Systemic Risk -- Federal Regulation of Large Insurance Companies

White House Asks U.S. Regulator For Large Insurers
    * By Arthur D. Postal
     P&C National Underwriter
     Published 3/26/2009

The Obama administration today asked Congress for authority to create a federal regulator with authority to administer large insurance companies.

Under the proposed scheme, federal administration would be based on “the financial system’s interdependence with the firm, the firm’s size, leverage (including off-balance sheet exposures), and degree of reliance on short-term funding.”

Another characteristic will be the importance of the firm “as a source of credit for households, businesses, and governments, and as a source of liquidity for the financial system.”

In testimony before the House Financial Services Committee, Treasury Secretary Tim Geithner said what he is asking Congress today is only the first step. Mr. Geithner's comments also included is remark that,"I think there is a good case for introducing an optional federal charter for insurance companies."

The comprehensive framework for regulatory reform will cover four broad areas: systemic risk, consumer and investor protection, eliminating gaps in our regulatory structure, and international coordination.

“In the coming weeks, I will present detailed frameworks for each of these areas,” he added.

Secretary Geithner outlined the administration’s plans in testimony before the House Financial Services Committee.

“Let me be clear: the days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers from losses must end,” said Mr. Geithner.

“We must cover financial institutions that have the potential to pose systemic risks to our economy but that are not currently subject to the resolution authority of the FDIC,” he added.

“This would include bank and thrift holding companies and holding companies that control broker-dealers, insurance companies, and futures commission merchants, or any other financial firm posing substantial risk to our economy,” he said.

He said that proposed legislation will be submitted to provide such a U.S. regulator with authority to put such firms into conservatorship or receivership and, “The regulator of these entities will also need a prompt, corrective action regime that would allow the regulator to force protective actions as regulatory capital levels decline, similar to that of the FDIC with respect to its covered agencies.”

The institutions that would be covered under such authority will be “financial institutions that have the potential to pose systemic risks to our economy but that are not currently subject to the resolution authority of the Federal Deposit Insurance Corporation.”

“This would include bank and thrift holding companies and holding companies that control broker-dealers, insurance companies, and futures commission merchants, or any other financial firm posing substantial risk to our economy,” he said.

In a research report, the Concept Capital, a New York-based investment management and research firm, said the proposal by Secretary Geithner aims to “give a systemic risk regulator unprecedented power over financial firms of all types.”

That means, the report said, “federal regulators will have the power to examine the books, capital position and leverage at insurance companies, hedge funds, private equity firms, and any other financial firm.

“The idea is to focus only on those financial firms that could pose a systemic risk to the financial system,” the report said.

The report noted that Secretary Geithner is not identifying which agency would be the systemic risk regulator, though House Financial Services Chairman Barney Frank, D-Mass., wants to give the job to the Federal Reserve.

New York Insurance Superintendent Eric Dinallo, reacting to Mr. Geithner’s testimony, said what is being sought is “some kind of oversight and resolution of the holding companies and lightly regulated parts of these conglomerates, like we saw at American International Group.” He called it a serious plan.

Mr. Dinallo added, however, that, “I believe that insurance companies standing alone, even very large ones, don’t present the same systemic risk as the financial supermarkets or large, leveraged institutions. I think we have to parse this out a bit. It wasn’t the insurance companies that caused this problem at AIG.”

The National Association of Insurance Commissioner issued a statement saying  they were "encouraged" by Mr. Geithner's remarks "that this proposal will maintain the important role that state regulators play in supervising insurance companies. We agree with his assetion that financial institutions must not be allowed to 'cherry pick' among competing regulators in search of the lowest standards and constraints."

NAIC said it agrees there is a need to address how resolutions would operate for financial structures and activities outside the existing FDIC system for banks and state guaranty fund system for insurers, adding that "any expansion of federal resolution authority should not displace those proven systems."