States Broke the Insurance Regulatory System

About six months after the U.S. government first injected taxpayer money into AIG,
the company continues to teeter on the brink of bankruptcy and soak up
taxpayer cash. Given what remains the official story—that AIG
is a mostly-profitable corporate powerhouse that got caught up in
disastrous investment decisions—this really shouldn’t be happening. A
better explanation, indeed, would go something like this: America’s
broken insurance regulatory system contributed to AIG’s
failures and only comprehensive reforms in the way America deals with
insurers can prevent the same thing from happening again.

a system that hasn’t changed fundamentally since the ninetieth century,
all fifty states assert independent rights to oversee virtually all
insurance activities. In the name of “solvency” and “consumer
protection” states can dictate rates, forbid or require the sale of
certain products, and mandate investment strategy. But nobody has an
effective overall view of what any large insurer does.

The system’s promise of “solvency” appears to have failed AIG.
Its core insurance businesses—supposed to have near-guaranteed profits
and near perfect financial stability as a result of state
regulation—can’t currently find buyers despite apparently healthy
balance sheets. And the company’s structure, 72 separate subsidiaries
before the collapse, makes it nearly impossible to know where its money
comes from. (State Farm, which has more U.S. customers than AIG, has only eight subsidiaries.) Indeed, only one of AIG’s insurance subsidiaries—the highly specialized HSB group—has found a buyer.

state insurance regulators continue to stick their heads in the sand.
For example, New York State Insurance Superintendent Eric Dinallo, who
has bragged about his department’s ability to keep AIG’s policyholders safe, oversaw less than 10 percent of AIG’s operations. The current insurance regulatory system, indeed, actually encourages them to build structures like AIG
that obfuscate their operations in order to escape regulatory scrutiny,
justify rates, and introduce new products. It appears quite possible
that AIG may have even outsmarted itself: the same structures that mislead some regulators may have fooled the company’s own managers.

introduced in the last Congress and likely to gain new life this year
would create a federal capacity to oversee the insurance industry while
simultaneously sweeping away a lot of the barriers that prevent
rational pricing and new product introductions. Companies wouldn’t need
to build structures like AIG’s and those that preferred the current system would see few changes. And the country would be better off.