Last year at this time, insurance industry observers were speculating about whether federal financial modernization legislation had a chance of passage, and if so, what impact it would have on insurance regulation. One year later, speculation about passage of such a law has become a reality. But the ultimate regulatory structure that will govern insurance and other financial services is far from certain.

The federal Gramm-Leach-Bliley Act (GLB), signed into law by President Clinton in November 1999, was designed to remove Depression-era barriers from banking, securities and insurance activities. While directed primarily at outdated banking regulations, the new law will also have a significant impact on insurance company operations. The law contains several provisions that could undermine the existing state-centered regulatory system by allowing the slow encroachment of federal oversight in some regulatory areas.

One of the most significant issues faced by insurers and regulators - and one with a time-certain deadline - is that of producer licensing. GLB contains a provision requiring state insurance departments to enact uniform or reciprocal agent licensing requirements. Unless at least 29 states adopt such requirements by November 2002, a national producer licensing organization, known as the National Association of Registered Agents and Brokers (NARAB), will be created under the auspices of the National Association of Insurance Commissioners (NAIC).

Standardized agent licensing is one of the most tangible ways to streamline and strengthen state regulation. But achieving uniform regulation in a majority of states is a daunting task that may not be possible to accomplish in the three-year time frame provided by GLB. The NAIC has wisely added reciprocity provisions to its Producer Licensing Model Act in the belief that reciprocity is easier for insurance departments to achieve than uniformity.

NAII has long supported reciprocity among the states when it comes to producer licensing. We believe strongly that producer licensing falls under the jurisdiction of state insurance departments and that the imposition of NARAB is an unnecessary federal encroachment on state regulatory authority. However, NAII has serious concerns about the provision in the model act that specifies the individuals required to be licensed. We believe that the current language could be interpreted to mean that virtually every insurance company and insurance agency employee who has any contact with policyholders must hold a producer's licence. Such a requirement would add millions of dollars in additional cost to the insurance product without adding one dollar of extra value to the consumer.

With the clock running on NARAB, the pressure is on state insurance departments and state legislatures to act quickly before their authority to regulate this portion of the industry is usurped by a pseudo-federal bureaucracy. In spite of this threat to their authority, however, only four states have enacted new producer licensing laws. While it is encouraging to note that many states are planning to introduce legislation during their 2001 sessions, successfully moving a bill from introduction to passage can often take more than one legislative session. In many cases, states simply don't have the luxury of that much time.

NAII continues to work with the NAIC on amendments to the model act clarifying that customer service representatives and other employees who are not involved with the sale of insurance products need not be licensed. In addition, NAII is actively involved in promoting adoption of reciprocity legislation on a state-by-state basis. However, the association will not support legislation that could require all agency and company employees to be licensed.

Progress at the NAIC

Thanks in large part to the leadership of NAIC president George Nichols, progress on producer licensing and other issues is being made. At the June NAIC meeting, regulators fine-tuned the Producer Licensing Model Act. Further revisions were expected to be made at the September NAIC meeting.

In addition, NAIC's Accelerated Licensure Evaluation and Review Techniques (ALERT) working group is developing a streamlined process for admitting insurance companies into a state. Moreover, thanks to the urging of NAII, the NAIC has agreed to send its proposed rate and form deregulation model to its Speed to Market working group in a move to develop a model act that more accurately reflects the need to modernize regulation in both commercial and personal lines. The model that was to be adopted by the NAIC earlier this year contained antiquated “prior approval” regulations that, in effect, were a step backwards from the laws currently on the books in many states.

Regulators agreed to create a “safe harbor” model outlining what is acceptable in transactions involving banks and the sale of insurance. The safe harbor provisions are a key element in protecting consumers from unscrupulous sales tactics by banks and other financial services providers. The NAIC safe harbor model will make it easier for states to get in line with GLB requirements.

Threat to state regulation still exists

Despite these positive developments, state regulation of insurance is still at risk. Of utmost concern to insurers is the outcome of the almost certain legal challenges over GLB provisions that would allow federal bank regulators to preempt any state law that “adversely affects” a bank's insurance operations.

One of the cornerstones of GLB is the concept of “functional regulation”. Essentially this means that the banking operations of any company - insurance, securities or bank - should be regulated by the appropriate banking regulator. Likewise, state insurance departments should have oversight over the insurance operations of any company.

Despite the clearly worded language on functional regulation contained in GLB, the US Supreme Court's ruling in the Barnett Bank case stating that federal banking regulators had the authority to preempt state laws that “prevent or significantly interfere” with a bank's insurance operation could threaten functional regulation.

Already banking advocates are using the Barnett Bank case to encourage a broad interpretation of GLB's “adversely affects” language. A spokesperson for the Association of Banks in Insurance states that “any law that adds administrative burdens...forces the hiring of additional personnel or that causes an inefficient use of resources should be preempted.”

Exploring regulatory concepts

No one can deny the passage of GLB puts insurers on the threshold of significant regulatory change. What role we play in shaping the regulatory system of tomorrow will determine in large part how the industry will operate for decades to come.

Some insurance industry observers believe that the only way to regulate a global marketplace is to establish a system in which federal regulation plays at least an ancillary role. NAII believes that despite the global implications of the “New Economy,” insurance is a fundamentally local business. As such, it should be regulated at the level closest to its operations - the states.

Several organizations have put forward proposals that would drastically change the way insurance and financial services are regulated. These proposals range from preserving the current state-based system to enacting a program that would allow companies to choose whether to be regulated by state or federal regulators.

NAII has classified each of these concepts and organized a task force to analyze all the regulatory proposals and to determine which system works best for consumers, companies and regulators. Concepts that the task force is considering include:

  • The current state regulatory system, with improvements through greater uniformity.

  • A coordinated state regulatory system with more extensive use of agreements or treaties between state insurance departments and centralized authority for some areas of oversight.

  • A coordinated state-federal regulatory system with federal standards for certain regulatory areas and oversight through state officials.

  • An alternative chartering system, sharing regulatory authority and oversight between state and federal officials. Options in this area include:

    - Pure alternative chartering (federal regulation for federally chartered firms/state regulation for state chartered firms);

    - Mixed alternative chartering (regulatory authority apportioned between federal and state regulators depending on subject);

    - Federal chartering and regulation for life and health insurers only;

    - Federal chartering and regulation for property/casualty companies only.

    But although many aspects of the business may have changed, the basics have not. Insurers develop products and services based on customer need, and set prices for those products based on sound actuarial guidelines. In large part, these are local, not global, decisions.

    The one overwhelming danger of a federal regulatory system is the nationalization of the US insurance market. Under the current system, one “bad apple” state regulator cannot do significant damage to the nationwide insurance market the way a single bad federal regulator could. Currently, the 50 state insurance departments serve as regulatory laboratories, testing the impact of regulation on consumers in each state. Good regulation can often be exported. Poor regulation, on the other hand, can be contained before doing widespread damage to consumers or the competitive market.

    Federal regulation may make insurance the stepchild of the trio of insurance, banking and financial services. And because insurers have more consumer-related issues, such as rates, underwriting restrictions and market conduct, federal involvement could be particularly harmful to personal lines and small commercial insurers.

    Even the proposed hybrid regulatory systems mentioned above could actually give the insurance industry the worst of all worlds, with regulation on three levels (state, federal and NAIC) instead of one.

    So, in many ways, we're right back where we started from last year. A great regulatory unknown looms ahead, one that will change the face of the industry. NAII stands ready to work with others in the insurance industry and in the banking and securities industries to be the architect for a regulatory framework that best serves consumers and companies alike.

    Jack Ramirez is president of the National Association of Independent Insurers.