Two publications of interest to insurance regulators (and former insurance regulators) were issued by the federal government in March 2008. The first, the U.S. Treasury’s Blueprint for a Modernized Financial Regulatory Structure, should have the most impact on insurance regulators since it recommends an optional federal charter (OFC) approach to insurance regulation.

The second, authored by the President’s Working Group on Financial Markets, was commissioned last summer by President Bush to determine the root causes of the subprime crisis and recommend changes. The group includes representatives from the Treasury, the SEC and the Federal Reserve Board of Governors. This report also impacts state insurance regulators, but to a lesser extent than Blueprint.

With respect to the first report, our objections begin with its title: Blueprint for a Modernized Financial Regulatory Structure. The word “modernization” always sticks in our craw when coupled with proposals to dramatically alter our financial regulatory landscape. What bothers us is the notion that any new proposal — regardless of how flawed it may be — would modernize our current system. We think a title such as Blueprint to Replace a Hopelessly Outmoded, Out-of-Date Regulatory Structure would more accurately reflect the authors’ anti-state bias.

What’s more, most of these proposals aren’t even new. They’ve simply been dusted off by long-time opponents of state regulation with the hope that they’ll be adopted under the rubric of regulatory reform.

The Working Group report points to “weak mortgage underwriting standards” between late 2004 and early 2007 as the prime reason for this nation’s financial troubles. If the lending practices of banks, which are largely federally regulated, are indeed primarily responsible for our current financial woes, why would we want to bring even more financial entities under the federal regulatory
tent?

In our book, weak mortgage underwriting standards means no underwriting standards when it comes to most adjustable rate subprime mortgages issued during that period. When prospective homeowners are permitted to submit mortgage applications with little or no documentation, prudent underwriting standards fall by the wayside.

Would state regulators permit auto insurers to discard underwriting rules and then sell those policies to third parties? Would they let it go on for more than two years? We don’t think so.

Online searches reveal that of the 16 Blueprint authors credited in the report, only one - Roy Woodall - appears to have any meaningful insurance regulatory background. He served briefly as Kentucky Insurance Commissioner more than 40 years ago, but spent a much longer time as an executive for the American Council of Life Insurers (ACLI) before joining the Treasury Department early in the current Bush Administration. The ACLI has long advocated an OFC approach to insurance regulation. In fact, the organization boasts that in 2000 it “developed a proposal to establish an optional federal charter for life insurers.”

As a general principle, we submit that it’s unwise for federal banking regulators to attempt to devise new approaches to insurance regulation.* For the most part, insurers and banks offer vastly different products. That’s a major reason why the convergence of banks and insurance that was so widely anticipated following the enactment of Gramm-Leach-Bliley failed to materialize.

Lastly, we wondered why — if a federal insurance regulatory system is so vastly superior to a state-based system — are insurers given an option under OFC to choose their favorite regulatory system? Doesn’t that just lead to a “race to the bottom,” whereby insurers choose the least onerous form of regulation? If federal regulation of the insurance industry is so clearly superior to the structure currently in place, why not just eliminate the state-based option altogether?

It’s a special kind of hubris that leads federal regulators in one financial services sector to believe they’re capable of regulating them all. It’s also a special kind of hubris to believe that when federal regulation fails, the answer is to bring more financial services entities into the fold. Will reason prevail? Stay tuned.

- W.C., May 2008

*At a NYSID in-house seminar a few years ago, we heard a former high-level Fed official confess he had just recently learned that the insurance industry was regulated by the states. We were only mildly surprised at the time since he was a bank, not an insurance, regulator. Ever since then, however, we’ve wondered how much most federal bank regulators really know about the business of insurance regulation.

This piece was adapted from an article, authored by Wayne Cotter, in the May 2008 issue of The Regulator, the newsletter of the Insurance Regulatory Examiners Society (IRES).