The Obama Administration criticized state insurance regulation, proposed the creation of an Office of National Insurance and acknowledged the need for “a modern regulatory framework for insurance” in its financial regulatory reform white paper unveiled today. Although the white paper stopped short of mandating complete federal oversight of the insurance industry, it expressly recognized the need for uniform insurance regulation whether through enactment of a federal charter or by state regulatory reform. The proposal indicts the more than 135-year history of state regulation, declaring that state regulation has led to a lack of uniformity, reduced competition [in] across the states and internationally, created inefficiencies, reduced product innovation, and, most searingly, caused increased costs to consumers.

During the past month there had been substantial uncertainty about how the Administration would proceed on insurance regulatory reform. Secretary of the Treasury Timothy Geithner has spoken favorably about optional federal chartering legislation; however, in the Administrations discussions during the past week of its upcoming white paper, insurance regulation had been conspicuously absent. It appears that what the Administration did was to adopt several key terms and establish a set of criteria consistent with legislation proposing federal regulation of insurance—though it ultimately stopped short of making such a proposal outright. In this sense, it can be argued that the Administration has kicked the can down the path, though the more critical question is determining where the path is heading. Based on the details of the white paper, the path leads to uniformity of regulation through two possibilities: federal chartering or through the states. And since the states are better are individuality than uniformity, they may have a difficult time meeting the Administration’s test.

The creation of an Office of National Insurance has been an idea long-circulated on Capitol Hill, most recently in the National Insurance Consumer Protection Act (H.R. 1880) sponsored by Rep. Melissa Bean (D-IL) and Rep. Ed Royce (R-CA). The Office of National Insurance, as proposed in the white paper, would not be s full-fledged regulatory agency, but it would be much more than the Office of Insurance Information envisioned in the Kanjorski bill. It would be tasked with gathering information on the insurance industry but it would also be required to identify [and identifying] potential regulatory problems that could contribute to financial instability and insurers that should be treated as Tier 1 Financial Holding Companies—firms that based on their size, leverage, and interconnectedness could pose a threat to financial stability. This is a critical responsibility, because the Tier 1 financial firms will come under broad Federal Reserve supervision. While it is unclear exactly what this would mean, it would, at the very least, mean Federal Reserve supervision of covered insurers that could supersede, to some undetermined degree, the current state regulation of them. The ONI would also assume responsibility for the Terrorism Risk Insurance Program under TRIA, thus placing operational authority with ONI substantially beyond an information gathering office. The ONI would be empowered to work on international agreements and cooperation. Finally, if a failing Tier 1 Financial Holding Company included an insurance company, the ONI would consult with the Federal Reserve and the FDIC Boards on insurance-specific matters under the white paper’s resolution regime.

The white paper identified six principles for Treasury support of proposals to modernize and improve insurance regulation:

  1. effective systemic risk regulation with respect to insurance;
  2. strong capital standards and an appropriate match between capital allocation and liabilities for all insurance companies;
  3. meaningful and consistent consumer protection for insurance products and practices;
  4. increased national uniformity through either a federal charter or effective action by the states;
  5. improve and broaden the regulation of insurance companies and affiliates on a consolidated basis, including those affiliates outside of the traditional insurance business; and
  6. international coordination.

These principles would serve as the framework for any proposed federal insurance regulation or effective state action.

Aside from the insurance-specific section, the Administration’s proposal also affects insurers with changes to the regulation of financial holding companies. The white paper recommends changes to the Gramm-Leach-Bliley Act to grant the Federal Reserve authority to conduct examinations and require reports from all Tier 1 FHCs, including their subsidiaries regardless of whether they have a primary supervisor. If the Office of National Insurance identifies an insurer as a Tier 1 Financial Holding Company, it could be subject to additional prudential regulation by the Federal Reserve to address systemic risk. The Federal Reserve would consult with the insurance subsidiary’s state insurance regulator before imposing additional requirements. The white paper envisions “consolidated supervision of a Tier 1 FHC [extending] to the parent company and to all of its subsidiaries.”

Similarly, the Administration’s proposed Consumer Financial Protection Agency (CFPA) could affect insurance, although it is far from clear from the white paper that they have insurance products in mind. The CFPA would be dedicated to consumer protection in credit, savings and payment markets and would have authority to reduce gaps in federal supervision and enforcement over financial markets and to “improve coordination with the states.” It would have “supervisory and enforcement authority over all persons covered by the statutes that it implements, including both insured depositories and the range of other firms not previously subject to comprehensive federal supervision.” Gaining authority over insurance products would need specific legislative authority which the white paper does not specifically propose.

More generally, the Administration proposes the creation of a Financial Services Oversight Council comprised of: (i) the Secretary of the Treasury, who would serve as the Chairman; (ii) the Chairman of the Board of Governors of the Federal Reserve System; (iii) the Director of the National Bank Supervisor; (iv) the Director of the Consumer Financial Protection Agency; (v) the Chairman of the SEC; (vi) the Chairman of the CFTC; (vii) the Chairman of the FDIC; and (viii) the Director of the Federal Housing Finance Authority. The Council would facilitate sharing of financial information and coordination, identify emerging risks, monitor systemic risk, and serve as a forum for resolving jurisdictional turf wars. Notably, the Council does not have an insurance seat on it. The NAIC has urged that it be the designated participant, but the paper leaves that question open. Interestingly, the head of the Office of National Insurance has the kind of responsibilities that would make it a logical choice for the seat, except the lack of specific regulatory responsibility. Its responsibilities for identifying insurers as Tier 1 Financial Holding Companies and its role as an advisor on insurance issues may well give it a leg up in the argument over who should fill that potential seat.

The Obama Administration conclusions about insurance regulation are clear: the Administration argues that today’s state insurance regulation system is inadequate and costly; that it ill-serves consumers; and that it causes problems for the United States internationally. The white paper acknowledged that it is not “the complete set of potentially desirable reforms in financial regulation.” Rather, the Administration has established the foundation for the debate, and a strong framework for federal regulation of insurance through federal chartering, if the states can’t make the reforms themselves. We must now look to see how the Congress will shape these ideas.