The United States Treasury called on Thursday for a greater federal role in the regulation of insurance, particularly in areas like mortgage insurance, the collection and use of personal data to set prices, and the use of secretive entities known as captives to keep risks off the books of insurers.
But the Treasury’s wide-ranging report on how to strengthen regulation still leaves broad areas of the $7 trillion industry under state oversight, as it has been for the last century.
The report, which was ordered by the Dodd-Frank financial overhaul law, said it was time to stop debating which level of government should be in charge and instead build a hybrid model that would give duties to both. Michael T. McRaith, director of the Treasury’s Federal Insurance Office and a former state regulator from Illinois, was the main author.
Treasury’s findings have been awaited warily by the states, which collect substantial taxes from insurers and do not want to give up their jurisdiction over them. The insurers themselves have mixed views on state versus federal regulation.
Mr. McRaith said that the groundwork for a hybrid model had already been laid in recent years as the federal government became more active in programs for insuring against crop failures, flooding and terrorism. He said state and federal officials should build on that foundation, and recommended places to begin.
He called for the development of uniform capital requirements, better methods for winding down insolvent insurers, and tighter requirements for the soundness of reinsurance deals. He said the federal government would begin working on developing the new standards, in some cases with international bodies. In anything involving international insurance business, the federal government would take the lead, he said, and it would be the sole regulator of the mortgage insurance industry, having already handled the conservatorships of Fannie Mae and Freddie Mac.
Some of the recommended changes would have to be enacted by Congress.
The National Association of Insurance Commissioners, a group that represents state regulators, responded with a statement that said: “We are pleased the Treasury Department continues to embrace the state-based system of insurance regulation. We are in the process of analyzing the report and the recommendations.â€
Members of the association already have extensive rules in the areas cited in the report. In recent years, however, a growing number of states have been taking advantage of the complexity and lack of uniformity in those rules to attract business investments and create jobs.
When a life insurer thinks its own state regulators require it to tie up too much capital in “redundant reserves,†for example, it can go to a state that allows questionable reinsurance deals that supposedly make the reserves unnecessary. States offer near-total secrecy for such arrangements.
In the past, insurers usually had to go to offshore havens like Bermuda for lighter regulations, but now many states are competing openly with Bermuda and with one another for such business, setting the stage for a regulatory race to the bottom.
Some state regulators, particularly New York’s Department of Financial Services, have expressed concern about the trend, calling it “financial alchemy†because it gives the illusion that the insurers are pulling money out of thin air.
The report said there was a need for single, uniform requirements for reinsurance and said the Treasury would begin to develop them, working with the United States trade representative.
The states have long argued that they are closer to ordinary consumers, can field complaints and so can provide the best protection. Mr. McRaith said the collapse of the American International Group during the financial crisis showed that state regulators were unable to supervise a complex global insurance conglomerate. A.I.G. ended up being bailed out by the federal government in 2008.
Mr. McRaith said the debacle showed the need for new methods of winding down insolvent insurers. Most steps of the process are governed by state laws, but in some states they do not correspond with the procedures outlined in federal bankruptcy law or international law.
Mr. McRaith also said that states needed to develop a uniform approach to settling and netting out derivatives contracts, because the current rules in some states do not match those of federal or foreign bankruptcy laws. If the discrepancies were not corrected, he said, they could promote the systemic risk that the federal rules were intended to reduce.
A Treasury official noted that in the areas where the federal government expected to expand, like mortgage insurance, the states could continue to license individual companies and collect taxes from them.
