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State and federal regulators in 'footrace' to finish state guaranty fund system 'overly burdensome.'

Changes in insurance industry regulation in the 1980s made managing companies more difficult, said North Dakota Insurance Commissioner Earl Pomeroy. His remarks, made at a recent American Bar Institute conference on insurance regulation held in Indianapolis, were an attempt to explain why insurance company insolvencies is such a hot topic these days.

Mr. Pomeroy also cited the shift from property to liability risks, a pricing cycle that has dropped to deeper levels, a lingering soft market and pollution risks that affect the adequacy of posted reserves as reasons for the concern.

In addition, he said life and health insurance is getting along on thinner profit margins, while health care costs continue to spiral out of control. If the trend continues, "In 70 years, 100 percent of the gross national product will be devoted to health care services," he said.

According to Mr. Pomeroy, competition without failure is impossible. However, he added that any resulting insolvencies must be kept within "a tolerable range."

Taking a swipe at the recent "Failed Promises" report of the House Subcommittee on Oversight and Investigations chaired by Rep. John Dingell (D-MI), Mr. Pomeroy maintained that the number of insolvencies runs only half of 1 percent among insurers in any given year. He added that the Executive Life Insurance Co. conservatorship action does not indicate an insurance industry solvency crisis and should not be compared to the recent savings and loan debacle.

"Dingell has completely condemned the existing regulatory structure without having another with which to replace it," Mr. Pomeroy said. "Just like Christopher Columbus, he doesn't know where he's going, didn't know where he was when he got there and made the trip on other people's money." He also said state regulation had little chance of becoming part of an overall federal regulatory structure.

Acknowledging the complexity of the insurance industry and the fact that many regulators were once relatively unsophisticated in such matters, Mr. Pomeroy said that by the late 1980s the National Association of Insurance Commissioners had committed 458 million to state solvency regulation-a level that the federal government, he added, is not likely to match.

In addition, the NAIC solvency plank includes the use of an annual statement blank to improve solvency policing requirements. The association, he said, has also enhanced its staff by 60 percent since 1989, raised its annual budget to $15 million and added peer review capability to identify financially troubled insurers.

"Perhaps the most important step has been developing minimum solvency regulation standards and getting all regulators to be governed by it," he said.

'Regulatory Footrace'

"What we're seeing is a regulatory footrace between the NAIC and the federal government to see who can regulate better," said Franklin Marsteller, president of Price Waterhouse and an adviser to the House Subcommittee on Oversight and Investigations. "History has taught us that enactment and implementation of model bills take time."

According to Mr. Marsteller, Sen. Dingell would like to establish a national insurance standards board similar to what regulators do on a state level.

"I could see national liquidation rules," he added, "instead of a patchwork of state laws to get companies to liquidate and present claims to various state guarantee funds." In addition, Mr. Marsteller said, Sen. Dingell is also considering developing a standard-setting federal oversight board and giving the federal government the power to handle criminal prosecutions.

"At the end of the day," he said, "the footrace on regulatory oversight has gotten doser."

The Marketplace Knows'

Taking issue with state and federal regulatory initiatives, David Grubb, a senior partner with Public Entity Risk Management Administration Inc., said the marketplace is the real regulator. "The marketplace governs pricing, not the government," he said. "The marketplace knows when a producer is in trouble and usually won't deal with him. When I was a risk manager I knew Mission was in trouble in 1984 by the way it underwrote my account."

Mr. Grubb said much of the regulator's resources are concentrated on local "hot" pricing issues, instead of the solvency issues at large.

"There is too much duplication of resources," he added. Just when insurance commissioners begin to know the business, they must leave office. And it takes years to enact model laws, and they are often watered down when enacted."

Giving the NAIC "legal teeth" to enforce uniformity is one measure, Mr. Grubb said, that should be explored. He also suggested that commissioners adopt a more "realistic" attitude toward pricing policies and focus on long-term issues. The insolvency of such major insurers as Transit Casualty Co. and Mission Insurance Co. and the receivership of First Executive Life Insurance Co. has not only cast a shadow over the insurance industry but has also sparked lively debate over the reliability of state guaranty funds to protect policyholders.

That debate recently resurfaced at the National Association of Insurance Commissioners' summer meeting in Indianapolis where representatives from the academic, consumer, producer and insurer communities testified before the NAIC's Special Committee on Guaranty Funds and Liquidations.

According to Paul Brown, director of governmental affairs for Risk and Insurance Management Society, problems with guaranty funds could come in the event of an expensive, multistate insolvency.

"Of primary concern to RIMS is the apparent lack of communication and cooperation between jurisdictions administering guaranty funds," he said. "This lack of cooperation between liquidators and state insurance departments may lead to delayed and inaccurate resolutions to major insolvencies."

Mr. Brown said even if each state similarly enacts the NAIC-sponsored Guaranty Association Model Act, as demanded by the accreditation process, a system of 50 distinct state guaranty fund administrators would still be "overly burdensome." He said a national guaranty fund with a centralized administration would benefit policyholders, insurers and regulators alike.

Speaking on behalf of the National Association of Professional Insurance Agents, Tammy Rudd, director of state affairs, agreed with the efficacy of establishing a national guaranty fund, but felt that centralizing the fund's money or its hands-on processing was unnecessary.

"Our national board would like to explore the idea of an interstate compact," she said. "This would allow the states to draft specific provisions and enter into contractual obligations on what the statutory regulatory provisions and administrative procedures will be."

Ms. Rudd said the likelihood of getting most states to agree to an interstate compact is more palatable and possible today than it was 10 years ago. "There is an unhappiness with the federal government and its one-size-fits-all approach," she said. "Consequently, dissatisfaction exists with the patchwork effect of 50 state regulations." She added that coordination and uniformity are desired without the bureaucracy and inefficiency that is synonymous with the federal government.

"Interstate compacts are not a panacea, but they are a useful idea," said james jackson, vice president and deputy general counsel of Transamerica Occidental Life Insurance Co. "Two-hundred interstate compacts already exist and constitute an enforceable agreement that cannot be unilaterally abrogated."

Mr. Jackson said a national guaranty fund would work if contributions to it were based on each insurer's percentage of risk and if it contained a proviso that no state legislature could borrow from the fund.

Such a fund, said Mr. jackson, would have one administrative unit, be prefunded and contain appropriate coinsurance.

States Are Doing Their job

Jim Long, NAIC president and North Carolina insurance commissioner, said the NAIC's state accreditation program for compliance with the association's financial standards "proves to the world" that the states are doing their job in trying to control insolvencies. "I'll match our 120-year track record against those responsible for commercial banks, savings and loans, the war on drugs, the plight of the homeless, inadequate access to health care, quality of our environment, quality of our food and water, telephone service and delivery of mail," he said.

In its continuing efforts to bring states up to NAIC solvency standards, the association announced the accreditation of Illinois and South Carolina, which brings to four the number of accredited states.

"Small states have the ability to be accredited," said South Carolina Insurance Commissioner John Richards. "My state has proven that." He added that it is the responsibility of insurance regulators to protect the people in their state by becoming accredited. "The federal government is not user-friendly," he said.

Cycles Cannot Be Controlled

Additional support for state regulation came in the form of a report presented at the meeting. In "Cycles and Crises in Property/Casualty Insurance" a team of NAIC-backed researchers found that shifting cycles in insurance pricing and availability are beyond regulatory control. The study, which reviewed underwriting cycles from 1926, found that insurance cycles were more volatile than general business cycles.

According to Scott Harrington of the University of South Carolina, "Rather than regulating rates, pricing should be monitored, and regulatory legislation should in effect be reduced."

J. David Cummins of the University of Pennsylvania said the research concluded that prices are inversely related to interest rates, and cycles would exist in reported profits even if prices did not fluctuate.

Richard Hsia of the New York Insurance Department interpreted the issue through a unique prism of his own-albeit more abstruse than scientific. "The underwriting cycle is more of a vortex," he said. "The industry is caught up in time warps."

In other matters, the NAIC fronting working group released its third draft of the Limitations on Reinsurance Activities of Insurers Model Act at the meeting. For details, see RM Spectrum on page 7 and Legal Considerations on page 61.) It's not worth it trying to prevent all insurer insolvencies, contends Benjamin Zycher, an economist at The Rand Corp. in Santa Monica, CA.

Speaking before insurance executives at the Insurance Information Institute's annual government briefing in Washington, DC, last month, Mr. Zycher said that, in some cases, "the cost of avoiding them exceeds the benefit of doing so." He added that the insurance industry is generally reliable, and then blamed its inefficiencies on state-run guaranty funds and the political aspirations of some regulators.

Market forces make insurer reliability profitable, he said, adding that price increases is the reward for insurers that deal honestly. "Profit-maximizing firms recognize that the stream of reliability payments is more valuable than the one-time gain from cheating," he said.

Government guaranty funds, however, erode the insurance market's efficiency. "The system reduces incentives for consumers to search for reliable insurers, and so imposes penalties on insurers that make their promises to honor claims more credible by enlarging their capital structures, thus reducing solvency risk," Mr. Zycher said.

The politicization of insurance rates, as in California, has further harmed the solvency position of insurers. "The increasing political aspirations of insurance regulators carry additional adverse implications for rates and thus solvency position," Mr. Zycher said.

What's needed is state solvency regulation and not rate regulation, he concluded.
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Author:Johnson, Tom
Publication:Risk Management
Date:Aug 1, 1991
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