaches in the testimony, but here is where we 
sort of come out.
    There is systemic risk in insurance. It is not as extensive 
as in banking, but we think a systemic risk regulator needs to 
look at insurance. We believe that in order to fully understand 
and control systemic risk in this very complex industry, the 
Federal Government should take over the solvency/prudential 
regulation of insurance as well.
    This conclusion is made even in light of the fact that the 
States have done a pretty good job since John Dingell's failed 
promises a few years ago in upgrading the quality of their 
solvency regulation And looking backward, you might say, well, 
they probably deserve to stay there. But looking forward and 
looking at the systemic risk, we think the Federal Government 
needs to move in on some of that area.
    We don't think the NAIC and the States are up to the task 
of taking on this systemic risk. Therefore, we think Congress 
should create a systemic risk regulator. That regulator should 
also be charged with solvency and prudential risk regulation, 
and should be a repository of insurance expertise engaging in 
such activities as data collection and analysis as well as 
dealing with international insurance matters. It should not be 
granted, however, vague and open-ended powers of preemption of 
what remains at the State level.
    The States are well-established in consumer protection 
regulation with great expertise. They regulate over 7,000 
insurers using over 10,000 staff, spending over a billion 
dollars a year in regulating insurance.
    We have complained about the weaknesses of the State 
systems, but there are some things that the States do well that 
the Federal Government could not match, we think. These include 
particularly dealing with people. States handle almost half-a-
million complaints a year and an additional 3 million requests 
for information. Several individual State insurance departments 
handle more inquiries and complaints than the entire Federal 
banking system does.
    Our recent study of State Web sites found good and 
improving information for consumers, and while many States are 
inadequate in rate and form and other market conduct 
examinations, we believe that with a few notable exceptions, 
there has been less gouging in State-regulated insurance 
pricing than in, for example, credit card, mortgage lending, 
and some federally regulated practices.
    The States, being near to the people, seem more responsive 
to consumers. Therefore, we believe the States should continue 
to handle consumer protection, addressing all the key areas 
such as claims abuses, unfair classifications, unavailability 
of insurance, and rate regulation.
    We think rate regulation is important. Our extensive study 
of decades of auto insurance data that we have completed a few 
months ago shows that those States that are regulated 
effectively with strong prior approval rate regulation also 
have, interestingly, and this is somewhat counterintuitive, the 
highest competition as measured by HHI and other indices.
    I must point out that while we support a greater Federal 
insurance role, we do vigorously oppose an optional Federal 
charter. We think it sets up regulatory arbitrage. We don't 
think a semi-option solves that problem. We think it would 
overrule any kind of State regulation. It would be a disaster 
for States like California.
    We also believe there are other things you should look at. 
You should look at the antitrust exemption that insurers enjoy, 
and we think it should end. We also believe that the FTC should 
be allowed to study insurance again as part of any regulatory 
reform, and that Federal data collection is very important, 
particularly for market performance data, sort of like HMDA.
    These are our preliminary thoughts. The ideas have not been 
vetted with other consumer groups as yet, but will be in the 
coming weeks. Insurance is mandatory, as you have just heard, 
sort of a public utility. States and lenders require many 
different types of insurance coverage, and to protect one's 
family, most people have to get insurance.
    Consumers can be easily misled by fine print, and abused by 
marketing and claims practices. Mr. Chairman, we ask that you 
give at least as much attention to enhancing consumer 
protection as you do to systemic risk as you go through this 
process.
    [The prepared statement of Mr. Hunter can be found on page 
90 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Hunter.
    And next we will hear from Dr. Martin F. Grace, the James 
S. Kemper Professor of the Department of Risk Management and 
Insurance at Georgia State University. Dr. Grace, you are 
recognized for 5 minutes.

STATEMENT OF MARTIN F. GRACE, JAMES S. KEMPER PROFESSOR OF RISK 
   MANAGEMENT; AND DIRECTOR, CENTER FOR RISK MANAGEMENT AND 
   INSURANCE RESEARCH, J. MACK ROBISON COLLEGE OF BUSINESS, 
                    GEORGIA STATE UNIVERSITY

    Mr. Grace. Thank you, Mr. Chairman. Thank you, Mr. Garrett, 
and the members of this committee for inviting me to testify 
before you today.
    As you heard, my name is Martin Grace. I have been a 
professor at Georgia State for 21 years, and in this background 
of financial services regulation and deregulation, this is 
where I have been focusing my work for almost my entire career.
    Most recently, in the last 4 or 5 years, I have been 
thinking about this particular problem. In fact, last year we 
even had a very large conference talking about not Federal and 
State regulation per se, but the optimal regulation of the 
insurance industry.
    So today what I am going to talk to you about is a lot 
about what I have done my work on in the last couple of years 
and what I think, from an economist's perspective, might be 
fruitful ways of thinking about the future of insurance 
regulation.
    I have three main points. The first point is the proper 
level of regulation, whether it is State or Federal. The second 
one is the placement of a systemic risk regulator in this 
functional area of regulation. And I would like to make some 
comments on what I believe is the future for the role of States 
in insurance regulation.
    My first point basically looks at whether we should have a 
Federal or a State system of regulation. The way to think about 
this is that the costs and benefits of regulation need to be at 
the same level. So if you think about the local restaurant 
regulator, the local county health inspector, all the benefits 
and costs of regulation are really to that county. But the 
airline safety regulation really has a national audience, and 
the costs of that regulation should be borne at that level.
    Now, not everything about insurance is cut and dried. Fifty 
years ago, insurance was really a local kind of contract, a 
local industry. But today, only about, on the average State, 
about 12 to 15 percent of the insurance is sold by domestic 
companies. It is really an interstate business. And as such, if 
the costs of regulation go beyond the States, it may be a 
reason for the level of regulation to be moved up to the 
Federal Government's level.
    My second point is how to think about the risk regulator, 
the placement of this risk regulator. We can think of this as, 
very simply, in part because if you think about just AIG, its 
failure caused problems not just across State insurance markets 
but across other types of markets, banking markets and 
international markets. This is not something the State can 
really deal with. So a Federal risk regulator that looked at 
systemic risk may be something that is important at the Federal 
level.
    The problem, however, with application to insurance is that 
not all companies are AIG. Most insurance companies are really 
very conservatively run. And to paint with a broad brush might 
be imposing an extra costly layer of regulation on some 
insurers. So the devil, again, is in the details about how you 
choose which company is regulated at the Federal level under 
the systemic risk regulator.
    At the same time, just the signal of choosing a company 
might be a bad thing. So if a company is chosen to be 
systematically important and people assert that choice is based 
because they might be too-big-to-fail, that will have dramatic 
effects on the private insurance market.
    My third point is the role of States in insurance 
regulation. Insurance regulation, as I mentioned before, has 
historically been at the State level. And if we think about it, 
it is because it is a transaction that occurs in or near your 
house. And that is still true, but it is by a company that 
could be many States away.
    So now we have to think about the effect of sort of 
duplicative compliance costs and the different types of other 
types of costs that are put on insurers that are paid by 
consumers and shareholders across the country. So all these 
States have duplicative regulation, and the question is, are we 
getting additional benefits from that regulation consistent 
with those costs? And I think most people think the answer is 
no.
    States also tend to be very reactive rather than proactive. 
One of the things about regulation is that we really have a 
good idea about the past problem. We never really think about 
the problems we haven't discovered yet.
    For example, I was going to mention the asteroid example, 
too, but thinking about things proactively in the future. 
Regulators are really good at figuring out things that happened 
in the past, but we should have a way of thinking about the 
future. I don't think the States are really up to that.
    States react to outside pressure. Congressman Dingell's 
report some 20-odd years ago pressured the States to change. 
The OFC pressure by the industry is pressuring the NAIC and the 
States to change. They won't do this on their own, in part 
because consumers in many respects don't care enough and don't 
make it a salient point.
    So in sum, I think the States are in a very difficult 
position going forward because they are not proactive enough. 
Thank you for your time.
    [The prepared statement of Professor Grace can be found on 
page 46 of the appendix.]
    Chairman Kanjorski. Thank you very much, Dr. Grace.
    And last, we have Dr. Scott Harrington, the Alan B. Miller 
Professor of the Wharton School of the University of 
Pennsylvania. Dr. Harrington?

STATEMENT OF SCOTT E. HARRINGTON, ALAN B. MILLER PROFESSOR, THE 
           WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA

    Mr. Harrington. Chairman Kanjorski, Ranking Member Garrett, 
and members of the subcommittee, I am very pleased to be here 
to talk about issues of such fundamental importance to 
businesses and individuals. I have three main points.
    First, I want to stress that insurance is fundamentally 
different from banking and should not be regulated the same 
way. The anomaly of AIG notwithstanding, compared to banking, 
insurance markets are characterized by much less systemic risk 
and by reasonably strong market discipline for safety and 
soundness. Any new regulatory initiatives that affect insurance 
should be designed not to undermine that market discipline.
    Systemic risks, the risk that problems at one or a few 
institutions may affect many other institutions and the overall 
economy, is much greater in banking than in insurance. 
Depositor and creditor runs on banks threaten the entire 
payment system. The bills don't get paid. The checks don't get 
written. Banking crises involve immediate and widespread harm 
to economic activity and employment.
    Systemic risk in banking provides some rationale for 
relatively broad government guarantees such as deposit 
insurance. But because guarantees undermine market discipline, 
they create a need for tighter regulation and more stringent 
capital requirements. That in turn creates significant pressure 
for many banks to relax capital requirements and improve their 
accuracy, or to circumvent the requirements through regulatory 
arbitrage.
    Insurance is inherently different, especially property/
casualty insurance and health insurance. There is much less 
systemic risk and then much less need for broad government 
guarantees to prevent runs that would destabilize the economy. 
Guarantees through the State guarantee associations have been 
appropriately narrow in insurance, or narrower than in banking, 
and capital requirements have been much less binding. And 
because they have been much less binding overall, their 
accuracy is less important.
    This is good economics. Any new insurance regulatory 
initiatives should follow this model and recognize the 
distinctions between banking and insurance. They should also 
recognize that apparently sophisticated capital regulation can 
produce significant distortions without sufficiently 
constraining excessive risk-taking.
    My second main point is the creation of a systemic risk 
regulator with authority to regulate systematically significant 
insurance organizations would likely have several adverse 
consequences. And I apologize for a bit of redundancy here, 
going last as I am.
    In general, the potential benefits of creating a systemic 
risk regulator encompassing non-bank institutions strike me as 
modest and highly uncertain. Regarding insurance specifically, 
if an entity were created with authority to regulate any 
insurer deemed systematically significant, market discipline 
could easily be undermined with an attendant increase in moral 
hazard and excessive risk-taking.
    An insurer designated as systematically significant would 
be regarded by many market participants very simply as too-big-
to-fail. Implicit or explicit government backing would lower 
its funding costs and increase its incentives to take on risk.
    I am skeptical that truly tougher capital requirements or 
tighter regulation would be adopted for such firms, and if so, 
whether they would be effective in limiting risk-taking. Over 
time, government/taxpayer bailouts could become more rather 
than less prevalent.
    Even if moral hazard would not increase under that 
scenario, it is hardly certain that a systemic risk regulator 
would effectively limit risk in a dynamic global environment. 
It could well be ineffective in preventing a future crisis, 
especially once memories of the current crisis fade.
    In addition, level competition by insurers designated as 
systematically significant and those not so designated would 
simply not be possible. The former would likely have a material 
competitive advantage. The results would likely include higher 
market concentration. The big will get bigger. Less competition 
and more moral hazard.
    Apart from AIG and specialized bond insurers, we have 
already heard insurance markets have withstood recent problems 
tolerably well. It is not surprising that some life insurers 
have been stressed, given what has happened in the asset 
markets and the nature of their products.
    My third and last point is that legislative proposals for 
Federal intervention in insurance regulation, such as optional 
Federal chartering, should specifically seek to avoid expanding 
the scope of explicit or implicit government guarantees of 
insurers' obligations. The goal should be central to any 
debate.
    Insurance markets, with the AIG exception, have been 
largely outside the scope of too-big-to-fail regulatory policy. 
Consistent with relatively low systemic risks, State guarantees 
have been relatively narrow. State guarantee associations have 
performed reasonably well. The post-insolvency assessment 
scheme works well, and I elaborate in my statement how it has 
various advantages.
    So I encourage you, when you consider those issues about 
optional Federal chartering, to remember not--to keep very 
close attention to the nature of guarantees and how they can 
create moral hazard.
    And last, I would also urge you, as part of that debate, to 
consider alternatives to optional Federal chartering, whether 
it be preemption of anti-competitive State activity or some 
sort of system that would create greater regulatory competition 
among the States. Thank you.
    [The prepared statement of Professor Harrington can be 
found on page 85 of the appendix.]
    Chairman Kanjorski. Thank you very much, Dr. Harrington. 
And that completes our panel's testimony. Now we will go to our 
questions, and I will lead off with my questions, if I may.
    Dr. Harrington, did I understand your testimony--you really 
did not take a position on whether or not we should have a 
Federal regulation of insurance? You seem to be less definite 
that we should or should not as some of the other witnesses.
    Mr. Harrington. I don't have a strong opinion on whether an 
appropriately designed optional Federal chartering and 
regulation program could be in the public interest. My 
attention thus far has been very much on the design issue and 
how it might--how Federal regulation might be achieved without 
expanding too-big-to-fail policy and creating moral hazard.
    Chairman Kanjorski. It seems to me--my experience, now, 
over the last several years, I think one of the opening 
statements of our colleagues indicated how simple the question 
was several years ago as to whether or not we should provide 
cheaper product introduction and less stringent costs and 
effectiveness of hiring brokers, etc. That was the question 2 
or 3 years ago.
    Today the question is a little different. The question is 
should someone--not necessarily the Federal Government--
restrict what an insurer can do, either domestically or 
internationally, that could have a material effect on their 
position as an existing corporation, such as AIG, should they 
be allowed to engage in financial products as they did in 
London in a relatively unregulated atmosphere, and does that 
jeopardize their insurability of protecting the consumer here 
in the United States on their various American products? And 
two, how can we effectively prevent that from happening?
    I have concluded that if we take no action to prevent this 
from happening or finding out whether it is happening, I would 
think there must be 50 entrepreneurs in the world, maybe half 
of which may not have the highest ethical positions, searching 
around for relatively small insurance companies, either here in 
the United States or abroad, hoping to capture them and then 
leverage them up to huge institutions and engage in playing the 
market, if you will, the derivative market, as AIG did.
    I am not convinced anybody knew what they were really doing 
over there with perhaps an extreme limited number of people, 
and they were not very good at it. The structures they put 
together or the purchases and counterparty positions they took 
seemed to be incredibly poor.
    Now, that being the case, how are we going to prevent that? 
Do we have an obligation to prevent it? Or do we just let the 
consumers swim for their own survival?
    Then I am getting pressure, and I mean pressure from 
insurance companies and from citizens who are living in the 
hurricane zone, living in the high-risk zone, that there is not 
available insurance coverage for high risk at rates that 
insurance commissioners, who are elected to office, are willing 
to allow to be placed.
    It is a beautiful quandary that they are in--you know, 
demand insurance companies provide coverage, but underfund the 
rate that makes them liable and capable of doing that, and then 
playing the role of a populist.
    The only way we could prevent something like that, it seems 
to me, is to move it out of the regulatory capacity of the 
individual States, particularly the coastal States, and take it 
into a larger entity of control that are less under the 
influence of either the electorate of the particular State or 
the insurance carriers that are involved in that State. We get 
nailed from both ends.
    Then something has happened most recently that I have been 
involved in--when I say recently, since 9/11, and now with the 
economic catastrophe. Everybody wants reinsurance, except they 
no longer want to go to the world market of reinsurance. They 
want to come to government.
    We are being asked to underwrite so many things now as a 
secondary reinsurer that it seems almost incredible. And people 
do not--not even the operators of the insurance companies see 
an inconsistency with what they are asking. They will walk into 
your office and say, ``I am a free marketeer.'' It reminds me 
of some of my friends on the other side of the aisle.
    Mr. Garrett. Present company excepted.
    Chairman Kanjorski. Excepted, present company. Right. They 
are free marketeers, and yet they want us to do something about 
underwriting their risk. And I find that humorous myself, and 
really humorous if it were not as serious as it is.
    But look what we have now. We have insurance that we offer 
for floods that does not sustain itself, so nobody else would 
possibly grant that type of insurance. But the Federal 
Government does. We have excess coverage for nuclear plants in 
case they explode. The taxpayer is on the hook to take care of 
it. And the premium pay is insufficient to cover the risk. We 
know that.
    With hurricanes, floods, and natural disasters, we have 
substantially the same thing. And now we are starting to go in 
and offer insurance for business success or continuity. If you 
are big enough and you get entwined in enough bad deals that 
could shake the system, such as AIG, basically we have very 
little choice but to come in. And when I say ``we,'' I mean the 
Federal Government.
    Now, I hear some of my colleagues, particularly on the 
other side of the aisle, say, you know, let's be covered or 
let's everybody play the market and what the market is intended 
to do, and the market provides the equalizer. And I was a great 
believer in that until I saw subprime loans.
    When you look at subprime securitization, everybody is on 
one side of the transaction making unusual and damned profits, 
if you will, and nobody is on the other side balancing out or 
arguing, as the marketplace is supposed to do.
    So it seems to me we no longer have certainly a free 
market, but now we have a distorted market. We have tremendous 
demand for support and backup. And I am not sure we have as 
many risk-takers as we used to have that are willing to get 
into business with their own equity to manage risk, but in fact 
are turning to their written or unwritten partner, the Federal 
Government, and asking us to provide cover.
    And I think the final straw that breaks the camel's back is 
that now the request for TARP funds for the insurance industry, 
a novel concept when you think about it, which--and this 
industry is probably the greatest defender of free markets. But 
they are escaping radically from that and going to government 
subsidy and protection.
    Are we too late? Can we close those doors? Or do we have an 
opportunity here to do something, but not do something radical? 
I agree with some of the witnesses that when you look at the 
200-year or 300-year history of insurance in the United States 
as managed at the State level, it has been relatively good.
    The insurance companies have gone bust before, and they 
have created pools to support and sometimes protect the 
consumer, certainly much better now than they did prior to the 
original Depression, the big Depression.
    But moving now into the international or global market, is 
that taken as so big, so great, and offering so much financial 
opportunity for chicanery that we are so at risk that only a 
governmental entity the size of the United States can get 
involved? Those are some of the questions I have.
    Now, I know I am not posing specific questions when I have 
made that dialogue. But maybe somebody can bail me out and get 
out of this a question, if you will. What do you think we 
really should do? Should we try and do something significant or 
should we patch, provide just little coverage?
    We could easily outlaw AIG financial products operations by 
insurance companies. We certainly can in the United States, but 
we cannot do it abroad. So we could--if we tried to outlaw 
American companies from doing that, we could give a decided 
advantage to foreign companies to do it. We have seen that 
happen in other areas of regulatory authority. We literally 
drive American companies away to foreign markets.
    Anyway, let us start. Anyone can give a little answer to 
some of those questions that I have asked. Mr. Webel?
    Mr. Webel. I think, to address your last question first, 
with regard to the impact of possibly driving industries 
offshore, I think that--I mean, and this can be broader, that 
essentially the way to deal with too-big-to-fail is don't let 
anybody get too big.
    And within the financial services industry, it is true that 
for non-bank financial services, the United States has 
historically enjoyed somewhere in the $25- to $30 billion trade 
surplus range.
    But I think that when you consider the cost of the last 
crisis, one can make a very good argument that yes, you might 
be giving up something in the year-to-year trade balance, but 
how much do we spend to clean up the crisis that is solved or 
that has to be solved when too-big-to-fail actually fails? So 
there are costs and benefits to having that kind of industry, 
and I think that has to be considered.
    As a counterpoint to that in the insurance-specific range, 
the United States has historically enjoyed--has suffered a 
deficit in the insurance side of the financial services. And I 
think that does say something interesting about our insurance 
regulatory system.
    The regulatory system at the State level is often pointed 
to as a trade barrier by our European allies. And it is 
interesting to see this protected industry that still is under 
a very significant trade deficit. Does this mean that is it--
would we have an even worse deficit if you didn't have this 
``protection,'' or is it the case that because somehow the 
State system is not permitting companies to be competitive 
abroad?
    So I think that--it brings up interesting questions as to 
the international competitiveness, and do you really want to be 
internationally competitive in some of these things.
    Chairman Kanjorski. Go ahead.
    Ms. Guinn. Thank you. Maybe I will take a slightly 
different tack on this and the notion of systemic risk. And we 
have had some conversation here today around, you know, does 
insurance present systemic risk to the economy?
    And I think about it a little bit differently, that the 
insurance industry today is not distinct and separate, but it 
is actually an interconnected part of financial services. One 
of the advents in risk management over the last decade or so 
has been something called enterprise risk management, the 
notion of managing risk across an enterprise holistically, so 
not managing and measuring credit risks separately from 
interest rate risks separately from an insurable risk.
    And in some ways, to me the notion of a Federal systemic 
regulator would be the equivalent of a Federal chief risk 
officer for the U.S. financial services sector for the U.S. 
economy. I don't think you can separate insurance, and I think 
it would be unfair to the industry to have other sectors 
package products which in their essence are insurance products 
under a different set of rules and regulations than the 
industry is forced to operate under.
    Chairman Kanjorski. Thank you.
    Mr. Hunter. Just a couple of points about what you said, 
Mr. Chairman. The Federal Government has rather failed in 
recent years of taking--moving into insurance, and certainly 
have not made it self-sustaining.
    The flood program by now, that I ran, should have been 
self-sustaining. But it isn't, in part because the maps are 
antiquated, in part because there is still unwise construction 
that should have been stopped from occurring. That needs to be 
done, and the mitigation has to work, and the prices have to 
really meet the risk. And it can, but it has to be enforced. 
And it isn't.
    TRIA, for example, is somewhat modeled after the old riot 
reinsurance program, except the only difference is the riot 
reinsurance program charged premiums. TRIA doesn't. The Federal 
Government refused to charge premiums when it took on the risk.
    Now, that is a decision Congress made, and the 
Administration. Whether that was right or not, the problem is 
you can't--a premium of zero is never going to break even. And 
so that--I wouldn't be so pessimistic. You can fix these 
things. It takes some will, though, because there is always 
pressure to go the other direction.
    And then finally, on too-big-to-fail, it is not just too-
big-to-fail. I think those are pretty easy to look at and find. 
But even within markets, consider title insurance. Two-thirds 
of the market is in two companies. Are they too-big-to-fail 
within the title insurance context? That is why I think you 
have to--the systemic risk regulator has to look at everything.
    Chairman Kanjorski. I agree. Yes?
    Mr. Harrington. The question about whether the train has 
left the station, or I guess the horse leaves the barn as well, 
is a really good one. With AIG and then the life companies 
asking for TARP money, I have had to ask myself, basically the 
safety net has now been extended so far and there is really no 
going back or constraining it.
    And I don't think so. I think that the AIG situation and 
the asset bubble, the housing bubble, is unique enough that if 
we pay close attention to what happened and why and think about 
patching the places where there was a clear breakdown, whether 
it is the Office of Thrift Supervision or whatever, that maybe 
we can then think about the bigger picture, which is if we need 
to guarantee banks because of the payment system, do we want to 
have that guarantee spread implicitly or explicitly broadly 
throughout the financial system?
    And if we are going to have it spread one way or the other, 
then we probably should make it formal and regulate 
accordingly. We will have to have a lot tighter regulation in 
principle. But I would think as part of that process, maybe we 
could revisit the whole issue of what activities are 
fundamentally central to the economy that require a strong 
guarantee, and maybe revisit whether or not we don't need to 
wall-off those activities.
    I was always skeptical with Gramm-Leach-Bliley about how 
you allegedly can have part of the bank holding company 
guaranteed, and there is not going to be any spillover on the 
unguaranteed parts. To me that is fine in theory, but in 
practice probably doesn't work, so maybe we need to reconsider 
it.
    Mr. Grace. I kind of agree with what everyone said in many 
different respects. I don't think it is ever too late to fix a 
problem. I don't want to ever throw my hands up and say we 
can't do something.
    But there is always going to be another problem. And if we 
get into the situation of just setting up a problem fix and 
then adding on another fix for another problem, and adding on 
another fix for another problem, then we are at the limit where 
Scott suggests we might be, where we are just insuring 
everything.
    So I think it is imperative that we think about the types 
of things that we can fix. Using the autopsy example that one 
of the members mentioned this morning, I think, is an excellent 
example to do that, find out where the gaps are, and use, you 
know, a scalpel rather than a sledgehammer to fix that. That is 
probably not a very good example, but I think you understand 
what I am getting at. My metaphors are mixed.
    And the second thing, and I like what Ms. Guinn said, is 
that the whole sort of academic risk management area now is 
about enterprise risk management. And if we think about what 
the Europeans--how they are thinking about Basel II accords, 
they are making every insurer be extraordinarily sophisticated 
about the risks they are carrying.
    Not only that, their extraordinary sophistication is 
supposed to be transparent. And the NAIC's way of regulating 
insurers' solvency is--it is not archaic yet, but it is kind of 
getting a patina on it where it looks old. And we really need 
to change that particularly solvency system. We need to be 
moving towards a capital model-based system.
    And this is something that I think the NAIC recognizes. But 
that will help. I mean, understanding what our risks are and 
then treating them appropriately at the entire organizational 
level is a major innovation. Right now, every company is sort 
of examined separately by the regulators, and they are not put 
together in a big whole, in a ``w-h-o-l-e,'' whole. And that is 
something I think from the very beginning would go to some 
extent to solve some of the patches that we need to put into 
our system of regulation.
    Chairman Kanjorski. Thank you very much, Dr. Grace. Since I 
have been so inconsiderate of my colleagues, taking 
considerably more time, and since we have a limited number of 
them here, without objection, we will extend everybody's 
opportunity to examine to 10 minutes, and I will be lenient on 
that, so that we can have a more concentrated examination. Is 
there any objection to that?
    There being none, then I recognize my colleague from New 
Jersey, Mr. Garrett.
    Mr. Garrett. I guess the only objection will be who is the 
last person waiting here to--
    Mr. Foster. Actually, Mr. Chairman, if it were possible to 
have multiple rounds with smaller time limits, I think that 
certainly those of us more junior on the committee might be 
enthusiastic.
    [laughter]
    Chairman Kanjorski. I will take that as an objection. Then 
we will stay with the 5-minute rule, and Mr. Garrett has been 
recognized. But we will have many rounds, and I will duck my 
next round or two.
    Mr. Garrett. Thank you, gentlemen and ladies. I found your 
testimony interesting on the systemic risk regulator, and the 
OFC comments quite intriguing as well as I continue to learn 
more about that.
    I think I guess we are trying to get the right word for it 
that we are looking for. We are looking for the optimal--I 
think that was your word--regulation that we are looking for, 
not more regulation, not less, but optimal.
    And I appreciate Randy's comment about the surgical 
metaphor, and I guess--so between Mr. Grace and Mr. Harrington, 
what we can take from that is--let me step back--a little bit 
of consensus is being made that, as we go forward with this 
whole global issue that we are dealing with, we need a 
comprehensive reform and not maybe piecework as far as getting 
it done because if you pieces today, another one tomorrow, and 
the next week, you may not get a total puzzle put together that 
is comprehensive.
    So really what we need is legislation that is comprehensive 
and a framework on all aspects. But part of that comprehensive 
reform legislation that we come up with may end up being, as 
opposed to something brand-new or totally different, maybe 
``scalpel-esque'' and ``patchwork-esque'' portions to it put 
in.
    Looking first to Mr. Harrington, you made a comment in your 
testimony where you used these words. With regard to the OFC 
and a chance of going there, you said, ``Another alternative 
that you suggest is encourage regulatory competition among the 
States.''
    Can you briefly, since I only have 5 minutes now, tell me 
what you are espousing there?
    Mr. Harrington. The idea there is probably more germane to 
some forms of anti-competitive regulation that exists at the 
State level regarding prices and price controls and 
restrictions on underwriting and rate classification, where if 
you had some sort of a passport system where an insurer could 
apply to a State to get its primary license from the State and 
perhaps be subject to solvency regulation in all States that it 
does business, but that it would be regulated regarding rates 
and perhaps market conduct or other non-solvency issues by the 
rules and the State that it gets its primary.
    And the notion then would be that companies could choose to 
go where there was a more competitive environment on those 
dimensions, and consumers would be able to choose accordingly, 
subject to adequate disclosure about the nature of a regulation 
about a particular company.
    Mr. Garrett. How interesting. Okay. And the whole issue of 
arbitrage has only now recently been brought up when we talk 
about OFC. We really didn't talk about that as much until this 
whole issue with bank regulation and the arbitrage, if you go 
to a systemic regulator and what have you.
    Just briefly, does anyone else on the panel have a comment 
on potential for arbitrage with regard to OFC that you may--
yes, thanks, Mr. Grace.
    Mr. Grace. This is not my idea, but I heard it at a 
conference I was at recently where the--I guess he is the head 
of the policy group that makes up all of the guarantee fund 
associations. He was saying that there really wouldn't be any 
regulatory arbitrage possibilities because if you basically 
chose to be at the State regulator or at the Federal regulator, 
once you choose Federal, there is no going back for a large 
nationwide company.
    And the reason is is that if you have--if you are operating 
in 48 or 49 States, going to the Federal regulator means you 
can reduce your basically compliance costs dramatically.
    If you threw away all those computer programs and all the 
knowledge that you built up over the years understanding each 
State and then you become a federally chartered company, the 
choice to go back is extraordinarily hard. It is very 
expensive. So it is really a one-way street, according to this 
gentleman.
    So there isn't a lot of flipping back and forth. I mean, 
potentially someone could do it, but--
    Mr. Garrett. Well, you don't see that also in the banking 
industry. There is not a lot of flipping back and forth with a 
particular bank.
    Mr. Grace. Banking is different, though, because you only 
have to obey one State's laws. Going back--if you are an 
insurer, you have to essentially follow the rules and 
regulations of every State that you are in.
    Mr. Garrett. But I think the argument would be--I mean, it 
is interesting. The argument would be that with the banking 
situation and with the regulators, the issue is do we go under 
the OTS or the OCC or what have you.
    Mr. Grace. Right. Exactly. Yes.
    Mr. Garrett. That decision that my bank makes I am only 
going to make one time because I am going to end up there and I 
am not going to switch back and forth. But the argument right 
now is that is part of the problem that we have, is there is 
arbitrage going on now.
    Mr. Grace. But your point is well taken.
    Mr. Hunter. But 30 States--according to a Washington Post 
article recently, 30 banks have returned to State regulation as 
they see regulation, reregulation, raising its head.
    Mr. Garrett. Thank you. I appreciate that.
    And Mr. Grace, you had made another comment. You said the 
States are not proactive in this area--or not in this area, but 
just States are not proactive in dealing with some of the 
issues that are before them due to various pressures and what 
have you.
    And I think that--I am quoting you, paraphrasing your 
comments--I think the chairman made some sort of comments on 
opening, and I want to paraphrase you. But Congress is also 
pretty reactive and not proactive as well. I mean, we are 
dealing with these issues today. We should have probably been 
dealing with these issues 10 years ago. But we deal with them 
after everything blows up, and then we bring you guys in to 
help us work our way through.
    So don't we have that same--and Mr. Hunter, you might want 
to chime in, and Mr. Hunter might want to chime in since my 
time is--here on the point of we are not the be-all and end-
all. You made the comment, Mr. Hunter, with regard to the 
credit card situation we didn't--you know, we regulate that. We 
didn't do a great job, present company excepted, in those 
areas.
    So for either one of you or anybody else, the Fed doesn't 
necessarily do the job better than other ones, I guess is the 
bottom line. Mr. Hunter first.
    Mr. Hunter. I have been both a Federal and a State 
regulator, and I know both can fail, from experience. And both 
have qualities that can be good. It really depends on the laws 
that are in place and the--and how the regulator is monitored, 
and can be good. But both can fail, and both have.
    Mr. Garrett. Thanks. Mr. Grace?
    Mr. Grace. That is true.
    Mr. Garrett. Yes. The problem is is that when the Federal 
regulator fails, such as the case with the OTS and AIG, 
sometimes the disaster is not only countrywide, it is 
worldwide. Countrywide, no pun intended. But there is a 
difference.
    Thank you very much.
    Chairman Kanjorski. I like that pun.
    We now have Ms. Bean for 5 minutes.
    Ms. Bean. Thank you, Mr. Chairman.
    My first couple of questions are for Mr. Webel. And I am 
going to give you a couple of them and let you answer them 
together in the interest of time.
    The subcommittee has talked a lot about the $200 billion in 
Federal tax dollars that have gone to AIG, and how it was 
essentially focused on the financial products unit. But almost 
$70 billion in taxpayer money did go to bailing out AIG 
insurance subsidiaries and their securities lending program.
    In the current State-based system, who is responsible for 
overseeing the insurance subsidiaries' securities lending 
program?
    Mr. Webel. It is a little unclear. I mean, the securities 
came up out of the insurance-related subsidiaries. Presumably, 
the insurance regulators at some degree okayed those securities 
coming up. I have seen different suggestions from the State 
regulators as to exactly how little oversight they had once the 
securities came up out of the subs. But presumably they would 
have had to approve the securities coming up out of the 
subsidiaries.
    Ms. Bean. So given the complexities of the securities 
markets, do you believe that individual State regulators or the 
NAIC has the sophistication to evaluate these types of 
activities of the insurers that they regulate? And I am going 
to give you two other questions that you can answer as well.
    Did the passage of Gramm-Leach-Bliley enable AIG to get 
into the CDS market? And the last question for you is, is the 
State system able to properly regulate insurance holding 
companies and their non-insurance subsidiaries?
    Mr. Webel. I mean, it is really unclear with regard to the 
securities lending again whether they didn't have the 
sophistication to know what was going on in AIG or didn't have 
the authority, or whether they just made the same mistakes that 
everybody else did, which was thinking that AAA-rated mortgage-
backed securities actually were good things to be investing in.
    With regard to Gramm-Leach-Bliley, from what I can tell and 
have been told, prior to Gramm-Leach-Bliley, prior to becoming 
an Office of Thrift Supervision holding company, the AIG at a 
holding company level would have been essentially unregulated.
    Ms. Bean. Yes. If they didn't have a thrift, they wouldn't 
have had--
    Mr. Webel. Right. So AIGFP existed before Gramm-Leach-
Bliley, and it seems to have been primarily pressure from the 
Europeans to have a sort of national-level regulator that drove 
AIG to become an Office of Thrift Supervision-regulated holding 
company.
    So that in terms of that specific aspect, it doesn't 
appear--it appears that, if anything, Gramm-Leach-Bliley may 
have increased the oversight on AIG, not lessened.
    Ms. Bean. Because there would have been none?
    Mr. Webel. Yes. And I am sorry, the last point was the 
State--
    Ms. Bean. Well, you know, I will hold it at that for right 
now. And then I am going to Mr. Grace--I have a little more 
time left--with regard to multi-State and national insurers, if 
you were to start from scratch in designing an effective 
regulatory structure, would it be national or would it be State 
to State?
    Mr. Grace. What was the very first part of that?
    Ms. Bean. If you were building the system from scratch, not 
from where we are?
    Mr. Grace. For multi-State? It would definitely be a 
Federal system. The way I was thinking about this before was 
that if we had an OFC, it would be--I'm kind of thinking the 
theoretical point of view--it would be the small single-State 
or two-State companies that would stay sort of locally 
chartered. And it would be the larger interstate companies that 
would move to the Federal charter. That's kind of the--sort of 
the economic theory perfect world argument.
    And I realize that some of the larger ones may stay State 
and some of the smaller ones may choose a Federal one. But the 
whole idea, there would be a separation between the two. And I 
think that would be the right way to think about it.
    Ms. Bean. Thank you. I have two other questions for you. 
That is, when the NAIC was founded in 1871, its stated purpose 
was to enable commissioners to work towards consistent laws 
across all States, which clearly, 140 years later, hasn't been 
achieved.
    Are there any real incentives for States to work together 
to create that uniformity?
    Mr. Grace. I think that there a number of people of 
goodwill that really are trying very hard right now in response 
to the OFC push by the industry. But there are so many 
different State interests at stake that I can't--they won't all 
play together. So we will never actually have a uniform system.
    Ms. Bean. In the bill that Congressman Royce and I 
introduced, we set the minimum for market conduct regulation at 
the national NAIC--or the NAIC market conduct model laws. That 
is the starting point.
    Do you think this is an appropriate place to start for 
consumer protections? And besides rate regulation, would you 
suggest anything additional in terms of consumer protections?
    Mr. Hunter. The NAIC market conduct model is not 
sufficient. You would have to get--for example, it doesn't 
collect market behavior data like HMDA would collect, which I 
think is important.
    Ms. Bean. Doesn't collect which data? I am sorry?
    Mr. Hunter. HMDA-type data. And so it is not sufficient as 
it is, and regulation is vital, we think, to any good 
protection for consumers, and actually improves competition.
    Ms. Bean. Anything beyond that that you would add?
    Mr. Hunter. Well, I would have to go through the whole 
model. But we had a whole list of complaints I could send to 
you if you would like.
    Ms. Bean. All right. Thank you. I will yield back.
    Chairman Kanjorski. The gentleman from California, Mr. 
Royce, is recognized.
    Mr. Royce. Thank you very much, Mr. Chairman. And I am 
going to pick up on some of the questions that Congresswoman 
Bean had asked. And I appreciate, Mr. Webel, your responses to 
that.
    I would also ask this of Mr. Grace and Mr. Harrington: Much 
of the focus of AIG's failure has been on their speculative use 
of CDS. There has been a lot of discussion as to whether CDS 
are insurance products, and it should have been regulated as 
such.
    There is no dispute, though, that State regulation failed 
to detect and address a number of these major problems with 
AIG. And in February of this year, a report surfaced from the 
Wall Street Journal, and I will quote from that: ``From $1 
billion in 1999, AIG's securities lending portfolio ballooned 
to $30 billion in 2003, and then 60 billion.'' And as Melissa 
shared with you, it then went to $70 billion. ``Much of that 
growth came from lending out corporate bonds owned by AIG's 
large life insurance and retirement services subsidiaries.''
    So over a period of about 7 years, AIG bled the assets of 
its insurance division, shifting these investments into an 
overseas casino-like CDS operation, while going completely 
undetected by the State insurance commissioners responsible for 
ensuring the solvency of its operations.
    Now, here is the punch line. Only when the company was on 
the brink of collapse, after multiple publicly-reported 
restatements of earnings, did the New York State insurance 
commissioner and governor propose to redirect $20 billion from 
the surplus of AIG's insurance company to its parent holding 
company. Now, fortunately, that plan was aborted. But that is 
the type--that is the scale of regulation and due diligence and 
oversight that existed.
    It turns out the problem was much bigger than State 
officials realized. And of course, the Federal Government 
intervened, and the American taxpayers are asked to cover one 
of the most expensive corporate bailouts in our history.
    Now, surely there was failure throughout AIG and throughout 
the regulatory structure overseeing AIG. But doesn't this 
tragic episode underscore the inability of State insurance 
regulators to exercise effective oversight of today's large, 
complex insurance companies?
    And I again think that Congresswoman Bean is on the right 
track, and I am a cosponsor of her bill, when we try to give a 
world-class Federal regulator here not only the authority but 
also the information to look at the entire financial 
institution that is involved in insurance and all of its 
affiliates.
    It just seems to me, Mr. Harrington, that in the wake of 
this mess, on top of all of the other arguments, as I say 
before--you know, we have a national market in everything else 
and a Balkanized one in this product. But now, on top of it, we 
deal with this product.
    So I would ask you, Mr. Harrington, your observations on 
that, and Mr. Grace as well.
    Mr. Harrington. I would like to see a really detailed 
analysis of the securities lending issue and exactly what 
happened, why it happened, what the nature of the breakdown 
was, to what extent New York's Insurance Department and various 
other State regulators may have been asleep at the switch.
    Securities lending had gone on for so long and had been a 
major part of so many operations, I think it was regarded as 
routine business with no mischief involved. Clearly, it now 
appears there might have been some real mischief. So there 
could seriously have been some State regulatory failure there. 
I would want to really look into the specifics of the 
securities lending.
    But I have to go back and say everybody failed here. The 
OTS failed. Foreign bank regulators failed. They were letting 
foreign banks load up on AIG paper, CDS paper. Presumably, if 
they were doing their job, they would have said, how can we 
have so much of our banking system dependent on the promise of 
a single United States institution?
    Bank regulators failed. I don't know about the Comptroller, 
but the Fed in many respects must have failed to allow so many 
banks to contract with AIG given that it was running amok, so 
to speak, on these dimensions. So the Fed was partially to 
blame.
    The FDIC seems to have been to blame. The SEC, you can lay 
a lot of blame at their feet. And then also the Federal Reserve 
in general. I mean, I won't go--we don't want to go to low 
interest rates and what that did to the incentives in the 
entire system.
    But my point would just be you may well be correct that 
there is blame to go around.
    Mr. Royce. Listen, I happen to agree with every point you 
said, including the central banks worldwide running negative 
interest rates in terms of inflation for 4 years running. Sure, 
all of this fed it. But that is my point. Every one of these 
entities that you have cited had a little piece of this puzzle.
    And what worries me about our failure to address the fact 
that we are not ready to embrace giving a world-class regulator 
the ability to have the ability to have the overarching piece--
I am not saying that regulators are going to catch every 
mistake.
    But by God, when you are leveraged 170 to 1 and nobody 
catches that, that is something that can be caught and probably 
can only be caught by giving one regulator all the pieces of 
the information. And that is why Congresswoman Bean has 
introduced this bill, and this is why I think she is right in 
this approach, in addition to a dozen other reasons.
    And so let me, Mr. Harrington, agree with your assessment, 
but to say at the same time that it is the overleveraging on 
top of all of the rest of this, and the fact that couldn't be 
caught because of the piecemeal patchwork quilt approach here. 
And Mr. Grace, let me ask you for your observations as well.
    Mr. Grace. I guess I agree with both of you. I mean, this 
is a hard question, and this really is--I think it comes down 
to this, now that I am thinking about it. If we had one more 
regulator, and there was--let's say there were 50 regulators. I 
am not talking about the State. I am talking about Federal 
regulators, foreign regulators, some State regulators. There 
were 50 different entities looking at this in some way.
    Would adding even a state-of-the-art world-class regulator, 
would they have caught this? And I think that--
    Mr. Royce. But the question, Mr. Grace, is because you 
assume that those 50 each had--
    Mr. Grace. Oh, and so it is a wider problem.
    Mr. Royce. You know, you have that problem. And that is 
what I think is the root of the problem here.
    Mr. Grace. The question would be also, then, if you had 
this world-class regulator, would it not fall into the same 
complacency trap? I mean, I agree. I think we should have 
something that is like that. But I don't know that it is a 
cure.
    Mr. Royce. I understand the point you are making. And let 
me say that, Mr. Grace, I agree that counterparty due diligence 
or market discipline is the most important factor in all of 
this and that can be circumvented, unfortunately, when the 
assumption is made that somebody is looking at it. So I agree 
with that philosophy.
    But I have to say that in order to catch this type of over-
leveraging, I think this would have been caught by a world-
class regulator if they had access to all of the information. 
And I think it is the amount, the sheer amount of 
overleveraging here, which created the systemic risk.
    So I am not saying that this would solve all problems. I 
concur with you on that. But I would ask if you would grant me 
that point.
    Mr. Grace. 170 times over-leveraging just boggles my mind. 
I don't see how somebody--I mean, I still agree with you. But I 
just don't see how someone didn't see that.
    Mr. Royce. Neither do I.
    Mr. Grace. Okay. If there are all these people looking at 
it and thinking about it--
    Mr. Royce. Nobody had all the pieces.
    Mr. Grace. That may be.
    Mr. Royce. That is the problem. Anyway, thank you, Mr. 
Chairman.
    Chairman Kanjorski. Thank you very much, Mr. Royce.
    The gentleman from Ohio, Mr. Wilson. You have been waiting 
now, Mr. Wilson. Go to it.
    Mr. Wilson. Thank you, Mr. Chairman.
    Ms. Guinn, did you have a comment to say?
    Ms. Guinn. I was just going to add to the prior 
conversation that this notion of regulatory arbitrage, that my 
point is very much related to the one that you have been 
making, Mr. Royce. It is around product level, regulatory 
arbitrage; and the difference between the financial guarantee 
insurers and the credit default swap markets is the primary 
example, is the poster child for this.
    The financial guarantee insurers have experienced 
substantial losses. Their loss ratio last year was on the order 
of 300 percent. But, by and large, they are still solvent. And 
they are solvent because of perhaps two factors.
    One is that they were required to hold capital against the 
policies they wrote. And secondly, the nature of their 
contracts had a more sensible limit on what the terms of the 
coverage were. The credit default swap market, on the other 
hand, was largely unregulated, limited capital requirements, 
and for the buyers of those contracts to be comfortable with 
counter party risk, the nature of the contract terms and the 
liquidity pressures that they had inherent in them actually 
caused the triggering of immense losses. Thank you.
    Mr. Wilson. Thank you.
    Mr. Royce. Would the gentleman yield for 1 second?
    Mr. Wilson. Certainly.
    Mr. Royce. I think she made my point. It was the investment 
side of the business that put at risk the underwriting side of 
the business. And that is why I think you need a Federal 
regulator to prevent that and to look at that.
    Mr. Wilson. Thank you. I would like to say, as a former 
State legislator, I have always been very pro keeping as much 
regulation local as possible. But with what we have seen happen 
in this last go-round with AIG and how we are going to be able 
to curb the systemic risk? I think there are ways to look 
otherwise than what my theory would normally be, and that is to 
keep it at the State level.
    In Ohio, we always had the Department of Commerce, and the 
Department of Insurance was part of that, and no real problems. 
But we certainly weren't doing deals like had been done in New 
York, and I think that was a big part of it.
    My questions start with Mr. Webel and then come down, if I 
may, to Dr. Harrington.
    So Mr. Webel, first of all, one of the comments you made 
earlier, and I thought it was really something and we should 
focus in on, is too-big-to-fail. And so if you would go back 
and touch on that for me. Then I have a second question for 
you.
    Mr. Webel. Well, I mean, the point is that--I mean, the 
question of competitiveness at an international level is 
frequently brought up when you talk about too-big-to-fail. The 
Citibanks, the Bank of Americas, are competing on a global 
level with Deutsche Bank, with Royal Bank of Scotland, with--in 
a globalized financial system. And this gains the country an 
immense amount.
    But if you approach too-big-to-fail and say, we are just 
not going to let things get too big, you know, one way to do 
that, one way to say is, okay, you have a systematically 
significant institution. We are going to put additional capital 
controls on it. We are going to put additional regulations on 
it to make sure that it is not as likely to fail.
    Another option would be to just say, we are just not going 
to let things get that big. One of the counter examples that 
people frequently point to is this lack of competitiveness, 
that you are not--you know, other countries are doing this. 
They are letting their institutions do this. Our balance of 
trade will suffer.
    And that is true. I would just point out that there are a 
lot of places in policy where the government basically says, 
okay, we could let the market go this way and it might make 
more profit. But for a social reason, we are not going to let 
it go that way. You know, you could mine in Yellowstone 
National Park, but as a society, we say we are not going to do 
that.
    If you look at the cost of the crisis that we are in, one 
might conclude that it would be worth it to say, okay, if other 
people, like Iceland, want to let their banks get to be 40 
times the size of their GDP or whatever it was, and then 
collapse when their banks collapse, they can go that route. We 
are going to say no. We are going to accept the fact that we 
are going to be uncompetitive in this particular area. But at 
least when the crisis hits, we are not going to suffer like 
they do.
    Mr. Wilson. I would like to follow up on that. Just if we 
can drill down a little more and say that Americans, just by 
nature, we are going to be competitive and we are going to want 
to be competitive with every country out there. So it tells me 
that if we are going to do that and we are going to control 
systemic risk, then we are going to have to put the controls in 
so that companies don't get too-big-to-fail.
    So given that nature, what would you think--I know you 
mentioned the capital markets and controls. Could you be more 
specific?
    Mr. Webel. Well, I mean, the most basic level is simply the 
amount of capital that you are going to have an institution 
hold. In response to an argument that we sometimes have among 
my colleagues, I came up with three reasons: If you just did 
these three things, you wouldn't have had this crisis.
    One of them is simply you don't let institutions get so 
leveraged. I mean, it is generally within the purview of most 
of the regulators we have, certainly the banking regulators and 
the insurance regulators, to determine how much capital the 
institutions are going to hold.
    Now, of course, if you hold more capital, you do make them, 
again, less competitive. They are going to be making less 
profits. But the flip side is that they are less likely to fail 
and less likely to need, you know, a takeover and possible 
government bailout when they do.
    Mr. Wilson. Good. Thank you. The other part is you had 
mentioned about the United States deficit insurance. Could you 
comment on that?
    Mr. Webel. Well, basically, I mean, it is convenient 
because the balance of trade accounting has two specific 
columns in it: One is for essentially insurance services; and 
one is for non-insurance financial services, i.e., primarily 
banking and securities.
    So I believe they release the data quarterly, or it may be 
annually. You know, when they release the new data, it is very 
easy to go to the Web site and say, okay, this is the amount 
that the trade deficit was in these services for the past year 
or the past quarter.
    And so you can look at it very clearly that it is fairly 
striking that in non-insurance financial services, we have 
consistently run a fairly substantial surplus. In insurance 
financial services, we have consistently run a fairly 
substantial deficit.
    And there isn't necessarily anything wrong with that in the 
sense that--you know, in the automobile industry, if you looked 
at imports and exports of SUVs versus small sports cars, the 
Germans and Italians probably import small sports cars--or we 
import them from Germany. We would export SUVs.
    So it is not unheard of to have the same industry with 
differentiation among product types, but it is still--I mean, 
it is still interesting to note that our banking system, our 
security system, seems to be very competitive on the world 
stage, and the insurance system isn't.
    Mr. Wilson. Thank you, Mr. Webel.
    Dr. Harrington, if I can, you had talked about regulatory 
reform, and you had mentioned earlier, I believe it was to Mr. 
Garrett, in regard to what approach you would think would be a 
good idea. Could you restate that?
    Mr. Harrington. My main comment was, one, that if we move 
towards having an optional Federal system of regulation for 
insurance, that the whole issue of how we decide to guarantee 
some insurers' obligations will be critical in determining how 
much we may lessen market discipline, increase moral hazard, 
and actually undermine safety and soundness. So if we go that 
route, that is just a linchpin of weight needs to be done.
    The other thing I just said, though, is that I am by nature 
an incrementalist, and I wonder if targeting certain problems 
with State regulation through less intrusive means that 
wouldn't require some of the risks that are associated with a 
Federal regulator couldn't achieve lots of the potential 
efficiencies that might arise from some sort of change.
    Now, to be sure, types of things that might be done there 
have become--they have sort of moved off the front page of the 
papers today because of the asset crisis and the housing 
crisis.
    But I am talking about things that would allow consumers 
maybe to have more choice in ways in which they buy products 
and the types of products they buy without having to abide by 
certain types of regulations at the State level, whether that 
be a passport system or whether it be some sort of Federal 
preemption of certain types of regulation that deprive some 
consumers of, really, the ability to get low-cost products 
because of the way the price is regulated.
    Mr. Wilson. Thank you. I like especially your second 
suggestion there. Thank you.
    Thank you, Mr. Chairman. I yield back the balance of my 
time.
    Chairman Kanjorski. Thank you very much, Mr. Wilson.
    Now we will hear from the gentleman from Illinois, Mr. 
Foster.
    Mr. Foster. Thank you. My first question, I hope, is a 
simple one. Can any of you assure me that there either are or 
are not other mini-AIGs hanging around there, that there are 
insurance problems that could explode tomorrow and have 
systemic risk?
    Mr. Webel. You know, we can't insure the future. But in 
looking--I have specifically in the past looked at the 
securities lending aspect of AIG, and into the sort of other 
insurance companies and what their securities lendings look 
like.
    And from what I have found, there wasn't anybody else who 
was approaching it nearly to the level that AIG did. And this 
was definitely a big way that they failed. So it doesn't look 
like this explosive failure is coming from that direction.
    Ms. Guinn. I would agree with Mr. Webel that in terms of 
participation in the credit default swap market and securities 
lending, coupled with the scope of AIG's operations, the 
complexity of it, the number of coverages it wrote, the number 
of legal entities, it is pretty unique in the industry.
    That is if there are other large companies and each company 
bears its own risks. So if there were--you know, the big quake 
came to California tomorrow, could other insurance companies, 
perhaps large ones, be impacted--
    Mr. Foster. Well, that is on the underwriting side more, 
which it is always going to be there.
    Mr. Hunter. It depends what your projection of what goes on 
with the economic situation. If it continues to deteriorate, 
you have several large life insurers that might be at risk.
    Mr. Foster. My next question is, Alan Greenspan and others 
have this interesting suggestion of dealing with too-big-to-
fail by simply imposing increasingly stringent capital 
requirements so that they would increase non-linearly as you 
increase in size, and that eventually there would be a 
motivation for a company that as it grew bigger, to split in 
two to get higher returns for its investors.
    And I was wondering if you have a reaction, if that would 
be appropriate for the insurance company. Yes, Mr. Harrington?
    Mr. Harrington. I would say with regard to the insurance 
sector, if we can get beyond AIG, that the capital requirements 
have been such that most companies have held vastly more 
capital than what is required by the requirements, especially 
on the property/casualty side, so that because of market 
discipline, many property/casualty companies are really well-
capitalized and a lot of life insurance companies have.
    In principle, if you have moral hazard problems and real 
systematize risk problems, I think this idea of increasing 
capital requirements, and increasing them more the more risk 
you take on, makes some sense. But I am still skeptical about 
whether it will ever work in practice because if you look at 
the last 20 years of banking regulation, the name of the game 
has been the move towards ostensibly sophisticated systems 
that, in effect, allowed banks to reduce the amount of capital 
they held.
    So I am just skeptical that you can actually make that type 
of system bite. In theory, I think it sounds like a good idea.
    Mr. Foster. Right. Well, a related suggestion is to have a 
fund, to pre-fund the systemic risk thing by basically taxing 
increasingly the large institutions, which is another obvious 
possibility.
    Let's see. Another attack on the too-big-to-fail problem 
has to do with just enforcing compartmentalization. And when 
you talk to Ed Liddy about this, you know, he is just dismayed 
at the prospect of anyone trying to run a business that was as 
diverse as that. And simply, if you had had the individual 
business units of AIG grow, become profitable, and then at that 
point just return dividends to shareholders, who want reinvest 
it wherever they thought it made sense.
    And by enforcing compartmentalization as a way of dealing 
with too-big-to-fail, it also makes the regulator's job a lot 
easier. And I was wondering if you have a reaction to that as a 
possible solution for the insurance industry.
    Mr. Harrington. Well, I mean, it seems to some degree that 
the insurance regulators were fairly successful in doing that 
with AIG. By all accounts, the insurance subsidiaries 
compartmentalized are okay.
    So that if you had taken AIG into a bankruptcy and split 
off all of the FP and other products and just had the insurance 
companies go forward, they would have been okay. But we still 
ended up with a mess in AIG.
    Mr. Foster. Yes?
    Mr. Hunter. I was just going to say I was a little unsure 
how they would do the compartmentalization. But if you mean to 
make the companies more of a monoline type of thing--
    Mr. Foster. For example, yes.
    Mr. Hunter. --that could be a serious problem because you 
could be a pretty small company and be a very large player in a 
single line, and your small company insolvency could actually 
have some significant damage, of course depending on the line, 
like if it was bonds.
    Mr. Foster. Any other comments on it?
    Mr. Harrington. Any compartmentalization, I think, would be 
broadly between insurance-type products and other products. I 
think there are lots of gains from diversification within 
insurance-type products. It is when you get into all sorts of 
ancillary products where the regulatory burden really becomes 
large.
    And of course, that is also true in banking. And in my 
comments before, I think we have to really think about whether 
or not we shouldn't maybe have more restrictions on activities. 
If you want to go to the deposit insurance till and be able to 
get that type of protection for depositors, maybe you have to 
give up some of your choices about what activities your overall 
entity would undertake.
    Mr. Foster. Okay. Thank you. I guess my time is done, so I 
will yield back.
    Chairman Kanjorski. Thank you very much, Mr. Foster.
    Now, Mr. Grayson, I will recognize you for 5 minutes.
    Mr. Grayson. Thank you, Mr. Chairman.
    There has been an awful lot of discussion about whether we 
should regulate, there has been a lot of discussion about who 
should regulate, and much less discussion about what the 
regulation should be.
    Let's assume, for the sake of argument, that we agree that 
something went badly wrong in the case of AIG, and that bailing 
out AIG was not the best use of $100 billion of taxpayer funds. 
Somewhere along the line, somebody should have had the 
authority and the guts to say to AIG, you are doing something 
wrong. You need to stop.
    And what I want to hear from you all is I would like to 
hear your best ideas about what the substantive rules should be 
in order to avoid a recurrence of the situation that we have 
had with AIG. And I am talking about specific limits because I 
am concerned that if we simply say to a systemic risk 
regulator, you figure it out, that is not being responsible.
    So we have to come up with rules that we can actually apply 
with some degree of regularity and avoid the problem that we 
have seen over and over again in this industry, which is 
capture, where the regulated becomes the regulator.
    So let's start with Mr. Hunter. What are your best ideas 
about when to tell AIG or any other insurance company that 
enough is enough?
    Mr. Hunter. Well, again, I think this is the role of a 
solvency regulator, solvency/systemic risk regulator, and that 
there should be specific limits on leverage.
    Mr. Grayson. What limits?
    Mr. Hunter. Well, it may depend upon the line of insurance. 
It does depend upon the line of insurance. If you are writing 
earthquake, you need a lot more capital than if you are writing 
life insurance.
    Mr. Grayson. Give me an example of when you would say 
enough is enough.
    Mr. Hunter. For earthquake insurance, I think you need at 
least two dollars of capital for every dollar of risk. For 
property/casualty insurance, you may need only one dollar for 
two dollars of risk. It depends on the line of insurance there, 
too.
    So you can come up with leverage limits. You can come up 
with size limits. I mean, some companies shouldn't grow beyond 
certain limits, particularly in markets. Ten percent--maybe a 
limit should be 10 percent within a line of insurance, for 
example. In a State, no company should get bigger that so that 
it would enhance both competition and to make a failure less 
damaging.
    Mr. Grayson. Is there a certain size when you think that 
enough is enough when it actually is beginning to invoke 
systemic risk? I mean, we know that a $1 million insurance 
company is not involved in systemic risk, and a $1 trillion 
insurance company is.
    Mr. Hunter. Yes.
    Mr. Grayson. Tell me where you think the line is.
    Mr. Hunter. I don't know. I haven't done the analysis. But 
I think it can be done. And again, it may vary by where you are 
writing and the kinds of risks you have in your portfolio.
    Mr. Grayson. Mr. Harrington, when is enough enough?
    Mr. Harrington. I would like to think I would know it when 
I saw it. But I would not be able to opine on that outside of 
the context of what in particular I was looking at. Clearly, it 
seems to me that someone with knowledge of what was going on at 
AIG should have been able to say, enough is enough. Nobody did.
    Mr. Grayson. You see, Mr. Harrington, that is sort of 
fundamental problem because if you were the systemic risk 
regulator, and you were faced with this situation, unless you 
had clear rules to apply, you might just say, I am just going 
to not deal with it.
    And that is the problem we are going to face unless we come 
up with specific rules. So let me hear from Mr. Webel what you 
think the specific rules should be.
    Mr. Webel. I really don't have--the difficulty is that the 
financial services industry is mutating so quickly, writing 
specific limits into laws puts you in a very difficult 
situation. I think that looking at market share is probably a 
reasonable place to start. But in doing that, to some degree, 
you are also cutting off consumer choice.
    I mean, if an insurance company is doing a great job and I 
want to buy insurance from them, and then the government comes 
along and tells me, oh, no, you can't buy from them because too 
many of your neighbors did--so I would really like to have a 
good number to tell you, but I am sorry. I don't.
    Mr. Grayson. Mr. Grace, when would you put your foot down?
    Mr. Grace. I can't answer directly, but I can give you an 
analogy that I think works really well. Twenty years ago when 
Congressman Dingell had his hearings, he put the insurance 
regulators to the test. And they came up with a system--
actually, this is the thing I was criticizing before. I think 
it has a patina on it now.
    But it was specific rules that happened when certain things 
occurred, and the regulator had no choice, or its choice was 
constrained. You know, he had to either shut it down or he had 
to investigate it, but it was something that had to be done.
    What we are talking about here, there isn't a rule that is 
applicable to every single company universally. Something else 
I also said was that the Europeans are going to this capital 
model, and they are putting all of the firms within an 
enterprise together to assess the type and the quality of 
capital and how it is going to support the risk that it is 
writing.
    And it may be that test can be used in--the risk-based 
capital rules are what I am talking about. But there were 
mandatory requirements that the regulator had to engage in when 
certain things occurred. Science has to be developed to develop 
those rules for current insurance and insurance-like 
enterprises. We don't have it yet.
    Mr. Grayson. Well, my time is up. But I will invite you to 
supplement the record and tell me directly what your best 
thoughts are on this subject. And I honestly find it a little 
disconcerting that five people who are experts in the industry 
and could end up being the systemic risk regulators for 
insurance, any one of you, would find it so difficult to answer 
a question like that.
    I am not blaming you for it, but I think it illustrates 
what a conundrum we are facing here. And I want your best 
thinking about how to solve it.
    Thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mr. Grayson.
    I want to thank the panel particularly before we close the 
session down. The interruption for an hour and 20 minutes was 
inexcusable, but that happens to be the way the House proceeds.
    I want to thank you very much for coming and being part of 
this panel specifically. And I would like to ask you to join us 
again. I hope maybe we could do something in a roundtable 
discussion where we could have play back and forth because I 
think you have a wealth of knowledge that certainly I am 
convinced we here on the subcommittee need if we are ever going 
to accomplish something.
    So again, thank you very much for coming. And I just want 
to caution you that we note that some members may have 
additional questions--I know Mr. Royce does--of this panel 
which they may wish to submit in writing. Without objection, 
the hearing record will remain open for 30 days for members to 
submit written questions to these witnesses and to place their 
responses in the record.
    Before we adjourn, the following written statements will be 
made a part of the record of this hearing: the American Academy 
of Actuaries; and Mr. Eric D. Gerst. Without objection, it is 
so ordered that they are part of the record.
    And now the panel is dismissed, and this hearing is 
adjourned.
    [Whereupon, at 1:49 p.m., the hearing was adjourned.]


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