[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
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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.
---------------------------------------------------------------------------
\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.
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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.
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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.
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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.
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\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\
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\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\
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\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.
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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.