Public Policy Analysis & Opinion

Debating the big financial fix

Insurance organizations weigh in on Congress’s financial services reform efforts

By Kevin P. Hennosy

While the United States Senate drew attention to itself debating health insurance, the House of Representatives passed legislation that applies limited re-regulation to the financial services sector. The Wall Street Reform and Consumer Protection Act of 2009 received a mixed bag of reactions from major insurance sector trade associations.

The bill (H.R. 4173) passed 223-202 from the House floor, with the Republican leadership withholding their caucuses’ support, as regularly occurs in this Congress. The bill includes insurance-related provisions including a Federal Insurance Office (FIO), a Consumer Financial Protection Agency (CFPA), systemic risk regulation, resolution, and derivatives regulation.

Leigh Ann Pusey, president and CEO of the American Insurance Association (AIA) issued a statement that offered general support for “the House to reform and modernize financial services regulation in response to the recent economic crisis.”

Said Pusey, “We are encouraged that the legislation establishes a federal office of insurance and believe that this provision offers a substantial contribution toward broadening and deepening our nation’s understanding of the critical role of insurance in our financial system.”

Still, the AIA did not endorse the bill as a whole but pledged to continue to work with Congress. The AIA statement expressed the trade group’s concern over provisions related to the creation of a dissolution fund for failures of institutions burdened with systemic risk.

Pusey observed, “Other provisions in the legislation cause us concern, most notably the structure of the proposed dissolution fund. To the extent property and casualty insurers are considered in these reforms, the nature of our business and regulatory standards, our existing resolution and guaranty processes, and the general risk our industry poses to the broader financial system have to be recognized.”

Furthermore, Pusey said that the “AIA opposes legislation that subjects our industry to pre-funding obligations for systemically important financial companies and assesses insurance companies to pay for the risks presented by the failure of non-insurance institutions.”

The Property Casualty Insurers Association of America (PCI) offered a more skeptical view of the House Legislation. After congratulating Chairman Barney Frank (D-Mass.), the members of the committee and committee staff, PCI President and CEO David A. Sampson, said: “We reiterate that home, auto, and business insurers did not cause the financial crisis and are not systemically risky. They are not highly leveraged or interconnected with other financial firms as a source of credit or liquidity. Because they are not systemically risky, they should not be forced into a duplicative federal regulatory system designed for companies that caused the economic crisis. We urge Congress not to fix what is not broken.”

PCI’s specific major concerns regarding systemic risk, resolution, and derivatives regulation are as follows:

Moral hazards. Creating a federal resolution fund that requires non-risky, responsible companies to bail out systemically risky firms creates a moral hazard. This could create an incentive for some firms to continue their risky activities with the knowledge that strong, responsible companies will bail them out if the risks go bad.

Insurers should not be subject to federal systemic risk regulation. Because insurers are not systemically risky, they should not be subject to a federal systemic risk regulator. At a minimum, the risk factors used to determine which companies are systemically risky should consider all relevant factors with a weighting toward those most indicative of systemic risk. Despite some improvements in the risk factor language, it does not go far enough to ensure that non-risky insurers will not be swept into a federal regulatory dragnet.

Insurers already pay for resolution. Insurers are subject to potential assessments to pre-fund the resolution fund, despite the fact that insurers are not systemically risky and already pay for their own resolution fund at the state level. Although the bill does include some improved language permitting the resolution authority to take into account insurer state guaranty fund payments, non-systemically risky insurers should be exempt from any federal assessments.

Needless forced conversions to bank holding company structures. The bill imposes bank holding company (BHC) status on holding companies with non-bank depository institutions (NBDIs). Many insurers own small thrifts, which are not systemically risky. Forcing their holding companies to convert to a BHC or to divest of their thrifts would impose a costly burden on them with no benefit to the consumer.

Systemic risk is not mitigated by forcing conversions of small NBDIs that are a negligible part of conglomerates into banks, and their holding companies into bank holding companies.

The bill also fails to provide regula­tors with adequate flexibility to permit companies to divest or restructure within reasonable timeframes.

Derivatives are not insurance contracts. Despite widespread agreement that insurance contracts should not be regulated as derivatives, the bill’s definition of derivatives could inappropriately sweep in insurance contracts.

PCI’s Sampson observed, “This issue now moves to the Senate where we will work diligently to improve the Restoring American Financial Stability Act in the hope that the final bill will take the appropriate steps to address the systemic risk issues our country now faces without impacting healthy, stable sectors of the financial services industry such as the property and casualty insurance industry.”

Clarification for agents

A few days prior to the bill’s consideration by the full house, the Financial Services Committee amended the bill to clarify that the definition of “insurer” for mandatory data collection by the FIO does not include insurance agents and agencies.

The Independent Insurance Agents & Brokers of America (IIABA or Big “I”) welcomed this amendment. “Without this amendment, the newly created [FIO] would have inadvertently had the ability to require countless agents, brokers, and adjusters to produce any data and information that the FIO might demand,” said Robert Rusbuldt, Big “I” president and CEO. “This amendment is critical to all agents and brokers across the country, and the Big ‘I’ greatly appreciates the hard work of Chairman Kanjorski, Rep. Childers, and Rep. Paulsen.”

The IIABA supports the creation of an FIO because the association believes such an office would improve two shortcomings in the current insurance regulatory framework:

1. The lack of a knowledge base or informational source in Washington, D.C. (something especially evident following the 9/11 attacks and Hurricane Katrina); and

2. The challenges state insurance regulators occasionally face to effectively represent the United States in multilateral insurance discussions or to enter into binding international agreements.

This second point is particularly important when one considers how the National Association of Insurance Commissioners (NAIC) exploits its quasi-governmental position in international trade talks. The NAIC has no standing as a public entity, but it has inserted itself into international negotiations simply because there is no federal office charged with insurance issues.

As a result, the NAIC has acted without public accountability in signing memorandums of under­standing with foreign regulators. Without public accountability, the NAIC-brokered agreements are open to charges of parochialism that put the interests of one company or sector ahead of the United States insurance market as a whole. Furthermore, the NAIC’s foreign travel budget presents the appearance of junket-based journeys awarded to commissioners who are subservient to the association’s senior staff.

According to Charles Symington, Big “I” senior vice president of government affairs, “While the Big ‘I’ believes that the state regulatory system should be preserved and reformed, it has become clear that the state system needs assistance to effectively address the inefficiencies that exist today in the regulation of insurance.”

Symington continued: “The Big ‘I’ has long supported the use of targeted federal legislation to help reform the state system without creating a federal regulator, and we believe [the amendment] adheres to these principles.”

The life insurance sector has long been more open to the creation of a federal entity charged with kid-glove jurisdiction over insurance. This is because most life insurers really want to be national banks when they grow up, and national banks recoil at the thought of state-by-state oversight, no matter how captive or inept that oversight might be.

In addition, life insurers have traditionally lusted for an Iron Triangle relationship in Washington, similar to the one enjoyed by banking and that made the financial collapse of 2008 much more possible. (In academia, the term Iron Triangle refers to the strong bond between a regulated sector, an executive branch regulatory agency and a congressional committee.)

Once an Iron Triangle is established, the regulated sector tends to control the two government entities through provision of information, campaign contributions and jobs to officials after their government service. Life insurance executives often lament their sector’s lack of an Iron Triangle arrangement in the creation of public policies aimed at investment products.

The American Council of Life Insurers (ACLI) issued a statement by its CEO, Frank Keating. Again, the statement begins with complimentary comments about Chairman Frank and other members of the committee, and it welcomes the creation of an FIO.

“We appreciate the provision that will create an FIO within the U.S. Department of Treasury. The FIO could be helpful to Congress as it considers issues that are vitally important to our industry and our customers.”

Nevertheless, the life insurance lobby is not completely comfortable with the bill. Keating said the ACLI questions “the plan to create a pre-funded systemic risk resolution fund that would pay for the failure of systemically important financial firms.”

Furthermore, he opined, “This provision would damage the economic recovery by reducing the capital available to financial firms which are already experiencing capital shortages due to the ongoing financial crisis. The nation’s hopes for an economic recovery would be seriously undermined by a provision that reduces the capital available for investment and growth.

“Moreover, there is no evidence that the existence of such a fund would deter the creation of new asset bubbles or other market distortions,” said Keating.

The ACLI appears to be trying to delay creation of a the pre-funded systemic risk resolution fund in the hope that after the next elections they will face a Congress that is less motivated to correct the problems that invited the financial crash of 2008.

“An amendment to H.R. 4173 sponsored by Reps. Daniel Maffei, (D-N.Y.) and Jared Polis, (D-Colo.) requires the Secretary of the Treasury to conduct a study analyzing how best to fund the resolution authority created under the bill. The amendment appears to be a step in the right direction but requires further analysis,” said Keating.

The Consumer Federation of America (CFA) issued a statement that praised the bill’s passage.

“The significance of the passage of this bill cannot be underestimated,” said Travis Plunkett, Legislative Director of the CFA. “Its passage is an important step toward delivering on the promise Congress made when it called on taxpayers to bail out the big banks, that it would adopt comprehensive reform to prevent a recurrence. We look forward to working with the Senate to include additional improvements, particularly regarding regulation of derivatives.”

With regard to derivatives, the CFA did not think the House went far enough. According to the CFA statement:

“Unfortunately, the provisions in the bill to regulate the over-the-counter derivatives market—while they bring some much needed new oversight to that massive market—are disappointingly weak. They allow too many trades to escape the central clearing requirement, provide an unwarranted and unsafe exemption from regulation for foreign exchange swaps, do too little to put an end to inherently abusive contracts, and prevent illegal contracts from being voided. Amendments that would have corrected these defects were defeated, while an amendment expanding the already dangerously expansive end user loophole was adopted.”

Said Barbara Roper, Director of Investor Protection for the CFA: “When Congress called on taxpayers to bail out the big banks in order to stabilize the economy, they promised the comprehensive regulatory reform necessary to prevent a recurrence. The derivatives reform measures in this bill fall short of that promise. It will be up to the Senate to repair these serious shortcomings.”

A few days after the House bill passed, a proposal surfaced from the Senate that could be called “mavericky.” Senators John McCain (R-Ariz.) and Maria Cantwell (D-Wash.), introduced a bill that would reinstate the Glass-Steagall Act. That 1933 act divided the businesses of banking, securities and insurance as a means to mitigate systemic risk.

“I am pleased to be working with Senator Cantwell on this important issue,” said Senator McCain. “My reasons for joining this effort are simple: I want to ensure that we never stick the American taxpayer with another $700 billion—or even larger—tab to bail out the financial industry. If big Wall Street institutions want to take part in risky transactions—fine. But we should not allow them to do so with federally insured deposits. It is time to put a stop to the taxpayer financed excesses of Wall Street.”

McCain continued, “No single financial institution should be so big that its failure would bring ruin to our economy and destroy millions of American jobs. This country would be better served if we limit the activities of these financial institutions.”

Oddly enough, former Senator Phil Gramm, who served as a key economic advisor to Senator McCain’s 2008 presidential campaign, was a champion of repealing Glass-Steagall.

The author
Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. 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.