VoxEU Column Global economy International Finance

Mind the gap: Moving towards federal insurance regulation

Will the US Dodd-Frank Act work? This column argues that unless institutional oversight shifts from the current fragmented structure to a federal one, the Dodd-Frank reforms could be prevented from having any significant positive effect on the surveillance of the financial system.

The European Parliament’s approval of the financial regulatory package for oversight of the financial system on 22 September 2010 marks a key moment in the integration of systemic risk in the supervisory approach for financial markets. The timing of the approval ultimately coincided with the approval of parallel measures in the US to address the myriad policy, regulatory, and institutional deficiencies that are perceived to have contributed to inadequate surveillance of the financial system. But in the build up and aftermath of these policy announcements, controversy has been close by (see for example Acharya et al. 2010, Claessens et al. 2010, Van Reenen 2010).

Both the EU and US reforms seek to introduce the institutional changes that can enhance systemic-risk assessment and monitoring with a view to improving cross-sectoral analysis and informing timely policy interventions. In the US, however, one barrier to achieving this has evaded attention: the state-by-state system of regulation currently in place for the insurance industry.

The McCarran-Ferguson Act adopted in 1945 provides that the regulation and taxation of insurance business be left with the individual states. Given the current developments in the international financial markets however, it is important to re-consider whether this continued delegation of power to the states best serves the interests of effective governance of the industry and is consistent with the objective of promoting stability of the financial system. Following the global financial crisis of 2007-2009 on a cross-jurisdictional basis, this regulatory issue requires further attention. Indeed, it is imperative that the dichotomy be brought to the fore of regulatory debate.

Little insurance against regulatory failure

The need to address the fragmented system of insurance supervision within the broader institutional framework for supervising the financial system is clearly acknowledged in the Dodd-Frank Act and the sector’s representation included to the extent feasible given the lack of consensus on the need for centralised oversight of the insurance sector. However in at least one key element of the reforms, the proposed introduction of a systemic risk board, the lack of a federal body poses clear challenges. In the absence of a federal regulatory authority for insurance, the proposal is instead to have a representative with expertise in the industry within the Financial Stability Oversight Council. While expertise and knowledge of the industry is clearly useful, such a placeholder cannot provide the level of insight into vulnerabilities, trends, and potential weaknesses that would be available to a centralised insurance regulator. In the absence of a federal regulator, the exercise of risk monitoring in the US insurance sector and the broader financial system is at risk.

State by state is out of date

A state-by-state system of insurance regulation is not only outdated and inappropriate, it falls down on a number of other levels. It fails to serve:

  • the modified model of insurer finance in the current global economy,
  • the changed (and evolving) use of insurance products and policies, and
  • the changing nature of insurance finance from the paradigm for which this fragmented supervisory structure was initially designed. Indeed, it does not reflect the role of insurance institutions in global finance.

On a forward-looking note, resistance to federal oversight is hardly conducive to the further development of global finance including the continued expansion of insurance markets and products and the continued development of risk management techniques. It does not provide a suitable environment for insurance industry development and growth. It does not safeguard the financial system from the implications of existing risk management tools or such further developments and innovations. The persistence of a state-by-state approach runs counter to the apparent trend to embrace "globalisation.”

Resistance to change

Given the current review of regulatory approaches, resistance to strong federal oversight can have further significant adverse consequences for the proposed introduction of systemic risk boards and the greater integration of macro-prudential oversight in both the US and EU. Justifications of the state-by-state system as providing a greater measure of consumer protection are hardly valid at this stage of international finance nor a regulatory objective presently confined to the insurance industry. It begs for a re-think on the concept of the consumer to include a broader range of protected interests. In purely pragmatic terms, the approach fails to recognise the systemic risk consequences of the financial sector and the significant difficulties of even conducting effective prudential supervision in a state-by-state system.

The multiplicity of regulatory actors and supervisory institutions that this fragmented system of supervision currently promotes is a hindrance. It dilutes the ongoing work to modernise and streamline the financial regulatory system. The approach fails to reflect the benefits of a simpler regulatory institutional model and runs counter to the need for increased consistency and harmonisation in regulatory standards. This in turn encourages – instead of deters – the potential for regulatory arbitrage.

It is to be hoped that the Dodd-Frank reforms will act as a precursor to more fundamental and overdue federal oversight of the insurance sector, one which would signal the true integration of insurance in international finance. In the absence of such fundamental change, the US system for more effective oversight of risk may be less effective than in the EU and the new regulatory system, in particular the proposed Financial Stability Oversight Council, may be unnecessarily and tragically impaired in its ability to provide the optimal level of surveillance of the financial system that the legislation is aiming for.


Acharya, Viral, Thomas F Cooley, Matthew Richardson, Richard Sylla, Ingo Walter (2010), “A critical assessment of the Dodd-Frank Wall Street Reform and Consumer Protection Act”, VoxEU.org, 20 October.

Claessens, Stijn, Richard J Herring, Dirk Schoenmaker (2010), “A safer world financial system: Improving the resolution of systemic institutions”, VoxEU.org, 8 July.

Van Reenen, John (2010), “Financial regulation: Can we avoid another great recession?”, VoxEU.org, 4 May.

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