Shifting the regulatory burden?

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By Joy A. Schwartzman, Michael C. Schmitz | 21 April 2008


April 21, 2008

Treasury Secretary Henry Paulson recently proposed an optional federal charter for the insurance industry.

This Spotlight is excerpted from a larger article on the subprime crisis that will appear in Insight magazine on May 10.

As part of his blueprint for financial services reform in the wake of the subprime meltdown, Treasury Secretary Henry Paulson proposed an optional federal charter for the insurance industry, an intermediate step that would lead to the creation of a new Office of National Insurance (ONI) within the Treasury Department. ONI would have broad powers to address international issues and competitiveness.

Q: Wasn't legislation similar to Secretary Paulson's proposal introduced in Congress last year, before subprime became an issue? What's the connection to subprime?

A: It is true that neither the issue nor the proposal is new, and the relationship to subprime is tangential at best. This proposal is the latest move in a tug of war that has been going on for more than a hundred years between those who favor the existing state-based system of insurance regulation and those who would like to see greater federal involvement. In 1869, the Supreme Court held in "Paul v. Virginia" that insurance was not interstate commerce and should be regulated by the states. In 1944, "Paul v. Virginia" was overturned, prompting Congress to pass the McCarran-Fergusson Act, giving insurers limited exemption from antitrust laws and preserving states' role as primary regulators. The solvency crises of the 1980s and early 1990s and the passage of Gramm-Leach-Bliley in 1999 added fuel to the debate. More recently, growing criticism that the current system is out of date and stifles competition has led to increasing pressure for some kind of overhaul.

Q: What kind of regulatory impact can we expect from Secretary Paulson's proposal, assuming it goes forward?

A: Very little in the short term; the process will take some time. Ultimately, the proposal calls for a dual regulatory scheme with oversight shared between the states and the federal government, much like the current banking system. Under Treasury's proposal, state-based regulation would continue for those companies electing not to be regulated at the national level.

Q: What has been the response of the industry to Secretary Paulson's proposal?

A: Mixed. Large national companies tend to favor a federal system while smaller companies and trade groups representing brokers and individual agents generally would like to see the state system retained. Both groups admit there are competitive and international issues that need to be addressed, but opponents of the Optional  Federal Charter (OFC) would like to see the state system revamped to make it more competitive before bringing in any federal component.

Q: What are the competitive and international issues driving the proposal and what effect could an OFC have on competitiveness?

A: Proponents point out that responding to 51 different sets of regulatory requirements is burdensome for national and international companies doing business in the United States. Those opposed suggest that competitiveness will actually suffer under a federal scheme, as it could lower the regulatory burden for large and international companies, encouraging them to enter state markets they have heretofore avoided, undercutting costs and putting smaller insurers out of business.

Joy Schwartzman is a principal and consulting actuary with the New York office of Milliman who specializes in property and casualty insurance.

Mike Schmitz is a principal and consulting actuary with the Milwaukee office of Milliman who runs a practice focused on credit and mortgage risk.