Washington

Witnesses and lawmakers today used a hearing on American International Group Inc. as a chance to debate the merits of federal regulation of insurance.

Rep. Ed Royce, R-Calif., a long-time supporter of letting insurers choose between state and federal regulation, said at a House Financial Services Committee capital markets subcommittee hearing on AIG, New York, that he has been warning of the “systemic risk” problems created by the state-based regulatory system for insurance since 2006.

The risk will continue to exist until a federal role for insurance is created, Royce said.

“Central to this discussion on AIG is what [Federal Reserve Board Chairman Ben] Bernanke told us,” Royce said in his opening statement. “He said the 54 various state insurance regulators didn’t have the capacity to deal with a global insurance company.”

Royce and Rep. Melissa Bean, D-Ill., have been promoting a bill that would give insurers the option of choosing between state and federal regulation.

The OFC bill would close the gap Bernanke was describing, Royce said at the hearing.

“Until we establish a world-class regulatory alternative that is able to deal with a global insurance company like this, that gap will remain,” Royce said.

In the meantime, “we should strike these bonuses,” he said.

Joel Ario, the Pennsylvania insurance commissioner, presented state regulators’ views on the role of the federal government in insurance regulation during his testimony.

“Some have rather disingenuously tried to use AIG’s problems as an argument for an optional federal charter for insurance companies,” Ario said. “There are some lessons to be learned from the AIG situation, but shifting the primary locus of insurance regulation to the federal level is the wrong lesson to learn from AIG.”

If Congress gives companies the ability to pick their own regulator, “you create the opportunity for regulatory arbitrage,” or the risk that companies will choose the loosest available regulator, Ario said.

The regulator chosen might demand less capital, Ario said.

Ario said the case of AIG “demonstrates the strength and efficacy of state insurance regulation.”

“The federal rescue of AIG would have been an even tougher call were it not for the well-capitalized insurance companies that provide the possibility that the federal government and taxpayers will be paid back,” Ario said. “AIG’s insurance companies remain strong, in part because state regulation continues to wall them off from the high risk activities engaged in by AIG Financial Products.”