Obama Administration Includes Federal Involvement in the Regulation of Insurance
as Part of a Broad Proposal for Financial Institution Regulatory Reform

Written by Attorneys Francine L. Semaya and William K. Broudy

Note: This article is an interpretation of current law and is offered for informational purposes only. This material is not legal advice and should not be construed or used as a substitute for the advice of an attorney.

In a report proposing broad and sweeping changes in the regulation of financial institutions (the "Report"), the Obama Administration has laid out several proposals for federal involvement in the regulation of insurance, including the establishment of a federal Office of National Insurance ("ONI") and a federal charter alternative.

According to the Report, a lack of expertise within the federal government regarding insurance has been highlighted by the current financial crisis. Blaming the current state insurance regulatory system for "inefficiency, reduced product innovation and higher costs to consumers", the Report announces the need for an ONI as part of a modern regulatory framework for insurance. The Report also asserts that while AIG's principal problems occurred outside its insurance businesses, losses also arose in its state-regulated insurance companies.

The ONI should be responsible for monitoring all aspects of the insurance industry. It should gather information and be responsible for identifying the emergence of any problems of gaps in regulation that could contribute to a future crisis. The ONI should also recommend to the Federal Reserve any insurance companies that the Office believes should be supervised as Tier 1 FHCs. The ONI should also carry out the government's existing responsibilities under the Terrorism Risk Insurance Act.[1]

Noting that of the 190 member countries of the International Association of Insurance Supervisors ("IAIS"), the United States is the only member country without a federal insurance regulatory entity, the Report states that "...the ONI will be empowered to work with other nations and within the IAIS to better represent American interests, have the authority to enter into international agreements, and increase international cooperation on insurance regulation".[2]

The Report sets forth the Treasury Department's six principles for insurance regulation.[3]

The six principles are:

●     Effective systemic risk regulation with respect to insurance.

      

       The Report acknowledges that the steps the Administration proposes will address systemic risks posed to the financial system by the insurance industry. Additional regulation specific to insurance will be considered if required to reduce systemic risk.

●     Strong capital standards and an appropriate match between capital allocation and liabilities for all insurance companies.

       Adequate capital standards and a strong capital position are important for all financial firms, including insurers, particularly the management of liquidity and duration risk.

●     Meaningful and consistent consumer protection for insurance products and practices.

       While many states have enacted strong consumer protection measures, such protections vary among the states. The Report calls for enhanced consumer protections, including the regulation of producers.

●     Increased national uniformity through either a federal charter or effective action by the states.

       This principle strongly attacks the current state insurance regulatory system as "highly fragmented, inconsistent and inefficient" resulting in "tremendous differences in regulatory adequacy and consumer protection among the states". The principle leaves the door open to what changes need to be made to the state regulatory system.

●    Improve and broaden the regulation of insurance companies and affiliates on a consolidated basis, including those affiliates outside of the traditional insurance business.

      The Report calls for addressing the current gaps in insurance holding company regulation to identify and prevent those gaps that allegedly arose with the AIG financial crisis.

●    International coordination.

      The objective of this principle is to "enhance the international competitiveness of the American insurance industry, and expand opportunities for the insurance industry to export its services".[4]

Several Congressional hearings are scheduled on the Administration's regulatory proposals, commencing on June 18, 2009. Insurance regulatory reform, although mentioned in the Report, is not the primary focus of the Report or the initial hearings. The Report states that in 2008 the insurance industry had $5.7 trillion in assets, compared with $15.8 trillion in the banking sector and that the 2.3 million jobs in the insurance industry make up almost a third of all financial sector jobs.[5] The Report concludes that the ONI is required, given the importance of a healthy insurance industry to the U.S. economy.[6] The ONI is an important first step toward insurance regulatory reform, but total reform of insurance regulation is not a key objective of the Proposal.

Overall, the insurance industry does not pose a systemic risk to the economy, but in the future, insurance holding companies will be under scrutiny to prevent potential systemic risk from arising and posing a threat to the U.S. economy.