The hot topics that Congress will continue to debate this year and into 2008 are whether to create an optional federal regulator for the insurance industry and how to fix the subprime mortgage mess.

Granted, while the subprime debacle just unfolded within the last year, reforming the insurance industry’s regulatory structure has been debated for some time–Congress held 15 hearings on the issue last year alone. Paul Kanjorski (D-Pennsylvania), chairman of the House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, held this year’s first hearing on insurance regulatory reform in early October, and vowed that more hearings would follow in the 110th Congress. These hearings, he said, will help educate the new members of the Capital Markets Subcommittee on the need to modernize the insurance industry’s regulatory structure, as about one-third of the subcommittee’s members were new in 2007.

Of course, there are those in the insurance industry who believe that creating an optional federal regulator for an insurance industry that has been regulated by the states is a bad idea. But there are plenty in the industry–and in Congress–who support some type of reform. In May, Sens. John Sununu (R-New Hampshire) and Tim Johnson (D-South Dakota), introduced the National Insurance Act of 2007 (S. 40), which would establish an optional federal insurance charter and a federal insurance regulator. Both senators introduced a similar bill last year, but the Senate Banking Committee did not act on it. The Senate bill affects life insurance and property/casualty insurance but not health insurance. It would create a National Insurance Commissioner, appointed by the President for a five-year term, and establish a Division of Consumer Affairs, Fraud, and Ombudsman. In July, Melissa Bean (D-Illinois) introduced in the House companion legislation (H.R. 3200) that would have the same effect as the Senate bill.

Opposing Voices on Reform

In his opening comments at Rep. Kanjorski’s House subcommittee hearing, Richard Baker (D-Louisiana) agreed that a federal regulatory option is a good idea, and stated that the insurance industry’s current state-based regulatory structure is “a mess.” Kanjorski stated plainly at the hearing that it’s “no longer a question of whether or not to pursue reform. The question we must answer is how best to achieve this reform.” But Kanjorski conceded that the issue is a complicated one. “The imposition of the federal government in some form into an area traditionally regulated by the states has enormous implications for insurers, businesses, and consumers,” he said. “Therefore, we should not rush ourselves into considering reform legislation.” Rather, he continued, “After establishing a need for reform, we will begin to explore policy options for reform.”

Kanjorski said his subcommittee will hold separate hearings at some point on solvency protections, enforcement systems, product approval, and best practices for reform implementation.

What, specifically, is so bad about the states continuing to regulate insurance? In his testimony before the subcommittee, Christopher “Kip” Condron, CEO of AXA Equitable, noted that besides the fact that each state has its own laws and regulations that lack uniformity, there are disparate and complex state-specific rules relating to agent licensing, “which impose different qualification, registration, and continuing education requirements for each state in which an agent seeks to do business.”

Those in the property/casualty insurance business argue, however, that a state-based regulatory system works best for them. John Bykowski, president and CEO of Secura Insurance Companies in Appleton, Wisconsin, told Congress that “state insurance regulation has the capacity to adapt to local market conditions, to the benefit of consumers and companies.” He said a state insurance commissioner “can develop expertise on issues particularly relevant to his or her state,” and that unlike banking and life insurance, “property-casualty insurance is highly sensitive to local risk factors, such as weather conditions, tort law, medical costs, and building codes.”

Playing the retirement card

On the other hand, a downside of state regulation is that it’s difficult to get products to market quickly, Condron and others testified, which “hampers the ability to address the retirement security crisis our nation is facing.” Today, Condron noted, most industries are looking at global regulatory structures, so from a competitive standpoint, the current state-based regulatory structure–which hasn’t been changed in 60 years–puts the U.S. at a competitive disadvantage, he argued. But questions arose during the hearing about whether a federal regulator would indeed help the U.S. insurance industry be a stronger global player.

Still, there are others like Alex Soto, president of InSource, an insurance agency in Miami, who spoke on behalf of the Independent Insurance Agents & Brokers of America (IIABA), who believe creating an optional federal regulator should be out of the question, and that Congress should instead modernize the current state structure. “State insurance regulators have done an excellent job of ensuring that insurance consumers, both individuals and businesses, receive insurance coverage they need and that any claims they may experience are paid,” Soto said. “These and other aspects of the state system are working well. The ‘optional’ federal charter concept would displace the components of state regulation that work well.”

Meanwhile, back at the subprime ranch…

In late September, members of the Senate Committee on Banking, Housing and Urban Affairs criticized the credit ratings agencies for their role in the subprime lending fiasco.

Some reform of the way credit ratings agencies operate came with The Credit Rating Agency Reform Act of 2006, which gave the SEC authority to oversee credit ratings agencies registered with the Commission as nationally recognized statistical rating organizations (NRSROs). The act gave the SEC the broad power to examine all books and records of NRSROs.

When asked by Senator Jack Reed (D-Rhode Island), whether the SEC has a plan to regularly examine ratings agencies, SEC Chairman Christopher Cox replied that examinations of NRSROs are now underway. Cox told the committee that SEC examiners are focused on ratings agencies’ resources–making sure they have adequate capitalization, and are “serious and not fly-by-night” players. SEC examiners are also looking at ratings agencies’ conflicts of interest and how they are managed, he said. Senator Robert Menendez (D-New Jersey) pointed out that ratings agencies are “not paid for the research, they are paid for the actual rating.” If the client doesn’t like the rating, he continued, “they don’t have to pay a dime” to the ratings agency. This unsettling fact “must be looked at” by Congress and the SEC, he said, and a more glaring conflict is the fact that ratings agencies are paid by the firms they are rating. The SEC is also assessing ratings agencies’ unfair and abusive practices, Cox said.

Ratings agencies register

The SEC granted on September 24 the registrations of seven credit ratings agencies as NRSROs. The firms are the first to be registered with the Commission under the Credit Rating Agency Reform Act of 2006. The seven firms are: A.M. Best Company, Inc.; DBRS Ltd.; Fitch, Inc.; Japan Credit Rating Agency, Ltd.; Moody’s Investors Service, Inc.; Rating and Investment Information, Inc.; and Standard & Poor’s Ratings Services. The Reform Act and the Commission’s new rules require registered credit rating agencies to disclose their procedures and methodologies for assigning ratings. The NRSROs, the SEC says, are also required to make public certain performance measurement statistics including historical downgrades and default rates.

Senator Richard Shelby (R-Alabama) ranking member of the Senate banking committee, said that the SEC never expected that ratings agencies would be relied on so much, and Cox agreed. “Is it appropriate to reconsider the reliance on the SRO ratings agency?” Shelby asked Cox. Cox said the SEC is now examining its own rules on credit ratings agencies to assess this.

Over the summer, ratings agencies downgraded a number of mortgage bond ratings, which some critics say helped to exacerbate the credit markets’ problems. During her testimony, Vickie Tillman, executive VP of Credit Market Services for Standard & Poor’s Rating Services, said credit ratings are “Not a promise of performance but an evaluation of the risk of default…Credit ratings speak to one topic and one topic only–the likelihood that rated securities will default. When we rate securities, we are not saying that they are ‘guaranteed’ to repay but the opposite: that some of them will likely default.” Michael Kanef, group managing director of Moody’s Investors Service, said Moody’s has improved its ratings process by “expanding the mortgage loan data we request from the issuer to include depth and breadth of borrower’s credit history” as well as increasing “our delinquency and loss expectations as well as the resulting credit enhancement we look for to support our various ratings.”


Washington Bureau Chief Melanie Waddell can be reached at mwaddell@investmentadvisor.com.