After having failed in an attempt to get bipartisan support for financial regulatory reform, Senator Christopher Dodd (D-CT) has gone ahead with his own regulatory reform bill, the American Financial Security Act of 2010, which was recently voted out of his Banking, Housing and Urban Affairs Committee. If the Dodd bill, or something like it, were to pass the full Senate—a very big “if”—there would be significant, although hardly revolutionary, changes in the way banks and investment firms are regulated in the United States.
But what about the regulation of insurance? Would the Dodd bill, if enacted into law, make any substantial changes in the way insurance is regulated? If the goal is comprehensive federal regulation of insurance, then the answer is no. Title V of the Dodd bill, which covers insurance regulation, embraces and reaffirms the state regulation of the insurance industry. The Office of National Insurance (ONI) that the bill would create would have a very limited role. In a section of Subtitle A of the bill entitled “Retention of Existing State Regulatory Authority” the legislation provides specifically that “Nothing [in the sections creating the ONI] shall be construed to establish or provide the [ONI] or the Department of the Treasury with general supervisory or regulatory authority over the business of insurance.”
Yet the Dodd bill contains very significant provisions in Subtitle B of Title V that could point the way to a much more efficient and uniform national insurance regulatory system, although still without a federal regulator. Subtitle B incorporates wholesale the “Nonadmittted and Reinsurance Reform Act” introduced by Representative Dennis Moore (D-KS) and adopted last year by the House (H.R. 2571). It is with this so-called “surplus lines” legislation that the Dodd bill, if enacted, would have the largest impact on insurance regulation in the United States.
1. The Office of National Insurance; Subtitle A of Title V
The Dodd bill sections that would create a new Office of National Insurance provide little for supporters of federal insurance regulation to cheer about. The ONI would have limited stature or authority. The director of the ONI would be a civil servant appointed by the secretary of the treasury to “monitor” all lines of insurance (except for health insurance), collect data on insurance activities, advise the secretary with regard to potential systemic risk by any insurer, and represent the U.S. at international meetings concerned with insurance. The director would be prohibited from preempting any state regulation of insurance rates, underwriting practices, sales, solvency or antitrust matters, except in the very limited instance when a state practice would violate an international regulatory agreement to which the United States is a party or would treat an alien insurer subject to such an international agreement less favorably than a domestic insurer. Even then the ONI would have to notify and coordinate with state regulators.
The value of the ONI lies primarily in its future potential. The Dodd bill would require that the ONI report to Congress within 18 months of the date the law is enacted as to how insurance regulation could be modernized, including how to achieve uniformity in state regulation, whether federal regulation of some lines of insurance would be practicable, and whether the federal government should become more involved in consumer protection. Essentially all the issues of insurance reform that the industry has been raising for years would be kicked further down the road, although with an 18-month deadline for recommendations. Assuming the ONI recommendations would call for greater federal involvement in insurance regulation, and assuming Congress responded to those recommendations, then perhaps there would be the possibility of legislating greater federal authority over insurance matters in a future Congress, depending on the political climate at that time. Until then, as the Dodd bill makes clear, state regulation remains intact.
2. Nonadmitted and Reinsurance Reform; Subtitle B of Title V
Far more significant than the ONI provisions, at least in the near future, are those that deal with surplus lines and reinsurance. Subtitle B incorporates the language of the House-passed “Nonadmitted and Reinsurance Reform Act of 2009.” That bill would solve the problem of multiple and overlapping state regulatory authority by designating the “home” state of a surplus lines insurer and, to a more limited extent, a reinsurer as the sole regulator for most purposes. Other states in which the surplus lines carrier or reinsurer operates, called the “host” states, would have very limited authority over them.
Under Subtitle B only the home state—that is, the state of domicile—could collect premium taxes on the insurance sold by the regulated surplus lines writer. All other states would be preempted from doing so, unless they agreed to enter into an interstate compact (to be created in the future) for sharing the premium taxes. Surplus lines brokers would only need a license from the home state of the surplus insurer they represent and with that license they could sell the products of the surplus lines carrier in all states. Host states could not impose additional eligibility requirements on the surplus lines brokers than those imposed by the home state, and they could not collect fees from those brokers except by participating in the NAIC national insurance producer database (which shares fees paid for a national license). Moreover surplus lines brokers could not be prohibited by any state regulator from placing business with alien companies—that is, non-U.S. companies that are not admitted in any U.S. state—so long as those companies are on the NAIC Quarterly List of Alien Insurers.
Subtitle B would relieve surplus lines brokers of any state of “due diligence” requirements when placing insurance for an “exempt commercial purchaser.” Under most state laws, surplus lines brokers must certify that the insurance they wish to place with a surplus lines writer is not available from an admitted company. That requirement would be removed—even if it is a requirement of the home state—for insurance sold to large commercial purchasers, defined as having their own risk managers and paying more than $100,000 a year in insurance premiums.
For reinsurers, Subtitle B provides that if the state of domicile of a ceding insurer is an NAIC-accredited state, or has financial solvency requirements substantially similar to the requirements necessary for NAIC accreditation (which could include non-U.S. jurisdictions, as well as unaccredited U.S. states), and recognizes credit for reinsurance for the insurer’s ceded risk, then no other state may deny such credit for reinsurance. Moreover, states other than the home state of the ceding company are preempted from applying any requirements on the reinsurance transactions that back risks in their states except for the collection of taxes and assessments. A reinsurer’s home state is solely responsible for its solvency, and no other state may require that it provide any additional information than what it files with its home state, although the host states are eligible to see the financial information filed with the home state.
So, for example, if a reinsurer domiciled in New York is determined by New York to be solvent, and that reinsurer provides reinsurance to a ceding company based in Pennsylvania, and Pennsylvania grants credit to the ceding company for that reinsurance, California cannot ask for more information or deny credit for reinsurance shown on the ceding company’s books, even for major risks insured by that ceding company in California.
These provisions, if enacted into law, would create a national license and a single regulator for each carrier providing surplus lines and reinsurance coverage in the United States. The only precedent for such treatment is the federal preemption of nonhome state regulators for risk retention groups created under the Liability Risk Retention Act of 1986 (LRRA). Risk retention groups, however, represent a small niche of self or mutually insured liability risks. The impact on the overall insurance market of allowing the much more common reinsurance transactions and surplus lines policies to be governed exclusively by the home states of the carrier, with all other state laws and regulations being preempted, could be substantial, especially since surplus lines writers would be free to write large commercial risks without any requirement that they show the inability of admitted companies to cover those risks. Enforceability could be a problem, however, since no federal agency would be responsible for ensuring that states respect the preemption provisions. Some risk retention groups have found that host states impose restrictions on their operations, even though the LRRA prohibits them from doing so, and situation-specific litigation is the only remedy. Many RRGs have had little choice but to accede to state regulation that appears to be unlawful under the LRRA.
The insurance industry is generally accepting of the Dodd bill, largely because it would have so little impact on insurance operations. There is one notable exception, however—the Dodd bill would levy assessments on insurers (and other financial firms) with more than $10 billion in assets as part of the bill’s resolution authority. The assessments would be levied to offset the costs of winding up large failed financial institutions, thus placing the cost of resolution and failure on the financial services industry, rather than on taxpayers. The insurance industry has objected to this procedure because insurers already participate in state guaranty funds designed to protect consumers from the fallout of a failed insurer, and it is unfair for low-risk, low-leverage entities, like insurers, to bear some of the cost of failed high-risk, high-leveraged institutions.
If the Dodd bill were to pass the Senate, and could be reconciled with the House (which has already approved the nonadmitted and reinsurance provisions of the bill), the measure would have a significant impact on insurance regulation in the United States by expanding the concept of a single regulator—namely the state of domicile, the “home” state—to reinsurance and surplus lines, with all other state regulators preempted by federal law from applying different or additional requirements. More conjecturally, the ONI report in 18 months might conceivably be a premise for other changes. This is not the federal regulation of insurance, but it would certainly qualify as regulatory reform.