Federal Insurance Chartering The Devil’s in the Details

Issue Analysis 2005 No. 1

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Of all the financial services firms in the United States, only insurance companies lack a federal regulator.  While crises in the industry led to occasional calls for federal oversight, until recently, the insurance industry has joined state regulators in opposing a federal role in regulating insurance firms and markets.1 Industry opposition to federal oversight has begun to weaken, however. Large, transnational insurance firms have expressed a growing interest in federal regulation.

There are several reasons for the industry’s sudden interest in optional federal regulation. We will first examine insurers’ support for—and their goals in seeking—an increased federal role. A brief look at the dual banking system, which allows banks to choose a federal or state charter, will help identify several of the key questions in designing a new regulatory structure. How policymakers answer these questions will determine whether a newly created “dual insurance” system will meet the goals of industry advocates.

Concern about efficient insurance regulation does not end with the executives and owners of the insurance companies. Policyholders and taxpayers also have an interest in creating an insurance regulatory system that encourages competition, innovation, and financial stability.2 The goal of policymakers should be to create a regulatory structure that enhances rather than impedes the operational advantages of a competitive market. Such a regulatory system will serve the needs of customers while maintaining the financial health of the industry. This requires an “incentive compatible” system in which regulators, whether state or federal, balance the multi-faceted interests of insurance company owners and their customers, as well as taxpayers. Incentive compatibility requires unambiguous goals, clear lines of responsibility, and the attachment of costs to those responsible for regulatory failures. The savings and loan crisis of the 1980s stands as a stark and costly example of what can go wrong when policymakers and regulators can shift responsibility for bad policy decisions.3

This study neither supports nor opposes a federal oversight option for the insurance industry. A well-designed system that includes a federal chartering option could benefit both insurance company owners and their policyholders. It is important to recognize, however, that federal chartering is not a panacea. A poorly designed system could irreparably harm both insurance companies and their customers.

1 See Scott E. Harrington, “Optional Federal Chartering of Property-Casualty Insurance Companies,” (Downer’s Grover, IL: Alliance of American Insurers, 2002), p. 31.

2 Under the current guaranty system that protects policyholders of failed insurance companies, states’ premium tax revenues are reduced in the wake of a failure. Therefore, an insurance company failure affects all taxpayers.

3 See Edward J. Kane, The Gathering Crisis in Federal Deposit Insurance, (Cambridge, MA: MIT Press, 1985) and The S&L Insurance Mess: How Did it Happen?, (Washington, D.C.: Urban Institute Press, 1989).