Yesterday, the House Financial Services Committee’s Subcommittee on Insurance Capital Markets and Government Sponsored Enterprises held a hearing entitled “Systemic Risk and Insurance.” The following witnesses testified at the hearing:
- Peter Skinner, Member, European Parliament
- Michael T. McRaith, Director, Illinois Department of Insurance on behalf of the National Association of Insurance Commissioners (NAIC)
- Teresa Bryce, President, Radian Guaranty Inc. on behalf of the Mortgage Insurance Companies of America
- Sean McCarthy, Chief Operating Officer, Financial Security Assurance, Inc.
- Kenneth F. Spence, Executive Vice President and General Counsel, Travelers
- Franklin Nutter, President, Reinsurance Association of America
- Patrick S. Baird, Chief Executive Officer, AEGON USA, LLC on behalf of the American Council of Life Insurers
- John T. Hill, President and Chief Operating Officer, Magna Carta Companies on behalf of the National Association of Mutual Insurance Companies
Subcommittee Chairman Paul E. Kanjorski (D-PA), who has introduced legislation that would create a federal Office of Insurance Information, opened the hearing by noting that “Insurance is a complex and important part of the U.S. financial industry” and that “We need to recognize this reality by modernizing the overall regulatory treatment of insurance.” He called for a “single point of contact for the United States” on insurance matters, and a “federal regulatory voice on par with the banking and securities sector” for insurers. Kanjorski hoped that the Administration’s “white paper” [which was released today] would “advance the debate about federal insurance regulation.”
Ranking Member Scott Garrett (R-NJ) argued that “a clear consensus on what to do in the area of insurance has not yet crystallized,” because there is no consensus on “what constitutes systemic risk.” “A systemic risk regulator, in conjunction with a resolution or ‘bailout’ authority regime” could create a situation where some companies are expected to be “too big to fail,” said Garrett. Garret also expressed skepticism that insurance firms could be “systemically significant.”
Mr. Skinner expressed his understanding of the “need for each trading bloc to establish its own sovereign rules and practices.” He argued that the principle of “recognition of equivalence … does not imply for the rules and principles” regarding insurance in the United States and Europe “to be the same, but rather to be recognized as similar in terms of their effect and outcome.” However, Skinner also stressed the need for “common approaches and regulatory structures” in the wake of the financial crisis and noted that the European Union is considering the creation of a European Systemic Risk Council that would collect information to identify risks in the financial services sector, prioritize those risks, issue warnings, recommend reactions to risk, and liaise with the IMS, the Financial Stability Board and third party counterparts. Skinner pointed to the EU’s movement toward a “one point of contact system,” a system favored in the U.S. by Chairman Kanjorski. He criticized the present state-based system in the U.S., claiming that it impedes effective “dialogue between the EU and USA.”
Speaking on behalf of the NAIC, Mr. McRaith presented the group’s definition of “systemic risk” as an entity whose “status and activities have the ability to ripple into the broader financial system and initiate problems for other counterparties, thereby requiring extraordinary mitigation efforts.” He opined that “even a major insurance failure will generally not impose systemic risk,” as “most lines of insurance have numerous market participants and ample capacity to absorb the failure.” Mr. McRaith conceded that some insurers, such as mortgage guarantee insurers, title insurers, life insurers and financial guarantee insurers, are more exposed to systemic risk than others. Defending the role of the states in insurance regulation, he argued that any federal regulation should “ensure effective coordination, collaboration and communication among the various and relevant state and federal” regulators. In contrast to Mr. Skinner, Mr. McRaith argued that U.S. insurance regulators lead “the effort around the world to create global standards,” and that the various state regulators speak uniformly through the NAIC.
Testifying on behalf of the Mortgage Insurance Companies of America (MICA), Ms. Bryce argued that the mortgage insurance’s industry’s state-imposed reserve requirements act as a “bulwark” against systemic risk, ensuring that the insurers can survive “a sustained period of heavy defaults.” Ms. Bryce also argued that the mortgage insurance industry is necessary to create sustainable and affordable housing. While acknowledging that regulation concerning systemic risk in the larger financial industry is “absolutely critical,” she stated that “neither private mortgage insurance firms nor private mortgage insurance contracts pose systemic risk.”
Mr. McCarthy argued for “mandatory federal regulation that is closer to that of banks” for the bond insurance industry, claiming that “it is a very different product from that of property and casualty, life and health insurance.” He pointed to such regulation as a means of the bond insurance industry to escape the views of credit rating agencies, which he believed “play too singular a role in the evaluation” of bond insurers’ financial strength. Such regulation, stated Mr. McCarthy, “would increase investor confidence and provide much needed transparency and stability to the capital markets.” Specifically, Mr. McCarthy supported requiring high capitalization levels, detailed disclosure on risks to both issuers and policyholders and annual stress tests.
Mr. Spence highlighted the need for insurance expertise at the federal level, and stated that the lack of such expertise creates challenges for both regulators and companies. He argued that the establishment of an Office of Insurance Information would lead to the development of insurance expertise at the federal level. When identifying systemic risk, Mr. Spence believed that such risk does not depend on the size of a company, “but rather the extent to which its financial health is—or could be—so interrelated with other institutions that its failure would cause broader and substantial economic dislocation.” He argued that the property and casualty insurance industry posed less systemic risk than most insurance industries, but that an “essentially unregulated holding company that owns such insurers” could represent such a risk. He also pointed to reinsurers that pose excessive risk as potentially problematic for the property and casualty insurance industry. Mr. Spence explained that any regulation should involve “corporate governance reform requiring systemically important institutions” to assign risk oversight to a committee of independent directors. He also supported the general idea of enhanced disclosure requirements for transactions, risks, and “other factors that could cause a systemically important company to fail.”
Mr. Nutter noted that present regulation of reinsurance is focused on ensuring the solvency of reinsurers. He argued that the multi-state regulatory system has caused all reinsurance companies formed after Hurricane Katrina to establish themselves outside of the U.S., providing “security though a trust or with collateral.” Mr. Nutter echoed Mr. Spence on the creation of an Office of Insurance Information, stating that its establishment would “go a long way” towards creating a broader system that is not weighed down by the interest of individual states. Any systemic risk regulator should have “clear, delineated lines of federal authority and strong preemptive powers,” said Nutter. He pointed to the EU’s Solvency II effort which leads to the categorization of countries as “equivalent for purposes of doing business in the European Union,” and warned that the entire U.S. system, if states remain the principal regulators, may not meet the EU standard.
Mr. Baird testified that “the life insurance industry is systemically significant,” and provides “protection and retirement security for millions of Americans.” However, he also argued that no “individual life insurance company can accurately be characterized as posing systemic risk.” To address this dichotomy, Mr. Baird suggested the inclusion of two elements in a regulatory regime: (1) a broader method of systemic risk oversight similar to that of the banking and securities industries, and (2) a federal insurance regulator available, on a voluntary basis, to all life insurance companies. He highlighted the necessity of a federal body on the international stage, so that the U.S. insurance industry can work with global counterparts, noting that the U.S. is the only member of the G20 without such an agency. Mr. Baird believed that a “federal tools” approach, in which state regulatory bodies adopt a set of federal standards, is “fatally flawed,” as it fails to address the issue of global cooperation.
Mr. Hill outlined six factors involved in the creation of systemic risk: leverage, liquidity, correlation, concentration, sensitivities and connectedness. He argued that property and casualty insurers adequately address all factors, and therefore pose less systemic risk than other insurers. Mr. Hill cautioned against institution-oriented systemic risk regulation, and indicated that companies identified as systemically significant would attract business away from their competitors. He supported a regulatory framework which formalizes coordination between state and federal regulators, enhances global cooperation and creates an Office of Insurance Information, primarily for global coordination. He also warned Congress against dismantling the state-based system as applied to property and casualty insurance, claiming that it has functioned well throughout the crisis.