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Testifying before the House of Representatives today, Treasury Secretary Tim Geithner asked for vast new powers to oversee banks, investment houses, hedge funds, and insurance companies. Although most media attention will focus on proposals to create clearer lines of regulatory authority for derivatives and hedge funds -- both currently undergo regulation but have no single regulator -- his proposals for new federal oversight for insurance may well prove even more important.
Insurance, after all, remains the largest economic activity regulated entirely at the state level. The rates insurance companies can charge, the way they invest income, and the products they offer all remain largely the providence of separate regulators in every state.
This fragmented 19th-century system stifles innovation, results in rates that rarely reflect risk, and provides all sorts of opportunities for poorly managed companies to escape regulatory scrutiny. Larger insurers have, for years, supported the idea of a federal regulator that could override state laws. And, structured properly, such a regulator would make it easier to introduce new products, charge “correct” rates, and police fraud. Thus, in its essentials, Geithner’s support for federal insurance regulation makes sense.
But Geithner’s specific proposals have problems. Simply subjecting certain “systemic” insurance companies to mandatory federal regulation and excluding less “important” companies would give “important” companies an enormous market advantage. Although nearly all insurers operate with protection from state-level guarantee funds, consumers would -- quite correctly -- believe that a federal declaration of systemic importance is worth more than a vague state guarantee. Federal regulation could easily become a “gift” for already successful companies if it’s taken as a promise that the federal government simply won’t let them fail.
Likewise, Geithner’s promises not to “supplant authority” of state insurance regulators appears contradictory in the context of a federal effort to oversee the insurance industry. Insurance regulators control prices that insurer’s charge in large part to make sure that companies remain solvent and don’t engage in fraud. A federal insurance regulator that didn’t intrude on the ability of state regulators to dictate insurance prices wouldn’t have the fundamental tool it needs to, well, regulate.
Smart legislative drafting and good rulemaking, however, could turn Geithner’s proposal into something a lot better.
To begin with, every insurer operating in multiple states should have an option of federal oversight. The largest insurers -- just about every company Treasury might rule “systemically important” -- would all sign up for federal regulation anyway rather than having to deal with the current state-level system. But smaller insurers that find the “big boys’” rules advantageous should have the option of playing by them as well. Second, Geithner and everyone in Congress need to recognize that any effective federal regulator will have to remove states’ authority to oversee insurance rates. There’s no way around that.
Federal insurance regulation makes sense. Secretary Geithner’s current proposal, however, has some serious flaws.