Public Policy Analysis & Opinion
AIG—not an insurance company?
Tell us another story, Commissioner Ario
The National Association of Insurance Commissioners (NAIC) is doing something it has not done in a long time, talking about regulating insurance; however, the regulators’ association is talking out of both sides of its mouth—and telling some whoppers to Congress in the process.
The most interesting bit of fast talking coming from the NAIC appeared in the form of a news release on March 19, 2009, in which the NAIC claimed that American International Group (AIG) is not an insurance company. In a self-described attempt to “correct misinformation,” the commissioners’ association asserted:
“First and foremost, AIG is typically described as the world’s largest insurance company. In fact, it is a global financial services conglomerate that does business in 130 countries. AIG owns 176 other companies, in addition to 71 U.S. state-regulated insurance subsidiaries.”
I suppose it was this “non-insurance company” standing that qualified AIG to pay the NAIC for the opportunity to file its financial statements (as required of insurance companies) with the association since the early 1970s. (Will the NAIC return the fees AIG paid to the regulators’ association as an insurance company to the cash-strapped conglomerate anytime soon?)
And when the NAIC wrote financial accounting rules, model investment laws and other financial guidelines that allowed AIG to grow to a size too large to regulate and too big to fail, the NAIC was only accepting AIG’s financial data as a favor to “global financial services conglomerates.”
If the NAIC continues this rhetorical trend, we can expect to hear that AIG is actually an alien life form from another galaxy, brought by an interstellar Tooth Fairy, which the NAIC only first heard about in the 4th quarter of 2008.
On March 18, 2009, Pennsylvania Insurance Commissioner Joel Ario testified before a subcommittee of the House Financial Services Committee, where he delivered the claim that AIG is not an insurance company.
Commissioner Ario is a difficult character to figure out. He began his journeyman career around insurance regulation as a consumer advocate with a Ralph Nader-aligned public interest group. He went to work as an insurance regulator in Oregon, where he rose through the ranks to become the state’s chief regulator. At the NAIC he fell into the cult of personality of former Executive Vice President Catherine J. Weatherford, who moved him into the NAIC leadership. Somewhere about this time, he must have met a shadowy figure at a rural crossroads at midnight under a new moon. He left Oregon and moved to Pennsylvania, where oddly enough he was appointed insurance commissioner.
Commissioner Ario likes to talk tough on consumer protection, but he has a history of “go along to get along” attitude toward NAIC senior staff, which keeps him in good standing with the NAIC leadership.
The Pennsylvania commissioner began his testimony by pointing out that much of AIG’s operations fall outside the homey and provincial jurisdiction of state insurance regulation. “State insurance regulatory authority is limited to the 71 U.S.-based insurance companies. Under the nationally coordinated system of state-based insurance regulation, state insurance departments have primary authority for those insurance companies domiciled in their state. In Pennsylvania’s case, we are the domestic regulator for 11 of AIG’s 71 U.S. insurance companies.”
This testimony runs counter to 15 years of NAIC statements, which presented the association and its membership as international troubleshooters for insurance regulation. The NAIC enters into Memoranda of Understanding with numerous foreign governments and regimes around the world. As recently as March 5, 2009, the NAIC issued a statement touting a paper delivered by Executive Vice President Therese M. (Terri) Vaughan, Ph.D, which features a discussion of how the NAIC and state regulators worked with foreign jurisdictions to shape global financial regulation.
If one would review the stamps on Vaughan’s U.S. Passport, they would include a stamp from China, where she traveled on the NAIC’s behalf when she was Iowa Insurance Commissioner. She played a role in negotiating a trade-oriented Memorandum of Understanding that the NAIC signed with Chinese officials, at a time when AIG was the only American insurance interest operating in China.
Yet, according to Commissioner Ario, if Congress wants to learn about AIG’s failure, the hayseeds at the NAIC and state insurance departments just are not the people to talk to. I guess all that international travel that various commissioners took on the NAIC’s dime in the past decade was just for giggles.
In addition, Commissioner Ario alleged in his testimony that the financial collapse of AIG was far beyond the knowledge base of the lowly state insurance regulator because the trouble started in a holding company.
“Now pay no attention to the man behind the curtain” who has a copy of the NAIC’s Model Holding Company Act, which was last materially updated after the failure of the Baldwin United Life Insurance Company in 1983. After the Baldwin United failure, which resulted from holding company-based financial shenanigans, the NAIC assured policymakers and the public that insurance regulators now had the tools to supervise and control holding company operations.
One can assume that Commissioner Ario missed the day in NAIC commissioner school when they mentioned state regulators’ responsibility over holding companies, rather than assume he was trying to mislead a congressional subcommittee.
Now, to explain this holding company that owns 71 insurers in the United States, yet operates beyond the comprehension of state insurance regulators, Commissioner Ario gave the subcommittee the following peek at the corporate shell game that regulators approved for AIG.
These 71 insurance companies are primarily involved in three lines of insurance: life and annuities, commercial lines (e.g., workers compensation and other business insurance), and personal lines (e.g., auto). AIG pools its business in each of these three lines and there are lead regulatory states for each line, starting with the state in which the lead AIG company in each pool is domiciled: Pennsylvania for commercial lines, New York for personal lines, and Texas for life and annuities.
Six of the Pennsylvania companies are members of AIG’s commercial lines pool, including the lead commercial lines company, National Union Fire Insurance Company of Pittsburgh, Pennsylvania. The other commercial lines companies are AIG Casualty Insurance Company, Insurance Company of the State of Pennsylvania, New Hampshire Insurance Company, American International South Insurance Company and Granite State Insurance Company.
The other five Pennsylvania domestics are personal lines companies: AIG Centennial Insurance Company, AIG Indemnity Insurance Company, AIG Preferred Insurance Company, AIG Premier Insurance Company and New Hampshire Indemnity Company.
AIG does not have any life insurance companies domiciled in Pennsylvania.
And the NAIC wonders why it has a credibility problem? And yet Commissioner Ario was not done spinning yarns. His testimony continued:
The core principle of our nationally coordinated financial accreditation system is the requirement that insurers hold conservative reserves to ensure that they can honor their obligations to policyholders and claimants. The concept sounds simple enough—companies must practice sound risk management by setting aside funds to pay obligations down the road—but it is a concept that other segments of the financial sector have failed to enforce. One clear lesson of the current crisis is the importance of having plenty of capital and not having too much leverage.
What Commissioner Ario neglected to tell the congressional subcommittee was that insurers’ “conservative reserves” are not as conservative as they once were. The old reserve rules made it difficult for insurance companies to offer products that had very little to do with insurance.
So in an act of charity, the NAIC developed something called “principles-based reserves,” which pushes aside capital reserve requirements to the extent that an insurer can hire an actuary to make the case. The conservative standards are still there, but they are no longer constrained by conservative actuarial tables and guidelines. Yes, Virginia, we are talking about blue smoke and mirrors. The principles-based reserve system is simply self-regulation.
In addition, when so-called regulators tell Congress that insurance has escaped the ravages of financial deregulation, investigators should look behind the fairy tales. For example, investigators should keep in mind that under NAIC rules the life insurance sector does not have to carry its bond holdings at market value. This archaic rule dates from times when life insurance products offered fixed benefits for fixed premiums over long periods of time; therefore, insurers were very likely to hold bonds until they reached maturity (par) value, so regulators could ignore market volatility. Very few life insurance products can now be described in the historic terms used above.
Today, “investment oriented” products dominate the market, so reality dictates that life insurers should be required to mark-to-market their bond holdings, as banks must do. Yes, that might mean that a large number of life insurers are statutorily insolvent, but we have learned the hard way what happens when we lie about the value of assets in financial services.
Buried toward the end of the Ario testimony is a gem that has been whispered about in insurance circles for years, that AIG was using predatory pricing to inflate premium volume. Ario tried to knock down this allegation, which would go to the heart of the powers delegated to the states by the Congress through the McCarran-Ferguson Act.
The Pennsylvania department has devoted special attention to the current allegations because both AIG and its competitors may have distorted incentives to put their competitive engines into overdrive—to preserve business on one side and to deliver a knock- out blow on the other side. With the caveat that these issues are very complex, we have not seen any clear evidence of under-pricing to date, though we continue to look both at individual cases and at aggregate numbers on both renewals and new business at AIG.
What the commissioner did not mention is that most states have quit regulating commercial insurance rates, which makes monitoring competition next to impossible. This deregulation violates the McCarran-Ferguson framework, which opens the door for direct application of federal antitrust law and Federal Trade Commission oversight to insurance.
Many states have adopted the NAIC Commercial Lines Rate and Form Model Act, which simply assumes competition in insurance markets and places impediments before regulators who want to investigate anti-competitive behavior. The model law is clearly crafted outside the McCarran-Ferguson framework and should not be qualified for the limited and contingent antitrust exemption under the act.
Therefore, if Congressman Barney Frank (D-Mass.) or Congressman Paul Kanjorski (D-Pa.), who chair the committee and subcommittee respectively, really want to know whether AIG is engaging in price fixing, they should just pick up the phone and call the U.S. Department of Justice Anti-Trust Division and ask for help. The states have deregulated insurance. Commercial lines insurance in particular has been deregulated in more than 35 states. The states have ceded jurisdiction back to federal antitrust officials, so let the chips fall where they may.
Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance Cos. and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.