Public Policy Analysis & Opinion

Happy days are here again?

An insurance writer heads to Denver, and looks back on NAIC’s summer meeting

By Kevin P. Hennosy

I am going to the Democratic National Convention in Denver, Colorado. I am not a delegate—pledged or not pledged. Nor am I a registered member of the news media, although Rough Notes will probably receive some copy without being on the hook for travel expenses.

I am just going to witness the pomp, pageantry, tackiness, fakery, commercialism, corruption and human degradation that is an American political convention. I have friends, or acquaintances, who question whether I have what it takes to cover a political convention, but after 20 years of following the movable frat party known as the National Association of Insurance Commissioners (NAIC)—I’ll manage.

When my cousin Jim Monaghan, a New Orleans bar and restaurant owner who grew up in Denver, called me and suggested that we attend the Democrats’ convention in his hometown, I balked.

A trip to Denver would take a considerable amount of time away from my usual life of reading works of fiction promulgated by the NAIC. I feared that if I took my eye off the ball, the NAIC might just do something daffy. I worry about such things. I know those people. It is the kind of schemes they concoct at NAIC Headquarters.

I was slow to respond to Jim’s idea, which I should know is a mistake I do not want to make.

You see, my cousin Jim is a strong-willed individual. He is proprietor of Molly’s at the Market in New Orleans, a place where journalists and politicians meet to lie to one another among a sea of thirsty Goths. This is the same man who when we were kids shot me in the leg with a bow and arrow set he had just gotten and immediately ordered me not to cry and not to tell my mother. I obeyed.

More recently, when Hurricane Katrina pummeled the Gulf Coast and tried to drown New Orleans, Jim dutifully closed his tavern at 6 p.m. on Sunday night as the storm approached, in accordance with a police order. By 4 p.m. on Monday, Jim had Molly’s at the Market re-opened. Sure, the bar lacked little things that give a place ambiance—like electricity and potable water—but if the city was going to survive, people needed a place to go. Most important the writers needed a place to drink, and my cousin stepped forward to fulfill a need.

Of course, he was right about going to the convention. This Democratic convention is something that must be witnessed. This convention rests on a fulcrum of history for the Democratic Party.

The same, but different

There are certain parallels between this Democratic convention and my experience at the NAIC. For most of the NAIC’s history, the association’s value depended on whether consensus could be reached between Illinois-based insurance interests and New York-based insurance interests that are respectively represented by the Illinois and New York Insurance Departments. Until recently, the Democrats were trying to seek a consensus between a Senator from Illinois and a Senator from New York, who have both received the attentions of their domestic insurance sector over the years.

Furthermore, the Democratic convention has been known to make declarative statements regarding insurance regulation in the United States. If you pick up your copy of the 1940 Democratic Party Platform you will find the following plank: “We favor the strict supervision of all forms of the insurance business by the several states for the protection of the policyholders.”

Sometimes conventions get it right.

With regard to that “other convention” known as the NAIC, which often works its way into this column for not getting it right, the commissioners met in San Francisco early this summer. In the city where the newborn United Nations conducted its first session, the NAIC continued its misguided effort to negotiate United States trade policy.

Coming out of its convention, the NAIC trumpeted a set of proposals that the group insists on calling the Solvency Modernization Work Plan. The U.S. regulators characterize the plan as a framework “which will analyze international solvency standards and propose related enhancements to the U.S. regulatory system.”

According to an NAIC statement, the proposal is aimed at a European audience: “The Work Plan compares the long-standing U.S. risk-based solvency system with the European Union’s proposed new Solvency II framework, which introduces a risk-based approach to solvency in Europe.”

Other analysts may see the NAIC as simply bowing to international insurance interests in order to keep hold of the states’ tenuous grasp on jurisdiction over insurance. State officials have proved willing to remove just about any load-bearing member of the regulatory framework in a frantic bid to preserve their relevance—and the ability to levy taxes and fees on the insurance sector. With regard to international insurance issues, the area holds the added attraction of overseas travel for insurance commissioners.

“With insurance markets reflecting the effects of globalization, it is critical that the U.S. regulatory framework holds to the highest supervisory standards,” said Alabama Insurance Commissioner Walter Bell, chair of the NAIC International Insurance Relations Committee. “As the world’s largest insurance market, the United States serves as a model for developing markets, as well as for the growing efforts to develop international standards of insurance regulation.”

In addition, the Work Plan analyzes the potential impact that Solvency II might have on U.S. insurers, focusing on the following areas: capital requirements; international accounting; group supervision; valuation issues; and reinsurance.

The risk-based approach is based more on hope than regulatory oversight. It allows the same class of speculators who gave us widespread use of subprime mortgages and regulation-by-hedge fund, the ability to authoritatively opine on the financial condition of insurers. The risk-based approach seeks to eliminate a standards-based approach for a perception-based approach: “The company ain’t broke until people think it is broke.”

“We are committed to using the strengths of the U.S. regulatory system—and our 137 years of regulatory experience—to arrive at modifications and fine-tuning that will result in enhancements to our solvency oversight,” said Virginia Insurance Commissioner Al Gross, vice chair of European Issues for the Committee. “We also will leverage our valuable relationships with regulators from Europe and around the world to ensure our work benefits global efforts for regulatory reform.”

NAIC members will seek input from the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) and the European Commission. The issue will be discussed during the next NAIC-EU Insurance Regulatory Dialogue, which was in the process of being scheduled at press time.

The Work Plan also calls for an analysis of potential trade barriers and coordination with the Office of the U.S. Trade Representative, as needed. Based on the NAIC’s recent history, the association will not find it necessary to coordinate with anyone who actually holds authority for U.S. trade policy with any regularity.

At the San Francisco meeting, the NAIC reversed a 10-year-old trend toward recommending that regulators cede authority to private rating agencies. The NAIC now recommends that insurers and regulators look to credit rating analysis done by its own Securities Valuation Office (SVO) instead of private rating agencies when selling bonds from downgraded bond insurers.

The change is part of a three-pronged regulatory response to recent concerns about the bond insurance market that (1) addresses the continued availability of AAA-rated bond insurance for municipalities; (2) deals with distressed companies by working to bolster contingency reserves; and (3) considers new and/or revised rules and regulations.

The NAIC issued a statement which asserted that this change “will help the municipal bond market by reducing pressure on insurance companies to sell bonds insured by downgraded bond insurers. The reform, which took effect July 1, will permit substituting a credit rating from the [SVO] for the rating from a credit rating agency.”

Wisconsin Insurance Commissioner Sean Dilweg, who made the proposal, said, “We know that many municipal bond credit ratings are no longer accurate because they are based on the downgraded rating of the bond insurer, not of the municipal issuer. So we are stepping in to make sure that insurance companies have accurate ratings. The SVO has the tools to fairly rate municipal issuers.”

New York State Insurance Superintendent Eric Dinallo, who chairs the NAIC Valuation of Securities Task Force, said, “Removing the current restrictions on our rating unit will permit insurance companies to submit downgraded municipal securities to it. The unit, where appropriate, will now be able to assign the correct rating to those municipal bonds. That will benefit both insurance companies and municipal issuers.”

Currently, when a bond insurer is downgraded, the municipal bonds it insures receive the same lower rating. That lower rating can result in the new rating for the bond being below the actual creditworthiness of the municipal issuer.

The NAIC contends that “the downgrading of bonds they hold can create problems for insurance companies. At a minimum, companies would have to reserve more capital against the downgraded bonds because reserves are determined by the risk of the investment. That reduces their appetite for municipal bonds. If bonds are downgraded to below investment grade, some insurance companies will no longer want to hold them. If many companies sell downgraded bonds, they would likely push down the market price and have to take a loss on the bonds. This could also increase municipalities’ cost of raising funds.”

In other words, there may be a whole lot of trouble lurking in the investment holdings of insurance companies, but major news organizations have not taken the time to look.

So the NAIC is going to step forward to do what it can to muddy the waters of the already murky world of insurance investment reporting. The NAIC statement continues, “To avoid these problems, insurance company investors will be allowed to submit their municipal bonds to the SVO for credit assessment. Previously, the SVO was not permitted to assign a credit rating higher than that assigned by a rating agency. The new procedure would allow the SVO to determine its own rating based on its own analysis of the issuer’s financial strength.”

The term “sell” comes to mind.

In the meantime, while NAIC probably tries to figure out an argu-ment for justifying an independent nuclear force capability, I think it is important for someone to cover the Democratic convention like a democrat. To seek out where the drinks are poured and the deals made. To push past the press releases filled with focus group-tested phrases, to see the hospitality suites where the under-secretary for risk transfer affairs will really be selected. It must be done. *

The author
Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He served as public affairs manager for the National Association of Insurance Commissioners (NAIC). He is currently writing a history of insurance and its regulation in the United States and is an adjunct professor of political science at Avila University.