On October 1, 2010, the new Financial Stability Oversight Council (FSOC) met for the first time, without "an independent member appointed by the President, by and with the advice and consent of the Senate, having insurance expertise," as provided for in the recently enacted Dodd-Frank bill that created the FSOC. The president has not even identified such a person. Does that mean that insurance issues will be marginal to the deliberations of the FSOC? A State Insurance Commissioner, selected by the National Association of Insurance Commissioners (NAIC) (Director John Huff of Missouri), attended the meeting, but the designated Commissioner is not a voting member of the FSOC, unlike the presidentially appointed insurance expert.
Since this first meeting began the process of deciding what criteria will be used to identify nonbank financial firms that are "systemically important," the absence of a voting member with insurance expertise is telling. Are the bank regulators and the Treasury Department representatives who dominate the new Council going to make decisions affecting the insurance industry? Or is the insurance industry simply going to be ignored as it may prefer?
Prior to the financial upheaval that began in 2008, the debate over what role, if any, the federal government should play in regulating insurance centered on whether insurers should be able to choose an "optional federal charter" under a dual-chartering scheme analogous to banking regulation. But after the financial crisis and increasing scrutiny on banking regulation, the dual-chartering idea fell out of favor. Opponents of federal insurance regulation pointed out that the state-based insurance regulatory system arguably performed better during the crisis than did the federal/state banking regime. Nevertheless the Dodd-Frank Act does increase federal participation in insurance regulation, even though in a tentative and limited way.
What does Dodd-Frank auger for the future? Is it the "camel's nose under the tent" that opponents of federal insurance regulation fear and that supporters hope for? Our reading of the tea leaves is that the role of the federal government in insurance regulation is growing and will continue to grow. That does not mean, however, that federal regulation will replace state regulation.
Insurance is a complex and highly varied business comprised of sectors with differing regulatory needs on a wide array of issues. There is no "one size fits all" regulatory answer. Sharp variations among policyholders and across lines of business call for solutions that provide a range of regulatory structures designed to meet those diverse situations. Some parts of the industry might best be regulated exclusively by the federal government, some parts may be served best by exclusive state regulation and yet others may function best in a system of mixed federal and state authority-as, for example, through the imposition of nationally uniform standards (perhaps developed by the NAIC) via federal legislation that are then enforced by the states. This approach would enable uniform national standards for insurance regulation, thereby alleviating some of the burdens on insurers and regulators alike, while preserving the expertise and authority of the states-a political and practical necessity.
Title V of the Dodd-Frank Act appears to be a first step in this direction. The Federal Insurance Office, while prohibited any "general supervisory or regulatory authority over the business of insurance," is authorized to participate in negotiation and implementation of international prudential insurance measures, subject to various limitations. International affairs are generally within the purview of the federal government. The creation of an office empowered to represent United States insurers' and insurance regulators' interests is an exercise of authority well within the federal government's traditional functions.
Similarly, Dodd-Frank's state-based insurance regulatory reforms, in the form of the Nonadmitted and Reinsurance Reform Act (NRRA), are an example of the third type of reform-using federal legislation to develop uniform national standards based on NAIC-developed concepts. The NRRA strikes a balance between national uniformity and deference to the expertise and experience of state regulators by using federal legislation to preempt additional regulatory burdens while empowering the relevant state regulator. Significantly, the NRRA contains a definition for an "exempt commercial purchaser" that may serve as the basis for additional reforms, such as development of uniform standards applicable to exempt commercial purchasers for specific lines of business, while preserving the more localized rules for personal lines and non-exempt commercial purchasers. This approach to regulation would preserve the integrity of the state regulatory system but also recognize a role for federal legislation (or regulation) to address the needs of exempt commercial purchasers or specific lines of business, such as life insurance.
While Dodd-Frank moves the debate over insurance regulatory reform in this new direction, the best legislative vehicle for comprehensive reform may be an amendment to the 65-year-old McCarran-Ferguson Act. A modernized version of McCarran could establish the kind of multi-tiered approach discussed above, rather than deferring entirely to the balkanized state system currently in effect. This approach could provide each of the stakeholders with enough of what they really want to ensure the necessary political support for reform. That is, there could be something important in a modernized McCarran-Ferguson Act for large insurers, small insurers, property casualty insurers, life and health insurers, producers, state regulators and governors, consumer representatives, business organizations, and the Democrats and Republicans in Congress as well as the Obama Administration, so that they could all feel reasonably comfortable with a regulatory restructuring that would define the industry for many years in the future. Ultimately what direction any additional federal involvement in insurance regulatory reform takes will be influenced both by the Federal Insurance Office (FIO) report regarding how best to modernize insurance regulation, due 18 months from the Dodd-Frank Act's enactment, and the outcome of Chairman Frank's hearings in 2011.