Ernst Csiszar considers how the bid-rigging scandal will impact the debate over modernising the US regulatory environment
For the most part, insurance company CEOs are quite happy when news coverage of the insurance industry in the US is buried in the back pages of the business section. But thanks to the allegations of illegal bid-rigging unveiled in the well-publicised investigation by New York Attorney General Eliot Spitzer, the industry has faced an onslaught of negative new coverage that has raised doubts about our credibility in the minds of consumers and public policymakers in the US and globally.
They say that time heals all wounds and over the past month much of the smoke created by Mr Spitzer has cleared. Legislators and regulators are focussing their efforts on addressing problems highlighted by the investigation.
Unfortunately, some legislators are also focussing attention on a number of perceived problems that were never part of the Spitzer probe, such as agent compensation. However, as time passes, a calmer, more rational approach is surfacing. This is good news as sound public policy is rarely created during a crisis.
The real impact of the Spitzer investigation may occur when Congress and state legislatures renew the debate over how the industry should be regulated and who should be responsible for its oversight. It is easy - and overly simplistic - to characterise this debate as one of 'federal versus state' regulation. I would argue that the discussion should be focussed on the 'good versus bad' regulation.
The venue for regulatory oversight is less important than the result.
A well-designed regulatory system yields a market in which consumers can choose a wide variety of products from an array of companies competing on price, product and service, in which effective and efficient regulation of critical factors such as solvency and market conduct create an atmosphere of consumer confidence.
Separating ourselves from the Spitzer spectre
The fallout from the Spitzer investigation has shifted from legitimate concern about illegal bid-rigging to the general value and validity of incentive compensation and the need for broad-based disclosure of the sources and amounts of compensation to clients.
Several state insurance regulators have announced plans to consider new rules that would require every insurance agent and broker to disclose the source and amount of his or her compensation and keep detailed records that such disclosure was made. We understand that regulators want to respond quickly to restore consumer confidence in the insurance industry. In fact, the Property Casualty Insurers Association of America (PCI) supports the general disclosure of broker compensation and believes that such disclosure is an important component of open, fair and well-regulated markets. However, some state insurance departments' proposals - most notably California's - miss the mark by expanding disclosure requirements to all insurance sales representatives, including agents and salaried employees of insurance companies.
PCI is urging state regulators to establish a 'bright line' test to determine when disclosure of compensation is necessary. Consumers need to know when broker compensation could create a conflict of interest. A single objective standard should be used: Where there is dual payment from both the client and the insurance company, there should be disclosure. There is no need for disclosure in the simple agent case since in that situation the agent is paid solely by the insurance company and no conflict of interest exists.
Recent allegations of misconduct do not involve the action of agents.
The California proposal goes well beyond disclosure and also requires insurance agents and brokers to place the client's business with 'the best available insurer'. Such a mandate would create a flurry of litigation against agents and brokers for failing to meet the ill-defined concept of 'best available insurer'. There is no way the term 'best available' could be easily understood. The regulation asks for an impossibly subjective determination likely to be questioned after the fact when a problem occurs.
Such actions are a misguided attempt to 'get tough' on the industry, but add little or no value to the insurance transaction. Moreover, unless states address this issue in a more uniform fashion, they run the risk of imposing 50 different sets of disclosure standards on insurers, agents, and brokers and, in so doing, call attention to the flaws in the US's state-based regulatory system.
The system must change
PCI members agree with the large majority of insurers, agents, regulators, state legislators, and members of Congress that the current insurance regulatory system is cumbersome, disjointed, expensive, and seemingly incapable of reforming itself.
The fragmentation of insurance markets is neither efficient nor effective.
When a company has to file over 350 versions of the same form in order to apply to sell one new product in fifty different jurisdictions, and it then takes some states 18 months to approve that product, clearly, we have a problem. The fragmentation of our regulatory system is also extremely taxing on consumers and the economy. It is estimated that our overly archaic regulatory structure costs consumers 8 to 15 cents for every premium dollar. That's a 15% tax on every insurance policy sold in the US.
The current system is too intrusive. It is based on an outmoded and dysfunctional ideology, and on the ill-conceived notion that government knows best.
As a result, we over-regulate the trivial and under-regulate the essential.
If the insurance regulatory system is going to change - and it must - then insurers must first help public policymakers understand how a well-regulated insurance market could and should be structured and how a competition-based market benefits insurance consumers.
On the flip side, state regulators can more easily adapt to the unique market conditions of each state. Population density, tort systems, legal environment, workers compensation rules, and weather patterns all shape the insurance markets of each state. The needs of consumers in New York are far different from those of Nebraska and a regulatory system that utilises state-based resources can be much more responsive to the needs of consumers in a particular market.
The vehicles for change
Despite flaws in the state-based system the creation of a federal insurance regulator is not the solution. Proposals for an optional federal charter are not only politically unfeasible, they also run the risk of making insurance a government entitlement program. An optional federal charter would create another bureaucracy in Washington that cannot serve the needs of its constituents. If you think the state can produce a lot of paper, wait until you see what the folks in Washington, DC can do.
A federal approach would also likely limit insurers' underwriting freedom and may result in the redistributing of risk. The two current federal insurance programs - the National Flood Insurance Program and the National Crop Insurance Program - do not allow insurers to use cost-based pricing to assess risks. There is no indication that this philosophy would change if federal regulatory oversight were expanded to include other lines of insurance.
A better approach is the State Modernization and Regulatory Transparency (SMART) Act, authored by House Financial Services Committee Chairman Michael Oxley (R-Ohio) and Capital Markets Subcommittee Chairman Richard Baker (R-La). The SMART Act proposes a series of federal initiatives designed to correct the flaws in the state system while utilising its strengths, and presents one of the most viable options for improving the regulatory environment.
The elimination of price controls and the movement towards competitive rating is the heart of the SMART Act. And this provision is the one generating the most heat from NAIC and individual state regulators. Rep. Baker told PCI member company executives gathered on Capitol Hill for the association's 2004 Legislative Action Day that "rate regulatory relief is the most critical part of the legislative package and the bill will not move without it."
In the short term, the SMART Act will continue to keep pressure on the states to modernise their regulatory environment or be faced with a federal system. In the long term, the proposal will form the baseline for a thorough debate on what a well-regulated market should look like, regardless of whom - state or federal officials - has oversight responsibility.
A better way to restore trust
Insurers can help restore the industry's integrity and ensure that insurance buyers, risk managers, and public policy makers in the states and in Congress are not blinded by the smoke from the Spitzer investigation. Companies, brokers, and agents who work hard for their clients and their employers, who operate ethically, who are compensated fairly and legally for the service they provide, and who value the trust on which our business is built need to speak out forcefully on this issue. We need to let everyone - consumers, regulators, legislators, and the media - know that the industry does not deserve to be tarred with the same brush.
At the same time, we must push hard for bold, comprehensive and meaningful regulatory reforms that serve consumers by increasing choice, trust and transparency. This means eliminating outdated, unnecessary, and ineffective price controls. It means focussing regulatory activity on critical issues such as solvency, accounting standards and market conduct.
The insurance industry is too frequently in the 'reactive' mode when it comes to public policy debates. We are perceived as holding back the forces of change. Every industry has undergone enormous transformations in the past 40 years; some industries and businesses have had to reinvent themselves. Insurance is the exception. We are still doing many things - including the way the business is regulated - like we did in the 1950s.
Consumers must have faith in their ability to fairly participate in the market. The actions of a few large brokers and insurers have shaken that faith. Because insurance is a fundamental building block of all economic development, the industry must come together to police itself and work on regulatory reforms that have a meaningful impact on consumers and the economy. We need to be much more vocal advocates for positive change and our actions must be guided by one simple principle: what is most important to the consumer.
Ernst Csiszar is president and chief executive officer of the Property Casualty Insurers Association of America.