Insurance Regulation: Federal Charter Legislation
Released: 2011-02-03T00:00:00

Background

Insurance is one of three primary sectors of the financial services industry. Unlike the other two, banks and securities, insurance is primarily regulated at the state, rather than federal, level. The primacy of state regulation dates back to 1868 when the Supreme Court found that insurance did not constitute interstate commerce, and thus did not fall under the powers granted the federal government in the Constitution. In 1944, however, the Court cast doubt on this finding. Preferring to leave the state regulatory system intact in the aftermath of this decision, Congress passed the McCarran-Ferguson Act of 1945, which reaffirmed the states as principal regulators of insurance. Over the years since 1945, congressional interest in the possibility of repealing or amending McCarran-Ferguson and reclaiming authority over insurance regulation has waxed and waned.

In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) preempting state laws governing many health benefit plans offered by employers, thus essentially federalizing much of the regulation of health insurance. In 1980, Congress curtailed the authority of the Federal Trade Commission (FTC) to investigate the insurance industry, reducing a small avenue of federal oversight on insurance. In the early 1990s, a bill to repeal the limited antitrust exemption granted insurers in McCarran-Ferguson, and thus expand federal oversight of insurance, was reported out of committee in the House, but never reached the House floor. In 1999, Congress passed the Gramm-Leach-Bliley Act (GLBA), which specifically reaffirmed the states as the functional regulators of insurance.

GLBA may have statutorily reaffirmed the primacy of state regulation of insurance, but it also unleashed market forces that were already encouraging a greater federal role. GLBA removed legal barriers between securities firms, banks, and insurers, which, along with improved technology, have been an important factor in creating more direct competition among the three groups. Many financial products have converged, so that products with similar economic outcomes may be available from different financial services firms with dramatically different regulators. Insurers face 50 different state regulators and state laws, many of which differ on some particulars of insurance regulation. This has led to industry complaints of overlapping, and sometimes contradictory, regulatory edicts driving up the cost of compliance and increasing the time necessary to bring new products to market. These complaints existed prior to GLBA, but the insurance industry generally resisted federalization of insurance regulation at the time. Facing a new world of competition, however, the industry split, with larger insurers tending to favor some form of federal regulation, and smaller insurers tending to favor a continuation of the state regulatory system. Life insurers tend to more directly compete with banks and securities firms, so they have tended to favor some form of federal charter more than property/casualty insurers.

Some members of Congress have responded to the changing environment in the financial services industry with a variety of legislation. In the 108 th Congress, Senator Ernest Hollings introduced S. 1373 to create a mandatory federal charter for insurance. In the 108 th and 109 th Congresses, Representative Richard Baker drafted, but never introduced, the SMART Act that would have left the states the primary regulators, but harmonized the system through various federal preemptions. The most consistent response has been the introduction of legislation calling for an Optional Federal Charter (OFC) for insurance.

OFC legislation was first introduced in the 107 th Congress, with bills being introduced in the 109 th and 110 th Congresses as well. Specifics of OFC legislation can vary widely, but the common thread is the creation of a dual regulatory system, inspired by the current banking regulatory system. OFC bills generally would create a federal insurance regulator that would operate concurrently with the present state system. Insurers would be able to choose whether to take out a federal charter, which would exempt them from most state insurance regulations, or to continue under a state charter and the 50 state system of insurance regulation. Given the greater uniformity of life insurance products and the greater competition faced by life insurers, some have suggested the possibility of OFC legislation that would apply only to life insurers, but no such bills have been introduced.

The recent financial crisis affected the debate over federal chartering for insurers in a variety of ways. Some aspects of the crisis gave additional arguments for federal chartering, whereas other aspects have given additional arguments against federal chartering. One specific concern that many have advanced in the crisis has been the negative aspects of allowing financial institutions to choose their regulators. The broad federal charter bill in the 111 th Congress, H.R. 1880 , addressed this by adding some mandatory aspects to a framework similar to the previous OFC bills.

During the December 2, 2009, House Financial Services Committee markup of H.R. 2609 , a bill to create a Federal Office of Insurance, two amendments were offered to create federal licenses and regulation of specific lines of insurance. Representative Dennis Moore offered an amendment (no. 3) that would have created an optional federal license for reinsurers, while Representatives Ed Royce and Melissa Bean offered an amendment (no. 7) that would have created an optional federal license for financial guarantee insurers. Both were withdrawn before votes were taken on the amendments. H.R. 2609 was incorporated into H.R. 4173 , which was ultimately enacted as the Dodd-Frank Act and included some insurance provisions, but did not include a federal charter for insurance. Representative Moore introduced his amendment creating a federal license for reinsurers as a standalone bill, H.R. 6529 , on December 16, 2010.

The Debate on Federal Chartering for Insurers

Many different arguments have been advanced for and against a dual regulatory system for insurance. While taking no position in this debate, many of these arguments are listed below.

Arguments For a Dual Regulatory System

In addition to the principal argument that the regulation of insurance companies needs to be overhauled at the federal level to enable insurers to become more competitive with other federally regulated financial institutions in the post-GLBA environment, other arguments advanced for dual chartering have included the following:

The recent financial crisis has shown that some insurers can present systemic risk and therefore should be regulated by a regulator with a broader outlook. A federal insurance regulator could be a knowledgeable voice and an insurance advocate in Washington, DC. (The Dodd-Frank Act addressed this to some degree through the creation of a "Federal Insurance Office," though this office has no regulatory powers.) The Comptroller of the Currency has successfully promoted the expansion of bank products through preemption of state laws, providing a model for the insurance sector. The increase of "speed to market" for product approval so insurers will not be at a disadvantage in product creation and delivery. The creation of a regulatory environment more accommodating of growth and innovation as a result of competition between federal and state regulators. The ability to achieve national treatment, so that a single charter would allow insurers to do business in all states and avoid higher costs of state regulation due to the need to comply with up to 50 state regulators. Potential difficulty insurers face in international trade without a regulator at the national level. Greater supply of insurance and lower cost to consumers as insurance companies are forced to compete on a national scale.

Arguments Against a Dual System and for State Regulation

The arguments of those who oppose federal regulation of insurance companies, preferring that the state insurance regulatory system be maintained, have included the following:

State regulated insurers have performed relatively well through the financial crisis, underscoring the quality of state regulation. State insurance regulators have a better understanding of local markets and conditions that would a federal regulator. State regulation is more flexible and adaptable to local conditions. The diversity of state regulation reduces the impact of any poor regulation and promotes innovation and good regulation. There are strong incentives, such as those provided by direct election, for state regulators to do the job effectively at the state level. The risk that the new federal bureaucracy would end up being redundant and costly. Fiscal damage to the states should state premium taxes be reduced by a federal system. The fragmentation of the overall insurance regulatory system that could result from dual chartering and state/federal oversight. The possibility of a "race to the bottom" as state and federal regulators compete to give insurers more favorable treatment and thus secure greater oversight authority and budget.

In the abstract, the federal chartering question could be simply about the "who" of regulation. Should it be the federal government, the states, or some combination of the two? In practice, however, federal chartering legislation has had much to say about the "how" of regulation. Should the government continue the same fine degree of industry oversight that states have practiced in the past? Aside from Senator Hollings' bill in the 108 th Congress, the federal chartering bills that have been introduced to this point have tended to answer the latter question negatively—the federal regulator to be created would exercise less regulatory oversight than would most state regulators. This deregulatory aspect of past bills has been source of controversy in addition to the introduction of federal regulation itself.

Previous Federal Chartering Legislation

111th Congress

The National Insurance Consumer Protection Act (H.R. 1880)

Representatives Melissa Bean and Edward Royce introduced H.R. 1880 in the House on April 2, 2009. The bill was referred to the House Financial Services Committee, House Judiciary Committee, and House Energy and Commerce Committee. No hearings or markups were held on this bill.

H.R. 1880 would have created a federal chartering and regulatory apparatus for the insurance industry, including insurers, insurance agencies, and independent insurance producers. The Office of National Insurance (ONI) and a National Insurance Commissioner (NIC) would have been established in the Department of the Treasury, but with significant independence; the Secretary of the Treasury would have been forbidden from interfering in specific matters before the commissioner; the ONI's budget would have been funded by fees and assessments on insurers; and the commissioner would have been appointed by the President, and confirmed by the Senate for a five-year term. These terms are similar to those of other financial regulators, such as the Office of the Comptroller of the Currency.

The federal regulatory system in H.R. 1880 would have applied to property/casualty and life insurance and reinsurance, with the exception of title insurance. Federally licensed insurance producers were specifically allowed to sell surplus lines insurance. Holders of a national charter or license would have been exempt from most state insurance laws, including "any form of licensing, examination, reporting, regulation, or supervision by a State relating to the insurance operations of such insurer." Thus, nationally licensed insurers, agencies, and producers would have been able to operate in the entire United States without fulfilling the requirements of the 50 states' insurance laws. This exemption, however, did not extend to state premium tax laws, so national insurers would have continued to pay these taxes. The bill would have affected state taxes with regard to surplus lines insurance, forbidding states that are not the home state of the insured from collecting these taxes.

In terms of the substance of regulation, the most significant specific change in H.R. 1880 compared with the way most states currently regulate insurance involves regulation of insurance rates and forms. Currently every state has some measure of rate and form regulation. In some states, insurers must get specific prior approval for changes to rates and forms, whereas in others insurers may have some freedom to change rates and forms with the possibility that the state insurance commissioner could disallow the change after the fact. This bill, however, would have specifically disallowed the NIC from regulating insurance rates. With regard to form regulation, the commissioner would have had the power to set general form requirements and insurers would have been required to file insurance forms with the commissioner along with a certification that the forms met the established requirements.

H.R. 1880 would have specifically addressed the issue of systemic risk brought to the fore in the recent financial crisis in two ways. It would have required that a financial regulator other than the ONI be designated a systemic risk regulator for insurance with power over both national insurers and state insurers. This regulator would have had broad oversight powers, including the ability, in consultation with the NIC, to require an insurer be federally chartered. H.R. 1880 would also have created a "Coordinating National Council for Financial Regulators" made up of the heads of the various federal financial regulators along with the Secretary of the Treasury. This council would have been responsible for monitoring the financial system for systemic risk with the specific power to determine when the systemic risk regulator could issue a rule or direct order covering an insurer that presented systemic risk.

H.R. 1880 shared many aspects with previous optional federal chartering bills, including legislation introduced by Representatives Bean and Royce. Under H.R. 1880 , many insurers would have had the option to choose whether to operate under a federal or state system. The system to be put in place by the bill, however, has two specific non-optional aspects: (1) The NIC had the specific authority to deny an application from a national insurer to convert to a state charter; and (2) the systemic risk regulator had the specific authority to require an insurer to become federally chartered.

The Federal License for Reinsurers Act of 2010 (H.R. 6529)

Representative Dennis Moore introduced H.R. 6529 on December 16, 2010. It was referred to the House Committee on Financial Services but no hearings or markups were held on the bill. H.R. 6529 would have created a federal license for reinsurers. The licensing and regulatory authority would rest with the Federal Insurance Office, which was created under the Dodd-Frank Act, which would have the authority to determine that state laws were inconsistent with federal law and thus preempted.

110th Congress

The National Insurance Act of 2007 (S. 40/H.R. 3200)

Senators John Sununu and Tim Johnson introduced S. 40 on May 24, 2007 and Representatives Melissa Bean and Edward Royce introduced H.R. 3200 on July 26, 2007. The bills were referred to the relevant committees (Senate Banking, Housing, and Urban Affairs, House Financial Services, and House Judiciary), but neither was the specific subject of hearings or markups. Two general hearings on insurance regulatory reform, however, were held by the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises in October 2007, and the possibility of an optional federal charter was a major topic of discussion in the subcommittee.

S. 40 and H.R. 3200 were very similar, but not identical bills. Both would have created the option of a federal charter for the insurance industry, including insurers, insurance agencies, and independent insurance producers. The bills would have created a federal regulatory and supervisory apparatus, including an Office of National Insurance and a National Insurance Commissioner. This federal regulator would generally have been overseen by the Secretary of the Treasury, but the secretary would have been forbidden from interfering in specific matters before the commissioner. The budget for the office would have been paid for by fees and assessments on insurers. The commissioner would have been appointed by the President, and confirmed by the Senate for a five-year term. Holders of a national license would have been exempt from most state insurance laws. Thus, nationally licensed insurers, agencies, and producers would have been able to operate in the entire United States without fulfilling the requirements of the 50 states' insurance laws. Some significant aspects of the bills included the following:

The federal system would have applied to property/casualty and life insurance, except for title insurance and including surplus lines insurance. Rate regulation would not have been applicable to national insurers. Form regulation, the ability of the regulator to control what will and will not be included in an insurance policy, would have been reduced substantially compared with most states. Fees covering the cost of the system would have been assessed on those operating under the federal system. National insurers would have continued to pay state premium taxes, so there should be no loss of premium tax revenue to the states. National insurers would have continued to be subject to state laws requiring participation in residual market entities, but only if rates charged by the residual market entity covers all costs incurred, and only if there were no rate and form requirements concurrent with participation. Reform of the state regulation of surplus lines insurance—only the state in which the insured resides or does business would be allowed to tax surplus lines insurance. National insurance producers would have been allowed to sell surplus lines insurance. Would have applied federal antitrust laws to national insurers, except to the extent that state laws continue to apply to them.

Differences between S. 40 and H.R. 3200 are relatively minor, including the following:

H.R. 3200 would have specifically allowed non-U.S. reinsurers to file financial data in accordance with International Financial Reporting Standards. H.R. 3200 would have limited jurisdiction over non-U.S. reinsurers to federal courts, rather than including state and local courts. H.R. 3200 would have broadened slightly and clarify antifraud language.

Beyond the general aspects inherent in the OFC concept, such as the dual, competing regulatory structures and uniform regulation across the country, the most striking specific aspect of S. 40 and H.R. 3200 was the lessening of the rate and form regulation under these bills as compared to the current system. Currently every state has some measure of rate and form regulation. In some states, insurers must get specific prior approval for changes to rates and forms, while in others insurers may have some freedom to change rates and forms with the possibility that the state insurance commissioner could disallow the change after the fact. S. 40 and H.R. 3200 specifically disallowed rate and form regulation for national property/casualty insurers. Such insurers would have been required only to maintain copies of the policy forms that they use. National life insurers would have been subject to general standards and a requirement to file forms with the commissioner before these forms would have been used.

109th Congress

The National Insurance Act of 2006 (S. 2509/H.R. 6225)

Senators John Sununu and Tim Johnson introduced S. 2509 on April 5, 2006. The House companion, H.R. 6225 was introduced on October 18, 2006. Neither bill saw direct committee action, although S. 2509 was repeatedly discussed at a hearing on "Perspectives in Insurance Regulation," held by the Senate Banking, Housing, and Urban Affairs Committee on July 18, 2006. These bills were very similar to the bills of the same name introduced in the 110 th Congress and discussed above. Differences between the bills in the two Congresses included the following:

The 2006 bills did not address surplus lines insurance. The 2007 bills added language requiring national insurer compliance with anti-money laundering laws. The 2007 bills specifically exclude national insurers from offering title insurance. The 2007 bills included new guaranty fund language, changing the focus from a qualified state, to a qualified association or fund. If a state's guaranty fund is not qualified, then the national insurers operating in that state must join the national guaranty fund to be established by the NIC.

108th Congress

Insurance Consumer Protection Act of 2003 (S. 1373)

On July 8, 2003, Senator Ernest Hollings introduced S. 1373 , "A bill to authorize and direct the Secretary of Commerce, through an independent commission within the Department of Commerce, to protect consumers by regulating the interstate sale of insurance, and for other purposes." The bill was referred to the Senate Commerce, Science, and Transportation Committee, where it was discussed in a general hearing on insurance regulation but was not acted upon further. Senator Hollings retired following the 108 th Congress.

S. 1373 would have created a mandatory federal charter for interstate property/casualty and life insurers, leaving only single state insurers to be regulated by the state where they were domiciled and operated. It thus would have preempted most current state regulation of insurance. Significant aspects of the bill included the following:

Creation of a federal commission within the Department of Commerce to regulate the interstate business of property/casualty and life insurance. Grant of full regulatory powers to the commission, including licensure, rate and form approval, regulation of solvency, and regulation of market conduct. Repeal of the antitrust exemptions in the McCarran-Ferguson Act. Creation of a federal guaranty fund.

107th Congress

The Insurance Industry Modernization and Consumer Protection Act (H.R. 3766)

H.R. 3766 was introduced on February 14, 2002, by Representative John LaFalce. It would have created an optional federal charter for "national insurers," but not for insurance agencies, brokers, or agents. It would have created a new federal agency within the Treasury Department, known as the Office of National Insurers and headed by a director, rather than a commissioner. Other significant aspects of H.R. 3766 included the following:

The federal charter would have provided for a national insurer to underwrite both life insurance and property/casualty insurance. The director would have had general regulatory authority over national insurers, including solvency oversight and policy forms, but rate regulation would have been left with state insurance regulators. Even though the legislation had no provision for the licensing of insurance producers, the director would have had the authority to enforce unfair and deceptive practices rules against state-licensed producers with respect to the sale of insurance products issued by national insurers, and all states would have been subject to federal minimum standards. National insurers would have been encouraged to invest in the communities in which they sell policies. National insurers would have been required to file reports containing community sales data for use by federal regulators in combating insurance redlining. Further, national insurers would have been prohibited from refusing to insure, or limiting coverage on a property, based solely on its geographic location.

The National Insurance Chartering and Supervision Act

This proposal was reportedly introduced late in 2001 by Senator Charles Schumer, but was never assigned a number, nor referred to either the Senate Commerce Committee or the Senate Banking, Housing, and Urban Affairs Committee. A draft of this proposal provided that the chartering, supervision, and regulation of National Insurance Companies and National Insurance Agencies be administered by the federal government in a newly created federal agency within the Treasury Department. The proposed agency, the Office of the National Insurance Commissioner, would have been headed by the NIC, appointed for a five-year term by the President and subject to Senate confirmation. National insurers and agents would have been exempt from most state insurance law. Significant aspects of the bill included the following:

application to all lines of insurance, including life, health, and property/casualty; imposition of fees as necessary to cover the expenses of the federal apparatus; and requirement that NICs participate in "qualified" state insurance guaranty associations and establishment of a federal backup guaranty association to cover "non-qualifying" states.

The broad powers granted to the NIC were not to include the authority to regulate rates or policy forms. Nor would the Schumer proposal have exempted federally chartered NICs from antitrust laws, except for purposes of preparing policy forms and participating in state residual market programs such as assigned risk pools in automobile insurance. The federal license would have specified the line or lines of insurance a NIC could underwrite, and no single NIC could be licensed to underwrite both life/health insurance and property/casualty insurance, although an affiliated group of insurance companies (state and/or federally chartered) could have included separate companies writing those different lines of insurance.