One on One: "We concluded [that] the federal charter option was the only real, viable second track"

Like the rest of the financial services industry, life insurers face major issues stemming from overlapping, inefficient regulatory regimes.

As the senior vice president and general counsel for the American Council of Life Insurers, Gary Hughes is the industry’s point man for coming up with policy solutions to those problems.

The biggest issue looming is whether there should be an optional federal charter for companies to use in place of the state regulation that the industry has clung to for decades. Along with other trade groups, Mr. Hughes has helped to formulate the industry response and is lobbying Congress for the federal option.

William Fisher, vice president and associate general counsel at Massachusetts Mutual Life Insurance Co. in Springfield, Mass., says Mr. Hughes is “a consummate professional” – technically adept, with a keen understanding of the issues, and good communication skills.

“That’s one of the more challenging positions,” Mr. Fisher says of trade association work. “By definition, a trade association is a voluntary association. Within this industry, there are always conflicting views on any issue.

“The role of the trade association person is to reconcile those views and reach some consensus. It’s like herding a group of cats. It’s not always the easiest thing in the world, and Gary does it in a non-offensive manner.”

Q Why does the insurance industry need a federal charter option?

A Historically life insurers competed against other life insurance companies. We knew the system of insurance regulation was inefficient, but it didn’t really translate to the bottom line.

Since everybody was subject to the same system, we were all subject to it uniformly. There was an acknowledgment that things ought to be running more efficiently, but it didn’t make all that much difference.

As insurance companies positioned themselves as providers of financial services, the competition was Wells Fargo, T. Rowe Price, competing head-on with commercial banks and mutual funds. Now suddenly the inefficiencies became important, mainly in the area of speed to market.

An example: You have a national bank, a mutual fund complex and a life insurance company. All decide they have an innovative product they want to use in the retirement market. The national bank can be doing a national business with that new product in a matter of weeks. The mutual fund company would have to get approval from the SEC, but in 60 to 90 days, you’ve cleared the SEC.

The life insurance company has to get approval in 51-plus jurisdictions. We’re looking at 12 to 18 months, sometimes up to two years. The math isn’t very good, weeks versus years. To remain efficient and competitive, this just became an increasing problem.

We did a two-year study [completed in 2000] about the state of life insurance regulation. The conclusion generally was that the laws on the books weren’t so bad, but it was the multiple jurisdiction of them, and the fact that states were doing things differently, not necessarily badly.

Companies were squeezing efficiencies out of their own operations. If the shelf life for a lot of these innovative products is two years, and it takes you two years to get your product approved, that’s not a good proposition.

The whole issue is speed to market, and lack of uniformity at the state level.

Q Will the federal government step in?

A It had better happen in one of the two places, or we as an industry are not going to fare well. Our board said we would go after a two-track strategy. [One part of that is] to redouble our efforts to work with the states to make a state-based system of life insurance regulation compatible with life in the 21st century. Whether it happens quickly or sometime down the road is the key question.

A lot of our member companies would like to remain state regulated, on a much more efficient basis. If the states can’t get that done, then it’s going to drive companies away that really would like to remain state regulated.

But our board said, “We’re not going to put all our eggs in one basket.” Some companies see their future tied to a federal charter. At the same time, we will begin serious exploration of whether a dual regulatory environment, similar to the commercial banking sector, would make sense for the life insurance business. We concluded [that] the federal charter option was the only real, viable second track.

Q What do you want in a federal charter?

A We’re just finishing drafting legislation now. The fundamental principle is to maintain charter neutrality. We don’t want to give the federal charter more advantages, like tax advantages, that the states can’t match. Companies would say, “I don’t have any choice.” We have tried to fix what needs fixing.

Q The states said the industry is trying to blackmail them by threatening a federal charter. Is that valid?

A If there are ways to increase the pressure on the states to modernize a system that even the states will acknowledge is badly outdated, I’m not sure I see that that is a bad idea.

The message we are sending to the states is, the status quo is not acceptable. If the states can [take care of problems in the system] fairly quickly, the likelihood of there being a federal charter is pretty remote.

Q Will the industry get involved in the government reinsurance issue?

A After Sept. 11, we are not in the same position as the property-casualty industry. Sept. 11 was tragic in the ways we all know. What it did not create is a tremendously significant mortality event.

But there are issues lurking. Is there still going to be a private market for life insurance that would insure against acts of terrorism? Many life insurance companies have said, “We have never had to worry about pricing for acts of terrorism.” Now we are. If life reinsurers exclude for acts of terrorism, then the primary carriers will have a hard time spreading that risk. Does that mean they’ll have exclusions? If so, there is no private market. How does that come out? I’m not sure.

Are there events of a much greater magnitude that would be significant? How high is the risk of a major mortality event? That’s speculation, but people are now wondering, “Would we need some mechanism, not necessarily a reinsurance pool, but some mechanism, to address that?” Is there still a private market, and are there events in the future that could overwhelm the life insurance business? If yes, what is the appropriate mechanism? Is it a private-sector initiative, a shared initiative with the federal government?

Q What are the major regulatory issues?

A Regulatory efficiency and modernization will be the substantial agenda item. That’s a lot of what’s going on in the states now.

[One of the regulatory initiatives is a] product-approval mechanism, a single point of filing. A group of regulators would react, have a drop-dead date [to act on the product application]. There would be a set of regulations to establish the criteria for that product.

All states in which a company wants to market that product would accept the approval. It’s in a pilot stage – 10 states, three products. It gets away from having to start from square one in every single jurisdiction that you want to sell your product in.

Also, make agent licensing more efficient.

Q What is the aftermath of financial services modernization legislation for the life insurance industry?

A Everybody thought the insurance industry was hasty in promoting Gramm-Leach-Bliley, because it was going to facilitate the industry’s acquisition by commercial banks. It hasn’t happened. Some of this is the banking industry saying, “We want to get rid of this barrier to our acquiring an insurance company.” If you tell somebody you can’t do something, the pressure builds up that, “Yes, I can.”

We all seem too preoccupied with keeping Wall Street happy. If life insurance has a lower return on equity than commercial banks do, acquiring one won’t find favor on Wall Street. For a life insurance company to acquire a bank, with a commercial bank having a higher return on equity, maybe Wall Street finds that to be a good deal.

SNAP SHOT

Gary Hughes, 54, senior vice president and general counsel, American Council of Life Insurers in Washington

Career: 1998, appointed general counsel of ACLI; 1981-98, headed ACLI’s securities and banking department; 1977, joined ACLI after spending four years with the Securities and Exchange Commission in the divisions of corporation finance and investment management

Education: law degree, William and Mary School of Law, 1973; bachelor of arts in business administration, cum laude, Principia College, 1970

Other background: He serves on the American Bar Association’s committee on developments in investment services, the committee on consumer financial services and the subcommittee on securities activities of insurance companies. He is also a member of the board of governors of the Association of Life Insurance Council and a past chairman of its securities section.