February 6, 2006
JS-4097

Remarks of
Assistant Secretary for Financial Institutions Emil Henry,
Jr.
before the
National Association of Insurance Commissioners
Conference

Naples, Fla. – Thank you. It is a real pleasure for me to be here with you today and participate in your Commissioners' Conference and to see some familiar faces. I am also delighted to do so and represent the Administration against a backdrop of such a robust and vibrant economic environment in which we now find ourselves.

You can likely infer from that brief introduction, that in my 20 years on Wall Street, I have trafficked in virtually every corner of our capital markets yet, admittedly, I cannot hold myself out as an expert in your arena. I am, however, quickly getting up to speed on all of the specific insurance issues in front of Treasury. Treasury is following several insurance-related issues which I would like to discuss with you today. These include the proposed insurance modernization legislation, reinsurance collateralization, TRIA implementation, flood insurance, and other natural disaster insurance programs.

In my relatively short time at Treasury, I have become familiar with the state-based insurance regulatory system, as well as the excellent work that the NAIC has done on behalf of state regulators. One of the reasons I am here today is to thank you. The NAIC has distinguished itself in my mind for the cooperation and assistance it has given to Treasury – especially in the implementation and reauthorization of TRIA. Our staff repeatedly complements the good work that you have done.

I have already had the pleasure and opportunity to discuss some of these issues with your leadership. Recently, I visited with your leadership and we had a very productive discussion. It was most helpful for me to get their insights. I am sure that our discussions today will be just as fruitful.

As you know, when Congress passed the Gramm-Leach-Bliley Act in 1999, the barriers preventing banks, securities firms, and insurers from affiliating and competing with each other were removed. The Act also provided for the regulation of financial products by function rather than by institution, and specifically reaffirmed the McCarran-Ferguson Act (1945). In addition, it recognized state insurance regulators as the functional regulators of the insurance industry.

After the passage of Gramm-Leach-Bliley, the insurance marketplace is certainly different from what it was even a few years ago, even though the anticipated convergence of banks and insurers still has not materialized. There is a new financial services marketplace that is accelerating and being driven by industry consolidation, globalization, and the advent of e-commerce.

These changes have led some insurers to maintain that in this new environment, they find themselves in direct competition with brokerage firms, mutual funds, and commercial banks – all of which they perceive as having a competitive advantage due to regulatory structures that allow for more efficient operations.

I am well aware, of course, that the NAIC acknowledged these changes in the marketplace and called for the modernization of the state-based insurance regulatory system. In 2000, you adopted the "Statement of Intent – The Future of Insurance Regulation," pledging to design and implement uniform standards for such regulatory functions as producer licensing, market conduct oversight, and rate and form regulation. Then in 2003, you released the "Insurance Regulatory Modernization Action Plan," in which time-lines were set for specific regulatory changes to be made. Your work and progress in carrying out these reforms thus far has been commendable.

I am also aware of the progress that you have made in formulating an Interstate Compact to deal with speed-to-market issues for approvals of life, annuity, disability, and long-term-care products. This is important work.

Despite these efforts, and as you are well aware, some insurers feel that more has to be done to modernize state insurance regulation, and have called for some degree of federal involvement. As I understand it, these additional proposals for federal involvement in the insurance regulatory process fall into three categories:

I recently discussed the Optional Federal Charter approach with your leadership. We had a very productive meeting and I received some valuable background and input from your leadership.

With all the noise and misinformation in the press, I feel compelled to say that Treasury has not taken a position on what approach, if any, should be taken to involve the federal government in the regulation of insurance. However, we do want to continue to consult with you and others as this issue proceeds. As we continue to examine this issue, there are, as I see it, several basic realities that are self-evident

• Most types of businesses that operate across multiple state lines would prefer not having to abide by 50-plus state standards.
• Even though states have improved the current producer licensing process by granting some degree of reciprocity, a lack of uniformity in many aspects of state regulation still remains.
• A dual regulatory environment as enjoyed by the banks involves regulatory competition, which can be positive if it leads to general deregulation, innovation, and increased consumer choice; but we realize that it can also have potential downsides.
• Property and casualty insurance products appear to be much more state-specific than life insurance products, and thus might call for differing regulatory approaches.
• Big picture, our country is well-served by an insurance marketplace whose players can compete and thrive on a level playing field, attracting risk capital to grow--all within the bounds and mindful of safety and soundness and proper consumer protection.

For some three years now, Treasury has been actively monitoring developments at the NAIC on the reinsurance collateralization issue. Non-U.S. reinsurers continue to tell us that the current 100 percent collateral requirement is discriminatory and should be changed. We have followed the discussions of the NAIC's Reinsurance Task Force.

We are fully aware of just how complicated and controversial this issue is. You tackled this issue last December in the White Paper on U.S. Reinsurance Collateral. The paper appears to have been generally well received by state regulators as well as by U.S. and non-U.S. reinsurers, and clearly touches on some key areas of concern. We feel that the paper succeeds in carrying out its goal of providing a balanced synopsis of the historical arguments in favor of and against changing the U.S. rule, and that it will, indeed, serve as a good starting point for future debate on the issue.

We do not believe that the controversy over reinsurance collateral is going away anytime soon. It is my understanding that you will be holding additional discussions on the White Paper at this Conference, and I hope that they will lead to some consensus on the issue. . I can assure you that Treasury will watch closely how this issue develops.

Following September 11, the President and Congress acted by passing TRIA. TRIA was enacted to address the significant wrenching economic dislocations that occurred in the wake of the attacks and served as an another unfortunate shock to our economy which was, at that time, in the midst of sustaining and digesting the impact of the bursting of the bubble economy preceding 2001. TRIA also ensured the continued widespread availability and affordability of commercial property and casualty terrorism coverage. As you know, TRIA placed the federal government in the commercial property and casualty terrorism risk reinsurance business.

From its inception, TRIA was intended as a temporary program – a "bridge" to allow the marketplace a transitional period to recover from the 9/11 losses, as well as to adjust to a new risk and design its own long-term, private-market solution.

In June of last year, Treasury delivered to Congress its report on the effectiveness of TRIA. We concluded that TRIA had been effective in achieving its fundamental goal of enhancing the availability and affordability of commercial property and casualty terrorism risk insurance, including allowing time for rebuilding the capacity of the private sector, but was "crowding out" further private market development.

During the transitional period provided by TRIA, industry surplus levels returned to and even exceeded pre-9/11 levels. At the same time, the economy had recovered and grown. Also, insurers had used the time to develop mechanisms to evaluate their risk accumulations, model their exposures, adjust their underwriting practices, develop their pricing, and, though not yet tested, develop models for terrorism. If there was any failure, it was on the part of the private market not preparing for the return to a TRIA-free marketplace. We are hoping to see more progress in the private sector in the years to come. I believe many of you would agree that not enough effort had been put into developing alternative sources to the capacity TRIA provides.

As Congress sought to extend TRIA, Secretary Snow laid out the Administration's key principles for accepting any extension. The Administration maintained that any extension of the program must:

• be temporary in nature;
• encourage the private insurance market to develop innovative solutions and build capacity; and
• reduce the exposure to taxpayers.

The end-of-year debate then dealt with policy issues related to various aspects of the competing House and Senate versions. Whereas the Senate's bill extended the program for two years with the necessary changes sought by the Administration, the House bill expanded the program and added additional complexities that, frankly, were not consistent with a temporary program. At the end of a very busy December, we were successful in keeping TRIA true to its original mission – a temporary program allowing for the gradual transition back to full private-sector provision of terrorism risk insurance.

President Bush signed the Terrorism Risk Insurance Extension Act of 2005 on December 22, 2005. The changes made achieved the Administration's key principles in extending the temporary program. As I am sure you are aware, the TRIA program continues temporarily until December 31, 2007.

What happens next? A provision in the TRIA extension requires an analysis by the President's Working Group on Financial Markets (PWG) regarding the long-term availability and affordability of terrorism insurance, including group life coverage and coverage for chemical, nuclear, biological, and radiological events. There is some confusion regarding the PWG. The PWG was created by executive order of President Reagan in 1988 in response to the 1987 market crash. Following the issuance of its report in 1988 and follow-up work in 1991, the PWG became largely inactive until 1994 when, at the urging of Congress and others, it was reactivated by the Secretary of the Treasury. Since that time, it has met on a regular basis. The PWG is chaired by the Secretary of the Treasury and includes the chairs of the Federal Reserve Board, the Securities and Exchange Commission, and the Commodity Futures Trading Commission. PWG meetings are small and allow for an open discussion among our economic leaders.

The PWG is required to consult with the NAIC and other industry and policyholder stakeholders. The report is due to Congress by September 30, 2006.

Treasury staff is coordinating with the staffs of the other PWG representatives. In my meeting with the NAIC leadership earlier this month we discussed, preliminarily, coordinating NAIC's consultation role with the PWG and what the NAIC plans to do independently leading up to that consultation.

As we move forward over the next two years, I want to encourage you to continue to work to create and incentivize market-based solutions for terrorism insurance. Treasury looks forward to working with you to achieve this shared objective.

In the aftermath of Hurricane Katrina, one of the many areas the federal government is looking at is strengthening the National Flood Insurance Program (NFIP). I know that this is also a priority for many of you as well, especially those of you who represent coastal states and that have tributaries subject to flooding.

As you know, our sister agency, the Department of Homeland Security (DHS) administers the flood program through FEMA and its Mitigation Division. DHS has the lead role in reforms involving the actual implementation of the program. Treasury often is called upon to fund the flood program when it needs to borrow in order to meet claim obligations.

Hurricanes Katrina, Rita, and Wilma resulted in flood claims that are estimated at about $23 billion. The President and Congress have raised NFIP's borrowing authority twice; the program's current borrowing authority is $18.5 billion. It is expected that legislation to further increase the borrowing authority (needed soon) will include reform proposals.

From Treasury's perspective, issues of concern involve the low number of insureds, deficiencies in the flood maps, subsidization of premiums, and addressing properties that suffer repetitive losses. We have also been attempting to quantify the level of compliance by financial institutions.

Several bills are being introduced which include various approaches to address these and other issues. The Administration continues to evaluate potential improvements to the NFIP and looks forward to working with Congress on this important issue.

At the same time we know that you are looking more "big picture" at the way natural disasters are insured throughout the country and whether there is a better model than the current federal and state insurance and reinsurance programs, such as high-risk pools. We appreciate you keeping us updated of your proposal for a natural catastrophe program.

Establishing a long-term, permanent federal government role in insurance or reinsurance for natural catastrophes presupposes that the private sector or other state-sponsored mechanisms can not fully manage natural disaster risks. At Treasury, we are not convinced that a federal government role is necessary but we are interested in hearing all aspects of the debate so please keep the lines of communication open.

Thank you for inviting me to speak to you today and thank you for listening. I'll be happy to answer a few questions.