Last week, as all eyes were fixed on the finalization of the Volcker Rule, another long-awaited Dodd-Frank document was released. The Federal Insurance Office (FIO), a Dodd-Frank-established bureaucracy within the Department of Treasury, published an insurance regulation modernization report that was due in January 2012. With the FIO eyeing greater federal oversight for insurance regulation, it looks as if the major changes in the insurance industry will not be limited to the medical insurance remodeling under the Affordable Care Act.
The FIO's mandate (which does not extend to medical insurance) was to report on, and provide recommendations with respect to, "how to modernize and improve the system of insurance regulation in the United States." Dodd-Frank elaborated on this mandate by setting forth six "considerations," including systemic risk, consumer protection, and international coordination. The statute also set forth seven "additional factors," including the costs and benefits of federal regulation and the effect of international regulatory developments. Reflective of this broad mandate, the report touches on many issues and makes numerous recommendations. These recommendations range from questioning whether insurance companies ought to consider marital status in their underwriting decisions, to directing states to establish character and fitness requirements for insurance company directors and officers, to recommending uniform approaches to solvency oversight and capital adequacy.
The report's underlying theme, however, is that state regulation is not working well and, if state insurance regulators do not act quickly, the federal government will have to step in. There are relatively few areas in which the report calls for immediate federalization. Regulation of mortgage insurers, the fortunes of which are intertwined with the future of Fannie Mae and Freddie Mac, is an area in which the FIO believes federal standards are needed. The FIO also wants to be involved in supervisory colleges, which bring together all of a complex insurance company's regulators to discuss the company's health and to share information. In making this recommendation, the FIO is emphasizing its systemic risk responsibilities. But as spelled out in Dodd-Frank, those responsibilities extend only to monitoring systemic risk related to gaps in insurance regulation, and do not include a regulatory role for the FIO.
The limited number of direct recommendations for immediate federal regulation must be viewed in context. The report implies that further calls for federal action may be coming soon in numerous areas. The report opens with a warning: "should the states fail to accomplish necessary modernization reforms in the near term, Congress should strongly consider direct federal involvement." Many of the report's sections conclude with a similar warning. For example, the report calls for "federal involvement . . . to ensure fair treatment of all policyholders," if the states do not adopt uniform policyholder recovery rules. The report also notes with respect to product approval that "[f]ederal action may become necessary if the current, and long-standing shortcomings are not improved in the near term." The FIO also believes that "federal action may be necessary" soon to ensure that retirees face uniform annuity rules.
The type of federal involvement the FIO seems to favor is federal (and, in some cases, international) standards enforced uniformly by the states. For example, the report contemplates "binding, uniform federal standards" for insurance scoring and recommends uniform producer licensing standards. If states do not have discretion about either the standards they are imposing or the manner in which they impose them, the involvement of the states in insurance regulation seems superfluous. After all, the principal advantage of a state-based insurance regulatory system is its ability to accommodate local peculiarities and to test regulatory and commercial innovations on a small scale before going national.
The question of whether the insurance industry should be regulated at the state or federal level has been a discussion topic for over a century. There are legitimate concerns about the efficiency and efficacy of the existing state-based system, which lacks uniformity and creates duplicative work and added costs for insurers, regulators, and consumers. Last week's report does a service in setting those issues out for consideration, but the implicit solution-state regulation guided by the FIO's heavy hand-may be inferior to more direct federalization of insurance regulation with attendant transparency, balanced governance, and accountability for the federal insurance regulator.