While state regulation of insurance has strong arguments in its favor, the breadth of the federal government's latest involvement in the financial sector could pull regulation of insurance into its orbit, according to an insurance consultant.

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

However, she noted, state regulators have a strong argument to preserve the current system because the solvency issue over American International Group involved the company's noninsurance entities, while the insurance arms remained strong. She said state regulators are already pointing out that the failure to regulate was not at the state end but the federal end.

“While we know that there will be calls for stricter insurance regulation, the idea that it will reside at the federal level is not an obvious improvement,” said Ms. Schwartzman. “However, the unprecedented size of the bailout may sweep insurance under the federal regulatory purview.”

One outgrowth of the financial crisis could be an increase in errors and omissions and directors and officers claims, noted Gary Wells, a principal and actuarial consultant with Milliman–potentially big claims.

Ms. Schwartzman said while there is pressure on increasing rates, there is little evidence that insurers plan to raise them. However, the soft market competition is finding carriers turning to AIG's clients and offering increased capacity. She said it remains to 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 in the short term to spread the risk.

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

Concerning insurers' investments in mortgage-backed securities and other collateralized debt assets in their portfolios, Ram Kelkar, a managing director at Milliman, said the write-down in values has already taken place, but the fear remains that the real estate and banking turmoil could result in additional write-downs.

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

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

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

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Economic Crisis Could Sweep Up State Regulation

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