Public Policy Analysis & Opinion

The fox in the henhouse

NAIC proposes new reinsurance regulation

By Kevin P. Hennosy

The National Association of Insurance Commissioners (NAIC) has proposed a framework for reinsurance regulation that relies on two elements. The first element would allow certain states to regulate reinsurers on behalf of other states through a “port-of-entry” approach. The second element would establish a regulatory oversight office within the NAIC, an entity that takes pride in being a “private association.”

Even if one does not believe that the NAIC is a corruption charge action waiting to happen, the association’s lack of knowledge regarding the history of insurance regulation is troubling. One of the major Supreme Court decisions that define the states’ jurisdiction and responsibilities under the McCarran-Ferguson Act would appear to rule out the very type of arrangement that the NAIC is proposing for reinsurance. In the words of historian David McCullough, “History is a guide to navigation in perilous times. History is who we are and why we are the way we are.” But the party line at the NAIC seems to ask, “Who needs history or the Supreme Court?”

At the very least, if the NAIC wants to move ahead with this proposal, it will need to seek statutory authority from Congress. Yet that little bit of the real world has not been widely recognized by the association’s membership or senior staff. There is no doubt that if Congress is asked to provide an enabling statute, it will place restrictions and responsibilities on the NAIC as well—in particular with regard to eliminating conflicts of interest, creating financial transparency and submission to congressional oversight.

The association is kidding itself if it moves forward under the assumption that it either does not need a federal enabling statute or to submit to expanded federal oversight. Until reality sets in, the NAIC is doing what it does best: making promises that it cannot keep.

“This proposal sets forth a conceptual framework only,” said New Jersey Banking and Insurance Commissioner Steven M. Goldman, chair of the NAIC Reinsurance Task Force, which drafted the proposal. “Now, we must focus on developing the specifics of this new regulatory regime and taking the appropriate legislative steps to make the proposal a reality.”

While the NAIC appears poised to move forward on this scheme without seeking congressional help, reality might pose a problem in the form of the United States Supreme Court.

On March 28, 1960, the Court issued an opinion in the case of Federal Trade Commission v. Travelers Health 362 U.S. 293 (1960). The case addressed the application of the McCarran-Ferguson Act of 1945, and whether or not one state might regulate on behalf of another.

In short, Court answered that inquiry with a clear and resounding “No.”

The majority opinion in FTC v. Travelers Health quoted from Senator Joseph C. O’Mahoney (D-Wyo.), who brokered the compromise that resulted in the act’s passage. O’Mahoney said, “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.”

Now while this statement from former Senator O’Mahoney which the Supreme Court chose to echo as a means of clarifying its position seems more than straightforward, to the NAIC the term “nothing in the law” leaves room to maneuver. An NAIC memo dated September 12, 2008, describes the proposal as follows:

U.S. insurance regulators have developed a framework that would allow for a state with the appropriate regulatory capacity to be a sole U.S. regulator of a reinsurer writing assumed business in the United States. The framework provides for two new classes of reinsurers in the United States, national reinsurers and POE reinsurers. Each would be supervised by a single state (the home state or POE state). National reinsurers would be licensed by the home state and POE reinsurers would be certified by the POE state.

When one compares the Supreme Court decision and the NAIC’s plans, one thing is certain: The Federal Trade Commission (FTC) and the Antitrust Division of the U.S. Department of Justice should start hiring their insurance staff now. This framework invites a federal lawsuit asking for immediate application of antitrust law and FTC oversight to the reinsurance sector, possibly more.

According to an NAIC statement, “The proposal creates two new classes of reinsurers in the United States: U.S.-domiciled national reinsurers and non-U.S.-based port of entry (POE) reinsurers, and introduces modified collateral requirements for eligible reinsurers. The proposal also establishes a new framework for state-based reinsurance regulation based on the concepts of supervisory recognition, single-state licensure for U.S. reinsurers and single-state certification for non-U.S. reinsurers from approved jurisdictions.”

The NAIC proposal also calls for the creation of a staff oversight for state regulatory frameworks for reinsurance. In theory, the NAIC department will be the arbiter of whether a state that wishes to act as a POE regime is capable of doing the job. It is unclear if the NAIC plans to retain the services of the Easter Bunny or the Tooth Fairy to lead this effort, but the NAIC’s record of playing a policing role over the regulatory actions of its members is at the least fantastical.

Again according to the NAIC statement, “The proposal creates the NAIC Reinsurance Supervision Review Department (RSRD), which will evaluate the reinsurance supervisory regimes of other countries and establish standards for a state to be certified to regulate reinsurance on a cross-border basis. In order to be certified as a POE reinsurer, a reinsurer must be licensed by a non-U.S. jurisdiction recommended as eligible for recognition by the RSRD.”

The only chance that the NAIC would have to play this kind of role would be if Congress passed enabling legislation to grant the association the necessary political and legal standing. Of course, Congress could craft legislation that empowers the NAIC to act and clears away any problems presented by McCarran-Ferguson. Yet if Congress were to do this, the enabling statute would probably place restrictions on the NAIC with regard to reporting, conflicts of interest and regular congressional oversight.

That is not an impossible legislative task; however, the NAIC and its membership have never been willing to subject themselves to federal law or oversight. It is interesting to note that the NAIC statement that touts the proposal makes no mention of a federal enabling statute.

The Reinsurance Association of America (RAA) takes a more realistic tact. On December 9, 2008, the RAA issued a statement that endorsed the NAIC proposal but underlined the need for a congressional enabling statute.

Frank Nutter, president of the Reinsurance Association of America commented, “We applaud Commissioner Goldman and the NAIC for recognizing the global nature of reinsurance and need for comprehensive reform in the regulation of reinsurance as a means to maximize competition and capacity while ensuring solvency. Much progress has been made.”

Lloyds of London also offered words of encouragement to the NAIC, while calling for federal legislation. Lloyd’s Director and General Counsel Sean McGovern observed: “We are pleased that the NAIC has adopted a new policy framework for the regulation of reinsurers. This has been a long time coming and is a major step forward. However, the focus must now switch to ensuring speedy and consistent implementation across all States. This is likely to require some form of federal legislation.”

The NAIC announced that it had adopted the following “Principles for the Creation of the RSRD,” which will be used to guide the NAIC Reinsurance Task Force as the implementation process proceeds.

• The RSRD should be created as a transparent, publicly accountable entity (contemplated to be part of the NAIC), with a governing board composed of state or district insurance regulators, and with director eligibility open to all state or district insurance commissioners, directors and superintendents.

•RSRD criteria relating to ceded premium volume will not unfairly discriminate against otherwise qualified small jurisdictions from approval as a home state or POE state supervisor.

While both domestic and foreign reinsurance trade groups are supportive of the NAIC proposal, when a proposal depends on a private association of state officials the odds of serving the national interest are pretty long.

Rather than relying on the NAIC as a model, the insurance industry and its customers would benefit more from a facility based on the Federal Reserve System. The market needs a reinsurer of last resort that could create some national standards for rates, forms and procedures based on the desire to access the reinsurance facilities for catastrophic losses. Like the Fed, the reinsurer of last resort could consist of regional facilities with boards consisting of representatives of insurers with significant ties to the geographical area. Each facility could hire professional administrative and research staff to monitor insurance and reinsurance markets.

A national board, appointed by the president with the advice and consent of the Senate, would oversee the system, provide regulation to companies and set broad policies with direct congressional oversight. This is a tried and tested format for financial oversight, but it is not receiving attention from policymakers.

NAIC news

In related news, the NAIC elected new leadership at its convention in early December 2008.

• NAIC President Roger Sevigny was appointed New Hampshire insurance commissioner in 2003. Prior to becoming insurance commissioner, Sevigny was assistant commissioner at the New Hampshire Insurance Department. He also worked at Travelers Insurance for more than 30 years in a variety of technical and management positions. He holds a commission in the U.S. Army, having retired at the rank of colonel. A native of New Hampshire, Sevigny graduated from St. Anselm College with a bachelor’s degree in biology.

• NAIC President-elect Jane Cline was appointed West Virginia insurance commissioner in 2001. Prior to her appointment as commissioner, Cline operated a government consulting firm, Jane L. Cline & Associates. Before that, Cline served as commissioner of the West Virginia Division of Motor Vehicles (DMV) and as deputy commissioner of the West Virginia Division of Highways. Cline earned a bachelor’s degree in business administration from West Virginia University and an MBA from the University of West Virginia College of Graduate Studies.

• NAIC Vice President Susan Voss was appointed Iowa insurance commissioner in 2005. Prior to her appointment as commissioner, she served as Iowa’s first deputy commissioner. Voss has held a number of different positions with state government, including assistant attorney general for the Iowa Department of Transportation, legal counsel to the state ombudsman, counsel to the Iowa Legislature in the area of taxation and economic development, and tax policy attorney for the Iowa Department of Revenue and Finance. She is a graduate of Simpson College in Indianola, Iowa, and earned a J.D. from Gonzaga University in Spokane, Washington.

• NAIC Secretary-Treasurer Kevin McCarty is the commissioner and agency head of the Florida Office of Insurance Regulation. McCarty became Florida’s first appointed insurance commissioner in January 2003. He is responsible for Florida’s insurance market, with oversight of company solvency, policy forms and rates, market investigations and new insurance business. McCarty began his career in public service in 1988, becoming an expert in workers compensation issues with the Florida Department of Labor and Employment Security. McCarty earned a bachelor’s degree in political science and a J.D. from the University of Florida.