The insurance business is regulated primarily by the states.1Legislative proposals currently under consideration by the Administration and Congress, however, may effect changes to the landscape of insurance regulation. Current federal insurance-related initiatives generally fall into three categories: (1) initiatives directed at financial services entities in general that may affect the insurance industry (such as those aimed at monitoring and responding to systemic risk2and improving information-sharing and coordination among regulators); (2) initiatives aimed at providing federal regulation for the insurance industry (ranging from the establishment of an optional federal charter for national insurance companies and producers to total federal preemption of the state-based insurance regulatory system); and (3) initiatives focused on particular, discrete insurance issues. Significant federal proposals are discussed below.3
Federal Initiatives To Overhaul The Regulation Of Financial Services, Including Insurance
In response to the current economic crisis, the Administration and Congress have proposed overhauling federal regulation of financial services. The Treasury Department recently announced proposals for financial regulatory reform, including draft legislation.4These proposals include designating a systemic risk regulator and creating federal procedures ( i . e ., resolution authority) for troubled systemically significant nonbank financial institutions, including insurance companies, the failure of which (and the resolution of such failure under otherwise applicable law) would have serious adverse effects on U.S. financial stability or economic conditions. If emergency action would avoid or mitigate such adverse effects, the company in question might either receive financial assistance or be put into conservatorship or receivership. This new resolution authority could be lodged in either an existing or a new agency.
With some similarities to the Administration proposals, companion bills, titled the "Financial System Stabilization and Reform Act of 2009," proposing to create an independent Financial Stability Council (the "FSC") to serve as a systemic risk regulator, were introduced in both houses of Congress. The FSC would be comprised of an independent chairperson and top regulators from various federal agencies. It would be charged with identifying financial products and activities (including those of insurers and their affiliates) that could pose a risk to the entire financial system and with taking action to prevent or mitigate their impact (including issuing and enforcing regulations) before they harm the U.S. economy.5
Proponents of the creation of a systemic risk regulator argue that such a regulator is necessary to fill a current regulatory gap, to monitor systemically significant companies (including those with insurance company subsidiaries) and to determine when action must be taken to limit the ripples that such a company might cause when in financial distress. There are many open questions about precisely how such a federal systemic regulator would fit in with, or affect, our current regulatory system, including with respect to insurance.
Federal Regulation Of Insurance Business
Certain legislative proposals have been introduced to address the inefficiencies, high costs and inconsistencies posed by state insurance regulation. Such proposals include creating methods for uniform and streamlined compliance and improving information-sharing and coordination among insurance regulators. Such initiatives could be enacted individually or incorporated into a comprehensive package for overhauling the regulation of insurance or all financial services.
Proposals to create an optional federal charter (an "OFC"), an alternative federal regulatory system in which insurance industry participants doing business on a national basis could choose to participate, have been debated for years. On April 2, 2009, H.R. 1880, titled the "National Insurance Consumer Protection Act," was introduced in the House of Representatives. This bill contains certain systemic risk proposals and also would authorize the creation of (a) an OFC, a parallel, national system of regulation and supervision for insurance companies, insurance agencies and producers (which, in most cases, could elect either national or state regulation, charters and licenses and could convert from state to national or vice versa), (b) a mandatory federal charter for insurers found to be systemically important and (c) an Office of National Insurance to supervise national insurers, national insurance agencies and national insurance producers.
Proponents of an OFC argue that it would allow streamlined regulatory requirements for companies doing business on a national basis and thus reduce compliance costs and eliminate inconsistencies or conflicts inherent in the current state regulatory system. Opponents argue that an OFC would result in regulatory arbitrage and that either an optional or a mandatory federal charter would weaken consumer protections.
Targeted Federal Insurance Initiatives
The following is a nonexclusive sampling of targeted federal proposals relating to insurance. Certain of these have been proposed in prior sessions of Congress and have gained considerable support. They may advance individually or in connection with more sweeping proposals like those discussed above.
The National Association of Registered Agents and Brokers Reform Act of 2008 ("NARAB II") updated a proposal to establish a national board to oversee licensing, continuing education and other nonresident insurance producer qualification requirements on a multistate basis. NARAB II was passed by the House of Representatives last year, but it is currently being redrafted to address perceived market and legal concerns (including potential reciprocity issues under the Gramm-Leach-Bliley Act). It is then expected to be reintroduced in the current Congress.
In December 2008, Senate Finance Committee Chairman Max Baucus posted a staff discussion draft bill proposing to disallow tax deductions for certain reinsurance premiums paid by U.S. property and casualty insurance companies to their offshore affiliates to the extent that they exceed the average percentage of premiums ceded to unrelated insurers (by line of business).6Proponents of the change argue that the current tax framework gives a tax haven to certain foreign-controlled insurers that cede their liabilities to offshore affiliates in low-tax or no-tax jurisdictions resulting in (a) a competitive advantage to these companies and (b) losses of billions of dollars in U.S. tax revenues. Opponents counter that companies reinsuring to offshore affiliates already pay comparable taxes to U.S. firms because some offshore cessions are to reinsurers in high-tax jurisdictions and offshore reinsurance is already subject to a one percent gross premium U.S. excise tax aimed at keeping the playing field level; and, therefore, that the proposal (a) would greatly disadvantage foreign-controlled reinsurers, particularly those in high-tax jurisdictions, (b) would increase the cost of, and decrease the availability of, coverage and (c) could result in retaliatory tariffs against U.S. firms.
Under the laws of most states, a domestic ceding insurer is permitted to take credit for reinsurance in its financial statements only if the counterparty reinsurer meets certain requirements. One means of satisfying reinsurance credit requirements is for an unauthorized reinsurer to post 100 percent collateral for its reinsurance obligations. Recently, the National Association of Insurance Commissioners (the "NAIC") adopted a conceptual framework that would reduce reinsurers' collateral requirements based on a new system of ratings for reinsurers. The NAIC recently prepared draft federal enabling legislation, which is currently subject to comment and further review, to implement the conceptual framework.7
Coverage that is difficult or impossible to obtain from licensed insurers in a particular state (such as coverage for unique risks that do not fit standard underwriting criteria) may be available from unauthorized insurers through the surplus lines market, via licensed surplus lines brokers. There appears to be a consensus that surplus lines insurers and brokers doing business in multiple states or nationwide would benefit from uniform licensing and regulatory requirements. For multistate risks, compliance and the allocation of premium tax have posed particular problems for the surplus lines industry because of inconsistent state laws. The best method for bringing about such uniformity ( e . g ., via federal legislation or a compact whereby the states agree to a uniform approach) has been debated for years. Proposals include limiting the compliance requirements of a surplus lines broker placing a multistate risk to the laws of the home state of the insureds and adopting uniform formulas and a clearinghouse for surplus lines premium taxes. In both houses of the last Congress, the "Nonadmitted and Reinsurance Reform Act of 2007" (the "NRRA"), was introduced to streamline regulation of surplus lines insurance and reinsurance by setting forth certain federal standards and certain limits on state regulations. The NRRA was passed by the House of Representatives in the past two sessions of Congress, and a similar bill may be reintroduced in the current Congress.8
It is difficult to predict which of the federal insurance initiatives described above is likely to proceed. We believe some federal regulation of insurance likely will be part of the upcoming financial services regulatory reforms; however, such reforms could take months or longer to develop. We do not expect a new federal insurance regulatory system to preempt completely the current state-based system. Rather, it is most likely that a federal systemic risk regulator will be created, along with new regulations governing financial holding companies (including those with insurance company subsidiaries), to fill current regulatory gaps. Also, a proposal for the creation of an OFC, which has been debated for years, is very likely at least to pass the House of Representatives. Some commentators have predicted that the OFCmight be limited to life insurers only, however. Ultimately, the federal initiatives that advance may look very different from those currently being proposed. 1 Congress set forth a reverse preemption for insurance via the McCarran-Ferguson Act of 1945, providing that unless a federal law specifically relates to the business of insurance, that law shall not apply where it would interfere with state insurance laws.15 U.S.C. § 1012 (1997).
2 The term "systemic risk" is generally used to mean risk that threatens the stability of the financial system as a whole, and a "systemically significant" company is one that poses systemic risk.
3 This article highlights several proposed bills and initiatives that, if adopted, would affect insurance regulation in general, and the property/casualty business in particular. Initiatives specific to the life and health insurance industry are not discussed herein.
4 News Release, U.S. Department of the Treasury, "Treasury Outlines Framework For Regulatory Reform - Provides new Rules of the Road, focuses first on containing systemic risk" (March 26, 2009), available at http://www.ustreas.gov/press/ releases/tg72.htm; News Release, Treasury Proposes Legislation for Resolution Authority (March 25, 2009), available at http://www.ustreas.gov/ press/releases/tg70.htm.The draft "Resolution Authority for Systemically Significant Financial Companies Act of 2009" is available at http://www.ustreas.gov/press/releases/reports/032509%20legislation.pdf.
5 See Press Release, Senate Committee on Homeland Security and Governmental Affairs, "Senator Collins Responds to Administration's Plan for Finanical [sic] Regulatory Reform - Senator introduced legislation creating a systemic-risk regulator" (March 26, 2009), available at http://hsgac.senate.gov/public/index.cfm?FuseAction=PressReleases.Detail&Affiliation=R&PressRelease_id=bb960c12-3b5b-4a68-9532-572867a34c8f&Month= 3&Year=2009.
6 The staff discussion draft, an explanatory document and received comments are posted on the Committee's website at http://finance.senate.gov/ sitepages/techcorrections.htm.A related bill, H.R. 6969, was proposed in the last Congress .
7 The March 24, 2009 draft "Reinsurance Regulatory Modernization Act" is available at http://www.naic.org/documents/committees_e_reinsurance_fed_legislation_draft.pdf.
8 "NAPSLO Optimistic About NRRA Passage After Capitol Hill Visit," National Association of Professional Surplus Lines Offices, Ltd. (March 27, 2009), available at http://napslo.blogspot.com/2009/ 03/napslo-optimistic-about-nrra-passage.html.
Leah Campbell is a Partner in the Corporate and Financial Services Department of the New York office of Willkie Farr & Gallagher LLP; she specializes in insurance regulation, insurance coverage and reinsurance. Marshal Bozzo is an Associate in Willkie's Insurance Department.