Federal Insurance Office Recommends Hybrid State/Federal Regulatory Regime to Enhance and Modernize U.S. Insurance Regulatory System

Dec 19, 2013


Entitled “How to Modernize and Improve the System of Insurance Regulation in the United States,” the Federal Insurance Office’s (“FIO”) long-anticipated report (“Report”) was finally released on December 12, 2013 after a delay of nearly two years.  While the Report is certain to generate substantial discussion, it is premature to predict whether it represents a blueprint for legislative action, inasmuch as some of the recommendations are contingent upon state or National Association of Insurance Commissioners’ (“NAIC”) action.  Other recommendations call for direct federal involvement.

Mandated by Title V of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), the Report is tailored to address the specific areas for investigation outlined by the landmark law.  The Dodd-Frank Act requires the FIO to consider several factors, including systemic risk regulation with respect to insurance, capital standards, consolidated supervision, consumer protection and affordability, the degree of uniformity of state insurance regulation and international coordination.  The law also expressly requires a consideration of the costs and benefits of federal regulation across various lines of insurance, along with issues relating to regulatory arbitrage and competitiveness.  The FIO Report examines all elements of the insurance industry, with the exception of health insurance. 

The FIO emphasizes that the debate is not whether insurance regulation should be state-based or handled at the federal level, but whether there are areas in which federal involvement under a state-based system is warranted.  Insurance regulation in the United States should best be viewed in terms of a hybrid model, the FIO suggests–one in which state and federal oversight play complementary roles, and where these roles are defined in terms of the strengths and opportunities that each brings to improving solvency and market conduct regulation.

Given the significance of the insurance sector in the U.S. economy and the globally active nature of U.S. insurance firms, the Report sets forth reforms for prudential regulation, which deals more with solvency and financial oversight, and market regulation, which governs an insurer’s business conduct.  It concludes that–in some circumstances–policy goals of uniformity, efficiency and consumer protection make continued federal involvement necessary if the status quo is to be improved.   While it does not propose a recommendation for every conceivable shortcoming of the insurance industry and its regulatory framework, it does illuminate areas in need of prompt modernization and improvement.

The areas of suggested direct federal regulatory involvement include the development and implementation of federal standards and oversight of private mortgage insurers, as well as implementation monitoring of the National Association of Registered Agents and Brokers Reform Act of 2013 (NARAB II), of which the FIO urges immediate passage.

Direct federal oversight of credit and insurance scoring data vendors was also strongly suggested, inasmuch as the methodologies used in ratings produced by this data can directly correlate to federally protected civil rights. 

Of note, the Report calls for a nationally uniform treatment of reinsurers pursuant to a “covered agreement” negotiated by the U.S. Treasury and the United States Trade Representative based upon the NAIC Credit for Reinsurance Model Law and Regulation.

To read the complete list of recommended areas for direct federal involvement in regulation, click here.

The FIO also confronts states’ failures to modernize and improve insurance regulation and provides potential federal solutions to problems such as the failure of surplus lines taxation reform.  In part, because the sheer cost of creating a new federal agency to regulate even part of the $7.3 trillion insurance industry would be prohibitive, the FIO recommends that significant federal involvement should only come under the consideration of Congress should states fail to accomplish meaningful reform.

Acknowledging that the business of insurance involves many products that are tailored and best delivered at a local level with corresponding local familiarity, the FIO repeatedly underscores that its goal is not to completely displace state-based regulation, but rather to urge states’ efforts toward modernization, since their progress to-date has been uneven, despite general consensus that change is needed. 

In addition to the state-specific recommendations, a complete list of which can be viewed by clicking here, the Report contains five key sections.  It also delves into notable sideline issues such as credit rating agencies, personal auto policies for service members, forms of rate regulation, access to insurance by Tribal entities and others.

The Sections are briefly summarized below:


Section One reviews the Report’s directives and background, gives the complete list of recommendations for modernizing U.S. insurance regulation and makes a general assessment of whether–and in what manner–federal oversight of insurance regulation should be undertaken.  The FIO lists suggested steps to be taken by states to accomplish the recommendations, combined with near-term and long-term actions that could follow from the federal government.


The Report’s second section describes the history of insurance regulation in the United States, highlighting significant events in its development and the century-long discourse over the need for uniformity in regulation across state jurisdictions.  This historical perspective helps frame the Dodd-Frank Act’s call for modernization by illustrating the different contexts and time periods in which the debate took shape on whether federal or state insurance regulation would best address the need for improved uniformity and oversight.

Section Two concludes by discussing the recent financial crisis and reforms enacted under the Dodd-Frank Act, including provisions that created the FIO.


Section Three presents the analysis underlying the FIO’s recommendations on prudential oversight issues.  It reviews the framework by which insurers are evaluated and regulated for solvency, inasmuch as these topics are currently being discussed between the U.S. and the international regulatory communities, including the European Union (“EU”) and the International Association of Insurance Supervisors (“IAIS”).  More specifically, this section analyzes the approaches state regulators use to assess an insurer’s capital adequacy, together with the resulting discretionary practices and emerging issues on reserving.  It also addresses the regulation of captives, a sector of the insurance market that has seen meteoric growth during the last several years.

Theoretically, under the current state-based system of regulation, consistency should occur only by uniform adoption and implementation of such standards and rules.  The FIO notes that, even with NAIC oversight, this has not happened. 

Solvency oversight and capital adequacy principles should be attuned to international developments and endeavor to integrate best practices, standards and principles developed through international consensus, the FIO says.  As the business of insurance become increasingly globalized, the FIO cautions that regulatory authorities must guard against capital arbitrage across international jurisdictions.

Insofar as the issue of credit for reinsurance, recent regulatory discussion and action–although “noteworthy and constructive”–points toward the need for federal oversight, according to the FIO, which describes the NAIC’s Reinsurance Collateral Model Law as a step forward, but a document that is currently incomplete. 

Section Three also discusses corporate governance matters and the absence of U.S. group supervision in the context of national and international insurance regulatory reforms.  Notably, even though state regulators conduct insurer fitness reviews, the absence of an NAIC corporate governance model law or regulation for insurers has come to the attention of international authorities, the FIO points out, particularly since internationally active insurers are rapidly expanding in size and complexity.  To address this issue, the FIO suggests that regulators should adopt appropriately scaled director and officer qualification standards that require individuals serving in those roles to have the expertise to assess strategies for growth and risks to the enterprise.

Existing and potential approaches to insurer resolution and guaranty fund processes are also evaluated.  While establishing an authority that would implement an orderly resolution of a failed financial firm is an essential component of the Dodd-Frank Act, the same law provides for states to handle that process in the case of an insurance company.  Because a significant part of global insurance groups’ activities fall outside of states’ resolution schemes, the FIO believes this fact warrants the development of separate, orderly and corresponding resolution plans.

The lack of U.S. insurance regulatory uniformity is especially noticeable among state guaranty associations.  The FIO points out that, even though the National Conference of Insurance Guaranty Funds reported its members have paid out more than $26.4 billion to claimants since 1976, some important consumer protection considerations remain, since laws pertaining to product payouts by guaranty funds to policyholders are not uniform across states.  To address this concern, the FIO recommends the enactment of uniform policyholder recovery rules so that all policyholders–regardless of where they reside–receive the same benefits from guaranty funds.  In the event that states fail to achieve that goal, then federal involvement may be necessary to ensure fair treatment of all policyholders.


Section Four presents analysis supporting the FIO’s recommendations on marketplace oversight and focuses on related issues that have been the subject of recurring debate on national regulatory uniformity.  Among these are insurance producer licensing, which creates duplicative administrative and regulatory burdens with no corresponding consumer benefit, the FIO explains, leaving small firms or agencies seeking producer licenses in multiple states to confront significant resource demands as a result.

To solve the problem, the FIO recommends rapid adoption of the National Association of Registered Agents and Brokers Reform Act of 2013 (NARAB II), punctuated by the FIO’s subsequent monitoring of its implementation. 

Another factor that may be contributing to the variability of rigor and professionalism from one state to another is the increasing dependence of state regulators on contract examiners to perform market conduct examinations.  States should develop explicit standards and protocols to govern these external examiners, including cost and schedule, education, professional background, training requirements and appropriate ethical standards on conflict of interest, confidentiality, privacy and report drafting, the FIO says.  State regulators should also develop a list of approved contract examiners based on an objective evaluation of expertise and training to examine specific issues or industry participants.

Insurance scoring and credit scoring–both increasingly prevalent methodologies for determining risk profiles for property and casualty personal lines–are also highly controversial.   To counter the possibility that use of the resulting data might implicate consumers’ rights secured under federal law, the FIO suggests prioritizing the regulation of data vendors instead–or regulating the insurer itself, if it is the one generating the data–since vendors that sell insurance scoring products and services are not subject to state regulatory oversight.  According to the Report, developing protocols to infuse transparency into the algorithms and data that affect eligibility, tier and price of coverage would enable a more meaningful evaluation of not only rates, but the processes whereby rates have been determined.

Adding further imperative to the issue, the FIO suggests the development and adoption of an appropriate model law that would subject insurance score vendors to licensing and examination standards.  It also emphasizes that, in support of its responsibility to monitor access to affordable insurance to traditionally underserved communities, the FIO will study the appropriate boundaries of use of personal information for insurance pricing and coverage purposes.

Section Four also reviews states’ regulatory treatment of insurance lines affected by natural catastrophes, the accessibility of insurance to Native American communities, collection of taxes for multi-state surplus lines placements and suitability standards for the sale of annuity products.

In its review of states’ seemingly haphazard participation in the Nonadmitted Insurance Multi-State Agreement and the Surplus Lines Insurance Multistate Compliance Compact, the FIO posits that the Nonadmitted and Reinsurance Reform Act’s (“NRRA’s”) intent to create uniformity in the surplus lines market has fallen into disarray.

Acknowledging that an NRRA compact seems no more likely now than before the NRRA became law, the FIO suggests that “near-term” federal action on the issue could be in order, inasmuch as states have not yet fulfilled the legislation’s intent.  Instead, some states have agreed to share the premium tax collected from multi-state surplus lines insurance placements, while others have opted to retain 100 percent of the premium tax based upon the insured’s home state.

Notwithstanding, the FIO reminds that the NRRA could be a model for insurance regulatory reform because it preserves state regulation, but provides incentives for states to act in a manner consistent with federal guidelines.  The agency urges them to simplify and homogenize U.S. regulation of surplus lines insurance in the United States. 


Section Five assesses the Report’s recommendations and the Dodd-Frank Act from the point of view of statutory criteria for measuring the effectiveness of an insurance regulatory system.  It also discusses insurance modernization in the context of basic principles of regulatory reform. 

In a holistic gathering of concepts driving the current market, the FIO lists the principles of insurance regulatory reform as systemic risk regulation, strong capital adequacy standards, meaningful consumer protection, increased national uniformity–either through a federal charter or effective action by the states–consolidated supervision and international coordination.


The FIO Report makes a strong case for greater federal involvement in the regulation of the insurance industry, contending that insurance markets are increasingly global, and that prompt modernization and improvement are needed.  While conceding that states have developed a system of entity-specific prudential oversight to address some of the fundamental regulatory objectives outlined in the Report, the FIO claims that much more needs to be done. 

With respect to market conduct regulation, the Report concludes that the state-based system is inherently limited in its ability to ensure an efficient and uniform regulatory system.  According to the FIO, “The status quo, or state-only solution, will not resolve the problems of inefficiency, redundancy or lack of uniformity, or adequately address issues of national interest.”  Federal involvement, therefore, will be necessary. 

Going forward, the FIO will monitor, coordinate policy, and work with all stakeholders in the insurance industry, including state regulators, policymakers and consumer advocates, in order to recommend other improvements to the United States insurance regulatory system. 

As the FIO warns, “Whether, and to what extent, those improvements will require federal involvement will often depend upon the subject matter, circumstances, and ability and willingness of the states to resolve the underlying issue.”  In short, to avoid outright federal involvement, the onus is now on the states, and to an extent on the NAIC, to enhance and modernize the regulation of the U.S. insurance industry.

Read the FIO’s Report here:  www.treasury.gov/initiatives/fio/reports-and-notices/Pages/default.aspx



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