Opportunity for option: opinion: insurers and consumers would benefit from an optional federal regulatory system that encourages market competition. (Industry Strategies).

Insurance is an integral part of the financial-services lifeblood of the United States; banking and the securities industry comprise the other major sectors. Banking and securities have a coherent national pattern of regulation. Insurance does not. Insurance is regulated very differently from the other two aspects of the financial-services industry. Our industry, which underpins the entire economy, and which must be flexible and market-sensitive, is still largely controlled by failed regulatory paradigms left over from the early 20th century.

It is not difficult to come up with issues which overwhelm the state-based system of insurance regulation. Consider the successful effort to develop a mechanism allocating risk for terrorism between the private and public sectors that arose out of the Sept. 11, 2001, attacks. This effort rightfully was undertaken at the federal level. It took about 15 months to complete. Now, the Terrorism Risk Insurance Act provides much-needed economic security against further terrorist attacks.

Today, property/casualty insurance is being called upon to address increasingly complex societal needs. The current regulatory regime, with its lack of flexibility and national reach, cannot rise to this challenge. Given its failure, a national dialogue about the need for some kind of federal option for insurers--one that could operate simultaneously with the state system, analogous in some ways to the current dual banking system--is developing. Playing out within the discussion about where insurance should be regulated is the argument about how it should be regulated. For example, should regulation continue to focus so heavily on price and product controls? Should the regulator be able to dictate the kind of product creativity that an insurer will use to bring products to the market? Unfortunately, these are not purely rhetorical questions. Such broad, intrusive government controls currently lie at the very heart of the business of insurance. The American Insurance Association believes this is exactly the wrong approach to regulating a healthy, vibrant, competitive insurance marketplace.

The Need for a Paradigm Shift 

The industry, its state regulators, and the National Association of Insurance Commissioners have been trying to come to grips with these issues for many years. But the hard rock of reality is that while they have been struggling with these problems, little tangible progress has been made. And, because the public policy decisions defining the regulatory system have been wrong--wrong from the standpoint of modern economics, wrong from the standpoint of business and consumer needs--we have quite by accident hit the regulatory trifecta. We have a system for property and casualty insurance regulation that is archaic and dysfunctional, and which corrupts the process of pricing and creating insurance products.

The current system enshrines economic theories that have been discredited at home and around the world over the past 50 years. It distorts regulatory emphasis by putting almost all the regulatory eggs in the price and product control basket. It distorts the marketplace because it discourages innovation and maximum competitive opportunities. It denies consumers maximum choice. All too often, it politicizes the pricing of insurance, which ends up shortchanging consumers and citizens in two basic ways. First, the current system destroys a primary societal function of insurance-providing an actuarial link between risky behavior and cost. In addition, insurance availability is reduced as companies unable to make a profit because of artificially low prices are driven out of heavily regulated states and lines of business.

It is no exaggeration to say that, in the current system, insurance companies essentially have to go to the state and beg for a reasonable price at which to sell their products, or beg to get a new product introduced into the marketplace. When that is how business and government interact with each other, it is inherently a corruption of both the business and the government enterprises--not corrupt individuals, but a corruption of the underlying and legitimate purposes of business and government. We can--and must--do better than that. In response to the failures in the state regulatory system, we and other advocates of regulatory modernization have developed federal legislation to provide an alternative for insurers that seek one. It would present a very different way of going about insurance regulation.

Every honest observer of the insurance regulatory system agrees that the current state system is failing. So the question that can no longer be ignored is this: how are these problems going to be repaired? The NAIC and many states have pursued reform efforts in an attempt to remedy the situation. They have been working to create uniform regulatory standards among the states to ameliorate the current patchwork of laws and regulations with which insurers must comply. There is some benefit to uniformity, but only if the standards themselves are market-oriented. Moreover, to the extent that the emerging standards really incorporate the same old command-and-control regulatory system where price is controlled and where product creativity is discouraged, uniformity only makes things worse; it does not fix the fundamental flaws of the state-based system.

We have worked with, continue to work with, and respect the NAIC and individual commissioners who are doing the best they can. But the talk of reform at the NAIC has been going on for a long time; results are episodic at best and vary dramatically from one state to another. Many reasonable people have concluded that the only way to achieve real reform is to provide another regulatory option.

Envisioning a Federal Option

Our proposal is a consumer-oriented approach. We think that market competition is the best regulator of price and the best way to attract new entrants into the marketplace. Both competitive pricing and a wide variety of readily available products and services directly benefit the insurance consumer. Moreover, it is critical that each insurance product meet every legal requirement in a particular market. Our proposal absolutely obligates insurers to do just that. What it does not do, however, is place roadblocks in the path of legal and creative products getting to market. The essence of our proposal, then, is market-oriented regulation.

Opponents of optional federal chartering often cite political and substantive concerns, such as state reluctance to give up tax revenue, effective functioning of state guaranty funds and the need for local market prerogatives. None of these challenges presents an insurmountable obstacle to the creation of a workable, optional federal charter as we envision it.

Premium Taxes. It should be made clear that there is absolutely no desire on the part of optional-federal-charter advocates to change state authority to collect and to levy premium taxes. When federal legislation passes, it will assuredly retain state premium-tax authority because there is no interest in doing anything to the contrary, and there is no constituency seeking anything to the contrary. That was one of the bases for the McCarran-Ferguson Act in the first place.

State Guaranty Funds. The current optional-federal-charter proposal does not do away with, attack or undermine state guaranty funds. State guaranty funds would remain intact; indeed, federally chartered insurers would be required to participate to the extent that states want to allow them to participate. Stability in the guaranty-fund environment is highly desirable, especially since the state guaranty system is now trader the greatest stress it has faced in more than 30 years. In some ways, optional federal chartering could actually strengthen the state-based system. Federal guaranty standards would likely be as rigorous as the best state standards and induce movement toward both high and uniform standards.

Market Conduct. An effective regulatory system (whether state or federally based) focuses on financial integrity through a tough--and smart--market-conduct examination process, empowering professionals involved in the financial or regulation side who are skilled and know what they are doing to get at the bad actors and take care of them quickly. In this connection, there is no doubt that a unified federal system can spot troublesome--or dangerous--trends much more quickly than 51 separate state efforts.

Addressing Local Needs. One of the objections sometimes raised to optional federal chartering is that insurance, unlike banking, securities or many other types of economic goods, is local in nature and therefore can only be regulated at the state level. While many economists would be puzzled by the characterization of insurance as inherently more local than other types of economic goods, it should be underscored that federal regulators are very effective at administering programs that connect down to the local level. Indeed, historically, the more critical the issue, the more likely that the resolution of that issue has been entrusted to federal authority. Do Americans believe that their assets held at federally chartered banks are less well protected than those held at state chartered banks? Would investors feel more confident in having the Securities and Exchange Commission replaced by 51 separate state securities regulators? The obvious answer to both these questions is "no," even though the states also have banking and securities agencies. The federal government also manages a nationwide program to make sure that workers get minimum wages and overtime protection. Now, after the passage of many years, Americans entrust the safety of our nation's workforce to a federal regulatory system because, in fact, the states were really not able to do it. Will every kind of federal system be perfect? Of course not. But the fact is that the nation has entrusted to a federal system the obligation to administer programs that must--and do--respond directly to the needs of citizens on the local level. And insurance would be no different.

Another question often raised about a potential federal regulator is, would insurers face a much more highly politicized and anti-market insurance environment at the federal level? It should be noted that the federal approach to price and product controls going back to the mid-1970s, when price controls were the norm in regulation, has led to having them removed for many industries, such as airlines and banks. Indeed, in the case of airlines, federal price deregulation has effectively democratized air travel in the United States.

We already have some recent experience in dealing with insurance regulation at the federal level in the Terrorism Risk Insurance Act. While not perfect, TRIA meets a very basic national insurance need. Also, the Treasury Department has been a model regulator in carrying out the TRIA statute. If experience is a guide to future behavior, we should be cautiously optimistic about a regulatory system that is managed by the United States Department of the Treasury. They have done an excellent job with implementing this law. They have been businesslike. They have preserved and assured the interests of the U.S. government without being needlessly aggressive. They have not taken positions that unnecessarily make it burdensome and difficult to do business. They have taken practical problems that we have brought to them and have proffered up practical solutions. Moreover, Treasury started out with very little experience and knowledge with regard to insurance, but they built their information and knowledge base dramatically. Anyone who claims that a federal regulatory operation system cannot work should take note of this experience.

The Importance of Having Options

The need for a new model of insurance regulation is long overdue. The costs inherent in the current system are growing daily for the industry and consumers. Despite this fact, there is still reluctance by some in the insurance community to have an optional federal regulatory system alongside the state-based one. Fortunately, any risks that arise out of development of an optional federal system are mitigated precisely by the fact that it is optional. The state-based system will remain in place. Even for the risk averse, pursuing optional federal chartering is a net positive, especially when considering the enormous costs of continuing the status quo.

We believe that the effort to put an optional federal-chartering system in place ultimately will bear fruit. Such a system can both improve insurance regulation and enable the insurance market to successfully meet the challenges facing it today, and that it will face for years to come. There is every reason to advocate such a system--to push ourselves and our regulators to a regulatory paradigm that is truly efficient and effective. There is simply no excuse to accept the broken system we have today; that would mean accepting a regulatory system that is designed to undercut the marketplace on a daily basis to the detriment of all concerned. Insurers and all of our commercial and personal lines customers deserve better.

RELATED ARTICLE: Optional federal charter, state regs or something else.

The American Insurance Association, American Council of Life Insurers and the American Bankers Association Insurance Association have collaborated on a legislative proposal for an optional federal charter, which also makes provisions for including health insurance in the future.

Conceptually, their idea focuses on financial integrity and market conduct--not rate and form regulation. It would create the Federal Insurance Chartering Office, a new agency in the Treasury Department. The director would serve a six-year term, would be appointed by the president and would look to the U.S. Senate for advice and consent.

While this federal regulator wouldn't regulate prices or rates, insurers would have to make forms available for inspection. The federal regulator would grant federal charters to qualified insurers and reinsurers and their agents.

Under the AIA-ACLI-ABAIA proposal, any insurer, reinsurer, agent or broker wanting to stay in the state system could do so without obligation to the federal system.

States would keep authority over insurance reparation laws, such as state automobile and workers' compensation laws. Otherwise, most state insurance regulation would be pre-empted for those choosing a federal charter.

Once a holding company put any of its businesses in a federally chartered insurer, the sole regulator of the holding company would be the federal regulator. For mergers and acquisitions, state regulators would have a role only if one or more of the insurers were state-licensed, under the AIA-ACLI-ABAIA proposal.

The Independent Insurance Agents & Brokers of America has a proposal which calls for Congress to create federal insurance standards that would be enforced by state regulators. IIABA opposes an optional federal charter but wants improvements in state regulation. It sees this concept as a middle ground, and the most politically plausible legislation that could get through Congress.

The IIABA scenario would use Congress to pre-empt some aspects of state regulation and set minimum standards--a proposal the agents say would fix about 90% of what's wrong with state regulation. Property/casualty and life insurers both would benefit, and the IIABA has said some 20 large and mid-sized insurers--some well-known names--have been involved in crafting the proposal. The proposal is still in draft form and not yet ready to be presented as a bill, but it's been shown to members of the House Financial Services Committee and to insurance trade associations.

The plan goes beyond direct concerns of agents, such as licensing, and encompasses areas that affect insurance companies, such as policy form and rate regulation, company licensing and state accreditation, and market-conduct examinations, according to a copy of the proposal. IIABA's concept doesn't call for Congress to threaten the states if they don't take actions by a certain date; it is pre-emption right off the bat.

On rates and forms, for example, the IIABA proposal would give states 30 days to approve or disapprove. If no action is taken, the rate or form would be deemed approved. It could solve the speed-to-market concerns of companies that say it can take a year or two to get product approvals from different state insurance departments.

As for agent licensing, an agent in good standing in one state should be able to sell insurance products in another, IIABA contends. Agents still would pay the state fee under IIABA's proposal, but the state where the agent lives would regulate the agent and do the background check.

--Dennis Kelly

Craig Berrington is senior vice president and general counsel of the American Insurance Association.