Washington

The highest ranking Republican on the Senate Banking Committee today signaled that the insurance industry will be involved in the upcoming general overhaul of financial services regulation.

In comments at a hearing on the need for modernizing insurance regulation, Sen. Richard Shelby, R-Ala., said the committee is moving towards “a very comprehensive regulator for the entire financial system.”

He also said recent events–including the need to bail out American International Group Inc., New York, — raise “some serious questions about the adequacy of state supervision.”

“Given the importance of insurers in our markets and overall economy, we should at least consider whether additional federal oversight is needed,” Shelby said.

“If insurers are managing risks on a national basis, it may make sense to consider regulating them on a national basis as well,” he said.

“We also need to examine whether the existing insolvency regime can handle the failure of a large insurer,” Shelby said. “If insolvency needs to be managed at the national level, then, once again, a federal insurance regulator may be our only option.”

Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee, was less critical.

Although the current financial crisis did not have its origins in the insurance industry, “its adverse effects have been keenly felt by participants in the insurance marketplace,” Dodd said.

Insurance is primarily state-regulated, but, “in recent decades the insurance industry has become increasingly national and even international, and some insurance companies have engaged in very complex and sophisticated transactions made possible by modern advances in financial engineering,” Dodd said.

“In response, many have observed that the regulation of insurance needs to be modernized accordingly,” Dodd said.

Dodd noted that “various approaches have been proposed.”

Shelby was more blunt.

He said that, even before the start of the present financial crisis, “there were legitimate questions about whether our insurance regulatory system was adequate for the 21st century.”

Recent events, “most prominently, the stunning collapse of insurance giant AIG,” have only further demonstrated the pressing need for a review of the insurance regulatory structure, Shelby said.

Shelby recalled that, at a committee hearing two weeks ago, it was revealed that “problems with the company’s state-regulated insurance entities played a role in the company’s collapse.”

AIG’s insurance subsidiaries suffered more than $20 billion in losses from their securities lending operations and had to be recapitalized with a loan from the Federal Reserve, Shelby said.

“The circumstances that permitted AIG’s securities lending operations to potentially threaten the solvency of several of its insurance companies and their counterparties suggest that our regulatory system has not been keeping up with developments in the market,” Shelby added.

For example, he said, it appears AIG sought to conduct its securities lending operations on a nationwide basis by pooling the resources of approximately a dozen separate insurance companies regulated by five different states.

“Because insurance is still regulated at the state level, it is unclear whether any single state insurance regulator was responsible for overseeing AIG’s entire securities lending operation,” Shelby said.