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COMMENTARY: State-controlled insurers may pose systemic risk


The debate over exactly what constitutes a systemically important financial institution subject to heightened regulatory oversight has been going on since the financial crisis of 2008 broke.

A key question has been whether property/casualty insurance companies can present a systemic risk to the economy as a whole. Most property/casualty insurers and the trade associations that represent them have argued persuasively that the very nature of property/casualty insurers precludes them from presenting such a risk.

As regulators consider exactly which institutions present a systemic risk under the Dodd-Frank Wall Street Reform and Consumer Protection Act, they ought to consider the comments recently sent to the International Association of Insurance Supervisors by the Washington-based R Street Institute.

R Street is a free market-oriented nonprofit that doesn't shy away from offering provocative solutions to public policy issues, including financial regulation and environmental affairs. In its comments, R Street notes that private insurers aren't the only players in the property/casualty insurance market. State-controlled entities such as Florida's Citizens Property Insurance Corp. and others also provide coverage.

In the comment, R Street senior fellow R.J. Lehmann noted that the IAIS considers “interconnectedness” as one of the two most important factors used to access the systemic importance of an insurer.

“The typical post-catastrophe funding mechanisms of large U.S. residual market entities must raise concerns about interconnectedness,” he wrote. “Rather than setting aside actuarially appropriate reserves to prepare for the risks they take on, entities like Florida Citizens rely on post-event borrowing as a source of liquidity after a major event. The loans taken out by these entities are then to be serviced over time using funds raised by assessments on private market insurers, which are then typically passed on to consumers.”

Mr. Lehmann said the case for closer regulatory oversight of these entities “is bolstered by the potential for regulatory conflicts of interest” and noted that, in some states, the state-controlled entities are overseen by the same regulators who oversee private insurers.

The impact the failure of a state-controlled insurer might have on the national or international economy as a whole hasn't received the attention it demands in the debate over what constitutes a SIFI. By definition, any large government-controlled or -sponsored financial institution presents real issues of interconnectedness; just look at what happened at Fannie Mae.

Subjecting government-controlled insurers to heightened regulatory oversight could increase those entities' costs of doing business. That could mean some additional costs for policyholders and taxpayers. But ignoring the potential for damage done by a state enterprise when determining what is a SIFI ultimately could lead to a considerably costlier bailout by the public should such an insurer fail.