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A balanced approach to insurance regulation reform.

THE MOOD IN THE NATION'S capital is one of eager anticipation. For the first time in 12 years, the Democratic Party controls the White House and both houses of Congress. The Clinton ad-ministration has promised an end to "legislative gridlock." As a result, the 103rd Congress will likely be the source of more legislation than any Congress in recent memory.

While insurance regulation has been on the agenda of the past several Congresses, there has really been only a modest opportunity for the passage of substantive legislation. Now, however, insurance regulatory reform legislation is a real possibility. The foundation for legislation has been laid in prior congressional sessions. Studies have been prepared by the Treasury, the Government Accounting Office, the Congressional Research Service, the Joint Committee on Taxation, and others. Hearings have been held, as well, by a variety of committees on a multitude of issues in both the House and the Senate.

While there have been numerous proposals for reform, there is one proposal that dominates all others. That is the Federal Insurance Solvency Act (H.R.4900) sponsored by Rep. John Dingell, D-Mich. Mr. Dingell is not only the chairman of one of the most powerful committees in the House, the Energy and Commerce Committee, he is also chairman of its Oversight and Investigations Subcommittee. This position provides him with the capability not only to push legislation that he may favor but also to investigate and "encourage" a non-responsive industry to see the wisdom in dealing with his committee and its staff.

But when it is the future of insurance regulation that is on the line, all alternatives, not just those promoting federal regulation, must be objectively explored to the fullest extent possible. A balanced regulatory approach may be the least favored alternative with the most active participants in the legislative process, namely, insurers, regulators, agents, self-insurers and others. However, from the perspective of policyholders, who should arguably be kept highest on the legislators' priority list, it may be the safest and least expensive alternative available.


H.R.4900 is presently being rewritten by the committee staff for introduction into the 103rd Congress. It represents a comprehensive effort to devise a federal answer to the complex problems presented by the current state-based insurance regulatory system. The Federal Insurance Solvency Act, as its name indicates, was initially stimulated by the desire to protect insurance policyholders from insolvency by insurance carriers. While H.R.4900 addresses insurance industry solvency and seeks to provide a federal solution, the bill has become the vehicle for the imposition of a federal solution to a variety of important insurance regulatory problems that are only distantly, if at all, related to solvency.

As currently written, H.R.4900 would: establish rate, form and market conduct preemption from state law for "highly capitalized insurers"; permit "market withdrawal," even over the objection of state regulators, to overcome capital lock-in statutes; permit qualified reinsurers to operate in 50 states and preempt all state laws to the contrary; and similarly preempt state laws relating to qualified surplus lines carriers and allow 50state operation. The bill would also facilitate nationwide operation by agents through the National Association of Registered Agents and Brokers and address the growing problem of accountant and actuary liability first, by requiring that accountants and actuaries be utilized and, then, by "holding them harmless" for "good faith" mistakes. H.R.4900 would similarly protect insurance agents from liability for placement with insurers that subsequently became insolvent.

These, among others, are significant regulatory problems that need to be addressed. However, it is only logical to question how these specific industry problems came to be addressed by this proposed legislation, while others remained unnoticed.

The answer lies in the legislative process itself. Congress is a reactive institution. Having only limited staff and access to the investigative and academic capability of other branches of government (such as the Congressional Research Service and the Government Accounting Office), Congress responds to the pressures placed upon it by the interest groups that are potentially affected by proposed legislation. It is therefore no accident that H.R.4900 addresses those problems of greatest concern to the interest groups that have sought to advocate their positions with the committee staff; those affected groups that have not done so may find their issues absent. H.R.4900 merely reflects its political environment. Like many proposed pieces of legislation, it was intended to address one issue - insurer solvency - and has become the vehicle to address many other problems in the insurance industry.

In this manner, H.R.4900 carries with it some of the baggage of the current regulatory system. For example, it does nothing to resolve the present competing objectives of antitrust and solvency regulation. Antitrust reform is designed, arguably, to enhance competition, while solvency concerns may require increased regulation. Under H.R.4900, solvency regulation for federally certified insurers will be performed at the federal level, while rate making for non-"highly capitalized insurers" will remain at the state level; and "highly capitalized insurers" will be subject to the federal antitrust laws, while other insurers will presumably still be able to take advantage of the McCarran-Ferguson Act exemption for the business of insurance.


The regulatory regime to be established by H.R.4900 in response to these stimuli calls for both federal and state regulation. The danger is that any dual regulatory system will be so burdensome and inefficient that the cure it proposes may be worse than any presently existing disease.

The first concern is that the conflict between federal and state regulation, which already exists in a limited way, could reach disastrous proportions under H.R.4900. The bill includes numerous areas of conflict between state and federal law regarding: the scope of regulatory authority; capitalization requirements; market conduct issues; activities of agents, accountants and actuaries; liquidation and rehabilitation; and other issues. These areas are only those that are obvious from an initial reading of H.R.4900. Experience with other federal statutes that preempt state law tells us that some multiple of that number will eventually occur.

The ramifications of these areas of conflict are substantial. First, the litigation costs that will result will be an enormous drain on the industry. Second, the uncertainty that would be created will not only be a deterrent to proactive management, but also an enormous expense in terms of lost opportunity costs and diminished benefits to consumers. Third, the areas of conflict between state and federal law may permit the unscrupulous to make a fortune at the expense of the consumer. The insurance industry provides the opportunity for a sophisticated con man to make a tremendous amount of money in a short period of time. One need only look to the preemption of state law by the Employee Retirement Income Security Act (ERISA) and the malfeasance of some multiple employer trusts to envision the scope of the problem.

In addition to the onerous problems resulting from federal/state conflicts, a dual regulatory system could have a substantial and unpredictable impact upon the makeup of the industry. Like any other piece of legislation, H.R.4900 would establish "winners" and "losers." Various aspects of the bill would favor one element of the industry over another. For example, H.R.4900 would result in increased cost to the industry (and consumers, ultimately) as a result of a five-year, $300 million per year assessment to initially fund a new federal agency, and other potential assessments, such as those for a national guaranty fund. Clearly, some insurers would be better able to afford this increase in cost than others.

Also under H.R.4900, a competitive advantage is potentially produced by the various forms of relief that result from state regulation for different classes of insurers. For example, "highly capitalized insurers" are relieved from rate, form and market conduct regulation, while federally certified insurers are relieved from the state regulation that relates to solvency but not rates, forms and market conduct. This imbalance will surely have an effect upon competition.

Another potential outcome is that federally certified insurers may benefit in the marketplace from the representation to consumers that their product is protected by a federal (as opposed to a state) guaranty fund. Furthermore, if federal certification is as desirable as it would appear to be, the phenomenon of "adverse selection" may occur, where the largest and most solvent insurers may elect for federal certification, leaving only the least financially capable companies subject to complete state regulation and the proportionately ever-increasing state guaranty fund assessment.

While some may assert that the marketplace needs to be shaken up, the current state regulatory system at least has the benefit of being predictable. We do not know what the marketplace will look like if H.R.4900 is adopted. Nonetheless, we can predict that there would be a substantial upheaval in the marketplace, and, consequently, some consumers will lose. That is a cost that needs to be factored into the deliberations of Congress.


Assuming that a dual regulatory system is not the answer, why not then consider complete federal preemption and the imposition of a federal system? There are a number of factors that should deter Congress from imposing a purely federal system. First, the record of the federal government in financial regulation (e.g., the savings and loan industry) has been less than stellar. Second, the creation of a new federal agency as envisioned by H.R.4900 would be costly and difficult in the current political environment. Third, a national guaranty fund would place political responsibility on the federal government for a bailout of the insurance industry, even though H.R.4900 states that the national guaranty fund that it establishes is not backed by the "full faith and credit of the United States." Why would the federal government want this responsibility when the 50 states and the insurance industry currently are saddled with it? Fourth, would members of the House and the Senate really vote for legislation that would endanger the jobs of the approximately 6,000 state employees that currently regulate the business of insurance, while endangering the premium tax that plays such a large role in financing many state governments?

What, then, is the answer? If complete federal preemption is not feasible or desirable, and dual regulation may result in industry dislocation and continuous litigation, what about a carve-out of certain discrete areas of insurance activity where little opportunity exists for federal/state conflict? This is an idea that holds some promise. These areas could include the federal regulation of alien insurance and reinsurance companies. A good case can also be made that the federal government can best regulate and attack the problem of interstate and international insurance fraud and other crime because a federal infrastructure, in the form of the Department of Justice and the federal courts, already exists and a mechanism for avoiding federal/state conflicts has been demonstrated.

Finally, what about the present state-based system? The National Association of Insurance Commissioners (NAIC) Financial Standards Review and Accreditation Program is, of course, the state regulatory response. Under the lash of stringent federal oversight, the state accreditation program has made substantial progress in enhancing state regulatory capability and consistency. In effect, the NAIC is seeking to approximate national minimum standards and national oversight without bringing in the federal government.

However, the NAIC has set December 31, 1993 as the date by which all states should be accredited. It will take a very substantial effort to ensure that even two-thirds of the states will be accredited by year end. Even if we assume that these 34 states are the largest and most capable states with the preponderance of all the premium volume flowing through them, there still will be a substantial minority of states that are not accredited. This in itself creates a system of "two-tiered," if not "dual," regulatory capability.

Regardless, however, of the progress that is being made at the state level, the state regulatory system will always be subject to the criticism that is frequently heard in the corridors on Capitol Hill - namely, that the states can only try to coordinate their efforts but cannot be required to do so because the NAIC is a voluntary arrangement. The NAIC does not, and cannot, it is argued, have any real "teeth."


It is the tendency in our nation's capital to look to the federal government for the answers to regulatory problems and to seek the wisdom of the legislators, academics and bureaucrats who reside "inside the beltway."A substantial portion of the rhetoric in this past political campaign was spent criticizing "trickle down economics" and "trickle down government." However, many of the most interesting and important governmental ideas do not emanate from Washington and trickle down to the states, but rather percolate up from the states and then become policy at the federal level. For example, the so-called "tax revolt"in California crossed the country and became the foundation for the Reagan tax reform of a decade ago. "School choice," welfare reform, health care reform, "enterprise zones" and tenant ownership of public housing similarly have emerged on the national agenda as a result of action at the state level. The most recent example of this phenomenon - term limits won overwhelming majorities in each of the 14 states in which it was on the ballot in the recent election and now threatens to foist itself upon a very reluctant Congress.

An idea that has emerged at the state level - but has not received the kind of attention that it deserves - is that of the interstate compact. While the adoption of uniform agreements among the states regarding insurance regulation would be a cumbersome and time-consuming process, it does offer a number of benefits that cannot be offered by any of the other proposed solutions since it would avoid: the regulatory meltdown that could result from federal/state conflicts; the expense and controversy surrounding the creation of a new federal agency; the loss of state regulatory jobs and the concern regarding the loss of the premium tax at the state level; and the imposition of federal liability for a national guaranty fund.

What the interstate compact system would not do is provide a "quick fix" to the very serious problems that are such a concern in the present state-based system: rate suppression, capital lock-in laws, residual market burdens, conflicting admission requirements for each of the 50 states, and so forth. However, an interstate compact-enhanced state-based system could provide the regulatory and rule-making structure that would permit these important problems to be addressed on a national basis.

The interstate compact idea deserves closer scrutiny. Unlike other proposals, it has the benefit of potentially being the subject of a limited experiment. Several states could enter into an agreement to share the expenses of enhanced regulatory capability or an agreement regarding uniformity of regulations and enforcement. This could lay the foundation for a determination regarding whether a fullblown national interstate compact would be feasible. Only a national compact would provide the potential to address the national problems that are confronting the industry.

The Achilles' heel of the interstate compact and other state-based ideas is that they demand two commodities that are in short supply in today's factious insurance industry a consensus on the problems faced by the industry and the discipline to pursue solutions that benefit the industry as a whole. Enhanced state regulatory capability, however, is an essential ingredient in any regulatory system that includes a meaningful role for the states.

The pressure for reform is building. However, the vision of the future presented by the dual regulation incorporated in H.R.4900 is bleak. Continuous and extravagantly expensive litigation, uncertainty, and market dislocation could result. All alternatives, including state regulation enhanced by interstate compacts and a federal carve-out that avoids federal/state conflicts, need to be explored. The definition of a good political compromise is one that makes everyone just a little unhappy. A balanced approach to insurance regulatory reform may be just exactly that kind of compromise.
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Title Annotation:alternatives to the Federal Insurance Solvency Act
Author:Myers, Robert H., Jr.
Publication:Risk Management
Date:Feb 1, 1993
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