Public Policy Analysis & Opinion

Feds have little good to say about NAIC

The power struggle continues

By Kevin P. Hennosy

The National Association of Insurance Commissioners (NAIC) is the subject of expanding oversight from federal officials. In recent years, Congress has focused on health insurance and investment-oriented life insurance products, but most observers expect the new Congress to advocate broad-based deregulation.

Insurance is interstate commerce, which falls under the constitutional jurisdiction of Congress. Several states receive a limited and contingent delegation of authority over insurance through the McCarran-Ferguson Act; however, Congress retains the ability to repeal and oversee the states' use of that authority.

In the 66 years since the passage of McCarran-Ferguson, Congress has looked to the NAIC to foster state compliance with the act. For better or worse, the NAIC is a cauldron where policy consensus among state jurisdictions and factions of the insurance sector is simmered. Federal officials stir the pot from time to time.

IIABA complaint

For example, in a letter addressed to the Department of Health and Human Services (HHS) dated January 6, 2011, Independent Insurance Agents & Brokers of America (IIABA) President and CEO Robert Rusbuldt criticized pressure placed on the NAIC by HHS during the drafting of the Medical Loss Ratio (MLR) policy.

The 2010 health care reform legislation charged the NAIC with developing suggested standards for adoption by HHS. This framework was used repeatedly in the 1980s and 1990s to draft federal guidelines for Medicare supplement insurance.

IIABA opposed inclusion of agent and broker commissions as an element of non-claims costs in the formula for setting an MLR. The health care reform law limits non-claims costs to 15% of premium revenue. Any premium revenue that exceeds the MLR must be rebated to the customer beginning in 2012.

IIABA argues that agent and broker commissions are not part of premium revenue because they are only a "pass-through fee." Consumer advocates and the HHS view agents and brokers as "agents" of the insurance company and not the purchaser; therefore, the compensation is a non-claims cost.

Rusbuldt observed in his letter:

HHS officials played an active role as the deliberations on the NAIC recommendations came to a close during the organization's Fall National Meeting in October, and federal representatives reportedly weighed in on the matter outside of the public eye, discouraged NAIC leaders from considering the popular and broadly supported amendment, and influenced what should have been an impartial and independent decision-making process among state insurance regulators. HHS officials never offered input or suggestions on this matter during the many weeks of public consideration or submitted comments in written form. It is clear that many state regulators and much of the insurance regulatory community at large strongly support the exclusion of agent and broker compensation from the MLR calculation, yet the interim final rule does not reflect their will.

GAO Report

Sometimes, the NAIC invites federal attention. The Government Accountability Office (GAO) issued a report on January 18, 2011, which criticized the NAIC and state insurance regulators for a lazy approach to regulating financial planners.

The criticism came in the pages of a report bearing the catchy title Consumer Finance: Regulatory Coverage Generally Exists for Financial Planners, but Consumer Protection Issues Remain. The GAO issued the report in compliance with provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The GAO found that the NAIC has failed to study and address the sale of "high-risk insurance products." The GAO recommended that the "NAIC assess consumers' understanding of the standards of care associated with the sale of insurance products."

In response to the GAO investigation, the NAIC said it would "consider" GAO's recommendation.

The GAO report describes the financial planning sector as an ill-defined and unregulated force in the market. According to the report, "[T]he number of financial planners in the United States rose from approximately 94,000 in 2000 to 208,400 in 2008, according to the Bureau of Labor Statistics."

The report concludes that the Securities and Exchange Commission is not funded or staffed to the extent it needs to be in order to apply public interest-oriented oversight to the financial advisor sector.

The report reserves its sternest criticism for the insurance regulatory framework because of a lack of uniformity in suitability requirements tied to the type of products or the age of the consumer:

According to NAIC, many states have requirements that insurance salespersons sell annuities only if the product is suitable for the customer. However, NAIC notes that some states do not have a suitability requirement for annuities. Consumer groups and others have stated that high sales commissions on certain insurance products, including annuities, may provide salespersons with a substantial financial incentive to sell these products, which may or may not be in the consumer's best interest.

The NAIC was warned about this problem a decade ago, by advocates for insurance producers and consumers alike, when the association was considering model rules governing life insurance and annuities.

Regrettably, the deliberations took place at a time when the NAIC was earnestly trying to curry favor with life insurance carriers in the wake of the repeal of the Glass-Steagall Act. The NAIC feared that life insurance companies would join calls to Congress for an optional federal charter for insurance companies. The NAIC fears this proposal because it is assumed that federally chartered insurers would never be subjected to state premium tax liability. The avarice for premium tax revenue put the normally amiable NAIC in a particularly flirty mood toward life insurers at the time that suitability recommendations were under consideration. Favors were done.

The working group responsible for writing the NAIC suitability recommendations was chaired by Iowa, the Hawkeye state, which turns a blind eye to the regulation of life insurance companies. The assumption is that the state made a trip to the proverbial crossroads in the early 1980s when agricultural land prices crashed. The employment and investment power of several life insurance enterprises became so important to the state that political leaders simply capitulated to the wishes of those institutions.

In the 1990s, when an Iowa insurance commissioner led an effort at the NAIC to write rules to protect senior citizens from corrupt life insurance sales, he was removed from office. The commissioner was replaced by a professor named Terri Vaughan, who cultivated close ties with the Iowa life insurance sector. Upon leaving office, Vaughan was rewarded with a seat on the board of an Iowa-based life insurance firm, and later she had a position created for herself at the NAIC.

It was Vaughan who, while at the Iowa insurance department, appointed a deputy commissioner to chair the NAIC Suitability Working Group—a woman who exhibited no interest in fair competition or efficient regulation and who chaired meetings with all the charm of your average troll.

As the NAIC Suitability proposal neared completion, the chair adopted amendments suggested by life insurance carriers that made it easier for unlicensed salespersons to compete for business and weakened consumer protections. The chair even closed down comments from the floor in opposition to the amendments. The fix was in.

As a result of the Iowa Insurance Division actions, the NAIC model suitability law was littered with loopholes. The law did not extend to financial planners, and insurance agents were free to present themselves as financial planners. The NAIC argued that most states could prosecute agents who present themselves as financial planners under the unfair trade practices act, but that was never true in all jurisdictions—and a very rare occurrence in most states.

This past January's GAO report does approvingly cite the NAIC's actions in adopting model prohibitions for "senior-specific designations" in the sale of life insurance and annuities; however, only half the states have adopted the recommendations.

The report also pointed out that the NAIC model laws and regulations governing life insurance in general do not include suitability requirements. The GAO cites the omission as a shortcoming.

The GAO provided the NAIC with the opportunity to provide written comments on the draft report, which is included as an attachment final report. The NAIC comments acknowledged that the association leadership "generally agrees" with the report's findings; however, the task of reviewing the report findings was sent to a committee chaired by none other than the Iowa insurance department.

Chairman Bachus

For the past six years, federal officials have focused on the NAIC's consumer protection record, but this might be changing. House Republican leaders can be expected to put pressure on the NAIC to reduce regulatory oversight at the state level.

Representative Spencer Bachus (R-Ala.) assumed the chair of the House Financial Services Committee in January. Rep. Bachus brings a viewpoint on the role of regulation that runs counter to consumer protection.

On April 9, 2009, Rep. Bachus told the Birmingham News, "Some of the men and women I work with in Congress are socialists." The next day he clarified his statement by telling the same paper that 17 members of Congress were socialists.

Then on December 13, 2010, Rep. Bachus told the Birmingham News, "In Washington, the view is that the banks are to be regulated, and my view is that Washington and the regulators are there to serve the banks." The Congressman later softened his remark by claiming that he just meant that regulators should not micromanage banks.

With the House Financial Services chairman holding such extremist views, it is not likely that the committee will ask for GAO reports on NAIC's consumer protection record in the near future.

Instead, one can expect the NAIC to face hearings and investigations aimed at weakening the regulatory framework. One can expect Chairman Bachus to revive in some form the State Modernization and Regulatory Transparency (SMART) Act, which would have federalized insurance regulation, encouraged financial consolidation and encouraged foreign competition to American companies.

On March 18, 2005, the NAIC released a statement in opposition to the SMART Act: "Our concerns are deeply rooted in the basic structure of the SMART Act that mandates federal preemption of state laws and regulations, federal supervision of state regulation, and complete rate de-regulation for all states. We do not believe that tweaking the language of the SMART Act discussion draft can resolve these basic conflicts."

Furthermore, the insurance commissioners warned: "The SMART Act would create unhealthy regulatory confusion in insurance markets by subjecting state regulations and orders to second-guessing and possible interference by a new federal entity called the State-National Insurance Coordination Partnership. In addition to raising serious legal and practical concerns regarding its composition, powers, and administration, this partnership would encourage time-consuming and expensive litigation by those who disagree with state regulatory actions, during which the legitimacy of state actions would hang under a cloud of doubt until a final resolution is reached in federal courts."

In the words of Bob Dylan, "Ya Gotta Serve Somebody."

The author

Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance Cos. and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.