A profound change: the SMART bill's most far-reaching change may be preemption of state approval of rates.

For decades, federal regulation of insurance has been either sought or fought, with equivalent passion, by and among the industry and state regulators. With release of a discussion draft of the "State Modernization and Regulatory Transparency Act," which is known by its acronym "SMART" it finally appears possible that Congress will enact such legislation within the next few years.

The House Financial Securities Committee under Chairman Mike Oxley and Rep. Richard H. Baker developed the draft bill. The SMART Act proposes numerous wide-ranging changes to the current state regulatory system, but is most notable, and likely of passage, for what it does not do. SMART does not create a federal licensing scheme and does not provide for the establishment of a federal regulator. Rather, the act seeks to build upon the experience of the states and the industry with the National Association of Registered Agents and Brokers as legislated by Gramm-Leach-Bliley.

GLB required that, within two years of its passage in 1999, a majority of the states had to either adopt uniform insurance producer licensing laws or see their producer licensing authority turned over to NARAB, a quasi-governmental independent licensing organization. The states met the deadline, and NARAB never materialized, thereby allowing state regulators to continue their historical role. In many states, the industry reaped the benefits of streamlined, rationalized licensing procedures. Supporters of SMART propose to take this carrot and stick approach to the next level, using it to achieve uniformity and reform among all states and across a breathtakingly broad swath of the insurance regulatory landscape.

The 27 separate titles of the bill reveal its scope, from insurer and producer licensing, life and property/casualty insurance, surplus lines and reinsurance to market conduct, antifraud, receivership, financial surveillance and state-national coordination. This is ambitious, intended to remove commercial impediments posed by traditional state regulation and its lack of homogeneity.

Perhaps SMART's most far-reaching change would be preemption of state approval of rates. "After the expiration of the two-year period beginning upon the effective date of this section, no State may require the approval, establishment or prior review of any rate charged for an insurance policy by an insurer," the bill says. Before expiration of the two-year period, a state may choose to regulate rates by introducing or continuing a flex-band percentage restriction on rate variations. However, even a state's ability to regulate rates for the two-year period is restricted, since commercial lines subject to deregulation under a different provision of the bill are not subject to temporary flex rating provisions. Credit, title, mortgage, gap and medical malpractice insurance are exempt from rating preemption, and would continue to be subject to regulation.

Chairman Oxley drew attention to the noncompetitive return on equity experienced by the insurance industry and the resulting capacity shortage in remarks to the National Association of Insurance Commissioners in March 2004. "If insurers cannot raise new capital, this marketplace is at risk for a major collapse, he said. Elimination of rate controls and a move to true competitive rating is seen by Oxley and supporters of the bill as central to insurers improving their ROE, attracting new capital and expanding capacity. However, there may be those who will dispute this view and point to the cyclical nature of the market. Therefore, competitive rating nearly across the board may wind up accelerating this cycle, and creating more rate and capacity instability without the desired effect on ROE.

The SMART Act promises to bring about the most far-reaching and profound changes in insurance regulation since the evolution of the modern state-based system. Of course, since the exposure draft of the act was released, the insurance industry has been rocked to its foundations by the Spitzer investigation and subsequent legal actions and investigations by numerous agencies across the country. Congress also has involved itself in the inquiry. How these developments will impact the SMART Act and its prospects for adoption are difficult to predict. Opponents of the SMART Act have declared it "dead in the water, while its proponents point to the industry's problems as further evidence of the need for its enactment.

Should the act ultimately be adopted in a form similar to that released for comment, the industry, regulators and consumers will come to know the meaning of the proverbial Chinese curse, "May you live in interesting times."

Nick Pearson is a partner in the Insurance and Reinsurance Department of national law firm Edwards & Angell. He may be reached at insight @bestreview.com.