    [Senate Hearing 111-77]
    [From the U.S. Government Publishing Office]

                                                             S. Hrg. 111-77

                          PERSPECTIVES ON MODERNIZING
                              INSURANCE REGULATION

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

                                    HEARING

                                   before the

                                  COMMITTEE ON
                       BANKING,HOUSING,AND URBAN AFFAIRS
                              UNITED STATES SENATE

                         ONE HUNDRED ELEVENTH CONGRESS

                                 FIRST SESSION

                                       ON

    EXAMINING THE STATE OF THE INSURANCE INDUSTRY, REVIEWING HOW INSURANCE
         IS REGULATED AND WORKING TO MODERNIZE THE REGULATORY STRUCTURE

                                   __________

                                 MARCH 17, 2009

                                   __________

      Printed for the use of the Committee on Banking, Housing, and Urban
                                    Affairs

    Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html

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                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                   CHRISTOPHER J. DODD, Connecticut, Chairman

    TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
    JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
    CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
    EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
    ROBERT MENENDEZ, New Jersey          MEL MARTINEZ, Florida
    DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
    SHERROD BROWN, Ohio                  JIM DeMINT, South Carolina
    JON TESTER, Montana                  DAVID VITTER, Louisiana
    HERB KOHL, Wisconsin                 MIKE JOHANNS, Nebraska
    MARK R. WARNER, Virginia             KAY BAILEY HUTCHISON, Texas
    JEFF MERKLEY, Oregon
    MICHAEL F. BENNET, Colorado

                     Colin McGinnis, Acting Staff Director

            William D. Duhnke, Republican Staff Director and Counsel

                   Charles Yi, Counsel/Senior Policy Advisor

                          Aaron Klein, Chief Economist

                      Drew Colbert,  Legislative Assistant

                    Mark Oesterle, Republican Chief Counsel

                       Andrew Olmem,  Republican Counsel

                           Dawn Ratliff, Chief Clerk

                          Devin Hartley, Hearing Clerk

                          Shelvin Simmons, IT Director

                              Jim Crowell, Editor

                                      (ii)
    ?

                                C O N T E N T S

                                  ----------

                            TUESDAY, MARCH 17, 2009

                                                                       Page

    Opening statement of Senator Dodd................................     1
    Opening statements, comments, or prepared statements of:
        Senator Shelby...............................................     4
        Senator Brown................................................     5
        Senator Crapo................................................     6
        Senator Merkley..............................................     7
        Senator Tester...............................................     8
            Prepared statement.......................................    43

                                   WITNESSES

    Michael T. McRaith, Director, Illinois Department of Financial
      and Professional Regulation, on behalf of the National
      Association of Insurance Commissioners.........................    10
        Prepared statement...........................................    43
        Response to written questions of Senator Crapo...............   126
    Frank Keating, President and CEO, the American Council of Life
      Insurers.......................................................    12
        Prepared statement...........................................    51
        Response to written questions of Senator Crapo...............   129
    William R. Berkley, Chairman and CEO, W.R. berkley Corporation,
      on behalf of the American Insruance Association................    14
        Prepared statement...........................................    54
        Response to written questions of Senator Crapo...............   130
    Spencer M. Houldin, President, Ericson Insurance Services, on
      behalf of the Independent Insurance Agents and Brokers of
      America........................................................    16
        Prepared statement...........................................    56
        Response to written questions of Senator Crapo...............   133
    John T. Hill, President and Chief Operating Officer, Magna Carta
      Companies, on behalf of the National Association of Mutual
      Insurance Companies............................................    17
        Prepared statement...........................................    62
        Response to written questions of Senator Crapo...............   135
    Franklin W. Nutter, President, The Reinsurance Association of
      America........................................................    19
        Prepared statement...........................................    73
        Response to written questions of Senator Crapo...............   139
    J. Robert Hunter, Director of Insurance, the Consumer Federation
      of
      America........................................................    21
        Prepared statement...........................................    79
        Response to written questions of Senator Crapo...............   140

                  Additional Material Supplied for the Record

    Statement of David A. Sampson, President & Chief Executive
      Officer, Property Casualty Insurers Association of America
      (PCI)..........................................................   144

                                     (iii)

                PERSPECTIVES ON MODERNIZING INSURANCE REGULATION

                                  ----------

                            TUESDAY, MARCH 17, 2009

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 9:40 a.m., in room SD-538, Dirksen
    Senate Office Building, Senator Christopher J. Dodd (Chairman
    of the Committee) presiding.

           OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

        Chairman Dodd. The Committee will come to order. Let me
    welcome our witnesses and colleagues who are here this morning.
    I thank them for coming out. The audience has gathered here
    this morning to hear our hearing on the perspectives on
    modernizing insurance regulation. I will share some opening
    comments, and then I will turn to Senator Shelby. And given the
    fact we have got just a few members here, I will ask them if
    they have any opening comments they would like to make as well
    before we get to our witnesses.
        I want to thank our witnesses. We have got an extra long
    table here for you this morning to accommodate all of you, and
    I appreciate immensely your willingness to participate in this
    discussion this morning. It is a critically important one as we
    go forward.
        As I mentioned, this morning the Committee will continue
    the series of hearings that we have been conducting this month
    on modernizing the regulation of our financial system. Today's
    focus will be on the vital component of our economy: the
    insurance industry.
        Before we do that, I want to say a few words about the
    furor surrounding AIG and the hundreds of millions of dollars,
    taxpayer dollars, being paid out in retention bonuses. The
    American people, as we all understand, are outraged, and they
    should be. All of us are. The Chairman of the Federal Reserve
    has said that the Government's efforts to prevent AIG from
    failing outright are akin to a neighbor smoking in bed and
    setting the house on fire. With these bonuses, what we are
    seeing is the folks responsible for picking the pockets of the
    firefighters and stealing the hubcaps off the fire truck. It is
    outrageous.
        This Committee wants to hear what steps the Fed is taking
    to address this situation. We want and expect an immediate and
    full briefing from the Federal Reserve and the Treasury, and we
    also want answers regarding where the Fed has been on
    conditions for these types of bonuses since this rescue effort
    began back in September.
        Second, it was in this Committee room 2 weeks ago that we
    insisted on knowing who the counterparties were that so much of
    the $170 billion in taxpayer funds were going to. Who, we
    asked, are we rescuing, exactly? Since that time, we have
    learned who they are, and here, again, I am hopeful that we
    will have a full and complete accounting of this situation.
        The administration wants to explore every legal means to
    recoup this funding, and I pledge today that if they need the
    help of this Committee to do so, they will get that assistance.
    At a time when we are both trying to put out the fire so that
    we can begin the process of rebuilding public confidence,
    public dollars must be used for one purpose and one purpose
    alone, and that is the public good. What happened at AIG should
    not, in my opinion, be confused with the industry with which it
    is most closely associated--that is, the insurance industry
    itself. But, nonetheless, that is what is in the public mind
    today, and they expect answers, and this Committee intends to
    be a part of finding those answers.
        More than 6 decades ago, the Supreme Court said, and I
    quote:

            Perhaps no modern commercial enterprise directly affects so
            many persons in all walks of life as does the insurance
            business. Insurance touches the home, the family, and the
            occupation or the business of almost every person in the United
            States.

        The Supreme Court said it exactly right in so many ways.
    Insurance is a critical underpinning of our economy, something
    that every person and every business depends upon literally
    every day to provide the certainty we need to live and work in
    an uncertain world. Insurance protects families and properties
    from harm and provides stability to every sector of our
    economy.
        Coming from Connecticut, a State with a long and proud
    history of providing insurance for families and businesses
    throughout the Nation, I am well aware that a strong and
    vibrant insurance marketplace is essential to the well-being of
    our Nation, the financial security of American families, and,
    of course, the growth of our economy.
        That is why we are very proud that we have been able to
    bring two insurance experts from my State today, Mr. Houldin
    and Mr. Berkley, to share their knowledge and experience with
    the Committee to help chart a course forward for the insurance
    industry, our economy, and the Nation.
        It is almost impossible to imagine a single transaction
    taking place in our economy today that does not involve
    insurance in some way, shape, or form. When a consumer buys a
    car or a family purchases a home, they need insurance. When a
    small business owner opens a store or a company builds a
    factory, they need insurance. And when parents seek to protect
    against unforeseen tragedies and provide their children with
    financial security, they need insurance, too.
        As I said in the Committee's hearing on AIG 2 weeks ago, if
    credit is the lifeblood of our economy and a healthy banking
    system is the heart that pumps the blood through that economy,
    then our insurance companies are the lungs that provide the
    oxygen we need to make sure that credit flows. For businesses
    to function, to create jobs, they need access to insurance to
    protect their investments. And during a financial crisis in
    which credit is frozen, the critical role of insurance cannot
    be overstated.
        As this Committee has established over many hearings in
    this Congress and the last, our Nation's regulatory structures
    are outdated and in need of significant overhaul. If we are
    going to build an economy to compete in the 21st century, then
    we are going to need a modernized regulatory structure that is
    rooted in core principles, such as consumer protection and
    sound underwriting. And while the current financial crisis did
    not have its origins in the insurance sector, its adverse
    effects have been felt keenly by participants in the insurance
    marketplace.
        Our goal must be to maintain a healthy, viable insurance
    industry that can and will play a critical role in bringing us
    out of the recession that is hurting families throughout our
    country, hurting them certainly in each of our respective
    States. Going forward, we must review how we regulate insurance
    in this country and carefully work to modernize the regulatory
    structure as appropriate.
        Unlike other sectors in the financial system, such as
    banking and securities, insurance is primarily regulated at the
    State level. The State-based system has been in place, as most
    in this room know today, since the 19th century and has been a
    source of innovation and consumer protection alike.
        However, in recent decades, the insurance industry has
    become increasingly national--in fact, international, and some
    insurance companies have engaged in very complex and
    sophisticated transactions made possible by modern advance in
    financial engineering. In response, many have observed that the
    regulation of insurance needs to be modernized accordingly.
    Various approaches have been proposed, and I would hope this
    hearing this morning will provide an opportunity to better
    understand and evaluate those approaches and produce a record
    upon which to determine future Committee action as we move
    forward in the modernization of financial regulations.
        Given the importance of insurance to our financial system
    and our economy, this Committee has held hearings in the last
    Congress to examine the state of the insurance industry and the
    regulatory framework in which it operates. Insurance regulation
    has also been the subject of hearings of this Committee in
    previous Congresses, and I commend Senator Shelby for his
    attention to this important issue in the past as Committee
    Chairman.
        I also want to take this opportunity to acknowledge the
    hard work of Senator Tim Johnson, who sits in this chair next
    to me, who has been a leader in efforts to modernize the
    regulation of insurance, and we appreciate his efforts.
        And, finally, I want to thank the witnesses who are here
    this morning. I look forward to hearing from you. I thank them
    for their time, their interest in the subject matter, and their
    suggestions on how we ought to proceed as we evaluate these
    very difficult set of questions that must be a part of our
    efforts to modernize the financial regulatory system.
        With that, let me turn to Senator Shelby.

                 STATEMENT OF SENATOR RICHARD C. SHELBY

        Senator Shelby. Thank you, Chairman Dodd.
        Today, the Committee will once again consider insurance
    regulatory reform. The structure of our insurance regulatory
    system, as Senator Dodd has reminded us, dates back to the 19th
    century, a time when few insurance companies operated in one
    State, let alone globally.
        Even before the start of the present financial crisis,
    there were legitimate questions about whether our insurance
    regulatory system was adequate for the 21st century. Recent
    events--most prominently, the stunning collapse of insurance
    giant AIG--have only further demonstrated the pressing need for
    a review of our insurance regulatory structure.
        Two weeks ago, this Committee held a hearing on AIG which
    revealed the problems with the company's State-regulated
    insurance entities and the role they played in the company's
    collapse. AIG's insurance subsidiaries suffered more than $20
    billion in losses from their securities lending operations and
    had to be recapitalized with a loan from the Federal Reserve.
    In addition, this past weekend, AIG disclosed that more than
    $40 billion of the $170 billion in Federal aid was used to pay
    off counterparties to its securities lending operation.
        The circumstances that permitted AIG's securities lending
    operation to potentially threaten the solvency of several of
    its insurance companies and their counterparties suggests that
    our regulatory system has not been keeping up with developments
    in the market. For example, it appears that AIG sought to
    conduct its securities lending operations on a nationwide basis
    by pooling the resources of approximately a dozen separate
    insurance companies regulated by five different States. Because
    insurance is still regulated at the State level, it is unclear
    whether any single State insurance regulator was responsible
    for overseeing AIG's entire securities lending operation. This,
    of course, raises some serious questions about the adequacy of
    State supervision.
        Given the importance of insurers in our markets and overall
    economy, I believe we should at least consider whether
    additional Federal oversight is needed. If insurers are
    managing risk on a national basis, it may make sense to
    consider regulating them on a national basis as well.
        We also need to examine whether the existing insolvency
    regime can handle the failure of a large insurer. If insolvency
    needs to be managed at the national level, then once again a
    Federal insurance regulator may be our only option.
        Finally, the collapse of AIG has also raised the question
    of whether the U.S. needs a Federal systemic risk regulator.
    Attempting to regulate insurers for systemic risk, however,
    presents now many difficult challenges. For example, it would
    likely involve the complex task of ascertaining if and to what
    extent Federal regulation would preempt State insurance
    regulation. On the other hand, if we establish a systemic risk
    regulator and leave insurance regulation to the States, what
    opportunities for regulatory arbitrage would we create? And
    would it actually undermine a systemic risk regulator?
        Given the complexity of insurance regulation, the
    Committee, I believe, needs to understand all of the promises
    and pitfalls of the various approaches to regulatory reform
    before it can begin to craft its own solution. While we cannot
    hope to cover the full range of issues in one hearing, we can
    make a good start today, Mr. Chairman, and thank you for
    scheduling this hearing.
        Chairman Dodd. Thank you, Senator Shelby. A very good
    statement as well.
        Let me turn to Senator Brown.

                   STATEMENT OF SENATOR SHERROD BROWN

        Senator Brown. Thank you, Mr. Chairman. Thank you for your
    leadership on these key issues associated with modernizing our
    regulatory system. Quite understandably, the American people
    want to know if the insurance industry is well run and well
    regulated. Families pay insurance premiums year in and year out
    so that when a crisis hits, they will be protected. That is how
    much of the industry has operated and how it continues to
    operate.
        Columbus, Ohio, in my State is the second largest insurance
    hub in the country. Ohio has scores of insurance companies that
    have faithfully and prudently invested the premiums of their
    policyholders. But over the past few decades, the best and the
    brightest minds on Wall Street have, in a word, belittled this
    business model as behind the times. At AIG, it was not enough
    to insure lives or property or health. A largely unregulated
    corner of the company decided it would make enormous bets on
    exotic financial arrangements, providing insurance where there
    were no actuarial tables, almost no actual experience, and no
    Government regulation and no oversight.
        You would think that such a colossal miscalculation would
    lead to contrition. In the world of Wall Street, you would be
    wrong. Americans have a hard time understanding why we need to
    spend hundreds of billions of dollars to prop up large
    financial institutions in the first place. Paying out hundreds
    of millions of dollars of bonuses to the employees of a company
    that is essentially insolvent smacks of greed, arrogance, and
    worse.
        The Federal Government--that is, taxpayers--has invested
    $173 billion in AIG because its collapse would signal disaster
    for everyday Americans and the global financial system as a
    whole. We know it is that serious. But we should not be
    financing one dime of bonuses for AIG employees, for executives
    whose actions took the form of reckless endangerment, and we
    need to know was AIG so arrogant that they used taxpayer
    dollars, tens of billions of dollars, to pass through to their
    customers, rewarding those bad business decisions of both their
    customers and themselves--Societe Generale, Deutsche Bank,
    Barclays, Goldman Sachs. The list is pretty long.
        We need tough insurance regulations that promote common
    sense and prevent Wall Street from building castles in the sand
    at Main Street's expense. We need to fix the regulatory system
    that created the AIG monster and let a bubble grow so large
    that when it burst, it took our Nation's economic and the
    world's economic stability with it.
        We can design that system if we focus on doing what is best
    for the American people and the U.S. economy in the long run.
    That means solid safeguards to prevent another financial
    meltdown in a regulatory environment defined by zero tolerance
    for snake oil salesmen.
        With common-sense rules, we can allow honest brokers
    literally and figuratively to earn an honest living, and we can
    allow policyholders to have confidence that the policy they
    bought will be there when they need it.
        Thank you, Mr. Chairman.
        Chairman Dodd. Thank you, Senator, very much.
        Senator Crapo.

                    STATEMENT OF SENATOR MIKE CRAPO

        Senator Crapo. Thank you very much, Mr. Chairman. This is
    one of those interesting hearings where I find myself in
    complete agreement so far with every one of my colleagues. I
    will not try to repeat everything, but I do want to say that as
    we approach this hearing, clearly in the context of regulatory
    reform, many of us are looking far beyond simply the insurance
    industry but to the entire financial system that we have in our
    country. And one of the obvious questions is whether we need to
    create a very broadly empowered systemic risk regulator.
        If we do need to create such a systemic risk regulator,
    would that regulator have authority over insurance for systemic
    risk regulation? If we do have that kind of insurance-covered
    systemic risk regulator with broad powers, how does that
    regulator coordinate with the functional or solvency regulator?
    And if that regulator is not just a single additional Federal
    regulator, how do we coordinate with the 50 States and deal
    with the kinds of issues that both our Chairman and Ranking
    Member have raised today?
        Those kinds of questions are important for us to answer as
    we move forward in the larger context of what our broad
    regulatory system will be for our financial institutions in
    this Nation, and I look forward to guidance from our witnesses
    on that today.
        I just want to mention one other item very quickly. I note
    that at least one of our witnesses has raised the possibility
    that it is not likely that there is any single insurer that is
    too big to fail. Obviously, we thought that AIG was too big to
    fail, and there are now analysts who are starting to question
    this notion of too big to fail, whether it be in the insurance
    industry or in other parts of our financial system.
        I am interested in that notion. If there are institutions
    that are too big to fail, how do we identify that? How do we
    define the circumstance where a single company is so
    systemically significant to the rest of our financial
    circumstances and our economy that we must not allow it to
    fail? And what does ``fail'' mean? Often, we are, in the
    context of AIG, now talking about whether we should have
    allowed an orderly Chapter 11 bankruptcy proceeding to proceed?
    Is that failure? And is that consequence something that we
    cannot work into our system of dealing with systemic risk and
    the larger questions of how the Federal Government will
    approach large multinational and systemically significant
    companies?
        I know that this raises a lot of almost ethereal questions
    that are going to be very difficult for us to answer, but the
    fact is that Americans are increasingly asking themselves why.
    Why are we going down these paths?
        When we first started putting resources into AIG, after the
    first tranche was put in, it was very commonly said by many to
    us here in Congress that, ``Well, this is not just an
    expenditure of taxpayer dollars that are going to be lost. In
    fact, as we unwind AIG and as we liquidate its assets, the
    taxpayers are going to make a profit.'' Anybody here hear that?
    That was the first tranche.
        Now we have gone through number 2, number 3, and number 4.
    Nobody is saying that anymore. And the question that I have is:
    As we move into this, we need to have a better idea of what
    this notion of too big to fail is, what it means in different
    aspects of our industry, and what our proper response to it
    should be. Should we regulate in such a way that we do not get
    into situations like that? Or should we have a regulatory
    system that contemplates circumstances where we face companies
    that are too big to fail and somehow puts together a rational
    approach to prop them up, or as some say, nationalize them?
        Now, I am very concerned by the implications of this entire
    question, and I realize we are not going to answer the question
    in today's hearing entirely. But I would be interested in the
    observations of our witnesses on this issue.
        Thank you very much, Mr. Chairman.
        Chairman Dodd. Thank you, Senator Crapo.
        Senator Merkley.

                   STATEMENT OF SENATOR JEFF MERKLEY

        Senator Merkley. Thank you very much, Mr. Chairman, for
    convening this hearing. The task of modernizing the insurance
    regulatory system is absolutely essential. Over the past 2
    years, the American people have been outraged to discover the
    existence of a $50 trillion insurance industry that was
    entirely unregulated; outraged that this industry could avoid
    regulation by the New York insurance regulators by using the
    term ``credit default swaps'' rather than ``credit default
    insurance''; outraged that firms within this industry went
    regulator shopping to avoid effective oversight; outraged that
    the activities of these firms created an asset bubble, the
    collapse of which has left millions of Americans out of work
    and millions more with their life savings obliterated; and
    absolutely enraged that the very same industry that did all
    these things is richly rewarding its employees with perks and
    bonuses funded with taxpayer funds. The situation is offensive
    to me; it is offensive to the American people.
        Mr. Chairman, we have a duty and obligation to fix our
    insurance regulatory system, to address regulatory arbitrage,
    to address systemic risk, to make sure that this situation does
    not ever arise again.
        Thank you.
        Chairman Dodd. Thank you very much.
        Senator Corker.
        Senator Corker. As is my custom, I will wait until the
    witnesses--out of respect for you, I will wait until you
    testify. I do look forward to that.
        Chairman Dodd. Senator Tester.

                    STATEMENT OF SENATOR JON TESTER

        Senator Tester. Thank you, Mr. Chairman. Thank you, Ranking
    Member Shelby.
        Before we get into the modernization of our insurance
    regulatory system, I do want to just say a couple things about
    AIG, specifically about what has transpired over the weekend on
    the $165 million bonuses.
        It was about 6 months ago that Secretary Paulson came into
    this Committee and said that we need some significant money
    invested in the financial system; otherwise, we will experience
    a financial meltdown. There were a lot of very, very difficult
    decisions that were made over the next few days that many
    people lost sleep over. A lot of taxpayer dollars were doled
    out. And there was a lot of discussion about additional
    compensation, particularly bonuses, to companies who were led
    down the wrong path, who were on the verge of going bankrupt.
        And now, once again, this weekend we hear of a company--AIG
    in particular--who has received $173 billion in taxpayer money
    doling out some $165 million in bonuses to their employees
    because supposedly it was the contract. Well, the fact is what
    would those contracts have been if the taxpayers would not have
    bailed them out. That company would have been broke. Those
    people would be part of the 600,000 unemployed that occur in
    this country a month, every month, and they would be on the
    street.
        So what do the taxpayers get for thanks for throwing $173
    billion into a company like AIG? Continued bonuses, the same
    old way of doing business. And what do we hear? We hear,
    ``Well, these bonuses have to be given out because this is our
    professional workforce.''
        I can tell you that this is incredibly unacceptable, and
    the fact is that these companies going broke, companies like
    AIG, it makes perfect sense to me now. If anybody did business
    like these folks do business, they would be in the same boat.
    And all I have to say, before I get into my brief statement, is
    that if this is the way Wall Street and AIG and all the others
    continue to do business, we cannot help with any amount of
    money we put forth to them. This is ridiculous.
        And, hopefully--hopefully--we will find some way--I do not
    care. Litigate it in court. This just is not right to be
    occurring. It is not right to be occurring because this company
    would be out of business, and those people would be on the
    street. And they need to understand that the only reason that
    they even have a job is because of the taxpayers and their
    ability to put forth money to this.
        Thank you, Mr. Chairman. I just want to say a few things
    about the modernization.
        I believe that you have put together a great panel of
    witnesses today to help provide perspective on this issue that
    we are about to confront, and that is regulatory reform in the
    financial sector, particularly insurance. And while I believe
    there is a need to act quickly to instill consumer confidence
    through the regulatory modernization, I believe we also need to
    be cautious. We do not want to overregulate, but we want to do
    it in a targeted, effective manner. And I feel that insurance
    regulation may be viewed by some as a candidate for wholesale
    regulatory overhaul where more deliberative measures would be
    more effective.
        However, I am interested in the spectrum of ideas. I truly
    do look forward to hearing from the witnesses so we can come up
    with some common-sense solutions for regulation in the
    marketplace.
        Thank you, Mr. Chairman.
        Chairman Dodd. Thank you very much, Senator Tester. And,
    again, we thank our witnesses for being with us this morning.
        I think you have heard as well here from all of us on the
    AIG matter, and one way or another, we are going to try and
    figure out how we are going to get these resources back.
        I would note as well, though, at the same time they were
    announcing the bonuses, there was a second story, and the
    second story was--my colleagues will recall at this hearing
    where we asked who the counterparties were 2 weeks ago, and
    there was reluctance, of course, to share with the Committee
    who the counterparties were, and for obvious--I understand why
    there was reluctance. But in that story we are discovering that
    there were companies that were getting as much as $12 billion,
    dwarfs the $165 million in a sense. And so that story ended up
    being sort of a secondary story because bonuses obviously
    attract more attention. But I would point out to my colleagues
    that the counterparty story is a much bigger story in many
    ways. Because the question I asked, I think at the outset of
    the hearing is: Who did we bail out? Who in a sense was
    rescued? And we are now discovering that they were companies,
    including foreign operations, that were receiving billions of
    dollars at 100 percent value.
        So while we can get angry about, and should, over the bonus
    issue, there is a secondary story that seems to be playing a
    second level that ought to be a source of far more aggressive
    action on our part to determine how that happened, why 100
    percent value, why the collateral that was left in their hands.
    There are many other questions in addition to the bonus issue
    that we need to address. But I am confident we can come up
    with--at least we should be able to try to come up with an
    answer on how to get back the bonus issue.
        Senator Shelby. Mr. Chairman, along those lines, if I can
    just make a brief comment. I hope that you as Chairman of the
    Committee will bring up the Inspector General of TARP, Mr.
    Barofsky, again, as he is doing his work, because I believe the
    American people want transparency and accountability on where
    all this TARP money went, including AIG, a lot of the money to
    the auto companies, who is benefiting from it, and so forth.
    And we just got a little of it, and we have had to extract that
    piece by piece. And I want to commend you, Mr. Chairman, for
    pursuing this.
        I think everybody on this Committee wants to know where
    this money went, who benefited, where it is. We have gotten a
    little, but there is a lot more to come.
        Chairman Dodd. That is a good suggestion, Senator, and we
    will follow up with that. Let me welcome our panel here and
    move on to the subject matter in front of us today.
        Michael McRaith is the Director of Insurance for the State
    of Illinois, and he is testifying on behalf of the National
    Association of Insurance Commissioners, and we thank you very
    much for being with us.
        Second is Frank Keating, who is President and CEO of the
    American Council of Life Insurers, a position that Mr. Keating
    has assumed since 2003, following his service as the Governor
    of Oklahoma. We thank you very much, Frank, for joining us.
        I mentioned during my remarks Bill Berkley, Chairman and
    CEO of the W.R. Berkley Corporation, and since founding the
    company in 1967, he has managed its growth into a Fortune 500
    property/casualty insurance company headquartered in my State
    of Connecticut. He serves, as well, as Vice Chairman of the
    Board of Trustees of the University of Connecticut. We thank
    you, Bill, for joining us.
        Spencer Houldin is the President of Ericson Insurance
    Advisers, which is headquartered in Washington Depot,
    Connecticut. We thank you for joining us. Mr. Houldin is
    testifying on behalf of the Independent Insurance Agents and
    Brokers of America, where he has served as Chairman of the
    Government Affairs Committee since 2008.
        John Hill is President and Chief Operating Officer of Magna
    Carta Companies, a commercial lines insurance headquartered in
    New York City, and we thank you, Mr. Hill, for being with us.
        Frank Nutter is the President of the Reinsurance
    Association of America, a position he has held since 1991. And,
    Frank, we thank you for being with us.
        Robert Hunter serves as the Director of Insurance for the
    Consumer Federation of America. I had the pleasure of
    addressing the Consumer Federation of America last week, and,
    once again, always important to have you at the table when
    matters like this are being discussed. So we thank you for
    joining us.
        We will begin with you, Mr. McRaith. We are going to try
    and limit you because we have a large panel. Try and keep your
    remarks to 5 minutes. I will not bang down the gavel, but if I
    am raising it, it means you should wrap it up.

    STATEMENT OF MICHAEL T. McRAITH, DIRECTOR, ILLINOIS DEPARTMENT
      OF FINANCIAL AND PROFESSIONAL REGULATION, ON BEHALF OF THE
                        NATIONAL ASSOCIATION OF
                        INSURANCE COMMISSIONERS

        Mr. McRaith. Chairman Dodd, Ranking Member Shelby, members
    of the Committee, thank you for inviting me to testify. I am
    Michael McRaith, Director of Insurance for the State of
    Illinois, and I speak today on behalf of the National
    Association of Insurance Commissioners.
        The insurance industry, even in these difficult times, has
    withstood the collapses that echo through the other financial
    sectors.
        Today, we may not agree on everything, but we likely do
    agree that insurance regulation must not only serve the
    industry, but most also prioritize U.S. consumers. Consumer
    protection has been, is, and will remain priority one for State
    regulators. We supervise 36 percent of the world's insurance
    market. Our States include four of the top ten, 28 of the top
    50 world markets, and alone we surpass two, three, and four
    combined. With the world's most competitive market, we, your
    States, are the gold standard for regulation in developing
    countries.
        Some in the industry take the opportunity of our crisis to
    clamor for the so-called option Federal charter or
    deregulation. Respectfully, this decade-old rhetoric does not
    warrant the important time of this Committee.
        To be sure, as with any dynamic industry, insurance
    regulation must modernize, and it does. We have worked with
    producers to improve national licensing uniformity and
    reciprocity. Working with producers, we commented in support of
    a proposal to improve how States deal with surplus lines. State
    regulators adopted a comprehensive reinsurance reform proposal
    and are presently developing implementation details. The
    Interstate Compact, a single portal for approval of annuity and
    life products, has been adopted by 34 jurisdictions.
        The NAIC maintains the world's largest insurance financial
    data base, a consumer information resource, licensing for more
    than 4 million producers, and other subject matter data. We
    want to ensure that this information serves Congress and the
    Federal executive branch.
        The NAIC is active internationally, collaborates regularly
    with our counterparts overseas, serves as technical adviser to
    the USTR, works with the OECD, the Joint Forum, and others. But
    accepting the limits of Article I, Section 10 of the
    Constitution, we acknowledge the need for a coordinator of
    Federal policy on international insurance matters. For these
    reasons, we work constructively to narrow aspects of preemption
    and supported creation of the Office of Insurance Information.
        With respect to Solvency II, the mythology of this EU
    directive far exceeds its factual merits. Details of the plan
    remain in dispute and incomplete, and agreement among the EU
    nations is a wilting aspiration.
        State regulators do support systemic risk regulation based
    on the principle of integration, but not displacement of
    functional regulators. State-based insurance regulation and
    national or international systemic regulation are inherently
    compatible. Information sharing and confidentiality protocols
    can be established, and coordination among financial regulators
    can be formalized.
        State regulators know that effective regulation coincides
    with corporate governance and comprehensive risk management,
    and supervisory colleges can require both. Preemption of any
    functional regulator should occur only with material risk to
    the solvency of the enterprise, the demise of which would
    threaten systemic stability.
        We must be ever vigilant, though, not to preempt the State-
    based consumer protections and solvency standards that serve
    our public so well. While conversation most often centers on
    industry concerns, in 2008 State regulators replied to over 3
    million consumer inquiries and complaints. Like you, we know
    that a single mother in a car wreck racing between jobs needs
    local and prompt assistance. And we know that an elderly
    gentleman on a fixed income sold an indexed annuity cannot wend
    his way through a Federal bureaucratic morass.
        After every incident, our consumers, your constituents,
    need to know that the company that collected their premiums,
    often for years, has the wherewithal to pay the claim.
        To conclude, we support systemic regulation, pledge our
    good-faith interaction, and renew our commitment to engage
    constructively with this Committee.
        Thank you for your attention, and I look forward to your
    questions.
        Chairman Dodd. That was right on 5 minutes to the second.
    Very good, Mr. McRaith.
        Mr. Keating?

      STATEMENT OF FRANK KEATING, PRESIDENT AND CEO, THE AMERICAN
                        COUNCIL OF LIFE INSURERS

        Mr. Keating. Mr. Chairman, Senator Shelby, Members of the
    Committee, thank you for giving me this opportunity to speak to
    the subject of regulatory modernization.
        The ACLI is the principal trade association for U.S. life
    insurance companies, and its 340 member companies represent 93
    percent of life insurance business and 94 percent of the
    annuity business in the United States.
        There are three points I would like to emphasize to the
    Committee this morning. The first is that the life insurance
    business is systemically significant, not only in terms of the
    protection and retirement security it provides to millions of
    Americans, but also in terms of the role it plays in capital
    formation in our economy. Decisions and initiatives addressing
    regulatory reform and economic recovery of the financial sector
    must reflect that fact.
        The second point is that, absent a Federal insurance
    regulator, the ability of Congress to fully and effectively
    implement whatever national financial regulatory policy you
    establish will be problematic, at best, with respect to
    insurance.
        And third, as Congress and the administration address the
    deepening crisis in the financial sector, decisions are being
    made that have a profound effect on the life insurance
    business. Unfortunately, Mr. Chairman, those decisions are
    being made without any real understanding of how our business
    operates and without any significant input from our regulators.
        Financial regulatory reform is focused at the moment on
    systemic risk, as we agree it should be. But if reform
    initiatives do not encompass all those segments of financial
    services that are systemically significant, there will almost
    certainly be gaps in systemic risk regulation. With our
    financial markets as interlinked as they are today, gaps
    relative to any one sector present an unacceptably high
    likelihood of widespread problems down the road.
        My written statement details the facts demonstrating that
    life insurance is by any measure a systemically significant
    component of U.S. financial services. Let me touch, though, on
    a few highlights.
        First, life insurance products provide financial protection
    for some 70 percent of U.S. households. There is over $20
    trillion in life insurance in force, and our companies hold
    $2.6 trillion in annuity reserves. Annually, we pay out almost
    $60 billion in life insurance benefits, over $70 billion in
    annuity benefits, and more than $7 billion in long-term care
    insurance benefits.
        We are the backbone of the employee benefits system. More
    than 60 percent of all workers in the private sector have
    employer-sponsored life insurance, and our companies hold over
    22 percent of all private employer-provided assets. Life
    insurers are the single largest source of corporate bond
    financing and hold approximately 18 percent of total U.S.
    corporate bonds.
        The last thing this Congress or this administration wants
    is for any one of those critical roles that life insurers play
    to be jeopardized. Placing the highest priority on measures
    designed to stabilize the payment system is appropriate, but
    doing so while ignoring other systemically significant segments
    of financial services or doing so at the expense of those other
    segments is not.
        My second point is on policy implementation. Whatever
    legislation Congress ultimately enacts will reflect your
    decisions on a comprehensive approach to financial regulation.
    Your policy should govern all systemically significant sectors
    of the financial services industry and should apply to all
    sectors on a uniform basis without any gaps that could lead to
    systemic problems.
        Without a Federal insurance regulator, on an optional
    basis, and without direct jurisdiction over insurance
    companies, and given clear constitutional limitations on the
    ability of the Federal Government to mandate actions by State
    insurance regulators, how will national regulatory policy be
    implemented with respect to the life insurance industry?
        The situation would appear to be very much analogous to
    privacy under Gramm-Leach-Bliley. Federal bank and securities
    regulators implemented that policy for banking and securities
    firms, but Congress could not compel insurers to subscribe to
    the same policies and practices on privacy. You could only hope
    that 50-plus State regulators would individually and uniformly
    decide to follow suit. Hope may have been an acceptable tool
    for implementing privacy policy, but it should not be the model
    for reform of U.S. financial regulation. The stakes are simply
    too high.
        My last point deals with the fact that critical decisions
    are being made in Washington affecting our business, but they
    are being made without any significant import or involvement on
    the part of our regulators. Some examples include the handling
    of Washington Mutual, which resulted in life insurers
    experiencing substantial portfolio losses, the suspension of
    dividends on the preferred stock of Fannie and Freddie, which
    again significantly damaged our portfolios and directly
    contributed to the failure of two life companies.
        The badly mistaken belief by some that mark-to-market
    accounting has no adverse implications for life insurance
    companies and more recently the cramdown provisions in the
    proposed bankruptcy legislation that would result, certainly
    could result in the unwarranted downgrades to life insurers'
    AAA-rated residential mortgage-backed securities investments.
        Those actions were all well intended, but in each instance,
    they occurred with little or no understanding of their effects
    on life insurance companies. And in each instance, the only
    voice in Washington raising concern was that of life insurers
    and their agents. Acting without input from an industry's
    regulators runs a high risk of unintended adverse consequences.
    And by ``input,'' I mean day in, day out, week in, week out.
    Insurance is the only segment of the financial services
    industry that finds itself in this unacceptable situation, and
    that must be changed.
        Let me conclude by reiterating that reforming U.S.
    financial regulation and stabilizing the financial markets must
    take into account all segments of the financial services
    industry, including life insurers. We urge Congress to
    recognize the systemic importance of our business to the
    economy and to the retirement and financial security of
    millions of Americans and to tailor reform and stabilization
    initiatives accordingly.
        We pledge to work closely with this Committee to help craft
    the best possible system for overseeing all segments of our
    financial markets.
        Thanks again, Mr. Chairman and members, for giving us this
    opportunity to comment on these extraordinarily important
    matters.
        Chairman Dodd. Thank you very much.
        Mr. Berkley.

    STATEMENT OF WILLIAM R. BERKLEY, CHAIRMAN AND CEO, W.R. BERKLEY
      CORPORATION, ON BEHALF OF THE AMERICAN INSURANCE ASSOCIATION

        Mr. Berkley. Thank you, Chairman Dodd, Ranking Member
    Shelby, and members of the Committee. I am testifying today not
    just as CEO of W.R. Berkley Corporation, but as Chairman of the
    Board of the American Insurance Association.
        I believe that I bring a unique and broad perspective to
    this discussion. I have been involved in the insurance business
    as an investor or manager for over 40 years. I am a leading
    shareholder of insurance and reinsurance companies, and I am
    also a majority shareholder of a nationally chartered community
    bank. I have witnessed the ebbs and flows of business cycles
    during that time, with the only constants being the existence
    of risk and the need to manage it. It is that challenge that
    brings us here today--the imperative of examining,
    understanding, and measuring risk on an individual and systemic
    level--and retooling the financial regulatory structure to be
    responsive to that risk. With that context in mind, I would
    like to focus my remarks today on three major themes.
        First, property/casualty insurance is critical to our
    economy, but it does not pose the same types of systemic risk
    challenges as most other financial services sectors.
        Second, because property/casualty insurance is so essential
    and is especially critical in times of crisis and catastrophe,
    Federal insurance regulation will enhance the industry's
    effectiveness, provide for greater consumer protection, and
    should be included as part of any well-constructed Federal
    program to analyze, manage, and minimize systemic risk to our
    economy.
        Third, given the national and global nature of risk assumed
    by property and casualty insurers, establishment of a Federal
    insurance regulator is the only effective way of including
    property/casualty insurance in such a program.
        Property/casualty insurance is essential to the overall
    well-being of the U.S. economy. We purchase close to $270
    billion in State and municipal bonds, pay almost $250 billion
    annually in claims, and, importantly, employ over 1.5 million
    hard-working Americans. Property/casualty insurance protects
    individuals and businesses against unforeseen risks and enables
    them to meet their financial responsibilities. Insurance allows
    all businesses to function effectively, Main Street and large
    businesses alike.
        Property/casualty insurance remains financially strong
    through this current crisis. There are several reasons for
    that, but importantly, property/casualty insurance operations
    are generally low-leveraged businesses, with low asset-to-
    capital ratios. They are more conservative investment
    portfolios and more predictable cash-flows that are tied to
    insurance claims rather than on-demand access to assets.
        Yet, despite the industry's strong financial condition
    during this crisis, there are compelling reasons to establish
    Federal regulation for property/casualty insurance in any
    regulatory overhaul plans. The industry could always face huge,
    unforeseen, multi-billion-dollar loss events such as another
    natural disaster or terrorist attack. It makes little sense to
    look at national insurance regulation after the event has
    already occurred, but a lot of sense to put such a structure in
    place before the crisis to help avoid the consequences or
    mitigate those consequences that are unforeseen. However this
    Committee resolves the debate on Federal financial regulatory
    modernization, the only effective way to include property/
    casualty insurance would be to create an independent Federal
    regulator that stands as an equal to the other Federal banking
    and securities regulators.
        I continue to believe this, with all due respect to the
    State insurance regulatory community. The State-based insurance
    regulatory structure is fragmented and frequently not well
    equipped to close the regulatory gaps that the current crisis
    has exposed. Each State only has jurisdiction to address those
    companies under its regulatory control. Even where the States
    have identical laws, the regulatory outcomes may still be
    inconsistent because of diverse political environments and
    regulatory interests. If this crisis has revealed anything, it
    is the need for regulatory efficiency, coordinated regulatory
    activity and sophisticated market analysis, and the ability to
    anticipate and deal with potential systemic risk.
        In addition, virtually all foreign countries have national
    regulators who recognize that industry supervision goes well
    beyond solvency. Effective contemporary regulation also must
    examine erratic market behavior by companies in competitive
    markets to ensure that those markets continue to function
    properly and do not either encourage other competitors to
    follow the lead of irrational actors or impede the competitive
    ability of well-managed enterprises.
        The reality is that no one State can effectively deal with
    mega-events or cross-border issues that impact multiple States,
    and no State can handle a global crisis. The American
    Association and its members have supported the National
    Insurance Act sponsored by Senator Johnson in the last Congress
    as the right vehicle for smarter, more effective insurance
    regulation.
        Yet we recognize that even the best legislative vehicle
    must be updated to be responsive to the evolving economic
    climate and to enhance strong consumer protections.
        Let me close by thanking the Committee again for opening
    the dialog on this critical issue. The time is ripe for
    thoughtful, measured, but decisive action. We stand ready to
    work with you on a regulatory system that restores confidence
    in our financial system.
        Thank you.
        Chairman Dodd. Thank you very much, Mr. Berkley.
        Mr. Houldin.

     STATEMENT OF SPENCER M. HOULDIN, PRESIDENT, ERICSON INSURANCE
      SERVICES, ON BEHALF OF THE INDEPENDENT INSURANCE AGENTS AND
                           BROKERS OF AMERICA

        Mr. Houldin. Good morning Chairman Dodd, Ranking Member
    Shelby, members of the Committee. My name is Spencer Houldin,
    and I am pleased to be here on behalf of the Independent
    Insurance Agents and Brokers of America. Thank you for the
    opportunity to provide our association's perspective on
    insurance regulatory modernization.
        The insurance arena is not immune from the effects of the
    current crisis, but I am happy to report that my business and
    much of the insurance marketplace remains healthy and stable.
    While the insurance business would benefit from greater
    efficiency and uniformity, we should be extremely cautious in
    the consideration of wholesale changes that could have a
    disruptive effect. We also believe that it is critically
    important to keep in mind how potential regulatory changes
    could impact small businesses.
        Few have been left unscathed by the recent economic crisis,
    and like most Americans, the property and casualty market has
    suffered investment losses due to the stock market decline. But
    the property and casualty insurance market is stable and
    continues to serve consumers well. There has not been one
    property/casualty insurer insolvency in the past year, and not
    one property/casualty insurer has sought access to TARP funds.
        If there is one thing to take from my testimony today, it
    is that the property and casualty insurance market continues to
    operate very well without the need for the Federal Government
    to provide any type of support.
        Some groups have pointed to the failure of AIG to drive
    their deregulation agenda, such as through an optional Federal
    charter. AIG is a unique institution in the financial services
    world and its holding company has a Federal regulator--the OTS.
    AIG is not Exhibit A for day-to-day Federal regulation,
    especially an OFC.
        Most observers agree that State regulation works
    effectively to protect consumers. State officials continue to
    be best positioned to be responsive to the needs of the local
    marketplace and local consumers.
        Additionally, it should not be overlooked that the State
    system has an inherent consumer protection advantage in that
    there are multiple regulators overseeing an entity and its
    products, allowing others to notice and rectify potential
    regulatory mistakes or gaps. Providing one regulator with all
    of these responsibilities could lead to more substantial
    problems where errors of that one regulator lead to extensive
    problems throughout the entire market.
        This crisis also has provoked a discussion of risks to the
    entire financial services system as a whole. While a clear
    definition of ``systemic risk'' has yet to be agreed upon, we
    believe the crisis has demonstrated a need to have special
    scrutiny of the limited group of unique entities that engage in
    services or provide products that could pose systemic risk to
    the overall financial services market. Federal action,
    therefore, is likely necessary to determine and supervise such
    systemic risk concerns.
        While State regulation continues to protect consumers and
    provide market stability, we have long promoted the use of
    targeted measures by Congress to help reform the State system
    in limited areas. By using limited, as-needed Federal
    legislation, we can improve rather than dismantle the current
    State-based system.
        For example, to rectify the problem of redundant and costly
    licensing requirements, we strongly support targeted
    legislation that would immediately create a National
    Association of Registered Agents & Brokers, known as NARAB, to
    streamline nonresident insurance agent licensing. Given the
    economic crisis in which we find ourselves today, it is
    somewhat surprising that we have to address the issue of an
    optional Federal charter. We oppose OFC because we believe it
    would worsen the current financial crisis as its theory of
    regulatory arbitrage has been cited as one of the key reasons
    why we find ourselves in the current situation. President
    Barack Obama and Treasury Secretary Geithner have both made
    comments that we should not allow regulated entities to cherry-
    pick from competing regulators. Does anyone really think that
    allowing AIG to choose where it was regulated would have solved
    their problems?
        Creating an industry-friendly optional regulator also is at
    odds with one of the primary goals of insurance regulation,
    which is consumer protection. OFC legislation deregulates
    several areas currently regulated at the State level, flying in
    the face of the nearly universal call today for stronger and
    more effective regulation of the financial services industry.
        As I previously mentioned today--and it bears repeating one
    last time--we believe that with the exception of a properly
    crafted systemic risk overseer, targeted modernization is the
    prudent course of action for reform of day-to-day insurance
    regulation.
        IIABA again appreciates the opportunity to testify, and we
    remain committed to continuing to work to improve State
    insurance regulation for both the consumers and market
    participants.
        Chairman Dodd. Thank you, Mr. Houldin.
        Mr. Hill, welcome to the Committee.

       STATEMENT OF JOHN T. HILL, PRESIDENT AND CHIEF OPERATING
       OFFICER, MAGNA CARTA COMPANIES, ON BEHALF OF THE NATIONAL
               ASSOCIATION OF MUTUAL INSURANCE COMPANIES

        Mr. Hill. Thank you, Chairman Dodd.
        Good morning, Chairman Dodd, Ranking Member Shelby, and
    members of the Committee. My name is John Hill, and I am
    President and COO of Magna Carta Companies. As someone who grew
    up in modest circumstances in rural New Jersey, it is truly an
    honor to testify before you on these important issues at this
    point in our Nation's history.
        Magna Carta was founded in New York in 1925 as a mutual
    insurance carrier for the taxicab industry. Today we employ 240
    individuals and write in 22 States. We very much remain a small
    mutual insurer with $170 million in direct written premiums.
        I am here today on behalf of the National Association of
    Mutual Insurance Companies to present our views on insurance
    regulation. NAMIC represents more than 1,400 property and
    casualty insurance companies ranging from small farm mutual
    companies to State and regional insurance carriers to large
    national writers. NAMIC members serve the insurance needs of
    millions of consumers and businesses in every town and city
    across America.
        I also have the privilege of serving as Chairman of NAMIC's
    Financial Services Task Force, which was created specifically
    to develop NAMIC's policy response to the financial services
    crisis. Our Nation faces an unprecedented financial crisis, and
    we commend the Committee for holding this hearing to explore
    the role of insurance regulation.
        To begin, it is important to understand the distinction
    between the property and casualty insurance industry and other
    financial services, including life insurance. For one,
    property/casualty insurers maintain a significantly higher
    ratio of capital to assets than do life insurers and other
    financial institutions. This means that property and casualty
    insurers are less affected by investment risk. Today, as other
    financial services companies are failing and seeking Government
    assistance, property and casualty insurers continue to be well
    capitalized and neither seek nor require Federal funding.
        We support a reformed system of State regulation. Property
    and casualty risks are inherently local in nature, and
    insurance contracts are dependent on State tort and contract
    law. The industry is competitive, solvent, and generally well
    regulated.
        The hallmarks of insurance regulation are solvency
    oversight and consumer protection. State regulators resolve
    literally millions of consumer inquiries each year. They also
    actively supervise all aspects of the business of insurance by
    establishing and enforcing strict solvency and investment
    standards and limiting unrelated activities of insurance
    affiliates. Moreover, in the rare event of an insurer
    insolvency, the State guarantee system provides another layer
    of protection for consumers.
        In 2008, 25 banks failed and an additional 17 have failed
    already this year, demonstrating a weakness in Federal banking
    solvency regulation. Now, contrast that with the property and
    casualty insurance industry which has had an excellent solvency
    record in 2008 in spite of a large drop in investment income
    and Hurricane Ike, the fourth most expensive hurricane in U.S.
    history. The State-based insurance regulatory system has, in
    fact, proven to be one of the few bright spots in our Nation's
    regulatory structure.
        We are painfully aware of the extraordinary measures that
    the Federal Government has been forced to take to prevent the
    collapse of AIG. Although it has been described as the
    insurance giant, AIG is, in fact, a financial conglomerate that
    is not typical of the insurance industry as a whole. The
    extraordinary problems experienced by AIG were largely caused
    by its non-insurance Financial Products unit. AIG's failure
    does not provide justification to supplant State-based
    insurance regulation.
        The current crisis demands that Congress act, but Congress
    must act prudently and responsibly, focusing limited resources
    on the most critical issues. We encourage Congress to adopt a
    measured approach to the problems at hand and avoid the
    inclination to rush to wholesale reform.
        As policymakers work to develop long-term solutions to our
    present financial crisis, NAMIC urges Congress to keep in mind
    the dramatic differences between Main Street organizations,
    continuing to meet the needs of their local markets and those
    institutions that caused this crisis and have either gone out
    of business or required unprecedented Government financial
    intervention.
        We recommend the following reforms to strengthen our
    Nation's financial regulatory system:
        One, address systemic risk by focusing on financial
    products that pose a risk to the entire financial system rather
    than particular institutions.
        Two, establish an Office of Insurance Information to inform
    Federal decisionmaking on insurance issues and facilitate
    international agreements.
        And, three, expand the President's Financial Working Group
    to include State regulators.
        We believe such reforms are measured, appropriate, and
    timely responses to the present crisis. As the process moves
    forward, we stand ready to work with the Committee to address
    the current problems and regulatory gaps while keeping in mind
    the legitimate interests of Main Street businesses and
    consumers.
        Again, we thank you for the opportunity to speak here
    today.
        Chairman Dodd. Thank you very much, Mr. Hill.
        Mr. Nutter, thank you.

      STATEMENT OF FRANKLIN W. NUTTER, PRESIDENT, THE REINSURANCE
                         ASSOCIATION OF AMERICA

        Mr. Nutter. Chairman Dodd, Ranking Member Shelby, thank you
    for this opportunity and for holding this important hearing.
        Reinsurance is a risk management tool for insurance
    companies--if you will, the insurance of insurance companies.
    And as such, it is probably the most global of the insurance
    businesses. My statement documents a number of statistics
    related to that. The majority of U.S. premiums ceded are
    assumed by reinsurers domiciled in ten countries throughout the
    world, but the entire global market is required to bring much
    needed capital and capacity to support the extraordinary risk
    exposure in the U.S. and to spread the risk throughout the
    world's capital markets.
        We believe that a streamlined national U.S. regulatory
    system will result in reinsurers conducting business more
    readily through U.S. operations and U.S.-based personnel. Thus,
    the RAA supports the modernization of the current regulatory
    structure and advocates a single national regulator at the
    Federal level. Alternatively, the RAA seeks Federal legislation
    that streamlines the current State system.
        An informed Federal voice with the authority to establish
    Federal policy on international issues is critical not only to
    U.S. reinsurers, which do business globally and spread the risk
    throughout the world, but also to foreign reinsurers, who play
    an important role in assuming risk in the U.S. marketplace.
        The U.S. State regulatory system is an anomaly in the
    global insurance regulatory world. In our view, the U.S. is
    disadvantaged by the lack of a Federal entity with authority to
    make decisions for the country and to negotiate international
    insurance agreements. International entities, like reinsurers,
    need an international regulatory framework. A single national
    regulator with Federal authority could negotiate an agreement
    with the regulatory systems of foreign jurisdictions that can
    achieve a level of regulatory standards, enforcement, trust,
    and confidence with their counterparts outside the U.S.
        There are several different ways to address meaningful
    modernization, including a Federal exclusive regulator for
    reinsurance, or Federal legislation that streamlines and
    modernizes the current State system. Although the RAA prefers a
    Federal regulator, the Nonadmitted and Reinsurance Reform Act,
    also called the ``surplus lines and reinsurance bill,'' twice
    passed by the House of Representatives, is a good start, but
    could be augmented by the recent NAIC-endorsed reinsurance
    modernization framework. The RAA supports the NAIC proposal to
    modernize this framework through a system of regulatory
    recognition of foreign jurisdictions, a single State regulator
    for U.S.-licensed reinsurers, and a port of entry for non-U.S.-
    based reinsurers.
        Given the challenges of implementing changes in all 50
    States and questions of constitutional authority for State
    action on matters of international trade, the NAIC's support
    for Federal legislation to accomplish this proposed framework
    is encouraging.
        I urge the Congress to move reinsurance regulatory
    modernization forward regardless of the ongoing debate about a
    systemic risk regulator--the subject of my concluding
    testimony.
        Various witnesses have addressed this Committee about
    issues associated with a systemic risk regulator. As has been
    mentioned by other witnesses, property/casualty insurers
    generate little counterparty risk, and their liabilities are
    for the most part independent of economic cycles or systemic
    failures. While the property/casualty reinsurance industry
    plays an important role in the financial system, it may not
    necessarily present a systemic risk. There are clear
    distinctions between risk finance and management products that
    are relatively new financial tools developed in unregulated
    markets, and risk transfer products like reinsurance whose
    issuers are regulated and whose business model has existed for
    centuries.
        Those addressing the authority of a systemic risk regulator
    envision traditional regulatory roles and standards for
    capital, liquidity, risk management, collection of financial
    reports, examination authority, authority to take regulatory
    action as necessary and, if need be, regulatory action
    independent of any functional regulator.
        Reinsurers are already regulated in much the same way as is
    being proposed for the systemic risk regulator. Thus, we are
    concerned the systemic risk regulator envisioned by some would
    be redundant with this system. This raises concerns that,
    without financial services and insurance regulatory reform, a
    Federal systemic risk regulator would be an additional layer of
    regulation, with limited added value; could create due process
    issues for applicable firms; and be in regular conflict with
    the existing multi-State system of regulation.
        Should Congress proceed with broad financial services
    reform, we ask that it be recognized that reinsurance is by its
    global nature different from insurance, and that the Federal
    Government currently has the requisite constitutional
    authority, functional agencies, and experience in matters of
    foreign trade to easily modernize reinsurance regulation.
        It is our recommendation that reinsurance be included in
    any meaningful and comprehensive financial services reform
    through the creation of a Federal regulator having exclusive
    regulatory authority over the reinsurance sector so there is no
    level of redundancy with State regulation. This should occur
    whether or not there is a systemic risk regulator included in
    financial services reform.
        Alternatively, Congress should create a single national
    regulator for reinsurance at the Federal level, but retain a
    choice or option for companies to remain in the State system.
    We recommend that any such financial reform incorporate
    authority for a system of regulatory recognition to facilitate
    and enforce foreign insurance regulation relationships.
        If Congress should choose not to include reinsurance in
    broader financial services reform, we encourage the enactment
    of legislation along the lines of the NAIC's reinsurance
    modernization proposal to streamline the State system as it
    relates to reinsurance by federally authorizing a port of entry
    for foreign reinsurers and single-State financial oversight for
    reinsurers licensed in the United States.
        Thank you very much.
        Chairman Dodd. Thank you very much, Mr. Nutter.
        Mr. Hunter, thank you for being with us.

       STATEMENT OF J. ROBERT HUNTER, DIRECTOR OF INSURANCE, THE
                     CONSUMER FEDERATION OF AMERICA

        Mr. Hunter. Thank you, Chairman Dodd, Mr. Shelby, members.
    I am Bob Hunter. I am Director of Insurance for the Consumer
    Federation. I was the Federal Insurance Administrator under
    Presidents Ford and Carter, and Texas Insurance Commissioner
    before.
        CFA is in the midst of a detailed review of our policy
    positions on insurance regulation to reflect the lessons we are
    learning from the economic meltdown. Here are some of our
    tentative conclusions.
        First, there is a need for an expanded role for the Federal
    Government in regulating insurance.
        Second, there are significant systemic risk issues
    associated with insurance that require oversight by a Federal
    systemic risk regulator. An example would be the guarantee
    associations, post-assessment plans everywhere by New York with
    no money to pay if an insurer goes under. They have to collect
    it later.
        With several life insurers in trouble today, the life
    insurance guaranty associations nationwide could muster under
    $9 billion if they were called upon. As I put it in my
    testimony, that would hardly pay the bonuses that these
    companies are offering.
        It is ironic that State regulators boast about the
    effectiveness of their capital and surplus requirements in
    stabilizing the insurers against systemic risk, even though
    several States at the individual level had to loosen these
    requirements today.
        Regarding consumer protection and prudential regulation,
    CFA places our focus on quality rather than who does it. At
    this stage of our research, it appears that a Federal office is
    needed to deal with more than just systemic risk, but also to
    be a repository of insurance expertise, to engage in
    international issues, and to monitor and enforce, if States opt
    not to, high consumer protection and prudential minimum
    standards set by Congress.
        The minimum standards to protect consumers must address all
    key consumer issues, such as claims abuses, unfair risk
    classes, unavailability of needed insurance, et cetera. They
    must contain, among other things, the capacity to regulate
    rates and classifications.
        Tough, thoughtful regulation, our study shows, is the most
    effective at protecting consumers while working well for
    insurers and enhancing competition. California has a system
    that I would encourage you to look at as a standard.
        CFA will oppose any system not based on high standards for
    consumer protection or which would have the potential to
    undermine the States that are doing a good job.
        Rather than enforcing congressional minimum standards
    through a Federal regulator, a State-based entity might be
    empowered by Congress. That would probably be the NAIC. But we
    are skeptical about the NAIC. If you do that, you need to have
    standards for the NAIC to prevent several problems. They need
    to have notice, comment rulemaking, on-the-record voting,
    accurate minutes, rules against ex parte communication, et
    cetera, like a real regulator and not like a trade
    organization, which they act like.
        As Congress attempts to create an agency that has knowledge
    about insurance, it should consider restoration of the ability
    of the FTC to study insurance, too.
        A Federal office should not be granted vague and open-ended
    powers of preemption regarding State laws, but only in areas
    where Congress has explicitly said we want to preempt. Nor
    should preemption apply to needed consumer protections.
        While CFA supports a greater insurance role, we vigorously
    oppose the optional Federal charter. Such a system cannot
    control systemic risk. It is impossible. It has failed
    miserably in protecting banking consumers. Thirty banks have
    left the Federal regulatory regime, according to a Washington
    Post article. And it sets up conditions for regulatory
    arbitrage. Our review determined there are regulatory functions
    that the States can do better than the Federal Government, such
    as complaint handling and other functions that would be done
    more effectively at the Federal level, such as systemic risk.
        The research suggests a role for the States in dealing with
    direct consumer needs while the Federal Government's role
    appears best addressing macro systemic trends and issues that
    cross State borders. These differential capacities suggest some
    sort of hybrid approach. This leads us to conclude that minimum
    Federal standards might be a preferred approach.
        Our research also supports differential treatment for
    property/casualty insurers compared to life insurers. Property/
    casualty insurers have local issues like catastrophic risk and
    legal requirements that are different State by State, versus
    life insurance, which is more national in scope and may lend
    itself more readily to Federal regulatory requirements.
        I emphasize these are our current ideas, and we are still
    studying it, still under some debate at CFA, and yet to be
    vetted with other consumer organizations, but I wanted to give
    you the advantage of our early thinking.
        I want to take just one final moment to reflect on what led
    to the situation we are in today.
        Reasonable profits are necessary in a vital insurance
    industry, but over decades, there has been a change in the
    insurer corporate cultures that led from a focus on
    policyholder interests to one that became obsessed with
    quarterly profits and stock price. Insurance professionals were
    pushed aside by financial gurus. For decades, the undoubted
    champion of insurer greed has been AIG. This is no surprise.
        Hank Greenberg, cheered on by Wall Street, maximized
    profit, every penny he could get a hold of, and he was well
    known on Insurance Street as someone if you had a claim
    against, you were going to be fought so that he could maintain
    his cash-flow.
        AIG's arrogance is manifest in partying and bonusing away
    taxpayer money, but encouraged by rating organizations, trade
    organizations, and compliant regulators, AIG gleefully did bid-
    rigging uncovered by Spitzer, did credit swaps and other
    things, exposing their clients constantly to danger to make
    more money.
        Other insurers have followed suit, seeing the praise and
    money being lavished on AIG. For example, Allstate has
    maximized its profit in part by using computer systems that
    arbitrarily underpay claims, and the leader who brought that
    innovation is now running AIG. So what do you expect? A perfect
    person to run AIG, and the resulting tone deafness that we are
    now all outraged--I have heard the outrage mentioned several
    times. Why would a party or a bonus be an issue if the
    corporate culture is totally focused on greed? It is no issue
    to them. That is why you see arrogant letters.
        This overarching insurance industry corporate culture of
    greed over policyholder interest is why Congress must look not
    only at the single fruit of greed known as systemic risk, but
    at the other greed that manifests throughout insurance,
    particularly the willingness to do harm to policyholders. A
    classic, current iteration of greed is the request for optional
    Federal charters so that insurers can flit back and forth to
    the regulator least interested in protecting people over greed.
        So, please, Mr. Chairman, Ranking Member, protect the
    policyholders as you work on this issue. We look forward to
    working with you on it.
        Chairman Dodd. Thank you very much, Mr. Hunter. Once again,
    you were very compelling in your comments and we thank you for
    being with us this morning.
        I will put the clock on here for about 5 minutes apiece so
    we can get to as many of our members here. And again, it is a
    strong panel. We thank you all for being with us.
        Let me just first of all ask you, I think we would all
    agree there is certainly a lack of expertise at the Federal
    level in insurance issues, generally speaking. Mr. Hunter
    pointed that out. While Congress has created Federal offices to
    handle specific insurance where there is a Federal involvement,
    including TRIA, flood insurance, obviously examples where there
    has been a Federal involvement in national programs, there is
    no central repository of information and analysis on insurance
    at the Federal level. I wonder if you might just express by
    maybe just even raising your hands how many would support
    creating the Office of Insurance Information within the
    Treasury Department. Is that something you would--we will start
    out with a unanimous position. That is a good start here.
        [Laughter.]
        Chairman Dodd. So I thank you for that. But I was going to
    make the point as well, I was just going over last night in
    preparing for this morning's hearing, and as someone who comes
    from a State that has a strong national and historic interest
    in the subject matter of insurance, just for the purposes of
    information--maybe my colleagues were aware of this--I wanted
    to give you some idea.
        According to public information, there are 2,723 property
    and casualty insurance companies in the United States and 1,190
    life-health insurance companies in the United States. We have a
    tendency to hear about the large companies we are all aware of,
    but almost 4,000 insurance companies around, most of which are
    not national companies or well-known, but to give you some idea
    of the magnitude of the number of companies that are out there.
    I thought you might find that interesting.
        Let me ask you, Mr. Hunter, if I can, I have made the case
    over and over again that I thought if we can get back to the
    point of consumer protection being the basis upon which you
    begin to look at these issues, then you have a totally
    different perspective, that we have bought into this notion, I
    think, for too long, at least too many have, that consumer
    protection is antithetical to economic growth, and you are
    making the point here that if you begin by thinking about the
    policy holder on this issue, begin thinking about the consumer
    and start from that point of view, that the issues of economic
    growth fall naturally into place.
        Do you believe that Federal regulation is necessarily
    weaker in terms of consumer protection than State regulation?
    This has been the case made over the years with people like the
    commissioners who come before us. My own commissioner has
    talked to us about it, independent agents and others have made
    the issue to Congress over the years that if you, in fact, have
    a Federal regulator, that almost guarantees weaker regulation
    than if you do it at the State level, where people are on the
    ground, watching it every day, more concerned, more sensitive
    of the consumer interest because they are there on the ground,
    at the level.
        I know you mentioned a hybrid kind of situation, but where
    do you come out on this issue today? And I realize it is an
    evolving issue, but nonetheless, where is the greater
    protection for consumers?
        Mr. Hunter. It has been my experience, having served both
    in the Federal and State areas, that it really has a lot to do
    with the laws and the people who are administering them. I
    think the Federal Government could do a great job. That is why
    I said earlier that consumers care a little less about the
    locus of regulation than the quality of it. And we see within
    the State system, there are some States that are pathetic in
    terms of protecting consumers and there are others that are
    very good. As I mentioned earlier, there are some States, like
    California, that have very tough regulation, but they have the
    highest Herthandal indices of competition and the profits are
    reasonable for the insurance companies, et cetera. So
    competition can work in a way that protects consumers, be very
    good for the industry, and still be a very competitive system.
    They don't have to--one does not displace the other.
        I think either the Federal Government or the State could do
    it. The reason I suggested a hybrid is they are seeing some
    things like three million complaints. I can't imagine a Federal
    agency would be doing a very good job with it. Now, it is
    possible, but you would have to set up a regional system to do
    that, I think.
        Chairman Dodd. How about any other comments on this? Mr.
    McRaith, what is your answer on that? I mean, I appreciate Mr.
    Hunter's answer, but I think venue does have an impact on
    whether or not you get good regulation or not. If it just is
    going to be dispersed among 50 jurisdictions, then you are
    going to end up with a spotty system. Some places it works,
    some places it doesn't, and that is hardly what I think
    consumers need. So depending on where you happen to live, you
    get good protection or you don't, as opposed to the idea, at
    least at a national system, you could have one strong system of
    rules that would at least raise the prospect of having a
    stronger set of regulations.
        Mr. McRaith. Mr. Chairman, you cited a number of
    approximately 4,000 companies earlier. The number that we have
    is actually closer to 7,700 companies, and as I mentioned in my
    opening comments, we are--the United States and the combination
    of States are the largest market in the world. We surpass two,
    three, and four combined.
        So the real question is what is the problem that we are
    trying to solve, and if the problem is one of consumer
    protection, it is important to understand, I think, that
    different States view that differently. Not all of them Mr.
    Hunter is comfortable with, of course, but what is appropriate
    for a consumer in the State of Illinois, for example, is going
    to be different from what is appropriate for a consumer on the
    coastline in Florida, or in California, for example. There is
    no secret about that. But that is not to say that one State has
    more or less protection. It is to say that those States, when
    determining what is appropriate public policy for their
    consumers, have made different decisions.
        When it comes to solvency, again, if we ask what is the
    problem or question we are trying to answer, the State system
    of financial solvency is coordinated. Fifty States are looking
    at national companies. You have multiple sets of eyes reviewing
    the financial status of any one company, whether it is a
    Connecticut-based company, an Illinois-based company. We, of
    course, also have a proud legacy of property and casualty
    insurers in our State. We work with other States and it is not
    one sole regulator who is determining whether that status, the
    financial status of that company is sufficient. It is multiple
    regulators with multiple skill sets evaluating a company from
    top to bottom.
        Chairman Dodd. Well, I appreciate your answer on that.
        Let me jump to the systemic risk, and this will be my last
    question. I am already violating the clock a little bit, but I
    wanted to get to the systemic risk regulator because most of
    you have advocated a systemic risk regulator. I think, Mr.
    Nutter, you may be the one exception, and that is in the
    reinsurance industry, at least you didn't speak for one, so I
    will let you respond to this in a minute.
        But let me begin by asking this. Excluding AIG, do any of
    you believe here that there are systemic important insurance or
    reinsurance companies per se out there at this moment? You
    mentioned whether it is 7,000 or 4,000. Are we looking at
    another company out there, aside from AIG, that could pose
    systemic risk as you see them today? Does anyone have a comment
    on that? Can anyone identify a company that we should be aware
    of?
        My interest in this, and again, if I look at a systemic
    risk regulator, I am more interested in practices rather than
    someone declaring themselves to be a certain type of company
    and then falling within a regulator or not. But the kind of
    practices that company engages in, and then on the basis of
    that, determining whether or not those practices pose systemic
    risk. So there are specific insurance products that are common
    practices among insurance or reinsurance companies that pose a
    risk to the financial system. I wonder if you might comment
    briefly.
        Why don't we begin with you, Mr. Nutter, because you took
    the position apparently of not necessarily endorsing the idea
    of a systemic risk regulator.
        Mr. Nutter. There is a concern that if you have a systemic
    risk regulator as described by Chairman Bernanke of the Fed,
    you really have a redundant system of regulation and a
    duplicate system for a functional regulator. Our point was, if
    you are going to do that, you really ought to have a Federal
    regulator for the reinsurance sector that would work with a
    systemic risk regulator. It wasn't to oppose a systemic risk
    regulator.
        It is hard for us to see how a systemic risk regulator is
    going to coordinate with a 50-State system of regulation with
    the complexity of that, at least in the area of a global
    marketplace like reinsurance, where frankly, the most important
    regulatory relationships between a regulator and a systemic
    risk regulator would be with other international regulators in
    other countries, trading partners, if you will. We just see
    that occurring more effectively at a Federal level with a
    Federal regulator.
        Chairman Dodd. Mr. Berkley, do you want to comment on this?
    You have been in the business for 40 years.
        Mr. Berkley. I think that, first, one has to understand
    what happened at AIG, and that is the good credit of the
    insurance business was used to guarantee the performance of
    other elements of the holding company. If there had been a
    Federal regulator overseeing AIG, they would have said, hey,
    what you are doing is you are suddenly changing the character
    of the risk and you are putting the good creditworthiness of
    the insurance company and allowing them to use it, in the case
    of financial products, to take a substantial risk. But there
    was no one overseeing it.
        The benefits of some Federal oversight is you get to look
    at the whole picture. It is not that there was particular risk
    in AIG's insurance business. Certainly, there is no systemic
    risk in their property casualty business. Even though they were
    the largest participant, the industry could have absorbed that
    business. It is that they effectively guaranteed the exposures
    in the financial products, something none of the other
    competitors did. All of the other big banks had independent
    subsidiaries without cross-guarantees in the financial products
    business. AIG guaranteed the performance of the financial
    products.
        Chairman Dodd. Let me turn to Senator Shelby, and I will
    come back. We will have a couple of rounds here.
        Senator Shelby. Thank you, Senator Dodd.
        Mr. McRaith, five AIG insurance companies are regulated by
    the State of Illinois, it is my understanding. Are you aware of
    any financial problems with any of those insurance companies in
    Illinois, and what steps have you taken to ensure that those
    insurers are prudently managed during this disorderly time for
    AIG overall, and are you aware of any attempt by AIG to pay
    retention bonuses to any employees of its insurance companies,
    and if so, would State insurance regulators have the power to
    call back such payments?
        First--I will go over it again. Are you aware of any
    financial problems with any of the five insurance, AIG-owned
    companies that are regulated by the State of Illinois?
        Mr. McRaith. Senator, the insurance companies that are
    domiciled in Illinois, we regulate those companies now and we
    have regulated them as long as they have been domiciled in our
    State, or, for that matter, in other States on a regular basis,
    quarterly, annually, top to bottom exams on a regular basis, as
    well. Those companies, like many companies, are encountering
    the turbulence of the current economic time, but as we have
    heard from other witnesses today, the insurance industry,
    including those companies, Senator, are in relatively good
    shape compared with other financial sectors.
        Senator Shelby. What does ``relatively'' mean?
        Mr. McRaith. Well, that means----
        Senator Shelby. You say they are in ``relatively'' good
    shape.
        Mr. McRaith. First of all, I would never say publicly
    whether any one company were in trouble, but at the same time,
    I am not going to mislead you, Senator. The companies that we
    are regulating, we are comfortable with their financial status.
        Senator Shelby. Are you aware of any attempt by AIG to pay
    retention bonuses to any of these employees?
        Mr. McRaith. Senator, I think it is an important question
    and it is important to distinguish that the bonuses that have
    been publicized recently are those bonuses that would be paid
    to the Financial Products employees, and we all know the
    colossal disaster that that division of AIG has caused. And
    frankly, I agree with everything that you and your colleagues
    said, for whatever my humble opinion is worth, that those
    bonuses should not be paid to Financial Products division
    employees of AIG. However, the insurance enterprises of AIG, as
    you know, are generally solid companies and their employees
    have performed, generally speaking, well. Now, I don't know
    whether any one employee has received a bonus or not within the
    insurance companies domiciled in our State.
        Senator Shelby. In recent weeks, and I will pick up on what
    Senator Dodd was asking a few minutes ago, Federal Reserve
    Chairman Ben Bernanke has discussed publicly the inadequacy of
    our insolvency regime for large global financial conglomerates,
    such as AIG. Chairman Bernanke has called for a new resolution
    regime that can better manage the insolvencies of systemically
    important firms while minimizing the risk to taxpayers. Do you
    agree, sir, with Chairman Bernanke that a new resolution regime
    is needed in America for companies like AIG?
        Mr. McRaith. Well, thankfully, there aren't a lot of
    companies like AIG, and we can hope we don't see another one
    anytime soon. The Chairman also made the comment that AIG was
    essentially a hedge fund attached to large stable insurance
    enterprises. As State regulators, we are proud of the fact that
    their insurance companies are the primary assets of AIG and its
    holding company. The solvency regime that we have for insurance
    companies is solid, and frankly, some of the concerns I have
    read expressed in testimony submitted today, I think are
    misplaced.
        Senator Shelby. Are you--go ahead.
        Mr. McRaith. If, for example, one company were to have
    financial challenge and to be placed into receivership, other
    companies, first of all, can fill the void in the marketplace
    but can also purchase the policies of that company, and that
    happens frequently because those policies themselves are
    viable, strong assets and other companies will pick them up
    right away. So the demands on the system will not be as
    outrageous as some would have us believe today.
        Senator Shelby. Are you telling us that the State insurance
    guaranty system could handle the insolvency of AIG or a
    similarly large company like that, the spread and all kinds of
    things?
        Mr. McRaith. What I am--well, when you say the insolvency
    of AIG, if we were talk----
        Senator Shelby. We are talking about AIG as a
    conglomerate----
        Mr. McRaith. Right.
        Senator Shelby.----you know, the insurance and otherwise.
        Mr. McRaith. Well, there is no system that is built to
    withstand an insolvency the size of the notional value of the
    credit default swaps AIG was invested in, which was, I believe,
    $2.4 trillion, which, of course, exceeds the gross domestic
    product of France as a country. However, their insurance
    operations, which as we know are strong assets of the holding
    company, if those were to encounter financial trouble, the
    State guaranty system is designed and would allow for an
    orderly disposition of those claims. But we also expect that
    many of those policies--and this is, again, completely
    hypothetical because those companies are financially strong at
    this point--that other companies would purchase the policies or
    groups of policies within an insurance company because those
    are assets. Other companies would want them.
        Senator Shelby. But aren't credit default swaps an
    insurance against default of something? In other words, it is
    an insurance product of some kind.
        Mr. McRaith. Well, I would agree with you, Senator, that
    credit default swaps as AIG was involved in those transactions
    did include a form of financial guaranty.
        Senator Shelby. Sure.
        Mr. McRaith. Unfortunately, OTS, of course, as we know, the
    Office of Thrift Supervision, was the primary regulator for the
    AIG holding company, and let us talk about the reality here,
    which is not whether there is a regulator. It is whether there
    is an effective regulator. And what we see with the AIG
    insurance companies is effective regulation. What we saw at the
    holding company level was a regulator who was not effective.
        Senator Shelby. Mr. Hunter, do you agree with his
    statement? What is your take on it.
        Mr. Hunter. I didn't hear him answer the question.
        Chairman Dodd. He did----
        Mr. Hunter. I don't think it could handle--I don't think
    the guaranty funds could handle it, no.
        Senator Shelby. Couldn't handle it----
        Mr. Hunter. That was your question, and I don't think
    they----
        Senator Shelby. It would be too big for them to handle,
    would it not?
        Mr. Hunter. Of course. Yes.
        Senator Shelby. I thought so, too. Thank you.
        Governor Keating, the Federal insurance regulation and
    systemic risk, an area you have done a lot of work in, your
    testimony cast doubt upon whether a Federal systemic risk
    regulator, Governor, could be established without a Federal
    insurance regulator also being created. You argue that without
    a Federal insurance regulator to coordinate and to implement
    policy with respect to insurers, Federal systemic regulation
    could be rendered ineffective. Along those lines, how should a
    Federal insurance regulator interact with a Federal systemic
    risk regulator to ensure that insurers are properly supervised
    for systemic risk as well as for solvency and consumer
    protection, the company itself?
        Mr. Keating. Well, Senator Shelby----
        Senator Shelby. It looks to me like they would be
    intertwined some.
        Mr. Keating. On a going-forward basis, it is important, as
    you well know, to get this right so we don't face again the
    kind of problems that we have faced in the recent past. But if
    the systemic risk regulator is a 30,000- or 40,000-foot entity,
    is it product specific or is it size-specific, and that is
    something obviously that members of this Committee are going to
    have to resolve.
        It is our view that to have a functioning and efficient
    system, you need to plug all the holes. Systemic could look at,
    for example, on size or on product the credit default swap. I
    mean, that is allegedly an insurance product, and yet there
    were no reserves. There was no ability to play claims, which is
    stunning to me that the State regulatory apparatus as well as
    the OTS didn't identify that early. Sixty-trillion dollars of
    those instruments are floating around the world.
        But what we would like to see on an optional basis, if you
    do have a functional regulator at the Federal level that would
    speak with one voice to our international and national players
    that more than likely would seek a functional regulator at the
    Federal level--most of our members, by the way, would remain
    State regulated--but we would like to see an ability on the
    part of somebody to break a tie. The systemic regulator would
    have to be that person to break a tie. If he or she sees
    conduct or activity or an entity that simply is threatening the
    system, it is systemic, then that individual ought to be able
    to tell the functional regulator what to do, or, for that
    matter, the State regulator what to do. Otherwise, we would
    have a multiplicity of the problems we faced recently.
        Senator Shelby. Governor, over the past year, our largest
    bond insurers have teetered on the edge of collapse due to
    imprudent bets on the value of mortgage-backed securities. The
    problems of the bond insurers have impacted our national
    economy as bonds they insured have rapidly gone down in value.
    Although the bond insurers played an important role in our
    overall market, they remain regulated at the State level. If
    the bond insurers had been regulated by a Federal regulator, if
    you can envision that, do you believe that their problems would
    have been addressed more effectively than what we have today?
        Mr. Keating. Well, I am in favor as an industry, and we
    represent the life insurance, annuity, long-term care, and
    disability income business, a regulator and a regulatory system
    that works, that is effective, that is tough, that is action-
    oriented. I think Mike McRaith is right. It is not particularly
    always where the regulator is housed. What is the regulator
    doing? Obviously, the OTS appeared to be looking the other way
    on credit default swaps, and in the bond insurance business,
    obviously somebody was looking the other way, and that is
    simply the antithesis of effective and appropriate regulation.
        Senator Shelby. Where was the New York Insurance Commission
    on all this, too? They were the regulator of the insurance
    part, were they not?
        Mr. Keating. Well, you might want to invite him in and have
    a conversation.
        Senator Shelby. We have had him in once. We will bring him
    back.
        Thank you, Mr. Chairman.
        Chairman Dodd. Thank you, Senator.
        Mr. McRaith. I would be happy to answer that question, too.
        Chairman Dodd. Yes. Let me get a chance to go to Senator
    Merkley.
        Senator Merkley. Thank you very much, Mr. Chair.
        Mr. McRaith, AIG has been described as an insurance company
    that had a hedge fund piggy-backed on it. Should the future
    regime basically prevent insurance companies dealing in areas
    like property insurance and life insurance and so forth from
    getting into the insurance of financial products with
    instruments like credit default swaps?
        Mr. McRaith. Senator, the problem with AIG and the
    challenge for this Committee, which I appreciate your wrestling
    with in a substantive manner, is how do you regulate a large
    enterprise like AIG when there are multiple services or
    products sold by one company, and some people would even say
    AIG had as many as several thousand individual companies or
    subsidiaries within its larger holding company.
        At the insurance company level, again, those insurance
    companies remain primary assets for the AIG holding company in
    solid financial condition today. So the question is what is the
    problem we are trying to solve? The problem is not the efficacy
    of State regulation. The problem is how do we integrate all of
    the different functional regulators so that they are
    coordinated and working together, and in that situation, the
    State system can work, coalesce with the other functional
    regulators, and to the extent that at some point there might be
    an enterprise whose viability is threatened, that the demise of
    that enterprise would threaten the stability of the system,
    that is when the systemic regulator can take the comprehensive
    action with respect to the enterprise as a whole.
        Senator Merkley. Thank you. If I could reframe what you
    just said, your answer to my question was, no, that the answer
    is not to prevent companies engaged in property life insurance
    from doing hedge fund-style activities, but to simply have a
    better regulatory system.
        Mr. McRaith. Let me be more clear. I think we need to be
    very cautious about allowing regulated enterprises that have
    direct consumer obligations from participating in hedge fund or
    hedge fund-like transactions. We have seen the risk of that. I
    think from a consumer protection perspective, we need to
    revisit and really answer the question you are asking, and my
    answer to your question is absolutely not.
        Senator Merkley. Thank you.
        Mr. Hunter, do you have any different perspective on that?
    Do you share that view?
        Mr. Hunter. No, I don't have a different perspective. I
    think the Congress should look at GLB again and see whether or
    not it led to some of these problems.
        Senator Merkley. GLB?
        Mr. Hunter. Gramm-Leach-Bliley.
        Senator Merkley. Thank you.
        So a broad question to all of you is whether the size and
    complexity of large firms like AIG basically defies effective
    regulation at the State level. I think in many cases, I
    understood your testimony to say we do need some Federal
    coordination, but I just want to reclarify that, if anyone
    wishes to comment on that.
        Mr. Berkley. I would like to just comment. I think, first
    of all, large parts of AIG were outside of the realm of State
    regulation. A huge amount of their business was overseas. It
    was an international business. Lots of other activities were
    outside of the realm of State regulation.
        You know, I think that you only can regulate what is within
    your purview, and part of the problem of AIG is so much was
    outside of the purview, and part of the problem of coming up
    with a solution were so many other non-U.S. authorities had
    control over pieces of the assets and we had no Federal
    regulator who could go and discuss with those various
    authorities how to have a solution.
        So in the case of AIG, it was not something that we had
    within our powers to deal with.
        Senator Merkley. Thank you.
        Mr. Hunter, before I run out of time, I wanted to ask about
    one aspect of your testimony, in which you noted that the
    Congress should repeal the antitrust exemption of the McCarran-
    Ferguson Act and, quote, ``collusion in pricing should not be
    allowed.'' Can you expand on your commentary in that case?
        Mr. Hunter. Sure, and I would refer you to the testimony I
    gave before the Senate Judiciary Committee, too, for a very
    full explanation, but back when the U.S. Supreme Court ruled
    for the first time that insurance was interstate commerce, and
    the States therefore were going to lose the regulatory
    authority, the States ran to Washington and got the McCarran-
    Ferguson Act. Congress debated whether or not to apply
    antitrust laws. In fact, they decided to apply antitrust laws
    after a moratorium.
        If you read the debates at the time, Senator Pepper raised
    the issue, well, this language could possibly be interpreted as
    being a permanent prohibition on applying the antitrust laws.
    McCarran and Ferguson both jumped up and said, ``No, no, that
    is not what we mean.'' But apparently the Supreme Court never
    read the legislative history because when it came before the
    Supreme Court, the Supreme Court decided that antitrust laws
    would not apply to insurance generally, except for coercion,
    intimidation, and boycott. And so we now have a situation
    where, like baseball, insurance is not subject to the antitrust
    laws.
        Senator Merkley. Thank you very much.
        Chairman Dodd. Thank you very much, Senator.
        Senator Corker?
        Senator Corker. Mr. Chairman, thank you, and I thank all of
    you for your testimony. Many of you have been in and out of our
    offices or you have had representatives in and out talking
    about this particular issue. Unlike some of the things we have
    dealt with most recently here on the Committee, and let me set
    AIG aside. I know we are talking about AIG today because of
    most recent occurrences. This is really not a hearing
    necessarily about AIG but about how we regulate the insurance
    industry in general.
        This feels not like a big issue for the country as much as
    it does sort of a family squabble, if you will, within the
    insurance industry throughout our country. This is more about
    competing interests, it feels to me, than it does about
    systemic risk.
        And so I know that everybody--Mr. Nutter agrees with the
    systemic regulator concept, it seems, or at least that is what
    everybody seemed to indicate, which might deal with sort of the
    AIG kind of thing. And it seems to me that a solution to this
    might be to have on the reinsurance side and on the life
    insurance side a Federal regulator, and even the guys that
    represent the insurance folks all around our country, the
    independent insurers that we all know and see when we go home
    on the weekends, even you all agree that it is really not about
    life insurance. It is really about property and casualty. I
    know you are worried about the camel nose under the tent, if
    you will, and if we do that on life insurance, we might do it
    on property and casualty.
        But why wouldn't we just look at the systemic regulator--
    except for Mr. Nutter--why wouldn't we just have a Federal
    regulator for reinsurance and life insurance and leave property
    and casualty like it is with State regulators, with the Office
    of Insurance Information that apparently everybody seems to
    like? Why wouldn't we just deal with this issue in this way and
    move on to something else? Anybody that wants to respond.
        Mr. Houldin. If I may, Senator.
        Senator Corker. OK.
        Mr. Houldin. My agency particularly, we work--about 20
    percent of our income comes from life insurance. I would like
    to address that specifically. Down on Main Street, America, the
    consumer concerns and complaints that we get, we feel are very
    well addressed at the State level. I can call Commissioner
    Sullivan at the Connecticut Insurance Department, or his team,
    anyway, and get immediate reaction to a concern, and with all
    the baby boomers coming up that are going to have life
    insurance questions in the next decade or so, I think keeping
    the consumer protection at the State level is extremely
    important, and for that reason is why we don't support any
    Federal----
        Senator Corker. You know, there are very few complaints. I
    mean, life insurance is not what drives complaints at your
    State Insurance Commissioner's officer, really, is it? It is
    just a small percentage, is it not?
        Mr. Houldin. Well, certainly the Commissioner can answer
    that better than I can, but the concerns that I get at my firm
    is you buy an insurance product, a life insurance product 30
    years prior and when it comes up, or your parent passes away
    and you look at his document, you don't even know who the agent
    was that sold it. You don't even know who this company is. You
    don't even know if it is still active. And so I get a lot of
    questions from my clients saying, ``I know you didn't sell me
    this policy, but can you please help me? I have no idea if this
    is active or if I can collect on it,'' and those types of
    questions, I think, are asked on a consistent basis. But the
    Commissioner can comment on that.
        Senator Corker. Yes, sir, Mr. Berkley or somebody?
        Mr. Berkley. Well, I think that the part where your view
    goes awry is for large companies. Of those 3,000 insurance
    companies that were referred to by Senator Dodd, probably 2,500
    of them would exactly fit the bill that you are talking about,
    but the others wouldn't and those are the larger companies that
    do business across frequently 50 States, frequently in other
    countries.
        So when I set up a business in Latin America, I had no
    Federal insurance regulator. I had to set up a new company in
    that country. When I went to the U.K., there were no reciprocal
    arrangements. There was no way I could license my U.S. company
    there straightforward. There was on dialog, even. I had to set
    up a new company there. The same, in fact, in Australia and----
        Senator Corker. This wouldn't solve that, though.
        Mr. Berkley. Yes. A Federal regulator would then open up a
    dialog, just like the company in the U.K. does business
    throughout the E.U. The national regulators have this dialog to
    allow you to do business in broader areas. I believe if we had
    a national regulatory policy for the largest companies, we
    could have a very different dialog and it would be a reciprocal
    arrangement because the large companies overseas have the same
    desire to do business here, and one of their big problems is
    the licensing State by State is very complicated. This is also
    addressed by Mr. Nutter's issues for reinsurers overseas.
        Mr. McRaith. Senator, if I might reply briefly, life
    insurance and annuity questions come into our offices with
    great regularity. The exact numbers, I don't know, but we get
    calls State by State probably in the hundreds, if not
    thousands, every year on these issues. We can't diminish the
    importance of each one of those calls. And the importance of a
    senior, for example, as I mentioned in my opening statement,
    who sold an indexed annuity. Where does that senior turn when
    they are on a fixed income and that annuity is not generating
    the income they were told they would receive?
        The real challenge for us as we talk about this is in your
    concept probably the largest expansion of Federal regulatory
    authority in the financial sector since the 1930s. As we talk
    about this, what is the question we are trying to answer? What
    is the problem we are trying to solve?
        Senator Corker. It appears to me like a family squabble we
    are trying to solve----
        Mr. McRaith. But let me explain. As I mentioned----
        Senator Corker. Which is not that interesting, candidly, so
    I would like to know what it is we are trying to solve.
        Mr. McRaith. Right. Exactly. So if the question is speed to
    market issues for life companies, they want to be able to
    introduce their products more quickly. Thirty-four
    jurisdictions have adopted the Interstate Compact, which gives
    a single portal, single approval opportunity for product that
    can then be sold in all 34 of those jurisdictions. Now, as a
    factual matter, we might need Congressional support to require
    all 50 States to join that Compact.
        When it comes to reinsurance, we have--all States have
    adopted or supported a proposal for comprehensive reinsurance
    reform. Now, we might, as we have adopted that proposal and
    spent a couple years working through the details, we might need
    Federal assistance--in fact, I am sure we will need
    Congressional assistance--in adopting that uniformly throughout
    the States. These are issues that we have addressed, are
    working to address every day in an even better fashion than we
    do already.
        When it comes to international collaboration, just with
    respect to Mr. Berkley's comments, the E.U. is far less
    coordinated than the 50 States are. We are significantly
    larger, remember. The State of Connecticut is larger than Spain
    in terms of its insurance marketplace. So as we talk about the
    E.U. as if it is a panacea, let us look at the reality. They
    not only have 23 different languages, they cannot agree on what
    exactly even their solvency framework should be.
        So yes, we can improve. We are working to improve and we
    look forward to working with you to help accomplish some of the
    uniformity goals that we all share.
        Mr. Hill. Senator, I would just like to make one other
    comment. At NAMIC, we clearly support your position with
    respect to property casualty. That is where our interest lies,
    and we do not see a role for a Federal charter with respect to
    property casualty.
        With respect to the international issues, as we have all
    talked about, we fully support the establishment of OII. We
    think that can be an excellent conduit to deal with the
    international issues and the cross-border issues like that. So
    again, that is our position on that.
        Mr. Nutter. Senator, if I might comment, I wouldn't want to
    come across as being opposed to a systemic risk regulator,
    though I have been characterized as that. I think the point
    that we were trying to make was that the descriptions of what a
    systemic risk regulator have been seem redundant to us of what
    a Federal regulator would be and that some assimilation of that
    may be appropriate. At a Federal regulatory level, you have
    greater capability of achieving that than you do in a system of
    50 State regulators and trying to overlay that on a global
    business like reinsurance, where many of the major companies
    are headquartered in trading partner countries and you need a
    constitutionally authorized system of recognition between the
    United States and those countries to deal effectively with
    global regulatory issues.
        Mr. Hunter. I just wanted to say that Congress--there are
    some systemic PC issues that Congress needs to study, including
    bond insurance. Directors and officers insurance is becoming
    widely unavailable and very high priced for banks. Now, you may
    try fixing the banks, but if they can't get D&O insurance, what
    is going to happen? That is a question the guaranty
    associations issue and reinsurance that can actually melt down
    beyond reinsurance into the primary market if reinsurers aren't
    there to back up because of a ``black swan'' or something with
    the hurricanes and terrorism all at once or something like
    that.
        Chairman Dodd. Very good. Senator Tester?
        Senator Tester. Thank you, Mr. Chairman.
        A couple of questions to start with. How many folks on this
    panel are in favor of the optional Federal charter? Raise your
    hands.
        [Show of hands by Mr. Keating, Mr. Berkley, and Mr.
    Nutter.]
        Senator Tester. Three. How many of those three are in favor
    of the premium taxes? Since we are talking a little turf here,
    we will talk a little money, the premium taxes staying with the
    State. Raise your hand.
        [Show of hands by Mr. Keating, Mr. Berkley, and Mr.
    Nutter.]
        Senator Tester. OK. The question I have for you three is
    that there is an historic issue with the Federal Crop Insurance
    Corporation. When it was first started out, those premium taxes
    were supposed to go to the State. A long story short, there was
    a lawsuit that said the State had no reason because they were
    federally preempted and they no longer could collect those
    premium taxes anymore. Do you see the same kind of scenario if
    an optional Federal charter was implemented? Do you see a
    similar situation with those premium taxes? Mr. Keating?
        Mr. Keating. Senator Tester, you know as a former
    legislator in your State, and I think probably many of the
    States represented around this table, premium taxes are a
    significant part----
        Senator Tester. It is $40 million in Montana, which is a
    lot of money in Montana.
        Mr. Keating. It is a significant part. But to show you how
    very frustrated and even desperate some of these companies are
    to be able to compete on a level playing field with the banks
    and securities, the companies that we represent are willing to
    have the premium tax remain in the States. Now, it would be up
    to the Congress to decide whether or not you someday down the
    line would ever attempt to preempt. Our view would be we are
    willing to pay for the cost of regulation for a variety of
    reasons, and it appears on occasion to be sort of a household
    spat, but we are an interstate and international marketplace.
    Our products are virtually the same from sea to shining sea.
        For us, and here is one example, I think, that you would be
    interested in, several years ago, one of the real serious black
    eyes to the life insurance industry were military base sales,
    abusive sales practices on military bases. The NAIC said, we
    have no jurisdiction there to address those, which was horribly
    frustrating to us because there was no Federal ability to stop
    it, so we were attempting to do it ad hoc basically industry by
    industry group, going to try to stop these practices. So that
    is the frustration we face, Senator.
        Senator Tester. So what you are saying is you believe that
    the premium tax will be able to stay with the State, that it is
    a legislative prerogative regardless if it is taken to court?
        Mr. Keating. We certainly concur on that.
        Mr. Berkley. We have no reason that it shouldn't stay
    there.
        Senator Tester. OK.
        Mr. Nutter. And Senator, with respect to the reinsurance,
    generally the reinsurers share in the cost of premium taxes
    with the underlying ceding company, wherever that tax is paid.
        Senator Tester. OK. So the next question is, and I will
    focus this back, Mr. Keating, and I would ask you to be a
    little more concise, but in Montana, and I am sure it is the
    same way around the country, this money goes to fund the Office
    of the Insurance Commissioner. So if the optional Federal
    charter was put into place, that money would have to come from
    the general fund of the Federal Government and I assume you
    would be in support of that, for the regulating portion of an
    optional Federal charter?
        Mr. Keating. We are willing to pay for our regulation.
        Senator Tester. OK. So you would be open to it--to another
    tax over and above the premium tax?
        Mr. Keating. I don't view that as a tax. I mean----
        Senator Tester. No, that is a fee out of----
        Mr. Keating.----the cost of regulation, because regulation
    is important----
        Senator Tester. OK. So you would be willing to pay for the
    additional level of regulation of an optional Federal--is
    everybody OK with that? All right. Sounds good.
        Mr. Hunter, in the questions by Senator Merkley, you had
    answered a question saying that we may want to revisit parts of
    Gramm-Leach-Bliley----
        Mr. Hunter. Yes.
        Senator Tester.----to see if it led to some of the AIG-
    related problems. That is an interesting point. I want you to
    expand upon it.
        Mr. Hunter. Well, before GOB, the banks and insurance
    companies could mix, for example, and securities dealers and
    insurance companies could mix some of the kinds of things that
    were involved there. They wouldn't have been there. And so I
    think it is just a question of if we join together all these
    different financial services, are we really creating a systemic
    risk situation that wasn't there before? So I think given the
    current situation, it might be worth another look at the role
    that GOB played in this.
        Senator Tester. So the next step would be, do you think it
    is reasonable to, if we are going to take a look at it, to
    really look at splitting them back out? Do you think that that
    is a reasonable solution in this----
        Mr. Hunter. If you find that the systemic risk can't be
    controlled in a joined-together organization, I think that is
    what Congress should look at, then I think you have to at least
    consider splitting them back out.
        Senator Tester. All right. I just want to thank all the
    members of the panel. Thank you very much. I wish we had more
    time, which we do, but I don't, so thank you very much, Mr.
    Chairman.
        Chairman Dodd. Thank you, Senator Tester.
        Senator Warner?
        Senator Warner. Thank you, Mr. Chairman. This has been very
    helpful education-wise for me.
        I want to go back to where Senator Corker was heading in
    trying to understand--I think I have got the frame of the
    challenge between the State versus the Federal regulation
    framing. Tell me if anyone on the panel--it does seem that Mr.
    Nutter's comments about reinsurance being more of a national
    and international business and less direct involvement on the
    consumer's standpoint, even if I didn't go as far as Senator
    Corker did, just from a first impression standpoint, that a
    Federal regulator at the reinsurance standpoint, particularly
    because of the international nature of a lot of this
    reinsurance, makes some sense to me. Give me a counterargument.
        Mr. McRaith. Senator, I think--Mr. Berkley----
        Mr. Berkley. Go ahead.
        Mr. McRaith. OK. Senator, I think it is important to
    understand that from a regulatory perspective, the quality of
    reinsurance, particularly on the P&C side, helps a regulator
    determine the viability or the financial status of a company.
    So reinsurance involves the seeding of risk by a primary
    carrier.
        Senator Warner. I understand.
        Mr. McRaith. In the event that reinsurance is in any way
    jeopardized or the status or financial condition of the
    reinsurer is in any way jeopardized, it has a direct impact on
    consumers.
        Senator Warner. But that again presupposes that you at the
    State level are going to better be able to assess that national
    or international reinsurer's ability to pay off that risk than
    a Federal regulator, doesn't it?
        Mr. McRaith. You are asking questions that have been the
    subject of several years of discussion and overwrought
    commentary at the NAIC and the State regulatory level, and I am
    happy to report that in December, the States adopted a reform
    proposal and we are right now implementing details that we
    intend to present to your colleagues and you to adopt as a
    national reinsurance standard for all the States to adopt.
        Senator Warner. I will be anxious to see it, but it would
    still seem to me that, at least in this area on reinsurance,
    because of the national and international nature of
    reinsurance, that a national standard amongst States--you have
    still got a point to convince me that that is still better than
    simply repositoring that information or that oversight at a
    Federal level.
        Mr. Nutter?
        Mr. Nutter. Senator Warner, if I could address that, to its
    credit, the NAIC has endorsed a reform proposal that would ask
    the Congress to pass legislation to create a single port of
    entry for non-U.S.-based reinsurers and a single licensing for
    U.S.-based reinsurers. The challenge for all of that, which
    goes to your point, is that the constitutional authority to
    deal with international trading partners in the E.U. or other
    parts of the world really lies with the Federal Government, and
    therefore Federal regulation is clearly going to be a preferred
    way for our country to deal with the global nature of the
    reinsurance marketplace. Alternatively, we would support the
    NAIC's approach, but we don't think that is the preferred one.
        Senator Warner. I have got a couple more questions, but my
    time is about up. Governor Keating, could you share with me one
    of your earlier comments when you described the life insurance
    industry, and this is a little off topic, but 18 percent of the
    corporate bonds, obviously a lot of other long-term holds in
    the debt market, I have had life insurers come by and because
    of the uncertainty at this point dramatically increasing the
    cash portions in their balance sheet and not being participants
    as actively in the marketplace right now because of regulatory
    and other concern and saying that many of the programs
    initiated by the Treasury and the Fed to kind of unlock the
    credit flows have benefited other areas, but we are leaving out
    one of the largest purchasers of these debt instruments, the
    life insurance industry, and I would love to hear your comments
    on that and what we should be looking at beyond the regulatory
    standpoint to make sure we get you folks back in the
    marketplace buying.
        Mr. Keating. Well, Senator Warner, I know metaphors
    sometimes are tired, but we look upon this really, or should,
    as a three-legged stool. We have $15 trillion in mutual fund
    assets, $10 trillion in banking assets, and $5 trillion in life
    insurance assets. By anybody's definition, that is systemic.
    The Congress in its wisdom put the life insurance industry in
    the TARP as a result of that very systemic belief, and yet when
    we first met with several of our CEOs with then-Secretary
    Paulson, because we have no Federal presence, Secretary Paulson
    said, well, I cannot--we don't know your industry. I can't put
    my arms around your industry. I can't figure out how to do it.
        How about maybe a couple or three insurance commissioners?
    And Mike is a superb insurance commissioner, but the reaction
    immediately was, well, the other 47 would be mad they are not
    at the table, or 48. Well, that won't work. So let us make it
    where you all have to buy a thrift. But remember, this is not
    for the walking wounded or for terminal cases. These are for
    robust companies that will use this money to buy bonds to get
    the wholesale side of the economy moving again. We have not
    heard back, because they still can't understand how to put
    their arms around this industry. And I think for the sake of
    the country and the growth of the economy, that is a real
    tragedy.
        Senator Warner. Mr. Chairman, I might add that I think, at
    least in recent press reports, we are still waiting for the
    Treasury to give some guidance in this area and an entity that
    has such a potential stimulative effect in terms of getting the
    credit markets reopened again, we need them at the table
    participating and the sooner we can get that answer from the
    Department on how or why or why not the industry can't
    participate in the TARP, I think the better for all of us.
        Chairman Dodd. I agree with that very much----
        Senator Warner. Thank you, Mr. Chairman.
        Chairman Dodd.----and know that history very well,
    Governor, and those days. Of course, the irony was in some
    cases, you had some industries actually out looking to actually
    get TARP money to buy the thrift in order to qualify to be at
    the table.
        Senator Warner. Mr. Chairman, I have got an entity that
    went through that, bought their S&L and then in the transition
    kind of got left out on the paperwork. It seems a little crazy
    that they had to go through this additional step to try to
    benefit from this program that we all want you to be involved
    in to get these credit markets open. And again, since you hold
    these for long, long term, these assets that may be not priced
    very well at this point, but if anybody is going to hold them
    for a long-term maturity, it seems to be your industry.
        Thank you, Mr. Chairman.
        Chairman Dodd. Thank you very much, Senator Warner.
        Senator Johnson?
        Senator Johnson. Thank you, Senator Dodd. I apologize for
    coming in late.
        Governor Keating, there seems to be some consensus that
    part of any regulatory modernization proposal must include a
    systemic risk regulator. Is there a regulator that you believe
    should begin this responsibility? What powers would this
    entail, and what kind of sanctions or other tools does this
    risk regulator need at his disposal?
        Mr. Keating. Well, Senator Johnson, our insistent message
    is that this industry, this $5 trillion industry benefits to
    retirees and to near-retirees precisely at a time the economy
    is suffering from people with limited savings and life
    insurance policies are used by business partners and staffs for
    annuitants, to make sure you can live in comfort for the rest
    of your life. These are very, very important pieces of the
    economy, and to consider these systemic, as I said to Senator
    Shelby, is hugely important, whether you focused on individual
    products that need regulation because of the systemic danger to
    the system or if you look at the size of the company. That is,
    of course, at the Senate and Congress's discretion. But we just
    need to make sure that the very noisy voice of this hugely
    significant part of the economy is part of that approach.
        Senator Johnson. For all the witnesses, going forward, what
    is the most logical way to regulate holding companies of
    insurance subsidiaries? Mr. McRaith?
        Mr. McRaith. Thank you, Senator. I think prior to your
    arrival, there was some discussion. Senator Merkley asked a
    similar question and I want to pick up on a comment made by Mr.
    Hunter, and that relates to Gramm-Leach-Bliley, which I know
    you are familiar with. I think it is important to go back to
    1932 and the Glass-Steagall Act, which established those
    firewalls that served our country so well by separating
    commercial banks and investment banks insurance companies. And
    as we look at regulating holding companies with insurance
    subsidiaries, I think we need to revisit the deterioration of
    those firewalls that Gramm-Leach-Bliley caused and I think we
    need to really answer the question of how to best protect
    consumers and at the same time allow our financial services to
    grow. There needs to be better regulation at the holding
    company level and we can be a part of that.
        Senator Johnson. Governor Keating?
        Mr. Keating. I want to say that during the course of this
    conversation this morning, Mr. McRaith and I have disagreed on
    a number of subjects, but on this one we agree, so it is a good
    way to end our conversation.
        Senator Johnson. Mr. Berkley?
        Mr. Berkley. I think that--obviously, I think we need some
    kind of oversight of holding companies because part of the
    problem is, and starting with AIG, with sophisticated financial
    tools, many of those old regulations have disappeared in their
    effectiveness. So, in fact, what we saw at AIG is the guaranty
    and the cross-collateralization from the industry companies to
    their other vehicles created substantial problems. So I think
    old legislation had the right idea, but I think we would need
    much more contemporary regulation, which is why we think
    Federal legislation is really required, because it is a much
    more sophisticated world we live in today. It is not just
    corporations under a holding company. It is legal obligations
    that cross one to another.
        Senator Johnson. Mr. Houldin?
        Mr. Houldin. Senator, I certainly think that an overseer is
    necessary as long as they don't get involved with the day-to-
    day regulation of insurance. More of a treetop approach
    certainly makes sense in light of what we have seen.
        Senator Johnson. Mr. Hill?
        Mr. Hill. Yes, Senator Johnson. We think part of the
    solution would be the establishment of the systemic regulator
    because we believe by focusing more product-based as opposed to
    institution-based, that regulator will then be able to foresee
    the problems that will occur with these various products. I
    mean, if we look at the sophistication of the credit default
    swaps, I think having someone with the expertise to regulate
    those products and products of that nature, that is the
    solution as opposed to looking to just target a holding company
    structure per se.
        Senator Johnson. Mr. Nutter?
        Mr. Nutter. Senator Johnson, the reinsurance sector is
    probably the most global of the insurance sectors. We have
    testified that you really do need a Federal regulatory regime
    that has authority to enter into agreements with non-U.S.-based
    regulators in other countries in order to achieve what you are
    talking about, that is the ability to look at a company
    holistically, both in the U.S. and outside the U.S.
        Senator Johnson. Mr. Hunter?
        Mr. Hunter. Thank you, Senator. It is part of the systemic
    risk. I think the systemic regulator would have to monitor set
    standards and then be able to bring down a company so that a
    company would never be too big to fail. Now, that would include
    the holding company and we think the logical approach is that
    financial institutions would have capital standards put on them
    based upon an analysis of their risk and not by just size, but
    other kinds of things--the type of activities, the
    interconnection to other financial markets, et cetera, and then
    that would obviously sweep in a holding company if it was part
    of another arrangement.
        Senator Johnson.
        [Presiding.] My time has expired. Mr. Shelby, do you have
    anything?
        Senator Shelby. I have no other questions, Mr. Chairman. I
    think we had a distinguished panel here today and I think
    everybody knows what our challenges are. In other words, how do
    we deal with problems in a new 21st century financial market,
    is so intertwined. Obviously, when AIG got in real, real
    trouble, the Feds got problems in dealing with it. The Chairman
    has said that. The States couldn't really deal with it. There
    is blame everywhere, but how do we prevent this from happening
    in the future? I think that's one of our problems, but I think
    that as we hold more hearings, we are going to see that this is
    very complex. We know that. And we have got to do this, and
    whatever we do, we do it right, because I think we are going
    down the road of looking at a very comprehensive regulator for
    all our financial system. I can see it coming down, and maybe
    we can make it happen this year. I hope we can.
        Mr. Hunter, you look like you want to comment on something.
        Mr. Hunter. Oh, no, no. I was just enrapt.
        Senator Shelby. OK.
        [Laughter.]
        Senator Shelby. I don't think you are in rapture of
    anything, but Mr. Hunter, do you agree with that, that that is
    our challenge, and our goal is there----
        Mr. Hunter. Yes. I think you have said it exactly right,
    Senator.
        Senator Shelby. In other words, we are dealing in the 21st
    century now.
        Mr. Hunter. Yes.
        Senator Shelby. And we are dealing with all kinds of new
    products. People think them up. A lot of them have not been
    approved, so to speak. A lot of people didn't realize the risk
    out there to our whole financial system. But the risk is real.
    We are feeling it every day. The taxpayer feels it big today as
    we speak.
        Thank you, Mr. Chairman.
        Senator Johnson. Senator Merkley, do you have anything
    else?
        Senator Merkley. No. Thank you.
        Chairman Dodd. With that, I thank you for coming and this
    hearing is adjourned.
        [Whereupon, at 11:50 a.m., the hearing was adjourned.]
        [Prepared statements, responses to written questions, and
    additional material supplied for the record follow:]
                    PREPARED STATEMENT OF SENATOR JON TESTER
        Thank you, Mr. Chairman, for holding this important hearing. I am
    pleased to be a member of this Committee as we begin the discussion
    about the next transportation reauthorization bill.
        In Montana, transit--buses especially--are critically important for
    transportation across the State. When we lose Essential Air Service, or
    a large air provider pulls out of an airport, it's generally intercity
    bus service that takes its place to move people hundreds and hundreds
    of miles across the State.
        There's no doubt about it--you cannot have economic development
    without a smart, effective transportation system. And transit is a key
    part of that, even in rural America. Five years ago, a significant
    increase in transit spending allowed rural States like Montana to
    expand intercity bus service, as well as local transit services, to
    almost all of our counties. It is critical that we maintain this
    important funding that has helped safely connect folks in isolated
    areas to commerce, medical care, and family members. However, there is
    still more to do. For instance, we must ensure that all paratransit
    vehicles are wheelchair accessible, and that transportation for
    veterans is also accessible for vets with disabilities.
        In Montana, we also have a high fatality rate for drivers on rural
    roads. I'd like to see--in the very least--students and elderly folks
    have access to a safe transit option to get to school, medical
    appointments, and local meetings.
        I appreciate you all coming today. As the Senate begins to look
    forward to the upcoming transportation reauthorization bill, I am
    hopeful that our Committee will be able to craft a transit portion that
    is fair to small and rural communities, where transit ridership has
    increased dramatically, even as the economy has gone into a downturn. I
    look forward to working with the new Secretary of Transportation,
    Secretary LaHood, the Chairman and this Committee to ensure a strong
    rural component to future transit and transportation infrastructure
    legislation.
                                     ______

                    PREPARED STATEMENT OF MICHAEL T. McRAITH
          Director of Insurance, Illinois Department of Financial and
         Professional Regulation, on behalf of the National Association
                           of Insurance Commissioners
                                 March 17, 2009
        Chairman Dodd, Ranking Member Shelby, and Members of the Committee,
    thank you for inviting me. My name is Michael McRaith. I am the
    Director of Insurance for the State of Illinois, and I testify on
    behalf of the National Association of Insurance Commissioners (NAIC). I
    am pleased to discuss efforts to modernize the State-based structure of
    insurance supervision and to offer a regulator's description of the fit
    for that system within the broader context of financial regulatory
    reform.
        Having regulated the U.S. insurance industry for over 135 years,
    State insurance officials have a demonstrable record of successful
    consumer protection and industry oversight. Consumer protection has
    been, is and will remain priority one for State insurance officials.
    Each day our responsibilities focus on ensuring that the insurance
    safety net remains available when individuals, families and businesses
    are in need. We advocate for insurance consumers and objectively
    regulate the U.S. insurance market, relying upon the strength of local,
    accountable oversight and national collaboration.
        With continually modernized financial solvency regulation, State
    insurance regulators supervise the world's most competitive insurance
    markets. Twenty-eight (28) of the world's fifty (50) largest insurance
    markets are individual States within our nation. As a whole, the U.S.
    insurance market surpasses the combined size of the second, third and
    fourth next largest markets. More than 2,000 insurers have been formed
    since 1995--leading to a total of more than 7,661 in the United
    States--with combined premiums or more than $1.6 trillion. States
    derive $17.5 billion in taxes and fees from insurers, with
    approximately 8 percent (8 percent) used to support regulation and the
    remainder supporting State general funds. With this proud record of
    success, State insurance regulation constantly evolves, innovates and
    improves to meet the needs of consumers and industry. My testimony
    today will focus on the prominent place for State-based insurance
    regulation within systemic risk regulation and discuss continuing State
    efforts to improve functional insurance regulation.
        Insurance companies are integral capital market participants and
    are not immune from the unprecedented global economic turmoil. However,
    insurers have not caused the turmoil and, as a whole, the industry is a
    source of calm in an otherwise turbulent time. Vigilant, engaged and
    effective prudential supervision by the States fosters this insurance
    marketplace stability, and we urge caution in any Federal initiative
    that may jeopardize the State-based platform for such oversight.
        To be clear, any reforms to functional insurance regulation should
    start and end with the States. Federal assistance may be necessary if
    targeted to streamline insurance regulator interaction and coordination
    with other functional regulators, but that initiative should not
    supplant or displace the State regulatory system. The insurance
    industry, even in these difficult times, has withstood the collapses
    that echo through other financial sectors.
    States Oversee a Vibrant, Competitive Insurance Marketplace
        In addition to consumer protection, State insurance officials are
    adept stewards of a vibrant, competitive insurance marketplace which,
    in turn, provides tremendous economic benefits for the States. When
    State insurance markets are compared to other national insurance
    markets around the globe, the size and scope of those States' markets--
    and therefore the responsibility of State regulators--typically dwarfs
    the markets of whole nations. For example, the insurance market in
    Connecticut is larger than the insurance markets in Brazil or Sweden.
    Likewise, the markets in California, New York and Florida are each
    larger than the markets in Canada, China or Spain, and the markets in
    Ohio and Michigan are each larger than the markets in India, Ireland or
    South Africa. Each of these markets demands a local, accountable and
    responsive regulator.
    Systemic Risk: State/Federal Partnership
        State insurance regulators support Federal initiatives to identify
    and manage national and global systemic risk. When defining a
    ``systemically significant'' institution, empirical or data-driven
    factors aid but do not conclude an analysis. As described in the Group
    of Thirty (G30) report released on January 15, 2009, State insurance
    regulators agree that four considerations are essential: (1) size, (2)
    leverage, (3) scale of interconnectedness, and (4) the systemic
    significance of infrastructure services.\1\
    ---------------------------------------------------------------------------
        \1\ See Financial Reform, A Framework for Financial Stability,
    Group of Thirty, January 15, 2009, p. 19.
    ---------------------------------------------------------------------------
        Insurance is one part of a far larger financial services economic
    sector. Insurance companies are not likely to be the catalyst of
    systemic risk but, rather, the unfortunate recipient of risk imposed by
    other financial sectors, as exemplified by the American International
    Group (AIG).
        Given that the U.S. has the world's most vibrant and competitive
    insurance marketplace, it is unlikely that any one insurer is ``too big
    to fail.'' If an insurer were to fail, regardless of size, State-based
    guaranty funds would protect existing policyholders and pay claims. As
    history demonstrates, competition and capacity allow other insurers to
    fill marketplace voids left by the failed insurer. States also operate
    residual markets to cover those unable to obtain an offer of insurance
    in the conventional market. Therefore, even a major insurer failure,
    while traumatic in terms of job displacement and, perhaps, for
    shareholders, will generally not impose systemic risk.
        Insurance risk management differs from risk in the banking sector
    because insurers are generally less leveraged than banks. Less leverage
    allows insurers to better withstand financial stress. State insurance
    regulators impose strict rules on the type, quality and amount of
    capital in which an insurer can invest. Also, insurer liabilities are
    generally independent of economic cycles in that the ripeness of a
    claim is not a function of economic conditions. This long-term reality
    reduces the likelihood an insurer will have to liquidate assets to
    satisfy short-term obligations.
        An insurance business having special interconnectedness to capital
    markets may be capable of generating systemic risk, however. The
    financial and mortgage guaranty lines, for example, have encountered
    difficulty because of mortgage-related securities which, in turn, have
    adversely impacted public sector and mortgage loan financing.
        Even strict accounting and investment standards do not inoculate
    insurers from the risks of recent systemic failures. A wholesale
    collapse of the stock market (to a greater degree than what we have
    recently seen) or the bond market would have a dire effect on insurance
    companies and could lead to insurance company failures. A collapse of
    the dollar and rampant inflation would increase claims costs for
    property and casualty insurers. A mixture of high inflation and a
    declining economy (stagflation) and low investment returns could create
    a perfect storm for all aspects of the economy. Regulation, of course,
    cannot ensure that insolvencies will not occur in extreme
    circumstances.
    Systemic Risk: Functional Regulators Work Together
        Unmanaged risk in one sector can deleteriously affect the viability
    of other sectors. The current financial crisis illuminates the need for
    a collaborative approach to regulation of financial conglomerates, or
    those enterprises of such magnitude that a failure would jeopardize the
    financial stability of an economy, or a segment of an economy.
    Cooperation and communication among the functional financial services
    regulators should be formalized in order to harmonize regulatory dialog
    and efficacy.
        State insurance regulators support Federal initiatives to ensure or
    enhance financial stability, while preserving State-based insurance
    regulation. Functional regulators can work and coalesce in a manner
    that protects consumers and promotes financial stability. State
    regulators support financial stability regulation that incorporates the
    following principles:

      (1)  Primary Role for States in Insurance Regulation: For
            systemically significant enterprises, the establishment of a
            Federal financial stability regulator, e.g., the Federal
            Reserve, will integrate but not displace State-based regulation
            of the business of insurance. Consumer access to State-based,
            local regulatory officials will remain the bulwark of consumer
            protection. A Federal financial stability regulator will share
            information and collaborate formally with other Federal and
            State financial services regulators. Appropriate information
            sharing authority and confidentiality protocols should be
            established between all Federal and State financial services
            regulators, perhaps including law enforcement.

      (2)  Formalization of Regulatory Cooperation and Communication:
            Federal financial stability regulation should ensure effective
            coordination, collaboration and communication among the various
            and relevant State and Federal financial regulators. A Federal
            financial stability regulator should work with functional
            regulators and develop best practices for enterprise-wide and
            systemic risk management. A fundamental aspiration for any
            supervisory oversight should include the preservation of
            functional regulation of the business being transacted by each
            independent entity.

      (3)  Systemic Risk Management: Preemption of functional regulatory
            authority, if any, should be limited to extraordinary
            circumstances that present a material risk to the continued
            solvency of the holding company, or ``enterprise,'' the demise
            of which would threaten the stability of a financial system.
            With the experience of decades of an evolving practice, State
            regulators know that effective regulation inevitably coincides
            with comprehensive risk management. ``Supervisory colleges''
            can be utilized to understand the risks within a holding
            company structure, and can be comprised of regulators from each
            financial services sector represented within the enterprise.
            The financial stability regulator should operate in a
            transparent, accountable and collaborative manner, and should
            defer to the functional regulator in proposing, recommending or
            requiring any action related to a regulated entity's capital,
            reserves or solvency. One company within a holding company
            structure should not be compromised for the benefit of another
            company within another sector.

        American International Group (AIG) exemplifies the circumstance in
    which systemic stability regulation must be bolstered. All reasonable
    minds accept as fact that AIG's State regulated insurance businesses
    did not cause AIG's problems. AIG's Financial Products subsidiaries,
    though, embraced risks that threaten not only the AIG parent company
    but also may cause reputational harm to AIG's insurers. AIG's insurance
    companies were not immune from the ripple effects created by the
    Financial Products division, as the subsequent downgrade of AIG due to
    credit default swap exposure put pressure on the insurers' securities
    lending practices when counterparties attempted to unilaterally
    terminate those transactions. Despite these challenges and others,
    AIG's commercial insurance lines--its core insurance businesses--
    generated significant underwriting profit during 2008.
        Subject to State regulatory oversight, insurance companies have
    weathered these extraordinary economic times relatively well while
    coping with both natural catastrophes (e.g., Hurricane Dolly,
    California fires) and challenging marketplace conditions. State
    regulators caution that partnership with Federal and other functional
    regulators is not acquiescence to Federal preemption. On the contrary,
    State insurance regulators have risk management, accounting standards
    and investment allocation expertise that can inform any Federal
    initiative.

    Office Of Insurance Information (OII)
        The most effective way to anticipate and mitigate systemic risk,
    both within a holding company and within an economy, is to understand
    where, and to what extent, that risk exists. The Federal Government
    does need relevant information and financial data on insurance to
    facilitate that effort. In its final form during the last Congress, the
    NAIC supported House legislation creating a Federal Office of Insurance
    Information (H.R. 5840 from the 110th Congress). The OII would
    construct an insurance data base within the Department of Treasury and
    be available to provide directly to the Congress and Federal agencies
    the encyclopedic insurance-related data and information presently
    compiled by the States. State regulators worked constructively to
    narrow the preemption aspects of the initial proposal.
        We agree that, as a key component of financial stability, insurance
    must be factored into an all-inclusive view of the financial system at
    the Federal level. This shared objective can, of course, be achieved
    without a Federal insurance regulator and without preempting State
    authority over the fundamental consumer protections, including solvency
    standards.

    Modernization Proposals: Optional Federal Charter--A Misguided Solution
        While contemplating perspectives on insurance regulatory reform, a
    group of the world's largest insurers continue to advocate for parallel
    Federal and State regulation. For more than 10 years, insurance
    industry lobbyists have called for the creation of a massive new
    Federal bureaucracy known as an optional Federal charter (``OFC''). The
    current climate of instability and insolvency in the banking sector
    illustrates this concept cannot work. An optional system where the
    regulated enterprise chooses the regulator with the lightest touch--as
    evidenced by AIG--leads to regulatory arbitrage, gaps in supervision,
    ineffective risk management and disastrous failures.
        Through the OFC, some of the largest insurers seek to unravel basic
    consumer protections and the essential solvency requirements that have
    nurtured the world's largest and most competitive insurance markets.
    The State-based system benefits both consumers and industry
    participants. The facts do not support the need for an OFC--it is a
    solution in search of a problem.

    Modernization Proposals: OFC Alternative--Interstate Insurance Compact
        Life insurers argue that life insurance provides wealth protection
    and, as a product, competes against banking products. This, in turn,
    warrants a streamlined approval process for entry into the national
    marketplace. While agreeing with the premise, insurance regulators know
    that such streamlined regulatory approval cannot come at the cost of
    consumer protection and solvency regulation. Insurance regulators have
    worked successfully to bring more cost-effective and sound insurance
    products to the market more quickly. Central to this effort has been
    the Interstate Insurance Compact (``the Compact'') for filing and
    regulatory review of life, annuities, long-term care and disability
    insurance products. The States heard the call for a more competitive
    framework in the life insurance sector, and have responded.
        The Compact is a key State-based initiative that modernizes
    insurance regulation to keep pace with global demands, while upholding
    strong consumer protections. Under the Compact, insurers file one
    product under one set of rules resulting in one approval in less than
    sixty days that is valid in all Compact Member jurisdictions. This
    example of State-based reform allows insurers to quickly bring new
    products to market according to strong uniform product standards. At
    the same time, the Compact preserves a State's ability to address
    front-line problems related to claims settlement, consumer complaints,
    and unfair and deceptive trade practices.
        States have overwhelmingly embraced the Compact, as to date 33
    States and Puerto Rico have joined by passing enabling legislation.\2\
    Over one-half of U.S. nationwide premium volume has joined the Compact.
    More States are expected to come on board in the near future, with
    legislation pending in Connecticut, New York, New Mexico, and New
    Jersey.
    ---------------------------------------------------------------------------
        \2\ Currently, 34 jurisdictions have joined the Interstate
    Insurance Product Regulation Commission (IIPRC). Compacting members are
    Alaska, Colorado, Georgia, Hawaii, Idaho, Indiana, Iowa, Kansas,
    Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan,
    Minnesota, Mississippi, Nebraska, New Hampshire, North Carolina, Ohio,
    Oklahoma, Pennsylvania, Puerto Rico, Rhode Island, South Carolina,
    Tennessee, Texas, Utah, Vermont, Virginia, Washington, West Virginia,
    Wisconsin and Wyoming.
    ---------------------------------------------------------------------------
    Modernization Proposals: Producer Licensing Reform
        By developing and utilizing electronic applications and data bases,
    State insurance officials have created much greater efficiencies in
    licensing insurance producers. Nevertheless, State insurance officials
    continue efforts to achieve greater uniformity in the producer
    licensing process.
        The National Insurance Producer Registry (NIPR) is a non-profit
    affiliate of the NAIC that assists regulators and insurers when
    reviewing an agent or broker license. With information on more than 4
    million producers, NIPR also provides an electronic format for non-
    resident producer licensing.
        In 2008 State insurance regulators worked with the Independent
    Insurance Agents and Brokers of America (the ``Big I''), and others, to
    offer refinements on H.R. 5611 (``NARAB 2'') designed to achieve the
    non-resident licensing uniformity goals of the 1999 Gramm-Leach-Bliley
    Act (``GLB''). While States were in compliance with nearly every aspect
    of GLB, State regulators continue to work to improve the system and
    efficiency of producer licensing. The NAIC supported the compromise
    legislation and continues working with the Big I to address the
    Constitutional concerns raised by the Department of Justice. Producer
    licensing is a topic that would benefit from uniformity nationwide, and
    State regulators are not averse to Federal Government involvement to
    achieve such uniformity. Our good faith, constructive efforts
    demonstrate our commitment to achieve the best possible insurance
    regulatory system.

    Modernization Proposals: Surplus Lines and Reinsurance Reform
        In both the 109th and 110th Congress, a bill known as the ``Non-
    admitted and Reinsurance Reform Act'' (the ``Act'') was introduced and
    passed the House of Representatives. Title I of the proposed Act refers
    to ``Non-admitted Insurance.'' State insurance regulators, through the
    NAIC, testified publicly in support of uniformity and modernization of
    surplus lines multi-State placement and recognize the need to improve
    uniformity for tax collection, form filing and non-admitted carrier
    eligibility. Working collectively, in April, 2008, State insurance
    regulators also submitted proposed improvements to Title I of the Act
    to Senator Jack Reed, Chairman Dodd, and others.
        Title II of the Act refers to ``Reinsurance'' and contains
    provisions wholly opposed by State regulators. While espousing
    principles in support of reinsurance reform, the NAIC opposed the Title
    II provisions as overtly threatening the solvency and other financial
    standards for ceding carriers. Consumer protection cannot be sacrificed
    to ease the industry's financial standards. Through the NAIC, State
    insurance regulators adopted a framework to modernize the regulation of
    reinsurance in the United States, and are drafting a specific
    legislative proposal to implement the reforms. State insurance
    regulators have publicly stated that implementation of the reform will
    necessarily include Congressional involvement.

    Consumer Protections: Strong Prudential Supervision
        As the current financial crisis graphically illustrates, effective
    solvency supervision is the ultimate consumer protection. The concepts
    of prudential supervision and consumer protection are not severable
    because the core obligation of an insurer is a promise to pay. Since
    1989, when the NAIC adopted a solvency agenda designed to enhance the
    ability of State regulators to protect insurance consumers from the
    financial trauma of insurer insolvencies, State insurance departments
    have continually improved this most elemental consumer protection. At
    the very core of those improvements is the NAIC's accreditation
    program, which requires each State to have statutory accounting,
    investment, capital and surplus requirements embedded in State law to
    further strengthen the solvency of the industry. Many of these laws
    increase regulators' ability to identify and act when a company's
    financial condition has weakened. These laws further benefit from the
    coordinated activity of the States.

    Financial Analysis Working Group
        The NAIC's Financial Analysis Working Group (``FAWG'') is a
    confidential, closed-door forum that allows financial regulators to
    assess nationally significant insurers and insurer groups that exhibit
    characteristics of trending toward financial trouble. FAWG evaluates
    whether appropriate supervisory action is being taken.
        Through FAWG and other standing committees and reporting
    mechanisms, States work together and form a complex network of ``checks
    and balances,'' ensuring that even basic judgments of one primary
    financial regulator are subject to the oversight of a similarly skilled
    colleague from another State. These improvements have allowed
    regulators to identify more easily when insurers are potentially
    troubled and react more quickly to protect policyholders and consumers.

    Solvency II
        The myth of the ``Solvency II'' directive, currently under
    consideration by the European Union, has been touted as the beacon of
    global insurance regulatory reform. In fact, Solvency II would lower
    reserve requirements--appealing to a large insurer, of course--that
    would threaten the independent solvency standards of U.S.-based
    insurers. At this moment in our nation's history, given that the
    paradigm of financial institutions appropriately pricing and managing
    risk has largely unraveled, a reduction in reserve requirements for
    insurers would not serve the interest of the consumer or the investing
    public. Today's headlines illustrate that an industry motivated by
    profit and market pressures does not always have the consumer's best
    interests at heart.
        Solvency II is years away from implementation. Under the current
    timetable, the Directive is not scheduled to be implemented by the
    various member countries until 2012. However, at this time, even the
    previously agreed upon standards are being re-evaluated and many will
    likely be disposed of entirely. Several smaller EU States have
    expressed reservations about its effect on their resident insurance
    consumers. Solvency II is far from a reality, even where it originated,
    and has a lore that far outshines its factual merits.
        State regulators are carefully evaluating aspects of Solvency II
    and principles-based regulation for potential application within the
    State-based system. We urge careful analysis of any proposal to achieve
    modernization of insurance supervision in the United States by applying
    global standards. Even well intended and seemingly benign
    ``equivalence'' standards can have a substantial adverse impact on
    existing State protections for insurance consumers.

    Consumer Protections: Local, Personal Response in the States
        Consumer protection has been, is, and will remain priority one for
    State insurance regulators. State insurance supervision has a long
    history of aggressive consumer protection, and is well-suited to the
    local nature of risk and the unique services offered by the insurance
    industry. State regulators live and work in the communities they serve,
    and respond accordingly. In a year, we resolve 400,000 formal
    complaints and respond to nearly 3 million consumer inquiries. This
    kind of consumer-oriented local response is the essential hallmark of
    State insurance supervision.
        Insurance is a uniquely personal and complex product that differs
    fundamentally from other financial services, such as banking and
    securities. Unlike banking products, which provide individuals credit
    to obtain a mortgage or make purchases, or securities, which offer
    investors a share of a tangible asset, insurance products require
    policyholders to pay premiums in exchange for a legal promise.
    Insurance transfers risk while investments and even deposits are an
    assumption of risk.
        Insurance is a financial guarantee to pay benefits, often years
    into the future, in the event of unexpected or unavoidable loss that
    can cripple the lives of individuals, families and businesses. The cost
    to insurers to provide those benefits is based on a number of factors,
    many of which are prospective assumptions, making it difficult for
    consumers to understand or anticipate a reasonable price. Unlike most
    banking and securities products, consumers are often required to
    purchase insurance both for personal financial responsibility and for
    economic stability for lenders, creditors and other individuals. Most
    consumers find themselves concerned with their insurance coverage, or
    lack thereof, only in times of critical personal vulnerability--such as
    illness, death, accident or catastrophe. State officials have responded
    quickly and fashioned effective remedies to respond to local conditions
    in the areas of claims handling, underwriting, pricing and market
    practices.
        State insurance regulators encourage consumers to be aggressive,
    informed shoppers. Through the NAIC, State regulators have proactively
    developed the latest and best tools to educate consumers on important
    insurance issues. These have included outreach campaigns, public
    service announcements and media toolkits. With its landmark Insure U--
    Get Smart about Insurance public education program,
    (www.insureuonline.org), the NAIC has demonstrated its deep commitment
    to educating the public about insurance and consumer protection issues.
    Insure U's educational curriculum helps consumers evaluate insurance
    options to meet different life stage needs. Available in English and
    Spanish, the Insure U Web site covers basic information on the major
    types of insurance--life, health, auto and homeowners/renters
    insurance. Insure U also offers tips for saving money and selecting
    coverage for young singles, young families, established families,
    seniors/empty nesters, domestic partners, single parents, grandparents
    raising grandchildren and members of the military.

    Conclusion
        State insurance regulators, working together through the NAIC, are
    partners with Congress and the Obama Administration, sharing jointly in
    pursuit of improvement to the financial regulatory system and,
    ultimately, improving consumer protections. The State-based insurance
    regulatory system includes critical checks and balances, eliminating
    the perils of a single point of failure and opaque or omnipotent
    decisionmaking. With a fundamental priority of consumer protection, and
    with a system that has fostered the world's largest, most competitive
    insurance market, State insurance regulators embrace this opportunity
    to build on our proven regime.
        The NAIC and its members--representing the citizens, taxpayers, and
    governments of all fifty States, the District of Columbia and U.S.
    territories--commit to share our expertise with Congress and to work
    with members of this Committee, and others. We welcome Congressional
    interest in our modernization efforts. We look forward to working with
    you.
        Thank you for this opportunity to testify, and I look forward to
    your questions.

                                     ______

                      PREPARED STATEMENT OF FRANK KEATING
              President and CEO, American Council of Life Insurers
                                 March 17, 2009

        Mr. Chairman and members of the Committee, my name is Frank
    Keating, and I am President and CEO of the American Council of Life
    Insurers. The ACLI is the principal trade association for U.S. life
    insurance companies. Its 340 member companies account for 93 percent of
    total life insurance company assets, 94 percent of the life insurance
    premiums, and 94 percent of annuity considerations in the United
    States.
         All sectors of U.S. financial services are at a critical juncture
    given the current state of the domestic and global markets. I
    appreciate the opportunity to discuss with you today the views of the
    life insurance industry on how insurance regulation can be modified to
    improve the current structure and how insurance regulation can be
    integrated most effectively with that of other segments of the
    financial services industry as well as with overall systemic risk
    regulation.
        Addressing systemic risk in the financial markets--both
    domestically and globally--has emerged as the driving force behind
    regulatory reform efforts. My comments today reflect that perspective
    and begin with the premise that the life insurance business is, by any
    measure, systemically significant.

    The Life Insurance Industry Is Systemically Significant
        Life insurance companies play a critically important role in the
    capital markets and in the provision of protection and retirement
    security for millions of Americans. Life insurers provide products and
    services differing significantly from other financial intermediaries.
    Our products protect millions of individuals, families and businesses
    through guaranteed lifetime income, life insurance, long-term care and
    disability income insurance. The long-term nature of these products
    requires that we match our long term liabilities with assets of a
    longer duration than those of other types of financial companies.
         Life insurers are the single largest U.S. source of corporate bond
    financing and hold approximately 18 percent of total U.S. corporate
    bonds. Over 42 percent of corporate bonds purchased by life insurers
    have maturities in excess of 20 years at the time of purchase. The
    average maturity at purchase for all corporate bonds held by life
    insurers is approximately 17 years. As Congress and the Administration
    continue efforts to stabilize the capital markets and increase the
    availability of credit, the role life insurers play as providers of
    institutional credit through our fixed income investments cannot be
    overemphasized. We are significant investors in bank bonds and
    consequently are an important factor in helping banks return to their
    more traditional levels of lending.
         Life insurers are also the backbone of the employee benefit
    system. More than 50 percent of all workers in the private sector have
    life insurance made available by their employers. Life insurers hold
    approximately 22 percent of all private employer-provided retirement
    assets.
         Our companies employ about 2.2 million people, and the annual
    revenue from insurance premiums alone was $600 billion in 2007, an
    amount equal to 4.4 percent of U.S. GDP. Some 75 million American
    families--nearly 70 percent of households--depend on our products to
    protect their financial and retirement security. There is over $20
    trillion of life insurance coverage in force today, and life insurers
    hold $2.6 trillion in annuity reserves. In 2007 life insurers paid $58
    billion to life insurance beneficiaries, $72 billion in annuity
    benefits and $7.2 billion in long-term-care benefits.

    Individual Company Systemic Risk
        We do not presume to suggest to Congress any definitive standard
    for determining which, if any, life insurance companies have the
    potential to pose systemic risk. We assume, however, that relevant
    factors for Congress to consider in this regard would include: the
    extent to which the failure of an institution could threaten the
    viability of its creditors and counterparties; the number and size of
    financial institutions that are seen by investors or counterparties as
    similarly situated to a failing institution; whether the institution is
    sufficiently important to the overall financial and economic system
    that a disorderly failure would cause major disruptions to credit
    markets or the payment and settlement systems; whether an institution
    commands a particularly significant market share; and the extent and
    probability of the institution's ability to access alternative sources
    of capital and liquidity.
        We do offer three general observations in this regard. First, moral
    hazard and the potential risk of competitive imbalances can be
    minimized by avoiding a public, bright-line definition of systemic risk
    and by keeping confidential any role a systemic risk regulator plays
    with respect to an individual company. Second, systemic risk regulation
    should have as its goal the identification and marginalization of risks
    that might jeopardize the overall financial system and not the
    preservation of institutions deemed ``too big to fail.'' And third, and
    specific to life insurance, systemic risk regulation must not result in
    the separation of those elements of life insurance regulation that
    together constitute effective solvency oversight (e.g., capital and
    surplus, reserving, underwriting, risk classification, nonforfeiture,
    product regulation). Having different regulators assume responsibility
    for any of these aspects of insurance regulation would result in an
    increase in systemic risk, not a reduction of it.
    Structural Considerations
        Without a clear indication of how Congress intends to address
    systemic risk regulation, we make two fundamental assumptions for
    purposes of this testimony. The first is that the role of a systemic
    risk regulator will focus on industry-wide issues and on holding
    company oversight but will not extend to direct functional (solvency)
    oversight of regulated financial service operating companies (e.g.,
    insurers, depository institutions and securities firms). The second is
    that the systemic regulator will be tasked with coordinating closely
    with functional (solvency) regulators and will facilitate the overall
    coordination of all regulators involved with the oversight of a
    systemically significant firm.
        The absence of a Federal functional insurance regulator gives rise
    to several important structural questions regarding how systemic
    regulation can be fully and effectively implemented vis-a-vis
    insurance. We urge Congress to keep these questions in mind as
    regulatory reform legislation is developed.

    Policy Implementation
        The first question involves the implementation of national
    financial regulatory policy. Whatever legislation Congress ultimately
    enacts will reflect your decisions on a comprehensive approach to
    financial regulation. Your policies should strongly govern all
    systemically significant sectors of the financial services industry and
    should apply to all sectors on a uniform basis without any gaps that
    could lead to systemic problems.
        Without a Federal insurance regulator, and without direct
    jurisdiction over insurance companies, and given clear constitutional
    limitations on the ability of the Federal Government to mandate actions
    by State insurance regulators, how will national regulatory policies be
    implemented with respect to the insurance industry? The situation would
    appear to be very much analogous to the implementation of congressional
    policy on privacy reflected in the Gramm-Leach-Bliley Act. Federal bank
    and securities regulators implemented that policy for banking and
    securities firms, but there was no way for Congress to compel insurers
    to subscribe to the same policies and practices. Congress could only
    hope that 50+ State insurance regulators would individually and
    uniformly decide to follow suit. Hope may have been an acceptable tool
    for implementing privacy policy, but it should not be the model for
    reform of U.S. financial regulation. The stakes are much too high.

    Coordination of Systemic and Functional Regulators
        As noted above, we assume that one aspect of effective systemic
    risk regulation will be close coordination between the systemic risk
    regulator and the functional (solvency) regulator(s) of a systemically
    significant firm. Moreover, we assume that the systemic regulator will
    be called upon to interact with the functional regulators of all
    financial service industry sectors to address sector risks as well as
    risks across sector lines. For firms deemed systemically significant,
    we also assume there will be a Federal functional regulator with whom
    the Federal systemic regulator will coordinate.
        If there are insurance firms that are deemed systemically
    significant, the question arises as to how the Federal systemic risk
    regulator will be able to coordinate effectively with multiple State
    insurance regulators? How will Federal policy decisions be effectively
    coordinated with State regulators who need not adhere to those policy
    decisions and who may differ amongst themselves regarding the standards
    under which insurance companies should be regulated?

    International Regulation and Coordination
        Today's markets are global, as are the operations of a great many
    financial service firms. Consequently, systemic risk regulation
    necessarily involves both domestic and global elements. While State
    insurance regulators are certainly involved in discussions with
    financial regulators from other countries, they do not have the
    authority to set U.S. policy on insurance regulation nor do they have
    the authority to negotiate and enter into treaties, mutual recognition
    agreements or other binding agreements with their foreign regulatory
    counterparts in order to address financial regulatory issues on a
    global basis. How can multinational insurance companies be effectively
    regulated and how can U.S. policy on financial regulation--systemic or
    otherwise--be coordinated and harmonized as necessary with other
    countries around the globe?
        Regulators, central governmental economic policymakers and
    legislators in Europe, Japan, Canada and many other developed and
    developing markets point to the lack of a comprehensive Federal-level
    U.S. regulatory authority for financial services as one factor that led
    to the current instability of at least one of the largest U.S.
    financial institutions. Discussions at the upcoming G20 meetings in
    London will focus on the need to coordinate a global response to the
    economic crisis will include representatives of the comprehensive
    financial services regulators of 19 nations, with the only exception
    being the U.S. because of its lack of a Federal regulator for
    insurance.
        The G20 work plan includes mandates for two working groups. The
    first is tasked with monitoring implementation of actions already
    identified and making further recommendations to strengthen
    international standards in the areas of accounting and disclosure,
    prudential oversight and risk management. It will also develop policy
    recommendations to dampen cyclical forces in the financial system and
    address issues involving the scope and consistency of regulatory
    regimes. The second working group will monitor actions and develop
    proposals to enhance international cooperation in the regulation and
    oversight of international institutions and financial markets,
    strengthen the management and resolution of cross-border financial
    crises, protect the global financial system from illicit activities and
    non-cooperative jurisdictions, strengthen collaboration between
    international bodies, and monitor expansion of their membership.
        We believe Congress needs to fill this systemic regulatory gap
    through the creation of a Federal insurance regulatory authority like
    every other member of the G20. This Federal authority is necessary so
    there can be a comprehensive approach to systemic risk allowing U.S.
    regulators to respond to a crisis nimbly and in coordination with other
    major global regulators. Only in this way will policymakers and
    regulators have confidence in the equivalency of supervision, and the
    authority to share sensitive regulatory information and the ability to
    provide mutual recognition as appropriate.

    Monitoring the U.S. Financial System
        A significant aspect of the mission statement of the Treasury
    Department is ensuring the safety, soundness and security of the U.S.
    and international financial systems. Long before the advent of the
    current economic crisis, the Treasury Department found it difficult to
    derive a clear and concise picture of the health of the insurance
    industry. In considering steps that might be taken to enhance the
    ability of Treasury to carry out these objectives--which now appear far
    more important than in the past--one must ask how, absent a Federal
    functional regulator with an in-depth understanding of the industry,
    vital information on the insurance industry can be effectively
    collected and analyzed?

    The Effects of Federal Decisions on a State Regulated Industry
        As Congress considers how to address systemic risk regulation and
    how it might be applied to the insurance industry, it is important to
    take into account the ramifications of recent Federal actions on the
    industry. Crisis-related decisions at the Federal level have too often
    produced significant adverse effects on life insurers. Examples
    include: the handling of Washington Mutual which resulted in life
    insurers, as major bond holders, experiencing material portfolio
    losses; the suspension of dividends on the preferred stock of Fannie
    Mae and Freddie Mac and the fact life insurers were not afforded the
    same tax treatment on losses as banks, which again significantly
    damaged the portfolios of many life insurance companies and directly
    contributed to the failure of two life companies; the badly mistaken
    belief on the part of some Federal policymakers that mark-to-market
    accounting has no adverse implications for life insurance companies
    when in fact its effects on these companies can be more severe than for
    most other financial institutions; and more recently the cramdown
    provisions in the proposed bankruptcy legislation that could
    potentially trigger significant downgrades to life insurers' Triple-A
    rated residential mortgage-backed investments.
        These actions were all advanced with the best of intentions, but in
    each instance they occurred with little or no understanding of their
    effects on life insurers. And in each instance the only voice in
    Washington raising concerns was that of the industry itself. In this
    stressed market environment, legislators or policymakers can ill-afford
    miscues resulting from a lack of information on, or a fundamental
    misunderstanding of, an important financial industry sector. Actions
    taken without substantial input from an industry's regulators carry
    with them a much higher likelihood of unintended and adverse
    consequences. Insurance is the only segment of the financial services
    industry that finds itself in this untenable position as decisions
    critical to our franchise are debated and decided in Washington.

    Conclusion
        There is no question that assuring the stability of our payment
    system is of paramount concern. However, reforming U.S. financial
    regulation and advancing initiatives designed to stabilize the economy
    must take into account the interests and the needs of all segments of
    financial services, including life insurance. Unfortunately, the
    absence of a Federal insurance regulator all too often means that we
    are afterthought as these important matters are advanced. We urge
    Congress to recognize the systemic importance of our industry to the
    economy and to the retirement and financial security of millions of
    consumers and tailor reform and stabilization initiatives accordingly.
    Failure to do so runs the very real risk of doing grave harm to both.
    We pledge to work closely with this Committee and with others in
    Congress to provide you with factual, objective information on the life
    insurance business along with our best ideas on how a comprehensive and
    effective approach to regulatory reform can be implemented. I am sure
    we all share the goals of maintaining confidence and strength in the
    life insurance business and restoring stability to the entire spectrum
    of U.S. financial services.
                                     ______

                    PREPARED STATEMENT OF WILLIAM R. BERKLEY
                 CEO of W.R. Berkley Corporation, on behalf of
                       The American Insurance Association
                                 March 17, 2009

        Thank you, Chairman Dodd, Ranking Member Shelby, and members of the
    Committee. My name is Bill Berkley. I am the CEO of W.R. Berkley
    Corporation, a multi-billion dollar commercial lines property-casualty
    insurance and reinsurance group that I founded in 1967, which is
    headquartered, Mr. Chairman, in Greenwich, Connecticut. I am testifying
    today not just as CEO of W.R. Berkley, but as Chairman of the Board of
    the American Insurance Association. I appreciate the opportunity to be
    here to discuss issues of great importance during this time of economic
    upheaval and to participate in the important work of reshaping our
    regulatory landscape to confront future challenges and protect
    insureds.
        I believe that I bring a unique and broad perspective to this
    discussion. I have been involved in the insurance business as an
    investor or manager for over 40 years. I am a leading shareholder of
    insurance companies that protect U.S. businesses of all sizes from the
    risk of loss and that provide reinsurance, but I am also a majority
    shareholder of a nationally chartered community bank. I have witnessed
    the ebbs and flows of business cycles during that time, with the only
    constants being the existence of risk and the need to manage it. It is
    that challenge that brings us here today--the imperative of examining,
    understanding and measuring risk on an individual and systemic level--
    and retooling the financial regulatory structure to be responsive to
    that risk, recognizing that you cannot forecast every problem.
        With that context in mind, I would like to focus my remarks today
    on three major themes:

      1.  Property-casualty insurance is critical to our economy, but it
            does not pose the same types of systemic risk challenges as
            most other financial services sectors.

      2.  Nonetheless, because property-casualty insurance is so essential
            to the functioning of the economy and is especially critical in
            times of crisis and catastrophe, functional Federal insurance
            regulation will enhance the industry's effectiveness and thus
            should be included as part of any well-constructed Federal
            program to analyze, manage and minimize systemic risk.

      3.  Given the national and global nature of risk assumed by property
            and casualty insurers, establishment of an independent Federal
            insurance regulator is the only effective way of including
            property-casualty insurance in such a program.

        Property-casualty insurance is essential to the overall well-being
    of the U.S. economy. Insurance contributes 2.4 percent to the annual
    GDP, with property-casualty insurance accounting for more than $535
    billion in capital, purchasing close to $370 billion in State and
    municipal bonds, paying almost $250 billion annually in claims and,
    importantly, directly or indirectly employing 1.5 million hard-working
    Americans. Because property-casualty insurance protects individuals and
    businesses against unforeseen risks and enables them to meet financial
    demands in the face of adversity, it is the engine that propels
    commerce and innovation. Without the critical coverage provided by
    property-casualty insurance, capital markets would grind to a halt:
    Main Street and large businesses alike.
        While property-casualty insurance plays an essential role in our
    economy, it has been successfully weathering the current crisis. It has
    had to carefully navigate through some heavy turbulence to do so, but
    the sector remains strong overall, today. There are several reasons for
    that, but importantly property-casualty insurance operations are
    generally low-leveraged businesses, with lower asset-to-capital ratios
    than other financial institutions, more conservative investment
    portfolios, and more predictable cash outflows that are tied to
    insurance claims rather than ``on-demand'' access to assets.
        Yet, despite the industry's relative stability in this crisis,
    there are compelling reasons to establish Federal functional regulation
    for property-casualty insurance in any regulatory overhaul plans even
    though it has not presented systemic risk. The industry could always
    face huge, unforeseen, multi-billion dollar loss events such as a
    widespread natural disaster or another terrorist attack on U.S. soil.
    It makes little sense to look at national insurance regulation after
    the event has already occurred, but all the sense in the world to put
    such a structure in place to help either avoid the consequences of an
    unforeseen event altogether or to temper them through appropriate
    Federal mechanisms, ultimately minimizing potential industry
    disruption.
        However this Committee resolves the debate on Federal systemic risk
    oversight, the only effective way to include property-casualty
    insurance would be to create an independent Federal functional
    insurance regulator that stands as an equal to the other Federal
    banking and securities regulators.
        I continue to believe this after much deliberation and with great
    respect for the State insurance regulatory community. The State-based
    insurance regulatory structure is inevitably fragmented and frequently
    not well-equipped to close the regulatory gaps that the current crisis
    has exposed. Each State only has jurisdiction to address those
    companies under its regulatory control, and only to the extent of that
    control. Even where the States have identical insurance codes or
    regulations, the regulatory outcomes may still be inconsistent because
    of diverse political environments and regulatory interests. If this
    crisis has revealed anything, it is the need for more--not less--
    regulatory efficiency, coordinated activity or tracking, sophisticated
    analysis of market trends and the ability to anticipate and deal with
    potential systemic risk before the crisis is at hand.
        In addition, virtually all foreign countries have national
    regulators who recognize that industry supervision goes well beyond a
    focus on solvency. Effective contemporary regulation also must examine
    erratic market behavior by companies in competitive markets to ensure
    that those markets continue to function properly and do not either
    encourage other competitors to follow the lead of irrational actors or
    impede the competitive ability of well-managed enterprises. Further,
    the U.S. Constitution prevents the States from exercising the foreign
    affairs and foreign commerce powers. Therefore, if we are to coordinate
    with other nations and their financial regulators to address global
    crises like the current one, we need a single insurance voice at the
    Federal level to do so. In sharing these observations, I want to be
    clear: This is not a criticism of State regulators; it is a conclusion
    about the inevitable limitations and gaps inherent in separate State
    regulation from one who has been in the business for decades.
        Equally important, functional Federal insurance regulation allows a
    single agency to be well-informed about all of the activities within
    the insurance sector, including those types of unforeseen mega-events
    that could affect other sectors of the economy. It also provides the
    foundation for equitable regulatory action in times of crisis and when
    the insurance sector is functioning normally. As even-handed as every
    State regulator may try to be, without the broadest responsibility
    exercised by a national regulator, we cannot expect to get that
    treatment where issues affect more than one State. The reality is that
    no one State can effectively deal with mega-events or cross-border
    issues equally, and among multiple States, the ability to deal with
    such events or issues on a global level declines dramatically.
        A centralized regulator at the Federal level would also have
    authority to examine the related issue of mathematical models. The
    methods of examining and measuring risk have undergone significant
    evolution during my 40-plus years in the insurance business. I believe
    there has been a growing and unhealthy over-reliance on numbers-driven
    models in the assumption of risk, and to the use of these models to the
    exclusion of common sense and underwriting experience. Although such
    models have an important role in insurance like they do in other
    financial services industries, risk evaluation and management
    inevitably suffer where such models are used in a vacuum.
        The AIA and its members have long supported the National Insurance
    Act sponsored by Senator Johnson as the right vehicle for smarter, more
    effective functional Federal insurance regulation. That bill already
    focuses on safety and soundness supervision, financial regulation, and
    rigorous market conduct oversight as core consumer protections. It even
    requires the national insurance commissioner to conduct an enterprise-
    wide review of financial data when examining national insurers. This--
    in and of itself--importantly distinguishes the National Insurance Act
    from current State regulation.
        Yet, we recognize that even the best legislative vehicle must be
    updated to be responsive to the evolving economic climate and to
    enhance strong consumer protections. As a result, we support amending
    the legislation to prevent even the theoretical ability of insurers to
    ``arbitrage'' the Federal and State regulatory systems by switching
    back-and-forth to try and escape enforcement actions.
        Let me close by thanking the Committee again for opening the dialog
    on this critical subject. The time is ripe for thoughtful, measured,
    but decisive action. We stand ready to work with you on a regulatory
    system that restores confidence in our financial system.
                                     ______

                    PREPARED STATEMENT OF SPENCER M. HOULDIN
      on behalf of the Independent Insurance Agents and Brokers Of America
                                 March 17, 2009

        Good morning Chairman Dodd, Ranking Member Shelby, and Members of
    the Committee. My name is Spencer M. Houldin, and I am pleased to be
    here today on behalf of the Independent Insurance Agents and Brokers of
    America (IIABA). Thank you for the opportunity to provide our
    association's perspective on insurance regulatory modernization. I
    serve as Chairman of the IIABA Government Affairs Committee as well as
    the Connecticut representative on the IIABA Board of Directors. I am
    also President of Ericson Insurance, a Connecticut-based independent
    agency that offers a broad array of insurance products to consumers and
    commercial clients across the country.
        IIABA is the nation's oldest and largest trade association of
    independent insurance agents and brokers, and we represent a network of
    more than 300,000 agents, brokers, and employees nationwide. IIABA
    represents small, medium, and large businesses that offer consumers a
    choice of policies from a variety of insurance companies. Independent
    agents and brokers offer a broad range of personal and commercial
    insurance products. Specifically regarding commercial property-casualty
    insurance, and some may be surprised to learn this, independent agents
    and brokers are responsible for over 80 percent of this market segment.

    Introduction
        Over the past several months, we have endured and continue to
    experience a financial crisis that few of us could ever have
    envisioned. We have seen the Federal Government take unprecedented
    action and spend hundreds of billions of dollars in attempts to rectify
    the problems and right our country's economic ship. And, unfortunately,
    we all know that our troubles are not over. We must carefully examine
    the causes of the current crisis, and determine how or if regulatory
    policy should change to ensure we do not repeat the mistakes of the
    past. It is a daunting task, and as a small businessman who must
    conduct business in the regulatory environment of the future, I implore
    policymakers to act judiciously and make sure that when you act, you
    get it right. Change for change's sake may result in regulations that
    do not further protect consumers, help to promote solvency or
    successfully address systemic threats.
        It is too soon to gauge the effectiveness of the substantial
    Federal actions of the past year, but policymakers must remain mindful
    of the moral hazard implications of such significant Federal
    intervention. We should strive for a system that promotes market
    discipline and protects taxpayers in the future. Much has gone wrong in
    the recent past, but there is still much which is very good in the
    current regulatory framework. I ask you to keep this in mind as you
    move forward.
        For a variety of reasons that I will outline in the course of my
    testimony, the insurance sector (and the property-casualty industry in
    particular) is weathering the financial storm with greater success than
    the banking, securities, and other elements of the financial services
    world. The insurance arena is certainly not immune from the effects of
    the current crisis, but I am happy to report that my business and much
    of the insurance marketplace remains healthy and stable. Accordingly,
    as you consider how to address this financial crisis in the short-term
    and begin the process of considering broader reforms to protect against
    similar problems in the future, I urge the Committee to be mindful of
    the differences between the recent experiences of the insurance
    industry and the other financial sectors and to be judicious and
    precise in your actions. While the insurance business would
    unquestionably benefit from greater efficiency and uniformity in
    regulation, we should be extremely cautious in the consideration of
    wholesale changes that could have an unnecessarily disruptive effect on
    the industry. Unlike other financial services markets, the insurance
    market, particularly property-casualty, is stable and does not need
    risky indiscriminate change of its current regulatory system. IIABA
    also believes that it is critically important to keep in mind how
    potential regulatory changes could impact small businesses. We want to
    ensure that there are no unintended consequences to main street
    businesses from regulatory reform, especially in light of the fact that
    a lot of attention and discussion of this crisis and reform has
    centered on large financial institutions.
        Some of my industry colleagues believe that now is the time to
    pursue deregulatory proposals and to establish a new and untested
    functional Federal regulator for the insurance industry. IIABA has long
    believed that the establishment of an optional Federal charter (OFC)
    system is misguided and will result in regulatory arbitrage, with
    companies choosing how and where they are regulated thereby pitting one
    regulatory system against the other in a race to the bottom. Such a
    proposal, which turns its back on over a century of successful consumer
    protection and solvency regulation at the State level, seems to make
    little practical sense in this current market environment. Some
    industry proponents are trying to use the failure of American
    International Group (AIG) to promote OFC and its deregulation of the
    insurance market. While AIG's troubles may strengthen the call for
    systemic risk oversight at the Federal level, we believe that the
    health of AIG's property-casualty insurance units, which were and are
    heavily regulated at the State level, point to the stability of the
    property-casualty marketplace. Improvements can certainly be made to
    insurance regulation (and are perhaps overdue), but State regulators
    have done and continue to do a solid job of ensuring that insurance
    consumers are protected and receive the insurance coverage they need.
        Today, I would like to provide IIABA's perspective on the financial
    services crisis, paying particular attention to the stability of the
    property-casualty insurance market in comparison to other financial
    services sectors. Central to the health of this market is the success
    of State regulation and its strong consumer protections--the primary
    goal of insurance regulation. I will therefore discuss the dangers of
    making blanket regulatory changes that could disrupt this system that
    works well to protect consumers and ensure market stability. With that
    said, though, no regulatory system is perfect, so I also will discuss
    methods that can be used to modernize and improve State insurance
    regulation. I will also provide IIABA's opinions on how best to address
    the issue of systemic risk and how to provide the insurance market with
    both a Federal and international voice without altering the day-to-day
    regulation of insurance.

    Financial Services Crisis
    Healthy Property-Casualty Market
        The recent economic crisis has impacted nearly every sector of the
    financial services industry, from small local financial institutions to
    the largest financial services conglomerate in the world. Few have been
    left unscathed, and it is clear that all participants in this broad
    market, regardless of responsibility, must work together to pull us out
    of this mess and make sure that we take precautions to prevent this
    from happening again. While IIABA is committed to helping improve the
    system, it is worth noting that relative to other segments of the
    financial services industry, the property-casualty insurance market has
    remained solid and vibrant. Even though, like most Americans, the
    property-casualty market has suffered investment losses due to the
    stock market decline, earlier this month A.M. Best reported that the
    outlook for the U.S. commercial and personal lines insurance markets
    remains stable. As we continue to endure almost daily bad news
    regarding some of our largest and most complex financial institutions,
    the property-casualty insurance market continues healthy operations and
    has not been a part of the overall crisis. In fact, while approximately
    40 banks have failed since the beginning of 2008, there has not been
    one property-casualty insurer insolvency during this time.
    Additionally, since the implementation of the Troubled Assets Relief
    Program (TARP) late last year, not one property-casualty insurer has
    sought access to these Federal funds. In short, the property-casualty
    insurance industry continues to operate without the need for the
    Federal Government to step in to provide any type of support.
        Along with being financially sound, it is also widely acknowledged
    that the property-casualty insurance industry today is intensely
    competitive and has sufficient capital to pay potential claims. In
    2007, there were over 2,700 property-casualty insurance companies
    operating in the United States. Policy surpluses are at solid levels
    and credit ratings have remained stable with actually more property-
    casualty upgrades than downgrades in ratings during the past year.
    IIABA therefore believes that given the current health of the property-
    casualty market, policymakers should resist any temptation to enact
    measures that could unbalance this competitive environment and
    jeopardize the level of solvency regulation and consumer protection
    currently being provided.

    AIG
        While property-casualty insurers are financially healthy, some
    groups have pointed to the failure of AIG and the Federal Government's
    commitment of over $180 billion to this conglomerate to somehow suggest
    that the insurance industry is unstable and in need of sweeping
    regulatory restructuring. Others have used the problems of AIG to
    justify and resuscitate imprudent proposals, such as measures to
    establish an OFC for the insurance market or to mandate day-to-day
    Federal regulation of insurance. It is important to remember that AIG's
    property-casualty insurance subsidiaries have been, and continue to be,
    healthy and stable and were not the cause of its failure.
        AIG is a unique institution in the financial services world and an
    anomaly in the insurance industry. Only approximately 1/3 of its
    subsidiaries were insurance-related, and it played heavily in exotic
    investments and made gigantic unhedged bets on credit default swaps
    (CDSs), which are unregulated at the Federal and State level. The
    catalyst of AIG's downfall was problems with its London-based Financial
    Products division (the main AIG player in CDSs), the collateral calls
    on those CDS transactions, and the rush of others to separate
    themselves from the company once its credit ratings were downgraded.
    These factors created a liquidity crunch for AIG and led to the Federal
    Government's decision to step in and attempt to save this company. It
    is true that AIG experienced significant losses with its securities
    lending operations related to its life insurance subsidiaries. However,
    these losses became a Federal concern because of the larger problems
    facing the company. Quite simply, AIG is not Exhibit A for a functional
    Federal insurance regulator, because there is no reason to believe that
    such a Federal regulator would have handled AIG's issues in a more
    effective manner that would have averted its collapse. It certainly
    does not make the case for an optional Federal charter, where AIG could
    have chosen where it was regulated. In fact, the Office of Thrift
    Supervision admitted in testimony in front of this Committee just
    twelve days ago that it was the consolidated supervisor of AIG and, by
    extension, the operations of AIG's Financial Products division. Clearly
    then, just the fact that an entity is federally regulated does not mean
    that it is effectively and responsibly regulated. Despite the fact that
    AIG's property-casualty insurance subsidiaries were sufficiently
    capitalized and likely had substantial assets that would have more than
    covered claim obligations if the overall company had failed, one of the
    lessons you can take from AIG is that systemic risk oversight may be
    necessary to prevent this from happening in the future.

    State Insurance Regulation Protects Consumers
        Policymakers have made it clear that financial services regulatory
    reform--including a debate over how to address systemic risk--is at the
    top of the agenda for this year and rightfully so. But as we undertake
    a review of current regulations in place and consider strengthening
    existing laws or adding additional ones, we must ensure that we do not
    simply toss out regulatory systems that work in an effort essentially
    to wipe the slate clean and start over. Unlike some Federal regulators
    of other financial industries, State regulators have done a commendable
    job in the area of financial and solvency regulation, which ensures
    that companies meet their obligations to consumers, and IIABA is
    concerned that direct Federal regulation of insurance would not provide
    the same level of protection. Insurance regulators' responsibilities
    have grown in scope and complexity as the industry has evolved, and
    State regulatory personnel now number approximately 13,000 individuals.
    Most observers agree that State regulation works effectively to protect
    consumers, which has been proven once again during this crisis.
        State officials also continue to be best-positioned to be
    responsive to the needs of the local marketplace and local consumers.
    Unlike most other financial products, which are highly commoditized,
    the purchaser of an insurance policy enters into a complex contractual
    relationship with a contingent promise of future performance.
    Therefore, the consumer will not be able to determine fully the value
    of the product purchased until after a claim is presented--when it is
    too late to decide that a different insurer or a different product
    might have been a better choice. When an insured event does occur,
    consumers often face many challenging issues and perplexing questions;
    as a result, they must have quick and efficient resolution of any
    problems. If one believes that a Federal regulator would better handle
    consumer issues, consider that according to the most recent annual
    numbers, the Office of the Comptroller of the Currency (OCC) received
    more than 90,000 calls, compared to just the New York State Insurance
    Department alone that responded to 200,000 calls (nationally there are
    over 3,000,000 consumer inquiries and complaints annually).
        Unlike banking and securities, insurance policies are inextricably
    bound to the separate legal systems of each State, and the policies
    themselves are contracts written and interpreted under the laws of each
    State. Consequently, the constitutions and statute books of every State
    are thick with language laying out the rights and responsibilities of
    insurers, agents, policyholders, and claimants. State courts have more
    than 100 years of experience interpreting and applying these State laws
    and judgments. The diversity of underlying State reparations laws,
    varying consumer needs from one region to another, and differing public
    expectations about the proper role of insurance regulation require
    officials who understand these local complexities. What would happen to
    this body of law if insurance contracts suddenly became subject to
    Federal law? How could Federal courts replicate the expertise that
    State courts have developed? How would Federal bureaucrats be able to
    quickly develop knowledge of regional differences that are embedded in
    State insurance laws? These are some of the extremely difficult issues
    that could be posed by direct Federal insurance regulation.
        Protecting policyholders against excessive insurer insolvency risk
    is one of the primary goals of State insurance regulation. If insurers
    do not remain solvent, they cannot meet their obligations to pay
    claims. State insurance regulation gets very high marks for the
    financial regulation of insurance underwriters. State regulators
    protect policyholders' interests by requiring insurers to meet certain
    financial standards and to act prudently in managing their affairs. The
    States modernized financial oversight in the 1990s and have a proven
    track record of solvency regulation. When insolvencies do occur, a
    State safety net is employed: the State guaranty fund system. If the
    worst case scenario does occur and an insurer does fail, other
    companies are well positioned to fill the gap as the marketplace is
    very competitive with many insurers competing for business.
    Additionally, it should not be overlooked that the State system has an
    inherent consumer-protection advantage in that there are multiple
    regulators overseeing an entity and its products, allowing others to
    notice and rectify potential regulatory mistakes or gaps. Providing one
    regulator with all of these responsibilities, consolidating regulatory
    risk and essentially going against the very nature of insurance of
    spreading risk, could lead to more substantial problems where errors of
    that one regulator lead to extensive problems throughout the entire
    market.

    Systemic Risk Oversight
        Along with the discussion of AIG and other financial services
    conglomerates that have been considered ``too big to fail'' or ``too
    interconnected to fail'' is the consideration of risks to the entire
    financial services system as a whole. While a clear definition of
    systemic risk has yet to be agreed upon, IIABA believes the crisis has
    demonstrated a need to have special scrutiny of the limited group of
    unique entities that engage in services or provide products that could
    pose systemic risk to the overall financial services market. Federal
    action therefore is likely necessary to determine and supervise such
    systemic risk concerns.
        Coupled with the stability of the insurance markets and the
    strength of State regulation, though, is the fact that few, if any,
    participants in the property-casualty market and few, if any, lines of
    property-casualty insurance, save for financial guaranty insurance,
    raise systemic risk issues. Again, the regulatory structure in place at
    the State level, specifically the State guaranty fund mechanism, and
    the general nature of the insurance business make it unlikely that a
    systemic risk to the financial services industry could emanate from
    property-casualty insurance markets. Therefore, while there may be a
    need to have some form of limited systemic risk oversight for a certain
    class of unique financial services entities at the holding company
    level, such oversight should not displace or interfere with the
    competent and effective level of functional insurance regulation being
    provided today. To avoid mission creep, any systemic risk regulator
    should have carefully defined powers and operate under a tight
    definition of what entities or activities are systemically significant.
    Such an entity should have the authority to receive data, analyze risk
    and at all times work through existing State regulators if problems are
    identified, but should not engage in day-to-day insurance regulation.
        As mentioned above, States already have strong financial and market
    regulations in place for insurers and effective solvency regulations to
    protect consumers. IIABA is concerned that the insurance market could
    be grouped with other financial services industries under a systemic
    risk umbrella that could include insurer solvency regulation. While
    IIABA is not in the position to assess whether other financial services
    industries need more effective solvency regulation at the Federal
    level, insurance solvency regulation, especially for the property-
    casualty segment, should remain the province of the functional
    regulators--the States.
        In the discussion of systemic risk and the need for more Federal
    insurance expertise, IIABA also believes that consideration should be
    given to establishing an Office of Insurance Information. This office
    could fill the void of insurance expertise at the Federal level and
    help solve the problems faced by insurance industry participants in the
    global economy. This legislation also is an example of the type of
    Federal reforms that are needed for the insurance market--Federal
    legislation that mandates uniformity where needed and when necessary
    via preemption and national standards without creating a Federal
    regulator.

    Targeted Insurance Regulatory Reform
        While State regulation continues to protect consumers and provide
    market stability, IIABA has long promoted the use of targeted measures
    by the Federal Government to help reform the State system in limited
    areas. However, Congress should only modernize the components of the
    State system that are working inefficiently and no actions should be
    taken that in any way jeopardize the protection of the insurance
    consumer. We believe that the best method for addressing the
    deficiencies in the current system continues to be a pragmatic approach
    that utilizes targeted legislation to establish greater interstate
    consistency in key areas and to streamline oversight. By using limited
    Federal legislation on an as-needed basis to overcome the structural
    impediments to reform at the State level, we can improve rather than
    dismantle or seriously impair the current State-based system and in the
    process produce a more efficient and effective regulatory framework.
    Especially given today's tough economic environment, such an approach
    would not jeopardize or undermine the knowledge, skills, and experience
    of State regulators by implanting an unproven new regulatory structure.
    Unlike other ideas, such as OFC, this approach does not threaten to
    remove a substantial portion of the insurance industry from local
    supervision.
        The most serious regulatory challenges facing insurance producers
    (agents and brokers) are the redundant, costly, and sometimes
    contradictory requirements that arise when seeking licenses on a multi-
    State basis, and the root cause of these problems is the fact that many
    States do not issue licenses on a consistent or truly reciprocal basis.
    State law requires insurance agents and brokers to be licensed in every
    jurisdiction in which they conduct business, which forces most
    producers today to comply with varying and inconsistent standards and
    duplicative licensing processes. These requirements are costly,
    burdensome, and time consuming, and they hinder the ability of
    insurance agents and brokers to effectively address the needs of
    consumers.
        To rectify this problem, IIABA strongly supports targeted
    legislation that would immediately create a National Association of
    Registered Agents & Brokers (NARAB), as first proposed in the Gramm
    Leach Bliley Act in 1999, to streamline nonresident insurance agent
    licensing. This approach would be deferential to States' rights as day-
    to-day State insurance statutes and regulations, such as laws regarding
    consumer protection, would not be preempted. By employing the NARAB
    framework already passed by Congress and utilizing the experiences and
    insights obtained over recent years to modernize this concept, Congress
    can help policyholders by increasing marketplace competition and
    consumer choice through enabling insurance producers to more quickly
    and responsively serve the needs of consumers. Such reform would
    eliminate barriers faced by the increasing number of agents who operate
    in multiple States, establish licensing reciprocity, and create a one-
    stop facility for those producers who require nonresident licenses. The
    NARAB Reform Act, which passed the House last year with broad industry
    and bipartisan congressional support, incorporates these principles and
    accomplishes the goal of agency licensing reform, and IIABA strongly
    supports this legislation.
        IIABA also supports targeted legislation to apply single-State
    regulation and uniform standards to the nonadmitted (surplus lines) and
    reinsurance marketplaces. As with the admitted market, surplus lines
    agents and brokers engaging in transactions that involve multi-State
    risks currently must obtain and maintain general agent or broker
    licenses and surplus lines licenses in many if not every jurisdiction
    in which the exposures are located. Some States require that these
    agents and brokers obtain and maintain corporate licenses as well. This
    means that a surplus lines broker or agent could potentially be
    required to obtain and maintain up to 100 separate licenses in order to
    handle a single multi-State surplus lines transaction. These
    duplicative licensing requirements cause administrative burdens which
    impede the ability of agents and brokers to effectively and efficiently
    service their customers' policies. Perhaps most importantly, these
    onerous licensing requirements create expenses which ultimately impact
    policyholders. The Nonadmitted Insurance and Reinsurance Reform Act
    alleviates the burdens of duplicative licensing requirements by relying
    on the insured's home State for licensing. IIABA is a strong supporter
    of this targeted Federal legislative reform.

    Optional Federal Charter
        I am actually quite surprised that, given the economic crisis in
    which we find ourselves today, I have to address the issue of an
    optional Federal charter for insurance. Most policy leaders seem to be
    in agreement that regulated entities should not be able to engage in
    regulatory arbitrage, where one regulator is pitted against another in
    a race for the regulated institution. An OFC would set up a system that
    would allow just that scenario to occur--under OFC a company like AIG
    could have avoided strong regulation by choosing where it was
    regulated. This clearly would only have exacerbated problems, not
    solved them. OFC legislation also would deregulate several areas
    currently regulated at the State level, flying in the face of the
    nearly universal call today for stronger or more effective regulation
    of the financial services industry. IIABA therefore continues to oppose
    this illogical call for a regulatory system that has the potential to
    negatively impact a market relatively unaffected by the recent crisis.
        Most importantly, we oppose OFC because it would worsen the current
    financial crisis as its theory of regulatory arbitrage has been cited
    as one of the key reasons why we find ourselves in the current
    situation. In announcing his seven principles for financial services
    regulatory reform on February 25th, President Barack Obama said his
    sixth principle is that ``we must make sure our system of regulations
    covers appropriate institutions and markets, and is comprehensive and
    free of gaps, and prevents those being regulated from cherry-picking
    among competing regulators.'' And just last Thursday, Treasury
    Secretary Timothy Geithner said one of the problems with the current
    financial regulatory system is that financial institutions were allowed
    to choose their regulators and create products in a way so as to avoid
    regulation. He said it is important to create a new regulatory
    structure that prevents ``this kind of regulatory arbitrage.'' can't
    say it any better than they have, but I will just pose this one
    question, does anyone really think that allowing AIG to choose where it
    was regulated, the Federal or State level, would have solved their
    problems?
        Creating an industry-friendly optional regulator, as OFC
    legislation is expected to provide, also is at odds with one of the
    primary goals of insurance regulation, which, as discussed earlier, is
    consumer protection. The best characteristics of the current State
    system from the consumer perspective would be lost if some insurers
    were able to escape State regulation completely in favor of wholesale
    Federal regulation. As insurance agents and brokers, we serve on the
    front lines and deal with our customers on a face-to-face basis.
    Currently, when my customers are having difficulties with claims or
    policies, it is very easy for me to contact a local official within the
    State insurance department to remedy any problems. If insurance
    regulation is shifted to the Federal Government, I would not be as
    effective in protecting my customers. I am very concerned that some
    Federal bureaucrat will not be as responsive to a consumer's needs as
    the local cop, the State insurance regulator.
        Even though it is commonly known as ``optional,'' the establishment
    of a Federal insurance charter would not be optional for agents.
    Independent agents represent multiple companies, and, under this
    proposal, presumably some insurers would choose State regulation and
    others would choose Federal regulation. In order to field questions and
    properly represent consumers, independent agents would have to know how
    to navigate both State and Federal systems, making them subject to the
    Federal regulation of insurance--meaning OFC would not in any way be
    optional for insurance producers. Even more importantly, ``optional''
    Federal charter would not be optional for insurance consumers. The
    insurance company, not the insurance consumer, would make that
    determination.
        Over the past several years, OFC supporters have pointed to the
    dual banking system as an example of how regulatory competition could
    work. But this is a comparison that should raise many concerns, not the
    least of which being the current State of Federal financial services
    regulation. Additionally, there are fundamental differences between
    banking and insurance. The banking industry has no distribution force
    like the insurance industry, nothing similar to the claims process
    exists in the banking industry, and unlike many insurance products,
    banking products are commoditized and national in scope. However, even
    as recently as earlier this month, in the face of the failure of
    several banks and Federal Government support of numerous others, OFC
    supporters continue to stress that the insurance industry needs the
    equivalent of an OCC. But, as we have seen in recent years with the
    OCC's forceful assertion of preemption, Federal regulatory schemes can
    do grave harm to State consumer protection regulations. IIABA therefore
    believes it would be unwise to subject insurance consumers to a similar
    potential fate.
        Prior OFC proposals also would create a confusing patchwork of
    solvency/guaranty regulation, the crux of insurance regulation and
    consumer protection. This dual structure proposed could have disastrous
    implications for solvency regulation by largely bifurcating this key
    regulatory function from guaranty fund protection. The States would not
    be able to regulate insurers on the front end to keep them from going
    insolvent, but would be responsible for insurer failures on the back
    end through the guaranty fund mechanism. With the recent failures in
    Federal financial oversight, this is a tremendous risk to take. In
    essence, these proposals would create an insurance version of the OCC
    without the integration of an FDIC into that supervisory system. Such
    proposals cherry-pick the features from several of these Federal
    banking laws to come up with a model which lacks the consumer
    protections found in any one of them and ignores the problems it would
    create for State insurers, guaranty funds, and their citizens. The
    equally unacceptable alternative would be to attempt to create a new
    Federal guaranty fund mechanism from scratch, and even if this
    initially was financed by industry, it ultimately would be guaranteed
    by taxpayers raising a whole host of additional concerns.

    Conclusion
        It is indisputable that our country, this Congress, and the new
    Administration have a lot of challenges ahead and difficult decisions
    to make in working to stabilize our economy and put us back on the road
    to growth and prosperity. Every participant in the financial services
    market must pitch in to help get us back on the right track, and IIABA
    stands ready to assist in any way possible. With the discussion of
    reforming financial services regulation, IIABA believes that such
    consideration presents a good opportunity to improve and modernize the
    State system of insurance regulation. But, as I've mentioned often
    today and it bears repeating one last time, IIABA believes that, with
    the possible exception of a properly crafted systemic risk overseer at
    the Federal level, targeted modernization is the prudent course of
    action for reform of insurance regulation. Therefore, any efforts to
    use this crisis and the failure of AIG as an opportunity to promote
    misguided measures that would allow a regulated insurance entity to
    choose its own regulator should be summarily dismissed as unacceptable
    in today's financial environment. Additionally, because the foremost
    goal of insurance regulation is consumer protection, any proposals that
    have the potential to disrupt the strong consumer protections in place
    at the State level should be rejected. Even though we have historically
    opposed measures such as OFC in the best of economic times, it is even
    more clear in these difficult times that the solution is not to
    displace effective regulation with an unproven regime harmful to
    consumers that could have the unfortunate effect of adding to, not
    solving, our country's financial problems. IIABA again appreciates the
    opportunity to testify today, and we remain committed to continuing to
    work to improve State insurance regulation for both consumers and
    market participants.
                                     ______

                       PREPARED STATEMENT OF JOHN T. HILL
                     President and Chief Operating Officer,
                    Magna Carta Companies, on behalf of the
               National Association of Mutual Insurance Companies
                                 March 17, 2009

        The National Association of Mutual Insurance Companies (NAMIC) is
    pleased to offer comments to the Senate Banking, Housing, and Urban
    Affairs Committee on insurance regulatory reform.
        My name is John T. Hill. I address the Committee in my capacity as
    chairman-elect of NAMIC and as the president and chief operating
    officer of the Magna Carta Companies. I also chaired NAMIC's board-
    appointed task force on Financial Regulatory Reform, which completed
    its work earlier this year. The views I will share with the Committee
    are based on my own 28 years experience in the property/casualty
    insurance industry and the perspective of more than 1,400 NAMIC
    members.
        Founded in 1895, NAMIC is the largest full-service national trade
    association serving the property/casualty insurance industry. NAMIC
    members are small farm mutual companies, State and regional insurance
    companies, and large national writers. The breadth of association
    members gives us an excellent perspective on the relationship between
    the recent financial crisis and the property/casualty insurance
    business. Our companies share a belief that competition and market-
    oriented regulation is in the best interest of the industry and the
    customers they serve. As mutual insurance companies, it is this goal of
    competitive markets that informs and shapes our views on insurance
    regulatory reform.
        Magna Carta Companies was founded in New York City in 1925 as a
    mutual insurance carrier for the taxicab industry. Throughout the
    decades, we have continuously expanded our product offering and
    underwriting territory. Today, Magna Carta specializes in underwriting
    the commercial real estate industry, and we are one of the largest
    mutual carriers of commercial business in America.
        Let me make clear upfront that NAMIC is a property/casualty
    insurance trade association. The products of the property/casualty
    insurance business are different than those of the other two major
    components of the insurance business, life and health. We believe that
    our products have played little or no role in the present crisis, that
    they are well regulated at the State level for solvency, and that any
    Federal systemic risk regulatory scheme should build on the strength of
    the State-based system and not supplant it. My testimony goes into
    detail on how the State system works, and makes suggestions for how
    Congress might structure a systemic risk regulator and encourage
    regulatory coordination and cooperation and information exchange.
        As the Committee contemplates reform of the nation's financial
    services sector, it is essential to consider what is the best structure
    for all constituents, including consumers, taxpayers, insurance
    companies, agents, and others affected by the insurance underwriting
    process. NAMIC's conclusion, reached through years of member
    involvement and research, is that the best construct is a reformed
    system of State insurance regulation, in which State officials
    coordinate and cooperate with other functional, prudential regulators
    and State governments and Congress exercise an appropriate oversight
    role. It is the closeness of these State regulators that is the
    essential ingredient to understanding unique regional property/casualty
    insurance markets.

    Prudential Insurance Regulation
        The first requisite of a good financial regulatory system is a
    prudential financial regulator, one that assures the safety and
    soundness of the institutions it regulates. For insurers, those
    regulators are the State insurance departments. This system is the
    direct result of Federal legislation.
        Following the Supreme Court decision in United States v. South-
    Eastern Underwriters Association, 322 U.S. 533 (1944), that insurance
    was interstate commerce and subject to regulation by the Federal
    Government, Congress, in 1945, enacted the McCarran-Ferguson Act (15
    USC 1011, et seq.). The McCarran-Ferguson Act recognizes the local
    nature of insurance and provides for the continued regulation of
    insurance by the States coupled with a narrow exemption from the
    general Federal antitrust laws.
        The State-based functional regulatory system and the corresponding
    application of the McCarran-Ferguson Act limited Federal antitrust
    exemption have worked well for decades to promote and maintain a
    healthy, vibrant, and competitive insurance marketplace. There are more
    than 7,000 insurers operating in the United States, the majority of
    which are relatively small. A number of studies over the years,
    including those conducted by the U.S. Department of Justice, State
    insurance departments, and respected economists and academics, have
    consistently concluded that the insurance industry is very competitive
    under classic economic tests.
        The national system of State regulation has for more than a century
    served consumer and insurer needs well, particularly in relation to the
    property/casualty insurance business. The State-based insurance
    regulatory system has proven to be adaptable, accessible, and
    effective, with rare insolvencies and no taxpayer bailouts. Each State
    has adopted specific programs and policies tailored to the unique needs
    of its consumers. State regulators and legislators consider and respond
    to marketplace concerns ranging from risks related to weather, specific
    economic conditions, medical costs, building codes, and consumer
    preferences. In addition, State regulators are able to respond and
    adapt to inconsistencies created by various State contract, tort, and
    reparation laws.
        Property/casualty insurance is inherently local in nature. The
    United States has 54 well-defined jurisdictions, each with its own set
    of laws and courts. The U.S. system of contract law is deeply developed
    and, with respect to insurance policies, is based on more than a
    century of policy interpretations by State courts. The tort system,
    which governs many of the types of contingencies at the heart of
    insurance claims, particularly those covered by liability insurance, is
    also deeply based in State law including, for example, the law of
    defamation, professional malpractice, premises liability, State
    corporation law, and products liability. State and local laws determine
    coverage and other policy terms. Reparation laws affect claims. Local
    accident and theft rates impact pricing. Geographical and demographic
    differences among States also have a significant impact on property/
    casualty coverages. Climate--hurricanes, earthquakes, etc.--differs
    significantly from State to State.
        With the ability to respond to unique local issues, the individual
    States serve as a laboratory for experimentation and a launch pad for
    reform. State-based regulators develop expertise on issues particularly
    relevant to their State. Insurance consumers directly benefit from
    State regulators' familiarity with the unique circumstances of their
    State and the development of consumer assistance programs tailored to
    local needs and concerns. State regulators, whether directly elected or
    appointed by elected officials, have a strong incentive to deal fairly
    and responsibly with consumers.
        The State insurance regulatory system, however, is not without its
    shortcomings. State insurance regulation receives justified criticism
    for overregulation of price and forms, lack of uniformity, and
    protracted speed-to-market issues. NAMIC continues to work with State
    legislators and regulators to address outdated, redundant, and
    conflicting regulatory policies and procedures and to modernize the
    insurance regulatory system to meet the needs of a 21st century
    marketplace.

    Consumer Protection
        The hallmarks of insurance regulation are solvency oversight and
    consumer protection. In the case of property/casualty insurance, State
    insurance officials and attorneys general play complementary and
    mutually supportive roles in consumer protection. The current
    regulatory structure works well to address consumer protection issues.
    State officials are keenly attuned to the needs of their residents and
    are accountable and accessible, both geographically and politically, to
    their consumers.
        The most important insurance consumer protection is ensuring the
    ability of the carrier to provide the promised coverage or service at a
    future date. Thus, ensuring the solvency and financial integrity of the
    financial service provider is the fundamental consumer protection. In
    addition, States enforce a variety of other consumer protection laws
    and regulations designed to ensure disclosure, fairness, and
    competitive equity.
        State insurance regulators actively supervise all aspects of the
    business of insurance, including review and regulation of solvency and
    financial condition to guard against market failure. Public interest
    objectives are achieved through review of policy terms and market
    conduct examinations to ensure effective and appropriate provision of
    insurance coverages. Regulators also monitor insurers, agents, and
    brokers to prevent and punish activities prohibited by State antitrust
    and unfair trade practices laws and take appropriate enforcement
    action.
        Insurers are subject to comprehensive review of all facets of their
    operation, including business dealings with customers, consumers, and
    claimants. The examination process allows regulators to monitor
    compliance with State insurance laws and regulations, ensure fair
    treatment of consumers, provide for consistent application of the
    insurance laws, educate insurers on the interpretation and application
    of insurance laws, and deter bad practices. Comprehensive examinations
    generally cover seven areas of investigation, including insurance
    company operations and management, complaint handling, marketing and
    sales, producer licensing, policyholder services, underwriting and
    rating, and claims practices.
        State insurance regulators also interact directly with consumers.
    As an example, nationwide, State insurance regulators handle and
    respond to more than 3.7 million consumer inquiries and complaints in a
    single year. Inquiries range from general insurance information to
    content of policies to the treatment of consumers by insurance
    companies and agents. Most consumer inquiries are resolved
    successfully.

    Guaranty Funds
        Although solvency and financial integrity are essential in the
    regulation of all financial services industries, the level and degree
    of regulation of financial institutions with explicit government
    guarantees differs from that of financial institutions without the same
    governmental financial responsibility. Unlike banking and pension
    interests, insurance products carry no Federal guarantee, but are
    backed by other insurance companies through the guaranty fund system.
        State guaranty associations provide a mechanism for the prompt
    payment of covered claims of insolvent insurers. All States and
    territories, with the exception of New York, have created post-
    assessment guaranty associations. In the event of insurer insolvency,
    the guaranty associations assess other insurers to obtain funds
    necessary to pay the claims of the insolvent entity. In the case of New
    York, the New York Security Fund and certain funds that cover only
    workers' compensation utilize a pre-assessment mechanism.
        Insurance companies writing property/casualty lines of business
    covered by a guaranty association are required to be a member of a
    guaranty association of a particular State as a condition of their
    authority to transact business in that State. Guaranty associations
    assess member insurers based upon their proportionate share of premiums
    written on covered lines of business in that State. Separate life and
    health insurance guaranty association systems also exist.
        Each guaranty association has established detailed procedures for
    handling of assets, filing of claims, and making assessments. With the
    exception of California, Michigan, New York, and Wisconsin, the
    guaranty association acts of the States and territories are based on,
    and are similar in most respects to, the National Association of
    Insurance Commissioners (NAIC) Model Act. State legislators and
    regulators have crafted statutes and regulations regarding the creation
    and operation of the funds based on the specific needs of policyholders
    and in coordination with State laws. The funds operate to ensure
    payment of claims by other industry companies, rather than utilize
    State or Federal financial backstops. The insurance guaranty system and
    the State regulatory and oversight structure function well for insurers
    and consumers. The current system avoids catastrophic financial loss to
    certain claimants and policyholders and maintains market stability,
    without governmental financial guarantees. As such, regulation and
    oversight of the guaranty fund system is appropriate at the State level
    and Federal oversight is unnecessary in the context of the industry-
    funded State-based system.

    Risk Regulation in the Property/Casualty Insurance Industry
        The heart of insurance is risk management. Insurers manage their
    individual risk through a variety of techniques including risk
    diversification, reinsurance, and securitization. Carriers avoid
    concentration of risk, assist policyholders in risk mitigation, invest
    in diversified investment portfolios, and carry adequate reinsurance
    coverage, among other techniques to ensure that they are not overly
    exposed to any particular risk and have adequate resources to meet
    their financial obligations. In addition to risk management practiced
    by individual companies, State regulators oversee risk within the
    industry.
        Risks to the health of the insurance industry as a whole include
    the financial stability of individual market players and the level of
    market concentration. To address these risks, State regulators subject
    insurers to strict financial and market regulation. State statutes give
    insurance regulators authority to supervise and regulate the financial
    condition of insurers licensed to do business in their State and to
    review market practices. Almost all States have adopted, either through
    statute or regulation, the financial regulation requirements in the
    NAIC Financial Accreditation Standards program, including the NAIC's
    annual and quarterly financial statements, accounting manual, auditing
    and actuarial requirements, and risk-based capital and examination
    model laws.
        Accounting standards for insurers are generally more conservative
    than other financial institutions. Statutory Accounting Principles
    (SAP) focus on solvency and, as a general rule, recognize liabilities
    earlier and/or at a higher value and recognize assets later and/or at a
    lower value than traditional Generally Accepted Accounting Principles
    (GAAP).
        In addition to more conservative accounting standards, insurers
    must maintain minimum levels of capital and surplus. In the early
    1990s, the NAIC developed a system that prescribes capital requirements
    corresponding to the level of risk of the company's various activities.
    The risk-based capital (RBC) formulas apply separate charges for an
    insurer's asset risk in affiliates, asset risk in other investments,
    credit risk, underwriting risk, and business risk, and each formula
    recognizes the correlation between various types of risk. The Risk-
    Based Capital Model Law also establishes levels of required company
    and/or regulatory action, ranging from company corrective action to
    termination of the entity. While the RBC system is intended to
    prescribe minimum capital levels, more and more, it is also regarded as
    an early warning system.
        The NAIC's financial solvency tools (FAST), including the insurance
    regulatory information system (IRIS), provides another early warning
    system to regulators on the financial condition of insurers. Based on
    specific company information, regulators examine a series of ratios
    designed to focus on critical financial conditions, including capital
    adequacy, changes in business patterns, underwriting results, reserve
    inadequacy, asset liquidity, cash-flows and leverage, profitability,
    asset quality, investment yield, affiliate investments, reserves, and
    reinsurance.
        State solvency regulation also includes model investment laws
    specifying the types of permitted investments, expectations regarding
    how insurer portfolios are selected, and limitations on what assets
    receive regulatory credit. A separate division of the NAIC, the
    Securities Valuation Office, provides warnings on suspect securities
    and advice to State financial examiners. States also uniformly impose
    requirements for professional actuarial review of reserve liabilities,
    require reporting of audited financial statements, and establish
    guidelines for selection of auditors.
        In addition, the State regulators participate in the NAIC Financial
    Analysis Working Group. This group of regulators and NAIC staff focus
    on the financial condition of nationally significant insurers. This
    process, which is confidential, provides regulatory peer review of the
    actions domiciliary regulators take to improve the financial condition
    of larger insurers. During quarterly calls with Federal regulators,
    State regulators routinely discuss the financial condition of the
    industry and specific players.

    Systemic Risk
        Traditional financial risk has focused on risks within the
    financial system; systemic risk focuses on risks to the financial
    system. Systemic risk refers to the risk or probability of breakdowns
    in an entire system, as opposed to breakdowns in individual parts or
    components. The precise meaning of systemic risk, however, is
    ambiguous; it means different things to different people, but must not
    be used to define the downturns resulting from normal market
    fluctuations.
        Some define systemic risk as the probability that the failure of
    one financial market participant to meet its contractual obligations
    will cause other participants to default on their obligations leading
    to a chain of defaults that spreads throughout the entire financial
    system and, eventually, to the nonfinancial economy. This conception of
    systemic risk is likened to the risk of a chain reaction of falling
    dominoes.
        Others conceive systemic risk as the risk of a major external
    event, or ``macroshock,'' that produces nearly simultaneous, large,
    adverse effects on most or all of the financial system rather than just
    one or a few institutions such that the entire economy is adversely
    affected. In this conception of systemic risk, the threat to the system
    is a market-oriented crisis rather than an institution-oriented crisis.
    Market-oriented crises tend to begin with a large change--usually a
    decline--in the price of a particular asset; the change then becomes
    self-sustaining over time.
        The domino theory definition has little relevance to the current
    situation, as the crisis was not caused by a single institution
    producing a contagion effect that spread to otherwise healthy
    interconnected institutions. The macroshock definition comes much
    closer to describing what has happened. Investors around the world
    suddenly realized that certain types of asset-backed securities and
    credit derivatives might not have been as safe as their ratings implied
    because of their often-hidden exposure to risky subprime mortgages.
    This sudden realization among investors was the large external shock
    that led to systemic failure, as the market for asset-backed securities
    suddenly dried up and intermediaries holding these securities were
    forced to sell them at distressed prices, leading to massive write
    downs and the freezing of the world's credit markets.
        Inasmuch as the current crisis was caused not by the risky behavior
    of a single institution or even a small group of institutions, but
    rather by an exogenous event--a shock to the system--it is difficult to
    imagine how similar crises could be avoided in the future by focusing
    regulation on particular institutions that are presumed ex ante by
    regulators to be systemically significant, as opposed to potentially
    significant events in the market.
        It must be noted that such market-oriented events could come from
    any number of sources. In the present crisis, while public attention
    has focused on the spectacular deterioration of certain large financial
    institutions, it was a common shock that led to their demise--a rapidly
    deflating housing bubble combined with a failure on the part of
    investors, intermediaries, and rating agencies to accurately assess
    subprime mortgage risk. That failure was facilitated in part by the
    growth of the ``originate to distribute'' model of mortgage lending,
    which served to create a disconnect between the ultimate bearer of risk
    and the initiator of credit, thus reducing the incentive to understand
    and monitor risk.
        Future crises are likely to arise from other types of asset
    bubbles, or other instances of widespread failure by market
    participants in evaluating certain types of risk. Past financial crises
    also suggest that market-oriented systemic risk is of greater concern
    than risk associated with supposedly systemically significant
    institutions. For example, the 1987 stock market crash was not
    precipitated by any particular institution or group of institutions,
    nor was it the proximate cause of the failure of any large bank.
    Instead, it was a market-oriented crisis that was viewed--at the time
    and since--as an event with potentially systemic consequences that
    warranted official-sector intervention. In addition to the 1987 stock
    market crash, examples of such crises might include the widening of
    interest rate spreads and decline in liquidity following the collapse
    of Long-Term Capital Management in 1998 and the collapse of the junk
    bond market in 1989-90.
        Creating a systemic risk regulator focused on particular
    institutions designated as systemically significant would do little to
    prevent a recurrence of the type of market-oriented systemic breakdown
    that has led to the current crisis, and which is likely to be the cause
    of future crises. Moreover, such an approach could have harmful side
    effects, particularly for the property/casualty insurance industry and
    its consumers if certain property/casualty insurance companies are
    deemed systemically significant and are regulated as such.
        The majority of the entities under scrutiny for systemic risk are
    regulated by one or more Federal or State regulators. The underlying
    operations of these entities are complex, and regulatory supervision
    requires a high level of expertise in the specific business. As such,
    it is imperative that any regulatory model both fill in existing gaps
    in the regulation of specific products and coordinate and complement
    the existing supervisory bodies.

    Systemic Risk in the Insurance Industry
        In the wake of problems facing the financial services industry,
    there have been calls for the creation of a Federal or international
    systemic risk regulatory body. As a trade association that represents
    property/casualty insurers, NAMIC's primary concern is the potential
    impact of institution-oriented systemic risk regulation on our member
    companies and the consumers they serve.
        The six primary factors that affect the probability that a
    financial institution will create or facilitate systemic risk are
    leverage, liquidity, correlation, concentration, sensitivities, and
    connectedness. NAMIC believes that an examination of these factors will
    demonstrate that there is no basis for regulating property/casualty
    insurance companies for systemic risk because, simply, they don't
    present such a risk. Again, let me emphasize that I am addressing only
    property/casualty insurance products, which are far different, in
    particular, from life insurance products that may offer investment
    features quite similar to bank and securities products and, as such,
    may warrant a different regulatory structure.

        Leverage

        Very few property/casualty insurers use commercial paper, short-
    term debt, or other instruments that may be used to leverage their
    capital structures, a fact that makes them less vulnerable than highly
    leveraged institutions when financial markets collapse. Because of
    their basic business model and strict capital requirements imposed by
    State regulators, property/casualty insurers are much more heavily
    capitalized in terms of their asset-to-liabilities ratios than banks
    and hedge funds. For these reasons alone, the banking system's
    perennial moral hazard of being ``too big to fail'' has no equivalent
    in the insurance industry. This, of course, is a completely different
    model than the banking world where leverage is a central component of
    the enterprise.

        Liquidity

        Unlike most other types of financial institutions, the nature of
    the products that property/casualty insurers provide makes them
    inherently less vulnerable to disintermediation risk. While banks are
    exposed to the risk that customer withdrawals can exceed available
    liquidity, the risk of a liquidity shortfall is minimal for insurance
    companies. Insurance companies are financed by premiums paid in
    advance, and payments are subject to the occurrence of insured events.
    Insurance policies are also in force for a contracted period of time,
    the terms of which are agreed to by both parties. If an insurance
    customer cancels a policy before the end of the contract, the premium
    is refunded on a pro rata basis and coverage is canceled. Whereas bank
    liabilities are short term and assets are long term, insurance has
    liquid assets but longer-term liabilities. Thus, for both business and
    regulatory reasons property/casualty insurers carry a liquid investment
    portfolio. As long as the insurance company has built up reserves and
    its investments are calibrated to match the statistically anticipated
    claims payments, there is no liquidity risk and no possibility of a
    ``run-on-the-bank'' scenario.

        Correlation

        Property/casualty insurers use underwriting tools specifically
    designed to identify and control certain types of correlation,
    including market concentration, in order to control catastrophe and
    underwriting exposures. Identifying and managing risks are at the core
    of insurance and these tools allow insurers to accurately price and
    underwrite risk. The side benefit of rigorous underwriting is a
    reduction in systemic risk exposure. It is also important to note the
    difference between asset-backed securities and other derivative
    products, where the underlying risk is financial or market (such as
    credit, price, interest rate, or exchange rate), and property/casualty
    insurance, where the underlying risk is a real event, such as an
    automobile accident, fire, or theft. While the former risks are likely
    to be correlated in that they will be affected by similar cyclical
    economic or financial factors, the latter are largely individual, non-
    cyclical idiosyncratic risks. Banking risks are often highly
    correlated, particularly in economic downturns. Traditional insurance,
    in contrast, pools uncorrelated idiosyncratic risks, and is not subject
    to systemic crises in the same way as banks.

        Connectedness/Sensitivities/Concentration

        Property/casualty insurers manage concentrations of investments and
    have regulatory limitations on both the type and concentrations of the
    assets in which they invest. These realities have the effect of
    reducing the property/casualty insurance industry's connectedness and
    sensitivity to the actions and conditions of other sectors of the
    financial services industry. The one possible exception to this rule is
    the small subset of monoline financial guaranty insurers that offer
    specialized products such as bond and mortgage insurance. Because
    financial guaranty insurance is by definition directly connected to
    financial products, it is conceivable that these specialty insurers
    could play a role in propagating systemic risk.
        The atypical business model of financial guaranty insurers,
    however, hardly provides justification for subjecting mainstream
    property/casualty insurers to systemic risk regulation. While property/
    casualty insurers, like virtually all investors, have suffered
    investment losses, no financial contagion has spread throughout the
    industry or to other financial markets. Even when a property/casualty
    insurer is held by a holding company that also holds other types of
    financial services companies, regulatory restrictions designed to
    protect policyholders operate to isolate the property/casualty
    insurer's capital and protect it from incursions caused by any problems
    of the other subsidiaries. Unlike the obligations of lightly regulated
    financial institutions such as investment banks and hedge funds, most
    of the obligations of property/casualty insurers are protected by the
    insurance guaranty fund system. This nationwide system, financed by the
    property/casualty insurers of each State, reduces the systemic impact
    of any failing property/casualty insurer by providing most customers or
    claimants with assurance that the insurer's obligations will be
    satisfied on a timely basis.

    Potential Adverse Consequences of Institution-Oriented Systemic Risk
            Regulation: How a Too-Big-to-Fail Regime of Regulation Would
            Create Moral Hazards and Unfair Competition that Could Lead to
            a Replication of the Problems with Government-Sponsored
            Entities
        Systemic risk regulation and oversight focused on particular
    institutions based on size, nature of business or perceived
    significance may well miss market-oriented events and trends that are
    the true sources of systemic risk. Some commentators have suggested
    that systemic risk regulation should focus on particular financial
    institutions that are considered to be ``systemically significant.''
    While the criteria for determining which companies are systemically
    significant are unclear at this point, most proponents of this approach
    seem to have in mind companies that are thought to be ``too big to
    fail'' or ``too interconnected to fail.''
        The act of identifying and regulating ``systemically significant
    institutions'' is likely to have unintended negative consequences,
    particularly if property/casualty insurance companies are among the
    institutions designated as systemically significant. If an insurance
    company is deemed, or suspected to be, systemically significant,
    investors and consumers will see it as an official declaration that the
    company will not be allowed to fail. This is because the whole purpose
    of regulating systemically important insurers is to prevent them from
    failing, because their failure would have an adverse systemic impact on
    the financial system or the economy generally.
        It seems quite likely that insurers designated as systemically
    important would gain a competitive advantage over other insurers.
    Companies carrying the official ``systemically significant''
    designation would be able to attract more customers and investment
    capital than their rivals thanks to the perception that ``systemically
    significant'' insurers will be backed by the Federal Government.
    Moreover, the implicit guarantee of a government backing for
    systemically significant insurers would create a moral hazard that
    could manifest itself in regulatory arbitrage, which is a strategy of
    identifying and exploiting loopholes in the systemic risk regulatory
    apparatus that would enable the company to engage in riskier, but
    potentially more profitable, underwriting or investment practices.
        To counteract the moral hazard produced by the ``systemically
    significant'' designation, the systemic risk regulator might err on the
    side of caution by preventing systemically significant insurers from
    engaging in any business practice that, in its view, could even
    remotely contribute to systemic risk. Overly restrictive regulation of
    this kind could decrease the availability of insurance coverage while
    increasing its cost. While systemic risk poses economic costs, so does
    regulation. The costs, both direct and indirect, of a systemic
    regulatory system could be high and care must be taken to avoid
    situations in which the costs outweigh the benefits. In addition to the
    direct costs of additional regulation, Congress must be wary of the
    moral hazard and disruption of the efficient evolution of markets that
    can result from inappropriate regulatory intervention.

    Options for Reform
    Single Financial Regulator
        The 2008 Treasury Blueprint for Financial Services Reform
    (``Blueprint'') proposed the creation of a single Prudential Financial
    Regulatory Agency (``PFRA''). Citing the experience of international
    trading partners, other proposals have advocated the consolidation of
    existing Federal functional regulators as well as the expansion of
    Federal authority to include insurance regulation.
        A single financial market regulator would prove more problematic in
    the United States than in other countries. Unlike the majority of
    countries that utilize a unitary legal system, the United States has 54
    well-defined jurisdictions, each with its own set of laws and courts.
    As noted, the U.S. system of contract law is deeply developed, and with
    respect to insurance policies, is based on more than a century of
    policy interpretations by State courts. The tort system, which governs
    many of the types of contingencies at the heart of insurance claims
    particularly those covered by liability insurance, is also deeply based
    in State law.
        There are also significant differences between property/casualty
    insurance and other insurance and financial service products that
    necessitate different specific regulatory treatment. Geographical and
    demographic differences among States would similarly pose additional
    difficulties for a single financial market regulator. NAMIC believes
    that attempts to establish a single financial regulator would threaten
    the fundamental underpinnings of the property/casualty marketplace.

    Federal Insurance Charter
        Proposals for a Federal insurance charter raise serious design and
    implementation questions. Enacting and implementing comprehensive
    insurance regulatory reform such as a Federal charter opens the door to
    numerous unanticipated problems and pitfalls. Inadvertent failure to
    properly act in any of a number of critical areas could damage the
    nation's insurance market by reducing competition and harming
    consumers.
        Numerous specific concerns arise when considering Federal
    regulation of insurance. Specifically:

        Insurance inherently differs from other financial products
            and services in that it is a promise of future financial
            protection, making solvency and consumer protection paramount.
            Federal regulation has proven no better than State regulation
            in addressing market failures or protecting consumer interests.
            Unlike State regulatory failures, Federal regulatory mistakes
            can have disastrous economy-wide consequences. The current
            high-profile failures of 25 federally regulated banks in 2008
            and 16 more already this year have shown weaknesses in Federal
            solvency regulation. Contrast this with the property/casualty
            insurance industry which had an excellent solvency record in
            2008 in spite of a large drop in investment income and the
            fourth most expensive natural disaster in U.S. history. The
            State guaranty system continues to work well to protect
            consumers without taxpayer bailouts and State regulators
            respond to thousands of consumer inquiries each year. In
            addition an optional Federal charter (OFC) system that
            establishes a national solvency fund for federally chartered
            companies or permits insurers operating under different
            financial regulatory standards to participate in State guaranty
            funds could impair the current guaranty system.

        Regulatory competition between State and Federal regulators
            could create an unlevel playing field favoring large national
            writers or specific lines of insurance. Despite assurances that
            all players could choose the regulatory system best matching
            their business model and consumer needs, the reality is that
            transaction costs as well as retooling and retraining expenses
            would effectively lock smaller and mid-size insurers into their
            original choice of regulator.

        As previously noted, the property/casualty insurance
            business is highly dependent on State and regional differences.
            These differences are particularly critical for personal lines
            property/casualty coverages (auto, homeowners, personal
            liability) making ``national'' products and regulation
            difficult.

        A Federal regulatory system that results in overlapping,
            dual or conflicting regulation would create regulatory
            confusion and significantly increase the cost of doing business
            for all insurers. It is foreseeable that insurers, even those
            opting for State regulation, would find themselves subject to a
            plethora of new Federal rules and regulations. The health
            insurance market is a vivid example of the pitfalls and
            confusion of dual regulation for consumers and insurers. This
            dual regulatory system must be avoided for the property/
            casualty insurance industry.

    Office of Insurance Information
        In April 2008, Rep. Paul Kanjorski, D-Penn., chairman of the House
    Financial Services Subcommittee on Capital Markets, Insurance and
    Government Sponsored Enterprises, introduced H.R. 5840, the Insurance
    Information Act of 2008. The legislation would create an Office of
    Insurance Information (OII) within the U.S. Department of the Treasury
    with jurisdiction for all lines of insurance, except for health
    insurance, to provide advice and counsel regarding domestic and
    international policy issues.
        The OII would be empowered and directed to collect, analyze and
    disseminate information and data; establish and enforce international
    insurance policy; and coordinate with the States with respect to
    insurance-related issues.
        NAMIC worked closely with Chairman Kanjorski and the Committee to
    resolve concerns related to the scope and authority of the OII, the
    confidentiality of the data, and the composition of the Advisory Group,
    and supported passage of the amended legislation.
        The establishment of a properly crafted OII within the Department
    of Treasury could play a vital role in the effort to streamline and
    modernize the State-based insurance regulatory system and provide
    essential information to Congress and the Federal Government.

    Federal Standards
        Uniformity is beneficial and achievable when State needs are
    similar and unnecessary regulatory differences significantly impede
    effective competition within the existing functional regulatory
    framework. Solvency regulation, for example, is basically uniform among
    the States. Financial reporting standards and financial examination
    standards do not suffer from inconsistencies and vagaries among the
    States. In recent years, insurers, regulators and legislators have
    turned their attention to promoting greater coordination and uniformity
    in other aspects of insurance regulation beyond financial reporting and
    solvency. While NAMIC opposes an OFC and consolidation of insurance
    regulation under a single Federal financial regulator, we believe
    Congress could play a role in achieving specific targeted reforms to
    achieve national uniformity and consistency.
        This approach has been adopted by the House in its approval of
    ``The Nonadmitted and Reinsurance Reform Act of 2007,'' which
    streamlines regulation for nonadmitted insurance and reinsurance
    carriers and surplus lines companies. Similar uniformity would be
    achieved by adoption of the ``National Association of Registered Agents
    and Brokers Reform Act of 2008'' (``NARAB II''), which would establish
    licensing reciprocity for insurance producers that operate in multiple
    States. The approach embodied in these bills allows Congress a
    meaningful role in modernizing the insurance regulatory system while
    leaving the day-to-day regulatory control at the State level. NAMIC
    supports NARAB II and the Nonadmitted and Reinsurance Reform Act and
    urges Congress to approve the bills in the 111th Congress.
        As Congress considers insurance regulatory reform proposals, NAMIC
    urges lawmakers to identify specific areas of reform that lend
    themselves to national standards. In addition to nonadmitted and
    surplus lines regulation and agent and broker licensing, NAMIC
    encourages Congress to consider Federal standards prohibiting States
    from limiting property/casualty insurers' (1) ability to set prices for
    insurance products, except when the insurance commissioner can provide
    credible evidence that a rate would be inadequate to protect against
    insolvency and (2) use of underwriting variables and techniques, except
    when the insurance commissioner can provide credible evidence that a
    challenged variable or technique bears no relationship to the risk of
    future loss. Targeted Federal legislation, such as the outlined
    proposals, could be more easily achieved and with less government
    interference, which would lead to more expeditious insurance regulatory
    reform.

    Interstate Compacts, Domiciliary Deference and Model Laws
        Interstate compacts are contracts between States that allow States
    to cooperate on multi-State or national issues while retaining State
    control. Interstate compacts have a deep history dating from their
    specific mention in the U.S. Constitution. There are more than 200
    interstate compacts and the average State participates in 25 separate
    contracts. As such, interstate compacts offer one method for resolving
    differences in State insurance regulation. Thirty-three States have
    adopted the Interstate Insurance Product Regulation Compact to develop
    uniform national product standards; establish a central point of filing
    for these insurance products; and review product filings and make
    regulatory decisions related to life insurance, annuities, disability
    income, and long-term-care insurance. Interstate compacts have also
    been suggested for natural disaster risks.
        Domiciliary deference vests responsibility with the regulator of an
    insurer's State of domicile to take the lead role in specified
    regulatory functions. In financial regulation, States focus on their
    domestic insurers and rely on the State of domicile to monitor the
    solvency and financial condition of foreign insurers doing business in
    their State. States also utilize the concept of domiciliary deference
    in other examinations, agreeing to forego routine or comprehensive
    exams and relying on the home State while retaining the right to
    examine targeted issues. The concept could be expanded to streamline
    regulatory processes and avoid redundant examinations and document
    productions.
        Model laws and regulations serve to increase uniformity and reduce
    inconsistencies among regulatory jurisdictions. Model laws and
    regulations have encountered difficulties in obtaining approval in a
    critical number of States; however, there are examples of the success
    of model laws. The NCOIL Credit-Based Insurance Scoring Model Act is an
    example of the effective use of model language. To date, laws or
    regulations in 27 States are based on the model.

    Effective Regulation
        NAMIC believes that the fundamental and significant differences
    among the wide variety of financial services and products argues
    against consolidation of financial services regulation for all
    industries and products under an umbrella supervisory body. Prudential
    regulation, particularly in the case of property/casualty insurance,
    continues to work well to meet consumer needs and should be preserved.
    Correspondingly, NAMIC believes that any effective regulatory reform
    proposal must sustain and enhance the regulatory strengths of the
    existing system of prudential regulation, including industry specific
    expertise, experience and focus.
        The current crisis demands that Congress act, but Congress must act
    prudently and responsibly, focusing limited resources on the most
    critical issues. We encourage Congress to focus with laser precision on
    the problems at hand and avoid the inclination to rush to wholesale
    reform. We believe there are a number of finite and concrete reforms
    that Congress could undertake to strengthen our nation's financial
    regulatory system, including enhanced regulatory coordination, improved
    international information sharing, creation of an Office of Insurance
    Information, adoption of selected national standards, and targeted,
    national focus on identifying, analyzing and addressing systemic risk.
        Likewise the national system of State-based insurance regulation is
    appropriate and well-suited to effectively regulate products and
    services that are local in nature, such as property/casualty coverages.
    There is no evidence that a Federal regulator would prove more
    effective in improving insurance solvency regulation, would have any
    greater operational knowledge than State regulators with respect to
    financial oversight, or be more responsive to consumers. NAMIC opposes
    the creation of a Federal charter for property/casualty insurers and
    cautions Congress against disrupting a fundamental bedrock of the
    financial fabric of our country, particularly during a period of
    economic crisis.
        NAMIC recognizes the interconnectedness of the industry segments
    within the financial industry and of the U.S. and international
    financial communities. We acknowledge the need for greater coordination
    and cooperation among and between U.S. prudential regulators and
    foreign regulatory bodies. We believe, however, that it is not
    necessary to replace the current functional regulatory framework to
    successfully achieve Federal interests in these areas. NAMIC believes
    Congress must maintain the State-based insurance regulatory system;
    however, we recognize that improvements can and should be made.
    Specifically, NAMIC supports:

        Formalized coordination between functional prudential
            regulators. A closer and more formalized working relationship
            between State regulators and their Federal counterparts is
            essential to ensure timely and effective information exchange
            and coordination of regulatory actions. Expansion of the
            President's Financial Working Group to include participation by
            State regulators, coupled with enhanced information sharing
            between and among the participants would provide a unique forum
            to integrate and coordinate financial services regulation,
            while preserving the benefits of prudential regulation.

        Enhanced international regulatory cooperation and
            coordination. Enhanced cooperation and coordination among the
            various global financial services regulatory bodies is needed.
            However, such cooperation and coordination should not come at
            the cost of abrogation of regulatory authority to foreign
            jurisdictions or quasi-governmental bodies.
         Movement of capital that is intended for risk or insurance
    generally flows freely at the present. Coordination of reporting or
    presentation standards to permit review and evaluation help to foster
    greater regulatory transparency and encourage competition. Present
    cooperation between the European Union and U.S. provide a sound basis
    for further collaborative efforts.
        U.S. insurance regulators through the NAIC participate in the
    International Association of Insurance Supervisors (IAIS). The IAIS
    develops international standards for insurance supervision, provides
    training to its members, and fosters cooperation between insurance
    regulators, as well as forging dialog between insurance regulators and
    regulators in other financial and international sectors. Regulators and
    staff participate in the work of the IAIS on a variety of issues,
    including international solvency supervision, accounting standards,
    reinsurance regulation and other issues of regulation of the business
    of insurance.

        Creation of an Office of Insurance Information. Legislation
            introduced by Rep. Paul Kanjorski in the 110th Congress would
            have also provided greater autonomy to the Department of the
            Treasury through a newly created Office of Insurance
            Information (OII) to engage with foreign jurisdictions on
            insurance matters. NAMIC supports greater coordination and
            limited preemptory authority over international insurance
            issues.

        Similarly, NAMIC acknowledges the need for increased insurance
    industry information at the Federal level. Rep. Kanjorski's legislation
    would also have authorized the OII to collect and analyze insurance
    industry information and make recommendations to Congress. NAMIC
    supports the creation of an OII with proper protections for the
    privilege and confidentiality of company data.

        Targeted Product-Focused Systemic Risk Regulation. With
            respect to systemic risk, NAMIC believes that regulators should
            work to identify, monitor, and address systemic risk. However,
            a systemic risk regulator should complement existing regulatory
            resources. Furthermore, NAMIC does not believe that the
            business or legal characterization of any institutions should
            be used as a basis for assessing systemic risk. Oversight and
            regulation of systemic risk should focus on the impact of
            products or transactions used by financial intermediaries.

        Attempting to define and regulate ``systemically significant
    institutions'' on the basis of size, business line, or legal
    classification--such as including all property/casualty insurers--would
    do little to prevent future financial crises. Indeed, a regime of
    systemic risk regulation that is institution-oriented rather than
    focused on specific financial products and services could divert
    attention and resources from where they are most needed, while at the
    same time producing distortions in insurance markets that would be
    harmful to consumers.
        However, at this time there is no evidence that the property/
    casualty insurance industry contributes any substantial amount of
    systemic risk to the global financial system. A new systemic risk
    regulator should not be tasked with supervising property/casualty
    insurers that are arbitrarily presumed to be ``systemically
    significant.'' Instead, any new systemic regulatory system should be
    given the flexibility to adapt to changing developments in the
    marketplace, and to anticipate events that could potentially cause a
    cataclysmic shock to the financial system and the broader economy.
        The classic rationale for regulation of financial institutions is
    that it should serve the public interest by efficiently mitigating
    market failures. For regulation to achieve this objective, however,
    there should be substantial evidence showing that existing or proposed
    regulatory interventions will efficiently address the failure. In other
    words, efficient regulation necessarily involves matching the
    appropriate regulatory tool to the specific market failure. Moreover,
    the benefits of regulation should outweigh its direct and indirect
    costs. This is particularly true as Congress debates fundamental reform
    of the nation's financial services industry.

    Conclusion
        NAMIC supports a strong, transparent, market economy. We encourage
    the Committee to fully explore all options for addressing the various
    challenges, including systemic risk, confronting the nation's economy.
    As the Committee and Congress evaluate solutions, NAMIC, on behalf of
    our member companies and their customers, encourages members to
    carefully weigh the costs and benefits of proposed regulatory
    processes. It is critical that any solution address real regulatory
    gaps, without implementing duplicative and ineffective new regulations
    where none are needed.
        As policymakers work to develop long-term successful solutions to
    our present financial crisis, NAMIC urges Congress to keep in mind the
    dramatic differences between main street organizations continuing to
    meet the needs of their local markets, and those institutions that have
    caused this crisis and have required unprecedented government financial
    intervention.
                                     ______

                    PREPARED STATEMENT OF FRANKLIN W. NUTTER
                 President, Reinsurance Association Of America
                                 March 17, 2009

         My name is Frank Nutter and I am President of the Reinsurance
    Association of America (RAA). The RAA is a national trade association
    representing property and casualty companies that specialize in
    assuming reinsurance.
        I am pleased to appear before you today to provide the reinsurance
    industry's perspective on regulatory reform. I commend Chairman Dodd
    and Ranking Member Shelby for holding this important hearing and
    welcome the opportunity to address the Committee about the current
    system for regulating the marketplace in light of recent developments
    in the financial markets. My testimony will highlight the function of
    risk management; how reinsurers doing business in the United States are
    regulated; why the current State-based insurance regulatory system does
    not work well for the sophisticated global reinsurance marketplace; the
    RAA's position in support of a single national regulator at the Federal
    level for the reinsurance industry, or alternatively, Federal
    legislation that streamlines the current State-based system; and the
    concept of a systemic risk regulator.

    I. BACKGROUND ON REINSURANCE
    a. The U.S. Reinsurance Market
        Reinsurance is critical to the insurance marketplace. It is a risk
    management tool for insurance companies to reduce the volatility in
    their portfolios and improve their financial performance and security.
    It is widely recognized that reinsurance performs at least four primary
    functions in the marketplace: to limit liability on specific risks; to
    stabilize loss experience; to provide transfer for insurers of major
    natural and man-made catastrophe risk; and to increase insurance
    capacity.
        Reinsurers have assisted in the recovery from every major U.S.
    catastrophe over the past century. By way of example, 60 percent of the
    losses related to the events of September 11 were absorbed by the
    global reinsurance industry, and in 2005, 61 percent of Hurricanes
    Katrina, Rita and Wilma losses were ultimately borne by reinsurers.
        Reinsurance is a global business. Encouraging the participation of
    reinsurers worldwide is essential to providing the much needed capacity
    in the U.S. for both property and casualty risks. This can be best
    illustrated by the number of reinsurers assuming risk from U.S. ceding
    insurers. In 2007, more than 2,500 foreign reinsurers assumed business
    from U.S. ceding insurers. Those 2,500 reinsurers were domiciled in
    more than 70 foreign jurisdictions.\1\ Although the majority of U.S.
    premiums ceded offshore is assumed by reinsurers domiciled in ten
    countries, the entire market is required to bring much needed capital
    and capacity to support the extraordinary risk exposure in the U.S. and
    to spread the risk throughout the world's financial markets. Foreign
    reinsurers now account for 56 percent of the U.S. premium ceded
    directly to unaffiliated reinsurers; a figure that has grown steadily
    from 38 percent in 1997.
    ---------------------------------------------------------------------------
        \1\ Reinsurance Association of America (RAA), Offshore Reinsurance
    in the U.S. Market 2007 Data (2008).
    ---------------------------------------------------------------------------
    b. U.S. Reinsurance Regulation--Direct and Indirect
        U.S. reinsurers are currently regulated on a multi-State basis.
    While the current State-based insurance regulatory system is primarily
    focused on solvency regulation with significant emphasis on regulating
    market conduct, contract terms, rates and consumer protection,
    reinsurance regulation focuses almost exclusively on ensuring the
    reinsurer's financial solvency so that it can meet its obligations to
    ceding insurers.
        Reinsurance is regulated by the States utilizing two different
    methods: direct regulation of U.S.-licensed reinsurers and indirect
    regulation of reinsurance transactions. States directly regulate
    reinsurers that are domiciled in their State, as well as those U.S.
    reinsurers that are simply licensed in their State, even if domiciled
    in another State. These reinsurers are subject to the full spectrum of
    solvency laws and regulations to which an insurer is subject,
    including: minimum capital and surplus requirements, risk-based capital
    requirements, investment restrictions, required disclosure of material
    transactions, licensing, asset valuation requirements, examinations,
    mandated disclosures, unfair trade practices laws, Annual Statement
    requirements and actuarial-certified loss reserve opinion requirements.
    Because the reinsurance transaction is between two sophisticated
    parties, there are no regulatory requirements relating to the rates
    that are negotiated between the parties or the forms used to evidence
    contractual terms.
        There is also indirect regulation of reinsurance transactions
    through the credit for reinsurance mechanism, which is the financial
    statement accounting effect given to an insurer if the reinsurance it
    has purchased meets certain prescribed criteria. If these criteria are
    met, the insurer may record a reduction in its insurance liabilities
    for the effect of its reinsurance transactions. One of the most widely
    discussed criteria is the ``collateral'' requirement that a non-
    licensed reinsurer must either establish a U.S. trust fund or other
    security in the U.S., such as a clean, irrevocable and unconditional
    letter of credit issued by an acceptable institution, to cover its
    potential liabilities to the insurer. This provision is based on the
    historic premise that State regulators do not have the regulatory
    capability or resources to assess the financial strength or claims
    paying ability of reinsurers that are not authorized or licensed in
    that State.
        For several reasons, including the cumbersome nature of a multi-
    State licensing system, capital providers to the reinsurance market
    have in recent years opted for establishing a reinsurance platform
    outside the U.S. and conducting business through a U.S. subsidiary or
    by providing financial security through a trust or with collateral.
    Following the events of September 11, 2001, 12 new reinsurers with
    $10.6 billion capital were formed. After Hurricane Katrina, at least 38
    new reinsurance entities with $17 billion of new capital were formed.
    Nearly all of this new capital came from U.S. capital markets, yet no
    new reinsurer was formed in the United States. Other than the U.S.
    subsidiaries of some of these new companies, not one U.S.-domiciled
    reinsurer has been formed since 1989. For these startups, the ease of
    establishment, capital formation, and regulatory approvals in non-U.S.
    jurisdictions contrasts with the cumbersome and protracted nature of
    obtaining licenses in multiple U.S. States. We believe that a
    streamlined national U.S. regulatory system will result in reinsurers
    conducting business more readily through U.S. operations and U.S.-based
    personnel.

    II. KEY ISSUES FOR THE U.S. REINSURANCE INDUSTRY
        The RAA seeks to modernize the current regulatory structure and
    advocates a single national regulator at the Federal level.
    Alternatively, the RAA seeks Federal legislation that streamlines the
    current State-based system. There are a number of key problems and
    inefficiencies with the current State-based framework for reinsurance
    regulation.
    a. The Need for a Single Federal Role
        As has been noted by a variety of commentators, as well as the 2008
    U.S. Treasury Blueprint for Financial Regulatory Reform (``the Treasury
    Blueprint''), the U.S. State-based insurance regulatory system creates
    increasing tensions in the global marketplace, both in the ability of
    U.S.-based firms to compete abroad and in the allowance of greater
    participation of foreign firms in the U.S. market. Foreign government
    officials have continued to raise trade barrier issues associated with
    dealing with 50 different U.S. insurance regulators, which makes
    coordination on international insurance issues difficult for foreign
    regulators and companies.
        An informed Federal voice with the authority to establish Federal
    policy on international issues is critical not only to U.S. reinsurers,
    which do business globally and spread risk around the world, but also
    to foreign reinsurers, who play an important role in assuming risk in
    the U.S. marketplace.
        The fragmented U.S. regulatory system is an anomaly in the global
    insurance regulatory world. As the rest of the world continues to work
    toward global regulatory harmonization and international standards, the
    U.S. is disadvantaged by the lack of a Federal entity with authority to
    make decisions for the country and to negotiate international insurance
    agreements, or alternatively, the lack of Federal-enabling legislation
    which empowers a single State regulator to do so.
    b. Mutual Recognition
        U.S. States impose a highly structured and conservative level of
    regulation on licensed reinsurers. However, it has long been recognized
    that there are several globally recognized methods of conducting
    reinsurance regulation.
        The RAA was encouraged by the inclusion of a system of mutual
    recognition among countries in ``The National Insurance Act of 2008''
    (S. 40), introduced in the last Congress. Mutual recognition seeks to
    establish a system where a country recognizes the reinsurance
    regulatory system of other countries and allows reinsurers to conduct
    business based on the regulatory requirements of its home jurisdiction.
    If such a system were established, European reinsurers would be
    permitted, for example, to assume reinsurance risk from the U.S.
    without having to obtain a U.S. license and without having a
    requirement in law to provide collateral for their liabilities to U.S.
    ceding insurers. In return, such a system would allow U.S. reinsurers
    to conduct business in the mutually recognized country based on U.S.
    regulatory oversight.
        A single national regulator with Federal statutory authority could
    negotiate an agreement with the regulatory systems of foreign
    jurisdictions that can achieve a level of regulatory standards,
    enforcement, trust, and confidence with their counterparts in the U.S.
    c. Extra-Territorial Application of Law
        The RAA also believes there is a need for greater efficiency in the
    regulation of reinsurance in the U.S. As a result of our 50-State
    system of regulation, significant differences have emerged among the
    States with respect to reinsurance regulatory requirements. Multi-State
    systems add extra costs to transactions. These costs are ultimately
    reflected in the premiums paid by consumers. The NAIC and State
    regulators are to be applauded for their efforts toward greater
    uniformity in the adoption of model laws and regulations and the
    creation of the accreditation system; yet, this has not prevented some
    States from pursuing varying and sometimes inconsistent regulatory
    approaches. One of the best examples of this is the extra-territorial
    application of State laws.
        Thirteen States apply at least some of their regulatory laws on an
    extra-territorial basis, meaning that the State law not only applies to
    the insurers domiciled in that State, but to insurers domiciled in
    other States if the extra-territorial State has granted a license to
    the insurer. For example, an insurer domiciled in a State other than
    New York, but licensed in New York, will find that New York asserts
    that its laws apply to the way it conducts its business nationwide.
    Since most U.S.-based reinsurers are licensed in all 50 States, this
    extra-territorial application of State law results in inconsistencies
    among State laws.
        As Congress proceeds to review the current regulatory structure and
    consider a new one for the future, we encourage the Committee to focus
    on streamlining reinsurance regulation to allow U.S. reinsurers to be
    more competitive in the global marketplace, maximize capacity in the
    United States, and make us a more attractive place for companies to
    locate their business. Any structure that is adopted should eliminate
    duplicative and inconsistent regulation like that which is caused by
    the extra-territorial application of State laws. Such a provision was
    included in the House-passed Nonadmitted and Reinsurance Reform Act of
    2008, although it lacked the necessary enforcement authority.

    III. GOALS OF EFFECTIVE REINSURANCE REGULATION AND CORE CHARACTERISTICS
            OF A REINSURANCE REGULATORY REGIME
        As we move forward with modernization efforts, the goals of
    effective reinsurance regulation in the United States should be to
    promote:

      1.  Financially secure reinsurance recoverables and capacity that
            protects the solvency of U.S. ceding insurers.

      2.  A competitive and healthy reinsurance market that provides
            sufficient capacity to meet ceding insurers' risk management
            needs.

      3.  Effective and efficient national reinsurance regulation.

        The core characteristics of an appropriate reinsurance regulatory
    structure that would assist in achieving these goals should include:

      1.  A single Federal regulator or regulatory system for reinsurance
            with national regulatory oversight and the power to preempt
            conflicting or inconsistent State laws and regulations in an
            effective and efficient manner.

      2.  The single regulator's authority should provide for the
            recognition of substantially equivalent regulatory standards
            and enforcement in other competent regulatory jurisdictions.

      3.  The regulatory structure should support global capital and risk
            management, taking into account capital adequacy, assessment of
            internal controls, recognition of qualified internal capital
            models and effective corporate governance.

      4.  The regulatory structure should provide for financial
            transparency that encourages and supports the cedents' ability
            to assess counter-party credit risk, including information
            regarding the reinsurer's financial condition and the
            reinsurer's performance in paying covered claims.

      5.  Regulators should have access to all necessary financial
            information with appropriate provision for the confidentiality
            of that information, as currently provided for under State law
            and regulatory practice.

      6.  The regulatory structure should have an effective transition
            mechanism between the current system and any future regime that
            is consistent with these core characteristics. Absent mutual
            agreement of the parties, any reduction in existing collateral
            requirements should only apply prospectively.

      7.  The regulatory structure should utilize principles-based
            regulation where appropriate.

        There are several different ways to address meaningful
    modernization. Changes to the current reinsurance regulatory structure
    to achieve these goals and core characteristics include, but are not
    limited to: (1) a Federal regulator for reinsurance, or (2) Federal
    legislation that streamlines and modernizes the current State system.
    Although the RAA prefers a Federal regulator, the Nonadmitted and
    Reinsurance Reform Act, also called the surplus lines and reinsurance
    bill, passed twice by the House, is a good start, but could be
    augmented by the recent NAIC-endorsed reinsurance modernization
    framework. The RAA supports the NAIC proposal to modernize the U.S.
    reinsurance regulatory system through a system of regulatory
    recognition of foreign jurisdictions, a single State regulator for U.S.
    licensed reinsurers, and a port of entry State for non-U.S. based
    reinsurers.
        The NAIC has acknowledged that ``in light of the evolving
    international marketplace, the time is ripe to consider the question of
    whether a different type of regulatory framework for reinsurance in the
    United States is warranted.'' The proposed NAIC framework, if
    implemented appropriately, would, in the words of the NAIC,
    ``facilitate cross-border transactions and enhance competition within
    the U.S. market, while ensuring the U.S. insurers and policyholders are
    adequately protected.'' Given the challenges of implementing changes in
    all 50 States and questions of constitutional authority for State
    action on matters of international trade, the NAIC's support for
    Federal legislation to accomplish this proposed framework is
    encouraging.

    IV. THE NEED FOR A SYSTEMIC RISK REGULATOR?
        I urge Congress to move reinsurance regulatory modernization
    forward regardless of the ongoing debate about a systemic risk
    regulator--the subject of my concluding testimony.
        If, as House Financial Services Committee Chairman Barney Frank
    indicated during a February 3 press conference, there is a preference
    for systemic risk regulation ``covering all forms of financial
    activity,'' significant issues about a systemic risk regulator remain
    unanswered, including, but not limited to:

      1.  What are the criteria for defining entities or markets that
            present a systemic risk?

      2.  How broad will this regulator's authority be?

      3.  How will this regulator's powers interact with those of the
            prudential regulator?

      4.  To what extent will the systemic risk regulator present
            duplicative regulation?

      5.  How will U.S. companies that are part of an international group
            headquartered outside the United States be treated?

      6.  How will the systemic risk regulator coordinate with the other
            international regulators?

        In general, property casualty insurers generate little counterparty
    risk and their liabilities are, for the most part, independent of
    economic cycles or other systemic failures. Even during the current
    financial turmoil, rating agency A.M. Best continues to maintain a
    stable outlook for the global reinsurance sector based on its sound
    underlying operating earnings generated over the most recent timeframe,
    strong underwriting discipline, and capital adequacy. While the
    reinsurance industry plays an important role in the financial system,
    it may not necessarily present a systemic risk. In its 2006 report,
    ``Reinsurance and International Financial Markets,'' the Group of 30
    found ``no evidence'' that the failure of a reinsurer ``has given rise
    to a significant episode of systemic risk.''
        Reinsurance is an important part of the risk transfer mechanism of
    modern financial and insurance markets. Yet, there are clear
    distinctions between risk finance and management products that are
    relatively new financial tools developed in unregulated markets, and
    risk transfer products like reinsurance whose issuers are regulated and
    whose business model has existed for centuries. In the case of
    reinsurance, regulatory reform is necessary to improve its regulatory
    and market efficiency and maximize capacity in the United States, but
    not to address the fundamental risk transfer characteristics of the
    product.
        Those addressing the authority of a systemic risk regulator
    envision traditional regulatory roles and standards for capital,
    liquidity, risk management, collection of financial reports,
    examination authority, authority to take regulatory action as necessary
    and, if need be, regulatory action independent of any functional
    regulator. At a speech before the Council of Foreign Relations last
    week, Federal Reserve Board Chairman Ben Bernanke acknowledged that
    such a systemic regulator should work as seamlessly as possible with
    other regulators, but that ``simply relying on existing structures
    likely would be insufficient.''
        As I noted earlier in my testimony, the purpose of reinsurance
    regulation is primarily to ensure the collectability of reinsurance
    recoverables and to maintain a method of accurate reporting of
    financial information that can be relied upon by regulators, insurers
    and investors. Because reinsurance is exclusively a sophisticated
    business-to-business relationship, reinsurance regulation is
    functionally different from insurance, and has other critically
    different characteristics: no rate or form regulation and no consumer
    protection because there is no legal relationship to insurance
    consumers. Reinsurance companies are already regulated in much the same
    way as is being proposed for the systemic risk regulator--financial
    reporting, risk-based capital analysis, examination, and regulatory
    authority to take action to address financial issues. If licensed in
    the United States, reinsurers are regulated in this way by the various
    States. If domiciled in a non-U.S. jurisdiction, reinsurers are
    similarly regulated in their home country. We are concerned the
    systemic risk regulator envisioned by some would be redundant with this
    system. This raises concerns that, without financial services and
    insurance regulatory reform, a Federal systemic risk regulator would:
    (1) be an additional layer of regulation with limited added value; (2)
    create due process issues for applicable firms; and (3) be in regular
    conflict with the existing multi-State system of regulation.

    V. FINANCIAL REGULATORY MODERNIZATION
        Most, if not all participants in the dialog about financial
    services modernization, acknowledge that most financial markets are
    global and interconnected. Federal Reserve Chairman Bernanke noted that
    the global nature of finance makes it abundantly clear that any reform
    in the financial services sector must be coordinated internationally.
    Among the financial services providers, no sector is more global in
    nature than reinsurance.
        Should Congress proceed with broad financial services
    modernization, we ask that it be recognized that reinsurance is by its
    global nature different from insurance, and that the Federal Government
    currently has the requisite constitutional authority, functional
    agencies and experience in matters of foreign trade to easily modernize
    reinsurance regulation. We believe that multiple State regulatory
    agencies in matters of international trade are at best inefficient,
    pose barriers to global reinsurance transactions, and do not result in
    greater transparency.
        It is the recommendation of the Reinsurance Association of America
    that reinsurance regulatory modernization be included in any meaningful
    and comprehensive financial services reform through the creation of a
    Federal regulator having exclusive regulatory authority over the
    reinsurance sector so there is no level of redundancy with State
    regulation. This should occur whether or not a systemic risk regulator
    is included in financial services reform.
        Alternatively, Congress should create a single exclusive national
    regulator for reinsurance at the Federal level, but retain a choice or
    option for companies to remain in the State system. We recommend
    further that any such financial reform incorporate authority for a
    system of regulatory recognition to facilitate cooperation and
    enforcement with foreign insurance regulators.
        If the Congress should choose not to include reinsurance in broader
    financial services reform, we encourage the enactment of legislation
    along the lines of the NAIC's reinsurance modernization proposal to
    streamline the State system as it relates to reinsurance by federally
    authorizing a port of entry for foreign reinsurers and single-state
    financial oversight for reinsurers licensed in the United States.
        Should Congress proceed first with a systemic risk regulator and
    defer financial services modernization, we encourage the Committee to
    provide a road map for addressing reinsurance regulatory reform along
    the lines described in this testimony.
        The RAA thanks Chairman Dodd, Ranking Member Shelby and members of
    the Committee for this opportunity to comment on regulation, and we
    look forward to working with all members of the Committee as it
    considers this most important issue.
                                     ______

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                        FROM MICHAEL T. McRAITH

    Q.1. The convergence of financial services providers and
    financial products has increased over the past decade.
    Financial products and companies may have insurance, banking,
    securities, and futures components. One example of this
    convergence is AIG. Is the creation of a systemic risk
    regulator the best method to fill in the gaps and weaknesses
    that AIG has exposed, or does Congress need to reevaluate the
    weaknesses of Federal and State functional regulation for
    large, interconnected, and large firms like AIG?

    A.1. The creation of a Federal systemic risk regulator is
    distinct from an examination of the effectiveness of functional
    regulation for large firms like AIG. As you know, AIG's 71
    U.S.-based insurers subject to State-coordinated oversight have
    met all obligations to policyholders and claimants. From an
    insurance regulator's perspective, our functional regulation
    proved a key element in preserving the value in the AIG
    insurance subsidiaries and protecting AIG's insurance
    consumers. With conservative but reasonable capital
    requirements, solvency standards and accounting principles,
    State insurance regulators ensured that the AIG insurance
    companies were, and remain, healthy enterprises within the
    larger corporate structure. Greater functional regulatory
    coordination is necessary to understand fully the risks posed
    by all sectors of a financial conglomerate, and to guard
    against threats to one subsidiary due to the demise of another.
        State-based and State-coordinated insurance regulation is
    inherently compatible with systemic regulation. State insurance
    regulators support Congressional initiatives to enhance
    financial stability through systemic risk regulation provided
    that such proposals preserve State-based insurance regulation.
    Working with the myriad functional regulators, the Federal
    Government should have fingertip access to information and the
    requisite authority to supervise or undertake corrective
    action, if necessary. Of course, such corrective action by a
    financial stability regulator should be undertaken only to
    prevent or minimize the risk of a financial conglomerate
    imposing undue burden on the larger financial system.
    Preemptive authority, though, should be limited to extreme
    instances of systemic risk and not displace State insurance
    regulation or other functional regulation.
        State insurance regulators, through the NAIC, recognize
    areas for improvement within the functional regulation of
    insurance at the State level. To that end, we are implementing
    and developing proposals to enhance regulatory efficiency.
        Also, our regulatory expertise and experience can be relied
    upon to improve financial regulation more broadly, protect
    consumers. We welcome the opportunity to partner with other
    functional regulators. Supervisory colleges comprised of
    functional regulators may prove useful if not essential in
    understanding the potential areas and impacts of systemic risk
    within an individual enterprise.
        To discard the expertise and demonstrable success of State
    insurance regulators would be a grave mistake, especially if
    based on misconceptions about the efficacy of State regulators
    to respond to a financial crisis. Insurance companies have
    generally fared better than other financial institutions. Of
    course, insurers encounter challenges based on the overall
    economy, but the vast majority are withstanding the stress
    better than other financial service sectors. Some large life
    insurers attempt to use the current economic stress in other
    financial sectors as support for an optional Federal charter or
    other broad regulatory reform. However, any such attempt to
    blame State insurance regulators for the overall downturn in
    the capital markets should be understood as transparently
    misplaced, particularly when the same companies have repeatedly
    criticized State regulation as too conservative.

    Q.2. Recently there have been several proposals to consider for
    financial services conglomerates. One approach would be to move
    away from functional regulation to some type of single
    consolidated regulator like the Financial Services Authority
    model. Another approach is to follow the Group of 30 Report
    which attempts to modernize functional regulation and limit
    activities to address gaps and weaknesses. An in-between
    approach would be to move to an objectives-based regulation
    system suggested in the Treasury Blueprint. What are some of
    the pluses and minuses of these three approaches?

    A.2. Without critiquing the merits of each of the above
    approaches, State insurance regulators refer the Committee to
    our regulatory modernization principles. Our principles
    recognize the need for greater collaboration among financial
    services regulators at the State and Federal level while also
    preserving, securing and maintaining expertise through
    effective functional regulation. This can be achieved through
    enhanced regulation at the holding company level, possibly
    through the introduction of supervisory colleges comprised of
    functional regulators.
        However, supervisory colleges should not be utilized to
    override functional regulators. Rather, supervisory colleges
    can--and should--be effectively utilized to understand the
    risks within the holding company structure. Functional
    regulatory expertise, as exemplified by State insurance
    regulators, has proved a key mitigating factor in averting an
    even larger financial crisis. Accordingly, preemption of
    functional regulatory authority, if any, should be limited to
    extraordinary circumstances that present a material risk to the
    continued solvency of a systemically significant holding
    company, or a risk that threatens the stability of a financial
    system.
        Any proposal should avoid the dual regulatory regimes that
    present the concurrent risks of both regulatory consolidation
    and regulatory arbitrage. A single consolidated regulator
    presents inherent risk. Simply put, regulators make mistakes.
    With only a single regulator, or a single perspective
    associated with a large, integrated conglomerate, the
    consequences of regulatory failure expand proportionately and
    become potentially systemic and catastrophic. Large complex
    institutions that have the potential for systemic failure need
    additional scrutiny, not less. Existing regulatory resources
    should be leveraged. As the State insurance regulatory model
    has shown, having coordinated oversight of multiple regulators
    reduces the likelihood of an industry push toward the regulator
    with the ``lightest touch.'' This collaborative model has
    proved effective in the case of State insurance regulation,
    through which many States coordinate the regulation of any one
    company, and could be applied to larger-scale functional
    regulatory collaboration.

    Q.3. What is the most effective way to update our rules and
    regulations to refute the assumption that any insurer or
    financial services company is too big to fail?

    A.3. For State insurance regulators, the issue involves
    managing risk within the larger financial system rather than
    refuting assumptions about particular companies. The regulatory
    modernization principles of State insurance regulators support
    systemic risk oversight and the utilization of supervisory
    colleges within a framework that preserves and enhances
    functional regulation.
        Of course, insurance is premised upon insurance companies
    assuming or receiving risk not creating risk. This principle
    also applies to systemic risk, which provides ample motivation
    for policymakers to move toward elimination of regulatory gaps
    in order to encourage greater financial stability. Insurers'
    exposure to systemic risk, though, typically results from
    linkages to the capital markets.
        Insurance also illustrates the difference between systemic
    risk and the risk of large failures. Most lines of insurance
    have numerous market participants and ample capacity to absorb
    the failure of even the biggest market participant. For
    example, if the largest auto insurer in the U.S. were to fail,
    its policyholders could be quickly absorbed by other insurers,
    and that insurer would be further supported by the State
    guaranty fund system. This scenario does not pose systemic risk
    since the impact is isolated, does not ripple to other
    financial sectors, and does not require extraordinary
    intervention to mitigate. Also, the State-based insurer
    guaranty fund system rewards policyholders and claimants as a
    priority in the event of an insolvency. Any system of financial
    stability regulation should focus on truly systemic risk, and
    not create redundant mechanisms for dealing with isolated
    disruptions.

    Q.4. Last week the WSJ had an article titled, The Next Big
    Bailout Decision: Insurers. It mentions the fact that a dozen
    life insurers have pending applications for aid from the
    government's $700 billion Troubled Asset Relief Program. What
    is the market-wide risk of life insurance and property and
    casualty insurance?

    A.4. The nature of life insurance and property and casualty
    insurance is to assume, pool, and spread existing risk, not
    create new sources of risk. Aside from a handful of mono-line
    financial guaranty and mortgage guaranty insurers, insurers'
    normal business operations have generally not been exposed to
    the larger financial crisis. As a result, insurance does not
    contribute to market-wide or systemic risk. Even where insurers
    are directly exposed to capital markets through direct
    investments and securities lending programs, State insurance
    regulators impose systems and controls that are constantly
    improved. As a result, economic downturns can be managed and
    policyholder dollars remain secure. Insurers play an important
    role in the capital markets, particularly in the area of long-
    term investments, such as corporate bonds and commercial and
    residential mortgages, but State insurance regulators balance a
    company's desire for increased participation in the capital
    markets with underlying policyholder obligations.
        Insurers' investment portfolios have been exposed to the
    same market forces as those of other investors. Unlike other
    investors, though, insurer exposure to market turmoil is
    reduced by State insurance laws that limit the percentage of
    assets an insurer can invest in particular asset classes. These
    investment limitations are one aspect of the conservative but
    reasonable State solvency regime that aids insurers with
    preservation of the critical ability to meet obligations to
    policyholders and claimants. While a handful of life insurance
    companies may have applications pending for TARP funds, State
    insurance regulators believe such applications stem from the
    inherent risk for any investor rather than shortcomings in any
    insurer's core life insurance operations. To be sure, insurers
    remain significant participants in capital markets. Insurer
    participation in the TARP program, therefore, may be consistent
    with the intent of the Emergency Economic Stabilization Act and
    may contribute to the strengthening of the economy.
        Capital investments by the Department of the Treasury
    through the Capital Purchase Program (CPP), as accessed by
    insurers with bank holding company status, indicate insurance
    sector strength. CPP is not a bailout and Treasury has been
    clear that participation in CPP is reserved for healthy, viable
    institutions. State insurance regulators agree with the
    positive implications of insurer participation in CPP to the
    extent that such participation relieves liquidity concerns and
    alleviates consumer concern about the financial health of
    specific insurance companies and the insurance industry.
        Please do not hesitate to contact me if you have more
    questions, or if you would like additional information in
    relation to this or any other topic. Thank you again for the
    opportunity to present to your Committee.
                                    ------

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                           FROM FRANK KEATING

    Q.1. The convergence of financial services providers and
    financial products has increased over the past decade.
    Financial products and companies may have insurance, banking,
    securities, and futures components. One example of this
    convergence is AIG. Is the creation of a systemic risk
    regulator the best method to fill in the gaps and weaknesses
    that AIG has exposed, or does Congress need to reevaluate the
    weaknesses of Federal and State functional regulation for
    large, interconnected, and large firms like AIG?

    A.1. Although we understand the interest of Congress in
    considering the establishment of a systemic risk regulator, the
    ACLI has no position on that approach as a solution to the
    economy's current situation. However we do believe that, should
    a systemic risk regulator be created and should that office
    have authority over insurers, it will be important for that
    office to have constant access to a regulatory office that
    understands the fundamentals of the insurance industry, and we
    don't think the Federal Government will have that resource
    without the creation of a Federal functional regulator.

    Q.2. Recently there have been several proposals to consider for
    financial services conglomerates. One approach would be to move
    away from functional regulation to some type of single
    consolidated regulator like the Financial Services Authority
    model. Another approach is to follow the Group of 30 Report
    which attempts to modernize functional regulation and limit
    activities to address gaps and weaknesses. An in-between
    approach would be to move to an objectives-based regulation
    system suggested in the Treasury Blueprint. What are some of
    the pluses and minuses of these three approaches?

    A.2. Although the ACLI has not done an analysis of one of these
    approaches over the other, we do feel strongly that whichever
    approach is taken to reform and modernize financial service
    reform regulation must include the establishment of a Federal
    insurance regulator. Not doing so would result in the
    continuation of a 19th century regulatory system being applied
    to a critical part of the financial services industry.

    Q.3. What is the most effective way to update our rules and
    regulations to refute the assumption that any insurer or
    financial services company is too big to fail?

    A.3. The ACLI has not done the in-depth analysis needed to
    adequately reply to this question.

    Q.4. Last week the WSJ had an article titled, ``The Next Big
    Bailout Decision: Insurers.'' It mentions the fact that a dozen
    life insurers have pending applications for aid from the
    government's $700 billion Troubled Asset Relief Program. What
    is the market-wide risk of life insurance and property and
    casualty insurance?

    A.4. The ACLI can only respond with regard to the life
    insurance industry. Life insurers play a vital role in our
    nation's credit markets. We are the nation's largest holder of
    corporate bonds, and we have substantial investments in
    commercial real estate and other areas. If the county's credit
    markets are going to begin functioning normally again, lending
    by life insurance companies must be a part of that. So to the
    degree life insurers receive funds intended to unfreeze the
    credit markets, it is a totally appropriate action.
                                    ------

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                        FROM WILLIAM R. BERKLEY

    Q.1. The convergence of financial services providers and
    financial products has increased over the past decade.
    Financial products and companies may have insurance, banking,
    securities, and futures components. One example of this
    convergence is AIG. Is the creation of a systemic risk
    regulator the best method to fill in the gaps and weaknesses
    that AIG has exposed, or does Congress need to reevaluate the
    weaknesses of Federal and State functional regulation for
    large, interconnected, and large firms like AIG?

    A.1. The lessons of AIG--and indeed the broader financial
    crisis--have further underscored the fact that Congress must
    reevaluate the weaknesses of the current regulatory structure.
    Thus, as Congress considers the creation of a systemic risk
    regulator to ``fill in the gaps,'' it must address the lack of
    an effective and efficient Federal insurance regulator. As I
    stated in my testimony, the only effective way to include
    property-casualty insurance under a systemic risk regulator
    would be to create ``an independent Federal functional
    insurance regulator that stands as an equal to the other
    Federal banking and securities regulators.''
        While stricter financial regulatory standards may have
    helped preserve the capital value of AIG's property and
    casualty subsidiaries, the fragmented State-by-State regulatory
    structure did not prevent the collapse of AIG as an enterprise
    and it has not stopped AIG's insurance subsidiaries from
    experiencing significant property and casualty underwriting
    losses, as well as historic losses in its life insurance
    operations from securities lending. With respect to the
    enterprise, the State regulatory system made it impossible for
    any one regulator to exercise comprehensive authority or
    supervision of the company across State lines, let alone across
    U.S. borders. Even if each State regulator did an outstanding
    job supervising entities in their jurisdiction, their inability
    to see transactions in the aggregate with companies outside
    their jurisdiction presents a challenge. Thus, no State could
    intercede to address an enterprise-wide problem because of
    limited nature of this regulatory jurisdiction. Moreover, this
    structure prevents risk evaluation on a regional, national, or
    global scale, something that we now know is imperative in the
    wake of the financial crisis.
        If a Federal insurance regulator is established, regulation
    should be comprehensive, not divided. For example, creation of
    a Federal solvency regulator while keeping the existing
    prudential regulation of insurance at the State level would
    lead to bifurcated, ineffective regulation and significant
    unintended consequences.
        If this crisis has revealed anything, it is the need for
    more--not less--regulatory efficiency, coordinated activity or
    tracking, sophisticated analysis of market trends and the
    ability to understand and anticipate as well as deal with
    potential systemic risk before the crisis is at hand. Yet,
    establishing systemic risk oversight without addressing the
    structural problems that exist in the current State insurance
    regulatory system will only defer those problems until the next
    crisis. To solve such as crisis there must be knowledge and
    expertise at the Federal level.

    Q.2. Recently there have been several proposals to consider for
    financial services conglomerates. One approach would be to move
    away from functional regulation to some type of single
    consolidated regulator like the Financial Services Authority
    model. Another approach is to follow the Group of 30 Report
    which attempts to modernize functional regulation and limit
    activities to address gaps and weaknesses. An in-between
    approach would be to move to an objectives-based regulation
    system suggested in the Treasury Blueprint. What are some of
    the pluses and minuses of these three approaches?

    A.2. As a practical matter, it might currently be impossible to
    put in place an entirely new financial services regulatory
    structure for the United States. At the same time, the serious
    regulatory flaws revealed during this crisis need to be
    addressed in a way that positions U.S. financial services
    companies--including property and casualty insurers--to compete
    effectively at home and abroad, while ensuring a healthy and
    vibrant financial services marketplace that works to the
    benefit of U.S. consumers. The 2008 Department of the Treasury
    Blueprint for a Modernized Financial Regulatory Structure and
    the Group of Thirty Framework for Financial Stability are both
    very serious and thoughtful discussions regarding a more
    efficient and more effective structure for financial
    regulation. The Treasury Blueprint calls for specific reforms
    in the way banking and securities are regulated at the Federal
    level, including the creation of an optional Federal charter
    regulatory regime to oversee insurers. The Group of Thirty
    report is designed to discuss financial regulation in broad
    concepts that can be applied to any country that has recently
    experienced financial disruption.
        Both the Treasury Blueprint and the Group of Thirty report
    explicitly recommend the ``establishment of a Federal insurance
    regulatory structure'' and a ``framework for national level
    consolidated prudential regulation and supervision over large
    internationally active insurance companies.'' Such a modern
    regulatory regime for insurance would benefit consumers and
    protect taxpayers by ensuring uniform rules and regulations,
    allow new products to quickly be brought to market, and enhance
    international competitiveness of American insurance companies.
    Moreover, a national regulatory structure supervising insurance
    companies would most certainly fill the gaps that exist under
    the current system.

    Q.3. What is the most effective way to update our rules and
    regulations to refute the assumption that any insurer or
    financial services company is too big to fail?

    A.3. It is more important for a regulator to understand risk
    and to set clear rules to mitigate risk in financial services
    conglomerates than it is to simply look exclusively at the size
    of a company. In the example of AIG, the good credit standing
    of the insurance business was used to guarantee the performance
    of the holding company. Thus the guarantee from the insurance
    company created intercompany exposure which was not clearly
    considered. A Federal regulator for insurance should be in
    place to oversee companies that fail to manage risk
    responsibly, and, for the reasons discussed above, should be
    available to others who need the expertise for risk oversight.
        The widely discussed concept of ``too big to fail'' is
    subjective in my view. Regulators should not be monitoring or
    regulating only the size of a company but rather regulating the
    practices, conduct and activities in which it engages. The
    level of a company's interconnectivity in the financial system
    doesn't necessarily correlate to one's size; the more important
    principle is to understand a company's transactions and its
    counterparties. Rather than monitoring a company for size, it
    would seem to be far more effective to take steps to encourage
    transparency so a regulator can monitor and detect risk by
    better understanding a company's business activities.

    Q.4. Last week the WSJ had an article titled, ``The Next Big
    Bailout Decision: Insurers.'' It mentions the fact that a dozen
    life insurers have pending applications for aid from the
    government's $700 billion Troubled Asset Relief Program. What
    is the market-wide risk of life insurance and property and
    casualty insurance?

    A.4. The property and casualty insurance industry has managed
    its risks well and is financially stable. Ours are generally
    low-leveraged businesses with conservative investment
    portfolios. The industry is systemically important in that
    huge, unforeseen multi-billion-dollar losses could occur with
    events such as another natural disaster or terrorist attack. No
    single State can effectively deal with such mega events, thus a
    Federal insurance regulator would be a smarter, more effective
    way to understand and manage risk in the industry.
        My expertise and experience is in the property and casualty
    industry so my comments will mostly be confined to that
    particular sector. However, it is instructive to the debate
    over regulatory reform that the dozen life insurers which
    applied for TARP funds were told by the Treasury Department
    that they needed to purchase thrifts--putting them under the
    regulatory oversight of the Office of Thrift Supervision--in
    order to be eligible for these capital injections. That
    condition was imposed apparently because Treasury did not feel
    comfortable providing significant capital to companies that are
    not under Federal supervision and that the Federal Government
    knows very little about. This would seem to be another
    compelling argument for national oversight of insurance.
                                    ------

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                          FROM SPENCER HOULDIN

    Q.1. The convergence of financial services providers and
    financial products has increased over the past decade.
    Financial products and companies may have insurance, banking,
    securities, and futures components. One example of this
    convergence is AIG. Is the creation of a systemic risk
    regulator the best method to fill in the gaps and weaknesses
    that AIG has exposed, or does Congress need to reevaluate the
    weaknesses of Federal and State functional regulation for
    large, interconnected, and large firms like AIG?

    A.1. The idea of a single entity to oversee systemic risk at
    the Federal level might make sense for the market, but
    specifically regarding insurance, it must collaborate and rely
    upon State insurance regulation, which is doing an excellent
    job of regulating day-to-day insurance operations of companies
    and producers. IIABA believes the financial services crisis may
    have demonstrated such a need to have special scrutiny of the
    limited group of unique entities that engage in services or
    provide products that could pose systemic risk to the overall
    financial services market. IIABA therefore believes that while
    limited systemic risk oversight should be considered, this
    should not displace or interfere with the competent and
    effective level of day-to-day State insurance regulation
    provided today.

    Q.2. Recently there have been several proposals to consider for
    financial services conglomerates. One approach would be to move
    away from functional regulation to some type of single
    consolidated regulator like the Financial Services Authority
    model. Another approach is to follow the Group of 30 Report
    which attempts to modernize functional regulation and limit
    activities to address gaps and weaknesses. An in-between
    approach would be to move to an objectives-based regulation
    system suggested in the Treasury Blueprint. What are some of
    the pluses and minuses of these three approaches?

    A.2. Speaking only on the insurance industry, IIABA believes
    that the current State regulatory structure has many positive
    elements that should not be disregarded, including expertise
    and resources in place from decades of regulatory experience,
    and strongly opposes consolidating functional regulation in one
    Federal regulator. The State insurance regulatory system has an
    inherent consumer-protection advantage in that there are
    multiple regulators overseeing an entity and its products,
    allowing others to notice and rectify potential regulatory
    mistakes or gaps. Providing one day-to-day regulator with all
    of these responsibilities, consolidating regulatory risk, could
    lead to more substantial problems where the errors of that one
    regulator lead to extensive problems throughout the entire
    market. IIABA believes insurance regulation should be
    modernized but strongly opposes day-to-day Federal regulation
    of insurance, whether through a mandatory consolidated
    regulator or through establishing an optional Federal charter
    for insurance, as proposed in the Treasury Blueprint. IIABA
    also opposes efforts to federally regulate segments of the
    property-casualty market, such as commercial or large
    commercial property-casualty. Along with its belief that
    limited Federal systemic risk oversight may be necessary for
    large financial services entities, IIABA also believes that
    consideration should be given to legislation that would create
    an Office of Insurance Information (OII) at the Federal level.
    However, such an office should not portend the creation of a
    Federal insurance regulator, because an OII would help fill the
    void of insurance expertise in the Federal government and help
    solve the problems faced by insurers in the global economy
    without day-to-day regulation of insurance at the Federal
    level.

    Q.3. What is the most effective way to update our rules and
    regulations to refute the assumption that any insurer or
    financial services company is too big to fail?

    A.3. II ABA believes that Federal systemic risk oversight may
    be necessary to prevent an AIG-type collapse and resulting
    government bailout from happening in the future. Entities that
    engage in services or provide products that could pose systemic
    risk to the overall financial services market likely need
    Federal oversight at the holding company level.

    Q.4. Last week the WSJ had an article titled, ``The Next Big
    Bailout Decision: Insurers.'' It mentions the fact that a dozen
    life insurers have pending applications for aid from the
    government's $700 billion Troubled Asset Relief Program. What
    is the market-wide risk of life insurance and property and
    casualty insurance?

    A.4. Speaking only of the property-casualty market, of which
    our members are primarily engaged, IIABA believes that few, if
    any, participants or lines in this insurance market raise
    systemic or market-wide risk issues.
                                    ------

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                           FROM JOHN T. HILL

    Q.1. The convergence of financial services providers and
    financial products has increased over the past decade.
    Financial products and companies may have insurance, banking,
    securities, and futures components. One example of this
    convergence is AIG. Is the creation of a systemic risk
    regulator the best method to fill in the gaps and weaknesses
    that AIG has exposed, or does Congress need to reevaluate the
    weaknesses of Federal and State functional regulation for
    large, interconnected, and large firms like AIG?

    A.1. The passage of the Gramm-Leach-Bliley Act (GLBA),
    financial services modernization legislation, eliminated Glass-
    Stegall's firewall and opened the door for greater integration
    within the financial services industry and convergence of
    products and services. Despite the projections for significant
    integration between other financial services firms--e.g.,
    banks, securities firms--and insurers prior to the passage of
    GLBA there has not been widespread integration or convergence
    of products within the property and casualty sector. A few
    large insurers under holding company structures have non-
    insurance financial affiliates; however, the large majority of
    the more than 3,000 property and casualty insurers are not
    involved in the convergence of financial products and services.
    Joint marketing agreements and affinity projects are evidenced,
    but large acquisitions or mergers have generally not occurred.
        GLBA properly maintained functional regulation for the
    separate financial functions. Functional regulation provides
    the specialized expertise necessary to regulate highly complex,
    unique financial products and services. However, greater
    cooperation and coordination among all applicable regulators,
    including State insurance regulators, should have been
    formalized to ensure full regulatory supervision for large
    complex financial institutions. Proper, well coordinated
    regulatory oversight by functional regulators working
    cooperatively would identify regulatory gaps, expose weaknesses
    and provide a complete picture of the activities of integrated,
    multi-layered enterprises, while maintaining the expertise and
    concentrated focus of specific substantive regulation.
        NAMIC believes a closer and more formalized working
    relationship between State regulators and their Federal
    counterparts is essential to ensure timely and effective
    information exchange and coordination of regulatory actions.
    Expansion of the President's Financial Working Group to include
    participation by State regulators, coupled with enhanced
    information sharing between and among the participants would
    provide a unique forum to integrate and coordinate financial
    services regulation, while preserving the benefits of
    prudential regulation. Similarly, enhanced cooperation and
    coordination among the various global financial services
    regulatory bodies would improve regulation of multi-national
    entities. However, such cooperation and coordination should not
    come at the cost of abrogation of regulatory authority to
    foreign jurisdictions or quasi-governmental bodies.
        With respect to systemic risk oversight, NAMIC believes
    that regulators should work to identify, monitor, and address
    systemic risk. However, a systemic risk regulator should
    complement, rather than duplicate or supersede, existing
    regulatory resources. Furthermore, NAMIC does not believe that
    the business or legal characterization of any institutions
    should be used as a basis for assessing systemic risk.
        Oversight and regulation of systemic risk should focus on
    the impact of products or transactions used by financial
    intermediaries. Attempting to define and regulate
    ``systemically significant institutions'' on the basis of size,
    business line, or legal classification--such as including all
    property/casualty insurers--would do little to prevent future
    financial crises. Indeed, a regime of systemic risk regulation
    that is institution-oriented rather than focused on specific
    financial products and services could divert attention and
    resources from where they are most needed, while at the same
    time producing distortions in insurance markets that would be
    harmful to consumers.
        NAMIC member companies understand that Federal policymakers
    must have better information about the insurance industry, and
    confidence in the financial health of property/casualty
    insurers. To that end, NAMIC has supported the creation of a
    Federal Office of Insurance Information. That measure, coupled
    with effective systemic risk regulation, could accomplish
    important policy objectives that are not currently being met.

    Q.2. Recently there have been several proposals to consider for
    financial services conglomerates. One approach would be to move
    away from functional regulation to some type of single
    consolidated regulator like the Financial Services Authority
    model. Another approach is to follow the Group of 30 Report
    which attempts to modernize functional regulation and limit
    activities to address gaps and weaknesses. An in-between
    approach would be to move to an objectives-based regulation
    system suggested in the Treasury Blueprint. What are some of
    the pluses and minuses of these three approaches?

    A.2. A single consolidated financial market regulator would
    prove more problematic in the United States than in other
    countries. Unlike the majority of countries which utilize a
    unitary legal system, the United States has 54 well-defined
    jurisdictions each with its own set of laws and courts. As
    noted, the U.S. system of contract law is deeply developed, and
    with respect to insurance policies is based on more than a
    century of policy interpretations by State courts. The tort
    system, which governs many of the types of contingencies at the
    heart of insurance claims, particularly those covered by
    liability insurance, is also deeply based in State law.
        There are also significant differences between insurance
    and other financial services and products which necessitate
    specific regulatory treatment. Geographical and demographic
    differences among States would similarly pose additional
    difficulties for a single financial market regulator.
        Another option for reform that has been proposed is a
    transition to principles-based regulation. The current legal
    and regulatory system in the United States is primarily
    ``rules-based.'' Recent attempts to adopt ``principles-based''
    approaches have been to add to, rather than replace existing
    ``rules-based'' regulations. NAMIC supports efforts to
    streamline the regulatory process and provide greater
    flexibility to respond to rapidly changing economic and market
    conditions. However, as regulators evaluate ``principles-
    based'' regulation careful attention must be given to legal and
    operational issues. Regulatory or accounting decisions based on
    principles, however, may not always be transparent or
    consistent with one another, and this can have significant
    competitive effects.
        Legal certainty is also a serious consideration when
    developing and implementing principles-based regulation.
    Whether a particular way of doing business conforms to the
    principle involved can be a matter of a particular regulator's
    opinion, and as regulators and circumstances change, so do
    interpretations. In addition, civil liability concerns must
    also be addressed if principles-based regulation is adopted. In
    the United States companies are subject to liability in private
    class actions in both Federal and State courts, civil rule
    enforcement by Federal and State regulators, and criminal
    enforcement by both the U.S. Justice Department and State
    attorneys general. Lack of legal certainty could create extreme
    vulnerability for regulated firms if not properly addressed in
    conjunction with such a shift in the regulatory paradigm. NAMIC
    urges regulators and lawmakers to carefully weigh all issues,
    including ensuring proper legal protection and regulatory
    transparency and avoiding arbitrary regulator conduct.
        The recent G30 Report urges international adoption of
    enhanced regulatory supervision to eliminate gaps and increase
    transparency. NAMIC agrees with the goals; however, our members
    oppose the recommendation for national level regulation of
    internationally active insurers. A dual regulatory structure in
    which some insurers are regulated at the State level and some
    at the national level would lead to competitive inequities and
    cause consumer confusion. Property and casualty insurance is
    inherently local in nature and State regulation remains
    appropriate.
        Regulatory processes must be flexible and dynamic to meet
    the changing market conditions and strong enough to avoid
    abrogation to the courts. Regulatory reform efforts should
    concentrate on targeting regulatory activities and maximizing
    existing resources.

    Q.3. What is the most effective way to update our rules and
    regulations to refute the assumption that any insurer or
    financial services company is too big to fail?

    A.3. State insurance regulators actively supervise all aspects
    of the business of insurance, including review and regulation
    of solvency and financial condition to ensure against market
    failure. Public interest objectives are achieved through review
    of policy terms and market conduct examinations to ensure
    effective and appropriate provision of insurance coverages.
    Regulators also monitor insurers, agents, and brokers to
    prevent and punish activities prohibited by State antitrust and
    unfair trade practices laws and take appropriate enforcement
    action, where appropriate.
        Specifically, insurers are subject to systematic,
    comprehensive review of all the facets of their operation in
    their business dealings with customers, consumers, and
    claimants. The examination process allows regulators to monitor
    compliance with State insurance laws and regulations, ensure
    fair treatment of consumers, provide for consistent application
    of the insurance laws, educate insurers on the interpretation
    and application of insurance laws, and deter bad practices.
    Comprehensive examinations generally cover seven areas of
    investigation, including insurance company operations and
    management, complaint handling, marketing and sales, producer
    licensing, policyholder services, underwriting and rating, and
    claim practices.
        Coordination among regulators is essential to effective
    regulation. To effectively evaluate the financial condition of
    national insurers, State regulators participate in the NAIC
    Financial Analysis Working Group. This confidential process
    provides regulatory peer review of the actions domiciliary
    regulators take to improve the financial condition of larger
    insurers. Expansion of such regulatory coordination between
    other financial services regulators would improve oversight of
    consolidated firms.
        The guaranty fund system also provides effective protection
    for insurance consumers against catastrophic disruptions from a
    single entity. A centerpiece of the State insurance regulatory
    system is the existence and operation of State guaranty
    associations. State guaranty associations provide a mechanism
    for the prompt payment of covered claims of an insolvent
    insurer. In the event of an insurer insolvency the guaranty
    associations assess other insurers to obtain funds necessary to
    pay the claims of the insolvent entity.

    Q.4. Last week the WSJ had an article titled, ``The Next Big
    Bailout Decision: Insurers.'' It mentions the fact that a dozen
    life insurers have pending applications for aid from the
    government's $700 billion Troubled Asset Relief Program. What
    is the market-wide risk of life insurance and property and
    casualty insurance?

    A.4. There is little market wide risk within the property/
    casualty industry. A recent survey conducted of the NAMIC
    membership indicated that members are confident in their
    ability to pay claims and overwhelmingly do not need and are
    not interested in receiving Federal money under TARP. As an
    industry, property/casualty insurance companies, particularly
    the nation's mutual insurance companies, are well capitalized
    and have adequate reserves to pay claims. Prudent management
    and the State-based regulatory systems under which these
    companies operate include strict solvency requirements that
    effectively build a protective barrier around their assets and,
    ultimately, their customers. Even the property/casualty
    subsidiaries of AIG are solvent and remain fiscally strong.
        Very few property/casualty insurers use commercial paper,
    short-term debt or other leverage instruments in their capital
    structures, a fact that makes them less vulnerable than highly
    leveraged institutions when financial markets collapse.
    Likewise, the nature of the products that property/casualty
    insurers provide makes them inherently less vulnerable to
    disintermediation risk. For business and regulatory reasons
    property/casualty insurers carry a liquid investment portfolio.
    Because property/casualty insurance companies have built up
    required reserves and their investments are calibrated to match
    the statistically anticipated claims payments, there is little
    liquidity risk and virtually no possibility of a ``run on the
    bank'' scenario.
        Some life insurers have been particularly hard hit by this
    downturn in the markets because their products, solvency
    regulations, and practices differ so dramatically from
    property/casualty insurers. Weak balance sheets have led to the
    credit ratings of many struggling life insurance companies
    being downgraded. This, in turn, makes it more difficult for
    the companies to raise cash, further weakening their balance
    sheets. The injection of Federal money directly into these
    companies will help them avoid further downgrades and alleviate
    the need to raise capital under onerous terms.
                                    ------

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                           FROM FRANK NUTTER

    Q.1. The convergence of financial services providers and
    financial products has increased over the past decade.
    Financial products and companies may have insurance, banking,
    securities, and futures components. One example of this
    convergence is AIG. Is the creation of a systemic risk
    regulator the best method to fill in the gaps and weaknesses
    that AIG has exposed, or does Congress need to reevaluate the
    weaknesses of Federal and State functional regulation for
    large, interconnected, and large firms like AIG?
    A.1. It has been suggested that the authority of a systemic
    risk regulator should encompass traditional regulatory roles
    and standards for capital, liquidity, risk management,
    collection of financial reports, examination authority,
    authority to take regulatory action as necessary and, if need
    be, regulatory action independent of any functional regulator.
    At a recent speech before the Council of Foreign Relations, for
    example, Federal Reserve Board Chairman Ben Bernanke
    acknowledged that such a systemic regulator should work as
    seamlessly as possible with other regulators, but that ``simply
    relying on existing structures likely would be insufficient.''
    The purpose of reinsurance regulation is primarily to ensure
    the collectability of reinsurance recoverables and reporting of
    financial information for use by regulators, insurers and
    investors. Because reinsurance is exclusively a sophisticated
    business-to-business relationship, reinsurance regulation
    should be focused on prudential or solvency regulation. The RAA
    is concerned the systemic risk regulator envisioned by some--
    one without clear, delineated lines of Federal authority and
    strong preemptive powers--would be redundant with the existing
    stated-based regulatory system. We also note that without
    reinsurance regulatory reform and a prudential Federal
    reinsurance regulator, a Federal systemic risk regulator would:
    (1) be an additional layer of regulation with limited added
    value; (2) create due process issues for applicable firms; and
    (3) be in regular conflict with the existing multi-State system
    of regulation.

    Q.2. Recently there have been several proposals to consider for
    financial services conglomerates. One approach would be to move
    away from functional regulation to some type of single
    consolidated regulator like the Financial Services Authority
    model. Another approach is to follow the Group of 30 Report
    which attempts to modernize functional regulation and limit
    activities to address gaps and weaknesses. An in-between
    approach would be to move to an objectives-based regulation
    system suggested in the Treasury Blueprint. What are some of
    the pluses and minuses of these three approaches?

    A.2. As regards regulation of reinsurance, the RAA seeks to
    minimize duplicative regulation while ensuring continued strong
    solvency regulation. The current 50-State system of regulating
    reinsurance is inefficient and does not adequately address the
    needs of a global business. An informed Federal voice with the
    authority to establish Federal policy on international issues
    is critical not only to U.S. reinsurers, who do business
    globally and spread risk around the world, but also to foreign
    reinsurers, who play an important role in assuming risk in the
    U.S. marketplace. The current multi-State U.S. regulatory
    system is an anomaly in the global insurance regulatory world.
    Following the recent financial crisis, the rest of the world
    continues to work towards global regulatory harmonization and
    international standards. The U.S. is disadvantaged by the lack
    of a Federal entity with Constitutional authority to make
    decisions for the country and to negotiate international
    insurance agreements. In the area of reinsurance, there is a
    need for a process for assessing the equivalence and
    recognition on a reciprocal basis of non-U.S. regulatory
    regimes. This process would assist non-U.S. reinsurers that
    supply significant reinsurance capacity to the U.S. insurance
    market by facilitating cross-border transactions through
    binding and enforceable international supervisory arrangements.

    Q.3. What is the most effective way to update our rules and
    regulations to refute the assumption that any insurer or
    financial services company is too big to fail?

    A.3. Any change to the current regulatory structure should
    minimize duplication while ensuring the application of strong,
    uniform regulatory standards. It will be important to ensure
    that any grant of regulatory authority is fully utilized and
    that there is structured coordination and communication among
    applicable regulators so that a company's corporate structure,
    its role in the marketplace and its products are fully
    understood so as to contain potential systemic risk.

    Q.4. Last week the WSJ had an article titled, ``The Next Big
    Bailout Decision: Insurers.'' It mentions the fact that a dozen
    life insurers have pending applications for aid from the
    government's $700 billion Troubled Asset Relief Program. What
    is the market-wide risk of life insurance and property and
    casualty insurance?

    A.4. No property casualty reinsurers have applied for TARP
    funds. The industry is conservatively invested and therefore
    would not appear to be of concern regarding a ``bailout.''
                                    ------

             RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                           FROM ROBERT HUNTER

    Q.1. The convergence of financial services providers and
    financial products has increased over the past decade.
    Financial products and companies may have insurance, banking,
    securities, and futures components. One example of this
    convergence is AIG. Is the creation of a systemic risk
    regulator the best method to fill in the gaps and weaknesses
    that AIG has exposed, or does Congress need to reevaluate the
    weaknesses of Federal and State functional regulation for
    large, interconnected, and large firms like AIG?
    A.1. Systemic risk regulation, while a useful supplement to
    function regulation, does not address all concerns. We believe
    improved functional regulation is essential. That should
    include closing regulatory gaps that allow certain products,
    institutions, and markets to operate outside the system of
    prudential regulation. It was AIG's involvement in the sale of
    unregulated credit default swaps and other structured finance
    vehicles that caused its downfall and led regulators to
    conclude that Federal intervention was necessary to prevent
    even further economic repercussions. Also, as the GAO study on
    regulatory oversight revealed, the quality of risk management
    oversight provided by the regulatory agencies was severely
    lacking. The attached testimony, which CFA Legislative Director
    Travis Plunkett presented to the House Financial Services
    Committee, provides greater detail on our views about the
    primary importance of strengthening functional regulation in
    enhancing the quality of financial oversight and the stability
    of financial markets.

    Q.2. Recently there have been several proposals to consider for
    financial services conglomerates. One approach would be to move
    away from functional regulation to some type of single
    consolidated regulator like the Financial Services Authority
    model. Another approach is to follow the Group of 30 Report
    which attempts to modernize functional regulation and limit
    activities to address gaps and weaknesses. An in-between
    approach would be to move to an objectives-based regulation
    system suggested in the Treasury Blueprint. What are some of
    the pluses and minuses of these three approaches?

    A.2. CFA does not believe that our regulatory failures were
    primarily structural in nature--with the notable exception of
    the banking arena where the ability to charter shop exerted a
    strong, downward pressure on regulatory protections. It is
    worth noting that the FSA model proved no more effective than
    the U.S.'s ``patchwork'' system in preventing abuses or
    addressing problems once they arose. We have attached our
    detailed critique of the Treasury Blueprint and a study CFA
    recently issued on regulatory reform more generally.

    Q.3. What is the most effective way to update our rules and
    regulations to refute the assumption that any insurer or
    financial services company is too big to fail?

    A.3. CFA strongly believes that we must restore the potential
    for failure for capitalism to work. Part of the approach is to
    create disincentives designed to discourage companies from
    becoming too big or too interconnected to fail--by
    significantly increasing capital requirements, for example, as
    companies increase in size or complexity. This method could
    also be used to discourage companies from adopting other
    practices that increase their risk of failure, such as taking
    on excessive leverage. Capital requirements for products traded
    away from an exchange could be set significantly higher than
    capital requirements for similar products traded on the
    exchange to reflect the heightened risk associated with this
    practice. In addition, we need to create a mechanism to allow
    for the orderly failure of non-bank financial institutions. One
    reason for the ad hoc nature of the current rescue efforts has
    been that lack of resolution authority for companies like AIG,
    Bear Stearns, and Lehman Brothers that got into financial
    difficulties. Providing that mechanism would give regulators
    more tools to use--and a more consistent basis for dealing
    with--insurers, investment banks, or others whose failure might
    otherwise destabilize the financial system and economy as a
    whole.

    Q.4. Last week the WSJ had an article titled, ``The Next Big
    Bailout Decision: Insurers.'' It mentions the fact that a dozen
    life insurers have pending applications for aid from the
    government's $700 billion Troubled Asset Relief Program. What
    is the market-wide risk of life insurance and property and
    casualty insurance?

    A.4. The systemic risk of insurance companies is relatively
    low, particularly for property/casualty insurance companies.
    Now there are some significant exceptions to this low risk
    requiring investigation as discussed in my testimony. For
    instance, Congress should study the potential systemic risk of:

       LBond insurance.

       LReinsurance and retrocession spread risk around the
            world in ways that normally lower risk but could, in
            certain circumstances, cause massive failure if a
            series of major impacts were to be felt at once--(i.e.,
            a ``black swan'' could cause great failure worldwide if
            reinsurance failed to deliver in its secondary market
            function). Major storms, earthquakes, terrorism attacks
            and other catastrophes could occur at about the same
            time that might bankrupt some of these significantly
            inter-connected secondary-market systems, for instance.

       LPeriodic ``hard markets'' that significantly impact
            a specific area of the economy, such as the periodic
            medical malpractice insurance shortages related to the
            economic cycle of property/casualty insurers. Another
            example currently is that banks are paying double last
            year's rates for directors and officers' coverage, if
            they can get it at all. If the degree of unavailability
            grows, Congress should study just what are the systemic
            implications if banks cannot hire officers or get
            directors to serve due to the lack of D&O coverage.
            Would the recovery of a bank be retarded by the flight
            of directors and officers from the institution if no
            insurance protection was available to protect them from
            shareholder or consumer suits?

       LSome State regulators themselves have recently
            introduced an element of systemic risk because of their
            willingness to cut consumer protections for life
            insurance by slashing reserves and other dollars of
            policyholder cushion at this time of great risk. Their
            theory seems to be that when consumers do not need to
            worry about the soundness of insurers they will keep
            high cushions of protection, but when policyholders
            most need this protection, they will change accounting
            standards at the request of insurers. Several States
            have lowered capital and reserve requirements for life
            insurers despite the fact that the NAIC ultimately
            refused to do so. NAIC acknowledged that it had not
            done the due diligence necessary to determine if the
            proposed changes would weaken insurers excessively.

       LEliminating post-assessment guaranty funds could
            also lower insurance systemic risk and replacing them
            by State directed, nationally based, pre-assessment
            funds, or by a Federal insurance guaranty agency
            modeled on the FDIC. For instance, the current life
            insurance solvency crisis is backed by State guarantee
            funds with no money on hand and the capacity to
            generate a mere $9 billion in the entire country should
            the dominoes fall.

       LInsurance systemic risk that could be generated by
            insurers being owned by other businesses or vice-versa
            could be lowered by repealing provisions of the Gramm-
            Leach-Bliley Act that allow firms to sell insurance in
            conjunction with other financial services, particularly
            credit and securities products.