The Federal Reserve's $123 billion bailout of American International Group (AIG) has revived the long-running debate about whether state commissions should step aside and allow the federal government to regulate insurance companies.

And, since AIG is a leading issuer of annuities in the U.S., the resolution of that controversy will have an impact on the retirement income industry.

State insurance officials argue that none of the AIG insurance subsidiaries that they regulate were directly harmed by the past year's economic turmoil. Only the AIG holding company, which is regulated by the Office of Thrift Supervision, ran into trouble.

"Ladies and gentlemen, the government did not bail out an insurance company," said Roger A. Sevigny, the New Hampshire insurance commissioner at a national meeting of the 50 state commissioners September 23. "The government bailed out AIG and some of its financial holdings."

But proponents of a so-called "optional federal charter" (OFC) argue that the AIG case shows that the state-based regulatory system can't handle the complexities of the modern insurance industry. In a Sept. 23 Wall Street Journal op-ed piece, they argued that more big failures would occur if Washington doesn't assume regulatory authority.

In the editorial, a bi-partisan group of legislators that included Senators John Sununu (R-N.H.) and Tim Johnson (D-S.D.), and Representatives Melissa Bean (D-Ill.) and Ed Royce (R-Calif.) said an OFC would "remove regulatory blind spots" from the insurance industry.

"The [bailout of AIG] is a clear sign that the status quo is no longer a pragmatic-or responsible-option," the lawmakers wrote. "Letting this 19th century regulatory model govern a 21st century global marketplace poses obvious and increasing risks to the health of the insurance industry, American taxpayers and our capital markets."

The Wall Street Journal article concluded that AIG, with over $1 trillion in assets, is too big for the states to regulate. "Clearly, some insurers have become too complex and too interconnected worldwide for the limited resources of state regulators to handle," the article said.

State officials don't believe that OFC argument holds water. According to a source at the National Association of Insurance Commissioners, speaking on condition of anonymity, "OFC proponents desire an environment of regulatory arbitrage where companies could choose the regulator with the weakest oversight. The argument for federal regulation is really an argument for deregulation."

"I'm not surprised by much in politics at my age, but I am disappointed in some of the attempts by proponents of an optional federal charter to use this situation to make their case," said Pennsylvania Insurance Commissioner Joel Ario. "They try to make an argument that is overly simple: AIG is an insurance company, AIG is in trouble, therefore insurance regulators failed in their job and we need a federal regulator. In fact the story is exactly the opposite."

The Blame Game

The Wall Street Journal article was not the first appeal for federal regulation of the insurance industry. In a March 2008 report, "Blueprint for a Modernized Financial Regulatory Structure," the U.S. Department of the Treasury argued that the wholly state-based regulatory structure was "inefficient, costly and harmful to U.S. competitiveness."

Jeremy Alexander, who tracks fixed annuities as president of Beacon Research, agrees the current system has inefficiencies and that the myriad variations from state to state can be maddening. But he prefers a hybrid regulatory model to one that strips states of all jurisdiction over insurers.

"The biggest reason I saw for federal oversight was the tremendous redundancy in paperwork and filings," he said. "But from a regulatory standpoint, it's hard to say that the states aren't making sure these carriers are healthy and doing the right things. A lot of the failure occurred at the federal level, so I don't understand how anyone could say that the answer is to take all the power away from the states."

Alexander notes that whenever a policyholder has a problem with their insurance or insurance company, the states take care of it. By taking away their authority, he said, "it seems you're inviting some problems that aren't even there."

The AIG holding company owns 71 U.S.-based insurance companies and 176 other financial services companies. Twelve of the insurance companies fall under New York's jurisdiction,

including American International Life Assurance Company, First SunAmerica Life Insurance Company, and United States Life Insurance Company in the City of New York.

In a report published on Oct. 6, New York State Insurance Superintendent Eric Dinallo said, "Some have tried to use AIG's problems as an argument for an optional federal charter for insurance companies. I am open to some federal role in regulating insurance and the non-insurance operations of financial services groups such as AIG. But what happened at AIG demonstrates the strength and effectiveness of state insurance regulation, not the opposite."

N.Y. Regulators Step Up

In New York State, where AIG employs over 8,000 people with a payroll of almost $900 million, state regulators reacted quickly to AIG's problems. While assuring policyholders that AIG could not raid its insurance carrier subsidiaries for emergency cash, regulators began exploring ways to help AIG leverage the assets of insurance companies.

On Sept. 15, according to Superintendent Dinallo's report, his office and Governor David Paterson proposed a plan in which AIG would temporarily access $20 billion in excess surplus assets held by its New York insurance subsidiaries.

Under that proposal, AIG would have sold some of its life insurance companies to its property insurance companies. In exchange for the life companies' stock, the property companies would have transferred municipal bonds to the troubled holding company for use as collateral. This plan was superseded, however, by the $85 billion federal bailout.

Only weeks later, when AIG needed more money, the insurance subsidiaries played a role in securing it. According to an Oct. 9 report in The New York Times, "the Federal Reserve Bank of New York agreed to accept up to $37.8 billion of fixed income securities from AIG's regulated life insurance subsidiaries and will give the subsidiaries cash collateral in return...to help the insurance subsidiaries to settle existing transactions in their securities lending business.

"In that business, the insurers lent securities to investors, like hedge funds, and received both the value of the securities and a fee in return. The insurers then invested those funds in other instruments, such as mortgage-backed securities.

"But now that the mortgage-backed securities have plummeted, AIG's insurance subsidiaries do not have the money to repay their securities-lending partners when they bring back the securities they borrowed and want their money back.

"By stepping in and permitting AIG to lend the securities onward to the New York Fed, the Fed will allow AIG to preserve cash. It will also keep AIG from having to mark down the value of the securities at a time when their market value is constantly changing."

Although their policyholders appear safe, AIG's insurance subsidiaries won't escape from the holding company's problems unscathed. On Oct. 3, Standard & Poor's indicated that the ratings on most of the subsidiaries would remain on CreditWatch with negative implications, meaning they could be downgraded.

 

 

Originally published by Retirement Income Reporter.