American International Group Inc. (AIG)’s near-collapse amid the financial crisis shows the need for coordinated U.S. insurance oversight, the Treasury Department’s Federal Insurance Office said.
AIG, recipient of a 2008 government bailout, demonstrated that none of its various regulators was able to supervise the company as a whole, the FIO said today in a report. The federal government should complement the existing state-based regulatory system rather than replace it, the FIO said.
“The U.S. system of insurance regulation can be modernized and improved by a combination of steps by the states and certain actions by the federal government,” according to the report. “Should the states fail to accomplish necessary modernization reforms in the near term, Congress should strongly consider direct federal involvement.”
Rules should be more consistent and gaps in oversight need to be plugged, the FIO said. Following the credit crisis, the Dodd-Frank Act helped strengthen the oversight of financial firms. It created the FIO, called for today’s report and expanded the U.S. government’s role in insurance regulation by giving the Federal Reserve oversight of non-bank financial firms deemed systemically risky.
AIG, once the world’s largest insurer, received a bailout that swelled to $182.3 billion after bets on housing soured amid the financial crisis, and finished repaying the U.S. last year. Its main federal regulator prior to the crisis was the Office of Thrift Supervision, which said in 2009 that it failed to recognize the risks of AIG’s bets on credit-default swaps.
U.S. insurers are primarily overseen by state regulators. The state authorities cooperate via the National Association of Insurance Commissioners, which holds meetings and can propose model regulation. The NAIC has resisted efforts to bulk up federal oversight of insurers.
The FIO, led by Michael McRaith, recommends an expanded federal role in overseeing mortgage insurers, which help cover lenders’ losses when homeowners default, because the firms are tied to the federal housing finance system. Three of the eight U.S. mortgage insurers failed during the housing collapse, and others saw their regulatory requirements loosened, the FIO said.
The FIO also called for stronger oversight of subsidiaries that some insurers use to offload risk from their main companies. Today’s document cited a report from New York’s insurance regulator, Benjamin Lawsky, that said such arrangements artificially inflate a measure of solvency monitored by regulators and called them “shadow insurance.”
McRaith’s department advocated a cautious approach to a new system of determining the level of funds insurers need to set aside for future claims, called “principles-based reserving.”
“It is very encouraging that the FIO has raised some of the same red flags New York has cited on both shadow insurance and principles-based reserving,” Lawsky said by phone. “These are two of the biggest threats to policyholder protection.”
Today’s report also deals with issues that directly touch consumers, such as marriage discounts for some insurance coverage. The FIO recommends that states reconsider whether to let insurers take marital status into account because discounts tied to marriage may put same-sex couples at a disadvantage in states that don’t recognize their unions.
The Financial Stability Board said in a report in August that the U.S. needs consistent insurance supervision and that the federal government should play an increased role. The FSB, led by Bank of England Governor Mark Carney, was established in 2009 and works to improve financial oversight.
Ben Nelson, the NAIC’s chief executive officer and a former Democratic U.S. senator from Nebraska, has said that the current system exemplifies ideals about restraints on centralized government.
“While we appreciate FIO’s suggestions for improvement, the states have the ultimate responsibility for implementing regulatory changes,” Nelson said today in a statement.
Jim Donelon, the NAIC’s president and Louisiana insurance commissioner, said NAIC members will discuss the report at a previously scheduled meeting in Washington this weekend.
The FIO advises the Financial Stability Oversight Council and aids the Treasury secretary on insurance issues. McRaith had been director of the Illinois Department of Insurance before he was named to lead the FIO in March 2011.
The oversight council, known as FSOC, has designated AIG and Prudential Financial Inc. (PRU) as systemically important non-banks, which places them under Fed supervision. MetLife Inc., the largest U.S. life insurer, is under review to be designated systemically risky.
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