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Regulation and Compliance > State Regulation

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After AIG’s bailout began in September (it had drawn $90 billion from the Federal Reserve by the end of October), the uncertainty in the industry hasn’t stopped. The $700 billion bailout from Congress set the stage for even more taxpayer-funded assistance for the financial industry, and rumor is that more insurance companies want a cut.

But the National Association of Insurance Commissioners (NAIC) pointed out very firmly at the time that the AIG-owned insurance companies subject to state regulations needed no assistance. Those companies were prohibited from indulging in risky investments, and had to have adequate reserves to honor all their obligations. The parent company, on the other hand, was free to invest in credit default swaps, which were its downfall.

NAIC has some ideas about how companies should behave that may affect how the industry does business going forward. Says NAIC president, Sandy Praeger, “This has brought to the forefront the difference between state regulation and federal.” To that end, NAIC is looking at a number of areas.

The group has formed a subcommittee to examine credit default swaps with an eye toward regulating the swaps–less than 20%, perhaps as little as 10%–that carry some element of risk transfer. These, says Praeger, could be pulled in by NAIC and “regulated as insurance, and we’re going to explore that in a coordinated fashion.” New York and Illinois have already begun reviewing that possibility, and whether it may require amendment of current laws or can be done simply through the definition of risk transfer, that is one option NAIC is considering. However, the majority of swaps, says Praeger, are “[t]he naked ones, the ones betting on whether a company will default; it’s just a bet that’s out there in thin air.”

Another option Praeger says was already being considered is the possibility of NAIC forming its own ratings agency. This could create another alternative for companies who want to have investments evaluated, she argues. “We’ve already had security evaluation on Wall Street for many years,” she says; the group is an affiliate of the national association, and state regulators are using them now “to evaluate these more creative investment tools.” This group, she adds, “raised the red flag about hybrid securities,” the ones with debt and asset combined into a single security, and voiced the opinion that they were riskier than traditional investments, requiring additional reserves. NAIC is exploring the legal issues surrounding such an agency, concerned that some companies that invested in these “creative” investments were assured by ratings agencies that they were sound and did not require larger reserves. This way, Praeger says, the organization can help companies understand the underlying risks of these instruments.

AIG’s behavior post-bailout hasn’t escaped NAIC’s scrutiny. Says Praeger flatly, it “wouldn’t have happened if state regulators had been handling it.” The notorius AIG-sponsored “spa experience” and other expenditures simply would not have been allowed. “When we take over a company,” she explains, “they have to get all expenditures approved. State regulators would have been on top of that.” Even though AIG claimed, she says, that the pricey jaunt wasn’t just for CEOs but was also a reward for their sales force, she asks, “Couldn’t they realize that even if they could justify it, it didn’t look good, to say the least?”

NAIC is on a “heightened state of alert” these days, Praeger says, adding that state commissioners have sent letters to their domestic companies asking for information on their investments. They’re also keeping a close watch on variable annuities, since there is “greater risk potential there” because there’s “not a lot of market right now.” Commissioners are also looking at Gramm-Leach-Bliley “to see where things went wrong,” and preparing a list of recommendations for the next Congress.

Marlene Y. Satter, a freelance business writer, can be reached at [email protected].


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