Regulating Systemic Risk in Insurance

As exemplified by the dramatic failure of AIG, insurance companies and their affiliates played a central role in the 2008 global financial crisis. It is therefore not surprising that the Dodd-Frank Act — the United States’ primary legislative response to the crisis — contained an entire title dedicated to insurance regulation, which has traditionally been the responsibility of individual states. The most important insurance-focused reforms in Dodd-Frank empower the Federal Reserve Bank to impose an additional layer of regulatory scrutiny on top of state insurance regulation for a small number of “systemically important” nonbank financial companies, such as AIG. This Article argues, however, that in focusing on the risk that an individual insurance-focused, nonbank financial company could become systemically significant, Dodd-Frank largely overlooked a second, and equally important, potential source of systemic risk in insurance: the prospect that correlations among individual insurance companies could contribute to or cause widespread financial instability. In fact, this Article argues that there are often substantial correlations among individual insurance companies with respect to both their interconnections with the larger financial system and their vulnerabilities to failure. As a result, the insurance industry as a whole can pose systemic risks that regulation should attempt to identify and manage. Traditional state-based insurance regulation, this Article contends, is poorly adapted to accomplishing this given the mismatch between state boundaries and systemic risks, as well as states’ limited oversight of noninsurance financial markets. As such, this Article suggests enhancing the power of the Federal Insurance Office — a federal entity primarily charged with monitoring the insurance industry — into supplement or preempt state law when states have failed to satisfactorily address gaps or deficiencies in insurance regulation that could contribute to systemic risk.