Be Warned: Federal Regulation Is Coming

Fair warning. Despite the spirited and well-organized defense of state insurance regulation conducted in recent weeks by officials of the National Association of Insurance Commissioners in the wake of the failure of American International Group, federal regulation of insurance is coming.

It is unclear whether the model for that will be legislation proposed in both the House and Senate to create an optional federal charter for insurers, or some umbrella federal oversight on top of the current state-based system, but it is coming.

According to industry lawyers who won’t write down their interpretation of what could potentially happen and demand to remain anonymous, several recent events give strong hints as to what is coming.

First, in the bailout package, insurance is included for the first time in the definition of “financial institution” eligible to participate in the program to sell toxic mortgage-backed instruments to the government.

And, in the August legislation disguised as a bid to help homeowners, but which really turned out to be no more than a bill enabling the federal takeover of Fannie Mae and Freddie Mac, there is a provision setting up a federal system to license and regulate mortgage brokers. You figure it out.

No matter how high or coordinated is the decibel level used by state regulators to reassure insurance consumers of the sanctity and beauty of their calling, it will be muted by the fact that official Washington, D.C. was blindsided by AIG’s problems, and it won’t be allowed to happen again.

However, the drama is played out in public, legislative decisions are made in backrooms by seasoned politicians who will not let the historic events of the past few weeks play out on their watch again.

According to a number of industry lobbyists, members of Congress were oblivious to what was happening on Wall St., even when it suffered a 500-point loss, until Treasury Secretary Henry Paulson raised the red flag Sept. 17, less than 24 hours after AIG negotiated its $85 billion emergency loan with the Federal Reserve.

Therefore, when the need for an emergency loan for AIG and another $700 billion to resuscitate moribund financial markets became public, members of Congress privately thought they were having an out-of-body experience, according to the lobbyists and congressional staffers.

In other words, despite the words of reassurance, a new wave of regulation is coming, and insurance will not be left out.

It was best stated in a Sept. 29 column by Newsweek political pundit Howard Fineman. “The era of cowboy capitalism has died, largely of self-inflicted wounds,” he wrote. “Who knows what’s coming now? I do: A new era of tight business regulation and government intervention in the markets.

“For now, and perhaps for many years, there will be no going back,” he concluded.