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State Vs. federal. (Industry Strategies).

Insurers and regulators continue to debate the pros and cons of insurance regulation as it is--on a state-by-state basis--and as some would like it to be--with an option for federal oversight. Proponents of state regulation rally around modernizing a system that has proven effective for more than 130 years. Those in favor of the federal option say it would relieve competitive pressures and allow companies to operate on a global level. In articles that begin on this page and the opposite page, we let both sides have their say.

Supporters of state regulation pose a question to those in favor of a federal option: Why fix something that has worked for more than 130 years? While proponents agree that the current state regulatory environment needs to be modernized, they are confident that the overall mechanism that has served the industry well for more than a century can continue as a guiding force for insurers.

"While there are things that need to be done to improve state regulation, it has successfully served customers over the years," said Tern Vaughan, Iowa Insurance Commissioner and president of the National Association of Insurance Commissioners. "State regulation has shown the ability to evolve as situations change, has remarkable resilience and ability to adapt to change, and, in light of the economic environment in which insurers operate, we need to be more efficient in the way we do things."

As proposals designed to place regulatory control in the hands of the federal government continue to be brought before legislators, supporters of state regulation believe these proposals will lessen the power of state regulators, jeopardize companies' competitive market structure and hinder consumer protection.

Preserving the System

The state vs. federal regulation debate is long-standing. For years, proponents have fought to keep control of insurance regulatory power in the hands of the states, while opponents, such as the American Insurance Association and the Council of Insurance Agents and Brokers, fought for the creation of a federal regulatory system. In 2000, the NAIC asked the industry how to streamline state regulation and bring it into line with the principles set forth by the Gramm-Leach-Bliley Financial Services Modernization Act.

"States have the incentive to do the job and are responsible at the end of the day for insolvencies and for problems that arise," said Wes Bissett, vice president of state government affairs for the Independent Insurance Agents Association.

The IIAA is adamant that the industry and consumers are better off reforming the state system than tossing it aside, he said. The IIAA has been a longtime supporter of state regulation and has concentrated much of its effort to fight increased intrusions from the federal government onto states' regulatory turf.

"Those who believe in the system and have successfully dealt with it over the years believe that while the system isn't perfect, it could be reformed to the point that it becomes more efficient and provides some safeties and securities to all participants," said F.W. Purmort, president and chairman for the Van Wert, Ohio-based Central Insurance Cos. and the current chairman of the Alliance of American Insurers.

"A lot of attention is now being given to the need for improvements to state regulation and that we need to make these improvements in terms of efficiency, better coordination and greater consistency and uniformity in laws," said the NAIC's Vaughan. "However, we shouldn't lose sight of the strong history that state regulation has?' Perhaps one of the most powerful examples that supports this long-enduring history is the events of Sept. 11, which resulted in the largest single loss for the insurance industry, with estimates ranging from $35 billion to $70 billion and an assumed $40 billion loss, she said. "It's a significant hit to the capital of the industry, however, we had no insurance company go insolvent as a result." She believes this is a testament to the strength of the system that, at its core, works well to protect consumers.

Several other trade associations that have long supported state regulation agree. "Having a functional state regulatory apparatus is imperative, because it's the legal nature of our product, because we are closest to our clients and because the nature of risks insured is highly regionalized," said Pat Borowski, senior vice president of government affairs for the National Association of Professional Insurance Agents. She views this approach as a business model that works best to accomplish these very tasks.

While some opponents criticize the ability of states to handle the never-ending task of regulating this complex industry, many believe that most states continue to meet that challenge head on. Success in producer licensing is one such example. The NAIC's statement of intent really laid out the vision for state regulation, including calling for a streamlined national producer licensing system, said Vaughan. "We needed to have greater uniformity in the laws of the state, and we wanted a national electronic process where agents could go to one place, complete an application, and if there were no regulatory problems or prior disciplinary action, have the application processed quickly." With the support of state legislators, the NAIC's Uniform Producer Licensing Model Act has been passed in 39 states and is in the legislatures of another 11 states.

"State insurance departments don't get enough credit for all that they do, including handling complaints and returning millions of dollars each year to consumers as a result of disputes with insurers," said Robert Mackin, executive director of the National Conference of Insurance Legislators, an organization of state legislators whose main area of public policy concern is insurance legislation and regulation. "And I'm not sure whether or not the federal government is up to that challenge?'

Fighting for Competition

While proponents agree that state regulation has a multitude of advantages, including spreading the exposure to the risk of bad regulation and having superior responsiveness to local issues, they believe its ability to foster a level competitive playing field is one of its greatest assets.

"Competition was built to create 50 strong athletes who field a good team rather than one lazy player," said NCOIL's Mackin.

Jack Ramirez, president of the National Association of Independent Insurers, agrees. "We believe greater competition means more companies from which customers can choose and more insurance products at better prices?"

State regulation proponents fear that an optional federal charter could hinder competition among smaller insurers. "If the playing field gets tilted because of dual charters and some costs are born by some carriers and not others, then how am I as a midsize carrier able to compete in some arenas that a federally chartered insurer competes in?" asks AAI's Purmort. Under the current state regulatory structure, hundreds of insurers are able to go to-eto-toe with any company in any state in which they do business.

Battling Federal Regulation

Supporters of state regulation question the logistics of a federal option. It is unclear whether it would be available to companies of any size and whether insurers could obtain a charter quickly and easily. It also is not known whether companies could move back and forth between federal and state charters or whether holding companies could have both state- and federal-chartered insurers. There are features that must be built into those elements so that one regulatory system doesn't create a competitive advantage over the other, Ramirez said.

"One problem with a federal solution is that it may create a new, untested guaranty fund," said IIAA's Bissett. "On the other hand, it may keep in place state guaranty funds. However, this doesn't make sense, because if you have federal regulation but it doesn't do the job, states are still on the hook."

In addition, Bissett believes a federal option will give rise to governance by more bureaucratic entities. "We don't want insurance regulators to be run under an IRS business model that is very centralized, based in Washington, D.C., and is removed from and insensitive to issues consumers care most about' he said.

State regulation proponents doubt whether a federal regulatory environment would be as responsive to consumers. Each year, state regulators receive nearly a half-million consumer complaints. "Issues of importance arise during a time of crisis, and to experiment with federal regulation on something with disastrous consequences is dangerous to do," said Bissett.

Opposing Other Options

A dual chartering framework is another option proposed by some federal regulatory backers, but that might threaten a significant source of income for states, said NCOIL's Mackin. Earlier this year, NCOIL sent a letter to Sen. Charles Schumer, D-N.Y., urging him to reconsider his sponsorship of optional federal chartering legislation. In the letter, NCOIL said the proposal for a bifurcated regulatory system would "threaten the revenue stream that now flows to the states in insurance premium taxes." According to the U.S. Census Bureau, states collected $9.7 billion in premium taxes in 2000.

Time is also a factor. Mackin believes the passage of a dual chartering system would take at least 10 years, and the cost of the transition, including setting up a new federal bureaucracy to handle the dual system, would be several billion dollars that would come from taxpayers.

State regulation supporters also fear that regulatory arbitrage may enable insurers to move back and forth between state and federal charter systems, allowing them to choose the regulatory system they prefer, rather than the one that ultimately serves customers best, said NAIC's Vaughan.

"I question the idea of switching back and forth between regulatory systems," said Rodger Lawson, president of the Alliance of American Insurers. "I don't think regulation should be set up so that one group of companies has favored regulation over another. A regulatory system shouldn't be dictated by who wins or loses." He uses the example of the banking industry which he believes is not working as well as many of its initial supporters first predicted. "To hold the banking regulation model out as something we should aspire to may not be a good model to use."

While some state regulation supporters, such as the Independent Insurance Agents of America, oppose the creation of a federal regulatory environment, they do suggest an alternative to streamline and modernize the current system. Under the "state-friendly" model, Congress would play a role in achieving desired state reforms by using existing legislative tools to bring about greater consistency across state lines and to enact needed reforms.

Next to modernizing the state regulatory system, some believe this approach is the path of least resistance. "While this would be simpler than constructing an entirely new federal regulatory system, the risks are still significant," Ramirez said. "Any time you invite Congress to step in and help solve your problem, you surrender control of the situation and almost always get more than you asked for."

Federal Ramifications

Supporters already are questioning what ramifications a federal initiative would have on insurers, and many are confident the negatives will outweigh the positives.

"I believe pursuing a full-blown federal regulatory system will open up Pandora's box," said the IIAA's Bissett. He anticipates that federal regulation would likely foster additional federal requirements that aren't already built into company proposals. "However, they will probably be built in through a legislative process." In addition, Bissett believes federal oversight will likely tie in other federal organizations such as the U.S. Federal Trade Commission and the U.S. Department of Housing and Urban Development, particularly to deal with redlining issues, and reporting requirements similar to those found in the Home Mortgage Disclosure Act. "Once data is obtained, there's no telling how federal regulators would ultimately use it," he said.

Insurers themselves are fearful of how a federal regulatory system would impact their operations. "First of all, we'd end up being regulated by both the state and federal governments, and that would add costs that would unfortunately be passed on to the consumer," said Herm Arends, chairman and chief executive officer of Lansing, Mich.-based Auto-Owners Insurance. In addition, he is unsure of the federal government's role in regulating coverage and pricing options. "While federal regulation proponents say the federal government wouldn't regulate pricing or coverage, it may be true on the banking side, but I'm not so sure if it would hold true for insurance."

Arends reiterates that cost is one of the major ramifications his company will feel if some type of federal initiative is passed in the coming years. "State regulation is a known quantity. However, going with a federal approach is an unknown quantity, and it's only going to add additional cost to our operation."

Supporters are skeptical that those in favor of federal regulation will likely see the type of legislation passed they are now proposing. "I don't think those entities promoting federal regulation would get what they are hoping for by the end of the legislative process," said Bissett. Therefore, he believes that Congress' best response will to be to modernize a state-based system.

Down the Road

The battle between state and federal regulation will likely continue in the coming months and years, and who will win remains anyone's guess.

"I think that while Congress will take an increasing interest in insurance issues and will want to improve the state system, it clearly won't want to establish a new unprecedented full-blown federal bureaucracy to regulate business out of Washington, D.C.," said Bissett. Instead, he believes Congress will favor a more limited, laser-like approach similar to the one being proposed by the IIAA.

State regulation proponents also question whether Congress has the bandwidth to take on this project. "Some are saying that the federal government isn't looking after things very well and why would we put another log on the fire," said the AAI's Purmort. "And as a result, I believe many will support that governmental oversight is better left in the hands of the states."

Purmont believes actions by the NAIC will seal the fate of state regulation. "If the NAIC steps up and says there are efficiencies that can be gained, state regulation is where it belongs and we can modernize it to the point that we can share those efficiencies with everybody, including policyholders, taxpayers and businesses, then I believe state regulation is here to stay for another 130 years."

RELATED ARTICLE: It's true that the argument for federal oversight of the insurance Industry rips away the niceties offered by discussions of reform at the state level. But those who support optional federal chartering of the insurance industry are tired of being polite.

The industry says it has been patient as state regulators have repeatedly promised change. Model laws from the National Association of Insurance Commissioners and legislation on the state level have failed to correct the inefficiencies of the state regulatory system. So now, it's time to give the industry a choice. It's time to establish a federal regulatory option, according to supporters of that change.

The goal of an optional federal charter is not to undermine state regulators, say its supporters, who include some insurers, bankers and trade associations. In fact, many who support a federal option have a high opinion of those who make up the current state-based regime. But the problem, they say, is that the system isn't working for insurers.

A federal regulatory system holds the promise of an industry that operates in a truly free market, where prices are determined by demand and not by burdensome rules. And as technology pulls the world closer together, insurers need a more streamlined regulatory system in order to operate on a global level. Under a federal system, supporters say, resources could be dedicated to ensure that equal attention is paid to companies across the nation on issues such as solvency, fraud detection and maintaining communication among the states in general.

Inefficiency creates a competitive disadvantage: This is the battle cry of those seeking a federal option. It takes too long to get products to market under the current system. And once a product is approved, the restrictions on pricing hinder profitability. Another problem: There are 50 states, each with different rules. Companies trying to sell insurance across the nation get lost in the quagmire of paperwork required to do business in multiple markets.

"We have 10 people who work in licensing to make sure that our people are properly licensed," said Glen Milesko, chairman of Banc One Insurance Group, Milwaukee. "It boggles the mind in terms of how cumbersome it is as far as the licensing procedure."

Milesko described a "patchwork quilt of state regulation," in which some states require only an application fee for an agent to obtain a license. Other states mandate a training regimen, while still others demand an affidavit and fingerprints for those who wish to sell within state borders. "It's just all over the board," Milesko said.

The Banking Model

As head of a bank insurance group, which is subject to both state and federal regulation, Milesko is familiar with how a federal regulatory system could streamline the system. "I think 50 states inhibit creation and innovation," Milesko said.

Banks have had the option of federal oversight for nearly 140 years, according to the American Bankers Insurance Association. Under the dual banking system, they can select to be chartered and regulated by either the federal government or by an individual state, depending upon the market to which they are targeting their products.

The ABIA believes that the dual banking system can be translated for use by the insurance industry. Executive Director Beth L. Climo pointed to the inefficiencies created by having 50 different states with 50 different sets of rules. "By the time you get approval [on a product], the market may have passed you by," Climo said.

If insurance companies had a choice between federal or state oversight, Glimo said, it may motivate the states to "come into the modem world."

The efforts of the NAIC and the states to modernize insurance regulation have not gone unnoticed, however.

"We are supportive of and commend the efforts of the NAIC to try to address some of these issues that have arisen from modernization," Climo said.

Leigh Ann Pusey, senior vice president, federal affairs, American Insurance Association, agreed. "There's a perception that being in favor of an optional federal charter equates to being opposed to state regulation," Pusey said. But that's not true. The problem is that the NAIC doesn't have the authority to enforce its model laws and model acts, she said.

"We will continue to stress reforms in the states," while simultaneously pushing for a federal option, Pusey said. "We're moving in both directions in desperate hope for regulatory reform."

A Chorus of Complaints

It's not just banks that feel stifled by the current regulatory system.

"The lack of uniformity creates huge hurdles for the industry. We view it as a competitive disadvantage," Pusey said. "We represent 370 insurance companies--many large, national, global companies...who are looking for streamlining."

"There are far too many regulatory approvals of both rate and form that impede the ability to do business and which provide very little, if any, benefits to consumers," said Peter Lefkin, senior vice president, government and industry affairs, and Washington-based lobbyist for Fireman's Fund Insurance Co., Novato, Calif. "There are times when you need to adapt very fast, and I am not sure that operating under the state system we can move quickly enough to accommodate the insurance needs of our agents, brokers and customers."

Even insurers that are not based in the United States struggle with the constraints of the current regulatory system. Hiroyuki Uemura, chairman of the Marine and Fire Insurance Association of Japan Inc., indicated the existence of a "virtual barrier, especially to foreign insurance companies who seek to enter the U.S. market."

"The current state-based regulatory system lacks uniformity among various states, it imposes a great deal of costs and burdens on insurers who operate on a multistate basis in the United States," said Uemura, who is also president and chief executive officer of Mitsui Sumitomo Insurance Co.

There is a very high cost of doing business today in the insurance industry, Banc One's Milesko said, and that hurts insurers as well as their customers. "if you could bring the costs down, the insurance products.. could be priced better and might be a better solution [for customers], because you take out a layer of inefficiencies," he said.

If states impede insurance companies from doing business, there are other entities--which are not subject to state regulation--that will snatch that business from traditional insurers, said Lefkin of Fireman's Fund. Captives, offshore entities and risk-retention groups, to name a few, are beginning to capture a share of the U.S. insurance market.

Milesko added that federally regulated banks and securities firms, which answer to the U.S. Securities and Exchange Commission, also pose a threat, because they sell products that compete with those offered by insurance companies.

Free the Market

"Our frustration is that the free market ought to be pricing products," Pusey said. What the MA envisions is a "one-stop shop" for rate and form filing, pricing and regulation in general. In July, the American Insurance Association released its proposal for an optional federal charter to regulate property/casualty insurers. The AIA's proposal was among the first of several that have emerged during the debate.

The key, Pusey said, is the regulation of insurers, not the regulation of insurance.

"We don't want to have a federal auto insurance policy, [or] one homeowners insurance policy," she said. Under the AIA's proposal, each state would retain the power to determine licensing issues and solvency issues, including the continued control of state guaranty funds. The AIA recognizes that state guaranty funds and the taxes that insurers pay are a tremendous source of income for the states. "We didn't want to see a drain on state revenues," Pusey said. The goal of giving insurers the option of federal oversight would be to streamline business operations for companies that do business on a national or global level, she said.

Technology creates another concern. The Internet has produced a real-time, global insurance marketplace. Streamlining the regulatory process "becomes more critical as more business is done via the Web, via the Internet, where it's harder to regulate across state lines," the ABIA's Climo said.

But many of the state insurance departments have outdated computer systems, and they just can't keep up with what's going on in the marketplace--technologically or otherwise.

"I think we're at a time now where the marketplace will really demonstrate the need for reform," Pusey said.

Telltale Signs

Ask supporters of the federal charter option how the state-based regulatory system has let down the insurance industry and they quickly produce examples: Martin Frankel, Reliance Insurance Co. and terrorism reinsurance, to name a few.

"We look at the demise of Reliance as a great example of how the system does not work effectively," said Ken Crerar, president of the Council of Insurance Agents and Brokers. The insolvency of Reliance Insurance Co. has been called the largest the United States has seen to date. At the time the Pennsylvania insurance department placed the company in liquidation, it was reported that Reliance had total admitted assets of $8.8 billion and liabilities of $9.9 billion--a shortfall of $1.1 billion.

"If that system had been working the way it should, there would have been early warning signals there," Crerar said. "It makes you wonder--at least in the solvency area in particular--who is regulating them [insurance companies]?"

Banc One's Milesko pointed to the Frankel case. Frankel is accused of masterminding a racketeering enterprise through which he allegedly embezzled at least $200 million. Insurance companies from Tennessee, Mississippi, Missouri, Oklahoma and Arkansas were victimized by the alleged fraud. "The states don't talk to each other," Milesko said.

And since Sept. 11, the industry has struggled to deal with a dried-up terrorism reinsurance market. "I think Congress wanted some answers," Milesko said. "They turned to insurance and they have 50 different voices saying 50 different things. One of the ramifications of that is that we don't have any terror reinsurance."

"I think we're all disappointed of the inability of Congress to act and fear the consequence in the marketplace," said Lefkin of Fireman's Fund. But he suggested that the reluctance of Congress to act on terrorism reinsurance may indicate that the time is not yet right for the federal government to assume a larger role in the regulation of insurance.

"There's not overwhelming appeal to this," Lefkin said of the optional federal charter. "Whether or not, when and if Congress acts, will probably be a response to external forces...Under the current situation, they probably won't do anything right now. They probably don't see a compelling reason to act."

Legislation Introduced

The discussion, however, is definitely under way. Two pieces of legislation--one in the Senate and one in the House--have been introduced. But the general feeling is that this is only the beginning of a long process.

Sen. Charles Schumer, D-N.Y, took the lead on the issue in Congress with legislation calling for optional federal chartering, regulation and supervision of insurance companies and agencies. On Dec. 21, Schumer introduced the National Insurance Chartering and Supervision Act, which calls for establishing an Office of the National Insurance Commissioner within the Treasury Department. The bill has not yet been assigned a number.

On Feb. 14, Rep. John LaFalce, D-N.Y, introduced a bill that would put the federal government in charge of insurance regulation, above state regulators. The Insurance Industry Modernization and Consumer Protection Act, also known as H.R. 3766, would establish an Office of the National Insurers within the Department of the Treasury to authorize the issuance of federal charters for carrying Out the underwriting and sale of insurance or any other insurance operations.

Most agree that these two pieces of legislation are only a starting point in the debate. But having the discussion on Capitol Hill is an important step, because the industry does not have an "insurance expert" within the federal regime.

"Our industry does not have a group of people in Washington that understand our business well enough to espouse our interest," said the CIAB's Crerar. "Clearly, the banking industry has benefited greatly by having representatives in the federal bureaucracy."

Pusey of the AIA agreed. "Insurers really have to be involved in the debate, because it's a complex industry," she said. "We really know our business best."
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Title Annotation:Insurance regulation
Comment:State Vs. federal. (Industry Strategies).(Insurance regulation)
Author:Chordas, Lori
Publication:Best's Review
Article Type:Brief Article
Geographic Code:1USA
Date:Apr 1, 2002
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