Insurance Regulation: Common Standards and Improved Coordination 
Needed to Strengthen Market Regulation (30-SEP-03, GAO-03-433).  
                                                                 
Consumers of insurance depend on state regulators to ensure that 
insurance companies are behaving fairly and in accordance with	 
the law. This report evaluates the states' use of market analysis
(information gathering to determine issues and identify companies
that may need attention) and on-site examinations in market	 
regulation and the progress the National Association of Insurance
Commissioners (NAIC) has made in creating more uniformity in the 
regulation of market conduct.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-433 					        
    ACCNO:   A08615						        
  TITLE:     Insurance Regulation: Common Standards and Improved      
Coordination Needed to Strengthen Market Regulation		 
     DATE:   09/30/2003 
  SUBJECT:   Insurance						 
	     Insurance companies				 
	     Regulatory agencies				 
	     Standards and standardization			 

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GAO-03-433

United States General Accounting Office

     GAO Report to the Chairman, Committee on Financial Services, House of
                                Representatives

September 2003

INSURANCE REGULATION

     Common Standards and Improved Coordination Needed to Strengthen Market
                                   Regulation

GAO-03-433

Highlights of GAO-03-433, a report to the Chairman, Committee on Financial
Services, House of Representatives

Consumers of insurance depend on state regulators to ensure that insurance
companies are behaving fairly and in accordance with the law. This report
evaluates the states' use of market analysis (information gathering to
determine issues and identify companies that may need attention) and
on-site examinations in market regulation and the progress the National
Association of Insurance Commissioners (NAIC) has made in creating more
uniformity in the regulation of market conduct.

GAO recommends that NAIC and the states give increased priority to
identifying a common set of standards for a uniform market oversight
program that includes all states. These standards should include
procedures for conducting market analysis and coordinating market conduct
examinations. Further, NAIC needs to establish a mechanism to encourage
state legislatures and insurance departments to adopt and implement the
standards.

www.gao.gov/cgi-bin/getrpt?GAO-03-433.

To view the full product, including the scope
and methodology, click on the link above.
For more information, contact
Richard J. Hillman at (202) 512-8678 or
[email protected].

September 2003

INSURANCE REGULATION

Common Standards and Improved Coordination Needed to Strengthen Market
Regulation

Market conduct regulation-oversight of insurance company practices such as
selling and underwriting policies-is the responsibility of the same state
agencies that oversee insurance companies' financial solvency. Unlike
financial regulation, however, with its nationwide standards that allow
for coordination among state regulators, no generally accepted standards
exist for market conduct regulation. While all states do some kinds of
market regulation, including issuing licenses and responding to consumer
complaints, two key tools-market analysis and on-site examinations-are
used inconsistently, if at all. The result is inconsistent and often
spotty coverage from state to state and potential gaps in consumer
protection. Formal and rigorous market analysis, which could be used to
determine which companies to examine and how broad the examination should
be, is in its infancy among state regulators, and states that do perform
examinations vary widely in the way they choose companies to examine and
the scope of the examinations they conduct. These inconsistencies in
performing market conduct examinations make it difficult for the states to
depend on each other for regulation, leaving each state with the virtually
impossible task of examining every company within its borders. And with
each state conducting its own examinations, some insurance companies find
themselves undergoing simultaneous examinations by several states, while
other companies may not be examined at all.

NAIC has been pursuing initiatives since the 1970s to improve uniformity
in standards and procedures for a market analysis program and market
conduct examinations, but progress has been limited. In 1975 NAIC first
published guidance for market conduct examinations and since then has
updated it regularly. NAIC has also developed and continues to improve a
tracking system that allows states to share examination schedules. But
states are not required to use the guidance, although many do, and may
choose which parts they wish to apply. Similarly, states are not required
to use the tracking system, and most have not. The success of NAIC's
initiatives will be determined in large part by regulators' willingness to
share in these efforts and to rely on regulators in other states to assess
an insurance operation. Recently, NAIC set as one of its major goals
improving the way states use market analysis and market conduct
examinations. However, it remains uncertain whether NAIC and the states
can agree on and implement a program that will result in the
standardization of market conduct regulation. Much work remains to be done
to promote the coordination and cooperation that are needed for consistent
market conduct regulation to protect insurance consumers.

Contents

  Letter

Results in Brief
Background
States Vary in How They Conduct and How Often They Use Market

Analysis and Market Conduct Examinations NAIC Has Identified Market
Analysis and Examinations as Areas

Needing Significant Improvement Conclusions Recommendation for Executive
Action Agency Comments and Our Evaluation

                                       1

                                      3 4

                                       7

19 25 26 26

Appendix I Objectives, Scope, and Methodology

Appendix II Market Conduct Exams Completed in 2001

Appendix III 	Number of Licensed Insurers and Total Market Conduct
Examinations in 2001

Appendix IV 	Number of Market Conduct Examiners and Total Licensed
Insurers in 2001

Appendix V 	Comments from the National Association of Insurance
Commissioners 38

GAO Comments 46

  Appendix VI GAO Contacts and Staff Acknowledgments 48

GAO Contacts 48 Acknowledgments 48

  Table

Table 1: Market Conduct Examinations and Licensed Insurers in 2001

  Figure

Figure 1: Market Conduct Examinations Completed in 2001 Relative to the
Size of the Insurance Market in Each State

Abbreviations

ETS Examination Tracking System
IRES Insurance Regulatory Examiners Society
MAWG Market Analysis Working Group
NAIC National Association of Insurance Commissioners

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
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copyright holder may be necessary if you wish to reproduce this material
separately.

United States General Accounting Office Washington, DC 20548

September 30, 2003

The Honorable Michael Oxley
Chairman, Committee on Financial Services
House of Representatives

Dear Mr. Chairman:

Millions of American consumers rely on property and casualty insurance
for protection from a wide range of perils and on life insurance to help
guarantee the payment of mortgages, the education of children, and the
general welfare of families after the policyholders' deaths. But choosing
an
insurance company and evaluating a policy are difficult tasks for most
consumers, who generally do not have access to the information needed to
make such comparisons. For this reason, insurance regulators are
responsible for regulating not only the financial solvency of insurance
companies but also their interactions with customers, or market behavior.
Market regulation is designed to make sure that insurance companies are
fair and nondiscriminatory in their dealings with customers, do not renege
on the terms of their contracts, and write policies that offer what state
laws require.1

Historically, state regulators have focused the majority of their time and
resources on financial regulation, which oversees accounting methods and
procedures and financial statements in order to verify that companies are
in good financial condition and able to pay policyholders' claims. States
generally have the systems and tools in place to regulate financial
solvency, but market regulation is hindered by limited resources, a lack
of
emphasis on important regulatory tools, and the framework of the system
itself, which requires individual states to oversee companies that operate
in many states or nationwide. As a result, market regulation is currently
based on overlapping and often inconsistent state policies and activities.
While it provides some oversight, it may also place an undue burden on
some insurance companies and, at times, may fail to adequately protect
consumers.

1For the purposes of this report, we use market regulation to mean the set
of regulatory processes and tools focused on an insurance company's
interactions with its customers.

The Congress has long been concerned with the need for the states to
improve the quality and uniformity of insurance regulation. As you
requested, this report provides information on state insurance regulators'
oversight of market activities in the insurance industry and emphasizes
how the states use market analysis and on-site examinations as regulatory
tools.2 Market analysis consists of gathering information on a company, an
agent, or a market and evaluating that information to identify issues,
problems, and trends. A market conduct examination is similar to a
financial solvency examination, with examiners visiting a company to
evaluate practices and procedures and check them against the company's
files. Specifically, this report (1) evaluates the states' use of market
analysis and on-site examinations in market regulation and (2) discusses
the progress of efforts by the National Association of Insurance
Commissioners (NAIC) to improve and coordinate market regulation at the
state level.

To address these objectives, we collected data and interviewed officials
from nine states' insurance departments-Arkansas, California, Indiana,
Maryland, Michigan, Missouri, New Mexico, Ohio, and Oregon-and from NAIC's
Kansas City headquarters. The states selected provide an array of
experience with different models of market regulation and different levels
of regulatory resources. Some of the states that we visited had market
conduct oversight operations that varied from independent organizational
units to units combined with financial oversight. The states we visited
also varied in the total number of examinations performed. We also
reviewed nationwide information on the market oversight activities of all
states, including data on the level of regulatory resources, the number of
market conduct examinations performed, and the number of licensed
companies. To meet our first objective, we reviewed states' operating
procedures for market analysis and on-site examinations and interviewed
state officials responsible for these activities. We also asked a selected
sample of 40 companies-20 each from among the largest 200 property and
casualty firms (based on direct written premiums) and the largest 200 life
companies (based on asset size)-questions about their experiences with
market conduct examinations from 1999 through 2001.3 To determine the

2We testified before the Subcommittee on Oversight and Investigations,
Committee on Financial Services, House of Representatives. See U.S.
General Accounting Office,

Insurance Regulation: Preliminary Views on States' Oversight of Insurers'
Market Behavior, GAO-03-738T (Washington, D.C.: May 6, 2003).

3Because our sample was nonstatistical, our results cannot be projected to
all insurers.

effectiveness of NAIC's efforts to improve its market regulation program,
we interviewed officials from NAIC, attended its national meetings to
identify current issues in market regulation, reviewed past market
regulation efforts, and reviewed past and current initiatives to improve
the market regulation program. We conducted our review from April 2002
through August 2003, in accordance with generally accepted government
auditing standards. Appendix I provides a more detailed description of our
scope and methodology.

                                Results in Brief

Because no generally accepted standards exist for market analysis and
market conduct examinations, each state decides how it will carry out
these activities. As a result, few states have formal programs for market
analysis, and examinations are used inconsistently and in some cases
infrequently. While all states perform some type of market analysis, only
three of the states that we visited had formal analysis programs. Further,
each of the three states' programs was unique, and two of the programs
were still in the developmental stage. We also found that the states had
no generally accepted criteria for determining which companies to examine
or which type of examination to perform. The nine states we reviewed did
only a small number of on-site examinations relative to the number of
companies operating in each state, and while variations in the number of
exams often reflected differences in the levels of resources devoted to
performing these reviews, the variations were not closely related to
differences in the size of the insurance market. Information collected by
NAIC showed that the number of examinations among the insurance
departments in the remaining states were also low. Because states lacked
common standards for market analysis and applied guidelines for
examinations inconsistently, states did not coordinate examinations or
depend on each other for help in regulating the market conduct of
insurance companies and agents. These differences meant that some
companies underwent frequent and expensive examinations while others were
examined infrequently or not at all.

Over the years NAIC has initiated a number of efforts aimed at finding
ways to facilitate uniformity in states' market analysis programs and
promote interstate coordination in market conduct examinations. However,
despite NAIC's long-standing efforts and some limited successes, progress
has been slow. For example, in 1975 NAIC developed

a handbook for market conduct examiners, which is updated regularly.4 The
handbook provides useful guidance on conducting examinations and reporting
the results, and most states use it to some extent. However, most states
are not required to use it, and it does not contain standards such as when
to hold examinations or how to choose companies to examine. NAIC also
developed the Examination Tracking System (ETS), a computer-based system
designed to help states coordinate examinations and thus reduce the
regulatory burden on insurers. Using the ETS, state regulators should know
when other states planned to hold examinations and which companies would
be examined. However, because the states have not used the system widely,
the hoped-for improvements in efficiency have not materialized as quickly
as anticipated. NAIC continues its efforts to improve the ETS. Recently,
NAIC leadership announced a major initiative to improve insurance
regulators' use of market analysis and market conduct examinations.
However, because progress in the past has been slow, results from the new
initiative are still uncertain.

This report includes a recommendation that NAIC, working with the states,
give priority to identifying a common set of standards for a uniform
market oversight program that will include all states. These standards
should include procedures for conducting market analysis and coordinating
market conduct examinations. Further, we recommend that these standards be
included in a program to encourage their adoption by states.

We received combined comments on a draft of this report from NAIC and the
state insurance departments that we visited. NAIC stated that, "Overall,
the report confirmed several concerns that state regulators and the
insurance industry share about market regulation and particularly, market
analysis and market conduct examinations." These comments are reprinted in
appendix V, along with our comments. NAIC's comments are also discussed in
greater detail at the end of this letter. NAIC and several of the states
also provided technical comments, which we incorporated as appropriate.

Background 	Insurance in the United States is an industry that generates
$735 billion a year in premiums, with about 900 to 2,000 insurance
companies providing policies for businesses, governments, and consumers in
each state. In

4National Association of Insurance Commissioners, Market Conduct Examiners
Handbook, vols.l and ll (Kansas City, Mo.: Spring 2001).

addition, 3.5 million individuals are licensed to sell insurance,
including independent agents who sell and service insurance policies for
at least two insurance companies, agents who sell and service insurance
policies for specific companies, and brokers who represent buyers rather
than companies by searching the marketplace for the best possible deals
for their clients.5

States have primary responsibility for regulating the insurance industry,
and each state has its own insurance department. NAIC, which is made up of
the heads of the insurance departments from the 50 states, the District of
Columbia, and 4 U.S. territories, provides a forum for regulators to
identify and share best practices and develop recommended laws and
regulations. NAIC also develops and operates information-sharing tools
such as the ETS.

Market regulation requires state insurance regulators to oversee a wide
range of company practices, including sales, underwriting, and claims
processing and payment. Because of the scope of the market activities they
must oversee, regulators perform a variety of oversight tasks that work
together to help protect consumers from unfair practices. In addition to
market analysis and market conduct examinations, these activities include

o  	approving the prices and contents of insurance policies in
rate-and-form reviews,

o  processing consumer complaints,

o  issuing licenses to producers and companies, and

o  providing consumer education.

According to the state regulators we spoke with, the rate-and-form review
is a first step in protecting insurance consumers, allowing regulators to
screen each product as it enters the market for price and coverage. During
a rate-and-form review, state insurance regulators examine a policy's
price, terms, and conditions for adherence to state laws and regulations.
Most states' regulations stipulate that while prices for insurance
products

5In this report, we use the term agent to refer to all individuals who are
involved in selling insurance to the public, thus including both agents
and brokers. The insurance industry and regulators use the term insurance
producers.

may ensure a return sufficient to meet a company's expenses, pay its
claims, and make a reasonable profit, they must also be low enough to be
fair to consumers. Some states allow companies to begin selling policies
before receiving approval for price and policy terms. In other states,
regulators must approve policies and prices before policies can be sold.
Recent efforts by regulators to speed up the product approval process may
reduce the time and attention given to approving individual products.

States also generally have procedures for receiving and responding to
consumer complaints and inquiries. Most states consider written grievances
against a specific insurance entity, such as an insurance company or
agent, complaints; general questions about rates and coverage are treated
as inquiries. In 2001, states received nearly 470,000 complaints and over
3 million inquiries. Complaints currently serve an important function in
the market regulation process, as they often offer regulators the only
opportunity to identify specific problems in the industry and to establish
patterns of behavior that help identify problems with companies and
agents. For consumers, the complaint process is generally the most
important-and often only-point of contact with an insurance company,
regulators, or both. Generally, the complaint process includes
acknowledging the complaint, screening it, and sending a query or
investigative letter to the company or agent in question. The company or
agent generally must respond within a certain period, after which the
regulator reviews the response for consistency with the provisions of the
contract and for violations of insurance laws and regulations of the
state.

As another part of their market regulation responsibilities, state
insurance departments issue licenses to companies and agents. In 2001, 3.5
million individuals were licensed to provide insurance services in the
United States. Licenses vary by state, with some states issuing one type
that covers all those who sell insurance and other states issuing separate
agent licenses and drawing distinctions between the services each can
offer. Most states have a prelicensing education requirement and an
examination or similar requirement for demonstrating competence in the
insurance field. Additionally, many states require agents and brokers to
attend continuing education courses in order to maintain their licenses.
However, state insurance departments generally do not routinely oversee
the ongoing activities of agents, although insurance regulators do
investigate and discipline agents identified through complaints. Insurance
companies also have some responsibility for overseeing the behavior of
agents selling their products.

  States Vary in How They Conduct and How Often They Use Market Analysis and
  Market Conduct Examinations

Further, states provide consumer education that is intended to help
protect the interests of insurance customers. These efforts may include
informative brochures, rate comparison guides, and seminars, especially
for senior citizens. These efforts are not consistent across states, with
some states spending far more than others to help educate consumers.

Each of these oversight tasks helps protect consumers from unfair
practices. However, market analysis and on-site market conduct
examinations provide information on the actual practices of insurers.
Market analysis is an important way for states to identify potential
misbehavior by insurance companies, and on-site examinations provide the
most systematic assessment of insurers' behavior and practices.

In the absence of generally accepted standards, individual states decide
if and how they will do market analysis and perform market conduct
examinations. All state insurance departments do some type of market
analysis, gathering information about companies in the course of making
regulatory decisions. But only a few of the states we visited had
established formal market analysis programs designed to help identify
problem companies earlier and more effectively. We found that those states
attempting to do more formal market analysis had very different approaches
that were for the most part still in a developmental phase. Similarly, we
found that states had no generally accepted criteria for market conduct
examinations that would help in determining which companies should be
examined or how thorough an examination should be performed.6 We found
that states generally performed few examinations relative to the size of
the insurance industry and devoted different levels of resources to their
examination programs. The lack of common standards for market analysis and
inconsistency in applying the guidelines for examinations made reciprocity
among states and mutual acceptance of examination results difficult. And
because the selection criteria and examination procedures differed across
states, some companies were being examined frequently and others not at
all.

6While the Market Conduct Examiner's Handbook includes a list of factors
that a state could consider to prioritize companies for examinations, they
do not constitute "generally accepted criteria" for determining when a
company should be examined for two reasons. First, states are not required
to follow the guidance in the handbook and may choose which parts, if any,
they wish to apply. Second, the factors listed in the handbook do not
provide clear and specific minimum standards for when and how these
factors should be applied. As a result, states are unlikely to respond
consistently to a given market conduct problem.

    Few States We Visited Did Systematic and Routine Market Analysis

According to NAIC, market analysis provides an important tool for
monitoring the broader marketplace, allowing states to identify regulatory
problems and better prioritize and coordinate market regulation functions,
and establishing an integrated system for responding to market problems.
Among other things, market analysis can provide information on insurance
companies' compliance with applicable laws and regulations, highlight
practices that could have a negative effect on consumers, and help
identify problem companies for examination. NAIC and some states recognize
that market analysis can be a significant regulatory tool, and all of the
states we visited performed some type of market analysis, but in most
cases these efforts were fragmented and lacked a systematic organization
and framework. We found that in many states market analysis consisted
largely of monitoring complaints and complaint trends and reacting to
significant market issues. Analyzing complaints and complaint trends does
provide regulators with useful and important information and should be
part of any market analysis program. However, other types of information
can also help regulators identify and deal with market conduct issues,
including data from financial reports, rate-and-form filings, other
company filings, routine and special requests for company data, and
information from other federal and state regulators. All this information,
consistently and routinely evaluated by well-trained analysts, can help
regulators identify companies that examiners need to look at more closely
or that merit regulatory actions.

Regulators in some states also performed desk audits, often classified as
a type of examination. For these audits, regulators rely on documents and
files the companies send for review. When done in the regulators' offices,
desk audits are actually a component of market analysis. When the review
of company files is part of an examination that includes a visit to the
offices of the insurance company, it becomes part of an on-site market
conduct examination.

Three states that we visited-Missouri, Ohio, and Oregon-have established
proactive and formal market analysis programs with processes for
monitoring company behavior to identify market trends, firms that vary
from the norm (outliers), and potential market conduct problems. Missouri
has been doing market analysis for a number of years while the Ohio and
Oregon programs are still in the developmental stages. The programs
differed in their approaches.

o  	Missouri requires all insurance companies to submit supplemental
market data reports along with their annual financial reports that include
information on companies' activities. Regulators used these data and

numerous other sources to evaluate market trends and conditions and to
identify companies that merited extra attention.

o  	Ohio gathers extensive information from selected company files that it
requests and, using computerized audit tools, analyzes how companies'
operations compare with norms identified by peer analysis and with state
law. In most states, this activity, less formally done, is called a desk
audit. Ohio did 184 of these "desk audits" in 2001 using data requested
from companies doing business in the state. This process allows Ohio's
regulators to identify companies meriting further regulatory attention
that might otherwise have escaped notice.

o  	Under Oregon's newly established program, analysts collect, organize,
and maintain data on companies. This information is drawn from various
sources, such as complaints and Internet information, to facilitate a
broad and ongoing review of company behavior.

Although the other six states we visited did not have formal market
analysis programs, they all performed some type of market analysis. For
example, all the states looked at complaints and complaint trends to
identify potential problems.

    States Varied in Their Approaches to Market Conduct Examinations

Because no generally accepted standards exist that stipulate how often or
even how regulators should examine companies, market conduct examination
policies and practices vary widely across the states. NAIC statistics show
that not all states perform market conduct examinations, and among states
that do, the criteria for choosing which companies to examine and what
type of examination to use differ widely. As we have noted, in 1975 NAIC
produced its handbook for market conduct examiners, but most states are
not required to use the handbook, and those that use it voluntarily may
decide which parts to apply. These differences in the way regulators
select companies to examine and carry out the reviews make it difficult
for regulators in one state to depend on the examinations done by other
states and hamper coordinated regulatory oversight. Because states do not
coordinate their market regulation

efforts, most state regulators feel responsible for overseeing all the
companies operating within their borders.7

Because of the nature of state-level insurance regulation, however,
coordinating market conduct examinations is important to efforts to
improve oversight-for example, to alleviate the burden on individual
states of examining every company within their purview. The importance of
cooperation and coordination in the market conduct examination process has
been widely recognized. The 1971 McKinsey study8 recognized that insurance
companies operations-and thus market regulation- frequently extended
across state borders. The study concluded that it was critical for the
states to share relevant market conduct information with other states and
to coordinate examinations.

A July 2000 report9 by PricewaterhouseCoopers, LLP also concluded that a
lack of cooperation, communication, and coordination were significant
issues in state regulation of the industry. The report found that insurers
believe there is duplication of effort and overlap by state insurance
departments performing market conduct examinations. The American Council
of Life Insurers has also pointed out that there is very little
coordination among states when conducting market conduct exams, even
though in the case of financial regulation, including financial
examinations, regulators have come to rely on the state in which a company
is chartered.

Among the nine states we reviewed, the practice of coordinating exams with
other states was not common and, when it did occur, varied substantially
across states. Some states coordinated their examination plans with other
states or reviewed other states' examination reports before exams. Some
states have also started to perform joint examinations. For example, Ohio
officials told us that they had started to

7Not all licensed companies in a state are actively selling insurance. For
example, some companies with existing business may be going out of
business, but still servicing existing customers in liquidation. These
companies may still have some active policies in the state but are not
selling any new policies.

8McKinsey & Company, Inc., Strengthening the Surveillance System, Final
Report, a report commissioned by National Association of Insurance
Commissioners, April 1974. McKinsey also issued preliminary reports in
1972 and 1973.

9PricewaterhouseCoopers, LLP, Insurance Market Conduct Examination Public
Policy Review, Final Report prepared for The Insurance Legislators
Foundation (Burlington, Vt.: July 6, 2000).

States Limited the Scope of Market Conduct Examinations

conduct collaborative examinations with Illinois, Nebraska, and Oregon,
and officials from Oregon told us that they recognized the need for more
interstate collaboration and reliance on examination results from other
states. Indiana officials said that they had recently completed a joint
examination of a large insurer with Colorado.

In general, on-site market conduct examinations fall into two categories:
comprehensive examinations and targeted examinations. A comprehensive
examination allows regulators to examine all or most of a company's
operational areas, using files and documents from company data banks. For
example, examiners can review types of products the company and its agents
sell, agents' sales practices, claims payment mechanisms, underwriting
standards, and policy provisions. Examiners can also review a company's
internal controls-those processes designed to ensure that the company, its
employees, and its agents adhere to all laws and company policies-and
"test" them by checking them against the company's files. A targeted
examination involves similar procedures but is limited to one or a few
business areas.

All the states we visited limited the scope of their market conduct
examinations. Most states limited the scope of their examinations by
performing mainly targeted examinations-for example, by focusing on how a
company processes claims, while largely ignoring underwriting, sales
practices, or other activities. However, some states still do
comprehensive market conduct examinations. Of the nine states we visited,
Arkansas, Missouri, and New Mexico continued to conduct comprehensive as
well as targeted examinations. Arkansas officials told us that they saw
comprehensive examinations as important for domestic companies because
they provide the most assurance that companies are complying with
insurance laws and regulations. However, the officials indicated that they
support the utilization of a targeted examination approach when examining
foreign licensed insurers unless circumstances indicate a comprehensive
examination is more appropriate. In every state we visited, however,
including those states that did comprehensive examinations, the scope of
examinations was further limited by restricting the examination to a
review of files of only those insurance consumers living in the examining
state.

Table 1 shows how many on-site market conduct examinations, both targeted
and comprehensive, were performed in the states we visited and what
percentage of insurers in each state the examinations covered.

       Table 1: Market Conduct Examinations and Licensed Insurers in 2001

         Market conduct                                         
         examinations completed                                 
         in                                                     
                  2001                                          
                                 Licensed     Licensed    Total Percentage of 
                                 domestic  nondomestic licensed      insurers 
                                                                     examined 
State  Targeted Comprehensive insurersa   insurersa insurers       in 2001 
                           Total                                

     Arkansasb       2        17   19      245     1,423    1,688       1.10% 
     California     148        0   148     229     1,171    1,400      10.57% 
      cIndiana       4         0    4      183     1,588    1,771       0.22% 
      Maryland      15        11   26      90      1,393    1,483      1.750% 
     Michigand       0         0    0      175     1,325    1,500       0.00% 
     Missourie       2        27   29      141     1,500    1,641       1.77% 
     New Mexico      1         7    8      20      1,575    1,595       0.50% 
        Ohio        42         0   42      280     1,505    1,785       2.35% 
       Oregon       15         0   15      49      1,404    1,453       1.03% 

Source: State insurance departments.

Note: Does not include follow-up exams or desk audits even though they are
done under a state's audit authority. For example, Ohio did 184 desk
audits during 2001 that did not result in an examination report. While
desk audits are an important component of market regulation for many
states, we have classified such off-site audits of company files as part
of market analysis rather than as market conduct examinations.

aA domestic insurer is a company that is chartered under the laws of a
particular state. For example, the (hypothetical) Acme Insurance Company
could be licensed to sell insurance in all 50 states, but it is a Michigan
domestic. A nondomestic insurer is a company that, while selling insurance
in a particular state, is chartered under the laws of some other state.
These companies are often called "foreign" companies to differentiate them
from domestic companies. Thus, while in Michigan regulators would consider
the Acme Insurance Company to be a domestic company, in all other states
it would be a nondomestic or foreign company.

bArkansas also examined 65 funeral homes' that sold prepaid funeral
insurance.

cThree of these were multistate exams.

dWe omitted 37 combined market conduct/financial examinations Michigan did
in 2001 because of their limited scope and focus when it came to market
conduct issues.

eDoes not include Missouri's 123 mutual domestic companies since, by
statute, the Missouri Department of Insurance cannot examine county
mutuals.

According to NAIC, 49 states and the District of Columbia reported on
their market conduct activities in 2001. Of these, 15 did only targeted
examinations, 4 did only comprehensive examinations, and 22 did both. The
remaining 9 did no market conduct examinations in 2001. State officials we
interviewed indicated that they used targeted examinations more often
because these examinations take less time, allowing regulators to do more
examinations with existing resources. Some officials said, however, that
the narrow scope of targeted examinations limited their

ability to fully assess a company's compliance with insurance laws and
regulations.

Recently, phase 2 of the PricewaterhouseCoopers study reported that
examinations as typically done by state insurance departments tended to
focus too little on reviewing internal controls and systems for
maintaining companywide compliance with laws, regulations, and ethical
practices. Instead, market conduct examiners sometimes tend to look for
isolated mistakes and errors by focusing on reviews of transactions files
rather than looking for broad patterns or practices of error or
illegality.10 As a result, some insurance companies report their
perception of comprehensive market conduct examinations as "fishing
expeditions" that provide opportunities for insurance departments to levy
fines rather than as regulatory tools designed to ensure the quality of
insurer performance and service.11

Since there are from 900 to 2,000 insurance companies licensed to sell
insurance in each state, regulators in the states we visited used a
variety of criteria to choose which companies should be examined. The most
commonly used factors for choosing from among the eligible companies were
the state in which the company was chartered and the number and severity
of complaints about the company. Regulators generally have the authority
to do a market conduct examination on any company that sells insurance in
their state. However, some states look only at domestic companies (those
chartered in their states), even though the majority of the insurers
selling in the state may be chartered elsewhere. For example, of the
states we visited, Arkansas and Michigan focused primarily on domestic
companies. In 2001, however, only 73 of Arkansas's 1,496 licensed
companies were chartered in the state. As a consequence, 1,423 nondomestic
companies, or 95 percent of all the companies that sold insurance to
Arkansas's citizens in 2001, were not examined in Arkansas and might or
might not have been examined in another state.

States Used Different Criteria to Select Companies to Examine

10The Market Conduct Examiners Handbook encourages examiners to focus on
the "general business practices" of the examinee. The handbook also
provides guidance on sampling techniques and recommended error rates that
could, if consistently used, reduce the focus on isolated or inadvertent
errors.

11PricewaterhouseCoopers, LLP and Georgia State University, The Path to
Reform-The Evolution of Market Conduct Surveillance Regulation,
preliminary report prepared for the Insurance Legislators Foundation, May
1, 2003.

Other states do not discriminate between domestic and nondomestic
companies when it comes to deciding which companies to examine. Of the
states we visited, California, Indiana, Maryland, Missouri, New Mexico,
Ohio, and Oregon fell into this group. These states used a variety of
other factors to select specific companies to examine. For example, all
the states we visited considered complaints and complaint trends as a
factor in targeting companies to examine. Indiana officials told us that
while other factors could influence the selection process, they primarily
used complaint data to identify potential problems and determine which
companies should be examined. A company with several similar complaints, a
rising trend of complaints, or even one particularly egregious complaint
(for example, mishandling of customer premium payments) would be a
legitimate examination target.

However, the use of complaint data has its limitations. One state
regulator told us that his state does not rely on consumer complaints as
the sole indicator of problems in the market because some kinds of
problems and violations may not be visible to consumers, who may then be
unaware that they have been subjected to unfair or deceptive practices,
such as violations of disclosure laws and sales tax reimbursement
requirements, rating errors, and unfair marketing strategies. The
usefulness of complaints as an indicator of a serious problem may also
vary with a company's primary line of business. Consumers are likely to
have more frequent interactions with their automobile or health insurers
than with their life insurance companies. As a result, an insurance
department may receive more complaints about a property or health insurer
than about a life insurance company, irrespective of how serious the
potential infraction might be.

Most states also used other ways of selecting companies for examination,
such as time since the last examination and market share, and the states
we visited generally used some combination of factors to determine when to
examine a company. For example, in Arkansas, California, Missouri, and New
Mexico regulators must examine certain companies every 3-5 years, although
other factors may also influence when an examination is performed. Some
states may also choose companies for examination based on the companies'
market share, in an effort to use limited state resources to cover the
largest percentage of the state's insurance consumers. New Mexico
officials also told us that they might not examine a company that they
knew had recently been examined by another state.

    States Did Relatively Few Examinations and Varied in the Staff Resources
    They Devoted to the Examination Process

As shown in table 1, each of the states we visited, with the exception of
California and Ohio, did on-site examinations of less than 2 percent of
the states' licensed companies in 2001. Based on the number of market
conduct examinations reported by the states to NAIC, it would take many
years for any of the states we visited to examine all of the companies
licensed in the state-in some cases, more than 100 years. While 2001 may
not have been a typical year for each state, information reported by the
states to NAIC suggests that, overall, 2001 was similar to 2000. Appendix
III provides state-by-state information on the number of insurers and the
number of market conduct examinations completed in 2001.

As figure 1 shows, the number of examinations completed bore little
relationship to the size of the insurance market in each state. This
comparison should not necessarily be taken as an indicator of the relative
regulatory performance of the nine states we visited because during
another year the ratios could differ. However, together with the
variations in the way states select companies for and conduct the
examinations, this added variability helps to further explain why states
may be reluctant to depend on other states' regulatory efforts.

Figure 1: Market Conduct Examinations Completed in 2001 Relative to the Size of
                       the Insurance Market in Each State

    Sources: State insurance departments, NAIC, and the U.S. Census Bureau.

Note: Does not include follow-up exams or desk audits. NAIC information
taken from 2001 Insurance Department Resource Report.

aTotal premium volume for life, health, and property/casualty insurance.

bArkansas also examined 65 funeral homes that sold prepaid funeral
insurance.

cThree of these were multistate examinations.

dMichigan did a limited review of market conduct issues as part of its 37
financial examinations.

The level of staff resources states dedicated to market analysis and
market conduct examinations also varied widely. In fact, NAIC's 2001
Insurance Department Resources Report does not even break out those
insurance department staff assigned to market analysis, although financial
analysts are separately identified.12 This report does give the number of
market conduct examiners reported by each state. Fourteen states, or 27
percent, did not report having any market conduct examiners on staff,
although 4 of the 14 did report using full-time contract examiners (see
app. IV). Even subtracting these 4, 10 states, or about 20 percent,
reported having no market conduct examiners at all. California had the
most market conduct examiners of the states we visited (44), while
Michigan had none. The number of licensed companies per examiner ranged
from a low of 32 to a

12National Association of Insurance Commissioners, 2001 Insurance
Department Resources Report (Kansas City, Mo.: 2002).

high of 430 (excluding Michigan and Indiana). Ordinarily a team of two or
more trained examiners would perform an examination.

Even though Michigan had no market conduct examiners, it did report doing
37 combined financial and market conduct examinations. Michigan regulators
told us that in these examinations, examiners doing routine financial
examinations on Michigan domestic companies also looked at market conduct
issues. These financial examiners receive little if any training in market
conduct examinations and focus primarily on financial solvency issues. One
official in another state told us that he believed it was difficult for a
financial examiner to do a good job in a market conduct examination
because the focus of the two examination types is so different. Financial
examiners are trained to verify that income and capital are at least high
enough to ensure the company's solvency-that is, that expenses are
relatively low and income and profits relatively high. Market conduct
examiners, however, attempt to ensure that the company is treating its
customers fairly. They may find that a company must pay more, pay faster,
or insure people that it might rather not insure-actions that may increase
costs and reduce profits. An examiner may have difficulty focusing on such
diametrically opposite objectives simultaneously.

Further, no generally accepted qualifications for market conduct examiners
exist. We found that states with market conduct examiners had very
different requirements for qualifications and training. Although financial
examiners in all states are required to have a recognized and
independently certified level of expertise, only two of the states we
visited-New Mexico and Oregon-required that their examiners become
certified through the Insurance Regulatory Examiners Society (IRES).
Despite the fact that the society offers several levels of certification
for market conduct examiners, these certifications are not prerequisites
to any examiner classification. In fact, NAIC's market conduct examiners
handbook-which recommends the specific IRES designations examiners should
obtain before they have earned one of the five examiners
classifications-does not require specific training requirements or
certification for the respective examiner classification.

Lack of Coordinated Many insurance companies, particularly the largest
ones, have publicly Oversight Burdened Some stated that they were subject
to frequent and sometimes simultaneous Companies and Left Others market
conduct examinations. We asked 40 of the largest national Unexamined
insurance companies-20 life insurers and 20 property-casualty insurers-

to provide information about their on-site market conduct examination
experience for the years 1999-2001. (See app. I for detailed information
on

our questionnaire.) Twenty-five companies responded. Of these, 19 had been
examined at their offices a total of 106 times during the 3-year period.
Six had been examined one or two times over the 3-year period, and 7
others had undergone 3 to 5 examinations. Thus, just over one-half of the
25 responding companies had been examined 1 to 5 times in 3 years.
However, 3 companies (2 property-casualty companies and 1 life insurance
company) each reported having had 15 examinations or more during the 3
years, with 1 company receiving 19 examinations-an average of over 6 a
year.13

To some extent, these results appear to support companies' concerns about
multiple, possibly duplicative, examinations. One of the most common
complaints received from the 25 insurers that responded to our survey was
that states did not coordinate their examinations with other states.
According to the responding companies, examinations can strain company
resources and result in considerable expense. One insurer wrote, "It takes
an insurer a tremendous amount of effort to prepare for and deal with
individual state insurance department's exams (every one is different,
plus states generally do not accept others exams in place of another
similar exam being done)."

Other responses to the questionnaire, however, presented another side of
the picture. Six companies, or nearly one-quarter of those responding, had
not been examined by any state during the period. Of these six companies,
two were last examined in 1997, and the other four reported that they had
no record of market conduct examinations. These companies, like all others
that reported, are large, multistate insurance companies. Several of the
states we visited told us that company size, or market share, was an
important factor in determining which companies to examine for market
conduct. This information, taken together with the relatively low numbers
of market conduct examinations that states have done, suggests the
possibility that many small and medium-size companies may not have been
examined recently, if at all.

13We did not verify the companies' responses with state regulators.
Moreover, we could not evaluate the basis on which the states selected
specific companies to examine. That is, multiple exams may or may not be
duplicative. For example, several states may examine the same company for
different reasons. Alternatively, multiple state examinations of the same
company may be necessitated by an insurance company's failure to take
corrective action in all jurisdictions that are affected by an
inappropriate activity.

  NAIC Has Identified Market Analysis and Examinations as Areas Needing
  Significant Improvement

The insurers responding to our survey reported that they paid an average
of $115,000 for comprehensive exams and $94,000 for targeted exams.
According to survey responses, the average length of time the states took
to complete all on-site exams, from the date regulators first told the
company that it would be examined to issuance of the final report, was 3.9
years. That is, for the insurers responding to our questions, it took an
average of just over 2 years to do the fieldwork for a market conduct
examination and an additional 1.8 years to finalize the report.14 These
numbers are self-reported and may not be reflective of the industry as a
whole. Moreover, the time needed to complete an examination depends on
many factors, such as the complexity of the issues being examined, state
resources, the level of company cooperation, and the company's right to a
formal administrative process. Nevertheless, some insurers responding to
our questionnaire suggested that with the high cost of the examinations,
the states should make greater efforts to reduce duplication.

NAIC identified the need for greater uniformity in market conduct
regulation as early as 1971, when it commissioned McKinsey & Company, Inc.
to review the financial and market conduct surveillance activities of
insurance companies. Since then, NAIC has launched a number of initiatives
intended to identify and address the issues and concerns caused by the
lack of uniformity in states' market conduct examinations and, more
recently, in their use of market analysis. For example, in March 2003 the
NAIC president announced that improving market conduct examinations and
market analysis would be one of the organization's major annual goals.15
However, despite NAIC's long-standing efforts and some successes, progress
has been slow, and it remains unclear whether the quality and consistency
of market conduct regulation will improve fundamentally, particularly in
these two key areas. Until NAIC and the states can identify and agree on
what constitutes appropriate and

14In congressional testimony, J. Robert Hunter, of the Consumer Federation
of America, presented data showing that, on average, it took 10 years for
the average state to complete any market conduct examination on a domestic
insurer and longer for a nondomestic insurer. Statement of J. Robert
Hunter, "Increasing The Effectiveness of State Consumer Protections,"
before the Subcommittee on Oversight and Investigations, Committee on
Financial Services, House of Representatives, May 6, 2003.

15NAIC's current emphasis on issues related to market conduct are in large
part a response to provisions in the Gramm-Leach-Bliley Act, Pub. L. No.
06-102, November 12, 1999, which addressed insurance regulation, and to
competitive pressures within the insurance industry.

consistent market regulation, significant improvement will likely be slow
to arrive.

    NAIC Has Long Recognized the Need to Improve Market Regulation but Has Made
    Slow Progress with Its Initiatives

Before the early 1970s, state insurance regulators emphasized financial
solvency. However, the McKinsey study recommended establishing a separate
and distinct program of market conduct surveillance, including market
conduct examinations that would be separate from financial examinations
and administered by different examination personnel.16 The study also
concluded, among other things, that some states had been dealing with
market conduct regulatory problems for many years, but that few states had
developed comprehensive, organized oversight systems that might respond to
these issues. In 1974, NAIC's Market Conduct Surveillance Handbook Task
Force issued a report, which recognized not only that market regulation
included issues distinct from those related to financial solvency but also
that market conduct examinations should be based on uniform policies and
procedures. In the years since, effective progress toward this goal has
been slow.

Pursuit of this goal has been primarily focused on the development of the
NAIC handbook for market conduct examiners, originally adopted in 1975. As
we have noted, in general, most states use the handbook as an examination
guide, although they have the option of following or modifying the
guidance for specific examinations. According to NAIC, the policy reason
behind this voluntary use is best summarized in the following statement
from the introduction to the handbook.

The Handbook was designed as a model reflecting established practices and
to assist each jurisdiction in developing its own market conduct
examination procedures. The NAIC model statutes and regulations were
selected as the basis for the handbook because insurance statutes in many
jurisdictions have evolved from NAIC model laws. For this reason, this
handbook is only a guide and should be used by each jurisdiction as a tool
for developing jurisdiction specific procedures and guidelines. To
effectively use this handbook, it is recommended that each jurisdiction
closely review the handbook to determine those standards that reflect the
statutes and regulations of the given jurisdiction and those that do not.
It is recommended that each jurisdiction develop its own manual of
procedures reflecting audit procedures based on the standards and
methodology set forth herein and modified to meet the specific
requirements of the laws of that jurisdiction.

16McKinsey & Company, Inc., Strengthening the Surveillance System, Final
Report, a report commissioned by the National Association of Insurance
Commissioners, April 1974.

For example, although the handbook lays out the steps for conducting an
exam, such as notifying the company, using sampling techniques, and
preparing an examination report, each state can go about those steps
differently. Moreover, the handbook does not cover some aspects of
examinations, including how often examinations should be done.

NAIC has also encouraged every state to set up a market regulation program
with established minimum standards in place for necessary resources,
staff, and statutes. In 1995, as part of this initiative, NAIC adopted the
Market Conduct Regulatory Guidelines, which suggested procedures and
services for state insurance departments to provide as part of their
market regulation programs. NAIC noted that model laws and regulations,
such as the Unfair Trade Practices Act and the Unfair Claims Settlement
Practices Act, constitute "essential elements" of these programs, as they
provide the necessary authorities for market conduct examinations. NAIC
also sees adoption of these models in all states as a vital step in
achieving uniform market regulation. Nearly 8 years have passed since NAIC
adopted the guidelines, yet the states have been unable to reach agreement
on the minimum resources and national regulatory standards necessary to
achieve effective market conduct examination programs and have made even
less progress in establishing those necessary for effective market
analysis. However, NAIC has recently established market analysis and the
creation of a market analysis handbook as a main priority.

NAIC has also created the ETS to assist in scheduling both financial and
market conduct examinations. NAIC designed the system to allow examiners
to communicate examination schedules and results among themselves. ETS
enables states to voluntarily report all upcoming examinations so that
other states can see them. Then, if another insurance department intends
to examine a company that is listed on ETS, it can either wait and use the
first state's results, ask to participate in the scheduled examination, or
at least schedule around the first state to avoid holding a simultaneous
examination at a listed company. Similarly, ETS allows regulators to post
examination results so that states can use other states' results to plan
their own examinations or to avoid having to do another examination at
all.

While the system has been successful for financial examinations, it has
not worked as well for market conduct examinations. We were told that ETS,
which was originally tailored to financial examinations, was inconvenient
and difficult to use for market conduct examinations. As a result, not all
states have used the system, rendering it inaccurate and incomplete. NAIC

surveyed states to find out how many used the ETS and concluded that about
two-thirds of the states consistently reported to NAIC on their market
conduct or combined market conduct/financial examination schedules.
However, we were told that few states reviewed others' planned schedules
or used the information in their own planning. Moreover, only 31 percent
of the states reported back to the ETS when they completed the examination
process.

NAIC is currently modifying ETS to make it more user-friendly and increase
the value it adds to the examination process in order to encourage more
states to use it. In December 2002, the system was divided into two
separate programs-financial and market conduct-to account for the
differences in the examination requirements in the two areas. It is too
early to determine whether these changes and others that have been
proposed to make the system easier to use will increase the number of
states using the ETS. According to NAIC officials, if states used the
tracking system, it could help reduce duplicative exams and potentially
reduce the number of unexamined companies.

In the spring of 2000, NAIC published a statement of intent that included
a directive to review the current focus, structure, and implementation of
market regulation programs across states and identify issues and concerns
in this area. One purpose of this review was to determine the merits of
voluntary uniform national standards as a basis for market conduct
examinations and enforcement actions. However, NAIC officials told us that
other issues in the statement of intent took priority over market conduct.
As a result, from 2000 through 2002 NAIC did not focus a great deal of its
attention on market regulatory reforms. Since 2002, NAIC's Market Analysis
Working Group (MAWG) has been developing a draft of the Market Analysis
Handbook. The guide is intended to provide regulators with information on
how to obtain and use up-to-date data and may include a "market conduct
annual statement" to help regulators identify priority issues and collect
data. This market conduct annual statement could be used to provide
regulators with market information analogous to the annual financial
statement. NAIC believes that MAWG can become a national forum for states
using the guide to share and coordinate their results. NAIC also believes
that as states begin to use the annual statement, market analysis will
become a more useful tool, leading to more effective market regulation. At
the time of our review, development continued on the Market Analysis
Handbook and the market conduct annual statement was being evaluated in a
pilot program in nine states.

In March 2003, NAIC announced that one of its major objectives for the
year was to improve market analysis and market conduct examinations.
NAIC's president stated that one of the organization's primary goals was
to improve the efficiency and effectiveness of market conduct efforts by
making market analysis more consistent across states and expanding the
number of joint examinations. Since this announcement, the attention and
resources devoted to market regulation by NAIC committees and work groups
have increased significantly. In testimony earlier this year, NAIC also
noted that it was pursuing what it called a "central reform" that would
increase awareness of the importance of market analysis as the most
effective regulatory tool for targeting the most serious consumer
problems.17 NAIC stated that in spite of industry criticism that focuses
on market conduct examinations, the complete package of state oversight
activities must include ongoing information gathering and analysis to spot
problems as early as possible and correct them:

Market conduct exams are a useful tool, but even if sufficient resources
were available to conduct more of them, such exams must be complemented by
other regulatory strategies for addressing problems before they become the
kind of business practice that exams typically seek to uncover.

Clearly NAIC recognizes that a combined system of market analysis and
market conduct examinations is the best way to oversee the behavior of
insurance companies in the marketplace. However, the development and
implementation of such a combined system by NAIC and the states is still
in its infancy.

For more than 12 years NAIC has had a program that successfully
demonstrates how to encourage states to adopt voluntarily standards that
are consistent and binding across the states. The financial accreditation
program has existed since the early 1990s, and nearly all the states now
participate. During this time, the program has demonstrated its value by
defining a common set of basic regulatory requirements for solvency
regulation and successfully engineering their adoption by nearly all the
states. Because of this program, nearly every state has increased the
quantity and quality of the resources it has available for financial
regulation; improved its regulatory processes; and adopted, where

Financial Regulation May Be a Model for Regulating Market Behavior

17Statement given by Joel Ario, Insurance Administrator for the State of
Oregon and Chairman of NAIC Market Regulation and Consumer Affairs
Committee, before the Subcommittee on Oversight and Investigations,
Committee on Financial Services, House of Representatives, May 6, 2003.

necessary, a consistent set of laws and regulations that are widely agreed
to be necessary for effective financial regulation. Because of these
improvements, most states are able to use their resources primarily for
overseeing the solvency of their domiciled companies while depending on
the regulation of other states for all other companies selling insurance
in their states. While the quality of regulation is still not entirely
consistent, the program has improved financial regulation across the
states. State insurance commissioners have discussed a similar solution
for problems of market regulation, perhaps adding market conduct
accreditation standards to the financial accreditation program or creating
a parallel program. However, to date the commissioners have not decided to
pursue the issue.

While the process state insurance regulators use to oversee solvency could
provide a model for overseeing market conduct as well, structural
differences between financial and market regulation would undoubtedly
affect the ultimate design of an improved market conduct oversight system.
First, market conduct oversight involves many more and different
activities and operations than financial regulation, a fact that has broad
implications for regulatory consistency and mutual dependence, including
requirements for training examiners and analysts. Second, regulators told
us that life insurers tend to use companywide business plans and
organizational structures, so that company operations tend to be
relatively consistent across an entire firm. Property-casualty insurers,
however, tend to use a regional business model and organizational
structure, so their operations could differ across geographic areas.
Clearly the life insurer model would be more directly amenable to
oversight by the state in which a company is chartered than the
property-casualty model, as any regional or state-by-state variances in a
company's operations would reduce the effectiveness of oversight by the
domiciliary state.

Third, some aspects of market conduct oversight are likely to remain state
specific because of the differences among the laws and requirements of
individual states. As a result, even when regulatory oversight becomes
more uniform, states will probably need to continue devoting some
attention to the activities of nondomestic insurers. However, knowing that
other states were doing consistent market oversight on domestic companies
could substantially reduce the level of attention states need to give
these companies. Finally, even to the extent that properly designed and
competently performed market analysis and examinations can effectively
monitor and regulate insurance company practices, these tools may not be
effective in identifying sales practice abuses by agents.

Conclusions

The Congress has been concerned that the current system of insurance
regulation does not provide consistent consumer protection across all
states and may be imposing an excessive regulatory burden on some
insurers. In the absence of uniform national standards for market analysis
and market conduct examinations, a patchwork of practices exists across
the states. The resulting inability of state insurance regulators to
depend on the oversight of other states has prevented regulatory
cooperation in overseeing the market behavior of multistate insurance
companies. Faced with the necessity of overseeing the market behavior of
all companies selling insurance in its state, whether domiciled there or
not, each insurance department has focused its scarce regulatory resources
in the way that seemed most appropriate to it. As a result, regulators may
examine some insurers too frequently and others infrequently or not at
all.18

We believe that a formal market analysis program in each state and
effective coordination of market conduct examinations would provide the
needed basis for truly effective market regulation nationwide. Careful,
thorough market analysis would provide the information needed to
understand the market, monitor company behavior, and identify those
companies that most need regulatory attention. Examinations coordinated
among states would allow regulators to follow up on problems and issues
identified through market analysis and ensure better regulatory coverage
of insurance companies.19 In addition, existing computerized audit tools
could allow regulators to substantially change the way examinations are
done by shifting the focus from a file review to a review of controls,
systems, and processes and possibly by shortening the time needed for the
examination.

But states will not have the resources to make these changes unless they
are able to accept the results of regulatory actions in other states and
to coordinate some activities. NAIC has been working since the 1970s to
improve and increase uniformity in market regulation, but progress has
been slow. We support NAIC's current goal of increasing the effectiveness
of market regulation through a nationwide market analysis program. But

18The scope of our work did not include an analysis of whether the "right"
companies were being examined or not, but no one else, including insurance
regulators, knows this for sure.

19Officials in Missouri, which has an active formal market analysis
program, emphasized this point, telling us that market analysis was not a
substitute for market conduct examinations but should interact with and be
integrated into the examination process.

  Recommendation for Executive Action

Agency Comments and Our Evaluation

we feel that NAIC, although recognizing market analysis as an important
component of market oversight, has taken only the first tentative steps
toward establishing such a program. Much work remains to be done, both on
market analysis and market conduct examinations, including establishing
appropriate laws, regulations, best practices, and resource requirements
to support the goal of creating an effective nationwide program of market
conduct regulation. However, at present it remains uncertain when-and even
whether-NAIC and the states can agree on and implement a program that will
accomplish this goal.

We recommend that NAIC, working with the states, give increased priority
to identifying a common set of standards for a uniform market oversight
program that will include all states. These standards should include
procedures for conducting market analysis and coordinating market conduct
examinations. Further, we recommend that a mechanism be established to
encourage state legislatures and insurance departments to adopt and
implement the identified minimum standards.

We provided a draft of this report to NAIC and the state insurance
departments that we visited- Arkansas, California, Indiana, Maryland,
Michigan, Missouri, New Mexico, Ohio, and Oregon. NAIC and six of the
states provided us with technical corrections to the report, which have
been included as appropriate. We asked the states to forward any comments
they had regarding the report message or policy issues to NAIC for
inclusion in NAIC's response. NAIC's comment letter is reproduced in
appendix V.

NAIC told us that, overall, the report confirmed several concerns that
state regulators and the insurance industry share about market regulation
and, particularly, about market analysis and market conduct examinations.
While NAIC recognized that our report focused on market analysis and
market conduct examinations, it reiterated that market regulation extends
beyond these two functions and is different than financial solvency
regulation. Moreover, it is more difficult to harmonize than financial
regulation. For example, the market behaviors of insurers can be quite
different from one state to another, both because the laws may be
different and because insurer compliance with the laws may vary by state.
NAIC's detailed comments on our report primarily focus on the following
three areas and its efforts to address these areas: (1) market analysis,
(2) uniform examination procedures, and (3) collaborative regulatory
efforts.

NAIC stated that it is aware of the varying approaches to market analysis
across the states and that it has made the creation of a more systematic
and structured market analysis system among the states a top priority.
NAIC identified two avenues through which it is pursuing improved and more
consistent market analysis-the development of a market analysis handbook
and the implementation of a market conduct annual statement pilot program.
We support NAIC's current goal of increasing the effectiveness of market
regulation through a nationwide market analysis program. However, we feel
that NAIC, although it recognizes market analysis as an important
component of market oversight, has taken only the first tentative steps
toward establishing such a program. Much work remains to be done, both on
market analysis and market conduct examinations, including establishing
appropriate laws, regulations, best practices, and resource requirements
to support the goal of creating an effective nationwide program of market
conduct regulation.

NAIC noted that in 2002 it adopted the Market Conduct Uniform Examination
Outline to help minimize variations in market conduct examinations so that
states can rely more on each other's examination findings. This outline
focuses on four areas of the examination process- (1) exam scheduling, (2)
pre-exam planning, (3) core examination procedures, and (4) examination
reports. NAIC's goal is to have at least 40 states certify compliance with
all four areas of examination uniformity and to develop a process for
resolving complaints about certifications. We support NAIC's efforts to
increase uniformity in the examination process. However, while useful, the
elements of the Market Conduct Uniform Examination Outline address only
some of the issues keeping states from relying on other states'
examinations. For example, as we discuss in the report, states that do
market conduct examinations tend to severely limit the scope of their
examinations. Moreover, one state may not have known whether another state
would commit sufficient resources to a market conduct examination or
require appropriate examiner expertise since there are no generally
accepted standards. The lack of common standards for market analysis and
for some areas of examinations and inconsistency in applying the
guidelines that do exist for examinations make reciprocity among states
difficult and reduce willingness to accept other states' examination
results.

NAIC agreed with our report that more collaborative efforts should be
initiated to eliminate the potential duplication of regulatory efforts. At
the same time, NAIC pointed out that not every case of multiple
examinations is duplicative. NAIC noted that multiple examinations would
not be duplicative if the states were examining the same company for
different

reasons. Moreover, the states' ability to eliminate duplicative efforts is
sometimes hindered by the insurance companies' failure to take corrective
action in all jurisdictions that are affected by an inappropriate
activity. We recognize in the report that all cases of multiple
examinations reported in response to our questionnaire may not have been
duplicative because we could not evaluate the basis on which the states
selected specific companies to examine. Among other efforts to reduce
inappropriate duplication of examinations, NAIC specifically mentions the
enhancements to the ETS that we discuss in the report and stated that as
of March 2003, 26 states had entered information on examination schedules
for 400 companies. As our report indicates, however, to be truly useful,
all states need to be using the ETS for entering information on their
scheduled and completed examinations and for checking other states'
entered information.

NAIC also reports on other efforts it is pursuing to increase the number
of collaborative examinations being held. Finally, NAIC suggests that in a
state-based system, in which different laws exist in each state to protect
consumers, the extent to which a state can rely on another state's market
conduct examinations is inherently limited. It points out that, as
government officials, state regulators cannot delegate to someone else,
even another state, the responsibility of enforcing their states' laws.
This statement is, true, however, we were told both by state regulators
and industry representatives that there are significant areas of market
regulation that are similar across the states. Moreover, state regulators
and state legislators should be working together to increase the
consistency of state consumer protections and other laws and regulations
related to market conduct of insurance companies. Thus duplication of
effort can be avoided if market analysis and examination standards and
processes are improved, adopted, and implemented across the states. We
also note that in addition to apparent duplication of market conduct
examinations for some companies, other responses to our questionnaire
indicated that other companies had infrequent market conduct examinations
or none at all. Improved consistency of laws, regulations, analysis, and
examination processes accompanied by better coordination among the states
could also allow those companies to receive better oversight.

Finally, as shown both in NAIC's comments and in our report, NAIC is
undertaking a number of initiatives intended to improve both market
analysis and market conduct examinations. The goal is worthwhile. However,
it should be noted that NAIC's activity is only the first of the steps
needed to make real improvements in market analysis and market conduct
examinations. The models developed by NAIC must then be

adopted and implemented by the states, either by regulation or by
legislation when needed.

We will send copies of this report to the Ranking Minority Member of the
House Committee on Financial Services and other interested congressional
committees. We will also send copies of this report to the Executive Vice
President of NAIC and to the 55 state and other governmental entities that
are members of NAIC and will also make copies available to other
interested parties upon request. This report will also be available at no
charge on GAO's Web site at http://www.gao.gov.

If you or your staff have any questions on this report, please contact me
on (202) 512-8678. An additional contact and other contributors are listed
in appendix VI.

Sincerely yours,

Richard J. Hillman Director, Financial Markets and Community Investment

Appendix I: Objectives, Scope, and Methodology

Our objectives were to (1) evaluate the use of market analysis and on-site
examinations in market regulation and (2) discuss the progress of the
National Association of Insurance Commissioners (NAIC) to improve and
coordinate market regulation at the state level.

To address our first objective, we visited and interviewed officials from
nine states' insurance departments-Arkansas, California, Indiana,
Maryland, Michigan, Ohio, Oregon, Missouri, and New Mexico-and from NAIC's
Kansas City headquarters. We also reviewed these states' operating
procedures for market regulation and interviewed staff from each of the
states' units responsible for the types of market regulation conducted by
the state.

To determine the use of market analysis and on-site examinations in market
regulation, we interviewed state officials responsible for these
activities. We also collected and analyzed data relating to the number of
licensed companies in each state, the number and types of examinations
conducted, and the resources allocated to these activities.

We designed and administered a questionnaire to obtain the perspectives of
life and property/casualty insurance companies on the extent and cost of
market conduct examinations. The questionnaire sought information about
the frequency and type of market conduct examinations that were completed
from January 1, 1999, through December 31, 2001. For each exam reported,
companies were asked to provide specific information about the exam,
including the state that performed the exam; exam costs and location; and
notification, fieldwork, and final report dates. The questionnaires
administered to the life and property/casualty companies were identical
with the exception of a set of items related to securities industry
examinations of life insurance companies.

We obtained the 2002 lists of the top 200 life and property/casualty
insurers from NAIC. For the purpose of this work, NAIC was deemed the most
accurate data source since insurers are required to regularly report to it
updated financial and other company-related information. Using the NAIC
rankings, a judgmental sample of 40 companies was selected. We selected a
random group of life and property/casualty companies that are licensed and
do business in all 50 states within several groups defined by size and
region. Size was measured according to total assets for life companies and
total premiums for property/casualty firms. Ten of the larger and 10 of
the smaller companies from our list of the 200 largest companies were
selected. To determine region, the companies were

Appendix I: Objectives, Scope, and Methodology

allocated across four geographical categories defined by the U.S. Census
Bureau.

The small, nonprobability sample prevents inferences to the population of
life and property/casualty insurers but still allows some documentation of
the extent of duplication among the selected firms. Because this
judgmental sample was not intended to be statistically representative of
the population of insurers, our results were not weighted to adjust for
the different probabilities of selection of each insurer we selected.

The selected insurers submitted their completed surveys through electronic
mail or facsimile. Responses were received from 25 (62 percent) of the
companies. The collection of insurer survey data began in October 2002 and
was completed in January 2003.

As a part of the survey design process, we also conducted survey pretests.
The companies selected to participate reflected the kinds of companies we
were interested in surveying, specifically in terms of company size and
the number of states in which a firm were licensed and did business. Each
pretest participant was sent a copy of the instrument and given several
days to return its completed survey to us. We instructed each participant
to route the survey to the best contact-the person most knowledgeable
about market conduct exams at the company. We also scheduled time to
discuss with each company contact the basis of the company's response to
each survey item.

To determine the effectiveness of NAIC's efforts to improve the market
regulation program, we interviewed officials from NAIC, attended its
national meetings to identify current market regulation issues, reviewed
its past market regulation issues, and reviewed its past and current
initiatives to improve the market regulation program.

Appendix II: Market Conduct Exams Completed in 2001

Combined financial and market conduct exams Market conduct exams only

                    Page 32 GAO-03-433 Insurance Regulation
                                                  Total                                   American                                                                                                                                                   District                                                                                                                                                                                                                                                                                                                                                                                                                                            New                 New                                
State/territory Routine Targeted Routine Targeted exams Alabama 10 5 0 2  Alaska 0 0 0 0   Samoa   N/A N/A N/A N/A N/A Arizona 0 0 0 131  Arkansas 16 2 0 0  California 0 0 N/A N/A 148a Colorado 0 0 0 24  Connecticut 0 0 39 2  Delaware 27 0 0 3     of    0 0 0 0  Florida 0 0 10 86  Georgia 0 0 17 8  Guam N/A N/A N/A N/A N/A Hawaii 0 0 3 0  Idaho 6 0 0 1  Illinois 0 0 8 19  Indiana 0 0 0 3 3 Iowa 9 0 24 0 33 Kansas 0 0 1 0 1 Kentucky 0 0 8 2 10 Louisiana 30 1 2 30 63 Maine 0 0 0 2 2 Maryland 0 0 10 42 52 Massachusetts 0 0 0 61 61 Michigan 34 2 0 0 36 Minnesota 4 0 0 0 4 Mississippi 13 1 0 4 18 Missouri 0 0 41 7 48 Montana 0 0 0 0 0 Nebraska 0 0 10 23 33 Nevada 2 0 9 8 19 Hampshire 0 0 0 12 12 Jersey 0 0 10 1 11  New           
                                                                                                                                                                                                                                                     Columbia                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  Mexico 6 0 0 2 8

Appendix II: Market Conduct Exams Completed in 2001

Combined financial and market conduct exams Market conduct exams only

      State/territory      Routine  Targeted  Routine  Targeted   Total exams 
         New York               62     1             4        92 
      North Carolina             0     0            22        17 
       North Dakota              0     0             1         1 
           Ohio                  0     0             0        38 
         Oklahoma               17     2             9         9 
          Oregon                 0     0            11         4 
       Pennsylvania              0     0            21         1 
        Puerto Rico            N/A    N/A          N/A       N/A          N/A 
       Rhode Island              0     0             6         0 
      South Carolina             7     1             1         8 
       South Dakota              0     0             0         3 
         Tennessee              26     0             0         0 
           Texas               142     2             0         5 
    U.S. Virgin Islands        N/A    N/A          N/A       N/A          N/A 
           Utah                  5     0             2         5 
          Vermont                0     0             3         1 

                          Virginia 0                         0  19  39     58 
                         Washington 0                        0   5   9     14 
                        West Virginia 3                      0   0   0      3 
                          Wisconsin 0                        2   0  14     16 
                           Wyoming 1                         0   0   0      1 
                           Total 420                         19 296 719 1,454 
Source: NAIC 2001 Insurance Department Resources Report,             
                       tables 22 and 23.                                

Legend: N/A - Not available

Note: The number of exams may not equal the totals in table 1. The data in
table 1 were obtained directly from the states and have not been
reconciled with data reported by the states to NAIC.

aNAIC reported that the breakout of the 148 market conduct exams completed
in California in 2001 was not available.

Appendix III: Number of Licensed Insurers and Total Market Conduct Examinations
in 2001

                    Page 34 GAO-03-433 Insurance Regulation
 Licensed Licensed  Total     Total                                                                                                       American                                                                                                                                                                           District                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             New                   New                       New                                           
 domestic foreign  licensed  market State/territory insurers insurers insurers examinations Alabama 53 1,277 1,330  Alaska 8 1,063 1,071   Samoa   0 22 22 N/A Arizona 398 1,525 1,923  Arkansas 74 1,464 1,538  California 219 1,210 1,429  Colorado 74 1,410 1,484  Connecticut 132 1,055 1,187  Delaware 144 1,426 1,570     of    23 1,347 1,370  Florida 201 1,612 1,813  Georgia 106 1,473 1,579  Guam 5 151 156 N/A Hawaii 117 926 1,043  Idaho 23 1,426 1,449  Illinois 446 1,469 1,915  Indiana 183 1,598 1,781  Iowa 220 1,403 1,623 33 Kansas 57 1,642 1,699 1 Kentucky 52 1,504 1,556 10 Louisiana 147 1,485 1,632 64 Maine 33 925 958 2 Maryland 96 1,392 1,488 52 Massachusetts 94 1,273 1,367 61 Michigan 142 1,383 1,525 36 Minnesota 94 1,438 1,532 4 Mississippi 70 1,428 1,498 18 Missouri 247 1,411 1,658 48 Montana 28 1,407 1,435 0 Nebraska 113 1,440 1,553 33 Nevada 39 1,704 1,743 19 Hampshire 49 859 908 12 Jersey 101 1,165 1,266 11 Mexico 19 1,476 1,495 8 New                
                            conduct                                                                                                                                                                                                                                                                                          Columbia                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    York 505 927 1,432 159

Appendix III: Number of Licensed Insurers and Total Market Conduct Examinations
                                    in 2001

                         Licensed     Licensed      Total        Total market 
                         domestic     foreign     licensed            conduct 
     State/territory       insurers     insurers    insurers     examinations 
     North Carolina              97        1,243       1,340               39 
      North Dakota               42        1,378       1,420 
          Ohio                  275        1,505       1,780 
        Oklahoma                104        1,480       1,584 
         Oregon                 139        1,486       1,625 
      Pennsylvania              313        1,404       1,717 
       Puerto Rico               38          275         313              N/A 
      Rhode Island               33        1,210       1,243 
     South Carolina              50        1,424       1,474 
      South Dakota               52        1,403       1,455 
        Tennessee               111        1,559       1,670 
          Texas                 512        1,529       2,041 
U.S. Virgin Islands            2          195         197              N/A 
          Utah                   45        1,423       1,468 
         Vermont                410          937       1,345 
        Virginia                 82        1,407       1,489 
       Washington                69        1,336       1,405 

West Virginia 20 1,304 1,324 3 Wisconsin 355 1,536 1,891 16 Wyoming 4
1,304 1,308 1 Total 7,065 --1,454

Source: NAIC 2001 Insurance Department Resources Report, tables 17, 22,
and 23.

Legend: N/A - Not available

Notes: Includes combination financial/market conduct exams and market
conduct exams only (see app. II). The number of exams and insurers may not
equal the totals in table 1. The data in table 1 were obtained directly
from the states and have not been reconciled with data reported by the
states to NAIC.

Appendix IV: Number of Market Conduct Examiners and Total Licensed Insurers in
2001

                    Page 36 GAO-03-433 Insurance Regulation
 Total     Total                                                                                                                                                                                            District                                                                                                                                                                                                                                                                                                                                                                                                                            
 number   number State/territory   conduct insurers Alabama 2 1,330 Alaska 3 1,071 American N/A  Arizona 0 1,923 Arkansas 2 1,538 California 29 1,429 Colorado 8 1,484 Connecticut 7 1,187 Delaware 0 1,570       of 3 1,370 Florida 14 1,813 Georgia 1 1,579 Guam N/A  Hawaii 0 1,043 Idaho 0 1,449 Illinois 19 1,915 Indiana 1 1,781 Iowa 4 1,623 Kansas 2 1,699 Kentucky 0 1,556 Louisiana 3 1,632 Maine 2 958 Maryland 10 1,488 Massachusetts 4 1,367 Michigan 0 1,525 Minnesota 0 1,532 Mississippi 0 1,498 Missouri 33 1,658 Montana 0 1,435 Nebraska 5 1,553 Nevada 1 1,743       New 3 908    New 15 1,266    New 0 1,495         
of         of                 examiners                                            Samoa                                                                                                                 Columbia                                                                                                                                                                                                                                                                                                                                                               Hampshire       Jersey          Mexico          New    
 market licensed                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  York 92 1,432

Appendix IV: Number of Market Conduct Examiners and Total Licensed
Insurers in 2001

Total 353 -Source: NAIC 2001 Insurance Department Resources Report, tables
                                   3 and 17.
  Total    Total                                                                                                                                                                                                                                          U.S.                                                                           
 number   number State/territory   conduct insurers    North 11 1,340  North 1 1,420 Ohio 12 1,780 Oklahoma 0 1,584 Oregon 3 1,625 Pennsylvania 11 1,717 Puerto N/A 313  Rhode 4 1,243    South 3 1,474  South 0 1,455 Tennessee 0 1,670 Texas 5 2,041  Virgin N/A 197 Utah 7 1,468 Vermont 1 1,347 Virginia 18 1,489            5 
     of       of                 examiners          Carolina          Dakota                                                                               Rico         Island         Carolina         Dakota                                         Islands                                                                     
 market licensed                                                                                                                                                                                                                                                                                                      Washington   1,405

West Virginia 2 1,324

Wisconsin 7 1,891

Wyoming 0 1,308

Legend: N/A - Not available

Notes: Full-time equivalent staffing. Includes domestic and foreign
insurers. The number of market conduct examiners and insurers may not
equal the totals in table 1. The data in table 1 were obtained from the
states and have not been reconciled with data reported by the states to
NAIC.

Note: GAO comments supplementing those in the report text appear at the
end of this appendix.

                    Page 38 GAO-03-433 Insurance Regulation

                    Page 39 GAO-03-433 Insurance Regulation

                    Page 40 GAO-03-433 Insurance Regulation

                    Page 41 GAO-03-433 Insurance Regulation

                    Page 42 GAO-03-433 Insurance Regulation

                                 See comment 1.

                    Page 43 GAO-03-433 Insurance Regulation

                                 See comment 2.

                                 See comment 3.

                    Page 44 GAO-03-433 Insurance Regulation

                                 See comment 4.

                                 See comment 5.

                                 See comment 6.

                    Page 45 GAO-03-433 Insurance Regulation

 Appendix V: Comments from the National Association of Insurance Commissioners

  GAO Comments

The following are GAO's comments on NAIC's letter dated September 9, 2003.

1. 	We recognize NAIC's role in providing data services to the states and
we have acknowledged and discussed the databases mentioned by NAIC in
previous reports.1 However, a discussion of all the databases mentioned by
NAIC would have been outside the scope of this report, which was directly
concerned with the existing market conduct analysis and examination
practices of the states.

2. 	The report states, "there are no generally accepted criteria for
determining which companies to examine"(page 3). We believe this to be a
true statement. Each of the state insurance departments that we visited
had its own criteria for determining when to do an examination and they
often varied substantially from state to state. While NAIC provided a list
of 14 factors from the Market Conduct Examiners Handbook that states may
consider when prioritizing companies for examinations, these factors do
not, in our opinion, constitute "generally accepted criteria." A criterion
that was generally accepted would be always or usually applied
consistently and predictably. We did not find this to be true in our
review of states' practices.

3. 	We modified the report to more clearly state PricewaterhouseCoopers'
finding that "market conduct examiners sometimes tend to look for isolated
mistakes and errors..." (Emphasis added) (page 13). We also added a
footnote noting the guidance provided in the Market Conduct Examiners
Handbook on looking for general business practices when conducting an
examination.

4. 	A note was added to table 1 which more clearly explaining that we have
classified desk audits and other off-site reviews of company files as part
of market analysis rather than as market conduct examinations, even though
we recognize their importance to many states, including Ohio.

5. On page 18 we added to the report the language suggested by NAIC.

1U.S. General Accounting Office, Insurance Regulation: Scandal Highlights
Need for Strengthened Regulatory Oversight, GAO/GGD-00-198 (Washington
D.C.: Sept 19, 2000), Financial Services Regulators: Better Information
Sharing Could Reduce Fraud, GAO-01-478T (Washington D.C.: Mar. 6, 2001),
and Regulatory Initiatives of the National Association of Insurance
Commissioners, GAO-01-885R (Washington D.C.: July 6, 2001).

 Appendix V: Comments from the National Association of Insurance Commissioners

6. 	We added NAIC's reference from the introduction of the Market Conduct
Examiners Handbook to the report in its entirety (see page 20).

Appendix VI: GAO Contacts and Staff Acknowledgments

  GAO Contacts Acknowledgments

(250050)

Richard J. Hillman, (202) 512-8678 Lawrence D. Cluff, (202) 512-8678

In addition to the persons named above, contributors to this report were
Monty Kincaid, Thomas H. Givens, Carl Ramirez, Kevin Jackson, Bonita
Vines, and Emily R. Chalmers.

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