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A new age for insurance regulation.

RISK MANAGERS TODAY LIVE IN interesting times, in the sense of the Chinese curse. Even with a relatively soft market, there have been changes in technology and in legal theories governing liability and coverage. Crucial markets such as employers' liability have also taken drastic turns. The globalization of business poses challenges to many companies that must become familiar with new markets and foreign legal systems, and the recent spate of insurer insolvencies has concerned risk managers, insurers and regulators alike.

As a new year begins, will there be less turbulent times ahead? Certainly, possible tort law and civil justice reforms may restore some predictability in certain markets. If there is a modest recovery in real estate, and stability or decline of interest rates reduce the temptation of cash-flow underwriting, insurer insolvencies may abate for a while. Nevertheless, the repercussions of major insolvencies continue to be heard in Congress and state legislatures. Even small company insolvencies (of which there are certain to be more) can considerably affect the regulatory environment when their impact is felt in politically sensitive areas. Legislators and regulators, like risk managers, are faced with challenges emanating from today's dynamic business environment. Even in tranquil times, regulators must balance solvency and safety with availability and affordability. Other considerations, such as the desire to protect local markets and businesses as well as to guard regulatory turf," also enter into the equation. The complexity of balancing these competing interests has increased greatly over recent years. Consequently, fractures have appeared in the once monolithic consensus among regulators, industry and risk managers that the existing state regulation system must be preserved. These fractures have been noticed by members of Congress who are considering several proposals that could radically alter the way the insurance industry is regulated in the United States.

Under the McCarran-ferguson Act, there wasn't a fundamental shift in the way insurance was regulated. This probably reflected a general satisfaction with the status quo until the mid-1980s; there was a sense that state regulation, on the whole, did a good job. Indeed, the limited protection from antitrust scrutiny afforded by McCarran-ferguson was strengthened by the Federal Trade Commission Improvements Act of 1980, which prohibits the FTC from studying the insurance industry unless specifically authorized by Congress. The crisis in property/casualty insurance of the mid-1980s, however, began to erode the consensus. Since 1985, Congress has seen several bills which either repeal or amend McCarran-ferguson, thereby curtailing the industry's protection from antitrust laws. Until 1991, these bills faced solid opposition from both the industry and state insurance regulators, although the National Association of Attorneys General endorsed McCarranFerguson repeal in 1988. In the face of this opposition, no bill progressed beyond the committee stage.

Last january, Rep. jack Brooks, D-TX, chairman of the House Judiciary Committee, introduced H.R. 9, the latest of a long series of McCarran-ferguson reform bills. This bill would modify the act by expanding the list of antitrust law prohibitions which apply to insurance, despite the "to the extent not regulated by state law" proviso.

Expansion would include price fixing, allocation of geographical areas or markets among competitors, "tying arrangements," under which an insurance product will only be offered with another insurance product, and attempts to monopolize the insurance business. The bill would provide limited exemptions to this increased antitrust exposure. It would allow insurers to continue to collect, compile and disseminate historical loss data, determine loss development factors and provide actuarial services to other insurers, as long as such services do not result in trade restraints.

While the American Insurance Association, Risk and Insurance Management Society and National Association of Insurance Brokers announced their opposition to H.R. 9, AIA and NAIB also offered to work with Rep. Brooks and the Judiciary Committee to develop an alternative bill which would be acceptable in expanding the "safe harbors" to include loss trending, pooling and other joint underwriting arrangements, development of common policy forms and joint inspections of property for possible fire hazards. Yet, other associations, including the American Council of Life Insurance, National Association of Life Companies, National Association of Independent Insurers and National Association of Mutual Insurance Companies, have continued to oppose any reform of McCarranFerguson. The significance is that the industry, including certain brokers and consumers, is no longer unanimously opposed to any modification. In effect, the prospect of a change is more real than ever; H.R. 9 has just been cleared by the judiciary Committee, and representatives of the two trade groups are continuing negotiations in preparation for its consideration by the full house.

Insolvency Issues Of all the possibilities for federal involvement in insurance regulation, however, McCarran-ferguson reform is not the only, or even the most important, development on the horizon. Several proposals, including one already introduced as a bill in the Senate, would invoke more comprehensive regulatory power, more disruptive of present state regulation. The insolvencies which occurred in the late 1980s and into the 90s, and their disturbing similarity, in the minds of some congressional members, to the savings and loan crisis, have led to increased concern with solvency and safety. A study of insolvencies by the Subcommittee on Oversight and Investigations of the House Energy and Commerce Committee, chaired by Rep. John Dingell, D-MI was scathingly critical of the job done by state regulators in monitoring and protecting the solvency of both insurers and reinsurers. In addition, a General Accounting Office study in May 1991 criticized the National Association of Insurance Commissioners' inability to require states to impose and enforce insolvency standards.

The subcommittee prepared an outline of proposed legislation last summer with recommendations greater in scope than any other federal intervention. These include establishing a Federal Insurance Solvency Corp. to set minimum standards for state regulation of solvency; federal certificates of authority issued to any insurer or reinsurer doing business across state lines; federal regulation of the reinsurance market; federal standards governing transactions with unlicensed alien insurers or reinsurers including trust fund requirements; and federal civil and criminal penalties for insurance fraud. In addition, the corporation would be required to investigate the insolvency of any insurer under its jurisdiction, and would be authorized to conduct studies of insurer or reinsurer solvency.

Metzenbaum vs. Dingell In August, Sen. Howard Metzenbaum, D-OH, introduced a bill which incorporates much of the Dingell subcommittee's outline. However, the Metzenbaum bill differs from the Dingell proposal in that it provides no mechanism for licensing alien direct insurers (as opposed to reinsurers), and it bars any insurer not domiciled in an accredited state from interstate commerce. The latter may, perhaps inadvertently, eliminate much or all of the alien surplus lines market. The Dingell proposal, by contrast, appears to enable licensing of alien insurers, and sets federal standards governing the export of surplus lines business. Also, while the Metzenbaum bill mandates a federal takeover of the rehabilitation and liquidation of insolvent insurers engaged in interstate commerce as well as establishes a federal guaranty fund for business written by federally licensed insurers, the Dingell proposal leaves the administration to the states.

As yet, there is no visible support for either proposal from industry. However, a group, led by Marsh & McLennan with Alexander & Alexander, Sedgwick james, American International Group and Dow Chemical, has proposed an alternate plan which would also result in a two-tiered federal and state insurance regulatory system. Under the Marsh & McLennan plan, insurers with a capital and surplus of at least $50 million which limit their business to large commercial and industrial risks could apply for federal charters. These insurers would be governed exclusively by federal regulation and would not participate in any guaranty fund, state or federal. States would regulate insurers of personal lines and of small commercial accounts; this business would be covered by state guaranty funds. This would result in a regulatory system similar to the European Community, in that the authority of member states to regulate "mass risk" business (personal lines and small commercial) is greater than that for large risks.

At the time the Dingell subcommittee was holding hearings on its outline proposal, the NAIC began to develop its own alternative, which is not yet final. A bill to be introduced in Congress, which would give the government power to establish minimum standards for foreign insurers or reinsurers to accept business from the United States, includes minimum capital and surplus requirements and the establishment of trust funds. Enforcement would be delegated to the NAIC by the government. There appears to be substantial opposition to this proposal within the NAIC. Some groups, including RIMS, have objected to specific aspects of circulated drafts. In particular, RIMS has opposed application of the proposal's capital and surplus standards to offshore captives.

The three proposals would all result in substantial federal involvement in the regulation of insurance markets, yet preserve some role for the states. The Dingell and Metzenbaum proposals would divide responsibility by regulatory function with the federal government responsible for solvency regulation and the states primarily concerned with insurance affordability and availability matters and market conduct. The Marsh & McLennan proposal would divide responsibility by markets, making the federal government the principal regulator of large commercial and industrial business. The NAIC alternative and other proposals would largely keep state regulation intact, while making it more uniform and effective. One way would be to have the federal government empower the NAIC to establish and enforce uniform insurance regulation throughout the states or to have the states adopt an interstate compact, a procedure which is authorized under the U.S. Constitution.

Is Change

Likely? Within the last year, the outlook for insurance regulation has revealed several possibilities for major change. What is the likelihood of these possibilities being realized? First the odds of McCarran-ferguson reform being enacted by Congress in 1992 appear better than even. Such reform is likely to include some, but probably not all, of the changes to the proposal by the AIA and the NAIB. It is difficult to predict what the effect of such reform would be. It would not, by itself, result in a federal takeover of insurance regulation, nor would it prevent one. It is possible, especially if it does not contain adequate "safe harbor" provisions for loss trending and similar joint activities, that it may lead to greater market concentration by forcing some smaller companies to merge or withdraw from business. The only sure prediction is that it will certainly trigger litigation, which will be needed to define its application to various activities, just as the McCarran-ferguson Act has generated litigation over its years in effect. Insurers, brokers and risk managers will need to develop a heightened sensitivity to antitrust issues. Indeed, even without McCarran-ferguson reform, increased antitrust awareness should be on every company's agenda. There have been several antitrust suits against insurers in recent years, based on grounds not included in the McCarranFerguson limited exemption; some of them have been successful. In fact, the U.S. Court of Appeals recently reinstated a major antitrust suit by 19 state attorneys general against insurers, reinsurers, brokers and trade associations, overruling the trial court's dismissal of the suit based partly on McCarran-ferguson. The likelihood of a radical restructuring of the insurance regulatory system in 1992, as embodied in the Dingell and Metzenbaum proposals, depends on whether there is another major insolvency or several small insolvencies which affect politically sensitive areas, such as automobile, life or health insurance, this year. Congress begins the year with a lengthy agenda of unfinished business in other industries, and the looming threat of an insurance crisis may spark it to act on such complex and far-reaching legislation.

The prospects for the Marsh & McLennan proposal appear even more cloudy. It seems to be motivated less by concern for solvency than by a desire to streamline regulation of the large commercial and industrial market and to remove from that market the burden of contributing to guaranty funds. This doesn't mean it's not a good idea, but this reduces its immediate political appeal. Its chances would be improved if more industry, broker and consumer supporters could be found and, more importantly, if it could secure effective sponsorship in Congress.

If a two-tiered federal and state regulatory system becomes a reality, it could have considerable effects on risk management. Federal solvency regulation might severely constrain both the foreign and domestic captive markets, as could federal regulation of reinsurance transactions. While risk retention groups are not specifically mentioned in either the Dingell proposal or the Metzenbaum bill, they could also be affected by their provisions. While the Dingell outline does not include a list of definitions, the definition of "insurer in the Metzenbaum bill is broad enough to include risk retention groups and specifically excludes only qualified employee benefit plans. On the positive side, federal regulation of large commercial and industrial business, as envisioned by the Marsh & McLennan proposal, could reduce insurers' costs of doing business, and thereby lead to lower rates.

Expect the Unexpected A final prediction is that, no matter what happens in the short run, efforts by the NAIC, the National Conference of Insurance Legislators and state regulators and legislators to tighten state insurance regulation will continue at an intense level. The NAIC has responded to the solvency crisis, for example, by instituting its state accreditation program, supporting tighter credit for reinsurance standards, increasing financial disclosure requirements and recommending more thorough regulation of transactions involving managing general agents. Individual states have also taken action, both by implementing NAIC recommendations and by taking the initiative, for instance, to institute stricter laws governing insurance company investments. Some efforts in this area may have immediate impact on risk managers, an example being the proposed restrictions on reinsurance fronting transactions now being considered by the NAIC, which could have serious adverse effects on captive arrangements.

In the current regulatory climate, risk managers should, as the maxim says, "expect the unexpected." While solvency is a top concern in today's regulatory arena, the return of a hard market could, at moment's notice, shift the focus back to insurance availability and affordability issues. Business globalization could, and eventually will, make regulation a necessity at the multinational level. Today's vexing problems await as yet unforeseen solutions. How, for example, can we deal comprehensively and meaningfully with the problem of so-called "transaction costs" in insurance? Is there an alternative to endless litigation over coverage questions as well as liability of the insured? Indeed, we live in interesting times. RM
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Title Annotation:Forecast 1992
Author:Scales, Claude M., III
Publication:Risk Management
Date:Jan 1, 1992
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