Reform Ideas Meet With Mild Applause

WASHINGTON

The recent slick rollout of the Obama administration’s “white paper” for financial services reform was for some reason greeted with enthusiasm by both sides of the federal-vs.-state-regulation-of-insurance debate.

Advocates for keeping reforms strictly within the current state-based system, led by the National Association of Insurance Commissioners, hailed the Obama administration’s proposal because it didn’t call outright for creation of an optional federal charter for insurance.

“While no one proposal is completely perfect, our initial read of the Administration’s financial overhaul plan seems to reflect what is most important to us: preserving the consumer protections and financial solvency oversight of the historically strong and solid system of state-based insurance regulation,” NAIC CEO Therese Vaughan said in a statement.

On the other hand, proponents of an OFC pointed to comments in the white paper for stronger federal involvement in insurance regulation, specifically including the establishment of a federal Office of National Insurance and the suggestion that a federal charter alternative be considered by Congress.

And I hope I never get an evaluation where the conclusion is that “our current insurance regulatory system is highly fragmented, inconsistent, and inefficient,” as the paper states.

But what is overlooked is that the administration proposals draw a clear line in the sand of giving a federal regulatory authority–the Federal Reserve Board–the power to make large, systemically important institutions come under stricter supervision and face a capital surcharge.

Giving the Fed such authority has generated intense debate by lawmakers on both sides of the aisle, but in the end, the lawmakers will likely find that only the Fed has the resources to assume such responsibility. The institutions that will be subject to the authority of this “systemic” regulator will include insurance companies.

And the administration will insist that a federal regulator, either the Federal Deposit Insurance Company or the Securities and Exchange Commission, be given the authority to act as a conservator over institutions, certainly including insurers, seen as in danger of defaulting.

The criteria to be used in determining whether an institution is taken over would be whether the firm is in danger of defaulting; whether its failure would have “serious adverse effects” on the financial system; and whether government action would help mitigate the crisis.

According to government officials, the plan calls for the FDIC or SEC to act as a conservator with broad powers to take action. Treasury would borrow to finance the costs, which would be recouped by fees assessed on the firm once it is sound and resold to private investors.

Even putting aside the fact that consumer protection of insurance products could conceivably be given to a proposed Consumer Financial Protection Agency, another large department, just the fact that federal regulators would have oversight and resolution authority over “systemically risky” insurance companies constitutes a major change.

First, it would give federal regulators strong supervisory authority over these insurance companies and mandate a capital surcharge. And the federal resolution authority would have the power to take funds from the operating subsidiaries of institutions it takes over, presumably giving them a role in their regulation.

There is the strong potential here that being declared a systemically risky institution could become a financial plague, substantively affecting a company’s profitability.

Moreover, the resolution authority could presumably have the power to sell the business or underlying affiliates to a non-insurance company as the least costly resolution alternative.