Now that the “stimulus” package has been enacted into law, Congress will turn its attention to a variety of issues. Among the foremost will be an investigation into the financial services industry’s regulatory scheme. Under ordinary circumstances, Congress would investigate and hold hearings on this massive issue at a snail’s pace. After all, it took almost 50 years for the Gramm-Leach-Bliley Act to amend the Glass-Steagall Act, which separated banking from commerce.
From the perspective of insurance regulatory and corporate practitioners, the prospects for reform are daunting. We always have examined the strengths and weaknesses of state insurance regulation in the context of the possibility of a federal alternative. However, recent events have demonstrated that this perspective is unrealistically narrow.
The problems in the United States financial system unrelated to insurance are so extensive that the regulation of the business of insurance will take a back seat in the 111th Congress. It is clear that the financial regulatory system of the United States has been overwhelmed by unanticipated forces and problems. The system of regulating banks, securities, and insurance through a variety of federal and state authorities has been the result of governmental responses to financial crises dating all the way back to the Civil War. As a result, we now have a regulatory system that is inadequate, overlapping and understaffed. The array of federal and state agencies and self regulatory organizations is vast and confusing. Here are just a few of the agencies represented by their acronyms: OCC, FRS, CFTC, SEC, FHFA, OTS, NCUA, FDIC, FINRA etc.
A good way to understand the current financial meltdown is to review the recent publication by the Government Accountability Office (“GAO”) entitled Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Regulatory System (GAO-09-216; January 2009). This study analyzes the multitude of important issues and developments that have contributed to the current state of affairs.
The foremost of these is issues the aggregation of financial market risks under what is designated as “systemic” risk. In addition to the fact that financial services – banking, securities, and insurance – are regulated separately and generally without regulatory reference to each other, i.e., in “silos,” many of the risks that have brought down the current system are not regulated at all. For example, hedge funds are largely unregulated because they are structured to qualify for exemptions from securities laws and regulations. Similarly, special purpose vehicles (“SPVs”) are designed to be “off balance sheet” entities. There are numerous other financial products and services, such as collateralized default obligations, credit default swaps, and derivative contracts, traded outside of regulatory frameworks.
Add to this mix the fact that the credit rating agencies have done a miserable job in anticipating the new forces in the financial marketplace and have contributed to the crash of the financial services business by shockingly optimistic credit ratings for entities whose financial strength has been demonstrably hazardous. Even though Congress was sufficiently alarmed in 2006 to pass the Credit Rating Agency Reform Act to provide the SEC with limited oversight, credit rating agencies instilled false confidence into the marketplace as late as the end of 2008.
The GAO report succinctly lays out the wide variety of issues that will need to be considered in any attempt to address the “systemic risk” that exists in the U.S. financial system. There are unregulated products and entities, forces favoring regulatory global harmonization, inadequate regulatory oversight, misleading financial analysts and rating organizations, overly trusting consumers, inappropriate accounting rules and practices, and an inflexible and, in some cases, antiquated regulatory system.
While Congress is attempting to sort this all out, insurance regulatory reform is likely to be kicked to the back of the line. Unless asset values continue to decline, thereby causing a major solvency crisis for insurers, Congress is likely to keep insurance reform as a relatively low priority.
Nonetheless, Congress is cognizant of the fact that the federal government does not regulate insurance, and, therefore, does not understand it. As a result, either by legislation or by administrative action by the Secretary, an Office of Insurance Information is likely to be established in the Treasury.
Robert “Skip” Myers is Co-Chairman of the firm’s Insurance and Reinsurance Practice and focuses in the areas of insurance regulation, antitrust, and trade association law. Skip received his bachelor’s degree from Princeton University and his law degree from the University of Virginia.