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WASHINGTON-The American Insurance Assn. is calling for "functional regulation" of the financial services industry as the relationship of banks and other financial institutions to the property/casualty insurance industry changes.

In a list of principles it wishes to see applied to financial services modernization legislation, the AIA says it prefers state or federal legislation that "establishes a level playing field" to court decisions or "regulatory pronouncement under current laws" as the way to set rules governing the relationship between depository entities and insurance.

"The regulation of all insurance activities should be by the insurance regulator carrying out the insurance laws. Bank regulatory authority, whether directed at bank solvency or otherwise, should not be used in a way to circumvent the functional regulatory structure of the legislation, or to try to affect insurance activities, or to broaden the powers of financial institutions," according to the AIA principles, which were announced last week.

The AIA also calls for allowing depository institutions to underwrite insurance only through a "separate corporate entity which is financially insulated from the bank." All such entities should also be required to participate in guaranty funds and any "relevant state residual markets" that insurers must support, the AIA holds.

Among the other principles are allowing banks and insurers to engage in joint ventures and other activities, prohibiting the characterization of property/casualty products as "banking," and enforcing adequate consumer safeguards against banks coercing customers to buy insurance from them.