U.S. insurance regulation in focus amid meltdown

NEW YORK (Reuters) - The United States is expected to embrace federal regulation of the insurance industry as early as 2009, according to financial and insurance executives, pushed to the forefront by the global economic crisis.

Federal regulation in the United States -- something that most other nations already have -- is expected, at least initially, to function in tandem with the existing state regulatory framework rather then supplant it, Lloyd's of London's chairman Peter Levene told Reuters on Tuesday.

"This is a halfway house," Levene said of a proposal devised by U.S. Treasury officials earlier this year that would create a federal office for insurance regulation.

"It is gaining quite a bit of traction, and if it happens in the next year, we would regard that as good progress," Levene added.

The near failure of insurance giant American International Group Inc (AIG.N) has propelled the likelihood of federal regulation of the industry. Insurers are now regulated by states.

The United States had to step in to save AIG in September, after state regulators ran out of resources to help the company address a severe cash crunch.

AIG's bailout -- pulled together by the U.S. Treasury, Federal Reserve and New York State insurance regulator over a matter of days as the insurer neared bankruptcy -- has swelled to $150 billion from an initial $85 billion.

Lack of federal regulation is proving thorny for some other insurers attempting to tap into a broader federal funding program, as they try to boost capital drained away by investment losses.

Eligibility for the government's $700 billion bailout of the financial services sector is limited to those that are federally regulated, leaving most insurers out in the cold.

FAVORING FEDERAL REGULATION

Lloyd's, the world's oldest and biggest insurance market, does significant business in the United States, and has long been in favor of the United States taking a federal regulatory approach. The prospect was shunted until recently because some in the industry, including state regulators, opposed it.

"Insurers would be better served" by a federal regulator, said Joseph Perella, managing partner of corporate advisory firm Perella Weinberg Partners, speaking at a forum on business risks hosted by Lloyd's.

Regulatory change more broadly is long overdue, Perella added, noting that oversight generally has not kept pace with massive shifts in business markets over the past few decades.

In the United States, "state and federal coordination must improve," he added.

Perella -- a veteran deal maker who founded his advisory firm after a long career in banking -- is an advisor to C.V. Starr, a firm run by former AIG Chief Executive Maurice "Hank" Greenberg.

C.V. Starr was AIG's largest shareholder before the government took an 80 percent stake as part of its rescue plan.

Several insurers, including Hartford Financial Services Group Inc (HIG.N), a large life and property insurer, have rushed to buy small banks, which are federally regulated, in order to meet eligibility for federal funding.

"You have got to expect these kind of things to happen when there is ($700 billion) on the table," said Perella.

More than 2 trillion euros (about $2.5 trillion) has been pledged for troubled financial services firms by European governments to date, and in the United States $700 billion has been set aside for the Troubled Assets Relief Program, or TARP, not including additional sums committed in the bailouts of government sponsored entities, giant insurer American International Group Inc, and others.

(Reporting by Lilla Zuill; Editing by Brian Moss)