Dodd-Frank's Impact - Federal Insurance Office and State Regulation: Bridges to Nowhere or Building a Bridge?

   By Carrie E. Cope, Shareholder, Schuyler Roche & Crisham, P.C.

            At one point or another, the availability of insurance has a substantial, and sometimes dramatic, impact on our lives. At the consumer level, it can mean the affordability of life-saving surgery or the accessibility of a home mortgage. In the business world, the availability of affordable insurance can similarly significantly affect business owners as certain types of insurance policies are an essential part of risk management. What large or midsize employer today would operate willingly without employment practices liability insurance? Consequently, how insurance is regulated, and who regulates it, impacts us on many levels.

            For insurers, developments impacting the operation and structure of regulation are, of course, pivotal. A regulator’s decision to disapprove a rate increase needed by an insurer, or a long delay in making a decision to approve a license or a rate or form filing in a geographic location that is critical to the insurer’s business plan, can significantly impact an insurer’s ability to do business and may impact whether the insurer is able to compete effectively in the market. Loss of market share can mean less resources for the development of new products which, in many lines, keeps the wheels of the insurance marketplace turning. In some instances, an insurer’s inability to sell or update its products or rates may eventually seriously impair the company’s ability to move forward at all. Given the important role insurance plays in both our personal lives and the business community, it is not surprising that the nature and scope of insurance regulation has been the center of a sometimes hotly contested debate for years.

            After the first insurance regulator, the New Hampshire Insurance Department, was created in 1851, it did not take too much time, relatively speaking, before the first turf battles began over whether the federal or state governments were in a better position to protect consumers without impeding the ability of insurance companies to do business. The battle has, over the years, waged on with varying levels of interest and intensity. After the Supreme Court held that the transaction of insurance involved interstate commerce in 1944, making it subject to federal regulation, insurers and State regulators fought hard to have Congress overturn that decision. Congress did so with the passage of the McCarran-Ferguson Act of 1945 which gave the states the authority to regulate the “business of insurance” without interference from federal regulation, unless federal law specifically provides otherwise.

            Over the years, often in response to pressure from the industry, the states have taken some steps toward “modernizing” insurance regulation, such as implementing measures for national uniformity of producer licensing, but critics of the state regulatory system have remained vocal. A number of bills have been introduced proposing a variety of changes to the current system including a federal charter option. However, until now, none have become law. Consequently, although the provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Act”) are not the primary focus of the Act, the introduction, and nature, of the insurance reforms set forth in the Act, regardless of their ultimate impact on the industry, appear to be a significant development in the history of insurance regulation.

            The Act gives the federal government what should be a pivotal role in the regulatory arena by establishing a Federal Insurance Office (“Office”) within the Department of Treasury and giving it some tall tasks which include studying and reporting on how to modernize and improve the system of insurance regulation in the United States. What the law does is put the federal government in a better position to shape the future of the insurance industry. Among the factors the new Director of the Office must consider are some that suggest what the future might hold for insurance regulation. As any good lawyer knows, how a question is phrased can often suggest the desired answer. The Act mandates that the Director consider the ability of any federal regulation or a federal regulator to “provide robust consumer protection for policyholders” as well as “the potential consequences of subjecting insurers to a federal resolution authority.” (Does it seem ironic to anyone else that the law has established a federal entity that is tasked with determining the need for an entity such as itself?) The Act also gives the Office the authority to coordinate federal efforts and develop federal policy on “prudential aspects of international insurance matters” and assist the Secretary of Treasury in negotiating “covered agreements” pertaining to insurance or reinsurance between the United States and one or more foreign governments, authorities or regulatory entities.

            Not surprisingly, as one of the primary purposes of the Office is to evaluate the current regulatory system, the Act places substantial constraints on the scope of the Federal government’s authority by declaring that neither the Office nor the Department of Treasury shall have supervisory or regulatory authority over the “business of insurance”. The Act specifically states that it does not preempt, among other things, any State insurance measure that governs an insurer’s rates, premiums, underwriting or sales practices or State coverage requirements for insurance. Capital and solvency requirements are similarly not preempted except to the extent that a State insurance measure results in less favorable treatment of a non-United States insurer than a United States insurer.  Nonetheless, the Office is not powerless as it has the authority to recommend to the Financial Stability Oversight Council (established by Section 111 of the Act), that it designate an insurer, including its affiliates, as an entity subject to regulation as a nonbank financial company supervised by the Board of Governors. The Office also has the power, through subpoena if necessary, to gather information (that is not available from another state or federal regulator or other publicly available sources), from insurers and issue reports regarding all lines of insurance except health insurance.

            Among other things, the Act also provides that no state, other than the insured’s home state, may require any premium tax payment for nonadmitted insurance. This is considered long overdue by insurers. The states may enter into a compact or establish other procedures to allocate premium taxes paid to an insured’s home state. The Act further addresses the regulation of credit for reinsurance and reinsurance agreements.

            While some parts of the current regulatory structure work well, as a result of the passage of time, as well as dramatic advances in technology and the globalization of financial markets, there is no question that other parts of the regulatory system need to be replaced or substantially renovated. The question is whether the provisions in the Act addressing insurance provide enough of a bridge between the status quo and the needs of an increasingly global marketplace, and between the state and federal governments, to ensure the effective operation of the insurance industry. The bridge may lead us to solid ground or, as the saying goes, nowhere.

Carrie E. Cope is a shareholder in the law firm of Schuyler Roche & Crisham, P.C. She is the head of the firm's regulatory and management liability insurance practice groups. She is the co-author of Directors' and Officers' (D&O) Liability: Exposures, Risk Management and Insurance Coverage as well as several Appleman's chapters on regulation and insurance law. Ms. Cope is also the author of the forthcoming Directors’ and Officers’ Liability Insurance Chapter in the second edition of New Appleman Law of Liability Insurance. She is also the author of New Appleman Insurance Law Practice Guide,  Ch. 37, Understanding Directors’ & Officers’ Insurance, New Appleman on Insurance Library Edition, Ch. 10, Regulation of Policy Forms.

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