Order Code IB10106
Issue Brief for Congress
Received through the CRS Web
Insurance Regulation and Competition:
Background and Issues
Updated January 28, 2003
Carolyn Cobb, Insurance Consultant
Government and Finance Division
Congressional Research Service ˜ The Library of Congress
CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
Present Regulatory Structure
Factors Promoting Change
State Regulatory Response
Legislative Activity in the 107th Congress
Proposals
Hearings
Other
Possible Legislative Activity in the 108th Congress
FOR ADDITIONAL READING
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Insurance Regulation and Competition: Background and Issues
SUMMARY
Insurance companies make up a major
national launch of a similar product. As a
segment of the U.S. financial services indus-
result, many insurers selling such products are
try. However, unlike banks and other finan-
calling upon Congress to pass legislation
cial institutions that are regulated primarily at
reinstating the federal government’s insurance
the federal level, insurance companies are
regulatory role.
regulated by the states. As financial services
have converged in response to globalization
Legislation presented in the 107th
and other market factors, the seemingly arbi-
Congress was modeled on the dual
trary distinctions separating various financial
state/federal regulation that now exists for the
products and services, as well as their provid-
banking industry. Though the 107th Congress
ers, have broken down.
did not address either measure, it is antici-
pated that additional proposals for a dual
In 1999 Congress passed the Gramm-
state/federal regulatory system, including
Leach-Bliley Act (GLBA) to reflect market-
additional optional federal chartering
place changes and to overhaul the laws gov-
proposals, will garner more consideration by
erning financial institutions. Rather than
the 108th Congress.
changing the regulatory structures for the
various financial institutions, GLBA embraced
Analogies to the perceived effectiveness
the concept of “functional” regulation. It
of state regulation of insurance in assuming
specifically reaffirmed the regulation of insur-
the duties conferred in the Terrorism Risk
ance by the states as granted by the 1945
Insurance Act of 2002 will likely infuse dis-
McCarran-Ferguson Act. Since 1945 Con-
cussions of optional federal chartering during
gress has reviewed the jurisdictional steward-
the 108th Congress. Some insurers may argue
ship entrusted to the states under McCarran-
that the Act’s implementation presented a test
Ferguson on various occasions. Until re-
case for state insurance regulation, which they
cently, however, efforts to transfer insurance
may say has failed. State regulators and other
regulatory authority back to the federal gov-
insurers will likely view the states’ implemen-
ernment were opposed by both the states and
tation of the Act as successful.
a united insurance industry.
Finally, the sunset of the Fair Credit Reporting
Some insurers now claim that in view of
Act’s preemption of state laws on sharing
the growing convergence of financial services
credit information among affiliates will likely
and products, they find themselves at a com-
ignite a debate over who should regulate insur-
petitive disadvantage because of the ineffi-
ers’ use of medical and financial information.
ciencies associated with being regulated by the
Insurer’s use of credit scoring in underwriting
states. For example, life insurers selling
homeowners and automobile insurance may
products aimed at retirement and asset accu-
inflame that debate, as may the lack of uni-
mulation must now compete with similar bank
form privacy protections among the states.
products. While banks can roll out their new
Critics of GLBA’s privacy provisions will
products nationwide in a matter of weeks, it
also join the debate. At issue will be the
sometimes takes 2 years or more for an insurer
effectiveness and efficiency of state regulation.
to obtain the necessary state approvals for a
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MOST RECENT DEVELOPMENTS
During the 107th Congress, legislation providing for optional federal chartering was
introduced in the House and presented in the Senate, but neither piece of legislation was
acted upon. Various insurance interests are currently working on updating their own
proposals to modernize the regulation of insurance. In an unprecedented effort mandated
by Congress in the Terrorism Risk Insurance Act of 2002, federal and state regulators are
cooperating closely to make the marketplace for terrorism insurance work for businesses,
consumers, and insurers.
BACKGROUND AND ANALYSIS
Present Regulatory Structure
Insurance companies comprise a major segment of the U.S. financial services industry.
However, unlike banks, insurance companies have been regulated solely by the states for the
past 150 years. That stems from a 1868 decision of the U.S. Supreme Court that insurance
was not interstate commerce and thus not subject to regulation by the federal government
under the Commerce Clause of the U.S. Constitution. Courts followed that precedent for the
next 75 years. Then, in 1944, the U.S. Supreme Court reversed its 1868 ruling and held that
insurance was interstate commerce and subject to federal oversight. By that time, however,
the state insurance regulatory structure was well established, and a joint effort led by state
regulators and insurance industry leaders to overturn the decision legislatively led to the
passage of the McCarran-Ferguson Act of 1945. That act relinquished to the states federal
authority to regulate insurance, subject to “effective” insurance regulation by the states, and
granted a limited federal antitrust exemption to the insurance industry.
After 1945, the jurisdictional stewardship entrusted to the states under McCarran-
Ferguson was reviewed by Congress on various occasions. Each time proposals were made
to transfer insurance regulatory authority back to the federal government, they were met by
opposition from the states as well as from a united insurance industry. Generally, such
proposals for federal oversight spurred a series of regulatory reform efforts at the state level
and by the National Association of Insurance Commissioners (NAIC). Such efforts were
directed at correcting perceived deficiencies in state regulation in order to forestall a federal
regulatory takeover, and they were generally accompanied by pledges from state regulators
to work for more uniformity and efficiency in the state regulatory process.
A major effort to transfer insurance regulatory authority to the federal government was
undertaken in the mid 1980s, following insolvencies of several large insurance companies.
Representative John Dingell, who chaired the House Commerce Committee and had
jurisdiction over insurance, questioned whether state regulation was up to the task of
overseeing such a large and diversified industry. He conducted several hearings on the state
regulatory structure and also proposed legislation that would have created a federal insurance
regulatory agency modeled on the Securities and Exchange Commission (SEC). State
insurance regulators and the insurance industry opposed his proposal and worked together
on a series of reforms at the state level and at the NAIC, including a new state accreditation
program setting baseline standards for state solvency regulation. Under those standards, in
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order to obtain and retain its accreditation, each state must have adequate statutory and
administrative authority to regulate an insurer’s corporate and financial affairs and the
necessary resources to carry out that authority. In spite of such reforms, however, another
breach in the state regulatory system occurred in the late 1990s, when Martin Frankel slipped
through the oversight of several states and looted some small life insurance companies of
some $200 million. Such a breach was a major embarrassment to state regulation, but it did
not have a long-term impact or bring additional calls for a federal regulatory system.
Factors Promoting Change
In 1999, Congress passed the Gramm-Leach-Bliley Act (GLBA – P.L. 106-102), an
historic piece of legislation, which instituted a massive overhaul of the federal laws
governing U.S. financial institutions. Most financial institutions supported the overhaul
because market forces had broken down the distinctions among financial products and
services, as well as the providers of once discreet products. Those market forces – such as
globalization, new technology, e-commerce, deregulation, market liberalization, increased
competition, tighter profit margins, and the growing number of sophisticated consumers –
had been driving all financial services providers to find growth, gain market share, create
new revenue streams, and enter new markets. U.S. banks looked to non-banking products
such as insurance and pension products to increase their profitability. They pointed, for
example, to European “bancassurers” that generate 20% to 30% of their profits from the sale
of insurance and investment products integrated into core retail banking businesses.
GLBA repealed federal laws that seemed inconsistent with the way that financial
services products were actually being delivered and removed many barriers that kept banks
or securities firms from competing with insurance companies. It ushered in a new
competitive paradigm in which insurance companies now find themselves in direct
competition with brokerages, mutual funds, and commercial banks. GLBA did not, however,
change the basic regulatory structure for insurance or other financial products. Instead, it
specifically reaffirmed the 1945 McCarran-Ferguson Act which had granted insurance
regulatory authority to the states, thereby recognizing state insurance regulators as the
“functional” regulators of insurance products and those who sell them. Some insurance
companies believe that in this new environment state regulation places them at a competitive
disadvantage. They maintain that their new non-insurer competitors have far more efficient
federally based systems of regulation, while they are subject to the perceived inefficiencies
of state insurance regulation, such as the multi-state prior approval of policy forms. Life
insurers with products aimed at retirement and asset accumulation compete with similar bank
products; however, banks can roll out such new products nationwide in a matter of weeks,
while some insurers maintain that it can take 2 years to obtain all the necessary state
approvals for a similar national insurance product launch.
GLBA also addressed the issue of modernizing state laws on licensing insurance agents
and brokers by creating a federal licensing agency, the National Association of Registered
Agents and Brokers (NARAB), which would come into existence only if the states failed to
enact the necessary legislation for state uniformity or reciprocity within the time limit
Congress specified.
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State Regulatory Response
Following the passage of GLBA, state insurance regulators working through the NAIC
embarked on an ambitious regulatory modernization program in response to both the
mounting criticisms of state insurance regulation and the growing convergence of financial
services and financial services products. In early 2000, NAIC members signed a Statement
of Intent: The Future of Insurance Regulation, in which they pledged “to modernize
insurance regulation to meet the realities of the new financial services marketplace” and “to
work cooperatively with all our partners – governors, state legislators, federal officials,
consumers, companies, agents and other interested parties – to facilitate and enhance this
new and evolving marketplace as we begin the 21st Century.” They formed new working
groups to implement GLBA, to prevent NARAB from coming into existence, and to
modernize state regulation in other ways to deter growing industry support for federal
oversight. The new groups addressed such key issues as state privacy protections, reciprocity
of state producer licensing laws, promotion of “speed to market” of new insurance products,
development of state-based uniform standards for policy form filings, and other proposed
improvements to state rate and form filing requirements.
According to NAIC, the states are now well underway in their efforts to modernize state
regulation. NAIC maintains that states are better positioned than the federal government to
serve the interests of American insurance consumers, emphasizing that state regulators are
better able to make sure that the personal interests of consumers are not lost in the arena of
commercial competition. To support this position, the NAIC points out that during 2000, a
total of some 12,500 state insurance regulatory personnel were employed by the states at a
cost of $880 million, and the states handled approximately 4.5 million consumer inquiries
and complaints regarding their policies and their treatment by insurance companies and
agents. Also, it reports that as of December 2002 it had certified 38 states as reciprocal
jurisdictions – far more than the 29 states needed under GLBA to prevent the establishment
of NARAB. The NAIC does concede that, in view of differing state legal systems, complete
uniformity may be an illusory goal, but state regulators believe that uniformity is not required
to maintain the level of effectiveness required by McCarran-Ferguson. The NAIC has
acknowledged, however, that the more national nature of life insurance products argues for
true uniformity. As a result, the NAIC recently endorsed an interstate compact to promote
regulatory uniformity for certain life insurance products, believing that such a compact is the
best mechanism to achieve uniformity within a state framework.
State regulators, in carrying out their pledge to modernize state insurance regulation,
hope to satisfy those within the insurance industry who feel that their needs would be better
served by a federal regulatory structure, or by a dual regulatory structure where insurance
companies could choose to be regulated either at the state or federal level. The insurance
industry itself is divided, with smaller insurers committed to improving the state-based
regulatory structure, and larger insurers to supporting a dual regulatory system. Three
industry trade groups, the American Council of Life Insurers (ACLI), the American Insurance
Association (AIA), and the American Bankers Insurance Association (ABIA), have each
released draft legislation creating an optional federal charter for insurance companies. They
have recognized similarities among their proposals and interests and are now working
together to reach a common position. Other industry groups, including the Alliance of
American Insurers (the Alliance), the National Association of Independent Insurers (NAII),
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and the National Association of Mutual Insurance Companies (NAMIC), are opposed to any
federal legislation, preferring that the needed regulatory improvements be made by the states.
Legislative Activity in the 107th Congress
Proposals
Senator Schumer presented legislation in December 2001 to provide for an optional
federal charter for insurers; it was not assigned a number during the 107th Congress. The
legislation was modeled on the dual state/federal regulation that now exists for the banking
industry and would have enabled insurance companies and agencies to choose between state
and federal regulation. It would have created a new federal agency within the Treasury
Department to charter, license, supervise, and regulate insurers and agents electing federal
regulation. The new agency would also have had the powers to impose fees to fund its
operations, to establish solvency and accounting standards, to enforce market conduct
standards, to approve changes in control, and to license and regulate reinsurers. The
legislation would also have required all insurers electing federal regulation to participate in
either state insurance guaranty associations or a federal backup guaranty association. It
would not have given the new agency authority to regulate insurance rates or policy content,
nor would it have exempted federally regulated insurers from antitrust laws, except for very
limited purposes.
Representative LaFalce introduced H.R. 3766 during the second session. It would have
created an optional federal charter for insurers, but not for insurance agents or brokers. Like
Senator Schumer’s proposal, it would have created a new federal agency within the Treasury
Department. It was generally similar to Senator Schumer’s proposal, but it differed in these
ways:
! H.R. 3766 would have allowed a federally regulated insurer to underwrite
both life insurance and property/casualty insurance in the same company.
! Though the new agency would have had general regulatory authority over
insurers electing federal regulation, only state insurance regulators would
have had authority to regulate rates.
! Though H.R. 3766 had no provision for the licensing of insurance
producers, the new agency would have had the authority to enforce rules on
unfair and deceptive practices against state-licensed agents selling insurance
for federally regulated insurers.
! It would have encouraged federally regulated insurers to invest in the
communities where they sell policies.
! It would have required federally regulated insurers to file reports with
community sales data to combat insurance redlining.
There were no hearings, markups, or committee reports on either Senator Schumer’s
proposal or on Representative LaFalce’s H.R. 3766 during the 107th Congress.
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Hearings
The House of the 107th Congress reorganized its committee structure to reflect GLBA’s
enactment and convergence in financial services. Jurisdiction over most insurance matters
was transferred to the newly formed Financial Services Committee, which incorporated into
its agenda several insurance-related issues, including agent licensing, states’ approval
processes for new insurance products, and a review of alternatives for improving the
efficiency, uniformity, and effectiveness of state regulation.
During 2001, subcommittees of the Financial Services Committee held three hearings
to examine the current structure of insurance regulation and assess its current inefficiencies.
The Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises
held a hearing on state efforts to comply with the GLBA requirement that at least 29 states
institute producer licensing reciprocity or face activation of a federal licensing agency known
as NARAB. The same subcommittee later held a hearing to review the state regulatory
approval process for new insurance products, referred to as “speed to market.” The
Subcommittee on Oversight and Investigations held a third hearing to review whether “over-
regulation” of automobile insurance denies consumers choice and competition. The
Committee had originally planned for additional hearings to be held during 2001, but those
plans were put on hold following the events of September 11.
During June 2002, the Subcommittee on Capital Markets, Insurance, and Government
Sponsored Enterprises reviewed various proposals for reform, holding a series of three
hearings on “Insurance Regulation and Competition for the 21st Century.” At the first
hearing, Representative Richard Baker, chairman of the subcommittee, said that some sort
of insurance regulatory reform was in order because insurance products that are not labeled
as such can enter the marketplace more freely than those labeled as insurance. Witnesses
representing banks, insurers, and agents agreed that insurance regulation needed to be
reformed, but they disagreed about whether the best way to accomplish that would be to
create an optional federal regulatory system or to reform the current state regulatory system.
Chairman Baker emphasized that if states believe that they can adequately reform their
existing system, they should be given a reasonable time limit in which to do so. He added
that the hearings would be a “first step” toward his drafting legislation to reform and
streamline insurance regulation that could be unveiled in 2003, but that he had no
preconceived ideas about its specific content.
At the second hearing, Representative Michael Oxley, chairman of the full committee,
urged a “go-slow” approach to reforming insurance regulation and expressed his hope that
the necessary state-based reforms could be made so that no federal action would be
necessary. The witnesses, representing individual insurers and various trade associations,
again expressed differing opinions on whether Congress should pass optional federal
chartering legislation or require the states to make specific reforms to improve the
competitive position of insurers. Subcommittee Chairman Baker repeatedly attempted to get
witnesses to recommend a “time-line” for the states to make the reforms necessary to
modernize state regulation and create a more level playing field for insurers in the financial
services marketplace.
At the third hearing, most of the witnesses were again representatives of insurance
industry groups with definite positions for or against dual chartering. One agent group
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announced, however, that it was developing a “middle ground” approach under which the
states would continue to regulate insurance, subject to federally mandated standards. The
president of a small life insurance company gave concrete examples of problems his
company has experienced with the current state regulatory system and asked that if Congress
were to enact federal chartering legislation, small companies like his not be excluded by high
capital or revenue minimums. The president of the NAIC testified that state regulators were
well on their way in their efforts to modernize state regulation, and that any federal
legislation dealing with insurance regulation risked undermining state consumer protections
by unintentionally or unnecessarily preempting state insurance laws and regulations.
Other
Two other events bore on the issues considered at the hearings. First, the General
Accounting Office (GAO) had released a statement for the record (GAO-02-842T) in which
it concluded that even though the NAIC has made a concerted effort in promoting more
uniform regulatory processes and requirements, it may not be able to achieve uniformity in
certain areas, and that “ongoing federal oversight and, possibly, federal intervention may be
needed to provide impetus for positive change and continuing improvement in state
regulation of insurance.” Second, a group of some of the largest financial services trade
groups favoring optional federal charter legislation – Financial Services Coordinating
Council, American Bankers Insurance Association, American Council of Life Insurers,
American Insurance Association, Council of Insurance Agents and Brokers, and Financial
Services Roundtable – announced that they had formed a coalition dedicated to
establishment of “a chartering system for insurers that mirrors the existing dual banking
system, which allows banks to choose between state and federal regulators.”
In September, following these events, Representative Baker conducted an open
roundtable discussion on the general subject of insurance regulatory reform. It involved
various members of the Subcommittee on Capital Markets, Insurance, and Government
Sponsored Enterprises, along with two panels of industry spokespersons. The first panel
favored state insurance regulation, and the second panel preferred an optional federal charter
and a dual federal/state regulatory structure. Most of the panelists were somewhat flexible
as to the details of needed insurance regulatory reform, but all were in agreement that the
status quo is not acceptable. Representative Richard Baker repeated his admonition that the
“clock is running” on the states’ efforts to modernize state insurance regulation.
Possible Legislative Activity in the 108th Congress
The Terrorism Risk Insurance Act of 2002 (TRIA) may affect the coming debate over
the effectiveness of state regulation. In the aftermath of the World Trade Center attacks,
insurance for terrorism risk became unavailable or unaffordable. A coalition of business
interests – including construction, real estate, entertainment, manufacturing, retailing and
transportation sectors – began working with the 107th Congress and the insurance industry
to create a federal backstop for insured terrorism losses. When the TRIA backstop became
law in November, a new test for state regulation emerged. Under TRIA, the Secretary of the
Treasury will administer the backstop program but states will continue to regulate the
business of insurance. Some advocates of optional federal regulation of insurers anticipate
that state regulation may fail to provide uniformly available and affordable terrorism
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insurance. Proponents of exclusive state jurisdiction anticipate that state regulation will
prove adaptive to local circumstances and therefore successful in providing coverage for
terrorism insurance. This debate is likely to surface in any hearings that Congress may have
on TRIA, on its implementation, or on optional federal chartering. It will be difficult,
however, to assess the marketplace – much less the effectiveness of state regulation – for
some time.
Other issues may arise during the 108th Congress that insurers favoring an optional
federal charter will present as support for their position. These include privacy of medical
and financial information generally, the lack of uniform protection among the states for that
information, and insurers’ use of credit scoring in underwriting automobile and homeowners
insurance. It is likely that all these issues – including the effectiveness of state insurance
regulation – will be raised during the oncoming debate over whether to renew the preemption
in the Fair Credit Reporting Act for sharing credit information among affiliates.
FOR ADDITIONAL READING
For additional information on the background of state insurance regulation and
proposals before Congress, see CRS Report RS21153, Optional Federal Chartering for
Insurers: Legislation and Viewpoints, by S. Roy Woodall, Jr.
For additional information on the major insurance industry groups and how they differ
in their positions on federal chartering of insurers, as well other organizations with an interest
in federal chartering and regulation of the insurance industry, see CRS Report RS21172,
Optional Federal Chartering for Insurers: Major Interest Groups, by S. Roy Woodall, Jr.
For additional information on P.L. 106-102, see CRS Report RL30375, Major Financial
Services Legislation, The Gramm-Leach-Bliley Act: An Overview, by William D. Jackson
and F. Jean Wells.
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