Improving Insurance Regulation
'Not Whether, but How' to Improve Insurance Regulation
Lawrence H. Mirel and Z. Xavier Baker
January 9, 2012
Appearing before a standing-room-only crowd on Dec. 9, 2011, during the Federal Insurance Office's (FIO) first public hearing, Director Michael McRaith outlined an ambitious agenda for the fledgling office.
Held against the backdrop of the FIO's October request for public comments and looming January 2012 deadline to report to Congress regarding modernization and improvement of insurance regulation, the public hearing presented an opportunity for public engagement between the U.S. Department of the Treasury and the insurance industry.
The goal, according to McRaith, was to have a lively discussion, rather than "everyone to walk out holding hands."
Deputy Secretary of the Treasury Neil Wolin served as the keynote speaker and used his remarks to highlight the need for the FIO while also reassuring state regulators. Wolin observed that despite the insurance industry's economic significance-representing approximately 8 percent of gross domestic product and 2 percent of total employment-until the Dodd-Frank Act created the FIO, the federal government lacked any expertise or insight into the industry.
The FIO will fill this void through its participation on the Financial Stability Oversight Council, representing U.S. interests in international prudential regulatory matters, studying the access to and affordability of insurance, and advising the Secretary of the Treasury.
But the FIO will not regulate insurance, stressed Wolin.
The hearing itself was divided into three panels of industry insiders, critics and a moderator on the following topics:
- Consumer protection and the business of insurance;
- International developments; and
- Prudential standards for insurance companies.
After opening remarks, the panelists responded to questions from the moderator and sometimes the audience, too. As McRaith had hoped, discussion was lively.
Consumer Protection and the Business of Insurance
University of Minnesota Law School Professor Daniel Schwarcz opened the discussion by calling for increased transparency for insurance products.
Echoing concerns that have surfaced throughout the financial services sector, Schwarcz argued that increasing consumer transparency about coverage variances between products, rates of claims payment and denial, market conduct data, and policy nonrenewals would strengthen regulation by creating an informed marketplace in which consumers would push for actions by regulators.
Such transparency, Schwarcz said, would supplement and support the existing framework of prescriptive regulation.
John Hill, chief executive officer (CEO) of Magna Carta Cos., noted that, as a mutual insurer, protecting his policyholders is his top priority. A robust solvency regulator is an essential component of consumer protection.
For Hill, modernization of the insurance regulatory system must preserve the existing framework of state guaranty funds and oversight, but should streamline burdensome and duplicative regulations that add costs ultimately borne by consumers.
Hill urged the FIO to serve as a strong voice for U.S. interests on international insurance issues, to make use of the "bully pulpit" and to work closely with all federal regulators that touch on insurance, including the U.S. Securities and Exchange Commission and U.S. Internal Revenue Service.
Johnny Johns, CEO of Protective Life, said that while the National Association of Insurance Commissioners (NAIC) has many strengths, its structure and approach to regulatory issues can be problematic. The NAIC takes a "bottom-up" approach and is a "reactive" organization. As such, it has trouble formulating strategic plans and staying on target.
Johns advocated a less duplicative, streamlined system of regulation by direct federal regulation, an optional federal chartering system, or-most intriguingly-a hybrid regulatory scheme akin to a "passport" system through which the FIO would promulgate regulatory standards and a handful of volunteer states would serve as "national" regulators.
Schwarcz was quick to object to any proposal in which regulated entities could select their regulator, citing this as one of the principal lessons of the financial crisis. Instead, Schwarcz argued, the way to compel modernization and change by state regulators is by having the federal government set priorities and pressure the states by threatening to take action itself.
Consumer Federation of America's director of insurance, Robert Hunter, chimed in that domicile state regulators are the worst regulators. Hunter also objected to the notion of a passport-style regulatory system, opining that "if Nebraska is regulating hurricane insurance in Florida and flood insurance in Georgia, we have a problem."
International Developments
Following some introductory remarks from moderator and Marsh CEO Brian Duperrault, the panel wrestled with the challenges of international regulation in an increasingly global marketplace. Not surprisingly, the second panel focused extensively on whether the current balkanized U.S. insurance regulatory system would be deemed "equivalent" under the European Union's Solvency II regime.
Texas Department of Insurance Commissioner Eleanor Kitzman pointed out that while international engagement on regulatory issues is important, regulators must recognize that there are a significant number of domestic companies with little to no interest in international markets.
That said, however, Kitzman was quick to note that U.S. regulators should seek to understand their foreign counterparts and that international developments may influence U.S. regulation.
But the commissioner also highlighted important areas where the states and foreign markets differ, namely solvency regulation and modernization-an area with which the FIO will have significant involvement.
Walter Bell, chairman of Swiss Re NA and a former NAIC president, highlighted the challenges of operating on a global basis and the need for cooperation and engagement with supervisory colleges.
Bell urged the FIO to eliminate regulatory arbitrage and establish a level playing field for reinsurance collateral through mutual recognition of collateral by regulators. He stressed that meaningful collateral reform is an essential component of achieving "equivalency" under Solvency II.
Prudential Vice Chairman Mark Grier said he hoped the FIO will help establish and support the insurance industry's distinct identity in the financial services marketplace. It would be a disservice to shoehorn international insurance concerns into a banking regulatory framework, he said.
Like the other panelists, Grier expressed concern about equivalency, especially given the variance between solvency accounting and investor-oriented accounting, and the lack of comparability across companies. He voiced his support for an outcomes-based approach to equivalency determination because of the very real concern that statutory balance sheets may not reconcile with Solvency II.
Liberty Mutual Senior Vice President and General Counsel Christopher Mansfield called for the FIO to act as a "field general" for insurance issues, providing guidance to the industry and serving as a primary voice in dealing with international bodies, such as the International Monetary Fund and Financial Stability Board.
Additionally, Mansfield expressed his hopes that the FIO can help engage and access international markets for U.S. companies.
Prudential Standards
McRaith moderated the last panel of the hearing, focusing on prudential regulation of insurance addressing such questions as whether insurance is systemically risky. Some panelists praised the existing framework of prudential regulation and guaranty funds, noting that the industry survived the recent financial crisis without widespread failures or the tumult experienced in the banking sector.
But Birny Birnbaum, executive director of the Center for Economic Justice, argued that the test of whether prudential regulations are sufficiently robust is not whether companies fail, but how consumers are treated in the aftermath of a failure. That a competitive market will result in some failed companies is the nature of capitalism, he said.
McRaith observed that insurance may be systemically important rather than systemically risky. Forrest Krutter, senior vice president and general counsel for Berkshire Hathaway responded to this by defining systemic risk as something that, if it failed, would cause contagion across multiple companies.
Birnbaum said that discussions of whether insurance is systemically risky should avoid generalizations about the industry and focus on particular lines of business. He explained that specific lines of insurance may be systemically risky-such as credit insurance and title insurance-because they are "ultra-concentrated" and tied to the broader financial market.
Given the rapid evolution of financial markets both domestically and internationally and the growing diversity in the insurance industry, McRaith asked whether state insurance regulators have sufficient expertise and resources to keep up.
Janice Abraham, president and CEO of United Educators Insurance, replied that states are capable and thorough regulators and their sophistication continues to grow alongside that of the companies they regulate.
Similarly, Krutter stated that, while the relative sophistication of state regulators may vary, state insurance departments are capable of determining whether a company is solvent and protecting consumers.
But Birnbaum contended that regulators are using 20th-century tools to evaluate a 21st-century market. Insurers make use of data mining and predictive analysis, while regulators do not. Birnbaum believes that regulators need more granular data and should use predictive analyses to keep pace with the marketplace.
Overall, the hearing was lively but respectful and did little to break new ground in the continuing debate over insurance regulation. Given Wolin's clear affirmation that the FIO will not regulate insurance, there can be no doubt that state regulation of insurance will remain intact.
But in light of McRaith's pronouncement that the question before the FIO is "not whether, but how" to improve and modernize insurance regulation, the issue becomes: how should the state insurance regulatory system change, while preserving its core role?
As Wiley Rein's own Larry Mirel suggested last fall ("The Future of Insurance Regulation: Does the Dodd-Frank Act Change Anything?" by Lawrence H. Mirel and A. Xavier Baker, October 2010) and Johnny Johns and other participants in the FIO hearing echoed, perhaps the most pragmatic and useful approach would be a hybrid system that makes use of both federal and state regulation.
The insurance industry is not susceptible to a one-size-fits-all regulatory regime - some companies operate locally, others internationally, and some lines of business require more robust consumer protection than others, such as personal versus commercial lines.
Some parts of the industry are well-served under the current system of state regulation, but others may be better regulated in a system of combined federal and state authority, as for example the adoption by the federal government of basic standards-perhaps developed by the NAIC-that are then enforced by the states.
These uniform national standards would lessen the regulatory burden on insurers while preserving the role of the states-a political and practical necessity.
January 2012 promises to be an exciting time for the industry. Once the FIO publishes its report, hearings in Congress will surely follow.
But the question remains, regardless of what course of action the FIO recommends: will anything be done about it?
SOURCE: www.lexology.com