[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
__________
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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
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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\
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\1\ See Financial Reform, A Framework for Financial Stability,
Group of Thirty, January 15, 2009, p. 19.
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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.
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\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.
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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.
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\1\ Reinsurance Association of America (RAA), Offshore Reinsurance
in the U.S. Market 2007 Data (2008).
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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.
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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.