Members will hear testimony on the current regulatory regime that governs the insurance industry and proposals for improving such industry regulation. Senator McCain will preside. Following is a tentative witness list (not necessarily in order of appearance):
The Honorable Fritz Hollings
For 150 years, insurance has been regulated by the states, and generally speaking, the industry has provided products that have enabled businesses and people to accept risks they otherwise would not. But there are trends developing that strike me as necessary to revisit the way the industry is regulated. First, the insurance industry itself comes to Congress asking for bailouts and backstops with increasing regularity. Then, the industry turns around and asks for further deregulation, and even the ability to pick their regulator, when there are significant problems in the market that calls for more vigorous oversight. Of course, the insurance industry wants the regulator they get to pick to have a light hand so they can compete with banks in a climate that emphasizes short-term profits over long-term stability. The GAO just weeks ago released a report analyzing the of market conduct regulation by the States. Market conduct regulation oversees how insurers treat consumers. The report said: "States generally have the systems and tools in place to regulate financial solvency. But market regulation is hindered by limited resources, a lack of emphasis on important regulatory tools, and the framework of the system itself, which requires individual states to oversee companies that operate in many states or nationwide. As a result, market regulation is currently based on overlapping and often inconsistent state policies and activities. While it provides some oversight, it may also place an undue burden on some insurance companies and, at times, may fail to adequately protect consumers." Due to the limits of this fragmented, state-by-state regulation, no one stopped the poor investments made by insurance companies during the late 1990s that have helped drive up premium increases during the past three years. The average policyholder may not know that insurance companies do not just profit on the difference between premiums collected and claims paid. Large portions of insurance company income is derived from investing premiums into stocks and bonds until they need the money for a large payout. An insurance company will often make more profit from investing the premiums of homeowner policies than on the margin between homeowner premiums and claims. By 2001, large insurance companies had more than half of their portfolios invested in corporate stocks and bonds. This leaves insurance companies vulnerable to the stock and bond markets as never before. According to the Foundation for Taxpayer and Consumer Rights, just 10 companies lost $274 million on investments in Enron, WorldCom, Adelphia, Global Crossing and Tyco. State Farm Mutual Auto increased its level of corporate investment by 32 percent since 1994, but lost $60 million on WorldCom and $13 million Enron. Allstate lost $23 million in the first half of 2002 as the company shed its Tyco shares. USAA had 57 percent of its portfolio in the stock market, and lost $63 million in international energy and telecom investments. It is no coincidence that we have seen insurance premiums rise as the stock and bond markets have lost value during the past couple years. When a customer receives a larger bill for homeowners insurance, it is not because the rate of homeowners claims has dramatically increased; it is because the insurance company is looking to recover the lost revenue from poor investment decisions. These companies reap the gains when investment returns are good, but then stick policyholders with the bill when investments go bad. Some insurance executives and representatives of tort "reform" interest groups have even admitted to this trend. Victor Schwarz, General Counsel of the American Tort Reform Association, was quoted in the April 20, 2003, Honolulu Star-Bulletin as saying, "Insurance was cheaper in the 1990s because insurance companies knew that they could take a doctor's premium and invest it, and $50,000 would be worth $200,000 five years later when the claim came in. An insurance company today can't do that." And Donald Zuk, CEO of Scpie Holdings, Inc., a leading malpractice insurer in California, told The Wall Street Journal in 2002 that recent premium rate increases by insurance companies were "self-inflicted" due to poor business management practices - not a spike in malpractice claims. We need real federal regulation, not "federal option charter" regulation, to correct these problems in the insurance industry. I have introduced S. 1373, the Insurance Consumer Protection Act of 2003 to do just that. This bill will establish the Federal Insurance Commission, an independent commission established within the Department of Commerce. It will be comprised of five commissioners serving seven year terms, regulating property and casualty lines as well as life insurance. Workers compensation and state residual workers compensation pools will be excluded. Under S. 1373, the McCarran-Ferguson antitrust exemption will be repealed. The Federal Insurance Commission will be the only regulator for interstate insurers. Insurers that only do business in the state in which they are domiciled (intrastate insurers) will be regulated by the states. The Commission will be responsible for: Licensing and Standards for the Insurance Industry Regulation of Rates and Policies Annual Examinations and Solvency Review Investigation of Market Conduct Establishment of Accounting Standards The Commission will be able to investigate the organization, business, conduct, practices and management of any person, partnership, or corporation in the insurance industry. The Commission will also create a central depository for insurance data for the purpose of studying the insurance industry. In addition, under S. 1373 an independent office will be created within the Commission to receive complaints and reports about improper insurance industry practices from the public, and to represent consumers before the Commission. Consumers will have a right to challenge rate applications before the Commission. The Commission will have the ability to issue cease and desist orders for practices that would place policyholders at risk, and to levy civil fines for violations of Commission regulations. Actions that require enforcement actions outside the scope of the Commission's mandate will be referred to the proper agency. Criminal prosecutions will be handed to the Department of Justice. Finally, a national guaranty corporation will be created to provide payment of life, property and casualty, and health claims when the insurer is unable to pay. The corporation will also be responsible for liquidating insolvent insurers. Real federal regulation as outlined in S. 1373 would protect consumers by giving them a voice in the setting of premium rates. Experiences with California's Proposition 103 legislation, which shares many of the same concepts as my bill, prove that involving the consumer in rate-setting will reduce insurance rates for consumers. Proposition 103 has saved California consumers billions of dollars via the prior approval regulatory structure it created. In the past two months alone, $62 million has been saved by doctors and homeowners due to rate challenges brought by consumers. This is a model that has worked in one of our largest and most populated states, and it should be a guidepost on how insurance regulation can provide consumer protection and stability. Good actors in the insurance industry also would benefit from federal regulation. Now, national insurance companies must navigate 50 different state laws regarding insurance, and must also navigate 50 different insurance commissions. Having one set of rules to govern the entire industry would create great efficiencies and competitive opportunities for these companies. By standardizing market conduct regulation standards, states could rely on examination results of other states, thus reducing the number of duplicative, expensive examinations companies now undergo. There is no doubt real federal regulation of insurance - not "federal option charter," which would allow each company to choose their regulator - would benefit the industry, the consumer, and the stability of our overall economy. I consider the bill a starting point to spark discussions about how we can transform our fragmented oversight of the insurance industry into a streamlined, comprehensive review process that will better protect consumers and the free marketplace. ###
The Honorable John McCain
· Good morning. The purpose of today’s hearing is to explore the effectiveness of the current state-based system of insurance regulation. In addition to examining the existing system of regulation, we will hear testimony about options for improving the current regulatory system, including initiatives to enhance state-level regulation and proposals to more actively involve the federal government in the regulation of the insurance business. · While the hearing topic may be straightforward, the question of how insurance should be regulated is complex and has long been debated. Over the decades, government officials, consumer groups, and industry participants have questioned whether the states should be the primary regulators of the insurance industry. Indeed, since the passage in 1945 of the McCarran-Ferguson Act, which granted the states the exclusive power to regulate the business of insurance, the federal government has taken an increasingly active role in the regulation of the insurance industry. Still, two major segments of the insurance industry remain almost exclusively within the jurisdiction of the states, namely property and casualty insurance and life insurance. Today’s hearing will focus on the regulation of those two lines of insurance. · As we continue to consider and debate the merits of whether the states or the federal government – or some combination of the two – should regulate the insurance industry, I would remind everyone that insurance is a unique business structured to protect both individuals and businesses from the risk of financial loss. Because insurance is a business, we need to make sure that insurance companies are not overly burdened by unnecessary regulation. Just as importantly, because insurance is so crucial to the day-to-day lives of Americans, we must also ensure that the interests of insurance consumers are protected regardless of whether the states or the federal government regulate insurance. · In sum, our overarching purpose should be to strike a balance to ensure that consumers are well protected and that insurance companies are not saddled with unnecessary regulation, which can hinder their viability and jeopardize the very consumers we are seeking to protect. · I thank the witnesses for appearing before the Committee today and I look forward to hearing their testimony.
Witness Panel 1
Mr. Ernst Csiszar
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Mr. Craig Berrington
Thank you, Mr. Chairman. My name is Craig A. Berrington, and I am Senior Vice President and General Counsel of the American Insurance Association ("AIA"). I appreciate the opportunity to testify here today on the important issue of insurance regulatory reform. Attached to my written statement is an article that appeared in the August 2003 edition of Best’s Review, which further details AIA’s position in favor of an optional federal charter. AIA is a national trade association representing more than 424 property and casualty insurers that write insurance in every jurisdiction in the United States, with U.S. premiums exceeding $103 billion in 2001. AIA member companies offer all types of property and casualty insurance including personal and commercial automobile insurance, commercial property and liability coverage, workers' compensation, homeowners' insurance, medical malpractice coverage, and product liability insurance. For AIA members, insurance regulatory reform is, and will continue to be, a key concern. The ability of insurers to bring products to market in a timely and cost-effective manner free from government price controls, along with uniform regulatory treatment regardless of where they are domiciled and where they do business, is critical. Real reforms are necessary if insurance is to remain a competitive, vibrant industry. The state insurance regulatory system for property and casualty insurance is premised on government price controls and on the imposition of barriers to bringing new products to market. This system is replicated 51 times, often in different and inconsistent ways. Even within each jurisdiction, there are often differing systems for different lines of business, making the process incredibly cumbersome, inefficient, and ultimately unresponsive to consumer needs. A limited survey of state requirements finds approximately 350 dictating how rates are to be filed and reviewed and approximately 200 relating to the filing and review of new products. We need a more efficient regulatory system than this. Recognizing that the long-term best interests of policyholders, insurers, and the overall economy are served by an efficient, effective regulatory system, AIA examined the “value chain” associated with the regulation of insurance companies and products and identified opportunities — based on both domestic and international regulatory models — to remove current regulatory impediments to competition, thus creating greater value for all stakeholders. From that discussion and analysis of the current regulatory system, several themes emerged. First, an entrenched state focus on government price and product controls discourages product innovation and competition, ultimately denying consumers choice. The current regulatory system concentrates on the wrong things. While repressing prices may be politically popular, it is ultimately economically unwise as it masks problems and over a period of time can lead to a crisis, forcing sizable subsidized residual markets and market withdrawals that exacerbate the problem. Any system that requires companies to “beg the government” in order to use their product and to establish a price improperly places the government in the middle of marketplace decisions. In contrast, a system that relies on marketplace competition and that makes the consuming public the central player in the system is well-focused. Second, there is inconsistency among state statutory and legal requirements and the administration of state systems. The need to meet differing regulatory demands in each jurisdiction increases compliance costs, discourages innovation, and makes it difficult for insurers to service customers doing business in more than one state. The current regulatory system is a jumble of individual state requirements. State insurance codes provide hundreds of different rate and form regulatory requirements for the various lines of insurance. Uncodified practices of many state insurance departments, known as “desk drawer rules,” impose additional, often needlessly onerous, procedural requirements. One problem that this causes in the marketplace is that companies wishing to launch a national product cannot do so until both the price and product have been separately approved in every state. Third, in many states, regulatory rate and form approval delays are chronic and increasing. Federally-regulated financial services industries have no similar regulatory obstacles to getting rates and products to market quickly. The emphasis on such controls in insurance slows products from entering the market and inhibits product creativity. Our industry stands out as one of the most heavily regulated sectors of the U.S. economy. But, it is not just a question of regulation. It’s the fact of misguided regulation. If the insurance industry cannot keep pace and cannot provide consumers with real choices, the economy suffers. Insurance provides much-needed security for businesses and individuals to innovate, invest and take on risk. Yet the ability to innovate, invest and take on risk is substantially impeded because insurers labor under the weight of a “government-first, market-second” regulatory system. This system rewards inefficient market behavior, subsidizes high risks and masks underlying problems that lead to rising insurance costs. The bottom line is that consumers ultimately will pay more for less adequate risk protection than would be the case under a more dynamic, market-oriented regulatory system. Debate & Solutions: Optional Federal Charter Proposal and Other Ideas There are a variety of views within the industry about the most appropriate solutions to this regulatory dilemma. Almost all those involved in the debate recognize that, on the whole, the current state system is under great stress. There is, in addition, we believe, a growing consensus – although certainly not unanimity – that the state system is not just stressed, it is broken. The only question remaining is how best to solve the problem; there are a variety of ideas. For AIA and a number of others, the solution is a new regulatory paradigm that eliminates government obstacles to getting prices and products to market, and thereby providing consumers with choice. Members of AIA were there at the creation of the state system. They have much invested in this system, which they know well. They have been at the forefront of efforts to reform the system and they approve of substantive reform efforts of individual state insurance commissioners and of the National Association of Insurance Commissioners (“NAIC”). However, recognizing systemic barriers to efficiency and competition, AIA’s Board of Directors decided more than 2 years ago that the kinds of reforms necessary to keep the industry vital and to maximize consumer benefits were unlikely to be achieved in a state regulatory environment. Thus, the AIA Board voted to support the enactment of optional federal chartering legislation, which would allow insurers to obtain a federal charter, but not to displace the state system for those who want it. One of the benefits of our optional federal charter proposal is that it accommodates those who believe their business is best served by local regulation. Other benefits will follow, including consumer choice, healthy competition and the ability of regulators to focus a national system on meeting core financial tests and on protecting consumer interests. AIA is not alone in advocating an optional federal charter solution. After our Board determined to advocate for this system, we were joined by the American Council of Life Insurers and the American Bankers Insurance Association. Further, non-AIA member insurers are looking increasingly at federal solutions as well. Support for the Optional Federal Charter Solution AIA believes that optional federal chartering will benefit consumers and boost the competitiveness of the insurance industry. Our proposal is designed to provide options for consumers, to achieve systemic efficiency, and to normalize regulation of insurers. While some aspects of the insurance industry are local in nature, the business is increasingly national and international in its customer focus and regulatory needs. The insurance industry is extremely diverse. A state-based regulatory approach may be appropriate for companies that operate on a single-state or regional basis, but, for national and international companies — as well as their customers — the current fifty-one-jurisdiction regulatory system is costly and inflexible. Reforms such as optional federal chartering would allow companies and customers to choose the regulatory approach that is most suitable for their size and scope of operations. Principles for Optional Federal Chartering Keeping this context in mind, our proposal focuses on financial integrity, not government rate and form regulation. The proposal creates a federal regulatory system in the Department of the Treasury to grant federal charters to qualified insurers and reinsurers – and to their agents – for the purpose of regulating their conduct. The proposal is designed to regulate federally chartered insurers, not to create or regulate state reparations laws, like the mandatory requirements of state automobile or workers’ compensation insurance laws. That authority over state reparations laws would remain within the state legislatures. The proposal otherwise preempts most state insurance regulatory laws for those insurers that obtain a federal charter. The proposal substantially normalizes the federal antitrust environment for federally chartered insurers, and allows any insurer, reinsurer, or insurance producer that wants to stay in the state regulatory system to do so without any obligation to the federal system whatsoever. In sum, the optional federal charter proposal fosters freedom of choice for insurers and their customers. More specifically, in terms of scope, the proposal would apply to all lines of property and casualty and life insurance. Insurers and holding companies would have essentially unrestricted options with regard to use of the federal chartering system. For example, a holding company could decide to have all of its insurance affiliates federally chartered, just some, or none. For mergers and acquisitions, states would have a role only if one or more of the insurers were state-licensed. The federal regulatory system would be organized around a new Treasury Department agency. The director of the new agency would serve a six-year term, and would be appointed by the President with the advice and consent of the Senate. The new federal agency would be funded by the federally chartered insurers, not by the public. It would have no rate regulation authority, but would have access to policy forms, which federally chartered insurers would be required to make available for inspection. Chartered insurers would also be required to file an annual list of their standard policy forms with the federal agency. The role of the new federal office would be to make concrete and to enforce the statutory standards for obtaining and retaining a federal charter through regulation. The office would also have full financial and market conduct regulatory and examination authority, including the authority to establish prohibitions on unfair trade and claims practices. An insurer could lose its federal charter for any knowing significant violation, and could also be fined or required to pay restitution. Except for non-preempted areas such as mandatory state residual market participation, a state insurance regulator could not bring a regulatory action against a federally chartered insurer, but could file a complaint with the federal agency. The proposal also includes a rehabilitation and liquidation process, incorporating the NAIC model, and authorizes insurers to establish self-regulatory organizations subject to federal oversight. In terms of the interplay between federal and state law, there are three critical areas – state law preemption, antitrust, and state tort and contract law – affected by the proposal. First, all state insurance laws and regulations would be preempted by the proposal unless specifically preserved. Examples of preempted areas of regulation include licenses; solvency and financial condition; mergers and acquisitions; rates and forms; marketing; underwriting; claims; so-called “take-all-comers” laws; and policy non-renewal or cancellation limitations. Major areas of state regulation that are expressly not preempted by the proposal include mandatory residual markets; premium tax laws; state guaranty funds; general corporate governance laws; mandatory coverage provisions of state reparations laws; workers’ compensation administrative mechanisms; and mandatory statistical or advisory organizations. Even for areas of state regulation that remain in effect, states cannot use those to discriminate against federally chartered insurers or their affiliates. The new federal agency can block any state laws that it finds discriminatory. In addition, it can block any other state law that is inconsistent with the optional federal chartering proposal. Second, with regard to the antitrust interplay, the proposal substantially normalizes the application of the antitrust laws to federally chartered insurers as the quid pro quo for a marketplace-oriented regulatory system. As a result, there is generally no McCarran-Ferguson Act protection from the federal antitrust laws, except for state-mandated activities. In practical terms, this means that collective ratemaking activities are subject to antitrust scrutiny, but that specific antitrust protection remains for policy forms development as the tradeoff for regulatory authority. Third, with respect to state tort and contract law, federal chartered insurers are still subject to state court tort and contract suits, as well as to state “bad faith” insurance regulation laws. NAIC Role and Limitations in Regulatory Modernization AIA has been actively engaged in advancing the elimination of government rate and form controls on a state-by-state basis for a number of years. AIA applauds the spirit of NAIC efforts and we will continue to work with the NAIC to produce needed regulatory reform in the states. AIA, as well as some other trades and insurers, fully supports continued efforts to modernize and improve the state regulatory system. But, we urge Congress to move forward with the creation of an optional federal charter because ultimately it is impossible for the NAIC to deliver uniformity or complete systemic reforms at the state level. Efforts at regulatory uniformity have consistently failed, because many states have refused to sign on to a united effort and there is no guarantee that any uniform standards would actually import the correct standard. What is left, at best, is a dysfunctional uniformity, such as: o Privacy: In response to the Gramm-Leach-Bliley Act’s (“GLBA”) privacy standards, the NAIC unanimously adopted its model "Privacy of Consumer Financial and Health Information Regulation" in September 2000. While AIA supported the adoption of that model, there has been little uniformity even where states purportedly base privacy laws and regulations on the model. States have enacted and promulgated privacy laws and regulations that depart in numerous ways from both GLBA and the NAIC model. This created a costly patchwork of privacy obligations. Compounding the problem is a 20-year old NAIC insurance privacy model that remains the law in sixteen states and differs in scope and form from the more recent model. o Producer Licensing: A year ago, the NAIC was supposed to certify that it had met the conditions of GLBA’s registered agent and broker provisions. Despite certification, key states are still not in compliance. Even those that have been certified by NAIC still allow variances – extra requirements like fingerprint and background checks – before a non-resident license is granted. o Interstate Compact Attempts: The NAIC has created model interstate compacts, though only for life insurance and not for property and casualty insurance. Since then, one state adopted a version different from the NAIC model, two large states publicly opposed the model, and three other large states began working on their own model. More than three years ago, the NAIC unveiled a “new” modernization effort designed to improve state insurance regulation, in its “Statement of Intent.” It declared that state insurance regulators must modernize insurance regulation to meet the realities of an increasingly dynamic, and internationally competitive, insurance marketplace. Even then, such pronouncements were not new – state insurance commissioners have been talking about uniform efforts since 1871. Last month, the NAIC issued a renewed commitment to its “Regulatory Modernization Action Plan.” This plan abandons previous efforts for substantive changes in the regulatory framework. For the most part, the NAIC plan focuses on incremental efficiencies that make no major systemic changes in today’s outmoded regulatory framework. The plan does not even reinforce the NAIC's own “Speed to Market” recommendations that the NAIC adopted in 2000. Consumers would benefit from a free market, without today’s antiquated product and price controls. But the NAIC’s latest plan not only fails to eliminate this discredited system, it retreats from previous and stronger recommendations in this area. To stimulate healthy regulatory competition in insurance, we must turn to a market-oriented environment. The NAIC has proven that it cannot force states to let such an environment flourish, so other, more effective avenues must be pursued. Conclusion AIA advocates a market-based approach to insurance regulation that does not rely on government review of prices or products, but permits competitive forces to respond to consumer demand. The state of the current regulatory environment makes comprehensive insurance regulatory reform imperative. There have been decades of NAIC reports and commissioner promises of reform, none of which has ever produced the system-wide reform that is needed. The failure to enact systemic reform is not for lack of effort, but is a product of 51 different jurisdictions with 51 different regulatory and political philosophies. Reform must occur at the federal level, and we ask that you consider the optional federal charter as the appropriate vehicle. I appreciate the Committee’s attention and the opportunity to speak today on this important issue. Thank you.
Mr. J. Robert Hunter
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Mr. Tom Ahart
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Mr. Stephen E. Rahn
Mr. Chairman and members of the Committee, my name is Steve Rahn, and I am Vice President, Associate General Counsel and Director of State Relations for The Lincoln National Life Insurance Company. I am appearing today on behalf of the American Council of Life Insurers, the principal trade association representing domestic life insurance companies. The ACLI’s 383 member companies account for over 70 percent of the life insurance premiums and 77 percent of annuity considerations of U.S. life insurance companies. I am also Chairman of the ACLI’s Policy Advisory Group, which has spearheaded the association’s efforts to develop a federal legislative solution to the issue of regulatory modernization. I appreciate the opportunity to appear before you today to discuss the pressing need to modernize the life insurance regulatory framework. In survey after survey of the ACLI membership, including one this summer of life insurer CEOs serving on the ACLI Board of Directors, regulatory modernization is the very top priority of our business. My message to you this morning is both simple and urgent. The life insurance business is a vital component of the U.S. economy, providing a wide array of essential financial and retirement security products and services to all segments of the American public. However, for the insurance business to remain viable and serve the needs of its customers effectively, our system of life insurance regulation must become far more efficient and be brought in line with the needs and circumstances of today’s marketplace. This is not a call for less regulation. It is a call for strong regulation administered efficiently, preserving the paramount importance of effective solvency regulation and appropriate consumer protections. I would like to focus on three points the morning. First, why regulation is so important to us at this juncture. Second, what the ACLI has done to assess the current regulatory environment and identify areas that are in need of improvement. And third, the options for improvement we are focusing on and how we are pursuing them. The Changing Marketplace and the Importance of Efficient Insurance Regulation The marketplace environment in which life insurers and other financial intermediaries compete has changed dramatically in the past several years. Importantly, the role of regulation in this new competitive paradigm has increased significantly. Historically, life insurers competed only against other life insurers. Whatever the inefficiencies of insurance regulation, companies incurred them equally. Existing companies had learned how to cope with the unwieldy regulatory apparatus, and potential new entrants almost always looked to existing companies and charters because of the difficulty of creating a new one. The status quo, while often frustrating, did not present insurers with serious competitive problems. Today, the situation is radically different. A generation ago, the average life insurer took in almost 90 percent of its premiums from the sale of life insurance, compared to only 13 percent from annuities. Today, those numbers are almost completely reversed, with 70 percent of premium receipts coming from annuities compared to only 30 percent from life insurance products. Today, life insurers administer over $1.8 trillion in retirement plan assets, amounting to over 25 percent of the private retirement plan assets under management in the U.S. The point is that life insurers, as providers of investment and retirement security products, find themselves in direct competition with brokerages, mutual funds, and commercial banks. These non-insurance firms have far more efficient systems of regulation, often with a single, principal federal regulator. Without question, the regulatory efficiencies they enjoy translate into very real marketplace advantages. Our system of insurance regulation now stands as perhaps the single largest barrier to our ability to compete effectively. In the context of this new competitive environment, insurers’ inability to bring new products to market in a timely manner is the most serious shortcoming of the current regulatory system. National banks do not need explicit regulatory approval to bring most new products to market on a nationwide basis. Securities firms typically get regulatory approval for new products in several months. By contrast, life insurers must get new products and disclosure statements approved in each state in which the product will be offered, and different jurisdictions often have widely divergent standards, interpretations, and requirements applicable to identical products. Without question there are individual states that are quite prompt in reviewing a company’s product form filings. Others are not. And the problem, of course, is getting approval in multiple jurisdictions, which is extremely costly, extremely time consuming, and can take a year or more - and in some instances much longer. With the average shelf life of innovative new life insurance products being approximately two years, it is easy to see why the current product approval process is so problematic. The advent of Gramm-Leach-Bliley and an increasingly diversified financial services landscape will only intensify concerns in this area. For example, there is clear evidence that firms having both insurance and securities operations are allocating capital away from the insurance unit due largely to the inefficiency of the insurance regulatory system. New securities products can be brought to market in a more timely and cost-effective manner than their insurance counterparts. Over the long run, the implications to insurers and their customers of these adverse capital allocation decisions are serious, and they can be expected to worsen as consolidation and cross-industry diversification continue. Even with respect to products such as whole life insurance, which have no direct analog in the banking or securities businesses, we face competition from other providers of financial services for the consumer’s attention and disposable income. Moreover, the costs of regulatory inefficiency are necessarily borne directly or indirectly by the public. The present state-based system of insurance regulation was instituted at a time when “insurance” was not deemed to be interstate commerce. Consequently, the underpinnings of that system - which remain pervasive today - contemplate doing business only within the borders of a single state. Today, most life insurers do business in multiple jurisdictions if not nationally or internationally. And, the system has been cumulative, with new laws, rules and regulations often added but old ones seldom eliminated. In short, our system of regulation has failed to keep pace with changes in the marketplace, and there is a very wide gap between where regulation is and where it should be. For many life insurers, making regulation more efficient is now an urgent priority. Companies no longer believe they have the luxury of being able to wait for years and years while incremental improvements are debated and slowly implemented on a state-by-state basis. Importance of the Life Insurance Franchise Failure to modernize the life insurance regulatory system risks marginalizing the life insurance franchise, and the resulting adverse consequences to consumers and the economy would be substantial. Life insurers are unique in that they are the only institutions capable of guaranteeing against life's uncertainties. Through life insurance, annuities, and other financial protection products, life insurers protect against living too long and not living long enough. With 76 million baby-boomers nearing retirement, there is the potential for a true retirement crises. We not only have an aging population with increasing life expectancies, but must also confront the fact that the average American nearing retirement has only $47,000 in savings and assets, not including real estate. Fully 68 percent of Americans believe they will not be able to save enough for retirement. Over 61 percent are afraid they will outlive their savings. The role of life insurers in addressing the retirement security needs of millions of Americans has never been more important. Retirees will depend increasingly upon the services only life insurance products provide; guaranteed income, long term care, and lifetime financial security. As the Congress faces the Social Security and Medicare challenges in the next fifty years, it will need a high performing life insurance industry to partner with and help shoulder the burden. Life insurers not only help in shaping how people plan for the future, but also in sustaining long-term investments in the U.S. economy. Fifty-seven percent of the industry's assets - $2 trillion - is held in long-term bonds, mortgages, real estate, and other long-term investments. The industry ranks fourth among institutional sources of funds, supplying 9 percent of the total capital in financial markets, or $3.4 trillion. Investments include: $417 billion in federal, state, and local government bonds, which help fund urban revitalization, public housing, hospitals, schools, airports, roads, and bridges; $251 billion in mortgage loans on real estate-financing for homes, family farms, and offices; $1.2 trillion in long-term U.S. corporate bonds; and $791 billion in corporate stocks. In 2002, life insurers invested more than $304 billion in new net funds in the nation’s economy. Lack of Uniformity Hampers Multi-State Insurers A significant impediment for multi-state insurers is the current state-based system’s inability to produce, in crucial areas, both uniform standards and consistent application of those standards by the states. I’d like to give you a brief outline of the business and regulatory complexities commonly faced by life insurers under the current system. Before a company can conduct any activities, it must apply for a license from its “home” or “domestic” state insurance department. A license will be granted if the company meets the domestic state’s legal requirements, including capitalization, investment and other financial requirements, for acting as a life insurer. If the company wishes to do business only in its home state, this one license will be sufficient. However, in order to sell products on a multi-state basis, a company must apply for licenses in all the other states in which it seeks to do business. Each additional state may have licensing requirements that deviate from those of the company’s home state, and the company will have to comply with all those different requirements notwithstanding the fact that the home state regulator will remain primarily responsible for the insurer’s financial oversight. Once a company has all its state licenses, it can turn its attention to selling policies. To do that, a company must first file each product it wishes to market in a particular state with that state’s insurance department for prior approval. A company doing business in all states and the District of Columbia must, for example, file the same policy form 51 different times and wait for 51 different approvals before selling that product in each jurisdiction. And this process must be repeated for each product the insurer wishes to offer. Since these 51 different insurance departments have no uniform standards for the products themselves or for the timeliness of response for filings, a company may receive approval from one or two jurisdictions in 3 months, from another ten jurisdictions in 6 months, and may have to wait 18 months or longer to receive approval from all jurisdictions. This process is further complicated by the fact that each insurance department may have its own unique “interpretation” of state statutes, even those that are identical to the statues in other jurisdictions. As a result, a company will be required to “tweak” its products in order to comply with each individual department’s “interpretation” of what otherwise appeared to be identical law. Since a company has to refile each product after it has been “tweaked,” the time lapse from original filing to final approval can very well be double that which was originally expected. And, as a result of the various “tweaks,” what started out as a single product may wind up as thirty or more different products. After a company has received approval to sell its products in a state, it needs a sales force to market those products. Here again we encounter the inefficiencies of the current state system. Each state requires that anyone wishing to act as an insurance agent first be licensed as such under the laws of that state. Each state has its own criteria for granting an agent’s license, and this criteria includes differing continuing education requirements once the license is issued. Like companies, insurance agents wishing to work with clients in more than one state must be separately licensed by the insurance departments in each of those states. And, because of the differing state form filing requirements for companies noted above which results in products being “tweaked” for approval in each of the various jurisdictions, persons granted agent licenses by more than one state will not always have the ability to offer all clients the same products. After this multitude of licenses and approvals has been secured, a company can begin to sell products nationwide. However, the lack of uniformity in standards and application of laws will continue to be a complicated and costly regulatory burden that the company must constantly manage. The very basic things that any business must do to be successful--such as employing an advertising campaign, providing systems support, maintaining existing products, introducing new products and keeping our sales force educated and updated--are all affected 51 different sets of laws, rules and procedures under the current regulatory structure. Add to this the fact that states also police actual marketplace activity by subjecting a company to market conduct examinations by the insurance departments of every state in which it is licensed. Even though state market conduct laws nationwide are based on the same NAIC model laws, there is minimal coordination on these exams among the various states. As a result, a company licensed to do business in all 51 jurisdictions is perpetually having states initiate market conduct examinations just as one or more other states are completing theirs, with the cost of each exam being borne by the company. And, because these examinations are largely redundant, the benefits derived relative to the costs incurred are marginal at best. In sum, these issues result in very real costs in terms of money, time, labor and lost business opportunities attributable to this cumbersome state regulatory system, which places a great competitive burden on individual companies, and on the industry as a whole. ACLI Study of Insurance Regulation By the late 1990s, life insurers had concluded that it was imperative for the industry to address the issue of regulatory reform. In September of 1998, the ACLI Board of Directors instructed the association to undertake a detailed study of life insurance regulation. The objective of this study was to pinpoint those aspects of regulation that are working well and those aspects that are hindering life insurers’ ability to compete effectively and thus in need of improvement. This study broke life insurance regulation down into 35 individual elements (e.g., agent and company licensing, policy/contract form approval, solvency monitoring, guaranty associations, nonforfeiture). Individual elements were then rated based on eight factors (uniformity, speed/timing, cost, objective achieved, necessity/relevance, expertise/capacity, sensitivity to industry needs/views, and enforcement/penalties) and assigned one of four overall “scores” based on the eight factors. The overall scores were excellent, good, needs improvement, and unsatisfactory. This study was completed in November of 1999 and revealed widespread dissatisfaction with the current regulatory system. No element of regulation was rated “excellent,” 14 elements were rated “good,” and 21 of the 35 elements received negative scores, with 16 rated “needs improvement” and five rated “unsatisfactory.” The study concluded that life insurers generally believe the laws and regulations on the books are necessary and appropriate. However, these laws are seldom uniform across all states and, even where uniform, are frequently subject to divergent applications and interpretations. Having to comply with even uniform laws 50+ times is costly and time consuming. When those laws differ and when interpretations of identical or similar laws differ significantly state-to-state, an insurer’s ability to do business in multiple jurisdictions is severely hindered. Given these considerations, the life insurers do not seek diminished regulation. Rather, they seek a far more efficient means of administering the laws and regulations to which they are now subject. A copy of the ACLI report, entitled “Regulatory Efficiency and Modernization: An Assessment of Current State & Federal Regulation of Life Insurance Companies and an Analysis of Options for Improvement,” is being made available separately to provide additional background on this issue. Solutions Pursuant to a policy position adopted by our Board of Directors and embraced by our membership, the ACLI is addressing regulatory reform on two tracks. Under the first track, the ACLI is working with the states to improve the state-based system of insurance regulation. Under the second, the ACLI has developed draft legislation providing for an optional federal charter for life insurers. Improvements to State Regulation Improving a state-based system of regulation has never really been an “option” for the ACLI: rather, it is a given. While substantial changes to the present system must be made, regulation of insurance by the states will always be a fundamental part of our regulatory environment. From the ACLI’s perspective, the yardstick for gauging the success of regulatory reform in the principal areas where change is necessary is quite simple: uniform standards; consistent interpretations of those standards; and a single point of contact for dealing with multiple jurisdictions. Only in this way will insurers doing a national business be able to operate effectively and provide their customers with the products and services they are demanding. The states and the leadership of the National Association of Insurance Commissioners (NAIC) deserve credit for the way in which they have stepped up to the task of developing strategies for implementing meaningful reform. The states are working to forge a strong consensus for progressive change. While the true measure of success, of course, will be the actual implementation of appropriate reforms, the NAIC has shown strong commitment and effort over the course of the last several years. Optional Federal Charter At the same time the ACLI Board reaffirmed its commitment to improve state regulation, it also directed the association to aggressively pursue an optional federal charter for life insurance companies. This decision reflects several different perspectives within our membership. A number of companies believe the insurance business is badly in need of a dual regulatory system analogous to that presently found in the commercial banking, thrift, and credit union businesses. Such a system enables institutions to select a state or federal charter based on the particular needs and circumstances of their operations. For example, companies doing business in multiple jurisdictions might be more inclined to opt for a federal charter so that they will have to deal with only a single regulator. On the other hand, companies doing business in a single state might find a state charter to be far more practical and cost-effective. Other companies are skeptical that at the end of the day individual state regulators and state legislators will be able to cede authority to the extent necessary to implement a system of uniform, efficient state regulation. Additionally, most life insurers are increasingly convinced that there is a need for a federal insurance regulatory “presence” in Washington. More than at any other time in our history, issues dramatically affecting our business are being debated and decided in Congress. Yet, unlike any other segment of the financial services industry, there is no regulator in Washington that can serve as a source of information and perspective for lawmakers. This lack of insurance regulatory presence was illustrated dramatically in the wake of the events of 9/11/01 when lawmakers had no ready source of information and advice on the immediate and longer-term insurance consequences of those events. The ACLI spent approximately a year and a half developing draft legislation providing an optional federal charter for life insurers. This effort involved over 300 ACLI member company representatives and brought to bear their considerable expertise on literally every aspect of life insurance regulation. The American Insurance Association and the American Bankers Insurance Association also developed draft optional federal charter legislation. These groups have worked closely over the last year and have reached agreement on a consensus draft of a bill providing for a federal charter option for all lines of insurance, insurance agencies and insurance agents. Congress Should Avoid Incremental Federal Legislation There have been suggestions that Congress should defer action on optional federal insurance charter legislation and instead see whether an incremental approach to regulatory efficiency might suffice. For example, discrete issues such as product approvals or coordination of market conduct examinations might be addressed along the lines of the NARAB provisions included as part of the Gramm-Leach-Bliley Act. Quite candidly, Mr. Chairman, I would argue strongly against this approach for a number of reasons. First, the effort of the states and the NAIC to enhance regulatory efficiency is, by its very nature, incremental. The states have identified several priority issues to tackle, and they are developing concepts to deal with them. Achieving some form of overall “national treatment” under a state regulatory regime should be an ultimate goal, but even the states have recognized that it is impractical to seek to achieve that goal in the near term. We simply do not need the states and the Congress employing incremental approaches to regulatory modernization. As noted above, ACLI is working aggressively with the states and the NAIC to improve state-based regulation. While we salute the NAIC and others for their efforts toward this end, the ACLI believes this effort should not be exclusive of but rather complementary to the pursuit of an optional federal charter. One of the fundamental values of a federal charter option is that it can achieve uniformity of insurance laws, regulations and interpretations the moment it is put in place. And only Congress can enact legislation that has this broad-based, immediate effect. As I noted at the outset, many life insurers believe regulatory modernization is a survival issue, and in that context the speed with which progressive change takes place is critical. Today’s marketplace is intolerant of inefficient competition. And the prospect of having to wait a number of years to see whether incremental federal legislation will even be enacted, and then, if it is, having to wait for some additional period of time to see whether it works is not even remotely appealing to me. Because if the answer turns out to be “no,” my company will likely have become irrelevant long before any meaningful steps have been taken. We are not willing to take that risk. In my judgment, Congress should not “finesse” this issue by putting a clock on the states either to force them to perform better or to see how much they can accomplish over some set period of time. This approach ultimately sidesteps the responsibility to protect a vital industry and the consumers it serves. I believe Congress should focus its attention on a global, comprehensive alternative to state insurance regulation expressly crafted to meet the needs of today’s national and multinational insurers. I believe an immediate and concerted effort to put in place an optional federal charter is the best course of action for providing needed regulatory solutions for our industry and for providing the states with strong incentive for improving their regulatory structure. In sum, the ACLI will work with the states to pursue important but incremental improvements to state insurance regulation. But we will look to Congress for the improvements that only Congress can provide in the form of an optional federal insurance charter. An Optional Federal Charter Is Not an Attack on States’ Rights Insurance is the only segment of the U.S. financial services industry that does not have a significant federal regulatory component. Under the optional federal charter concept being advanced by the ACLI and others, the states would retain a greater, or at least as significant, a role in insurance regulation as their state regulatory counterparts now have in the banking and securities industries. The federal charter proposal does not mandate federal insurance regulation of all insurers. Rather, it allows an insurance company the option of seeking a federal charter if company leadership believes that to be more complementary to the company’s structure, operations or strategic plan. It is not an affront to states’ rights to seek the elimination of conflicting or inconsistent laws. A principal objective of the ACLI proposal is to reduce the regulatory burden caused by such conflicts and redundancies and to do so by adopting the best state laws and regulations as the applicable federal standards. A further objective of the federal charter option is to modernize the insurance regulatory framework and, in so doing, make insurers significantly more competitive in the national and global marketplace. Enhancing competition is a sound and legitimate role for Congress and substantially outweighs concerns over any diminution of the regulatory role of the states. The importance of insurance protection was underscored by the events of September 11, as was the fact that it is in the national interest to have a federal authority with expertise and involvement in the U.S. insurance industry given the industry’s significant and substantial importance to the overall financial health of the nation. Establishing an agency to fill this void is not, and should not be characterized as, a diminution of states’ rights. Finally, the concept of an optional federal charter is far less an infringement on states’ rights and prerogatives than preemptive federal standards, minimum or otherwise. The latter apply to all insurers and suggest that the states are incapable of dealing with important regulatory matters even as they pertain to state chartered carriers. An Optional Federal Charter Will Not Foster Regulatory Arbitrage Some have suggested that the implementation of a federal charter option will lead to regulatory arbitrage and a regulatory “race to the bottom” as companies seek increasingly lax regulation and regulators rush to accommodate. Nothing could be further from the truth. First and foremost, the ACLI and its member companies are not seeking to migrate to a federal system of insurance regulation that is lax. To the contrary, we are seeking an strong regulator located in the Treasury Department that will administer a comprehensive system of regulation predicated on the “best-of-the-best” drawn wherever possible from existing state statutes or NAIC model laws. Only where the state system is irreparably broken (e.g., the product approval process) have we sought to create new regulatory concepts. Second, the notion that adding one more system of regulation on top of the 51 that already exist will somehow give rise to regulatory arbitrage is groundless. Today, companies have the right in virtually all jurisdictions to change their state of domicile – that is, to move to a different state that would have primary responsibility for the company’s financial oversight. Consequently, there are 51 opportunities for regulatory arbitrage today. It is inconceivable that Congress would put in place a federal regulatory option that was not at least as strong as the better - if not the best - state system. How, then, would we be creating some new opportunity for this dreaded “race-to-the-bottom?” What possible harm would come from companies moving to a federal system of regulation that is as strong as, if not stronger than, the one they are leaving? Inherent in this assertion of possible regulatory arbitrage is the notion that a company executive could wake up one morning and simply decide to flip a company’s charter. Quite simply, business does not work that way. Such a change carries with it countless significant consequences and considerations and is not entered into lightly. It is costly, time consuming and initially highly disruptive. The notion of regulatory arbitrage implies that companies would be inclined to move into and out of regulatory systems on a whim or whenever decisions were made or likely to me made that would be adverse to their interests. In the real world, this does not and would not occur. The Federal Charter is Optional We urge you to keep in mind that all advocates for a federal insurance charter believe that the charter should be optional. Companies that do a local business or that for other reasons would prefer to remain exclusively regulated by the states are perfectly free to do so. The ACLI has worked hard to draft a federal charter option that, to the extent reasonably possible, remains “charter neutral.” For example, we have avoided building into the federal option advantages (e.g., tax advantages) that companies would be hard pressed to turn their backs on even if they wished to remain state regulated. While individual motives may vary, our member life insurance companies are strongly united in our desire to modernize our regulatory system so we can regain our competitive footing and effectively serve our customers. Some feel that a federal charter is in the long-term best interest of their company and customers. Others have indicated they would prefer to remain state chartered even if a federal charter were available to them. Like other financial service firms, we believe insurers must have the ability to select the charter that best suits our operations, products, markets and long-term strategies An Optional Federal Charter Will Not Disrupt State Premium Tax Revenues Opponents of an optional federal charter have suggested that if such an option were to become a reality, national insurers would, over time, somehow escape state premium taxes, which constitute a significant source of revenue for all states. This concern is totally unfounded. As this Subcommittee knows better than most, with the exception of Government Sponsored Enterprises, all for-profit federally chartered financial institutions such as commercial banks, savings banks and thrifts pay state income taxes. For insurers, this state tax obligation takes the form of a state premium tax. There is no precedent for, nor is there any expectation of, exclusion from this state tax obligation. Indeed, all versions of the optional federal charter legislation expressly provide for the continuation of the states’ authority to tax national insurers. There is presently debate in some jurisdictions over whether insurers should pay a state net income tax in lieu of a state premium tax. This debate will continue irrespective of whether there is an optional federal insurance charter. Simply put, state tax revenue is not a material factor in the debate over an optional federal charter. Consumer Protections Will Not Diminish Under an Optional Federal Charter We believe insurance consumers will also benefit if an optional federal charter becomes a reality. Strong solvency oversight and strong consumer protections are the cornerstones of any effective insurance regulatory system. The ACLI draft optional federal charter legislation and the consensus version being finalized by the ACLI and other interested groups is built on these cornerstones. In this regard, the draft legislation duplicates the following important aspects of state insurance laws: · It guarantees that consumers are protected against company insolvencies by extending the current successful state-based guaranty mechanism to national insurers and their policyholders. · It ensures the financial stability of national insurers by requiring adherence to statutory accounting principles that are more stringent (conservative) than GAAP. · It duplicates the stringent investment standards currently required under state law. · It mirrors the strong risk-based capital requirements of state law to ensure companies have adequate liquid assets. · It duplicates state valuation standards that ensure companies have adequate reserves to pay consumers’ claims when they come due. · It reproduces the requirement that companies submit quarterly financial statements and annual audited financial reports. · It mirrors the existing nonforfeiture requirements under state law that guaranty all insureds receive minimum benefits under their policies. In addition, consumers who deal with national insurers may very well enjoy significant added protections and benefits over those afforded by the states. For example, consumers will experience uniform and consistent protections nationwide and will enjoy the same availability of products and services in all 50 states. Consumers will also benefit from uniform rules regarding sales and marketing practices of companies and agents, and for the first time consumer issues of national importance will receive direct attention from a federal regulator. Conclusion Life insurers today operate under a patchwork system of state laws and regulations that is not uniform and that is applied and interpreted differently from state to state. The result is a system characterized by delays and unnecessary expenses that harm companies and disadvantage their customers. Failure to reform insurance regulation will pose a severe and ever larger competitive burden that could threaten the viability of the life insurance industry and those it serves in an increasingly competitive global economy. Mr. Chairman, we encourage you in the strongest terms to work with us to put in place an appropriate federal regulatory option available to insurance companies, insurance agencies, and insurance producers. It is in the best interests of our industry, its customers and our overall economy to do so as expeditiously as possible. On behalf of the member companies of the American Council of Life Insurers, I would like to conclude by thanking you and members of the Committee for the opportunity to express our views on this most important subject.
Mr. Douglas Heller
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