Industry representatives presented examples of accounts, set-asides, reserves and “surplus surplus” that make budget analysis, at the least, difficult.
Public Policy Analysis & Opinion
They who pay the piper
NAIC management oversteps its bounds on budget
by Kevin P. Hennosy
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Industry representatives presented examples of accounts, set-asides, reserves and “surplus surplus” that make budget analysis, at the least, difficult. |
Twenty years ago, I ran for state representative in Ohio in a sacrificial lamb race. The party needed someone to run in the district to round out the ballot and force the other side at least to have to spend something above the filing fee.
It was a “great experience” campaign. I had no chance in the world of winning. I ran in the most one-sided district in the state—the hardest of rock-ribbed Republican districts, and I was a Democrat. The morning paper ran a story in which my “campaign” was mentioned under the headline: “Parties always able to find someone willing to lose.”
My cousins in Columbus enjoyed that headline, and let they me know it—repeatedly. So several years later, I moved to Kansas City, Missouri, and began a new life writing about insurance. The family still insists that I steal family pets for sale to animal testing labs, which generally puts an end to questions from friends about what happened to Kevin.
One reason I still think the public drubbing was worth it is that from time to time I remember some nugget of political smarts that party elders imparted to their candidates. If I had not “done them a favor,” I would not have been in the room to benefit from their experience.
Vernal G. Riffe was the dean of Ohio politics for more than a quarter century. I remember hearing him address his candidates for the statehouse in 1984—even the candidates chosen for electoral cannon fodder.
Vern Riffe told us that he never voted against a budget. “No matter how bad, how fake or how corrupt a budget might be, voting against it is political suicide.” He explained that there were too many good things in the worst of budgets—good things that the other side could use against you in the next election.
In other words, a budget can establish tax breaks and kickbacks for the governor’s family, contributors and political cronies. The budget might be based on ridiculous revenue or expense assumptions. Nevertheless, when the budget comes to the floor for the final vote, Riffe’s Rule on Budget Resolutions remains clear: vote “Yea.”
That same budget contains funding for schools, the elderly, veterans’ homes, stray animals etc. Vote “Nay” and your next opponent will buy an ad pointing out that you voted against schoolchildren, grandma, the heroes of past wars and Benji. Your mother will vote against you and your cousins will force you to leave the state.
The “used car” syndrome
I remembered the Riffe Rule the other day when I was looking over the budget of the National Association of Insurance Commissioners (NAIC). (Just call me “Mr. Excitement.”) I am the first to admit that I am a “word guy” and not a “numbers guy,” so I cannot opine on the accounting correctness of the figures; however, when I read the narrative declarations that accompany the NAIC budget, I get the feeling that I am about to purchase a used car.
I am not alone. The insurance industry trade associations that oversee the NAIC’s operations raised material questions about the NAIC budget. These questions were not limited to the funding of one NAIC policy initiative, which is rather common. Industry representatives questioned the transparency of NAIC’s budgeting procedures.
Without directly charging deception, the industry representatives presented examples of accounts, set-asides, reserves and “surplus surplus” that make budget analysis, at the least, difficult. From a layman’s perspective, the approach seems deliberately confusing.
The primary area of conflict centers on the NAIC staff’s proposal to build a “100% reserve”—enough money to run the association for one year without cutting current expenditures.
The industry representatives blanch at this proposal. According to a comment letter signed by a consortium of trade associations, “A budget with such a large projected surplus provides for very little expense discipline.” Furthermore, the trade association representatives argue that the NAIC administrators have not documented the financial risks that the reserve is supposed to balance.
This is not the first time that industry representatives have raised the issue of the NAIC financial reserve. In the past, the arguments appeared contrived—designed to keep the NAIC weak and beholden to the regulated industry.
The NAIC began the practice of holding a reserve in the early 1980s. An outside audit of the association’s management recommended a reserve of 75%.
At the time, the vast majority of NAIC revenue came from fees paid by insurers when they filed their annual financial statements. In 1981, industry leaders threatened to withhold these fees as a coercive measure to change regulatory policy. The auditors believed the reserve would “purchase” the NAIC at least nine months of independence.
Two forces converged to force a reduction in the NAIC operating reserve in 1991. First, the NAIC had received IRS approval to sell data, which increased the association’s revenue and decreased its reliance on database fee revenue. Second, the General Accounting Office, responding to a request from Rep. John Dingell (D-Mich.), had reviewed NAIC finances and recommended a reduction based on its revenue sources and other factors.
In the mid-1990s, a large number of property/casualty insurers did withhold filing fees from the NAIC. The boycott was widely understood as a response to NAIC’s investigation of urban red-lining. The 50% reserve softened the impact of the protest.
It was not until 2004 that NAIC management pushed for an increase in the reserve. A 10% increase received approval over grumbling from the industry.
The NAIC management argues that the association faces greater risk of unexpected expenditures and loss of income. In a statement released to the media, NAIC President and Pennsylvania Insurance Commissioner Diane Koken defended the 100% reserve proposal. “The increase in the reserve, up to a target reserve of 100%, is a prudent reaction to the growing risks and uncertainties facing state insurance regulation and the NAIC’s business and finances,” said Koken. Contributing factors include introduction of federal tools and dual charter legislation in Congress, participation with the U.S. Treasury in the Terrorism Risk Insurance Act, and initial start-up capitalization of the Interstate Compact Commission, among others.
Trade groups see no threat
Industry advocates simply do not see the threat that the NAIC leadership sees. In written comments, the trade group representatives make some strong points.
With regard to the federal tools legislation, the trade association representatives observed: “Introduction of this legislation would not add any expense burden to the NAIC. In fact, the NAIC will see no cost associated with this until and unless such a proposal is enacted, and, even then, the timing of enactment is speculative, at best. We applaud the intention of the NAIC in assisting the states with their uniformity effort, although we believe that it should be each state’s responsibility to fund the vast majority of this initiative. We don’t believe that the NAIC should try to pre-fund possible unfunded federal mandates.”
The dual charter (optional federal charter) proposal might reduce NAIC revenue by reducing the number of companies under state supervision, but that is indeed speculative. Most observers believe that federally chartered companies would form one or more state-chartered subsidiaries.
The trade association representatives observe: “[S]hould dual chartering ever become a reality, the NAIC should consider reserves as only a stopgap to allow an orderly transition to a smaller organization or enhanced revenue generation. Reserves cannot be used as a long-term revenue replacement.”
Trade association representatives discount the expenses related to the Terrorism Risk Insurance Act. The Treasury Department has borne most of the cost associated with implementation of this act.
Trade groups also seem tired of hearing NAIC management point to the need for seed money to start up the Interstate Compact Commission. According to the trade association statement: “[T]he NAIC has already budgeted $350K for the initial start-up costs of the Commission, in the form of a note from the NAIC to the Commission. We see no reason that future start-up costs cannot be funded similarly, which would not require the maintenance of a contingency reserve for such costs (other than, possibly, lost investment income for below-market interest charges).”
Talking to a number of long-time NAIC observers, it is impossible to come away believing they trust the current management. More than one source familiar with the NAIC budget referred to the lack of “transparency” in the budget. If industry leaders trusted NAIC management, transparency would not be as important. Without transparency, rebuilding trust will not be possible.
One can also assume that the NAIC executive vice president, Cathy Weatherford, knows she has a problem. She tried to address the transparency issue in a statement released to the news media a day after the budget hearing. The statement offers a quote from Weatherford: “We have always stressed that transparency is the most critical component of the budget-planning process.” The need to make such a statement seems to underline the problem.
Whether it is the old Riffe Rule at work or whether insurance commissioners just don’t apply oversight to NAIC senior management, the association’s budgets generally receive a rubber stamp from the membership. This should change.
In the words of Commissioner Koken, “The states’ reliance on the NAIC is growing at a very fast pace, and more than ever before.” That is a very interesting observation. The NAIC is already a nonprofit entity, which makes it a type of public trust. As state officials depend on NAIC support and services, the NAIC may be viewed as a quasi-governmental agency. With that standing, the NAIC should be held to a higher standard of public accountability than it now receives.
At the very least, the NAIC membership should be more engaged in how the association is managed. One can only wonder what would happen if one of the commissioners, or maybe a small group of them, showed up unannounced one day at NAIC headquarters with a CPA or two in tow. “Okay, Cathy, open up the books and let’s have a look.” n
The author
Kevin Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance Companies and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate. He is currently writing a history of insurance and its regulation in the United States. Hennosy publishes a quarterly briefing paper on the activities of the NAIC, which is available at www.spreadtherisk.org.