A recent paper on insurance supervision by a Wharton School professor suggests that the industry’s current state-based regulatory system is out of date, is “focused on the wrong problems,” and that the federal government needs to play a stronger role in overseeing an industry that is becoming increasingly globalized.
The report was published in the Jan. 22 issue of The New York Times.
It was written with the naïve belief that Congress may use it soon for prompt action in determining how the industry should be regulated going forward. But it should be scrutinized by everyone in the insurance industry as raising the issues that Congress will ultimately deal with when it returns to the middle from its current dysfunctional state.
The report was prompted by the Federal Insurance Office’s (FIO) recent report on insurance regulation that calls for greater federal oversight of insurance regulation.
It also comes amidst signs that the Financial Stability Oversight Council is examining whether Berkshire Hathaway, which has a number of insurance units, should be designated as systemically significant and therefore overseen by the Federal Reserve Board.
The report in the Times was produced by David Zaring, an assistant professor of legal studies at the Wharton School of Business. He said the FIO report “set down a marker” for the kinds of reforms “that will be part of the conversation when Congress takes the matter up.”
Let me make clear that Congress is not going to “take the matter up” anytime soon. Members of Congress at the moment are jockeying to raise the campaign funds needed to win control of the next Congress, and are focusing on doing everything they can to ingratiate themselves to an industry that has been in motion since the Sept. 2008 collapse of American International Group, faces a host of operating problems and rightly believes that any changes in industry oversight are not imminent.
But while members of Congress at the moment are focused on who will control the next Congress, by no means are the issues not on the minds of a lot of industry officials.
For example, several state-insurance regulators in November visited President Obama, who was reeling from the flawed rollout of the health-insurance exchanges, making clear that uppermost in the minds is the minds of state regulators is remaining relevant in the aftermath of the collapse of American International Group (AIG).
Changing the subject from the health exchange crisis that prompted the meeting, the regulators secured from the president a commitment that he would tell Treasury Secretary Lew to consider a role for states in any talks aimed at establishing international-insurance standards.
At the same time, designation of Berkshire Hathaway as systemically significant is also a long-term issue. If designated, it will not be for a while. The FSOC is being very deliberate in weighing whether a nonbank financial company would pose a threat to the financial system if it collapsed,
But the Zaring report articulates the regulatory problems that surfaced when it was it was necessary for the federal government to invest billions to bail out AIG in September of 2008. The report said that the “collapse of AIG, along with the failure of a host of its bond insurers, suggests that the insurance industry was not necessarily a stable, staid keeper of our rainy day funds.”
And despite current efforts by some to rewrite history, other insurance companies sought federal aid during the 2008-09 economic downturn.
The Federal Reserve Board has assigned staff to at least three of its regional banks as well as its Washington headquarters to increase its knowledge of how the industry works, and establish quantitative tools to evaluate performance. And, through a provision of the Dodd-Frank Act, the Fed now is the consolidated regulator of insurance companies that operate savings and loan holding companies.
Zaring also said the crisis’s aftermath suggested that “the rest of the world is increasingly adopting a different set of priorities” than the consumer protection and contract-law oversight that state law and regulators focus on.
That priority, Zaring said, with Europe as the example, is to ensure the ability of the insurance industry to survive financial shocks, “and the empowerment of a continent-wide insurance supervisor.”
He implied that one of the concerns raised by the Treasury report is that the European Union’s Solvency II framework, which U.S. insurers criticize, “raises the specter” that Europe may use its solvency rules to keep foreign insurers out of European markets “on the grounds that they are too risky to trust with the money of European consumers.”
Zaring added, “That threat, among other things, means that copies of the European approach are taking root across the world.”
That isn’t consistent with the current U.S. approach, Zaring said. “… keeping pace with Europe doesn’t work well with the American system of insurance regulation, where the federal role is minimal and each state has a different regulatory scheme,” he said.
Zaring noted that that this is where the Treasury Department’s call for a stronger role in insurance regulation, “something that the largest insurance companies would like to see, makes sense.”
Zaring makes clear that a “stronger,” but not necessarily “exclusive” role for federal regulation is what the FIO report suggests.
See related: FIO report: The hinge on insurance regulation
He said the FIO report did not urge the repeal of the McCarran-Ferguson Act, and that the report “seemed happy to let the state court systems and insurance commissioners take the lead on policy payout disputes, market conduct regulation and the like, though it did urge the states to try to develop a consistent approach to these matters.”
Zaring said that foreign insurance regulators “have consistently complained” about the difficulties of doing business with their disaggregated American counterparts. “But given the long history of state-based insurance regulation, there could be some logic in the Treasury report’s recommendation that federal-state cooperation be embraced,” he said.
Zaring suggested that states might continue to perform the consumer-protection role, which, he said, “has never been a strength of federal-financial regulation.”
The federal government could then worry about overall systemic stability, and “perhaps some nationwide insurance markets where it makes little sense to give the states a role.”
Zaring said the “division of labor” advocated in the FIO report, might, if implemented, “make it possible for the United States to keep up with its international counterparts in thinking about the stability of insurance companies.”