Senate Banking, Housing and Urban Affairs Committee

Hearing on H.R.10 - "The Financial Services Act of 1998"
(Second Hearing in a Series)

Mr. Chairman and members of the Committee, my name is John Biggs, and I am Chairman and Chief Executive Officer of TIAA-CREF. I am also chairman of the CEO committee of the American Council of Life Insurance ("ACLI") that deals with policy in the area of financial services. I am appearing this morning on behalf of not only the ACLI, but also the American Insurance Association, the Alliance of American Insurers, the National Association of Independent Insurers, the Reinsurance Association of America, and the National Association of Mutual Insurance Companies. These associations represent in the aggregate most of the life insurance, property and casualty insurance, and reinsurance companies domiciled in the United States. Some lines of insurance may have other, specific concerns which are not treated here. This statement is intended to reflect the broad consensus of the industry on financial modernization.

Insurance companies are substantial stakeholders in the debate over how the laws governing this country's financial service firms should be revised. While insurers historically have not supported the concept of permitting affiliations with commercial banks, all of the associations noted above have reversed their policy in recent years and now endorse the concept - provided it is implemented by Congress on a rational and fair basis.

As discussed in more detail below, this policy reversal reflects the inevitable and rapidly accelerating changes occurring within the financial service industry and, more importantly, illustrates why we believe the status quo is no longer acceptable or defensible. Protectionist laws ostensibly segmenting the various components of the financial service industry have proved extremely porous and are being sidestepped or largely ignored by regulators and institutions alike. This process of deregulation by administrative fiat and marketplace action is often not grounded in sound regulatory policy. Regulators are increasingly confronted by corporate arrangements they are ill-equipped to oversee, safety and soundness concerns are growing, and consumer protections are more and more difficult to assure. Additionally, inappropriate and unnecessary competitive inequities are arising that threaten the ability of some financial service firms to position themselves as effectively they must to retain their vitality in the years ahead.

In short, a comprehensive overhaul of the laws governing financial service firms is already long overdue. The need for prompt action by Congress is critical if financial service firms in this country are to retain their prominent position in the domestic and global marketplaces. And only Congress is in a position to balance the interests of all institutions and their regulators in a way that is effective and fair.

In the following pages, we explain why it is so important for Congress to act on financial modernization legislation this year. We then discuss those issues that are particularly important for insurance companies in the context of this legislation.

Why Financial Modernization Legislation Must Be Enacted Now

The Marketplace Has Made Existing Laws Obsolete

What we see in the financial services marketplace today is not a situation where outdated and restrictive laws are preventing all institutions from pursuing new strategies and organizational structures. Rather, many institutions, often with the help of their regulators, are simply circumventing those laws.

Banks' involvement in the insurance business is a good example. Roughly a decade ago, national banks were limited to selling insurance products out of small town locations and only to customers in and around those small towns. And there was no thought that banks could underwrite insurance (other than some credit related products) in any way shape or form. States had the authority to prohibit banks from selling or underwriting insurance within their borders, and there was no question that the states could fully regulate those insurance activities in which national banks were permitted to engage. Today, national banks can, from their small town locations, sell all types of insurance to customers located anywhere in the country. The Office of the Comptroller of the Currency ("OCC") has asserted and the courts have agreed that fixed and variable annuity contracts can be sold without any geographic limitation. The courts also sustained the OCC's assertion that states can no longer restrict the sale of insurance by national banks if doing so would prevent or significantly interfere with banks' sales authority. Indeed, the states' fundamental authority to regulate the insurance activities of national banks has repeatedly been called into question. More recently, the OCC has adopted controversial rules - as yet untested by the courts - suggesting that national bank operating subsidiaries might be able to underwrite insurance products that the bank itself would be prohibited from underwriting. Again, it is important to keep in mind that all of these significant expansions of banks' insurance powers have occurred without one word of federal banking law being changed.

Expansion of powers is, however, only the tip of the iceberg. Consolidation in all segments of the financial services marketplace is occurring at a pace far beyond what even the boldest forecasters of this phenomena predicted. News of another so-called "mega-merger" is almost routine as we pick up the daily financial press. The American Banker newspaper noted recently that the RJR/Nabisco deal, once the largest of all business combinations, had been bumped from the top ten by the spate of financial mergers. Importantly, a number of these mergers have crossed industry lines, a situation that even the most progressive lawyers would have thought unimaginable even a few years ago. And there is nothing to suggest that these trends will not continue.

Expansion of powers by administrative action and cross-industry mergers give rise to important questions regarding the adequacy of the current regulatory structure, including: whether regulators can do their jobs effectively when dealing with large, diversified financial service firms; whether these transactions, which seem to be occurring despite laws now on the books rather than in conformance with them, are consistent with conventional notions of safety and soundness; and whether consumers are being adequately protected. Clearly, laws that were enacted 50 or more years ago when the business environment was radically different are inadequate for the tasks at hand. Marketplace changes have simply rendered many of these laws ineffective and obsolete.

The Need to Assure Institutional and Consumer Protections

There are two types of protections that are essential if diversified financial service firms are to prosper: those assuring the safety and soundness of the institutions themselves; and those assuring that the interests of consumers dealing with these institutions are addressed. Both types of protection have become problematic given events of the last several years.

As noted above, laws governing the insurance, securities and banking industries were passed at a time when the separation between these industries was well-defined and clearly understood. Laws aimed at preserving institutional safety and soundness did not need to take into account the prospect of banks and insurers being commonly owned. Even more recent laws, such as those mandating prompt corrective action for depository institutions falling below well-capitalized levels, did not contemplate, for example, having an insurance company and a bank under common control. Similarly, the Bank Holding Company Act, including the Fed's so-called "source-of-strength doctrine," was predicated on the notion of bank holding companies controlling only banks and banking related businesses. That act did not envision a financial holding company controlling a bank, an insurer, and a securities firm. If the bank's capital position is impaired, does source-of-strength or prompt corrective action mandate taking assets away from nonbanking affiliates that are themselves regulated enterprises? What are the jurisdictional boundaries for insurance, securities and banking regulators? Can, for example, a state insurance regulator get enough information on an affiliated depository institution to satisfy itself that the financial integrity of the insurer will not be adversely affected by potential problems in the depository institution? Or can a state insurance regulator prevent a federal bank regulator from pulling assets out of the insurer to enhance the capital position of the bank? If the OCC permits bank operating subsidiaries to underwrite insurance, could insurance solvency protections be preempted or ignored? We believe that careful analysis of these questions and related issues underscores the need for immediate legislative action.

Consumer protections are also in jeopardy. For example, insurance products sold through conventional distribution channels, including career and independent agents, direct marketing, and broker/dealers are clearly subject to the comprehensive consumer protection regimen of state insurance law. In recent years, however, questions have arisen over the extent to which insurance products sold through national banks are subject to those same laws. Many banks have argued that state consumer protections provisions are preempted by federal banking law.

The advent of large, diversified financial service firms does not mean that safety and soundness and consumer protection cannot be achieved. However, current law clearly must be revised to assure that these protections will continue. Congress should understand that the potential consequences of ignoring these issues are enormous.

The Need to Assure Competitive Balance Among Segments of the Financial Service Industry

This country has traditionally put a high premium on protecting the integrity of the payments system. Rigorous regulation of depository institutions, along with the extensive protections of the federal safety net, have combined to create a system which functions efficiently and in which depositors have the highest level of trust and confidence. It is truly a model envied by the rest of the world. This legitimate focus on the security of the payments system, however, has evolved into a mentality among bank regulators that whatever is done to benefit the financial strength of banks is in the best interests of the country, notwithstanding what effects those actions may have on others. To a large degree, it is this "banks-are-the-center-of-the-universe" view that stymied H.R. 10 for so long in the House and threatens to do so now in the Senate.

Banks are important, and their well-being is vital to our financial markets. But in the context of modernizing the financial services industry, it would be inappropriate and unwise to establish an environment in which just one segment of the industry prospers. For financial modernization to reach its full potential in terms of efficiency and value to consumers and stockholders, all three segments of the industry, banking, insurance and securities, must be positioned to compete effectively.

The mantra continuing to issue from the Treasury is that H.R. 10, which allows banks either directly or indirectly to engage in every financial activity under the sun, somehow diminishes the value of the national bank charter. That is a very difficult argument to sustain. A more realistic assessment is that by allowing broad affiliations between different types of financial service providers, the bill enhances the value of all financial charters.

One side-effect of functional regulation is that no segment of the financial service industry will enjoy a regulatory advantage over any other segment or have any incentive to try to encroach on another segment's product line. That may come as a disappointment to the OCC, which has enjoyed bestowing nonbanking powers unilaterally on national banks, but it hardly can be characterized as diminishing the value of the national bank charter. If H.R. 10 is enacted, a national bank charter will continue to be highly valuable to those who want to be in the banking business. To those who want to be in the insurance or securities businesses, an insurance or securities charter will be the answer. If a single corporate enterprise desires to control all three charters and their respective benefits, it may do so. Whatever legislation is ultimately adopted, however, should not favor one segment over another.

The Essential Role of Congress Is Being Usurped

When the House passed H.R. 10 last month, it marked almost ten years since either body had attempted to enact financial restructuring legislation. As noted above, despite this inertia on the part of Congress, the financial landscape has changed dramatically over this period, with a handful of regulators and the courts making all the key decisions with predictable bias and self-interest. The perils of this ad hoc approach to changing the structure of financial services may be temporarily obscured by a strong economy. Sooner or later, however, the pitfalls of such parochial initiatives are going to be felt. Congress is running out of time to establish sound policy to protect both consumers and competitiveness in financial markets.

Regulators focusing narrowly on one industry segment simply cannot be objective on these issues, and no one expects them to be. That is why it is so critical for Congress, with its broader perspective, to balance the interests of the affected parties and move the process forward. H. R. 10 represents such a balance. It is not perfect and provides only one possible approach to financial modernization, but it has achieved the broadest consensus yet on how to deal with this vital and complex issue. Congress would be well-advised to seize this opportunity to modernize the financial laws which were designed to address problems in a world far less complex than the one in which we find ourselves today.

Some Senators have expressed reservations about advancing legislation of this importance without having more time to examine the relevant issues. We would observe, however, that this issue was fully aired in the Senate throughout the 1980s. Twice, reform bills passed the Senate but were not taken up by the House. The core issues have not changed, nor has the basic ingredient for achieving balance and fairness - functional regulation. The principal difference between now and 1988, when the Senate last sent such a financial modernization bill to the House, is that banks now enjoy a regulatory advantage which some are reluctant to give up in exchange for a bill which is merely fair.

More time will not make the hard political choices any easier. As for the prospect of the Senate taking this legislation up in the next Congress, we would urge members of this Committee to confer with their colleagues on the House Banking and Commerce Committees, who look back on their two-year experience of producing a bill with the same fondness as Russians do the Siege of Leningrad. In this case, more is not necessarily better.

Further, if this opportunity is missed, Congress may well have passed on its last real chance to be relevant in the context of national financial policy for the foreseeable future. Several things are important in this regard: First, moving H.R. 10 through the House was a bruising process which Members will not soon forget and which they certainly will not want to repeat next year. Second, without legislation this year, there will undoubtedly be a proliferation of applications for unitary thrift charters, which will, when granted, further complicate the banking and commerce issue and make it that much more difficult to balance industry interests down the road. Third, the OCC is likely to further muddy the waters by extending new authority to national banks, thus increasing litigation and uncertainty as well as adding to the present competitive imbalance.

In short, this is the best and perhaps the last opportunity for Congress to do take this important step. More time is not the answer. And in any event, passage of H.R. 10 this year should not be considered the last word on this broad subject. Subsequent Congresses will have ample opportunity of revisit the policy decisions reflected in H.R. 10 as additional developments in the marketplace continue to unfold.

International Considerations

While much of the debate has focused on domestic pressures to revamp our financial markets, the threat which inaction poses from an international perspective is often overlooked. This danger arises from two distinct, but related, causes.

First, within the U.S. market, foreign financial competitors face the same limitations on activities as their U.S. counterparts. But, because of their current ability to affiliate abroad, they are getting a valuable head start with regard to consolidating and managing multi-faceted financial conglomerates, merging customer lists, devising cross-marketing strategies, and acquiring and allocating capital between and among divisions. In addition, they are already acquiring U.S. firms in anticipation of an eventual change in our financial laws. The net result is that when our laws do change, these foreign competitors will have a meaningful advantage over U.S. companies within our domestic market.

Second, in emerging markets in Europe, Asia and elsewhere, foreign competitors with broader financial authority are making inroads that threaten the historic dominant position of U.S. financial intermediaries in the world economy. This situation will only worsen over time.

U.S. financial institutions are the strongest in the world and our financial markets the most stable, but they must adapt to changing conditions in international finance if they are to remain so. We are already behind foreign competition in our efforts to modernize financial services. Further delay will damage our ability to compete internationally for years to come.

Key Issues for Insurance Companies

Functional Regulation

As insurance companies set out to formulate a legislative strategy in the House almost two years ago, we elected to pursue a minimalist approach to the provisions we sought in a bill. By and large, we were willing to give banks the one insurance power they have not gotten (and might never get) through regulatory and court decisions - and that is insurance underwriting. In return, insurers have asked for functional regulation. That is, if banks wish to diversify into insurance, they should be generally subject to the same regulatory requirements to which we are subject. We have no interest in preserving or gaining any competitive advantage over banks through the legislative process, and we do not believe this process should preserve or afford banks any regulatory advantage over us.

We have heard complaints from some quarters that insurance companies got everything they wanted in H.R. 10 and that they must therefore give up some of their gains in the Senate - presumably to make the legislation more "fair" to banks. We are not rigidly wedded to the exact language of most of the insurance provisions in H.R. 10. We would emphasize, however, that each of the provisions in H.R. 10 that are important to insurance companies and summarized in this section of our statement are central to assuring a fundamentally equitable and balanced bill for all financial service firms - not just insurers. Functional regulation, properly crafted, permits banks, insurers and securities firms reasonable access to one another's businesses while at the same time assuring essential regulatory oversight.

While we are open to discussing different approaches for implementing functional regulation, each of the four elements of that concept - a definition of insurance, a balancing of the interests of state and federal regulators, elimination of judicial deference accorded federal regulators in certain narrow circumstances, and protection of the safety and soundness of insurance companies when they are under common ownership with a bank - are essential from our perspective. We believe each of these elements is reasonable, and we believe each is necessary and fully consistent with the idea of broad financial services modernization. Each of these elements is discussed below.

Definition of Insurance - Since the mid-1980s, a principal tool of the OCC in granting banks expanded insurance powers without changes in law is what might be called definitional sleight-of-hand. The OCC has repeatedly asserted that products that have historically been viewed as part of the business of insurance and regulated by the states as such are, when sold or otherwise dealt with by national bank, not insurance at all but part of, or incidental to, the business of banking. Indeed, in the view of the OCC legal staff, literally every aspect of the business of an insurance company could be categorized as part of, or incidental to, the business of banking. The OCC's definitional gambit has been applied to variable and fixed annuities, credit insurance, municipal bond guaranty insurance, mortgage completion insurance, and crop insurance to name but a few examples. When coupled with judicial deference enjoyed by the OCC in federal courts, the practice of relabeling insurance products as banking has been very productive for the OCC and those it regulates.

If there are to be functional "rules of the road" for diversified financial service firms, the mischief of relabeling products to gain regulatory or marketplace advantages must be curtailed. H.R. 10 gives banks full authority to sell insurance products and underwrite insurance through affiliates. The insurance rules of the road laid down by Congress must govern these activities. There is no point in enacting legislation requiring banks engaged in insurance to follow the insurance rules of the road if bank regulators can circumvent those requirements simply by asserting that a product or activity is really not insurance but rather part of the business of banking.

The definition of insurance is one provision in H.R. 10 that we would urge the Senate to leave unchanged. It is the product of extensive negotiations with the banking industry and represents a evenhanded approach to defining our business as well as protecting the business of banking from overreaching by state regulators. Existing banking and insurance products would retain their present character and remain subject to their present regulatory regimes, so there would be no risk of products now in the marketplace being shifted from the insurance to the banking side of the ledger or vice versa. For products developed in the future, the definition of insurance would be tied to the Internal Revenue Code. If a new product is entitled to insurance tax treatment under federal tax law, it would be insurance. If the product is not entitled to insurance tax treatment, even if it is first issued (underwritten) by an insurer, it could be issued by a bank subject to the exclusive jurisdiction of bank regulators. By tying the definition of insurance for new products to the federal tax code, there is no opportunity for any party - regulator or regulated - to play games with the system. We believe this definition is necessary to assure that functional regulation will in fact remain the foundation of our financial services system.

Judicial Deference - The issue of judicial deference involves a doctrine articulated by the Supreme Court to deal with increasingly crowded court dockets. In a 1984 case (Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc.), the Court held that if a statute is not clear on its face, and if a federal agency's interpretation of that statute is reasonable, the federal agency's judgment is afforded "controlling weight," and the reviewing court need not address the case on its merits. It is clear for several reasons that judicial deference as established by Chevron is inappropriate in the context of a "modernized" financial services environment.

First, judicial deference, like definitional sleight-of-hand, has been a useful tool for the OCC and national banks in gaining expanded insurance powers. However, since H.R. 10 or whatever financial modernization legislation Congress ultimately passes will explicitly give banks directly or indirectly all insurance powers, judicial deference will no longer be necessary in this context.

Second, banks have argued that any constraints on Chevron would damage the national bank charter. Quite simply Chevron is not, and has never been, a facet of the national bank charter. The case dealt with an oil company, an environmental group, and a ruling by the Environmental Protection Agency. While it is true that the OCC and national banks have benefitted greatly from courts sustaining OCC actions based on Chevron, that does not magically transform judicial deference into an integral part of the national bank charter.

Third, H.R. 10 addresses the judicial deference issue quite narrowly. It eliminates deference only where legitimate disputes arise between federal bank regulators and state insurance regulators. Chevron would remain in full force and effect for any insurance dispute involving private litigants (i.e., insurers, banks, agents) and would be unaffected in its application to any other matters not involving insurance and bank regulators.

Fourth, in this limited context all the elimination of deference does is require a reviewing court to decide a disagreement between state and federal regulators on its merits. It does not in any way prejudice a case against the OCC or any other bank regulator. Regulatory disputes would simply be decided without any special or controlling weight given to state or federal regulators. Is the OCC that fearful that its interpretations would be struck down if they are considered on their merits? Or does the agency simply want to preserve an unfair advantage in the courts to further its own interests? The answer seems obvious.

Balancing Regulatory Interests - Over the years, substantial distrust has characterized the relationship between the insurance and banking industries. Insurers distrust the OCC because of repeated power grabs through regulatory action, and banks fear that the states will hamper their ability and authority to engage in insurance activities, particularly insurance sales. In all fairness, concerns on both sides have a degree of merit.

H.R. 10 attempts to balance the interests of federal bank and state insurance regulators in a way that imposes some constraints on each but essentially preserves these regulators' fundamental and legitimate roles. The states would be prevented from preventing or significantly interfering with the insurance sales and cross-marketing activities of banks. Further, the states would be required to treat insurance underwriters affiliated with banks exactly the same as they treat unaffiliated underwriters. The OCC would, on the other hand, be precluded from preempting actions by the states that are consistent with the above limitations and would no longer be able to assert that insurance products are really not insurance but part of the business of banking. On balance, each regulator would retain all the authority necessary to carry out its statutory responsibilities effectively.

The language in H.R. 10 attempting to strike this balance may not be perfect and may benefit from additional refinement. But the concept is essential if disparate regulatory agendas are to be balanced in this legislation.

Preservation of Institutional Safety and Soundness - In a diversified financial service firm, each functional regulator needs to have the tools and the jurisdiction necessary to assure that nothing in the operation of the overall enterprise will jeopardize the safety and soundness of the piece of the pie it regulates. One essential tool is the ability to acquire financial information from other functional regulators or affiliated institutions. For example, the OCC and the Federal Reserve should have the ability to accurately evaluate the financial condition of an insurance underwriter affiliated with a bank. Likewise, the states should have adequate means of assessing the financial condition of a depository institution affiliated with an insurer.

Relatedly, each functional regulator should have the authority to take whatever steps it deems necessary to protect the safety and soundness of the financial firm for which it is responsible. Federal and state bank regulators should be in a position to prevent state insurance or state and federal securities regulators from taking any actions that would threaten the financial position of a bank. And state insurance regulators must be in a position to prevent bank regulators from weakening an insurer to bolster the capital position of an affiliated bank.

Reciprocal Authority

Given the intensely competitive environment in which financial service firms find themselves competing, it is essential that insurers, banks, and securities firms have the same competitive opportunities. If banks are to be permitted to affiliate with insurance companies, insurance companies must be permitted to affiliate with full service banks. As explained at the outset, one of the key reasons why insurance companies dropped their opposition to affiliations with banks was concern over competitive equality. We did not want to see the OCC succeed in permitting national banks to own insurance underwriters through the operating subsidiary loophole while insurers remained prohibited from owning national banks. While most insurers are not intent on acquiring banks at the present time, the ability to do so if circumstances warrant is viewed as essential. If affiliations with banks prove to be a strategic necessity, insurers must be in a position to react accordingly.

Redomestication of Mutual Insurance Companies

Mutual insurance companies are organized in cooperative form and have no stockholders, only policyholders. A mutual company may own the stock of a downstream subsidiary, but, having no shareholders, it cannot itself be the subsidiary of an upstream holding company. Accordingly, absent special legislation, a mutual insurance company is confined to a downstream structure for purposes of diversification. This structure imposes serious limitations on the ability of a mutual company to make significant acquisitions. These limitations include, among other things, quantitative investment limits and risk-based capital constraints. In addition, a mutual insurer cannot sell stock in the capital markets, thereby limiting its ability to raise capital for diversification purposes. Taken together, these factors place mutual insurers at a substantial disadvantage in an affiliated environment.

A number of states have now enacted legislation addressing this problem. These states permit their domiciled mutual insurers to reorganize into "mutual holding companies" with stock insurance company subsidiaries and one or more intermediate stock holding companies. A number of other states are considering such legislation. These mutual holding companies may then raise capital by selling portions of the stock of their intermediate holding companies. Moreover, like any acquisition made at the holding company level, an intermediate stock holding company of a mutual holding company could acquire a bank without encountering the limitations noted above that apply to downstream acquisitions.

Mutual insurers are now encouraged that the mutual holding company mechanism would place them in a better competitive position once insurer/bank affiliations are permitted under federal law. However, a number of mutual companies are domiciled in states that do not permit reorganization into mutual holding company form, leaving these companies at a distinct competitive disadvantage.

While state laws generally permit insurers to change their state of domicile, states are capable of imposing significant practical barriers to such redomestication. We do not believe that a mutual insurer's ability to participate fully in an affiliated financial services environment should depend solely on its state of domicile.

For these reasons, we support the language in Sections 311-316 of H.R. 10. These provisions enable a mutual insurance company domiciled in a state that does not have a mutual holding company law to redomesticate to another state that does in order to reorganize into mutual holding company form. Any company seeking to redomesticate for this purpose would have to meet all the regulatory requirements of the prospective state of domicile relative to such a transaction. We believe that the redomestication provision in an important and necessary element in any modernization legislation because it will enable mutual insurers to participate more meaningfully in a restructured financial service marketplace.

Appropriate Corporate Structure

Umbrella Regulator -- Functional regulation requires a rationalization of state insurance regulation with the roles of other regulators in an affiliated environment. Just as state insurance regulators have the obligation to protect insurer solvency and the interests of policyholders, the SEC is responsible for ensuring that brokerage firms maintain adequate capital levels. The OCC is responsible for assuring the safety and soundness of national banks, and state bank supervisors have similar obligations for state-chartered institutions. The OTS oversees thrifts, while the FDIC is charged with protecting the deposit insurance funds. Lastly, the Federal Reserve has extensive regulatory authority under the Bank Holding Company Act to protect insured institutions and the payments system. The challenge of financial restructuring is to permit all of the entities regulated under these differing regimes to exist under common ownership, making certain that each regulator can continue to carry out its statutory responsibilities effectively.

Insurers believe that the holding company model provides the most appropriate means to facilitate functional regulation in an affiliated environment. Solvency and other substantive regulatory requirements should be imposed largely at the institutional level, with umbrella oversight by the Federal Reserve limited largely to regulatory coordination, information gathering and the monitoring of affiliate activities. If the operations of affiliates pose risks to an insurer, insurance regulators should be able to deal with the threat by directing additional requirements at the insurer - not the insurer's affiliates. The same should be true for other functional regulators dealing with the entities over which they have primary authority.

In our view, H.R. 10 as passed by the House affords the Fed broader authority at the holding company level than is necessary to protect the integrity of the payments system. However, our concerns in that regard have been lessened by the inclusion of so-called "Fed-lite" provisions and limitations on the ability of the Fed to impose capital requirements on insurers beyond those approved by state regulators. As a result, we support the regulatory structure for holding companies as contained in H.R. 10.

Operating Subsidiaries -- Another key structural consideration is where to locate insurance underwriting activities in an entity that includes a bank. The Treasury maintains that convenience and flexibility dictate that such activities be permitted either in a direct operating subsidiary of a bank or in a holding company affiliate of the bank. We strongly oppose the use of bank operating subsidiaries for insurance underwriting for the following reasons:

• Permitting insurance underwriting in a bank operating subsidiary puts insurance companies and their policyholders at risk by inappropriately creating the potential for insurance industry assets to backstop parent banks falling below the well-capitalized level. When a national bank experiences financial difficulty, the OCC has the authority - and perhaps the obligation - to use capital from the institution's nonbank subsidiaries to restore the bank's capital position. If an insurer is one of the operating subsidiaries, the OCC may feel perfectly free to pull capital out of the insurer, even to the point of causing the insurer to become insolvent.

Unlike bank failures which are covered by the FDIC, the obligations of a failed insurance company must be picked up by other insurance companies as part of a state-operated, post-failure assessment guaranty system. The insurance industry will strongly oppose any financial modernization legislation that positions insurance companies as a buffer between capital-impaired banks and the federal deposit insurance funds.

There is every incentive for the OCC to utilize insurance company assets in this manner, since the subsequently-depleted insurer will be a problem for the states, policyholders and other insurance companies, not the federal government and federal taxpayers. Bank capital problems caused by poor banking practices or inadequate bank regulatory judgements should not be remedied by the insurance industry and its policyholders.

• The use of operating subsidiaries to engage in capital intensive nonbanking activities such as insurance underwriting allows banks to convert the capital cost subsidy of the federal safety net into a competitive advantage vis-a-vis nonbank financial service providers. It is acknowledged in many quarters that deposit insurance and the other elements of the federal safety net allow banks to attract capital more cheaply than nonbank financial service providers. Additionally, banks that encounter a capital squeeze may, unlike nonbank financial services firms, secure necessary capital on an immediate basis at below market rates at the Federal Reserve discount window. Permitting banks to use this capitalization advantage or access to the discount window to create and operate nonbanking subsidiaries that compete directly with businesses which must raise capital without federal backing is inherently unfair. These problems are minimized by requiring nonbanking activities like insurance underwriting to be conducted through holding company affiliates of the bank.



• The use of operating subsidiaries to engage in nonbanking activities creates an unfair regulatory advantage for banks. Under the terms of H.R. 10, if an insurance company acquires a bank - whether as a downstream subsidiary or as an upstream holding company affiliate - the insurer would, by operation of law, become part of a bank holding company system subject to regulation by the Federal Reserve Board. There is no practical way for an insurer to acquire a bank without becoming subject to Fed jurisdiction. On the other hand, if a bank is permitted to acquire an insurance underwriter as an operating subsidiary, neither the bank nor the insurer would be subject to Fed jurisdiction. This is not to suggest that Fed regulation is unreasonably burdensome or oppressive. But it is significant, and it certainly entails regulatory costs. There is no public policy justification for legislatively mandating this type of disparate regulatory structure.

The Treasury's argument that the operating subsidiary alternative for owning insurance underwriters is necessary for the flexibility and convenience of national banks does not outweigh any of the above concerns individually and certainly does not outweigh them collectively. In fact, the lack of substantive underpinnings for Treasury's push for expanded operating subsidiary authority for national banks only serves to highlight the obvious conclusion that most observers have already drawn - that this is simply a fight between the Treasury and the Fed over jurisdiction.

Conclusion

The time has come for Congress to make some hard decisions about how our financial markets will be structured and regulated. We can no longer afford to leave these decisions to unelected regulators with narrow, parochial interests. H.R. 10 as passed by the House provides a good basic structure for financial modernization, although it is by no means the only possible answer to the complex issues which this subject presents.

Insurance companies have supported financial modernization legislation primarily as a means of assuring equal competitive opportunities and to make certain that banks diversifying into our business do not have regulatory or marketplace advantages resulting from unilateral decisions by federal regulators or the courts. Our guiding principle in pursuing legislation has been straightforward and reasonable - banks engaged in insurance activities should generally be subject to the same laws and regulations that are imposed on insurers who are not affiliated with banks. While Congress may conclude that some additional requirements are appropriate for insurance sales, a simple nondiscrimination standard is fully adequate for insurance underwriting.

We have supported H.R. 10 because it embodies these principles and is otherwise fair to every segment of the financial services industry. It lets every player compete without creating or perpetuating unfair advantages for some.

For years Congress has pleaded with the various groups within the financial services industry to come up with an approach that all could support. H.R. 10 is as close to a consensus as is possible in that regard. Virtually the entire insurance and securities industries and a significant segment of the banking industry is behind it. Without trying to be over-dramatic, there is no guarantee, given further regulatory decisions and developments in the marketplace, that the stars will ever align like this again. It has taken more than sixty years to get to this point. If Congress does not take this opportunity to rationalize the financial markets, it may be lost for many years to come.

For all these reasons, we strongly urge the members of this Committee to make every effort to bring H.R. 10, or something like it, to the Senate floor this year.

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