NAIC UPDATE
NAIC proposes interstate compact
to counter federal charter proposal
By Kevin P. Hennosy
In what can best be described as a desperate attempt to prevent life insurers from asking Congress for federal charter legislation, the National Association of Insurance Commissioners (NAIC) has proposed emulating one of the greatest failures in American history: The Articles of Confederation. The Articles were established under a theory known as "compact federalism" where sovereign jurisdictions act under an agreement to address specific matters of public policy.
At the NAIC's spring national meeting, the association leadership announced that a working group would investigate the formation of an "interstate compact" to govern life insurance and annuity premium rate, policy form and advertising review. Michigan Insurance Commissioner Frank Fitzgerald and Texas Insurance Commissioner Jose Montemayor will co-chair the Interstate Compact Working Group.
"Our ultimate goal is to create a national system of state-based insurance regulation for life and annuity products as an option for companies seeking to sell products on a multi-state basis," said NAIC President and Iowa Insurance Commissioner Terri Vaughan. "We will do this by developing a single set of standards, creating a single point of filing and instituting prompt turnaround on approval decisions. We are drafting an interstate compact agreement in order to accomplish these goals."
Empowering legislation must pass the legislature and receive approval by the governor in each participating state. The U.S. Congress may strike down, by a simple majority vote, any compact agreement deemed to reduce the authority of Congress through collective state action.
The NAIC working group plans to coordinate with the National Conference of Insurance Legislators (NCOIL), National Conference of State Legislatures (NCSL) and National Governors' Association (NGA) to build support for the formation of a compact drafting process.
So it appears that in early 2003, insurance regulators and life insurance company lobbyists will fan out across the country to take the NAIC Interstate Compact Road Show to a state capital near you.
Compacts
The March 18, 2002, news release that announced the NAIC's entrance into the nether-world of compact federalism reassures the reader that this "type of multi-state agreement is quite common; in fact, there are more than 200 interstate compacts currently in use in the United States."
Of course, the NAIC did not mention that most of the 200 compacts consist of two or three states under the coordination of federal agencies like the Department of the Interior or Housing and Urban Development. Most address water rights, transportation infrastructure or waste disposal. In addition, six oil- and gas-producing states coordinate in the regulation of energy through an interstate compact, which served the state of California so well in 2001.
Many of these simple arrangements lead to complex litigation between and among states, arising from disagreements over the administration of the compact. An interstate compact for nuclear waste disposal in the Midwest has resulted in years of expensive litigation.
In some cases, compacts come to an end not with a litigious bang but with a political whimper. The last interstate compact arrangement associated with the NAIC addressed the administration of insurer insolvencies. The membership in the compact swelled to three states. One state withdrew after a short time and the other two states have discussed terminating the agreement.
If the NAIC's mission is to establish "a single set of standards, creating a single point of filing and instituting prompt turnaround on approval decisions," then it will take more than three states participating to reach that end. Furthermore, the regulation of "live" companies will place more tension on the compact agreement than the administration of insurer "estates."
CARFRA
To be fair, the NAIC's latest flirtation with interstate compact construction has a noble enough goal beyond the preservation of regulatory turf for its members. A core group of state regulators wants to preserve a program that allows states to coordinate regulatory reviews for premium rates, policy forms and advertising. The NAIC called the program the Coordinated Advertising, Rate and Form Review Authority, or CARFRA.
The CARFRA program was designed to address insurance company complaints about the cumbersome process of seeking regulatory approval in multiple state jurisdictions. Ten states participate in the program, which represents ten times the number of products that CARFRA has reviewed.
Although CARFRA was designed with insurer wishes in mind, the insurance industry has ignored
the program.
For decades the property/casualty insurance trade associations have complained that the rate and form approval process was slow, parochial and inefficient. Based on these complaints, many observers expected property/casualty companies to welcome the CARFRA initiative. Instead, the companies said CARFRA didn't apply to property/casualty products and ignored it, turning their lobbying
focus to the issue of commercial
lines deregulation.
Life insurers have welcomed CARFRA, but the American Council of Life Insurers (ACLI) has complained that the program has not fully addressed its dream for one set of immovable rules governing life insurance in the United States.
To the limited extent that the CARFRA program has been tested, it has performed well from a system perspective--although its reliance on borrowed employees from a small number of state insurance departments invites charges of chauvinism.
The program's lack of authority to establish standards and enforce their use remains CARFRA's greatest design flaw. The CARFRA program is a private entity free from public accountability and so it possesses no regulatory authority.
In early 2002, the program's boosters began serious discussions about how to imbue CARFRA with authority. In a democracy, public authority comes only with public oversight. The question was: To what public entity could CARFRA submit itself to receive authority in a multi-state jurisdiction?
The most obvious and simplest answer was the federal government. State officials could petition Congress for a federal charter for the CARFRA program itself. The federal-chartered CARFRA option is orderly, national in scope and well-tested in other areas of public policy.
Such a charter would subject the program to oversight by one or more Congressional committees and/or an executive agency. The thought of federal oversight was apparently enough to make CARFRA planners queasy. Instead, the NAIC leadership announced that it would initiate the formation of an interstate compact to replace the CARFRA program.
Clause
What is an interstate compact? The concept of an interstate compact has a long and troubled record in American history. A very few interstate compacts have successfully served the public interest--such as the Port Authority of New York and New Jersey--but most interstate compacts fail under the weight of parochial interest.
In Article IX Section 3, the Constitution prohibits the states "to enter into any Agreement or Compact with another State," without the consent of Congress; therefore, compacts with the consent of Congress were allowed. Through this backdoor the Federalist framers of the Constitution tossed a political bone to the Antifederalists who dogged every effort to organize a national government.
The political philosopher Charles Montesquieu developed the theory of compact federalism that inspired the Antifederalists. The theory sought to construct a state that was large enough to defeat external threats but weak enough to avoid despotism. To do so, Montesquieu downplayed the importance of nationhood and national interest.
The Antifederalist opponents of the Constitution, let by James Wilson, championed the theory in America. The Antifederalists feared change. Men like Wilson believed that change would undermine the revolution by leading to a return to despotism--if not monarchy.
Fear of despotism won the day for the Antifederalists following the revolution. Those arguments and compact federalism shaped the Articles of Confederation. And the experiment nearly cost the United States its independence and nationhood.
Factions and inequality
The Articles of Confederation were undermined by local "factions," the 18th century term for special interests that controlled state governments. Local commercial interests could shape state policy because they were big fish in little ponds. Under compact federalism, local factions were empowered to control, or more often undermine, national policy through control of state governments.
The Articles impeded national commerce through state laws that protected local factions from out-of-state competition. To compound the problem the national policies were difficult to establish.
The Articles failed because compact federalism works on the basis of consensus of member jurisdictions, making national policy next to impossible to establish. One holdout jurisdiction can forestall the adoption of policy. Member jurisdictions learn to use this leverage to their advantage by withholding support until they garner special treatment for their local interests.
Under compact federalism, each jurisdiction retains the right to withdraw from the compact, which results in uneven treatment of member jurisdictions. Jurisdictions with large markets or commercial centers have more practical influence over the policy of the compact. These "super-members" have so much political and economic importance that the other members cannot allow them to withdraw over a policy disagreement. So the other members of the compact defer to the "super-members" on major policy decisions.
Failure
To this day, American school children learn that the Articles of Confederation were a resolute failure. The Articles failed because of a flawed theory of compact federalism, which also serves as the basis of interstate compacts under the Constitution.
The shortcomings of compact federalism led to the Federalist movement that shaped the U.S. Constitution. The Federalists won the debate on the Constitution because attendees to the convention were living under the failed governmental framework known as the Articles of Confederation. This shared experience made Federalist arguments for a strong national government convincing.
The shortcomings that marred the effectiveness of the Articles of Confederation apply to interstate compacts today. Critics point to how special interests control compacts like the arrangement for oil and gas. In addition, many states resisted joining the insurer insolvency compact because of Illinois' dominance over it. Furthermore, unexpected demands or withdrawals from a future compact by participating states could undermine the NAIC's efforts.
There is no reason to expect that these shortcomings would not mar an interstate compact for life insurance rate, form and advertising review. But it appears that this will not deter the NAIC from designing yet another Rube Goldberg framework for insurance public policy. *
The author
Kevin Hennosy, an insurance writer specializing in the history and politics of insurance regulation, covers the proceedings of the NAIC (National Association of Insurance Commiss-ioners) for Rough Notes readers. Hennosy began his career with Nationwide Insurance Companies and then served as public affairs manager for the NAIC. He has written extensively on insurance regulation and testified before the NAIC as a consumer advocate. He is currently writing a history of insurance and its regulation in the United States.