Public Policy Analysis & Opinion Can NAIC work without pressure? The association takes up statistical agency examinations free from scandal or Congressional prodding By Kevin P. Hennosy A working group of the National Association of Insurance Commissioners (NAIC) is considering whether or how state regulators should examine national and regional insurance statistical agencies. Who says the NAIC does not know how to have fun? Statistical agencies conduct the nitty-gritty work of measuring risk. Risk is an invisible commodity, which policyholders pay insurers to haul away. Risk cannot be smelled or tasted; however, statistical agents can measure the weight of risk like some kind of gaseous treasure. The origin of statistical agencies goes back to the system of fire insurance cartels that dominated fire insurance between the Civil War and World War II. The cartel organizations developed the facilities to compile data, compute rates and create forms. Now, please understand that I am not alleging cartel behavior in today’s statistical organizations. A little thing known as the U.S. vs. South-Eastern Underwriters Association decision crushed the old cartel organizations in 1944. The cartel offices collected loss data, computed it and created rates and policy forms based on those computations. The cartel system could enforce the use of its work products. Contemporary statistical agencies issue advisory rates and forms. An uncharted array of national, regional and local statistical agencies operates across the country. At the NAIC meeting conducted in early December 2005, regulators reported that they were finding statistical agencies that they never knew existed. What many regulators have also found out in recent years is that they are directed by statute to examine statistical agencies’ operations. At the NAIC meeting one regulator lamented that it was “one of those things put in state law back in the ’40s or ’50s.” That dismissive observation is probably accurate, but the lack of institutional memory in the hallowed halls of insurance regulation is lamentable. Don’t these people have the seven-volume set of the Armstrong Report over their mantle too? State legislatures put a lot of regulatory requirements into insurance codes in the immediate post-war period. This was because Congress passed something called the McCarran-Ferguson Act that required the states to regulate insurance in order to hold jurisdiction to tax insurance. Originally, congressional drafters of McCarran-Ferguson assumed that there was no need for states to regulate statistical agents because statistical agents would not exist. The drafters assumed that states would collect and compute the loss data necessary to establish rates and forms. As the legislation received final approval, the conference committee negotiators addressed the role of statistical organizations. They reminded the states that the cartel offices should have no role in the new regulatory framework. The committee report states: “Nothing in the proposed law would authorize a State to try to regulate for other States, or authorize any private group or association to regulate in the field of interstate commerce.” 91 Cong. Rec. 1483. States balked at the idea of hiring the personnel necessary to replace the work previously done by the cartel offices. Remember this was at a time when such work was conducted through mechanical tabulators and manual adding machines. State officials and the NAIC went back to congressional leaders and asked whether there was a way for the old cartel institutions to continue doing the labor-intensive number crunching. Working with former Senator Joseph C. O’Mahoney, who brokered the compromise on McCarran-Ferguson, state officials developed frameworks where statistical agencies could be deputized to provide support to governments without transferring regulatory authority. In addition, the states would provide oversight (including examinations) to statistical agents to test the validity of the computations made for insurance industry clients. Once this agreement was reached, states started amending statutes to require oversight. It appears that many states never acted on this statutory requirement. At the NAIC meeting in December, representatives of several states stood up and announced that they had the requirement on the books but had never conducted a single examination. In the intervening half-century, the role and organization of statistical agents changed. The greatest change came in 1971, when consolidation in the sector led to the formation of the Insurance Services Office (ISO). The ISO has grown to become the preeminent source of information on risk. The organization maintains a database of information gleaned from insurance policies, claims and other resources. The ISO subjects the data to testing and cross checks to assure accuracy. The ISO plays an important role in the business of insurance. Insurers throughout the country and across many lines use ISO data, expertise and advisory recommendations to shape prices and products as well as conduct business operations. In addition to ISO, many other statistical agencies serve geographical regions or particular markets. A reasonable observer can do little but opine that the role of statistical agencies is fully integrated in the business of insurance. Since the McCarran-Ferguson Act only grants authority to the states and exempts the insurance sector from direct federal oversight contingent upon state application of regulation to insurance, state oversight of statistical agencies appears prudent. At the December 2005 NAIC meeting, the working group discussed the fact that only two states regularly examine the ISO: Georgia and New York. As the meeting wore on, representatives of other states came forward to discuss the fact that statutory examination requirements have been ignored. This presents a troubling problem for ISO and several other smaller but regional agencies. As state insurance departments awaken from another aspect of their somnambulate existence, statistical agencies could face a line of state examiners and a stack of examination invoices. The NAIC and state regulators have several policy options from which to choose. First, policymakers could make an effort to remove the statistical agency examination provisions from state insurance codes. Ten years ago, in the initial spasms of insurance deregulatory fervor, such legislation might have been possible. Not today. That era of deregulation ended with New York Attorney General Eliot Spitzer’s insurance investigation. The political paradigm has changed. Second, policymakers could maintain the status quo. This means regulators could continue to ignore the examination provisions of their laws and hope that they are never pulled in front of a legislative oversight committee or angry judge. Or the regulators could cue up to conduct redundant examinations on ISO and other organizations at great cost. In addition, regulators could maintain the status quo by simply adopting the examination reports of one or two states—without regard to their local laws and regulations. The “just accept another state’s report” might sound like an elegant compromise, but the ghost of Congress’s past might rear its ugly head. Remember that definition of regulation that the conference committee on McCarran-Ferguson provided and the Supreme Court wrote into jurisprudence? That definition reads in part, “Nothing in the proposed law would authorize a State to try to regulate for other States …” If states simply adopt the reports of New York and Georgia to fulfill the statutory requirement to examine statistical organizations, are the states really not relying on New York and/or Georgia to regulate for them? The answer requires further inquiry, but if the states do not conduct other affirmative regulatory activities other than reviewing the examination report—it sure looks like one state regulating for another state. A third option borrows from the financial examination framework and, I believe, offers the model to use. Regulated entities file a relatively uniform data set with regulators on an annual or quarterly basis that receives analysis from the NAIC and the states. The NAIC focuses on national trends and the states focus on local results. This analysis produces baseline statistical norms and identifies where a regulated entity exhibits results outside of the norm. Either national or local analysts can identify whether this anomaly is harmful or not. If more information is necessary, the analysts can call for a targeted examination on a single state or cooperative multi-state basis. If necessary, states can order corrective or enforcement actions. This third approach calls for the inclusion of statistical issues and agencies into the market regulatory system. The NAIC is slowly responding to pressure to build such a system for market issues based on the states’ relatively successful system of solvency oversight. The NAIC could launch this integration of statistical agencies into the market regulatory framework. The association’s committee system currently places a firewall between statistical issues and market regulation for no good reason. The NAIC maintains a Statistical Task Force under a Property/Casualty Committee rather than the Market Regulation Committee. In addition, the committee formed a working group to look into regulatory examination issues related to national or regional statistical organizations. The working group received the following direction from the NAIC Executive Committee in 2005: Develop protocol for examination of national or multi-state rating organizations to be more comprehensive, efficient, and possibly less frequent than the current patchwork of single state exams. Solicit input and collaboration from other interested and affected task forces and committees. Among important issues to resolve are: • Initiation of exam and participation by one or more interested states • Collaboration of participating states on the scope of exam • Maintaining confidentiality of exam information by states and contractors, if any • Access to data from, or relating to, non-participating states • Process for curtailing use of data for which access is denied or not readily available • Sharing sensitive state-specific information with non-participating states • Allocation of examination costs Regulators collect and review statistical data for market regulatory purposes, so it only makes sense to integrate the Statistical Task Force and the working group on examinations into the jurisdiction of the Market Regulation Committee. These issues seem completely related to market regulation. The working group on the examination of statistical agencies reports directly to the Property Casualty Committee. At the meeting in December, the debilitating effects of this firewall between statistical reporting and market regulation became clear. Several senior members of the working group had no understanding of the greater market regulatory framework. Some were not even aware that the NAIC Market Conduct Examiners Handbook contains a chapter on the examination of statistical agencies. This lack of understanding could result in real harm done to the current system. For example, in an exchange over the proper scope of examinations, an interested party mentioned the issue of ownership and control of statistical organizations. A senior regulatory member of the working group said that he did not think the charge of the working group should expand to that issue. Several observers commented that the current examination framework includes disclosure of ownership and control and the charge directs the working group to look at the examination process. The same regulator then opined authoritatively that the working group would not expand examinations to include ownership and control issues. The NAIC is confronted by what should be a welcome opportunity. The association has been asked by its members to create policy recommendations without being under the usual outside pressure. There is no scandal. There is no pressure from Congress to do something. It will be interesting to note whether the NAIC can operate under such amenable conditions. * The author |
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