A Treasury Department official declined last week to endorse any of the various proposals for federal involvement in insurance regulation, but acknowledged the regulatory challenges facing the industry and conceded that corrective action by Congress might be required.

In testimony before the U.S. Senate Banking Committee, Treasury Undersecretary for Domestic Finance Randal Quarles said his department has been "monitoring the developments of the various approaches to modernizing insurance regulation."

He said they had been examining proposals by the National Association of Insurance Commissioners, as well as bills being debated in Congress to either establish federal standards that would be enforced by states, or to create an optional federal charter framework.

"While we are still evaluating what approach we believe to be the most appropriate, what is clear is that each of them should be assessed" in light of the issues facing the industry, he added.

Insurance, like other financial services, Mr. Quarles noted, plays an important role in the U.S. economy due to the enormous amount of assets managed by carriers, and the potential for "ripple effects" of conditions in the industry being felt across the general economy.

"Unlike the banking and securities sectors," he added, "insurance is solely regulated at the state level, and while this multiplicity of regulators can provide certain benefits in the form of local expertise and control, it does raise a number of issues that deserve further consideration."

Among the main problems, Mr. Quarles said, are the potential inefficiencies within the current state-based regulatory scheme, especially through price and form controls, as well as the system's inability to recognize and adapt to the evolving and growing needs of the industry and international issues.

On the international front, Mr. Quarles noted that the European Union has been working to establish one insurance regulatory regime for all of its members, and that the fractured U.S. regulatory scheme is generally among the top trade issues in discussions with EU representatives.

Other witnesses also testified on the need for federal action, and were equally unspecific as to what form that action should take.

Scott Harrington of the Wharton School of Business at the University of Pennsylvania said he had been opposed to federal regulation as recently as 2002.

However, he said that after conducting research for an issues paper on the topic this year, "I concluded that a transformation of insurance regulation was necessary to promote healthy price and product competition and to eliminate regulatory micromanagement of price and product decisions, and that such a transformation could not be achieved without federal intervention."

Robert Klein, a former chief economist for the NAIC and current director of the Center for Risk Management and Insurance Research at Georgia State University, said he recognizes the need for further reforms, but prefers a system of state regulation with strong federal standards and oversight.

"In essence, the states need to appropriately and efficiently regulate things that need to be regulated and not regulate things that do not need to be regulated," he said. "If this cannot be achieved under the [current] arrangement, I would prefer an optional federal charter approach."

In response to questioning from the committee, both Mr. Klein and Mr. Harrington rejected the concept of separating the industry by life and property-casualty lines to create a "life only" federal charter.

Although the greater uniformity among products in the life industry would make the process of establishing a federal charter simpler, they said many of the problems that make a federal solution necessary--such as the varying regulations from state to state--are more keenly felt in p-c lines.

Another issue that would need to be resolved prior to enacting a federal system is that of guaranty fund participation, the witnesses testified.

Indeed, Mr. Harrington said that in the short term, any federal charter proposal would likely have to mandate that federally regulated companies contribute to the guaranty funds of the states they operate in to avoid severely weakening those funds as insurers move to federal oversight, but that a federal guaranty fund could be established to resolve the problem over the long term.

Special Reports /

'Treasury Cites Regulatory Shortcomings, But Will Not Commit On Reform Bills

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