[Senate Hearing 112-377]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-377
 
                EMERGING ISSUES IN INSURANCE REGULATION

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON

                 SECURITIES, INSURANCE, AND INVESTMENT

                                 of the

                              COMMITTEE ON

                   BANKING,HOUSING,AND URBAN AFFAIRS

                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

           EXAMINING EMERGING ISSUES IN INSURANCE REGULATION

                               __________

                           SEPTEMBER 14, 2011

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


                 Available at: http: //www.fdsys.gov /





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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

         Subcommittee on Securities, Insurance, and Investment

                   JACK REED, Rhode Island, Chairman

              MIKE CRAPO, Idaho, Ranking Republican Member

CHARLES E. SCHUMER, New York         PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey          MARK KIRK, Illinois
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
HERB KOHL, Wisconsin                 JIM DeMINT, South Carolina
MARK R. WARNER, Virginia             DAVID VITTER, Louisiana
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
TIM JOHNSON, South Dakota

               Kara M. Stein, Subcommittee Staff Director

         Gregg Richard, Republican Subcommittee Staff Director

                                  (ii)



                            C O N T E N T S

                              ----------                              

                     WEDNESDAY, SEPTEMBER 14, 2011

                                                                   Page

Opening statement of Chairman Reed...............................     1
    Prepared statement...........................................    27

                               WITNESSES

Baird Webel, Specialist in Financial Economics, Congressional 
  Research
  Service........................................................     3
    Prepared statement...........................................    27
Therese M. Vaughan, Chief Executive Officer, National Association 
  of Insurance Commissioners.....................................     5
    Prepared statement...........................................    36
Mary A. Weiss, Deaver Professor of Risk, Insurance, and 
  Healthcare Management, Temple University.......................     6
    Prepared statement...........................................    41
Daniel Schwarcz, Associate Professor, University of Minnesota Law 
  School.........................................................     8
    Prepared statement...........................................    44

                                 (iii)


                EMERGING ISSUES IN INSURANCE REGULATION

                              ----------                              


                     WEDNESDAY, SEPTEMBER 14, 2011

                                       U.S. Senate,
        Subcommittee on Securities, Insurance, and 
                                        Investment,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 9:30 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Jack Reed, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF CHAIRMAN JACK REED

    Chairman Reed. Let me call the hearing to order. First, 
unfortunately, Senator Crapo is slightly under the weather and 
will not be able to join us, and I regret that because he is an 
extraordinarily insightful, competent, and thoughtful person 
when it comes to these issues and a whole range of issues. But 
I am sure he will be back before we know it, and that is good 
news for us.
    I want to welcome everyone to the hearing on emerging 
issues in insurance regulation. We take our responsibilities in 
this Subcommittee very seriously, Senator Crapo and I, and one 
of our major issues is insurance. And, frankly, this is an 
opportunity for us to get up to speed with experts about the 
current status of the industry, the challenges that the 
industry faces, particularly in the context of a globalized 
world economy and the changes that are resulting from Dodd-
Frank.
    The 2008 financial crisis revealed many levels of 
interdependencies within the financial system. Insurance 
companies are a vitally important component of the financial 
system and as investors in the financial system. Insurance 
companies also face challenges as asset prices fell and noncore 
activities of the groups such as securities lending produced 
large losses. However, according to recent figures provided by 
the Financial Stability Oversight Council, only 28 of the 
approximately 8,000 insurers within the United States became 
insolvent, and State regulators are ensuring the orderly 
resolution of these insurers.
    The United States and international regulators are 
continuing to assess the financial system, and both have 
challenges in developing approaches to enhance the stability of 
the financial system in the wake of the 2008 financial crisis. 
Understanding the interdependencies and connections is key to 
assessing where the stress points can become cracks and where 
cracks become fissures and deep chasms.
    Banking and insurance are related, but the insurance 
industry is fundamentally different, and our approach toward 
regulators must consider those differences. The Dodd-Frank Wall 
Street Reform and Consumer Protection Act, the Dodd-Frank Act, 
contains certain provisions that affect insurance regulation in 
a number of ways. The Dodd-Frank Act created the Federal 
Insurance Office, FIO, within the Treasury Department to gather 
information about the insurance industry and to advise the 
Treasury Secretary and Financial Stability Oversight Council on 
domestic and international insurance policy matters.
    The Dodd-Frank Act recognizes the importance of having 
individuals with deep insurance industry expertise and 
experience in key roles. It also recognizes the importance of 
ensuring that the perspectives of insurance regulators, 
industry participants, and affected constituencies are 
considered.
    Accordingly, the Dodd-Frank Act provided for an individual 
with insurance expertise to serve as an independent voting 
member of the Financial Stability Oversight Council. Further, 
the Dodd-Frank Act required a nonvoting member to be a State 
insurance commissioner.
    The Treasury Department has also formed the Federal 
Advisory Committee on Insurance, FACI, which will provide a 
forum to provide advice and recommendations to the Federal 
Insurance Office. According to Treasury officials, members of 
this Committee will be announced shortly.
    The Dodd-Frank elements are important considerations. 
However, the focus of this hearing is assessing the current 
state and looking forward. What is the current state of the 
insurance industry? How have the insurance industry and its 
regulations changed since the passage of the Dodd-Frank Act? 
What are the current emerging issues in insurance regulation? 
What international issues affect domestic insurance regulation? 
What changes or improvements, if any, can or should be made to 
improving the functioning of insurance regulation?
    The insurance industry is vitally important, and I look 
forward to hearing from all of our witnesses on the emerging 
issues affecting insurance regulation.
    One final point I might stress is that traditionally the 
insurance industry has been regulated by States, and I think 
that tradition was recognized in Dodd-Frank, and that is the 
context, the great context, as we proceed forward.
    Now, let me introduce the witnesses and then ask them to 
make their statements.
    First, Baird Webel is a specialist in financial economics 
with the CRS Government and Finance Division. He has worked at 
CRS, the Congressional Research Service, for more than 8 years. 
His focus is on financial institution policy, particularly 
nonhealth insurance issues, as well as the Troubled Asset 
Relief Program and other actions taken to address the recent 
financial crisis. Before joining CRS, he worked as a 
congressional staffer for 7 years handling a wide variety of 
issues. Thank you very much.
    Dr. Therese ``Terri'' Vaughan is the chief executive 
officer of the National Association of Insurance Commissioners, 
a position she assumed in February 2009. As CEO, Dr. Vaughan 
oversees the operations of the NAIC and serves as the 
association's primary representative and chief spokesperson in 
Washington, DC. Over her career Dr. Vaughan has held a variety 
of positions in academia and regulation. Prior to her current 
position, she was the Robb B. Kelley Distinguished Professor of 
Insurance and Actuarial Science at Drake University, where she 
focused on the regulation and management of financial 
institutions. From 1994 to 2004, she was the Iowa insurance 
commissioner. Thank you, Doctor.
    Dr. Mary Weiss is a professor, indeed the Deaver Professor 
of Risk, Insurance, and Healthcare Management at the Fox School 
of Business of Temple University. She is editor of Risk 
Management and Insurance Review and an coeditor for the Journal 
of Risk and Insurance. Her research has focused on financial 
services conglomeration, efficiency measurement of insurers, 
no-fault automobile insurance, reinsurance, regulation, and 
underwriting cycles. Dr. Weiss has been on the faculty of 
Temple University since 1986. Between 2009 and 2010, she served 
as a distinguished scholar at the NAIC's Center for Insurance 
Policy and Research. Thank you, Dr. Weiss.
    Finally, Mr. Daniel Schwarcz, Professor, is an associate 
professor of law at the University of Minnesota Law School, 
where he teaches insurance law, health care regulation and 
finance, contract law, and commercial law. His research focuses 
on consumer protection and regulation in insurance markets with 
an emphasis on property casualty markets. Professor Schwarcz is 
also a funded consumer representative to the National 
Association of Insurance Commissioners. Thank you, Professor 
Schwarcz.
    All of your statements, your written statements, will be 
made part of the record so you could summarize, and we ask you 
to keep your remarks initially to about 5 minutes, and we will 
start with Mr. Webel. Mr. Webel, please.

 STATEMENT OF BAIRD WEBEL, SPECIALIST IN FINANCIAL ECONOMICS, 
                 CONGRESSIONAL RESEARCH SERVICE

    Mr. Webel. Senator Reed, thank you very much for having me 
here to testify today. As you said, my name is Baird Webel. I 
am a specialist in financial economics at the Congressional 
Research Service, and my written testimony covers really a wide 
gamut of issues that the Congress might consider in insurance. 
I would like to highlight two of them in my testimony here.
    The first has to do with the oversight of insurers, 
particularly from a systemic risk perspective. Historically, 
insurers have always been seen as presenting very low systemic 
risk, and the regulatory system reflected that. The financial 
crisis, however, very much challenged this view both with the 
specific failure of AIG and the failures of the smaller bond 
insurers. And the question that we really faced since then is: 
Were these failures one-off events that were caused by a 
specific characteristic of the insurers? Or should these 
failures really cause us to challenge our previous view that 
insurers did not present systemic risk?
    I think that if you examine the regulatory changes that 
have occurred both in Dodd-Frank and at the State level, to a 
large degree at least the implicit conclusion is that the 
insurers do not present large scale systemic risk. And so the 
focus has been on relatively smaller changes, for example, the 
elimination of the OTS, which was AIG's holding company 
regulator during the crisis.
    The one change that was done in Dodd-Frank, the creation of 
the Financial Stability Oversight Council, really does have a 
promise for broad systemic risk oversight. But it really 
remains to be seen how much of an impact that is going to have 
on insurance companies. The FSOC has yet to release the list of 
the companies it would consider systemically significant, and 
at least judging by comments that were made when they put out 
proposed rules and the general argumentation certainly within 
the industry itself very much seems to be that to a large 
degree the insurance companies are going to remain outside of 
this systemic risk regulation structure that we have in the 
United States. And even if to the degree that the insurance 
holding companies may come under the purview of the Fed, it is 
not really clear how much of an interest or expertise the Fed 
has in overseeing insurance companies. It has not been a role 
that the Federal Reserve has played to a great deal in the 
past. So I think that is very much an open question as to 
whether or not the systemic risk provisions that were 
instituted will have an impact or perhaps should have an impact 
on insurance companies.
    The other issue I think I would like to highlight is what I 
have termed ``the convergence of financial products,'' and by 
this I mean for the past years, decades, we have seen a number 
of different financial products come to market that have been 
introduced by different types of companies, by banks or by 
securities firms or by insurance companies, but with relatively 
similar economic characteristics. This, as I said, long 
preceded the financial crisis. To some degree it was a spark 
for the 1999 Gramm-Leach-Bliley Act, and examples of what I am 
talking about are things like credit default swaps and 
financial guarantee insurance.
    If you look at the economic characteristics of these 
things, they are pretty similar. But one is produced largely by 
securities firms, or at least as a securities product under 
securities rules. The other is an insurance product, and it is 
regulated by States. The content of that regulation can be very 
different, and when you look at it in the crisis, I think the 
outcome can be very different between this different content of 
regulation. This has happened in several other areas as well.
    For example, if you look at the comparison between checking 
accounts and money market mutual funds, one is a banking 
product, one is a securities product. From an economic point of 
view, these things are almost identical. During the crisis we 
saw what was essentially a run on money market mutual funds. 
That was a very big event during the crisis. We did not see a 
run on banks. To a large degree that was because of the 
difference in the regulatory system, particularly, obviously, 
the Federal Deposit Insurance System.
    Now, a functional regulatory system, which at least was 
envisioned in Gramm-Leach-Bliley in 1999, could take care of 
some of these problems by insisting that an insurance product 
gets regulated by an insurance regulator, regardless of whether 
it is a bank or an insurance company that is producing it. But 
in practice, we have largely continued to see a system where 
the regulation of the product is determined by the charter of 
the company that is producing it. And I think it is a 
particular problem in the insurance realm because with the 
insurance being regulated by the States, if there is a State-
Federal conflict, typically it is going to be the Federal 
regulator that wins out.
    With that, I will finish.
    Chairman Reed. Well, thank you very much.
    Dr. Vaughan, please.

   STATEMENT OF THERESE M. VAUGHAN, CHIEF EXECUTIVE OFFICER, 
        NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS

    Ms. Vaughan. Thank you very much, Senator.
    Chairman Reed. Turn on your microphone.
    Ms. Vaughan. Is that on? OK. Thank you. Thank you for the 
opportunity to testify today. I am Terri Vaughan. I am the CEO 
of the National Association of Insurance Commissioners, the 
standard-setting and regulatory support organization of the 
chief insurance regulators from the States and territories.
    The NAIC is heavily focused today on international activity 
and issues. We are a founding member of the International 
Association of Insurance Supervisors, the international 
standard-setting body for insurance, similar to the Basel 
Committee and IOSCO. While the IAIS activity is nonbinding, the 
potential impact of its work warrants our significant 
involvement to ensure that our perspective is appropriately 
reflected.
    Through the IAIS we are revising insurance core principles 
which form the basis of the IMF Financial Sector Assessment 
Program, or FSAP. During the most recent U.S. FSAP review in 
2010, the IMF found that State insurance regulators observed or 
largely observed 25 of the 28 principles, and they noted the 
overall resilience of our sector through the financial crisis. 
Indeed, they stated that elements of our system are world 
leading.
    The NAIC is also active in the development of the IAIS' 
ComFrame. This project will establish a multijurisdictional 
approach to group supervision for internationally active 
insurance groups, emphasizing robust oversight and cooperation 
while protecting home authorities and avoiding prescriptive new 
requirements.
    Regulators are increasingly focused on identifying systemic 
risks to the financial system. Related FSOC activity could 
affect some insurers, and the only insurance regulator 
representative to FSOC is John Huff, the director of Missouri's 
Department of Insurance. He highlights the differences between 
banking and insurance to ensure that FSOC decisions will not 
create unintended consequences for our sector while ensuring 
that any potential for systemic risk, however remote, is 
identified and mitigated.
    Meanwhile, the Financial Stability Board is addressing 
systemic risk through the identification of global systemically 
important financial institutions, or G-SIFIs. The FSB has asked 
an IAIS committee, vice-chaired by the NAIC, to develop the 
indicators for identifying globally systemic insurers in this 
effort. We continue to stress that the insurance business model 
needs to be distinguished from the banking business model when 
considering any new regulatory requirements.
    The day-to-day supervision of insurance in the United 
States requires extensive coordination among State regulators. 
Similar efforts to coordinate at the international level are 
evolving. We actively pursue memoranda of understanding that 
support information exchanges, and we are promoting the use of 
supervisory colleges to assess globally active insurers.
    The NAIC also chairs the IAIS' Supervisory Forum, which 
allows regulators to discuss emerging issues and trends and 
foster candid dialog on the challenges of oversight.
    The NAIC engages in regulator dialogs with representatives 
from jurisdictions around the world along with our fellow U.S. 
financial regulators and agencies. We provide technical 
assistance to foreign regulators and have hosted more than 143 
foreign insurance regulators from 24 countries in our 
fellowship program.
    Last week a delegation of State insurance regulators, NAIC 
staff, and a staff member of the FIO traveled to Germany for a 
dialog with European counterparts. Europe is pursuing reform 
through Solvency II and the U.S. through our Solvency 
Modernization Initiative. While Solvency II is still a few 
years away from being operational, it will assess the solvency 
supervision of third countries to determine equivalence. We in 
the U.S. do not intend to implement Solvency II in the States, 
and there are clear differences between the regulatory and 
legal structure of our markets. We do believe that our system 
of supervision is at least equivalent to Solvency II on an 
outcomes basis.
    SMI is the backbone of our domestic efforts to refine 
insurance oversight in the United States. It is a top-down 
review of our regulatory requirements, our solvency system, and 
it focuses on capital requirements, governance and risk 
management, group supervision, statutory accounting and 
financial reporting, and reinsurance.
    We have made changes to our model laws and regulation for 
holding company supervision, giving more insight into 
activities within a company. We are moving forward on an Own 
Risk and Solvency Assessment tool, which requires insurers to 
provide self-assessments of their risk to regulators.
    Apart from SMI, we have been reducing our reliance on 
rating agencies, and we have worked with insurers to assess the 
exposure of the industry to RMBS and CMBS on a security-by-
security basis. Insurer regulators are working both 
domestically and internationally to ensure a strong and 
competitive U.S. insurance market.
    Thank you for the opportunity to testify today, and I look 
forward to answering any questions.
    Chairman Reed. Thank you very much, Dr. Vaughan.
    Professor Weiss.

     STATEMENT OF MARY A. WEISS, DEAVER PROFESSOR OF RISK, 
    INSURANCE, AND HEALTHCARE MANAGEMENT, TEMPLE UNIVERSITY

    Ms. Weiss. Thank you very much for the chance to be here. 
Most of my comments today will be focused on emerging issues in 
insurance regulation, including international issues. And so 
the following, I believe, are important issues in insurance 
regulation. Supervision of insurance groups, Federal chartering 
of large insurers, developments under Solvency II and the Swiss 
Solvency Test which might be implemented in the United States--
actually, Dr. Vaughan touched on some of what I wanted to say 
already--leverage in the U.S. life insurance industry, and 
development of global accounting standards.
    First let us consider the supervision of insurance groups. 
Most insurance in the United States is carried out by a member 
of an insurance group, and insurance groups are families of 
insurance companies under common ownership. Insurance groups 
can be complex and opaque in nature, and this makes regulating 
them very difficult. So questions have begun to be asked as to 
whether insurance groups or even individual insurance companies 
are systemically risky. And all of the evidence to date seems 
to indicate that insurance activities are not systemically 
risky. (In saying that, I am excluding credit guarantee 
insurance, so that might be an exception.) But most of the 
evidence says that insurance is not systemically risky.
    However, many groups are involved in noninsurance 
activities, and these noninsurance activities are usually done 
through the subsidiary of the holding company for the group. So 
these subsidiaries involved in noninsurance activities may--if 
they are involved at all in capital markets, for example, 
involved in banking or if they are involved in providing credit 
guarantees--might be considered systemically risky. So I guess 
the moral of the story is insurance activities themselves are 
not systemically risky, but noninsurance activities that may be 
somewhat associated with a group can be systemically risky, and 
it is these noninsurance activities that really deserve the 
regulatory attention.
    Many groups operate internationally. In spite of this, at 
least to date, most regulation of insurance has been national 
and domestic in nature. And so it would be desirable, as Dr. 
Vaughan mentioned already, for the regulators of a group to 
coordinate with each other to be able to assess the overall 
riskiness and the overall performance of a group. And this 
could be done through supervisory colleges. Supervisory 
colleges are in use today, but usually they are used on an ad 
hoc and kind of intermittent basis. And what I would suggest is 
that these be used on a more permanent basis so that we can 
avoid financial distress in a group because we would know 
beforehand what the riskiness of the group is.
    Now let us consider optional Federal chartering of 
insurers. I realize you started out by saying that State 
regulation is the way that we are going, which I am very glad 
to hear about. However, if you Google insurance, you are going 
to come up with this Federal chartering of insurance issue, and 
I think that there are some efficiency arguments in favor of 
Federal chartering. However, I think that there are better 
arguments not to go down that road.
    For example, if optional Federal chartering were to become 
the norm, then it would probably be the large insurers which 
would participate in the Federal charter, and these large 
insurers could present an extremely powerful lobbying force for 
the Federal insurance regulator so that the regulator might be 
subject to regulatory capture. And regulatory capture theory is 
an economic theory that says that regulators tend to end up 
serving the regulated industry rather than pursuing the 
traditional goals of insurance regulation.
    The next thing I would like to talk about are changes in 
insurance regulation in Europe. As Dr. Vaughan indicated, under 
Solvency II companies will be required to file with regulators 
an Own Risk Solvency Assessment document, or an ORSA document, 
and I do think that that would be a good idea for the United 
States.
    Under the Swiss Solvency Test, insurers are required to 
respond to very detailed questionnaires concerning corporate 
governance and internal controls, and some of these 
questionnaires are at the group level. I think that these sorts 
of things could also be very useful and help to enhance 
insurance regulation.
    The fourth issue then is that although insurer assets are 
generally considered to be liquid and of high quality, there 
may be some danger signals in the life insurance industry. So 
life insurers have a significant investment in mortgage-backed 
and asset-backed securities, and these account for 18.4 percent 
of their assets. Even more startling is that this accounts for 
169.8 percent of their surplus or their equity. And the 
capital-to-asset ratio for life insurers seems to be rather 
low. The capital-to-asset ratio for life insurers was 6.3 
percent in recent years, and this compares unfavorably with 
banks where the capital-to-asset ratio was 10.9 percent.
    The last thing I would like to talk about is global 
accounting for insurance. Much U.S. solvency insurance 
regulation relies on statutory statements. For example, capital 
requirements under RBC are found by multiplying factors with 
items that are in the statutory statements, and the NAIC also 
conducts extensive financial ratio analysis of insurers. But a 
new global accounting system is now in force in over 100 
countries in the world, and insurers in Europe under Solvency 
II and under the Swiss Solvency Test are required to report 
their statements using market values. Therefore, I think that 
there might be a lot of pressure on U.S. insurance regulators 
to adopt these global standards. And if that were to happen, 
that would require the revamping of some of the solvency 
regulation that is taking place.
    So these are my comments. Thank you for your time.
    Chairman Reed. Thank you very much, Professor Weiss.
    Professor Schwarcz, please.

 STATEMENT OF DANIEL SCHWARCZ, ASSOCIATE PROFESSOR, UNIVERSITY 
                    OF MINNESOTA LAW SCHOOL

    Mr. Schwarcz. Thank you very much, Senator. State insurance 
regulation consists predominantly of relatively strict rules, 
such as capital requirements and underwriting restrictions. 
Such rules are often appropriate mechanisms to regulate as 
complex an industry as insurance. Unfortunately, State 
insurance regulators have historically ignored an equally 
vital, and much less intrusive, regulatory strategy: promoting 
transparency.
    Currently, most States do a remarkably poor job of 
promoting transparent insurance markets. This failing occurs at 
two levels. First, most States do not empower consumers to make 
informed decisions among competing carriers. For instance, in 
personal lines markets--such as home, auto, and renters 
insurance--consumers have no capacity to identify or evaluate 
the substantial differences in carriers' insurance policies. 
Consumers cannot acquire policies before, or even during, 
purchase; instead, they receive them only weeks after the fact. 
Meanwhile, no disclosures warn consumers to consider 
differences in coverage, much less enable them to evaluate 
those differences.
    Similar deficiencies prevent consumers from comparing 
carriers' claims-paying practices. Consumers neither receive 
nor access reliable measures of how often or how quickly 
carriers pay claims.
    Finally, consumers are almost never informed that 
ostensibly independent agents typically have financial 
incentives to steer them to particular carriers who may not 
provide optimal coverage. Given this lack of transparency, it 
is hardly surprising that several large national companies have 
started to hollow out their coverage and embrace aggressive 
claims-handling strategies.
    The failure of State regulators to provide consumers with 
sufficient information extends to life insurance markets as 
well. Perhaps the most notable example is that consumers have 
virtually no means of comparing prices or costs for the cash 
value life insurance products that different companies offer. 
When combined with skewed--and nondisclosed--salesperson 
incentives, this too has produced distressing results. For 
instance, a substantial majority of life insurance sold in this 
country is cash value, even though less expensive--and, for 
insurers, less profitable--term coverage is a better option for 
the vast majority of individuals.
    The second broad transparency failing of State insurance 
regulators involves the absence of publicly available market 
information. Unlike the consumer disclosures discussed above--
which must be simple, focused, and properly timed--this second 
form of transparency involves making detailed market 
information broadly available, typically through the Internet. 
Most consumers, of course, are unlikely to consult such 
information. But this form of transparency is nonetheless 
crucial for markets to operate effectively and efficiently 
because it allows market intermediaries--including consumer-
oriented magazines, public interest groups, and academics--to 
police marketplaces, identify problems, and convey relevant 
information to consumers, newspapers, and lawmakers.
    Currently, insurance regulation does a dismal job of making 
publicly available the information that market intermediaries 
need to perform this watchdog role. For instance, carriers' 
terms of coverage are not generally publicly accessible. 
Insurers do not post their insurance policies online, and most 
State insurance regulators do not maintain up-to-date or 
accessible records on the policies that different companies 
employ. Company-specific market conduct information--including 
data on how often claims are paid within specified time 
periods, how often claims are denied, how often policies are 
nonrenewed after a claim is filed, and how often policyholders 
sue for coverage--is also hidden from public scrutiny and 
treated as confidential. Virtually no States make available 
geo-coded, insurer-specific application, premium, exposure, and 
claims data, similar to that required of lenders by the Home 
Mortgage Disclosure Act. Product filings with the States and 
the Interstate Insurance Product Regulation Commission are not 
made public before approval, thus precluding public comment. 
And even companies' annual financial statements are only 
accessible on the Internet for a fee, in notable contrast to 
the public availability of companies' SEC filings.
    To be sure, the National Association of Insurance 
Commissioners has started to address some of these issues. But 
the results to date have ranged from preliminary to simply 
inadequate. Its model annuity and life disclosure regulations, 
for instance, rely on generic buyers' guides and broad 
standards for insurer disclosure without affirmatively 
developing tools that consumers need to make cross-company 
comparisons, such as the mortgage disclosure forms that the 
Consumer Financial Protection Bureau has developed in recent 
months. Work in the personal lines context has only recently 
started after years of consumer pressure. And in many domains, 
the NAIC has affirmatively rejected transparency. Examples 
include its refusal to make publicly available data on 
carriers' market conduct or on the availability and 
affordability of property insurance in specific geographic 
areas.
    In sum, State insurance regulation has generally failed at 
a core task of consumer protection regulation--making complex 
markets comprehensible to consumers and broadly transparent to 
those who may act on their behalf. This type of transparency is 
fundamental to fostering competitive and efficient markets. 
Historically, State insurance regulators have responded 
promptly to Federal pressure: in the face of such scrutiny, 
they shored up solvency regulation, coordinated agent 
licensing, and streamlined product review. The Federal 
Government should apply similar pressure on State regulators to 
develop a robust and thoughtful transparency regime. 
Specifically, Congress should press the new Federal Insurance 
Office to work with consumer groups to assess transparency in 
consumer insurance markets. That office should compare the 
state of affairs with the transparency standards under 
development at the Federal level in the context of consumer 
credit and health insurance. The sharp contrasts that are 
revealed will hopefully either prompt States to correct these 
problems or precipitate Federal regulation doing so.
    Thank you.
    Chairman Reed. Well, thank you very much. This is excellent 
testimony and I am in a very fortuitous position. I know 
Senator Crapo wanted to be here and would have added immensely 
to the hearing. He cannot, so I am left with a panel of 
extremely bright and knowledgeable people and the opportunity 
to ask lots of questions, so please bear with me.
    Let me begin with Dr. Vaughan. I am going to try to cover a 
broad swath. But first, recently, there was an article in the 
New York Times with respect to the attempts by certain States 
to lure captive insurance companies to come in by making it a 
really attractive offer in terms of sort of the lowering what 
were traditional standards. In fact, the implication was that, 
typically, they wanted to pull some of these offshore entities 
into the particular States.
    And it raises a question of a race to the bottom, of 
competition between States by lowering regulations, by being 
not transparent but very opaque so that companies will come 
there. And the question, I think, is should we be concerned? 
What is NAIC doing? And I think, again, sort of in response to 
many of the points that Professor Schwarcz raised, the goal 
should be sort of transparency, market information, not making 
it attractive to sort of, you know, hide out. So, Dr. Vaughan, 
you can start, and if others have comments, please.
    Ms. Vaughan. Yes. Thank you very much, Senator. And first, 
I think maybe I have to explain a little bit how the NAIC 
operates with respect to areas outside of the captives, and 
then I will come back to the captives. Unless the Congress has 
taken some action to preempt our ability to influence each 
other, then we do influence each other through pressure on--we 
pressure the domestic State on how they regulate a company by 
the actions in other States with respect to whether that 
company can do business in their State. So if State Farm wants 
to do business in Iowa, the Iowa regulator has to be 
comfortable that Illinois is regulating State Farm effectively.
    The only place where we run into difficulty in terms of the 
possibility of a race to the bottom is where the Congress has 
limited our ability to do that, and that is where we have to be 
very clear that we have standards at the NAIC that are going to 
compel States to have high quality regulation. We do that with 
risk retention groups. We have been working in our 
accreditation program to have a more effective set of standards 
around risk retention groups.
    But I think one of the areas that the New York Times 
article had touched on was specifically in the area of life 
insurance, and if I could talk about that for just a minute and 
clear up some misunderstanding. We have had a reserving 
standard in insurance for life insurance companies that is what 
we call formula based. It is an old system, and given the 
complexity of some of the products that we have today, is 
something that needs to be updated. So we have been working on 
updating that.
    The reserves that it establishes for some products are 
excessive, and we know this. And for some products, they are 
not adequate, and we are working on that. So we are improving 
that standard. In the meantime, while we improve our system of 
setting reserving requirements, we needed a short-term fix in 
order to allow companies to rightsize their reserves and that 
is where the use of captives in the life insurance area came 
up.
    This is something where the regulators are watching the 
companies in how they are using it. We have got a lot of 
activity at the NAIC around making sure that what the States 
are doing is appropriate. And so we are, I think, comfortable 
that we are moving in the right direction on that. And once we 
get principles-based reserving in place, our reserving issues 
in life insurance and the use of captives should go away.
    Chairman Reed. Before I open it up to comments--other 
panelists might have comments, it is not necessary, on this 
particular issue--you touched on a point that has always 
intrigued me, which is there are different capacities at the 
State level to regulate insurance.
    Ms. Vaughan. Yes.
    Chairman Reed. So the point that one of the checks on the 
operation of an insurance company home based in Illinois is 
that they will not be able to write insurance in Rhode Island. 
Well, guess what. One, we would have a very small group of 
people who are working very hard, but they are not aware of 
everything that is going on. And two, frankly, and this might 
be sort of urban legend, is that there is always the implicit 
threat, particularly in smaller States, that you are not big 
enough for us to worry about, so if you give us any problems, 
we just do not write in your State. And the commissioners are 
faced with the choice of do they want more products in the 
State or do they want to force it out. So it is a variable 
response.
    Ms. Vaughan. Yes.
    Chairman Reed. If you are New York State or you are 
Illinois or you are California and you are talking to insurance 
companies, you talk with a lot more authority than, I would 
suspect, many of the other States. How does NAIC deal with that 
if----
    Ms. Vaughan. Yes, and I think this goes to the process of 
developing national standards. Through our accreditation 
program, we have set some national standards that States are 
expected to adhere to in order to be accredited and, therefore, 
for their companies to be able to do business more seamlessly 
on a national basis.
    And the process of developing those standards is very much 
a thorough vetting of proposals. It goes through a process 
where all of the States are engaged and they will participate 
and offer guidance. It is very transparent. We get lots of 
input, education from industry and consumer groups. As 
Professor Schwarcz mentioned, we have a funded consumer group 
so that they can also provide input. And so when it comes 
through the NAIC process, it has been very well vetted and it 
is something that the States are able to buy into, by and 
large.
    You know, one of the other things I would add is that not 
every State--the great strength of the State system is that you 
do not have to have all of the expertise in every State. We do 
a great job of leveraging each others' expertise. So we have 
actuaries in a given State who will say, what is the--I have a 
problem in this area. Who has expertise here? And they reach 
out and they get help from the other State. So it is a very 
collaborative system, and I will say it has not always been 
that way. This is something that has taken us years to get to. 
And the NAIC has staff support that helps to make sure that 
that collaboration occurs when it needs to occur.
    Chairman Reed. Any other comments on this issue? Professor 
Schwarcz.
    Mr. Schwarcz. So, notably, you will see that my testimony 
was focused on different issues than many of the other 
witnesses, and that is because it is true that solvency 
regulation is in many ways the core of insurance regulation. 
And so I think that it is a very important issue, and I 
actually do think that it is true that the NAIC has done a good 
job with its accreditation program, of monitoring one another, 
of ensuring that if a State is falling below levels that other 
States are watching. So if Rhode Island, for instance, is 
falling below the standards that are set at the national level, 
then that is not only a problem for Rhode Island. That is a 
problem for other States, and they are constantly watching one 
another.
    Now, I say this to contrast it with market conduct and 
other forms of consumer regulation because there is no 
accreditation program on the market conduct side. There is no 
real effective way by which States pressure one another to 
ensure that claims are paid fairly, that issues are 
transparent, that policies are available.
    And so I think one of the--and again, Dr. Vaughan mentioned 
the fact that, well, it took us a while to get to this 
accreditation program. How did they get there? They got there 
because the solvency regime was completely inadequate, 
resulting in a lot of insolvencies in the 1990s, and the 
Federal Government started noticing this, writing reports. They 
wrote a very well known report in insurance circles, ``Failed 
Promises.'' It led to massive change at the NAIC and I do think 
it has been very effective.
    But there has not been that level of focus on the types of 
issues that I am talking about, on simple issues. If you buy 
insurance, you should have some ability to know what that 
policy provides. You should have some ability to say, hey, can 
I see the policy beforehand? Can you tell me how it is 
different than other carriers? The lack of transparency is 
distressing and it really is a theme, I have tried to 
emphasize, and I think it comes from the fact that there has 
been such an emphasis on solvency--and rightly so. I am not 
saying that solvency is not important, but we have not seen 
action----
    Chairman Reed. Before--I do want to recognize--I think 
Professor Weiss wants to comment and Mr. Webel, too, but I 
think it is encouraging that both you and Dr. Vaughan have said 
very positive things about the solvency regime. But going back 
to your point about buying insurance, it is very difficult for 
consumers to know which is the stronger company versus which is 
the weaker company, particularly when you get into some of 
these esoteric insurance annuity products where you have to be 
betting that the company is there 25 years from now. I wonder 
if you might want to comment on that very briefly, and then Dr. 
Vaughan very briefly, because that issue of how do we tell 
people in a Web site that, yes, well, this company has a very, 
very good product but it is on our D list, not our A list.
    Quickly, Mr. Schwarcz and then Dr. Vaughan, and then I 
know, Dr. Weiss, you have other comments.
    Mr. Schwarcz. One thing I would say on that is that a 
simple way to do this would be to require insurers to disclose 
what their financial ratings are. That is another thing that 
States do not do that seems like a simple, easy thing to do, 
and they have not done it.
    The other thing is we need to focus not just on the claims 
paying capacity but on the products. You need to be able to 
say, well, is the State Farm policy better than the Allstate 
policy? Is this annuity product better than some other? What 
are the costs? There needs to be--I mean, I think what we have 
recognized at the Federal level is it is not enough to have 
sort of disclosures that just inundate, that just overwhelm 
consumers. We need to help consumers.
    Chairman Reed. Dr. Vaughan, and then Dr. Weiss. I have not 
forgotten. Very quickly.
    Ms. Vaughan. Thank you very much, Senator. The first thing 
I want to say, I agree with Professor Schwarcz that the level 
of our collaboration in market regulation is behind the level 
of collaboration in solvency regulation and that is something 
we have been working on for a number of years, to try to 
increase the collaboration.
    I think we have made some great progress. We are doing 
more. For example, if we find a company that has a problem 
paying claims, we are tending to take action more on a multi-
State basis now than we did 10 or 15 years ago, for example. So 
that is happening.
    With respect to your question on how do consumers know that 
a company is going to be around 15 years from now, that is a 
critical question and that is why the solvency and the solidity 
of insurance companies is so important, not just on a short-
term but on a long-term basis. It is a really, really tough 
thing. It is a tough thing for regulators to be able to say, we 
know that this company is going to be around in 20 years, 
because the marketplace changes so much.
    You know, one thing is the ratings, which Professor 
Schwarcz mentioned, ratings by organizations like A.M. Best and 
Moody's and S&P. But then on the other hand, you want to not 
have excessive reliance on ratings. We have seen that was a 
problem in the financial crisis.
    Chairman Reed. Right.
    Ms. Vaughan. So what we try to do is educate consumers 
about the critical importance of this issue. We spend a lot of 
money on consumer education. We created a Web site, Insure U 
Web site, for consumers to go to to get information so that 
they can make some decisions on--they have some understanding 
of how to look at these issues. We provide some very basic 
financial information on companies.
    I think it is a tough one. There are not any real answers. 
But educating consumers about the kinds of questions that they 
can ask, I think, is a start.
    Chairman Reed. Mr. Webel, do you have a comment, because I 
have a broader question for Professor Weiss which I think will 
allow you to respond on not only this one but another aspect.
    Mr. Webel. Yes. I was just going to circle back briefly to 
the captives question, and I think that it is important to 
recognize that different captives are doing different things. 
If you have captives that, for example--if a large company, if 
Wal-Mart wants to set up a captive to provide fire insurance 
for all of its stores, there may be legitimate tax and 
accounting reasons and risk management reasons for them to do 
that as opposed to not purchasing insurance at all, which is, 
of course, an option. And so I think that that, depending on 
how a captive is used and what it is doing, it presents very 
different questions.
    I was actually struck in that New York Times article when 
they talked about the insurance companies themselves setting up 
captives because that is not what you typically think of.
    Chairman Reed. Right.
    Mr. Webel. And the experience with the risk retention 
groups, the Federal Act and the captives underneath that which 
are limited to liability insurance and commercial insurance, 
has generally paralleled the experience that you have with, 
quote-unquote, ``regular'' insurance companies.
    Chairman Reed. I think that is an excellent point, because 
if this was a commercial enterprise, rather than self-insuring 
on a balance sheet, setting up a company for tax reasons, 
accounting reasons, that is a lot different than an insurance 
company thinking of a very sophisticated way to do something 
which----
    Mr. Webel. Yes.
    Chairman Reed. ----to date has not been done a lot. So I 
would urge the NAIC to look closely at the point that Mr. Webel 
has raised.
    Dr. Weiss, not only in response to this question----
    Ms. Weiss. Shoot. That was going to be my comment.
    [Laughter.]
    Chairman Reed. Well, I am going to give you a chance to 
make some comments----
    Ms. Weiss. OK.
    Chairman Reed. ----because I thought, again, like all the 
testimony, yours was really superb. But you point out sort of 
the nature of insurance companies. Now, it is not your 
grandfather's or grandmother's insurance company. There are 
very complicated groups of different issue subsidiaries. AIG is 
the poster child for why we are having this conversation today, 
in a way, and I will over-simplify.
    They had a Financial Products Group that dealt in very 
complicated, sophisticated products, credit default swaps, and 
Professor Schwarcz has talked about that sort of notion of if 
it is not vanilla life insurance, then we have got an issue of 
who regulates it. Is it the charter regulator or is this 
functional regulator. I think that was Mr. Webel's point, too. 
That is one aspect of the AIG problem, and it went colossally 
bad.
    But one of the ironies, I recollect, is at the point they 
recognized in London, their Financial Products, that this was 
problematic and started trying to disengage, ironically, the 
company regulated by the Insurance Commission of New York began 
to start lending their securities for cash and investing that 
cash in mortgage-backed securities, which one hand was not 
talking to the other. But it raises the issue at the heart of 
your testimony.
    You know, if this is just an old fashioned, let me say, 
insurance company that is writing life policy, that is 
reserving, et cetera, but now they are just--how do we deal 
with these different aspects of sophisticated products in one 
division, maybe a captive now, and we just raised that issue, 
and then the traditional sort of regulation by the insurance 
commissioner of solvency and products that are pretty much 
vanilla. So I will give you that opening.
    Ms. Weiss. OK. Thank you. I talk a little bit about this in 
my written testimony, but one thing that would have prevented 
the AIG fiasco is if there were more cooperation among the 
different regulators for the subsidiaries of the holding 
company. So in my talk, I mention that it would be nice for 
insurance regulators to work together from different countries. 
Well, it really should extend beyond that. You should also 
bring in the regulators involved with the noninsurance 
subsidiaries so that way you will have a better idea of what 
goes on in the group.
    And it would be sort of an example of what happens at the 
NAIC. The more eyes you have looking at a problem, the more 
likely you are to see a problem when it arises. So I think that 
if we had had more complete regulation or a more complete 
overview of AIG and all of its operations with the 
participation of all the regulators, that the AIG crisis would 
not have occurred.
    You know, there are a lot of changes anticipated both in 
insurance regulation and in regulation of other financial 
institutions. So it is very important that this regulation be 
consistent across the different types of institutions. 
Otherwise, regulatory arbitrage would occur if products or 
capital requirements for one type of institution were different 
than for competing institutions.
    If I can go back for just a minute about the captives and 
the captive article----
    Chairman Reed. Yes.
    Ms. Weiss. ----I think that the presentation of captives in 
that article was a little stilted. This murky backroom kind of 
business is not really the way that most people think about 
captives. So most companies form captives because they really 
want to retain the risk, and if they are going to retain it, it 
would be nice to have a tax benefit associated with it. 
Otherwise, firms form captives because they really want 
insurance, but they want access to the reinsurance market and 
the captive allows them to have access.
    So another thing that happens with captives, and this is 
particularly true for workers' compensation and for providing 
employee benefits through a captive, is that the captive is 
required to use a fronting insurer. In other words, the company 
that owns the captive actually has an insurance policy from a 
regulated insurer and then there is an understanding that that 
insurance company will reinsure the business with the captive. 
But if the captive goes broke, it is still the insurance 
company, the fronting insurer, that would be responsible for 
paying losses. So it is not quite as murky as what was made out 
in the article.
    Chairman Reed. Well, thank you.
    Let me raise another issue, Professor Weiss, that you in 
your written testimony highlighted. You said that there are 
some danger signals in the life insurance industry that 
leverage might well be a problem for many life insurers, and we 
have understood from the crisis that leverage is a, not a 
double-edged sword, it could be a----
    Ms. Weiss. It could be a contributing factor. So it is 
something that could allow a financial crisis, I think, to 
spread, that is, can spread more easily if companies are more 
levered. I did not bring out everything before, but also many 
of the investments that life insurers have are illiquid, for 
example, privately placed bonds. And again, if you add up 
private placement of bonds with all the asset-backed and 
mortgage-backed securities, and you compare those to insurance 
companies' surplus or equity, then you are talking about 300 
percent of insurers' equity or a policyholder's surplus.
    Now, the only thing that has to be kept in mind is that 
these numbers that I am throwing around are based on statutory 
statements and statutory accounting is very conservative, which 
means that it tends to understate assets and overstate 
liabilities. So the situation is probably not quite as serious 
as the initial numbers would seem to make out. Nevertheless, I 
think that there may be something worthwhile to investigate 
here, and I would hope that the investigation would show that 
there is nothing wrong, but I think that it does raise 
questions.
    Chairman Reed. Let me put a plug in for the Office of 
Financial Research, which was created under Dodd-Frank. This is 
one of those topics that is very important and would be 
something that they could provide, we hope, the kind of 
analytical, apolitical analysis together with NAIC, et cetera, 
so that we really do have a sort of a forecast, if you will, or 
whether there is a storm growing or this is just, you know, 
sort of background.
    Ms. Weiss. Yes.
    Chairman Reed. But thank you very much for that point.
    Let me shift back, again, to Dr. Schwarcz, but if someone 
has comments, please feel free. You have made the point, I 
think very articulately, about the opaqueness of the system 
from the consumer's perspective. Typically, in my very limited 
responsibility, you buy insurance based upon two things: One, 
either the brand or the company you like, or the agent who is 
the Little League coach in your neighborhood. So a lot of what 
we presume is being done in terms of guiding consumers through 
this, you know, the solvency of the company, the 
appropriateness of product, is being done by the agents.
    One of the points you make in your testimony is the 
potential conflict of interest of agents being steered to 
particular products because of compensation. We saw this 
dramatically and disastrously in the mortgage broker business. 
But let me raise the issue specifically about your point about 
the steering phenomenon, but more importantly the role of the 
agents. Do they know enough, and it goes back to Dr. Vaughan, 
et cetera, and are they, in terms of the licensing 
requirements, have the kind of responsibilities to their 
clients that would force them, require them to search out some 
of the information that you think is very opaque. Professor 
Schwarcz.
    Mr. Schwarcz. Thank you very much. So I think it is a very 
important issue. Let me first distinguish between two types of 
agents that really populate these markets. There are captive 
agents, which work just for one company, and those tend to 
dominate many of the consumer lines. So you go to the agent 
that you know. You maybe go to a company. But at that point, 
you have already made a choice about a company.
    So you have gotten zero guidance from the marketplace, from 
the NAIC, from public information, about, well, does Allstate 
pay claims more quickly than State Farm? Do they tend to deny 
claims more? Is their policy less restrictive? Can I find out 
if their policy is less restrictive? Can I even get a copy of 
that policy and compare it if I happen to be sophisticated? So 
there are not--so many consumers bypass that type of guidance 
because it is cheaper. Now, there is something to be said for 
that. But the fact that we have agents, even if we had really 
great independent agents, would remedy that problem.
    But there are independent agents and independent agents 
have the capacity to probably, or to potentially solve some of 
these problems. The problem is, even these independent agents, 
first, do not have some of the information I am talking about. 
They do not know--all they have is sort of their own personal 
experience. They do not have concrete information on how 
quickly different carriers pay claims. They may have the policy 
forms, but if you actually talk to a lot of independent agents, 
they do not necessarily have the expertise to say, well, gee, 
this policy is more generous or less generous than others. Some 
do. Many do not, though.
    But the final point is that even with respect to the 
independent agents, and that is maybe, depending on the market, 
20, 30 percent of agents out there, they--very often, they are 
going to get higher commissions for sending you from one 
company to another. Sometimes, that will be really clear, 
because one agent will get 17 percent from one company and 15 
percent from another. Sometimes, it is very opaque, because the 
way that the commissions are calculated is based on a year-end 
calculation and it is very hard to actually say how the 
incentives are going to work out. I mean, you may have--it 
creates all sorts of dynamics that are not really obvious.
    So a simple solution is to say you cannot call yourself an 
independent agent unless you receive the same compensation from 
all companies. Otherwise, you are not really independent and 
you have to provide a disclaimer. Nothing like that is done.
    And what is shocking to me is that so much attention was 
paid to this issue when Eliot Spitzer sued Marsh and Aon many 
years ago and it became a huge issue in the commercial 
insurance market, all sorts of regulations to deal with it. 
Nothing happened in the consumer insurance market. There is no 
disclosure, by and large. New York has been trying to do it. No 
other State has really tried to deal with this issue. No States 
have tried to pressure independent agents to disclose their 
commissions or to accept--so to me, it is shocking that 
something that really is about consumer or purchaser 
information, so much more emphasis was placed on the commercial 
market where we expect buyers to be sophisticated and root out 
this information and nothing has been done where we actually 
think--where it is much more likely that the problem will 
occur. I am still mystified by that.
    Chairman Reed. Dr. Vaughan, I think you want to respond.
    Ms. Vaughan. Thank you very much, Senator. I share 
Professor Schwarcz's passion for consumer disclosure, consumer 
information, and educated consumers. I think an consumer is--
they are the front line in making sure that the right decisions 
are made. And we have spent--I have already mentioned to you 
some of the things that we have tried to do at the NAIC in 
terms of consumer outreach, creating our Insure U Web site and 
having a consumer information source where consumers can go and 
get some basic information about the company, including, for 
example, the complaints about--complaints that have been made 
about companies and how the level of complaints compares to 
others. More recently, we have done consumer guides for 
homeowners and auto insurance.
    But I think the more interesting project is one that 
Professor Schwarcz is actually providing some input into and 
that is our new Working Group on Transparency and Readability 
of Consumer Information. This was something that the funded 
consumer representatives recommended, that we have greater 
focus on consumer disclosures, and so we have a working group 
that is looking at things like should we have some kind of a 
guide that will help consumers better understand variations in 
coverage, answers to specific coverage questions, underwriting 
guidelines, how rates are determined, mandatory coverages and 
discounts. What kinds of rate disclosures, rate comparison 
guides should we recommend that States have? How can we better 
give consumers the ability to comparison shop on the basis of 
differences in coverage?
    So this work is ongoing. We have recently, as a result of 
the Patient Protection and Affordable Care Act, health 
insurance reform, we have worked on disclosures for health 
insurance and so we have some experience in how these might 
work and this working group is moving forward.
    Chairman Reed. Just in response to Professor Schwarcz's 
comments about the compensation arrangements with the agents, 
are you working on that issue, because again, my experience in 
Rhode Island is these people are not only very competent and 
very decent, but community leaders, et cetera, so they are good 
people----
    Ms. Vaughan. Right.
    Chairman Reed. ----except when you have a situation where 
the economics is such that you can direct people to one policy, 
which is not a bad policy but it might not be the best policy. 
Are you working on that?
    Ms. Vaughan. Right. Well, after the activities related to--
that Professor Schwarcz mentioned----
    Chairman Reed. Right.
    Ms. Vaughan. ----Attorney General Spitzer's activities, the 
NAIC did have a group that worked on this issue and made some 
changes to our producer licensing, Model Producer Licensing 
Act, that addressed disclosure. I would be happy to go back and 
see what has happened with that and whether anything further 
has----
    Chairman Reed. Just let me make a comment, too, and again, 
I think the NAIC has been doing a very good job, but it is like 
every institution. It is a competition. You play at a high 
level if the competition is there. Interestingly enough, some 
of the discussion of the Federal charter, I think, energized 
the States and NAIC to be much more proactive because, frankly, 
a lot of arguments about the Federal charter was, well, you 
know, it would be better in terms of protecting consumers, 
better in terms of solvency, et cetera. And the Attorney 
Generals' actions, not just New York but around the country, 
that is a human phenomena. But again, these issues are coming 
at us so fast and so furiously. Your work is not only 
appreciated, but----
    Ms. Vaughan. Thank you. Thank you, Senator.
    Chairman Reed. Keep it up, and----
    Ms. Vaughan. Thank you, Senator. I have----
    Chairman Reed. Keep moving faster.
    Ms. Vaughan. All right. I have to say, I have always said I 
appreciate that Congress puts some pressure on us because it 
makes us up our game.
    Chairman Reed. Well, that is--I think the purpose of this 
hearing is not so much pressure, but this is an important set 
of issues and we want to devote ourselves to listening but also 
providing at least support for your efforts and suggestions 
based upon the panel of places we have to do more.
    Let me just turn to another, just a comment. That is, in 
your notion, too, about simplifying, et cetera, the Consumer 
Financial Protection Bureau, and Professor Schwarcz mentioned 
this, has now modeled mortgage sort of language. I presume that 
you are working toward, your comments, sort of model language 
for disclosures, for transparency. Is that----
    Ms. Vaughan. That is what we did in the health insurance 
side.
    Chairman Reed. Right.
    Ms. Vaughan. And that is--this working group is discussing 
how to do that. I have to say, my suspicion is it is going to 
be a little harder in insurance given the variety of the 
products. It is a little more complex than it is in the 
mortgage area.
    Chairman Reed. Right. But I think for that reason also it 
might be even more necessary so that your efforts are 
appreciated and should be expedited.
    Let me just open this question up, and, again, it is 
probably Dr. Vaughan and Dr. Weiss, but anyone--and Mr. Webel. 
In the crisis several insurance companies got help from the 
Fed, and because of liquidity issues, because of other issues. 
Stepping back, are you concerned about companies that in a very 
difficult time--and this goes back to the point that Dr. Weiss 
raised in her testimony about the stress test essentially that 
Europeans are using. Are you contemplating or is NAIC 
contemplating or States contemplating the kind of stress 
testing that is done now routinely in Europe that will 
essentially at least help us predict those companies that may 
be in a range, that would need assistance? Because the point is 
that after Dodd-Frank the appetite by the Fed, even, to come up 
with these ingenious ways to help is much less, and certainly 
the public appetite is probably nonexistent.
    Ms. Vaughan. Senator, thanks very much for raising that 
subject. I have to say that often what we do at the NAIC we do 
not talk about a lot publicly, and so while there was a lot of 
public discussion about stress testing in the banking sector 
and the insurance sector in Europe, this is something that we 
have done behind the scenes for some time. Insurance companies 
have to provide cash-flow testing that looks at the results of 
their cash-flows over a period of time in the future under 
different scenarios. This is a requirement we have had for life 
insurance companies for some time. They have to look at what 
the results would be under a variety of interest rate 
scenarios. So we have looked at low interest rate scenarios for 
some time to see what the impact might be.
    There is a constant sort of improvement, sort of continuous 
improvement that goes on in insurance regulation through the 
States and through the NAIC, and as a result of this crisis--
and I think Mary's comments about liquidity--not liquidity 
issues, the leverage issues in the life insurance industry, are 
very well taken. As she pointed out, you have to be careful 
about the numbers because the accounting regimes are different. 
And our tradition in insurance regulation has been to have very 
conservative financial statements, so we have certain assets we 
do not count. We do not let the insurance companies count them. 
We have conservative liabilities, and this is something that 
has helped us during times of financial crisis.
    As we move forward, we know that, you know, the markets are 
changing, things are getting more complex. There are more 
complicated ways for companies to take risk now, and we have to 
continue to improve our tools in order to understand how that 
risk is being taken. That is why we have recently amended our 
holding company model so that we can get more information from 
other areas of the firm and do a better job of group 
supervision and looking at risks throughout the group. We have 
created a new reporting requirement for insurance companies, an 
enterprise risk filing requirement where they have to report to 
us the risks and their management of those risks. We are 
looking at some kind of a group capital assessment. So we are 
constantly, constantly creating new tools in recognition of the 
complexity that is there.
    Stress testing is not a new tool for us. We just have not 
been as public about it as some.
    Chairman Reed. I should know the answer, but let me ask the 
question. You promulgate model codes and best practices, et 
cetera, but the States are not required to take them up. In 
fact, I would assume that the State Assembly would have to pass 
the laws to effectively actuate what you recommend. So other 
than moral suasion, how do you get the States--because there 
is--again, with the issue of arbitrage, there is always the 
attractiveness of saying, yes, this is a great model, but if we 
do not have it, then we can--they can flock to us.
    Ms. Vaughan. Right.
    Chairman Reed. And the other context of that is just, you 
know, one of the big discriminators among States is their tax 
regimes. But just the question of how do you sort of ensure 
that all of this good stuff is being done by every State and 
not just the most progressive?
    Ms. Vaughan. This is where our accreditation program comes 
in. The accreditation program, we have a committee of 
regulators that are constantly looking at States to make sure 
that they have the standards that we have set for the 
accreditation program in place. We annually look at the laws of 
the State. We go in every 5 years actually for an onsite visit 
to see: Does the State do examinations properly? Do they do 
analysis properly? Do they get the kind of company reports that 
they should be getting?
    And the accreditation program, the hook in the 
accreditation program is that it is a stamp, sort of a Good 
Housekeeping Seal of Approval on a State system of solvency 
regulation. So that if a State is not accredited, then other 
States are not going to accept that State's supervision of its 
domestic companies.
    I recall a time back when I was a commissioner, so this 
goes back many years, we had a State that had some issues. We 
went in, looked at their examinations, and had concerns about 
the way they were doing examinations, and their accreditation 
was suspended for a period of time. They had a very large 
national company that was based in that State, and as a result, 
we said--the rest of the State said we are not going to accept 
the examination that you do on this company. And we had to put 
together a team of examiners from other States to go in and 
examine the company.
    So that is how this multi-State peer pressure and checks 
and balances work, and I personally think it is a very 
effective system.
    Chairman Reed. Dr. Weiss, please.
    Ms. Weiss. I would just like to add, since Dr. Vaughan did 
not mention it, there is also the work of the Financial 
Analysis Working Group. I will let Dr. Vaughan talk about it 
because she is more familiar with it. But I think that that 
also goes to your question.
    Ms. Vaughan. Thank you, Dr. Weiss. The Financial Analysis 
Working Group was created in the early to mid-1990s, and it is 
the top insurance regulators from around the country. I cannot 
remember, 14 or 16 of the most senior regulators. They have 
been through the wars. They have had troubled companies. They 
know how to look at financial statements. They know what things 
companies do when they start to get into trouble. And it serves 
as a kind of peer review and support mechanism for a State that 
has a company that might be in trouble.
    We have a team of people at the NAIC called the Financial 
Analysis Division that is constantly monitoring nationally 
significant insurance companies. They are looking at things 
like their annual statements that they file with the NAIC. They 
are looking at public company statements, the SEC filings, 
credit spreads on the company's debt, short sales of the 
company's stock--just anything that you can get your hands on, 
constantly scanning. If they see an issue, then it is referred 
to the Financial Analysis Working Group, and the Financial 
Analysis Working Group will either send a letter to the State 
saying, ``Tell us about this.'' Or they will say, ``Come on in 
and talk to us about this.'' And then the regulator from that 
State will go in and be asked a series of questions that they 
are sort of expected to be able to answer.
    So I have used the phrase sometimes, you know, there is 
always a question who watches the regulators, and one of the 
great strengths of our system is that we watch each other. We 
call each other on the carpet. And that was very effective 
during the financial crisis when we had--you know, everyone was 
concerned about a variety of issues, and it was a way to get 
the right level of communication and coordination across the 
States around companies that people had questions about.
    Chairman Reed. Thank you.
    Just a quick question to Professor Schwarcz, and then I 
want to wind up by sort of polling you all on what questions we 
missed and what insights you want to leave with us. But in your 
testimony, Professor Schwarcz, you talked about in terms of 
homeowner insurance, systematically more expensive and less 
available in certain low-income urban areas, which is a 
problem, obviously. It harkens back to red-lining and things 
like that. How can we deal with that? That is a problem, I 
presume.
    Mr. Schwarcz. Yes. The truth of the matter is we do not 
have enough evidence. The reason we do not have enough 
evidence--we have some States that make data available on a 
geo-coded basis so you can see in specific regions is the 
insurance systematically less available and more expensive. But 
very few--the vast majority of States do not make this 
information available, and it is the exact same information 
that is required at the Federal level by mortgage lenders under 
the Home Mortgage Disclosure Act.
    Now, there is a provision in Dodd-Frank that authorizes the 
Federal Insurance Office to collect this information, but what 
is unclear--and I do not know the answer to this--is, one, 
whether they are required to collect this information; and, 
two, whether they are going to disclose it. And I just want to 
emphasize the way to watch the regulators is to have 
transparent information so that the public can see what they 
are doing and can call them on the problems. We do not have 
that transparency in all of the respects that I talk about in 
my written testimony. And to me that is the fundamental 
problem.
    So the way to do is very simple. Require States to--or have 
the Federal Insurance Office to disclose this information.
    Chairman Reed. Let me just follow up with another quick 
question raised by your testimony. You point out the number of 
bond issuers that have failed causing higher costs to 
municipalities. Baird, this is your question. Some of it is 
because regulators failed to appreciate the additional risks 
that they were taking on, that they were getting into mortgage-
backed securities as well as a much more placid market for 
municipal securities. And I wonder, what actions have you seen 
to address this problem, and what actions would you suggest?
    Mr. Webel. Well, I think that--as you said, what happened 
is they moved from municipal securities into mortgage-backed 
securities, thinking that since, among other things, housing 
prices had never gone down in the United States, it should not 
be a problem. To a large degree it has really been the market 
response that has taken care of the problem in the sense that 
people are not really trusting the financial guarantee insurers 
anymore. I think it is questionable whether the market needs 
this kind of guarantee insurance or whether it was just sort of 
a historical accident that it still existed.
    There has been, I think, increased oversight on it by the 
State regulators, an appreciation of the dangers there, because 
what had largely happened is the State regulators were 
concentrated on an overall solvency question; whereas, the 
companies themselves were depending on AAA ratings. So the 
downgrade of the bond insurers essentially ended their business 
even though the companies may have still been completely 
solvent, but the regulators were not at the time paying 
attention to that. Now, of course, they appreciate those risks 
much more. But at the moment, I think there is only one 
monoline insurer that is still actually actively writing 
insurance. Warren Buffett created a new one to get into the 
market and then has largely suspended operations because he 
does not see it as a profitable place to be. So whether or not 
the entire sectors served the market need or will it continue 
to exist is a very open question.
    Chairman Reed. Well, let me go ahead and ask you now just a 
final open-ended question. What are the issues we have missed? 
What are your big concerns going forward in terms of the 
industry that we should focus on or we should encourage the 
State regulators to focus on? Baird, you might start out.
    Ms. Webel. I think one of the things that was now--it was 
certainly touched on, the international aspects, the European 
Union Solvency II, the question of equivalence. There will 
inevitably be--if it comes to the point where the Europeans are 
not going to recognize the American system as equivalent--
certainly a great hue and cry about disadvantages that it might 
put our insurers at, and I just would want to bring up a 
question of, whether, sometimes an equivalency decision, if it 
is not truly equivalent, can cause greater problems than it 
solves. AIG largely became an OTS holding company because it 
wanted equivalency with Europe, and got it. And then 10 years 
later, because the OTS supervision was not equivalent to it----
    Chairman Reed. The British FRA, too.
    Ms. Webel. Right. This is where we ended up. So sometimes 
the concept of having an internationally competitive financial 
services industry leads you down the road to Iceland, and I 
think that that is something that probably needs to be kept in 
mind going forward.
    Chairman Reed. And I think that is also something, with 
these new members, the FSOC, the new office in Treasury, is 
something that they have to be acutely aware of, because, you 
know, one of the sort of institutional impediments is that we 
had, you know, the NAIC that was representing the States, but 
we had this sort of gap between NAIC and who is going to be 
negotiating with the G-7, G-20, and the EU in terms of these 
standards.
    Mr. Webel. Yes.
    Chairman Reed. So that is a point well taken and one that 
is clearly within our framework of what we should be worrying 
about at the Federal level.
    Your generalized comments and conclusion, Dr. Vaughan?
    Ms. Vaughan. I would say I just agree with Baird completely 
that the international is an area to pay attention to. Since 
the financial crisis, the International Association of 
Insurance Supervisors has become more and more important, and 
the activities of the Financial Stability Board in the area of 
insurance have become more important. There are certain 
pressures coming down to the IAIS from the Financial Stability 
Board, and a lot of this is driven by the question of how do we 
supervise internationally active insurance groups. 
Internationally active insurance groups tend to be among the 
most complex of the groups, and so how do we do it?
    I do not know if Baird exactly said this. You raised some 
questions about the whole concept of equivalence, and I share 
sort of the questions he raised. The NAIC's view is that this 
really should not--the ultimate answer is not about a series of 
bilateral equivalence assessments--you know, the U.S. and 
Europe, the U.S. and Japan, Japan and Europe, Bermuda and the 
U.S. That is not the way to do this. The way to do this is to 
do it at an international level through the International 
Association of Insurance Supervisors and focus on building a 
system with the kinds of checks and balances that we have that 
we know work when you have entities that are operating in 
multiple jurisdictions--something that is focused on 
collaboration and communication. We are working very, very hard 
to try to make sure that that philosophy gets into the 
international arena.
    Chairman Reed. Thank you.
    Dr. Weiss, again, your insights, conclusions, what we have 
missed and what we should be thinking about.
    Ms. Weiss. I would just follow up on what Dr. Vaughan said. 
International cooperation and commitment should really involves 
all regulators associated with the activities of the groups so 
that we actually have cooperation from banking regulators and 
the regulators from other financial institutions.
    One other comment I might make is that it seems that when 
Dr. Vaughan and Mr. Schwarcz were talking about consumer 
affairs, it occurred to me that the conversation that was going 
on was at two different levels. So I heard Dr. Vaughan saying 
that the NAIC is very much concerned with educating consumers 
and has put a lot of effort into trying to explain 
underwriting. But it seemed to me that what Mr. Schwarcz was 
talking about was much more specific, for example, being able 
to compare insurance products at different institutions and 
actually post--it almost sounded like recommendations--as to 
which insurers might have the best policies. And I am not sure 
that advocating certain insurance companies is really the best 
thing for the insurance regulator to be directly involved with. 
This is just something that I cannot quite connect in my brain.
    Chairman Reed. Thank you very much.
    Professor Schwarcz.
    Mr. Schwarcz. Thank you. It is true that there is a 
disconnect in terms of what the NAIC is doing and what a lot of 
people are talking about in terms of my testimony. The NAIC's 
approach has been: We will tell you about insurance; we will 
teach you about insurance. We are not going to tell you 
anything about any particular company because God forbid we 
recommend someone and then we have that company coming in 
lobbying us.
    Well, the way you have to have disclosure is not by telling 
people here is what insurance is and here are the questions you 
need to think about. You need to provide them with the 
information they need to make decisions. That is what the 
Consumer Financial Protection Bureau is doing with their 
mortgage disclosure document. They are not recommending 
particular carriers, but they are saying: Here is what you need 
to know. Here are the numbers you need to know and compare. 
Here are the important terms you need to know and compare. They 
are empowering consumers to make decisions, because we have 
realized that it is not the case that consumers can navigate 
immensely complex markets.
    So I really just want to fundamentally disagree with the 
notion that we can just provide generic buyers' guides and 
general information and not take seriously the fact that 
empowering consumers is hard, and it means providing good 
information that is tested, that is specific, and that may make 
some companies look bad and then force them to do a better job. 
You know, if that is the market response, that helps the 
market.
    The other thing I just want to finish up on is it is true 
that the NAIC did a fantastic job on health insurance 
disclosures, and contrast that with what they have done in 
other areas and ask why. It is because they were forced to by 
PPACA, which required them or told them to draft this type of 
disclosure, that their disclosures were inadequate, that they 
were not fostering a transparent market. And then they acted, 
and they did an admirable job.
    So my claim is not that State insurance regulators cannot 
do this. It is that they do not do it until they are pressured. 
We saw the same thing in solvency regulation where now they 
are--as I said, they are doing a nice job after the pressure. 
And you made that point, too. So I really want to--I hope that 
you and your fellow Senators and policymakers keep the pressure 
up and say: What are you doing on these disclosures? Why is 
there such a difference in health insurance versus other areas? 
Why can't I know whether my agent who is telling me something 
has financial incentives to sell me a particular policy? Why 
can't I compare cash value products and have some sense of what 
is going on in the marketplace? Because the notion--I mean, it 
really is a problem, and it is a problem that is underaddressed 
because everyone is so focused on solvency that they forget all 
these other important regulatory issues.
    Chairman Reed. Well, thank you all very, very much. This 
has been an extraordinarily thoughtful panel, and I have had, 
as I said, the luxury of being able to ask a number of 
questions and engage in, I think, a very interesting and 
collaborative discussion on these issues. I thank you all. Your 
testimony has been thoughtful, and it will be of great 
assistance to us as we go forward.
    Again, we do recognize that this is typically the province 
of States, and the NAIC, whether of their own volition or 
because of the encouragement, has been taking a lead in many 
important issues. But we still have important Federal areas and 
particularly as we get to the international arena.
    Now, my colleagues may have written statements which they 
will submit for the record or additional questions, and we will 
get those questions to you. I would ask that any of my 
colleagues, who obviously are not present but very well may 
have questions, submit them by Wednesday, September 21st, and 
then we will get them to you and ask the witnesses to respond 
as quickly as possible, within 2 weeks if you can.
    Again, thank you. We will note that the record will be 
closed after 6 weeks in order that we can print it, but if 
there is additional material you would like to submit or 
anything else, responses, please do so.
    With that, again, let me thank the panel for 
extraordinarily insightful testimony, and the hearing is 
adjourned.
    [Whereupon, at 10:55 a.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
                PREPARED STATEMENT OF CHAIRMAN JACK REED
    I want to welcome everyone to our hearing this morning entitled 
``Emerging Issues in Insurance Regulation.''
    The 2008 financial crisis revealed many levels of interdependencies 
within the financial system. Insurance companies are an important 
component of the financial system. They are also investors in the 
financial system. During the financial crisis of 2008, insurance 
companies also faced challenges as asset prices fell and noncore 
activities of the group, such as securities lending, produced large 
losses. However, according to recent figures provided by the Financial 
Stability Oversight Council, only 28 of the approximately 8,000 
insurers became insolvent.
    Since the passage of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act), U.S. and international regulators are 
continuing to assess the financial system. Both have challenges at 
developing approaches to enhance the stability of the financial system. 
Understanding the interdependencies and connections between financial 
players is one of the keys to assessing where the stress points can 
become cracks, and where cracks can become holes.
    Banking and insurance are related, but the insurance industry is 
fundamentally different and our approach toward overseeing such firms 
must consider those differences.
    Dodd-Frank Act contains a number of provisions that affect 
insurance firms and regulation of insurance in a number of ways. The 
Dodd-Frank Act created a Federal Insurance Office (FIO) within the 
Treasury Department to gather information about the insurance industry 
and to advise the Treasury Secretary and Financial Stability Oversight 
Council on both domestic and international insurance policy matters.
    The Dodd-Frank Act also recognizes the importance of having 
individuals with deep insurance industry expertise and experience in 
key oversight roles. In particular, the Dodd-Frank Act provided for an 
individual with insurance expertise to serve as an independent voting 
member of the Financial Stability Oversight Council and required a 
State insurance commissioner to be a nonvoting member.
    The Treasury Department also has decided to form a Federal Advisory 
Committee on Insurance (FACI), which will provide a forum to provide 
advice and recommendations to the new Federal Insurance Office. 
According to Treasury officials, members of this committee will be 
announced shortly.
    Although the new provisions affecting the business of insurance in 
the Dodd-Frank Act are important considerations, the focus of this 
morning's hearing is assessing the current state and of the insurance 
industry. How has the insurance industry and its regulation changed 
since the passage of the Dodd-Frank Act? What are the current issues in 
the area of insurance that Congress and regulators should be paying 
attention to? What international issues affect insurance regulation? 
What changes or improvements, if any, can or should be made to improve 
the functioning of insurance regulation? The American insurance 
industry is vitally important, and I look forward to hearing from all 
of our witnesses on this topic.
                                 ______
                                 
                   PREPARED STATEMENT OF BAIRD WEBEL
   Specialist in Financial Economics, Congressional Research Service
                           September 14, 2011
    Mr. Chairman, Ranking Member, my name is Baird Webel. I am a 
Specialist in Financial Economics at the Congressional Research 
Service. Thank you for the opportunity to testify before the Committee. 
This statement responds to your request for hearing testimony 
addressing issues in insurance regulation that may be the focus of the 
Committee's attention. It begins with a brief introduction on the 
insurance sector and the regulation of insurance. Following this is a 
discussion of the role insurance played in the recent financial crisis, 
the recent Dodd-Frank Act, and the issues arising from the crisis and 
Dodd-Frank. Finally, my testimony will briefly summarize current 
proposals addressing insurance regulation at the Federal level and the 
ongoing issues that this legislation addresses.
    CRS's role is to provide objective, nonpartisan research and 
analysis to Congress. CRS takes no position on the desirability of any 
specific policy. The arguments presented in my written and oral 
testimony are for the purposes of informing Congress, not to advocate 
for a particular policy outcome.
The Insurance Industry and the Regulation of Insurance
    Insurance companies constitute a major segment of the U.S. 
financial services industry. The industry is often separated into life 
and health insurance companies, which also often offer annuity 
products, and property and casualty insurance companies, which include 
most other lines of insurance, such as homeowners insurance, automobile 
insurance, and various commercial lines of insurance purchased by 
businesses. Premiums for life/health companies in 2010 totaled $543.4 
billion and life/health companies held $5.3 trillion in assets. 
Premiums for property/casualty insurance companies totaled $424.7 
billion and these companies held $1.6 trillion in assets. \1\ In 
general, the insurance industry has weathered the recent financial 
crisis and its aftermath fairly well. A.M. Best, an insurance rating 
firm, reports a total of 29 insurer impairments from 2008 to 2010. \2\ 
In contrast, the Federal Deposit Insurance Corporation's (FDIC's) 
Failed Bank List includes more than 320 banks in the same time period. 
\3\ The current year could prove challenging with insurer exposure to 
sovereign debt and a relatively large number of catastrophic weather 
events.
---------------------------------------------------------------------------
     \1\ Statistics from A.M. Best, 2011 Statistical Study: U.S. 
Property/Casualty--2010 Financial Results, March 28, 2011, and A.M. 
Best, 2011 Statistical Study: U.S. Life/Health--2010 Financial Results, 
March 28, 2011. Premium amounts used are net premiums written; assets 
amounts are admitted assets.
     \2\ A.M. Best, ``Best's Impairment Rate and Rating Transition 
Study--1977 to 2010'', May 16, 2011.
     \3\ http://www.fdic.gov/bank/individual/failed/banklist.html
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    Different lines of insurance present very different characteristics 
and risks. Life insurance is typically a longer-term proposition with 
contracts stretching into decades and insurance risks that are 
relatively well defined in actuarial tables. Property/casualty 
insurance is typically a shorter-term proposition with 6 month or 1 
year contracts and greater exposure to catastrophic risks. Health 
insurance has evolved in a very different direction, with many 
insurance companies heavily involved with healthcare delivery including 
negotiating contracts with physicians and hospitals and a regulatory 
system much more influenced by the Federal Government through Medicare, 
Medicaid, the Employee Retirement Income Security Act of 1974 (ERISA), 
\4\ and the Patient Protection and Affordable Care Act (PPACA). \5\ 
When this testimony refers to ``insurance,'' it addresses life 
insurance and property/casualty insurance unless health insurance is 
specifically included. \6\
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     \4\ P.L. 93-406, 88 Stat. 829.
     \5\ P.L. 111-148, 124 Stat. 119.
     \6\ For more information on health insurance, see CRS Report 
RL32237, ``Health Insurance: A Primer'', by Bernadette Fernandez.
---------------------------------------------------------------------------
    Insurance companies, unlike banks and securities firms, have been 
chartered and regulated solely by the States for the past 150 years. 
One important reason for this is an 1868 U.S. Supreme Court decision. 
\7\ In Paul v. Virginia, the Court held that the issuance of an 
insurance policy was not a transaction occurring in interstate commerce 
and thus not subject to regulation by the Federal Government under the 
Commerce Clause of the U.S. Constitution. Courts followed that 
precedent for the next 75 years. In a 1944 decision, captioned U.S. v. 
South-Eastern Underwriters Association, the Court found that the 
Federal antitrust laws were applicable to an insurance association's 
interstate activities in restraint of trade. \8\ Although the 1944 
Court did not specifically overrule its prior holding in Paul, South-
Eastern Underwriters created significant apprehension about the 
continued viability of State insurance regulation and taxation of 
insurance premiums. By 1944, the State insurance regulatory structure 
was well established, and a joint effort by State regulators and 
insurance industry leaders to overturn the decision legislatively led 
to the passage of the McCarran-Ferguson Act of 1945. \9\ The Act's 
primary purpose was to preserve the States' authority to regulate and 
tax insurance. \10\ The Act also granted a Federal antitrust exemption 
to the insurance industry for ``the business of insurance.'' \11\
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     \7\ Paul v. Virginia, 75 U.S. (8 Wall.) 168 (1868).
     \8\ U.S. v. South-Eastern Underwriters Association, 322 U.S. 533 
(1944).
     \9\ 15 U.S.C. Sec. 1011 et seq.
     \10\ Richard Cordero, ``Exemption or Immunity From Federal 
Antitrust Liability Under McCarran-Ferguson (15 U.S.C. 1011-1013) and 
State Action and Noer-Pennington Doctrines for Business of Insurance 
and Persons Engaged in It'', 116 ALR Fed 163, 194 (1993).
     \11\ 15 U.S.C. 1012(b). The Supreme Court has made clear that the 
business of insurance does not include all business of insurers. Group 
Health and Life Insurance, Co. v. Royal Drug, Co., 440 U.S. 205, 279 
(1979). For further explanation of this distinction, see, CRS Report 
RL33683, ``Courts Narrow McCarran-Ferguson Antitrust Exemption for 
`Business of Insurance': Viability of `State Action' Doctrine as an 
Alternative'', by Janice E. Rubin.
---------------------------------------------------------------------------
    Since the passage of McCarran-Ferguson, both Congress and the 
Federal courts have taken actions that have somewhat expanded the reach 
of the Federal Government into the insurance sphere. The two large 
overhauls of financial regulation in the last two decades, the Gramm-
Leach-Bliley Act of 1999 (GLBA) \12\ and the Dodd-Frank Wall Street 
Reform and Consumer Protection Act of 2010 (Dodd-Frank), \13\ expanded 
the Federal role in insurance to some degree but the States continued 
as the primary regulators of insurance following these acts.
---------------------------------------------------------------------------
     \12\ P.L. 106-102, 113 Stat. 1338.
     \13\ P.L. 111-203, 124 Stat. 1376.
---------------------------------------------------------------------------
    GLBA removed legal barriers between securities firms, banks, and 
insurers, allowing these firms to coexist under a financial holding 
company structure. Such a holding company was overseen by an umbrella 
regulator--the Federal Reserve for holding companies, which included 
bank subsidiaries, or the Office of Thrift Supervision (OTS), for 
holding companies with thrift or savings association subsidiaries. 
Within the holding company, GLBA established a system of functional 
regulation for bank, thrift, securities, and insurance subsidiaries of 
holding companies. This meant that insurance company subsidiaries 
within a bank or thrift holding company were functionally regulated by 
State insurance authorities, with limited oversight by the Federal 
regulator of the holding company. Should there be no functional 
regulator for a subsidiary, the financial holding company regulator 
assumed primary regulatory responsibility for that subsidiary.
    The Dodd-Frank Act altered the GLBA structure, although to a large 
degree it left the basic functional regulatory structure intact. It 
appears that the Act will affect insurance regulation in three primary 
ways: (1) the creation of a Federal Insurance Office (FIO) with 
information gathering and very limited preemptive powers; (2) the 
provisions addressing systemic risk, such as the creation of a 
Financial Stability Oversight Council (FSOC) with the authority to 
oversee systemically important nonbank financial firms, including 
insurers; and (3) the provisions harmonizing \14\ the tax and 
regulatory treatment of surplus lines insurance and reinsurance (the 
Nonadmitted and Reinsurance Reform Act). \15\ Under Dodd-Frank, primary 
regulatory power over insurance firms continues to rest with the 
individual States and there is no Federal chartering authority.
---------------------------------------------------------------------------
     \14\ These provisions had been introduced as separate legislation 
before being included in Dodd-Frank.
     \15\ For more information on the specific insurance provisions in 
the Dodd-Frank Act, see, CRS Report R41372, ``The Dodd-Frank Wall 
Street Reform and Consumer Protection Act: Insurance Provisions'', by 
Baird Webel.
---------------------------------------------------------------------------
Issues Arising From the Recent Financial Crisis
    In the past, insurance has generally been seen as presenting little 
systemic risk. The recent financial crisis brought this assumption into 
question with the individual failure of American International Group 
(AIG) and the multiple failures of monoline bond insurers. These 
failures brought issues to the fore that are likely to remain issues 
before Congress and financial regulators in the future.
AIG and the Oversight of Large and Complex Insurers
    The failure of AIG was one of the most prominent business failure 
during the financial crisis and might be used as a case study of what 
can go wrong in overseeing a large, complex financial institution. AIG 
was a large company, with more than 175 subsidiaries identified by the 
National Association of Insurance Commissioners (NAIC). It listed a 
total of more than $1 trillion in assets in its 2007 annual filing with 
the Securities and Exchange Commission (SEC). Although most of the 
subsidiaries of AIG were, and are, insurance companies, AIG also had a 
thrift subsidiary, which put the entire holding company under the 
umbrella supervision of the OTS. AIG's derivatives operation, its 
Financial Products division (AIGFP), dealt in financial products not 
within the jurisdiction of any of the Federal functional regulators. 
OTS as umbrella regulator of the AIG holding company was responsible 
for overseeing AIGFP. Thus, the Federal regulator of the thrift 
industry, OTS, had broad oversight over a holding company with 
approximately $1 trillion in assets that listed its business as 
``insurance and insurance-related activities'' \16\ and specific 
oversight on a derivatives subsidiary with $2 trillion in notional 
value of derivatives outstanding.
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     \16\ American International Group, Annual Report (Form 10-K) for 
the fiscal year ended December 31, 2007, February 28, 2008, p. 3.
---------------------------------------------------------------------------
    AIG's failure is generally perceived to have resulted from risk-
taking that flourished in holes created by overlapping, but incomplete 
oversight. AIGFP took on billions of dollars in liabilities from credit 
default swaps (CDS) tied to the U.S. housing market while securities 
from the insurance subsidiaries were being transferred to another AIG 
subsidiary for a securities lending program. The collateral for this 
securities lending was also invested in securities tied to the U.S. 
housing market. Paradoxically, the securities lending program was 
increasing its exposure to the housing market at the same time (2006) 
that AIGFP had concluded that it was overexposed to this market and was 
attempting to reduce its risks. As the housing market slumped and the 
financial markets reached a panic state in September 2008, billions of 
dollars flowed out of AIG as a result of losses in both CDS and the 
securities lending program. Ultimately, the Federal Reserve and U.S. 
Treasury extended approximately $200 billion in financial commitments 
to prevent an AIG default.
    Regulatory lapses associated with AIG have been indentified at 
multiple levels. In hindsight, it appears that whatever company-wide 
risk assessments were performed by AIG or by OTS underestimated the 
scope of its exposure to the housing market. It also appears that OTS 
either did not understand the risk inherent in the CDS being sold by 
AIG or did not seriously consider scenarios as destabilizing as the 
housing bust that sparked the crisis. The functional regulators of the 
insurance subsidiaries were focused on the condition of the individual 
subsidiaries and did not effectively exercise what authority they did 
have over the holding company, such as overseeing what was done with 
the securities that originated with the insurance subsidiaries.
    The perceived regulatory lapses associated with AIG have largely 
been addressed in some way in the aftermath of the crisis. Dodd-Frank 
abolished the OTS and dispersed its functions among the Federal banking 
regulators, making the Federal Reserve the sole regulator of bank, 
thrift, and financial holding companies. The Act's systemic risk 
provisions provide for increased oversight of insurers deemed 
systemically important. In addition, derivatives in general were 
brought under Federal oversight and regulation split between the SEC 
and the Commodity Futures Trading Commission (CFTC). At the State 
level, the insurance regulators responded with new model laws and 
regulations increasing oversight on insurance holding companies 
generally and on securities lending in particular. The effectiveness of 
these steps, of course, may not be clear until the next financial 
crisis. It may be worth remembering that, for example, large banking 
institutions overseen by the Federal Reserve, such as Citigroup and 
Bank of America, also required exceptional, multibillion dollar rescues 
from the Federal Government during the crisis.
    The statutory framework that Dodd-Frank has established addressing 
the perceived regulatory failures may have been put into place, but 
such statutory changes are only a beginning step. At the Federal level, 
regulators first promulgate regulations implementing the new law and 
then undertake ongoing regulatory action to see that these regulations 
are indeed followed. This latter step, regulators fully enforcing both 
letter and spirit of the law over the years or decades following 
adoption, is perhaps the most important, and underestimated, step.
    Of particular interest going forward will be the decision by the 
FSOC as to which, if any, insurers might be designated as systemically 
important and what actions the Federal Reserve takes in its role of 
overseeing systemically significant insurers. Insurers are generally 
arguing that the precrisis view that the sector presents little 
systemic risk was correct and that AIG was an outlier. The overall 
expectation seems to be that few insurers will be deemed systemically 
important. At the State level, the process may take longer because the 
NAIC model laws must first be adopted by the individual State 
legislatures in order to take effect. This process can take substantial 
amounts of time and, in addition, State legislatures are not required 
to pass the NAIC models as suggested by the organization. This may 
alter the effectiveness of the models or introduce variation in 
regulation among different States.
The Bond Insurer Failures and Oversight of Smaller Insurers
    With arguments being made, and possibly accepted, that even large 
insurers present little systemic risk, one might expect the oversight 
of smaller insurers to receive at best passing mention in testimony 
such as this. The experience with the failure of several ``monoline'' 
insurers who focused on insuring municipal bonds and moved into 
insuring mortgage-backed securities (MBS), however, raises issues that 
may bear future consideration.
    Before the crisis, there were only about a dozen bond insurers in 
total, with four large insurers dominating the business. This type of 
insurance originated in the 1970s to cover municipal bonds but the 
insurers have expanded their businesses since the 1990s to include 
significant amounts of MBS. In late 2007 and early 2008, strains began 
to appear due to exposure to MBS. Ultimately some smaller bond insurers 
failed and the larger insurers saw their triple-A ratings cut 
significantly. Some insurers are still operating, but the volume of 
insurance is greatly reduced. The insurer downgrades rippled throughout 
the municipal bond markets, causing unexpected difficulties in sectors 
previously perceived as unrelated to rising mortgage defaults. 
Individual investors in auction rate securities, which had been 
marketed as liquid and safe investments, found their assets frozen 
because the markets had depended on the bond insurers' high ratings as 
backing for the securities. Municipalities, particularly smaller ones, 
faced great difficulty and higher costs in accessing credit markets to 
fund projects like roads, sewer systems, and schools. While the bond 
insurer failures had unexpected spillover effects, whether or not such 
insurers would, or should, be considered systemically important under 
the systemic risk regulatory structure created by Dodd-Frank is an open 
question.
    The failure of the bond insurers, unlike that of AIG, was not a 
story of multiple regulators and holes in regulatory oversight. The 
bond insurers were, and are, State-regulated entities, operating as 
permitted by the regulators. What occurred was a failure by both 
regulators and insurers to appreciate the additional risks being 
undertaken when the insurers moved from their initial business of 
insuring State and municipal debt into insuring MBS. In addition, the 
danger of a ratings agency downgrade, as opposed to the actual 
inability of the insurers to pay claims, was not well understood. The 
regulatory failures coupled with the spillover effects that occurred 
prompted some to call for Federal regulation of the financial guaranty 
insurance with an amendment to do so being offered, and then withdrawn 
in the House Financial Services Committee markup of the insurance 
titles of the Dodd-Frank Act.
Issues Arising Directly From Dodd-Frank
Implementation of the Federal Insurance Office
    Title V, Subtitle A of the Dodd-Frank Act creates a Federal 
Insurance Office (FIO) inside the Department of the Treasury. FIO is to 
monitor all aspects of the insurance industry and coordinate and 
develop policy relating to international agreements. It has the 
authority to preempt State laws and regulations when these conflict 
with international agreements. This preemption authority is somewhat 
limited. It can only apply when the State measure (1) results in less 
favorable treatment of a non-U.S. insurer compared with a U.S. insurer 
and (2) is inconsistent with a written international agreement 
regarding prudential measures. Such an agreement must achieve a level 
of consumer protection that is ``substantially equivalent'' \17\ to the 
level afforded under State law. FIO preemption authority does not 
extend to State measures governing rates, premiums, underwriting, or 
sales practices, nor does it apply to State coverage requirements or 
State antitrust laws. FIO preemption decisions are also subject to de 
novo judicial review under the Administrative Procedure Act. \18\ The 
monitoring function of FIO includes information gathering from both 
public and private sources. This is backed by subpoena power if the 
director issues a written finding that the information being sought is 
necessary and that the office has coordinated with other State or 
Federal regulators that may have the information.
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     \17\ 31 U.S.C. 313(r)(2) as added by P.L. 111-203 502; the law 
renumbers the current 31 U.S.C. sec. 313 as 31 U.S.C. Sec. 312.
     \18\ 5 U.S.C. 551 et seq.
---------------------------------------------------------------------------
    Since the passage of the Dodd-Frank Act, the FIO has begun hiring 
staff, and a director, former Illinois Insurance Commissioner Michael 
McRaith, has been appointed. The process, however, has taken longer 
than some hoped as Mr. McRaith did not take up the position of director 
until June 2011. This raised particular concern within Congress and the 
insurance industry in relation to the FIO director's role in FSOC 
discussed below. Also as part of the creation of FIO, Treasury has 
announced the creation of a Federal Advisory Committee on Insurance to 
be composed of various stakeholders and experts from the State 
regulatory system, the insurance industry, academia, and public 
advocates. The Dodd-Frank Act requires a report to Congress by January 
21, 2012, on how to modernize and improve the insurance regulatory 
system in the United States. \19\ The Treasury Department has in the 
past advocated for additional Federal oversight of insurance \20\ and 
the Dodd-Frank study may provide insight into how FIO will approach 
this issue.
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     \19\ Eighteen months after the July 21, 2010, date of enactment of 
the act.
     \20\ See, for example, the 2008 ``Treasury Blueprint for a 
Modernized Financial Regulatory Structure'', which proposed an optional 
Federal charter for insurers as part of an overall reform of the U.S. 
regulatory structure. Available at http://www.treasury.gov/press-
center/press-releases/Documents/Blueprint.pdf.
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NRRA/Surplus Lines Insurance
    Title V, Subtitle B of the Dodd-Frank Act addresses a relatively 
narrow set of insurance regulatory issues predating the financial 
crisis. In the area of nonadmitted (or ``surplus lines'') insurance, 
the Act harmonizes, and in some cases reduces, regulation and taxation 
of this insurance by vesting the ``home State'' of the insured with the 
sole authority to regulate and collect the taxes on a surplus lines 
transaction. Those taxes that would be collected may be distributed 
according to a future interstate compact or agreement, but absent such 
an agreement their distribution would be within the authority of the 
home State. It also preempts any State laws on surplus lines 
eligibility that conflict with the NAIC model law unless the States 
include alternative uniform requirements as part of an agreement on 
taxes and implements ``streamlined'' Federal standards allowing a 
commercial purchaser to access surplus lines insurance. For reinsurance 
transactions, it vests the home State of the insurer purchasing the 
reinsurance with the authority over the transaction while vesting the 
home State of the reinsurer with the sole authority to regulate the 
solvency of the reinsurer.
    The general effective date for the surplus lines provisions of 
Dodd-Frank was 12 months after the date of enactment or July 21, 2011. 
If the States wished to enter into a compact or adopt other measures to 
effectively supersede the provisions specifying that the home States 
would have the sole right to collect premium taxes before these 
provisions took effect, the States were required to do so within 330 
days from the date of enactment, a deadline that has now passed. NAIC 
and the National Conference of Insurance Legislators (NCOIL) both 
developed interstate agreements that would have superseded the Federal 
provisions. The two models that were developed, however, differed 
significantly as to the extent of authority that would be ceded by the 
States to the new body overseeing the agreement. NCOIL's Surplus Lines 
Insurance Multi-State Compliance Compact (SLIMPACT) is a broader 
agreement that would address surplus lines regulatory issues and taxes 
whereas the NAIC's Nonadmitted Insurance Multi-State Agreement (NIMA) 
is more narrowly focused on tax allocation. Each approach has been 
ratified by some States, but neither has been ratified by a majority. 
This lack of uniformity was criticized at a July 2011 hearing before 
the House Financial Services Committee and representatives of the NAIC 
and NCOIL pledged to address this, possibly through some sort of 
blending of the two approaches. \21\
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     \21\ See, U.S. Congress, House Committee on Financial Services, 
Subcommittee on Insurance, Housing and Community Opportunity, 
``Insurance Oversight: Policy Implications for U.S. Consumers, 
Businesses and Jobs'', 112th Cong., 1st sess., July 28, 2011, 
particularly the statements by Mr. Clay Jackson and Ms. Letha E. 
Heaton, available at http://financialservices.house.gov/Calendar/
EventSingle.aspx?EventID=252895.
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Issues Predating the Financial Crisis
Financial Services Industry Convergence
    The financial regulatory structure implemented by the Gramm-Leach-
Bliley Act (GLBA) was nominally a functional regulatory structure 
wherein insurers and insurance products would be regulated by insurance 
regulators, banks and banking products by banking regulators, and 
securities firms and securities products by securities regulators. 
Issues arise in such a structure, however, as financial innovation 
results in, for example, products sold by banks or securities firms 
taking on insurance characteristics or vice versa. Who decides what 
product belongs in what category, and thus, who regulates it? While 
GLBA was in part a response to financial industry convergence, it did 
not fully resolve this question. The de facto outcome has been that 
whatever charter the producing firm holds has determined which 
regulator regulates the product. The Dodd-Frank Act may affect this as 
the FSOC could act as such a referee, particularly for products deemed 
systemically important, but it is unclear how much of a role FSOC will 
play in this regard.
    Financial product innovation that resulted in mismatched regulation 
played a central role in the financial crisis. One example of this is 
the experience with credit default swaps (CDS). Economically, a CDS 
shares a much greater similarity with an insurance policy than with a 
more traditional swap, such as an interest rate swap. Because a CDS is 
structured as a swap, which is a securities product, it generally did 
not fall under the purview of insurance regulators. This had a huge 
impact on the usage of CDS and the role that CDS played in the crisis. 
Were CDS regulated as an insurance product, the regulators would have 
required that capital be held to back each CDS as it was written, 
putting an additional cost in the creation of CDS. Because this was not 
the case, firms could essentially create as many CDS as the market 
would bear. This stoked the boom in structured financial products, as, 
for example, CDS were used as raw material to create synthetic 
collateralized debt obligations, increasing the overall exposure to the 
housing market and deepening the crash once the bubble burst. Other 
examples include lending by nonbank institutions backed by securities 
markets and banklike accounts, such as money market mutual funds, 
offered by securities firms and outside of the deposit insurance 
system.
Multi-State Licensing of Agents and Brokers (NARAB II)
    Licensing of insurance agents and brokers is currently a 
responsibility of the individual States with different States sometimes 
having differing requirements. An agent or broker serving a client 
seeking a policy that would cover risks in multiple States is thus 
required to be licensed in multiple States. This multiplicity of 
licensure has resulted in complaints from the insurance industry. In 
1999, Congress included provisions in the GLBA calling for the creation 
of a federally backed licensing association, the National Association 
of Registered Agents and Brokers (NARAB), to supersede multiple State 
licenses. NARAB was to have come into existence 3 years after the date 
of enactment if at least 29 States failed to enact the necessary 
legislation for State uniformity or reciprocity. Following GLBA, the 
requisite number of States enacted this legislation, and thus the NARAB 
provisions never came into effect. The issue of insurance producer 
licensing reciprocity or uniformity continued to be of concern, 
however, as some continue to see problems in the actions taken by the 
individual States. \22\ In addition, although 47 States were identified 
by the NAIC as meeting GLBA's requirements, those that have not, 
California, Florida, and Washington, are not small States, representing 
together approximately 20 percent of the Nation's population.
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     \22\ See, for example, the April 16, 2008 testimony by Tom Minkler 
on behalf of the Independent Insurance Agents and Brokers made before 
the House Financial Services Subcommittee on Capital Markets, 
Insurance, and Government Sponsored Enterprises at http://
www.house.gov/apps/list/hearing/financialsvcs_dem/minkler041608.pdf.
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    Recent Congresses have again seen legislation (H.R. 1112 in the 
112th Congress) to create a NARAB, with such legislation generally 
referred to as ``NARAB II.'' H.R. 1112 would establish private, 
nonprofit corporation, whose members, once licensed as an insurance 
producer in a single State, would be able to operate in any other State 
subject only to payment of the licensing fee in that State. The NARAB 
member would still be subject to each State's consumer protection and 
market conduct regulation, but individual State laws that treated out 
of State insurance producers differently than in-State producers would 
be preempted. NARAB would be overseen by a board composed of five 
appointees from the insurance industry and four from the State 
insurance commissioners. The appointments would be made by the 
President and the President could dissolve the board as a whole or 
suspend the effectiveness of any action taken by NARAB. NARAB II 
legislation has been passed by the House of Representatives in previous 
Congresses, but has not been acted upon by the Senate. H.R. 1112 has 
not been acted upon by either chamber in the 112th Congress.
Expansion of the Liability Risk Retention Act
    Risk retention groups (RRGs) and risk purchasing groups (RPGs) are 
alternative insurance entities authorized by Congress in the Liability 
Risk Retention Act (LRRA). \23\ These groups are chartered in single 
States, but are then authorized by the LRRA to operate throughout the 
country with minimal oversight by the other 49 States. The goal was to 
expand insurance supply through a simplification of insurance 
regulation. Membership in risk retention and purchasing groups is 
limited to commercial enterprises and governmental bodies, and the 
risks insured by these groups are limited to liability risks. Although 
the RRGs and RPGs are a relatively minor part of the insurance 
marketplace, some believe they have served a meaningful role at various 
times over the past decades, particularly in serving lines of insurance 
under stress, such as medical malpractice. \24\
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     \23\ 15 U.S.C. Sec. 3901 et seq. See, CRS Report RL32176, ``The 
Liability Risk Retention Act: Background, Issues, and Current 
Legislation'', by Baird Webel.
     \24\ For example, ``RRGs have had a small but important effect in 
increasing the availability and affordability of commercial liability 
insurance for certain groups.'' U.S. Government Accountability Office, 
``Risk Retention Groups: Common Regulatory Standards and Greater Member 
Protections Are Needed'', GAO-05-536, August 2005, p. 5.
---------------------------------------------------------------------------
    Legislation has been introduced in the House during the last few 
Congresses (H.R. 2126 in the 112th Congress) to expand the LRRA's 
preemption of State laws to allow the sale and purchase of property 
insurance by RRGs and RPGs in addition to liability insurance. Such 
expansion has been resisted by those, such as the State insurance 
regulators, who worry that the lessened oversight on these groups, and 
the lack of coverage by State insurance guaranty funds, may lead to 
insured parties not receiving the purchased coverage in the case of a 
loss. In addition to expanding the scope of the law, H.R. 2126 would 
also place new corporate governance standards on the groups and 
authorize the director of the Federal Insurance Office to issue a 
determination as to whether a particular State law or regulation should 
be preempted by the Act. LRRA expansion legislation has not been acted 
on by the House, nor introduced in the Senate.
The McCarran-Ferguson Act's Antitrust Exemption
    The 1945 McCarran-Ferguson Act prohibits application of the Federal 
antitrust laws and similar provisions in the Federal Trade Commission 
Act, as well as most other Federal statutes, to the ``business of 
insurance'' to the extent that such business is regulated by State 
law--except that the antitrust laws are applicable if it is determined 
that an insurance practice amounts to a boycott. While this exemption 
has been limited by courts over the years, \25\ this exemption has been 
seen by some as allowing the insurance industry to undertake collusive 
practices having negative effects on consumers. Over the years, 
numerous bills have been introduced to eliminate the exemption either 
entirely \26\ or for particular lines of insurance. \27\
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     \25\ See, CRS Report RL33683, ``Courts Narrow McCarran-Ferguson 
Antitrust Exemption for `Business of Insurance': Viability of `State 
Action' Doctrine as an Alternative'', by Janice E. Rubin.
     \26\ The latest was H.R. 1583 in the 111th Congress.
     \27\ H.R. 1150 and H.R. 1943 in the 112th Congress would address 
the exemption solely for the health insurance industry.
---------------------------------------------------------------------------
    The insurance industry argues that the antitrust exemption allows 
for information sharing and other cooperation among insurers that 
result in greater efficiency and overall lower rates for insurance. 
Small insurers, in particular, depend on the sharing of information in 
order to accurately assess risks. If McCarran-Ferguson antitrust 
protection for ``the business of insurance'' were to be curtailed or 
abolished, many lawsuits challenging some of these insurer practices as 
violations of the Federal antitrust laws seem likely. Depending on the 
outcome of such litigation, major changes in the operation of insurers 
could result, particularly by small insurers that do not have large 
pools of information from their own experience. Should additional data 
be unavailable to small insurers in some way, it would, ironically, 
likely spur further consolidation in the insurance industry as small 
insurers may merge in order to gain the competitive advantage of 
additional information. This outcome, however, is only one of a range 
of possibilities. It is also possible that many of the cooperative 
activities that insurers engage in would be found to be permissible 
under the ``State action'' doctrine. \28\
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     \28\ The State action doctrine was first enunciated by the Supreme 
Court in 1943 (Parker v. Brown, 317 U.S. 341). It is based on the 
concept of federalism, and is the reason why Federal antitrust laws are 
not applicable to the States. The doctrine has, over the years, been 
interpreted, clarified and expanded to the point that it now confers 
antitrust immunity not only on the States qua States (including State 
agencies and officials who act in furtherance of State-directed 
activity, but also on those who act pursuant to State-sanctioned, but 
not necessarily mandated, courses of action). Its essence is captured 
in the two-part test set out in California Retail Liquor Dealers Ass'n 
v. Midcal Aluminum, Inc. (445 U.S. 97 (1980)): first, the challenged 
restraint must be ``clearly articulated and affirmatively expressed as 
State policy'' (e.g., in a legislatively enacted statute); second, the 
policy must be ``actively supervised'' and subject to enforcement by 
the State itself. See, CRS Report RL33683, ``Courts Narrow McCarran-
Ferguson Antitrust Exemption for `Business of Insurance': Viability of 
`State Action' Doctrine as an Alternative'', by Janice E. Rubin, for a 
brief analysis of that doctrine as it pertains to the insurance 
industry.
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Federal Chartering for Insurers
    Although proposals for some form of Federal chartering for insurers 
have existed for decades, interest in the concept was particularly 
sparked by the Gramm-Leach-Bliley Act in 1999. While GLBA statutorily 
reaffirmed the primacy of State regulation of insurance, it also 
unleashed market forces that were already creating more direct 
competition among banks, securities firms, and insurers. The insurance 
industry increasingly complained about overlapping and sometimes 
contradictory State regulatory edicts driving up the cost of compliance 
and increasing the time necessary to bring new products to market. 
These complaints existed prior to GLBA, but the insurance industry 
generally resisted federalization of insurance regulation at the time. 
Facing a new world of competition, however, the industry split, with 
larger insurers tending to favor some form of Federal regulation, and 
smaller insurers tending to favor a continuation of the State 
regulatory system. Because life insurers tend to compete more directly 
with banks and securities firms, they have tended to favor some form of 
Federal charter to a greater extent than have property/casualty 
insurers.
    Some Members of Congress have responded to the changing environment 
in the financial services industry with a variety of legislative 
measures. In the 108th Congress, Senator Ernest Hollings introduced S. 
1373 to create a mandatory Federal charter for insurance. In the 108th 
and 109th Congresses, Representative Richard Baker drafted, but never 
introduced, the SMART Act \29\ that would have left the States as the 
primary regulators, but harmonized the system through various Federal 
preemptions. Such a State-centric approach was generally favored by the 
smaller stakeholders, while larger stakeholders tended to favor an 
Optional Federal Charter (OFC) for insurance, with OFC legislation 
being introduced in the 107th, 109th, and 110th Congresses.
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     \29\ This Act was the subject of a June 16, 2005, hearing in the 
House Financial Services Subcommittee on Capital Markets, Insurance, 
and Government Sponsored Enterprises entitled ``SMART Insurance 
Reform.''
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    OFC legislation can vary widely in the specifics, but the common 
thread is the creation of a dual regulatory system, inspired by the 
current banking regulatory system. OFC bills generally would create a 
Federal insurance regulator that would operate concurrently with the 
present State system. Insurers would be able to choose whether to take 
out a Federal charter, which would exempt them from most State 
insurance regulations, or to continue under a State charter and the 50-
State system of insurance regulation. Given the greater uniformity of 
life insurance products and the greater competition faced by life 
insurers, some have suggested the possibility of OFC legislation that 
would apply only to life insurers, but no such bills have been 
introduced. There were proposals to implement narrow Federal regulation 
for reinsurance and for financial guaranty insurance in the 111th 
Congress, but neither were adopted. \30\
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     \30\ During the December 2, 2009, House Financial Services 
Committee markup of H.R. 2609, a bill to create a Federal Office of 
Insurance, Representative Dennis Moore offered an amendment (no. 3) 
that would have created an optional Federal license for reinsurers, 
while Representatives Ed Royce and Melissa Bean offered an amendment 
(no. 7) that would have created an optional Federal license for 
financial guarantee insurers. Both were withdrawn before votes were 
taken on the amendments. Representative Moore introduced his amendment 
creating a Federal license for reinsurers as a standalone bill, H.R. 
6529, on December 16, 2010.
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    The recent financial crisis amplified concerns about the negative 
aspects of allowing financial institutions to choose their regulators. 
Perhaps in response to these concerns, the broad Federal charter bill 
in the 111th Congress, H.R. 1880, added some mandatory aspects to a 
framework similar to the previous OFC bills. There have been no Federal 
chartering bills introduced into the 112th Congress.
International Issues
    Although banking, insurance, and other financial services sectors 
do not produce a tangible goods shipped across borders, the trade in 
such services makes up a large amount of international trade. The 
United States has generally experienced a surplus in trade in financial 
services, other than insurance, but in insurance services in the United 
States has consistently run a deficit with the rest of the world. \31\ 
Consolidations in the insurance industry are creating larger 
international entities with growing market shares, particularly in the 
reinsurance market. Some have speculated that the growing 
``internationalization'' of the financial services industry means 
governments may find it difficult to reform their regulation in 
isolation. The need for a single voice at the Federal level to 
represent U.S. insurance interests on the international stage is a 
frequently heard argument for increased Federal involvement in 
insurance regulation and the Federal Insurance Office is specifically 
tasked with developing Federal policy in international insurance 
matters.
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     \31\ U.S. exports of noninsurance financial services were $66.4 
billion in 2010 vs. imports of $13.8 billion. Insurance exports in 2010 
totaled $14.6 billion vs. imports of $61.8 billion. See the Bureau of 
Economic Analysis Web site at http://www.bea.gov/ international/bp_web/
simple.cfm?anon=71&table_id=22&area_id=3.
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The European Union and Solvency II
    The European Union (EU), the United States' biggest trading partner 
in insurance services, is implementing a comprehensive program to 
transform the EU into a single market for financial services. Part of 
this is an updated solvency regime for insurers--known as Solvency II--
attempting to more closely match the capital required by regulators to 
the risks undertaken by insurers. It is

        an ambitious proposal that will completely overhaul the way we 
        ensure the financial soundness of our insurers. We are setting 
        a world-leading standard that requires insurers to focus on 
        managing all the risks they face and enables them to operate 
        much more efficiently. \32\
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     \32\ Charlie McCreevy, ``European Union Internal Market and 
Services Commissioner'', quoted in `` `Solvency II': EU to take global 
lead in insurance regulation'' available at http://europa.eu/rapid/
pressReleasesAction.do?reference=IP/07/1060&format=HTML& 
aged=0&language=EN&guiLanguage=en. The general EU Web site on Solvency 
2 is http://ec.europa.eu/internal_market/ insurance/solvency/
index_en.htm.

    The European Parliament passed Solvency II legislation in 2009 with 
implementation recently delayed until January 1, 2014. As part of the 
project, the EU has created a new European Insurance and Occupational 
Pensions Authority (EIOPA) with the ability develop regulations and 
rules that are binding at a European level, rather than merely advisory 
as was the case with its predecessor. If the EU truly creates a more 
efficient regulatory system, this could improve the competitive 
standing of EU insurers compared with U.S. insurers. Concerns have also 
been expressed that the new EU system might result in discrimination 
against U.S. insurers, particularly if State supervision of U.S. 
insurers is judged insufficient to allow the same ``single passport'' 
access to all EU countries that EU insurers will enjoy. EIOPA has 
published draft reports on equivalence for Switzerland, Bermuda, and 
Japan, but has not done so for the United States. There have been 
suggestions in the past that an EU regulatory change might serve as ``a 
useful tool in international trade negotiations as it could help 
improve access for European reinsurers to foreign markets,'' such as 
the United States. \33\ The EU has also cited the overall complexity of 
the regulatory system in the United States as a barrier to overseas 
companies operating in the United States. \34\
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     \33\ European Commission, ``Commission Proposes a Directive To 
Create a Real EU-Wide Market for Reinsurance'', Internal Market: 
Financial Services: Insurance: Press Release, http://europa.eu/rapid/
pressReleasesAction.do?reference=IP/04/513& 
format=PDF&aged=1&language=EN&guiLanguage=en.
     \34\ See, for example, p. 54 of the European Commission's U.S. 
Barriers to Trade and Investment Report for 2007, at http://
trade.ec.europa.eu/doclib/docs/2008/april/tradoc_138559.pdf.
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Reinsurance Collateral
    Although U.S. insurers see access to the EU as a significant issue 
under Solvency II, access to the U.S. market for insurance is also an 
issue for EU insurers. Of particular concern have been the State 
regulatory requirements that reinsurance issued by non-U.S. or 
``alien'' \35\ reinsurers must be backed by 100 percent collateral 
deposited in the United States. Alien reinsurers have asked State 
regulators to reduce this requirement to as low as 50 percent for 
insurers who meet particular criteria, pointing out, among other 
arguments, that U.S. reinsurers do not have any collateral requirements 
in many foreign countries and that the current regulations do not 
recognize when an alien reinsurer cedes some of the risk back to a U.S. 
reinsurer. In the past, the NAIC has declined to recommend a collateral 
reduction, citing fears of unpaid claims from alien reinsurers and an 
inability to collect judgments in courts overseas. In 2009, the NAIC 
proposed draft Federal legislation to create a board with the power to 
enforce national standards for reinsurance collateral, including the 
reduction of collateral for highly rated reinsurers. \36\ In 2010, an 
NAIC Task Force approved recommendations to reduce required collateral 
based on the financial strength of the reinsurer involved. This 
proposal is working its way through the NAIC process and may be 
approved by the full NAIC by the end of 2011. Some States, such as New 
York, Florida, and New Jersey, have already begun lowering reinsurance 
collateral requirements. \37\
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     \35\ In the United States, the term ``foreign'' insurer generally 
denotes an insurer that is chartered in a different State; those 
insurers from a different country are termed ``alien'' insurers.
     \36\ The NAIC proposal can be found on their Web site at http://
www.naic.org/committees_e_reinsurance.htm.
     \37\ See, for example, ``NY DOI Approves Lloyd's Request to Post 
Lower Collateral'', BestWire, July 29, 2011.
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                                 ______
                                 
                PREPARED STATEMENT OF THERESE M. VAUGHAN
      Chief Executive Officer, National Association of Insurance 
                             Commissioners
                           September 14, 2011
Introduction
    Chairman Reed, Ranking Member Crapo, and Members of the 
Subcommittee, thank you for the opportunity to testify today. My name 
is Terri Vaughan. I am the Chief Executive Officer of the National 
Association of Insurance Commissioners (NAIC). The NAIC is the U.S. 
standard-setting and regulatory support organization created and 
governed by the chief insurance regulators from the 50 States, the 
District of Columbia, and the five U.S. territories. Through the NAIC, 
State insurance regulators establish standards and best practices, 
conduct peer review, and coordinate their regulatory oversight. Our 
members, working together with the central resources of the NAIC, form 
the national system of State-based insurance regulation in the U.S.
    Our system has a strong track record of protecting consumers and 
maintaining effective solvency oversight. The insurance sector in the 
U.S. weathered a devastating financial crisis and remains resilient in 
coping with equally devastating natural catastrophe losses across the 
country. Comprehensive data collection and analysis, rigorous hands-on 
supervision, and transparency for consumers and investors are the 
hallmarks of the U.S. system.
    Over the past few years we have made several enhancements to the 
regulation of insurance. Some of these refinements were implemented to 
address, in part, certain aspects of the financial crisis such as new 
securities lending reporting rules, a reduction of a regulatory 
reliance on credit ratings, and increased focus on noninsurance 
affiliates and their potential impact on the insurer and its 
policyholders. Other changes are being driven by the evolving business 
of insurance. Today, insurance markets are becoming increasingly global 
and interconnected, and this trend is likely to continue.
    For these reasons, the NAIC's international involvement has been 
increasingly focused on the supervision of insurers that operate in 
multiple countries, or internationally active insurance groups (IAIGs). 
In light of the financial crisis and the evolving insurer business 
model, insurance regulators recognize it is vital to improve 
coordination and collaboration to better supervise IAIGs, and we are 
developing structures and tools to better identify internal and 
external risks to the insurance sector. These new tools will enable us 
to better anticipate risks that are evolving beyond our borders and 
outside our respective jurisdictions. Today, I would like to discuss 
recent improvements to our State-based system and our efforts abroad.
International Standard Setting
    The NAIC participates as a founding member in the International 
Association of Insurance Supervisors (IAIS), which was established in 
1994. The IAIS is the international standards setting body for 
insurance, similar to the Basel Committee on Bank Supervision (BCBS) 
setting international bank standards and the International Organization 
of Securities Commissions (IOSCO) setting international securities 
standards. State insurance regulators or their NAIC representatives are 
active members in all of the major IAIS committees and subcommittees. 
We also worked within the IAIS to ensure that the new Federal Insurance 
Office would be a voting member of this body. While IAIS activity is 
nonbinding on its member jurisdictions, the scope and importance of the 
IAIS work and its potential impact on U.S. insurers has increased 
significantly since the financial crisis, and subsequently our 
involvement at the IAIS has increased to ensure that the U.S. 
regulators' perspective is reflected in its projects.
    In particular, we are actively working on revisions to the IAIS 
Insurance Core Principles (ICPs), which set out the fundamentals to 
effective insurance supervision. The ICPs are of paramount importance 
in that they form the basis of the International Monetary Fund's (IMF) 
Financial Sector Assessment Program (FSAP), which is designed to assess 
a particular jurisdiction's regulation of financial institutions. Such 
assessments are conducted periodically on a rolling basis; the United 
States' system of insurance regulation was most recently assessed in 
2010. In that FSAP, the IMF found that U.S. insurance regulators 
observed or largely observed 25 of the 28 international standards, and 
noted the overall resilience of the insurance sector through the 
financial crisis. The IMF stated: ``There is generally a high level of 
observance of the Insurance Core Principles. Aspects of regulatory work 
such as data collection and analysis in relation to individual 
insurance companies are world-leading. There are mechanisms to ensure 
individual States implement solvency requirements effectively.'' The 
IAIS is currently revising the ICPs, and we are working to ensure 
strong U.S. regulator input into the process.
    The NAIC is also active in the development of the IAIS Common 
Framework for the Supervision of Internationally Active Insurance 
Groups, or ``ComFrame.'' This project aims to make group-wide 
supervision of IAIGs more effective by creating a multijurisdictional 
approach that emphasizes robust oversight and supervisory cooperation 
while maintaining the proper balance between home and host authorities. 
While the ultimate role of ComFrame remains under discussion and 
development, the intent is given by its name--a common framework--one 
that lays out how supervisors around the globe can work together to 
supervise internationally active insurance groups. ComFrame is neither 
intended to be a forum to create prescriptive ways to promote a 
particular means for solvency standards, nor to create additional 
layers of regulation.
    While all regulators have a vested interest in harmonizing 
regulatory approaches with their international counterparts where 
appropriate, we cannot abdicate our responsibility for U.S. insurance 
companies and consumers. We must remember that there are different 
regulatory systems and approaches around the globe, so regulatory 
convergence must involve arriving at common outcomes and not 
necessarily at universal standards or structures. Moreover, global 
convergence should heavily focus on information sharing and include 
mechanisms for peer review. Imposing national or regional concepts 
unilaterally is particularly counterproductive as it undermines the 
ability to achieve common regulatory goals.
Identification of G-SIFIs
    In the aftermath of the financial crisis, regulators in the United 
States and around the world have been increasingly focused on 
identifying systemic risks to the financial system. In the United 
States, the Financial Stability Oversight Council (FSOC) is developing 
criteria to identify and designate systemically important nonbank 
financial institutions (SIFIs) for heightened supervision by the 
Federal Reserve--potentially impacting some insurers. The insurance 
regulator representative to FSOC is John Huff, Director of Missouri's 
Department of Insurance, Financial Institutions, and Professional 
Registration. Director Huff has been an active participant in FSOC 
discussions since he was selected by his fellow insurance regulators 
last year. He has been working closely with the new Director of the 
Federal Insurance Office, Michael McRaith, and he is looking forward to 
working with insurance expert Roy Woodall if and when he is confirmed 
by the full Senate. Of critical importance to Director Huff and his 
fellow regulators is highlighting the distinctions that exist between 
banking and insurance to ensure that FSOC decisions don't create 
detrimental unintended consequences for the insurance sector, while 
ensuring that any potential for systemic risk, however remote, is 
identified and mitigated.
    The U.S. is not alone in wrestling with the challenge of systemic 
risk. Finance ministers, central banks, and regulators from around the 
globe convene through the Financial Stability Board (FSB) to address 
systemic risk issues through the identification of global systemically 
important financial institutions (G-SIFIs). As part of this work, the 
FSB has asked the IAIS to develop indicators for identifying global 
systemically important insurers. U.S. insurance regulators have 
extensive input into the IAIS process as the NAIC chairs the IAIS 
Financial Stability Committee work on this issue.
    In both the FSOC and FSB efforts, it is critical for members making 
systemic designations to access unique expertise in particular subject 
areas. Such knowledge helps ensure that appropriate methodologies are 
being considered, and gives participants the insights of hands-on 
regulators with unique expertise in assessing the systemic relevance of 
certain products or activities.
    The U.S., represented by the United States Treasury Department, 
Federal Reserve Board of Governors, and the Securities and Exchange 
Commission, is a member of the FSB, which is engaging directly with the 
IAIS on critical issues including G-SIFI identification. The 
involvement of insurance regulators is essential as the FSB is a bank-
centric organization, yet its decisions have an impact beyond banking. 
Through the IAIS, we continue to stress that the insurance business 
model needs to be distinguished from the banking business model when 
discussing and applying any new regulatory requirements.
    Additionally, the Treasury Department coordinates input from the 
various functional regulators or their representatives on FSB projects 
and priorities, and we have been active and constructive contributors 
to those discussions. The FSB has taken on an increasingly active role 
in attempting to coordinate regulatory developments around the globe. 
However, some activities have raised questions of coordination, such as 
how the timing and outcomes of the FSB's process for identifying G-
SIFIs relates to domestic processes like FSOC's to identify 
systemically important financial institutions within our country. I 
would encourage Federal regulators and legislators alike to be mindful 
of both the scope and speed of the board's activity, and work to ensure 
that appropriate deference should be provided to the regulatory 
authorities of member nations.
Communication, Collaboration, and Cooperation Among Supervisors
    Beyond identifying systemic risk, the day-to-day supervision of 
insurance in the U.S. requires extensive coordination among our 
regulators. We have a long history of coordination through the NAIC, 
and have embedded systems of peer review into our processes to promote 
consistent oversight. Similar efforts to coordinate at the 
international level are evolving, so U.S. regulators along with their 
international counterparts are redoubling efforts to strengthen 
supervision through enhanced coordination.
    Insurance regulators are involved in technical exchanges, training 
programs, and other forms of regular dialogue. We actively pursue 
necessary bilateral and multilateral information agreements or 
Memoranda of Understanding that provide the foundation for these 
regulatory exchanges. U.S. regulator leadership in these efforts help 
us understand the various supervisory practices and cultures that 
exist, and better appreciate the global risk trends that may impact 
domestic insurers and policyholders. This type of increased cooperation 
has been discussed internationally for some time, particularly with a 
focus on improved efficiency and teamwork among regulatory systems, but 
the recent financial crisis has accelerated the current efforts on 
developing and implementing best practices to eliminate the risk of 
systemic threats.
    Increased international supervisory coordination and collaboration 
has taken a variety of forms. A key initiative to increase coordination 
is the IAIS Supervisory Forum, which the NAIC chairs. The objective of 
this forum is to strengthen insurance supervision and to foster 
convergence of supervisory practices through exchange of real-world 
experiences. The work of this group will also contribute to the 
development and operationalization of ComFrame.
    U.S. regulators also participate in supervisory colleges; forums 
for enhancing supervisory cooperation and coordination among 
international regulators relating to a specific insurance group. U.S. 
and international regulators are in the process of developing best 
practices for participating in these discussions, including guidance on 
the coordination and communication of information to cross-border and 
other functional regulators and through international roundtables.
    Beyond these formal structures and tools, increased collaboration 
hinges on establishing trust and relationships among regulators. To 
help foster such an environment, the NAIC engages in recurring 
regulator-to-regulator dialogues with representatives from the EU, 
North America, China, Japan, Switzerland, and other jurisdictions 
around the world. We also participate in similar international 
dialogues with our fellow U.S. financial regulators and agencies, such 
as the Treasury Department, Federal Reserve, and the Securities and 
Exchange Commission. We provide technical assistance to foreign 
regulators in the form of training, and have hosted more than 143 
foreign insurance regulators from 24 countries in our International 
Fellows program. Furthermore, we recently provided training to Thai 
regulators on the importance of data to perform automated financial 
analysis on the solvency of the insurance industry, and to South Korean 
regulators to help them identify and prevent insurance fraud. We also 
have conducted similar training here in the U.S. for Armenian 
regulators, coordinating with the Treasury Department's Financial 
Crimes Enforcement Network and the Federal Bureau of Investigation. 
These efforts promote best practices abroad and are critical as U.S. 
insurers branch into new markets.
    Just last week, a delegation of State insurance regulators, NAIC 
staff, and a representative of the Federal Insurance Office traveled to 
Frankfurt, Germany to engage European counterparts on international 
regulatory issues. The dialogue was especially timely as the European 
Union (EU) and the U.S. both continue to modernize insurance 
regulation; Europe through Solvency II, and the United States through 
our Solvency Modernization Initiative (SMI). Together, the U.S. and the 
EU oversee more than 70 percent of the global insurance market. Last 
week's agenda included discussions on regulatory developments, Solvency 
II implementation and U.S. equivalence, and the process for designating 
global systemically important financial institutions (G-SIFIs). Both 
sides agreed that this continued engagement was critical and further 
agreed to establish joint working groups to resolve various technical 
issues before the next dialogue in early 2012.
    In particular, I would like to highlight our discussions on 
equivalence. The Solvency II initiative requires an assessment of 
``third countries'' to determine if their levels of solvency 
supervision are equivalent to Solvency II, notwithstanding that 
Solvency II is still a few years away from being operational. To the 
extent that Europe does not find our system of supervision equivalent, 
it could have negative implications on U.S. insurers doing business in 
Europe and European insurers doing business in the U.S. Europe is 
committed to assessing other jurisdictions on an outcomes basis, where 
they review the overall objective of protecting policyholders and 
ensuring strong solvency oversight, rather than requiring adoption of 
Solvency II itself. Although the U.S. insurance regulators do not 
intend to implement Solvency II in the States, and there are clear 
differences between the regulatory and legal structure of our markets, 
we do believe that our system of supervision is at least equivalent to 
Solvency II on an outcomes basis. The IMF assessment of our system and 
the performance of our market relative to other sectors during the 
financial crisis reinforce this view. We strongly encouraged our 
European colleagues to review our system on an outcomes basis and find 
our system equivalent to avoid any disruptions in the transatlantic 
insurance market.
Domestic Improvements to Insurance Regulation
    Representatives from the NAIC have frequently testified before 
Congress on our continuing efforts to improve the State-based system of 
regulation. While this work was underway well before the financial 
crisis, that event certainly underscored a need for State insurance 
regulators to enhance and improve policies and processes in a number of 
areas.
    In June 2008, State insurance regulators commenced the Solvency 
Modernization Initiative (SMI); a critical self-examination of the U.S. 
insurance solvency system. While the existing system helped protect the 
relative stability of the insurance sector during the financial crisis, 
no regulatory system can remain stagnant in a world of constant change. 
The SMI project is focused on several major areas: (1) group 
supervision; (2) capital requirements; (3) governance and risk 
management; (4) accounting and financial reporting; and (5) 
reinsurance. Under SMI, we are examining international developments 
regarding insurance supervision, banking supervision, and international 
accounting standards in order to consider their use in U.S. insurance 
regulation. We believe that, ultimately, this open and transparent 
process will drive changes to our overall regulatory system. We must 
learn from international developments and collaborate where 
appropriate, but we cannot abdicate our responsibility for U.S. 
insurance consumers and companies.
    One key area of focus for the SMI project has been enhancing our 
system of group supervision. Our experience with AIG taught us that we 
needed to increase our scrutiny of areas outside the regulated 
insurance company to better understand the risk that exists in other 
areas of the group.
    Traditionally, insurance regulators have mainly focused on ring-
fencing the insurance company to protect it from risk that exists in 
other parts of the group. While we still have an appreciation for the 
importance of these ``walls,'' we also recognize the need to look 
through the ``windows'' to identify risks that could pose a contagion 
to the insurance company.
    In December of last year, the NAIC adopted revisions to the 
Insurance Holding Company System Model Act and the Insurance Holding 
Company System Model Regulation With Reporting Forms and Instructions. 
These revisions are intended to provide regulators the ability to 
better assess the enterprise risk within a holding company system and 
its impact on an insurer within the group. Ultimately, this enhanced 
``windows and walls'' approach should provide greater and much-needed 
breadth and scope to solvency regulation while maintaining the highest 
level of policyholder protection.
    We are undertaking a comprehensive review of our risk-based capital 
requirements. We are also looking at incorporating a review of a firm's 
group capital assessment as a part of a requirement that firms conduct 
their ``Own Risk and Solvency Assessment'' (ORSA).
    During the past 2 years, we have made significant changes in the 
way we assess risk and capital requirements for structured securities. 
The financial crisis revealed that insurance market participants and 
regulators overly relied on credit ratings issued by the Nationally 
Recognized Statistical Rating Organizations (NRSROs). In an effort to 
reduce our reliance on these rating agencies, the NAIC acted to more 
closely align the capital requirements for residential mortgage-backed 
securities (RMBS) and for commercial mortgage-backed securities (CMBS) 
with appropriate economic expectations. These two asset classes 
represent over $300 billion in carrying value of invested assets for 
the U.S. insurance industry.
    The NAIC developed alternative methodologies for evaluating CMBS 
and RMBS investments, and the new process results in a more accurate 
reflection of the risk of loss for each specific insurer that is then 
mapped to a risk-based capital factor. At the conclusion of our most 
recent year of effort in this regard, the NAIC made available projected 
expected losses on a list of approximately 19,500 residential mortgage-
backed securities and 5,200 commercial mortgage-backed securities to 
insurers, the Federal Reserve and other Federal agencies. While the 
NAIC continues to use the NRSROs for other asset classes, our Valuation 
of Securities Task Force, as well as our Rating Agency Working Group, 
are monitoring these other asset classes to determine whether continued 
reliance is appropriate.
    One concern for insurance regulators during the financial crisis 
was over securities lending activities by AIG; work that was separate 
from the noninsurance problems at the AIG Financial Products Division 
overseas. U.S. insurance regulators had discovered the change in AIG's 
management of the securities lending program in 2007 during a regular 
financial examination, and immediately began working with the company 
to wind down the activity and provide additional public disclosure of 
the structure and risks facing the program.
    In the time since the AIG Securities Lending discovery, insurance 
regulators have taken a number of actions to ensure transparency in any 
such activities at insurance companies in the future. We improved the 
guidance for such activity in 2008, as well as annual financial 
statement disclosure requirements in order to obtain summary 
information on the duration of when related collateral is required to 
be returned to the counterparty. This allows regulators to more readily 
identify if an insurer's securities lending program could cause 
excessive liquidity strains under stressed scenarios. Furthermore, the 
NAIC adopted a new Schedule DL in 2010 to strengthen transparency in 
securities lending agreements utilized by insurers by requiring 
detailed disclosure of the program's collateral instruments.
Conclusion
    While much work has been done to enhance insurance supervision over 
the past few years, regulating IAIGs through the creation of common 
standards and enhanced coordination is an area that regulators here and 
abroad will continue to focus on to ensure that approaches keep pace 
with the insurer business model. It is also equally critical that the 
uniqueness of that model be acknowledged internationally, since 
regulatory approaches used for other types of financial institutions 
may not be appropriate for insurance. We continue to refine our system, 
mindful of and engaged directly in developments abroad. Our goal is to 
constantly improve our system for the benefit of insurance companies 
and consumers. We have spent a tremendous amount of time and energy on 
these issues and will continue to do so in the coming months and years.
    Thank you again for the opportunity to testify today. I would be 
happy to answer any questions.
                                 ______
                                 
                  PREPARED STATEMENT OF MARY A. WEISS
Deaver Professor of Risk, Insurance, and Healthcare Management, Temple 
                               University
                           September 14, 2011
    My comments for this hearing are mostly directed to emerging issues 
in insurance regulation, including international issues. The following 
issues, I believe, are important issues for the insurance industry and 
insurance regulators:

    1. (International) Group Supervision. Most insurance carried out in 
the U.S. is done by families of insurance companies called groups. 
Companies within the group are related to each other by common 
ownership. Recent history has shown that groups can be complex and 
opaque in nature. In some cases this can hamper insurance regulation, 
as discussed below.
    Many groups are involved in noninsurance activities. \1\ These 
noninsurance activities may be regulated or they may not. Importantly 
these activities, especially if they are unregulated and involve 
capital markets, could make a group systemically risky (as was the case 
for AIG). That is, a convincing case can be made that the insurance 
activities carried out by insurers do not create systemic risk. 
However, when insurers drift towards noninsurance activities that 
involve capital markets, the latter activities can be a source of 
systemic risk. U.S. insurance regulators at present do not have the 
authority to supervise these noninsurance activities, and there appears 
to be no mechanism in place that allows regulators of the insurance and 
noninsurance activities to work together in maintaining the viability 
of the total enterprise or even to assess the riskiness of the 
enterprise as a whole. Even worse, no regulatory authority is present 
to cooperate with if the noninsurance activities are conducted by a 
nonregulated entity.
---------------------------------------------------------------------------
     \1\ Group and the group holding company are used interchangeably 
here.
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    The factors discussed above have an important bearing in 
determining capital requirements for insurers that are part of a group. 
For example, it raises the question of whether insurance regulators 
should put in place capital requirements for noninsurance activities 
(especially unregulated ones). There are many other questions 
concerning determination of group capital requirements. For example, 
there is a question about whether insurers that are part of a group 
should be allowed to recognize diversification benefits because they 
operate across different geographic areas and/or in very different 
lines of business. The latter issue, of course, is one raised by 
insurers.
    Also, some of the products offered by insurers are similar to 
products offered by other financial institutions. For example, some 
life insurance products compete with banking products. Therefore care 
must be taken that regulation of these products are consistent. 
Regulatory arbitrage can occur if a product of one type of financial 
institution is considered to be regulated less rigorously than products 
offered by the other type of institution. Thus, direct coordination 
between financial institution regulators is required to prevent 
regulatory arbitrage of this type from occurring.
    Many groups operate internationally. Yet, insurers are actually 
regulated by national domestic bodies. The wind-up of a perhaps complex 
insurance group raises questions as to how assets of the group will be 
distributed among the different countries that the group operates in. 
This points to the need for direct coordination and cooperation among 
regulators from different countries. At present, there is some degree 
of coordination among international insurance regulators when a group 
experiences financial distress. In this case a ``supervisory college'' 
consisting of regulators of companies in the group is convened to deal 
with the problem. However, these supervisory colleges are in place only 
so long as the group is in financial distress--they are disbanded when 
the problem is resolved. Thus supervisory colleges are ad hoc and 
intermittent. To prevent problems in the first place, coordination 
among regulators of companies in a group should be ongoing, with 
regulators in the supervisory college in regular communication with 
each other.

    2. Optional Federal Chartering. A perennial issue that arises is 
whether insurers should be able to choose to be regulated at the 
Federal level, leaving the remaining insurers to continue to be 
regulated at the State level. Arguments exist in favor of this Federal 
chartering option--many of which are related to efficiency (e.g., 
streamlined producer and company licensing, speed to market for 
products, removal of rate regulation). For example, currently an 
insurer that wants to write insurance in all States must meet the 
statutory requirements of all of these States. This is cumbersome and 
time consuming, for U.S. insurers and foreign insurers alike.
    Although there are arguments in favor of Federal chartering, I 
believe there are better reasons not to follow such a route. In my 
opinion, large insurers would likely opt for Federal chartering, and 
these insurers could present a powerful lobbying force to the Federal 
regulator. In fact, the regulator might be prone to regulatory capture, 
a phenomenon in which the regulator ends up serving the interests of 
the regulated entities rather than pursuing traditional goals of 
regulation. One has only to contrast the lobbying power of insurers 
now--lobbying 50 State regulators--with the lobbying power of insurers 
if one Federal regulator/agency is in place to see how there could be a 
problem.
    Optional Federal chartering is sometimes compared to the dual 
system of banking regulation that exists in the U.S. But the cost to 
multi-State, Federally chartered insurers to switch back to State 
regulation in multiple States might be larger than it is for banks to 
switch from Federal to State chartering. Further, it is not clear that 
Federal regulators would not succumb to the same political pressures of 
State regulators to provide cross-subsidies to policyholders across and 
within States (e.g., making insurance affordable by mandating lower 
insurance prices or limiting risk classification for underwriting 
purposes). The latter would defeat some of the arguments in favor of 
optional Federal chartering. Finally there are substantial risks and 
cost involved with setting up a Federal insurance regulatory agency. 
For example, Federal policies might be put in place that have 
unintended consequences and such mistaken policies then would have 
national effects. Finally, Federal regulation was unable to fend off 
the most recent financial crisis and may in fact have contributed to it 
through some deregulation policies preceding the crisis.
    Alternatives to optional Federal chartering exist. These might 
entail minimum Federal standards that States must meet (e.g., about 
licensing or product approval). Streamlining of insurance regulation 
might also be achieved by allowing an insurer to choose a primary State 
for the purpose of rate, policy form, and perhaps other types of 
regulation. Then the insurer would be allowed to operate in all other 
States they are licensed in without having to meet regulations such as 
rate and policy form regulations that are governed by the primary 
State. Note that the primary State regulations would govern only select 
aspects of regulation so that solvency regulation or market conduct 
regulation could still be regulated by each individual State the 
insurer operates in. \2\
---------------------------------------------------------------------------
     \2\ For further explanation, see, Scott Harrington, 2006, 
``Federal Chartering of Insurance Companies: Options and Alternatives 
for Transforming Insurance Regulation'', Policy Brief, Networks 
Financial Institute at Indiana State University.

    3. Solvency II, the Swiss Solvency Test and U.S. Insurance 
Regulation. The Swiss Solvency Test (SST) is now in force in 
Switzerland. Solvency II is slated to go into effect sometime in 2012. 
Both systems represent a major overhaul of the way insurance will be 
regulated in Europe. A major aspect of Solvency II concerns capital 
requirements. An insurer's required capital will be determined by a 
risk-weighted formula (similar to an RBC approach as used in the U.S.) 
or on the basis of an internal model created by the insurer which 
purports to accurately capture the riskiness of the insurer's 
activities. The basic idea is that large insurers will use the model 
approach while smaller insurers (for whom developing a model is likely 
to be expensive) would use the risk based formula approach. Obviously, 
the modeling approach is radically different from the regulatory 
approach used in the U.S., and I believe it is unlikely that relying on 
a company's own model to determine its capital requirements will be 
adopted here. \3\
---------------------------------------------------------------------------
     \3\ This is not to say that modeling or principles-based 
regulation does not occur in the U.S. In fact it does exist for certain 
life insurance products.
---------------------------------------------------------------------------
    Nevertheless there are some important aspects of Europe's new 
regulation framework that could prove to be quite useful in the U.S. 
For example, under the Swiss Solvency Test, insurers are required to 
undergo stress tests to see how solvency would be affected by adverse 
economic or loss development. Stress tests consist of scenarios that 
would severely affect the insurer. For example, a life insurer might 
undergo a stress test in which a pandemic is assumed to occur that 
results in major reinsurer insolvencies and panic in the capital 
markets.
    Also under Solvency II, insurers will be required to provide the 
regulator with a document entitled the Own Risk Solvency Assessment 
(ORSA) which details the major risks the insurer faces, among other 
things. This document is treated confidentially and the use of such a 
document in U.S. regulation could be quite useful.
    The new European insurance regulatory regime also embraces the 
importance of corporate governance and internal control systems. Under 
the Swiss Solvency Test, insurers are required to complete two 
questionnaires that detail the corporate governance and risk management 
controls within the insurer. These types of questionnaires could be 
useful in the U.S.
    I believe that stress tests, ORSA, and the Swiss Quality Assessment 
questionnaires are being considered under the Solvency Modernization 
Initiative (SMI).

    4. Leverage, Assets, and Life Insurance. Although insurer assets 
are generally liquid and of high quality, there are some danger signals 
with respect to the life insurance industry. Life insurers hold 18.4 
percent of their assets in mortgage-backed and other asset-backed 
securities (MBS and ABS), including pass through securities such as 
CMOs. Even more startling, the amounts invested in MBS and ABS 
represent 169.8 percent of life insurer equity (policyholders' 
surplus). These numbers are relevant because ABS and MBS were 
especially problematical during the financial crisis. Thus, even minor 
problems with asset defaults and liquidity demands could significantly 
threaten the solvency of many life insurers. Somewhat offsetting their 
asset liquidity risk, life insurers receive a significant amount of net 
cash from operations, defined as premiums plus investment income net of 
benefit payments, expenses and taxes. Life insurers' net cash from 
operations represents 39 percent of equity.
    The capital to asset ratios of life insurers was approximately 6.3 
percent in 2010, while that for banks was 10.9 percent. Therefore at 
the present time, banks have about 75 percent more capital relative to 
assets than life insurers. Excessive leverage is risky because it 
exposes a firm's equity to slight declines in the value of assets. 
Therefore, the statutory statements of life insurers make them appear 
excessively leveraged, especially considering their exposure to 
mortgage-backed securities.
    It is possible that the true leverage ratios of life insurers are 
much lower than indicated above. This is because statutory accounting 
is very conservative--overstating liabilities and understating assets. 
Nevertheless, I believe that leverage might well be a problem for many 
life insurers.

    5. New global accounting standards are being used around the world, 
and the new insurance solvency systems for Europe rely on market value 
accounting. These accounting standards are very different from 
statutory accounting standards used in the U.S. Pressure is likely to 
develop on regulators to abandon statutory accounting and use 
accounting standards that are more universally in use. If statutory 
accounting is continued, this will require firms to continue to 
maintain two systems of accounting which is cumbersome and expensive.
    Much regulation of insurers is underpinned by statutory statements. 
For example, RBC requirements consist of factors that are applied to 
statutory accounting values. Other solvency tests, such as ratio 
analysis (under the FAST system) rely on statutory accounting as well. 
Thus changing insurance accounting standards would have serious 
repercussions on how insurers are assessed for regulatory purposes.

    6. Passage of the NAIC Reinsurance Modernization Proposal. This 
proposal entails creation of two new classes of reinsurers in the U.S., 
national reinsurers and ``port of entry'' (foreign) reinsurers. Each 
type of reinsurer would be regulated by only one State (the domiciliary 
State or the port of entry State). That is, a single State would be the 
sole regulator of a reinsurer writing assumed business in the U.S. 
Federal legislation could make this improvement in the regulatory 
system possible.
    Otherwise, reinsurers (both foreign and domestic) must meet the 
requirements under the NAIC Model Credit for Reinsurance Law. Under the 
latter, U.S. insurers can take balance sheet credit for reinsurance as 
long as the reinsurer is ``authorized,'' i.e., licensed in the ceding 
insurer's State of domicile, accredited in the ceding insurer's State 
of domicile, or licensed in a State with substantially similar credit 
for reinsurance laws. Insurers can take credit for unauthorized 
reinsurance only if the reinsurer posts collateral, in the form of 
funds held in the U.S. or letters of credit from U.S. banks. The NAIC 
and several individual U.S. States have begun to liberalize 
collateralization rules, and the process is ongoing.
                                 ______
                                 
                 PREPARED STATEMENT OF DANIEL SCHWARCZ
        Associate Professor, University of Minnesota Law School
                           September 14, 2011
    State insurance regulation consists predominantly of relatively 
strict rules, such as capital requirements and underwriting 
restrictions. Such rules are often appropriate mechanisms to regulate 
as complex an industry as insurance. Unfortunately, in their focus on 
command and control regulation, State insurance regulators have 
historically ignored an equally vital, and much less intrusive, 
regulatory strategy: promoting transparency in consumer-oriented 
property/casualty and life insurance markets.
    Currently, most States do a remarkably poor job of promoting 
transparent insurance markets. This failing occurs at two levels. 
First, most States do not empower consumers to make informed decisions 
among competing carriers. For instance, in personal lines markets--such 
as home, auto, and renters insurance--consumers have no capacity to 
identify or evaluate the substantial differences in carriers' insurance 
policies. Consumers cannot acquire policies before, or even during, 
purchase; instead, they receive them only weeks after the fact. 
Meanwhile, no disclosures warn consumers to consider differences in 
coverage, much less enable them to evaluate these differences. Similar 
deficiencies prevent consumers from comparing carriers' claims-paying 
practices. Consumers neither receive nor can access reliable measures 
of how often or how quickly carriers pay claims. Finally, consumers are 
almost never informed that ostensibly independent agents typically have 
financial incentives to steer them to particular carriers who may not 
provide optimal coverage. Given this collective lack of transparency, 
it is hardly surprising that several large national companies have 
started to hollow out their coverage and embrace aggressive claims 
handling strategies.
    The failure of State regulators to provide consumers with 
sufficient information extends to life insurance markets as well. 
Perhaps the most notable example is that consumers have virtually no 
means of comparing prices or costs for the cash value life insurance 
products that different companies offer. When combined with skewed (and 
nondisclosed) salesperson incentives, this too has produced distressing 
results. For instance, a substantial majority of life insurance sold in 
this country is cash value, even though less expensive (and, for 
insurers, less profitable) term coverage is a better option for the 
vast majority of individuals.
    The second broad transparency failing of State insurance regulators 
involves the absence of publicly available market information. Unlike 
the consumer disclosures discussed above--which must be simple, 
focused, and properly timed--this second form of transparency involves 
making detailed market information broadly available, typically through 
the Internet. Most consumers, of course, are unlikely to consult such 
information. But this form of transparency is nonetheless crucial for 
markets to operate effectively because it allows market 
intermediaries--including consumer-oriented magazines, public interest 
groups, and academics--to police marketplaces, identify problems, and 
convey relevant information to consumers, newspapers, and lawmakers.
    Currently, insurance regulation does a dismal job of making 
publicly available the information that market intermediaries need to 
perform this watchdog role. For instance, carriers' terms of coverage 
are not generally publicly accessible--insurers do not post their 
policies online and most insurance regulators do not maintain up to 
date or accessible records on the policies that different companies 
employ. Company-specific market conduct information--including data on 
how often claims are paid within specified time periods, how often 
claims are denied, how often policies are nonrenewed after a claim is 
filed, and how often policyholders sue for coverage--is also hidden 
from public scrutiny and treated as confidential. Virtually no States 
make available geo-coded, insurer-specific application, premium, 
exposure, and claims data, similar to that required of lenders by the 
Home Mortgage Disclosure Act. Product filings with the States and the 
Interstate Insurance Product Regulation Commission (IIPRC) are not made 
public before approval, thus precluding public comment. And even 
companies' annual financial statements are only accessible on the 
Internet for a fee, in notable contrast to the public availability of 
companies' SEC filings. \1\
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     \1\ Individuals can download five free reports a year if they 
agree not to use them for commercial purposes.
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    To be sure, the National Association of Insurance Commissioners 
(NAIC) has started to address some of these issues. But the results to 
date have ranged from preliminary to inadequate. Its model annuity and 
life disclosure regulations, for instance, rely on generic buyers' 
guides and broad standards for insurer disclosure without affirmatively 
developing tools that consumers need to make cross-company comparisons, 
such as the mortgage disclosure forms that the Consumer Financial 
Protection Bureau has developed in recent months. Work in the personal 
lines context has only recently started after years of consumer 
pressure. And in many domains, the NAIC has affirmatively rejected 
transparency. Examples include its refusal to make publicly available 
data on carriers' market conduct or on the availability and 
affordability of property insurance in specific geographic areas.
    In sum, State insurance regulation has generally failed at a core 
task of consumer protection regulation--making complex markets 
comprehensible to consumers and broadly transparent to those who may 
act on their behalf. This type of transparency is fundamental to 
fostering competitive and efficient markets. Historically, State 
insurance regulators have responded promptly to Federal pressure: in 
the face of such scrutiny, they shored up solvency regulation, 
coordinated agent licensing, and streamlined product review. The 
Federal Government should apply similar pressure on State regulators to 
develop a robust and thoughtful transparency regime. Specifically, 
Congress should press the new Federal Insurance Office to work with 
consumer groups to assess transparency in consumer insurance markets. 
That Office should compare this state of affairs with the transparency 
standards under development at the Federal level in the context of 
consumer credit and health insurance. The sharp contrasts that are 
revealed will hopefully either prompt States to correct these problems 
or precipitate Federal regulation doing so.
More Detailed Information on Failed Transparency in Insurance Markets
    In evaluating the lack of transparency in insurance markets 
described above, consider first the core product that insurers sell: 
insurance policies. Unlike virtually any other market, it is virtually 
impossible for purchasers of personal lines coverage--including 
homeowners, renters, and auto insurance--to scrutinize this product 
before they purchase it. \2\ Insurers only provide consumers with an 
actual insurance contract several weeks after they purchase coverage. 
They do not make sample contracts available to consumers on the 
Internet or through insurance agents. Marketing materials and other 
secondary literature from regulators and consumer organizations provide 
virtually no guidance about how different carriers' policies differ. 
And most States have essentially zero laws requiring insurers to 
provide any types of presale disclosure to consumers regarding the 
scope of their coverage.
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     \2\ This analysis is based on my forthcoming article, 
``Reevaluating Standardized Insurance Policies'', 77 University of 
Chicago Law Review (forthcoming 2011), available at http://ssrn.com/
abstract=1687909.
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    This distressing lack of transparency can be traced back to the 
assumption of regulators that personal lines policies are completely 
uniform, meaning that disclosure just does not make sense. Historically 
this assumption was premised on laws that required complete uniformity: 
most States, for instance, mandated the use of State promulgated fire 
insurance policies. But these rules gradually faded, in large part 
because insurers voluntarily adopted uniform policies in new insurance 
lines, such as homeowners. As often happens, though, market conditions 
changed. Today, homeowners insurance policies, and likely other 
personal lines insurance policies, often differ radically with respect 
to numerous important coverage provisions. In fact, some of the largest 
insurers in America have substantially degraded the scope of the 
coverage they provide in their policies. Yet State insurance regulation 
currently does nothing to provide consumers with the information they 
need to identify these companies and make their market decisions 
accordingly.
    A second arena in which State insurance regulation fails to promote 
market transparency involves information on the claims-paying records 
of carriers. \3\ Most States collect extensive market conduct data in 
various lines of insurance, including private passenger auto, 
residential property, and life and annuities. These data measure, on a 
company-specific basis, crucial issues that reflect companies' claims-
paying practices, such as such as how often claims are paid within 
specified time periods, how often claims are denied, how often policies 
are nonrenewed after a claim is filed, how often consumers complain to 
the company directly, and how often policyholders sue for coverage.
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     \3\ I have also discussed this issue in my previous work, 
including ``Regulating Insurance Sales or Selling Insurance Regulation? 
Against Regulatory Competition in Insurance'', 94 Minnesota Law Review 
1707, 1761 (2010), available at http://ssrn.com/abstract=1503127.
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    Although obviously central to evaluating the quality of different 
insurance products, regulators do not systematically make this 
information available to the public. \4\ Instead, regulators treat it 
as confidential. In many cases, this claim is legally dubious: at least 
some of this information occasionally appears in publicly available 
market conduct exams for specific companies. But the larger issue is 
why insurance regulators have not worked to alter State laws to the 
extent that they require this confidentiality, given the importance of 
this information to assessing the quality of coverage that different 
carriers provide. In almost all cases, the claim that these data are 
proprietary is facially implausible: the data reveal how well different 
companies fulfill their obligations, information which in no sense is 
the result of insurers' investments in knowledge production.
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     \4\ The only insurer-specific market-conduct information that 
regulators do provide to consumers is information about how often 
consumers complain to insurance departments about their carriers. 
Although this data is valuable, it is hardly a substitute for the more 
specific market conduct data described above. Most importantly, only a 
small and unrepresentative subset of consumers ever complain to State 
insurance departments. Additionally, consumer complaints concern myriad 
issues that are disaggregated only in very imprecise ways.
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    Yet a third arena in which State insurance regulation fails to 
promote transparency involves the availability and cost of property/
casualty insurance in low-income or minority residential communities. 
\5\ Such insurance is a prerequisite to a wide range of activities, 
from starting a business to purchasing a home. Moreover, it has long 
been recognized that certain pricing and marketing practices may 
disproportionately impact low-income communities. Even if these 
practices do not involve discriminatory intent, they may constitute a 
violation of the Fair Housing Act if they have a disparate impact on 
protected groups and a less discriminatory alternative is available. In 
response to these concerns, Federal law, through the Home Mortgage 
Disclosure Act (HMDA), has long required lenders to provide the public 
with robust information on the availability of home loans. HMDA 
requires lenders to report and make publicly available geo-coded 
information regarding home loans, loan applications, interest rates, 
and the race, gender, and income of loan applicants. This information 
has promoted richer understanding of credit availability and 
discrimination, helped identify discriminatory lending practices, and 
prompted various initiatives to make credit more available in 
traditionally under-served areas.
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     \5\ See, generally, Gregory D. Squires, ``Racial Profiling, 
Insurance Style: Insurance Redlining and the Uneven Development of 
Metropolitan Areas'', 25 Journal of Urban Affairs 391 (2003); Gregory 
D. Squires and Charis E. Kubrin, ``Privileged Places: Race, Uneven 
Development and the Geography of Opportunity in Urban America'', 42 
Urban Studies 47 (2005).
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    By contrast, the vast majority of insurance regulators have 
repeatedly refused to provide the public with any HMDA-like data 
regarding the availability of homeowners insurance. One survey found 
that only four States make insurer-specific, geo-coded data publicly 
available for homeowners insurance, and no State makes publicly 
available loss or pricing data for individual insurers. Most State 
regulators have repeatedly ignored requests to devise a model law that 
would require such data collection and dissemination. This is 
particularly troubling because the evidence that is available suggests 
that homeowners insurance is systematically more expensive and less 
available in certain low-income, urban areas. Thankfully, the Dodd-
Frank Act specifically authorizes the Federal Insurance Office to 
collect and publish this data. \6\
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     \6\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. No. 111-203, Sec. 502(a) (2010).
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    Insurance regulators have also generally refused to promote 
transparency with respect to the compensation and incentives of 
ostensibly independent insurance agents. \7\ Insurance agents 
frequently receive different amounts of compensation for placing 
consumers with different carriers. Often this is a result of 
``contingent commissions,'' which are essentially year-end bonuses to 
agents based on the volume and/or profitability of the business sent to 
the insurer. Alternatively, some carriers may simply pay higher up-
front ``premium'' commissions. Either way, differential compensation of 
agents creates obvious incentives for agents to place customers with 
particular carriers who may not always be optimal for the individual 
consumer.
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     \7\ To be sure, I have argued before and continue to believe that 
the regulatory problems created by contingent commissions are 
particularly resistant to disclosure-based responses. See, Daniel 
Schwarcz, ``Differential Compensation and the Race to the Bottom in 
Consumer Insurance Markets'', 15 Connecticut Insurance Law Journal 723 
(2009), available at http://ssrn.com/abstract=1333291; Daniel Schwarcz, 
``Beyond Disclosure: The Case for Banning Contingent Commissions'', 25 
Yale Law & Policy Review 289 (2007), available at http://ssrn.com/
abstract=953061. At the same time, though, effective disclosure-based 
responses in this domain are clearly better than the status quo, 
wherein ostensibly independent insurance agents market themselves to 
consumers as trusted, independent advisors while operating under strong 
incentives to steer customers to particular carriers.
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    Despite this, the vast majority of States do not require 
independent agents to disclose this potential conflict of interest to 
their customers, nor do they limit the capacity of these agents to 
promote their ``independence'' to consumers. Most States do not 
currently have any regulations regarding the disclosure of agent 
compensation. Those that do typically do not require any such 
disclosure unless the agent received compensation from the customer, 
which is highly atypical in most consumer transactions. Only a single 
State, New York, requires that agents disclose prior to sale that ``the 
compensation paid to the insurance producer may vary depending on a 
number of factors, including (if applicable) the insurance contract and 
the insurer that the purchaser selects, the volume of business the 
producer provides to the insurer or the profitability of the insurance 
contracts that the producer provides to the insurer.'' \8\
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     \8\ New York Regulation 194, codified at 11 NYCRR Part 30.
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    In the life insurance arena, the NAIC has seemingly devoted more 
attention to promoting transparency, as it has developed Life Insurance 
and Annuities Disclosure Model Regulations in recent years. Both rules 
require consumers to be provided with a generic buyers' guide and 
establish basic standards for the provision of additional information 
by companies. Although better than nothing, these rules do little to 
affirmatively empower consumers to choose among the immensely complex 
products being offered by different companies. To achieve this, 
regulators must design specific, consumer-tested, required disclosures 
that combine essential product information into a few basic indices 
and/or measures. Good examples of such disclosures include the mortgage 
disclosure forms that the Consumer Financial Protection Bureau recently 
unveiled as well as the health insurance disclosure form that Health & 
Human Services recently proposed (and developed in conjunction with the 
NAIC). If motivated, insurance regulators could easily draft analogous 
disclosures in the life insurance arena. Indeed, extensive work already 
exists on how regulators could design and implement disclosures for 
cash value life insurance policies that would allow consumers to 
effectively compare the cost and expected rate of returns of different 
policies. \9\
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     \9\ See, Joseph Belth, ``Information Disclosure to the Life 
Insurance Consumer'', 24 Drake Law Review 727 (1975); James H. Hunt, 
``Variable Universal Life Insurance: Is It Worth It Now?'' (2007), 
available at http://www.consumerfed.org/elements/www.consumerfed.org/
file/finance/VariableUniversalLife2007ReportPackage.pdf.
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    Standardized, regulator-designed, disclosures have numerous 
important advantages over the generic buyers' guides and broad 
standards currently relied upon in life insurance regulation. Most 
importantly, they recognize the fact that consumers have a limited 
capacity and willingness to compare complex financial instruments and 
they affirmatively assist consumers in making decisions. Additionally, 
because they are standardized and developed by regulators, they can be 
tested for effectiveness. They give consumers an incentive to invest in 
learning how to use disclosures, because they are consistent in content 
and design across companies. And they are relatively easy to police, 
compared to approaches that give companies discretion to disclose in 
any manner consistent with broad standards.
    In sum, the lack of transparency in consumer-oriented property/
casualty and life insurance markets is immensely troubling. To put it 
bluntly, insurance regulators have failed in a core feature of consumer 
protection. Transparency is fundamental to the operation of efficient 
markets: it allows consumers to make decisions consistent with their 
preferences and forces firms to adjust the products and practices to 
meet these preferences. Indeed, transparency is ultimately at the heart 
of recent reforms in the domains of consumer credit and health 
insurance. And while these reforms have surely been controversial, even 
their critics have tended to embrace the idea that effective 
competition requires open and transparent markets.
