In a paper that examines the concept of an optional federal insurance charter, an academic specializing in insurance and risk management has voiced a concern that once an insurer elects U.S. regulation they will find it cost prohibitive to go back to the state.
The commentary by Georgia State University Professor Martin Grace was unveiled at a recent Networks Financial Institute Insurance Reform Summit held in Washington.
Mr. Grace also said he is "uncomfortable but dimly in favor of moving toward a national regulator."
Professor Grace is also a senior fellow at Networks Financial Institute, which is based at Indiana State University.
He explained that once an insurer decided to accept regulation, it would provide "the federal regulator with a captive market and an incentive to extract extreme rates."
He made his observation about the high cost of moving back to state regulation in the context of suggesting that one alternative to the current "weaknesses inherent in both state and federal regulation would be regulation based on "competitive federalism."
He said that under a competitive federalism approach, insurance companies doing business in multiple states could select the state under which they wanted to be chartered and move their regulatory state as
needed.
But, he cautioned, a federalism approach would require states to recognize regulations imposed by other states, something that does not exist at present.
Professor Grace cited three primary concerns with an optional federal charter.
First, he said that while the proposals'
intentions to reduce compliance costs and lower costs for consumers are good, the proposals could create incentives that could lead to "mispriced risk."
He explained that new proposals may shift risk from low-risk to high-risk individuals, "resulting in mispriced risk."
Secondly, he expressed that the new proposals "are old models rewritten," with no thought about the fundamentals of regulation.
Finally, he cautioned that the proposals do not account for other costs that might be
imposed on society through mispriced risk.
Professor Grace argued in his paper that all insurance crises in the past 30 years could be attributed to mispriced risk and that the new proposals do not address the issue.
"Compulsory markets could be potentially affected and guaranty funds could be further stressed," he argued.
Despite Mr. Grace's concerns, so far no legislation dealing with OFC has been introduced with the kind of framework he envisions.
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