Panelists Square Off At NAVA Show

The NAIC preferred to let individual commissioners assess capital requirements on a case-by-case basis, Vaughan said.

Given the fragile state of the credit markets and the economy, she said, more conservative capital requirements might send the wrong signals to consumers about a company’s financial health, making an insurer’s condition look worse than it actually is.

“In the financial press, there is a lot of discussion about the need for capital reserve requirements to be counter-cyclical, meaning that you boost capital requirements in good times and lower them in bad times,” Vaughan said. “I’m not talking here about making a financially troubled company look better than is warranted. This is about recognizing that financially markets are incredibly stressed now and that a traditional approach to reserving may therefore be counterproductive. It’s important to set reserve requirements to accurately reflect a company’s financial condition on an [operating] basis.”

As to changes needed to stabilize the financial system, Vaughan said that reform should engender both the creation of a systemic risk regulator and functional relation of the banking, insurance and securities industries.

The NAIC wants to be a “full partner” of Congress in the effort, Vaughan said.

“In our state-based regulatory system, we have many eyes focusing on an issue, including some 13,000 people across the states,” she said. “Because of that, we’re less likely to miss things and to come down on the side of dogmatic solutions.

Sununu agreed with Vaughan that a “collaborative approach” among federal and state agencies is needed to deal with systemic risk in the financial sector.

Investing all power in one regulatory body, he said, would “create a single point of failure” and likely increase “moral hazard”–making taxpayers liable for the costs of heightened risks borne by institutions, Sununu said.

Sununu pointed also to the practical difficulties of regulating systemic risk. In theory, he said, the government should be able to identify, and impose necessary restrictions on, “systemically significant firms” before a crisis occurs. But, in practice, either one of two outcomes will occur: The creation of “dozens” of Fannie Mae- and Freddie Mac-like institutions that are candidates for a bailout; or the imposition of such onerous capital requirements on institutions as to place them at a competitive disadvantage.

“In modernizing our regulatory structure, we need to ensure that we get it right,” Sununu said. “That means, first, avoiding creating new moral hazard and avoiding the pitfall of unintended consequences. So much of what I dealt with while in Congress was about fixing legislation that passed 20, 30 or 40 years ago. We all want consumer protection, but the products and services that financial firms offer are directly related to their safety and soundness. If you remove that responsibility for consumer protection and oversight from the safety and soundness regulator, then you create moral hazard. Whether at the state or federal level, those responsibilities should be together.”

Sununu spoke up for the concept of giving states a choice between state and federal regulation through an optional federal charter system.

The banking industry has had a positive experience with dual federal and state chartering, Sununu said.

Federal chartering would be a preferred option for large insurance firms, because they would be better able to compete both nationally and internationally if they were subject to a uniform set of regulations, Sununu said.