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Regulation and Compliance > State Regulation

Panelists Square Off At NAVA Show

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A Financial Industry Regulatory Authority representative clashed with Therese Vaughan and former Sen. John Sununu earlier this week here at a forum on regulatory modernization.

Thomas Selman, an executive vice president at FINRA, Washington, appeared in the panel discussion with Vaughan, the new chief executive of the National Association of Insurance Commissioners, Washington, and Sununu, a Republican who represented New Hampshire in the Senate, at a marketing conference organized by NAVA, Reston, Va.

Regulatory reform must give equal priority to both protecting investors and to managing systemic risk, Selman said.

Selman defined “systemic risk” as a potentially catastrophic collapse of the financial system due to the failure of one or more major institutions.

In years past, Selman, regulators viewed these objectives as being independent of, or at odds with, each other.

“Managing systemic risk and protecting investors are essential to the smooth operation of our financial markets and to the financial health of our citizens,” Selman said. “In my view, they are two sides of the same coin. We must develop a more coherent way to calibrate risk-taking, as well as monitor and correct systemic deficiencies across all financial institutions.”

To that end, he added, regulators must decide how to oversee financial institutions that are too big or interconnected to fail.

The U.S. Securities and Exchange Commission’s adoption of Rule 151A, which is scheduled to bring most equity-indexed annuities under the agency’s jurisdiction in January 2011, will permit such equal protection, Selman said.

Without the shift to SEC regulation, he said, the EIA fee disclosure rules and suitability rules that apply to a specific consumer would depend on where a consumer lives, Selman said.

“Why should a purchaser of an equity-indexed annuity receive less protection than the purchaser of a variable annuity?” Selman asked. “How are investors better off by maintaining this regulatory disparity? I fully acknowledge that state insurance commissioners have made great strides in recent years by imposing standards on insurance products. However, the disparity still exists.”

Vaughan noted the NAIC and the National Conference of Insurance Legislators, Troy, N.Y., jointly filed a petition for review earlier this month with the U.S. Court of Appeals for the D.C. Circuit to block implementation of the rule.

Implementing 151A would undermine existing state consumer protections and implementation of future safeguards, Vaughan said.

Vaughan also questioned why insurers should not be allowed to sell EIAs outside of the current system of securities regulation.

Vaughan noted that the NAIC chose not to make account changes requested by the American Council of Life Insurers, Washington, in November 2008.

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.