The release of a report — one that was due more than a year ago — on how the insurance industry should be modernized has taken on new urgency.
The Federal Insurance Office (FIO) report is seen as the hinge on the door of establishing a blueprint for how state, federal and international regulators can work together to reshape insurance in the wake of the 2007–2010 worldwide economic crisis.
The report, which was mandated by the Dodd-Frank financial services reform law, was due Jan. 21, 2012. It required the FIO, directed by former Illinois insurance commissioner Michael McRaith, to prepare a report on the gaps that exist in an insurance regulatory system devised by the states and mainly unchanged for 150 years, and suggest how it should be modernized.
The need for greater central oversight was illustrated in September 2008 when the federal government was forced to provide a lifeline — in the form of billions in cash — to help the world’s largest insurer, American International Group (AIG), remain afloat.
Many hands in the pot
A key concern for Congress is the ongoing role of the politically powerful state regulators and the National Association of Insurance Commissioners (NAIC). And, the Federal Reserve Board, which has been developing a system to understand and regulate insurance companies and their holding companies over the last several years, has made it clear that, as the operational component of the federal regulatory system, it wants a strong voice in the domestic and international efforts to devise rules and establish monitoring systems that work to ensure a crisis similar to the AIG debacle doesn’t happen again. That could impact the role Congress envisioned for the FIO.
Furthermore, just before its annual meeting in Taipei the week of Oct. 14, the International Association of Insurance Supervisors (IAIS) unveiled a memo that laid out plans to develop a first-ever risk-based global insurance capital standard by 2016.
"It is undeniable that the business of insurance is global, and global issues demand global responses,” said Peter Braumüller, chair of the IAIS Executive Committee, in the announcement.
At a global finance meeting in Washington, Daniel Tarullo, a Federal Reserve Board governor, made statements seemingly questioning whether those who have no authority at home should be leading regulation. Tarullo is the Fed governor primarily overseeing implementation of the Dodd-Frank Act. In that role, he has overseen the Fed’s efforts to develop insurance regulatory expertise. He asked the same thing about the FIO and brought up the same issues at a regulator conference in February.
His comments were against the background of the fact that Elise Liebers, an NAIC staff member, is now acting chair of the IAIS Financial Stability Committee and that McRaith chairs the IAIS Technical Committee.
"It's important to have someone who has [supervisory] responsibilities chairing the committees,” Tarullo stated at the conference. “You don’t want someone whose full-time job is chairing an international committee but doesn't have any authority at home."
And, in a memo prepared for the Taipei meeting, IAIS officials reorganized its committee structure. The new structure is seen by U.S. industry players as cutting out “observers” — that is, non-regulators who are usually industry officials, their lawyers, consultants and even consumer advocates — from the process that will be used to establish international insurance regulatory guidelines.
“Observers and other stakeholders will have additional opportunities to provide timely, high quality input to IAIS work,” said IAIS spokesperson Andrew Stolfi. “In whole, our package of measures is meant to bring the IAIS' processes and procedures up to date to meet the increased role the IAIS has taken within the international financial community over the last several years and better enable us to meet our objectives.”
The IAIS is just one of many agencies emerging as players in the regulatory structure that will govern insurance going forward. The Financial Stability Oversight Council (FSOC) is another. The FSOC has already designated AIG as a systemically important financial institution (SIFI), which means it will be subject to federal as well as state oversight. And, Prudential Financial must tell the FSOC by Oct. 23 whether it will accept its designation as systemically important or challenge it in court. The company said it is weighing its options.
That means that, in addition to state regulation, the Federal Reserve Board will have consolidated oversight of these companies and can establish greater capital standards. It can also evaluate management and do whatever it must to ensure that the company does not present a systemic risk to the global financial system. Other life insurance and property and casualty insurers are under the microscope, as are large hedge funds and asset managers.
State vs. Federal
A key reason the FIO report is crucial is that the current state-based insurance regulatory system is at a crossroads, as acknowledged in comments early last month by Larry Mirel, a former state commissioner and now a partner in the Washington, D.C., office of Nelson Levine de Luca & Hamilton. Mirel is fully aware that the G-20, the group of large industrialized nations, is going to the U.S. government as representatives of the U.S., not the NAIC, as it tries to set standards to prevent future economic crises.
According to Mirel, the NAIC is going to have to clarify what it is. Mirel said that the recent international economic crisis pointed out that the NAIC lacked the authority to regulate complex insurance companies with international operations, especially those whose operations run outside of insurance.
“The states are making a claim that they can be the regulator of all insurance companies, including those who operate on a worldwide basis, but I think less and less that is going to be the case,” he said. “A state insurance regulator has authority only within its own, and has no authority to regulate insurance companies that are doing business outside the state and outside the country,” he said.
Congressional officials are also aware that changes in insurance regulatory structures are underway, that the FIO report is urgently needed, and that the NAIC’s ongoing role in insurance regulation should be clarified.
For example, Rep. Ed Royce, R-Calif., a senior member of the House Financial Services Committee (FSC), recently called for congressional hearings on the NAIC’s role. He wants Congress to determine whether it is appropriate for the NAIC to be a de facto regulator of insurers.
Royce said the reason he will ask Congress’s oversight panel for a hearing is that creation of the FIO, along with Federal Reserve’s oversight of insurers organized as thrift holding companies in addition to the SIFIs has created a “new normal for insurance regulation,” a system of “layered/overlapping regulation.”
Specifically, he said, the states “are the historical regulator,” the NAIC is the “de facto regulator” and “the Federal government is the new and expanding regulator.” He also noted that, through its disparate impact regulation “the Department of Housing and Urban Development (HUD) is venturing into the world of homeowners insurance.”
Royce is a strong supporter of the FIO and testified in June before the House FSC that Congress should support a strong role for the new agency in overseeing the insurance industry because state regulation discourages uniformity.
He said he looks upon the pending release of the long-awaited modernization report “as a watershed moment for future regulation” of the insurance industry and he is hopeful the upcoming report “will point to areas where we can improve uniformity of regulation and licensing and lower costs to consumers.”
Indeed, Congress is growing impatient with the FIO over its tardiness in not filing the report. For example, the chairman of the Subcommittee on Housing and Insurance wrote a sharply worded letter dated Oct. 7 to FIO Director Michael McRaith, demanding to know why the modernization report, as well as two other reports required by the Dodd-Frank Act, had still not been submitted to Congress.
In the letter to McRaith, Rep. Randy Neugebauer, R-Texas, says Congress has not been given any legal justification of why FIO has not met its multiple report deadlines so far, including the modernization report, and asked for a written response detailing the reasons — whether personnel, budgetary, political, operational or technical — the reports have not yet been submitted.
People with knowledge of the report say it likely touches upon many commerce issues overseen at the federal level by the Treasury Department. Commercial activities overseen by other agencies, such as the U.S. Trade Representative’s Office (USTR), and the Commerce Department, are also believed to be touched on in the report. It has also undergone significant vetting over the months by the agencies involved, as well as by White House staff officials.
In March, even as the report was being readied, Neugebauer asked FIO and McRaith to explain their roles and involvement in issues of insurance regulation domestically and internationally in response to NAIC and industry frustrations.
FIO’s work with IAIS began to become a rhetorical target of the NAIC in recent months as the fledgling office sought to establish itself in the international arena on global supervisory projects such as ComFrame, that is, serving as the voice of insurance oversight internationally. Indeed, the way the law is written, FIO can flex more direct muscle overseas than domestically on issues.
According to Dodd-Frank, FIO can develop federal policy on prudential aspects of international insurance matters, including representing the United States, as appropriate, in the IAIS, and assisting the Treasury secretary in negotiating covered agreements. Under the law, FIO, with the Treasury Secretary, can work with USTR jointly, to negotiate and enter into covered agreements on behalf of the United States.
However, before it enters into any such agreement, both the Treasury Secretary and the USTR must jointly consult with the House Committees on Financial Services and Ways and Means and the Senate Committees on Banking, Housing, and Urban Affairs and Finance.
Domestically, FIO has the bully pulpit on insurance issues for the administration and has the ear of the cabinet secretary. It can also request data from insurers as it monitors aspects of the industry, including consumer issues such as availability and affordability of insurance.
Under Dodd-Frank, FIO can weigh in on potential pre-emptions of state insurance measures if they are overtaken by covered agreements and, of course, can consult with the NAIC regarding insurance matters of national importance and prudential insurance matters of international importance.
Mirel acknowledges that as time goes on, it is the NAIC that may see its role diminished.
“Who can look at the overall activities of these giant institutions and make sure they are meeting the standards that will deal with potential economic problems?” he asked. “Insurance institutions operating worldwide handle billions of dollars every day. It is not going to be the South Dakota insurance regulator, or the New York insurance regulators to whom international regulators contact when there is a crisis. That is the problem the NAIC faces.”
In fact, he said, they are looking to the U.S. government to represent U.S. institutions in the international financial markets. The U.S. can now do it for banks, but it doesn’t regulate insurance companies. “So something has to give here,” Mirel said. “The NAIC is not a regulatory agency; states have only authority in their own states, so who is going to create international standards to deal with international issues?” he asks. “It has to be the federal government with or without the NAIC. The NAIC can play a constructive role, but it has to be the U.S government that deals with these large cross-border insurance companies,” he said.
And now there is great danger that, absent prompt agreement on a blueprint for a more realistic system of regulation because of the gaps shown by AIG’s need for federal aid and the near-collapse of the worldwide financial system, new and powerful interests will present Congress, industry and state regulators with a more centralized and uniform system that they develop on an ad hoc basis.