Federal Charter: A Future ‘Insurance Subprime’ Debacle?

The banking and securities industry is facing worldwide subprime mortgage-related losses, which knowledgeable sources – including the International Monetary Fund — now suggest could top $1 trillion, according to Reuters. There is more than a hint of irony simultaneously to be suggesting that state regulation of insurance — while far from perfect — be replaced with an as yet undescribed system of federal regulation.

My colleagues and I at Anderson Kill & Olick have been legal advocates for insurance policyholders for decades. We have long noted the disparity of organization among sellers of insurance (insurance companies) and intermediaries (insurance brokers) on the one hand, and purchasers of insurance (policyholders) on the other. The disparity of organization — and lobbying effort — is a defining characteristic of the insurance marketplace.

For example, a new insurance industry organization called the Optional Federal Charter Coalition recently launched a Web site (a href=”http://www.OFCcoalition.com” target=”_blank”>www.OFCcoalition.com) and organized a large group including the Agents for Change, American Bankers Association, American Bankers Insurance Association, American Council of Life Insurers, American Insurance Association, Council of Insurance Agents and Brokers, Financial Services Forum, Financial Services Roundtable, Life Insurers Council, National Association of Independent Life Brokerage Agencies and Reinsurance Association of America. We know of no equivalent insurance consumer group with such an organizational effort.

Some consumer groups such as the Consumer Federation of America have spoken on behalf of consumers on the issue. CFA’s director of insurance, former Texas Insurance Commissioner J. Robert Hunter, has noted that an optional insurance charter has been debated for the past decade and is unlikely to pass now. Hunter has described a dual federal-state regulatory system as a race to the bottom that would pressure states to loosen their insurance standards so that more companies would choose to operate under state law.

Industry Opposition

Similarly, National Association of Insurance Commissioners President Sandy Praeger, while asserting that “the insurance regulatory scheme is working,” told the Wall Street Journal that with an OFC available insurance companies might attempt to “find the path of least resistance.” State insurance regulators plainly view themselves as better able to avoid an insurance “subprime” crisis of the future.

Some groups within the insurance industry, including the Independent Insurance Agents and Brokers of America and the National Association of Mutual Insurance Companies, have stated their opposition to the federal charter plan. The latter fears that smaller insurers will find it more difficult to switch regulatory regimes and will thus suffer a competitive disadvantage.

Those in favor of the Treasury recommendation cite the enhanced uniformity of regulation that a single federal charter might provide, and the coincident efficiency of markets such uniformity of regulation might create. According to Marc Racicot, president of the American Insurance Association, “The inclusion of an optional federal charter for insurance, as outlined in the federal Treasury blueprint, is a major milestone in that it recognizes the important role that the insurance industry now plays in this new financial world of integrated and interconnected markets. Providing insurers with the option of a single regulator would benefit consumers and be more efficient, effective and rational given the ‘increase intention’ a state-based regulatory system creates.”

Deregulatory Fervor

While uniformity and efficiency are proper aims, they are all too often invoked to justify regulatory streamlining that eviscerates consumer protection. It’s important to recognize that the OFC is a product of the same deregulatory fervor that created the current regulatory regime for banks. In April 2006, when Sens. John Sununu and Tim Johnson introduced the National Insurance Act that would establish an OFC, their press release presented the legislation as the next step in a “highly successful” financial industry deregulation:

“Unlike the modernization of banking and securities of the late 1990s under the Gramm-Leach-Bliley Act, the insurance industry remains subject to a patchwork of state regulations that have stifled competition, innovation, and growth. The existing governing system spreads across more than 50 jurisdictions and has proven burdensome and expensive for all concerned. A more uniform regulatory environment mirroring the highly successful dual banking system is long overdue and stands to substantially improve the environment for those who buy, sell, and underwrite life and property and casualty insurance.”

In light of the blind spots in the current regulatory regime for banks uncovered by the subprime crisis, now is a peculiar time to suggest revamping insurance regulation along similar lines.

What price would consumers of insurance products pay for pursuit of this goal of uniformity and efficiency? Are we experiencing the benefits of uniformity and efficiency with our federally regulated mortgage market?

State regulation of the insurance industry certainly is not perfect. But an optional federal charter, at least in its currently proposed form, may create more problems than it solves. Perhaps an able consumer advocate should be involved directly in redrafting the federal proposal. We’d like to see a plan that avoids causing any future subprime insurance crisis.

Topics Trends Carriers Agencies Legislation Market