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Public Policy Analysis & Opinion

NAIC faces no good options in Royce inquiry

Past deceptions come back to haunt Delaware Corporation

By Kevin P. Hennosy

William “Fishbait” Miller, who served as Doorkeeper of the House of Representatives for the better part of three decades, referred to politicians who found themselves in public trouble through personal carelessness as having his or her “tail caught in a crack.”

The colorful phrase conjures visions of a worried creature, in full view of predators, unable to move forward or backward, secured by its southern appendage to a fissure in a floor or wall after carelessly allowing its tail to slip into an unforgiving place.

The National Association of Insurance Commissioners (NAIC) appears to have its proverbial tail caught in a crack.

Since the late winter of 2012, Congressman Edward R. Royce (R-Calif.) has grabbed hold of the NAIC's long tail and he is not letting go.

In a letter dated July 12, 2012, to the director of the Federal Insurance Office (FIO), Congressman Royce cited a document which is very familiar to regular readers of this column: The Conference Committee Report on the McCarran-Ferguson Act. As the Congressman notes, the late Senator Joseph C. O'Mahoney (D-Wyo.) said: “There are three forms of regulation—'state regulation,' 'federal regulation' and regulation by private groups ... through private rules and regulations.”

The McCarran-Ferguson Act became necessary when the Supreme Court ruled in U.S. v. South-Eastern Underwriters Association that insurance is interstate commerce, which places the business of insurance under congressional jurisdiction.

The decision cleared the way for U.S. Justice Department Antitrust Division enforcement action against a network of fire insurance associations, which, at the time, acted as a cartel over the sale, underwriting and pricing of insurance. In response to unrelenting political pressure beginning just after the Civil War, the states had ceded practical de facto authority to regulate insurance to the local, regional, and national “bureaus” organized by stock fire insurance companies.

The McCarran-Ferguson Act asserts that affirmative insurance regulation and taxation by the states is in the public interest; however, if the states do not regulate insurance, federal antitrust law and Federal Trade Commission oversight “shall be applicable to the business of insurance to the extent that such business is not regulated by State Law.”

The act does not provide a deregulation clause other than the full and immediate application of federal jurisdiction. The statute provided a “moratorium” on the application of federal oversight for two years, in an effort to allow states to construct regulatory frameworks to replace federal antitrust oversight. After the moratorium and in the absence of state action, insurers become subject to the same federal antitrust and fair trade rules and enforcement mechanisms as any other unregulated business. Of course, states initiated a coordinated effort to create regulatory frameworks in order to retain jurisdiction over insurance after the moratorium.

The conference committee report makes clear that no private entity may wield regulatory authority over insurance, nor may any state regulate on behalf of any other state. Congressman Royce explains in his July 12 letter that the Supreme Court recognized Congress's intent to “outlaw private regulation” through the Court's opinion in FTC v. Travelers Health Association, 362 U.S. 293 (1960).

Again, regular readers of this column will recognize the section of the conference report cited by the Court in the FTC v. Travelers decision:

When the moratorium period passes, the Sherman Act, the Clayton Act, and the Federal Trade Commission Act come to life again in the field of interstate commerce, and in the field of interstate regulation. Nothing in the proposed law would authorize a State to try to regulate for other States, or authorize any private group or association to regulate in the field of interstate commerce.” (91 Cong. Rec. 1483.)

In the July 12 letter to the FIO Director Michael McRaith, Congressman Royce opines, “The NAIC appears to be engaging in regulatory activity.” The congressman cited the NAIC's System For Electronic Rate and Form Filing (SERFF) as an example of that activity.

In addition, Congressmen Royce cites several examples of the NAIC participating in collaborative efforts in market conduct regulation. The letter cites several statements issued by insurance commissioners that stress the NAIC's active participation in the collaborative actions. The July 12 Royce letter cites:

• A market conduct examination report, published on January 3, 2008, which stated that the multistate examination was initiated in 2005 by the [NAIC].

• An October 18, 2010, statement by a New York Superintendent of Insurance, which refers to an “NAIC multistate examination,” and “the NAIC examination.”

• A 321-page report titled “NAIC Multistate Market Conduct Examination Report” on the activities of State Farm Insurance, which also explains that the NAIC “sanctioned an initial multistate examination.”

• A May 19, 2011, statement by Ohio's Lt. Governor, which says, “Ohio supports the NAIC efforts to review the extent of these practices in the life and annuity industry.”

Of course, if the congressman's staff wished to extend their research beyond the most elementary Google search, the letter could have focused on numerous instances of collaborative efforts to conduct financial examinations and the cartel that NAIC initiated over life insurance products and pricing.

This latter entity joins states together through an interstate compact in order to regulate life insurance, annuities and long-term care insurance. While the Constitution affords the states the capability to form compacts to address local and regional issues, any compact that reduces the constitutional authority of the Congress must be approved by Congress. Since insurance remains under Congressional jurisdiction, and the states cannot transfer the authority extended to them under McCarran-Ferguson, the regulatory activities conducted by the “compact commission” deserve attention from Congress and the courts.

In addition to the regulatory activity alleged by Congressman Royce, the letter hammers the NAIC for closed-door meetings. “The very reason why Congress insisted that 'nothing in' McCarran-Ferguson 'would authorize any private group or association to regulate in the field of interstate commerce' was to avoid the application of authority by groups who do not follow the accountability and due process requirements of public bodies.”

As has been noted in numerous editions of this column, the NAIC tends to describe its activities using a stacked deck of cards. The NAIC throws down the card it needs to win the hand being played without concern for what is right or wrong.

Rough Notes readers know that the NAIC brings much of this trouble upon itself. The association created a legal entity using Delaware's incorporation statute, which is the least transparent in the nation. The NAIC holds a nonprofit tax exemption opinion letter from the IRS, but the association refuses to file a Form 990 financial disclosure form like other tax-exempt organizations.

Congressman Royce seems intent on forcing the NAIC, which claims to be 141 years old, to decide what it wants to be when it grows up, or if it grows up.

Regular readers of this column are well aware of the NAIC's penchant for assuming a multitude of personas in order to further sometimes conflicting goals. At times, the NAIC dons the mask of an “instrumentality of the states” when it wishes to avoid filing annual financial statements with the Internal Revenue Service. Other times, the NAIC wraps itself in the cloak of a nonprofit corporation in order to avoid state Freedom of Information Act jurisdictions and to evade payment of state sales taxes. The association at one time considered assuming the garb of a trade association of state officials for God-knows-what reason. Most recently, the NAIC applied some lipstick to dress up its international bona fides when it started calling itself a “standards-setting organization.”

The only constant in NAIC's public persona is the burka of secrecy that covers its finances and management processes.

It was the claim to be a “standards-setting organization” that attracted the attention of Congressman Royce. “Standards-setting” suggests an active regulatory role. Without a specific sanction from Congress, as in the case of developing Medicare Supplement Insurance Standardized Benefit Packages in the 1990s, the NAIC holds no authority to establish binding standards on anything. The NAIC can suggest like any other lobbying interest, but it cannot regulate.

The most pathetic aspect of this “standards-setting organization” ruse is that it appears designed for no reason other than to provide overseas travel for senior staff members and a few insurance commissioners.

The NAIC's pretense of official influence is reminiscent of nouveau riche Americans trying to enter the European aristocracy. Terri Vaughan could not sit down with central bankers if she was simply the over-paid flack of a lobbying group that answers to various insurance trade associations.

On December 20, 2011, the NAIC conducted a special conference call to adopt a new “official” description of the association:

The [NAIC] is the U.S. standards-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best practices, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collective views of state regulators domestically and internationally. NAIC members, together with the central resources of the NAIC, form the national system of state-based insurance regulation in the U.S.

In truth, and contrary to the NAIC statement, the NAIC is not a standards-setting organization. The NAIC can be loosely described as generating standards in three areas: 1) Medicare supplement insurance, where Congress charges the NAIC to write standards subject to the approval of the Federal Department of Health and Human Services, 2) the annual financial statement, and 3) the codified system of insurance accounting. The last two work products depend on state legislatures to “set” the standard in statute.

In each of these cases, the NAIC wields extensive authority to create uniform policy frameworks—rather than uniform standards. The application of the term “standard” is most accurately applied to the area of Medicare supplement insurance, where oversight from Congress and federal regulators does not allow the NAIC much freedom.

With regard to the policy financial statement and the codified accounting rules, neither body of work is streamlined enough to merit the term “standard.” The annual financial statement was the first project addressed by the NAIC in 1871. Since that time, the reporting framework has established a general level of consistency. Nevertheless, the multiple reporting forms, alternative interrogatories and state supplemental rules make this work product more of a framework than a set of standards.

Even the NAIC's Financial Regulation Standards and Accreditation Program (FRSAP) cannot be viewed as a standards-setting activity. While 25 years ago, then NAIC leaders under pressure from powerful members of Congress tried to pressure state implementation of uniform solvency laws and regulations, push back by conservative officials shilling for industry lobbyists put a quick end to that activity. The NAIC quickly pushed standards aside and stressed the concept of “substantially similar” policy approaches, which over two decades became more vague and submissive in meaning.

In a pathetic act of meekness, the NAIC dropped the word “regulation” from the name FRSAP in a letter to Congressman Royce dated March 20, 2012. The omission of the word regulation cannot be excused as a “typo.” The Financial Regulation Standards have carried the same name for a quarter century. The name of that document was integrated into the accreditation program in 1990. With this knowledge, it becomes clear that the NAIC attempted to mislead Congressman Royce by not including the full name of the program in the letter.

Congressman Royce's letter to Director McRaith asks the latter to provide opinions drawn from a series of questions about the NAIC:

1. What is the NAIC?

2. Is it consistent for the NAIC to claim regulatory authority in one breath and deny regulator activity in another?

3. Is it inconsistent for the NAIC to opine that the SERFF program does not amount to regulation of interstate commerce or regulatory activity, while at the same time directing the SERFF board to support the use of SERFF for regulatory initiatives?

4. Do the NAIC's general actions amount to regulatory activities, or cross the line established by the Supreme Court's interpretation of the McCarran-Ferguson Act?

5. Are the NAIC's self-imposed transparency rules adequate?

6. Should NAIC close meetings to discuss market conduct regulation concerning particular companies?

7. Does NAIC provide a public record of its closed meetings, and are meetings closed on a regular basis?

8. Should the NAIC reform its budget process and open meetings policy?

It is a positive step to see a member of Congress express an interest in the NAIC, even if it appears his interest seems shaped by insurers who believe that state regulation should mean “no regulation.”

The fixation on open meetings at the NAIC is an old one; however, it is disingenuous. If all the meetings at an NAIC meeting were “open” they would be open only to a posse of several hundred insurance lobbyists—which hardly amounts to public transparency. In addition, the focus seems restricted to market conduct regulation, when the public has an equal need to know whether an insurer is financially or ethically bankrupt.

More important than the open meetings question is the NAIC's refusal to file basic financial disclosures by claiming to be an instrumentality of the states, while claiming exemption from public accountability as a private corporation. The NAIC's claim to set standards as a means to gain standing to participate in international trade policymaking should be exposed as the canard it is. At some point an IRS audit will come.

The NAIC is sitting exposed to observation with its proverbial tail caught in a crack.

The author

Kevin P. 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 Cos. 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.


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