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This year, Congress will consider whether to dramatically change the way the business of insurance is regulated. What makes this unusual is that over a half-century has elapsed since Congress last acted to alter the fundamental structure of insurance regulation. The problem currently sparking congressional interest and action is simple: a dysfunctional state insurance regulatory system that is parochial and based on outdated, discredited economic theories. It is a system that straitjackets the insurance marketplace and fails our economy and consumers. As a free-market economic power and a democracy, the United States depends on insurance to make risks manageable. Everything from fender-benders to catastrophic disasters (e.g., hurricanes, terrorism) requires a flexible regulatory system that is market-sensitive and able to respond to increasingly complex societal needs. Like banking and securities, insurance is integral to the financial services lifeblood of the country and the national interest; yet it is regulated very differently from those two industries. Insurance is overseen through a 51-jurisdiction system obsessed with imposing price and product controls that require government review before rates and forms are “permitted” into the market. Insurance pricing in many states is a political pawn, not a product of free markets. This is particularly true for property-casualty insurance. Both the process and standards of the current system are hopelessly inconsistent. Insurers face 51 different state regulatory systems and philosophies. There are approximately 350 different filing and review systems for rates, and 200 different regulatory approaches to policy forms. The resulting inefficiencies associated with complying with these multiple jurisdictional requirements needlessly add to the cost of insurance and frustrate consumer needs for new, timely insurance products. Given these constraints, it is hardly surprising that the current insurance regulatory system has become stressed and dysfunctional to the breaking point. Even among state regulators there is widespread agreement that the system needs meaningful and substantial reform. Yet decades of good-faith efforts to reform the system have failed. Attempts to achieve uniform standards on key insurance issues in order to minimize problems related to multiple jurisdictional requirements have broken down in the implementation process. States deviate from “model laws” by adding additional requirements, thus undermining potential gains in efficiency from uniformity. More important, the standards themselves, even if uniform, are not market-based. The failure of reform efforts over many years only partly explains why Congress is re-examining state insurance regulation. Today, advanced technology and globalized markets transcend state boundaries, creating critical national security and economic reasons for insurance regulatory reform. Within hours after the Sept. 11 terrorist attacks, the Federal Reserve conducted conference calls with the CEOs of major banks to ensure sufficient liquidity in the monetary system; there was, by contrast, no federal mechanism to gather information or help focus the insurance industry’s response to the single largest loss in its history, demonstrating the current lack of a national reach. MODERNIZING THE MARKETPLACE The long-standing argument over how to regulate insurance goes back to 1869, when the Supreme Court in Paul v. Virginia held that Congress had no authority to regulate the business of insurance, which, according to the Court, involved intrinsically local transactions. This remained the law until 1944, when the Supreme Court decided United States v. South-Eastern Underwriters Ass’n, holding that Congress could regulate insurance. That decision triggered a political firestorm — shortly thereafter leading to enactment of the McCarran-Ferguson Act in 1945, which reserved regulatory authority over the business of insurance for the states absent specific federal legislation to the contrary. As Congress re-enters the debate, a growing consensus is creatively rethinking how insurance should be regulated. The lack of tangible progress in modernizing the state-based regulatory system and the dramatic change in the financial services landscape are fueling the need for a new regulatory paradigm. Reform measures would be premised on key regulatory principles that emphasize market-driven processes: regulatory uniformity; “national treatment” that allows an insurer to obtain one charter to do business in all jurisdictions; regulatory equality among insurers and other financial services; and regulations facilitating use of new technologies. One proposal, supported by the American Insurance Association, the American Council of Life Insurers, and the American Bankers Insurance Association, calls for a system of optional federal chartering (or national insurance charter). This approach would focus on financial integrity and eliminate government price and product controls. It would emphasize market-based regulation and strong oversight mechanisms, including effective solvency regulation and appropriate consumer protections. Most important, it would allow insurers either to choose the federal regulatory route or to continue on the state regulatory path, depending on which approach proved most beneficial to the size and scope of their operations. This would be similar to the banking regulatory system. A federal regulatory system located in the Treasury Department would grant national charters to qualified insurers and reinsurers and have authority to regulate market conduct. For national insurers, outdated state insurance laws would be pre-empted. However, national insurers would be required to abide by state insurance laws’ mandatory coverage provisions. In addition, they would be required to pay state premium taxes. In exchange for having price flexibility, national insurers would be subject to the normal application of antitrust laws (which are now limited under the McCarran-Ferguson Act) and would remain subject to state tort and contract law. Under an optional federal chartering system, the financial stability of national insurers would be regulated by sound investment standards and risk-based capital requirements, ensuring that companies have adequate assets to pay claims. Federal regulators would also focus on financial integrity and employ a single, uniform market conduct process so that patterns of misconduct could be quickly detected. Currently, consumer protection regulation varies from state to state. Federal oversight would enhance consumer protections by allowing the national regulator to discern patterns of regional and national conduct that might currently go unnoticed by state regulators. Hearings were held in the House and Senate during 2003 on the state insurance regulatory crisis. The hearings examined the federal regulatory option, and also focused on potential reforms of the state system. SOME ARGUMENTS AGAINST Several arguments are offered by optional federal chartering opponents. The first is that the state-based system can reform itself, moving toward market-oriented pricing and product flexibility, and creating uniform standards. While there are a few notable examples of states letting the market regulate prices and products, the current system remains focused on government price and product controls. Repeated attempts to achieve uniformity of state standards also have failed. A second objection to optional federal chartering is that Congress and federal regulators might adopt their own version of price and product controls. This is certainly a possibility, but Congress has eliminated government price controls from numerous industries since the 1970s (starting with airline travel), making it unlikely that such restrictions would be imposed on the insurance industry. In any case, reform proponents — who have no interest in merely carrying over to the federal level the failed economic policies of the states — would vigorously oppose such legislation. Some critics claim consumers are better served by state regulators, who may be more attentive to local concerns. Yet some of the most successful consumer-oriented programs are administered by federal regulators. Historically, the more critical the issue, the more likely a federal regulator has been entrusted with it. Federal administration of programs involving minimum wages and overtime is a good example of direct federal response to public needs on the local level. Some opponents predict substantial litigation regarding the scope of the federal pre-emption of state insurance law and the changes in the antitrust environment, creating uncertainty and destabilizing the insurance marketplace. While legal issues could arise, well-crafted legislation could limit this potential problem. Moreover, the current regulatory system is hardly litigation-free. Under our proposal, at least, disputes would be resolved quickly and uniformly. The argument is sometimes made that small insurers would be disadvantaged under an optional federal chartering system. This objection presumes without justification that small insurers would neither be able to obtain nor want a national charter. Another objection is that, with normalization of antitrust laws under optional federal chartering, small insurers would not have access to the kind of actuarial data currently shared. In reality, most types of historical data sharing are perfectly appropriate under antitrust laws. Moreover, any insurer concerned with this issue could choose to remain regulated by the states. One final concern sometimes raised is the possibility of having a single, federalized guaranty system. It should be noted that the state guaranty fund system, which taps solvent insurers to pay claims for insolvent insurers, is now more stressed than it has been in over 30 years. Several recent, high-profile insolvencies and other substantial problems plague the system. No doubt the role of guaranty funds will be an important — perhaps critical — part of the broader regulatory debate. RISKS OF THE STATUS QUO The economic case for establishing a meaningful federal role in insurance regulation is overwhelming. Moreover, most serious observers of the current state system agree that it is failing and that a regulatory paradigm shift is urgently needed. The question really centers on whether the current system can successfully make that shift. Those of us advocating change are willing to accept the burden of showing that optional federal chartering can provide an insurance regulatory framework that will bring the insurance marketplace into the 21st century and meet our national needs as well. Advocates for change, however, are not the only ones who have a burden to meet. Supporters of the status quo have an equally compelling burden — to move beyond rhetoric and achieve real reform. Good-faith state reform efforts should continue. Given the critical importance of managing risk in our economy and society, it is imperative that we have a fully functional insurance marketplace. Craig A. Berrington is senior vice president and general counsel of the American Insurance Association in Washington, D.C.

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