Public Policy Analysis & Opinion
He said, she said
Congressional oversight hearings could reverse decades of decline in regulation
By Kevin P. Hennosy
The 142-year-old war between the forces of state and federal insurance charters flared up again in February. The February 10 edition of Roll Call, the Capitol Hill newspaper, ran a guest column by U.S. Rep. Paul Kanjorski (D-Pa.) in which he blamed the failure of bond insurers on state regulators. In response, the National Association of Insurance Commissioners (NAIC) Executive Vice President Cathy Weatherford released a statement which charged that the blame rested with federal officials.
Being an agreeable and positive kind of guy, I would like to congratulate both combatants on being correct. And in the spirit of helpfulness, let me hold your coats while you head to the battlefield.
Rep. Kanjorski is a Congressional Democrat of the Old School who chairs the Capital Markets Subcommittee of the House Financial Services Committee. He represents the heavily Democratic 11th Congressional District, which encompasses Scranton, Hazelton and Wilkes-Barre, Pennsylvania. Before being elected to Congress in 1984, against the Reagan landslide, Kanjorski was a trial attorney and an administrative law judge dealing with workers compensation cases. Like the insurance sector’s old tormentor, Rep. John Dingell (D-Mich.), Kanjorski understands the use of congressional oversight to further policy development—but without gaining the reputation for meanness associated with Rep. Dingell.
Chairman Kanjorski has advocated for an Optional Federal Charter (OFC) for insurance companies for several years now, which is generally viewed as a pro-banking proposal. The consolidation of financial services—banking, insurance and securities—has not occurred to the extent that it was predicted when the Glass-Steagall Act was repealed in 1999. The continued existence of state-by-state regulation under the McCarran-Ferguson Act has cooled bankers’ interest in entering the insurance sector. An OFC would allow banks or insurance companies to operate nationally under a federal framework. Until the Democratic takeover of the House of Representatives in 2006, most advocates expected the federal framework to be relatively light and un-intrusive.
Like generations of powerful chairs who came before him, Kanjorski seems to understand how to use the power of congressional oversight to shape policy as well as legislation. A powerful chairman is patient. He or she waits for problems to arise that provide examples of why their proposals should be accepted by Congress or the bureaucracy.
When the subprime mortgage bubble burst, several bond insurers faced downgrades in their financial ratings. The downgrades introduced volatility into financial markets with a heavy bias toward selling. To make matters worse politically, mayors, city council members and other local officials watched aghast as faith in municipal bonds plummeted. As municipal bond prices fell, so did the political prospects of local politicians who now would have to cut budgets, services and building plans. These officials were not shy about calling their congressional delegations to complain.
Chairman Kanjorski observed the problem and used it to his advantage. He announced his intention to hold hearings and to investigate how the state-regulated bond insurers were allowed to operate on such dodgy financial footing. Like any other insurance company, bond insurers are subject to state regulation under the McCarran-Ferguson Act.
In his Roll Call column, Chairman Kanjorski expressed disappointment in the generally low level of regulation that states applied to bond insurers. The chairman opined that the financial condition of state-regulated bond insurers provides “the strongest argument yet for why a federal insurance regulator may be needed.”
The chairman probably sees only the tip of a very cold and very large iceberg floating in the shipping channels of American interstate commerce. If he would assign a staff member to review the NAIC Proceedings, or ask the Government Accountability Office (GAO) to report on the NAIC’s development of a Model Investment Law, and the debate over Securities Valuation Office (SVO) deference to private rating agencies, Chairman Kanjorski would be holding hearings at a faster pace.
In particular, congressional investigators would find it very interesting to review reams of communications among the NAIC, insurance lobbyists and investment firm lobbyists during the debates that produced a relatively weak Model Investment Law. Investigators would find arguments for deregulation based on the need to provide “innovative products.” In addition, “sophisticated buyers,” such as insurance company investment officers do not need the protection of regulatory frameworks.
To defend the tarnished and tired reputation of state insurance regulators, the NAIC issued a statement over the rubber-stamped signature of Executive Vice President Catherine J. Weatherford. The rubber stamp signature seems particularly symbolic of the state of insurance regulation during an age when electronic scanning of documents is so inexpensive, easy and efficient. In some areas of American enterprise, 19th century business practices linger on—and insurance regulation is one of those areas.
The Weatherford statement casts a well-deserved heap of aspersions on federal officials:
“Remember, lax federal oversight caused the current disruption in the bond market. The Office of the Comptroller of the Currency allowed banks to offer unaffordable subprime loans to homeowners over the objection of state regulators, who sought to protect consumers from these unsafe products. The Federal Reserve allowed banks to hold risky derivative investments based on these subprime loans, which resulted in billions of dollars in write-downs. The Securities and Exchange Commission not only authorized these derivatives, it failed to supervise how credit agencies rated them. Everyone on the federal level who contributed the kindling, logs and matches that caused this fire should not now take away authority from state regulators who have been keeping the flames in check.”
This commentator has to admit that he liked the “kindling, logs and matches” line best of all, although, one would be remiss to ignore the significant amount of dead wood that gathers in the Halls of State Regulation, but at least someone there seems to have read a book. That is a nice change for someone who reads one happy-talk statement after another published by the NAIC.
Of course, the NAIC does not mention that the states could have taken steps to counter the decisions taken by the federal agencies or private rating agencies. Reserve standards, accounting standards, policy forms and other elements within state regulators’ purview could have been adjusted to counter-balance the mounting weight of risk. Responsible state action was not taken. State officials were quite happy to let the regulated sector have its way, with the full knowledge that they could hide behind those irresponsible decisions cited by the Weatherford statement.
The Weatherford statement continues, “The role of state insurance regulators is to ensure that bond insurers have the financial ability to pay claims, and to date, they have.”
Actually, that is only a small part of the role of state insurance regulators under the McCarran-Ferguson Act. Weatherford’s statement is just part of a fairy tale told by insurance lobbyists as well as state legislators and regulators who are “too close to the industry”—Insurance regulation is only about solvency.
The Supreme Court dispelled that fairy tale 39 years ago in the case of SEC v. National Securities, Inc., 393 U.S. 453 (1969). The court ruled that the McCarran-Ferguson Act created a jurisdiction for the states over the “business of insurance,” which Justice Thurgood Marshall defined:
“The relationship between insurer and insured, the type of policy which could be issued, its reliability, interpretation, and enforcement—these were the core of the ‘business of insurance’ [when the Congress passed the McCarran-Ferguson Act].”
The idea that states have a responsibility only to makes sure claims are paid, without regard for how the business is conducted has no basis in history or law. Chairman Kanjorski should not allow regulators or insurance advocates to get away with repeating this canard.
The Weatherford statement contains another attempt at arguing “it is not our fault.”
“State insurance regulators allowed bond insurers to insure structured debt instruments in response to the demand for innovative products,” explains Weatherford. Once again, her explanation invites interpretation from higher authority. For example, how many mothers have told their offspring, “If your friends said they were all going to jump off a bridge would that mean you should do it too?”
But if we do not want to appeal to ultimate authorities like Motherhood, we can once again look to the Supreme Court for guidance.
In an even older and more settled area of law, the Court ruled in German Alliance Insurance Co. v. Lewis, 223 U.S. 389, 416-17 (1914). In that opinion, the Court ruled that insurance was imbued with a public interest. Because insurers spread the risk of loss across a large population, all policyholders have an interest in all policies written—not just the policy they hold. State regulators are supposed to act on behalf of all policyholders and not just consider whether one company or one policyholder wants an “innovative product.”
Weatherford takes another roundhouse swipe at federal officials with a statement trashing the reliance on for-profit rating agencies: Since federal oversight has obviously failed, and this business model hinges on opinions of for-profit rating agencies, we are now considering a business model that is based on financial strength ratings developed by state regulators.
What Weatherford fails to mention is that the NAIC is just as much at fault when it comes to relying on for-profit rating agencies. In direct response to “regulators” from Illinois and New York, advocating on behalf of insurance trade associations and private rating agencies, the NAIC recently ceded the independence of its SVO to private rating agencies.
As this debate heats up, neither camp of advocates has a very strong case to make. The states have deregulated wide swaths of the insurance sector since the mid-1990s. The current regulatory framework cannot in the least be compared to what Justices Marshall or McKenna described. Federal regulatory frameworks have been allowed to rust going back to President Carter’s panic-driven embrace of deregulation in the late 1970s. Since then, a Reagan-era Congress passed legislation that undermined the statutory foundation of financial regulation—culminating in the repeal of the Glass-Steagall Act under Clinton.
Yet, with regard to insurance, the worst problem seems to be the very problem that Chairman Kanjorski is trying to resolve: the lack of Congressional oversight hearings. From 1995 to 2007, Congress either closed its eyes to insurance regulation, or used its power to bully states into deregulation.
This commentator is not yet convinced that OFC legislation is the cure to what ails the insurance sector and its customers. I would rather see a Federal Reinsurer of Last Resort modeled on the Federal Reserve System, which could encourage uniformity and adjust capacity. Yet Chairman Kanjorski is asking the right questions, of the right people and in the proper tone. Congratulations Chairman Kanjorski. *
The author
Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance Cos. and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). He has written extensively on insurance regulation and testified before the NAIC as a consumer advocate. 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.