NAIC Representative: State Based Regulation Best for Systemic Risk

Illinois Insurance Director Michael McRaith, testified yesterday on behalf of the National Association of Insurance Commissioners (NAIC), telling the government body that state regulation is a “sound approach” to systemic risk regulation.

Asked to address the role of systemic risk in insurance, McRaith’s testimony focused on the inherently compatible role of state regulation in any sound approach to systemic risk regulation.

"Insurance companies are more often the conduits or receivers of risk rather than the creators since the assumption of risk, after all, is fundamental to the insurance business," McRaith told members of the U.S. House Committee on Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises. "With respect to systemic risk, insurers also do not originate risk, but most often receive risk—a fact that provides ample motivation to close regulatory gaps and encourage greater financial stability."

McRaith highlighted the fact that insurers' exposure to systemic risk typically flows from linkages to the capital markets. Citing American International Group as an example, McRaith noted that AIG's unregulated credit default swap (CDS) transactions impaired the holding company, resulting in a downgrade that threatened policyholders' confidence in the otherwise stable insurance subsidiaries. He also pointed out that AIG's insurance companies were directly exposed to systemic risk through securities lending partnerships with other financial institutions.

Noting that the insurance industry has fared better than its banking and securities counterparts in the current economic crisis, McRaith testified, "Insurers' high capitalization requirements and low leverage have kept them from incurring the steep losses faced by other financial institutions." He cited the state guaranty fund system as an essential backstop to protect insurance policyholders in the event an insurance company was to fail.

"The state-based insurance regulatory system is one of critical checks and balances, without the perils of a single point of failure and omnipotent decision making," McRaith emphasized. "States have a long history of consumer protection and market stability—the two pillars on which any system of financial stability regulation can, and must, be built."