Be wary. While there is disagreement amongst advocates of continued state regulation of insurance, there is considerable evidence that as federal regulators start to implement the Dodd-Frank financial services reform act, they will have the authority to more than merely look over the shoulder of state regulators within several years–regardless of whom is in power.
As federal regulators start to turn the law into regulations, their initiatives show that they have the power to ensure that they won’t ever be caught off-guard again by a crisis on the magnitude of AIG.
Just check the fine print. The request for comment on implementation of a provision of the law creating the Financial Stability Oversight Council, and the powers granted to an arm of the agency, the Office of Financial Research, puts out in boldface the authority of federal regulators to monitor insurance companies and holding companies.
“It does provide authority for the OFR to look into the insurance companies, not only the holding companies, and therefore get around state regulators,” said Fred Bellamy, a partner at Sutherland, Asbill & Brennan LLP in Washington, D.C. “It will allow the FSOC to get information about insurance companies.”
Mary-Jane Wilson-Bilick, another Sutherland partner, agrees. “The definition of financial institution in the Dodd-Frank bill explicitly includes insurance companies,” she said.
And, she said, the OFR has “strong rule-making power to standardize all the types and formats of data that has to be collected–and it also has subpoena power.”
Moreover, the OFR, which will be an arm of the Treasury Department, has authority under the law to develop tools for risk management and monitoring and developing best practices. It will also be charged with collecting and maintaining a database on all financial companies, including insurance companies, she said.
And, the Treasury’s new research and analysis unit has the authority to develop the metrics for reporting risks on financial stability. “These are considerable powers,” Wilson-Bilick said.
Francine L. Semaya, a New York Insurance regulatory attorney who chairs the Federal Involvement in Insurance Regulation Modernization Task Force of the Tort Trial and Insurance Practice Section of the American Bar Association, however, disagrees.
She says the law gives the FSOC the authority to have the Board of Governors of the Federal Reserve System supervise “a nonbank financial company” and to subject it to “prudential standards” if such an entity is deemed systemically risky. But she added that it was uncertain if insurance companies would ultimately fall under the definition of “a nonbank financial company.”
“Additional layers of federal regulation are not required for an industry that is not systemically risky to the financial stability of the United States,” she argues.
But, she does acknowledge that “one has to wonder if the FSOC will not cross the line and look at the insurance industry through a magnifying glass, especially as it looks at the relationships of insurers with other financial institutions.”
She said that as she reviews the criteria being considered, she is unsure how the insurance industry can “escape” FSOC scrutiny.
In the event that an insurer does come under scrutiny, she asks whether the FSOC will be able to set up criteria that takes into account the current state regulatory scheme that governs the financial standards insurers must meet as it studies other financial institutions that have “relationships” with such insurers.
“Will state insurance investment laws, reserve requirements and other financial standards protect insurers from the tentacles that will reach out to nonbank financial institutions?” Wilson-Bilick asks.
She says that state insurance regulators, and most of the insurance industry, believe the current state system is the correct regulatory scheme to prevent industry failure. But will it be enough?
“Only time will tell, but the insurance advocates on the FSOC must continue to demonstrate both the financial strength of the industry and that the current regulatory controls have and will continue to keep insurers from being a systemic risk,” she says.