Amidst the fallout of the current economic crisis, Paul Kanjorski (D-PA) dramatically shifted the arc of the Capitol Hill debate on federal insurance regulation, yesterday, with his assertion that the debate on federal regulation could no longer be about whether to do it, but, rather, how to do it. Kanjorski is chairman of the House Financial Services Committee's Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises.
Kanjorski's statement came in a hearing he called to hear views principally from the academic and research communities on insurance regulation. The "academic" panel assembled for the hearing included Martin Grace, from Georgia State; Scott Harrington, from the Wharton School; Bob Hunter, from the Consumer Federation of America; and Patricia Guinn, from Towers Perrin. During the course of the hearing, Kanjorski also asserted that federal regulation should not expand the role of state insurance departments beyond insurance regulation. Because of the complexity of insurance and the broader financial marketplace, the federal government must not only respond to the current crisis, but also determine how best to regulate these broader issues.
Ranking Member Scott Garrett (R-NJ) agreed that some regulatory reform is necessary, but cautioned that what emerges at the end of the legislative process might be something else entirely from what proponents want. Rep. Judy Biggert (R-IL) urged that, however federal regulation of insurance may emerge, Congress should be careful not to dismantle a state regulatory system that seems to have been functioning properly. Similarly, Rep. Jeb Hensarling (R-TX) pointed out that states, rather than the federal government, possess insurance regulatory expertise and proposed that the focus should be on smarter regulation rather than more regulation.
Two key themes emerged as subcommittee members weighed in: systemic risk and regulatory arbitrage. Hensarling argued that if a federal systemic risk regulator were to designate an insurance company as systemically important, the public and other financial market participants might rely on an implicit federal guarantee of the insurer that flowed from the systemic designation. The insurer, in turn, might pursue riskier ventures, falling prey to moral hazards and creating a self-fulfilling prophecy about that company's systemic risk.
Rep. Jackie Speier (D-CA), went after the arbitrage argument. An emerging power player in the Financial Services Committee, Speier voiced her opposition to federal insurance regulation by asserting that regulatory arbitrage was a primary culprit in the broader financial services industry meltdown during the last year. Rep. Speier argued that recent events do not favor federal regulation of insurance, but instead suggested that the Gramm-Leach-Bliley (GLB) Act be repealed. GLB is the 1999 Act that repealed the Depression-era Glass-Steagall Act, which, among other things, had created ownership barriers between national banks and insurance companies. Speier added that in her view, federal regulation of insurance amounted to little more than life insurers trying to leverage their positions.
Representatives Melissa Bean (D-IL) and Ed Royce (R-CA) undertook the task of rebutting the federal regulation critics. Bean and Royce are the sponsors of the recently introduced National Insurance Consumer Protection Act (H.R. 1880), which is a shortened version of their earlier bill, "The National Insurance Act," that had been introduced in the last Congress. Bean described the bill as creating a federal regulatory system that would have oversight of insurance holding companies—not just the insurance subsidiaries—and be able to establish a "best-in-class" national regulatory system not undercut by the fragmentation of 50 different state laws and approaches. Bean also pointed out that unlike the earlier National Insurance Act, the new bill also authorizes the creation of a systemic risk regulator for both state and federally chartered insurers that would become part of a broader systemic risk regulatory system for the financial services sector. Royce added that the presence of a regulator that has access to all of the necessary financial information concerning a financial services company could prevent and manage systemic risks. To combat regulatory arbitrage under the new Bean-Royce bill, federally chartered insurers would be unable to switch from a federal charter to a state charter without the permission of the federal regulator, according to Bean.
Prof. Martin Grace, of George State, testified that fears of regulatory arbitrage are overblown because, as a practical matter, once an insurer opts for a federal charter, its compliance costs would fall dramatically and it would shed the institutional knowledge and mechanisms of operating under the multi-state system. In short, it would be prohibitively expensive for an insurer to toggle back and forth between state and federal regulation.
The Bean-Royce bill also provides consumer protections based on the National Association of Insurance Commissioners (NAIC) model laws and requires that the federal regulator establish local offices in each state to respond to consumer protection issues. Bob Hunter, who testified on behalf of the Consumer Federation of America, rejected the idea that NAIC model laws provided adequate consumer protection. Mr. Hunter also called for rate regulation, which he deemed vital for robust consumer protection. Later in the hearing, Kanjorski implicitly rebutted Hunter's assertion of the need for price controls. Kanjorski pointed to a vicious cycle in which consumers exposed to high risks are unable to obtain insurance because insurers are unable to offer coverage based on price controls mandated by a state regulator. In response, a populist regulator is elected claiming that he would increase the availability of coverage by further controlling prices, driving even more insurers out of the market.
Given Kanjorski's declaration that the federal government must assume some regulatory oversight of the insurance industry, the witness panel explored a variety of mechanisms, when prompted by questions from the Congressional panel. One approach would seek to limit federal oversight to issues concerning systemic risk, such as solvency and prudential regulation of insurers while preserving state regulation of consumer protection issues, such as market conduct exams and claims handling. This view was endorsed by Mr. Hunter, who argued that a systemic risk regulator at the federal level would provide critical oversight that the NAIC and state insurance departments simply cannot. He asserted, however, that federal authority should not be vague or open-ended, and urged that it not preempt state regulation of consumer protection issues. Interestingly, while Hunter urged that federal law not preempt state consumer protection laws, he also asserted that those very same laws—based on the NAIC models—are insufficient.
Patricia Guinn, from Towers Perrin, took a different approach. She argued for enterprise risk management through a "holistic" regulatory scheme. Guinn and Grace expressed similar views about the need for a federal regulator to oversee systemic risk and integrate oversight of capital requirements and risk management for insurance holding companies, subsidiaries and other participants in the financial markets. Guinn explained that although insurance companies, when compared to banks, have weathered the current economic crises fairly well, insurance is not isolated from the broader financial services industry; rather, it is tethered to and intertwined with it. Grace echoed her sentiments and called for aggregation of piecemeal information on insurers and the financial services industry so a federal regulator could develop a picture of the companies as a whole. Grace explained that state insurance regulation emerged at a time when most companies were small, local operations that may have operated in only a few lines of business. According to him, that system is antiquated and ill-equipped to cope with the array of holding companies, multi-line and multi-national insurers.
Harrington was skeptical about the efficacy of a federal regulator. He testified that insurance markets have less systemic risk than banking and should not be regulated as if they were banks. To do so, he said, could undermine strong market discipline and reduce competition without alleviating systemic risk. Any federal regulation, he cautioned, should be designed to preserve market discipline, competition, and to minimize actual or perceived government guarantee of insurers' obligations.
Thursday's hearing signaled that the push for federal regulation of insurance has turned a corner. Never before had Kanjorski stated so clearly and so powerfully that federal regulation is necessary. The unimaginable turmoil in the financial markets, the bond insurance crisis, the creation of TARP and a host of other events has propelled the federal insurance regulation debate from a matter of "if" to a matter of "how." Insurers, agents, consumers and others are lining up on all sides to participate in the legislative conversation. This promises to be a dynamic session on the Hill as everyone seeks to be at the table and to design the menu for the legislative meal.
Below are the prepared witness and member statements:
Mr. Baird Webel, Specialist in Financial Economics, Congressional Research Service;
Ms. Patricia Guinn, Managing Director, Global Risk and Financial Services Business, Towers Perrin;
Mr. J. Robert Hunter, Director of Insurance, Consumer Federation of America;