Protecting the pledge: the quest for cohesive U.S. insurance regulation spans three centuries, and an end to the journey still isn't assured.

Key Points

* Central themes of U.S. insurance regulation--regular financial reporting, safeguarding insurers' solvency and ensuring fairness to consumers--emerged early in the nation's history.

* The need for more uniform regulation became clearer with time, but despite 134 years of effort through the National Association of Insurance Commissioners, regulators have yet to put the goal within reach.

* An increasingly global economy has heightened the pressure for consistent nationwide rules, and Congress appears to be losing patience.

Insurance is as real as risk itself and as intangible as a promise. Casting a regulatory net over such a business has challenged generations of government officials from the earliest days of the U.S. insurance industry.

Two U.S. Supreme Court rulings, 76 years apart, capture the elusiveness of insurance as a regulatory target. The 1868 ruling in Paul vs. Virginia found that a New York agent's business in Virginia didn't constitute interstate commerce, as the policies were mere local contracts, not real, tradable goods moving across state lines. Insurance was exempted from the Commerce Clause of the U.S. Constitution, and the states kept their emerging primacy in regulating the industry.

By 1944, a more mature industry find legal framework led the high court to a different conclusion in United States vs. South-Eastern Underwriters Association, an antitrust case brought under the Sherman Act of 1890. This court ruled insurance was indeed commerce and thus could be federally regulated. The ruling raised fears--particularly among the antitrust defendants find the dissenting justices--that state regulation itself would evaporate overnight. That threat led to swift passage of the McCarran-Ferguson Act, to this clay the foundation of the states' primary authority over insurance.

Insurance regulation now may be nearing its most fundamental change since McCarran-Ferguson. Legislation that's been discussed in Congress for nearly two years could give the federal government unprecedented power to bring long-sought uniformity to state insurance laws and regulations.

Territorial Imperatives

The states claimed the turf of insurance regulation early on, and the federal government raised little objection.

State legislatures chartered individual insurance companies as early as the Colonial era, but by some accounts Massachusetts gave birth to modern U.S. insurance regulation with one 1799 charter--that of Massachusetts Fire & Marine Insurance Co. The act limited the company's real estate holdings, and perhaps most significantly, required sworn financial statements from the company's management upon demand of the Legislature.

While that landmark charter was issued to a fire and marine insurer, life insurance received more attention in the early days of insurance regulation, at least in Massachusetts. Prudent reserving and fair policy valuations, scientifically calculated, were the cornerstones of life regulation there, and one of the state's first insurance commissioners, Elizur Wright, is viewed as a pioneer in the field. Massachusetts had the nation's first reserving law for life companies.

Massachusetts and New York were among the first states with stand-alone regulatory bodies for insurance, although New Hampshire also created a board of commissioners in 1851. Massachusetts established a board of insurance commissioners--later reduced to a single insurance commissioner--during the 1850s. New York's first superintendent of insurance took office in 1860.

All of this predated the first attempt at federal insurance regulation in 1866: a failed bill in Congress that invoked the Commerce Clause. Two years later, the Paul vs. Virginia ruling destroyed the underpinnings of that bill, creating a legal preserve in which state regulation became deeply rooted over the next several decades.

Tying It Together

On May 24, 1871, what would become the National Association of Insurance Commissioners met in New York. Of the nation's 31 top insurance regulators, 19 answered New York Superintendent George W. Miller's invitation to the National Insurance Convention. His letter to colleagues may ring eerily familiar to those who attend today's quarterly meetings of the NMC, stating that the "increase in the number of state departments, each established under different laws and adopting different forms, rules, and regulations, has naturally tended rapidly to increase the labors and consequent expenses of insurance companies."

Among the commissioners' first acts, they agreed to recommend that state legislatures adopt common annual statement forms. The statement quickly became a critical task; the Committee on Blanks for Annual Statements was established at that first meeting, and its work continues uninterrupted today in the Blanks Working Group of the Accounting Practices and Procedures Task Force.

The delegates also determined they should agree on uniform terminology and consider developing common reserving standards for life, fire and marine business. Then as now, the commissioners held uniformity and reciprocity as collective ideals, though they proved elusive in practice.

By their second meeting in October 1871, 30 of the 31 commissioners attended, and the group became known as the National Convention of Insurance Commissioners.

The ensuing decades saw gradual steps toward greater cooperation and coordination among the states. The NCIC's early activities included creation of a special committee to evaluate and report on the assets in insurers' portfolios. The Committee on Valuation of Securities became permanent in 1910, forming the precursor to the modern NAIC's Securities Valuation Office.

The NCIC in 1936 revised its constitution and bylaws and adopted its current name--the National Association of Insurance Commissioners. Important new provisions included:

* Recognizing the Committee on Blanks and requiring it to meet at least once a year to consider amendments;

* Making formal provisions for multistate examinations of insurers;

* Requiring the securities valuation committee to report annually on the NAIC's recommended valuations of securities; and

* Authorizing the NAICs secretary-treasurer to seek voluntary contributions from members to fund expenses authorized by the executive committee, and authorizing the chairman of the securities valuation committee to seek separate contributions supporting that group's work.

Within a decade, however, the increasingly settled nature of state regulation would be shaken. Trouble sprang from the industry's system for ratemaking, a haphazardly regulated patchwork of underwriting associations or compacts that pooled member companies' information to set premiums and commissions while heading oft destructive price wars.

About Face

The South-Eastern Underwriters case was an antitrust action brought by the government against an association of nearly 200 fire insurers that allegedly conspired to fix prices and monopolize fire and allied business for the group's members in Alabama, Florida, Georgia, North Carolina, South Carolina and Virginia.

The association had argued it wasn't subject to the provisions of the Sherman Act, based on the Paul vs. Virginia decision. A federal district court had agreed, dismissing the indictment, but the majority of the justices essentially reversed the 76-year-old ruling cited by the lower court. The high court held that insurance consisted of a larger transaction than the policy contract itself, and therefore it was commerce. "In short, a nationwide business is not deprived of its interstate character merely because it is built upon sales contracts which are local in nature," Justice Hugo Black wrote for the majority.

The majority opinion dismissed as "exaggerated" the argument that the Sherman Act "necessarily invalidates many state laws regarding insurance," but the minority, disagreed.

"The Court's decision at very least will require an extensive overhauling of state legislation relating to taxation and supervision," warned Justice Robert Jackson in a partial dissent." The whole legal basis will have to be reconsidered. What will be irretrievably lost and what may be salvaged no one now can say, and it will take a generation of litigation to determine. Certainly the states lose very important controls and very considerable revenues."

Congress promptly headed off that "generation of litigation." The next year, the McCarran-Ferguson Act became law. It addressed the immediate issue of antitrust by granting insurers a limited exemption from such laws, provided their business was regulated by state law. It also cemented the states' position as the principal insurance regulators.

The NAIC and the industry moved quickly to establish a state-level, statutory framework that would prevent federal antitrust action. The resulting model laws laid the foundation for modern property/casualty rate regulation, including rate-filing provisions and the prohibition against "excessive, inadequate or unfairly discriminatory" pricing.

Federal Encroachments

While the intent of McCarran-Ferguson appeared to be securing the states' primary authority over insurance, the federal government's role nevertheless expanded greatly in the decades that followed, especially in health insurance. Among the federal measures:

* The Federal HMO Act of 1973 sought to foster the creation of health maintenance organizations.

* The Employee Retirement Income Security Act of 1974 established standards for employee-benefit plans, including health plans, which gained significant exemptions from state regulation.

* Congress in 1979 established minimum loss ratios for both individual and group Medicare supplement policies, and in 1990 the Onmibus Budget Reconciliation Act delegated the NAIC to standardize Medicare supplement coverage by designing a maximum of 10 plans.

* The Health Insurance Portability and Accountability Act of 1996 made health coverage portable for workers at small employers.

* The Medicare+Choice program, and later Medicare Advantage, marked another federal/state effort in health insurance.

More broadly, the question of state vs. federal regulation always lingered, though the debate stayed largely out of public view. In the December 1970 issue of Best's Review, Richard E. Stewart, then New York's insurance superintendent, maintained long-standing defenses of state regulation and warned against federal oversight. "On the regulatory side, it would sweep away much of the accumulated, prescriptive competence to be found in the best state agencies," Stewart wrote. "On the business side, such a shift would put in doubt for years many of the rules within which the business has taken shape and would leave many in the industry with no familiar way of making their views heard as those rules were being redesigned. On the consumer side, the known local points for applying citizen pressure would be dispersed, obscured and removed."

Stewart also ventured a prediction: "If state regulation goes, it will go with a bang or a whimper; after a sudden economic collapse or after years of miscellaneous encroachments."

About 20 years later, some thought the bang had occurred. In February 1990, the Oversight and Investigations Subcommittee of the House Energy and Commerce Committee issued its "Failed Promises" report on insolvencies in the insurance industry, examining the failures of four property/casualty insurers and the near collapses of two others. In an accompanying letter, the committee's chairman, Rep. John Dingell, D-Mich., declared: "The Subcommittee found that the present system for regulating the solvency of insurance companies is seriously deficient."

Dingell used the report as a springboard to introduce the Federal Insurance Solvency Act. In broad concept, the bill would divide regulation between the states and the federal government, putting solvency oversight in federal hands while leaving consumer issues to the states. The proposal exposed a divide in the industry between large, national commercial carriers, which generally favored a greater federal role, and smaller, regional and personal-lines players, which argued for fixing the state-based system. The measure died when Dingell lost his chairmanship in the Republican takeover of Congress in 1994, essentially shelving the issue for another 10 years in terms of congressional action.

Even as Dingell was issuing his report and floating his proposals, the insurance industry faced other storms. A string of failures plagued the life business, hitting newcomers and old-timers alike--Executive Life, First Capital Life, Mutual Benefit Life and Kentucky Central Life among them. Soon after, sales practices in the life business attracted suspicion, sparking several years of investigations and litigation--over allegedly deceptive sales illustrations, life policies disguised as savings plans, "churning" of policies and more.

Civil Wars

The insolvencies, the market-conduct controversies and congressional scrutiny highlighted enormous strains on the state regulatory system. The NAIC, which as late as 1946 had no central office, no staff and an annual budget of $8,000, had become an organization with a sizable central office, scores of paid staff and a multimillion-dollar budget. The NAIC found itself at the center of renewed efforts to streamline and harmonize state-based oversight, using tools that never had been contemplated before. This steered it toward a collision with some of the very states it sought to knit together in a cohesive regulatory fabric.

Central to the NAIC's effort was its accreditation program, which was to certify states based on their adoption of selected NAIC model laws and meeting NAIC standards for the funding, staffing and professional competency of their insurance departments. Failure to meet the accreditation standards could have effectively isolated nonaccredited states, whose financial examinations might not be accepted by accredited states. The concept met opposition, however, from state legislators, who objected that through accreditation the NAIC, a nongovernmental body with uncertain accountability, could violate state sovereignty.

At the same time, growing costs associated with NAIC were becoming a sore point with the states and with insurers that were funding it through various assessments and fees. Even some of the NAICs own members argued that the organization was increasingly inefficient, secretive, overreaching and ineffective. A period of upheaval climaxed in 1994 and 1995, as insurers protested--and in some cases withheld--database fees they had been paying to the NAIC, and the National Conference of Insurance Legislators contemplated constitutional challenges to the NAIC's authority.

By late 1995, the furor was dying down as the NAIC pulled back from its aggressive approach to accreditation and opened its finances and deliberations to greater scrutiny. But in a field marked by debates that tend to span decades, another long-running struggle was about to reach a climax.

The Next Big Thing

The Glass-Steagall Act and the Bank Holding Company Act for decades had separated insurance, banking and securities. They effectively kept banks and insurers out of each other's business, with narrow exceptions. Proponents of more integrated financial services had chipped away at those laws, both legislatively and judicially, and by the 1990s, they were making headway in the courts. In 1999, the legislative breakthrough came with the Gramm-Leach-Bliley Act, which enabled new kinds of cross-ownership, affiliation and distribution.

The new law added more privacy regulations to those in the 1996 HIPAA law, creating a new avenue of federal encroachment on insurance regulation. Of crucial importance to the insurance industry, the law also threatened the creation of the National Association of Registered Agents and Brokers--unless the states met standards of uniformity and reciprocity in licensing of producers by Nov. 12, 2002.

The threat of NARAB proved a powerful tool for compliance, and the states met the requirement with time to spare. But NARAB's success may return to haunt supporters of existing state regulation. In March 2004, at a closed session of the NAIC in New York, Rep. Michael Oxley, R-Ohio, chairman of the House Financial Services Committee, unveiled a new box of "federal tools" that may be brought to bear in driving further reform of state regulation. Soon, many of those tools were packaged in the proposed State Modernization and Regulatory Transparency Act, which doesn't contemplate dual state-federal regulation but essentially would require states to achieve uniformity in key areas or have their noncompliant laws preempted by national standards. The SMART Act made little headway in the 2004 congressional session, but it was expected to be reintroduced in the 109th Congress.

The proposal goes too far for some parties to the debate and not far enough for others. Perhaps most controversial, it would end most regulation of property/casualty insurance rates, a step many state regulators and consumer advocates vehemently oppose.

Meanwhile, many life and national commercial insurers for years have advocated an optional federal charter that would allow companies to choose whether they are regulated by the states or the federal government.

Regardless of the fate of these initiatives, it seems clear that the quest for uniformity in state regulation, now well into its second century, will gain urgency in an increasingly global economy. It's no longer merely an internal matter of the United States; the fragmented nature of the state regulatory system now is perceived in international trade discussions as a barrier to foreign companies seeking to enter U.S. insurance market. It's a complaint Congress may find hard to ignore.

Insurance Regulation: A Work in Progress

1868

U.S. Supreme Court ruling in Paul vs. Virginia found that a New York agent's business in Virginia didn't constitute interstate commerce. As a result, states kept their emerging primacy in regulating the industry.

1871

The precursor to the National Association of Insurance Commissioners first met in New York on May 24, 1871. One of the commissioners' first acts was to recommend that state legislatures adopt common annual statement forms.

1944

U.S. Supreme Court ruling, United States vs. South-Eastern Underwriters Association, reversed the earlier decision, saying that insurance was indeed commerce and could be federally regulated. That threat led to swift passage of the McCarran-Ferguson Act, to this day the foundation of the states' primary authority over insurance.

1970s

Bellwether federal legislation changed the scope of insurance regulation. The Federal HMO Act of 1973 fostered health maintenance organizations. The Employee Retirement Income Security Act of 1974 established standards for employee-benefit plans with significant exemptions from state regulation. In 1979, Congress established minimum loss ratios for both individual and group Medicare supplement policies.

1996

The Health Insurance Portability and; Accountability Act of 1996 made health coverage portable for workers at small employers.

1999

The federal Gramm-Leach-Bliley Act ushered in the possibility of financial modernization, repealing Depression-era barriers that separated banking, insurance and securities.

Brendan Noonan is senior editor.