Bond Business Needs Regulation

Posted February 10, 2008 at 11:00pm

Bond insurance represents a relatively small segment of the insurance industry. We now know, however, that it has the capability to produce many profound effects on the broader economy. Congress must examine these matters in order to take action.

According to the Association of Financial Guaranty Insurers, total premiums collected in 2006 by bond insurers and reinsurers amounted to just $3.2 billion. In comparison, the total direct premiums collected by health and life insurers and property-casualty insurers totaled a staggering $619.7 billion and $447.8 billion, respectively, in 2006.

Bond insurance is a relatively new financial product. Since the issuance of the first license in the early 1970s, bond insurers have guaranteed a stable risk: the timely payment of principal and interest on municipal bonds. Municipalities have used this insurance to lower their borrowing costs. Historically, municipal bonds have defaulted at a rate of less than 1 percent.

In the past decade, many bond insurers strayed from their original mission. They branched out to guarantee more complex and risky debt products, including those backed by subprime mortgages. These business decisions and the decline of the value of subprime debt have now resulted in downgrades by credit-rating agencies.

To learn more about these matters, I recently initiated an examination of the bond insurance industry, focusing on its strength, the resulting implications for the financial marketplace and municipalities of ratings downgrades and the potential need for regulatory reforms. As a part of the examination, I contacted key regulators in late January, and I will hold a hearing on these matters on Thursday.

The spillover of the ratings downgrades of a few bond insurers has proved worrisome for many. It already has caused much volatility for Wall Street trading. Moreover, ratings downgrades have reduced the values of banks’ holdings, causing them to maintain higher amounts of capital or take write-downs. Two banks recently reported large losses related to their bond insurance exposures.

Additionally, they have affected local communities, including many in my own district in northeastern Pennsylvania, which often use municipal bonds to operate more efficiently, ease budgeting shortfalls and build needed infrastructure. These downgrades will cause financial strain. They could force localities to pay more for the bond insurance going forward. They also might force the delay of needed infrastructure improvements or result in higher local taxes to pay for needed projects.

With all of the recent news stories about the potential economic fallout resulting from the downgrades of several bond insurers, it seems that this bond insurance has become the tail wagging the dog of the economy. We therefore need to reform its regulation.

State insurance regulators currently oversee bond insurers. These regulators have the responsibility to keep an eye on the solvency and claims-paying ability of insurers. Because insurance regulators generally have jurisdiction only within their borders, it is not their responsibility to examine the implications for the financial stability of the nation’s economy. The current problems in bond insurance highlight the need for a federal presence in this field.

Last fall, I started a series of hearings on insurance regulation from my position as chairman of the Financial Services Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises. We already have convened two hearings on the need for regulatory reform.

We discussed the creation of an optional federal charter for insurers at each of these hearings. Creating an optional federal charter for insurers would place them on par with banks, which have long had the ability to choose between state and federal oversight.

While I long have seen the potential benefits that such a charter could bring to certain sectors of the industry, I have remained hesitant to view this idea as the solution to all of its problems. The widespread effects of the bond insurers’ ratings downgrades, however, provide the strongest argument yet for why a federal insurance regulator may be needed.

In addition to overseeing insurers, a federal regulator could have the important mandate of monitoring national financial stability. After Sept. 11, a lack of terrorism insurance coverage halted construction projects. We passed the terrorism reinsurance backstop to fix this problem.

Today, we are seeing the impact another sector of the insurance industry has had on the overall economy. At the very least, the federal government should collect data on the insurance industry and have the information to foresee the national impacts that the insurance industry has on the economic well-being of our country.

While the bond insurance industry appears deceptively small, the ricocheting economic effects of ratings downgrades demonstrate just how important it really is. Because we need better federal oversight of the insurance industry, I will continue to hold hearings and work toward regulatory reform. During these proceedings, I expect discussions about creating a federal regulator to continue. It clearly is one potentially effective solution to a very complex problem.

Rep. Paul Kanjorski (D-Pa.) is chairman of the Financial Services Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises