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The federal government is exerting increasing control over insurers — and insurers, by and large, are seeking even greater federal regulation. Most of American businesses today aim to reduce the extent to which federal agencies oversee their operations or at least to prevent expanded regulation. Why is insurance heading in the opposite direction? And why are insurance industry leaders active proponents of the change? THE STATES’ SHOW The answer has historical roots. Since 1945, when Congress enacted the McCarran-Ferguson Act, “the business of insurance” has largely been regulated by state insurance commissioners. Where so regulated, it has generally been immune from federal oversight. The unusual primacy of state regulation created by McCarran-Ferguson is superseded only when Congress expressly provides that legislation is intended to govern insurance. Until recently, Congress rarely took that course. While the precise scope of the immunized “business of insurance” has been extensively litigated, state regulators oversee the finances of insurers, the rates charged to their policyholders, and the lion’s share of insurance transactions. The terms under which insurance is sold and insurance companies enter and exit the marketplace are even more pervasively controlled by the state commissioners. For many decades the predominance of state regulation was just fine with virtually all insurers — property/casualty and life/health, stock and mutual, large and small — and with insurance agents and brokers, who often dealt directly with insurance purchasers. Today, however, many in the industry see things differently. The situation began to change with recent federal initiatives. Over the past several years, both Congress and federal agencies have become more willing to regulate insurers. Privacy provisions of the Health Insurance Portability and Accountability Act of 1996 and the Gramm-Leach-Bliley Act of 1999 have affected the operations of insurance businesses. With express congressional authorization, the Federal Trade Commission is examining the widespread use of credit scoring in underwriting insurance, an area already aggressively reviewed by several state insurance departments. And in the aftermath of inquiries initiated by New York Attorney General Eliot Spitzer, the Securities and Exchange Commission has been intensively investigating finite risk reinsurance arrangements. The growing number of subject-specific exercises of federal power over insurance has already significantly shifted the balance between Washington and state capitals. This trend will almost certainly continue. TERRORISM AND ASBESTOS Two new subject-specific federal initiatives are playing out on a larger and more politically significant scale than was typical in the past. The first of these developments is unfolding rapidly, even over the current August congressional recess. Congress is considering possible replacement legislation for the Terrorism Risk Insurance Act of 2002 (TRIA). In TRIA, Congress provided that if a loss from international terrorism exceeded certain thresholds, the federal government would provide reinsurance. TRIA, however, “sunsets” at the end of this year. It was enacted as a temporary, emergency measure, with many in government expecting the traditional commercial marketplace to assume the terrorism risk by the end of this year. In reality, the risk of a new terrorist attack in the United States remains too large and uncertain for even the best capitalized and most sophisticated insurance markets to handle. Instead, after the London Underground attacks, a new consensus seems to have emerged about TRIA. It concludes that the federal government must continue to provide catastrophic reinsurance, but that private insurers need to carry a larger and expanding portion of the risk, though probably through a special pool rather than via normal insurance arrangements. Any creation of a national risk pool, even as a private entity subject to federal oversight, would entail direct federal government regulation of a crucial insurance operation, thereby further tilting the balance away from state regulation. Until recently, asbestos appeared to be another field in which federal control of insurance was likely to expand — again with the support of insurers and Congress. The unending proliferation of bodily injury claims arising out of long-ago exposure to asbestos has imposed a massive burden on casualty insurers and some industrial companies. Following the urgings of many judges, Congress has sought to create a national no-fault compensation scheme for current and future asbestos claimants, funded by assessments on insurers and companies that used asbestos. The current bill, written by Sen. Arlen Specter (R-Pa.), chairman of the Senate Judiciary Committee, would require insurers to contribute $46 billion to the compensation fund, with the allocation among different insurers to be determined by a commission. The size of the contribution, coupled with possible uncertainty about whether the legislation would truly terminate insurers’ asbestos exposure, has caused most implicated insurers to reverse their former enthusiasm and oppose the bill. It now faces a most uncertain prospect in Congress. Even as they differ about its specific terms, however, insurers, asbestos companies, and, indeed, all relevant constituencies save the plaintiffs lawyers seem to favor the core concept of a new federal plan to address this problem. Thus, the serious possibility that Congress could enact a national asbestos compensation plan constitutes another major step toward federal predominance in insurance regulation. A NATIONAL SYSTEM? The rapid expansion of subject-specific federal intervention in the insurance industry is only half the story, however. The second impetus behind growing support for an increased federal role is dissatisfaction with existing state regulation. The burden of duplicative but often varied requirements in 50 states (plus the District of Columbia, Puerto Rico, etc.) is a frequent subject of criticism. Consider just one quantitative measure of that burden in the context of new entry into the insurance business: A “shell” insurance company, without any ongoing business or brand-name cachet but with valid licenses to do business in all U.S. jurisdictions, is worth at least $1 million in today’s marketplace. The substance of much of state insurance regulation also impedes price competition and product innovation. The American Insurance Association has estimated that the states impose approximately 350 separate requirements as to how rates are to be filed and reviewed and about 200 separate requirements for filing and reviewing new insurance products. In response to these and other concerns, many in the insurance industry and some in Congress have proposed turning to the federal government. Their proposals have taken two forms. The more sweeping would permit insurers to choose between being chartered and largely regulated by the federal government or by the states. Proponents of that approach analogize it to the parallel system of federal and state regulation of banks that has existed for many years. Support for this idea is quite widespread in the insurance industry, including among the members of the American Insurance Association, the American Council of Life Insurers, and the American Bankers Insurance Association, as well as among numerous individual insurers. In Congress, however, the optional federal chartering idea has not gained comparable support to date. Instead, the congressional leaders who are most focused on insurance — Rep. Michael Oxley (R-Ohio), who chairs the House Financial Services Committee, and Rep. Richard Baker (R-La.), who presides over the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises — have fashioned a proposed act that would require more limited but still quite significant changes. The proposed State Modernization and Regulatory Transparency Act (SMART) would force greater coordination and uniformity among the state insurance departments through the imposition of federal standards. A central role would be played by a state-national insurance coordination panel consisting of three state insurance commissioners and one representative each from the SEC, the Treasury Department, and the Federal Reserve System. The chair would be nominated by state commissioners but appointed by the president. The SMART bill, although under discussion for more than a year, has yet to be formally introduced in Congress, with an anticipated August submission now delayed because of the need to concentrate on TRIA. Moreover, its terms are still in flux. The most controversial substantive standard in earlier drafts of the SMART bill would have eliminated state prior approval of rate changes, but that provision might not survive. Other anticipated provisions would require standardized and reciprocal state licensing of insurers, agents, and brokers; provide for a single, nationally effective point of electronic filing for commercial insurance forms; and streamline examinations of market conduct by state insurance departments. While the need for improved regulatory efficiency and responsiveness is widely recognized, important constituencies strongly oppose any federal role in that process, either through federal chartering or the SMART innovations. In particular, state insurance regulators and legislators vehemently oppose both proposals. The National Association of Insurance Commissioners has launched such initiatives as the Interstate Insurance Product Regulation Compact — adopted by 15 states to date — but it has not offered anything but criticism of the SMART proposal; its position prompted Rep. Baker in May to decline further discussions with the group until it offers an alternative proposal for federal involvement. Some insurers, particularly smaller regional carriers, and some local insurance agents also strongly favor exclusive state regulation. A FEDERAL FUTURE? No one today can predict with any confidence precisely what the federal government’s role will be in the regulation of the insurance industry in five or 10 years. In areas of particular concern to Congress, such as privacy and security, the expansion of the federal role seems likely to continue. Exercise of existing federal regulatory authority, such as the SEC’s oversight of publicly traded insurers, is also probable where financially significant issues arise. Questions of broad national importance, such as terrorism and asbestos, are also good candidates for at least intensive debate in Congress that may, or may not, yield legislation. But whether general federal regulation of the mainstream business of insurers — by way of optional federal chartering, the SMART hybrid approach, or some other form — will come to pass is quite uncertain. What is clear is that proponents will advocate forcefully for its adoption. The period of flux and controversy is probably just beginning.
Thomas W. Brunner is a partner in the D.C. office of Wiley Rein & Fielding and head of its insurance practice group and represents insurers.

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