While state regulation of insurance has strong arguments in itsfavor, the breadth of the federal government's latest involvementin the financial sector could pull regulation of insurance into itsorbit, according to an insurance consultant.

Joy Schwartzman, an insurance consultant with the Seattle-basedactuarial and consulting firm Milliman, said that the involvementof the Federal Reserve in any bailout of insurers will elevate thelevel of discussion about some federal regulation of insurance.

However, she noted, state regulators have a strong argument topreserve the current system because the solvency issue overAmerican International Group involved the company's noninsuranceentities, while the insurance arms remained strong. She said stateregulators are already pointing out that the failure to regulatewas not at the state end but the federal end.

“While we know that there will be calls for stricter insuranceregulation, the idea that it will reside at the federal level isnot an obvious improvement,” said Ms. Schwartzman. “However, theunprecedented size of the bailout may sweep insurance under thefederal regulatory purview.”

One outgrowth of the financial crisis could be an increase inerrors and omissions and directors and officers claims, noted GaryWells, a principal and actuarial consultant withMilliman–potentially big claims.

Ms. Schwartzman said while there is pressure on increasingrates, there is little evidence that insurers plan to raise them.However, the soft market competition is finding carriers turning toAIG's clients and offering increased capacity. She said it remainsto be seen if this move is a short-term play or a long-term trend.The move, she added, would mean an increased use of reinsurance inthe short term to spread the risk.

“Ironically, it is the same spreading of risk–a foundingprinciple of insurance and reinsurance product–that has contributedto the enormous reach of this financial crisis,” she said.

Concerning insurers' investments in mortgage-backed securitiesand other collateralized debt assets in their portfolios, RamKelkar, a managing director at Milliman, said the write-down invalues has already taken place, but the fear remains that the realestate and banking turmoil could result in additionalwrite-downs.

“[However], it is possible that markets have overreacted as theyusually do and thus current mark-to-market levels may have alreadyovershot expected loss estimates,” said Mr. Kelkar.

He noted that a recent study of insurance company holdings showsthey hold only 10 percent of outstanding residential debt and 5percent of the losses primarily because of tighter regulatorycontrols and capital requirements over the insurance industry.

A copy of the complete discussion is online atwww.milliman.com/perspective/spotlight-on-risk/money-for-nothing-09-92-08.php.