Paulson Blueprint Promotes Insurance Industry Shell Game

There’s something peculiar in the report on financial market regulation issued today by Treasury Secretary Henry Paulson. The plan, touted by some as a bold expansion of federal control over capital markets and dismissed by others as a mere rearranging of the deck chairs on the financial Titanic, includes an incongruous section on the insurance industry.

While insurance is a financial service, it hasn’t been at the center of the implosion of the housing market or (aside from the bond insurance crisis) linked to the instability on Wall Street. The Paulson plan, nonetheless, provides a resounding endorsement of a “reform” that key players in the insurance industry have been seeking for at least 15 years—allowing large national carriers to do an end run around the current state-based insurance regulatory system. Such carriers would be permitted to adopt an “optional federal charter” and thereby put themselves under the supervision of a federal regulatory agency that does not yet exist.

Big Insurance has not sought federal oversight because it wants more regulation. After all, this is the industry that pioneered offshoring when some carriers moved their official headquarters to tax havens such as Bermuda. While it is true that many state regulators have been toothless watchdogs, other states have been aggressive in protecting the interests of policy holders and the public.

In fact, the Paulson proposal comes just a couple of weeks after insurers were celebrating the downfall of New York Gov. Eliot Spitzer in a prostitution scandal. During his time as New York’s attorney general, Spitzer pursued major insurance companies such as Marsh & McLennan and American International Group for offenses such as bid rigging. Marsh ended up settling for $850 million in 2005, and AIG paid a whopping $1.6 billion the following year. While it is true that Spitzer went after the industry as a prosecutor rather than a regulator, he did so in the overall context of state oversight.

The insurance industry swears that it supports the optional federal charter in the name of modernization (as does the Paulson report), but it is significant that the reform has been supported by groups such as the Competitive Enterprise Institute and the American Enterprise Institute that are no friends of regulation (some Democrats in Congress are also in favor). When word of Paulson’s insurance proposal leaked out over the weekend, the American Insurance Association rushed out a press release hailing it, saying that the optional federal charter “will be more efficient, effective and rational given the ‘increasing tension’ a state-based regulatory system creates.”

Throughout its history, the insurance industry has avoided “tension” by trying to minimize government interference in its affairs. In 1945 the industry supported the McCarran-Ferguson Act, which responded to a Supreme Court ruling by affirming the regulatory role of the states. In recent times, the industry has wanted the option of federal oversight on the assumption that it would be less onerous. I’ll let the legal scholars decide whether state or federal regulation is inherently more appropriate. The issue is whether an industry not known for generous treatment of its customers (think of Katrina victims denied coverage) is going to be subjected to some strict oversight somewhere.