By Thomas E. Hampton, Senior Advisor, SNR Denton, 202-408-6401, firstname.lastname@example.org
As the United States economy slowly recovers from the 2008 recession, the focus of Capitol Hill has turned to the Wall Street financial institutions, many of whom needed Washington to provide them capital for their excessive risk taking. Both chambers of Congress are developing financial services regulatory reform legislation to address this issue. The House has completed H.R. 4173, the "Wall Street Reform and Consumer Protection Act of 2009," and the Senate is currently working on its version of financial regulatory reform. As the pertinent bills work their way through the legislative process, the financial services industry and its regulators have been monitoring the effect these proposed changes may have on business. As stated by Senate Committee on Banking, Housing and Urban Affairs Chairman Christopher Dodd (D-Conn.), "We must restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them."1 The analysis of this economic crisis revealed that some financial services entities were under-regulated, and some financial services products may not have been regulated at all. The intent of both the Senate and House versions of the bill is to establish regulatory tools that will reduce - or possibly eliminate - the risk of a similar economic crisis from occurring in the future.
Insurance regulators emphasized that none of the regulatory problems that ignited this economic crisis occurred with companies under state regulatory authority. Unlike the banking and securities sectors, the insurance industry is the only one regulated primarily by the states. The mantra expressed by NAIC Chief Executive Officer Therese M. Vaughn, Ph.D., is "State regulation's strong solvency system and consumer protections have served consumers well, as evidenced by the relative stability in the insurance markets. [Insurance regulators] advocate for insurance consumers and objectively regulate the U.S. insurance market, relying upon the strength of local, accountable oversight and national collaboration."2
However, with insurance companies headquartered in the United States operating nationally and internationally, the focal point in the future will be less on the consumer protections provided to local constituents by the current state insurance regulatory system, but rather on the ability to answer the question: "What is this the most appropriate system of regulation for domestic entities that operate on a national and international basis going forward?"
State Based Regulatory System Attempts to Operate Nationally
The primary responsibility of state insurance regulation is to protect the interest of insurance consumers through the administration and enforcement of laws. Since 1871, the NAIC has been a forum used by state insurance regulators to discuss issues affecting insurance regulation. The current membership of the NAIC includes regulators from all 50 states, the District of Columbia, and the five U.S. territories. At the NAIC, regulators develop best-practice statements as well as create model laws and regulations for promulgation by its member jurisdictions. The NAIC also provides a forum for the development of uniform regulatory policy when uniformity makes regulation more effective and efficient for consumers.
One of the best examples of this uniformity was the creation of the Statutory Accounting Principles (SAP) format, in which insurance accounting is based. SAP is a more conservative accounting valuation method than Generally Accepted Accounting Principles (GAAP), which is used by companies in other industries. This conservatism provides an additional layer of capital that can be used to pay policyholder obligations when a company is placed in liquidation. The required uniform enactment of accounting principles and other financial regulatory standards was included as a part of the NAIC Financial Accreditation program.
Other regulatory requirements being discussed at the NAIC - from licensing standards to market conduct regulation - do not have the threat of accreditation, making it hard to accomplish uniformity (or substantially similar legislation), even when uniformity will ultimately benefit the American consumer. The movement for uniformity of producer licensing requirements, surplus lines, reinsurance - as well as the implementation of an interstate compact for the approval of life insurance products - has not been adopted by all states. As a result, in response to the daunting challenge of getting all its member states to enact the surplus lines and reinsurance model laws, the NAIC supported the Non-Admitted and Reinsurance Reform Act introduced by Congress.3
Creation of an International Insurance Regulatory Association
As more insurance companies operate on a national and international level, the need for consistent regulation in the United States and abroad has become more apparent. In the United States, more than 50,000 different insurance laws and over 12,000 different regulations exist. Yet the complexity of complying with insurance regulation in the United States does not begin to compare with the range of international insurance regulatory requirements. With most of the emerging insurance markets located overseas, U.S. insurance regulators understand that the capital and resources of its large domestic insurance companies are migrating to foreign countries.
In an effort to establish a dialogue with international insurance regulators, the NAIC supported the establishment of the International Association of Insurance Supervisors (IAIS). State insurance regulators believe that the need for an international insurance regulator association was so great and important to the mission of consumer protection that IAIS was originally housed in the NAIC Washington, D.C., offices, until it was relocated to its current office in Basel, Switzerland.
Established in 1994, IAIS currently represents insurance regulators and supervisors in approximately 190 jurisdictions in nearly 140 countries, constituting 97 percent of the world's insurance premiums. In addition, the association has more than 120 observers. In the introduction section of the IAIS paper on Supervision of International Insurers and Insurance Groups, it states that "The overall objective of insurance supervision is to maintain efficient, fair, safe and stable insurance markets for the benefit and protection of policyholders."4 This objective is relatively similar to the regulatory goals of the NAIC.
The primary difference between the two associations is how insurance regulatory schemes are developed. IAIS develops papers detailing the principles, standards, and guidance that insurance regulators should adopt for the supervision of international active insurance companies.5 The NAIC primarily uses the model law process to recommend the most efficient regulatory scheme for its member jurisdictions.
The quandary is that members of the NAIC, who represent the United States on several IAIS committees (including the technical and reinsurance committees), have no authority to bind the jurisdiction they represent or the United States on any of the agreed upon final IAIS position papers, even if they recommended its adoption. An example of this problem concerns the position paper on reinsurance supervision. Specifically, an insurance commissioner from the United States performed an excellent job chairing the reinsurance committee at the IAIS and the Reinsurance Task Force at the NAIC, and that commissioner developed a regulatory scheme for reinsurers that was approved by the appropriate members. At the IAIS, the assumption is that when an IAIS member is involved in the development of a position paper and this position is approved by the membership, that member is representing their particular country and that country's legislature would support the enactment of the final position paper. After many years of NAIC meetings and conference calls, the reinsurance regulatory proposal was adopted as a Model Law and its members recommended enactment of a state-based reinsurance regulatory scheme similar to the IAIS position paper on reinsurance. However, it was determined by the NAIC that although this model law was in the best interest of consumers and companies, the most expeditious way to enact this bill in an uniformed basis would be through federal legislation rather than by state legislatures.
Establishment of Federal Insurance Office (FIO)
One of the provisions in both versions of the financial services regulatory reform legislation relating to insurance companies is the establishment of an FIO. The House version of the Financial Services Regulatory Reform Act (known as H.R. 4173, the "Wall Street Reform and Consumer Protection Act of 2009") would establish an FIO in the Department of the Treasury to address a number of the above concerns.
Pursuant to H.R. 4173, some of the functions and authority of the FIO would be to perform the following:
(1) Monitor the insurance industry to gain expertise;
(2) Identify issues or gaps in the regulation of insurers that could contribute to a systemic crisis;
(3) Recommend to the Financial Services Oversight Council that it designate an insurer, including its affiliates, as an entity subject to stricter standards; and
(4) Coordinate federal efforts and develop federal policy on prudential aspects of international insurance maters, including representing the United States, as appropriate, in IAIS.6
Hence, this bill, as currently worded, would establish a mechanism to develop stricter standards for insurance companies that are determined to be systemically risky and would alleviate the inherent contradictions currently being experienced when state insurance regulators participate in international insurance regulatory forums such as the IAIS.
The government bailout of Wall Street financial institutions has made the need for stricter regulatory standards and increased capital requirements prudent. Sen. Dodd is working to develop a bipartisan financial services regulatory bill that will likely be discussed in the Senate this spring. With the political climate in Washington exacerbated by the election of Scott Brown (R-Mass.), the Senate's financial regulatory reform bill, if passed, will most likely differ from H.R. 4173 and require House-Senate negotiations before a final compromise bill is presented to the president to sign into law. It should be noted, however, that the spotlight of these Senate discussions has not been on the FIO proposal, which has received bipartisan support. If the current FIO proposal remains in the bill and is enacted into law, these FIO provisions can provide a framework for insurance companies operating on an international basis to work with the Department of Treasury to harmonize a regulatory system throughout the United States.
Since this insurance supervisory system will be developed at the federal government level, the focal point of national and international insurance companies could shift from the NAIC, as the regulatory incubator, to the IAIS. Therefore, the final deliberations of this financial services regulatory reform bill and its potential implementation into law are something everyone in the insurance industry should be monitoring closely.
__________________________________1 U.S. Senate Committee on Banking, Housing and Urban Affairs, "Restoring American Financial Stability Act" Summary Committee Print (Washington, D.C.; November 19, 2009), 1. 2 NAIC News Release, "NAIC Praises Preservation of State Regulation Under Obama Administration's Plan, (June 17, 2009). 3 The NAIC has modified its support of this Act until Congress incorporates the latest version of the NAIC Reinsurance Regulatory Modernization Act of 2009. 4 International Association of Insurance Supervisors, Technical Committee, "Principles Applicable to the Supervision of International Insurers and Insurance Groups and their Cross-Border Business Operations," Approved December 8, 1999, page 3. 5 In 2008, the NAIC established the Solvency Modernization Initiative Task Force, which has the charge of reviewing the issue papers developed by the IAIS. 6 "Financial Stability Improvement Act, Title VI, Section 8002, (c)(1). __________________________________
Thomas E. Hampton previously served as Commissioner of the D.C. Department of Insurance Securities and Banking from 2005 to 2009 and as Deputy Commissioner from 2000 to 2005.