Just as any kid hates when mommy and daddy are fighting, I hate to see tempers flare between two public figures I respect. But should such a thing transpire – as it did in a March 7 hearing of the House Financial Services Subcommittee on Housing and Insurance – the least I can do as a relatively neutral third party is to try to keep score.
In one corner is Rep. Dennis Ross, R-Fla., whose bona fides as an insurance policymaker date back to his days in the Florida Legislature. In 2007, he was one of just two state House lawmakers (former R Street Senior Fellow Don Brown was the other) to vote against then-Gov. Charlie Crist and then-House Speaker Marco Rubio’s disastrously wrong-headed property insurance bill. I also should disclose that I testified last summer before the full Financial Services Committee in support of legislation Ross sponsored with Rep. Kathy Castor, D-Fla., to offer regulatory clarity regarding which privately underwritten flood insurance policies satisfy federal lending rules.
In the other corner is Daniel Schwarcz, a professor at the University of Minnesota Law School, and for my money, the most consistently thoughtful and engaging consumer advocate in the insurance space today. I certainly don’t always agree with Dan, but whether the topic is lack of transparency in insurance contracts or inadequacies in group supervision or rethinking a modern approach to rate regulation, the concerns he raises and the arguments he makes can never be easily batted away.
The subject that brought these combatants to rhetorical blows is H.R. 5059, the State Insurance Regulation Preservation Act. Co-sponsored by Reps. Keith Rothfus, R-Pa., and Joyce Beatty, D-Ohio, the measure seeks to lift duplicative group supervision by both the Federal Reserve and state insurance regulators of roughly a dozen savings-and-loan holding companies whose members are engaged primarily in the business of insurance. Companies that qualify under the legislation would continue to see the Office of the Comptroller of the Currency serve as regulator of their thrift units, and the Fed would continue to oversee the holding company, but regulation of the group would shift almost entirely to the lead domiciliary state.
In a nutshell, Ross supports the bill and Schwarcz opposes it. More specifically, there are three areas of the law about which they clashed. I endeavor here to offer my best assessment of who won each round.
Does the bill call for ‘less stringent’ regulation?
The first point on which Ross and Schwarcz clashed, and really the issue that most seemed to get Ross’ dander up, is whether the bill calls for “less stringent” regulation than the status quo. Seeking to defend the state-based system of insurance regulation as plenty stringent, or at least sufficiently stringent, Ross got himself out on a rhetorical limb in asserting that regulation under H.R. 5059 would be just as stringent as without it.
But if that really were the case, there’d be little reason for the bill. The whole issue the legislation seeks to address is the belief that the status quo is excessively stringent. I’m sympathetic to the argument that it is, or at least, to the argument that its costs exceed its benefits.
Another of the hearing’s witnesses—Michael Mahaffey, the chief strategy and risk officer of Nationwide Mutual Insurance Co.—testified that compliance with the Federal Reserve’s financial examinations and information requests amount to roughly 25 percent of the company’s regulatory compliance budget, even though Nationwide’s thrift accounts for only about 3 percent of the company’s assets. Perhaps that money would be well-spent, if the Fed’s supervisory process added a commensurate level of prudential safety and soundness. But does it?
While it is true that holding companies that include thrifts always have had to submit to federal oversight (before the Dodd-Frank Act, it was through the now-defunct Office of Thrift Supervision) the post-Dodd-Frank supervisory regime under the Fed has been seen as sufficiently onerous that major insurance groups like Allstate Corp. and Hartford Financial Services sold off their thrifts to avoid the additional regulatory burden, while others – most notably, Prudential Financial — have shed deposits in order to deregister. Thrift and trust functions are services these companies would otherwise offer to their consumers. To be efficient, whatever additional value Fed oversight of the group provides must exceed both that consumer loss and whatever regulatory costs are passed on to consumers through the price of insurance and other financial products. For reasons I will get to later, I am skeptical that it does.
In short, yes, H.R. 5059 would provide for less stringent regulation. Schwarcz thinks that’s a bad thing and I don’t necessarily agree. But by definition, if you remove a layer of regulatory oversight – even one that’s duplicative, redundant and inefficient – you are making the regime less stringent. Therefore, I call this one…
An ‘and’ or an ‘or’
A separate debate arose over who, precisely, would qualify to become what the bill calls an “insurance savings and loan holding company.” This is both the area where I have my greatest concerns with the bill’s text and also a point on which several members of the subcommittee – including both Ross and Subcommittee Chairman Sean Duffy, R-Wis. – appeared to be under a misimpression.
The text of the bill stipulates three possible paths to qualify. One must be either:
(i) a top-tier savings and loan holding company that is an insurance underwriting company;
(ii) a savings and loan holding company that held 75 percent or more of its total consolidated assets in an insurance underwriting company or insurance underwriting companies, other than assets associated with insurance for credit risk, during the 4 most recent consecutive quarters, as calculated in accordance with generally accepted accounting principles or the Statutory Accounting Principles of the National Association of Insurance Commissioners, as applicable; or
(iii) a top-tier savings and loan holding company that—
(I) was registered as a savings and loan holding company before July 22, 2010; and
(II) is a New York not-for-profit corporation formed for the purpose of holding the stock of a New York insurance company.
Both Ross and Duffy indicated they thought any group seeking regulatory relief under H.R. 5059 would need to have 75 percent of their assets held by an insurance underwriter, while Ross suggested the company also would have to have been registered as a thrift before July 2010. This suggests they were under the impression the requirements were additive.
Schwarcz correctly noted that, in fact, these three potential definitions are joined by an “or,” not an “and.” This prompted Ross to shoot back: “So you’re suggesting we put an ‘and’…that would resolve it?”
But, of course, it wouldn’t. Replacing the “or” with an “and” would make it so that the bill doesn’t apply to anyone at all. The most obvious reason for that is that the third part of the definition clearly was written to cover a single company — one that isn’t covered by either of the first two parts.
It also doesn’t take much of a sleuth to figure out that company – a nonprofit New York corporation chartered before July 22, 2010, to hold the stock of a New York insurance company – is TIAA. Its top-tier holding company is not an insurance underwriter, and it wouldn’t meet the 75 percent threshold test because the bulk of its assets are actually held by its very large asset management units. I have no strong feelings about whether TIAA should be subject to Fed oversight, but jury-rigging a statutory definition to cover a single firm is inappropriate and reeks of cronyism.
The bigger concern Schwarcz raised in the hearing, and it’s one I share, is the unintended consequences of the first part of the definition, which would qualify any group whose top-tier holding company is an insurance underwriter for treatment as an insurance savings and loan holding company. The notion makes intuitive sense, in that it describes most of the existing companies the drafters have in mind – insurance companies who happen to own thrifts.
But as Schwarcz rightly points out, this language would create a mammoth regulatory loophole. All that just about any thrift holding company would need to do to avoid Fed oversight would simply be to get itself licensed as an insurance underwriter in some state, et voila. Schwarcz’s specific example of JPMorgan Chase isn’t quite right, both because JPMorgan is a bank, not a savings and loan, and because it is already designated a systemically important financial institution (SIFI) by the Financial Stability Oversight Council. Nonetheless, his point is well-taken and the bill should be amended to address it.
The best way to address it would probably be to strike the first and third parts of the definition, and rely entirely on the asset test laid out in the second part. The intent of the legislation is to allow a group that is predominantly insurance-focused to be overseen primarily by state insurance regulators. If 75 percent of group assets are held by insurance underwriters, that’s a reasonable threshold to set for defining an “insurance group.” But I must note that this approach would not be without complications of its own.
How you measure assets is important and the current language is pretty vague in suggesting that they be “calculated in accordance with generally accepted accounting principles or the Statutory Accounting Principles of the National Association of Insurance Commissioners.” GAAP and SAP are not remotely compatible accounting systems. Among other things, the former is marked-to-market and the latter is not. Which you use, and how you use them, matters quite a bit. A depository’s highly leveraged total assets under the valuation-focused GAAP system and an insurer’s risk-matched net admitted assets under SAP are basically apples and oranges.
So, I would submit this section of H.R. 5059 needs a bit more work, though I think it is salvageable. But because conjunctions do matter, I award this one…
Are the states up to the task?
At the heart of the Ross-Schwarcz fight is disagreement over whether state insurance regulators are equipped to do the sort of groupwide supervision provided under this legislation. Ross contends that state regulation has been “the best” and is also closest to consumers. Schwarcz makes essentially two points:
- It has always been the case that financial services holding companies that include a thrift are subject to federal oversight; and
- The states’ group solvency regime, as embodied by the Own Risk Solvency Assessment process, is both relatively new and untested by crisis.
Both points are true, yet I don’t find either especially persuasive in this case.
I actually agree with Schwarcz—and he’s written persuasively on the topic elsewhere—that insurance can be a source of systemic risk and that insurance regulators bear more responsibility for failures during the financial crisis than is commonly understood. For example, it is almost certainly the case that the securities-lending scheme undertaken by American International Group’s life insurance subsidiaries would have taken down the company by itself, had the collateral calls on AIG Financial Products’ credit default swaps not done so first.
Moreover, the Wisconsin Office of the Commissioner of Insurance failed to catch the problems at Ambac Financial and the New York State Insurance Department was similarly negligent when it came to MBIA. The collapse of these monoline insurers in late 2007 and early 2008 were among the most important early warning signs in what became the financial crisis. For that matter, let’s not forget that the crisis’ undisputed canary in the coalmine was the failure of New Century Financial Corp., which was regulated by the California Department of Corporations.
But taking a broader view of the crisis, one can hardly conclude that federal regulators covered themselves in glory, either. As Schwarcz himself acknowledges, OTS in particular had a lot to answer for. In addition to overseeing AIG, it also was the primary supervisor of Countrywide Financial, IndyMac and Washington Mutual.
But OTS is hardly the only federal regulator that failed to see what was coming. Most obviously, the Commodity Futures Trading Commission did nothing to avert the nuclear meltdown of the $62.2 trillion credit default swaps industry – literally more than all the money in the world, as global gross domestic product was about $60 trillion in 2007.
Then there was the Securities and Exchange Commission, the primary regulator of broker-dealers, asset managers and REITs. It failed to head off the problems at Bear Stearns, American Home Mortgage, Carlyle Capital, Merrill Lynch and Lehman Brothers. And, of course, neither the Office of Federal Housing Enterprise Oversight nor its successor, the Federal Housing Finance Agency, acted to avert the problems at Fannie Mae and Freddie Mac.
For that matter, even the vaunted OCC and Federal Reserve themselves oversaw a long list of high-profile failures on their watch, including Wachovia, National City and two of the biggest bailouts of the TARP era — Citigroup and GMAC.
Nor can these problems be laid solely at the doorstep of “regulatory arbitrage.” The same financial crisis that gripped the United States was even deeper and more prolonged in Europe, where most nations have a unitary regulator for financial services. The widespread failures there weren’t just in the fringe PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) but extended to the French Prudential Supervision and Resolution Authority failing to catch the problems at BNP Paribas and Britain’s Financial Services Authority laying down on the job when it came to Northern Rock.
Let’s not even speak of the carnage that ensued in Iceland.
While state insurance regulators certainly weren’t flawless, I think the state-based regulatory system acquitted itself reasonably well, all things considered. We did not, for instance, experience runs on life insurers here, and such runs are possible. Indeed, AIG’s AIA, ALICO and Nan Shan Life units in Asia all experienced policyholder runs to some extent or another at the height of the crisis, most acutely in Singapore.
Likewise, while it is true that it is only relatively recently that the states have delved in to group oversight in a serious way, it is just as recent that the Fed has applied its prudential oversight process to insurance enterprises. Of the two, I have more confidence in the states, largely due to two background beliefs:
- That the states and the National Association of Insurance Commissioners have made greater progress in getting a handle on group solvency than the Fed has made in getting a handle on insurance; and
- That the states – at least, since the creation of risk-based capital standards in the 1990s – have a better track record at seeing and responding to excess risk in insurance than federal regulators, including the Fed, have at seeing and responding to excess risk at the enterprise level.
Litigating those points is beyond the scope of what is already a far too lengthy blog post. Needless to say, those who disagree with those premises are likely to disagree with my conclusion. Which is that, on this point, I score the fight…
The Little League outfield problem
One must, and I do, take seriously Schwarcz’s prevailing concern about the need to treat federally insured depositories as a special kind of risk. The moral hazard that accompanies both implicit and explicit taxpayer guarantees is not a small matter. I am mostly satisfied that by preserving 1. OCC oversight of the thrift itself; 2. the Fed’s continuing window into asset transfers into and out of the thrift; 3. the FSOC designation process for institutions that pose real systemic risk; and 4. the backstop of the Fed’s powers to exert emergency power in exigent circumstances, H.R. 5059 keeps in place sufficient checks on any new risks that might arise from removing the Fed’s day-to-day authority over insurance savings and loan holding companies and leaving state insurance regulators in charge. But I will concede that there are risks.
However, I also think there are risks to maintaining the status quo. The OTS failed to see the problems in AIG not only because it was a subpar regulator, though it was. It also failed to see them because both the OTS and AIG’s state regulators acted as if the other party was exercising oversight that, in fact, it wasn’t. Like Little League outfielders who blow their assignments, everyone assumed it was someone else’s job to get the ball.
This lack of accountability is always a problem where you have overlapping and duplicative regulation, and I don’t know that substituting the OCC and the Fed for the OTS resolves the issue. The bank-centric nature of the Fed’s prudential regime suggests that it will defer quite a bit to the states to catch risks that arise from insurance activities, including among members of an insurance group. Meanwhile, the looming presence of the Fed as the uber-regulator could unintentionally cause the states to be less mindful of group risks and less observant of the need to coordinate among themselves. Regulators face moral hazard, too.
Ultimately, I believe groups that are predominantly engaged in insurance are most likely to encounter risks that stem from insurance, and that their oversight is best left to those who know insurance best. After all the shouting, I believe the states fit that bill better than the Fed.