On December 12, the U.S. Department of the Treasury’s Federal Insurance Office (FIO) released and submitted to Congress its long-awaited report on How To Modernize And Improve The System Of Insurance Regulation In The United States (Report). [1] Originally due by January 21, 2012, the Report was prepared pursuant to Title V of the Dodd-Frank Wall Street Reform and Consumer Protection Act, [2] which, in the wake of the 2007-2009 financial crisis, established the FIO [3] and directed it to “conduct a study and submit a report to Congress on how to modernize and improve the system of insurance regulation in the United States.” [4] The Dodd-Frank Act sets forth a number of “considerations” that the FIO study and Report are to “be based on and guided by,” including “[s]ystemic risk regulation with respect to insurance,” capital standards, consumer protection, and “[t]he degree of national uniformity of State insurance regulation,” [5] as well as certain “additional factors,” which include, among other things, “[t]he costs and benefits of potential Federal regulation of insurance across various lines of insurance.” [6]
The Report concludes that, at least in certain circumstances, “policy goals of uniformity, efficiency, and consumer protection make continued federal involvement necessary to improve insurance regulation … [g]iven the significance of the insurance sector in the U.S. economy, and the globally active nature of U.S. insurance firms.” [7] The FIO does not recommended, however, that the federal government should displace state regulation completely. Rather, the Report concludes “that insurance regulation in the United States is best viewed in terms of a hybrid model, where state and federal oversight play complementary roles and where the roles are defined in terms of the strengths and opportunities that each brings to improving solvency and market conduct regulation.” [8] The considerations supporting the FIO’s conclusions are outlined further below and are discussed at length in the 65-page Report.
By way of background, the FIO developed its Report based on information gathered over the past two years, including through a request for public comment published in the Federal Register on October 17, 2011 [9] and an initial round of consultations with “nearly 40 different insurance sector participants, ranging from insurance regulators, to insurers, to consumer advocates” in November and December 2011. [10] FIO also hosted a conference at the Treasury Department on December 9, 2011, entitled Insurance Regulation in the United States: Modernization and Improvement, during which “participants representing the interests of consumers, insurers and reinsurers, producers, and academics discussed regulatory modernization.” [11] The FIO’s study and consultations with a variety of stakeholders continued throughout 2012 and 2013. [12]
The Report is organized into five principal sections. Section I presents the FIO’s particular recommendations for modernizing insurance regulation in the United States. [13] Section I also includes the FIO’s “general assessment of whether federal involvement is necessary in the regulation of insurance and, if so, what manner that involvement should take.” [14] Significantly in this regard, the FIO determines in its Report that “[r]egulation at the federal level would improve uniformity, efficiency, and consistency, and it would address concerns with uniform supervision of insurance firms with national and global activities.” [15] FIO also notes that “[a]ny system with 56 independent jurisdictions is inherently limited in its ability to regulate uniformly and efficiently” and that “[t]his remains true for the state-based system of insurance regulation in the United States.” [16] The FIO Report finds that “[t]he impact of this lack of uniformity is felt acutely in both prudential [otherwise known as “solvency”] matters and in certain areas of marketplace oversight.” [17]
Nevertheless, the FIO concludes that “[t]he limitations inherent in a state-based system of insurance regulation… do not necessarily imply that the ideal solution would be for the federal government to displace state regulation completely.” [18] On this point, the FIO notes, among other things, that “[t]he business of insurance involves offering many products that are tailored for and delivered at a local level,” thus requiring local knowledge, local relationships, and local regulation. [19] The FIO further notes that “establishing a new federal agency to regulate all or part of the $7.3 trillion insurance sector would be a significant undertaking,” which would “require an unequivocal commitment from the legislative and executive branches of the U.S. government.” [20]
In view of these considerations, and while acknowledging what one commentator aptly described as “the raging debate over whether states or the federal government should take the reins in insurance regulation,” [21] the FIO reframed the long-standing federal-versus-state debate, asserting that “the proper formulation of the debate at present is not whether insurance regulation should be state or federal, but whether there are areas in which federal involvement in regulation under the state-based system is warranted.” [22] Having reframed the debate in this manner, the FIO states that “the basic question with respect to reforming any aspect of insurance should be whether federal involvement is warranted at this time and, if so, in what areas[?].” [23] The FIO answers the initial part of this twofold basic question in the affirmative and FIO concludes that the U.S. system of insurance regulation can be modernized and improved in the short term by “a combination of steps by the states and certain actions by the federal government.” [24]
The FIO’s recommendations, as articulated in Section I of the Report, are set forth below.
Recommendations for Modernization of Insurance Regulation in the United States
The FIO in its Report makes recommendations concerning prudential (or “solvency”) oversight, which the FIO describes as “oversight of an insurer’s financial condition and its ability to satisfy policyholder claims,” [25] and “marketplace” oversight, which “governs an insurer’s business conduct, such as the pricing of premiums, advertising, minimum standards governing the terms of insurance policies, licensing of insurance agents and brokers (producers), together with general issues of consumer protection and access to insurance.” [26]
The recommendations take a two-prong approach, which identifies (1) areas of near-term reforms for the states; and (2) areas for direct federal involvement in regulation.
(1) Areas of Near-Term Reform for the States
The FIO makes 18 recommendations of “near-term” reform for the states, which focus on the following three areas: (1) capital adequacy and safety/soundness; (2) reform of insurer resolution practices; and (3) marketplace regulation. The recommendations as stated in the Report are listed below:
Capital Adequacy and Safety/Soundness
1) For material solvency oversight decisions of a discretionary nature, states should develop and implement a process that obligates the appropriate state regulator to first obtain the consent of regulators from other states in which the subject insurer operates.
2) To improve consistency of solvency oversight, states should establish an independent, third-party review mechanism for the National Association of Insurance Commissioners Financial Regulation Standards Accreditation Program.
3) States should develop a uniform and transparent solvency oversight regime for the transfer of risk to reinsurance captives.
4) State-based solvency oversight and capital adequacy regimes should converge toward best practices and uniform standards.
5) States should move forward cautiously with the implementation of principles-based reserving and condition it upon: (1) the establishment of consistent, binding guidelines to govern regulatory practices that determine whether a domestic insurer complies with accounting and solvency requirements; and (2) attracting and retaining supervisory resources and developing uniform guidelines to monitor supervisory review of principles-based reserving.
6) States should develop corporate governance principles that impose character and fitness expectations on directors and officers appropriate to the size and complexity of the insurer.
7) In the absence of direct federal authority over an insurance group holding company, states should continue to develop approaches to group supervision and address the shortcomings of solo entity supervision.
8) State regulators should build toward effective group supervision by continued attention to supervisory colleges.
Reform of Insurer Resolution Practices
9) States should: (1) adopt a uniform approach to address the closing out and netting of qualified contracts with counterparties; and (2) develop requirements for transparent financial reporting regarding the administration of a receivership estate.
10) States should adopt and implement uniform policyholder recovery rules so that policyholders, irrespective of where they reside, receive the same maximum benefits from guaranty funds.
Marketplace Regulation
11) States should assess whether or in what manner marital status is an appropriate underwriting or rating consideration.
12) State-based insurance product approval processes should be improved by securing the participation of every state in the Interstate Insurance Product Regulation Commission (IIPRC) and by expanding the products subject to approval by the IIPRC. State regulators should pursue the development of nationally standardized forms and terms, or an interstate compact, to further streamline and improve the regulation of commercial lines.
13) In order to fairly protect consumers in all parts of the United States, every state should adopt and enforce the National Association of Insurance Commissioners Suitability in Annuities Transactions Model Regulation.
14) States should reform market conduct examination and oversight practices and: (1) require state regulators to perform market conduct examinations consistent with the National Association of Insurance Commissioners Market Regulation Handbook; (2) seek information from other regulators before issuing a request to an insurer; (3) develop standards and protocols for contract market conduct examiners; and (4) develop a list of approved contract examiners based on objective qualification standards.
15) States should monitor the impact of different rate regulation regimes on various markets in order to identify rate-related regulatory practices that best foster competitive markets for personal lines insurance consumers.
16) States should develop standards for the appropriate use of data for the pricing of personal lines insurance.
17) States should extend regulatory oversight to vendors that provide insurance score products to insurers.
18) States should identify, adopt, and implement best practices to mitigate losses from natural catastrophes. [27]
As detailed in the Report, many of the areas for which FIO recommends reform relate to subject matter areas in which the states already have been working to make changes. However, FIO notes that “[f]or a variety of reasons… progress has been uneven despite the absence of any dispute about the need for change.” [28] Therefore, FIO recommends that “should the states fail to accomplish necessary modernization reforms in the near term, Congress should strongly consider direct federal involvement,” emphasizing that the “precise manner of federal involvement is a matter for Congress to determine.” [29] FIO further explains that federal involvement could entail adoption of national rules and standards that would preempt state law but leave direct enforcement to the states, or direct federal regulation of selected areas or aspects of the insurance industry, “whether it be oversight of one element of the distribution chain (e.g., multi-state producer licensing) or a particular line of insurance.” [30] It should be noted that no specific timeframe is suggested and “near-term” is certainly capable of a relatively broad interpretation.
(2) Areas for Direct Federal Involvement in Regulation
The FIO Report also identifies 9 areas for direct federal involvement in insurance regulation as listed below:
1) Federal standards and oversight for mortgage insurers should be developed and implemented.
2) To afford nationally uniform treatment of reinsurers, FIO recommends that Treasury and the United States Trade Representative pursue a covered agreement for reinsurance collateral requirements based on the National Association of Insurance Commissioners Credit for Reinsurance Model Law and Regulation.
3) FIO should engage in supervisory colleges to monitor financial stability and identify issues or gaps in the regulation of large national and internationally active insurers.
4) National Association of Registered Agents and Brokers Reform Act of 2013 should be adopted and its implementation monitored by FIO.
5) FIO will convene and work with federal agencies, state regulators, and other interested parties to develop personal auto insurance policies for U.S. military personnel enforceable across state lines.
6) FIO will work with state regulators to establish pilot programs for rate regulation that seek to maximize the number of insurers offering personal lines products.
7) FIO will study and report on the manner in which personal information is used for insurance pricing and coverage purposes.
8) FIO will consult with Tribal leaders to identify alternatives to improve the accessibility and affordability of insurance on sovereign Native American and Tribal lands.
9) FIO will continue to monitor state progress on implementation of Subtitle B of Title V of the Dodd-Frank Act, which requires states to simplify the collection of surplus lines taxes, and determine whether federal action may be warranted in the near term. A complete list of the FIO recommendations for modernizing and improving insurance regulation in the United States is found under Section I of the report. [31]
The FIO emphasized in the Report that “federal involvement should be targeted to areas in which that involvement would solve problems resulting from the legal and practical limitations of regulation by states, such as the need for uniformity or the need for a federal voice in U.S. interactions with international authorities.” [32]
Looking Forward
The FIO notes that while its “Report does not propose a recommendation for every conceivable shortcoming of the insurance industry and its regulatory framework, it sheds light on areas in need of prompt modernization and improvement.” [33] FIO states that it “will monitor state regulatory developments, including those called for in this Report, and will present options for federal involvement as such options become necessary.” [34] FIO concludes that it “will recommend additional improvements to the U.S. system of insurance regulation that best integrate the interests of U.S. insurers and consumers” and notes that “[w]hether, and to what extent, those improvements will require federal involvement will often depend upon the subject matter, circumstances, and ability and willingness of the states to resolve the underlying issue.” [35]
As a takeaway, it is important to remember that the Report is unlikely to lead to any swift changes to the current manner in which insurance is regulated. The FIO does not have regulatory authority, and the majority of its recommendations for federal involvement would require Congressional action.
[2] Subtitle A of Title V of the Dodd-Frank Act, entitled the Federal Insurance Office Act of 2010, is codified at 31 U.S.C. §§313-14.
[3] The Dodd-Frank Act gives the FIO the authority, among other things, “to monitor all aspects of the insurance industry, including identifying issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or the United States financial system.” Id. §313(c)(1)(A). It also vests FIO with the authority “to coordinate Federal efforts and develop Federal policy on prudential aspects of international insurance matters, including representing the United States, as appropriate, in the International Association of Insurance Supervisors [IAIS] (or a successor entity) and assisting the Secretary [of the Treasury] in negotiating covered agreements[.]” Id. §313(c)(1)(E). Additional FIO functions are set forth at 31 U.S.C. §313(c)(1).
[5] Id. §313(p)(2)(A-D). The remaining “considerations” include “[t]he regulation of insurance companies and affiliates on a consolidated basis” and “[i]nternational coordination of insurance regulation.” Id. §313(p)(2)(E-F).
[6] Id. §313(p)(3)(A). The other “additional factors” are set forth at 31 U.S.C. §313(p)(3).
[13] The remaining principal sections provide background and support for the recommendations. Section II describes the history of insurance regulation in the United States, highlighting significant events in its development and the debate over the need for uniformity in regulation across state jurisdictions. Sections III and IV present the FIO’s analysis underlying and supporting its recommendations concerning, respectively, solvency (or “prudential”) oversight and “marketplace” oversight. Section V discusses insurance modernization in the context of basic principles of regulatory reform. Section VI provides the Report’s conclusion.
[15] Id. at 5. The FIO notes that “[t]he federal government’s predominant role in foreign affairs is one reason for the necessity of a federal presence in insurance regulation,” stating that “[i]t would be much less costly, much less prone to arbitrage, and much easier to negotiate internationally for more efficient and effective oversight of the insurance sector if U.S. insurance regulation had greater uniformity and predictability.” Id.
[25] Id. at 1; see also id. at 23 (“In the context of insurance, ‘solvency’ generally refers to the ability of the insurer to meet its obligations. Solvency regulation has been and continues to be primarily the responsibility of state regulators.”). As to insolvency oversight, the FIO concludes that “[w]hile not beyond reproach, and in need of specific reforms identified in th[e] Report, state regulators have developed a system of entity-specific financial oversight that satisfies this most fundamental regulatory objective.” Id. at 65.
[26] Id. at 1; see also id. at 46 (“‘Marketplace oversight’ refers to those aspects of insurance regulation that concern consumer protection, insurance access, and affordability. Marketplace regulation displays substantial state-by-state variance… Insurers and consumer advocates have criticized… lack of uniformity and the absence of coordination on regulatory matters on grounds of duplication, inefficiency, delay, and uneven consumer protections.”).
