By Karl L. Rubinstein1
Title V of the new Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) is named the “Federal Insurance Office Act of 2010.” Several provisions of Title V---foreshadow massive federal intrusion into the insurance industry and a likely federal takeover.
Historically, insurance regulation is accomplished by individual states pursuant to their police power. But in South-Eastern Underwriters Association, 322 U.S. 533 (1944), the U.S. Supreme Court applied the anti-trust provisions of the Sherman Act to insurance, ruling that the Commerce Clause trumped states rights as to interstate commerce. An industry backlash resulted in Congressional passage of the McCarran-Ferguson Act that placed most regulation back with the states. Over ensuing decades, McCarran-Ferguson has been interpreted to permit ever increasing Federal intervention. Now, Title V threatens to swallow it all.
The legislation is too massive to be discussed in a single article. Because the law applies to large non-bank financial companies as well as large banks and bank holding companies, many of its provisions impact insurance. This article will focus upon key provisions of Title V and its new creation: The Federal Insurance Office.
Powers of the Federal Insurance Office:
Title V2, Section 313 creates, within the Treasury Department, the Federal Insurance Office (“FIO”) which, among other things, has the authority to:
... monitor all aspects of the insurance industry, including identifying issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or the United States financial system; to recommend to the Financial Stability Oversight Council that it designate an insurer, including the affiliates of such insurer, as an entity subject to regulation as a nonbank financial company supervised by the Board of Governors pursuant to title I of the Restoring American Financial Stability Act of 2010...
While the word, “monitor” is used, a close study reveals “control” is what’s created. The authority of the FIO to “monitor” extends to all lines of insurance except health, long-term care, and crop insurance, all of which are covered under other federal laws. The power of the FIO to “recommend” that the Financial Stability Oversight Counsel3 designate an insurer and its affiliates as subject to regulation as a non bank financial company under the supervision of the Board of Governors of the Federal Reserve permits preemption of state regulation and, among other things, allows federal authorities to take over insurance insolvencies.
In a bit of Orwellian “newspeak” that’s typical of this legislation, Section 313 (k) is titled “Retention of Existing State Regulatory Authority.” But the actual provision states:
Nothing in this section or section 314 shall be construed to establish or provide the Office or the Department of the Treasury with general supervisory or regulatory authority over the business of insurance. (underlining added).
The phrase general supervisory or regulatory authority is misleading because many provisions of the law provide for specific preemption. Three such areas relate to insurer insolvencies, international agreements, premium tax, reinsurance credits, and surplus lines insurance.
Among several other provisions in the legislation giving lip service to the notion the states will continue to handle insurance regulation is Sec. 203 (e) (1) of Title I which states insurance company liquidations will be handled under state law. But this general statement is subject to the exception set out in Sec. 203 (e) (3) that gives “Backup Authority” to the federal government whereby the FDIC may itself file an insolvency action in state court if “the appropriate regulatory agency has not filed the appropriate judicial action in the appropriate State court to place such company into orderly liquidation under the laws and requirements of the State.” In this event, the FDIC may file liquidation proceedings in the state court, thereby shoving aside state insurance regulators, many of them duly elected state officers. In these cases, state law is preempted and a systemic inconsistency is created. What does the state insurance commissioner or equivalent do while the FIO runs the insolvency?
State Law Preempted by International Agreements:
Under Title V, Section 313 (c) (E) and (f) the FIO may decide state law is preempted by international agreements relating to “prudential measures.” These “prudential measures” would relate to risk-based capital, liquidity requirements, leverage, concentration, and so on. See, for example, Sec. 115 (b) (1) of Title I for a list of such measures. The statutory language is broad enough to become a dragnet.
Not only may the FIO preempt state insurance laws by international agreements relating to “prudential matters,” it can, under Section 313 (f) and (k), preempt if a non-U.S. insurer is receiving “less favorable,” treatment than a U.S. carrier domiciled or admitted in a particular state. Of course, the question of what’s “less favorable” or what’s “prudential” might vary from regulator to regulator, or federal employee to federal employee. What if, for instance, the particular state’s mandates for reserves and admitted assets are more stringent than the non U.S. carrier’s? Is that less favorable treatment? Language in the statute indicates disputes over such issues might be determined under federal administrative procedure. If not, then they’ll be decided in federal court.
Under Section 314, the Secretary of the Treasury is permitted to enter into new international agreements on “prudential matters.” Under this power, the Secretary could enter into sweeping treaties preempting state law. Officials usually use the powers at their disposal and one must assume this provision would not be in the law unless the Secretary and/or Congress had something in mind.
The legislation has many other references to international agreements and foreign law. One gets a flavor of internationalization which might signal more control of state laws through international treaties. This could lead to constitutional law clash over whether the federal government can, through its treaty powers, preempt state police power. This is no idle issue these days when the Tenth Amendment--designed to limit the federal government to its enumerated powers and leave all other powers with the once sovereign states—is under attack. Current litigation between various states and the federal government over federal health care laws and immigration laws are examples of concerted federal efforts to use the commerce and external affairs clauses to increase its “enumerated” powers.
Preemption of State Premium Tax, Reinsurance Credits, and Surplus Lines Laws:
Subtitle B, of Title V is tagged, “State Based Insurance Reform.” Section 521 mandates that only the home state may tax non-admitted carriers’ premiums. The states are given the chance to come up with a compact to allocate these premiums among themselves. A report on this compact may then be submitted to Congress. Nothing says Congress has to accept the system or that it won’t be preempted. In fact, Section 521 (b) (4), which is titled “Nationwide System,” states:
The Congress intends that each State adopt nationwide uniform requirements, forms, and procedures, such as an interstate compact, that provides for the reporting, payment, collection, and allocation of premium taxes for nonadmitted insurance consistent with this section.
The ensuing sections of the statute set other requirements relating to surplus lines and non-admitted carriers. Section 531 (a) requires states to give credit for reinsurance if the ceding insurer’s home state does so. Section 531(b) preempts state laws that (1) restrict arbitration clauses, (2) require a certain state’s law to govern the reinsurance contract, (3) attempt to enforce a reinsurance contract on terms different than those set forth in the contract, or (4) otherwise apply the state laws to reinsurance agreements of ceding insurers not domiciled in that state.
In other words, the regulators are to be controlled by the contracts of the regulated entities even if the contracts violate state law. And now the states cannot apply state laws to non-domiciled reinsurers even if they are doing business in that state either directly or through “long arm” rules.
There are other provisions with similar impact on state laws and which expand the non-admitted insurance business. One assumes this reflects a congressional intent to open up insurance markets across state lines, but surely this is dangerous territory that nullifies individual states’ opportunity to protect its citizens from the loose regulation of another state or by the terms of contracts concocted by the regulated entities.
These provisions are a predatory application of the commerce clause. They place burdens on state law through the acts of companies attempting to enter into the state’s market, a market the state is entitled to protect through its police powers. The federal government seeks to create interstate commerce by requiring the states to accept non-admitted carriers into their markets upon terms dictated by the federal government.
FIO’s Rights to Documents and Information from Industry:
Under Section 313 (e) the FIO has vast authority to “require an insurer, or any affiliate of an insurer, to submit such data or information that the FIO may “reasonably require in carrying out [its] functions.” The FIO may issue subpoenas to enforce these powers. Insurers or affiliates (and officers and employees) may be held in contempt by a federal district court if they fail to comply. The law does provide that the data will be kept confidential and that legal privileges will not be altered. But how effective will these protections be?
Consultation with State Regulators:
There are scattered provisions requiring the FIO to coordinate, inform, or consult with state insurance regulators. But these are also examples of “newspeak” because the whip remains in the FIO’s hands since it’s not required to accept advice from the state regulators.
The Handwriting on the Wall:
I apologize for the length of the following quotation of Section 313 (m) of the law, but it’s key:
Not later than 18 months [from the date of the act] the Director shall...submit a report to Congress on how to modernize and improve the system of insurance regulation [focusing on] Consumer protection for insurance products and practices, including gaps in state regulation....The degree of national uniformity...regulation of insurance companies and affiliates on a consolidated basis...International coordination...costs and benefits of potential Federal regulation of insurance across various lines of insurance (except health insurance).The feasibility of regulating only certain lines of insurance at the Federal level...The ability of any potential Federal regulation...to eliminate or minimize regulatory arbitrage....[and] to provide robust consumer protection...The potential consequences of subjecting insurance companies to a Federal resolution authority, including the effects of any Federal resolution authority on the operation of State insurance guaranty fund systems...on the international competitiveness of insurance companies...Such other factors as the Director determines necessary or appropriate...(underlining added).
Language never simply falls into a statute. Most litigators would recognize these provisions as likely designed to support a later complete take-over by the federal government through its right to control interstate commerce and external (international) affairs. One predicts the study, funded by taxpayers, will find that there are gaps in state regulation, that state laws are not sufficiently uniform, that insurers and affiliates need to be regulated on a consolidated basis. Further, it will probably find it’s not feasible to have federal regulation over only some lines of insurance and, health insurance now being controlled by the feds, then find it’s only logical to take it all over. Under the general mandate that the Director may consider “other factors,” one suspects he or she will find numerous other reasons that state regulation is no longer sensible.
My concern is not per se the idea of federal regulation. One supposes that, in broad theory, federal regulation could work. But as we pass from broad theory to real life, it’s easy to see this new federal intrusion as ham-handed in its half-in and half-out approach which disrupts current systems and doesn’t replace them with a coherent alternate. Moreover, there are serious constitutional law issues raised by the efforts to use the commerce clause and treaty powers to swallow up states rights.
Then there’s the historic ineptitude of federal regulation. The horrible financial crisis from which we have yet to recover was brought to us largely through federal policies that extend over several administrations. You have to ask: where were the SEC, the Treasury, and the other federal agencies during the run-up to the crash? Who was asleep at the switch as exotic investments filled portfolios with hot air, when sub-prime mortgages inflicted toxicity upon the economy, when Madoff did his thing, and...you name it? These are the agencies now moving their dubious skills (and their once-touted theory that financial markets will regulate themselves) farther into insurance regulation.
The state regulatory system is far from perfect, but anybody that thinks a newly created federal system—or a half-fed/half-state system--won’t have lapses, gaps, and inadequacies is kidding themselves. The “cure” may well become the disease.
1 Mr. Rubinstein was chief outside council for insurance commissioners in several of the largest U.S. insurance insolvencies. He also acted as special deputy insurance commissioner and special insurance examiner for several insurance departments. See www.karlrubinstein.com for more detail.
2 Title V is an amendment to Subchapter I of 18 chapter, 3 of subtitle I of title 31, United States Code. Hence the 300 series section numbers cited herein.
3 The Oversight Council is a new creation composed of the Treasury Secretary, The Comptroller of Currency, the Chair of the Commodity Futures Trading Commission, the Director of FHA, the Board of Commissioners of the FED, and one “independent” person. It also has several non-voting members.