Optional Federal Charter
August 2007
Insurance in the United States has traditionally been regulated by individual states. Now many in the insurance industry see the current state system as overly complex, anticompetitive and unduly burdensome in that it increases the cost of compliance and delays the launching of new products.
Dual Reporting and Modernization
Reform proposals at the national level are moving in two directions. One is a dual (federal/state) chartering system similar to the banking industry’s dual regulatory system that would allow companies to choose between the state system and a national regulatory structure that would eliminate the need to comply with 51 sets of different regulations. The other is modernization of the state system. One proposal would create a framework for a national system of state-based regulation, which would create uniform standards in such areas as market conduct, licensing, the filing of new products and reinsurance. Among those supporting an optional charter are large insurers that sell coverage to major corporations, reinsurers, brokerage firms, life insurers and banks that are moving into the insurance business.
Under the 1999 Gramm-Leach-Bliley Financial Services Modernization Act, insurance activities — whether conducted by banks, broker-dealers or insurers — are regulated by the states. The Act specifically protected 13 areas of state insurance regulation from federal preemption. However, it spurred the enactment of uniform insurance agent licensing laws or reciprocity measures.
Recent Developments
Dual Insurance Charter: In May 2007 two members of the Senate Banking Committee, Republican Sen. John Sununu of New Hampshire and Democratic Sen. Tim Johnson of South Dakota, reintroduced a bill that would establish an optional federal insurance charter and a federal insurance regulator. Sununu and Johnson introduced a similar bill last year, but the Banking Committee did not act on it. The bill affects life insurance and property/casualty insurance but not health insurance. It would create a National Insurance Commissioner, appointed by the President for a five-year term, and establish a Division of Consumer Affairs, Fraud and Ombudsman. Under the law, state licenses would not be needed to write lines of business under the national license. On July 26 Rep. Melissa Bean, D-Illinois and Rep. Ed Royce, R-California, introduced companion legislation,(H.R. 3200), in the House.
Under the proposal, federal companies would not need to file rates with regulators or file forms used for their policies as required by most states for most lines of business. It states: “The Act does not authorize the commissioner to require a National Insurer to use any particular rate, rating element, price or form.” Federal regulation would set minimum financial requirements for federal insurers while states would continue to set requirements for insurers that choose to be licensed by the states. The bill calls for onsite exams to be held at least once every three years and a fund to be set up to pay the claims of insolvent insurers, as with current state regulation.
The bill includes a provision that would allow state companies to do business on a surplus lines basis and allow surplus lines companies to be affiliated with national insurers. Surplus lines are specialized insurance companies that exist to take on risks that the regular market rejects and which are less regulated than regular insurers.
Another bill deals more specifically with surplus lines regulation. In 2006 HR 5637, a bill that would apply a single-state regulation and uniform standards to reinsurance and surplus lines, was easily approved by the House. It was based largely on provisions contained in the earlier draft proposal known as the State Modernization and Regulatory Transparency (SMART) Act. The bill was reintroduced as HR 1065 in early 2007. It has the support of insurance groups both for and against optional federal chartering.
Other Proposals: Life insurance companies have been long been in favor of a federal charter for insurance regulation. In the absence of that option, the NAIC developed a state-based system that borrows from the concept of federal regulation. The NAIC’s Interstate Insurance Product Regulation Compact, known as the Compact, was launched in 2002 to develop uniform standards and a central clearinghouse to provide prompt review and regulatory approval for life insurance products. The Compact requires individual states to pass legislation enabling it and, as of June 2007, 29 states had done so, a sufficient number to bring the compact into force. However, if Sununu/Johnson bill becomes law and a national charter become an option, some life insurance companies may prefer that form of regulation.
Studies: In May 2007 the American Council of Life Insurers (ACLI) released a study that found that a federal charter would save life insurers approximately $5.7 billion a year in compliance costs related to supervision by multiple state regulators. The study also found the extra costs of compliance are passed along to customers in the form of higher premiums or fees.
Background: Insurance as a State-Regulated Business: Insurance regulation began in an era when states regulated railroads, utilities, and almost all other domestic commerce with minimal federal involvement. At the time, small mutual companies insuring property risks were the norm and the vast majority of insurance was sold by companies that operated in a single state, or at most a very small region. Gradually, large interstate life and property/casualty insurance stock companies came to dominate the market. States with a large insurance presence put together regulatory systems that worked reasonably well. Connecticut and New York were pre-eminent in developing law and regulatory procedures because many large insurers were incorporated there.
In 1871, the National Association of Insurance Commissioners (NAIC) was founded to coordinate the work of state insurance commissioners. Over the years the group has become a strong force in strengthening solvency regulation. It developed an accreditation program that required state insurance departments to meet certain prescribed standards. It also established minimum capital requirements for insurers, based on the riskiness of their business.
Interest in Federal Regulation: The issue of federal regulation has surfaced before, but in response to different circumstances. Currently, it is being driven by concerns about competition and cost inefficiencies. In the 1980s, it stemmed from perceptions about the effectiveness of state solvency regulations after several major bankruptcies.
These insolvencies and the fallout from the savings and loan crisis prompted a Congressional study which culminated in the February 1990 report, "Failed Promises: Insurance Company Insolvencies." Known as the Dingell report after the chairman of the committee that investigated the insolvency cases, Rep. John Dingell (D-MI), the study looked at the insolvencies of Mission Insurance Co., and Transit Casualty Co., both with headquarters in California although Transit Casualty was chartered in Missouri, Integrity Insurance Co. of New Jersey and Anglo-American Insurance Co. of Texas and found what it called "disturbing" parallels between the mismanagement and fraudulent activity that led to the four insurer insolvencies and the factors that precipitated the savings and loan crisis. Specifically, it attributed the insurance company failures to rapid expansion, unsupervised delegation of authority, extensive and complex reinsurance arrangements, underpricing, reserve problems, false reports, reckless management, incompetence, fraud, greed, and self-dealing. Debate over the failings of the companies gave rise to proposals for a federal regulatory system.
Pressure Builds to Bring Regulation into the 21st Century: More than a decade later, the concern is not so much failure of the regulatory system as delays in the approval process. All insurers, regardless of their specialty or size, are in favor of modernization. They want a system that responds faster so that they can bring new products to the marketplace in a more timely fashion. However, insurers are sharply divided over the kind of regulatory system that should be in place to implement changes that oversee the industry. Insurers who argue for the continuation of a purely state system of regulation say that state legislators and regulators are more keenly aware of what is needed in their respective states and are better able to respond to the concerns and problems of consumers. They say that a system of individual state regulation encourages experimentation and innovation that may become a model for other states. Others, particularly life insurers and large property/casualty insurers that write commercial coverages, believe that an optional federal charter will best allow them to compete with other financial services firms. Insurance industry observers say it can take as long as two years for a new life insurance product to be approved by all 51 jurisdictions.
The passage of the federal Gramm-Leach-Bliley financial services reform law in 1999, which allows insurance companies and banks to engage in a broad range of financial services, spurred some activity although in one sense the law preserved the status quo. The legislation said that insurance activities — whether conducted by banks, broker-dealers, or insurers — are functionally regulated by the states. It specifically protects 13 specific areas of state insurance regulation from federal preemption. These areas, known as safe harbors, protect states from federal interference in state laws and practices, if they remain within boundaries that protect against discrimination.
However, the Act also put the U.S. financial services industry as a whole more on a par with that of other developed countries and moved insurance agents toward an era of greater regulatory standardization. Under the Act, if within three years (2002) a majority of states had not enacted uniform insurance agent licensing laws or reciprocity measures, a private national licensing organization would be created. This National Association of Registered Agents and Brokers would function as a self-regulating organization much like the National Association of Securities Dealers. The states met that goal.
In September 2003 the NAIC issued "A Reinforced Commitment: Insurance Regulatory Modernization Action Plan," emphasizing the renewed commitment of state regulators to continue modernizing the state-based system of insurance regulation, including the implementation of its Interstate Insurance Product Regulation Compact plan to create uniform product standards for life insurers. The NAIC said that it hoped the Compact would be operational in at least 30 states or states representing 60 percent of the premium volume for life insurance, annuities, disability income insurance and long-term care insurance products by year-end 2008.
Source:Insurance Information Institute Inc