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By CYRIL TUOHY, managing editor of Risk & Insurance®

PHILADELPHIA---Insurance industry executives on Friday, April 8, reiterated their support for a state-based system for regulating insurance, saying that, while it was at times inefficient, the latest financial crisis had once again proven that state-based regulation is effective.

The fact that the bulk of the property/casualty industry came out of the Great Recession relatively unscathed proved that the state-based system of U.S. insurance regulation was sound, he said. State regulators stay close to the issues facing the carriers they regulate, the reasoning goes.

In a rush to shore up financial services regulation, Congress last June passed a sweeping package of reforms known as the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The law creates the Federal Insurance Office, but the new office amounts to "a grand compromise," for the industry, said Howard Schweitzer, former chief operating officer of the Troubled Assets Relief Program.

So long as state regulators do their jobs and remain vigilant, there's no reason to superimpose another layer of federal regulation on top of the state system, the executives in Philadelphia reasoned.

At AIG, it was a rogue, unregulated unit that brought the entire company perilously close to oblivion. At Hartford Financial Services Group Inc., massive losses came more from the life and health unit than the property/casualty side of the business.

As a rule, insurance industry failures were often limited to small, thinly capitalized or undiversified companies--mortgage insurers for example--the executives said.

The executives also noted, with more than a hint of irony, how deeply the rot had set into the federally regulated banking system. There were 157 bank failures in 2010, up from 140 failures in 2009 and 25 failures in 2008, according to data compiled by the Federal Deposit Insurance Corp., and posted by calculator.plus.com. As of April 8, a total of 28 banks have failed so far in 2011.

The near-collapse of the nation's banking system proves that federal supervision doesn't guarantee the integrity and the orderly functioning of the financial services industry.

Slapping federal rules onto an existing state framework, therefore, isn't necessarily the answer, they reasoned, since the issue is not so much whether federal or state rules prevailed, but whether regulators did their job.

Thomas F. Motamed, chairman and CEO of CNA Financial,. noting that the industry remained liquid and open for business paying claims right through the Great Recession, said that changes are warranted only if and when they make sense.

To label insurance and reinsurance companies as "systemically risky" institutions based on size alone is "dubious" at best, said Robert Hartwig, president and chief economist of the Insurance Information Institute.

Any authority contained in Dodd-Frank to pre-empt state laws will not be easy to carry out, however, in part because the U.S. Treasury Department, under which the FIO is located, doesn't have the IT infrastructure to analyze the industry in any serious depth.

As a result, "in the first instance, this office is going to study the industry and will be preparing a road map for policy makers with respect to the modernization of insurance regulation," said Schweitzer, a member of the law firm Cozen O'Connor.

In March, Michael McRaith, the insurance commissioner of the state of Illinois and secretary-treasurer of the National Association of Insurance Commissioners, was appointed to lead the Federal Office of Insurance.

Whatever ultimately becomes of the federal office, Schweitzer and James Maguire, founder and chairman emeritus of the Philadelphia Insurance Cos., said that the FIO is likely the first step--for better or for worse--of more federal involvement in the industry.

Dodd-Frank, Maguire said, could be the first in a series of steps to wean the industry from state regulation to federal regulation.

April 12, 2011

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