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Hearing Of The Subcommittee On Capital Markets, Insurance, And Government Sponsored Enterprises Of The House Financial Services Committee - "How Should The Federal Government Oversee Insurance?"

Hearing Of The Subcommittee On Capital Markets, Insurance, And Government Sponsored Enterprises Of The House Financial Services Committee

Subject: "How Should The Federal Government Oversee Insurance?"

Chaired By: Rep. Paul E. Kanjorski (D-Pa)

Witnesses: Baird Webel, Specialist In Financial Economics, Congressional Research Service; Patricia Guinn, Managing Director, Global Risk And Financial Services Business, Towers Perrin; J. Robert Hunter, Director Of Insurance, Consumer Federation Of America; Martin F. Grace, James S. Kemper Professor, Department Of Risk Management And Insurance, Georgia State University; Scott Harrington, Alan B. Miller Professor, Wharton School, University Of Pennsylvania

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REP. KANJORSKI: (Sounds gavel.) We meet today to continue the review by the Capital Markets Subcommittee of insurance regulation. Our panel has taken the lead in Congress during the last few years in debating insurance matters and finding consensus for reforms to modernize our national insurance laws.

Unlike other financial sectors that have evolved over time to include some degree of federal and state regulation, states alone continue to have the primary authority to regulate insurance today. For that reason, Congress has historically only passed insurance legislation to respond to a crisis, address a market failure, or adopt narrowly-focused insurance reforms.

For example, after September 11, Congress ultimately passed the Terrorism Risk Insurance Act so that construction could continue after the terrorist attacks, and businesses could obtain coverage to protect their liability. After a series of hearings debating the insurance reform last Congress, this committee considered and approved four narrow insurance bills.

One of those bills, the Insurance Information Act, could help the federal government build a knowledge base on insurance matters so that the federal government could see the complete picture of the insurance industry, rather than intermittently seeing the brushstrokes of a particular problem in the industry, or at a particular company.

We are very fortunate that this committee has a long history of working in a bipartisan fashion. I hope we continue in that vein, and find common ground on these matters.

Throughout, broadly supported legislative reforms are usually the most successful. We must however, also move swiftly yet deliberatively, in developing a new game plan to involve the federal government in more direct oversight of the insurance industry.

Today, we are both responding to a crisis of sizable proportions and seeing the big picture of an interconnected modern financial services system for the first time.

After the turmoil in the bond insurance marketplace, the decision to provide substantial taxpayer support to American International Group, and the requests of numerous insurers to get capital investments from the Treasury, we can no longer continue to ask the question about whether the federal government should oversee insurance.

The answer here is clearly yes. The events of the last year have made and have demonstrated that insurance is an important part of our financial markets. The federal government therefore should have a role in regulating the industry.

As such, we now must ask how the federal government should oversee insurance going forward. This question is the topic of today's hearing.

The answer to this question is difficult. The bond insurance crisis showed that even small segments of the industry can have a large economic impact.

AIG taught us that the business of insurance has become complex and no longer always fits nicely into the state regulatory box.

Moreover, some companies operate unlike traditional insurers in today's markets. Instead of insuring assets, these companies insure financial transactions and use substantial leverage.

My assessment should not be taken as criticism of the present state regulatory system. By and large, state regulators have performed well, despite the growing complexity of the financial services system.

That said, I am also not suggesting that we expand the mission of state insurance departments beyond insurance. At the very least, this Congress must address insurance activities as it creates a new legislative regime to monitor systemic risks and unwind failing non- depository institutions.

The administration's proposal to create a resolution authority properly includes insurance holding companies. Oversight of any financial activity, insurance or otherwise, as it relates to the safety and soundness of our economic system must also be mandatory.

Insurance is complex, and it is time for the federal government to appreciate its importance. Equally important to me is that Congress not limit itself to simply responding to this latest crisis.

Many insurance products are either of national importance or uniform in nature. We must therefore consider whether to regulate these elements of the industry nationally.

In sum, we have asked our witnesses to help us to examine these issues. Their fresh perspectives can point us in the right direction as we think about these matters in a new light.

I'd like to recognize the Ranking Member Mr. Garrett for five minutes for his opening statement.

REP. SCOTT GARRETT (R-NJ): Thank you, Mr. Chairman, and I look forward to an interesting discussion today on the appropriate role of the federal government to regulate insurance going forward, particularly in the context of proposals for risk regulators and resolution authority for these large non-bank financial institutions.

You know, as I have outlined in my previous hearings is I have concerns with some these proposals and the likely unintended consequences if they are to be implemented. As for a systemic risk regulator, we have been told throughout history that more regulation will solve our problems.

Now, the Federal Reserve itself was created to "ensure" that these asset bubbles and panics would never happen again. It was back in 1914 that the then Comptroller of the Currency had high expectations when speaking about the law that created the Fed.

He said, "Under the operation of this law, such financial and commercial crises or panics that the country experienced in 1873, and 1893, and 1907 seem to be mathematically impossible." Clearly he was mistaken, and he's had a lot of company since then.

A certain level of regulation is appropriate, but many of the reforms being talked about now will reduce market discipline and increase moral hazard. With the resolution authority being proposed by Secretary Geithner and others for instance, I have real doubt that this can be implemented without institutionalizing an entire segment of too big to fail companies.

So I have concerns in general about systemic risk regulation and resolution authority, but what they seem particularly inappropriate is for the insurance industry. The insurance companies, especially those dealing primarily with retail customers are different in nature from banks, for example.

They are not nearly as interconnected with the rest of the financial service sector and the economy as a whole. Additionally, we have -- already have the state guaranty funds to deal with insolvent insurance companies. And quite frankly these funds have historically worked very well.

Bond insurance, as you mentioned, of course is a bit of an outlier here and the committee I think will address some of the unique challenges facing that sector on a different track. I also have concerns in this current environment, and with the makeup of the present administration and congressional leadership, with proposals calling for significant regulatory changes.

To supporters of these proposals I would say, be very careful what you wish for. And when you think about it, it's not too far- stretched to see a tri-layered or even quadruple-layered regulatory structure for insurance when all the dust settles.

You'd have state regulation, federal regulation, systemic risk regulation, and resolution authority regulation on top of that. So while the topic of federal versus state regulation of insurance fosters intense debate, I believe we all can agree that a multilayered regulatory structure for the insurance industry would not provide the best model for a competitive and a robust marketplace.

Finally one other piece of the regulatory puzzle. I've been working with Congressman Dennis Moore and we've been directly involved in the Nonadmitted and Reinsurance Reform Act.

As you may know this a piece of legislation that passed the House overwhelmingly in past Congresses -- past two Congresses, and what do we do with update and streamline state regulation in a nonadmitted or surplus lines and the reinsurance market.

So the surplus lines bill is an area of insurance regulatory reform where there is broad consensus, and I look forward to working with my colleague on the other side of the aisle to make sure that we get that piece of legislation done during this term of Congress. And with that I yield back.

REP. KANJORSKI: Thank you very much, Mr. Garrett. Now, I recognize the gentleman from California, Mr. Sherman for two minutes.

REP. BRAD SHERMAN (D-CA): Thank you Mr. Chairman. When we first started talking about a federal role in insurance, we were dealing with the problem that certain life and annuity products were being approved too slowly through the multi-state regulatory process.

And I dream of those old days when the biggest issue facing the subcommittee might be that consumers were being denied creative annuity products on a timely basis. Such problems seem almost quaint. But we should try to achieve faster approval of new products through the multi-state process, or through some federal involvement.

But we should recognize that traditional insurance was well- regulated. And while all the other houses on the block blew down, the state regulated insurance policies and annuity contracts are still standing. In analyzing this issue, we have to ask what is insurance.

The president today has talked about an open, transparent market for derivatives. I think we have to look at many of these derivatives, particularly credit default swaps as insurance, and we don't allow people to sell insurance without regulation and without reserves.

And finally, I think Mr. Chairman, we have to avoid an issue of forum shopping where we create a circumstance where you get to pick your regulator. Not only will some insurance companies pick the easiest regulator, but you'll also see what we saw to some extent among bank regulators, competition to be the friendliest regulator.

Now, I'm all for friendliness, but that should not be the basis on which regulators are selected and evaluated. I yield back.

REP. KANJORSKI: Thank you, Mr. Sherman.

Now I'll recognize the gentleman from California, Mr. Royce for three minutes. But also Mr. Royce is the author with Ms. Bean, one of the important pieces of the legislation pending before the committee. So maybe we can get some insight into that field as we have this hearing today.

Mr. Royce, three minutes.

REP. EDWARD R. ROYCE (R-CA): Thank you, Chairman. Thank you for your continued leadership on this and the hearings that you held last year and now on this issue of insurance regulation.

I think that a consensus was formed that modernization of our regulatory structure was necessary, and I think part of that consensus is that there's a federal role here in insurance. I think the events of last year really changed the debate on insurance regulatory reform.

I think prior to last year, the regulatory structure of 50-plus separate regulators, that was criticized as being inefficient, as being duplicative, as being anticompetitive, certainly costly for consumers. But in early 2008 we had another issue surface, and we saw many of the top bond insurers suffered significant losses, and subsequent rating downgrades, resulting from their exposure to the U.S. mortgage market.

Their rating downgrades contributed to the freezing of credit markets and that fed of course into the larger economic crisis and turmoil that we've had in this country. And then came the fall of AIG, and the bets that brought down AIG were made through the firm's securities lending division as well as the financial products unit.

As we consider the events of the past as they pertain to regulatory reform, it's worth noting that the securities lending division was facilitated and funded by AIG's insurance subsidiaries as a vehicle to make unwise bets on the U.S. housing market. At least, that's the way I put it since they were leveraged a 170 to 1.

Using capital from their insurance subsidiaries, with the approval of the various state insurance regulators, the securities lending division, in tandem with the financial products unit put at risk the entire company and to some degree the broader financial system.

The AIG debacle has also reminded us of exactly how global in scope the insurance market really is. AIG had subsidiaries operating in 130 countries and jurisdictions. The now notorious financial products unit has a significant presence in London.

In order to adequately understand the flex within our own financial system, our regulators must be able to look at the entire picture which often means relying upon, you know, to a certain extent upon equivalent regulators overseas.

The European Union continues to move closer to facing the Solvency II Directive, and that is probably going to pass this year.

Solvency II will create one market for insurance throughout all of Europe, while we have, you know, 50-plus separate markets here in the U.S. Another aspect of Solvency II is meant to increase the global cooperation effort by bringing equivalent regulators from around the world into closer consultation with each other.

Now, unfortunately, we have not held up our end of the bargain. The various state insurance regulators simply do not have the authority to negotiate with foreign regulatory bodies on behalf of the U.S. market, and as a result of our fragmented state-based system we will not have that regulatory presence capable of understanding risks from around the globe.

I have co-authored the National Insurance Consumer Protection Act with Representative Melissa Bean to establish a federal insurance regulator that would have the capacity and the legal authority to address these issues and the many others that have surfaced over the years.

And in closing, I believe any regulatory reform effort will be incomplete without the inclusion of a world-class federal insurance regulator. And I look forward to hearing from our panel of witnesses on this topic.

And again, I thank you, Mr. Chairman, for your leadership on this issue.

REP. KANJORSKI: Thank you very much, Mr. Royce. And now we'll hear from the gentlemen from Georgia, Mr. Scott for two minutes.

REP. DAVID SCOTT (D-GA): Thank you very much, Mr. Chairman. I want to congratulate you and the ranking member for holding this very important hearing regarding insurance regulation reform.

I think it is very important that as we move forward that we realize and learn from the experiences we've just gone through, especially with AIG, as we move forward to deal with this issue. Most experts would agree that the problems with AIG stem from their excessive trading and credit default swaps out of their financial products unit in both London and in Connecticut.

That was not regulated by the state commissioners, but was regulated at the federal level with the federal Office of Thrift Supervision. And also the majority of the insurance companies are indeed solvent. They are functioning well.

So the fundamental question as we go forward is this. Does this not only suggest that a radical overhaul of the insurance regulation at the federal level might not only be unnecessary, but it could also be potentially dangerous?

I think it's very important that we take into account as we move forward, the actual operations of these businesses, take into account the complexities of them, the areas in which they must be free to compete.

We have to make sure we understand how to ensure that whatever actions we take that it does not deter competition; that it does not lessen efficiency, or increase costs of operating from the development of global markets to the various and detailed policy rationales towards pursuing regulatory reform, we must take all of these into account.

We must look into both sides of this issue before taking further action. This is an extraordinary, important facet of our financial regulatory reforms. I will soon be introducing or reintroducing legislation, which is called the National Association of Registered Agents and Brokers Reform Act or NARAB, which I believe is a start to reforming one part of the insurance industry and ensuring adequate agent and broker licensing which is extraordinarily important.

The legislation is straightforward. Insurance agents and brokers who are licensed, in good standing in their home state, can apply for membership in NARAB, which will allow them to operate in multiple states.

Last Congress, this bill garnered 52 bipartisan democratic and republican co-sponsors. And I believe that with continued strong support and interest, this provision will be included in our insurance regulatory reform package as we move forward.

Again, I congratulate you, Mr. Chairman, and our ranking member, and I look forward to the testimony of our distinguished visitors.

REP. KANJORSKI: Thank you very much, Mr. Scott. We'll now hear from the gentle lady from Illinois, Ms. Biggert; three minutes.

REP. JUDY BIGGERT (R-IL): Thank you, Mr. Chairman.

And I'd like to thank you and the Ranking Member Garrett for holding today's hearing. It's important that insurance be a part of the conversation at the federal level on how to monitor institutions that could pose a systemic risk to the financial system.

Should an insurance representative be a part of a federal systemic risk council? Who would that representative be? Should Treasury have an office of insurance information? What regulator could or should unwind or dismantle a failed company like AIG?

Whatever the solution, I'm interested in hearing from today's witnesses about how insurance regulators and the insurance industry will have voice at the federal level without dismantling the state insurance regulatory structure, a structure that has not failed.

Notwithstanding AIG, the U.S. insurance industry is alive and well, and state regulators, especially in home state of Illinois, are doing a good job. In recent memory, the industry has survived terrorist attacks, the 2005 Gulf Coast hurricanes, and many of other disasters that caused significant harm to our country and citizens.

We as federal law makers should be careful not to throw out a regulatory system that seems to be functioning properly as we consider broader proposals to establish a federal systemic risk overseer.

With that, I thank you, and yield back.

REP. KANJORSKI: Thank you very much, Ms. Biggert. And now, we'll hear from the gentle lady from Illinois who is the coauthor with Mr. Royce of the pending piece of legislation before the full committee.

Gentle lady, Ms. Bean, three minutes.

REP. MELISSA L. BEAN (D-IL): Thank you, Mr. Chairman, and Ranking Member Garrett, for today's hearing and for yielding me time.

The topic of today's hearing, how the federal government should oversee insurance is a subject that Congressman Royce and I have worked on tirelessly for years to address the lack of federal regulatory authority over the insurance industry.

Our predominant focus has been on increasing consumer choice and protections, providing advantages to agents, and improving industry efficiency.

Consumers tell us that they want product and pricing options, innovative new products available to them, the benefits of market pricing, consistency of products across state lines, and the peace of mind that knowing that they can preserve the trusted relationships with the agents that they've worked with even if they do move their families or their businesses, whether they be military seniors, families, students, or small businesses.

Agents are frustrated with the need to spend hours learning and training duplicative rules and regulations across state lines. Nationwide licensing provided in our legislation would allow them to eliminate that.

They won't have to fight so hard to keep and grow their customer- base or have the unnecessary costs of those duplicative training efforts. And that ($)8 billion to ($)13 billion that the industry spends across those multiple bureaucracies would be saved and could be passed on to consumers in savings.

Since we started working on this issue, much has changed in our system.

After committing nearly 200 billion of taxpayer dollars to AIG, with more money expected to be granted to several other insurance companies, the need for federal regulatory oversight has never been greater.

In April, Congressman Royce and I introduced H.R. 1880, the National Insurance Consumer Protection Act to create a national insurance regulator with the resources and authority to regulate insurance companies whose breadth and complexities far exceed the capabilities of the state-based system.

H.R. 1880 is very different from past bills to create a national insurance regulator. This bill includes best in class nationwide investor and consumer protections, exceeding the scope and resources of the current state system, and any federal legislation previously introduced on the subject.

It establishes a national insurance commissioner to regulate national insurance companies, reinsurance, property and casualty and life insurance, agencies, agents, and brokers similarly as the comptroller of the currency regulates national banks.

It will not only monitor insurance subsidiaries, but also the activities of the holding company and non-insurance affiliates such as AIG's well-known financial products unit.

Unlike national bank regulation, this bill includes strong protections against regulatory arbitrage by prohibiting nationally chartered insurers from switching to a state charter without the approval from the national insurance commissioner.

Unlike past legislation, our bill deals with systemic risk. It recognizes that Congress will create a systemic risk regulator which will subject all insurance companies, national or state chartered, to a systemic risk review.

In instances when an insurance company is deemed to be systemically significant, the systemic risk regulator and the national insurance commissioner can require an insurer to be regulated at the federal level.

The robust consumer protections of this bill provide best in class, uniform national consumer protections starting with the model market conduct laws of the NAIC, and localizes the office of national insurance by requiring each state to have a physical office of their division of consumer affairs.

H.R. 1880 was recently introduced and intended to serve as a new starting point for the discussion of national insurance regulation. I believe the subcommittee should move a comprehensive bill that establishes federal regulation of all lines of insurance, property and casualty, reinsurance, and life.

Insurance rates should be actually sound -- actuarially sound, and not subject to arbitrary rate caps. And we should include strong, uniform consumer protections.

I look forward to working with the chair, our ranking member, and my colleagues towards that end, and I yield back.

REP. KANJORSKI: Thank you very much, Ms. Bean.

Now, we'll hear from the gentleman from Texas, Mr. Hensarling, for three minutes.

REP. JEB HENSARLING (R-TX): Thank you, Mr. Chairman. Knowing that votes are on, I'll attempt to be brief here. Clearly, the issue that has been before this committee for some time, optional federal charter, I have listened closely to the arguments.

Frankly, I think it is appealing on a number of different fronts. I think potentially it has the ability to make our markets more competitive.

I think it could provide consumers with more choices at reduced cost. And having said that, I haven't quite signed on to the final product, because I think there are some downsides as well.

Now, clearly there is a gap in expertise in insurance in Washington D.C. We know that on March 18th, in a full committee hearing on AIG, that the head of the OTS in open hearing told us that they had the resources, they had the power, they had the authority, they had the expertise to prevent the debacle that became AIG.

They just missed it. They just didn't do it, which is a lesson to all of us that again federal regulation is not necessarily a panacea. It would be in interesting to know also exactly how this would intersect with the administration's intent to give some type of resolution authority to some federal body for large insurance companies.

Many of us fear that this become a self-fulfilling prophecy to designating certain firms as systemically risky and create all kinds of little Fannie and Freddies, or perhaps a better way of phrasing it might be a large Fannie and Freddie throughout our economy, ticking fiscal time bombs for the American taxpayer.

So clearly, federal regulation has not proven to be a panacea. Witness Fannie, and Freddie, and Wachovia, and WaMu, and the problems with City and Bank of America and we've already mentioned AIG.

So I believe that at the end, Mr. Chairman, we need to clearly move to smarter regulation, which is not necessarily more regulation. We need to figure out some way to end the too big to fail phenomena.

And our goal should be to ensure that taxpayers have market competition, market discipline, and ensure that they are ultimately protected.

And with that I yield back the balance of my time.

REP. KANJORSKI: Thank you very much, Mr. Hensarling.

We'll now hear from the gentle lady from California, Ms. Speier for three minutes.

REP. JACKIE SPEIER (D-CA): Thank you, Mr. Chairman, and Ranking Member Garrett. The subject of today's hearing is how should the federal government regulate insurance?

I think the first -- at first, we really need to answer the question should the federal government regulate insurance. Here in Washington, the common perception seems to be that federal regulation is always preferable to state regulation.

In this case, however, I believe the move towards replacing state regulatory authority with federal, particularly if it creates a dual optional federal structure; it is seriously misplaced and misguided. AIG, the world's largest insurance company, is often cited as the poster child for the need for federal regulation of insurance.

The case of AIG proves just the opposite. AIG's insurance operations, or the fact that they were regulated by the states, and required to hold risk-based reserves is the only reason AIG was salvageable, even if it took a $150 billion in taxpayer money to bailout the federally regulated holding company.

If the state regulators hadn't prevented the holding company from raiding state-based reserves, even the insurance subsidiaries would have gown down, jeopardizing consumers and state guaranty funds all across our country.

In my opinion, AIG makes the argument not for federal regulation of insurance, but for the reintroduction of Glass-Steagall. In the words of AIG CEO Liddy before this committee, and just yesterday before the Government Oversight Committee, AIG needs to return to doing what it does best, insurance.

If it had stuck to insurance, and hadn't been able to buy or sell savings and loans, so that it could choose OTS as its regulator, we likely wouldn't be facing the crisis we are facing today.

Instead, it launched them to the high risk and supposedly high reward world of derivatives where federal regulators were largely asleep at the switch.

OTS has admitted to this committee that they really had no idea what was going on.

I think we can all agree that the regulator shopping among the financial institutions has been a disaster. And we should not now be considering giving that opportunity to insurance companies.

The insurance industry changed under state regulation, not because of the onerous regulatory burdens, but because states imposed stringent capital reserve requirements, and because of the ability in some states like California to pass tough consumer protection laws and rate regulations.

Let me be blunt; I think the discussion is all about life insurance companies being further able to leverage their positions. I served as chair of the California State Senate Banking, Finance and Insurance Committee for eight years.

The insurance industry lobbyists were always looking to weaken consumer protections. I think one of the frequent refrains, that they needed to be free of state restrictions, so they could be able to feed creative and innovative products to market, so that they could compete with Wall Street, has been shown to be the fallacy that it was and is.

Insurance is an essential part of our economy. It needs to be strong and robust. Protections for the consumers and taxpayers must be equally strong and robust. I yield back.

REP. KANJORSKI: Thank you very much, Ms. Speier.

Now, we'll hear from Mr. Neugebauer for three minutes.

REP. RANDY NEUGEBAUER (R-TX): Well, thank you, Mr. Chairman, and Ranking Member for having this hearing. One of the problems of being kind of last in the queue here is a lot of things that I wanted to say have already been said.

But I think one of things as we go down this road of regulatory reform, one of the things we need to make sure is we understand what happened. I think there is always a rush when something unexpected happened or something bad happens that somehow they blow the whistle and ask the government to come and fix it.

And quite honestly, the record of the government on fixing things is not all that good. And so as we go down this road, I think we need to make sure we understand what happened, and where were the holes in the system.

And in some cases, I think we're going to find that it wasn't -- it's not necessarily we need more regulation, it's we need better regulators, or regulators that are actually doing their jobs. And so what we don't need to do is to try to pass a bunch of regulations, because regulators weren't necessarily doing their jobs.

When it comes to the insurance industry, for example, AIG was a little bit different vehicle or entity than a typical insurance company. And so is there a need to separate the activities of some of these organizations?

I think what we're going to find in our large banks, and we're going to find in our larger institutions that got into trouble is that the regulators that were primarily responsible for them were looking at the core set of their business instead of some of the unrelated businesses that those entities were in.

And maybe those regulators didn't actually understand those businesses that they're in. And so maybe a more appropriate regulatory structure is to make sure that you have regulators that have the expertise within the organization to make sure that they are analyzing all of the risks that are being taken.

Particularly, when we look at some of our life insurance companies, our insurance companies that are state-regulated, and as one of my -- several of my colleagues have said before is we don't want to be throwing another blanket over it.

In other words, if the other blankets failed, then I think a larger question there is what happened and why didn't those regulators -- able to ascertain what happened to those entities rather than adding another layer.

There are some that are calling for quick regulatory reform that could do this very quickly. I think the more important thing is do it right and to do it smart.

And so I would hope as we go down this road that -- Mr. Chairman, that we take a role of first doing what people do in the medical community; somebody gets sick or something happens unexpectedly, and they die, they do an autopsy.

I think what's in order here is a major autopsy of the areas where we had fallacies and failures, to determine what happened, and then look at what the appropriate steps are going to be necessary to keep those from happening again.

But I think the underlying thing that the American people and investors and everybody needs to understand that federal government cannot keep bad things from always happening.

People take risks, and they look like a reasonable risk at the time, but not every business plan, and not every business investment, pans out like it is proposed -- purported to do. And to think that regulation will fix that I think sends a poor signal not only to the investors, to policyholders, but to everyone else, that is that the government is not responsible for making things go up and down.

It's responsible to make sure that there is integrity and transparency in the marketplace, and in the regulatory scheme of making sure that people are following generally good business practices. With that I yield back.

REP. KANJORSKI: Thank you very much, Mr. Neugebauer.

As everyone is aware, we have a series of votes on. We've estimated it to be at least an hour and 10 minutes. So the committee will stand in recess for at least an hour and 10 minutes, then we'll return immediately after the last vote. (Sounds gavel.)


REP. KANJORSKI: (Sounds gavel.) The subcommittee will reconvene. I will now introduce the panel. First of all, thank you for waiting for an-hour-and-a-half for us.

Thank you for appearing before this subcommittee today. Without objection, your written statements will be made part of the record, and you will each be recognized for five minutes of summary, so we can move through your direct testimony and get to some of the examination of the committee members.

First, we have Mr. Baird Webel, specialist in Financial Economics with the Congressional Research (Center ?).

Mr. Webel, you're recognized for five minutes.

MR. WEBEL: Chairman Kanjorski, Ranking Member Garrett, members of the subcommittee, thank you very much for your invitation to testify at today's hearing. First, just a formality to get out of the way, I just want to clarify that CRS' role is to provide objective, non-partisan research and analysis to Congress.

CRS takes no position on the desirability of a specific policy and the arguments that I presented in my testimony are for the purpose of informing Congress.


My written testimony provides a range of options for Congress to consider as it approaches revamping of the insurance regulatory system. And I would like to highlight a couple of aspects of it in -- right now.

The first is that the options that I present are not mutually exclusive. You can see that in the Bean-Royce bill that was mentioned by the members before. It combined both an optional federal charter and a systemic risk regulator.

Insurance is a wide ranging business.

There are a variety of different regulatory approaches that you could consider, and a variety of different ways that you could split up the business if so desired. For example, the option of splitting the regulation of life insurance and property/casualty insurance has been mentioned frequently. There's also a reinsurance component that could be considered.

One -- there is a currently existing regulation that's very different at the state level between commercialized insurance for large insurers and personalized insurance by individual consumers. There are vast differences between the scope and reach of large insurers versus small insurers.

There are aspects of market conduct to consumer protection that could be regulated differently than insolvency. There are a lot of different options, and different ways. It's not necessarily the case that one size needs to fit all.

The second thing I'd like to talk about is the newest concept that's really come out of the last couple of --- the last year or so of a systemic -- specifically of a systemic risk regulator. As the newest idea that's really out there, is also I think the least fleshed out of the concepts that we have.

And with so many things the devil truly is in the details. Who would be the systemic risk regulator? What would a systemic risk regulator do? What would we want him to do?

And starting this as the definition, you know, just as the definition of systemic risk, one finds frequently different concepts. One of my colleagues, when we started into this discussion a few months ago, came around that there are people -- (inaudible) -- itself, is an asteroid about to hit the United States to be considered a systemic risk to financial services industry?

And after the sort of initial amusement at the idea, and when people started thinking about it, you know, you start to take it a little more seriously. What is a financial systemic risk regulator to do about this?

You know, is it regulating how people would respond to an asteroid strike? Is it you stopping the asteroid strike from the beginning?

If you replace asteroid strike with say global warming, or a pandemic flu, or the destruction of the financial infrastructure in New York, suddenly, it's not -- you know, it brings up questions that are really a little more serious than when you first -- when you first thought about it.

The powers that a systemic risk regulator could have, that have day-to-day oversight of financial firms, but does it fit a 20,000 feet and identify the problems and then expect the other regulators to do something about it?

If so, does it have preemption powers if it identify the systemic problems, but the regulators don't act on it? When you apply it to insurance, you get even more complicated because of the existing state regulatory system.

Its questions of how you balance federal power versus state power of 50 different regulators that would have to be interacting with the systemic risk regulator. There has been a suggestion of a council with the heads of the various federal regulatory bodies.

Well, who sits on that council for insurers? I mean, presumably you're going to have someone there, but who? And when you get down into -- (inaudible) -- of insurance, I think that there is a particular flashpoint with rate regulation.

Many of the states consider rate regulations to be a bedrock consumer protection. But of course, the question of rates, the needs, well, what is appropriate for the risk entailed is a definite solvency concern which feeds into a definite systemic risk concern if it's a large insurance company.

And how that could be managed within the system or within whatever the federal systemic risk regulator would be, will certainly be a challenge. I'm happy to be here, and happy to answer any other questions you might have. Thank you.

REP. KANJORSKI: Thank you very much, Mr. Webel.

We'll now hear from Ms. Patricia Guinn, managing director of the Global Risk and Financial Services Business of Towers Perrin.

Ms. Guinn, five minutes.

MS. GUINN: Thank you.

Chairman Kanjorski, Ranking Member Garrett, and members of the subcommittee, it's an honor to testify today on behalf of Towers Perrin. Towers Perrin is a global professional services firm that helps organizations improve their performance through effective people, risk, and financial management.

The insurance industry is a particular focus of our firm, and I appreciate this opportunity to offer our perspective on the important issue of insurance industry oversight.

Without a doubt, the financial crisis has had a significant adverse impact on the balance sheets and profitability of insurance companies. However, with the obvious exception of AIG, the insurance industry as a whole has not been severely impacted by the crisis as has the banking industry.

Insurers have benefited from strong risk management practices particularly in the property/casualty sector. In addition, the focus of the current state regulatory framework on solvency and policyholder protection has served the industry well.

That said, the financial crisis has exposed a number of issues that raise valid questions about the adequacy of the current regulatory systems. And while it's a relatively small part of the overall financial services industry, insurance has a far reaching impact on our economy as a whole.

Think of your own experience. The businesses you rely on can't open their doors each day without liability insurance, workers' compensation, and various other coverages. And as individuals, we can't register our automobiles, or get a mortgage without appropriate insurance.

Furthermore, insurance companies are major investors in the U.S. financial markets with trillions of dollars of invested assets. Finally, the insurance industry fills a less well-known role as the provider of financial guarantee insurance to enhance the credit quality of a wide range of municipal bonds and structured security.

The importance of this role has been highlighted in the current financial crisis. These are sufficient reasons for the insurance industries to warrant federal attention, yet in our opinion there is no need to start from scratch.

Any new federal role in insurance regulation should build on the industry's very positive risk management characteristics and the current regulatory structure.

Federal oversight also should address the challenges presented by systemic risk, regulatory arbitrage, and an increasingly complex landscape that blurs the lines between insurers and other financial services players. We've made a number of suggestions in our written testimony that I will briefly summarize.

First, we recommend a more holistic regulatory framework for the financial services industry that's underpinned by economic capital requirements based on enterprise-wide stress-testing. This would improve transparency into an organization's ability to withstand extreme loss scenarios on a consolidated basis.

To be effective, federal oversight of the insurance industry needs to recognize the industry's unique characteristics. We recommend that the federal government avoid a one-size-fits-all approach derived from the larger banking industry.

And one way to do that is to build an insurance industry knowledge base with contributions from state regulators along with industry and professional association.

Next, the federal government should avoid direct participation in insurance markets. Except in the most dire of circumstances, the private insurance and reinsurance markets have continued to function well, and are able to finance a wide variety of risks.

While the state insurance guaranty associations have also performed well, we believe a federal resolution authority from multi- jurisdictional, and multi-entity conglomerates, should be considered.

Finally, risk management professionals with appropriate training, credentials, and professional standards can play an important role in the federal oversight of financial services.

The current state regulatory framework for insurance requires actuaries to give a professional opinion on the adequacy of an insurance company's reserves to meet its future obligations to policyholders.

We can easily envision expanding this role to the evaluation of other financial obligations and hard-to-value assets. Thank you for the opportunity to express our views.

REP. KANJORSKI: Thank you very much, Ms. Quinn.

And next, we'll hear from Mr. J. Robert Hunter, director of insurance with the Consumer Federation of America.

Mr. Hunter.

MR. HUNTER: Good morning -- good afternoon, Mr. Chairman, and Ranking Member Garrett. I am Bob Hunter and I formerly served as federal insurance administrator under Presidents Carter and Ford, and also as Texas insurance commissioner.

CFA has undertaken a major and extensive study of insurance regulation in America, given all the developments in recent times, and we are nearing an end to that. So I am going to give you today our current thinking, which is expressed in some detail in my written testimony, and I've also answered your questions in that testimony that you've raised in your letter of invitation.

The tentative conclusions we're reaching right now are the -- as far as what we've discussed what we think Congress should consider. I've gone through all the pros and cons of different approaches in the testimony, but here's where we've sort of come out.

There is systemic risk in insurance, not as extensive as in banking, but we think a systemic regulator needs to look at insurance. We believe that in order to fully understand and control systemic risk in this very complex industry, the federal government should take over the solvency/prudential regulation of insurance as well.

This conclusion is made even in light of the fact that the states have done a pretty good job since John Dingell's failed promises a few years ago in upgrading the quality of their solvency regulations.

And looking backward, you might say well, they probably have deserved to stay there. But looking forward, and looking at a systemic risk, we think the federal government needs to move in on some of that area.

We don't think the NAIC and the states are up to the task of taking on this systemic risk. Therefore we think Congress should create a systemic risk regulator.

That regulator should also be charged with solvency and prudential risk regulations, and should be able a repository of insurance expertise, engaging in such activities as data collection and analysis, as well as dealing with international insurance matters.

It should not be granted, however, vague and open-ended powers of preemption of what remains at the state level. The states are well- established in consumer protection regulations with great expertise.

They regulate over 7,000 insurers using over 10,000 staff, spending over a billion dollars a year in regulating insurance. We'd complained about the weaknesses of the state systems, but there are some things that the states do well that the federal government could not match we think.

These include particularly dealing with people; states handle almost a half-a-million complaints a year, and an additional 3 million requests for information. Several individual state insurance departments handle more inquiries and complaints than the entire federal banking system does.

Our recent study of a state website found good and improving information for consumers, and while many states are inadequate in rate, and form, and other market conduct examinations, we believe that with -- a few notable exceptions, there has been less gouging in state-regulated insurance pricing than in, for example, credit card, mortgage lending, and some federally regulated practice.

The states being nearer to the people seem more responsive to consumers. Therefore, we believe the state should continue to handle consumer protection, addressing all the key areas, such as claims abuses, unfair classifications, unavailability of insurance, and rate regulations.

We think rate regulation is important. Our extensive study of decades of auto insurance data that we completed a few months ago, shows that those states that are regulated effectively with strong prior approval rate regulation also has interestingly, and it's somewhat counterintuitive, the highest competition as measured by HHI and other indices.

I must point out that while we support a greater federal insurance role, we do vigorously oppose an optional federal charter. We think it sets up regulatory arbitrage.

We don't think a semi-option solves that problem. We think there are -- it would overrule any kind of state regulation; it would be a disaster for states like California.

We also believe there are other things you should look at. You should look at the anti-trust exemption that insurers enjoy, and we think it should end. We also believe that the FCC should be allowed to study insurance again as part of any regulatory reform, and that federal data collection is very important, particularly for market performance data, sort of like HMDA.

These are our preliminary thoughts. The ideas are -- have not been vetted with other consumer groups as yet, but we will be in the coming weeks.

Insurance is mandatory as you've just heard, a sort of a public utility. States and lenders require many different types of insurance coverage, and to protect one's family, most people have to get insurance. Consumers can be easily misled by fine prints, abused by marketing and claims practices.

Mr. Chairman, we ask that you give at least as much attention to enhancing consumer protection as you do to systemic risk as you go through this process.

REP. KANJORSKI: Thank you very much, Mr. Hunter. And next we'll hear from Dr. Martin F. Grace, James S. Kemper professor of the Department of Risk Management and Insurance at Georgia State University.

Dr. Grace, you're recognized for five minutes.

MR. GRACE: Thank you, Mr. Chairman, thank you, Mr. Garrett, and members of this committee for inviting me to testify before you today.

As you've heard, my name is Martin Grace. I've been a professor at Georgia State for 21 years. And I've -- in this background of financial services regulation and deregulation, this is where I've been focusing my work for almost my entire career.

Most recently, in the last four or five years, I've been thinking about this particular problem. In fact, last year we even had a very large conference talking about not federal and state regulation per se, but the optimal regulation of the insurance industry.

So today, what I'm going to talk to you about is a lot about what I've done my work on in the last couple of years, and what I think from an economist's perspective might be fruitful ways of thinking about the future of insurance regulation.

I have three main points. The first point is the proper level of regulation, whether it's state or federal. The second one is the placement of a systemic risk regulator in this functional area of regulation. And I'd like to make some comments on what I believe is the future of -- for the role of states in insurance regulation.

My first point basically looks at whether we should have a federal or a state system of regulation. The way to think about this is that the cost and benefits of regulation need to be the same level.

So if you think about the local restaurant regulator, the local county health inspector, all the benefits and costs of regulations are really to that county.

But the airline safety regulation really has a national audience. And the cost of that regulation should be borne at that level.

Now, not everything about insurance is cut-and-dry. Fifty years ago, insurance was really a local kind of contract, a local industry. But today only about -- on the average state about 12 percent to 15 percent of the insurance is sold by domestic companies; it is really an interstate business.

And as such, if the costs of regulation go beyond the state, it may be a reason for the level of regulations to be moved up to the federal government's level.

My second point is how to think about the risk regulator, the placement of this risk regulator. You can think of this as very simply, in part because if you think about just AIG, its failure caused problems not just across state insurance markets, but across other types of markets, banking markets and international markets. This is not something the state can really deal with.

So a federal risk regulator that looks at systemic risks may be something that is important at the federal level. The problem however with the application to insurance is that not all companies are AIG.

Most insurance companies are really very conservatively run, and to paint with a broad brush might be imposing an extra-cautious layer of regulation on some insurers. So the devil again is in the details about how you choose which regulator -- which company is regulated at the federal level under the systemic risk regulator.

At the same time, just the signal of choosing a company might be a bad thing. So if a company is chosen to be systemically important, and people assert that that choice is based because they might be too big to fail, that will have dramatic affects on the private insurance markets.

My third point is the role of states in insurance regulation. Insurance regulation, as I mentioned before, has historically been at the state level. And if we think about it is because -- it is a transaction that occurs in or near your house. And that is still true, but it's by a company that could be many states away.

And now we have to think about the effects of duplicated compliance costs, and the different types of other types of costs that are put on insurers, that are paid by consumers, and shareholders across the country. So all these states have duplicative regulations, and the question is, are we getting additional benefits from that regulation consistent with those costs?

And I think most people think the answer is, no. States also tend to be very reactive rather than proactive. One of the things about regulation is that we really have a good idea about the past problems, we never really think about the problems we haven't discovered yet.

For example, I was going to mention the asteroid example too. But thinking about things proactively in the future -- regulators are really good at figuring out things that happened in the past, but we should have a way of thinking about the future. I don't think the states are really up to that.

States react to outside pressure. Congressman Dingell's report from 20-some-odd years ago pressured the states to change. The OFC's pressure by the industry is pressuring the NAIC in the states to change.

They're going through this on their own, in part because consumers in many respects don't care enough and don't make it a salient point. So in sum, I think the states are in a very difficult position going forward because they're not proactive enough. Thank you for your time.

REP. KANJORSKI: Thank you very much, Dr. Grace.

And last we have Dr. Scott Harrington, the Alan B. Miller professor of The Wharton School at the University of Pennsylvania. Dr. Harrington.

MR. HARRINGTON: Chairman Kanjorski, Ranking Member Garrett, members of the subcommittee, I'm very pleased to be here to talk about issues of such fundamental importance to businesses and individuals.

I have three main points. First, I want to stress that insurance is fundamentally different from banking and should not be regulated the same way. The anomaly of AIG notwithstanding, compared to banking insurance markets are characterized by much less systemic risk, and by reasonably strong market discipline for safety and soundness.

Any new regulatory initiatives that affect insurance should be designed not to undermine that market discipline.

Systemic risk, the risk, the problems that one or a few institutions may affect many other institutions in the overall economy is much greater in banking than in insurance. Depositor and creditor runs on banks threaten the entire payment system; the bills don't get paid, the checks don't get written.

Banking crises involve immediate and widespread harm to economic activity and employment. Systemic risk in banking provides some rationale for relatively broad government guarantees such as deposit insurance.

But because guarantees undermine market discipline, they create a need for tighter regulations and more stringent capital requirements. That in turn creates significant pressure for many banks to relax capital requirements and improve their accuracy for it to circumvent the requirements for regulatory arbitrage.

Insurance is inherently different, especially property/casualty insurance and health insurance. There's much less systemic risk, and then much less need for broad government guarantees to prevent runs that would destabilize the economy.

Guarantees through the state guarantee associations have been an appropriately narrow in insurance or narrower than in banking, and capital requirements have been much less binding. And because they've been much less binding overall, their accuracy is less important.

This is good economics. Any new insurance regulatory initiative should follow this model and recognize the distinctions between banking and insurance. And they should also recognize that apparently sophisticated capital regulations can produce significant distortions without sufficiently constraining excessive risk-taking.

My second main point is the creation of a systemic risk regulator with authority to regulate systemically significant insurance organizations would likely have several adverse consequences, and I apologize for a bit of redundancy here, going last as I am.

In general, the potential benefits of creating a systemic risk regulator encompassing non-bank institutions strike me as modest and highly uncertain. Regarding insurance specifically, if an entity were created with authority to regulate any insurer deemed systemically significant, market discipline could easily be undermined with an attendant increase in moral hazard and excessive risk-taking.

An insurer designated as systemically significant would be regarded by many market participants very simply as too big to fail. Implicit or explicit government backing would lower its funding costs and increase its incentives to take on risk.

I'm skeptical that truly tougher capital requirements or tighter regulation would be adopted for such firms, and if so whether they would be effective in limiting risk-taking over time, government taxpayer bailouts could become more rather than less prevalent.

Even if moral hazard would not increase under that scenario, it's hardly certain that a systemic risk regulator would effectively limit risk in a dynamic global environment. It could well be ineffective in preventing a future crisis, especially once memories of the current crisis fade.

In addition, level competition between insurers designated as systemically significant and those not so designated would simply not be possible. The former would likely have a material competitive advantage.

The results would likely include a higher market concentration. The big will get bigger, less competition, and more moral hazard.

Apart from AIG, and specialized bond insurers, we've already heard insurance markets have withstood recent problems tolerably well. It's not surprising that some life insurers have been stressed, given what's happened in asset markets, and the nature of their products.

My third and last point is that legislative proposals for federal intervention and insurance regulation such as optional federal chartering should specifically seek to avoid expanding the scope of explicit or implicit government guarantees of insurers' obligations.

The goal should be central to any debate. Insurance markets, with the AIG exception, have been largely outside the scope of too big to fail regulatory policy. Consistent with relatively low systemic risk, state guarantees have been relatively narrow. State guarantee associations have performed reasonably well. The post-insolvency assessment scheme works well, and I elaborate in my statement how it has various advantages.

So I encourage you, when you consider those issues about optional federal chartering to remember not to keep very close attention to the nature of guarantees and how they can create moral hazard.

And last, I would also urge you as part of that debate to consider alternatives to optional federal chartering, whether it be preemption of anticompetitive state activity or some sort of system that would create regular regulatory competition among the states. Thank you.

REP. KANJORSKI: Thank you very much, Dr. Harrington. That completes our panel's testimony. Now, we'll go to our questions. I'll lead off with my questions, if I may.

Doctor, I'm just -- did I understand your testimony really didn't take a position on whether or not we should have federal regulation of insurance? You seemed to be less definite that we should than shouldn't, and so -- (off mike.)

MR. HARRINGTON: I don't have a strong opinion on whether an appropriately designed optional federal chartering and regulation program could be in the public interest. My attention thus far has been very much on the design issue, and how it might -- how federal regulation might be achieved without expanding too big to fail policy in creating moral hazard.

REP. KANJORSKI: It seems to me -- my experience now over the last several years, I think one of the opening statements of our colleagues indicated how simple the question was several years ago as to whether or not we should provide a cheaper product introduction, and less stringent cost-effectiveness of hiring brokers, et cetera, that was the question two or three years ago.

Today the question is a little different. The question is should someone, not necessarily the federal government, restrict what an insurer can do either domestically or internationally that could have a material effect on their position as an existing corporation such as AIG?

Should they be allowed to engage in financial products as they did in London, in relatively an unregulated atmosphere or -- and does that jeopardize their insurability of protecting the consumer here in the United States on their various American products?

And two; how can we effectively prevent that from happening? I've concluded that if we take no action to prevent this from happening or finding out whether it is happening. I would think there must be 50 entrepreneurs in the world, maybe half of which may not have the highest ethical positions searching around for relatively small insurance companies, either here in the United States or abroad, opening the caption and then leverage them up through huge institutions, and engage in a playing market, if you will, a derivative market as AIG did.

I'm not convinced anybody knew what they were really doing over there with perhaps an extremely limited number of people, and they weren't very good at it, with the structures they put together, or the purchases, the counter-party positions they took seemed to be relatively poor.

Now, that being the case, how are we going to prevent that, or do we have an obligation to prevent that? Or do we just let the consumers swim by their own survival?

Then I'm getting pressure, and I mean pressure from insurance companies and from citizens that are living in the hurricane zone, living in the high-risk zone; there is not available insurance coverage for high risk at rates that insurance commissioners who are elected to office are willing to allow to be placed on a burdened citizen.

It's a beautiful quandary that they're in; you know, demand that insurance companies provide coverage, but other -- under-fund the rate that makes them viable and capable of doing that, and then playing the role of a populist.

The only way we could prevent something like that it seems to me is to move it out of the regulatory capacity of the individual states, particularly the coastal states, and take it into a larger entity of control that are less under the influence of either the electorate of the particular state, or the insurance carriers that are involved in the state.

We get nailed from both ends. Then something has happened most recently that I've been involved -- when I say recently, since 9/11, and now with the economic catastrophe, everybody wants reinsurance, except they no longer want to go to the world market of reinsurance, they want to come to government.

And we're being asked to underwrite so many things now, as the secondary reinsurer that it seems almost incredible. And people don't -- not even the operators of the insurance companies see an inconsistency with what they're asking.

You know, they'll just walk into your office and say, I'm a free marketeer; you must meet some of my friends on the other side of the aisle, except -- (off mike).

Because they're free marketeers, and yet they want us to do something about underwriting their risk. And I find that humorous myself, and really humorous if it weren't as serious as it were; but look what we have now. We have insurance that we offer for floods that don't sustain themselves in cost.

So nobody else would possibly grant that type of insurance, but the federal government does. We have excess coverage for nuclear plants in case they explode. The taxpayer is on the annals (ph) to take care of it, and the premium pay is insufficient to cover the risk. We know that.

And with hurricanes, floods, and natural disasters we have substantially the same thing. And now we're starting to get in and offer insurance for business success or continuity.

If you're big enough, and you get entwined in enough bad deals that could shake the system, such as AIG, basically we have very little choice but to come in. And when I say we, I mean the federal government.

Now, I hear some of my colleagues, particularly I mean, inside the House, I hear, you know, let's be covered, or let's -- everybody play the market, and what the markets are intended to do, and the market provides the equalizer. And I was great believer in that until I saw subprime loans.

And when you look at subprime securitization, everybody is on one side of the transaction making unusual and damned profits, if you will. And nobody is on the other side, balancing out or arguing as the marketplace is supposed to do.

So it seems to me we no longer have certainly the free market, but now we have a distorted market. We have tremendous demand for support and backup.

And I'm not sure we have as many risk-takers as we used to have that are willing to get into business with their own equity to manage risk, but in fact are turning to their written or unwritten partner, the federal government, and asking us to provide.

And I think the final straw that breaks the camel's back is that, you know, now the request for TARP funds for the insurance industry -- a novel concept when you think about it -- which we -- and this industry is probably the greatest defender of free markets. But they are escaping radically from that going to government subsidy and protection.

Are we too late? Do we close those doors, or do we have an opportunity here to do something, but not do something radical? I really don't -- I agree with some of these witnesses that when you look at the 200-year, 300-year history of insurance in the United States and managed at the state level, it's been relatively good. The insurance companies had gone bust before and they have created pools to support, sometimes protect the consumers.

Certainly they're much better now than did prior to the original depression, the big depression. But moving now into the international or global market, is that taken a so big, so great, and offered so much financial opportunities with chicanery, that we're so at risk that only a governmental entity as the size of the United States could get it going? That's some of the questions I have.

Now, I know I'm not posing specific questions when I made that dialog. But maybe somebody can help me bail out and get out of this question, if you will. What do you think we really should do? Should we try and do something significant, or should we patch, provide just little coverage? We can easily outline or outlaw AIG Financial Products operations by insurance companies.

We certainly can in the United States, but we can't do it abroad. So we could -- if we try to outlaw American companies from doing that, we could give a decided advantage to foreign companies to doing. We've seen that happen in other areas of regulatory authority; we literally drive American companies away to foreign markets. Anyway, let's start. Anyone can take a little answer to some of those questions that I'm having.

Mr. Webel.

MR. WEBEL: I think to address your last question first --


MR. WEBEL: -- with regard to the impact of possibly driving industries offshore. I think that -- I mean -- and this can be even broader that eventually the way to deal with too big to fail is don't let anybody get big. And within the financial services industry, it's true that for non-bank financial services, United States has historically enjoyed somewhere in the ($)25 billion to $30 billion trade surplus range.

But I think that when you consider the cost of the last crisis, one can make a very good argument that yes, you might be giving up something in the year-to-year trade balance, but how much do we spend to clean up the crisis that is solved or that has to be solved when too big to fail actually fails? So there are costs and benefits to having, you know, to having that kind of industry. And I think that has to be considered.

As a counterpoint to that, in the insurance specific range, United States has historically enjoyed a -- enjoyed -- has suffered a deficit in the insurance side of the financial services. And I think that that does say something interesting about our insurance regulatory system. The regulatory system at the state level is often pointed to as a trade barrier by our European allies.

And it's interesting to see this protected industry that still is under a very significant trade deficit. Does this mean that -- is it -- would we have even worse deficit if you didn't have this, quote, "protection," unquote, or is it the case that because of somehow the state system is not permitting companies to be competitive abroad?

So I think that it brings up interesting questions as to the international competitiveness and people really want to be internationally competitive in some of these things.

REP. KANJORSKI: (Off mike.)

MS. GUINN: Thank you. Maybe I'll take a slightly different tack on this and the notion of systemic risk. And we've had some conversation here today around, you know, does insurance present systemic risk to the economy. And I think about it a little bit differently that the insurance industry today is not distinct and separate, but it's actually an interconnected part of financial services.

One of the advents in risk management over the last decade or so is something called enterprise risk management -- the notion of managing risk across an enterprise holistically, for not managing and measuring credit risk separately from interest rate risk separately from an insurable risk.

In some new ways, to me the notion of a federal systemic regulator would be the equivalent of a federal chief risk officer for the U.S. financial services sector for the U.S. economy. I don't think you can separate insurance, and I think it would be unfair to the industry to have other sectors' package products -- which in their essence are insurance products -- under a different set of rules and regulations than the industry is forced to operate under.

MR. : Yeah, just a couple of points about what you said, Mr. Chairman. The federal government has rather failed in recent years of moving into insurance, and certainly have not made it self-sustaining. The -- (inaudible) -- by now that Iran should have been self- sustaining. But it isn't, in part because their maps are antiquated, in part because there is still unwise construction that should have been stopped occurring. That needs to be done.

And the mitigation has to work and the prices have to really meet the risk. And it can, but it has to be enforced, and it isn't. TRIA, for example, is somewhat modeled after the old Riot Reinsurance Program, except the only difference is the Riot Reinsurance Program charged premium, TRIA doesn't. The federal government receives the charged premiums when it took on the risks.

Now, that's a decision Congress made and the administration. Whether that was right or not -- the problem is you can't -- a premium of zero is never going to break even. And so that same -- I don't -- I wouldn't be so pessimistic. You can fix these things. It takes some will, though, because there's always pressure to go the other direction.

And then finally on too big to fail -- it's not just too big to fail. I think those are pretty easy to look at, fine. But even within markets -- consider title insurance. Two-thirds of the market is in two companies. Are they too big to fail within the entire insurance context? That's why I think you have to -- the systemic risk regulator has to look at everything.

MR. : The question about whether the train has left the station or -- I guess the horse leaves the barn as well is a really good one. With AIG and then the Life companies asking for TARP money, I've had to ask myself, this is -- is basically, the safety net has now been expanded so far and there is really no going back or constraining it. I don't think so.

I think that the AIG situation and the asset bubble or the housing bubble is unique enough that if we pay close attention to what happened and why and think about patching the places where there was a clear breakdown -- whether it's the Office of Thrift Supervision or whatever -- that maybe we can then think about the bigger picture which is, if we need to guarantee banks because of the paying of such funds, do we want to have that guarantee spread implicitly or explicitly broadly throughout the financial system.

And if we are going to have it spread one way or the other, then we probably should make it formal and regulate accordingly. But we'll have to have a lot tighter regulation and principle. But I would think as part of that process, maybe we could revisit the whole issue of what activities are fundamentally central for the economy that require a strong guarantee, and maybe revisit whether or not we don't need to wall off those activities.

I was always skeptical with Gramm-Leach-Bliley about how you allegedly can have part of the bank holding companies guaranteed and those not going to be -- still overrun the un-guaranteed parts. To me that -- in theory, fine, but in practice probably doesn't work or maybe we need to reconsider it.

MR. GRACE: I kind of agree with what everyone said, and then you just respect. I think that it's -- I don't think it's ever too late to fix a problem. I don't want to ever throw my hands up and say we can't do something, but as always could be another problem.

And if we get into the situation just setting up our problem fixed, and then adding on another fix for another problem, adding on another fix for another problem, then we are at the limit where Scott suggests we might be lower, we are just insuring everything. So I think it's imperative that we think about the types of things that we can fix.

Using the autopsy example that one of the members mentioned this morning, I think is an excellent example to do that. Find out where the gaps are and use, you know, a scalpel better than a sledgehammer to fix that. I think that's probably not a very good example, but you understand what I'm getting at. Then my metaphors are mixed.

And the second thing -- and I like what Ms. Guinn said -- is that the whole sort of academic risk management area now is about enterprise risk management. And if we think about what the Europeans, how they are thinking about that or -- (inaudible) -- they are making every insurer be extraordinarily sophisticated about the risk they are carrying.

Not only that, their extraordinary sophistication is supposed to be transparent. And the NAIC's way of regulating insurer solvency is it's not archaic yet, but it's kind of getting a patina on it where it looks old, and we really need to change that particular solvency system. We need to be moving towards a capital model-based system.

And this is something that I think the NAIC recognizes, but that will help in understanding what our risks are, and treating in appropriate at the entire organizational level is a major innovation.

Right now every company is sort of examined separately by the regulators and they are not put together in as a whole -- w-h-o-l-e, whole, and that's something, I think, in the very beginning would go to some extent to solve some of the patches that we need to put in, to -- (inaudible) -- the regulation.

REP. KANJORSKI: Thank you very much, Dr. Grace.

Since I've been so inconsiderate with my colleagues taking considerably more time, and since we have a limited number here, if without objection we extend everybody's opportunity to examine to ten minutes. And I'll be lenient on that so that we can have more concentrated examinations. Is there any objection to that?

(No audible response.)

There being none, then I recognize my colleague (off mike). If the -- (inaudible) -- but who is the last person getting here, they will have --

REP. : Yeah. Actually, Mr. Chairman, if it's -- Mr. Chairman --


REP. : -- if it were possible to have multiple rounds with longer time limits, I think that certainly those of us more junior in the committee might be enthusiastic.

REP. KANJORSKI: (Laughs) -- I think that is an objection. Then we'll stay with the five minute rule. The -- (off mike.)

REP. : Thank you, gentlemen and ladies. I found your testimony interesting on the systemic risk regulator and the OFC comments quite intriguing as well, as I continue to learn more about that. I think -- I guess we are trying to get the right word for it, that we are looking for, I believe, for the optimal, I think that was the -- (inaudible) -- word.

Regulation, we're looking for not more regulation, not less, but optimal. And I appreciate Ranny's (ph) comment about the surgical metaphor. And I guess -- so between Mr. Grace and Mr. Harrington, what we take from that is, a little bit of dissent that is being made that as we go forward this whole local issue that we are dealing with.

We need a comprehensive reform and not maybe piece work as far as getting it done because if we do pieces today another one tomorrow and the next one next week, you may not get a total, although put together that's comprehensive. So really what we need is legislation with comprehensive framework on all aspects.

But part of that comprehensive piece -- comprehensive reform legislation that we come up with, may end up being as opposed to something brand new or a totally different maybe scalpel -- (inaudible) -- and patchwork desk portions to it put in. You know, I'm looking first to Mr. Harrington. You made a comment in your testimony were you use these words.

With regard to the OFC and a chance going there, you said -- another alternative that you suggested is encourage a regulatory competition among the states. Can you briefly -- because I only have five minutes now -- tell me what you're espousing there. There you go.

MR. HARRINGTON: The idea there is probably more germane to some forms of anti-competitor regulations that exist at the state level regarding prices and price controls and restrictions on underwriting and rate classification where if you have some sort of a passport system where an insurer could apply to a state to get its primary license from the state and perhaps be subject to solvency regulation in all states it does business, but that it would be regulated regarding rates and perhaps market conduct or other non-solvency issues by the rules in the state that it gets a primary license.

And the notion then would be that companies could choose to go where there was a more competitive environment on those dimensions, and consumers would be able to choose accordingly subject to adequate disclosure about the nature of the regulation for a particular company.

REP. : Interesting. Okay. And the whole issue of arbitrage has only now recently been brought up when we talked about OFC. We didn't really talk about that at as much until this whole issue with bank regulation and arbitrage that if you go to a systemic regulator. Can you just briefly, anyone else on the panel have a comment on potential for arbitrage with regard to OFC that you may -- yeah, thanks, Mr. Grace.

MR. GRACE: This is not my idea, but I heard it at a conference I was at recently where the -- I guess he's the head of the policy group that makes up all of the guarantee fund associations. He was saying that there really wouldn't be any regulatory arbitrage possibilities because if you basically chose the state regulator or the federal regulator, once you choose federal, there is no going back for a large nationwide company.

The reason is that if you have -- if you are operating in 48 or 49 states, going to the federal regulator means you can reduce your safety compliance costs dramatically. If you threw away all those computer programs and all the knowledge that you've built up over the years understanding the states and then you become a federal chartered company, the choice to go back is extraordinarily hard, it's very expensive.

So it's really a one-way street according to this gentleman. So there isn't a lot of flipping back and forth. I mean if potentially someone could do it but --

REP. : -- also in the banking industry there is no flipping back and forth. But when we think of banks --

MR. : Banking is different, though, because you only have to obey one state's law. Going back -- if you're a insurer, you have to potentially follow the rules and regulations of every state that you are in.

REP. : But I think the argument would be if -- I mean, essentially the argument would be -- is that with the banking situation and with the regulators the issue is do we go to under the OTS or the OFC, what have you --

MR. : Right, and --

REP. : -- that decision that my bank makes, I'm only going to make that one time, because if I'm going to end up there, I'm not going to switch back and forth. But the argument right now is that part of the problem that we have is there is arbitrage going on there. But I -- your point is well taken.

MR. : About 30 states, according to the Washington Post article recently, 30 banks have returned to states regulation and as they see regulation -- re-regulation is raising its head.

REP. : Thank you. Appreciate that.

And Mr. Grace, you made another comment. You said the states are not proactive in this area or in -- not in this area, but just states are not proactive in dealing with some of the issues that are before them due to various pressures and what have you. And I think that -- I'm quoting you -- sort of paraphrasing your comment -- I think the chairman made some sort of comments on opening -- I don't want to paraphrase you.

But Congress is also pretty reactive and not proactive as well. I mean we are dealing with these issues today. We should have probably been dealing with these issues 10 years ago, but we deal with them after everything boils up and then we bring you guys in to help us work a way through.

So don't we have that same -- and Mr. Hunter, you might want to chime in -- and Mr. Hunter might want to chime in because my time is -- as well on the point of -- we are not the be-all end-all. You made the comment, Mr. Hunter, with regard to the credit card situation. We didn't, you know, re-regulate that.

We didn't do a great job. (Inaudible) -- company all accepted in those areas. So for either one of you or anybody else. The Fed doesn't necessarily do the job better than other ones, they get to the bottom line. Mr. Hunter --

MR. HUNTER: I've been both a federal and a state regulator, and I know both can fail. It's from experience and both have qualities that can be good. It really depends on the laws that are in place and how the regulator is monitored, and it can be good. But both can fail and both have.

REP. : Mr. Grace.

MR. GRACE: That's a fair cause, I mean, its true, no.

REP. : The problem is that when the federal regulator fails such as the case with the OTS and AIG, sometimes the disaster is not only countrywide, it's worldwide -- countrywide, no pun intended -- but there is a difference. Thank you very much.

REP. KANJORSKI: We have Ms. Bean for five minutes.

REP. BEAN: Thank you, Mr. Chairman.

My first couple of questions are for Mr. Webel. And I'm going to give you -- couple them and let you answer them together in the interest of time. This subcommittee has talked a lot about the ($)200 billion in federal tax dollars that have gone to AIG and how it was essentially focused on the financial products in it.

But almost ($)70 billion in taxpayer money did go to bailing out AIG insurance subsidiaries in their security funding program. In the current state-based system who's responsible for overseeing the insurance subsidiaries security funding program?

MR. WEBEL: It's a little unclear. I mean the securities came up out of the insurance-related subsidiary. Presumably, the insurance regulated that some degree okayed those securities coming up. I've seen different suggestions from the state regulators as to exactly how little oversight they had once the securities came up out of the sub.

But presumably, they would have had to approve the securities coming up out of the subsidiary.

REP. BEAN: So given the complexity of the securities markets, do you believe that individual state regulators or the NAIC has the sophistication to evaluate these types of activities of the insurers that they regulate? And I'm going to give you two other questions that you can answer as well. Did the passage of Gramm-Leach-Bliley enable AIG to get into the CDS market?

And the last question for you is is the state system able to properly regulate insurance holding companies and their noninsured subsidiaries?

MR. WEBEL: I mean it's really unclear with regard to the securities lending, again, whether they didn't have occasion to know what was going on at AIG or didn't have the authority or whether they just made the same mistake that everybody else did, which was thinking that triple-A rated mortgage-backed securities actually were good things to be investing in.

With regard to Gramm-Leach-Bliley, from what I can tell and has been told, prior to Gramm-Leach-Bliley prior to becoming an office of thrift holding company, Office of Thrift Supervision holding company, the AIG at a holding company level would have been essentially unregulated.

REP. BEAN: Now, if they didn't have a thrift, they wouldn't have had --

MR. WEBEL: Right. No, AIGFP existed before Gramm-Leach-Bliley, and it seems to have been primarily pressure from the Europeans to have a sort of national level regulator that drove AIG to become an Office of Thrift Supervision regulator holding company so that in terms of that specific aspect, it doesn't -- it appears that if anything, Gramm-Leach-Bliley may have increased the oversight on AIG, not lessened.

REP. BEAN: Because there would have been none.

MR. WEBEL: Yes. And in -- I'm sorry, the last point was the states --

REP. BEAN: Well, you know, I'll hold you to that for right now, and then I'm going to ask Mr. Grace -- I have a little more time left. With regard to multi-state and national insurers, if you were to start from scratch in designing an effective regulatory structure, would it be national or would it be state to state?

MR. GRACE: What was the very first part of that?

REP. BEAN: If you were building the system from scratch not from --

MR. GRACE: Multi-state -- it would -- definitely a federal system. The way I was thinking about this before was that if we had an OFC, it would be -- I was kind of thinking that theoretical point of view -- it would be the small single state or two-state companies that would stay, sort of locally chartered, and it would be the larger interstate companies that was moved to the federal charter.

That's kind of the sort of the economics theory perfect world argument. I realize that some of the larger ones may stay state; some of the smaller ones may choose the federal one. But the whole idea -- there would be a separation between the two, and I think that would be the right way to think about it.

REP. BEAN: Thank you. I have two other questions for you. That is when the NAIC was founded in 1871; its stated purpose was to enable commissioners to work towards consistent laws across all states which clearly, 140 years later, hasn't been achieved. Are there any real incentives for states to work together to create that uniformity?

MR. GRACE: I think that there are a number of people of goodwill that really are trying very hard right now in response to the OFC push by the industry. But there is so many different state interests at stake that I can't -- they won't all play together. So we'll never actually have a uniformity.

REP. BEAN: I have a question for Mr. Hunter. In the bill that Congressman Royce and I introduced, we set the minimum for market conduct regulations at the national NAIC market conduct model law that set the starting point. Do you think this is an appropriate place to start for consumer protections? And besides rate regulation, would you suggest anything additional in terms of consumer protections?

MR. HUNTER: The NAIC market conduct model is not sufficient. You'd have to get -- for example, it doesn't collect market behavior data like HMDA would collect which I think is important --

REP. BEAN: It doesn't collect which data, I'm sorry?

MR. HUNTER: HMDA type data. And so it's not sufficient as it is. And rate regulation is vital, we think, to any good protection for consumers and actually improves competition.

REP. BEAN: Anything beyond that that you would add?

MR. HUNTER: Oh yeah. Well, I have to go through the whole model, but we had a whole list of complaints I could send to you if you'd like.

REP. BEAN: Fine. Thank you. I yield back.

REP. KANJORSKI: Gentleman from California, Mr. Royce, is recognized for five minutes.

REP. ROYCE: Thank you very much, Mr. Chairman.

And I'm going to pick up on some of the questions that Congresswoman Bean had asked and I appreciate it.

Mr. Webel, your response to that -- I would also ask this of Mr. Grace and Mr. Harrington. Much of the focus of AIG's failure has been on their speculative use of CDS. There's been a lot of discussion as to whether CDS or insurance products should have been regulated as such. There is no dispute, though, that state regulation failed to detect and address a number of these major problems with AIG.

And in February this year, a report service from the Wall Street Journal -- and I quote from that. "From ($)1 billion in 1999, AIG's securities-lending portfolio ballooned to ($)30 billion in 2003 and then ($)60 billion" unless it shared with either, then went to $70 billion. "Much of that growth came from lending out corporate bonds owned by AIG's large life insurance and retirement services subsidiaries," unquote.

So over a period of about seven years, AIG bled the assets of its insurance division shifting these investments into an overseas, casinolike CDS operation, while going completely undetected by the state insurance commissioners responsible for ensuring the solvency of its operations.

And here is the punch line. Only when the company was on the brink of collapse after multiple publicly reported restatements of earnings, did New York State insurance commissioner and governor propose to redirect $20 billion from the surplus of AIG's insurance company to its parent holding company. Now fortunately, that plan was aborted.

But that's the type -- that's the scale of regulation and due diligence and oversight that existed. It turns out the problem was much bigger, as state officials realized, that caused the federal government to intervene, and the American taxpayers were asked to cover one of the most expensive corporate bailouts in our history.

Now, surely the bail was failure throughout AIG and throughout the regulatory structure overseeing AIG. But doesn't this tragic episode underscore the inability of state insurance regulators to exercise effective oversight of today's large, complex insurance companies? And I again think that Congresswoman Bean is on the right track, and I'm a cosponsor of her bill.

When, you know, we try to give a federal -- world class federal regulator here, not only the authority but also the information to look at the entire, you know, financial institution that's involved in insurance and all of its affiliates, it just seems to me that -- Mr. Harrington, that in the wake of this mess, on top of all of the other arguments as I say before, you know, we have a national market in everything else, a balkanized one in this product.

But now on top of it, we deal with this problem. So I would ask, Mr. Harrington, your observations on that and Mr. Grace as well.

MR. HARRINGTON: I would like to see a really detailed analysis of the securities lending issue and exactly what happened, why it happened, what the nature of the breakdown was, to what extent New York's insurance department and various other state regulators may have been switched, securities lending had gone on for so long, and has been a major part of so many operations.

I think we regard to its routine business with no mischief involved. Well, clearly, now it appears there might have been some real mischief, so that could seriously evince some state regulatory failure there.

I would want to really look into the specifics of the securities lending, but I have to go back and say everybody failed here. The OTS failed. Foreign bank regulators failed. They were letting foreign banks load up on AIG papers, CDS paper.

Presumably, if they were going their job, they would've said, how can we have so much of our banking systems dependent on the promise of a single United States institution. Bank regulators failed.

I don't know about the comptroller, but the Fed in many respects must've failed to allow so many banks to contract with AIG given that it was running amok, so to speak, on these dimensions.

So the Fed was partially to blame. The FDIC seems to have been to blame. The SEC, you can lay a lot of blame at their feet, and then also the Federal Reserve in general. I mean, I won't go -- we don't want to go to low interest rates, to what that did to the incentives in the entire system.

But my point would just be you may well be correct that it's -- (inaudible) -- go around --

REP. ROYCE: I happen to agree with every point you said including the central banks worldwide running negative interest rates in terms of inflation for four years running.

Sure, all of this fed it. But that's my point. Every one of these entities that you've cited had a little piece of this puzzle, and what worries me about our failure to address the fact that we are not ready to embrace giving a world-class regulator the ability to have the overarching piece.

I'm not saying that regulators are going to catch every mistake, but by God when you're leveraged a 170 to 1, and nobody catches that, that's something that can be caught and probably can only be caught by giving one regulator all the pieces of the information. And that's why Congresswoman Bean has introduced this bill. And this is why I think she's right in this approach in addition to a dozen other reasons.

And so let me, Mr. Harrington, agree with your assessment.

But to say at the same time that it is the overleveraging on top of all of the rest of this. And the fact that that couldn't be caught, because of the piecemeal patchwork quell approach here.

And Mr. Grace, let me ask you for your observations as well.

MR. GRACE: Thank you. I guess, I'm -- I agree with both of you. I mean, this is a hard question, and it really is -- I think it comes down to this, now that I -- thinking about it. If we had one more regulator, and there's -- let's say, we -- there was 50 regulators.

I'm not talking about the state. I'm talking about federal regulators, foreign regulators, some state regulators. There were 50 different entities looking at this in some way, would adding even a state-of-the-art world class regulator, would they have caught this? And I think talking about --

REP. ROYCE: But the question, Mr. Grace is because you assumed that those 50 --

MR. GRACE: Oh -- (cross talk) -- problem.

REP. ROYCE: -- you know, you've got that problem, and that's what I think is the root of the problem here.

MR. GRACE: But what would be -- the question would be also then if you had this world class regulator, would it not fall into the same complacency trap? I mean, I agree, I think we should have something that's like that, but I don't know that it's a cure. I -- maybe it's --

REP. ROYCE: I understand the point you're making, and let me say that Mr. Grace, I agree that counterparty due diligence or market discipline is the most important factor in all of this. And then that that can be circumvented, unfortunately, when the assumption is made that somebody's looking at it.

So I agree with that philosophy. But I have to say that in order to catch this type of overleveraging, I think, this would have been caught by a world-class regulator if they had access to all of the information. And I think it's the amount -- the sheer amount of overleveraging here, which created the systemic risk. So I'm not saying that this would solve all problems.

I concur with you on that. But I would ask if you'd grant me that point.

MR. GRACE: A 170 times overleveraging just boggles my mind. I mean I don't see how somebody -- I mean, I still agree with you, but I just don't see how someone didn't see that. I mean, so if --

REP. ROYCE: Neither do I.

MR. GRACE: Okay. If there's all these people looking at and thinking about it --

REP. ROYCE: Nobody had all the pieces.

MR. GRACE: That --okay, that maybe --

REP. ROYCE: That's the problem.

Anyway thank you, Mr. Chairman.

REP. KANJORSKI: Thank you very much, Mr. Royce.

Gentleman from Ohio, Mr. Wilson. We've been waiting now, Mr. Wilson, go do it.

REP. CHARLES A. WILSON (D-OH): Thank you, Mr. Chairman.

Ms. Guinn, did you have a comment to say?

MS. GUINN: I was just going to add to the prior conversations that this notion of regulatory overarbitrage, that my point is very much related to the one that's used to making a steroid (ph), it's around product level -- regulatory overarbitrage and the difference between the financial guarantee insurers and the credit default swap market is the primary example, the poster child for this.

The financial guarantee insurers have experienced substantial losses. Their loss ratio last year was down the order of 300 percent. But by and large, they're still solvent, and they're solvent, because of perhaps two factors. One is that they were required to hold capital against the policies they wrote. And secondly, the nature of their contracts had a more sensible limit on what the terms of the coverage were.

The credit default swap market, on the other hand, was largely unregulated, limited capital requirement. And for the buyers of those contracts to be comfortable with counterparty risk, the nature of the contract terms and the liquidity pressures that they had inherent in them actually caused the triggering of immensive losses.

Thank you.

REP. WILSON: Thank you.

REP. KANJORSKI: Would the gentleman yield for one second?

REP. : certainly.

REP. KANJORSKI: I think she made my point. It was the investment side of the business that put at risk the underwriting side of the business. And that's why I think you need a federal regulator to prevent that and to look at that. So I --

REP. : Okay. Thank you. I would like to say as a former state legislator, I've always been very pro keeping as much regulation local as possible. But what we've seen happen in this last go-around with AIG and how we're going to be able to curb the systemic risk, I think there's ways to look otherwise than what my theory would normally be, and that is to keep it at the state level.

In Ohio, we always had -- the department of commerce, and the department of insurance was part of that, and no real problems. But we certainly weren't doing deals like had been done in New York, and I think that was a big part of it.

My question starts with Mr. Webel and then come down, if I may, to Dr. Harrington.

So Mr. Webel, first of all, one of the comments you made earlier, and I thought it was really something we should focus in on is too big to fail. And so if you'd go back and touch on that for me then I have a second question for you.

MR. WEBEL: Well -- I mean, the point is that -- I mean, the question of competitiveness at international level is frequently brought up when you talk about too big to fail.

The Citibanks, the Bank of Americas are competing on global levels with Deutsche Bank, with Royal Bank of Scotland, with -- in a globalized financial system. And this gains the country an immense amount.

But if you approached too big to fail and say we're just not going to let things get too big -- you know, one way to do that -- one way to say is, okay, you have a systemically significant institution, we're going to put additional capital controls on it, we're going to put additional regulations on it to make sure that it's not as likely to fail.

Another option would be to just say we're just not going to let things get that big. One of the counter examples that people frequently point to is this lack of competitiveness, that you're not, you know -- other countries are doing this. They're letting their institutions do this. Otherwise balance and trade will suffer. And that's true. I would just point out that there are a lot of places in policy where the government basically says, okay.

You know, we could let the market go this way and it might make more profit.

But, you know, for a social reason, we're not going to let it go that way. You know you could mine in Yellowstone National Park.

As a society, we say we're not going to do that. If you look at the cost of the crisis that we're in, one might conclude that it would be worth it to say, okay, if other people want to let their banks like Iceland get to be 40 times the size of their GDP or whatever it was and then collapse when their banks collapse, they can go that route.

We'll -- we're going to say, no. We're going to accept the fact that we're going to be uncompetitive in this particular area, but at least when the crisis hits, we're not going to suffer like they do.

REP. : I'd like to follow up on that. Just -- if we can drill down a little more and say that, you know, Americans just by nature we're going to be competitive, and we're going to want to be competitive with every country out there.

So it tells me that if we're going to do that then we're going to control systemic risk, then we're going to have to put the controls in so that companies don't get too big to fail. So given that nature what would you think on -- I know you mentioned the capital markets and controls. Could you be more specific?

MR. WEBEL: Well, I mean, the most basic level is simply the amount of capital that you're going to have an institution hold in response to arguments that we sometimes have among my colleagues.

I came up with three reasons, if you just did these three things, you wouldn't have this crisis. One of them is simply, you don't let institutions get so leveraged. I mean, it is generally within the purview of most of the regulators that we have. Certainly, the banking regulators and the insurance regulators, to determine how much capital the institution is going to hold. Now, of course, if you hold more capital, you do make them again less competitive.

You know, they are going to be making less profit, but the flipside is that they are less likely to fail and less likely to need, you know, a takeover and possible government bailout when they do.

REP. : Okay. Thank you. The other part is -- you had mentioned about United States deficit insurance. Could you comment on that?

MR. WEBEL: Basically -- I mean, it's convenient, because the balance in trade accounting has two specific columns in. One is for essentially insurance services, and one is for non-insurance financial services, i.e. primarily banking and security.

So, yeah, I believe they release the data quarterly or it may be annual. You know, when they release the data, it's very easy to go to the website and say, okay, this is the amount that the trade deficit was in these services for the past year or the past quarter.

And so you can look at it very clearly that it is clearly striking that in non-insurance financial services, we have consistently run a fairly substantial surplus. In insurance financial services, we have consistently run a fairly substantial effort.

And there isn't necessarily anything wrong with that in the sense that, you know, in the automobile industry if you looked at imports and exports of SUVs versus small sports cars. You know, the Germans and Italians probably import small sport cars, and then we import them from Germany, we would export SUVs. So it's not unheard of to have the same industry with differentiation among product types.

But it's still -- I mean, it's still interesting to note that our banking system, our security system seems to be very competitive on the world stage and the insurance business.

REP. : Thank you, Mr. Webel.

Dr. Harrington, if I can -- you've talked about regulatory reform, and you had mentioned earlier, I believe it was to Mr. Garrett, in regard to what approach you think would be a good idea. Could you restate that?

MR. HARRINGTON: My main comment was one that if we moved towards having an optional federal system of regulation for insurance that the whole issue of how we decide to guarantee some insurers' obligations will be critical in determining how much we've made less in market discipline, increase moral hazard, and actually undermine safety and soundness.

So if we go that route, that's just a linchpin of what needs to be done. The other thing I just said though is that I'm by nature an incrementalist, and I wonder if targeting certain problems with state regulations through less intrusive means that wouldn't require some of the risks that are associated with the federal regulator couldn't achieve lapse of the potential efficiencies that might arrive through some sort of change.

Now, to be sure the types of things that might be done there have become -- they sort of moved off the front page of the papers today, because of the asset crisis from the housing crisis.

But I'm talking about things that would allow consumers maybe to have more choice in ways in which they buy products and the types of products that they buy, without having to abide by certain types of regulations at the state level, whether that'd be a passport system, or whether it'd be some sort of federal preemption of certain types of regulation that deprived some consumers of, really, the ability to get low cost products, because of the way the price is regulated.

REP. : Thank you. I liked especially your second suggestion there. Thank you.

Thank you, Mr. Chairman. I yield back the balance of my time.

REP. KANJORSKI: Thank you very much, Mr. (Off mike).

Now, we'll hear from the gentleman from Illinois, Mr. Foster.

REP. BILL FOSTER (D-IL): Thank you. However, my first question, I hope, is a simple one. Can any of you show me that there either are or not other many AIGs hanging around there, that there are insurance companies that could explode tomorrow and have systemic risk?

MR. : You know, we can't insure the future, but in looking -- I have specifically in the past looked at the securities lending aspect of AIG, and into the -- sort of other insurance companies in what their securities lending looked like.

And from there -- from what I found, there didn't -- there wasn't anybody else that was approaching it nearly to the level that AIG did. And this was definitely a big way that they failed, but it doesn't look like that this explosive failure is coming from that direction.

MS. GUINN: I would agree with Mr. Webel, that in terms of participation in the credit default swap market and securities lending coupled with the scope of AIG's operations, the complexity of it, the number of coverages they wrote, the number of legal entities, it's pretty unique in the industry.

That's if there are other large companies and each company bears its own risks. So if there were -- you know, if the big quake came to California tomorrow, could other insurance companies, perhaps large ones be impacted --

MR. : Well, that's on the underwriting side more. So the question is always going to be there.

MR. : If the -- it depends what your projection of what goes on with the economic situation if it continues to deteriorate. You have several large life insurers that might be at risk.

REP. FOSTER: Okay. Let's see, my next question is, Alan Greenspan and others have this interesting suggestion of dealing with too big to fail by simply imposing increasingly stringent capital requirements, so that they would increase nonlinearly as you increase in size, and that eventually there would be a motivation for a company, that as it grew bigger, to split in two to get higher returns on -- for its investors.

And I was wondering if you have a reaction if that would be appropriate for insurance company.

Yes. Mr. Harrington?

MR. HARRINGTON: I'd say with regard to the insurance sector, if we can get beyond AIG, the capital requirements have been such that most companies have held vastly more capital than what's required by the requirements, especially on the property-casualty side so that because of market discipline many property-casualty companies are really well capitalized than a lot of life insurance companies have.

In principle, if you had moral hazard problems and real systemic risk problems, I think this idea of increasing capital requirements and increasing them more, the more risk you take on, makes some sense but I'm so skeptical about whether it will ever work in practice.

Because if you look at the last 20 years of banking regulation, the name of the game has been to move towards extensively sophisticated systems that in effect allowed banks to reduce the amount of capital they held. So I'm just skeptical that you can actually make that type of system by -- in theory, I think it sounds like a good idea.

REP. FOSTER: Right. And well, a related suggestion is to have a fund -- to pre-fund the systemic risk thing then by basically -- you know, taxing increasingly large institutions, which is another, you know, obvious possibility.

But let's see -- another attack on the too big to fail problem has to do with just enforcing compartmentalization, and when you talk to Ed Liddy about this, you know, he was just dismayed at the prospect we're trying -- anyone trying to run a business that was as diverse as that.

And then simply if you would have the individual business units of AIG grow, become profitable, and then at that point just return dividends to the shareholders who would reinvest it wherever they thought it made sense. And by enforcing compartmentalization as a way of dealing with too big to fail, it also makes the regulators' job a lot easier, and I was wondering if you have a reaction to that as a possible solution for the insurance industry.

MR. : Well -- I mean, it seems to some degree that the insurance regulators were fairly successful in doing that with AIG. I mean, if -- by all accounts, the insurance subsidiaries, compartmentalized, are okay. So that if you had taken AIG into a bankruptcy and slit off the -- all of the FD and other products and just have the insurance companies go forward, they would've been okay. So they've -- what we still ended up with the mess in AIG.

REP. FOSTER: Do you have something -- (off mike)?

MR. : I was just going to say that I was a little unsure how they would do the compartmentalization, but if you mean to make the companies more of a monoline type of thing, that could --

REP. FOSTER: For example, you know --

MR. : -- that could be a serious problem if you -- because it'd be a pretty small company and be a very large player in a single line, and you're insolvent. It's all of a small company; insolvency could actually have some significant damage, of course. It's depending on the line like it was bonds.

REP. FOSTER: Any other comments on it?

MR. : Any compartmentalization, I think, would be broadly between insurance type products and other products. I think there are lots of gains from diversification within insurance type products. It's when you get into all sorts of ancillary products where the regulatory burden really becomes large, and of course that's also true in banking.

And in my comments before, I think, we have to really think about whether or not we shouldn't maybe have more restrictions on activities. If you want to get -- if you want to go to the deposit insurance still and be able to get that type of protection for depositors, maybe you have to give up some of your choices about what activities your overall entity would undertake.

REP. FOSTER: Thank you. I guess my time is up, so I yield back.

REP. KANJORSKI: Thank you very much, Mr. Foster, appreciate it.

Now, Mr. Grayson, recognize you for five minutes.

REP. ALAN GRAYSON (D-FL): Thank you, Mr. Chairman.

There's been an awful lot of discussion about whether we should regulate. There's been a lot of discussion about who should regulate, and much less discussion about what the regulation should be.

Let's assume for the sake of the argument that we agree that something went badly wrong in the case of AIG and that bailing out AIG is not the best use of a $100 billion of taxpayer funds.

Somewhere along the line somebody should've had the authority and the guts to say to AIG you're doing something wrong, you need to stop. And what I want to hear from you all is I'd like to hear your best ideas about what the substantive rule should be in order to avoid a recurrence of the situation that we've had with AIG.

I'm talking about specific limits, because I'm concerned that if we simply say to a systemic risk regulator, you figure it out, that's not being responsible. So we have to come up with rules that we can actually apply with some degree of regularity and avoid the problem that we've seen over and over again in this industry which is capture, where the regulated become the regulator.

So let's start with Mr. Hunter. What are your best ideas about when to tell AIG or any other insurance company that enough is enough?

MR. HUNTER: Well, again, I think this is a -- the role of a solvency regulator -- solvency/systemic risk regulator and that there should be specific limits on leverage.

REP. GRAYSON: What limits?

MR. HUNTER: Well, it may depend upon the line of insurance -- it does depend upon the line of insurance. If you're writing earthquake, you need a lot more risk capital than if you're writing life insurance.

REP. GRAYSON: Give me an example of when you would say, enough is enough?

MR. HUNTER: For earthquake insurance I think you need at least $2 of capital for every dollar of risk. For property casualty insurance you may need only $1 for $2 of risk. It depends on the line of insurance there too.

So you can come up with leverage limits. You can come up with size limits. It means some companies shouldn't grow beyond certain limits particularly in markets, 10 percent may be -- maybe a limit should be 10 percent within a line of insurance.

For example, in a state no company should get bigger than that. So that enhance both competition and to make a failure less damaging.

REP. GRAYSON: Is there a certain size when you think that "enough is enough" when it actually is beginning to invoke system risk? I mean, we know that a $1 million insurance company is not involved in systemic risk and a $1 trillion insurance company is.

MR. : Yeah.

REP. GRAYSON: Tell me where you think the line is.

MR. HUNTER: I don't know. I haven't done the analysis, but I think it can be done, and again it may vary by way you're writing and the kinds of risks you have in your portfolio.

REP. GRAYSON: Mr. Harrington, when is enough enough?

MR. HARRINGTON: I'd like to think I would know it when I saw it, but I would not be able to opine on that outside of the context of what I -- what in particular I was looking at.

Clearly, it seems to me that someone with knowledge of what was going on at AIG should've been able to say enough is enough. Nobody did.

REP. GRAYSON: You see, Mr. Harrington, that's the sort of fundamental problem, because if you were the systemic risk regulator, and you were faced with a situation, unless you had clear rules to apply, you might just say I'm just going to not deal with it.

And that's the problem we're going to face unless we come up with specific rules. So let me hear from Mr. Webel what you think the specific rule should be.

MR. WEBEL: I really don't have -- the difficulty is that the services industry is mutating so quickly. Writing specific limits into laws put you in a very difficult situation.

I think that looking at market share is probably a reasonable place to start, but in doing that, to some degree you are also cutting out consumer choice. I mean, if an insurance company's done a great job then I want to buy insurance from them and then the government comes along and tells me oh no, you can't buy from them, because too many of your neighbors did. So I would really like to have a good number to tell you, but I'm sorry, I don't.

REP. GRAYSON: Mr. Grace, why don't you put your foot down?

MR. GRACE: I can't answer directly, but I can give you an analogy that, I think, works really well. Twenty years ago, when Congressman Dingell had his hearing, he put the insurance regulators to the test. And they came up with a system -- actually, this was the thing I was criticizing before -- I think, it has a patina on it now, but it was specific rules that happened when certain things occurred. And the regulator had no choice, or its choice was constrained.

You know, he had to shut it down, or he had to investigate it, but there was something that had to be done. What we're talking about here, there isn't a rule that is applicable to every single company universally. Something else I also said was that the Europeans are going to this capital model.

And they are putting all of the firms within that enterprise together to assess the type and quality of capital and how it's going to support the risk that it's writing. And it may be that that test can be used in a --

REP. GRAYSON: What was --

MR. GRACE: The -- (inaudible) -- I'm talking about, but there were mandatory requirements that the regulator had to engage in, when certain things occurred. Science has to be developed to develop those rules for current insurance and insurance-like enterprise. We don't have it yet.

REP. GRAYSON: Well, my time is up, but I will invite you to supplement the record and tell me directly what your best thoughts are on the subject. And I actually find a little disconcerting that five people who are experts in the industry and could end up being the systemic risk regulators for insurance, any one of you, would find it so difficult to answer a question like that.

I'm not blaming you for it, but I think it illustrates what a conundrum we're facing here, and I want your best thinking about how to solve this. Thank you, Mr. Chairman.

REP. KANJORSKI: Thank you very much, Mr. Grayson.

I want to thank the panel particularly before we close the session down. The interruption for an hour and 20 minutes was unexcusable, but that happens because of the way the House proceeds.

I want to thank you very much for coming and being part of this panel specifically, and I'd like to ask you to join us again. I hope maybe we could do something at a roundtable discussion where we could have five play back and forth, because I think you have a wealth of knowledge. Certainly, I'm convinced, we here on the subcommittee need that knowledge if we're ever going to accomplish something.

So again thank you very much for coming. And I just want to caution you that we note that some members may have additional questions -- I know Mr. Royce does -- of this panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses to place their responses in the record.

Before we adjourn, the following written statements will be made part of the record at this hearing. The American Academy of Actuaries and Mr. Eric D. Gerst. And without objection, it is so ordered that they are part of the record, and now the panel is dismissed, and this hearing is adjourned. Thank you. (Sounds gavel.)

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