Putting plain-vanilla swaps on public exchanges might be appropriate, but life insurers believe financial institutions’ swaps should continue to move through an over-the-counter system.

Scott Sleyster delivered that message on behalf of the American Council of Life Insurers, Washington, Wednesday at a House Financial Services Committee hearing.

Swaps are derivatives that give parties the ability to trade anticipated streams of cash. Problems with swaps operations at American International Group Inc., New York, and other large financial services companies contributed to the severity of the recent economic crisis, lawmakers say.

Life insurers want Congress to ensure that derivatives regulation is reasonable and effective, because life insurers are major users of derivatives, and they will be affected immediately by any changes in federal derivatives laws and policies, Sleyster testified at the hearing, according to a written version of his remarks posted on the Financial Services Committee website.

Sleyster, an executive at Prudential Financial Inc., Newark, N.J., noted that financial institutions use swaps to manage risk for products of very long duration.

If Congress tries to force trading in the kinds of customized derivatives that insurers use into multiple, single-product clearinghouses, that “could increase, rather than decrease risks in these markets,” Sleyster said.

“Clearinghouses could decrease collateral flexibility for end users, increasing frictional costs at minimal benefit to the stability of the financial system,” he testified.

Today, he said, insurers’ collateral arrangements with their direct OTC counterparties normally allow for insurers to post a range of different types of investment securities as collateral.

This flexibility is not available through exchanges or clearinghouse systems, where cash and U.S. Treasury securities are normally required to be posted, Sleyster said.

“A clearinghouse system which does not have the current OTC market’s flexibility and requires the posting of cash and Treasuries exclusively, or imposes onerous haircuts on other collateral classes, would greatly increase the hedging costs of our members and could force them to abandon hedge strategies that are too costly,” Sleyster said.

Otherwise, he said, insurers might have to increase product prices or reduce benefits.

House Financial Services Committee Chairman Barney Frank, D-Mass., convened the hearing to get comments on a bill draft his committee released earlier this week.

The draft is based on a proposal the Obama administration sent to Congress in July.

Life insurers’ use of derivatives is “carefully and prudently” regulated by state insurance departments pursuant to state laws and regulations, Sleyster testified.

These laws and regulations uniformly prohibit life insurers from using derivatives as a means of speculation or proprietary trading, he added.

“Federal pre-emption of market and product regulation should leave intact state and federal functional regulators’ jurisdiction over derivatives usage by insurers and other financial institutions,” Sleyster said.