Federal Insurance Regulation Optional Federal Chartering Bills Come to the Big Top: The Substance and Politics of Act IICraig Berrington
September 2007 | Washington Perspective
After a decade of discussion, federal insurance reform legislation finally made it to the Big Top in the last Congress. With an impressive showing of bipartisan initiative, Senators John Sununu (R-NH) and Tim Johnson (D-SD) introduced in early 2006 their "Optional Federal Chartering" (OFC) bill, entitled the "National Insurance Act." Essentially the same legislation was later introduced in the House of Representatives by Rep. Ed Royce (R-CA). However, unlike the Senate bill, the House bill had no Democratic cosponsor. OFC legislation has now been reintroduced in the new 110th Congress, with new provisions, additional bipartisanship and new muscle. This article provides an introduction to the politics and substance of the current OFC legislation and debate.
The 2007 Political Landscape
The original OFC legislation generated much discussion in the insurance industry, as well as initial congressional hearings, but did not move forward in either chamber of the Republican Congress. Now, with a narrow Democratic majority in the new Congress, the legislation's advocates face new opportunities, new problems and one overriding, continuing issue.
Proponents' first new opportunity is the Democratic majority itself, which appears to be more open to the OFC legislation than their Republican predecessors. For better or for worse, the Democrats are not afraid of new federal responsibilities or new federal agencies, and they are less tied to the concept of state regulation. This is a far cry from saying they will embrace OFC or that, if they do, the OFC bill they endorse will be a bill that the industry can support. But there seems little doubt that the atmosphere in this Congress is much more hospitable to the big OFC reform initiative than the atmosphere of last year.
This is especially true in the Senate, where the Senate Banking Committee is now chaired by Senator Christopher Dodd (D-Conn.), who has publicly stated that OFC is on his priority list for legislative consideration. In the House, however, House Financial Services Committee (HFSC) Chair Barney Frank (D-MA) has been famously skeptical of the OFC legislation in the past. Indeed, Chairman Frank has allegedly said, not wholly in jest, "One reason I left the state legislature was to get rid of all those irate constituent calls about insurance rates and claims. Why would I ever want to start getting all those calls, all over again, here in my congressional office?!" Despite this pretty much unanswerable question, Mr. Frank has made comments since becoming committee chair that indicate he is increasingly interested in the OFC concept. Similar statements have come from Rep. Paul Kanjorski (D-PA), the critical and cerebral chair of the HFSC's Capital Markets Subcommittee.
Proponents' second new opportunity, which, ironically, is also their first new problem, is the sponsorship of the legislation in the new Congress. Importantly, the OFC legislation is now bipartisan in both houses. Not only have Senators Sununu and Johnson reintroduced their bill as S. 40 in the new Congress, but the House version of the legislation is now bipartisan, as well, with Illinois Democrat Melissa Bean joining Republican Ed Royce in sponsoring the new House bill, H.R. 3200. Indeed, Bean, who is now the lead sponsor of the House bill, gets strong support from such disparate groups as the U.S. Chamber of Commerce and the influential Democratic women's PAC, EMILY's List. It is also of more than footnote interest that Bean hails from the one state that has no rate regulation, while Royce comes from a state that has, for the last two decades, reveled in the price control regulatory regime ushered in by Prop 103, a voter proposition propelled by the auto insurance crisis of the mid-1980s in California. With Bean and Royce both being members of the HFSC-and there being more sympathetic Committee leadership-the OFC bill looks to be poised for serious consideration after the TRIA reauthorization debate is concluded.
On the Senate side, the situation is more complex. While Banking Committee Chair Chris Dodd almost certainly will support OFC when the time comes, there are significant uncertainties about the futures of the key sponsors. Both Sununu and Johnson are up for re-election in 2008, and their re-elections are by no means assured. Republican Sununu comes from the increasingly purple state of New Hampshire and is likely to have a very tough re-election battle, even though his political independence may be as strong as his Republican provenance. Democrat Johnson not only comes from deeply red South Dakota, where Democrats are, by definition, always an endangered species, but is recovering from a brain hemorrhage that almost killed him less than nine months ago. While Johnson's medical recovery has been impressive-with his first public outing in late August, when he gave a short speech to a big "Welcome Home" crowd-whether he runs for re-election and, if so, whether he can hold onto a seat he originally won by fewer than a thousand votes is very much an open question. So, it is possible that the two key Senate OFC sponsors won't be in the next Senate, at the very time that the legislation's future may hang in the balance.
The second new problem-which, with equal irony, has the potential to become a great new opportunity for OFC's advocates-the emergence of other big-time insurance issues: how to handle natural disasters and what to do about the McCarran-Ferguson Act's antitrust exemption for state-regulated insurance activities. So far, the OFC legislative track has been kept pretty clean of other insurance issues, but if OFC gets political legs, while the natural disaster legislation favored by many Gulf State Republicans and Democrats languishes in Committee limbo, there will almost certainly be an effort to engraft some version of that legislation onto a moving OFC bill. If the natural disaster legislation were actually molded into good public policy, it could, in fact, become "the engine that could" pull the OFC bill to enactment. But, if it turns out to be bad public policy, it would almost certainly doom OFC in this Congress. The same can be said about Senator Trent Lott's (R-MS) desire to punish the insurance industry over Katrina claims issues by getting the McCarran-Ferguson antitrust exemption repealed, an effort supported philosophically by Judiciary Committee Chair Patrick Leahy (D-VT) and the Ranking Republican Judiciary Committee member, Arlen Specter (R-PA).
Many years ago, Senator Russell Long-of the Louisiana Longs-famously recited his recipe for getting legislation passed. Long reportedly said, "Legislation is just like gumbo. You keep putting stuff in until it tastes just right. Then it's done." Of course, Long's recipe didn't take into account the possibility of adding arsenic just for seasoning! One suspects, however, that Long-the great legislative chef-sometimes did precisely that. OFC is insurance reform legislative gumbo, and big reform legislation almost never gets passed without a big crisis propelling it-adding just the ingredient to make the gumbo taste right. So, the current insurance crisis just might be used to by its insurer advocates-if they are daring enough and have a little luck-to transform a promising OFC bill into a palpable opportunity for an OFC law that benefits both them and their customers. But it will take a boldness rare in any legislative effort.
Having noted these new opportunities and problems, perhaps the most important observation is not about anything new at all, but about something as old as the OFC debate, itself: the continuing split in the insurance industry. The legislative momentum has clearly been moving towards OFC. There is new support for it in Congress, which comes from:
- The perception (fair or unfair) that the states-failed-to deal adequately with the insurance issues arising out of Katrina;
- The archaic nature of many state regulatory systems that focus on price controls-a matter that is now increasingly mentioned in congressional hearings as a fact of life, like the sun rising in the east; and
- The perceived inconsistency between state regulation and international business.
Yet the old splits in the industry remain the most constant theme of the debate. Although certain of the insurance trade associations and companies have shown some movement, the hostility of many small insurers and much of the agent community remains as intense and as effective as ever. One suspects that if the OFC legislation really looks as if it is moving forward, the more savvy of the groups representing the insurance opposition will find ways to negotiate changes that will satisfy their most important constituent needs-but not a moment before.
The 2007 OFC Legislation
The new OFC bills introduced in the Senate and the House are 98% the same as the bills introduced in the last Congress. Yet, there are some noteworthy changes from the last versions, including the following:
- Both bills now use the same numbering system-perhaps the greatest change of all!
- Both bills have amended the ombudsman provisions, so that only nationally chartered insurers and agents may invoke the ombudsman's assistance in dealing with regulatory and enforcement issues.
- Both bills tighten up the state pre-emption language to make clearer the very limited nature of state "compulsory coverage" and "residual market" laws that may be applied to a nationally chartered insurer.
- Both bills direct the National Commissioner to issue regulations assuring confidentiality in anti-fraud investigations. The House bill, in addition, creates a national anti-fraud program that emphasizes co-operation with law enforcement agencies, insurance anti-fraud organizations (like the National Insurance Crime Bureau) and both state-licensed insurers and federally chartered insurers, and applies the bill's immunity "actual malice" standard to those who assist in anti-fraud activities.
- Both bills now permit a nationally chartered insurance agency to be organized in any form otherwise authorized under law, rather than solely as a stock company.
- Both bills add corporate law flexibility for nationally chartered insurers.
- Both bills explicitly allow nationally chartered insurance agencies to sell surplus-lines insurance. They also limit premium taxes for surplus-lines transactions to the policyholder's state.
- Both bills explicitly authorize the National Commissioner to take prompt corrective action against any nationally chartered entity in financial trouble.
- Both bills make a number of changes in the reinsurance provisions dealing with collateral for reinsurance and the rights of federally chartered reinsurers to be free of state interference in their reinsurance contract provisions. The House bill also includes language with regard to financial reporting for non-U.S. reinsurers; licensing of non-U.S. reinsurers; and credit for reinsurance standards.
- Both bills add explicit language stating that a state may not impose any type of tax or fee on a nationally chartered entity for any state service that does not benefit that nationally chartered entity.
- Both bills now explicitly provide that a state-licensed insurer may sell the products of a nationally chartered insurer.
- The receivership and guaranty fund provisions have been substantially reworked to, among other things, substitute statutory text for reference to NAIC model laws and to provide absolute immunity from liability for guaranty fund officers and employees.
- The House bill now requires that property/casualty insurers not only make available to the National Commissioner an annual list of their standard policies, but also make available the policies themselves.
- The House bill includes a Government Accountability Office study evaluating the new law, to be submitted to the Congress three years after enactment.
With these changes incorporated, here is-by popular demand-our updated guide to the Optional Federal Chartering legislation, first published May 24, 2006, in Washington Perspective.
What Is the Option in "Optional Federal Chartering" and Who Gets It?
The bill establishes a federal legislative option broadly similar in concept to federal banking laws, which allow banks to become federally chartered or to be chartered by the states. To that conceptual extent, S. 40 and H.R. 3200 (herein, "the OFC bills") do not plow new ground; rather, they plant a new crop in ground well plowed over the years.
Thus, under the OFC bills, the choice of whether to become federally regulated rests wholly with the insurance entity. Absent an affirmative "opt-in," the insurance entity continues as a state-regulated business. If you run an insurance entity and you want nothing to do with federal insurance regulation, then you don't exercise the "opt-in," and you continue to be regulated by the states as if the federal law had never been enacted. The option is available to life insurers, property/casualty insurers, reinsurers and the agents and brokers selling the products of all of them, but not to health insurers. For a single, stand-alone insurer, the option to become a "National Insurer" is easy to describe. If the insurer wants to go into the federal system, it files the papers, and if it meets the financial and integrity criteria, it is in.
For holding companies with numerous insurance subsidiaries, the choice gets more complex and potentially more interesting because, unlike today, the bill would allow the holding company to make its decisions-subsidiary by subsidiary-based solely on its business model. So, the holding company might decide to keep all of its subsidiaries in the state system. Or it might convert all the subsidiaries to the federal charter. Or it might decide to keep some of its subsidiaries in the state system and convert the others to the federal charter. Finally, it might decide to collapse all of its subsidiaries into one federally chartered insurer and thus eliminate the overhead of maintaining multiple subsidiaries. For those few companies that have both life and property/casualty subsidiaries-once a fairly common arrangement, though not anymore-two federal charters would be needed one for each.
Reinsurers also get to exercise the option. They can stay wholly outside the federal system, or they can come into it, as National Insurers, just like primary insurers. But reinsurers can also opt for a federal license, without becoming a National Insurer. Once they get the federal license, the bill provides that they are treated (and regulated) as if they had actually become a National Insurer, which means that they will operate within the federal regulatory system.
Although the bill does not set out the reason for this additional pathway to federal regulation, the option would appear to be of greatest interest to non-U.S. reinsurers looking for a way to gain "legitimacy" in the U.S. without either going through state-licensing procedures or formally becoming a National Insurer. As a practical matter, however, they apparently would be governed by all the same regulations as a reinsurer that opted for a National Insurer charter. This is an area of the bill that has continued to be reworked as the bill has matured. Additional work is likely still to be necessary, as the sponsors struggle with such issues as the proper standards for providing collateral for reinsurance and approaches to state-licensed insurers obtaining reinsurance from federally chartered or licensed reinsurers. However, one festering current problem of the state system is decisively resolved in the new OFC bills: the states are specifically prohibited from imposing reinsurance contract terms on any reinsurance contract where the reinsurer is federally chartered, regardless of the status of the cedent.
Agents and brokers are also given broad latitude under the bill. They can avoid the federal system in its entirety, or they can become federally licensed. Agent and brokerage businesses are also eligible for a "National Agency" designation. Under the original OFC bills, [agents and brokers] had to be organized as stock companies if they wanted a federal charter; under the new OFC bills, that limitation has been removed. When an agency gets its national license, it also automatically gets a national producer's license. When an agent or broker gets a producer's license (after passing an examination), that license is national in scope, and no separate state licenses can be required. However, both nationally licensed and state-licensed producers are authorized to sell the insurance products of both National Insurers and state-licensed insurers. Early drafts of optional federal chartering bills had required a national producer's license in order to sell insurance products from National Insurers, but that is not the approach taken in the OFC bills, which explicitly place state-licensed insurers on the same plane as nationally licensed insurers with regard to access to the products of National Insurers. The new OFC bills now also explicitly say that a nationally licensed agent may sell surplus-lines insurance-language that was technically unnecessary, but politically important.
Two more options are worthy of quick mention. The first is that a National Insurer may convert from mutual to stock, and vice versa. And any covered insurance entity may not only switch from state license to national charter, but may switch back again, at its option. Thus, covered entities continuously "vote" through the option they select and are not permanently bound by that option. Rather, they can move to the system that works best for them. The bill limits neither the number of times that "conversion" can take place, nor the timing of the "conversion."
Who Would Be the Federal Regulator?
When an insurance entity opts for federal regulation, it brings its business principally (but not solely) under the regulatory authority of the Office of National Insurance, headed by the Commissioner of National Insurance, who is appointed by the president for a five-year term, with the "advice and consent" of the Senate.
When the OFC idea was in its earliest conceptual stages, there was a tough debate about where in the federal government the regulatory authority ought to be housed. Some advocated the Commerce Department. Some advocated a new, independent federal commission, along the lines of the Federal Communications Commission. But in the end, the idea of placing a single official in charge of an agency in the Treasury Department won out. And the OFC bills have taken the same approach.
Putting the authority in Treasury has several obvious benefits. As one of the original cabinet departments, Treasury is automatically on the government "A" list. Moreover, Treasury is the place where federal banking regulatory authority generally is located; putting insurance regulation on the same level as banking regulation has always been a goal of the OFC supporters, and having the Secretary of the Treasury as an advocate of sound insurance practices before the Congress and in the executive branch was felt to be a substantial advantage. Finally, by putting regulatory responsibility in a single official (the National Commissioner), who would need to be approved by the Senate Banking Committee and then confirmed by the full Senate, the general view of the advocates was that no president could afford to allow the position to become a political throwaway, but rather, would do much to assure first-class appointments to the position. The fact that Treasury has responsibly handled matters arising under the Terrorism Risk Insurance Act has added to the belief that the agency is the right place to put the broad OFC regulatory authority.
The new National Insurance Office will have its headquarters in Washington, DC, but is statutorily obligated to have at least six regional offices around the country and is authorized to have as many local offices as it determines necessary, as well as offices outside the U.S. The idea of mandating the creation of regional offices is probably linked to the criticism often leveled by opponents to federal regulation that the federal government can never be as close to the people as state governments. Certainly, establishing six regional offices is not likely to convince opponents that the "home-town touch" obligation has been met, but the OFC bills have some other interesting innovations that may help their advocates in the debate. For example, the bill establishes an ombudsman position as a liaison between any insurer adversely affected by the Office's activities and the commissioner. The original ombudsman provisions also allowed the ombudsman to take complaints from the general public; that broader authority has been eliminated in the new OFC bills. It is uncertain how-and whether-this narrowing will play in the debate. In any case, the bills also establish Divisions of Consumer Affairs and Insurance Fraud, both of which will have the national scope that no state insurance department can possibly have. In addition, the House OFC bill creates for the first time a truly national anti-insurance fraud program; the sponsors of the legislation are almost certainly going to use this innovation as another reason to seek broader support for the legislation.
What Would Be the Role of Self-Regulation?
In an interesting regulatory experiment, the bill incorporates a concept that has been used in some other federal regulatory environments but has not been used for insurance regulation: the authorization of
Self-Regulatory Organizations (SRO). An SRO is an organization composed of regulated entities that undertakes, subject to the Commissioner's overall approval and oversight, many of the day-to-day regulatory responsibilities that are otherwise entrusted to the Commissioner, while reserving to the Commissioner certain key functions that SROs can never be authorized to perform. The most well-known SROs are the National Association of Securities Dealers (NASD) and the New York Stock Exchange. Like the securities community, the regulated insurance community may well determine that SROs would be a more effective and responsive day-to-day regulator than the National Insurance Office; if they do, they can set them up by submitting a plan to the Commissioner.
How Would Premium Taxes Work?
Opting for federal regulation also means continuing to pay state premium taxes and, at the same time, paying for the federal regulation. The bills could have been drafted to relieve National Insurers of state premium tax obligations, but the sponsors have decided to the contrary, so that the major financial benefit to the states of the historic state regulatory system-their premium taxes-remains undisturbed. The sponsors could also have decided to provide funding for the federal system through the congressional appropriations process, but it appears they concluded that direct funding by those who choose the federal regulatory system would provide a more certain and less political financing stream for the system, while also essentially eliminating any significant costs to the federal Treasury, which is always a major hurdle to getting bills through Congress. Fee-based financing is also the way that many state insurance departments get their funding today, and it is how the federal banking regulatory system is financed.
In one area, the bill breaks its rule about leaving state-licensed insurers and agents to the state regulatory system, and that is with regard to surplus-lines insurance. Surplus-lines insurance is "safety valve" insurance that is sold by specially licensed agents on behalf of insurers that are not licensed in the state. The insurance can only be sold for risks in that state for which the necessary insurance is unavailable from a licensed insurer in the state. Surplus-lines insurers represent the beachhead of the free market in insurance, since they are subject to neither state rate review nor form filing laws, but they have become a political football, tossed around by the states that are arguing amongst themselves about who gets to charge and keep the premium tax on specific transactions. The new OFC bills resolve that issue by saying that only the domiciliary state of the policyholder can charge a premium tax. In taking this position, the OFC legislation mirrors other federal bills that have been aimed at this issue and reflects the view even within the state regulatory community that this problem can only be solved with federal legislative help.
How Would Federal Regulation Work?
Once an insurance entity is in the federal system, it will find some radical departures from most state insurance regulation. It will also find a lot of similar concepts. On the radical departure side, the element most likely to be hotly debated is the elimination of government price controls-or, as they are called in insurance-regulation-speak, "rating laws."
Today, while state government price controls are not generally a part of life insurance regulation, they are at the core of property/casualty insurance regulation. At the same time, the federal McCarran-Ferguson Act frees insurers (most importantly, property/casualty insurers) from the application of federal antitrust laws to their collaborative activities relating to the collection of data and the ultimate setting of price, so long as those activities are within a state regulatory system.
The OFC legislation proposes to change that formula dramatically. Under the OFC bills, National Insurers (those that have a federal charter) will be freed from government price controls (the ubiquitous rating laws) but become subject to federal antitrust laws. By adopting this radical approach, the advocates of the bill argue that it has achieved two critical public policy goals. First, it has given consumer groups what they have been advocating for decades-elimination of what they have always contended is government protection through the McCarran-Ferguson Act for "insurer price fixing." But, second, at the same time, the bill has provided National Insurers with the same right to price their products in the marketplace that other business have, free of the type of governmental price controls that have been eliminated for other industries over the past several decades.
The OFC bills handle the regulation of insurance forms in a similar but not identical way. Under the Senate bill, National Property/Casualty Insurers must maintain for inspection by the Commissioner every form that they use and must file with the Commissioner a list of all its standard forms; in addition, the new House bill requires that they must also file a copy of each form. Under both bills, a National Life Insurer may not issue a policy until a copy of the form has been received by the Commissioner, accompanied by a certification from the Insurer that it meets legal requirements. As the bills retain regulatory oversight for forms, they also create a narrow antitrust "safe harbor" for the development, dissemination and use of standard forms by insurers collectively. While the bills do not authorize or contemplate prior review of forms, they do not relieve a National Insurer of any applicable legal requirement that would otherwise govern the insurance product addressed by that form.
Beyond the area of rate and form regulation, the structure and requirements of the OFC bills will look pretty familiar to those who have toiled in the insurance regulatory vineyards. The bills cover all aspects of the business of insurance, including financial regulation (e.g., accounting, auditing, actuarial, investment and risk-based capital standards), market conduct, unfair methods of competition, unfair and deceptive practices, unfair claims practices, acquisitions and mergers, receivership and liquidation, and special provisions for life insurers (e.g., valuation standards and benefit nonforfeiture standards). For many of these requirements, the bills require the Commissioner to start with model standards promulgated by the National Association of Insurance Commissioners no later than the date on which the OFC bills were introduced.
In this connection, there have been many questions about how a federal chartering law would handle state guaranty funds. Under current law, each state has guaranty funds to provide some protection for those with certain types of claims against an insolvent insurer. These funds differ by state and type of insurance, but the general concept is that all insurers writing a particular line of business will have responsibility for making good-through the guaranty fund-the claims payment obligations (in whole or in part) of an insolvent insurer.
The short answer to those questions is that the bills require all National Insurers to continue to belong to state guaranty funds in those states where they write business, so long as the states do not discriminate against them and so long as the state funds meet certain "safety and soundness" criteria established by the federal law. The bills then create a backup federal guaranty fund, solely for National Insurers, to provide for circumstances where a state fund fails either the "safety and soundness" test or is found to have discriminated against a National Insurer. With this approach, the bills' supporters believe that what could have been a major political issue may have been defused.
Finally, the bills provide the Commissioner with broad investigatory and directive authority. There is no aspect of a federally chartered insurer's business that is not subject to that authority. As companion authority, the bill requires that any "person" (i.e., insurer, customer or interest group) that has an issue that falls within the statute's purview-statutory language or regulation-must first go to the Commissioner and get a decision. Only then can anyone go to court.
Thus, in short, if the OFC legislation were to be enacted, opting into the federal regulatory system would mean that an insurer gets a national regulatory regime that allows free-market price competition but, at the same time, exposes insurers to federal antitrust laws. It would allow National Insurers to do business across the country with one license in one comprehensive regulatory system and then allow them to establish SROs to handle much of the day-to-day regulation of their business. This same approach would be established for reinsurers and for agents and brokers, who can sell nationally by meeting the bill's eligibility criteria.
But opting into the federal regulatory system would not mean that a National Insurer is entirely free of state law, as we discuss below.
When the Federal Option Is Exercised, What State Law Still Applies?
The first principle of the OFC legislation is that an insurance entity that decides not to exercise the federal option continues its regulatory rights and obligations in the state system as if the federal system didn't exist. The reverse, however, is not necessarily true. While a National Insurer would come under federal jurisdiction and generally operate outside state law, there are some important exceptions. As mentioned above, all National Insurers must continue to pay state premium taxes and participate in state guaranty funds.
Beyond these basic requirements, a limited number of important other state-based obligations would continue to apply to National Insurers. First, any National Insurer writing motor vehicle insurance or workers' compensation insurance in a state must follow any "compulsory" coverage requirements in that state's law that prescribe the minimum extent of the insurance protection that must be afforded a policyholder. So, for example, if a state law mandates that all of an employer's employees must be covered by workers' compensation policies and provided certain benefits, then a National Insurer must sell only workers' compensation policies in that state that provide for that coverage. Similarly, for motor vehicle insurance (apparently commercial auto insurance, as well as personal auto insurance), if the state mandates a certain dollar amount of liability coverage, a National Insurer's policies must meet that requirement. Importantly, however, the legislation is quite explicit that even in these two lines of insurance-motor vehicle insurance and workers' compensation-a state may not dictate in any way the price at which a National Insurer sells its policies to the public.
The OFC legislation adopts essentially the same approach for state "residual markets" (e.g., assigned risk plans and mandatory joint underwriting associations) used in the property/casualty sector, and for participation in state-mandated statistical or advisory organizations. Residual markets are backup systems designed to assure the availability of a specified type of insurance for individuals or entities that are unable to get it in the private market. When these backup markets are established, the state generally requires all insurers selling that type of insurance in the state to participate. Under additional language in the new legislation, a residual market is limited to an entity required by and established pursuant to state law to provide coverage for persons who cannot obtain insurance in the private market. This language was intended to relate solely to natural persons, but since the statutory definition of "person" includes a corporation, including an insurer, could a state (1) determine that insurers were not able to get reinsurance in a market, (2) create a residual market for that reinsurance and (3) then require federally chartered insurers to join? The answer isn't entirely clear, so this is a matter that will need to be addressed as the legislative discussion proceeds.
Under the bill, a National Insurer doing business in a state would be required to participate in any residual market that would also require its participation if it were a state-licensed insurer. However, under the bill, the National Insurer cannot be told what rate to charge for the insurance. Moreover, unless the rates established by the plan are sufficient to cover the risks that the plan covers (i.e., the plan's rates will cover the actuarially expected losses), a National Insurer need not participate in it. This intriguing provision was apparently included in the bill to prevent states from playing games with their residual markets by using artificially low rates in order to pump up the residual market and denude the private marketplace.
Statistical and advisory organizations generally relate to collection and analysis of data, the development of "loss costs" (certain of the factors that go into a rate) and, in unusual circumstances, "final rates." The two most prominent are the Insurance Services Office and the National Council of Compensation Insurance. These entities also often develop standard policy forms. As in the other areas of mandatory participation, a state cannot use mandatory participation as a way to impose governmental pricing or price controls on a National Insurer or require a National Insurer to use a particular policy form.
Finally, a state may require a National Insurer to adhere to any workers' compensation "administrative mechanism" that the state has established, but, again, the state cannot use this required participation as a back door to imposing rate and price controls, or to force additional state regulation on National Insurers.
What Happens to the McCarran-Ferguson Act?
As we noted earlier, the legislation would free National Insurers of state government price and form regulation, but it exacts a price in doing so, by allowing the application of federal antitrust laws to activities that are no longer subject to state regulation.
The way this works requires a little explanation, but can be generally described in a sentence. As the McCarran-Ferguson Act only applies to state regulation of the "business of insurance," it does not, by definition, apply to any activity that is not state regulated, including a National Insurer's activity under federal regulation. So, McCarran-Ferguson as currently enacted does not apply to any activity of a National Insurer that is not conducted under state insurance regulation. The courts have so held repeatedly. As we have seen, those remaining state-regulated activities form a very short list under the OFC bills, focusing principally on mandated state activities, such as residual markets or workers' compensation administrative mechanisms. Thus, in these areas where there is still state regulation of federally chartered insurers, the McCarran-Ferguson Act would continue to apply to the actions related to these state regulatory provisions, including McCarran's prohibitions on boycotts, intimidation and coercion.
Therefore, without ever amending the McCarran-Ferguson Act, the legislation would work a revolution in the application of the McCarran-Ferguson Act to insurers, but only to the extent that they decide to become federally regulated.
Where Do We Go from Here?
When we published the first version of this article in May 2006, we paraphrased Winston Churchill's famous line about the Normandy invasion-that the introduction of the OFC legislation was "not the end, nor even the beginning of the end, but it may well be the end of the beginning."
We went on to observe that "never in the 150 years of state insurance regulation had so thorough a proposal been introduced in Congress to offer so dramatic a regulatory shift for insurers and their customers. It is too early to tell whether the bill will 'get legs' or, instead, become merely an object of historic curiosity."
One year later, we still don't know whether OFC will become law or merely a historical curiosity. However, it is probably safe to say that never before has the OFC concept been more a part of the federal legislative vocabulary, or had more support in the industry or in Congress, or benefited from a more favorable legislative climate than exists today. It is equally true, however, that all of this is not nearly enough. To achieve enactment of the OFC legislation, advocates will need more: more commitment, more consistency, more constituency, more advocacy and more cash.
While it is hard to believe that the U.S. in the 21st century continues to have the most local of regulatory systems for the most international of all businesses, it is also true that this local, state-based system-as creaky and inefficient as it may be-has coexisted with the most dynamic insurance marketplace in the world and will not easily yield its place under the regulatory sun. But the debate has been teed up, key players have been coming aboard and movement of the legislation may be no more than one insurance crisis away.
This article provides only the basic outline of the bills and the issues. We invite your feedback, questions and suggestions.
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