The Fatal Flaw of Proposals to Federalize Insurance

While the federal government has had the option of regulating insurance since the decision by the U.S. Supreme Court in the United States v. South-Eastern Underwriters Ass'n, 322 U.S. 533 (1944), the states have retained almost exclusive control over insurance regulation. Within the past seven years, Congress, however, has considered three different methods of federalizing insurance regulation. One would require the states to adopt uniform laws and it was embodied in the State Modernization and Regulatory Transparency Act (the "SMART Act"). Another would give insurance companies the option of seeking a federal insurance charter instead of a state insurance charter. This method was embodied in the National Insurance Act of 2007 ("NIA"). The third would require multistate insurers to obtain a federal charter and only allow single-state insurers to remain subject to state regulation. This method was embodied in the Insurance Consumer Protection Act ("ICPA"). Some members of the insurance industry see the federalization of insurance regulation as a mean of eliminating the problems in the current state system, which they view as costly, cumbersome and confusing. In the hearings before Congress regarding the proposals for federalizing insurance, state regulators and consumer advocates have repeatedly stated that insurance is a "unique" financial service. The opponents of federalizing insurance use this uniqueness to justify why insurance regulation should only be done by the states. The proponents of federalizing insurance use this uniqueness to justify why a completely new agency must be created at the federal level if the federal government is going to begin to regulate insurance. Both sides are mistaken to view insurance as a completely, unique financial service. While insurance may have been a completely distinct financial service decades ago, it no longer is. Today insurance products are part of a continuum of financial services that are increasingly fungible with one another. The distinctiveness of insurance will only diminish with time as more hybrid products are being developed every year. These products combine elements of banking products and insurance products or of securities products and insurance products. None of the current proposals to federalize insurance recognizes the extent to which the boundaries between insurance products and other financial services products have disappeared. As a result, the current proposals will not adequately address the problems facing regulators. This article will discuss three alternative structures would place the regulation of insurance in the context of the evolving financial services industry. Each of these structures offers advantages over both the other proposals to federalize insurance and the current system of state regulation. The alternative structures are: (1) create a federal agency that would regulate insurance, securities, commodities and futures and would merge the Securities and Exchange Commission and the Commodities Futures Trading Commission into it; (2) create a twin peaks structure with two federal agencies that regulate all financial services but one agency would be responsible for regulating prudential risks and the other agency would be responsible for regulating market conduct risks and protecting consumers and investors; and (3) create a single, financial services regulator that would be responsible for regulating all aspects of financial services. These structures offer several advantages over the current structure and the proposals to federalize insurance, because, among other things, they would better reflect how the financial services industry operates than the existing structure, would reduce the total number of agencies regulating financial services, and would reduce the problem of agency capture. If the United States is going to federalize insurance, it should adopt a structure that recognizes the current realties of the financial services industry and not one that memorializes how the industry operated decades ago.