(March 10, 2008, Washington, D.C.) — Turmoil in the bond markets, continuing fallout from the home-foreclosure crisis, and uncertainty regarding the Democratic Party’s 2008 presidential nominee set the stage for a vigorous dialogue during the 5th annual Insurance Reform Summit presented by Networks Financial Institute at Indiana State University on Wednesday, March 5. Held at the Ronald Reagan Trade Center in Washington, D.C., the Summit convened members of Congress, the insurance community and academia to discuss pivotal issues impacting the industry. The agenda included an update on ongoing industry issues, most notably the role of a federal regulator, and the safety and solvency of the industry. However, the agenda also brought forth discussion on emerging issues that will impact the industry’s future, including climate change and the 2008 presidential election.
Insurance and the Legislative Landscape
United States Representative Ed Royce (R-CA) who along with Rep. Melissa Bean (D-IL) co-authored the National Insurance Act of 2007 (S. 40) presented his support of a federal charter to regulate the nation’s insurance industry. Rep. Royce noted that since its infancy as a republic, the U.S. has a heritage of developing and enforcing regulation at the federal level. He noted that the nation’s founders quickly determined that state authority over commerce was neither effective nor efficient, while also noting the passage of modern federal regulation in the past decade, including Sarbanes-Oxley, the Fair Credit Reporting Act and Gramm Leach Bliley.
Rep. Royce cited the fallout in the U.S. bond markets as an example of the turmoil that arose in an industry operating without federal regulation. He also noted the trade challenges the U.S. faces as it competes in a global market, comparing the U.S. state-regulated insurance system with the autonomy European nations are creating in the insurance sector. Rep. Royce noted that the structure of the banking and securities industries provide them with an authoritative industry voice to leverage in international trade opportunities. “The National Association of Insurance Companies (NAIC) lacks the authoritative power to leverage the industry. It does not make laws,” he noted.
While the U.S. Treasury Department’s report assessing regulation in the insurance industry has not yet been made public, Rep. Royce noted that the legislative landscape is positive for insurance reform. He cited positive comments by U.S. Department of Treasury Secretary Henry Paulson regarding the role of a federal charter as well as a “stinging indictment” regarding insurance state charters published in the 2007 Economic Report of the President. More specifically, he cited a 2007 report by consulting firm McKinsey & Co. that discussed how the U.S. is losing ground in a global marketplace and how an optional federal charter could serve as an antidote to the problem. “The European Union has liberalized markets and established a regulatory framework that is effective. The lack of a federal charter will result in U.S. insurance company’s lacking sufficient capital to compete in markets around the world,” Rep. Royce noted. He further cited the U.S. Chamber of Commerce as concluding that Congress should establish an optional federal charter.
Rep. Royce expressed that a federal charter would benefit more than trade and commerce. He advocated that a federal charter would present superior consumer protection to that currently offered by the state regulated system. From a population mobility perspective, Rep. Royce argued that a structure with federal oversight could more effectively and efficiently serve consumers as they move across state lines.
Regulatory Considerations – What is the Cost to the Consumer?
Michael McRaith, Illinois Director of Insurance, for the National Association of Insurance Commissioners, expressed that the insurance industry would suffer if a federal regulatory structure is imposed, suggesting it would, in effect, result in deregulation. “Deregulating the life and health and property casualty industry would be the biggest regulatory overhaul since the New Deal,” he noted. In contrast to Rep. Royce’s comments about federal regulation being the desire of the nation’s founders, McRaith discussed the stringent review of federal regulation that has taken place over the past century including the creation of Social Security and the Federal Deposit Insurance Corporation. “To assume insurance was overlooked during a period of stringent regulation is erroneous,” he noted.
McRaith argued that ultimately insurance is not about the company but about the consumer who has a claim. “The insurance transaction is local, personal and very different from the securities industry. In other financial arenas such as securities, the buyer is assuming a risk, but in insurance the buyer is spending money to protect against a risk,” he said. He noted the provisions and regulations that would be required under a federal charter and doubted whether most consumers would read all of the provisions, while further noting that the legislation proposed does not include standards for credit scores or rating factors, ultimately putting the buyer at risk. From a rate regulation perspective, McRaith stated that the state-chartered structure already promotes a competitive market that invites self-policing and avoids the costs associated with enforced rate regulation.
McRaith turned to recent history to discuss possible cost and inefficiency consequences of a federal regulatory structure. He cited some economists’ attributions of loose BASIL II capital standards as a contributor to the current credit crisis. He further cited the federal government’s slow response in the aftermath of Hurricane Katrina and the 1980’s federal bailout of the savings and loan industry. “Do we want to risk these kinds of disasters in the insurance world?” he asked.
Finally, McRaith cited the tremendous cost burden that would be associated with a federal charter as well as the time burden. For the National Insurance Act to be effective, the U.S. government would have to invest a tremendous sum in government staffing. McRaith noted that the Act’s proponents had argued that it would enhance global trade opportunities but stated that the legal and judicial systems of Europe do not make this an accurate assumption.
McRaith stated that the 2008 elections will most certainly impact legislation and regulation governing the industry. “Be careful what you wish for. Regardless of the Senator who wins the Presidential Election, he or she will expect increased responsibility on the part of insurance companies,” he noted. However, McRaith also noted that the U.S. electorate does not rate insurance as a high priority item in comparison to larger issues such as the economy, healthcare and education.
Perspectives from the Industry
Following the positions on regulation put forth by Rep. Royce and Director McRaith, a panel of industry experts weighed in on the prospect of a federal charter.
J. Kevin McKechnie, Executive Director of the American Bankers Insurance Association, stated that the insurance industry enjoys a “tidal wave” of industry support for an optional federal charter. “States simply have limited reach due to their geographies,” he noted. McKechnie echoed Rep. Royce’s comment that the NAIC does not make or pass laws and therefore lacks the power to adequately regulate and enforce practices. “The industry needs one set of rules in order to create consistency and uniformity across thousands of markets,” he noted.
Stephen Rahn, Vice President & Associate General Counsel, Lincoln Financial Group, agreed with McKechnie’s call for uniformity. “Risk-based standards and consumer protection must be standard across the nation. Life needs speed and uniformity and a federal charter can provide that,” he noted. Rahn further noted that insurance products and consumers are national by nature and that the state-based regulatory system is not equipped to deal with customers’ mobility. He cautioned the industry to consider the bond market’s current problems and noted that like insurance, the bond industry does not have a federal regulatory structure. “We can continue the Band-Aid approach or recognize that we need an optional federal charter. It’s not a question of if, but when,” he stated.
Debra Ballen, Executive Vice President, Public Policy Management of the American Insurance Association, advanced the organization’s perspective that a federal charter does not mean choosing between consumer protection and business practicalities. She argued that a federal charter would provide the scope and size necessary for U.S. insurance companies to compete efficiently while also creating a deregulated rate structure that would enhance consumer value. Ballen cautioned against delaying a federal regulatory structure. “We can’t wait for another market crisis to strike; rather, we need to identify pressure points in advance,” she summarized.
Gregory Wren, Executive Director of the Coalition Opposed to a Federal Insurance Regulator, expressed that the industry’s problems cannot be solved by assigning them to a federal regulating body. “The act of creating an agency with the authority and power to act does not guarantee that the agency will act,” he stated. Wren stated that a broader network of state regulators enhances the likelihood that a problem will be detected by one of the 51 regulatory bodies. From a consumer protection perspective, he argued that a state-regulated industry is better equipped to deal with the 14 million consumer complaints that were tracked just in 2006.
Tom Koonce, Assistant Vice President, Federal Government Affairs of the Independent Insurance Agents and Brokers of America (IABA) acknowledged that the insurance industry is divided but that the IABA vigorously opposes a federal charter. He cited consumer protection as the basis for the organization’s stance, noting that local regulation works best for consumers and ensures a level of responsiveness not available at the national level. He further expressed concern that a dual-structure system where companies choose their method of regulation would confuse the consumer. “Companies would have a choice but consumers would not,” he noted. Koonce advocated targeted federal legislation that will modernize the industry, citing the Surplus Lines Bill that establishes a uniform system of premium tax allocation and collection for surplus lines as a good example of effective federal legislation.
Robert Detlefsen, Vice President, Public Policy, National Association of Mutual Insurance Companies, expressed a more balanced assessment on the role of a federal regulating structure. He noted that coverage mandates, price restrictions and price controls such as rate regulation are standard parts of many state's regimes and that they can be harmful to markets, companies and consumers. Dr. Detlefsen stated that an optional federal charter is an intriguing approach to the federal charter proposal and presents a more consumer and company friendly option However, he noted that in order for a dual-structured regulatory system to work, the federal charter would have to work the way proponents intended, including continued use credit scoring and other risk-based underwriting variables. He further noted that a dual-structured system would need to provide companies with the flexibility to change their chartering structure if their regulator did not behave responsibly. He noted, "Companies will also further need financial resources to change their charters. This scenario could result in more regulatory discussion at both the federal and state levels that could ultimately leave the industry worse off than where it is today."
State Regulation and Consumer Protection in the Insurance Industry
Professor Sharon Tennyson of Cornell University presented an analysis of states’ efforts to track complaints in the insurance and banking industries. Professor Tennyson’s studies focused on market conduct in the presence of each sector’s attempt to monitor and track consumer complaints. Her data indicated that state insurance regulators handled a combined 392,482 consumer complaints in 2006, compared to just 54,851 for bank regulators. The majority – 65 percent - of consumers' insurance complaints in a sample of four states focused on the claims process. Just 32 percent of the complaints were deemed justified and only 3.7 percent of complaints resulted in enforcement action, with 24 percent of complaints receiving information. States’ efforts to respond to consumers’ insurance complaints were varied as well. While 49 states provided online complaint posting invitations, just 39 offered an online form to initiate a complaint, and 26 states posted complaint data online. Forty-five states offered a toll-free hotline for consumers’ complaints.
Professor Tennyson noted that the insurance industry’s customer service appears to exceed that offered by the banking industry. The banking industry is harder to measure and is largely policed by a broader set of regulations and a primary focus on solvency, including more focused exams. With tighter exam processes, complaint monitoring and consumer focus appear to be less intense in the banking sector. Less than half of state bank regulators – 20 states – offer toll-free hotlines. While every state offers an online complaint invitation to bank customers, just 18 states provide an online complaint form and only one state posts complaint statistics online. Yet, as insurance companies have increased their complaint staffing since 1994, the trend in complaints has actually declined.
Tennyson noted that banks’ customer service appears to be compromised due to banks’ compliance requirements with both state and federal regulations. “If consumer focus is needed in insurance, then ultimately a state provision for regulation may be superior,” noted Tennyson.
Professor Tennyson also noted concerns that federal regulation would result in less industry attention on consumer protection and that regulatory competition spawned by an optional federal charger would further reduce all regulators’ focus on consumer protection.
Solvency Under a Federal Charter – the Role of Prompt Corrective Action
Professor Therese Vaughan, Distinguished Professor of Insurance and Risk Management, Drake University and former President NAIC, discussed the implications of prompt corrective action for insurance firms. She reviewed the structure of the banking industry’s prompt corrective action model which sets specific statutory capital requirements based on risk-based capital and the institution’s leverage (capital/assets) ratio. Within the banking model, discretionary and mandatory action as well as resolution is required as a bank’s capital falls under specific thresholds. Professor Vaughan noted that the banking industry has largely enforced action and resolutions well before the action tripwires are triggered.
Similarly, the insurance industry adopted state enacted risk-based capital laws in the 1990s, again specifying mandatory actions as capital levels fall below established tripwires. Like banks, insurance firms are required to submit restoration plans and at a certain level, the regulatory entity must assume control of the firm. Differences lie primarily in that banking triggers are based on leverage ratios along with risk-based capital and that banking regulations require regulators to limit specific bank activities at lower capital levels while permitting the regulator to move the bank to a more restrictive action level based on the bank’s CAMEL rating.
In summary, Professor Vaughan noted that the prompt corrective action model should be included in a federally regulated insurance structure, although the triggers should not be identical to those used in banking. She noted that the NAIC’s Risk-Based Capital Model Law contains provisions that meet PCA’s objectives of forcing regulator action at low capital levels and motivating insurers to maintain capital above those established levels. She cautioned that oversight of capital levels is insufficient in itself and that regulators must be authorized with the discretion to intervene.
The current state-based receivership process has been criticized as insufficient. Professor Vaughan noted that S. 40: resolves the hazardous financial condition of an insurer effectively and efficiently with the fewest possible losses. In contrast, the banking industry’s FDICIA minimizes losses to the deposit insurance fund. Under this “least-cost resolution” the problem of “too big to fail” could occur, motivating the focus on minimizing losses to the deposit insurance fund. A merging of the receivership and guaranty fund processes in the insurance industry (as with the FDIC) could also create a “too big to fail” scenario for the industry. Professor Vaughan noted that greater transparency of costs and ex-post reviews of insurer insolvencies would support the loss minimization objective.
Beyond the Financial Environment – Emerging Factors that Will Influence the Industry
Dr. Howard Frumkin, Director of the National Center for Environmental Health, Agency for Toxic Substances and Disease Registry, of the Centers for Disease Control, presented environmental and public health research conducted in collaboration with Dr. Paul Epstein of Harvard University, and sponsored in part by Swiss Re. Dr. Frumkin identified climate change as one of the most looming public health challenges. Increases in carbon dioxide, the Earth’s rising surface temperature and rising tides continue to accelerate. The Intergovernmental Panel on Climate Change (IPCC) 2007 report notes that since 1979, the Arctic ice cap has experienced a 20 percent reduction and that the melt rate in Greenland doubled between 2001 and 2006.
Dr. Frumkin noted that these climate changes have real implications for the public health community, impacting conditions ranging from allergies to malaria, while introducing diseases to regions previously non-afflicted with a particular condition. He noted a Wall Street Journal report linking global warming to increased allergies, noting that certain plants such as ragweed, actually thrive as the climate becomes warmer.
Concurrently, the world is beginning to experience the arrival of environmental refugees as climate change and natural disasters displace them. As more than half of the global population resides in urban areas, the problems are accelerated. “We are on a collision course with the convergence of urban migration and global warming,” Dr. Frumkin noted. Beyond the atmosphere, the global warming phenomenon and urban migration present threats to food security, mental health and ultimately major economic implications. In addressing the public health challenges posed by climate change, Dr. Frumkin noted key processes that will need to be addressed including preparedness and prevention, an ethical mandate among those that contribute the most to share in the resolution, and the facilitation of constructive engagement among parties to address public health issues. “Ultimately, climate change will have substantial economic implications,” Dr. Frumkin noted.
Moving Toward the 2008 Elections
Morton Kondracke, Co-host of The Beltway Boys and Executive Editor of Roll Call, shared his perspective just one day after the March 4 presidential primaries in Vermont, Rhode Island, Ohio, and Texas. Kondracke noted both Senator Clinton and Senator Obama’s efforts to separate themselves from NAFTA in Ohio, while noting that NAFTA has not been a problem for the state which actually sends 57 percent of its exports to Canada and Mexico. While noting that NAFTA was not a factor, Kondracke noted that race has, and will continue to play, a major role in the 2008 electuions. He noted that while 20 percent of Senator Clinton’s voters said race was a factor in their decision, 55 percent of those indicated that they voted for Clinton. Similarly, 90 percent of African Americans have voted for Senator Obama. While Kondracke expressed that Senator Obama remains in the lead in terms of popular votes and delegates, the prospects of uncounted Michigan and Florida delegates remains uncertain.
Beyond the tabulation, Kondracke said the “real story” is the emergence of Obama as a “rock star” personality. “Obama offers an end to the poisonous partnership that prohibits stuff from getting done,” he noted. He noted that the 2008 electorate has indicated that above all else, they want to elect a candidate who will take action and stop the polarization that has stymied progress with healthcare, social security reform, education, energy prices and other topics they deem important. “Senator Obama’s opportunity is to position himself as an alternative to the polarization that has gripped American politics,” Kondracke noted. He discussed how both Senator Clinton and Senator Obama have dramatically similar proposals to address healthcare, troop withdrawal, trade agreements and taxes. “They agree on issues; the difference is in style. Obama offers a sense of unity and Hillary offers a sense of a fight,” he stated.
On the Republican front, Kondracke characterized Senator McCain as a “conviction politician” recognizing that he has failed to waiver on his stance with regards to immigration and other issues. He noted that many conservatives still perceive Senator McCain as too liberal and that he expects Senator McCain to create a sense of separation between himself and President Bush as the campaign continues. He said that McCain’s electoral success may rest on his ability to convey the importance of his experience and role in national security, but that he will need to create a competing optimistic vision for America.
Kondracke noted that the in an environment where voters continue to largely classify themselves as “independent,” the momentum currently resides with the Democratic Party. Given Senator McCain’s age and the race/gender status of Senators McCain and Clinton, he noted that the running mate will be especially important on the 2008 ticket.
Continuing to address the issues
Liz Coit noted in concluding remarks that despite the changing issues impacting the insurance industry, the focus of the event remains to bring a voice to the myriad issues the financial services industry impacts, and that impact the financial services area. Networks Financial Institute at Indiana State University is focused on facilitating independent research, policymaker insight and stakeholder data to advance financial services work.
First held in 2004, the Annual Insurance Summit is presented by Networks Financial Institute at Indiana State University. The Summit has gained a reputation as a leading forum for advancing dialogue related to the changing regulatory environment of the insurance industry.
Networks Financial Institute at Indiana State University was founded in 2003 with a grant from Lilly Endowment. NFI strives to facilitate broad, collaborative thinking, dialogue and progress in the evolving financial services marketplace, concentrating on the areas of education, outreach and research. Headquartered in Indianapolis with offices in Washington, D.C., and on the campus of Indiana State University, and with outreach internationally, NFI’s goal is to serve as a catalyst for change in the financial services industry.