While the Dodd-Frank Wall Street Reform and Consumer Protection Act of 20101 falls short of establishing federal regulation of the insurance industry, the Act does lay the foundation for future steps in that direction in a number of ways. Importantly, the Act establishes the Federal Insurance Office (the “FIO”), the first federal entity tasked solely with the oversight of insurers, though, for now, with powers largely limited to information gathering. The Dodd-Frank Act also allows for Federal Reserve regulation of systemically significant insurers and preempts state laws in favor of federal authority over certain international prudential insurance agreements. Finally, the Act begins to eliminate state conflict of law by specifying a single governing authority (for now, a designated state) in two limited areas.
1. Who is the federal regulator of insurers?
There is no federal regulator of insurers. Adopted in 1945, the McCarran-Ferguson Act2 exempted the business of insurance from most federal regulation. It does this by providing that no federal law preempts a state law regulating the business of insurance, unless the federal law expressly purports to regulate the business of insurance.3 Congress has availed itself of this provision at least once, allowing risk retention groups of commercial product liability insurers licensed in one state to operate nationwide exempt from the laws and regulations of all other states.4
2. Does the Dodd-Frank Act create a federal insurance regulator?
No. For a number of years, many in the insurance industry have sought a federal charter comparable to that of national banks. Their intent is to provide for federal supervision and regulation of federally chartered insurers, for which inconsistent state law would be preempted. While the idea was considered by Congress, concerns that industry-specific issues would not be addressed adequately in trying to fit insurers within a bank and financial services framework left the proposal for future legislative consideration. Co-author of the Act Representative Barney Frank recently announced at the National Conference of State Legislators that he expects Congress in 2011 to consider legislation to create an optional federal insurance charter with the FIO, the information-gathering entity created by the Dodd-Frank Act, as regulator. Although Dodd-Frank does not create a federal insurance charter, it takes several small steps in that direction and lays a foundation for future action.
3. Does the Federal Reserve now supervise insurers?
Somewhat. If an insurer owns a bank, it is a bank holding company subject to Federal Reserve supervision and regulation. On the other hand, if a bank holding company (a company that controls a bank) controls an insurer, the Federal Reserve has supervisory authority over the bank holding company and only limited oversight of the insurer. The Dodd-Frank Act has increased the Federal Reserve’s authority over these insurers. Under the Gramm-Leach-Bliley Act, enacted in 1999, the Federal Reserve had oversight of these insurers, but their activities continued to be regulated on a functional basis by state insurance supervisors. The Federal Reserve was limited in its ability to obtain reports, examine or impose capital adequacy requirements on such insurers.5 Section 604 of the Dodd-Frank Act eliminates some of those barriers allowing that the Federal Reserve may request and is entitled to receive promptly reports and information provided or available to state insurance regulators, as well as to examine any insurance subsidiary in connection with assessing systemic risk.
4. Does the Dodd-Frank Act grant the Federal Reserve increased supervisory authority over insurers?
Potentially yes. The Financial Stability Oversight Council (the “Council”) established by the Dodd-Frank Act will determine whether a financial organization, that is not a bank holding company or a foreign bank with a branch or agency in the United States, should be designated as a “nonbank financial company” (“NFC”).6 An NFC is a company predominately engaged in financial activities deemed to be the case if at least 85 percent of consolidated revenues or at least 85 percent of consolidated assets derive from such activities.7 The Council will determine whether an NFC could pose a threat to the financial stability of the United States.8 If the Council’s determination becomes final, the NFC will be supervised by, and subject to the prudential standards of, the Federal Reserve.
The Council is expected to have at least some amount of familiarity with insurance as one of the ten voting members must be an independent voting member with insurance expertise.9 Furthermore, the Director of the Act-created FIO, discussed below, and a state insurance supervisor will be nonvoting members of the Council.10 The Council may well determine that an NFC insurer or an insurance holding company should be subject to enhanced Federal Reserve supervision. However, the nonfinancial activities of any NFC-designated insurer or company under its control would not be subject to Federal Reserve supervision.11
For an in-depth analysis of provisions relating to NFCs, we refer you to our Dodd-Frank Act client alert on Systemic Nonbank Financial Companies.12
5. Will insurers undergo stress tests?
Yes. NFCs and bank holding companies that are insurers or insurers that are subsidiaries of NFCs or bank holding companies will have to undergo annual Federal Reserve stress tests.13 The Federal Reserve will coordinate with the NFC’s primary federal regulator, which in the case of an insurer is its domiciliary insurance supervisor,14 and the new FIO, discussed below.
In addition, such insurers must conduct a semiannual stress test. In this case, the stress test will be pursuant to the requirements of the company’s primary federal regulator, in coordination with the Federal Reserve and the FIO.15
6. How does the Volcker Rule affect insurers?
The Volcker Rule16, as more fully discussed in our Dodd-Frank Act client alert on that provision17, is applicable to certain insurance companies. If an insurer is a bank holding company or a subsidiary of a bank holding company, it will be a banking entity subject to the prohibitions of the Volcker Rule against proprietary trading and investing in hedge funds and private equity funds.18 There is a significant exception for “regulated insurance companies”, which is regrettably an undefined term.19 The exception permits a regulated insurer to engage in proprietary trading in any securities for its own general account despite that other banking entities are not permitted to engage in such trading. Because many insurers engage in their investment activities through the services of an affiliate, the exception includes proprietary trading done through an affiliate solely for the general account of the insurer.
These purchases and sales must be consistent with applicable state or relevant laws (which generally permit insurers to use general accounts for trading related to customer investment products). In addition, the appropriate federal banking agencies in consultation with the Council and relevant state or territorial insurance commissioners must determine that the relevant insurance laws are sufficient to protect the safety and soundness of the banking entity affiliated with the insurer and the financial stability of the United States.
The insurer exemption from the Volcker Rule is limited only to proprietary trading. Insurers considered “banking entities” would be subject to the Volcker Rule limitations on ownership and sponsorship of hedge funds and private equity funds.20
7. Will the Financial Stability Oversight Council be involved in insurance matters?
Yes. This Council will be monitoring domestic and international financial regulatory developments relating to insurance.21
The Council can recommend to a state insurance commissioner or commissioners that an activity or practice should be subject to new or heightened standards or safeguards. The commissioners would have 90 days to impose such recommendations or explain their reasons for not doing so, in which case the Council could ask Congress to act.22
8. Will an insurer be covered under the Dodd-Frank Act liquidation regime?
Possibly. While insurance companies are technically covered by the Dodd-Frank Act liquidation provisions, the liquidation or rehabilitation of an insurance company, and any subsidiary or affiliate of the insurance company, is required to be conducted under state insolvency laws. If the appropriate state insurance supervisor fails to act within 60 days of a systemic risk determination, however, then the FDIC may act in place of such agency and pursue relief under state law.23
9. Why is there the need for the Federal Insurance Office?
Foreign insurers, especially reinsurers, have complained over the years that the United States lacked a federal authority that could address insurance issues and better ensure national treatment. While the Treasury Department did get involved in insurance issues, its operations were relatively low-key. At the same time, state insurance regulators and the National Association of Insurance Commissioners (“NAIC”) were not keen on the concept of a federal insurance chartering and supervisory authority or any federal intrusion into the insurance regulatory arena. At meetings of the International Association of Insurance Supervisors, the United States was represented by an insurance commissioner selected by the NAIC.
In the early stages of the Administration’s financial reform proposal, the Administration recognized the need to promote national coordination in the insurance sector. The FIO is Congress’ first step in that direction.
10. What is the Federal Insurance Office?
The FIO is an office within the Treasury Department.24 It will be headed by a director who will be a senior-level, career employee, as opposed to a Presidential appointee. The director of the FIO will be a nonvoting member of the Council and, in addition, is tasked with advising the Treasury Secretary on major domestic and prudential international insurance policy issues.
11. What will the FIO do?
The FIO could be described as an official observer of the insurance industry, within and outside the United States.25 The Act expressly states that the FIO and the Department of Treasury do not have general supervisory or regulatory authority over the business of insurance.26 The FIO must continually collect information and conduct critical analysis of the insurance industry and the state insurance supervisory regimes, with a view to identifying areas for improvement in order to lessen the potential for systemic risk. The FIO may recommend to the Council those insurers or affiliates of insurers, which could include insurance holding companies, that should be deemed NFCs subject to Federal Reserve supervision.
The FIO will represent the United States at meetings of the International Association of Insurance Supervisors. It will also assist the Secretary of Treasury in negotiating international agreements governing insurance, as discussed below.
A significant portion of the FIO’s duties will be gathering information on the insurance industry and reporting to Congress and the President annually on the US and global insurance industry. While it has broad authority to report on and gather information from all insurers (except for smaller insurers), including through the use of subpoenas, the FIO cannot issue reports regarding health insurance or stand-alone long-term care insurance, which fall within the jurisdiction of Department of Health and Human Services.27 The FIO must coordinate with other federal and state insurance regulators in conducting these activities.28
12. Will there be further steps in the area of federal regulation of insurance?
Within 18 months of enactment of the Dodd-Frank Act, the FIO director must issue a broad-based report to Congress on how to improve the regulation of insurance in the United States.29 It is likely that the report will address the need for federal regulation or supervision of insurance, including the need for a federal charter similar to the national bank charter in the US dual-banking system. The Act expressly tasks the FIO with considering the uniformity or lack thereof of current regulations across states, as well as international coordination of regulation. Also, as noted above, members of Congress have indicated an intent to present legislation for an optional federal insurance charter.
13. What authority is granted to the Treasury Secretary?
The Treasury Secretary’s portfolio is expanded to include advising the President on major domestic and international prudential policy issues regarding all lines of insurance except healthcare and stand-alone long-term care insurance (not included in a life or annuity policy), which remain the responsibility of the Secretary of Health and Human Services.30
The Secretary and the United States Trade Representative (“USTR”) are jointly granted the authority to enter into prudential insurance agreements, termed “covered agreements.”31 A covered agreement is a bilateral or multilateral agreement with a foreign government or regulatory organization regarding prudential supervision of insurance and reinsurance.32 These agreements must seek to achieve a level of protection for consumers of insurance that is substantially equivalent to the level of protection achieved under state insurance or reinsurance regulation. In other words, a covered agreement cannot result in a harsher level of insurance regulation on US insurers than the level that already exists in the United States. A covered agreement would preempt state law if the latter would result in less favorable treatment of a non-US insurer. In that regard, a covered agreement can result in national treatment for non-US insurers operating in the United States.
Prior to commencing a covered agreement negotiation, the Treasury Secretary and the USTR must jointly consult with the appropriate congressional committees regarding the nature of the agreement and its effect on state laws.33 A covered agreement will enter into force 90 days after the date it is submitted to the relevant congressional committee.34
14. Does a covered agreement preempt state law?
The Dodd-Frank Act settles a long-running battle over the preemption accorded national banks.35 Unfortunately, the insurance provisions create a new one, and one not without controversy. Representatives of the NAIC have expressed concerns about agreements negotiated in backrooms where the US insurance supervisors may not be present. One might expect the FIO to take steps to ensure some coordination in this area. A covered agreement or an FIO action will preempt a state prudential insurance measure if the state insurance measure is inconsistent with a covered agreement and the state law results in less favorable treatment to a non-US domiciled insurer than a US domiciled, licensed or admitted insurer.36 In sum, the effect of a covered agreement will be to provide national treatment to a non-US insurer. For many years, non-US reinsurers have complained about discriminatory treatment under state law. The determination as to whether a state insurance regulatory provision is preempted will be made by the Director of the FIO, who must comply with stated procedural requirements,37 including the Administrative Procedures Act.38
The Act expressly states that the FIO does not have authority to preempt state laws in other areas of regulation, including rates, premiums, underwritings, sales practices, coverage requirements, antitrust and capital rules.39
15. Does the Dodd-Frank Act preempt state insurance laws in other regards?
Yes, in two limited areas. The Act establishes single-state jurisdiction over activities of multistate nonadmitted surplus line insurers and requires that states may not deny credits for reinsurance if the ceding insurer’s domiciled state recognizes such credits.
With respect to surplus lines, the Dodd-Frank Act seeks to improve the efficiency, availability and cost of surplus insurance by establishing single-state regulation and requiring that all states adopt uniform eligibility standards for insurers.40 US or foreign insurers offering multistate surplus lines in states in which they are not licensed (nonadmitted insurers) will need to comply only with the reporting and payment requirements of the insured’s home state. Further, only the home state is entitled to levy and collect premium taxes and will be responsible for their allocation to other states involved. Congress envisioned that states will adopt uniform requirements and enter into a compact to allocate among themselves premium taxes paid to the home state. The GAO Comptroller General is tasked with conducting a study to determine the effects of these new rules on the displacement of admitted insurers in the same markets.41
The Dodd-Frank Act also preempts state law governing reinsurance agreements.42 If the state of domicile of a ceding insurer is NAIC-accredited or has substantially similar financial solvency requirements, then no other state may deny the credit for reinsurance recognized by the ceding insurer’s domicile state.43 That state becomes solely responsible for regulating the financial solvency of the reinsurer. The laws of all states, other than the ceding insurer’s state of domicile, also are preempted to the extent they restrict the rights of the ceding insurer to resolve disputes by contractual arbitration.
16. Will any provisions of the Dodd-Frank Act require insurers to change their products and services?
Possibly for retail products and services. Though insurance companies are not covered by the requirements governing banks, brokerages and other financial service firms, Act-imposed changes on the products and services of those entities may affect insurers or their affiliates.
For insurers marketing an array of financial products, two studies dictated by the Dodd-Frank Act may result in subjecting their retail activities or those of their affiliates to increased federal oversight. One study to be conducted by next January requires the GAO Comptroller General to evaluate the need for licensing and oversight of “financial planners”,44 a designation sometimes used by insurance agents acting in a dual capacity as broker-dealer salesmen. The study could result in the presently non-regulatory financial planner designation becoming subject to new federal licensing and compliance requirements. A second study to be completed by the SEC may result in requiring the sales staff of securities firms to meet an elevated standard of care or fiduciary duty in marketing to retail customers.45 An insurer’s sales force may be subject to any new increased requirements to the extent that the sales staff acts as both insurance agents and broker-dealer registered representatives,
On the other hand, the Dodd-Frank Act does clarify the classification of indexed annuities (offering the potential for enhanced stock-indexed returns) putting to rest SEC and insurance industry disagreement. The Act preempts SEC regulation and leaves indexed annuities under the purview of state insurance regulators.46