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For more than two years, Congress, the insurance industry and insurance consumers have been waiting for the report of the Federal Insurance Office (FIO) — an agency set up within the Treasury Department by the Dodd-Frank Act. The report was supposed to make recommendations for the modernization of U.S. insurance regulation, and it finally arrived last week, landing with a thud on desks in Washington and elsewhere.
Certainly, the FIO should be commended for the report’s formal recognition that the U.S. regulatory system for life and property/casualty insurers is in need of modernization but, frankly, more might have been expected from this agency when both President Obama and the FIO’s director are from Illinois, the one state that has demonstrated the viability and effectiveness of a state-based system that has allowed the competitive marketplace to establish insurance prices. Indeed, the director of the FIO, Michael McRaith, was formerly the insurance director for Illinois, and surely must have seen the benefits to consumers and others from the competitive environment there.
But the FIO report is a modest, some might say timid, call for reform. “Progress of state modernization efforts,” it mildly observed, “have been uneven.” And “should states fail to accomplish necessary modernization reforms in the near term, Congress should strongly consider direct federal involvement.” That leaves things about where they have always been. For that we needed an FIO? One senses that the long delay in the report’s publication came not from concern that it was too bold, but because it restates the obvious without recommending real modernization efforts.
The report recognizes the confusion and uncertainty that can be brought about by 51 different state insurance regulatory jurisdictions, but FIO might have had some better suggestions for achieving uniformity than “state regulators should pursue the development of nationally standardized forms and terms, or an interstate compact, to further streamline and improve the regulation of commercial lines.” How many years has that been idea been floating around? The current U.S. system has not been able to provide the uniformity necessary to deliver high quality financial services nationally, let alone internationally, since the NAIC first enunciated the goal of uniformity in 1871, as the FIO report itself acknowledges.
The insurance regulatory system is an anomaly when compared to banking and securities, the other major and in many cases competitive financial services. This is not to say that insurance regulation is worse than banking and securities; in fact, in many respects the insurance industry is more stable than the banking and securities industries, which were seriously damaged by the 2008 financial crisis. But stability in the face of a financial crisis came largely from the nature of the insurance business — its need for long term assets to match its long term liabilities — and can only be partially credited to its regulatory structure.
Making things worse, the Dodd-Frank Act adds more uncertainty, complexity and the potential for conflicting regulation. These conflicts have been a problem for insurers subject to the Federal Reserve’s supervision as savings and loan holding companies, and will be a problem for insurers, such as AIG and Prudential Financial, that have been designated thus far as systemically important financial institutions (SIFIs) by the Financial Stability Oversight Council (FSOC). The Federal Reserve thus far has shown little recognition of the vast differences between insurance and bank capital accounting or the keys to insurance solvency.
There is no way to know how the Federal Reserve will treat these large companies, but it is clear that these firms will, under the Fed’s hand, be following a completely different regulatory path than others with which they will be competing. This is another area where the FIO could have weighed in, but there was nothing in the report to indicate that FIO would use its expertise in insurance accounting and regulation to assist the Federal Reserve in developing its insurance regulatory regime.
Although states have an effective nationally-developed risk-based capital framework to promote insurer solvency, in many states these systems include price controls and are being used to keep insurance prices below actuarially sound levels for providing coverage. This has caused insurers to leave, kept competition out of some markets, and left consumers with fewer choices. The experience in Director McRaith’s home state of Illinois shows that competition can keep rates down while offering consumers a variety of choices better tailored to their needs.
The FIO report implicitly recognized this situation, but recommended only that “states should monitor the impact of different rate regulation regimes on various markets in order to identify rate-related regulatory practices that best foster competitive markets.” Was it too much for the Obama administration to say “states should consider (or experiment with) deregulating rates in order to foster competition. The FIO stands ready to assist in this process and will monitor the steps taken in this direction. If limited progress makes it necessary, FIO will bring the issue of rate deregulation to the attention of Congress”? Congress, insurance consumers and the insurance industry still await a federal government report that will spur real insurance industry regulatory modernization.
Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute. His book, “Bad History, Worse Policy: How a False Narrative About the Financial Crisis Led To the Dodd-Frank Act” was published last February.
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