WASHINGTON BUREAU — State insurance regulators say they could have protected the insurance company subsidiaries of American International Group Inc. (NYSE:AIG) even if the parent company had collapsed.
Officials of the National Association of Insurance Commissioners, Kansas City, Mo., make that argument in a letter to members of Congress.
Treasury Secretary Timothy Geithner and former Treasury Secretary Henry Paulson contended last week during a hearing before the House Oversight and Government Reform Committee that state insurance regulators did not know what was going on at AIG, New York, as a whole.
"We respectfully disagree with the assertion that insurance regulators could not have separated the insurance units from 'those companies that had taken terrible risks,'" NAIC President Jane Cline and Therese Vaughan, NAIC's chief executive officer, write in the NAIC letter.
AIG's problems are no reason to justify creating a new federal bureaucracy by giving insurers the option of choosing between a state charter and a federal charter, Cline and Vaughan write.
Geithner and Paulson testified at the House hearing that the Federal Reserve Bank of New York agreed to pay 100 cents on the dollar on AIG obligations to AIG derivatives counterparties because regulators feared that demanding discounts, or "haircuts," could have led to immediate downgrades of AIG's credit ratings.
Rating downgrades could have triggered a new round of derivatives counterparty collateral calls and made AIG's problems even worse, Geithner and Paulson testified.
"The people who were responsible for looking at those insurance companies, frankly, had no idea of the risks to the insurance firms, and you could not separate those companies from the companies that had taken terrible risks," Geithner testified.
Geithner also testified that the insurance businesses were "tightly connected" to the parent company.
Paulson said the healthy parts of AIG had been "infected" by the "toxic assets."
If the parent company had not been shored up by the government, "one part of the company would have contaminated the other," Paulson said.
Geithner acknowledges in the written version of his testimony that a bankruptcy filing by the AIG holding company "would have caused insurance regulators in the United States and around the world to take over AIG's insurance subsidiaries," Cline and Vaughan write in the NAIC letter.
"Without a doubt, insurance regulators had the ability and the legal authority to seize AIG's insurers from the holding company if needed to protect AIG policyholders through our state receivership and guaranty fund systems," Cline and Vaughan write.
Cline and Vaughan accuse "proponents of an optional federal insurance regulator" of politicizing the extraordinary efforts to stabilize the non-insurance units of AIG to "justify a new federal insurance bureaucracy."
"The financial crisis in general and the AIG situation in particular illustrate the problems with regulatory arbitrage created by such a system," Cline and Vaughn write.
State regulators "were not aware of the risks posed to the AIG insurance companies by AIG's federally regulated or unregulated non-insurance units," Cline and Vaughan write.
The best response to that kind of information gap is for regulatory bodies to do a better job of sharing information, Cline and Vaughan write.
"We also agree that complex groups like AIG call for a systemic approach to supervision," Cline and Vaughan write. "This is why we have called for strong, effective consolidated supervision of holding companies that leverages the expertise of each functional regulator; in fact, such supervision could have helped avoid the turmoil at AIG."
Cline and Vaughan were replying to a letter that Rep. Melissa Bean, D-Ill., and Rep. Ed Royce, R-Calif., sent to colleagues.
Bean and Royce write in their letter that the hearing showed by lawmakers need to give insurers the option of choosing a federal charter.
An optional federal charter is needed because "uneven state based system of insurance regulation with state insurance commissioners with different legal authorities, different funding levels, and varied levels of expertise and priorities, has not provided a comprehensive look at the insurance market," Bean and Royce write.
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