Insurance industry needs federal oversight

Congress is likely to begin a review of the financial oversight system next month, with an eye toward revamping regulation. Banking, of course, will take center stage, especially now that the federal government has a direct stake in many of the nation’s largest banks.

But with the government’s in-volvement in American International Group Inc. of New York claiming more than $180 billion from taxpayers, insurers should also come under the congressional microscope.

The issue of insurance regulation has been simmering for years.

Large insurance companies have lobbied for federal regulation to escape what they see as a crazy quilt of state rules — and to create a new overseer that they could eventually co-opt.

State regulators fear an erosion of their power — and the loss of campaign donations from insurance companies and future jobs with carriers.

Both sides cloak their narrow self-interests in the mantle of consumer protection.

Behind the wrangling between regulator and regulated, however, lies a more fundamental question — one that our elected representatives would do well to consider before designing a new regulatory system: What is the purpose of insurance regulation?

As a society, do we regulate insurers to protect the purchasers of insurance from fraud, from the financial insolvency of the carriers or to protect the financial system from an insurer’s excessive and inappropriate risk-taking?

If we regulate for all three purposes, which seems to be the case, even if rarely articulated as such, the best way to accomplish our collective goals may be to bolster and augment the existing system, rather than dismantle it.

One way to do this would be to convert the National Association of Insurance Commissioners, the Kansas City, Mo.-based organization of state regulators that reviews and drafts model laws and policy forms for the states, into a regulatory organization under federal oversight.

Along those lines, the NAIC would be required to add several public members to make it more effective and to ensure that it operates in the public interest.

A broader-based NAIC would continue to monitor insurance company capital, but also would establish and support uniform rules so that insurers could not “shop” states for the lowest level of regulation.

Uniform rules also would eliminate the situation in which some states require fingerprinting of agents and some don’t (InvestmentNews, May 18). In that case, the NAIC has recommended that states have access to the FBI database, but has no authority to do anything more than squawk.

The federal overseer of an en-hanced NAIC would focus primarily on the investment and risk-related activities of big insurers. The AIG experience has demonstrated that certain big carriers — such as giant banks — are too big to fail.

But they aren’t too big to be denied government largesse. And since that is the case, they are prime candidates for federal oversight.

A new federal oversight body for large carriers should further the work of the NAIC’s Insurance Regulatory Information System, which monitors insurers’ solvency, and extend the group’s risk-based capital requirements, so that the wide range of insurance risk-taking — including the credit default swap business — comes under the regulatory umbrella.

Despite the mood of the moment, in which federal regulation and federal intervention seem to remedy every problem that plagues us, we should move carefully and in a measured way if we contemplate even limited federal oversight of the insurance industry.

Insurers should continue to be monitored by a state system that combines the best of local oversight and broader enforcement power. But for insurers large enough to bring down the nation’s financial system, a federal risk manager may be appropriate.