For the last several years, we have lived in a world where the economic stakes for a major insurance failure have become too large to ignore. When AIG imploded in September 2008, kicking off a global financial meltdown that in turn has become the Great Recession, it revealed to all the risks we run by pairing a diverse and yet intertwined financial services industry with a porous, patchwork system of regulatory powers to oversee the whole thing. I have repeatedly called out the National Association of Insurance Commissioners for its relentless support of a state-based regulatory model that does not do nearly enough to protect consumers, and which is the ultimate go-along, get-along game, with regulators taking their cues from the regulated, many of whom they once worked for and intend to work for once again when they leave their governance post.
Some of my colleagues have chided me for this, especially when I say that the NAIC’s failure to oversee insurance companies holistically helped to contribute to AIG’s catastrophe. The NAIC is just there to overlook insurance, I am told. True, but a lot of insurance companies are more than insurance companies, and it does no good to regulate one half of them if the other half is going buck wild and creating risks that threaten the entire operation and those who do business with it. Saying your mission is only to look at insurance and washing your hands of the AIG fiasco is like being the lookout on the Titanic and saying that your job was only to look for other ships, not icebergs.
With this in mind, I draw your attention to a press release I received from the American Insurance Association yesterday. The AIA, of course, is a powerful voice for insurance lobbying, and unsurprisingly, it applauded Oklahoma’s signing of a “self-audit privilege bill” that essentially hands over to insurers the responsibility of determining for themselves if they are in regulatory compliance or not. This is like letting my nine-year-old son determine whether his room is really clean.
What’s worse, the rule allows for insurers to report to the state board of insurance if they are not in compliance with regulations, but confidentially. In what way does it serve the consumer for insurers to have the privilege of keeping their compliance shortcomings concealed from the public? This is the recipe for a no-transparency environment in which nothing good can happen. Indeed, there is something to be said for the industry’s own financial acumen, and when you look at the age-old struggle between insurers and regulators to set appropriate reserves, you do feel for insurers who are hamstrung by overly zealous regulations. But for Oklahoma to simply wash its hands of regulatory responsibility in this manner is more than a gimme to the industry, and more than a suggestion that lobbying efforts have been successful in that state. It is simply irresponsible.
I mentioned this on my Facebook feed, and kicked off an interesting conversation about the nature of government regulation. One friend of mine noted that it was strange that people would get upset over this if they didn’t live in Oklahoma. It was like getting upset over Oregon’s gun laws if you lived in North Carolina. Except that the comparison doesn’t really hold up.
There is a systemic nature to insurance that makes the regulation of any given company only as strong as the weakest link in the chain. And with this new self-auditing rule, Oklahoma has become a weak link, indeed. Why not re-domicile in Oklahoma and take advantage of what appears to be a regulatory environment that consists of little more than pinkie swears that everybody will maintain best practices and that nobody will get too aggressive with unsound financial strategies?
Bah, I was told. This is bush league; anybody can just dump their money in an offshore domicile and take advantage that way. They could, but Bermuda has committed to Solvency II equivalency; going offshore is likely to be a more rigorous regulatory environment than what you have in Oklahoma. And what states are to follow? I shudder to think what Iowa has up its sleeve, being the capital of the annuities industry, and having a state regulatory regime that is nothing if not completely friendly to insurers.
Regulators aren’t supposed to be the bad guys. Their job is not to make the industry miserable. And it’s not even necessarily to hold the industry back; the insurance industry can and does do great things when left to its own entrepreneurial devices. But failures, missteps and collapses also show us that it is an industry too important to leave underregulated. And somehow, Oklahoma has forgotten the lessons of AIG and figured that surely, the industry can’t possibly run itself into the ground again. Right?
The sad thing is Oklahoma will think it is proven right with each quarter and year that passes without a major compliance fiasco. This will prove that hands-off is the way to govern insurance. Only it’s not. This is like not enforcing earthquake readiness in building codes for a city on a fault line. Everything seems fine until one day, it won’t be. And that day will always come. It is just a matter of when.
In the meantime, Oklahoma – and any state that considers following its lead – should bear in mind that it is this kind of weird, you-help-me, I-help-you approach to regulation that has utterly eroded the credibility of the state-based regulatory system. It has, in turn, empowered the spread of federal regulation on multiple fronts as citizens and legislators alike see an insuracne industry they are increasingly reliant on for their personal financial security, and are increasingly uncertain that the indsutry can and will act in their best interests. When you have states telling insurers to regulate themselves, is it any wonder that the folks in Washington feel a need to step in? The FIO is just the start. We have seen other federal agencies – from Health and Human Services to the Treasury – extend their jurisdiction to the insurance industry on multiple occasions. As long as the industry keeps giving them reason to do so, the feds will keep coming. Who really wants that?