AIG Insurance Units' Risk Misunderstood By Treasury: NAIC

"We respectfully disagree with the assertion that insurance regulators could not have separated the insurance units from those companies that had taken terrible risks," the NAIC letter said.

At the hearing before the House Oversight and Government Reform Committee, Timothy Geithner, former president of the Federal Reserve Board of New York and now Treasury secretary, and Henry Paulson, then Treasury secretary, said they needed to provide AIG with federal bailout cash to prevent problems at its insurance subsidiaries.

Mr. Paulson and Mr. Geithner said they felt they had to pay off AIG financial holding company liabilities in full because a request to AIG bank trading partners to take less than a full payout would have led rating agencies to downgrade the conglomerate, creating problems for its insurance companies.

Mr. Geithner testified that "the people who were responsible for looking at those insurance companies frankly had no idea of the risks to the insurance firms, and you could not separate those companies from the companies that had taken terrible risks."

Mr. Geithner also testified that the insurance businesses were "tightly connected" to the parent company.

Mr. Paulson added that the healthy parts of AIG had been "infected" by the "toxic assets," and noted that "one part of the company would have contaminated the other."

The NAIC letter was signed by Jane Cline, West Virginia insurance regulator and NAIC president, and Therese Vaughn, NAIC CEO.

It noted that Secretary Geithner's written statement acknowledged that a bankruptcy filing by the AIG holding company "would have caused insurance regulators in the United States and around the world to take over AIG's insurance subsidiaries."

Ms. Cline and Ms. Vaughn added, "Without a doubt, insurance regulators had the ability and the legal authority to seize AIG's insurers from the holding company if needed to protect AIG policyholders through our state receivership and guaranty fund systems."

Moreover, they said, "It is unfortunate that proponents of an optional federal insurance regulator continue to politicize the extraordinary efforts to stabilize the non-insurance units of AIG and the broader financial system in a misguided effort to justify a new federal insurance bureaucracy."

"The financial crisis in general and the AIG situation in particular illustrate the problems with regulatory arbitrage created by such a system," Ms. Cline and Ms. Vaughn said.

At the same time, the letter acknowledged that state regulators "were not aware of the risks posed to the AIG insurance companies by AIG's federally regulated or unregulated non-insurance units," as noted by Treasury officials in their testimony.

"We agree," Ms. Cline and Ms. Vaughn said, but they added that the answer to such problems is "greater information sharing among regulatory bodies to better understand and anticipate how operations outside our respective authorities could affect the group as a whole."

The letter added, "We also agree that complex groups like AIG call for a systemic approach to supervision."

"This is why we have called for strong, effective, consolidated supervision of holding companies that leverages the expertise of each functional regulator; in fact, such supervision could have helped avoid the turmoil at AIG," the letter said.

NAIC's message was sent in response to a "Dear Colleague" letter sent by Rep. Melissa Bean, D-Ill., and Rep. Ed Royce, R-Calif., to fellow lawmakers.

The "Dear Colleague" letter said that comments at a recent hearing on why the Federal Reserve Board and the Treasury Department decided to pay off AIG's partners to credit default swaps showed the need for a federal insurance charter.

In their letter, Reps. Bean and Royce said that an optional federal charter is needed because the "uneven state-based system of insurance regulation with state insurance commissioners with different legal authorities, different funding levels, and varied levels of expertise and priorities, has not provided a comprehensive look at the insurance market."

Meanwhile, in an opinion piece published today in The Wall Street Journal, former New York Insurance Superintendent Eric Dinallo noted that Mr. Geithner had not said that state insurance regulation caused AIG to fail. Any financial regulation reform he wrote, "should learn from state insurance regulation" and "insurers are required to keep enough reserves to meet their promises. If that principle applied to all financial services, a replay of the crisis of 2008 would be much less likely. "