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Life Health > Life Insurance

Insurance Can Be Systemically Risky, Says Expert

By Arthur D. Postal and Elizabeth D. Festa

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WASHINGTON—A funded consumer representative to the National Association of Insurance Commissioners today questioned insurance industry and NAIC arguments that insurance companies do not pose systemic risks to the economy. As such, this also questioned the argument that insurers do not, in fact, need federal oversight.

In testimony before Congress, Daniel Schwarcz, an associate professor at the University of Minnesota Law School, argued that even traditional insurance activities can pose some systemic risks, particularly in the domain of life insurance.

He also cited the experience of American International Group.

“Perhaps most importantly, our experience with AIG in 2008 taught us that we do not fully understand the systemic risks involved in insurance holding company systems,” Schwarcz said.

Schwarcz made his comments in testimony before the Housing and Community Opportunity Subcommittee of the House Financial Services Committee on insurance oversight and legislative issues.

The hearing dealt with three legislative proposed being considered by the panel that would scale back the authority of the Financial Stability Oversight Council, the Federal Insurance Office and the Office of Financial Research, both within Treasury, to independently monitor insurers.

Officially, the NAIC is not pushing this legislation, and has stated it has no official postion on Dodd-Frank or on any proposals to modify it. At the same time, in his testimony before the Subcommittee on Insurance, Housing and Community Opportunity of the Committee on Financial Services, Deputy Director and Superintendent of Insurance and Banking for the State of Rhode Island Joseph Torti did stress that any implementation or modification of Dodd-Frank should keep state-based regulation in mind.

“The NAIC does…strongly believe that the implementation ofDodd-Frank by the federal financial agencies or any legislative efforts to amend it should beconsistent with Dodd-Frank’s recognition of the uniqueness of the insurer business model andthe strength of the national state-based system of insurance regulation,” Torti testified.

One of the legislative proposals being considered would revoke the authority of the Federal Insurance Office and the Office of Financial Research within the Treasury to subpoena information from insurance companies.

The second would “explicitly and entirely” exclude insurance companies, including mutual insurance holding companies from the Federal Deposit Insurance Corporation’s “orderly liquidation authority” for troubled large non-banks.

The third would “preclude” the Federal Reserve from establishing higher prudential financial standards to troubled insurance companies it would oversee as ordered by the Financial Stability Oversight Council.

All of these powers were given to federal regulators through the Dodd-Frank financial services reform law.

While the law left insurance regulation mostly in the hands of the states, it did give federal financial regulators authority to monitor the industry and regulate an insurer as systemically significant, if the FSOC so determined.

Michael Lanza, executive vice president and general counsel of Selective Insurance Group, Inc., Branchville, N.J., testified before the panel that the legislation is appropriate.

He said DFA provisions regarding insurers should be “clarified” to ensure that federal regulators do not impose conflicting or duplicative regulatory requirements.

Lanza testified on behalf of Selective and the Property Casualty Insurers Association of America.

In his testimony, Lanza said that “We do not believe that the proposals – in any way – scale back any powers that Dodd-Frank granted federal agencies to regulate the types of risky activities that gave rise to the financial crisis.”

He said that. “Home, auto, and business insurers, while important to our customers in times of need, did not cause the financial crisis and generally are not systemically important to the financial markets.”

Lanza added that the property & casualty industry “is stable and healthy.”

“Most importantly, as a whole, the industry did not need federal assistance during the recent financial crisis,” Lanza added.

But Schwarcz disagreed.

He testified that, “collectively, the proposed amendments limit the authority of federal entities to regulate and monitor insurers that may pose systemic risks.”

Schwarcz added that “the rationale for these amendments is simply not convincing: the existing provisions of DFA that the legislation targets create only minimal costs and uncertainty for the insurance industry.

“Ultimately, it is simply premature to embrace a regulatory approach to systemic risk that defines away the domain of insurance,” Schwarcz said.

This inflexible approach would perhaps be defensible if we could be completely confident in the view that insurance could never pose any systemic risk. But while it is indeed true that insurance is generally thought to pose limited systemic risks, this conclusion is hardly unassailable or absolute.

He said this is so in because life insurers, like banks, are theoretically susceptible to policyholder runs, as many life insurance products allow policyholders to borrow against their policy or cash out their savings.

“As a result, policyholders who become concerned about their carriers’ solvency can demand withdrawals, producing a downward spiral analogous to those found in classical bank runs,” Schwarcz said.

In fact, he said, several life insurers have experienced exactly these types of runs by their policyholders.

“While there is limited historical evidence of policyholder runs at one insurer triggering runs at other insurers, this is hardly impossible, especially since state guaranty funds are much less reliable and complete than FDIC insurance,” Schwarcz said.

He said such guaranty funds are not generally pre-funded, they are not backed by the full faith and credit of the federal government, and they limit payouts to amounts that are often well below the face value of policies.

“Moreover, state-based guaranty funds are premised on the capacity of non-troubled insurers to cover the obligations of failing insurers,” Schwarcz said.

As such, he said, their capacity to handle several major insolvencies concurrently is highly doubtful.

“Indeed, attempting to force surviving carriers to shoulder the burden created by several large insolvencies could actually endanger the health of otherwise solvent insurers, thus generating a downward spiral in insurance markets,” Schwarcz testified.

Regarding AIG, Schwarcz said, “the AIG experience suggests that, before 2008, state insurance regulation had largely failed to appreciate the risks that affiliates of insurance companies can pose to otherwise healthy insurers.”

The issue of a run on insurers was brought up during the hearing by Rep. Judy Biggert, R-Ill., chairman of the panel.

Biggert asked the panel if there are substantive differences between banks and insurers and asked if there could be a run on the insurance company..

Rep. Nydia Velazquez, D-N.Y., asked if there was any protection by state regulators against systemic risk.

Joseph Torti, III, Rhode Island superintendent of insurance, responded by saying it is “hard to imagine” systemic risk in an insurer.

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