Insurance regulation: a time for change; can the states fix the age-old system of insurance regulation to meet the needs of the modern economy, or will a federal takeover leave consumers to fend for themselves?

A bride and groom stand before a majestic view as the Beatles song plays, "When I get old and losing my hair, many years from now..." The commercial moves through images of the couple's life together: having children, paying for college and then, as seniors, embracing as they look blissfully into the distance.

"When you spend your Life in Good Hands," it reads across a black background, "you end up in a good place." It then reveals the sponsor, Allstate, flashing the company's lines of service--auto, home and life insurance--before leaving "Allstate Retirement" on the screen to linger.

"Will you still need me, will you still feed me ... when I'm 64?"

The television ad is a clever signal of a new era in financial services. The federal Financial Modernization Act of 1999--also called Gramm-Leach-Bliley--tore down Depression-era barriers to permit affiliations and integration among insurance companies, banks and securities firms. Now, with a backdrop of scandal among top brokerage firms like Merrill Lynch and Morgan Stanley, companies like Allstate, State Farm and Nationwide are looking to capitalize on strong reputations as household insurance names to gain ground in the new market. They're no longer "insurance" but "financial" companies.

Although these new firms offer banking and investment services, too, the rubber meets the road for states when it comes to insurance products--specifically long-term, investment-oriented insurance policies known as "asset-based" insurance. These include life insurance, annuities, disability income and long-term care insurance.

Whereas banks are regulated under a dual chartering system where the institution picks its regulator, state or federal, and the Securities and Exchange Commission (SEC) is responsible for securities oversight, the states regulate insurance--and have for 152 years.

"Insurance is a different kind of financial service," says Representative Frank Mautino, who chairs the insurance committee in the Illinois House. "Where banks and securities are about access to capital and risk-taking, insurance is about guarantees--a promise to pay benefits, if and when certain things happen."

Because they are more accessible, accountable and sensitive to local economic and social conditions than the federal government, states can provide the higher degree of consumer protection that insurance requires, he says.

But the 50-state regulatory system also can cause problems for some insurance companies as they try to market asset-based insurance policies nationally to compete with the products of federally regulated banks and securities firms, like money market accounts and mutual funds.

At a June 2002 hearing before the U.S. House Committee on Financial Services, Joseph Gasper, the president and CEO of Nationwide Financial, made the case for federal regulation on behalf of the American Council of Life Insurers.

"The current state of the insurance regulatory system is lacking in uniformity and efficiency," he said. "These lapses diminish the ability of insurers to compete effectively in a changed financial services marketplace or to serve our customers' needs in the most productive and efficient manner."

Gasper told Congress that, where banks can roll out an innovative credit instrument like a certificate of deposit within 30 days and the SEC might take 60 days to approve a securities product, getting approval in all states for a new life insurance policy or annuity product can take up to two years. And the company could wind up with 35 to 40 versions to satisfy myriad state standards.

"The competitive implications of this disparity in regulatory efficiency are enormous," he said.

State officials acknowledge the need for reforms to meet the needs of the modern economy, particularly to address the speed to market issues raised by Gasper. However, they emphasize that consumer protection--and not commercial competition--is what insurance regulation is all about.

"We don't want to throw the baby out with the bath water," Iowa Insurance Commissioner Tern Vaughan told the same U.S. House committee on behalf of the National Association of Insurance Commissioners (NAIC).

"You cannot create a federal regulatory system in Washington without affecting the important consumer protections that we have in place," said Vaughan. "So the question is can we find a targeted solution for life insurance and annuity products without gutting the rest of the system."

Insurance commissioners say the answer is an interstate insurance compact. The new question is whether state legislatures will agree.

152 YEARS LATER

States have been the sole regulators of the business of insurance for 152 years--since New Hampshire established the first regulatory agency in 1851. Although hard to imagine now, it was a 1869 U.S. Supreme Court ruling that declared that insurance wasn't interstate commerce (it actually said it wasn't commerce, either), that it wasn't subject to the Commerce Clause of the Constitution and that it couldn't be regulated by the federal government.

By the time the nation's highest court changed its mind 75 years later and said that it could be federally regulated, the state system was well established. Congress moved quickly to pass the McCarran-Ferguson Act of 1945, which returned the authority to regulate insurance to the states.

State regulation along with the Glass-Steagall Act--a Depression-era law that forbade affiliations among insurance companies, banks and securities firms--permitted the business of insurance to evolve in its own way at its own pace. Insurers were typically local and often mutual companies. Insurance agents provided a personal connection. And the very nature of insurance--to be there when you're ill, when your home's destroyed or when a loved one dies--made it a very different kind of service.

State insurance regulation successfully fulfilled its primary purpose, to protect consumers and ensure the safety and financial soundness of the insurance companies. However, with the exception of a movement in the early 1990s--spurred by the threat of federal regulation--to enact uniform financial solvency requirements in the response to a rash of company insolvencies related to the savings and loan scandals, states did little to streamline regulatory systems or coordinate basic functions.

It really wasn't until 1999 with the passage of Gramm-Leach-Bliley that state regulation-and the industry itself-woke up to the reality that the business of insurance had become a $1 trillion a year financial service, a full 10 percent of the nation's gross domestic product. The industry had been insulated from the larger market forces of e-commerce, market consolidation and globalization.

The federal act changed all that. Suddenly banks, which were more ready for the change than most insurers, were marketing insurance policies to their customers and putting investment advisors in their branches to create one-stop financial shopping. Insurance companies soon reorganized and launched campaigns, like Allstate's, to enter the new integrated marketplace.

THE PACE OF REFORM

Besides tearing down the barriers between the financial service sectors, Gramm-Leach-Bliley also placed specific mandates on the states to create a system of reciprocity to license out-of-state insurance agents and establish minimum privacy standards for financial information.

At the time, most people thought that the federal act set the states up to fail and signaled the beginning of the end for state insurance regulation. Yet state regulators responded with lightning speed. Then-NAIC president and Kentucky insurance commissioner, George Nichols, rallied state insurance commissioners behind an ambitious blueprint of regulatory reform, supported by all the states.

States quickly satisfied the federal mandates, but they are still working to streamline, simplify and coordinate state systems. Over the last three years, commissioners have retooled virtually every aspect of insurance regulation--from implementing a uniform electronic product filing system to standardizing company licensing applications to rewriting the handbook for market conduct exams that are used to audit and examine company practices.

Yet, while acknowledging some successes, key federal legislators have expressed disappointment with insurance commissioners' lack of progress at "speed to market" reforms--those to streamline product approval to allow companies to get products to market nationally more quickly.

Congressman Michael Oxley from Ohio, who chairs the U.S. House Financial Services Committee, said in June that it may not be the commissioners fault.

"To a large degree, their hands are tied," he said. "The NAIC can approve initiative after initiative, but it is the state legislatures that must act on them. Unfortunately, it is becoming increasingly apparent that insurance commissioners may be facing an insurmountable task."

State policymakers believe the task is doable, but say it takes time.

"Adjusting government oversight of a $1 trillion a year industry is not an easy task," says Senator Kemp Hannon of New York. "Many issues have been handled already at the regulatory level. We now have a clearer picture where state legislatures must take a leading role, such as getting new products to market more quickly."

If fact, it wasn't until the 2003 legislative sessions that insurance commissioners first put speed to market reforms before legislators. On the property and casualty side, this includes an NAIC model act to reform of commercial lines. Other models that include personal lines--such as auto and homeowners insurance--are getting legislative attention, too.

A MATTER OF LIFE AND ANNUITIES

The threat of federal action increasingly seems to boil down to whether states can find a solution to the "speed to market" issue for life insurance and annuity products.

The idea of an interstate insurance compact has been around for years, but it wasn't until last year that insurance commissioners advanced the idea to modernize state systems. The compact that they adopted in December would create a central clearinghouse for regulators to receive, review and quickly make decisions on product filings according to national standards that member states would create. The compact would be limited to asset-based insurance products, including annuities, life insurance, disability income and long-term care insurance.

Commissioner Vaughan calls the compact a "win-win-win" for consumers, the industry and regulators.

"The compact promises to raise product standards, improve the quality of review and give insurers the regulatory efficiency that they need to compete," she says. "It can do this all while maintaining and enhancing the state-based regulatory system that's been protecting American consumers for more than 150 years."

Some legislators have raised questions about the delegation of state authority, the purpose and scope of the compact, legislative and consumer participation, and the compact's management.

"Ultimately, the success of the compact will be decided in the halls and chambers of the state capitols," said Representative Kathleen Keenan of Vermont. "Having answers to the issues raised by state legislators will make the prospects of the creation of the compact more likely."

Commissioner Frank M. Fitzgerald, who heads the Office of Financial and Insurance Services in Michigan and who led the working group of insurance commissioners who drafted the compact, says that the model includes many provisions that were added to take care of these very concerns.

For instance, Fitzgerald says that the compact preserves state authority by allowing legislatures to opt out of product standards or to withdraw from the compact entirely, if the state perceives that it isn't working. He says that the compact would regulate only the content of products while preserving states' authority to oversee market conduct and enforce consumer protections. He also points to legislative notice requirements, legislative and consumer advisory committees, and a balanced management structure that encourages consensus as important safeguards that address these concerns.

"The strength of the interstate compact is that legislatures initiate a state's participation," says Fitzgerald. "Legislators then can exercise their oversight powers to assure that their constituents benefit from their state's participation in the compact."

A FEDERAL REGULATOR?

Regardless of whether the compact is the answer, states are under increasing pressure to act.

"States have a small window to modernize state insurance regulation before Congress seriously considers legislation," says Connecticut Representative Sonya Googins, who chairs the NCSL Financial Services Standing Committee. "It's not just that federal regulation will or will not happen within the next year or two but that, unless states reach consensus on what state-based reforms should be, key federal legislators will begin to make up their minds against us."

"We'll either act together, or get acted upon," she says.

Encouraged by the industry, Congressman Richard Baker of Louisiana is expected during the 108th Congress to introduce legislation to create optional federal regulation for life insurers. Although not the first bill to create a federal regulator, Baker's proposal is helped politically because--like the compact--it narrowly focuses on asset-based insurance products and because of Baker's powerful position as chair of the U.S. House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises.

Industry representatives are quick to point out that they don't seek to replace the state system, but instead to offer insurers a choice between federal and state regulation similar to the banking system. Under this system, banks that opt for national regulation get to bypass most state standards and consumer protections.

However, state officials say that the federal banking regulator--the Office of the Comptroller of the Currency--is an antagonist of the state banking system. In recent years, the comptroller has actively encouraged state-regulated banks to flip to federal charters and has sided regularly with national banks to preempt states' authority to subject national banks and their affiliates to consumer protection and fair lending laws.

In 2002, the Office of the Comptroller of the Currency successfully struck down several state and local laws that provided higher privacy protections to banking customers and placed limits on ATM fees. A new 0CC regulation to preempt state anti-predatory lending laws is anticipated in early 2003.

"Federal insurance regulation modeled on the banking system would be devastating for consumers," says Delaware Representative Donna Stone, chair of the House Economic Development, Banking and Insurance Committee.

"When constituents call today with an insurance problem, legislators can do something about it," she says. "A federal system would take away our ability to help and leave consumers at the mercy of a distant bureaucracy or having to get a lawyer."

A NEW FRONTIER 

Just as states have experience with federal preemption, they're not entirely new to interstate compacts. With over 200 in operation, they have been used to tackle difficult issues from vehicle registrations to environmental matters to the collection of state sales and use taxes. Some have described interstate compacts as "a new frontier of federalism" where states can work cooperatively on multi-state issues while preserving local control and consumer protections.

As with most legislation, however, the devil's in the details. The commissioners' model already has witnessed several rounds of compromise. For instance, the industry got its uniform standards and a central clearinghouse to review and approve filings, but it had to accept a voluntary system where states could withdrawal from product lines through legislation or regulation if they don't like the standards.

Consumer groups secured consumer protection guarantees for long-term care insurance, a provision that allows states to opt out of long-term care in advance and a funded consumer advisory committee, but did not obtain a $600,000 a year office of consumer advocate that they had sought.

State attorneys general also are reviewing the document to ensure that it does not infringe on their authority to protect consumers through the courts.

In the end, state legislatures will be the final arbiter of whether an interstate compact will work for insurance regulation--and possibly whether the states will continue to regulate insurance, as they have for 152 years.

"There's no question that the interstate insurance compact would break new ground, but new approaches are required if government is going to keep up with the economic engines that we regulate," says Senator Hannon. "States have been on the forefront of policy innovation for decades, and I don't see why the effort to preserve state insurance regulation should be any different."

RELATED ARTICLE: THE INTERSTATE INSURANCE PRODUCT REGULATION COMPACT

The nation's insurance regulators--working through the National Association of Insurance Commissioners--have adopted an interstate insurance compact plan to regulate some insurance products.

The compact would establish a central clearinghouse where regulators would review and quickly make decisions on product filings according to national standards developed by member states. The compact would be limited to asset-based insurance products, including annuities, life insurance, disability income and long-term care insurance, and would not include property and casualty lines, such as auto insurance, home insurance or workers' compensation.

The compact's ruling body would regulate only policy content. States would retain their authority to scrutinize market conduct, ensure claims are settled properly, investigate consumer complaints, take action against companies that violate the terms of an insurance policy and enforce consumer protection laws.

Under the agreement, states also would preserve their authority to decide whether to accept a product standard. If a uniform standard for a specific product line failed to measure up, a state could "opt out" through legislation or regulation. The compact also allows states to opt out of all product standards for long-term care insurance when enacting the agreement. It does include minimum product standards for long-term care insurance to ensure that consumer protections for this especially sensitive line of insurance will be adequate. A legislature also could withdraw from the compact at any time if legislators concluded that it was not working.

The compact includes many key features to promote broad participation among states, strong consumer protections and decisions through consensus.

* A commission of one member from all member states would govern the compact.

* A management committee of up to 14 states would manage the organization. Six large states would have permanent seats; 11 mid-size states would rotate among four seats; and 33 smaller states and the District of Columbia would rotate by region among four seats.

* The management committee and the full commission would require two-third super majorities to adopt uniform product standards.

* A legislative committee would oversee activities and make recommendations and be responsible for keeping lawmakers informed.

* Consumer and industry advisory committees would be created to allow the exchange of information and ideas with the commission.

Insurance commissioners believe that the interstate insurance compact is the right mechanism both to address legitimate industry concerns and to preserve and improve state consumer protections. By pooling state resources and expertise, the compact could improve the scrutiny that new products receive and raise consumer protections while allowing companies to market their products nationally more quickly.

Cheye Calvo handles insurance issues in the NCSL's Washington, D.C., office.