CRITICAL ISSUE REPORT
Market conduct reform has always been difficult to achieve
By Kevin P. Hennosy
Market conduct regulation appears poised to lead the agenda of the National Association of Insurance Commissioners (NAIC) in 2002. If the association does indeed recommend reforms to govern how states regulate the interaction of insurers and the public, this will be an historic year.
Market conduct has traditionally played the same role in insurance regulation that the Ottoman Empire played in 19th century Europe--too large to ignore but too weak to take seriously. If the Ottoman Empire was called the "sick man of Europe," then market conduct is "the ugly stepchild of insurance regulation."
Insurers often accuse market conduct regulators of appearing ineffectual and parochial. This unfavorable assessment should not reflect on the individuals in state insurance departments who work in market conduct oversight. The system they must implement is fatally flawed by design and has needed reform for a long time.
Oregon Insurance Administrator Joel Ario chaired the NAIC's efforts to reform market conduct in 2001. According to Ario a new system must: "1) Apply better analysis to target resources more effectively, 2) Apply more interstate collaboration to enhance efficiency, 3) Use uniform exam procedures to enhance consistency, and 4) Adopt resource guidelines to assist states that are under-resourced."
Creation
Market conduct has existed as a separate discipline of insurance regulation for about 25 years, but market conduct activities go back to the earliest days of insurance regulation. The actuary and reformer Elizer Wright was collecting information on insurers' treatment of the public and the background of insurance executives in the 1850s.
The complaints filed by federal and state officials that resulted in the U.S v. South-Eastern Underwriters Association case, which led to the McCarran-Ferguson Act, dealt with market conduct issues. For the most part the complaint cites anti-competitive acts by insurers aimed at forcing businesses to buy insurance from cartel-approved agents.
In short, the need for market conduct regulation in a free market has been recognized for a long time. Nevertheless, there have always been enemies of meaningful reform.
Most insurance analysts trace the beginning of modern market conduct regulation to April 1974, when the NAIC sponsored an assessment of insurance regulation by McKenzie & Co. The consultants reviewed the regulatory framework and criticized the lack of coordinated attention that insurers gave to consumer concerns.
The McKenzie report recommended reforms to the oversight of solvency and market conduct. The report called for two separate but equal disciplines of an integrated regulatory framework.
The private consultants recommended that both solvency and market conduct oversight contain the following facets: 1) uniform reporting requirements, 2) statistical analysis of company results and comparative analysis against industry norms, 3) targeted examinations based on the statistical results, and 4) uniform and transparent examination practices and reports.
The consultants recommended keeping market conduct separate from solvency oversight based on practical experience. At the time, financial examiners were responsible for reviewing market-oriented data elements but rarely fulfilled the charge.
With the financial and political support of insurance companies, the NAIC and state insurance departments implemented a solvency surveillance system consistent with the McKenzie report recommendations. Similar support was not given to building a uniform system of market conduct oversight.
When state officials tried to build a similar system for market conduct regulation, they ran into political opposition from insurers. In addition, insurers withheld their financial support for the NAIC when trade association leaders charged that "solvency" money was being used for market conduct purposes.
Unequal
The concept of "separate but equal" has a long record of failure in American history, whether one looks at education, public accommodations or insurance regulation. The idea that market conduct and solvency surveillance were separable in an effective insurance regulatory framework has not proved true. Just as the Supreme Court found in Brown v. The Board of Education, when it comes to market conduct and solvency regulation, "separate but equal is inherently unequal."
The primacy of solvency regulation, often to the exclusion of market conduct oversight from regulatory examination, remains the status quo in most states. Only a literal handful of states fields active market conduct programs. A few more states have a market conduct division in name but do not project an active regulatory force into the marketplace.
GLBA deal
The NAIC took up the issue of market conduct reform in 2000, following the passage of the Gramm-Leach-Bliley Act (GLBA), but outside of several confused meetings on the topic, did nothing all year. Instead, the association spent the year scrambling to find political friends who would not call for a federal insurance charter. In an effort to curry insurers' favors, the NAIC promised to enact "speed-to-market" amendments that deregulate insurers' activities. At the same time, the regulators promised consumer advocates that they would improve market conduct regulation by increasing regulation at the "back-end."
The Consumer Federation of America's (CFA) Director of Insurance J. Robert Hunter still questions the value of removing front-end regulation and relying on back-end consumer protection. Hunter said, "It's silly to let bad products into the market" that could be stopped by prior approval of rates and forms.
Proposed reforms
In 2001, market conduct reform suddenly moved to the front burner when Ario was appointed chair of the NAIC committee on market conduct reform. Administrator Ario brought a creative and active approach to his charge. Very quickly, he invited competing proposals for a new market conduct regulatory system.
In late summer 2001, the design of a new system started to take shape. The proposed system followed the basic tenets of the McKenzie report with its reliance on statistical reporting, analysis, targeted exams and national uniform procedures. With the basic plan in place, Ario and his colleagues began the detail work in December 2001.
In January 2002, Ario told Rough Notes: "We've established the foundation for a strong market analysis program and built consensus for uniformity in exam procedures. We're still at the experimental stage in defining the best model for interstate collaboration, and are just starting to build some common understanding of what goes into an effective regulatory program on the non-financial side."
Data mining
The NAIC effort has just begun defining what data elements regulators need to receive for effective market regulation. For many years, insurer advocates have called for a system that analyzed consumer complaint data as the basis for market conduct regulation. The McKenzie report also called for such an emphasis but not necessarily limited to complaint data.
Consumer advocates and many insurance regulators agree with the report, pointing to problems with sole reliance upon consumer complaints as a measure of healthy markets because complaints are under-reported. According to Hunter: "Many consumers do not know if they have been abused. Redlined people don't know. When told a claim is not valid, many policyholders accept that." In addition, consumers may not know where to file a complaint or that it even is possible to file a complaint. In addition, complaint data are not easily comparable across jurisdictions. Differences in complaint rules or definitions make statistical analysis of complaint data invalid.
For these and other reasons, consumer advocates believe that NAIC recommendations for market conduct reform should not be limited to complaint data alone; however, insurers will fight any significant expansion of data collection. Still, market conduct regulators could make use of many data sets that are already reported as part of financial and market filings to bolster complaint data, including examinations.
According to Ario: "Rigorous analysis of complaint and other data is key if we are to use our resources wisely, but data analysis will never substitute for on-site examination of the 'bad apples.'"
Analysis
The NAIC has borrowed from the experience of financial regulators when designing its proposed new system for market conduct. A proposal for comparative analysis of insurer market conduct data similar to the Insurance Regulatory Information System (IRIS) from the financial regulation will receive consideration this year.
The establishment of a market IRIS system would address one forgotten recommendation of the 1974 McKenzie report. The IRIS system has helped financial regulation target limited examination resources for 30 years, and market conduct regulators could use the same type of tool.
Such a system would reflect the financial model not only in comparative analysis but in that falling outside norms would not mean that companies who fail one or more tests violate rules. Like the financial system, a market IRIS system would only compare individual company results to industry norms. A company that fell outside of norms would receive analysts' attention to determine if there is a problem.
The NAIC will also borrow from the financial system when it establishes a Market Analysis Working Group (MAWG). The working group will have jurisdiction to encourage, develop and coordinate regulatory responses to multi-state market conduct problems.
Uniformity
The question of uniformity of market conduct standards has long been a politically difficult one to answer. From the founding of the Republic, states have excelled at parochial action. States compete to attract business through parochial rules and policies. It is very difficult to establish uniformity at the state level without federal guidelines.
NAIC has failed miserably to introduce uniform standards into market conduct regulation. A relatively weak set of NAIC standards adopted at the committee level seven years ago was ignored in the states. For example, most state insurance codes do not even provide statutory authority for market conduct regulation.
In 2001, the NAIC adopted a new set of "minimum resource requirements" for market conduct regulation. Consumer advocates have questioned whether these requirements will be any more effective than previous recommendations unless the NAIC establishes an accreditation program for market conduct similar to the program for solvency regulation. Some advocates argue that the solvency program should be expanded to include market conduct issues.
Hunter says that an accreditation program is vital to improvement. The consumer advocates who attend the NAIC meetings will make the establishment of an accreditation program a priority for 2002.
To date, insurance company trade groups have not committed significant lobbying effort for or against the reforms. The American Council of Life Insurers (ACLI) has presented testimony that is generally supportive of reform--if the reforms bring more uniform oversight. Property/casualty groups have not been as supportive, but they have not yet launched a major effort to stop the reforms. Producer groups have not actively worked the issue.
Joel Ario will need to strike a balance between competing policy and political aims if NAIC is to succeed in finally bringing improvement to market conduct regulation. He has a chance to do just that, but the job is not yet done. *