On May 20th, the NY Times ran an editorial titled “Regulatory Shopping”. The very valid point of the editorial is that if you give the regulated the option to choose their regulator, no good can come of it:
And yet, legislation recently introduced in the House would allow insurance companies, currently regulated by the states, to opt for federal regulation instead — and, in general, if they don’t like that, to switch back after a spell. If the bill were enacted, the race to the regulatory depths would continue, and the nation would be headed in exactly the wrong regulatory direction.
Agreed, no argument. I take issue, however, with the assumption of the NYT that state insurance regulators have covered themselves in glory. Robust defenders of the rights of policyholders? Not exactly. In the pocket of the insurance industry? Sometimes. Opaque? Always. And that’s without addressing the quagmire/insanity that is insurance insolvency regulation and the guaranty fund system.
Think about AIG’s security lending program. That was the program whereby AIG lent securities held by its life insurance subsidiaries to hedge funds which in turn shorted the stock. The more interesting part is what AIG did with the cash it received as collateral for loaned securities. AIG took that money and invested in risky subprime Residential Mortgage Backed Securities in a sordid quest for “an additional 0.2 percentage point in yield, or roughly $150 million in revenue.” Who was minding the store? Allegedly, state insurance regulators. At a certain point, apparently AIG told the regulators and promised to have the holding company protect the insurance companies from some of the losses; but then the bottom fell out. A must read on this is Serena Ng and Liam Pleven’s history of the program (along with many other Ng-Pleven excellent AIG stories). It was only after the damage was done that the regulators even began to discuss regulating this kind of activity. As National Underwriter reported, even in December 2008, after the AIG imploded, state regulators didn’t agree that the activity needed to be regulated:
The regulatory accounting for these programs is not sufficient, according to Mr. Dinallo. Regulators, he said, are able to examine assets which the insurer still owns but do not get to see what happens to the cash.
During a regulator-only session at the meeting, according to Connecticut Insurance Commissioner Tom Sullivan, “the lack of consistency around these vehicles” was described as “deeply alarming.”
Mr. Dinallo added that “one could have a reasonable discussion over whether insurers should be involved in this activity.” He said that if regulators are trying to build a “regulatory moat” around insurance companies, then these programs can be likened to a “drawbridge” that bridges insurers to other financial services areas.
Tom Hampton, commissioner of the District of Columbia, said that he understood the concern over these programs but also urged caution. “We want to be careful. We don’t want to disadvantage insurance companies in the financial marketplace.”
This wasn’t AIGFP. This was reckless behavior with insurance company assets. Are state insurance regulators equipped to deal with the next “sophisticated” trading scheme of some of our largest financial institutions? Is anyone?