WASHINGTON BUREAU — Any new oversight system for big, non-bank financial institutions must complement, rather than displace, the “coordinated, national system of state-based insurance supervision,” an insurance regulator told the House today.

Thomas Sullivan, the Connecticut insurance commissioner, was testifying on behalf of the National Association of Insurance Commissioners, Kansas City, Mo., at a House Financial Services Committee hearing on the Financial Stability Improvement Act discussion draft.

Another witness, Steven Kandarian, chief investment officer at MetLife Inc., New York, (NYSE:MET) said Congress must ensure that all the pieces included in the regulatory reform bills they are drafting fit together.

MetLife is particularly concerned about “how new regulators and regulatory structures would coordinate with existing regulators and regulatory structures, both on the domestic and the international front,” Kandarian said.

The FSIA draft is the product of efforts by the U.S. Treasury Department and the House to create a system for handling serious problems at large, “systemically important” financial services companies.

THE DRAFT

The FSIA draft would give a proposed Financial Services Oversight Council responsibility for determining whether an institution was systemically risky.

Only federal financial services regulators could be FSOC voting members. A state insurance regulator and a state banking regulator would be advisory members.

The Fed would be the systemic regulator, and it would make recommendations about the corrective actions needed to keep a potentially troubled institution solvent. The Fed would have to consult with state regulators before making those recommendations.

The Federal Deposit Insurance Corp. would have broad authority to resolve insolvent institutions declared systemically risky.

Insurance industry lawyers said they have not completed their analysis of what authority the FDIC would have to resolve systemically risky institutions.

The FSIA draft also would give the government broad authority to have large financial institutions cover the cost of resolving a troubled large bank, insurer, securities firm or hedge fund.

WITNESSES’ VIEWS

“A regime change that results in redundant, overlapping responsibilities will result in policyholder confusion, market uncertainty, regulatory arbitrage and a host of other unintended consequences,” Sullivan said.

Sullivan cited the problems at American International Group Inc., (NYSE:AIG) in his congressional testimony, noting that the insurance subsidiaries remained solvent “while the holding company spiraled into failure.”

“The NAIC’s solvency and capital standards have ensured that policyholder commitments are met and companies remain stable,” Sullivan said. “State regulators have placed appropriate restrictions on the investments held by insurers.”

The FSIA draft should be revised to “wall off” of insurance company holdings from the broader holding company, and there should be federal-state coordination on a proposed Financial Services Oversight Council, to facilitate information sharing, Sullivan said.

The current draft of the bill limits state insurance and banking regulators to having an advisory role on the council.

Any new regulatory scheme should also “respect the strong policyholder protections states have in place,” Sullivan said.

“Multiple sets of eyes” in the examination of holding companies “allows for checks and balances,” Sullivan said.

Kandarian said one bill under consideration, which would create a Federal Insurance Office, does not consistently require other regulators to consult and coordinate with that office or state insurance departments when they are taking actions that could impact a specific insurer or the insurance industry.”

He said MetLife would “propose that whenever an action taken by a federal official will affect a specific insurer or the insurance industry, that official should consult with the FIO.”

Also, he said, new disclosure requirements should be reconciled with existing securities laws or exchange rules and requirements. “We think it is critical that these questions be addressed as part of the regulatory reform process,” he said.

Regarding the systemic risk legislation, he said MetLife is concerned that creating a system under which companies are subjected to different requirements will result in an unlevel playing field, which will raise its own issues and problems.

“This issue becomes particularly problematic if only a single company (or very small number of companies) in an industry is designated as a Tier 1 Financial Holding Company,” Kandarian said.

“As proposed, we believe the concept of designating Tier 1 FHCs and subjecting such companies to enhanced prudential standards, including risk-based capital requirements, credit concentration limits, leverage limits, liquidity requirements and risk management requirements will create vulnerabilities in the financial system and result in an unlevel playing field,” he said.

MetLife suggests that Congress consider regulating systemic risk by regulating – or enhancing existing regulation of – the activities that contribute to systemic risk and requiring that such regulation be applied and enforced without regard to the type or size of institution that is conducting the activity, Kandarian said.

“Linking regulatory requirements, such as capital or risk management practices, to the activity rather than to the size of the institution engaging in the activity will help closing existing – and prevent future – regulatory gaps that could be exploited by companies looking to operate under a more lenient regulatory regime,” he said.

Also at the hearing, Daniel Tarullo, a Federal Reserve System governor, defended the FSIA draft.

Creating new, comprehensive oversight for systemically risky financial firms would prevent troubled financial institutions which have received aid from the Troubled Asset Relief System from gaming the system, Tarullo said.

The insurance industry is concerned about an FSIA draft provision that would remove the restraints on the Federal Reserve Board’s authority over companies subject to consolidated regulation under the Gramm-Leach-Bliley Financial Services Modernization Act of 1999.

The current GLB provision limits the ability of a consolidated supervisor to monitor and address risks within an organization and its subsidiaries on a groupwide basis, Tarullo said.

Changing GLB supervision restrictions “would serve as a kind of insurance policy against the possibility of a firm that opted for the benefits of being a bank holding company during the financial crisis deciding to exit that status during calmer times,” Tarullo said.

Tarullo said the FSIA legislation would close an “important gap in our regulatory structure by providing for all financial institutions that may pose significant risks to the financial system to be subject to the framework for consolidated prudential supervision that currently applies to bank holding companies.”

A consolidated banking supervisor “needs the ability to understand and address risks that may affect the risk profile of the organization as a whole, whether those risks arise from one subsidiary or from the linkages between depository institutions and nondepository affiliates,” Tarullo said.