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S. HRG. 111–301 

REGULATORY MODERNIZATION: 

PERSPECTIVES ON INSURANCE 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

ON 

EXAMINING THE MODERNIZATION OF INSURANCE REGULATION 

JULY 28, 2009 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KAY BAILEY HUTCHISON, Texas 

EDWARD SILVERMAN, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

AMY FRIEND, Chief Counsel 

CATHERINE GALICIA, Counsel 

CHARLES YI, Senior Policy Adviser 

JOE HEPP, Professional Staff Member 

DREW COLBERT, Legislative Assistant 

DEBORAH KATZ, OCC Detailee 

MARK OESTERLE, Republican Cheif Counsel 

ANDREW J. OLMEM, JR., Republican Counsel 

JIM JOHNSON, Republican Counsel 

DAWN RATLIFF, Chief Clerk 

DEVIN HARTLEY, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)
C O N T E N T S 

TUESDAY, JULY 28, 2009 

Page 

Opening statement of Chairman Dodd .................................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 2 

Prepared statement ................................................................................... 36 

Senator Johnson 

Prepared statement ................................................................................... 36 

WITNESSES 

Travis B. Plunkett, Legislative Director, Consumer Federation of America ...... 4 

Prepared statement .......................................................................................... 37 

Responses to written questions of: 

Senator Brown ........................................................................................... 117 

Baird Webel, Specialist in Financial Economics, Congressional Research 

Service ................................................................................................................... 6 

Prepared statement .......................................................................................... 95 

Responses to written questions of: 

Senator Brown ........................................................................................... 118 

Senator Vitter ............................................................................................ 119 

Hal S. Scott, Nomura Professor of International Financial Systems, and 

Director, Committee on Capital Markets Regulation, Harvard Law School ... 7 

Prepared statement .......................................................................................... 104 

Responses to written questions of: 

Senator Brown ........................................................................................... 120 

Martin F. Grace, J.D., Ph.D., James S. Kemper Professor of Risk Management, and Associate Director, Center for Risk Management and Insurance 

Research, Georgia State University ................................................................... 9 

Prepared statement .......................................................................................... 109 

Responses to written questions of: 

Senator Brown ........................................................................................... 121 

(III)

(1) 

REGULATORY MODERNIZATION: 

PERSPECTIVES ON INSURANCE 

TUESDAY, JULY 28, 2009 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 9:35 a.m., in room SD–538, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. The Committee will come to order this morning. Let me just announce that when we have a quorum, we have 

an executive calendar nomination to consider that has been cleared 

on both sides, a very competent and talented woman, Deborah 

Matz, to be the Board Member designee of the National Credit 

Union Administration. And so if we achieve that number, we will 

interrupt the hearing for that purpose, and if not, then I will try 

and schedule it off the floor after a vote that is convenient for everyone, either this morning or later this afternoon. 

But pending the arrival of 12 Members, I want to thank our witnesses this morning and those who have gathered in the hearing 

room to listen to our hearing this morning entitled ‘‘Regulatory 

Modernization: Perspectives on Insurance.’’ We had a hearing back 

in, I think, March on the subject matter, and this is an important 

issue, obviously, for all of us. As we talk about the modernization 

of financial services, insurance plays a very, very critical role. The 

insurance industry provides millions of Americans, as we know, in 

our country with the safety net they need both as individual homeowners, small businesses, as well as larger enterprises. And in 

times such as these, people are already faced with uncertainty. Millions have lost their jobs, their homes, and their retirement. We 

need to provide them with the peace of mind to protect the policyholders as well and make sure that our insurance industry is 

strong and stays strong during this time of economic difficulty. 

But it is a critically important industry, and it has played a very, 

very important role in capital formation throughout a good part of 

the 20th century, and as we get into the 21st century, the role of 

insurance is going to be even that more important. 

So we live in an uncertain world, as we all know these days. The 

economic crisis has claimed as casualties millions of our fellow citizens who have lost jobs and homes, retirement savings, and their 

family’s economic security. But even in the best of times, there is 
2 

always risk, and that is why the insurance industry exists: to provide stability to families and businesses. 

Today’s hearing is the latest in a series examining our financial 

regulatory system and exploring ways to modernize it for the 21st 

century. At issue is what should be done to better regulate the insurance industry. As always, our primary concern is protecting 

working families in this Nation who have paid the highest and the 

most unfair price for our regulatory deficiencies. 

What to do about insurance regulation is complicated. Some have 

called for Federal regulation of insurance, while others strongly defend the current system of State regulation. It is important, obviously, that we get this right. A strong economy requires the effective flow of capital. Insurance, and the security it brings, is a key 

element in getting credit moving again. 

In my home State of Connecticut, we have had a long and proud 

history of acting as a home, the major home to insurance firms that 

provide a foundation of security for all manner of transactions, 

from the purchase of a home to the building of a new factory. And 

so there is a solid case to be made that State-based regulation of 

insurance has worked well for more than a century. Millions of 

American families, too, have relied on one form of insurance or another in a time of crisis—when they needed to rebuild their homes 

after a devastating fire or such loss or needed economic security 

after the loss of a breadwinner in their family. 

But there is also a case to be made that it is time for change. 

Insurance companies have become more global and more complex, 

and even though the insurance industry did not create the economic crisis, like almost every other industry, it has been hit hard, 

and as a result, many are calling us to modernize regulations and 

reflect the 21st century in which the insurance industry exists. 

The Administration’s plan for regulatory modernization would 

create an Office of National Insurance within the Treasury to collect information and coordinate insurance policy at the Federal 

level. It is one of the many ideas that we will be considering in the 

coming weeks, and so today we have assembled an impressive 

panel of academics and experts. I am grateful to each and every 

one of you for being here. You are extremely knowledgeable on the 

subject matter and can provide some insight and thoughts as to 

how we might progress in this area of modernizing our financial 

regulatory structure, and particularly with emphasis on insurance 

and the insurance industry. So I thank you all for coming. 

I am going to turn to Senator Shelby for any opening comments 

he may have, and then unless my colleagues would care to be 

heard on the subject matter at the outset, we will turn right to our 

witnesses. Senator Shelby. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. 

Over the past 2 years, we have seen how problems in our insurance markets can disrupt our national economy. The crumbling of 

our largest bond insurers called into question the value of financial 

guarantees these firms had issued on billions of dollars of securities. In addition, the spectacular failure of AIG sent shock waves 
3 

throughout our economy and led to a $170 billion bailout by the 

Federal Government. 

These events revealed that comprehensive insurance regulation 

must be a part of our reform effort. Unfortunately, I believe the 

Administration has taken a pass on comprehensive insurance reform thus far. Under the President’s proposal, the Federal Reserve 

would regulate only insurance companies that it deemed to be systemically significant. The President also proposes the creation of an 

Office of National Insurance that would collect information and advise the Treasury Secretary on insurance matters. While this concept may have some merit, it certainly is not comprehensive reform 

and leaves unanswered the difficult question of whether and how 

insurance regulation should be modernized for the vast majority of 

insurers. 

The goal of today’s hearing is to answer that question, as well 

as to examine the President’s reform proposal as it relates to insurance. In particular, I am interested in learning whether our witnesses believe that the Fed is an appropriate regulator for insurers. 

Does it have the expertise necessary to supervise complex insurance companies? Would establishing a separate Federal insurance 

regulator be a better choice? If a Federal regulator is established, 

should all insurers have the option of being regulated at the Federal level? If a Federal regulator is not established, what steps 

need to be taken to ensure that there is proper coordination? Last, 

how do we make sure that there are no gaps in our regulatory system like those that appear to have played a role in the collapse of 

AIG? 

Reforming our insurance regulation will be complex and very 

challenging. The level of difficulty should not prevent us from seeking a comprehensive solution to financial regulation that includes 

insurance. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator. 

Do any of my colleagues want to make any quick opening comments? If not, your opening statements will all be included in the 

record. And let me just say to our witnesses because I know, having read over some of your testimony last evening, you are going 

to want to have it included in the record, I presume, because I do 

not know how—Travis, there is no way in 5 minutes you are going 

to have your testimony included in this record in 5 minutes. So I 

will make sure that your comments and thoughts and additional 

ideas will be a part of the record. I will say that at the outset so 

you do not have to ask consent to that. With that, let me introduce 

our panel. 

Travis Plunkett is the Legislative Director of the Consumer Federation of America. He is a regular fixture in this Committee, has 

been sitting at that desk on numerous occasions, at least during 

my tenure in the last 21⁄2 years, on numerous, numerous issues 

that have come before us, and we thank you once again for being 

here today. 

Baird Webel is the Specialist in Financial Economics at the Congressional Research Service, which provides nonpartisan analysis 

and research for members of Congress. Mr. Webel has authored 

and contributed to a number of reports related to insurance and 
4 

the regulation of insurance, and for those of us who have been here 

and I note for new Members that the Congressional Research Service is an invaluable service for us up here. It has been a great 

source of nonpartisan information, and we thank you immensely. 

Hal Scott is certainly well known on this subject matter, the 

Nomura Professor and Director of the Program of International Financial Systems at Harvard Law School, where he has taught since 

1975. He is also the Director of the Committee on Capital Markets 

Regulation. Professor Scott, we thank you for being here. We appreciate your participation. 

Martin Grace is the James Kemper Professor of Risk Management at Georgia State University. He was the Associate Director 

and Research Associate for the Georgia State Senate for Risk Management and Insurance Research. He is currently an associate editor of the Journal of Risk and Insurance, and, again, we appreciate 

your knowledge and background and experience in the subject matter as well, and we thank you for joining us today as a witness. 

With that, Travis, we will begin with you, and, again, I am not 

going to be rigid on the clock here. But, nonetheless, if you try and 

keep it at 5 to 7 minutes, I would appreciate it very much. Then 

we will turn to our colleagues for questions. 

STATEMENT OF TRAVIS B. PLUNKETT, LEGISLATIVE 

DIRECTOR, CONSUMER FEDERATION OF AMERICA 

Mr. PLUNKETT. Thank you, Mr. Chairman, Ranking Member 

Shelby, and Members of the Committee. Once again, it is a pleasure to be before you to talk about insurance regulation and reforming and modernizing insurance regulation. 

Unfortunately, our insurance director, Bob Hunter, could not be 

here today. He sends his apologies. He is tending to a sick family 

member. As he mentioned in his testimony before the Committee 

in March, we are revisiting our policy positions on insurance regulation to learn from the regulatory failures that contributed to the 

economic meltdown. 

The first lesson that we have learned is that Congress should, in 

fact, create a systemic risk regulator for insurance. Our analysis 

indicates that there is some systemic risk in insurance requiring a 

regulator. In order to fully understand and control systemic risk in 

this very complex industry, the Federal Government should take 

over solvency and prudential regulation of insurance as well. 

This conclusion is made even in light of the fact that, looking 

backward, a strong case can be made that the States have done a 

pretty good job of solvency regulation of insurers in recent years, 

primarily because of the creation of NAIC’s accreditation program. 

That track record was stained, however, last winter when NAIC 

agreed in secret meetings to fast-track several significant changes 

to life insurance accounting and reserve practices which would 

have weakened the financial condition of life insurers and misled 

the public about the financial strengthen of some of these insurers. 

Although NAIC eventually backtracked and rejected these changes, 

they were adopted by several regulators in important States with 

large insurers. Looking forward, we see no other way to understand 

and control national systemic risk other than under a single solvency prudential regulator. 
5 

The second lesson for us is that the Federal systemic risk regulator should be housed in an agency that is also tasked with prudential and insolvency regulation. The office should be a repository 

of insurance expertise. It should engage in activities like data colleague and analysis. While this office should be completely knowledgeable about all aspects of insurance, it should not be granted 

vague and open-ended powers of preemption regarding international agreements that would affect State consumer protection 

laws or rules in areas that Congress has chosen not to explicitly 

preempt. 

The third lesson for us is that we need to create a financial consumer protection agency to put minimum standards on the books 

regarding credit-related insurance transactions, including credit 

and title insurance. The agency should also study insurance matters that are important to consumers and small businesses and appear before the States or the courts on behalf of consumers regarding personal lines of insurance, such as auto and homeowners coverage. 

That is what we would recommend that Congress do for starters 

regarding regulatory restructuring. Here is what we would recommend that Congress not do. 

First is to block the States from being the primary insurers of 

insurance regarding consumer protection. The States are well established in insurance regulation with great expertise and experience. They regulate over 7,000 insurers. They have 10,000 staff 

working on insurance matters. Over the years, we have documented many weaknesses in this State-based system, but the truth 

is that they are very good at some things, especially handling complaints for consumers, and their capacity to do so far outstrips current Federal capacity, for example, on banking in terms of handling 

complaints. 

However, we should not set up an optional Federal charter system. That system, we think, is designed to reduce consumer protection to exert downward pressure on the quality of insurance regulation. It has failed miserably at the banking level. Banks and thrifts 

switch charters freely at the Federal level and between the State 

and Federal level to avoid strong regulation, leading to sharp 

downward pressure on the quality of regulation. The results are obvious, and they have affected our economy. So we very strongly encourage this Committee not to take that approach to regulatory 

modernization. 

Finally, let me conclude by just saying that insurance is a mandatory aspect of life today for American consumers. States and 

lenders require many different types of coverage. If they do not require it, the need to act responsibly to protect one’s family in the 

event of an unexpected emergency means that purchasing other insurance products is a virtual necessity. Consumers can easily be 

misled by the fine print, and we urge this Committee to continue, 

as it has, to put a strong focus on consumer protect when it looks 

at insurance regulation. 

Thank you all. 

Chairman DODD. Thank you very much, Mr. Plunkett. 

Mr. Webel. 
6 

STATEMENT OF BAIRD WEBEL, SPECIALIST IN FINANCIAL 

ECONOMICS, CONGRESSIONAL RESEARCH SERVICE 

Mr. WEBEL. Good morning. My name is Baird Webel. I am a Specialist in Financial Economics at the Congressional Research Service, and I would like to thank you, Chairman Dodd, Senator Shelby, and the rest of the Members of the Committee for having me 

here. I appreciate the opportunity to provide whatever assistance 

I can to the Committee as it considers insurance regulatory modernization. 

My written testimony provides a range of options that Congress 

could consider as it approaches revamping the insurance regulatory 

system, and I would like to highlight some particular aspects. 

To begin, I would just highlight that the options that I present, 

and many of the other options, are not mutually exclusive. Insurance is a very wide-ranging business. It is quite possible to envision an approach that takes different regulatory approaches for different aspects of the insurance business. You have extreme differences between life insurance and property-casualty insurance, 

between personal lines and commercial lines that are about big 

businesses. You could approach large and small insurers differently. You can approach market conduct and consumer protection differently than you might solvency regulation. This is not to 

say that one single regulatory body might not be the way to go, but 

there are numerous options to consider as you consider. 

The insurance regulatory reform debate is not new. It goes back 

really all the way to 1868 or so. It has been spurred along by this 

financial crisis, but many of the proposals that may come before 

Congress really predated the financial crisis. 

To some degree, many of these proposals have been in legislative 

language for quite some time. There has been a chance to vet them 

and to examine the language for various interest groups to consider 

what this language might mean, and for the people to line up on 

one side or the other as they have the battle over whether or not 

you would want to see a proposal enacted. 

There are some new proposals, however, and these I think really 

have not been vetted to the same degree that the older ones have, 

which is not to say that they are not good proposals. There are certainly old proposals that have been on the table for a long time and 

left on the table for a reason. And there are new proposals that 

maybe we do not know exactly what the impact might be but might 

be the right thing to do. 

The newest proposal, of course, is what was released by the Administration in the last week with legislative language coming out 

of the Treasury, and I think that particularly with regard to the 

insurance aspect of it, the Obama administration’s plan leaves insurance relatively intact in the current regulatory system. The 

States remain the primary regulators of insurance under the plan. 

The principal two ways that the plan touches insurance is through 

the aforementioned Office of National Insurance, which would have 

some preemptive powers over State laws, and through the systemic 

risk regulator language. 

What is interesting, though, is that the systemic risk regulatory 

language that was released hardly mentioned the term ‘‘insurance.’’ 

I think that the primary way that it does is actually in the phrase 
7 

‘‘Federal deposit insurance.’’ So that presumably insurers are included under the very broad definition of ‘‘financial company’’ that 

is in the law, but it does not treat a lot of the questions that would 

arise when you have the systemic regulator on top of the current 

system. And I think that these questions are sort of magnified by 

the split between a State and a Federal regulatory body. 

The relationship between two Federal regulatory bodies may be 

a little different than when you have a Federal regulatory body and 

a State regulatory body. I think there are some constitutional or 

legal questions that come up in terms of how does a Federal regulatory body interact, what kind of preemptive powers does it have, 

that are operative in the insurance realm that really do not apply 

to the same degree in the banking realm. And I think that the Administration’s proposal is really sort of silent on exactly how these 

issues may be resolved. 

Of interest as well is the fact that the Financial Services Oversight Council that is foreseen in the legislation does not appear to 

have any specific representative with an insurance background on 

it. You have the heads of the various Federal regulatory bodies, but 

the draft that I saw did not include the head of the new Office of 

National Insurance on the Financial Services Oversight Council, 

did not see any representation from the State insurance regulators 

as well. And I think that that is just an interesting aspect of how, 

once again, insurance to a large degree at the Federal level is being 

seen—I mean, I would not say as a second-class citizen, but it is 

secondary to the banking system and, to some degree, the securities system, primarily because the Federal Government has not 

had the direct oversight over insurance in the past. 

I will be happy to answer any questions that the Committee has. 

Chairman DODD. Thank you very much, Mr. Webel. I appreciate 

it. 

Mr. Scott, thank you again for being with us. 

STATEMENT OF HAL S. SCOTT, NOMURA PROFESSOR OF 

INTERNATIONAL FINANCIAL SYSTEMS, AND DIRECTOR, 

COMMITTEE ON CAPITAL MARKETS REGULATION, HARVARD 

LAW SCHOOL 

Mr. SCOTT. Thank you, Chairman Dodd, Ranking Member Shelby, and Members of the Committee, for permitting me to testify before you today on regulatory modernization as it relates—— 

Chairman DODD. Mr. Scott, that microphone of yours, you have 

to pull it up close to you, too. I am sorry about that. 

Mr. SCOTT. OK. Should I start over? 

Thank you, Chairman Dodd, Ranking Member Shelby, and Members of the Committee, for permitting me to testify before you today 

on regulatory modernization as it relates to the insurance industry. 

As the Committee knows, the insurance industry represents an 

important place in the U.S. financial system. As of the first quarter 

of 2009, the total assets of U.S. life and property-casualty insurers 

were $5.7 trillion, quite significant when compared with total assets of U.S. commercial banks of $13.9 trillion. Despite being a national—indeed, international—business, insurance, unlike the 

banking and securities sector, is regulated almost exclusively by 

each of the 50 States instead of the Federal Government. 
8 

I favor changing the system by creating an optional Federal charter, OFC, and I have three major reasons for taking this position. 

First, the current framework of multistate regulation is inefficient. One study finds that the total additional cost of having 

multistate regulation of the life insurance industry is about $5.7 

billion each year. These costs are ultimately borne by the purchasers of insurance. 

Second, the current framework impedes achieving uniformity of 

standards and regulations. NAIC’s attempts to attempts to reduce 

these costs have not been entirely successful. The surest way to 

solve this problem is to have Federal rather than State regulation. 

Third, the current system puts the insurance industry at a competitive disadvantage to other financial services firms offering competing products. Federally regulated financial institutions can ask 

their Federal regulators for nationwide approval of a product and 

receive one approval within a relatively shorter period of time than 

it takes insurers to obtain multistate approvals. 

And, finally, the creation of a Federal chartering agency would 

enable greater cooperation in the international arena among the 

various national insurance regulators. 

Some contend that an OFC may lead to reduced consumer protection since State regulators may be more responsive to local complaints and concerns than a Federal regulator, and I think to some 

extent this has been true in the past. However, the Obama administration’s proposal for a new consumer financial protection agency, 

which I think should have jurisdiction over federally regulated insurers, should greatly alleviate that concern. 

Where should the new Federal regulator fit in the current regulatory structure? From a broad perspective, I believe the overall 

U.S. financial regulatory structure is in need of significant reform. 

In May 2009, the Committee on Capital Markets Regulation 

issued a comprehensive report entitled ‘‘The Global Financial Crisis: A Plan for Regulatory Reform’’ that called for the U.S. financial 

system to be overseen by only two or, at most, three independent 

regulatory bodies: the Federal Reserve, a newly created independent U.S. Financial Services Authority called the USFSA, and 

possibly another new independent investor/consumer protection 

agency. I believe this model is the right one to replace our highly 

fragmented and ineffective regulatory structure. 

If this proposal were to be adopted, regulation of federally chartered insurance companies would be shared, as it was for banks 

and securities firms between the Federal Reserve, the USFSA, and 

this third investor/consumer protection agency, and we would envision that the Treasury Department would resolve regulatory conflicts for insurance companies as well as other financial institutions 

between these two or three bodies. 

Two final points. First, my testimony has assumed that Federal 

chartering will be optional. However, Federal regulation, if not 

Federal chartering, should be mandatory for large insurance companies since the failures of such firms pose risk to the financial 

system and taxpayers, as demonstrated by AIG. 

Second, the Federal Government must require these large insurance firms to have sufficient capital as a buffer against their failure and the expenditure of taxpayer funds. Our committee would 
9 

have lodged that capital regulation authority with the Federal Reserve. 

However, we must bear in mind that these requirements for capital will have to be different than for banks, as insurance firms engage in very different activities and, thus, incur different risks. 

Thank you. I look forward to answering your questions. 

Chairman DODD. Thank you very much, Professor Scott. 

Mr. Grace, Professor Grace. 

STATEMENT OF MARTIN F. GRACE, J.D., PH.D., JAMES S. KEMPER PROFESSOR OF RISK MANAGEMENT, AND ASSOCIATE DIRECTOR, CENTER FOR RISK MANAGEMENT AND INSURANCE 

RESEARCH, GEORGIA STATE UNIVERSITY 

Mr. GRACE. Thank you. Mr. Chairman, Ranking Member Shelby, 

and Members of the Committee, good morning and thank you for 

giving me the opportunity to testify before you today on the topic 

of insurance modernization. 

My name is Martin Grace, and I have spent my entire career at 

Georgia State University conducting research in insurance regulation and taxation. Since the industry is regulated at the State 

level, this has been predominantly an exercise in the study of State 

regulation. However, the question of whether the State is the appropriate level of regulation is becoming more important, and I 

have spent the last 4 to 10 years, depending on how you count it, 

thinking about that regulation. 

This brings me to what I am going to talk about today. 

First is the value of regulation in the insurance industry. There 

are valid rationales for insurance regulation, but the business of insurance is quite different than banking and has a need for a different style of regulation. 

Second, I have a mild but, nonetheless, important critique of the 

current proposals to regulate the insurance industry. An optional 

Federal charter is not necessarily the only way to think about insurance regulation, and I would like to concur with Professor Scott 

that maybe there are certain companies that should be regulated 

and certain companies that have the option of being regulated at 

the Federal level. However, the current proposal is cobbled together 

from a Federal banking law that goes back quite some time and 

decades old State insurance protection—consumer protection model 

laws. 

My third point is that something like the Office of National Insurance as a source of expertise and advice to the Federal Government about the insurance industry is needed, but it should not by 

itself be used to restructure the relationship between Federal and 

State regulation through its use of preemption. 

Well, we have probably heard a number of different people 

throughout the last year or so talking about why we regulate insurance, but I want to compare the historical rationale with insurance 

regulation to the current way people are thinking about it. 

Historically, insurance has been regulated to reduce asymmetric 

information between consumers and producers and shareholders 

and policyholders, and also to reduce the cost of alleged market 

power in certain product lines. These historical arguments are really not why we are here today. The more important and immediate 
10 

application of regulation concerns systemic risk, and this is that 

regulators should prevent market failures caused by the externality 

of one company leading to the loss of consumer or commercial confidence in the financial system. 

Historically, insurers did not present a real contagion risk to the 

financial system, but this may no longer be true. Financial companies are interconnected in ways that are without historical precedent. A bank with an insurance operation can extend the contagion 

risk to those insurance operations. 

In insurance, the focus of regulation has been on the individual 

company and not on the group or holding company. This needs to 

change at some level to allow for the proper accounting of systemic 

risk. A State regulator cannot realistically regulate an insurer for 

its possible systemic risk or its effect on national and international 

markets especially in situations where the insurer within the State 

is a separately organized corporation from the corporation which 

might induce a systemic risk issue. 

We can talk a little bit about what level the regulation of insurance should be laid out, whether optional Federal chartering makes 

sense. You have probably heard most of these arguments, so I am 

going to skip to my final point, which has to do with the current 

role for the Federal Government in insurance regulation. 

The proposed Office of National Insurance is an important first 

step in any role the Federal Government may have in the future. 

Even if the Federal Government decides in the near future to pass 

on regulating insurance completely, the Office of National Insurance still may be an important innovation for three main purposes. 

First, there is a paucity of individuals at the Federal level who 

know its component industries, its market structures, its products, 

its taxation, or its pricing. Second, because of the unique nature of 

insurance—premiums are received now but claims are paid at some 

time in the future—there are a number of important technical accounting and actuarial issues that need to be understood regarding 

reserving and pricing. This type of knowledge currently resides at 

the State level. 

Finally, there is an important issue that may arise depending 

upon the powers granted to the Office of National Insurance. However, while it does provide the opportunity to provide information 

to the Federal Government, especially with international treaties 

regarding solvency regulation, the main point here is not likely information provision to the negotiators of the Department of Commerce but a real possibility of the office having or eventually obtaining significant ability to preempt State laws inconsistent with 

international accords. This would be a piecemeal change of the insurance regulatory system that would likely lead to real disruptions in regulations. However, a top-down reexamination of the regulation of the industry would provide for a more systemic or systematic review of the proper role of the Federal and State regulatory powers. 

Thank you, and I would be happy to answer any questions. 

Chairman DODD. Those were very, very helpful, very knowledgeable. And again, your full statements, I found tremendously illuminating. They were very comprehensive and I regret we don’t 

have more time for you to go into greater detail, at least in your 
11 

opening comments, but I appreciate very much what you have submitted to the Committee. 

Let me sort of pick up, if I can, Mr. Grace, on your last point and 

just quickly ask the rest of you, and again, I am not suggesting 

that those of you who have recommended more, that that be excluded, but at least to begin with the notion of the Office of National Insurance. Is it fair to assume, based on what I have heard, 

that all of you would agree that this is, at the very minimum, this 

is a step that ought to be taken? Is that correct? Mr. Scott, do you 

agree with that, as well? 

Mr. SCOTT. Yes. 

Chairman DODD. Mr. Webel. 

Mr. WEBEL. There does seem to be a lack of information at the 

Federal level on insurance. 

Chairman DODD. And Mr. Plunkett, you agree with that, as well? 

Mr. PLUNKETT. Yes, Mr. Chairman. 

Chairman DODD. I thank you. That helps. In fact, in March, I 

asked a very similar question of the panel and had a similar response, but I think it is helpful, at least to begin on a point of common interest in all of this. 

Let me turn to you, Mr. Plunkett, and ask you, I have said many 

times before, I believe that consumer protection is a fundamental 

principle that should guide our deliberations, in thinking about 

that shareholder, that depositor, that borrower, that policy holder, 

if we begin by what is in their interest. Obviously, you want stability of your financial institutions as a critical component. But obviously, the confidence and optimism of that individual who goes 

and buys that policy, deposits that check, buys that share, takes 

out that mortgage, obviously you have got to restore the confidence 

of those individuals for them to succeed. 

But what is your view of the proper role of the Federal Government? We have heard the conversation here about the systemic 

risk issues, which obviously contributed significantly. Insurance 

plays a critical role. And while AIG’s problems were not related to 

its insurance activities—at least, I think most people come to the 

conclusion their problems occurred as a result of alternative activities that were not part of the main function that had built AIG 

over the years—there is this risk and danger that if we don’t really 

take a greater central role in the regulation of this major industry 

in the 21st century, that, in fact, we will be leaving a gaping whole 

in the systemic risk obligations. 

If we all acknowledge that that is a critical risk and the role that 

these industries could play in systemic risk, then why wouldn’t 

you, while not necessarily at this juncture here, make that transition to a Federal charter rather than leaving this at the State 

level? 

Mr. PLUNKETT. Mr. Chairman, we have proposed new regulation 

by the Federal Government. In particular, we do believe there is 

systemic risk in insurance—some—for particular lines especially, 

like bond insurance. And as a result, we believe that prudential 

regulation is very associated with proper systemic regulation. Our 

recommendation is to shift prudential regulation from the States to 

the Federal level. You can’t do systemic regulation without having 

the capacity to do prudential regulation at the same time. 
12 

Regarding consumer protections, though, as we have heard, the 

States have the expertise. Some States have a much better track 

record than others. But we are leery of shifting consumer protection regulation from the State to the Federal level at the current 

time, in particular because the insurance industry has made it 

clear that they will vehemently oppose what we view as core aspects of consumer protection regulation. 

Finally, we have proposed a minimum standards role, as the 

President has. We have endorsed the President’s call for this new 

Consumer Financial Protection Agency to regulate credit-related 

insurance policies—like title insurance, credit insurance, mortgage 

insurance—because they are so closely associated with the credit 

matters that this agency will have authority over, but only on a 

minimum standards basis so the States could improve on those 

standards, if necessary. 

Chairman DODD. Let me jump, if I can, and if any of you want 

to comment on this point as I ask other questions, you certainly 

may do so. I was intrigued, Mr. Grace, in what you call a mild but 

nonetheless important critique of the current proposals in your prepared statements. You say that an optional Federal charter is not 

necessarily the only way to proceed, and again, you made this point 

in your presentation to us this morning, and that the current proposal is cobbled together from a Federal banking law that is decades old, and I don’t disagree with that conclusion. 

And yet as you point out, there has been little discussion of other 

insurance reform ideas outside of the optional Federal charter. I 

can’t recall if it was you or Mr. Scott who made the point about 

having the charter—drawing a distinction between the charter obligations and the regulatory obligations. I think it was Mr. Scott who 

made that point. 

I worry about this notion of arbitrage, regulatory arbitrage that 

goes on. In fact, I wish we would take the word ‘‘optional’’ out of 

this discussion altogether because I think it is sort of an antiquated 

idea in light of events over the last couple of years. Either you are 

going to be one or the other, it seems to me, and this idea of bouncing around, trying to choose where you want to be, I think has contributed in some significant way to the problems we are facing 

today. 

But anyway, let me ask both of you, if I can, do you think there 

should be a systemic discussion of modernizing insurance regulation that could review all of the available ideas, and again, the Office of National Insurance thing does that to some degree, but 

share with us if you would, Mr. Grace, some of these other ideas 

you think which we should be considering other than just the optional Federal charter. 

Mr. GRACE. I was thinking that there are a number of different 

ways you could go with this, but there would have to be some 

thought about are there some companies that really are interstate, 

international in scope, and should they have the option to become 

a Federal charter? I would say, if they want to, yes, of course. 

But what if there were certain companies that were interstate, 

international in scope and decided not to want to become a federally chartered insurer? Would there be an ability by the Federal 

Government to say, you know, you really are a different type of or-
13 

ganization, and because of your ties to a holding company system, 

because of your ability to perhaps become systemically related to 

a banking concern or some other kind of financial services company, that you become very important to us? 

Well, I would think that the Federal Government would want to 

have sort of the reverse option, if you will, of bringing that company within the Federal charter, however you might want to think 

about it. 

Chairman DODD. So it wouldn’t be necessarily—you are not leaving the decision up to the industry, but rather the Federal Government ought to be saying, in light of the activities you are engaged 

in, you don’t have the option. 

Mr. GRACE. Right. That is the second option. The first option is 

people—smaller companies might want to be federally regulated for 

whatever reason. And then larger companies, though, because of 

their activities, might need to be federally regulated, which I am 

agreeing with what you are saying. So it is an option that the Federal Government would have based upon certain characteristics of 

the complexity of the firm, the markets it is in, the types of activities its activities are related to. That would be enough to make it— 

I don’t want to call it systemically important, because that is not 

really what I am saying. I just think that the company is significantly complicated and organized in such a way that a single State 

regulator has a difficult time putting the entire company together 

under its jurisdiction. 

Chairman DODD. Mr. Scott, do you want to quickly comment on 

this notion of that distinction between charter and regulation? Is 

that a distinction without difference in the sense of allowing sort 

of this migration back and forth when it comes to the industry deciding where it wants to be? And obviously, the problems seem related. 

Mr. SCOTT. Well, on the charter point, what I was thinking is if 

you had an optional Federal charter system, not all insurance companies get a Federal charter. But on the other hand, you might 

build in on top of that a requirement—and, by the way, anyone 

that did get a Federal charter would be federally regulated, obviously. You might build on top of that mandatory chartering/regulation for large insurance institutions, and I say large and I am not 

saying systemically important—it is not an accident—because I 

think it is inherently difficult to define what is a systemically important institution and they are going to change from time to time 

and it has negative moral hazard problems, as has been widely discussed in recent weeks. 

So I think if we picked them on large, we wouldn’t be branding 

people right off the box. We might get some that really didn’t have 

that much real systemic risk, but if they are large enough, it seems 

to me that most of those very large insurance companies could, if 

they engaged in certain activities, result in systemic risk. 

So I would have at the Federal level an option for everybody, 

large or small, but large would have to be mandatorily regulated 

at the Federal level. 

Chairman DODD. Thank you very much. 

Senator Shelby. 
14 

Senator SHELBY. Professor Scott, in the derivatives area, are a 

lot of the derivatives insured by insurance companies, in other 

words, credit default swaps and things like that? 

Mr. SCOTT. Well, they write—insurance companies do. 

Senator SHELBY. They write insurance? 

Mr. SCOTT. Yes. Not in the regulated insurance company, but 

like in their holding company. I don’t know that anyone has done 

it to the extent that AIG has done it. 

Senator SHELBY. If an insurance company is involved in derivatives on the national, international scale, how could States regulate 

them? 

Mr. SCOTT. Well, I don’t think very successfully. 

Senator SHELBY. They haven’t, have they? 

Mr. SCOTT. I would just generalize that problem to say that if 

you are talking about interstate and international activities, there 

is a limited ability of the States acting individually to address this 

problem, even when they are coordinated by some kind of association. 

Senator SHELBY. Professor Grace, have you studied how many insurance firms would actually be considered as a systemic risk, generally speaking, of the insurance companies in this country? 

Mr. GRACE. No, sir. 

Senator SHELBY. Shouldn’t that be an appropriate study somewhere? I am not suggesting to you academics what to do, but—— 

Mr. GRACE. I agree to some—— 

Senator SHELBY. ——that work could help us some. 

Mr. GRACE. I agree to some extent that the problem is we don’t— 

in order to study something, we have to know what it is, and I 

think that is sort of a chicken-and-the-egg problem. 

Senator SHELBY. In how you define it? 

Mr. GRACE. Exactly, sir. 

Senator SHELBY. How you define it. I guess what I am trying to 

get at, what percentage of insurance companies would be subject 

to bringing the system, the financial system down? 

Mr. GRACE. I thought about that question sort of hypothetically 

and then I said, how many companies look like AIG? I said, how 

many in the United States? And I couldn’t come up with any. I 

said, how many worldwide, and there might be some. I am not an 

expert on international companies. But their organization was so 

different than the typical United States insurer. But there are 

other types of risks that insurers engage in that in different circumstances might yield problems. 

Like one of the things, and I am not an expert in this area, but 

the National Association of Insurance Commissioners is concerned 

about lending of securities by life insurers, which has some optionlike characteristics and how do you reserve for those types of 

things is very important. 

Senator SHELBY. Sure. 

Mr. GRACE. And most State regulators may not even be aware 

of the extent of this type of activity because it is just not public. 

People don’t talk about it. They don’t think about it. 

Senator SHELBY. But aren’t a lot of the problems that we have 

encountered that insurance, and, of course, banks, too, are involved 
15 

in things without adequate capital to back up what they are involved in, the risk that they take? 

Mr. GRACE. Yes, I agree, and this leads me to—perhaps not in 

this testimony, but in other things I have written, I have been critical of the NAIC for not really pushing on capital adequacy. Thirty 

years ago, Congress pressed the NAIC on solvency regulation quite 

hard and they did a number of things to modernize how they examined and how they thought about risk-based capital for insurers. 

But, you know, those laws are now 15 years old and there are 

many other approaches that are probably more sophisticated. 

Whether or not they are totally a major improvement, I am not 

sure, but there are just a lot of things that have been talked about 

and done, the States just haven’t moved on yet. 

Senator SHELBY. Professor Scott—and I will address this question to both of you professors here—do you believe that the States 

can adequately oversee the failure of other large insurance companies, looking at how involved and how complex they are, not only 

in this country, but internationally? 

Mr. SCOTT. In short, no, I don’t believe they can, and Senator, 

I think it has to do with the way the States deal with insurance 

companies. As you know, one insurance company can be licensed 

for different products in multiple States. So the problem is, where 

is the overview? What does it all add up to, when we take each of 

these separate State operations, because what we saw in the financial crisis were problems for firms, OK, as a result of their cumulative activity in many areas, and certainly in the banking system. 

And so most States can have the overall view, it seems to me, 

of what is going on in a particular insurance company which is 

composed of all these separate companies that are chartered in individual States. 

Senator SHELBY. Professor Grace, have you got any comment? 

Mr. GRACE. Yes. I think it is very difficult for States to resolve 

insurance insolvencies, if you are talking about after the bankruptcy. And in part, because—— 

Senator SHELBY. You are speaking of large insurance companies? 

Mr. GRACE. Yes. 

Senator SHELBY. Ones that are really involved in everything? 

Mr. GRACE. In part, because States do not have a bankruptcy 

code the same way the Federal Government does and there is no 

bank, or corresponding uniform bank bankruptcy code that applies 

to insurance. So it is a State-run enterprise from top to bottom and 

there are no State bankruptcy judges. There are just a lot of costs 

involved in dealing with these things and they are just not experienced at it. 

Senator SHELBY. I know you said you hadn’t done any studies. 

You have done a lot of research, both of you, in this area. But we 

have, I don’t know how many insurance companies doing business 

in our country, State to State, 50 States. Most of them would not 

cause or bring about a systemic risk. So I think whatever we do, 

that has got to be separated, has it not, at some level. Otherwise, 

we are wasting our time and we are waiting for the next crisis, are 

we not? 

Mr. GRACE. The NAIC has something they call a Nationally Significant Company, and it has a certain level of assets and writes 
16 

in 17 or more States. That is a nice dividing line. That group of 

companies writes about, I want to say 50 percent of the business 

in the entire United States. 

Senator SHELBY. Was AIG considered one of those—— 

Mr. GRACE. Yes, it was. Yes, it was. And there probably, if you 

think about just the insurance groups, there may be only 350 

groups. But if you think of State Farm, for example, they have 20 

companies within their group. So the number of agents that you 

have to oversee in this is a countable number. There are 7,000, I 

think we heard, companies in the United States, but—— 

Senator SHELBY. Quickly, is the Fed really the appropriate agency to regulate insurance companies, because they have no history 

there. In my judgment, I think they have failed as a regulator of 

the holding companies. And if it has no expertise, no history in insurance regulation, does it have a good record on consumer protection? A lot of people, including my Chairman here, would probably 

argue against that. What do you think, Professor Scott? 

Mr. SCOTT. Well, I would distinguish, Senator, between regulation and supervision. So if we talk about regulation, let us take 

probably the most important form of regulation, which is capital requirements—— 

Senator SHELBY. Is that a question of degree there, supervision, 

regulation? 

Mr. SCOTT. Supervision is sort of going in and examining what 

people are doing and checking, sort of like we do with large banks, 

or actually all banks—— 

Senator SHELBY. OK. 

Mr. SCOTT. ——as opposed to writing rules, OK, as to what people can do. Now, I think if you are going to pick an agency that 

had expertise in capital, it would be the Fed. Yes, it is true that 

the Fed has not regulated the capital for insurance, but I think it 

is true that the Fed has thought much more deeply than any other 

regulatory agency about capital in general. They have been part of 

the Basel process, et cetera. 

On supervision, however, OK, that is hands-on supervision of insurance companies, I don’t think the Fed should do that. Indeed, 

our committee doesn’t think, or had thought maybe—some thought 

would be an option—I, personally, would say we should have a unified prudential regulator, OK, who should do that for insurance, 

banking, and securities, not the Fed. 

Senator SHELBY. Do you have any comment? I know my time is 

up, but—— 

Mr. GRACE. I think I agree with Professor Scott. I would think 

someone whose focus is capital, you know, all they are doing is 

thinking about prudential regulation, would have a much stronger 

interest in doing it properly. 

Senator SHELBY. Thank you. 

Chairman DODD. Thank you very much. 

Senator Reed. 

Senator REED. Well, thank you very much, Mr. Chairman, and 

welcome. 

Professor Scott, with an optional Federal charter, I presume, and 

I want your opinion, that we would also have to construct a Federal guarantee fund, a Federal reinsurance fund to complement—— 
17 

Mr. SCOTT. In my written testimony, Senator, I talk about this. 

I think in large part, there has been pretty good experience with 

State guarantee funds, but that said, I don’t think it is feasible to 

have Federal regulation and State guarantee funds. I mean, it is 

sort of the opposite of what we had with State chartered banks. 

You have the States chartering the banks and regulating them, 

and if they didn’t do a good job, the Federal Deposit Insurance Corporation paid the bill. This would be the reverse. You have the Federal Government regulating them but the States paying the bill if 

they fail. So I think you have to put those two things together, and 

so we should have to create a Federal guarantee fund for the federally chartered or mandatorily regulated insurance companies. 

Senator REED. Another aspect of this is that to the extent that 

State laws would be preempted, would your view be a total preemption of State laws or leave it to us? 

Mr. SCOTT. I don’t know if I would go total, and, of course, what 

is total given the court’s recent decision is questionable. I certainly 

wouldn’t go so far as to preempting State Attorney Generals from 

enforcing the law. 

But when it comes to consumer protection, which I think is the 

sort of crux of the matter of preemption here, yes, I would say if 

they are federally regulated, there should be preemption now. I 

think there is a very legitimate question, OK, as to whether Federal consumer protection would be adequate. As long as it was left 

with the banking agencies, I think there would be a big question 

about that. But if at the same time we create this Federal authority, we have a strong Federal Consumer Protection Agency, OK, 

then I think that concern should be greatly alleviated. 

Senator REED. Mr. Plunkett, just a quick comment on this issue 

of the consumer protection and then I am going to turn to Professor 

Grace. Go ahead, please. 

Mr. PLUNKETT. Senator, thank you. We actually agree with the 

professor on one key point, which is that prudential regulation 

needs to be at the Federal level, but not through an optional charter. It should not be optional. That drives standards down. 

On consumer protection, we propose the opposite kind of competition to improve standards, which means on the agency that the 

President has proposed, we start with credit-related insurance 

products and we set minimum standards at a high level. That will 

assure quite a bit of uniformity, And then if there are exceptional 

circumstances, the States can exceed that. That is the right way 

from our point of view to do consumer protection for starters. 

Senator REED. Thank you. Professor Grace, it seems that there 

are two general ways insurance companies can get in trouble. They 

can have a subsidiary, like AIG Financial Products, that deals with 

credit default swaps that is very loosely regulated, and not by the 

insurance regulator, or their own underwriting and insurance investing is the problem. In fact, AIG had both of those things. 

I would suspect whatever we do, is that subsidiary company with 

the subsidiary that might get in trouble will be a financial holding 

company regulated by the Federal Reserve. I think our approach 

would be to give that—not to be deferential to the functional regulators, but to have the whole broad suite, particularly for large 

companies. So in effect, I think that that part will be addressed 
18 

quite specifically. It will be a financial holding company that will 

fall in like all the other financial holding companies. 

The other part, though, is I think where we really have to focus 

some attention. That is the investments and the underwriting of 

the insurance company, which now is traditionally done by the 

States. Traditionally, it is done by the States. So to what extent 

should we have a company that has no subsidiaries, it is a vanilla 

insurance company, because of size alone, does it make sense to 

bring that into the Federal orbit? 

Mr. GRACE. It depends on what comes with that. I would think 

that if there are benefits to the insurer for basically saying—having 

one standard for consumer protection across every State, they are 

going to want to do that. But you are right that the plain vanilla 

insurance company is not going to have the same kind of problems, 

insolvency-related problems, that one that has multiple different 

types of subsidiaries doing all different types of financial services 

products. But if the insurer thought it was in its best interest to 

get, in exchange for some Federal oversight, but to get that one set 

of duplicative costs wiped off its books, I think it would want to do 

that. 

But I just want to comment a little—— 

Senator REED. Go ahead. 

Mr. GRACE. Sorry. I think optional Federal regulation, if we just 

went with that, is a one-way street. Unlike banks, I think it would 

be very difficult for insurers to go back to being regulated by the 

State, because I think at the biggest companies, they are already 

being regulated by 50 different States. And they go to one, the Federal regulator, they are not going to want to go back to the 50. It 

is not like going from bank regulator to bank regulator. It is a very 

different regulator. 

Senator REED. Thanks very much. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman, and I thank each of 

you for your testimony. 

Mr. Plunkett, on the consumer protection piece, just based on 

your experience, is there a different level of need for life insurance 

than there is for property and casualty? 

Mr. PLUNKETT. It is a very good question—— 

Senator CORKER. At the State level. 

Mr. PLUNKETT. Yes. There are some differences. Life insurance, 

especially term, is more of a national market. Property-casualty, 

often regional markets, local markets. So the uniformity already 

exists in many cases in the types of products that are being offered. 

Whether life is overseen at the State or the Federal level, though, 

we have to ensure that there is not this, once again, regulatory 

structure that keeps standards lower than they should be for life 

insurance. 

Senator CORKER. So there is a greater need at the State level for 

consumer protection in property and casualty, generally speaking, 

than there is in life? 

Mr. PLUNKETT. Well, I think what I was saying, Senator, is there 

is greater variance at the State level. The need is just as high. But 
19 

in terms of the differences between the policies, the need for local 

know-how in regulating, it is greater with property-casualty. 

Senator CORKER. OK. 

Mr. PLUNKETT. I mean, think about all the hazards in your State 

that might be different than, say, earthquakes in California. 

Senator CORKER. OK. Mr. Grace, you have focused some on capital requirements. In that same vein, is it not different for life insurance companies than it is for property and casualty as it relates 

to capital requirements? 

Mr. GRACE. Well, the capital requirements are different, but I 

don’t know if the regulation of them needs to be done by two different people. I don’t know if that makes a lot of sense. The difference really is that a life insurance contract is generally a longterm contract so investments are made for long-term, while a P&C 

contract is really a short-term contract and investments are made 

for short-term. So even though the risk-based capital formulas are 

different, they are not so different that we need to have two different levels of regulation to look at them. 

Senator CORKER. But I guess from our perspective, there are two 

issues at hand. There is the one of trying to figure out the issues 

of risk to the public, systemic risk, and then there is the issue of 

trying to resolve this sort of family feud that exists between whether these guys are going to be regulated at the State or Federal 

level. Those are two different issues. And from the standpoint of 

just us looking at overall systemic risk, there is a difference, is 

there not? 

Mr. GRACE. Well—— 

Senator CORKER. I mean, are we going to find much systemic 

risk in the P&C category? 

Mr. GRACE. Oh, OK. No, I don’t—well, it just depends on who— 

because AIG really was a P&C company with some life business 

and financial products. So it just depends on what you—the plain 

vanilla P&C company is going to be simple, in essence. But who 

knows what the company looks like. 

Senator CORKER. Well, then to that point—and then we will get 

you, Mr. Webel—Mr. Scott, you were mentioning that large companies, quote, ‘‘need to be regulated at the Federal level.’’ How large 

is large? 

Mr. SCOTT. I cannot answer that, Senator, but I don’t think that 

is an unanswerable question. In the area of capital regulation at 

the Fed, Members may be aware, we took the 20 largest banking 

organizations and separated them out to different ways of calculating their capital. I don’t know where that cutoff, I don’t recall 

what it was, but we made a cutoff, OK. And I think you could 

make a cutoff here. It is not going to be perfect, but I would submit 

it is better than trying to figure out who is systemically important. 

And remember, that could change from day-to-day. I mean, people invent new products. Look at AIG. If we looked at them 10 

years before they came into financial products, they would have 

looked a lot differently. So I think you are generally going to—you 

are not going to capture everybody. It could be over-inclusive to 

some extent and under-inclusive. But you are going to get it 95 percent right with size and I think that is as good as you can do. 
20 

Senator CORKER. So I am going to ask one last question and 

start with you, Mr. Webel, since you have been raising your hand 

at a couple of these, and you might answer the other questions, too. 

But we keep talking about systemic risk and it is in vogue how because of the things that have happened. I just wonder, is our emphasis on systemic risk or having a regulator to see all, the Fed 

or the Council or whoever it might be, is that misplaced and would 

we be better off just making sure that the regulation we have for 

entities, you know, the issue of a clearinghouse for derivatives, 

looking at what mortgage brokers are doing out there as it relates 

to the type of loans that are being originated, looking at rating 

agencies, would we be better off focusing on the individual regulatory pieces, or are we sort of bailing out, if you will, by trying to 

create somebody who is the Wizard of Oz or who knows all and can 

solve all by being a systemic risk? Mr. Webel, since—and that is 

my last question. 

Mr. WEBEL. Senator, I think—I mean, I think it is a very wellphrased question and a very good one. It has been easy to go that 

route of a systemic risk regulator because we were just presented 

with a systemic crisis. But I will admit I do have—I have had a 

little bit of difficulty as I have thought about it, coming up with 

the situation where if you had really good prudential regulation at 

the firm, that you would end up with a systemic crisis coming out 

of the firm. 

That essentially if, to take the example, the Office of Thrift Supervision had done perhaps a better job overseeing AIG and had 

either made them keep more capital for the derivatives they were 

writing, if the securities lending program had operated in a better 

way either through OTS or through the insurance regulators, AIG 

shouldn’t have failed. If AIG doesn’t fail in the way they do, there 

isn’t a systemic risk. 

So I think it is a very good point that if you rerun the crisis the 

way it happened, what would a systemic risk regulator have done? 

There were papers coming out of the Fed in 2005 that there is a 

housing bubble. Well, is the Fed going to act in 2005 to drive down 

the value of all the houses in the United States? I don’t think it 

is going to happen. So we may be putting a little too much faith 

in the idea that we are going to have someone at 20,000 feet that 

is going to stop these kind of things. 

Mr. GRACE. I agree, if I could interrupt. The chance of that—we 

had a number of different regulators looking at AIG and one more 

looking at it and being right, I don’t know how high it is. I mean, 

I think everybody was looking at AIG but sort of passing the buck. 

I guess the only thing is if there wasn’t a buck-passer but one that 

was relied upon at the bottom to make a decision, that is the only 

reason that a systemic risk regulator would work. But we had regulators looking at AIG, as you were saying. 

Chairman DODD. Thank you very much. 

Senator Warner—or Senator Johnson. 

Senator JOHNSON. Mr. Plunkett, Professor Scott, and Professor 

Grace, late last week, the Treasury sent up its legislative language 

to create an Office of National Insurance. In your opinion, is anything missing in this proposal that, if included, would make it more 

effective in monitoring and regulating insurance companies? Does 
21 

this proposal do enough to address the insurance issues brought to 

light by the AIG situation? Mr. Plunkett. 

Mr. PLUNKETT. Thank you, Senator. We support the information 

function of the office. We support eventually considering the office 

as the prudential or systemic regulator for insurance. And as you 

know, we have proposed systemic and prudential regulation to be 

vested at the Federal level, but not optionally. 

The big question in our mind is the authority granted in the legislation to the agency and the Secretary of the Treasury regarding 

preemption, interpretation of international treaties, and then preemption. It does exclude, from what we can tell, some State consumer protection functions, such as insurance rates, premiums, 

sales, underwriting, antitrust, and insurance coverage. 

We are going to be examining that language, though, to make 

sure it is not too broad and does not lead to a conclusion of an 

international agreement then that, directly or indirectly, preempts 

State efforts to improve consumer protection. 

Senator JOHNSON. Professor Scott. 

Mr. SCOTT. Senator, I do not think it goes far enough. As I have 

testified, I think we need a system for optional Federal charters, 

plus mandatory regulation for large insurance companies, which is 

beyond what the Administration has recommended. 

I would also say that if we go in that direction, I do not believe 

that this regulator should be part of the Treasury Department, 

that is, an office. I think it should be independent of the executive 

branch, much as the SEC and the Fed are. 

Senator JOHNSON. Professor Grace. 

Mr. GRACE. Thank you, Senator. I guess the way I am thinking 

about it now, this is a good first step, and let us see how the first 

step goes. I would not want to—I mean, I agree with Professor 

Scott in sort of the long-run game here, but I would like to actually 

have a discussion—or I would like to conceive of the Federal Government having a discussion of what to do next after it has information. And, you know, just adding things right at this stage does 

not make sense yet. 

Mr. JOHNSON. For all the panelists, the Treasury’s regulatory restructuring, the white paper, says that it will support proposals 

which increase national uniformity through either a Federal charter or effective action by the States. Do you believe a Federal chart 

or action by the States will be most effective in increasing national 

uniformity? Mr. Plunkett. 

Mr. PLUNKETT. Senator, for now, for the most part, we would like 

to keep consumer protection regulation at the State level. We have 

supported authority in the President’s Consumer Financial Protection Agency to, on a minimum standards basis, regulate credit-related insurance products, credit insurance, title insurance, et 

cetera. 

The NAIC has to do a better job on consumer protection from our 

point of view, and we are looking to you all to spur them along on 

that front. 

Senator JOHNSON. Mr. Webel. 

Mr. WEBEL. If the goal is uniformity, I do not know that a Federal charter is absolutely necessary, but I think that Federal action 

certainly is. The NAIC has been in existence with the goal of har-
22 

monization since 1871. Getting 50 State legislatures together to try 

to enact the same sets of laws I think has proven to be unrealistic. 

So whether it is a Federal push that says we are going to have the 

States set standards and it is going to apply it everywhere, or 

whether it is the Federal standards directly, I think one can debate 

over which is better. But I think that if you want uniformity, you 

need a Federal push. 

Senator JOHNSON. Mr. Scott. 

Mr. SCOTT. I agree with that, but I would also add that in order 

to achieve this uniformity, you would have to have Federal preemption. Otherwise, you would not achieve uniformity because each 

State in the consumer protection area would be free to enact laws 

that were different than what the Federal standard was. 

Again, I would come back that I would not lightly want to see 

this happen unless we were very confident that we had a very 

strong Federal consumer protection presence, which I think, by the 

way, the Obama proposal would give us. 

Senator JOHNSON. Professor Grace. 

Mr. GRACE. I think I agree in substance with what everyone has 

said—well, the last two speakers. The States are just not proactive, 

and even if you have a proactive State that wants to do a better 

job, getting its neighbor or the other 48 to go along with it is a 

long, long, hard process. If you look at just the harmonization efforts that have been going on, model laws are proposed all the 

time, and, you know, 30 or 40 is a good number. We rarely see 50. 

There might be some, but it is only a handful. 

So I would suggest that a Federal charter would do better at increasing uniformity. 

Senator JOHNSON. My time is expired. 

Chairman DODD. Thank you very much, Senator. 

Senator Johanns. 

Senator JOHANNS. Mr. Chairman, thank you, and I find it to be 

a fascinating conversation. I will warn each of you that the guy 

asking the questions now is a former Governor and a former 

mayor. And here is what troubles me about what I am hearing 

today, and I am not picking on you, Professor Grace. But, you see, 

if I took your argument to a logical extreme, the solution to all the 

world’s problems is to pass a Federal law that preempts every 

State law on every subject, and then we will just have a big powerful Federal Government that kind of tells the States what to do in 

every area. And, you see, as a former Governor and mayor, I am 

just so enormously troubled by that. I do not even think the Constitution anticipated that. 

Here is what my comment is leading to, however. It seems to me 

that we are mixing things up today. Maybe there is a policy reason 

for a Federal charter. Maybe there is not. But I think that is a policy debate that we somehow have to hash out and figure out 

whether that is the right approach. And there are pros and cons 

on both sides of that. 

Then there is this whole other issue of the kind of risk that AIG 

engaged in, which, upon reflection, looks stupid to me, but it is the 

kind of risk that literally could bring the economy down. 

Now, that seems to me a whole different area of regulation than 

whatever you want to call it—Federal charter, optional Federal 
23 

charter, et cetera. And by, you know, working these two together, 

it seems to me like we are ending up with a gummed-up mess here. 

Anyone want to wade into that and offer some comments on 

that? Professor, I started on you, so I think it is fair you get the 

first shot at this. 

Mr. GRACE. Thank you, Senator. Anyone who knows me thinks 

of me as, I guess, a small-government libertarian, and when they 

hear me talk about this, their eyebrows go up. But I am focusing 

on a very narrow segment of the industry, I think. I am thinking 

about big companies who operate nationwide, and if you think 

about the optional Federal charter, they would have one regulator. 

That would lower their costs. If you think about the types of burdens imposed by State regulation that do not necessarily have any 

value—if 50 States are doing exactly the same thing slightly differently, is that slight difference really valuable? And I think the 

answer to that is not always. So that is why I have sort of gone 

to that level of allowing companies to opt to have a single standard 

for regulation. 

But going to your second point, if you have a company that engages in significant activities that are different than insurance outside the jurisdiction of the insurance regulator and that imposes a 

risk to the entire economy, the State cannot do that. So these two 

types of regulation, as you rightly pointed out, are different. But 

they get mixed together for the reason I am just discussing. 

Senator JOHANNS. Mr. Webel. 

Mr. WEBEL. I think the gummed-up mess that you are seeing is 

partly because we have taken the old debate that you had preexisting, and then we had a financial crisis, and so everybody piles 

the new arguments on to the old ones, and particularly—— 

Senator JOHANNS. If I might just interject there, because I think 

you have touched upon something. Post-9/11, everything became if 

you could box it under the title of ‘‘national security,’’ then you had 

a better chance of getting this, that, or the next thing done, or getting a Federal grant or Federal funding or Federal something. And 

that is almost what I am sensing here today, is we do have a policy 

issue here on the Federal charter or the optional Federal charter, 

but I think that is really a very vastly different debate than regulating systemic risk engaged in by insurance companies. 

Mr. WEBEL. Well, I think the question, the place where they 

intersect, besides just an opportunism to try to get ones you previously wanted passed passed, is sort of coordination between the 

regulatory bodies. You know, if you envision a Federal Reserve or 

a new Federal systemic risk regulator interacting with Federal 

banking regulators, that is a little easier, to some degree, to envision how that is going to work than interacting with 50 different 

State insurance regulators—which is not to say you could not set 

up a good systemic system where you had a Federal systemic risk 

regulator and the 50 insurance regulators. It is something that it 

is kind of an easy thing to say, well, you know, if we are going to 

have this Federal body at the top doing the systemic risk, you 

know, doesn’t it make sense to some degree to have a Federal body 

that they interact with that is actually overseeing especially the 

day-to-day operations of these huge insurers? 

Senator JOHANNS. Mr. Plunkett. 
24 

Mr. PLUNKETT. Senator, if I could just jump in on one part of 

your comment, I think you are absolutely right to be skeptical of 

the notion that Federal preemption is going to solve all problems. 

We only have to look at to the banking sector, in the Office of—— 

Senator JOHANNS. Look at the Madoff case. 

Mr. PLUNKETT. ——the Comptroller of the Currency, or the OCC 

preempting the States on lending and then replacing those State 

standards with virtually nothing. So Federal preemption does not 

solve all problems, and uniformity by itself should not be the goal. 

The goal should be high-quality regulation at the highest level of 

uniformity that is possible. 

Senator JOHANNS. Yes, Professor. 

Mr. SCOTT. I think you are right that we are mixing two issues 

together, but they are both important issues. The objectives of the 

optional Federal charter, of course, which was a debate that we got 

engaged in long before the financial crisis, were to achieve efficiency and uniformity and to reduce cost. That is the objective. 

The objective with mandatory regulation of large or systemically 

important institutions is addressed to the risk to the financial system of insurance companies or others engaging in certain activities. 

A totally different concern. 

On the other hand, both involve possible Federal action, either 

because we would allow a particular insurance company to get a 

Federal charter or we would require a particular insurance company. Both would lead to some kind of Federal regulation of insurance companies. 

So I think it is for that reason that we are putting them together, but you are quite right, the objectives that are sought to be 

achieved by an optional Federal charter and mandatory regulation 

are very different. 

Senator JOHANNS. I am out of time, Mr. Chairman, but I will just 

wrap up with this thought: Your testimony, your written comments, the Chairman is right, they were really very good, very 

thought provoking. If there is any research that is done out there 

or if there is any interest to offer some thoughts on this issue of 

systemic risk management, regulation, whatever, versus this whole 

other issue of optional charter, Federal charter, or Federal charter, 

I would be happy to receive it, because, again, I see a distinction 

here. I have met with so many people on the Federal charter, and 

they come in and they talk about, ‘‘Well, you know, Mike, when you 

were Governor in your State, we could get things done, but in other 

States we could not, and that is not efficient.’’ And so it threw me 

for a loop when all of a sudden systemic risk and optional Federal 

charter got entangled together. I do see the intersection, but I do 

think there are some pretty fundamentally different policy issues 

here. 

I would hate to have this get swept along on this whole issue of 

systemic risk management when really I think there is a pretty important States rights issue here. There are efficiency issues. I 

mean, there are good arguments on both sides of this, and I would 

hate to get that all mixed together in a way that does not make 

sense. 

Thank you, Mr. Chairman. 
25 

Chairman DODD. Well, Senator, thanks very much. I tell you, you 

bring a wonderful perspective to this, I think. It is a very clear 

point you were making. It is sort of what we have been wrestling 

with on all these matters and how to move, and to some extent I 

suppose argues for the notion of having this Office of Insurance at 

the Federal level to allow this to go forward. At the same time, 

again, I think there was a legitimate point made by Senator Corker 

on systemic risk. We can get so fixated on something that we lose 

sight of the means by which to deal with things. But that one probably has a more immediacy to us to be able to identify that when 

that occurs. But you raise some very, very good points, I think, and 

I thank you for it immensely as well. 

Senator JOHANNS. You know, if I just might warn the panelists, 

I think the next Senator up is also a former Governor. 

Chairman DODD. I was going to make that point. It is going to 

be a tough road here. 

Senator Warner, former Governor of Virginia. 

Senator WARNER. Thank you, Mr. Chairman, and I want to 

thank my colleague from Nebraska for, I think, teeing up—I think 

you teed up a very good point that—you know, and I come as a 

nonbiased party to this optional Federal charter or State charter 

debate, and this panel has been helpful. 

I do think, though, that, you know, of the various frustrations 

sitting on this Committee, one of the most frustrating aspects, for 

me at least, in this last 6 months has been our Federal Government response to the AIG crisis. And I think one of the things, you 

know, sitting here time after time when we hear Administration officials and others say we have got to pay out 100 cents on the dollar to counterparties and a complete lack of knowledge at the Federal Government level of how to even get their arms around this 

entity, does argue in some form, whether it is this Office of National Insurance or something else, at least somebody in the Federal Government understanding what is happening in the insurance world and being prepared to deal with consequences in the 

case of AIG, where there was no appropriate resolution ability at 

the State level and the American taxpayers ended up getting—footing the bill. 

So I want to comment, again, following up on Senator Corker’s 

comments as well, I do think we kind of struggle to define what 

a systemic risk is going to be. And we have not got it right. Senator 

Shelby and I have talked about this at times. But my hope—and, 

again, one of the reasons why I am not a fan on giving this responsibility to the Fed and thinking an independent systemic risk council with an independent chair is a better option—is that the very 

presence of that type of entity out there, hopefully never having to 

be called upon, can be that check on the day-to-day prudential regulators to do a better job so they never have to get one of their 

problems bumped up to a systemic risk council. My hope would be 

we would have a systemic risk council that would have this ability 

to see above the silos, but hopefully rarely, if ever, have to be 

called upon to act. 

So I want to come back to the panel on as we struggle through, 

one of the things we have not talked about this morning, you know, 

one of the things we hear on the financial side a lot are the ‘‘too- 
26 

big-to-fail’’ issues, something that, again, I think most of us never 

want to hear again after the resolution of whatever reform we put 

forward. 

I would like the panel to comment, though, on, you know, one of 

the ways we have thought about on the financial side is can we put 

in place higher capital requirements, so, in effect, the way Chairman Bair from the FDIC has constantly said, let us put a price on 

getting too big. We cannot draw an arbitrary line. I think that is 

too much intervention in the marketplace. But can we put a price 

of getting too big? Is there also ability to have additional capital 

requirements or some other burdens that we could put on for those 

entities—AIG, again, being a classic example that seems to have 

gotten away from the traditional insurance model and went off into 

this whole new product range that clearly had ramifications not 

only for its new products division or its financial services division, 

but indirectly had implications for its insurance division, which 

was still relatively healthy. How do we—what are the kind of barriers to prevent the ‘‘too-big-to-fail’’ circumstances within the insurance area? Increased capital being one. Are there other increased 

capital or other requirements that might be put on different product placements? Anybody on the panel. 

Mr. GRACE. I will start. I think you are right. In fact, I have had 

numerous conversations with my colleagues about how do you 

make something too big to fail, and you essentially increase the 

cost of holding capital, and so companies will not—it has to be the 

right cost. I am not just talking about a crazy tax. I am talking 

about one that reflects the social cost of having to bail the company 

out. 

Senator WARNER. A smart tax? 

Mr. GRACE. No. An intelligent tax. But the idea being that it 

would be related to the risk of the company, not just an ad hoc tax 

placed on all companies. So it would be basically having significantly relevant risk-based capital holdings. 

Senator WARNER. So both increased capital, but then as you got 

into—— 

Mr. GRACE. Yes. 

Senator WARNER. If you choose to do a whole series of what 

would be viewed by someone as a risky product line, there would 

be additional cost to it. 

Mr. GRACE. Right. Every type of activity has some risk to it, and 

you would be charged for engaging in that risk. But it would be— 

as I said, it is not a tax unrelated to the company. It is a tax directly related to what the company does. 

Senator WARNER. If everybody could answer fairly quickly, because at the Chairman’s discretion, I would like to get one more 

question. 

Mr. SCOTT. Senator, I think capital is our first line of defense 

against systemic risk, and there should be more capital for more 

risk. 

That having been said, our track record on setting those capital 

requirements for banks has not been very good. So let us not fool 

ourselves—— 

Chairman DODD. I was going to make that point to you, by the 

way, especially the Fed be the one to set capital standards. Had the 
27 

Fed gotten its way earlier, we would be in much deeper trouble on 

this point. 

Mr. SCOTT. I would say that there is a collective responsibility 

here in all the regulatory agencies, and the fact that the Fed did 

not get it right, in my view, is not the reason not to give it to the 

Fed in the future, because I still think they have more expertise. 

But putting that aside, as I said in my written testimony—and I 

think in my oral testimony—capital requirements for insurance 

companies are a different set of issues than they are for banks because their activities are different. And so we do not have Basel 

process. Some insurance companies have used Basel, but we have 

to think very hard about how to set capital requirements. 

In terms of, yes, should riskier firms have more capital, for sure. 

Banning—— 

Senator WARNER. But somebody still has to define whether you 

are a riskier firm by your product line. 

Mr. SCOTT. Exactly. So I am saying, you know, our whole riskbased capital approach depends on an adequate determination of 

risk. 

Senator WARNER. Which would be a difficult assessment to make 

at a State level. 

Mr. SCOTT. Exactly. It has been for banks, so let us not fool ourselves it is going to be easy for insurance companies. 

Then I think there is another part of your question which says 

should we kind of ban certain activities. I mean, if you are kind 

of creating a bomb that is going to blow up, maybe this is not a 

capital issue, this is should we have these kinds of products. And, 

you know, I think if we could be sure we were just doing that on 

a very selective basis, it would be OK. But, again, you know, to be 

now defining exactly what products firms can offer per se I think 

gets you into a very difficult—— 

Senator WARNER. Mr. Webel. 

Mr. WEBEL. I would just point out one other thing that you are 

going to hear as you start talking about this, and that would be 

essentially the competitiveness of the American financial services 

industry. And right now, in noninsurance financial services we run 

a very, very large trade surplus in the financial services. 

There will be people who will come to you when you start talking 

about putting on higher capital charges and say essentially, you 

know, you are going to be costing American jobs that are going to 

go to London or go to Tokyo or go to wherever where they do not 

put these same kind of requirements on. It is an argument—whether or not it is a good one—— 

Senator WARNER. We heard that before, and it was not like the 

U.K. was spared—— 

Mr. WEBEL. Well, the extreme to this, I think, can go to Iceland, 

where you end up with banks that are several times GDP and do 

you really want a financial—— 

Senator WARNER. Buyer beware—— 

Mr. WEBEL. ——services industry that large. But I just wanted 

to—you will hear that. 

Senator WARNER. Mr. Chairman, can I get one—I know Mr. 

Plunkett quickly, and can I get one more question in? 

Chairman DODD. Go ahead. 
28 

Mr. PLUNKETT. Senator, I will just add, of course, looking at capital is important for proper risk assessment. Risk assessment can 

also relate to not necessarily size but the sensitivity of the line of 

insurance that is being offered, bond insurance being the obvious 

example there, but also lines you might not necessarily think of 

first, such as title insurance, highly concentrated market, handful 

of insurers control the market, if one of them got in trouble financially actually could have effect, especially regionally, on mortgages 

and the real estate market in some parts of the country. 

Senator WARNER. Mr. Chairman, thank you for letting me have 

one more question in. One issue that has not been that touched on 

today and something that Senator Corker and I have been working 

on, I think we both share a frustration that we have not had a robust enough resolution authority in the financial sector, and Senator Corker has taken the lead and I am supportive of his efforts 

to look at how we can, at least in the financial sector, deal with 

the FDIC with some level of expanded authority and a premise 

that when somebody is failing, we ought to have a mechanism to 

allow that entity to go ahead and fail and not simply be propped 

up by taxpayer funds and limp along. 

One challenge is to kind of put a ring around some of that area, 

resolution in the financial sector, as we kind of get into the notion 

of resolution in the insurance field. My rudimentary understanding 

is that at the State level you have got kind of mutual funds that 

insure each other, but as we see in the case of AIG, when you have 

got these behemoths, you know, no single State resolution authority is going to be nearly enough. And how do we get to a resolution 

authority around these larger institutions in insurance, number 

one? And, number two, do you have any ideas on—I personally believe we need to have some mechanism in a sense of a prefunding 

of resolution so that we do not end up as taxpayers being caught 

basically footing the bill for the resolution of an actor that has 

taken undue risks. And even if you then have a post facto charge 

to the remaining players in the industry, the bad actor never has 

it all contributed beforehand to paying for their own demise. 

So a long question about resolution authority. Again, if we can 

go down the line quickly, realizing I have gone way beyond my 

time. 

Mr. GRACE. Yes, I agree. There is just—you have asked a very 

complicated but important question. The States, the way they have 

been set up to deal with this, the amount that they would bear depends upon the number of policies or the value of the policies that 

are in their State, and they are net of any—they are only for the 

extraordinary amounts above whatever assets are left in the company. So the amount that the States actually have to bear is not 

very much, but remember, most States that deal with this, deal 

with very small companies failing. They do not deal with a big company failing. 

And so I know really do not know, you know, the ability, what 

would happen—you know, I guess I can conjecture all sorts of bad 

things, but I do not really have a feeling for what the bad things 

might be for a State that is subject—— 
29 

Senator WARNER. The big question we have, we have no resolution authority for the whole nonbank half of the financial world 

that in many ways caused our problem. 

Mr. SCOTT. Senator, I applaud your efforts in addressing this 

issue because I think it is very important. 

I think we would—the Committee on Capital Markets Regulation 

recommended that there be an extended resolution authority, 

something like the Obama administration has proposed. 

I think where that would fit into insurance is that any federally 

chartered, either as a result of an optional charter or mandatorily 

chartered and regulated because of systemic risk, that any of those 

companies should be subject to the same resolution authority that 

hedge funds would be, et cetera, some Federal mechanism. 

In terms of the funding, which I think is extremely difficult, I 

really think we need to study that more carefully. I do not think 

there have been any good studies of the advantages or disadvantages of prefunding, ex post funding for this new resolution authority. So I do not have a view on that right now. 

Mr. WEBEL. The lack of resolution authority certainly seems a 

hole in the aftermath of the crisis. I have heard some interesting 

arguments, though, that, you know, maybe the regular bankruptcy 

procedure which is in place—Lehman went through it—was not as 

disruptive in Lehman’s case as everybody sort of thought it was 

going to be going in. So that I think that it is—it may be interesting to try to do some thought experiments of, OK, if AIG had 

gone into bankruptcy what happens? You know, there may be some 

lesson learned from Lehman having gone through bankruptcy 

versus AIG not having gone through bankruptcy. 

Mr. PLUNKETT. Senator, I will just flag for you the situation with 

the State guarantee funds when you bring the very important discussion you are having on resolution down to sort of the consumer 

level, we have in our testimony an assessment of the fragility in 

some cases of the State guarantee funds, particularly regarding life 

insurance, and our concern that they may not be able to handle 

multiple—not just a single, but multiple failures. And with the exception of New York, to your point on prefunding, these funds are 

not prefunded. They are postfunded. And that is a concern. 

Senator WARNER. I apologize, Mr. Chairman, for going on so 

long. 

Chairman DODD. Not at all. This is very important. This is a 

good discussion. 

Let me pick up on something Senator Corker raised earlier. 

Again, all of us who go around talk about these issues, at every 

gathering you go to, if there is any interest in the subject matter, 

we spend a lot of time talking about the various lines of insurance, 

types of insurance, and the tendency to sort of lump everything together here, I think raises some issues. 

I mean, basically, States under the present system do three 

things. One is you deal with solvency. Two, you set rates. And 

three, market activities, what your responsibilities are to consumers at a local level. 

And it seems to me that there are different risk assumptions 

based on the various kinds of insurance products. Obviously, you 

have title insurance, automobile insurance, for instance, property 
30 

and casualty in a way also falls in this where there are some 

unique qualities or characteristics that make sort of a local involvement—at least I understand the value of that. 

Going back to the point you made earlier, Travis, about the one 

I have made a distinction on in terms of life insurance, again, in 

the term area, there seems to be more of a national scope on that. 

There are different risk assumptions, as you point out. There are 

different capital needs and requirements in a life insurance industry than there is in an automobile insurance or property and casualty-related areas. 

And I wonder if in a sense you might pick up on this. I can’t recall whether or not just Mr. Plunkett responded to this question, 

but do the rest of you have any—I guess you did, Mr. Webel, you 

talked about it a little bit—this distinction here. My impression 

was that at the conclusion of Senator Corker’s question, you didn’t 

think the distinctions were that significant that they would warrant necessarily treating these different insurance products differently from a State regulatory standpoint or a national or a Federal charter. 

Do all of you sort of agree with Travis Plunkett about that, or 

Mr. Webel, that really is a distinction here we shouldn’t dwell on 

so much? Go ahead. 

Mr. SCOTT. I sort of would agree with your statement, but I 

would add and come back to another point, which is I am troubled 

by splitting up the regulation of the same firm at the Federal level 

with some product, at multiple State levels with other products. 

Where is the big picture? It is the failure of the overall firm that 

is going to impact the financial system, not just a subsidiary in a 

particular State. So I think this is a risk of the separation and say, 

oh, let us keep property and casualty at the States. Let us have 

life insurance at the Federal level. Then you have a single firm 

being regulated by multiple States and the Federal Government for 

different parts of their business. 

Chairman DODD. How do you do that, though? I mean, some 

States have tough laws on who gets to drive a car. They have written tough laws about kids being in the car alone, driving at night 

and so forth. So there is going to be a different—some States say, 

at age 15, go ahead and drive the car, and that is about it. I mean, 

I am exaggerating here to some degree, but the point is, now you 

are an insurance company. There are two very different models and 

you are going to charge at different rates, and certainly I have the 

right to do it, it seems to me, based on State law in that area. 

Having a Federal regulator try and sort that out and set rates 

in two different States with two various sets of laws that are very 

different seems to me to raise some very serious questions 

about—— 

Mr. PLUNKETT. Senator, there is one more difference, as well, at 

the State level. They have different insurance regimes. Some 

States are no fault. Some States aren’t, for example, with auto. 

Chairman DODD. Yes? 

Mr. WEBEL. I don’t know whether—well, first of all, under the 

optional Federal charter bills that have been introduced, the answer to that question is the States can’t set rates. So the way that 

the bills to some degree answer that is, well, you are not going to 
31 

worry about that because we are specifically saying the States can’t 

set rates. 

I think that the thing is, I mean, the insurance companies have 

to do this. I mean, the insurance companies are operating in all 

these States in these different regimes. It seems—I mean, I think 

that there really are very good arguments on both sides, that yes, 

on the one hand, it is local. The local insurance regulators are 

going to understand that market the best. But you have a national 

insurance company that is able to operate in these States. You are 

telling me that a national insurance regulator would be incapable 

of figuring it out, too? As I said, there doesn’t—there seem to be 

really good arguments on both sides. 

Chairman DODD. Senator Shelby. 

Senator SHELBY. Senator Dodd and I have been on this Committee together more years than people would dream, over 50 

years, and I believe we are grappling here in the Banking Committee with maybe the most challenging, complex piece of legislation or proposed legislation that we have ever had. I was just 

thinking a minute ago, bifurcated regulation, how do you do this 

and what are the consequences of it? 

I can see, and I don’t know, I think I asked Professor Grace how 

many insurance companies do we have in this country that are 

doing business? What size are they? What are their risks? How 

many would be subject to systemic meltdown? And I think a lot of 

that would be size and what they are involved in. I can see an optional Federal charter for some people, but others, maybe they 

don’t want to. Maybe they are too small. Maybe they don’t operate 

in enough States. I don’t know that. 

But whatever we do, and Senator Warner, Senator Corker, Senator Johanns, and I guess all of us to some extent have raised 

these questions. We haven’t fleshed it out yet, but we have got to 

do this and do it right. 

Something comes to mind. If you have a systemic regulator to 

companies that are systemic risk, what you want to do is prevent 

a meltdown and so forth. In a sense, if you create the systemic regulator, you are creating a Federal Insurance Czar, at least for certain big companies that are in this area. So how this intersects the 

so-called ‘‘Insurance Czar,’’ someone to deal with things that Senator Corker and Senator Warner are trying to grapple with, how 

do we create some entity that could deal with another AIG, for example, and wrap it up, take it over, do something? We don’t have 

that mechanism today, but will this do it? I don’t know. I see some 

intersections here, but they are not clear yet and maybe all of you 

guys can help us clear it. 

Thank you, Mr. Chairman. 

Chairman DODD. Senator Corker. 

Senator CORKER. Yes, sir, Mr. Chairman. Thank you for another 

great hearing. I was just going to make a closing statement, but 

something was brought up I just want to chase for a second. 

Mr. Scott, you mentioned that the Capital Markets Group you 

are a part of has recommended supporting what the Administration has come forth with as it relates to resolution. We actually— 

I thought it was—— 
32 

Mr. SCOTT. Senator, something like it. We are not on all fours 

with it, but in that direction, yes. 

Senator CORKER. We have been working on—I mean, I think a 

lot of people have felt that what the Administration has brought 

forth is really sort of codifying TARP. In other words, they have the 

ability per what they have laid out to actually use taxpayer monies 

not to resolve a company, but actually to keep a company alive 

through conservatorship and then put it back out. And I think 

many of us have thought we would be better off just having a resolution entity that could resolve it appropriately, but certainly not 

create the moral hazard that I just described that we see in the Administration’s proposal. I am not trying to harp on them. I don’t 

think most people are going to buy that anyway, but I just wondered if you would give any editorial comments in that regard. 

Mr. SCOTT. Senator, I think for most institutions, we should resolve them and the shareholders and the debt holders should take 

a hit. But we still have to build into the system, and we have got 

it for banks today without any reform, call it open bank assistance, 

call it what you want, to keep alive a bank, the significantly large, 

systemically important bank whose failure, that is resolving it, 

closing it in a sense, would have a huge impact on the financial 

system. We have to build in the possibility of doing that. 

We should do it on only extreme circumstances, OK, and maybe 

AIG, if we had had resolution authority, we wouldn’t have had to 

have kept it alive. But we have to build a system to give us that 

capability. But bound it, OK, in having it go through a lot of hoops, 

get approvals, maybe ultimately the President or whatever, but I 

think you have got to have that capability in any system you design. 

Senator CORKER. Thank you. I am not sure I agree with that answer, but I appreciate you clarifying that. 

Mr. Chairman, we have had a number of hearings and they have 

been very good. I think today, we saw that there is a difference between the financial risk to citizens versus other kinds of risk that 

exist. I know you chased that, talked about that some in your questioning. 

I fear that we have this sort of personality culture here even in 

our Government. We have a lot of czars to solve problems. It is like 

instead of doing the heavy lifting, really getting to the bottom of 

issues, we find some person that we have a lot of faith in, and a 

lot of proposals have certainly talked about the Fed coming in, and 

certainly the Fed is an important position in our country. 

I do hope that we will examine—I know you made a comment 

later—this whole systemic risk issue. I mean, do we need to be concerned about systemic risk? Yes. But do we need someone who does 

that and in doing so takes on large amounts of powers, and in essence it keeps us from actually digging in and creating legislation 

to solve many of those problems ourselves. Instead, we sort of punt, 

if that makes any sense, to some omnipotent person that is going 

to in essence solve all these problems. 

So I really appreciate some of the comments you made and I do 

hope that we might even consider having a hearing that is sort of 

an antisystemic regulator hearing, where we have people come in 

and talk about solving it by actually putting in place proper dis-
33 

ciplines throughout the system that would actually keep that from 

happening. 

But again, I thank you so much for—— 

Chairman DODD. No, not at all, and I appreciate you coming. 

And this is, as Senator Shelby and I have said, this is a very dynamic process we are involved in. I make this point over and over 

again. Maybe people are not believing me on this. But being involved in both the health care debate and this discussion is instructive to me, because in a sense, the health care debate is just loaded 

with ideology and politics. We have all come to that. 

This discussion, the fundamental difference is that my sense of 

the 23 or 24 of us that sit on this Committee particular, is there 

is a great appetite for trying to figure out what works. Now, maybe 

there are some who are going to bring some luggage to this debate 

that will show up along the way. But my sense is, and certainly 

in every conversation I have had with Senator Shelby, with Senator Corker, with others, is let us figure out what works and draft 

something and try to put something together that makes sense, 

recognizing that this is a unique opportunity—and but, frankly, but 

for the crisis, if you want to call it that, we are in, we probably 

wouldn’t get close to doing it. But the fact of the matter is, we don’t 

want to miss the opportunity that the crisis has posed to really go 

back and reflect—not that we are going to solve every problem. 

I take great exception to people who think, if we do this, we will 

never, ever, ever again face problems like this. Yes, we will. I 

promise you, we will. And so we ought to get rid of that notion altogether. 

We are trying to look back in that rear view mirror and say what 

happened here, where were the flaws. If there was an absence of 

regulation, do we need some? If there was regulation but it wasn’t 

being exercised, why, and what is happening? I think that deliberate approach in thinking this thing through has been tremendously rewarding, I think, for all of us. 

And it is still very dynamic, Bob, I tell you. I am certainly—I am 

still very agnostic on a lot of these questions. I am very anxious 

to hear debates. I am intracted about the Council idea and the Fed. 

But I am not there yet. I am willing to listen to that debate about 

the Fed and the role it can play. And I am willing to listen to 

smart, bright people who spend their lives thinking about this before I settle on an answer. 

So I want to confirm your ambition here, and that is that we are 

going to do our job here over the coming weeks, even in this break 

in August, our staffs working, meeting with people, talking about 

these various ideas, and then try to come together as a group of 

Democrats, Republicans, but more importantly, as Members of this 

Committee who I think share that notion of trying to figure this 

out and get together around some ideas here that make some 

sense, with the full knowledge we are not going to solve every problem known to mankind and we are not going to necessarily create 

Mount Olympus here with people who sit on high and are going to 

solve every problem in the future we may have. So it is a good 

point and I thank you for making it. 

Senator SHELBY. Mr. Chairman. 

Chairman DODD. Senator Shelby. 
34 

Senator SHELBY. I think we have got ourselves in a real jam in 

this country when we come up with the doctrine of ‘‘too big to fail’’ 

and then we say, gosh, we have got to create a systemic regulator 

to deal with this. How do we prevent it in the future? There will 

be failures in the future. 

Mr. Webel brought up something earlier, and I think I understood it. I thought we always had a resolution authority for companies who did not make it on their own, and that is the Bankruptcy 

Court. We will never know what would have happened to AIG or 

to the markets and everything else. But the sky didn’t fall when 

Lehman went under, and as he mentioned, a lot of people thought 

Lehman maybe came out of that better than a lot of people 

thought. That is arguable. 

But I believe if we enshrine—and that is where we are headed— 

the ‘‘too-big-to-fail doctrine,’’ we are going to have problems down 

the road because we are picking companies, our banks, insurance 

companies. That is going to become an unsettling event or syndrome in the marketplace of banks, securities, insurance, and so 

forth, and I think we had better deal with this. 

Mr. Webel, I think you wanted to say something. 

Mr. WEBEL. Yes. I have agreed with some of the people who that 

have started to talk about size instead of systemically significant, 

because size is a lot easier to deal with than systemic significance. 

Senator SHELBY. Yes. 

Mr. WEBEL. Where it kind of starts to break down, though, is the 

experience with bond insurers. These were not huge companies. 

These were companies that, by all rights, they weren’t complicated. 

They weren’t necessarily even complicated companies. I mean, the 

State of New York did—— 

Senator SHELBY. Bond insurance? 

Mr. WEBEL. Right. 

Senator SHELBY. Regulated by the States? 

Mr. WEBEL. You know, the State of New York oversaw most of 

them, and I think the people there are pretty competent. They 

could have done—I don’t think it was outside of their absolute competence to oversee companies of that size. 

So the question is, when you are thinking about systemically significant, where do you slot the bond insurance experience into the 

narrative? Would that have been covered by a systemic regulator? 

If not, were they systemically significant? I mean, they certainly 

had a huge ripple impact on all of our States and municipalities 

and how they were able to borrow, or not borrow, as the case may 

be. So that sort of outlier is just something to think about as we 

go forward. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman DODD. Let me just say, too, because again, Bob Corker 

has raised this and I couldn’t agree more on this whole notion— 

if you don’t need any better example, I think the AIG one. Had 

there been a resolution mechanism as an alternative to what we 

confronted in September of last year—— 

You know, again, it has been pointed out, Richard Breeden, the 

former Chairman of the SEC, he and I have had lengthy conversations. He was the one, I think the trustee, I think on WorldCom, 

if I am not mistaken. It took 4 years, but they disassembled that 
35 

operation. It exists today and employs thousands of people. I am 

told they are a rather vibrant company in many ways. It didn’t disappear, but it was reorganized and restructured in a way that 

didn’t involve—no one was involved in shoring it up. I mean, there 

was a mechanism by which you could deal with it. 

And I think your point that you made, Mr. Scott, is worthwhile, 

and that is sort of where I am on this, and that is I want to get 

rid of this ‘‘too-big-to-fail’’ notion altogether and that you ought to 

have the flexibility and the creativity and the imagination enough 

to be able to respond to situations in a variety of ways. Today, we 

have two, and that is pump billions of dollars into them or let them 

fail. It seems to me to be creative enough to say there are circumstances in which you ought to be able to manipulate this in a 

way that doesn’t end up costing the taxpayer billions of dollars, 

and simultaneously doesn’t cost thousands of jobs if you can reorganize something. 

I think that could have been done with AIG, in a way. So I appreciate your point. How that works is challenging, but clearly, a 

resolution mechanism is critical. I don’t know how we word that, 

but I sense among our Members up here there is a strong appetite 

for including something like that, and I think the point, Bob, you 

made a week or so ago, I think, that had that alone been in place, 

you might have had a different response to a lot of what occurred, 

in a sense. Had that vehicle been out there, that in itself might 

have had the desired effect of slowing things down. I think that 

was the point you were making a week or so ago. 

Anyway, thank you all very much. It has been very instructive. 

We may have some additional questions from Members who 

couldn’t be here this morning, so we will keep the record open for 

a while and we thank you. We would like to have you stay in touch 

with us on this matter, obviously a complicated one, and we invite 

your participation with us. 

The Committee will stand adjourned. 

[Whereupon, at 11:28 a.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 
36 

PREPARED STATEMENT OF SENATOR RICHARD C. SHELBY 

Thank you, Mr. Chairman. Over the past 2 years, we have seen how problems 

in our insurance markets can disrupt our national economy. The crumbling of our 

largest bond insurers called into question the value of the financial guarantees those 

firms had issued on billions of dollars of securities. 

In addition, the spectacular failure of AIG sent shockwaves throughout our economy, and led to a $170 billion bailout by the Federal Government. These events reveal that comprehensive insurance regulation must be a part of our reform effort. 

Unfortunately, the Administration has ‘‘taken a pass’’ on comprehensive insurance 

reform. Under the President’s proposal, the Federal Reserve would regulate only insurance companies that it deemed to be ‘‘systemically significant.’’ 

The President also proposes the creation of an Office of National Insurance that 

would collect information and advise the Treasury Secretary on insurance matters. 

While this concept may have some merit, it certainly is not comprehensive reform 

and leaves unanswered the difficult question of whether and how insurance regulation should be modernized for the vast majority of insurers. 

The goal of today’s hearing is to answer that question, as well as to examine the 

President’s reform proposal as it relates to insurance. In particular, I am interested 

in learning whether our witnesses believe that the Fed is an appropriate regulator 

for insurers. 

• Does it have the expertise necessary to supervise complex insurance companies? 

• Would establishing a separate Federal insurance regulator be a better choice? 

• If a Federal regulator is established, should all insurers have the option of 

being regulated at the Federal level? 

• If a Federal regulator is not established, what steps need to be taken to ensure 

that there is proper coordination? 

• Lastly, how do we make sure there are no gaps in our regulatory system, like 

those that appear to have played a role in the collapse of AIG? 

Reforming insurance regulation will be complex and challenging. The level of difficulty, however, should not prevent us from seeking a comprehensive solution to financial regulation that includes insurance. Thank you, Mr. Chairman. 

PREPARED STATEMENT OF SENATOR TIM JOHNSON 

Mr. Chairman, I am pleased you are holding an insurance hearing today. As this 

Committee considers financial regulatory restructuring proposals, I have said many 

times that insurance regulation must be a component of reform. I appreciate your 

recognition of that with this hearing. 

During the last two Congresses I introduced legislation to modernize the current 

system of insurance regulation. I remain concerned that the State-by-State regulatory system is outdated, inefficient, and bad for consumers. I am also deeply troubled that there remains no Federal agency to collect data on insurance companies, 

products and risks, to provide a voice on national insurance issues, and to represent 

our country on international insurance issues. Insurance plays a key part in a functioning economy and it should have appropriate regulation. 

Late last week, the Treasury sent up their legislative proposal to create an Office 

of National Insurance within the Department of the Treasury. I think this is a step 

in the right direction. I look forward to hearing the witnesses’ views on this proposal 

and other proposals to modernize the regulation of insurance. 
37 

PREPARED STATEMENT OF TRAVIS B. PLUNKETT 

LEGISLATIVE DIRECTOR, CONSUMER FEDERATION OF AMERICA

JULY 28, 2009 
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1 15 U.S.C. §§1011–1015. 2P.L. 93-406, 88 Stat. 829. 

3See CRS Report RL33683, Courts Narrow McCarran-Ferguson Antitrust Exemption for 

‘‘Business of Insurance’’: Viability of ‘‘State Action’’ Doctrine as an Alternative, by Janice E. 

Rubin. 4P.L. 97-45 as amended by P.L. 98-193 and P.L. 99-563, 15 U.S.C. §3901 et seq. 5P.L. 106-102, 113 Stat. 1338. 

PREPARED STATEMENT OF BAIRD WEBEL 

SPECIALIST IN FINANCIAL ECONOMICS, CONGRESSIONAL RESEARCH SERVICE

JULY 28, 2009 

Mr. Chairman, Ranking Member, my name is Baird Webel. I am a Specialist in 

Financial Economics at the Congressional Research Service. Thank you for the opportunity to testify before the Committee. This statement responds to your request 

for hearing testimony aiding the Committee’s deliberations about modernizing the 

regulation of insurance. It begins with a brief introduction focusing on insurance 

and the recent financial crisis, and differentiating between lines of insurance. Following this is a discussion of seven broad options for the Federal Government’s role 

in insurance regulation. These options should be seen as encompassing a continuum, 

and it may be possible to combine aspects from different options, particularly for 

different lines of insurance. Finally, the testimony includes a brief summary of recent proposals addressing insurance regulation at the Federal level. 

CRS’s role is to provide objective, nonpartisan research and analysis to Congress. 

CRS takes no position on the desirability of any specific policy. The arguments presented in my written and oral testimony are for the purposes of informing Congress, 

not to advocate for a particular policy outcome. 

Insurance Regulation and the Recent Financial Crisis 

As reaffirmed by Congress in the McCarran-Ferguson Act of 1945, 1 the primary 

locus of insurance regulation currently rests with the individual States. Since the 

passage of this act, however, both Congress and the Federal courts have taken actions that have somewhat expanded the reach of the Federal Government into the 

insurance sphere. Examples of this include Employee Retirement Income Security 

Act of 1974 (ERISA), 2 which effectively federalized health insurance regulation for 

a large swath of the American population; various court decisions limiting the 

phrase ‘‘the business of insurance’’ contained in McCarran-Ferguson; 3 and the Liability Risk Retention Act (LRRA), 4 which preempted the ability of nondomiciliary 

States to regulate certain types of property/casualty insurance. 

Nevertheless, the Gramm-Leach-Bliley Act of 1999 (GLBA), 5 which enacted the 

most sweeping financial regulatory changes since the Great Depression, specifically 

continued to recognize the States as the functional regulators of insurance. GLBA 

also removed legal barriers between securities firms, banks, and insurers. This legal 

freedom, along with improved technology, has been an important factor in creating 

more direct competition among the three groups. Many financial products have converged, so that products with similar economic characteristics may be available from 

different financial services firms with different regulators and different regulation. 

Increasing competition between insurers, banks, and securities firms has played 

a role in increased industry demands for a wide-ranging federalization of the insurance industry. These demands have typically focused on various inefficiencies in 

navigating the multiple regulators in the State system as well as what some characterize as the overbearing content of some State regulation, particularly State rate 

and form regulation. 

The financial crisis can at least partly be traced to failures or holes in the financial regulatory structure. This has given increased urgency to calls for overall regulatory changes and Federal oversight of insurance. While insurers in general have 

appeared to weather the crisis reasonably well so far, the insurance industry has 

seen two significant failures, one general and one specific. The first failure was 

spread across the financial guarantee or monoline bond insurers. Before the crisis 

there were only about a dozen bond insurers in total, with four large insurers dominating the business. This type of insurance originated in the 1970s to cover municipal bonds but the insurers expanded their businesses since the 1990s to include significant amounts of mortgage-backed securities. In late 2007 and early 2008, strains 

began to appear due to exposure to mortgage-backed securities. Ultimately some 

smaller bond insurers failed and the larger insurers saw their previously triple A 

ratings cut significantly. These downgrades rippled throughout the municipal bond 

markets, causing unexpected difficulties for both individual investors and munici-
96 

6See CRS Report R40438, Ongoing Government Assistance for American International Group 

(AIG), by Baird Webel. 7 Health insurers are often included within the category of life insurers. Since health insurance is largely outside of the scope of the Committee’s interest, this analysis concentrates purely 

on life insurance. 

palities who might have thought they were relatively insulated from problems stemming from rising mortgage defaults. 

The second failure in the insurance industry was a specific company, American 

International Group (AIG). 6 AIG had been a global giant of the industry, but it essentially failed in mid-September 2008. To prevent bankruptcy in September and 

October 2008, AIG was forced to seek more than $100 billion in assistance from, 

and give 79.9 percent of the equity in the company to, the Federal Reserve. Multiple 

restructurings of the assistance have followed, including up to $70 billion through 

the U.S. Treasury’s Troubled Asset Relief Program (TARP). AIG is currently in the 

process of selling off parts of its business to pay back assistance that it has received 

from the Government; how much value will be left in the 79.9 percent Government 

stake in the company at the end of the process remains an open question. 

The near collapse of the bond insurers and AIG could be construed as regulatory 

failures. One of the responsibilities of jobs of an insurance regulator is to make sure 

the insurer remains solvent and is able to pay its claims. Since the States are the 

primary insurance regulators, some may go further and argue that these cases specifically demonstrate the need for increased Federal involvement in insurance. 

There are aspects of both the bond insurer crisis and AIG’s failure that may mitigate the arguments for Federal involvement, particularly because AIG was also regulated by the Federal Office of Thrift Supervision. 

Lines of Insurance and Federal Involvement in Insurance 

The insurance industry is not monolithic, but rather very diverse, serving multiple markets. Companies range in size from multiline insurers serving the entire 

country to small ‘‘captive’’ insurers that may insure a single company. In general, 

insurers fall into two broad segments: life insurers and property/casualty insurers. 

Some companies are organized as stock companies, whereas others operate as mutual or fraternal companies. Some companies are very large in size, whereas others 

are midsize or small. Some companies specialize in large commercial accounts, 

whereas others write personal lines of business such as homeowners, automobile, or 

individual life and health policies. Still others concentrate on reinsurance, or the 

selling of insurance to insurance companies to assist them in spreading their risks. 

Life Insurance 

Life insurers 7 in general face long-term and relatively stable risks and losses. Life 

insurance contracts typically last decades and actuarial tables are well developed. 

It may be impossible to estimate which individual people are going to die in a given 

year, however, with a large pool, actuaries can be very accurate in projecting the 

overall number of deaths and thus the overall losses a life insurer will likely incur. 

This increases the importance of the investment side of the life insurance business 

to generate profits. If life insurers face solvency problems, it is likely to be a result 

of poor investment decisions rather than huge unexpected losses. The risks covered 

in life insurance are much more uniform across the country and policyholders are 

relatively likely to be covered by a policy purchased in a different State from their 

current residence. Life insurers also offer many annuity products, which combine aspects of insurance and investment products. These annuity products also represent 

a significant exposure to investment gains and losses for life insurance companies. 

Property/Casualty Insurance 

Property/casualty insurers face a very different set of economic challenges. Most 

property/casualty contracts are relatively short-term, often 6 months or 1 year. The 

risks to these insurers can be much more variable than those faced by life insurers. 

In some lines, catastrophic losses can occur that will wipe out years of previously 

accumulated premiums. Accordingly, investment returns are important to the business, but to a lesser degree than they are in life insurance. Property/casualty policies can be much more localized and tailored to specific risks in specific areas. With 

relatively short-term contracts, policyholders are much less likely to maintain their 

policies as they move from State to State. Property/casualty policies are often required by a third party. For example, purchase of State licensed auto insurance is 

a common requirement for auto licensing and banks often require specific insurance 

purchases for a property loan. The near mandatory nature of some property/casualty 

insurance purchases has tended to engender increased regulatory oversight and various mechanisms to ensure availability and affordable pricing for consumers. 
97 

8See, for example, an op-ed by the President and CEO of the Property Casualty Insurers Association of America, David A. Sampson, ‘‘Property, casualty insurers don’t pose systemic risk’’, 

The Hill, April 27, 2009, available at http://thehill.com/opeds/property-casualty-insurers-dontpose-systemic-risk-2009-04-27.html. 9Testimony by Max Stier, President and CEO, Partnership for Public Service, before the 

House Oversight and Government Reform Subcommittee on the Federal Workforce, Postal Service, and the District of Columbia, April 22, 2009. Retrieved through CQ Congressional Testimony. 

Such differences have led to suggestions for different Federal involvement for different lines of insurance. The most common proposal in the past has been to provide 

for a Federal charter for life insurers while leaving property/casualty insurers in the 

State system. During the recent financial crisis, life and property/casualty insurers 

sometimes favored different Government policies. Several life insurers have sought 

and received assistance through TARP, even going so far as to convert their corporate form to a Federal bank or thrift holding company to qualify for the assistance. Property/casualty companies have generally shunned Federal aid, with one industry group arguing strenuously that property/casualty insurers typically do not 

present systemic risk and the Federal Government should avoid providing assistance to them. 8

Options for Insurance Regulatory Reform 

Seven particular options for Federal involvement are presented in the following 

sections. These options range from minimal, or no, Federal involvement to a Federal 

takeover and complete restructuring of insurance regulation. To some degree many 

of these options have elements that are not mutually exclusive. Congress could take 

various aspects and apply them differently, for example, to different lines of insurance or to different aspects of regulation. Most of these options have been present 

in some form in proposals that predate the recent crisis. 

1. Do Nothing 

While insurers have unquestionably been affected by the financial crisis, the instruments and practices generally identified as driving the crisis, the outsized 

losses, and the bulk of the Federal assistance are concentrated in other areas of the 

financial services industry. This may be due to good regulation, good business practices, or simply good fortune for insurers, and it may very well change in the future, 

but for the moment the financial crisis is focused elsewhere. It could be argued that 

effort and attention should also be focused on the areas in crisis. One could even 

go further and argue that in such a time of general market uncertainty, it is not 

helpful to the market to introduce additional regulatory uncertainties. ‘‘First do no 

harm’’ may be applicable to sick financial markets as well as sick medical patients. 

On the other hand, making regulatory changes now, before insurers might be facing 

failure, could help prevent such failures from occurring at all. 

2. Create a Federal Office of Insurance Information 

One of the correlates of the absence of direct Federal regulatory authority over 

insurance has been a relative lack of awareness, information, and expertise on nonhealth insurance matters within the Federal Government. Other testimony before 

Congress has indicated that the Office of Thrift Supervision, which oversaw AIG, 

had only one insurance expert on staff 9 and informal inquiries have indicated to 

CRS that the Treasury Department does not have all that many more. 

This lack of information and insurance expertise has been noted before the crisis, 

and how large an impact it had on the crisis may be debated; however, the crisis 

has generally shown how important accurate information can be. Much of the market uncertainties can be traced to lack of information about specific companies’ exposures to mortgage-backed securities. Lack of information on the size of and exposures to the credit default swap market has also complicated regulatory responses 

to the crisis. Should a significant crisis event arise involving large insurers, additional information and expertise on the issues at the Federal level would likely be 

helpful. 

Some, particularly those strongly supporting the current State regulatory system, 

have expressed concern that such a Federal office might be essentially a precursor 

to an eventual Federal regulator. An alternate response to address such concerns 

might also be to increase cooperation and communication between Federal officials 

and the National Association of Insurance Commissioners (NAIC). The NAIC is currently a major source of information regarding insurance issues and would likely be 

significant source of information for any Federal office. This would particularly be 

the case if, as was included in the proposed Insurance Information Act (H.R. 5840 
98 

10 15 U.S.C. §1011. 

in the 110th Congress/H.R. 2609 in the 111th Congress), the Federal office would 

be largely limited to collecting publicly available data. 

3. Harmonization of State Laws Via Federal Preemption 

Most stakeholders in the insurance industry recognize the need for some harmonization, if not uniformity, of insurance regulation among the different State regulators. The NAIC has served as the primary forum for this since its founding in 

1871. For harmonization to occur through State efforts, however, every State legislature must pass substantially similar legislation, a very difficult task. Federal law, 

however, would have the power to preempt State legislation and create such harmonization without State legislative approval. This is the approach, for example, taken 

by the Liability Risk Retention Act, which preempts most State insurance regulation of risk retention groups, except for regulation by the home State regulator. Application of similar principles to other areas, such as surplus lines or the licensing 

of agents, has been a feature of several bills in the past few years. Federal preemption of State regulation of the business of insurance is a congressional prerogative, 

and even the McCarran Ferguson Act which declared a policy of ‘‘the continued regulation and taxation by the several States of the business of insurance,’’ 10 recognizes the congressional authority to regulate the insurance industry. 

This approach could be argued to be a ‘‘best of both worlds’’ approach, combining 

the experience and many of the strengths of the State regulatory system while ensuring greater efficiency through the ability of insurers to operate throughout the 

country. Much of the effectiveness of this approach, however, would depend on the 

specific details chosen. As an approach, it is very broad. Congress could choose to 

preempt specific aspects relating to a single line of insurance, or a State’s entire approach to insurance regulation. Without specifics about what State laws are being 

preempted and what they might be replaced with, it is difficult to analyze the partial preemption approach. If one were specifically trying to address issues related 

to the financial crisis, it may be difficult to do so through piecemeal Federal preemptions. Much of crisis management and avoidance will be a question of individual regulatory decisions, which are more difficult to address through broader preemption 

efforts. 

4. Create a Federal Systemic Risk Regulator 

One new regulatory option being discussed in the current financial crisis is the 

concept of a ‘‘systemic risk regulator.’’ The Committee has held an entire hearing 

devoted to the subject, so I will focus on the systemic risk regulator and the insurance system. 

Given the near systemic collapse that the financial system experienced last September, the need for someone to look after the entire system may seem self-evident 

to some. As concepts for a systemic risk regulator have become more advanced, however, the difficulties of going from the concept of needing someone to look after the 

system to how this concept would work in practice have become more apparent. Particularly with regard to the insurance regulatory system, there are a number of 

questions to consider, including: 

• Do any insurers present a systemic risk? If so, what criteria would be used to 

identify these systemically significant institutions? 

In the past, a familiar concern was that financial institutions may become 

too big to fail. In the recent crises, however, the concept of ‘‘too interconnected to fail’’ has also been injected into the debate. Metrics for ‘‘interconnectedness’’ are even less clear than those for size. Historically, insurers 

have generally not been considered to present systemic risks; insurers’ liabilities are much more stable than those of banks and insurers have not 

suffered from depositor runs like banks have. The recent crisis, however, 

has brought a different sort of run on financial institutions, namely the 

withdrawal of short term credit and demand from other counterparties for 

collateral payments. Such a ‘‘run’’ brought AIG down and other insurers 

might be vulnerable, although none have failed since AIG. 

• Who would make the decision on which institutions would fall under the systemic regulator’s purview? 

The State insurance regulators would most likely expect some role in the 

process of identifying systemically significant insurers. If the insurance regulators and the systemic regulator disagree, however, a mechanism must 

be in place to arrive at a final decision. 
99 

• Would a systemic regulator have day-to-day oversight over insurers judged to be 

systemically significant? 

If it were to have day-to-day oversight, then the systemic risk regulator 

would be tantamount to a Federal insurance regulator, which is the heart 

of the Federal chartering debate and will be explored further later in this 

testimony. 

• If not, what specific preemptive powers would a systemic regulator have over the 

State regulators’ decisions? 

A particularly controversial aspect of such preemptive powers may surround regulation of insurance rates. Many States require specific regulatory 

approval for insurance rates. If these rates were insufficient to cover an insurer’s risks, thus making insolvency more likely, it could directly concern 

a systemic risk regulator. 

• Would the systemic regulator have resolution authority over failed systemically 

significant institutions or would this be left to the State regulators and the guarantee funds? 

The failure of large institutions like AIG and Lehman Brothers, who did 

not fall under existing resolution provisions as banks do, has been identified by many as a particular issue to be addressed by a systemic risk regulator. Broader Federal resolution authority could, however, have a significant impact on the current system for resolving insurance company failures. 

Under current law, failed insurance companies are resolved by the State insurance regulators and guarantee funds. Generally, insured policy holders 

are paid off by the guarantee funds under certain guidelines with the guarantee funds then occupying a senior position with regard to claims on insurer assets. What position individual policyholders or guarantee funds 

might have under a Federal resolution authority, however, is up to whatever laws would be approved by Congress. The current Treasury proposal 

for resolution authority does not change the current authority over insurance subsidiary assets. If the enacted resolution authority did change this, 

a systemic risk regulator might have an incentive to use the assets of a 

company such as AIG to satisfy creditors who are themselves systemically 

significant rather than directing these assets to satisfy policyholder claims. 

• What impact would identifying particular insurers as systemically significant 

have on the marketplace, particularly on competitors of these firms? 

Competitors of AIG today have voiced many complaints that AIG is using 

Federal support to undercut their prices. If an insurer were identified as 

systemically significant, and thus presumably one that is not allowed to 

fail, this could give such firms a competitive advantage. If this occurs, others would presumably seek to merge or otherwise grow in size so they 

might gain this advantage. This could have the paradoxical effect of making 

a future crisis worse as more financial institutions would have the potential 

to spread systemic harm in the event of their collapse. 

• Would being identified as systemically significant promote risk taking in these 

institutions, and thus make future crises more likely? 

This problem of ‘‘moral hazard’’ is well known in the insurance industry. 

In order to deal with it on the individual level, insurers institute a variety 

of policies, such as deductibles and copayments. Identifying an institution 

as systemically significant implies it will not be allowed to fail, which also 

creates moral hazard. To address this, a systemically significant designation could also include other policies, such as increased capital requirements or other regulatory scrutiny. 

5. Create a Federal Solvency Regulator 

Regulation of insurers can be broken down broadly into oversight of the company’s 

interaction with customers (market conduct or consumer protection regulation) and 

oversight of its future ability to pay claims (solvency or prudential regulation). In 

the United States, regulation of both aspects is done by the individual States. Some 

other countries, however, separate these functions and have two distinct agencies 

for the two tasks. In theory, this could allow for increased focus on both tasks as 

each agency only has one goal. Adapting this approach to the United States could 

lead to the possibility of assigning consumer protection functions to the individual 

States, while giving solvency regulatory powers to the Federal Government. Such 

an approach would also dovetail with some arguments already advanced in the optional Federal chartering debates. Proponents of the State regulatory system often 
100 

cite consumer protection as a particularly successful area for the States and one in 

which the States can give much more individual attention to citizens than they are 

likely to receive from a Federal bureaucracy, while proponents of a Federal chartering system cite the increased complexity of financial instruments and company 

balance sheets which makes solvency regulation more difficult, thus requiring additional expertise which would presumably come with a Federal regulator. 

The operation of such a mixed system would ideally include substantial communication and trust between the consumer protection regulators and the solvency regulators. Establishing this trust in the aftermath of a Federal takeover of solvency 

regulation could be a challenge. Another flashpoint might be the regulation of rates, 

as mentioned previously. Rates have a direct impact on insurer solvency, but regulation of rates is seen by many as a bedrock aspect of consumer protection. To limit 

conflict between the States and Federal regulators, implementing legislation would 

need to clarify what power the Federal solvency regulators might have to overrule 

State regulators, or vice versa. 

6. Establish a Federal Insurance Charter 

The debate over the possibility of a Federal charter for insurers has been ongoing 

for the past several years with the Committee hearing previously from both the proponents and opponents of the idea. A common proposal has been for an Optional 

Federal Charter (OFC) for insurers modeled on the dual banking system. 

Current focus on the idea of a Federal insurance charter dates largely to the passage of GLBA, which specifically reaffirmed the States as the functional regulators 

of insurance but also unleashed market forces encouraging a greater Federal role. 

This has led to increasing industry complaints of overlapping, and sometimes contradictory, State regulatory edicts driving up the cost of compliance and increasing 

the time necessary to bring new products to market. 

Arguments advanced for Federal chartering have included the following: 

• The regulation of insurance companies needs to be modernized at the Federal 

level to make insurers more competitive with other federally regulated financial 

institutions in the post-GLBA environment. 

• The recent financial crisis has shown that some insurers present systemic risk 

and should be regulated by a regulator with a broad, systemic outlook. 

• Insurance needs a knowledgeable voice and advocate in Washington, DC. 

• The current system is very slow in approving new products, putting insurers 

at a distinct disadvantage in product creation and delivery. 

• Insurers have difficulty in expanding abroad without a regulator at the national 

level. 

• Consumers will benefit from a greater supply of insurance and lower cost to 

consumers as insurance companies are forced to compete on a national scale. 

Arguments advanced for State regulation have included the following: 

• State regulated insurers have performed relatively well through the financial 

crisis, underscoring the quality of State regulation. 

• State insurance regulators have unique knowledge of local markets and conditions and are flexible and adaptable to local conditions. 

• The diversity of State regulation reduces the impact of bad regulation and promotes innovation and good regulation. 

• Strong incentives, such as direct election, exist for State regulators to do the 

job effectively at the State level. 

• A substantial and costly new Federal bureaucracy would need to be created in 

a Federal system. 

• States would suffer substantial fiscal damage should State premium taxes be 

reduced by the Federal system. 

• A ‘‘race to the bottom’’ could occur under an optional Federal charter as State 

and Federal regulators compete to give insurers more favorable treatment and 

thus secure greater oversight authority and budget. 

In the abstract, the Federal chartering question could be simply about the ‘‘who’’ 

of regulation. Should it be the Federal Government, the States, or some combination 

of the two? In practice, however, OFC legislation has had much to say about the 

‘‘how’’ of regulation. Should the Government continue the same fine degree of industry oversight that States have practiced in the past? The OFC bills that have been 

introduced to this point have tended to answer the latter question negatively—the 

Federal regulator that they would create would exercise less regulatory oversight 
101 

than most State regulators. This deregulatory aspect of past and present OFC bills 

can be as great a source of controversy as the introduction of Federal regulation 

itself. 

7. Completely Reform the Financial Services Regulatory System 

The question of Federal involvement in insurance regulation could expand beyond 

the confines of insurance and instead be subsumed within a more comprehensive 

reform to the whole approach to regulating the U.S. financial system. General financial regulation in the United States is carried out by an overlapping set of bodies 

created at various periods during the past 150 years. Historically, the regulatory 

body was dictated by the charter of a given institution: banks were regulated by 

various banking regulators, thrifts by thrift regulators, insurers by insurance regulators, etc. Although GLBA aimed to refocus the system along functional lines, so 

that, for example, insurance regulators would regulate insurance activity whether 

it was carried out by banks or by insurers, regulation has still largely fallen along 

institutional lines. Simplification of the regulatory system is not a result that most 

observers would ascribe to GLBA. Even before the financial crisis, arguments were 

advanced that the system needed a significant overhaul, perhaps by combining overlapping institutions or completely rethinking the structure of the regulatory system. 

Several other countries have confronted similar policy choices in the past two decades with two regulatory models gaining favor: a ‘‘unitary’’ regulator and a ‘‘twin 

peaks’’ model. 

A unitary model calls for a single regulator to oversee financial institutions regardless of the charter type or business activity that the institutions engage in. 

Such a regulator could oversee all aspects of financial activity, from systemic stability to individual institution solvency to consumer protection. Advantages of such 

an approach include a focus on financial regulation that avoids consumer confusion 

about who to call in the case of problems; clear regulatory authority over innovations in the financial system; and no possibility that financial institutions would 

‘‘game the system’’ by playing one regulator off against another. The strengths of 

a unitary system when the regulator gets things right, however, are also its weakness if the regulator gets things wrong. With only one regulatory body, there are 

few checks and balances. If a mistake is made, it can more easily affect the whole 

system rather than be isolated within a particular type of institution or geographic 

area. Examples of countries adopting a unitary approach include Japan and the 

United Kingdom. 

A twin peaks model typically separates the regulatory authority between solvency 

and consumer protection functions, with separate entities responsible for each. Such 

an approach arguably can offer many of the same advantages of a unitary system 

with relative uniformity of regulation across different financial institutions regardless of charter and an even clearer regulatory focus within each of the two regulators. Overlap between the two regulators could be minimized, but having two 

voices in the system offers at least the possibility of minimizing the impact of regulatory mistakes rippling throughout the system. Examples of countries adopting a 

twin peaks approach include Australia and the Netherlands. 

Recent Proposals/Legislation Reforming the Insurance Regulatory System 

President Obama’s Financial Regulatory Reform Plan 

In June 2009, the Treasury Department released a report entitled ‘‘Financial Regulatory Reform: A New Foundation,’’ outlining President Obama’s plan to reform financial regulation in the United States. Since the release of the overall plan, legislative language to implement various aspects of the plan has also been released. The 

plan is generally portrayed as a middle of the road approach to reform the overall 

system. It does not foresee revamping the entire system following the unitary or 

twin peaks model, but it would substantially change the financial regulatory system, 

including explicitly introducing systemic risk oversight by the Federal Reserve, combining the Office of Comptroller of the Currency and the Office of Thrift Supervision 

into a single banking regulator, and creating a new Consumer Financial Protection 

Agency. 

Most of the regulatory changes under the President’s plan would be focused on 

areas other than insurance. Most insurance products, for example, are excluded 

from the jurisdiction of the new Federal consumer protection agency. In general, the 

States would continue their preeminent role in insurance regulation. Insurance regulation, however, would be specifically affected through two aspects of the President’s plan, the regulation of large financial companies presenting systemic risk and 

the creation of a new Office of National Insurance (ONI) within the Treasury. 

Systemic risk regulation would be the primary responsibility of the Federal Reserve in conjunction with a new Financial Services Oversight Council made up of 
102 

the heads of most of the Federal financial regulators. The powers to regulate for systemic risk enumerated in the draft legislation extend to all companies in the United 

States engaged in financial activities. While the draft legislation does not specifically name insurers as subject to Federal systemic risk regulation, the language 

would seem to include them under the Federal jurisdiction. Companies judged to be 

a possible threat to global or U.S. financial stability may be designated Tier 1 Financial Holding Companies and subject to stringent solvency standards and additional examinations. Such companies would also be subject to the enhanced resolution authority rather than standard bankruptcy provisions. While the draft language does make reference in some places to State functional regulatory agencies, 

it is unclear exactly how the Federal Reserve as regulator of the financial holding 

company would interact with the State regulators of the individual insurance subsidiaries. Under the current regulatory system, where there are some federally regulated holding companies that are primarily insurers, the Federal regulators generally defer to the State insurance regulators. Whether or not this deferral would 

continue under the new legislation may be an open question. 

While systemic risk regulation would likely apply to a relatively small number of 

insurers, the called-for creation of an Office of National Insurance (ONI) could have 

a broader impact. Unlike the similarly named office in other legislation, such as 

H.R. 1880, President Obama’s ONI would not oversee a Federal insurance charter 

and have direct regulatory power over insurers. This ONI would operate as a broad 

overseer and voice for insurance at the Federal level, including collecting information on insurance issues, setting Federal policy on insurance, representing the 

United States in international insurance matters, and preempting State laws where 

these laws are inconsistent with international agreements. These functions are similar to those of the Office of Insurance Information (OII) to be created by H.R. 2609. 

The ONI under President Obama’s plan would seem to have more authority, however, than the OII under H.R. 2609. For example, the ONI would have subpoena 

power to require an insurer to submit information rather than relying voluntary 

submissions and publicly available information. 

The National Insurance Consumer Protection Act (H.R. 1880) 

Representatives Melissa Bean and Edward Royce introduced H.R. 1880 in the 

House on April 2, 2009. 

This bill would create a Federal charter for the insurance industry, including insurers, insurance agencies, and independent insurance producers. The Federal insurance regulatory apparatus would be an independent entity under the Department of the Treasury and would preempt most State insurance laws for nationally 

regulated entities. Thus, nationally licensed insurers, agencies, and producers would 

be able to operate in the entire United States without fulfilling the requirements 

of each individual 50 States’ insurance laws. 

H.R. 1880 would also address the issue of systemic risk by designating another 

entity to serve as a systemic risk regulator for insurance. The systemic risk regulator would have the power to compel systemically significant insurers to be chartered by the Federal insurance regulator. Thus, although the bill shares some similarities with past optional Federal charter legislation, and would allow some insurers to choose whether to obtain a Federal charter, it can not be considered purely 

an optional Federal charter bill. 

The National Association of Registered Agents and Brokers Reform Act of 2009 (H.R. 

2554) 

This bill was introduced by Representative David Scott along with 34 cosponsors 

on May 21, 2008. 

H.R. 2554 would establish a National Association of Registered Agents and Brokers (NARAB). NARAB would be a private, nonprofit corporation, whose members, 

once licensed as an insurance producer in a single State, would be able to operate 

in any other State subject only to payment of the licensing fee in that State. The 

NARAB member would still be subject to each State’s consumer protection and market conduct regulation, but individual State laws that treated out of State insurance 

producers differentially than in-State producers would be preempted. NARAB would 

be overseen by a board made up of five appointees from the insurance industry and 

four from the State insurance commissioners. The appointments would be made by 

the President and the President could dissolve the board as whole or suspend the 

effectiveness of any action taken by NARAB. 

The Nonadmitted and Reinsurance Reform Act of 2009 (H.R. 2571/S. 1363) 

Representative Dennis Moore and 21 cosponsors introduced H.R. 2571 on May 21, 

2009, while Senators Mel Martinez, Bill Nelson, and Mike Crapo introduced S. 1363 

on June 25, 2009. 
103 

11See CRS Report RS22506, Surplus Lines Insurance: Background and Current Legislation, 

by Baird Webel. 12See CRS Report RL32176, The Liability Risk Retention Act: Background, Issues, and Current Legislation, by Baird Webel. 13 U.S. Treasury, ‘‘Treasury Releases Blueprint for Stronger Regulatory Structure’’, press release, March 31, 2008, http://www.ustreas.gov/press/releases/hp896.htm. 

These bills would address a relatively narrow set of insurance regulatory issues. 

In the area of nonadmitted, or surplus lines, insurance, the bills would harmonize, 

and in some cases reduce, regulation and taxation of this insurance by investing the 

‘‘home State’’ of the insured with the sole authority to regulate and collect the taxes 

on a surplus lines transaction. Those taxes that would be collected may be distributed according to a future interstate compact, but absent such a compact their distribution would be up to the home State. These bills also would preempt any State 

laws on surplus lines eligibility that conflict with the NAIC model law and would 

implement ‘‘streamlined’’ Federal standards allowing a commercial purchaser to access surplus lines insurance. For reinsurance transactions, they would invest the 

home State of the insurer purchasing the reinsurance with the authority over the 

transaction while investing the home State of the reinsurer with the sole authority 

to regulate the solvency of the reinsurer. 11

The Insurance Information Act of 2009 (H.R. 2609) 

Representative Paul Kanjorski and four cosponsors introduced H.R. 2609 on May 

21, 2009. 

This bill would create an ‘‘Office of Insurance Information’’ for nonhealth insurance in the Department of the Treasury. The Deputy Assistant Secretary heading 

this office would be charged with collecting and analyzing insurance information 

and establishing Federal policy on international insurance issues, as well as advising the Secretary of the Treasury on major insurance policy issues. State laws or 

regulations that the head of the office finds to be inconsistent with the Federal policy on international insurance issues would be preempted, subject to an appeal to 

the Secretary. 

The Increasing Insurance Coverage Options for Consumers Act of 2008 (H.R. 5792, 

110th Congress) 

This bill was introduced by Representative Dennis Moore, along with Representatives Deborah Pryce, John Campbell, and Ron Klein, on April 15, 2008. 

H.R. 5792 would have amended the Liability Risk Retention Act (15 U.S.C. 3901, 

et seq.) to allow risk retention groups and risk purchasing groups to expand into 

commercial property insurance, while adding requirements on corporate governance 

including the addition of independent directors on risk retention group boards and 

a fiduciary duty requirement for group directors. The bill would have required risk 

retention groups be chartered in a State that has adopted ‘‘appropriate’’ or ‘‘minimum’’ financial and solvency standards. It would also have strengthened the current preemption from State laws enjoyed by risk retention and risk purchasing 

groups. 12

2008 Treasury Blueprint 

In March 2008, then-Secretary of the Treasury Henry Paulson released a ‘‘Blueprint for a Modernized Financial Regulatory Structure.’’ Although the recent financial crisis had begun at that time, the Treasury blueprint was not primarily a response to the crisis, but instead an attempt to create ‘‘a more flexible, efficient, and 

effective regulatory framework’’ 13 A wide-ranging document, the blueprint foresaw 

a completely revamped regulatory structure for all financial services. The final 

structure envisioned in the Treasury blueprint has been described as ‘‘twin peaks 

plus.’’ The 2008 Treasury model was to ultimately create a prudential regulator 

overseeing the solvency of individual companies, a business conduct regulator overseeing consumer protection, and a market stability regulator overseeing risks to the 

entire system. As an intermediate step, it made two specific recommendations on 

insurance regulation. First, it called for the creation of a Federal insurance regulator to oversee an optional Federal charter for insurers as well as Federal licensing 

for agents and brokers. Second, recognizing that the debate over an optional Federal 

charter was ongoing in Congress, it recommended the creation of an ‘‘Office of Insurance Oversight’’ in the Department of the Treasury as an interim step. This office 

would be charged with two primary functions: (1) dealing with international regulatory issues, including the power to preempt inconsistent State laws, and (2) collecting information on the insurance industry and advising the Secretary of the 

Treasury on insurance matters. 
104 

1Federal Reserve, Statistical Release Z.1 (June 11, 2009). 

2Portions of this testimony are excerpted from my prior work on the subject, namely Martin 

F. Grace & Hal S. Scott, ‘‘An Optional Federal Charter for Insurance: Rationale and Design’’, 

in The Future of Insurance Regulation in the United States 55–96 (Martin F. Grace & Robert 

W. Klein, eds. Brookings Press, 2009), and the Committee on Capital Markets Regulation’s recent report entitled ‘‘The Global Financial Crisis: A Plan for Regulatory Reform’’ (May 2009). 3P.L. 15, March 9, 1945 (codified at 15 U.S.C. §§1101–15). 

PREPARED STATEMENT OF HAL S. SCOTT 

NOMURA PROFESSOR OF INTERNATIONAL FINANCIAL SYSTEMS AND DIRECTOR, 

COMMITTEE ON CAPITAL MARKETS REGULATION, HARVARD LAW SCHOOL

JULY 28, 2009 

Thank you, Chairman Dodd, Ranking Member Shelby, and Members of the Committee for permitting me to testify before you today on regulatory modernization as 

it relates to the insurance industry. 

As the Committee knows, the insurance industry represents an important place 

in the U.S. framework of financial regulation. As of the first quarter of 2009, the 

total assets of U.S. life and property-casualty insurers were $5.7 trillion, quite significant when compared with total assets of U.S. commercial banks of $13.9 trillion. 1 Despite being a national (indeed international) industry within the financial 

sector whose size can be measured in the trillions, insurance—unlike the banking 

or securities sector—is regulated almost exclusively by each of the 50 States instead 

of the Federal Government. 

This structure comes from a bygone era and, in the wake of the ongoing global 

financial crisis, must be reconsidered and changed. I believe reform, at least initially, should come by way of establishing an optional Federal charter (OFC). 

My testimony is organized in three parts. 2 Part I addresses the case against the 

status quo and the need for an OFC. Part II outlines how an OFC regime should 

be structured, and Part III introduces some additional issues to consider in reforming insurance regulation in the United States. 

I. The Need for an Optional Federal Charter 

In contrast to other financial services, such as securities and banking, Congress 

has not sought to exercise either concurrent or preemptive authority over insurers. 

Indeed, the McCarran-Ferguson Act of 1945 explicitly found State regulation of insurance to be in the public interest and provided that no Federal law should ‘‘invalidate, impair, or supersede’’ any State insurance regulation or tax. 3 The net result 

of congressional abstention has been that more than 50 regulators currently regulate insurance within their jurisdictions. Yet it has not always been assumed that 

the States should be the exclusive regulators of insurance. There have been numerous proposals for a Federal role in insurance regulation since the time of the National Banking Act, which set up the dual-chartering provisions for the banking industry in the 1860s. Indeed, many such proposals have been put forward recently. 

For example, in April 2009 Representatives Melissa Bean (D-Ill.) and Ed Royce (RCalif.) introduced H.R. 1880, the National Insurance Consumer Protection Act, 

which sets forth a scheme for an OFC for life and property-casualty insurers (as 

well as reinsurers), largely modeled on the National Bank Act of 1864. 

A. The Case for Abandoning the Status Quo 

The status quo is undesirable for at least three reasons: (1) State-based regulation 

is inefficient; (2) the current system stifles uniformity, innovation, and speed to 

market; and (3) the fragmented framework puts the insurance industry at a competitive disadvantage with other firms offering the same products. We need to create an OFC to remedy these problems, although I acknowledge the political difficulties of doing so. 

1. State-Based Regulation Is Inefficient—The most basic problem with the current 

framework of multistate regulation is its sheer inefficiency. The precise costs of that 

inefficiency are somewhat difficult to calculate. A simple cost comparison between 

current State and Federal financial regulatory systems is only partially informative, 

because each State agency has a slightly different mission. For example, some 

States expend a great deal of time on rate regulation and issues related to pricing, 

profitability, and market conduct. Other States have relatively little price regulation 

but may spend more resources and time on other issues salient to voters in the 

State. 

Scholars and economists that have attempted to quantify the costs associated with 

multistate regulation agree they are significant. For example, Professor Steven 

Pottier of the University of Georgia finds that the total additional cost of having 
105 

4Steven W. Pottier, ‘‘State Insurance Regulation of Life Insurers: Implications for Economic 

Efficiency and Financial Strength,’’ in Report to the American Council of Life Insurers (2007). 5Laureen Regan, ‘‘The Option Federal Charter: Implications for Life Insurance Producers’’ in 

Report to the American Council of Life Insurers (2007). 6 National Association of Insurance Commissioners, Annual Statement (Kansas City, MO, 

2006). 7Martin F. Grace & Hal S. Scott, supra note 2 at 61–64. 8 Id. at 65. 9See http://www.insurancecompact.org/. New York, Illinois, and California do have proposed 

legislation. 

multistate regulation of the life insurance industry is about 1.25 percent of net premiums annually. 4 This translates into approximately $5.7 billion each year. While 

these figures are for the life insurance industry, one would expect similar results 

for property-liability firms. 

Like many others, I believe that if a significant portion of insurance regulation 

was aggregated at the Federal level, many of these duplicate costs would be eliminated. The outcome would be lower regulatory costs to the Government and lower 

compliance costs to the regulated firms. For example, every State undertakes regulation of insurance agents. According to Professor Laureen Regan of Temple University, the average life agent has about nine State licenses. 5 This cost is born by the 

agents, their employers, and their customers. Further, every State licenses the companies operating within its jurisdiction. The average property-liability company 

holds 16 State licenses and the average life-health company holds twenty-five. 6 An 

optional Federal charter with one licensing regime could eliminate these multiple 

layers of cost. 

A particular industry or product should be regulated at the jurisdictional level 

best able to capture all the costs and benefits of regulation within its limits. In layman’s terms, the more interstate the business, the stronger the argument is for Federal regulation. There was a time in American history when the sale and provisioning of insurance of differing kinds was primarily a local business. But that time 

has long passed. Based on information available from the National Association of 

Insurance Commissioners (NAIC), Professor Martin Grace and I calculated that for 

2006, out-of-State insurers provided over 80 percent of all insurance in the United 

States. 7 In certain categories of insurance, the numbers are even more striking. 

While the in-State market share for property-liability insurers is 18.13 percent, for 

life-health insurers the average in-State market share is only 7.52 percent. 8

2. State-Based Regulation Threatens Uniformity, Innovation, and Speed to Market—Related, but distinct from the inefficiency of multistate regulation, is the potentially negative effect of the status quo on the uniformity of standards and regulations, product innovation, and the speed with which new products enter the marketplace. The promulgation of Federal laws and regulations—particularly those with 

the requisite force to preempt State laws—would, by definition, be uniform throughout the United States. Uniformity not only produces greater cost efficiency but also 

enables consumers and regulators to monitor the compliance of a particular company or product with a set of standards applied across State boundaries. 

Multistate regulation has arguably impeded the ability of the insurance industry 

to provide consumers with improved products. If products are approved quickly, 

then firms can compete more efficiently on product innovation and design. However, 

if products are approved slowly, the incentive for insurers to develop and market 

new ideas is reduced. The problem is exacerbated if a product is approved in one 

State with a certain set of conditions and in another State with a different set of 

conditions, as is presently the case. NAIC’s attempts to reduce these costs have not 

been entirely successful. Most recently, NAIC has tried to improve the process by 

the formation of the Interstate Insurance Product Regulation Commission (IIPRC) 

for life insurance, an interstate compact. According to information on the IIPRC, 36 

States and related jurisdictions were members as of July 2009. However, five large 

insurance States are missing from the compact: New York, California, Illinois, Florida, and Connecticut. 9

3. State-Based Regulation Creates Horizontal Inequity with Other Financial Industries—A final point is that the current multistate framework puts the insurance industry at a competitive disadvantage to other financial services firms offering competing products. Noninsurance financial institutions can ask their Federal regulators for nationwide approval of a product and receive an answer within a relatively short period of time, compared to the time it takes for insurers to obtain 

State approval. This provides these other financial institutions a significant advan-
106 

10Kelly Greene, ‘‘Mutual Funds Pitch Alternative to Annuities’’, Wall Street Journal, at D8 

(Jun. 9, 2008). 11Martin F. Grace, et al., ‘‘Insurance Company Failures: Why Do They Cost So Much?’’ 

(Washington: American Council of Life Insurers 2007). 12 At this time, I do not advocate a mandatory Federal charter for all insurance companies, 

though a mandatory role for the Federal Government may be necessary with respect to certain 

large insurance firms. See Part III.A. 13 Committee on Capital Markets Regulation, The Global Financial Crisis: A Plan for Regulatory Reform 203-210 (May 2009), available at http://www.capmktsreg.org/research.html. 

tage over insurers for the marketing of similar products. 10 Furthermore, States are 

often more restrictive on product offerings than is the Federal Government. For example, federally regulated financial institutions are permitted to use relatively aggressive hedging strategies, which can reduce their risk, whereas insurers typically 

are not. 11 The market is quickly and dramatically changing, yet States typically resist allowing insurers to use the strategies commonly used by other financial institutions. It may be that State regulators are apprehensive because they lack the resources to monitor and evaluate these strategies. A Federal regulator with better 

analytical resources could permit life insurers to engage in investment and hedging 

strategies that would be more appropriate, more efficient, and less risky. 

B. The Benefits of an OFC 

As explained above, the status quo no longer represents an effective means of regulating the U.S. insurance industry. The question thus becomes whether the addition of an optional Federal charter 12 will bring more benefits than costs. Although 

there are costs arising from maintaining regulation at two levels of Government, 

such costs should be more than offset by the efficiencies of the emerging Federal 

system. Some also contend an OFC may lead to reduced consumer protection since 

State regulators may be more responsive to local complaints due to the political consequences of not doing so. However, the Obama administration’s proposal for the 

new Consumer Financial Protection Agency, which, as discussed below, should have 

jurisdiction over federally chartered insurers, may greatly alleviate that concern. 

Furthermore, an OFC would reduce the negative externalities imposed on out-ofState customers and insurers resulting from the current State-based regulatory system. Finally, the creation of a Federal chartering agency would enable greater cooperation in the international arena among the various national insurance regulators. In sum, the need for an OFC is clear, and the ongoing financial crisis presents a compelling reason and an unparalleled opportunity for meaningful reform 

of U.S. insurance regulation. 

II. Design of the Regulator of Federally Chartered Insurance Companies 

Apart from possessing the requisite technical expertise, the Federal entity created 

to regulate, supervise, and enforce a new OFC regime will have to be situated within the U.S. financial regulatory structure. There is also an important issue of whether the Federal regulator should charter lines of business or firms. 

A. Place in the Regulatory Structure 

From a broad perspective, I believe the overall U.S. financial regulatory structure 

is seriously in need of reform. A rapidly dwindling share of the world’s financial 

markets is supervised under the fragmented, sectoral model still employed by the 

United States. In May 2009, the Committee on Capital Markets Regulation (CCMR) 

issued a comprehensive report entitled The Global Financial Crisis: A Plan for Regulatory Reform that called for the U.S. financial system to be overseen by only two, 

or at most, three independent regulatory bodies: the Federal Reserve, a newly created independent U.S. Financial Services Authority (USFSA), and possibly another 

new independent investor/consumer protection agency. 13 I believe this model is the 

right one to replace our highly fragmented and ineffective regulatory structure. 

Under the CCMR approach, the Federal Reserve would retain its exclusive control 

of monetary policy and its lender of last resort function as part of its key role in 

ensuring financial stability. In addition, its regulatory power would be enhanced to 

deal with systemic risk, such as exclusive control of capital, liquidity and margin 

requirements, as well as payment and clearing and settlement. The USFSA, on the 

other hand, would regulate all other aspects of the financial system, including market structure, permissible activities, and safety and soundness for all financial institutions (and possibly consumer/investor protection with respect to financial products 

if this responsibility were lodged within the USFSA). It would comprise all or part 

of the various existing regulatory agencies, such as the Office of the Comptroller of 

the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodities Futures 
107 

14 Note that the Consumer Financial Protection Agency proposed by the Obama Administration does not have consumer protection authority over insurance companies. This makes sense 

as long as these insurance companies are exclusively State-regulated. Otherwise, there could be 

irreconcilable conflicts between State safety and soundness and Federal consumer protection requirements. To the extent that Federal consumer protection requirements overrode State safety 

and soundness concerns, the States, through State guaranty funds, would have to bear the cost. 

If insurance companies become federally chartered, however, both safety and soundness and consumer protection regulation could be conducted, and reconciled in some fashion, at the Federal 

level. 15 U.S. Dep’t of the Treasury, ‘‘Blueprint for a Modernized Financial Regulatory Structure’’ 

126-133 (Mar. 2008), available at http://www.treas.gov/press/releases/reports/Blueprint.pdf. 

Trading Commission. For its part, the Treasury Department would coordinate the 

work of the two (or perhaps three) regulatory bodies, and would be responsible for 

the expenditure of public funds used to provide support to the financial sector. 

If the U.S. financial regulatory structure is consolidated and improved as CCMR 

has recommended, then regulation of federally chartered insurance companies would 

be shared, as it would be for banks, between the Federal Reserve and the USFSA. 

The chartering authority itself would reside within the USFSA, which would also 

have resolution authority over all insolvent institutions, including federally chartered insurance companies. Regulation of insurance would thus be independent of 

the Executive Branch, insulated to some extent from political pressures while, at 

the same time, integrated into the overall supervisory framework. The USFSA 

would work closely with the Federal consumer-investor protection regulator—whether it is a division within the USFSA or an independent entity along the lines of 

what the Obama Administration envisions. If there is to be a Federal charter, then 

Federal—rather than State—consumer protection laws should apply to those institutions. 14 Some have opposed an OFC out of concern that consumer protection would 

be weakened but this need not be the case if a strong, dedicated agency or division 

of a USFSA were created. Furthermore, if a robust Federal consumer protection regulator is created, any regulations promulgated by it should entirely preempt any relevant State laws or regulations. The same should be true with respect to other financial services industries where strong Federal consumer protection laws and regulations apply. The need for State enforcement may exist under our current weak 

Federal protection of consumers—a need, with its attendant multistate inefficiencies, which would not exist in the presence of strong Federal consumer protection. 

We must also consider what a Federal regulator should look like if the current 

sectoral regulatory structure remains in place, i.e., if no USFSA-type structure is 

created. In this respect, it is useful to consider how State insurance regulators are 

organized and funded. The typical State insurance regulator is constituted as an autonomous agency, formally part of the executive branch, with one chief official appointed by the governor. No State insurance regulator appears to operate through 

a multimember commission. A minority of States has an elected chief official for insurance, but this structure cannot be constitutionally replicated within the Federal 

administrative structure. Another minority of States brings insurance regulation 

within another executive department, which is usually devoted either to commerce 

and consumer affairs or to banking and other financial services. State experience 

suggests that the Federal regulator of insurance should be independent of the executive branch—unlike the recommendation of the Bush Treasury Department’s Blueprint which proposed an Office of National Insurance to be part of the Treasury Department. 15

In addition, the latitude currently given to State insurance departments in the 

setting and collecting of fees suggests that a Federal insurance regulator should be 

self-funding, at least in part. Self-funding would further enhance the regulator’s degree of independence from the political process. 

B. Licensing of Firms or Products 

Currently, insurance companies are organized and chartered by the States as lifehealth companies, as property-liability companies, or as specialty companies such as 

title insurers. Legally, a life-health insurer can offer various lines or products within 

its general area, such as term life policies, whole life policies, and annuities. Similarly, a property-casualty insurer may offer personal auto and homeowners, as well 

as commercial lines like commercial multiperil and workers’ compensation. So one 

insurance firm may be chartered through different companies to conduct different 

insurance businesses in the same State. Thus, it is common for a number of affiliated insurance companies to belong to a group owned by a parent or holding company. 

Some prior proposals, such as the Bush Treasury Department’s Blueprint, have 

contemplated Federal chartering by business line, as currently exists among the 
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16See U.S. Dep’t of the Treasury, Blueprint for a Modernized Financial Regulatory Structure 

129 (Mar. 2008), available at http://www.treas.gov/press/releases/reports/Blueprint.pdf (‘‘An 

OFC should be issued specifying the lines of insurance that each national insurer would be permitted to sell, solicit, negotiate, and underwrite.’’). 17Minimum capitalization requirements vary by line and by State. During the 1990s the National Association of Insurance Commissioners (NAIC) sought to harmonize State regulation by 

adopting model minimum risk-based capitalization (RBC) requirements for most lines (including 

life and property-casualty). See for example N.Y. Ins. L. sec. 4103; see also. Kathleen Ettlinger, 

et al., ‘‘State Insurance Regulation’’ (Malvern, PA: Insurance Institute of America 2005). A 

multistate, multiline insurer generally must meet the greater of its minimum RBC requirements 

or the minimum capital requirements of each State in which it is licensed to do business. There 

is no reason that a Federal regulator could not promulgate solvency regulations that would be 

not only equally sensitive to the different risks posed by different product lines but also more 

uniform. 

States. 16 Many have advocated keeping property and casualty insurance at the 

State level. Thus, for a given insurance holding company or parent firm, some of 

its companies and products would be chartered and regulated at the Federal level 

and others at the State level. It would therefore be possible for firms to have the 

choice of being regulated at the Federal level for some businesses but not others. 17

I might note that there is a very strong case for a Federal licensing option for reinsurance, as this is not a consumer product that directly affects the welfare of the 

citizens of a particular State. Although proposals for the Federal chartering of distinct business lines have merit, I do not believe they are optimal. 

The cleanest and most efficient solution would be to license firms, rather than sectors, lines, or functions. Indeed, we have no Federal historic experience with the licensing of lines of business: the entire national bank or securities firm experience 

is based on the chartering or licensing of firms, not products. I see no reason to depart from that practice in this context. Indeed, the financial crisis teaches us that 

one regulator should have authority over an entire firm. It is bad enough to divide 

responsibility at the Federal level for a single firm; it would be even worse to do 

so as between Federal and several State authorities. 

An important question related to the operations of the Federal regulator is whether it should establish a guaranty fund system similar to those present in many 

States. These funds are in place to compensate for the losses suffered by third parties and policyholders due to insurance company insolvency. If licensing and regulation of insurance activities were to be conducted at the Federal level, for firms 

choosing Federal charters, State guaranty funds would then be at risk for Federal 

regulatory failures. This is the reverse of our past problems with State-chartered 

banks whose regulation put the Federal deposit insurance system at risk. This is 

an inherently unstable situation. 

I recommend simply installing a Federal guaranty fund for federally chartered insurers. Such a fund would successfully tie Federal regulation to a Federal guaranty. 

There might also be some subsidiary benefits of a Federal fund. It would imply uniformity of protection for federally chartered insurers. In addition, if a diverse group 

of insurers choose to operate under Federal charter, then there might be better pooling of risk as compared with State funds, which have a more limited geographic 

base from which to draw members. 

III. Additional Issues To Consider: Mandatory Federal Charter and Capital 

Requirements 

As I hope to have demonstrated above, State-by-State regulation is simply not an 

effective means of regulating what is truly a complex national industry. What is 

more, I hope to have established a persuasive case for an optional Federal charter. 

Before I bring my testimony to a close, there are two additional issues I would like 

to raise for the Committee’s consideration. 

A. Mandatory Federal Charter for Large Institutions 

The above discussion assumes that Federal chartering will be optional. However, 

it may well be that Federal regulation, if not chartering, should become mandatory 

for large insurance companies over a certain asset threshold. Firms that are too big, 

too interconnected, or too complex to fail impose added costs to the Government and, 

ultimately, the taxpayer in the form of Government assistance. These institutions 

are ‘‘systemically important,’’ although I do not recommend that they be so identified ex ante and publicly by regulators, in order to minimize moral hazard and avoid 

an implicit Federal guarantee. In addition, such determinations will be difficult to 

make and could rapidly change for some firms, like hedge funds. In most cases, use 

of a simple metric like size would avoid these problems. 

A traditional insurance company may pose less of a systemic risk than the typical 

bank for a number of reasons—they have less leverage and interconnectedness. Nev-
109 

18See Hal S. Scott, ed., Capital Adequacy Beyond Basel: Banking, Securities, and Insurance 

3-14 (Oxford University Press 2005). 

ertheless, as the AIG case shows, there are certain large insurers that have a potential for imposing systemic risk on the economy. To date upwards of $150 billion in 

taxpayer funds have been used in some form or another to bail out AIG. If such 

firms are to be rescued by the Federal Government, it seems reasonable to insist 

that the Federal Government have supervisory and regulatory powers over such 

firms. To be sure, AIG was the exception rather than the rule in the insurance industry. AIG’s troubles stemmed not from its traditional insurance activities but 

from the derivative business of its holding company. That said, the key derivative 

was the credit default swap, which is essentially a type of insurance against the default of a specified firm. The failure of an insurance company to honor either its 

derivative or insurance obligations could raise systemic risk concerns. 

B. Capital Regulation 

The final issue—but in many ways the most fundamental of all—is how to establish an effective capital adequacy regime for insurance companies as well as more 

traditional financial institutions. At the center of the global financial crisis was the 

complete failure of our regulatory system to ensure that financial institutions maintained sufficient capital cushions. When banks found their individual balance sheets 

unable to sustain declining asset values, capital firewalls proved inadequate to prevent the contagion from spreading throughout financial markets. 

The case of AIG, as noted above, illustrates the potential for insurance companies 

to suffer similar erosion in their capital bases, which can lead to systemic tremors 

and Government bailouts. A mandatory Federal charter for certain large institutions 

will bring with it Federal prudential supervision. But I believe more than supervision is needed for large insurers—they should also be subject to robust capital requirements established by Federal regulation in conjunction with those requirements set for other similarly sized, federally regulated financial institutions. The 

overall methodology for setting capital adequacy standards for insurance firms 

should be different than that used for banks and lending institutions, taking into 

account the differing nature and risk of the industry. 18 Exactly how to set such capital requirements for insurance companies—particularly in light of the failure of the 

existing Basel II framework for banks—is beyond the scope of this hearing but 

should be an important part of this Committee’s agenda. 

Thank you and I look forward to answering your questions. 

PREPARED STATEMENT OF MARTIN F. GRACE, J.D., PH.D. 

JAMES S. KEMPER PROFESSOR OF RISK MANAGEMENT AND ASSOCIATE DIRECTOR, 

CENTER FOR RISK MANAGEMENT AND INSURANCE RESEARCH, GEORGIA STATE

UNIVERSITY

JULY 28, 2009 

Introduction 

Mr. Chairman, Ranking Member Shelby, and Members of the Committee good 

morning and thank you for the opportunity to testify before the Committee on the 

topic of modernizing insurance regulation. 

My name is Martin Grace. I am the James S. Kemper Professor of Risk Management at the J. Mack Robinson College of Business at Georgia State University. I 

am also the Associate Director of the Center for Risk Management Research and 

an Associate at the Andrew Young School of Policy Studies. I have been at Georgia 

State for 21 years coming to GSU from the University of Florida where I earned 

a law degree and a Ph.D. in economics. Previous to that I attended the University 

of New Hampshire where I earned my undergraduate degree. 

My entire career at Georgia State has been spent conducting research in insurance regulation and taxation. Since the industry is regulated at the State level, this 

has been predominately an exercise in the study of State regulation. However, the 

question of whether the State is the appropriate level of regulation is becoming 

more important and I have spent the last 4 years thinking about that question. 

This brings me to what I have been asked to talk about today. I will focus on 

three main points in today’s testimony. 

• First is the value of regulation in insurance industry. There are valid rationales for insurance regulation, but the business of insurance is quite different 

than banking and has a need for a different style of regulation. 
110 

1See Skipper and Klein (2000) for a more thorough treatment of how economists think about 

the regulation of insurance. 2This standardization is common in personal lines products (like homeowners and auto), but 

it does not always solve all problems as there are new problems with contract interpretation 

that are costly to resolve. The Katrina wind/water litigation is just an example of this problem. 

• Second, is a mild but nonetheless important critique, of the current proposals 

to regulate the insurance industry. An Optional Federal Charter (OFC) is not 

necessarily the only way to think about insurance regulation. The current proposal is cobbled together from a Federal banking law and decades old State insurance model laws. 

• Third, something like the Office of Insurance Information, as source of expertise 

and an advice to the Federal Government about the insurance industry is needed, but it should not by itself be used to restructure the relationship between 

Federal and State regulation. 

The question of who should regulate the insurance industry has been debated in 

the United States since the time of the Civil War. Insurance continues to be regulated by the States despite several challenges to their authority over the years. The 

States’ authority over insurance was supported in various courts’ decisions until the 

Southeastern Underwriters case in 1944. In Southern Underwriters, the Supreme 

Court determined that the commerce clause of the Constitution applied to insurance 

and that insurance companies (and agents) were subject to Federal antitrust law. 

The Court’s ruling caused the States and the industry to push for the McCarranFerguson Act (MFA) in 1945, which delegated the regulation of insurance to the 

States. 

At that time, the majority of insurance companies favored State over Federal insurance regulation. However, today the bulk of insurance is written by national (and 

international) companies operating across State borders. Many of these insurers 

have come to view State regulation as an increasing drag on their efficiency and 

competitiveness: these insurers now support a Federal regulatory system. This is reflected in recent proposals that would establish an optional Federal charter (OFC) 

for insurance companies and agents. The proposal would allow them to choose to 

be federally regulated and exempt from State regulation. As you are quite aware, 

there is fierce opposition to an OFC from the States and from State-oriented segments of the industry. 

One of the main problems with the OFC approach is that it is based upon a structure designed in the 1860s through the National Banking Act and cobbled together 

with State consumer protection language. The OFC approach is based on a view of 

the world that had changed significantly in the last 2 years. While the authors of 

the proposal now add a systemic risk regulator to the mix, they still beg some questions about who should be subject to Federal regulation. 

The current problem facing insurance regulation, though, is quite different from 

regulatory issues of the past century. Today’s problem is not based on regulation 

of solvency, market conduct, or insurance pricing which have been undertaken by 

the States. It is, instead, the problem of systemic risk which, for the most part, has 

not been an issue with the insurance industry. Further, systemic risk is of national 

rather than State in scope. Specifically, the types of market failures used historically to justify regulation of the insurance industry have been ones that pertain to 

local markets. This is in direct contrast to the effects a failure of a company like 

AIG has on national and international markets. 

Why Regulate Insurance? 

Economists believe the role of Government is to rectify market failures. 1 In the 

insurance industry, potential market failures are due, in essence, to imperfect information. Customers cannot, for example, observe the behavior of insurance company 

management. For a life insurance consumer, this might be important because of the 

long time between when a contract is purchased and when a payout might occur. 

Also, there is no effective way to discipline the insurer’s management. For example, 

a life insurance consumer cannot ‘‘punish’’ a ‘‘bad’’ company by exchanging his long 

term policy for one with another insurer. Thus, economists would argue that Government can and should monitor a firm’s solvency position and take action to prohibit insurer actions which reduce the value of life insurance contracts. 

A second potential market failure is related to the imperfect information embodied 

in the insurance contract itself. An insurance contract is a complicated financial 

agreement, so the Government could standardize contracts or approve contract language to reduce errors and misunderstandings in the contracting process. 2
111 

3Prior to the introduction of the National Insurance Consumer Protection Act and the creation of a systemic risk regulator, I thought legislation that granted the Federal Reserve the 

right to assess systemic risk through the use of normal administrative agency powers of investigation would be sufficient for any firm that might create systemic risk. New legislation which 

sets up a formal systemic risk regulator will likely spell out these powers and their scope in 

more detail. 

A third informational problem might arise from an insurer’s strategy and marketing structure. Because insurers have different marketing (direct versus independent agents) approaches and different levels of capital backing, shopping for the 

right policy is costly to consumers because they do not have the information to make 

accurate judgments about the services and the quality of services provided by insurers. Arguably, the Government could guarantee a level of service after a claim or 

set prices so that a consumer would know that the contract is priced fairly. In addition, prices could be set to keep insurers from using their market power to exploit 

consumers through higher prices. This last rationale is often provided for price regulation of insurance, even though most personal lines insurance markets (which are 

the most likely to be regulated) are competitive markets. There are many competitors in these markets which reduces the likelihood of any one of firms being able 

to influence prices (Tennyson, 2007). 

These arguments form the standard historical rationales for insurance regulation. 

A further rationale, with a more immediate application in banking regulation, is 

that regulators should prevent market failure caused by the externality of one bank 

failure leading to a loss of consumer confidence in the financial system and other 

bank failures should be prevented. Banks have solvency regulation to protect depositors and to defend the banking system from contagion risk. Historically, insurers did 

not present a real contagion risk to the financial system, but this may no longer 

be true. Financial companies are now interconnected in ways that are without historical precedent. Holding companies have evolved which contain many different 

types of regulated and unregulated firms. A bank with an insurer as part of its operations can extend the contagion risk to its insurance operations. Alternatively, an 

insurer with a large and unregulated derivative trading business which suffers large 

losses can trigger questions about the overall soundness of the insurance operations. 

Counter parties to trades by such an unregulated entity can cause significant harm 

and potentially disrupt the banking system. In insurance, the focus of regulation 

has been on the individual company and not on the group or holding company. This 

needs to change, at some level, to allow for the proper accounting of systemic risk. 3

A State regulator cannot realistically regulate an insurer for its possible systemic 

affects on national and international markets especially in situations where the insurer within the State is a separately organized corporation from the corporation 

which might induce a systemic risk issue. 

The Level at Which Regulation Should Be Applied 

Ideally regulation should be applied at the level where the greatest costs and benefits due to the regulation arise. A simple example would be the proper placement 

for restaurant safety inspections versus airplane safety inspections. Local governments would be the obvious choice for restaurant cleanliness because local patrons 

would obtain the benefits and bear the costs of the safety inspections. In contrast, 

airplane safety inspections costs and benefits are national in scope and air travel 

is conducted nationwide. Thus it makes sense for air safety to be regulated at the 

national level. 

A large percentage of insurance premiums are written interstate. If there are 

interstate externalities to insurance regulation, then it makes sense for the Federal 

Government to regulate it. Phillips and Grace, in a 2007 paper, document some of 

these interstate externalities in terms of how States can export the costs of regulation to other States. The authors were not able to measure the benefits of regulation, so it is not possible to provide a conclusion about the role of Federal versus 

State regulation. 

Some of the benefits of State regulation are that local tastes and preferences are 

best met by State legislatures responding to local voters’ concerns about the insurance industry. This is often touted as a rational for federalism. Yet, I suspect that 

with some exceptions (price regulation, for example) a few voters could discuss their 

State’s insurance regulations. Due to diverse State regulations, nationwide companies often have significant compliance costs which increase the price of insurance 

without providing any benefits provided by a federalist laboratory. States do not 

look to see if there is a better way to regulate insurance. So, there is tremendous 

inertia in State’s regulatory processes and it is a rare event that causes all States 

to act together. 
112 

4 A recent report (NAIC, 2008) states that 43 States are in compliance. What is important 

is that three important States (FL, NY, and CA) are not in compliance some 9 years after enactment of the Gramm-Leach-Bliley Act. Without the large States participation, compliance costs 

are not reduced and the supposed benefits of increased State cooperation as a reason for avoiding an OFC bill are illusory. 5 Essentially, there is a double option on the table now. From the description in the press, 

insurers could opt to become federally chartered, but the Federal Government could opt to regulate a State chartered company if part of a holding company that might create a systemic risk. 6 Note, though, that if New York did not exempt the AIG Financial Products subsidiary and 

treated it like a bond insurer it would have had some level of reserves. Further, because it 

would have to place reserves for each new bond insured it would have also limited the scope 

of the sale of CDSs as well as the scope of the eventual losses. 

If the criterion for a State-based insurance regulatory system to be successful is 

that States must regulate to minimize compliance costs, then the current State regulation of insurance is doomed to failure. One of the major rationales for Federal 

regulation is reduction of nationwide insurer costs of trying to satisfy multiple 

States’ regulators. The NAIC has stated that it is trying to reduce these types of 

costs through model legislation and interstate compacts. Its good intentions notwithstanding, it is not capable of getting the States to operate quickly and efficiently 

together. Even Congress cannot obtain quick compliance from the States. In the 

Gramm-Leach-Bliley Act of 1999, Congress mandated that the States set up a nationwide licensing system for agents. After 10 years, not all of the States participate 

in this system to reduce multistate licensing costs. 4

In 2007, for example, the NAIC proposed the Military Sales Model Practices Regulation as a result of a law enacted by Congress in 2006. This regulation is designed 

to protect young soldiers, sailors, marines, and airmen from aggressive sales tactics 

directed at military personnel. As of late last year, only 18 States have enacted it. 

Presumably, this was an important issue for Congress, yet it has not been adopted 

by a majority of States in its first 2 years. Depending on universal action among 

the States to enact laws that prompt action is just not feasible. Grace and Scott 

(2009) document a number of other examples which suggest that joint actions by 

the States are never going to be able to solve national problems regarding compliance costs and uniformity quickly and efficiently. 

The Potential Federal Role and Regulatory Modernization 

There is a role for the Federal Government in insurance regulation. Where it can 

succeed and be economically valuable is in the area of removing the costs of conflicting State laws and reducing the effect of systemic risk on all financial markets. 

Reduction of compliance costs is the rationale behind the 2009 OFC proposal introduced by Representatives Bean and Royce called the National Insurance Consumer 

Protection Act. The new proposal includes the role of a systemic risk regulator who 

will have the authority to mandate that certain insurers be federally chartered companies. 5 With the exception of this concept, there is little modern thinking in the 

NICPA about how insurance regulation should work. 

The authority of the systemic risk regulator is very important. It is only now 

being discussed. However, how this is undertaken can cause significant disruptions 

in markets. If the risk regulator’s authority is associated with a ‘‘too-big-to-fail’’ certification, then the underlying competitive insurance market might be at risk. Firms 

designated as ‘‘too big to fail’’ will have an implicit incentive to take on more risk 

(sell more insurance and other risky products) knowing the Government will provide 

assistance. A rational firm may decide not to compete in that market. Thus underlying insurance markets are likely to wither away leaving only those firms that are 

too big to fail. 

If all insurers are subject to the systemic risk regulator’s jurisdiction, there is no 

signal that every firm is too big to fail. However, most insurers will never be systematically important but will be subject to another layer of regulation that does 

little for its customers, its shareholders, or society in general. Even large, significant 

insures operating nationwide are not necessarily important from a systemic risk 

perspective. So the question becomes how does one determine whether a firm should 

be subject to risk regulation? Ideally, one would want firms undertaking risk outside 

of insurance risks to fall under the authority of the risk regulator. For example, suppose a future AIG-like company petitions its primary regulator to exempt its ‘‘Financial Products’’ subsidiary from insurance regulation. Because of that exemption, the 

firm should fall under the jurisdiction of the risk regulator. The risk regulator can 

examine the risk and require appropriate reserving techniques if needed. 6 By having to show the risk regulator the insurer’s underlying business model a specific 

finding can be made if a systemic risk is possible and remedies to mitigate the sys-
113 

temic risk can be implemented. Ideally what the risk regulator’s job would be is to 

prevent possible systemic risks through evaluation by a competent regulator. 

One of the dangers of merely just prohibiting financial innovation is that economically valuable innovations would never evolve. However, permitting financial innovation without proper reserving is also harmful to society. Thus, the risk regulator 

must be more sophisticated about these products than a typical State insurance department in two ways. First, it must be able to understand the product and its 

risks. Second, it must appreciate the rewards of such innovation. 

Problems With Current Federal OFC Proposals 

As mentioned above, the OFC proposal is cobbled together from banking and insurance law. There has been little discussion of the structure of a regulatory body 

from a fresh perspective. A recent paper by Grace and Scott (2009) examined a portion of the issue from an administrative law viewpoint and showed how little discussion there was of how a Federal insurance regulator should be organized. There are 

a number of regulatory models available in the United States. For example, there 

is the multicommissioner, administrative body like the SEC. This is in direct contrast to the single administrator overseeing the Office of the Comptroller of the Currency. There is also an independent (from the executive branch) administrative 

agency like the Federal Reserve Board of Governors. Again, this contrasts directly 

with the administrator of the Office of the Comptroller of the Currency. The fact 

that the 2009 OFC proposal merely copies the structure of the banking system and 

begs the question why is the national banking system structured this way? The 

Treasury Blueprint as well as others (see, e.g., Brown (2008)) discuss other options. 

What is noteworthy is that these options were not conditioned on the current financial crisis. The Blueprint’s proposal is to use a three-pronged regulatory approach 

with a systemic risk regulator, a solvency regulator, and a market conduct regulator 

that would oversee all financial services including securities and commodities trading. This would be a major innovation in financial regulation in the United States. 

The OFC bills, in contrast, are not innovative from the perspective of what is regulated or how the regulation is accomplished as the approach in both bills (with the 

exception of a systemic risk regulator) is to shift traditional regulatory powers from 

the States to the Federal Government. 

Other methods of regulation of the insurance industry are also possible. Some insurers have joined unofficial self-regulatory organizations like the Insurance Marketplace Standards Association (IMSA) to increase their ability to understand their 

customers and to increase the likelihood that their policies will more closely meet 

the needs of those customers. These types of standards are different from Statebased rules which are often decades old and have not suffered an across-the-board 

reexamination, except after a regulatory failure. From a practical point of view, Congress is not likely to delegate monitoring powers to private entities for some time. 

The approach of organizations like IMSA, can assist in the development of modern 

approaches to market conduct regulation. 

In sum, there has been no real systematic discussion of modernization of the regulatory approach over the last decade outside of allowing for greater integration of 

financial services through enactment of the Gramm-Leach-Bliley Act of 1999 (GLB). 

Other than allowing banks and insurers to be owned by a common parent, GLB did 

not change the content of insurance regulation beyond mandating that States attempt to resolve interstate differences in agency licensing. Other important substantive aspects of insurance regulation have not been reexamined. For example, 

there has been little, until recently, discussion of the proper and economically efficient regulation of risk. 

In addition, solvency regulation has not been scrutinized since Congress made 

States and the NAIC do so in the late 1980s and early 1990s. Bank regulators have 

adopted aspects of the Basel accords, but insurance regulators have not. Many insurers are complying with Basel II by developing their own capital models and the 

tests which support the models. They are not required to do so by law but are doing 

it to be responsible stewards of capital. To be fair, there has been an attempt to 

standardize certain product approval processes through the use of the new Interstate Insurance Product Regulation Commission. However, the Commission has 

taken time to get started and was created, at least in part, to stave off any OFC 

type of regulation. This history of insurance regulation suggests that State regulation in this area is reactive. Regulation only changes because of a crisis or Congressional pressure. It is interesting that Congress (and not the States) also proposed 

the SMART Act that would have preempted the States’ ability to regulate and 

transferred that authority to the Federal Government. This proposed Act started a 

conversation about regulation, but it did not address the fundamentals—just what 

level of regulation is appropriate for insurance. The OFC bills have structured this 
114 

debate in such as way as to eliminate discussion of reform. Given that many aspects 

of regulation are important, more reform ideas should be on the table. 

A Role for an Office of Insurance Information 

A proposed Office of Insurance Information (OII) is an important first step in any 

role the Federal Government may have in the future. Even if the Federal Government decides in the near future to pass on regulating the insurance industry the 

OII still may be an important innovation for three main purposes. First, there is 

a paucity of individuals at the Federal level who know its component industries, its 

market structures, its products, its taxation or its pricing. Further, because of the 

unique nature of insurance (e.g., premiums are received now and claims are paid 

at some future time), there are a number of important technical accounting and actuarial issues that need to be understood regarding reserving and pricing. This type 

of knowledge currently resides at the State level. 

One could argue that the NAIC or National Council of Insurance Legislators 

(NCOIL) could provide this type of information to the Federal Government, but 

there is no real incentive for them to do so unless these organizations think by doing 

so they can postpone or reduce the likelihood of any eventual Federal regulation. 

Further, having to rely upon other organizations which have their own agendas for 

the needed insurance expertise has its own costs. 

Finally, there is an important issue that may arise depending upon the powers 

granted to the OII. Because financial markets are international in scope the Federal 

Government is often on the forefront of negotiation with other countries about regulation and international cooperation in regulation. By providing negotiators with information about the industry better policy can be made. However, the main point 

here is not likely information provision to negotiators, but the real possibility of the 

OII having (or eventually obtaining) the ability to preempt State laws inconsistent 

with international accords. Many foreign companies (and governments) view State 

insurance regulation as a barrier to entry (See, e.g., Cooke and Skipper, 2009). The 

OII and the Federal Government, through preemption, could conceivably dismantle 

the current system of State regulation. 

This would be a piecemeal change of the insurance regulatory system that would 

likely lead to real disruptions in regulation. However, a top down reexamination of 

the regulation of the industry would provide for a more systematic review of the 

proper role of the Federal and/or State regulatory power. 

The Role of the State and Federal Governments in the Future of Insurance 

Regulation 

The future role of States in insurance regulation is in question. There are serious 

barriers to coordination among the States which prohibit them from being effective 

regulators on certain issues. There is also a dearth of expertise on insurance at the 

Federal level. In addition, because of the predominance of nationwide operations, 

there are potential externalities that can be remedied by a Federal approach to regulation. To be fair, there are also potential problems with Federal regulation that 

need to be addressed. State regulation does protect the industry from bad regulation 

in the sense that if a State were to make a serious error regarding regulation, the 

negative effects of the error will likely be most felt in the State with the ‘‘bad’’ regulation. In contrast, a mistake at the Federal level hurts the entire industry nationwide. Further, merely copying State regulation without thinking about the merits 

of the regulation is also inefficient. A third and final problem with Federal regulation is the possibility that risks that previously were insured in private markets 

may become more socialized in the sense that Federal regulations may reduce the 

ability of private insurers to set risk based prices. 

Conclusion 

The policy debate regarding the regulation of insurance concerns the appropriate 

level of regulation for the industry. Ideally, the appropriate level of Government 

would be the one that would be able to contain all of the benefits and costs of regulation within the State (or Federal level) borders. Further, it is possible solvency 

and market regulation conduct arguably can be conducted at the Federal level at 

lower cost to society than separate State regulation of these same activities. Evidence suggests there are some economies of scale in these activities and the costs 

of regulation are spread beyond the borders of a single State. 

Insurance regulation needs to move beyond this level of discussion. It is important, but the other aspects of regulatory improvements must not be forgotten. The 

proposed 2009 version of the OFC bill does address the issue of systemic risk. While 

this is important to prevent future events like AIG, it is not clear how relevant it 

is for a supermajority of other insurers. However, if a risk regulator bill is passed, 

one could predict we would have a better understanding of the relationships be-
115 

tween various aspects of the financial service industries. This is a beneficial aspect 

of the law, but there is still avoidance of real subject matter regulatory reform. 

Finally, I am pessimistic about the role for the State in the future of insurance 

regulation. States have absolutely no ability or incentive to be proactive. At best 

they are reactive and cannot reach anything like a consensus when one is needed. 

The perfect example is the inability for every State to integrate its agency licensing 

system or join an interstate product licensing commission, even in the face of Federal preemption of a significant part of regulatory authority. Thus, a State-based 

understanding and appreciation of systemic risk and how it should be treated in a 

holding company structure is not likely to be implemented on a relatively uniform 

base any time soon. 

Extended Bibliography 

Baily, Martin Neil, Robert E. Litan, and Matthew S. Johnson. 2008. The Origins 

of the Financial Crisis. In Fixing Finance Series, Washington: The Brookings Institution. 

Butler, Henry N., and Larry E. Ribstein. 2008. A Single-License Approach To Regulating Insurance. Regulation 31.4 (Winter):36–42. 

Commissioners, National Association of Insurance. 2008. Producer Licensing Assessment Aggregate Report of Findings. Kansas City, MO: NAIC. 

Cooke, John, and Harold D. Skipper. 2009. An Evaluation of U.S. Insurance Regulation in a Competitive World Insurance Market, In The Future of Insurance Regulation, edited by M.F. Grace and R.W. Klein. Washington: The Brookings Institution Press. 

Congleton, Roger D. 2009. On the Political Economy of the Financial Crisis and 

Bailout of 2008. Fairfax, VA: Center for the Study of Public Choice, George Mason 

University. 

Cummins, J. David. 2000. Deregulating Property-Liability Insurance: Restoring Competition and Increasing Market Efficiency, Washington: Brookings Institution 

Press. 

Day, John G., United States Department of Transportation Automobile Insurance 

and Compensation Study. 1970. Economic Regulation of Insurance in the United 

States. Washington: USGPO. 

Grace, Martin F. 2009. A Reexamination of Federal Regulation of the Insurance Industry, Networks Financial Institute Policy Brief No. 2009-PB-02. Available at 

SSRN: http://ssrn.com/abstract=1350538. 

Grace, Martin F., and Robert W. Klein. 2009. Insurance Regulation: The Need for 

Policy Reform, In The Future of Insurance Regulation, edited by M.F. Grace and 

R.W. Klein. Washington: The Brookings Institution Press. 

Grace, Martin F., and Hal S. Scott. 2009. Optional Federal Chartering of Insurance: 

Rationale and Design of a Regulatory Structure. In The Future of Insurance Regulation, edited by M.F. Grace and R.W. Klein. Washington: The Brookings Institution Press. 

Grace, Martin F., Robert W. Klein, and Richard D. Phillips. 2008. Insurance Company Failures: Why Do They Cost So Much? SSRN. 

Harrington, Scott E. 2006. Federal Chartering of Insurance Companies: Options and 

Alternatives for Transforming Insurance Regulation. Networks Financial Institute 

Policy Brief No. 2006-PB-02. Available at http:// 

www.networksfinancialinstitute.org/Lists/Publication%20Library/Attachments/ 

36/2006-pb-02lHarrington.pdf 

Insurance Information Institute. 2009. Compulsory auto/uninsured motorists. III 

2009 [cited February 20 2009]. Available from http://www.iii.org/media/ 

hottopics/insurance/compulsory/. 

Kaminski, Janet L. 2006. Territorial Rating for Auto Insurance. In OLR Research 

Report. Hartford: Connecticut General Assembly. 

Knowlton, Donald. 1960. Present Status of the Investigation of the Business of and 

the Regulation of Insurance by the Antitrust Subcommittee of the United States 

Senate, Insurance Law Journal 1960:641–652. 

Rothstein, Mark A. 2004. Addressing the Emergent Dilemma of Genetic Discrimination in Underwriting Life Insurance. Cambridge, MA: MIT Press. 

Scott, Kenneth E. 1977. The Dual Banking System: A Model of Competition in Regulation. Stanford Law Review 30 (1):1–50. 

Skipper Jr., Harold D., and Robert W. Klein. 2000. Insurance Regulation in the Public Interest: The Path Towards Solvent, Competitive Markets. Geneva Papers on 

Risk & Insurance—Issues & Practice 25 (4):482–504. 

Tennyson, Sharon L. 2007. Efficiency Consequences of Rate Regulation in Insurance 

Markets. Networks Financial Institute Policy Brief 2007-PB-03. Available at 
116 

http://www.networksfinancialinstitute.org/Lists/Publication%20Library/Attachments/15/2007-PB-03lTennyson.pdf. 

U.S. Department of the Treasury. 2008. Blueprint for a Modernized Financial Regulatory Structure. 

U.S. Treasury, Comptroller of the Currency. 2003. National Banks the Dual Banking System. Washington: USGPO. 

Willenborg, Michael. 2000. Regulatory Separation as a Mechanism To Curb Capture: A Study of the Decision To Act Against Distressed Insurers. The Journal of 

Risk and Insurance 67 (4):593–616. 
117 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN 

FROM TRAVIS B. PLUNKETT 

Q.1. If Congress were to establish an optional Federal charter, how 

can we be sure that there would be effective consumer protections, 

for the products and services offered and stringent regulation of the 

qualifications of insurance professionals? 

A.1. The Consumer Federation strongly recommends against creating a Federal insurance charter that is optional. Allowing insurance companies to chose whether they are regulated at either the 

Federal or State level puts pressure on both sets of regulators to 

reduce consumer protections through regulatory arbitrage. Any 

Federal role in insurance regulation must not be optional for insurers. The best way to keep the strengths of State insurance regulation, while improving consumer protections and uniformity of regulation, would be to establish Federal minimum standards. That is 

the approach the President has recommended regarding creditbased insurance in his proposal to establish a Consumer Financial 

Protection Agency. 

Q.2. Could the implementation of an optional Federal charter for 

the insurance industry create an environment for regulator shopping? 

A.2. Yes. That is exactly what has happened with the dual charter 

banking system, and with multiple Federal banking charters, 

which is a model we should seek to avoid with insurance regulation. 

Q.3. The Administration’s proposed Consumer Financial Protection 

Agency (CFPA) would have authority to regulate credit insurance, 

mortgage insurance, and title insurance. Should the CFPA also 

have authority to regulate other insurance products and services? 

What would be the benefits and drawbacks of giving the CFPA that 

authority? 

A.3. CFA strongly supports providing the CFPA with authority to 

establish minimum regulatory standards for credit-related insurance, such as credit insurance, mortgage insurance and title insurance. The sale of these products is obviously closely tied to credit 

transactions over which the CFPA would have authority and have 

been the subject of many abusive practices, such as deceptive sales 

practices and significant overpricing. Providing the CFPA with authority to set minimum consumer protection standards for other 

property-casualty insurance products and services might well be a 

very good idea and should be studied. The main advantage of such 

an approach would be to require the many States that have not 

had the will or the resources to establish meaningful consumer protection requirements regarding insurance rates, forms and claims 

practices, while allowing the States that have been effective regulators to continue to establish strong standards. A potential disadvantage is that insurance companies could try ensure that these 

standards are weak, as they have successfully done in many States, 

and then federally preempt effective regulation in the handful of 

States that now guarantee strong consumer protection standards. 
118 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN 

FROM BAIRD WEBEL 

Q.1. If Congress were to establish an optional Federal charter, how 

can we be sure that there would be effective consumer protections, 

for the products and services offered and stringent regulation of the 

qualifications of insurance professionals? 

A.1. Under an optional Federal charter, the substance of protections for insurance consumers and the qualifications for insurance 

professionals would be determined by the Federal regulator according to the law enacted by Congress. While some optional Federal 

charter proposals have been criticized as containing fewer consumer protections than current State regulations, the substance 

and the locus of regulation are issues that can be considered separately. If a particular State were considered to have effective consumer protection regulation, the Federal system could adopt a similar approach. 

Q.2. Could the implementation of an optional Federal charter for 

the insurance industry create an environment for regulator shopping? 

A.2. Yes. This is a danger in any system where the regulated can 

choose their regulator. One central factor would be the ease of 

changing from one regulator to another, either in a legal sense or 

in a practical sense. It is possible that a Federal charter might 

have specific restrictions on changing regulators, such as those contained in H.R. 1880, which specifically gives the Federal regulator 

the power to deny a conversion from the Federal to the State system. It is also possible that practical factors may limit the 

attractiveness of switching regulators. For an insurer to convert 

from a Federal insurance charter to operating in the current State 

system would require regulatory submissions and approvals in the 

individual States, which could potentially be costly and time consuming. 

Q.3. The Administration’s proposed Consumer Financial Protection 

Agency (CFPA) would have authority to regulate credit insurance, 

mortgage insurance, and title insurance. Should the CFPA also 

have authority to regulate other insurance products and services? 

What would be the benefits and drawbacks of giving the CFPA that 

authority? 

A.3. Giving the CFPA the authority to generally regulate insurance 

products and services would be a substantial increase in direct 

Federal authority over insurance. This could make it more straightforward for Members of Congress to address concerns that might 

arise over insurance products. Under the current system, should a 

Member of Congress have a specific concern over, for example, 

whether or not auto insurance rates should change based on a driver’s zip code, the Member may consider two questions. First, is the 

substance of the regulatory change desirable, and second, should it 

be the Federal Government, as opposed to the States, regulating 

insurance in this way? If so, it may also be unclear who in the Federal Government would enforce the desired regulation. Including 

all forms of insurance under the CFPA would resolve many ques-
119 

tions about the locus, though not the substance, of proposed Federal regulation. 

Currently, insurance regulation at the State level has resulted in 

a patchwork system with somewhat different consumer protections 

across States. CFPA authority over insurance could significantly 

harmonize this system, could leave it essentially intact, or could result in even more disparities due to overlapping State and Federal 

regulation. Which outcome might occur depends largely on future 

CFPA regulations and court decisions. 

Under the proposed CFPA language, Federal consumer protection regulations are essentially a floor—the Federal law would not 

preempt State laws and regulations that provide greater consumer 

protection than the Federal regulation. The CFPA itself decides 

what constitutes greater consumer protection, subject to court review. Federal banking regulators have historically interpreted 

broadly their preemption powers over State regulations; however, 

whether this would continue under the CFPA is unclear. What the 

substance of the CFPA regulations might be with regard to insurance is especially hard to predict as there is little existing Federal 

law dealing with insurance consumer protection. 

One particular flashpoint could be a CFPA decision as to whether 

rate regulation in insurance constituted greater or lesser consumer 

protection, and thus whether it might be subject to Federal preemptions. Many States have forms of direct control over insurance 

rates. Such controls have largely been removed from Federal banking and securities regulation. Some argue that rate regulation 

should be considered a fundamental form of consumer protection, 

while others argue that it harms consumers through market distortions. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER 

FROM BAIRD WEBEL 

Q.1. What would be the effect of an optional Federal charter on 

State guarantee funds and State budgets? How are these issues addressed in legislation in Congress or proposed by the Administration? 

A.1. State budgets receive significant revenues from the insurance 

industry. State taxes on insurance premiums amounted to more 

than $15 billion in 2008 and assessments, fines, and fees added approximately $3.3 billion to this. Federal chartering legislation typically has included language (e.g., Section 321 of H.R. 1880) giving 

States the authority to continue taxing the premiums of national 

insurers. Assuming such language, an optional Federal charter 

should have little impact on State premium tax revenues. The 

money received by States in assessments, fines, and fees, however, 

may be affected. The extent of the impact would depend on precisely how many insurance companies and producers left the State 

system for a Federal charter or license. This is very difficult to predict, as it would largely depend on the specific details of Federal 

regulation and possible responses by the States to make the State 

system more attractive. 

How State guarantee (or guaranty) funds might be addressed 

under a Federal charter is less straightforward than the premium 
120 

tax issue, since guaranty funds are typically connected in some way 

to the safety and soundness regulation designed to prevent failure 

in the first place. CRS Report RL32175, Insurance Guaranty 

Funds, addresses guaranty funds in detail, and I will summarize 

some of the issues here. State guaranty funds are largely integrated into the State insurance regulatory system, so that those 

who oversee the insurers day-to-day are also essentially responsible 

for dealing with insurer failures if they occur. In nearly every 

State, the funds needed to pay for insurer insolvencies are raised 

by after-the-fact assessments on insurers licensed in the State. 

Thus, the regulatory incentives and power are relatively closely 

aligned and focused on avoiding insurer insolvency. Creating a dual 

regulatory system could change these incentives in that the day-today insurance regulators may no longer be the primary actors responsible for addressing insurer failures, or the funding to pay for 

an insurer failure may come from insurers outside the purview of 

the entity overseeing the insolvency. Some fear that this could 

weaken the focus on preventing insurer insolvency. 

The treatment of guaranty funds has differed in past Federal 

chartering legislation. The current National Insurance Consumer 

Protection Act (H.R. 1880) would create a Federal guaranty fund 

to handle insolvencies of national insurers, while also requiring national insurers to participate in the State guarantee fund system. 

In the 110th Congress, the National Insurance Act of 2007 (S. 40/ 

H.R. 3200) would have required all federally licensed insurers to 

participate in State guaranty funds, with the possibility of a Federal guaranty fund if the State guaranty funds do not treat national insurers in the same manner as State insurers. Versions of 

the National Insurance Act (S. 2509/H.R. 6225) were also introduced in the 109th Congress. In the 108th Congress, the Insurance 

Consumer Protection Act of 2003 (S. 1373) would have established 

a prefunded national insurance guaranty association and required 

all interstate insurers to pay into the fund. In the 107th Congress, 

the Insurance Industry Modernization and Consumer Protection 

Act (H.R. 3766) would have required all insurers electing Federal 

regulation to participate in State guaranty associations. 

Guaranty funds, along with the vast majority of insurance regulation, are not addressed in the financial regulatory reform proposals recently advanced by the Administration. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN 

FROM HAL S. SCOTT 

Q.1. If Congress were to establish an optional Federal charter, how 

can we be sure that there would be effective consumer protections, 

for the products and services offered and stringent regulation of the 

qualifications of insurance professionals? 

A.1. This could be done by creating a new consumer financial protection agency that had jurisdiction over these matters. Perhaps 

preferable would be to lodge this function in a division of a new 

consolidated supervisor and regulator, a U.S. Financial Services 

Authority. These options are discussed in the May 2009 Report of 

the Committee on Capital Markets, The Global Financial Crisis: A 

Plan for Regulatory Reform. 
121 

Q.2. Could the implementation of an optional Federal charter for 

the insurance industry create an environment for regulator shopping? 

A.2. Clearly the option of a Federal or State charter does provide 

this opportunity. This issue could be addressed by having a mandatory Federal charter for the largest or most interstate insurance 

companies. 

Q.3. The Administration’s proposed Consumer Financial Protection 

Agency (CFPA) would have authority to regulate credit insurance, 

mortgage insurance, and title insurance. Should the CFPA also 

have authority to regulate other insurance products and services? 

What would be the benefits and drawbacks of giving the CFPA that 

authority? 

A.3. It is problematic to have Federal consumer regulation of any 

services provided by State regulated insurance companies. This 

concern would become even more serious if the scope of CFPA regulation of insurance products were expanded. In general, Federal 

regulation of consumer protection for insurance products would create the situation in which Federal regulation could make insurance 

providers less financially sound, with the potential consequence 

that State guaranty funds would bear the costs. While excluding 

consumer regulation of banking products from the purview of the 

banking agencies also raises the conflict between consumer protection and safety and soundness, that conflict is entirely at the Federal level and thus is more easily resolved. The same could be said 

for federally regulated insurance companies (as a result of either 

optional or mandatory Federal charters), assuming there were also 

Federal guaranty funds. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN 

FROM MARTIN F. GRACE 

Q.1. If Congress were to establish an optional Federal charter, how 

can we be sure that there would be effective consumer protections, 

for the products and services offered and stringent regulation of the 

qualifications of insurance professionals? 

A.1. Answer not received by time of publication. 

Q.2. Could the implementation of an optional Federal charter for 

the insurance industry create an environment for regulator shopping? 

A.2. Answer not received by time of publication. 

Q.3. The Administration’s proposed Consumer Financial Protection 

Agency (CFPA) would have authority to regulate credit insurance, 

mortgage insurance, and title insurance. Should the CFPA also 

have authority to regulate other insurance products and services? 

What would be the benefits and drawbacks of giving the CFPA that 

authority? 

A.3. Answer not received by time of publication.