Public Policy Analysis & Opinion

Duck test offends NAIC

Years of acting like a business tags NAIC with trade association label

By Kevin P. Hennosy

The National Association of Insurance Commissioners (NAIC), which informed observers recognize as The Old Gray Mare of Insurance Public Policy, is facing identity issues.

The NAIC will convene March 3-6, 2012, in New Orleans, a city that has a long tradition of "masking," as in wearing a mask to hide the recognizable features of one's face. Masking often allows participants to engage in acts or exhibitions that they would not usually take part in if their true identity was recognizable.

As noted in this column in the December issue, in legislative testimony and other communications, the NAIC describes itself as "the U.S. standard-setting and regulatory support" body. To anyone familiar with the insurance public policy process, applying the term "standard-setting" to the NAIC triggers open laughter. Nevertheless, the chipper public relations juggernaut that the NAIC leadership believes itself to be is doing everything it can to mask its true nature.

The term "standard" is difficult to apply to the crazy quilt of parochial public policy which serves as the insurance regulatory framework in the United States. A standard usually refers to a norm or requirement, and there are countless examples of NAIC representatives arguing against the "one size fits all" approach to policy formation. As such, the NAIC serves as an echo chamber for parochial preference much like "The People's Front of Judea" in the satirical movie The Life of Brian.

The term "standard-setting" communicates the authority to enforce consistency, if not uniformity. At the very least, setting standards requires a level of influence or respect to establish a least common denominator in public policy.

Standards generation

The NAIC can be loosely described as generating standards in three areas: 1) Medicare Supplement Insurance, where Congress charges the NAIC to write standards subject to the approval of the Federal Department of Health and Human Services, 2) the annual financial statement, 3) the codified system of insurance accounting. The last two work products depend on state legislatures to "set" the standard in statute.

In each of these cases, the NAIC wields extensive authority to create uniform policy frameworks—rather than uniform standards. The application of the term "standard" is most accurately applied to the area of Medicare Supplement Insurance, where oversight from Congress and federal regulators do not allow the NAIC much freedom.

With regard to the financial statement and the codified accounting rules, neither body of work is streamlined enough to merit the term "standard." The annual financial statement was the first project addressed by the NAIC in 1871. Since that time, the reporting framework has established a general level of consistency. Nevertheless, the multiple reporting forms, alternative interrogatories and state supplemental rules make this work product more of a framework than a set of standards. The accounting system is anything but standardized: a Christmas tree festooned with parochial ornaments.

Even the NAIC's Financial Regulation Standards and Accreditation Program (FRSAP) cannot be viewed as a standards-setting activity. While 20 years ago, the NAIC leaders under pressure from powerful members of Congress tried to pressure state implementation of uniform solvency laws and regulations, push-back by conservative officials shilling for industry lobbyists put a quick end to that activity. The NAIC quickly pushed standards aside and stressed the concept of "substantially similar" policy approaches, which over two decades became more vague and submissive in meaning.

No enforcement

In the 1990s, NAIC spokesperson Thomas G. Goddard tried to counter congressional criticism that the NAIC FRSAP "had no teeth" to deal with states that did not want to improve regulatory oversight. When the NAIC proposed that accredited states should not accept examination reports from non-accredited states, Goddard called the proposal "The Big Tooth." When states like New York threatened to sue the NAIC for trying to assume authority over states without public authority, The Big Tooth quickly decayed.

The NAIC lacks the public authority to set standards because the association is not subject to public accountability. No elected state or federal regulatory body provides public interest-oriented oversight to the NAIC.

Instead, the NAIC calls its docile commercial interaction with insurance trade associations and individual insurance companies "public accountability." In terms of New Orleans history, the interactive dynamic at the NAIC calls to mind the old Storyville district, where for a price all kinds of "consensus" could be had.

The political accountability of the NAIC to the industry lobby is indisputable. NAIC model laws, model regulations and guidelines—or standards—are not implemented in the states without the lobbying support of insurance industry lobbyists. So the insurance lobby shapes the NAIC "standard" and then has a chance to alter or kill it at the state level.

Because of the NAIC's inability to establish the content of its policy-oriented work products or how its work products are used, it is difficult to call those products "standards" or call the NAIC a standards-setting organization.

Three weeks after Rough Notes first called attention to the NAIC's neo-nomenclature, The National Underwriters' LifeHealthPro published a story by Elizabeth Festa and Arthur D. Postal, which recounted how regulators took umbrage at U.S. Treasury officials who referred to the NAIC as a "trade association."

Apparently this appellation really got under the skin of the association leadership. On December 20, the NAIC conducted a special conference call to adopt a new "official" description of the association:

The [NAIC] is the U.S. standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best practices, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collective views of state regulators domestically and internationally. NAIC members, together with the central resources of the NAIC, form the national system of state-based insurance regulation in the U.S.

If it quacks like a duck

The NAIC's identity issues stem from decades of efforts to avoid paying federal, state or local taxes, and dodging any semblance of public oversight.

From 1871 until the 1940s, the NAIC operated as an unorganized convention of state officials funded by the largess of insurance industry interests. In the late 1940s, and again in the mid-1950s, the NAIC solicited two opinion letters from the IRS that deemed the association "an instrumentality of the states," which was exempt from all levels of taxation.

In the early mid-1980s, the still unincorporated NAIC secured another IRS opinion letter for the purpose of evading New York State tax on sales revenue generated by the Securities Valuation Office (SVO). This letter opined that the NAIC operated consistent with the section 501c(3) of the Internal Revenue Code, which pertains to education, research and charitable organizations.

This did not mean that the NAIC ceased using the "instrumentality of the states" opinion letter from the 1950s. The association used both letters depending on which one served its purposes.

In 1989, the NAIC secured a third IRS opinion letter, which established NAIC as operating consistent with Section 501c(6), which applies to…trade associations! The NAIC obtained this letter in order to establish that it had the legal ability to sell data it collected for regulatory purposes.

A decade later, then NAIC Executive Vice President Cathy Weatherford was furiously working to ingratiate herself to the corporate overlords. This effort to undermine insurance regulation in the public interest included a series of meetings to discuss, "What is the NAIC?"

The NAIC leadership rejected the "instrumentality of the states" concept. Opponents of this viewpoint argued that if the NAIC was tied to the states organizationally, it could be subject to Freedom of Information Act and Sunshine Requests from any member jurisdiction. The NAIC has too many secrets to survive in that kind of sunlight.

The option of organizing as a trade association under Section 501c(6) of the Internal Revenue Code did receive consideration. Progressive commissioners cringed at the thought of public service activity in insurance regulation being classified a "trade."

Less altruistic commissioners worried that as a trade association, the NAIC might fall under the jurisdiction of federal antitrust law. The association's regulatory and moneymaking activities in data collection and producer licensing could be vulnerable to charges of anti-competitive behavior.

Ultimately, the NAIC leadership decided to incorporate for the first time under the notoriously weak corporate registration rules in Delaware, and operate as a research and charitable institution. It is unclear whether the NAIC hides behind an IRS opinion letter issued to the unincorporated association, or whether the new organization sought a new opinion letter.

Policy development

If the NAIC does not want to be seen as a trade association, it needs to stop acting like one—and then submit to the public accountability necessary to legally serve a public role. At present, the NAIC holds neither the gravitas nor the authority to be a "standards setting" organization.

Since the mid-1990s, when Cathy Weatherford decided to sell the association's submission to the whims of a few insurance carrier trade associations in return for an obscene compensation package, the NAIC has focused on how it could make money.

If this commercial drive and devotion to insurance carriers were ever removed from the NAIC, the association could serve a positive role—as it has in brief spasms through its long history with the help of aggressive congressional oversight.

As things stand today, the NAIC cannot serve a regulatory (i.e., standards-setting) role. The Delaware-chartered corporation, doing business as "the NAIC," cannot receive regulatory authority from the states. The authority to regulate the interstate commerce in insurance rests with the Congress under the Constitution, which the Congress lent to the states under disciplined restrictions.

At the time the Congress made that limited and contingent delegation of authority to the states, the statutory drafters wrote: "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."

The Supreme Court established this restriction in insurance case law by quoting the conference committee report in the opinion in FTC v. Travelers Health Association, 362 U.S. 293 (1960).

That means you, NAIC.

However, the Congress could provide a federal charter to incorporate the NAIC and make it subject to direct congressional oversight and budget authorization. The employees of the NAIC would then come under both federal ethics rules and compensation standards.

Some would say this would be an unconstitutional attempt by the federal government to control state governments; however, this contention is not so clear when one considers that constitutional jurisdiction over insurance regulation rests with Congress.

What the Congress gives, it can take away, or oversee.

If federal incorporation is not applied to the NAIC, then it must act within the limits afforded to non-governmental bodies; therefore, it cannot set standards.

Neither is the NAIC a trade association, because insurance regulation is not a trade—even if Cathy Weatherford misused it for profit.

Without federal action to make NAIC a public body, it should operate as a research and education organization under Section 501c(3). In other words, NAIC should conduct research resulting in regulatory policy development. (I would use the term "Think Tank" but after watching the NAIC leadership over the past 15 years, I just cannot bring myself to do it.)

However, as a 501c(3) non profit, the NAIC should quit flouting the law and file the financial disclosures contained in IRS Form 990. Furthermore, the NAIC should file those reports over the past 12 years when it knowingly failed to comply with the law. If U.S. Treasury officials want to see the NAIC come into compliance sooner rather than later, they should file a complaint with the IRS.