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



                                                         S. Hrg. 111-77

 
                      PERSPECTIVES ON MODERNIZING
                          INSURANCE REGULATION

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

                                HEARING

                               before the

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

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

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

                               __________

                             MARCH 17, 2009

                               __________

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


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



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

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

                 Colin McGinnis, Acting Staff Director

        William D. Duhnke, Republican Staff Director and Counsel

               Charles Yi, Counsel/Senior Policy Advisor

                      Aaron Klein, Chief Economist

                  Drew Colbert,  Legislative Assistant

                Mark Oesterle, Republican Chief Counsel

                   Andrew Olmem,  Republican Counsel

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        TUESDAY, MARCH 17, 2009

                                                                   Page

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

                               WITNESSES

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

              Additional Material Supplied for the Record

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

                                 (iii)


            PERSPECTIVES ON MODERNIZING INSURANCE REGULATION

                              ----------                              


                        TUESDAY, MARCH 17, 2009

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

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

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

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

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

             STATEMENT OF SENATOR RICHARD C. SHELBY

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

               STATEMENT OF SENATOR SHERROD BROWN

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

                STATEMENT OF SENATOR MIKE CRAPO

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

               STATEMENT OF SENATOR JEFF MERKLEY

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

                STATEMENT OF SENATOR JON TESTER

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

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

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

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

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

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

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

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

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

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

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

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

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

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

    Mr. Hunter. Thank you, Chairman Dodd, Mr. Shelby, members. 
I am Bob Hunter. I am Director of Insurance for the Consumer 
Federation. I was the Federal Insurance Administrator under 
Presidents Ford and Carter, and Texas Insurance Commissioner 
before.
    CFA is in the midst of a detailed review of our policy 
positions on insurance regulation to reflect the lessons we are 
learning from the economic meltdown. Here are some of our 
tentative conclusions.
    First, there is a need for an expanded role for the Federal 
Government in regulating insurance.
    Second, there are significant systemic risk issues 
associated with insurance that require oversight by a Federal 
systemic risk regulator. An example would be the guarantee 
associations, post-assessment plans everywhere by New York with 
no money to pay if an insurer goes under. They have to collect 
it later.
    With several life insurers in trouble today, the life 
insurance guaranty associations nationwide could muster under 
$9 billion if they were called upon. As I put it in my 
testimony, that would hardly pay the bonuses that these 
companies are offering.
    It is ironic that State regulators boast about the 
effectiveness of their capital and surplus requirements in 
stabilizing the insurers against systemic risk, even though 
several States at the individual level had to loosen these 
requirements today.
    Regarding consumer protection and prudential regulation, 
CFA places our focus on quality rather than who does it. At 
this stage of our research, it appears that a Federal office is 
needed to deal with more than just systemic risk, but also to 
be a repository of insurance expertise, to engage in 
international issues, and to monitor and enforce, if States opt 
not to, high consumer protection and prudential minimum 
standards set by Congress.
    The minimum standards to protect consumers must address all 
key consumer issues, such as claims abuses, unfair risk 
classes, unavailability of needed insurance, et cetera. They 
must contain, among other things, the capacity to regulate 
rates and classifications.
    Tough, thoughtful regulation, our study shows, is the most 
effective at protecting consumers while working well for 
insurers and enhancing competition. California has a system 
that I would encourage you to look at as a standard.
    CFA will oppose any system not based on high standards for 
consumer protection or which would have the potential to 
undermine the States that are doing a good job.
    Rather than enforcing congressional minimum standards 
through a Federal regulator, a State-based entity might be 
empowered by Congress. That would probably be the NAIC. But we 
are skeptical about the NAIC. If you do that, you need to have 
standards for the NAIC to prevent several problems. They need 
to have notice, comment rulemaking, on-the-record voting, 
accurate minutes, rules against ex parte communication, et 
cetera, like a real regulator and not like a trade 
organization, which they act like.
    As Congress attempts to create an agency that has knowledge 
about insurance, it should consider restoration of the ability 
of the FTC to study insurance, too.
    A Federal office should not be granted vague and open-ended 
powers of preemption regarding State laws, but only in areas 
where Congress has explicitly said we want to preempt. Nor 
should preemption apply to needed consumer protections.
    While CFA supports a greater insurance role, we vigorously 
oppose the optional Federal charter. Such a system cannot 
control systemic risk. It is impossible. It has failed 
miserably in protecting banking consumers. Thirty banks have 
left the Federal regulatory regime, according to a Washington 
Post article. And it sets up conditions for regulatory 
arbitrage. Our review determined there are regulatory functions 
that the States can do better than the Federal Government, such 
as complaint handling and other functions that would be done 
more effectively at the Federal level, such as systemic risk.
    The research suggests a role for the States in dealing with 
direct consumer needs while the Federal Government's role 
appears best addressing macro systemic trends and issues that 
cross State borders. These differential capacities suggest some 
sort of hybrid approach. This leads us to conclude that minimum 
Federal standards might be a preferred approach.
    Our research also supports differential treatment for 
property/casualty insurers compared to life insurers. Property/
casualty insurers have local issues like catastrophic risk and 
legal requirements that are different State by State, versus 
life insurance, which is more national in scope and may lend 
itself more readily to Federal regulatory requirements.
    I emphasize these are our current ideas, and we are still 
studying it, still under some debate at CFA, and yet to be 
vetted with other consumer organizations, but I wanted to give 
you the advantage of our early thinking.
    I want to take just one final moment to reflect on what led 
to the situation we are in today.
    Reasonable profits are necessary in a vital insurance 
industry, but over decades, there has been a change in the 
insurer corporate cultures that led from a focus on 
policyholder interests to one that became obsessed with 
quarterly profits and stock price. Insurance professionals were 
pushed aside by financial gurus. For decades, the undoubted 
champion of insurer greed has been AIG. This is no surprise.
    Hank Greenberg, cheered on by Wall Street, maximized 
profit, every penny he could get a hold of, and he was well 
known on Insurance Street as someone if you had a claim 
against, you were going to be fought so that he could maintain 
his cash-flow.
    AIG's arrogance is manifest in partying and bonusing away 
taxpayer money, but encouraged by rating organizations, trade 
organizations, and compliant regulators, AIG gleefully did bid-
rigging uncovered by Spitzer, did credit swaps and other 
things, exposing their clients constantly to danger to make 
more money.
    Other insurers have followed suit, seeing the praise and 
money being lavished on AIG. For example, Allstate has 
maximized its profit in part by using computer systems that 
arbitrarily underpay claims, and the leader who brought that 
innovation is now running AIG. So what do you expect? A perfect 
person to run AIG, and the resulting tone deafness that we are 
now all outraged--I have heard the outrage mentioned several 
times. Why would a party or a bonus be an issue if the 
corporate culture is totally focused on greed? It is no issue 
to them. That is why you see arrogant letters.
    This overarching insurance industry corporate culture of 
greed over policyholder interest is why Congress must look not 
only at the single fruit of greed known as systemic risk, but 
at the other greed that manifests throughout insurance, 
particularly the willingness to do harm to policyholders. A 
classic, current iteration of greed is the request for optional 
Federal charters so that insurers can flit back and forth to 
the regulator least interested in protecting people over greed.
    So, please, Mr. Chairman, Ranking Member, protect the 
policyholders as you work on this issue. We look forward to 
working with you on it.
    Chairman Dodd. Thank you very much, Mr. Hunter. Once again, 
you were very compelling in your comments and we thank you for 
being with us this morning.
    I will put the clock on here for about 5 minutes apiece so 
we can get to as many of our members here. And again, it is a 
strong panel. We thank you all for being with us.
    Let me just first of all ask you, I think we would all 
agree there is certainly a lack of expertise at the Federal 
level in insurance issues, generally speaking. Mr. Hunter 
pointed that out. While Congress has created Federal offices to 
handle specific insurance where there is a Federal involvement, 
including TRIA, flood insurance, obviously examples where there 
has been a Federal involvement in national programs, there is 
no central repository of information and analysis on insurance 
at the Federal level. I wonder if you might just express by 
maybe just even raising your hands how many would support 
creating the Office of Insurance Information within the 
Treasury Department. Is that something you would--we will start 
out with a unanimous position. That is a good start here.
    [Laughter.]
    Chairman Dodd. So I thank you for that. But I was going to 
make the point as well, I was just going over last night in 
preparing for this morning's hearing, and as someone who comes 
from a State that has a strong national and historic interest 
in the subject matter of insurance, just for the purposes of 
information--maybe my colleagues were aware of this--I wanted 
to give you some idea.
    According to public information, there are 2,723 property 
and casualty insurance companies in the United States and 1,190 
life-health insurance companies in the United States. We have a 
tendency to hear about the large companies we are all aware of, 
but almost 4,000 insurance companies around, most of which are 
not national companies or well-known, but to give you some idea 
of the magnitude of the number of companies that are out there. 
I thought you might find that interesting.
    Let me ask you, Mr. Hunter, if I can, I have made the case 
over and over again that I thought if we can get back to the 
point of consumer protection being the basis upon which you 
begin to look at these issues, then you have a totally 
different perspective, that we have bought into this notion, I 
think, for too long, at least too many have, that consumer 
protection is antithetical to economic growth, and you are 
making the point here that if you begin by thinking about the 
policy holder on this issue, begin thinking about the consumer 
and start from that point of view, that the issues of economic 
growth fall naturally into place.
    Do you believe that Federal regulation is necessarily 
weaker in terms of consumer protection than State regulation? 
This has been the case made over the years with people like the 
commissioners who come before us. My own commissioner has 
talked to us about it, independent agents and others have made 
the issue to Congress over the years that if you, in fact, have 
a Federal regulator, that almost guarantees weaker regulation 
than if you do it at the State level, where people are on the 
ground, watching it every day, more concerned, more sensitive 
of the consumer interest because they are there on the ground, 
at the level.
    I know you mentioned a hybrid kind of situation, but where 
do you come out on this issue today? And I realize it is an 
evolving issue, but nonetheless, where is the greater 
protection for consumers?
    Mr. Hunter. It has been my experience, having served both 
in the Federal and State areas, that it really has a lot to do 
with the laws and the people who are administering them. I 
think the Federal Government could do a great job. That is why 
I said earlier that consumers care a little less about the 
locus of regulation than the quality of it. And we see within 
the State system, there are some States that are pathetic in 
terms of protecting consumers and there are others that are 
very good. As I mentioned earlier, there are some States, like 
California, that have very tough regulation, but they have the 
highest Herthandal indices of competition and the profits are 
reasonable for the insurance companies, et cetera. So 
competition can work in a way that protects consumers, be very 
good for the industry, and still be a very competitive system. 
They don't have to--one does not displace the other.
    I think either the Federal Government or the State could do 
it. The reason I suggested a hybrid is they are seeing some 
things like three million complaints. I can't imagine a Federal 
agency would be doing a very good job with it. Now, it is 
possible, but you would have to set up a regional system to do 
that, I think.
    Chairman Dodd. How about any other comments on this? Mr. 
McRaith, what is your answer on that? I mean, I appreciate Mr. 
Hunter's answer, but I think venue does have an impact on 
whether or not you get good regulation or not. If it just is 
going to be dispersed among 50 jurisdictions, then you are 
going to end up with a spotty system. Some places it works, 
some places it doesn't, and that is hardly what I think 
consumers need. So depending on where you happen to live, you 
get good protection or you don't, as opposed to the idea, at 
least at a national system, you could have one strong system of 
rules that would at least raise the prospect of having a 
stronger set of regulations.
    Mr. McRaith. Mr. Chairman, you cited a number of 
approximately 4,000 companies earlier. The number that we have 
is actually closer to 7,700 companies, and as I mentioned in my 
opening comments, we are--the United States and the combination 
of States are the largest market in the world. We surpass two, 
three, and four combined.
    So the real question is what is the problem that we are 
trying to solve, and if the problem is one of consumer 
protection, it is important to understand, I think, that 
different States view that differently. Not all of them Mr. 
Hunter is comfortable with, of course, but what is appropriate 
for a consumer in the State of Illinois, for example, is going 
to be different from what is appropriate for a consumer on the 
coastline in Florida, or in California, for example. There is 
no secret about that. But that is not to say that one State has 
more or less protection. It is to say that those States, when 
determining what is appropriate public policy for their 
consumers, have made different decisions.
    When it comes to solvency, again, if we ask what is the 
problem or question we are trying to answer, the State system 
of financial solvency is coordinated. Fifty States are looking 
at national companies. You have multiple sets of eyes reviewing 
the financial status of any one company, whether it is a 
Connecticut-based company, an Illinois-based company. We, of 
course, also have a proud legacy of property and casualty 
insurers in our State. We work with other States and it is not 
one sole regulator who is determining whether that status, the 
financial status of that company is sufficient. It is multiple 
regulators with multiple skill sets evaluating a company from 
top to bottom.
    Chairman Dodd. Well, I appreciate your answer on that.
    Let me jump to the systemic risk, and this will be my last 
question. I am already violating the clock a little bit, but I 
wanted to get to the systemic risk regulator because most of 
you have advocated a systemic risk regulator. I think, Mr. 
Nutter, you may be the one exception, and that is in the 
reinsurance industry, at least you didn't speak for one, so I 
will let you respond to this in a minute.
    But let me begin by asking this. Excluding AIG, do any of 
you believe here that there are systemic important insurance or 
reinsurance companies per se out there at this moment? You 
mentioned whether it is 7,000 or 4,000. Are we looking at 
another company out there, aside from AIG, that could pose 
systemic risk as you see them today? Does anyone have a comment 
on that? Can anyone identify a company that we should be aware 
of?
    My interest in this, and again, if I look at a systemic 
risk regulator, I am more interested in practices rather than 
someone declaring themselves to be a certain type of company 
and then falling within a regulator or not. But the kind of 
practices that company engages in, and then on the basis of 
that, determining whether or not those practices pose systemic 
risk. So there are specific insurance products that are common 
practices among insurance or reinsurance companies that pose a 
risk to the financial system. I wonder if you might comment 
briefly.
    Why don't we begin with you, Mr. Nutter, because you took 
the position apparently of not necessarily endorsing the idea 
of a systemic risk regulator.
    Mr. Nutter. There is a concern that if you have a systemic 
risk regulator as described by Chairman Bernanke of the Fed, 
you really have a redundant system of regulation and a 
duplicate system for a functional regulator. Our point was, if 
you are going to do that, you really ought to have a Federal 
regulator for the reinsurance sector that would work with a 
systemic risk regulator. It wasn't to oppose a systemic risk 
regulator.
    It is hard for us to see how a systemic risk regulator is 
going to coordinate with a 50-State system of regulation with 
the complexity of that, at least in the area of a global 
marketplace like reinsurance, where frankly, the most important 
regulatory relationships between a regulator and a systemic 
risk regulator would be with other international regulators in 
other countries, trading partners, if you will. We just see 
that occurring more effectively at a Federal level with a 
Federal regulator.
    Chairman Dodd. Mr. Berkley, do you want to comment on this? 
You have been in the business for 40 years.
    Mr. Berkley. I think that, first, one has to understand 
what happened at AIG, and that is the good credit of the 
insurance business was used to guarantee the performance of 
other elements of the holding company. If there had been a 
Federal regulator overseeing AIG, they would have said, hey, 
what you are doing is you are suddenly changing the character 
of the risk and you are putting the good creditworthiness of 
the insurance company and allowing them to use it, in the case 
of financial products, to take a substantial risk. But there 
was no one overseeing it.
    The benefits of some Federal oversight is you get to look 
at the whole picture. It is not that there was particular risk 
in AIG's insurance business. Certainly, there is no systemic 
risk in their property casualty business. Even though they were 
the largest participant, the industry could have absorbed that 
business. It is that they effectively guaranteed the exposures 
in the financial products, something none of the other 
competitors did. All of the other big banks had independent 
subsidiaries without cross-guarantees in the financial products 
business. AIG guaranteed the performance of the financial 
products.
    Chairman Dodd. Let me turn to Senator Shelby, and I will 
come back. We will have a couple of rounds here.
    Senator Shelby. Thank you, Senator Dodd.
    Mr. McRaith, five AIG insurance companies are regulated by 
the State of Illinois, it is my understanding. Are you aware of 
any financial problems with any of those insurance companies in 
Illinois, and what steps have you taken to ensure that those 
insurers are prudently managed during this disorderly time for 
AIG overall, and are you aware of any attempt by AIG to pay 
retention bonuses to any employees of its insurance companies, 
and if so, would State insurance regulators have the power to 
call back such payments?
    First--I will go over it again. Are you aware of any 
financial problems with any of the five insurance, AIG-owned 
companies that are regulated by the State of Illinois?
    Mr. McRaith. Senator, the insurance companies that are 
domiciled in Illinois, we regulate those companies now and we 
have regulated them as long as they have been domiciled in our 
State, or, for that matter, in other States on a regular basis, 
quarterly, annually, top to bottom exams on a regular basis, as 
well. Those companies, like many companies, are encountering 
the turbulence of the current economic time, but as we have 
heard from other witnesses today, the insurance industry, 
including those companies, Senator, are in relatively good 
shape compared with other financial sectors.
    Senator Shelby. What does ``relatively'' mean?
    Mr. McRaith. Well, that means----
    Senator Shelby. You say they are in ``relatively'' good 
shape.
    Mr. McRaith. First of all, I would never say publicly 
whether any one company were in trouble, but at the same time, 
I am not going to mislead you, Senator. The companies that we 
are regulating, we are comfortable with their financial status.
    Senator Shelby. Are you aware of any attempt by AIG to pay 
retention bonuses to any of these employees?
    Mr. McRaith. Senator, I think it is an important question 
and it is important to distinguish that the bonuses that have 
been publicized recently are those bonuses that would be paid 
to the Financial Products employees, and we all know the 
colossal disaster that that division of AIG has caused. And 
frankly, I agree with everything that you and your colleagues 
said, for whatever my humble opinion is worth, that those 
bonuses should not be paid to Financial Products division 
employees of AIG. However, the insurance enterprises of AIG, as 
you know, are generally solid companies and their employees 
have performed, generally speaking, well. Now, I don't know 
whether any one employee has received a bonus or not within the 
insurance companies domiciled in our State.
    Senator Shelby. In recent weeks, and I will pick up on what 
Senator Dodd was asking a few minutes ago, Federal Reserve 
Chairman Ben Bernanke has discussed publicly the inadequacy of 
our insolvency regime for large global financial conglomerates, 
such as AIG. Chairman Bernanke has called for a new resolution 
regime that can better manage the insolvencies of systemically 
important firms while minimizing the risk to taxpayers. Do you 
agree, sir, with Chairman Bernanke that a new resolution regime 
is needed in America for companies like AIG?
    Mr. McRaith. Well, thankfully, there aren't a lot of 
companies like AIG, and we can hope we don't see another one 
anytime soon. The Chairman also made the comment that AIG was 
essentially a hedge fund attached to large stable insurance 
enterprises. As State regulators, we are proud of the fact that 
their insurance companies are the primary assets of AIG and its 
holding company. The solvency regime that we have for insurance 
companies is solid, and frankly, some of the concerns I have 
read expressed in testimony submitted today, I think are 
misplaced.
    Senator Shelby. Are you--go ahead.
    Mr. McRaith. If, for example, one company were to have 
financial challenge and to be placed into receivership, other 
companies, first of all, can fill the void in the marketplace 
but can also purchase the policies of that company, and that 
happens frequently because those policies themselves are 
viable, strong assets and other companies will pick them up 
right away. So the demands on the system will not be as 
outrageous as some would have us believe today.
    Senator Shelby. Are you telling us that the State insurance 
guaranty system could handle the insolvency of AIG or a 
similarly large company like that, the spread and all kinds of 
things?
    Mr. McRaith. What I am--well, when you say the insolvency 
of AIG, if we were talk----
    Senator Shelby. We are talking about AIG as a 
conglomerate----
    Mr. McRaith. Right.
    Senator Shelby.----you know, the insurance and otherwise.
    Mr. McRaith. Well, there is no system that is built to 
withstand an insolvency the size of the notional value of the 
credit default swaps AIG was invested in, which was, I believe, 
$2.4 trillion, which, of course, exceeds the gross domestic 
product of France as a country. However, their insurance 
operations, which as we know are strong assets of the holding 
company, if those were to encounter financial trouble, the 
State guaranty system is designed and would allow for an 
orderly disposition of those claims. But we also expect that 
many of those policies--and this is, again, completely 
hypothetical because those companies are financially strong at 
this point--that other companies would purchase the policies or 
groups of policies within an insurance company because those 
are assets. Other companies would want them.
    Senator Shelby. But aren't credit default swaps an 
insurance against default of something? In other words, it is 
an insurance product of some kind.
    Mr. McRaith. Well, I would agree with you, Senator, that 
credit default swaps as AIG was involved in those transactions 
did include a form of financial guaranty.
    Senator Shelby. Sure.
    Mr. McRaith. Unfortunately, OTS, of course, as we know, the 
Office of Thrift Supervision, was the primary regulator for the 
AIG holding company, and let us talk about the reality here, 
which is not whether there is a regulator. It is whether there 
is an effective regulator. And what we see with the AIG 
insurance companies is effective regulation. What we saw at the 
holding company level was a regulator who was not effective.
    Senator Shelby. Mr. Hunter, do you agree with his 
statement? What is your take on it.
    Mr. Hunter. I didn't hear him answer the question.
    Chairman Dodd. He did----
    Mr. Hunter. I don't think it could handle--I don't think 
the guaranty funds could handle it, no.
    Senator Shelby. Couldn't handle it----
    Mr. Hunter. That was your question, and I don't think 
they----
    Senator Shelby. It would be too big for them to handle, 
would it not?
    Mr. Hunter. Of course. Yes.
    Senator Shelby. I thought so, too. Thank you.
    Governor Keating, the Federal insurance regulation and 
systemic risk, an area you have done a lot of work in, your 
testimony cast doubt upon whether a Federal systemic risk 
regulator, Governor, could be established without a Federal 
insurance regulator also being created. You argue that without 
a Federal insurance regulator to coordinate and to implement 
policy with respect to insurers, Federal systemic regulation 
could be rendered ineffective. Along those lines, how should a 
Federal insurance regulator interact with a Federal systemic 
risk regulator to ensure that insurers are properly supervised 
for systemic risk as well as for solvency and consumer 
protection, the company itself?
    Mr. Keating. Well, Senator Shelby----
    Senator Shelby. It looks to me like they would be 
intertwined some.
    Mr. Keating. On a going-forward basis, it is important, as 
you well know, to get this right so we don't face again the 
kind of problems that we have faced in the recent past. But if 
the systemic risk regulator is a 30,000- or 40,000-foot entity, 
is it product specific or is it size-specific, and that is 
something obviously that members of this Committee are going to 
have to resolve.
    It is our view that to have a functioning and efficient 
system, you need to plug all the holes. Systemic could look at, 
for example, on size or on product the credit default swap. I 
mean, that is allegedly an insurance product, and yet there 
were no reserves. There was no ability to play claims, which is 
stunning to me that the State regulatory apparatus as well as 
the OTS didn't identify that early. Sixty-trillion dollars of 
those instruments are floating around the world.
    But what we would like to see on an optional basis, if you 
do have a functional regulator at the Federal level that would 
speak with one voice to our international and national players 
that more than likely would seek a functional regulator at the 
Federal level--most of our members, by the way, would remain 
State regulated--but we would like to see an ability on the 
part of somebody to break a tie. The systemic regulator would 
have to be that person to break a tie. If he or she sees 
conduct or activity or an entity that simply is threatening the 
system, it is systemic, then that individual ought to be able 
to tell the functional regulator what to do, or, for that 
matter, the State regulator what to do. Otherwise, we would 
have a multiplicity of the problems we faced recently.
    Senator Shelby. Governor, over the past year, our largest 
bond insurers have teetered on the edge of collapse due to 
imprudent bets on the value of mortgage-backed securities. The 
problems of the bond insurers have impacted our national 
economy as bonds they insured have rapidly gone down in value. 
Although the bond insurers played an important role in our 
overall market, they remain regulated at the State level. If 
the bond insurers had been regulated by a Federal regulator, if 
you can envision that, do you believe that their problems would 
have been addressed more effectively than what we have today?
    Mr. Keating. Well, I am in favor as an industry, and we 
represent the life insurance, annuity, long-term care, and 
disability income business, a regulator and a regulatory system 
that works, that is effective, that is tough, that is action-
oriented. I think Mike McRaith is right. It is not particularly 
always where the regulator is housed. What is the regulator 
doing? Obviously, the OTS appeared to be looking the other way 
on credit default swaps, and in the bond insurance business, 
obviously somebody was looking the other way, and that is 
simply the antithesis of effective and appropriate regulation.
    Senator Shelby. Where was the New York Insurance Commission 
on all this, too? They were the regulator of the insurance 
part, were they not?
    Mr. Keating. Well, you might want to invite him in and have 
a conversation.
    Senator Shelby. We have had him in once. We will bring him 
back.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator.
    Mr. McRaith. I would be happy to answer that question, too.
    Chairman Dodd. Yes. Let me get a chance to go to Senator 
Merkley.
    Senator Merkley. Thank you very much, Mr. Chair.
    Mr. McRaith, AIG has been described as an insurance company 
that had a hedge fund piggy-backed on it. Should the future 
regime basically prevent insurance companies dealing in areas 
like property insurance and life insurance and so forth from 
getting into the insurance of financial products with 
instruments like credit default swaps?
    Mr. McRaith. Senator, the problem with AIG and the 
challenge for this Committee, which I appreciate your wrestling 
with in a substantive manner, is how do you regulate a large 
enterprise like AIG when there are multiple services or 
products sold by one company, and some people would even say 
AIG had as many as several thousand individual companies or 
subsidiaries within its larger holding company.
    At the insurance company level, again, those insurance 
companies remain primary assets for the AIG holding company in 
solid financial condition today. So the question is what is the 
problem we are trying to solve? The problem is not the efficacy 
of State regulation. The problem is how do we integrate all of 
the different functional regulators so that they are 
coordinated and working together, and in that situation, the 
State system can work, coalesce with the other functional 
regulators, and to the extent that at some point there might be 
an enterprise whose viability is threatened, that the demise of 
that enterprise would threaten the stability of the system, 
that is when the systemic regulator can take the comprehensive 
action with respect to the enterprise as a whole.
    Senator Merkley. Thank you. If I could reframe what you 
just said, your answer to my question was, no, that the answer 
is not to prevent companies engaged in property life insurance 
from doing hedge fund-style activities, but to simply have a 
better regulatory system.
    Mr. McRaith. Let me be more clear. I think we need to be 
very cautious about allowing regulated enterprises that have 
direct consumer obligations from participating in hedge fund or 
hedge fund-like transactions. We have seen the risk of that. I 
think from a consumer protection perspective, we need to 
revisit and really answer the question you are asking, and my 
answer to your question is absolutely not.
    Senator Merkley. Thank you.
    Mr. Hunter, do you have any different perspective on that? 
Do you share that view?
    Mr. Hunter. No, I don't have a different perspective. I 
think the Congress should look at GLB again and see whether or 
not it led to some of these problems.
    Senator Merkley. GLB?
    Mr. Hunter. Gramm-Leach-Bliley.
    Senator Merkley. Thank you.
    So a broad question to all of you is whether the size and 
complexity of large firms like AIG basically defies effective 
regulation at the State level. I think in many cases, I 
understood your testimony to say we do need some Federal 
coordination, but I just want to reclarify that, if anyone 
wishes to comment on that.
    Mr. Berkley. I would like to just comment. I think, first 
of all, large parts of AIG were outside of the realm of State 
regulation. A huge amount of their business was overseas. It 
was an international business. Lots of other activities were 
outside of the realm of State regulation.
    You know, I think that you only can regulate what is within 
your purview, and part of the problem of AIG is so much was 
outside of the purview, and part of the problem of coming up 
with a solution were so many other non-U.S. authorities had 
control over pieces of the assets and we had no Federal 
regulator who could go and discuss with those various 
authorities how to have a solution.
    So in the case of AIG, it was not something that we had 
within our powers to deal with.
    Senator Merkley. Thank you.
    Mr. Hunter, before I run out of time, I wanted to ask about 
one aspect of your testimony, in which you noted that the 
Congress should repeal the antitrust exemption of the McCarran-
Ferguson Act and, quote, ``collusion in pricing should not be 
allowed.'' Can you expand on your commentary in that case?
    Mr. Hunter. Sure, and I would refer you to the testimony I 
gave before the Senate Judiciary Committee, too, for a very 
full explanation, but back when the U.S. Supreme Court ruled 
for the first time that insurance was interstate commerce, and 
the States therefore were going to lose the regulatory 
authority, the States ran to Washington and got the McCarran-
Ferguson Act. Congress debated whether or not to apply 
antitrust laws. In fact, they decided to apply antitrust laws 
after a moratorium.
    If you read the debates at the time, Senator Pepper raised 
the issue, well, this language could possibly be interpreted as 
being a permanent prohibition on applying the antitrust laws. 
McCarran and Ferguson both jumped up and said, ``No, no, that 
is not what we mean.'' But apparently the Supreme Court never 
read the legislative history because when it came before the 
Supreme Court, the Supreme Court decided that antitrust laws 
would not apply to insurance generally, except for coercion, 
intimidation, and boycott. And so we now have a situation 
where, like baseball, insurance is not subject to the antitrust 
laws.
    Senator Merkley. Thank you very much.
    Chairman Dodd. Thank you very much, Senator.
    Senator Corker?
    Senator Corker. Mr. Chairman, thank you, and I thank all of 
you for your testimony. Many of you have been in and out of our 
offices or you have had representatives in and out talking 
about this particular issue. Unlike some of the things we have 
dealt with most recently here on the Committee, and let me set 
AIG aside. I know we are talking about AIG today because of 
most recent occurrences. This is really not a hearing 
necessarily about AIG but about how we regulate the insurance 
industry in general.
    This feels not like a big issue for the country as much as 
it does sort of a family squabble, if you will, within the 
insurance industry throughout our country. This is more about 
competing interests, it feels to me, than it does about 
systemic risk.
    And so I know that everybody--Mr. Nutter agrees with the 
systemic regulator concept, it seems, or at least that is what 
everybody seemed to indicate, which might deal with sort of the 
AIG kind of thing. And it seems to me that a solution to this 
might be to have on the reinsurance side and on the life 
insurance side a Federal regulator, and even the guys that 
represent the insurance folks all around our country, the 
independent insurers that we all know and see when we go home 
on the weekends, even you all agree that it is really not about 
life insurance. It is really about property and casualty. I 
know you are worried about the camel nose under the tent, if 
you will, and if we do that on life insurance, we might do it 
on property and casualty.
    But why wouldn't we just look at the systemic regulator--
except for Mr. Nutter--why wouldn't we just have a Federal 
regulator for reinsurance and life insurance and leave property 
and casualty like it is with State regulators, with the Office 
of Insurance Information that apparently everybody seems to 
like? Why wouldn't we just deal with this issue in this way and 
move on to something else? Anybody that wants to respond.
    Mr. Houldin. If I may, Senator.
    Senator Corker. OK.
    Mr. Houldin. My agency particularly, we work--about 20 
percent of our income comes from life insurance. I would like 
to address that specifically. Down on Main Street, America, the 
consumer concerns and complaints that we get, we feel are very 
well addressed at the State level. I can call Commissioner 
Sullivan at the Connecticut Insurance Department, or his team, 
anyway, and get immediate reaction to a concern, and with all 
the baby boomers coming up that are going to have life 
insurance questions in the next decade or so, I think keeping 
the consumer protection at the State level is extremely 
important, and for that reason is why we don't support any 
Federal----
    Senator Corker. You know, there are very few complaints. I 
mean, life insurance is not what drives complaints at your 
State Insurance Commissioner's officer, really, is it? It is 
just a small percentage, is it not?
    Mr. Houldin. Well, certainly the Commissioner can answer 
that better than I can, but the concerns that I get at my firm 
is you buy an insurance product, a life insurance product 30 
years prior and when it comes up, or your parent passes away 
and you look at his document, you don't even know who the agent 
was that sold it. You don't even know who this company is. You 
don't even know if it is still active. And so I get a lot of 
questions from my clients saying, ``I know you didn't sell me 
this policy, but can you please help me? I have no idea if this 
is active or if I can collect on it,'' and those types of 
questions, I think, are asked on a consistent basis. But the 
Commissioner can comment on that.
    Senator Corker. Yes, sir, Mr. Berkley or somebody?
    Mr. Berkley. Well, I think that the part where your view 
goes awry is for large companies. Of those 3,000 insurance 
companies that were referred to by Senator Dodd, probably 2,500 
of them would exactly fit the bill that you are talking about, 
but the others wouldn't and those are the larger companies that 
do business across frequently 50 States, frequently in other 
countries.
    So when I set up a business in Latin America, I had no 
Federal insurance regulator. I had to set up a new company in 
that country. When I went to the U.K., there were no reciprocal 
arrangements. There was no way I could license my U.S. company 
there straightforward. There was on dialog, even. I had to set 
up a new company there. The same, in fact, in Australia and----
    Senator Corker. This wouldn't solve that, though.
    Mr. Berkley. Yes. A Federal regulator would then open up a 
dialog, just like the company in the U.K. does business 
throughout the E.U. The national regulators have this dialog to 
allow you to do business in broader areas. I believe if we had 
a national regulatory policy for the largest companies, we 
could have a very different dialog and it would be a reciprocal 
arrangement because the large companies overseas have the same 
desire to do business here, and one of their big problems is 
the licensing State by State is very complicated. This is also 
addressed by Mr. Nutter's issues for reinsurers overseas.
    Mr. McRaith. Senator, if I might reply briefly, life 
insurance and annuity questions come into our offices with 
great regularity. The exact numbers, I don't know, but we get 
calls State by State probably in the hundreds, if not 
thousands, every year on these issues. We can't diminish the 
importance of each one of those calls. And the importance of a 
senior, for example, as I mentioned in my opening statement, 
who sold an indexed annuity. Where does that senior turn when 
they are on a fixed income and that annuity is not generating 
the income they were told they would receive?
    The real challenge for us as we talk about this is in your 
concept probably the largest expansion of Federal regulatory 
authority in the financial sector since the 1930s. As we talk 
about this, what is the question we are trying to answer? What 
is the problem we are trying to solve?
    Senator Corker. It appears to me like a family squabble we 
are trying to solve----
    Mr. McRaith. But let me explain. As I mentioned----
    Senator Corker. Which is not that interesting, candidly, so 
I would like to know what it is we are trying to solve.
    Mr. McRaith. Right. Exactly. So if the question is speed to 
market issues for life companies, they want to be able to 
introduce their products more quickly. Thirty-four 
jurisdictions have adopted the Interstate Compact, which gives 
a single portal, single approval opportunity for product that 
can then be sold in all 34 of those jurisdictions. Now, as a 
factual matter, we might need Congressional support to require 
all 50 States to join that Compact.
    When it comes to reinsurance, we have--all States have 
adopted or supported a proposal for comprehensive reinsurance 
reform. Now, we might, as we have adopted that proposal and 
spent a couple years working through the details, we might need 
Federal assistance--in fact, I am sure we will need 
Congressional assistance--in adopting that uniformly throughout 
the States. These are issues that we have addressed, are 
working to address every day in an even better fashion than we 
do already.
    When it comes to international collaboration, just with 
respect to Mr. Berkley's comments, the E.U. is far less 
coordinated than the 50 States are. We are significantly 
larger, remember. The State of Connecticut is larger than Spain 
in terms of its insurance marketplace. So as we talk about the 
E.U. as if it is a panacea, let us look at the reality. They 
not only have 23 different languages, they cannot agree on what 
exactly even their solvency framework should be.
    So yes, we can improve. We are working to improve and we 
look forward to working with you to help accomplish some of the 
uniformity goals that we all share.
    Mr. Hill. Senator, I would just like to make one other 
comment. At NAMIC, we clearly support your position with 
respect to property casualty. That is where our interest lies, 
and we do not see a role for a Federal charter with respect to 
property casualty.
    With respect to the international issues, as we have all 
talked about, we fully support the establishment of OII. We 
think that can be an excellent conduit to deal with the 
international issues and the cross-border issues like that. So 
again, that is our position on that.
    Mr. Nutter. Senator, if I might comment, I wouldn't want to 
come across as being opposed to a systemic risk regulator, 
though I have been characterized as that. I think the point 
that we were trying to make was that the descriptions of what a 
systemic risk regulator have been seem redundant to us of what 
a Federal regulator would be and that some assimilation of that 
may be appropriate. At a Federal regulatory level, you have 
greater capability of achieving that than you do in a system of 
50 State regulators and trying to overlay that on a global 
business like reinsurance, where many of the major companies 
are headquartered in trading partner countries and you need a 
constitutionally authorized system of recognition between the 
United States and those countries to deal effectively with 
global regulatory issues.
    Mr. Hunter. I just wanted to say that Congress--there are 
some systemic PC issues that Congress needs to study, including 
bond insurance. Directors and officers insurance is becoming 
widely unavailable and very high priced for banks. Now, you may 
try fixing the banks, but if they can't get D&O insurance, what 
is going to happen? That is a question the guaranty 
associations issue and reinsurance that can actually melt down 
beyond reinsurance into the primary market if reinsurers aren't 
there to back up because of a ``black swan'' or something with 
the hurricanes and terrorism all at once or something like 
that.
    Chairman Dodd. Very good. Senator Tester?
    Senator Tester. Thank you, Mr. Chairman.
    A couple of questions to start with. How many folks on this 
panel are in favor of the optional Federal charter? Raise your 
hands.
    [Show of hands by Mr. Keating, Mr. Berkley, and Mr. 
Nutter.]
    Senator Tester. Three. How many of those three are in favor 
of the premium taxes? Since we are talking a little turf here, 
we will talk a little money, the premium taxes staying with the 
State. Raise your hand.
    [Show of hands by Mr. Keating, Mr. Berkley, and Mr. 
Nutter.]
    Senator Tester. OK. The question I have for you three is 
that there is an historic issue with the Federal Crop Insurance 
Corporation. When it was first started out, those premium taxes 
were supposed to go to the State. A long story short, there was 
a lawsuit that said the State had no reason because they were 
federally preempted and they no longer could collect those 
premium taxes anymore. Do you see the same kind of scenario if 
an optional Federal charter was implemented? Do you see a 
similar situation with those premium taxes? Mr. Keating?
    Mr. Keating. Senator Tester, you know as a former 
legislator in your State, and I think probably many of the 
States represented around this table, premium taxes are a 
significant part----
    Senator Tester. It is $40 million in Montana, which is a 
lot of money in Montana.
    Mr. Keating. It is a significant part. But to show you how 
very frustrated and even desperate some of these companies are 
to be able to compete on a level playing field with the banks 
and securities, the companies that we represent are willing to 
have the premium tax remain in the States. Now, it would be up 
to the Congress to decide whether or not you someday down the 
line would ever attempt to preempt. Our view would be we are 
willing to pay for the cost of regulation for a variety of 
reasons, and it appears on occasion to be sort of a household 
spat, but we are an interstate and international marketplace. 
Our products are virtually the same from sea to shining sea.
    For us, and here is one example, I think, that you would be 
interested in, several years ago, one of the real serious black 
eyes to the life insurance industry were military base sales, 
abusive sales practices on military bases. The NAIC said, we 
have no jurisdiction there to address those, which was horribly 
frustrating to us because there was no Federal ability to stop 
it, so we were attempting to do it ad hoc basically industry by 
industry group, going to try to stop these practices. So that 
is the frustration we face, Senator.
    Senator Tester. So what you are saying is you believe that 
the premium tax will be able to stay with the State, that it is 
a legislative prerogative regardless if it is taken to court?
    Mr. Keating. We certainly concur on that.
    Mr. Berkley. We have no reason that it shouldn't stay 
there.
    Senator Tester. OK.
    Mr. Nutter. And Senator, with respect to the reinsurance, 
generally the reinsurers share in the cost of premium taxes 
with the underlying ceding company, wherever that tax is paid.
    Senator Tester. OK. So the next question is, and I will 
focus this back, Mr. Keating, and I would ask you to be a 
little more concise, but in Montana, and I am sure it is the 
same way around the country, this money goes to fund the Office 
of the Insurance Commissioner. So if the optional Federal 
charter was put into place, that money would have to come from 
the general fund of the Federal Government and I assume you 
would be in support of that, for the regulating portion of an 
optional Federal charter?
    Mr. Keating. We are willing to pay for our regulation.
    Senator Tester. OK. So you would be open to it--to another 
tax over and above the premium tax?
    Mr. Keating. I don't view that as a tax. I mean----
    Senator Tester. No, that is a fee out of----
    Mr. Keating.----the cost of regulation, because regulation 
is important----
    Senator Tester. OK. So you would be willing to pay for the 
additional level of regulation of an optional Federal--is 
everybody OK with that? All right. Sounds good.
    Mr. Hunter, in the questions by Senator Merkley, you had 
answered a question saying that we may want to revisit parts of 
Gramm-Leach-Bliley----
    Mr. Hunter. Yes.
    Senator Tester.----to see if it led to some of the AIG-
related problems. That is an interesting point. I want you to 
expand upon it.
    Mr. Hunter. Well, before GOB, the banks and insurance 
companies could mix, for example, and securities dealers and 
insurance companies could mix some of the kinds of things that 
were involved there. They wouldn't have been there. And so I 
think it is just a question of if we join together all these 
different financial services, are we really creating a systemic 
risk situation that wasn't there before? So I think given the 
current situation, it might be worth another look at the role 
that GOB played in this.
    Senator Tester. So the next step would be, do you think it 
is reasonable to, if we are going to take a look at it, to 
really look at splitting them back out? Do you think that that 
is a reasonable solution in this----
    Mr. Hunter. If you find that the systemic risk can't be 
controlled in a joined-together organization, I think that is 
what Congress should look at, then I think you have to at least 
consider splitting them back out.
    Senator Tester. All right. I just want to thank all the 
members of the panel. Thank you very much. I wish we had more 
time, which we do, but I don't, so thank you very much, Mr. 
Chairman.
    Chairman Dodd. Thank you, Senator Tester.
    Senator Warner?
    Senator Warner. Thank you, Mr. Chairman. This has been very 
helpful education-wise for me.
    I want to go back to where Senator Corker was heading in 
trying to understand--I think I have got the frame of the 
challenge between the State versus the Federal regulation 
framing. Tell me if anyone on the panel--it does seem that Mr. 
Nutter's comments about reinsurance being more of a national 
and international business and less direct involvement on the 
consumer's standpoint, even if I didn't go as far as Senator 
Corker did, just from a first impression standpoint, that a 
Federal regulator at the reinsurance standpoint, particularly 
because of the international nature of a lot of this 
reinsurance, makes some sense to me. Give me a counterargument.
    Mr. McRaith. Senator, I think--Mr. Berkley----
    Mr. Berkley. Go ahead.
    Mr. McRaith. OK. Senator, I think it is important to 
understand that from a regulatory perspective, the quality of 
reinsurance, particularly on the P&C side, helps a regulator 
determine the viability or the financial status of a company. 
So reinsurance involves the seeding of risk by a primary 
carrier.
    Senator Warner. I understand.
    Mr. McRaith. In the event that reinsurance is in any way 
jeopardized or the status or financial condition of the 
reinsurer is in any way jeopardized, it has a direct impact on 
consumers.
    Senator Warner. But that again presupposes that you at the 
State level are going to better be able to assess that national 
or international reinsurer's ability to pay off that risk than 
a Federal regulator, doesn't it?
    Mr. McRaith. You are asking questions that have been the 
subject of several years of discussion and overwrought 
commentary at the NAIC and the State regulatory level, and I am 
happy to report that in December, the States adopted a reform 
proposal and we are right now implementing details that we 
intend to present to your colleagues and you to adopt as a 
national reinsurance standard for all the States to adopt.
    Senator Warner. I will be anxious to see it, but it would 
still seem to me that, at least in this area on reinsurance, 
because of the national and international nature of 
reinsurance, that a national standard amongst States--you have 
still got a point to convince me that that is still better than 
simply repositoring that information or that oversight at a 
Federal level.
    Mr. Nutter?
    Mr. Nutter. Senator Warner, if I could address that, to its 
credit, the NAIC has endorsed a reform proposal that would ask 
the Congress to pass legislation to create a single port of 
entry for non-U.S.-based reinsurers and a single licensing for 
U.S.-based reinsurers. The challenge for all of that, which 
goes to your point, is that the constitutional authority to 
deal with international trading partners in the E.U. or other 
parts of the world really lies with the Federal Government, and 
therefore Federal regulation is clearly going to be a preferred 
way for our country to deal with the global nature of the 
reinsurance marketplace. Alternatively, we would support the 
NAIC's approach, but we don't think that is the preferred one.
    Senator Warner. I have got a couple more questions, but my 
time is about up. Governor Keating, could you share with me one 
of your earlier comments when you described the life insurance 
industry, and this is a little off topic, but 18 percent of the 
corporate bonds, obviously a lot of other long-term holds in 
the debt market, I have had life insurers come by and because 
of the uncertainty at this point dramatically increasing the 
cash portions in their balance sheet and not being participants 
as actively in the marketplace right now because of regulatory 
and other concern and saying that many of the programs 
initiated by the Treasury and the Fed to kind of unlock the 
credit flows have benefited other areas, but we are leaving out 
one of the largest purchasers of these debt instruments, the 
life insurance industry, and I would love to hear your comments 
on that and what we should be looking at beyond the regulatory 
standpoint to make sure we get you folks back in the 
marketplace buying.
    Mr. Keating. Well, Senator Warner, I know metaphors 
sometimes are tired, but we look upon this really, or should, 
as a three-legged stool. We have $15 trillion in mutual fund 
assets, $10 trillion in banking assets, and $5 trillion in life 
insurance assets. By anybody's definition, that is systemic. 
The Congress in its wisdom put the life insurance industry in 
the TARP as a result of that very systemic belief, and yet when 
we first met with several of our CEOs with then-Secretary 
Paulson, because we have no Federal presence, Secretary Paulson 
said, well, I cannot--we don't know your industry. I can't put 
my arms around your industry. I can't figure out how to do it.
    How about maybe a couple or three insurance commissioners? 
And Mike is a superb insurance commissioner, but the reaction 
immediately was, well, the other 47 would be mad they are not 
at the table, or 48. Well, that won't work. So let us make it 
where you all have to buy a thrift. But remember, this is not 
for the walking wounded or for terminal cases. These are for 
robust companies that will use this money to buy bonds to get 
the wholesale side of the economy moving again. We have not 
heard back, because they still can't understand how to put 
their arms around this industry. And I think for the sake of 
the country and the growth of the economy, that is a real 
tragedy.
    Senator Warner. Mr. Chairman, I might add that I think, at 
least in recent press reports, we are still waiting for the 
Treasury to give some guidance in this area and an entity that 
has such a potential stimulative effect in terms of getting the 
credit markets reopened again, we need them at the table 
participating and the sooner we can get that answer from the 
Department on how or why or why not the industry can't 
participate in the TARP, I think the better for all of us.
    Chairman Dodd. I agree with that very much----
    Senator Warner. Thank you, Mr. Chairman.
    Chairman Dodd.----and know that history very well, 
Governor, and those days. Of course, the irony was in some 
cases, you had some industries actually out looking to actually 
get TARP money to buy the thrift in order to qualify to be at 
the table.
    Senator Warner. Mr. Chairman, I have got an entity that 
went through that, bought their S&L and then in the transition 
kind of got left out on the paperwork. It seems a little crazy 
that they had to go through this additional step to try to 
benefit from this program that we all want you to be involved 
in to get these credit markets open. And again, since you hold 
these for long, long term, these assets that may be not priced 
very well at this point, but if anybody is going to hold them 
for a long-term maturity, it seems to be your industry.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator Warner.
    Senator Johnson?
    Senator Johnson. Thank you, Senator Dodd. I apologize for 
coming in late.
    Governor Keating, there seems to be some consensus that 
part of any regulatory modernization proposal must include a 
systemic risk regulator. Is there a regulator that you believe 
should begin this responsibility? What powers would this 
entail, and what kind of sanctions or other tools does this 
risk regulator need at his disposal?
    Mr. Keating. Well, Senator Johnson, our insistent message 
is that this industry, this $5 trillion industry benefits to 
retirees and to near-retirees precisely at a time the economy 
is suffering from people with limited savings and life 
insurance policies are used by business partners and staffs for 
annuitants, to make sure you can live in comfort for the rest 
of your life. These are very, very important pieces of the 
economy, and to consider these systemic, as I said to Senator 
Shelby, is hugely important, whether you focused on individual 
products that need regulation because of the systemic danger to 
the system or if you look at the size of the company. That is, 
of course, at the Senate and Congress's discretion. But we just 
need to make sure that the very noisy voice of this hugely 
significant part of the economy is part of that approach.
    Senator Johnson. For all the witnesses, going forward, what 
is the most logical way to regulate holding companies of 
insurance subsidiaries? Mr. McRaith?
    Mr. McRaith. Thank you, Senator. I think prior to your 
arrival, there was some discussion. Senator Merkley asked a 
similar question and I want to pick up on a comment made by Mr. 
Hunter, and that relates to Gramm-Leach-Bliley, which I know 
you are familiar with. I think it is important to go back to 
1932 and the Glass-Steagall Act, which established those 
firewalls that served our country so well by separating 
commercial banks and investment banks insurance companies. And 
as we look at regulating holding companies with insurance 
subsidiaries, I think we need to revisit the deterioration of 
those firewalls that Gramm-Leach-Bliley caused and I think we 
need to really answer the question of how to best protect 
consumers and at the same time allow our financial services to 
grow. There needs to be better regulation at the holding 
company level and we can be a part of that.
    Senator Johnson. Governor Keating?
    Mr. Keating. I want to say that during the course of this 
conversation this morning, Mr. McRaith and I have disagreed on 
a number of subjects, but on this one we agree, so it is a good 
way to end our conversation.
    Senator Johnson. Mr. Berkley?
    Mr. Berkley. I think that--obviously, I think we need some 
kind of oversight of holding companies because part of the 
problem is, and starting with AIG, with sophisticated financial 
tools, many of those old regulations have disappeared in their 
effectiveness. So, in fact, what we saw at AIG is the guaranty 
and the cross-collateralization from the industry companies to 
their other vehicles created substantial problems. So I think 
old legislation had the right idea, but I think we would need 
much more contemporary regulation, which is why we think 
Federal legislation is really required, because it is a much 
more sophisticated world we live in today. It is not just 
corporations under a holding company. It is legal obligations 
that cross one to another.
    Senator Johnson. Mr. Houldin?
    Mr. Houldin. Senator, I certainly think that an overseer is 
necessary as long as they don't get involved with the day-to-
day regulation of insurance. More of a treetop approach 
certainly makes sense in light of what we have seen.
    Senator Johnson. Mr. Hill?
    Mr. Hill. Yes, Senator Johnson. We think part of the 
solution would be the establishment of the systemic regulator 
because we believe by focusing more product-based as opposed to 
institution-based, that regulator will then be able to foresee 
the problems that will occur with these various products. I 
mean, if we look at the sophistication of the credit default 
swaps, I think having someone with the expertise to regulate 
those products and products of that nature, that is the 
solution as opposed to looking to just target a holding company 
structure per se.
    Senator Johnson. Mr. Nutter?
    Mr. Nutter. Senator Johnson, the reinsurance sector is 
probably the most global of the insurance sectors. We have 
testified that you really do need a Federal regulatory regime 
that has authority to enter into agreements with non-U.S.-based 
regulators in other countries in order to achieve what you are 
talking about, that is the ability to look at a company 
holistically, both in the U.S. and outside the U.S.
    Senator Johnson. Mr. Hunter?
    Mr. Hunter. Thank you, Senator. It is part of the systemic 
risk. I think the systemic regulator would have to monitor set 
standards and then be able to bring down a company so that a 
company would never be too big to fail. Now, that would include 
the holding company and we think the logical approach is that 
financial institutions would have capital standards put on them 
based upon an analysis of their risk and not by just size, but 
other kinds of things--the type of activities, the 
interconnection to other financial markets, et cetera, and then 
that would obviously sweep in a holding company if it was part 
of another arrangement.
    Senator Johnson.
    [Presiding.] My time has expired. Mr. Shelby, do you have 
anything?
    Senator Shelby. I have no other questions, Mr. Chairman. I 
think we had a distinguished panel here today and I think 
everybody knows what our challenges are. In other words, how do 
we deal with problems in a new 21st century financial market, 
is so intertwined. Obviously, when AIG got in real, real 
trouble, the Feds got problems in dealing with it. The Chairman 
has said that. The States couldn't really deal with it. There 
is blame everywhere, but how do we prevent this from happening 
in the future? I think that's one of our problems, but I think 
that as we hold more hearings, we are going to see that this is 
very complex. We know that. And we have got to do this, and 
whatever we do, we do it right, because I think we are going 
down the road of looking at a very comprehensive regulator for 
all our financial system. I can see it coming down, and maybe 
we can make it happen this year. I hope we can.
    Mr. Hunter, you look like you want to comment on something.
    Mr. Hunter. Oh, no, no. I was just enrapt.
    Senator Shelby. OK.
    [Laughter.]
    Senator Shelby. I don't think you are in rapture of 
anything, but Mr. Hunter, do you agree with that, that that is 
our challenge, and our goal is there----
    Mr. Hunter. Yes. I think you have said it exactly right, 
Senator.
    Senator Shelby. In other words, we are dealing in the 21st 
century now.
    Mr. Hunter. Yes.
    Senator Shelby. And we are dealing with all kinds of new 
products. People think them up. A lot of them have not been 
approved, so to speak. A lot of people didn't realize the risk 
out there to our whole financial system. But the risk is real. 
We are feeling it every day. The taxpayer feels it big today as 
we speak.
    Thank you, Mr. Chairman.
    Senator Johnson. Senator Merkley, do you have anything 
else?
    Senator Merkley. No. Thank you.
    Chairman Dodd. With that, I thank you for coming and this 
hearing is adjourned.
    [Whereupon, at 11:50 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                PREPARED STATEMENT OF SENATOR JON TESTER
    Thank you, Mr. Chairman, for holding this important hearing. I am 
pleased to be a member of this Committee as we begin the discussion 
about the next transportation reauthorization bill.
    In Montana, transit--buses especially--are critically important for 
transportation across the State. When we lose Essential Air Service, or 
a large air provider pulls out of an airport, it's generally intercity 
bus service that takes its place to move people hundreds and hundreds 
of miles across the State.
    There's no doubt about it--you cannot have economic development 
without a smart, effective transportation system. And transit is a key 
part of that, even in rural America. Five years ago, a significant 
increase in transit spending allowed rural States like Montana to 
expand intercity bus service, as well as local transit services, to 
almost all of our counties. It is critical that we maintain this 
important funding that has helped safely connect folks in isolated 
areas to commerce, medical care, and family members. However, there is 
still more to do. For instance, we must ensure that all paratransit 
vehicles are wheelchair accessible, and that transportation for 
veterans is also accessible for vets with disabilities.
    In Montana, we also have a high fatality rate for drivers on rural 
roads. I'd like to see--in the very least--students and elderly folks 
have access to a safe transit option to get to school, medical 
appointments, and local meetings.
    I appreciate you all coming today. As the Senate begins to look 
forward to the upcoming transportation reauthorization bill, I am 
hopeful that our Committee will be able to craft a transit portion that 
is fair to small and rural communities, where transit ridership has 
increased dramatically, even as the economy has gone into a downturn. I 
look forward to working with the new Secretary of Transportation, 
Secretary LaHood, the Chairman and this Committee to ensure a strong 
rural component to future transit and transportation infrastructure 
legislation.
                                 ______
                                 
                PREPARED STATEMENT OF MICHAEL T. McRAITH
      Director of Insurance, Illinois Department of Financial and
     Professional Regulation, on behalf of the National Association
                       of Insurance Commissioners
                             March 17, 2009
    Chairman Dodd, Ranking Member Shelby, and Members of the Committee, 
thank you for inviting me. My name is Michael McRaith. I am the 
Director of Insurance for the State of Illinois, and I testify on 
behalf of the National Association of Insurance Commissioners (NAIC). I 
am pleased to discuss efforts to modernize the State-based structure of 
insurance supervision and to offer a regulator's description of the fit 
for that system within the broader context of financial regulatory 
reform.
    Having regulated the U.S. insurance industry for over 135 years, 
State insurance officials have a demonstrable record of successful 
consumer protection and industry oversight. Consumer protection has 
been, is and will remain priority one for State insurance officials. 
Each day our responsibilities focus on ensuring that the insurance 
safety net remains available when individuals, families and businesses 
are in need. We advocate for insurance consumers and objectively 
regulate the U.S. insurance market, relying upon the strength of local, 
accountable oversight and national collaboration.
    With continually modernized financial solvency regulation, State 
insurance regulators supervise the world's most competitive insurance 
markets. Twenty-eight (28) of the world's fifty (50) largest insurance 
markets are individual States within our nation. As a whole, the U.S. 
insurance market surpasses the combined size of the second, third and 
fourth next largest markets. More than 2,000 insurers have been formed 
since 1995--leading to a total of more than 7,661 in the United 
States--with combined premiums or more than $1.6 trillion. States 
derive $17.5 billion in taxes and fees from insurers, with 
approximately 8 percent (8 percent) used to support regulation and the 
remainder supporting State general funds. With this proud record of 
success, State insurance regulation constantly evolves, innovates and 
improves to meet the needs of consumers and industry. My testimony 
today will focus on the prominent place for State-based insurance 
regulation within systemic risk regulation and discuss continuing State 
efforts to improve functional insurance regulation.
    Insurance companies are integral capital market participants and 
are not immune from the unprecedented global economic turmoil. However, 
insurers have not caused the turmoil and, as a whole, the industry is a 
source of calm in an otherwise turbulent time. Vigilant, engaged and 
effective prudential supervision by the States fosters this insurance 
marketplace stability, and we urge caution in any Federal initiative 
that may jeopardize the State-based platform for such oversight.
    To be clear, any reforms to functional insurance regulation should 
start and end with the States. Federal assistance may be necessary if 
targeted to streamline insurance regulator interaction and coordination 
with other functional regulators, but that initiative should not 
supplant or displace the State regulatory system. The insurance 
industry, even in these difficult times, has withstood the collapses 
that echo through other financial sectors.
States Oversee a Vibrant, Competitive Insurance Marketplace
    In addition to consumer protection, State insurance officials are 
adept stewards of a vibrant, competitive insurance marketplace which, 
in turn, provides tremendous economic benefits for the States. When 
State insurance markets are compared to other national insurance 
markets around the globe, the size and scope of those States' markets--
and therefore the responsibility of State regulators--typically dwarfs 
the markets of whole nations. For example, the insurance market in 
Connecticut is larger than the insurance markets in Brazil or Sweden. 
Likewise, the markets in California, New York and Florida are each 
larger than the markets in Canada, China or Spain, and the markets in 
Ohio and Michigan are each larger than the markets in India, Ireland or 
South Africa. Each of these markets demands a local, accountable and 
responsive regulator.
Systemic Risk: State/Federal Partnership
    State insurance regulators support Federal initiatives to identify 
and manage national and global systemic risk. When defining a 
``systemically significant'' institution, empirical or data-driven 
factors aid but do not conclude an analysis. As described in the Group 
of Thirty (G30) report released on January 15, 2009, State insurance 
regulators agree that four considerations are essential: (1) size, (2) 
leverage, (3) scale of interconnectedness, and (4) the systemic 
significance of infrastructure services.\1\
---------------------------------------------------------------------------
    \1\ See Financial Reform, A Framework for Financial Stability, 
Group of Thirty, January 15, 2009, p. 19.
---------------------------------------------------------------------------
    Insurance is one part of a far larger financial services economic 
sector. Insurance companies are not likely to be the catalyst of 
systemic risk but, rather, the unfortunate recipient of risk imposed by 
other financial sectors, as exemplified by the American International 
Group (AIG).
    Given that the U.S. has the world's most vibrant and competitive 
insurance marketplace, it is unlikely that any one insurer is ``too big 
to fail.'' If an insurer were to fail, regardless of size, State-based 
guaranty funds would protect existing policyholders and pay claims. As 
history demonstrates, competition and capacity allow other insurers to 
fill marketplace voids left by the failed insurer. States also operate 
residual markets to cover those unable to obtain an offer of insurance 
in the conventional market. Therefore, even a major insurer failure, 
while traumatic in terms of job displacement and, perhaps, for 
shareholders, will generally not impose systemic risk.
    Insurance risk management differs from risk in the banking sector 
because insurers are generally less leveraged than banks. Less leverage 
allows insurers to better withstand financial stress. State insurance 
regulators impose strict rules on the type, quality and amount of 
capital in which an insurer can invest. Also, insurer liabilities are 
generally independent of economic cycles in that the ripeness of a 
claim is not a function of economic conditions. This long-term reality 
reduces the likelihood an insurer will have to liquidate assets to 
satisfy short-term obligations.
    An insurance business having special interconnectedness to capital 
markets may be capable of generating systemic risk, however. The 
financial and mortgage guaranty lines, for example, have encountered 
difficulty because of mortgage-related securities which, in turn, have 
adversely impacted public sector and mortgage loan financing.
    Even strict accounting and investment standards do not inoculate 
insurers from the risks of recent systemic failures. A wholesale 
collapse of the stock market (to a greater degree than what we have 
recently seen) or the bond market would have a dire effect on insurance 
companies and could lead to insurance company failures. A collapse of 
the dollar and rampant inflation would increase claims costs for 
property and casualty insurers. A mixture of high inflation and a 
declining economy (stagflation) and low investment returns could create 
a perfect storm for all aspects of the economy. Regulation, of course, 
cannot ensure that insolvencies will not occur in extreme 
circumstances.
Systemic Risk: Functional Regulators Work Together
    Unmanaged risk in one sector can deleteriously affect the viability 
of other sectors. The current financial crisis illuminates the need for 
a collaborative approach to regulation of financial conglomerates, or 
those enterprises of such magnitude that a failure would jeopardize the 
financial stability of an economy, or a segment of an economy. 
Cooperation and communication among the functional financial services 
regulators should be formalized in order to harmonize regulatory dialog 
and efficacy.
    State insurance regulators support Federal initiatives to ensure or 
enhance financial stability, while preserving State-based insurance 
regulation. Functional regulators can work and coalesce in a manner 
that protects consumers and promotes financial stability. State 
regulators support financial stability regulation that incorporates the 
following principles:

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

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

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

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

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

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

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

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

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

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

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

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

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





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

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

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

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

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

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

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

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

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

Conclusion
    There is no question that assuring the stability of our payment 
system is of paramount concern. However, reforming U.S. financial 
regulation and advancing initiatives designed to stabilize the economy 
must take into account the interests and the needs of all segments of 
financial services, including life insurance. Unfortunately, the 
absence of a Federal insurance regulator all too often means that we 
are afterthought as these important matters are advanced. We urge 
Congress to recognize the systemic importance of our industry to the 
economy and to the retirement and financial security of millions of 
consumers and tailor reform and stabilization initiatives accordingly. 
Failure to do so runs the very real risk of doing grave harm to both. 
We pledge to work closely with this Committee and with others in 
Congress to provide you with factual, objective information on the life 
insurance business along with our best ideas on how a comprehensive and 
effective approach to regulatory reform can be implemented. I am sure 
we all share the goals of maintaining confidence and strength in the 
life insurance business and restoring stability to the entire spectrum 
of U.S. financial services.
                                 ______
                                 
                PREPARED STATEMENT OF WILLIAM R. BERKLEY
             CEO of W.R. Berkley Corporation, on behalf of
                   The American Insurance Association
                             March 17, 2009

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

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

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

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

    Property-casualty insurance is essential to the overall well-being 
of the U.S. economy. Insurance contributes 2.4 percent to the annual 
GDP, with property-casualty insurance accounting for more than $535 
billion in capital, purchasing close to $370 billion in State and 
municipal bonds, paying almost $250 billion annually in claims and, 
importantly, directly or indirectly employing 1.5 million hard-working 
Americans. Because property-casualty insurance protects individuals and 
businesses against unforeseen risks and enables them to meet financial 
demands in the face of adversity, it is the engine that propels 
commerce and innovation. Without the critical coverage provided by 
property-casualty insurance, capital markets would grind to a halt: 
Main Street and large businesses alike.
    While property-casualty insurance plays an essential role in our 
economy, it has been successfully weathering the current crisis. It has 
had to carefully navigate through some heavy turbulence to do so, but 
the sector remains strong overall, today. There are several reasons for 
that, but importantly property-casualty insurance operations are 
generally low-leveraged businesses, with lower asset-to-capital ratios 
than other financial institutions, more conservative investment 
portfolios, and more predictable cash outflows that are tied to 
insurance claims rather than ``on-demand'' access to assets.
    Yet, despite the industry's relative stability in this crisis, 
there are compelling reasons to establish Federal functional regulation 
for property-casualty insurance in any regulatory overhaul plans even 
though it has not presented systemic risk. The industry could always 
face huge, unforeseen, multi-billion dollar loss events such as a 
widespread natural disaster or another terrorist attack on U.S. soil. 
It makes little sense to look at national insurance regulation after 
the event has already occurred, but all the sense in the world to put 
such a structure in place to help either avoid the consequences of an 
unforeseen event altogether or to temper them through appropriate 
Federal mechanisms, ultimately minimizing potential industry 
disruption.
    However this Committee resolves the debate on Federal systemic risk 
oversight, the only effective way to include property-casualty 
insurance would be to create an independent Federal functional 
insurance regulator that stands as an equal to the other Federal 
banking and securities regulators.
    I continue to believe this after much deliberation and with great 
respect for the State insurance regulatory community. The State-based 
insurance regulatory structure is inevitably fragmented and frequently 
not well-equipped to close the regulatory gaps that the current crisis 
has exposed. Each State only has jurisdiction to address those 
companies under its regulatory control, and only to the extent of that 
control. Even where the States have identical insurance codes or 
regulations, the regulatory outcomes may still be inconsistent because 
of diverse political environments and regulatory interests. If this 
crisis has revealed anything, it is the need for more--not less--
regulatory efficiency, coordinated activity or tracking, sophisticated 
analysis of market trends and the ability to anticipate and deal with 
potential systemic risk before the crisis is at hand.
    In addition, virtually all foreign countries have national 
regulators who recognize that industry supervision goes well beyond a 
focus on solvency. Effective contemporary regulation also must examine 
erratic market behavior by companies in competitive markets to ensure 
that those markets continue to function properly and do not either 
encourage other competitors to follow the lead of irrational actors or 
impede the competitive ability of well-managed enterprises. Further, 
the U.S. Constitution prevents the States from exercising the foreign 
affairs and foreign commerce powers. Therefore, if we are to coordinate 
with other nations and their financial regulators to address global 
crises like the current one, we need a single insurance voice at the 
Federal level to do so. In sharing these observations, I want to be 
clear: This is not a criticism of State regulators; it is a conclusion 
about the inevitable limitations and gaps inherent in separate State 
regulation from one who has been in the business for decades.
    Equally important, functional Federal insurance regulation allows a 
single agency to be well-informed about all of the activities within 
the insurance sector, including those types of unforeseen mega-events 
that could affect other sectors of the economy. It also provides the 
foundation for equitable regulatory action in times of crisis and when 
the insurance sector is functioning normally. As even-handed as every 
State regulator may try to be, without the broadest responsibility 
exercised by a national regulator, we cannot expect to get that 
treatment where issues affect more than one State. The reality is that 
no one State can effectively deal with mega-events or cross-border 
issues equally, and among multiple States, the ability to deal with 
such events or issues on a global level declines dramatically.
    A centralized regulator at the Federal level would also have 
authority to examine the related issue of mathematical models. The 
methods of examining and measuring risk have undergone significant 
evolution during my 40-plus years in the insurance business. I believe 
there has been a growing and unhealthy over-reliance on numbers-driven 
models in the assumption of risk, and to the use of these models to the 
exclusion of common sense and underwriting experience. Although such 
models have an important role in insurance like they do in other 
financial services industries, risk evaluation and management 
inevitably suffer where such models are used in a vacuum.
    The AIA and its members have long supported the National Insurance 
Act sponsored by Senator Johnson as the right vehicle for smarter, more 
effective functional Federal insurance regulation. That bill already 
focuses on safety and soundness supervision, financial regulation, and 
rigorous market conduct oversight as core consumer protections. It even 
requires the national insurance commissioner to conduct an enterprise-
wide review of financial data when examining national insurers. This--
in and of itself--importantly distinguishes the National Insurance Act 
from current State regulation.
    Yet, we recognize that even the best legislative vehicle must be 
updated to be responsive to the evolving economic climate and to 
enhance strong consumer protections. As a result, we support amending 
the legislation to prevent even the theoretical ability of insurers to 
``arbitrage'' the Federal and State regulatory systems by switching 
back-and-forth to try and escape enforcement actions.
    Let me close by thanking the Committee again for opening the dialog 
on this critical subject. The time is ripe for thoughtful, measured, 
but decisive action. We stand ready to work with you on a regulatory 
system that restores confidence in our financial system.
                                 ______
                                 
                PREPARED STATEMENT OF SPENCER M. HOULDIN
  on behalf of the Independent Insurance Agents and Brokers Of America
                             March 17, 2009

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

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

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

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

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

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

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

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

Conclusion
    It is indisputable that our country, this Congress, and the new 
Administration have a lot of challenges ahead and difficult decisions 
to make in working to stabilize our economy and put us back on the road 
to growth and prosperity. Every participant in the financial services 
market must pitch in to help get us back on the right track, and IIABA 
stands ready to assist in any way possible. With the discussion of 
reforming financial services regulation, IIABA believes that such 
consideration presents a good opportunity to improve and modernize the 
State system of insurance regulation. But, as I've mentioned often 
today and it bears repeating one last time, IIABA believes that, with 
the possible exception of a properly crafted systemic risk overseer at 
the Federal level, targeted modernization is the prudent course of 
action for reform of insurance regulation. Therefore, any efforts to 
use this crisis and the failure of AIG as an opportunity to promote 
misguided measures that would allow a regulated insurance entity to 
choose its own regulator should be summarily dismissed as unacceptable 
in today's financial environment. Additionally, because the foremost 
goal of insurance regulation is consumer protection, any proposals that 
have the potential to disrupt the strong consumer protections in place 
at the State level should be rejected. Even though we have historically 
opposed measures such as OFC in the best of economic times, it is even 
more clear in these difficult times that the solution is not to 
displace effective regulation with an unproven regime harmful to 
consumers that could have the unfortunate effect of adding to, not 
solving, our country's financial problems. IIABA again appreciates the 
opportunity to testify today, and we remain committed to continuing to 
work to improve State insurance regulation for both consumers and 
market participants.
                                 ______
                                 
                   PREPARED STATEMENT OF JOHN T. HILL
                 President and Chief Operating Officer,
                Magna Carta Companies, on behalf of the
           National Association of Mutual Insurance Companies
                             March 17, 2009

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

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

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

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

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

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

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

    Leverage

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

    Liquidity

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

    Correlation

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

    Connectedness/Sensitivities/Concentration

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Conclusion
    NAMIC supports a strong, transparent, market economy. We encourage 
the Committee to fully explore all options for addressing the various 
challenges, including systemic risk, confronting the nation's economy. 
As the Committee and Congress evaluate solutions, NAMIC, on behalf of 
our member companies and their customers, encourages members to 
carefully weigh the costs and benefits of proposed regulatory 
processes. It is critical that any solution address real regulatory 
gaps, without implementing duplicative and ineffective new regulations 
where none are needed.
    As policymakers work to develop long-term successful solutions to 
our present financial crisis, NAMIC urges Congress to keep in mind the 
dramatic differences between main street organizations continuing to 
meet the needs of their local markets, and those institutions that have 
caused this crisis and have required unprecedented government financial 
intervention.
                                 ______
                                 
                PREPARED STATEMENT OF FRANKLIN W. NUTTER
             President, Reinsurance Association Of America
                             March 17, 2009

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

I. BACKGROUND ON REINSURANCE
a. The U.S. Reinsurance Market
    Reinsurance is critical to the insurance marketplace. It is a risk 
management tool for insurance companies to reduce the volatility in 
their portfolios and improve their financial performance and security. 
It is widely recognized that reinsurance performs at least four primary 
functions in the marketplace: to limit liability on specific risks; to 
stabilize loss experience; to provide transfer for insurers of major 
natural and man-made catastrophe risk; and to increase insurance 
capacity.
    Reinsurers have assisted in the recovery from every major U.S. 
catastrophe over the past century. By way of example, 60 percent of the 
losses related to the events of September 11 were absorbed by the 
global reinsurance industry, and in 2005, 61 percent of Hurricanes 
Katrina, Rita and Wilma losses were ultimately borne by reinsurers.
    Reinsurance is a global business. Encouraging the participation of 
reinsurers worldwide is essential to providing the much needed capacity 
in the U.S. for both property and casualty risks. This can be best 
illustrated by the number of reinsurers assuming risk from U.S. ceding 
insurers. In 2007, more than 2,500 foreign reinsurers assumed business 
from U.S. ceding insurers. Those 2,500 reinsurers were domiciled in 
more than 70 foreign jurisdictions.\1\ Although the majority of U.S. 
premiums ceded offshore is assumed by reinsurers domiciled in ten 
countries, the entire market is required to bring much needed capital 
and capacity to support the extraordinary risk exposure in the U.S. and 
to spread the risk throughout the world's financial markets. Foreign 
reinsurers now account for 56 percent of the U.S. premium ceded 
directly to unaffiliated reinsurers; a figure that has grown steadily 
from 38 percent in 1997.
---------------------------------------------------------------------------
    \1\ Reinsurance Association of America (RAA), Offshore Reinsurance 
in the U.S. Market 2007 Data (2008).
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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.
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         RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                    FROM MICHAEL T. McRAITH

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

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

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

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

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

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

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

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


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                       FROM FRANK KEATING

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                      FROM SPENCER HOULDIN

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                       FROM FRANK NUTTER

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

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

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

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

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

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

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


         RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO
                       FROM ROBERT HUNTER

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

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

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

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

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

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

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

   LBond insurance.

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

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

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

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

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

        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
        
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