Should the states continue to regulate insurance, or should the federal government take it over? The debate has been joined, and it will be some years before the outcome is clear. But I think defining the issue as state versus federal regulation is too simplistic. The goal should be rational, effective and efficient regulation of insurance. That goal theoretically can be achieved by state regulation or by federal regulation, or by some combination of the two. The goal of better regulation, moreover, can just as easily be frustrated by some new form of federal regulation as by continued state regulation.
State regulation of insurance is an anachronism, based on the fiction that insurance is not interstate commerce. It is maintained by the McCarran-Ferguson Act, which Congress enacted in 1945 to overturn a 1944 Supreme Court decision that found insurance to be interstate commerce and therefore subject to federal regulation. No one today can seriously contend that the business of insurance is not interstate in character. But there are substantial political and even practical benefits from state regulation of the business of insurance.
The state system of insurance regulation works remarkably well and has over many years. The National Association of Insurance Commissioners (NAIC), which was organized in 1871, is an excellent institution that provides real value in insurance regulation - drafting and vetting model laws, establishing standards for quality through its accreditation system, and bringing a large degree of cooperation and even uniformity to the state-based insurance regulatory system. But the NAIC has its limits. It is a consensus organization, with no authority to impose its rules on the states. Moreover, because it operates on the basis of one state/one vote, the larger jurisdictions, such as California, New York, Florida and Texas, which among them have more than half of the total U.S. insurance market, are often frustrated by the NAIC process and abstain from the collective decisions of the smaller jurisdictions.
Federal regulation can be effective, but it also has its limitations. The availability of a federal charter to banks, for example, does provide a degree of choice and flexibility unknown to insurers. But federal bank regulation is no panacea. Several different federal agencies, with distinct but overlapping authority, can impose regulations on the same banks, and there are constant issues over whether state banking authorities have any residual authority over federally chartered banks, or whether federal banking regulators have authority over state-chartered banks. When it comes to consumer protection - especially the handling of individual consumer complaints against specific financial institutions - there is little doubt that state regulators are much more effective in resolving those problems than are federal agencies.
There are good examples of effective state regulation within a federal system. For example, in the United States only states issue drivers' licenses. There is no federal Department of Motor Vehicles. Yet you can drive in New York with your Connecticut driver's license, although you must obey New York's traffic laws. If you are a Connecticut insurance company, however, you need a New York insurance license to do business in that state, and a license in every state where you want to do business. Why not have a system for insurance companies that works like the one we use for drivers' licenses?
Similarly, there is no European Union insurance regulator. The EU relies on the various national insurance regulatory agencies to make sure that insurance companies follow the laws. But a French-licensed insurance company can operate freely throughout the EU, without the need to obtain a German license to sell in Germany, or a British license to do business the UK There is no reason why a similar system could not operate effectively in the United States - that is, a single regulator but not a federal regulator; a license issued by the home state regulator that would allow the company to operate throughout the U.S.
The NAIC has made strenuous efforts in recent years to provide uniformity among states, so that companies can sell the same products in all states and be subject to uniform financial requirements. While a great deal of progress has been made, especially in the area of financial solvency regulation, the states are a long way from a single and uniform system of laws and regulations. The latest effort by the NAIC is to create an interstate compact that would allow a NAIC-created body to review and approve products for sale throughout the country. The effort is going slowly, with opposition from some state legislators and attorneys general, who believe the compact is a diminution of state sovereignty. A more promising approach, in my view, is a initiative by the California, Texas and Florida insurance regulators to do joint reviews of new products. Because those states represent such a large proportion of the U.S. market, a single review of a new product that would allow it to be sold in all three of those jurisdictions is a very significant advantage. Moreover, other states are signing on the big-state initiative, including Georgia, Nevada and the District of Columbia. Insurers, however, are not entirely happy with the big-state initiative, because California, Florida and Texas have some of the most stringent regulatory standards in the country. Products that would be approved in other jurisdictions may not pass muster in California or Florida or Texas.
This points up the problem with any kind of single regulatory authority, state or federal. The industry in general prefers less regulation to more. It would like the Illinois system of open competition in auto insurance rates to be made universal, for example, but not the California system of prior approval. Who knows how a federal regulator would regulate? Would a federal regulator approve the use of credit scoring, for example? Some states prohibit or severely restrict the use of credit scores in insurance underwriting, while other states permit them. The state regulatory system at least allows companies to stay out of states that have onerous regulations. There would be no avoiding of onerous federal regulation.
Instead of a sterile debate over state versus federal regulation, it would make more sense to seek wide agreement on what constitutes effective insurance regulation, and then look for the implementation of a system - federal, state, or mixed - most likely to achieve that goal. My list of desirable objectives includes:
A single license that would allow a company to market throughout the U.S. That could be a federal license, or it could be a license issued by the domiciliary state. Under the federal Liability Risk Retention Act, an insurance company that can qualify as a risk retention group can operate nationwide with the license issued by its home state. This is an example of how federal law can be used to override state-specific requirements, but without setting up a federal regulator.
A method for single approval of insurance products that would allow an approved product to be sold everywhere in the U.S. This would be especially valuable for certain lines of insurance ( e.g., life, annuities) where state laws governing them are quite uniform. In other lines, where there are significant variations in state laws (private passenger auto, health), the method should allow for one general approval, with endorsements required in some jurisdictions to meet local mandates. This could be an approval by a federal regulator or it could be approval by a state or group of states, as negotiated among the states or as authorized by federal law.
A single regulator responsible for financial solvency and market conduct for each insurer. That could be a federal regulator or it could be the home state regulator, the commercial state regulator ( i.e. the regulator in the state where the company does its largest volume of business), or it could be a regulator of a designated state, a system used by state securities regulators. But whoever it is, that regulator would have exclusive jurisdiction, and other regulators would not be permitted to conduct similar inquiries.
Local systems for handling complaints, with a national central database to log complaints by company, by type, and by the nature of the resolutions, if any. Under such a system, each state would be authorized to protect its own citizens, but information would be aggregated so that all state regulators would be able to determine whether the complaints of its citizens mirror a broader problem with the particular company complained against.
It is important to keep in mind why the insurance industry is so heavily regulated. Consumers pay money up front for a promise that they will be compensated if certain future events come to pass. Regulators must make sure that the insurance companies keep their promises, and that they have the resources necessary to do so. We should be debating how best to achieve that goal, with the greatest protection for the consumers and the least burdens on the industry. How we regulate insurance is much more important than who regulates.
Lawrence H. Mirel, former Commissioner of Insurance, Securities and Banking for the District of Columbia, joined Wiley Rein & Fielding as a Partner in the firm's Insurance Practice on October 3, 2005. Mr. Mirel is spearheading the firm's insurance regulatory activities, providing clients with extensive inside-the-Beltway expertise, a sophisticated understanding of the intricacies of the insurance industry and a highly knowledgeable perspective on state insurance regulation and on the workings of the National Association of Insurance Commissioners (NAIC). As the District's Insurance and Securities Commissioner since 1999 and DC's Banking Regulator since March of 2004, Mr. Mirel has been at the forefront of emerging policy issues and trends affecting the insurance industry, acting as a voice for big city interests during the creation of the Terrorism Risk Insurance Act (TRIA), working to position the District as a major national and international center for insurance (including innovative self-insurance arrangements), banking and other financial services. He can be reached at (202) 719-7449. This article originally appeared in the WRF newsletter "Washington Perspective: The Changing Climate of Insurance Regulations."