Why the Feds Shouldn’t Regulate Insurance Yet, and Certainly not Own Insurers

Insurance is complex by nature.  Anytime one brings in a third party to be a protector/guarantor against adverse events, it creates some weird dynamics.  Now, a few of the states, including the best of them, New York, have been regulating insurance for a long time.  But the Feds have not dealt with insurance in any significant way, because that role has been ceded to the states.

With the failure of AIG, and it getting acquired by the Feds, the questions of regulation have taken on new significance.  I have written before about the Federalization of insurance regulaton, indicating some indifference about who regulates it, but pointing out the difficulties — what an effective insurance regulator needs to learn.

The following is personal to me in four ways:

  • I used to work for AIG (’89-’92)
  • My main local paper is the Baltimore Sun (though I don’t subscribe, because of lack of value)
  • Elijah Cummings is my Congressman, at least since the last gerrymander. (Hey, give him credit, he voted against the bailout.)
  • I have interacted with many insurance regulators of varying abilities over the last 20+ years.

Elijah Cummings and some other congressmen have gotten offended over seemingly extravagant expenses over conferences, particularly for agents/representatives of the company.  Now, as a young actuary, I would sometimes say, “Why do the agents get to go to all of the fun conferences?”  Not true — only the top agents went to those conferences, and it was a reward that would stimulate extra performance (and the real reward was bragging rights — the companies often made money off of conference-type rewards).  Actuaries are nice, and all that, but the ability to sell product, particularly in life insurance and annuities, is rare.

When the government gets involved in industry, the incentives become messy:

A1) We need to do a lot of mortgage workouts for the good of mortgage payors and those in residential real estate.

A2) We need to minimize the cost of the mortgage bailout to the taxpayer.  Or, we can’t borrow that much.

B1) We must reduce tobacco smoking in our state; it is harming our dumbest citizens.

B2) But we issued tobacco bonds against the recent settlement with the tobacco companies.  We can’t afford to lose revenue.

C1) We’ve got to crack down on shady life insurance sales practices.  Too many people are getting cheated.

C2) That insurance company employs a lot of people in our state, and they are located in the district of the head of the commerce committee.

D1) Gambling has introduced new forms of addiction to our state, and perhaps organized crime as well.

D2) We can’t afford to give up the tax proceeds from gambling — the schools depend on it.

Have I made it clear?  Politicians want political results, and they want tax revenues, which are often opposed to each other.  They aren’t typically businessmen, so they don’t understand the tradeoff.  Rather, they swing from one to the other, as political convenience dictates.

And so in this situation, I would say that the amounts in question are rather nominal.  Why fuss over the conferences?  Rewarding top performers is important, and if you don’t do that, you will lose business, and the government will lose on its “investment” (what a word 😉 ) in AIG.  Most companies have conferences like AIG, and I can tell you, they wil think twice about coming under the government’s umbrella for that reason, as well as many other reasons that have political significance, but harm corporate performance.

State legislatures took time to build up expertise in insurance regulation.  Some more so like New York (we should move the NY regulators to DC if we federalize), and some less so.  Congress doesn’t have the vaguest idea on what to do with insurance and AIG.  The ignorant statements of Rep. Cummings are a great example.  Ed Liddy has only been on the job for less than two months.  Why call for his head?  Insurance companies are complex organizations where most significant things are planned a year in advance or so.

Now, so I like the AIG bailout?  No, perhaps we should have let the holding company fail, and the underlying insurance subsidiaries would have been fine.  Some CDO holders would have been hurt, but what are you doing dabbling in CDOs, anyway?  And why didn’t you question why so much of your CDO exposure was AIG guaranteed?  When only one company guarantees much of the business, that is a bad sign (underpricing).

But seeing the ruckus here, this is why it is bad for the government to own an insurance company.  All of the incentives are confused, which will lead to a greater failure, and more expense to the taxpayers.

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UPDATE 1PM 11/13/08  Adam corrects me below.  Cummings voted against the initial bailout bill, and for the final bailout bill.  Thanks for the correction, Adam.