AIG Crisis Restarts Debate Over State vs. Federal Insurance Regulation

September 17, 2008

The crisis surrounding giant insurer American International Group has reignited the debate within insurance circles over whether state or federal regulation is preferable.

The parent AIG got into trouble with credit transactions that were beyond the oversight of state insurance regulators. These ventures led to the situation that culminated in its $80 billion government loan. However, its insurance subsidiaries remain solvent.

Wasting little time, the insurer trade group, the American Insurance Association (AIA), used the AIG crisis to repeat its call for letting the federal government regulate insurers.

Marc Racicot, AIA president, said the recent turmoil in the financial markets and emergency government loan to AIG highlight a need to revisit the regulatory framework of the property/casualty insurance industry.

“Policymakers should look for solutions that avoid the potential for market crises and consider more effective ways of regulating the financial services sector and protecting consumers without compromising the efficiency benefits that free and open markets provide,” Racicot said.

He said that insurers should have the option to be regulated by a federal agency rather than various states.

“For highly-diversified financial services conglomerates that operate in multiple regions of the country and around the world, it makes little sense to continue to single out insurance for regulation on a piecemeal basis at the state level. It makes a great deal more sense for a federal regulator to monitor systemic risk and exercise group-wide supervision on a national basis to ensure safety and soundness,” Racicot said.

Not so fast, say state regulators, who point out that the problem with AIG is not its insurance operations that are regulated by them but with risky operations that federal regulators missed.

“The key distinction here is that AIG’s insurance subsidiaries did not cause this crisis — rather, they will play a critical role in the solution,” maintained Sandy Praeger, Kansas insurance commissioner who also heads the National Association of Insurance Commissioners.

“Calls for federal regulation of insurance in light of these events are simply unable to be supported. State regulatory oversight has kept the AIG insurance subsidiaries solvent, despite the actions of its federally regulated parent and non-insurance entities. If future developments challenge that solvency, there are state insurance regulatory safeguards in place to protect policyholders,” she said.

AIG’s non-insurance parent company is federally regulated and not held to the same investment, accounting and capital adequacy standards as its state-regulated insurance subsidiaries, according to Praeger. “This allowed various non-insurers to engage in risky credit transactions (huge positions in credit derivative swaps on mortgage-backed securities) without the appropriate limits and minimum capital/surplus to protect the company from a downswing in the mortgage-backed security markets,” she said.

She predicted that it will likely be the insurance subsidiaries — or their blocks of business and assets — that will be sold in an attempt to return the AIG parent company to a more stable financial position.

The NAIC has established a working group to oversee AIG insurance interests in the current financial situation and to coordinate with federal regulators. New York State Insurance Superintendent Eric Dinallo is chair of the working group and Pennsylvania Insurance Commissioner Joel Ario will serve as vice-chair.

Under the federal Gramm-Leach-Bliley Act (GLBA), insurance regulatory authority only applies to actual insurance entities and transactions with those entities. Within AIG, there are 71 U.S. insurers subject to this authority. The remaining 176 entities are split between foreign entities and non-insurance U.S. entities. The lead U.S. regulator of AIG financial holding company is the Office of Thrift Supervision (OTS), a federal banking regulator.

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