State insurance regulators are thinking about tightening the rules governing securities lending.

Pennsylvania Insurance Commissioner Joel Ario discussed the topic last week, while testifying before a House Financial Services Committee capital markets subcommittee panel on the problems at American International Group Inc., New York.

AIG’s difficulties “exposed some problems” in the securities lending area, “and improvements are under way,” Ario said. “Going forward, state insurance regulators are considering changes to regulations involving holding company groups, as well as investments held by insurers.”

The issues at the AIG holding company securities lending program that affected AIG’s U.S. life units “will be key considerations in these discussions,” Ario said.

Although Ario defended state regulation, he cited state securities lending regulations as examples of state regulations in need of modernization.

Other types of state regulations in need of revisions include producer licensing regulations and product review regulations, Ario said.

Securities lending “did not pose unmanageable systemic risk and was not the reason for federal intervention,” Ario testified.

The problems in the derivatives operations at AIG’s federally regulated AIG Financial Products Corp. unit caused the run on AIG and “exacerbated a securities lending problem that state regulators were otherwise on the way to resolving,” Ario said.

Furthermore, he said, “even with the collateral damage caused by the Financial Products crisis, it must be noted that the securities lending problems at AIG have been defined, contained and fixed, meaning that securities lending is not any part of the ongoing challenges at AIG.”

But Ario acknowledged that the federal government helped handle the securities lending problems after it intervened to rescue AIG in September 2008.

“To avoid massive losses from sudden forced sales, the federal government, as part of its rescue, provided liquidity to the securities lending program,” Ario said. “And, last November, the Federal Reserve Bank of New York created Maiden Lane II, a special purpose vehicle that used about $20 billion in federal funds to purchase the remaining securities lending collateral at market value.”

Ario said state regulators discovered in 2006 that AIG had established a special, unregulated unit to undertake securities trading.

The special unit, consolidated at the holding company level, lent $76 billion in quality assets held by AIG’s life insurance companies, including 12 domestic life insurers.

Most of the securities purchased by AIG using life insurance company assets as collateral were “top-rated assets,” Ario said.

About 60% of the assets were mortgage-backed securities, and about 29% were backed by subprime mortgages, Ario said.

In September 2008, the value of the special unit’s assets had fallen to $58 billion, Ario said.