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NCSL EXECUTIVE COMMITTEE TASK FORCE TO STREAMLINE AND SIMPLIFY INSURANCE REGULATION
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SEVENTH MEETING PRELIMINARY MEETING MINUTESNote: The preliminary meeting minutes provide a detailed review of the presentations and discussion that occurred at the meeting. A brief meeting summary also is available. Task Force Members Commissioners Staff OPENING AND INTRODUCTIONSenator Hannon opened the meeting on Saturday, March 22, 2003, at 9:15am. Introductions were made. He reviewed that agenda and said that the plan was to discuss the interstate insurance compact in the morning and to hear a presentation on property and casualty issues in the afternoon. He said that the task force had worked with the NAIC during 2002 as commissioners were drafting the compact, they receive an initial presentation by the NAIC on the compact in December immediately after insurance commissioners adopted the model act. Representative Mautino said that he thought it was important for the task force to come out of the meeting with a plan and timetable to address the important issues and to move toward making recommendations to the NCSL Executive Committee. He said that Congress is ready to act, which makes it very important for the task force to move forward with specific recommendations. PANEL ON THE INTERSTATE INSURANCE COMPACTSenator Hannon said that he was very pleased for the task force to have with them the distinguished panel of speakers: Terri Vaughan, Joseph Zimmerman, Gayle Yeomans, and Peter Gallanis. He then called on Commissioner Terri Vaughan of Iowa, the NAIC immediate past president. Commissioner Vaughan said that insurance commissioners adopted a statement of intent in early 2000 to pursue a national system of insurance regulation for certain lines of insurance. Commissioners quickly concluded that a national system for regulating the approval of life insurance and annuity products was especially important due to the competition that these product face from banking and securities products in the national market. Commissioner Vaughan said that the issue of "speed to market" for life insurance products had caught the attention of Congress. It soon became clear that regulation was going to change; the only question was who would drive the change, she said. Commissioner Vaughan said that, in late 2000, commissioners launched CARFRA -- the Coordinated Advertising, Rate and Form Review Authority -- in 10 states. CARFRA was intended to be a state-based entity that would serve as a single point of filing and review for life, health and annuity products in multiple states according to newly formulated national standards. However, Commissioner Vaughan said that it soon become clear that CARFRA was not solving the problem because there were hundreds of deviations from the national standards, just in the 10 CARFRA states. Although companies could file the product with CARFRA, the deviations required that they still had to have a different product in every state. When they tried to go through the process of solving the problem and going state by state to eliminate the deviations through legislation, she said that commissioners concluded that the massive amount of work that would be required made it impossible. Commissioner Vaughan said that the NAIC met in early February 2002 and spent about a day and a half discussing possible solutions. They discussed the possibility of state giving deference to the domestic state, but decided that it would not work because of different state standards and concern that those standards would not be high enough. They also talked about continuing down the CARFRA path but decided that it was not going to solve the problem. She said that they even discussed having Congress enact federal uniform standards for life insurance but concluded that that really was not the right answer and that it would be better for the states to do it themselves. However, they concluded that they had to find a way whereby states could act collectively to create a set of uniform standards that everyone could accept and then to make a single decision on the approval, she said. Commissioner Vaughan said that, as soon as they decided that a collaborative system was the way to go, they knew that there were talking about an interstate compact because that is what a compact is. It is an agreement among the states to act collectively, she said. Therefore, the interstate compact was not the first choice of commissioners but instead the decision that they reached after they had discussed all the other options that existed. Commissioner Vaughan said that, during 2002, commissioners proceeded to draft the interstate compact. They produced 11 drafts, held five public hearings and created the document that they have now recommended to the NCSL, she said. The basic structure of the compact applies to four product lines, including life insurance, annuities, disability income and long-term care insurance. A state must enact the compact model act in order to join the compact. The member states then would join the uniform standards that would be applied to the products that are filed with the compact commission. A state may opt out of the compact standard for a particular product line if they do not like them after they had been developed and may opt out of long-term care insurance when the compact is adopted. States can opt out by legislation at any time or by regulation if they give notice in a timely manner and demonstrate that the compact standards do not reasonably protect consumers in the state. When the state does not opt out, the compact's standards become the state's standards for purpose of products that are filed with the compact, said Commissioner Vaughan. Where the compact approves a product, it is the same as approval by the state. Commissioner Vaughan said that the compact creates a system whereby uniformity becomes the default. A state still can move away from uniformity by opting out, but it requires that they take action if they want to deviate. The NAIC believes that changing this dynamic goes a long way toward promoting greater uniformity. She said that that the compact moves states toward uniformity in a way that preserves state sovereignty. Unlike federal insurance regulation, Commissioner Vaughan said that, under the compact, states decide whether to join the compact, whether to withdrawal from the compact, and whether to opt out of a uniform standard by legislative and regulation. It also protects states' market regulation activity such as sales practices, consumer complaint, and other market conduct issues, she said. Therefore, it solves a very targeted problem -- the product approval process for four product types. To put the targeted solution in context, Commissioner Vaughan said that, of the 90 employees of the Iowa Insurance Department, only one reviews life products. The state receives thousands of life insurance product filings, and she said that she's not convinced that the state does an superb job of reviewing many products, particularly the very complicated ones. The compact could be a great thing in assuring the quality of the reviews of the products that are to be sold in Iowa, especially as the products get increasingly complicated, like equity index products, products with different kinds of guarantees and other types of new features, she said. In review, Commissioner Vaughan said that the compact makes sense because it addresses an evolving market, it improves the quality of reviews on a national basis, it allows leveraging of the collective expertise of the states in setting national standards, it allows better use of limited resources to prevent duplicate efforts, and it responds to the increased mobility of the population. Commissioner Vaughan said that there also are issues being raised about the compact that should be examined. She said that she breaks the issues into two sets. One, there are some concerns about legality, constitutionality and delegation of powers that Professor Zimmerman is better qualified to discuss, she said. However, she said that the NAIC looked at these issues closely and is confident that these issues are not a problem. The second set of issues is of a public policy nature, she said. These ask, first, whether the compact is the right way to go. Commissioner Vaughan said that insurance commissioners have done their own analysis and decided that it is. Then there are questions about how it should work, such as the role of consumer advocates, the effect of the compact on state laws, the operation of the opt out system. She said that these were things that the NAIC discussed extensively but encourages the NCSL to go through its own process and reach its own conclusions. Commissioner Vaughan said that commissioners believe that the compact is a "win-win-win" for consumers, the industry and regulators. It meets the industry's need for a regulatory system that responds to the current market and the conditions that they face. For consumers, it raises the quality of review at a time that products are more numerous and complex. For regulators and legislators, it gives us a better use of resources while maintaining state regulation and states' ability to protect consumers locally. Senator Hannon thanked Commissioner Vaughan and said that the task force would hold questions until the end. He added that there was an outline of the compact at about the third tab in the meeting book. Senator Hannon then called on Professor Joseph Zimmerman of the State University of New York at Albany. Professor Zimmerman said there were six different methods of achieving uniform or harmonious regulation: 1) reciprocity statutes, 2) uniform state laws, 3) interstate administrative agreements, 4) interstate compact, 5) federal interstate compact, and 6) congressional preemption. Professor Zimmerman said that interstate compacts are traceable to inter-colonial compacts. The Articles of Confederation included a provision that authorize interstate compacts with the consent of the unicameral Congress, he said, and one such compact was enacted during this period -- one with Maryland and Virginia involving fishing rights in the Potomac River. The U.S. Constitution took Article I, Sec. 10, on interstate compacts almost verbatim from the Articles of Confederation, he said. This provision reads, "No state shall enter into a compact or an agreement with any other state without the consent of Congress." Many may be aware of what is termed the "silences of the Constitution," said Professor Zimmerman. Literally read, the provision requires congressional consent for all interstate compact. However, he said that the U.S. Supreme Court in the 1893 case, Virginia v. Tennessee, distinguished between political and non-political compacts. The case said that only political compacts -- those that encroach upon the powers of the national government -- require the consent of Congress, he said. Professor Zimmerman said that the compact device is very flexible and can involve anywhere from two states to 50 states and the territories. The current subject matter runs from A to W -- agriculture to water and everything in between. Some compacts are simply study compacts that create a commission to examine an issue. Others are service compacts where one state provides services to another state or states jointly provide services. The also are facility compacts such as the Port Authority of New York and New Jersey, emergency management compact, civil defense compacts and many other types. A compact also necessarily does not have to encompass an entire state. In theory, there could be an interstate city and there exists an interstate school district in New Hampshire and Vermont, he said. Negotiating the compact is usually the most difficult problem, said Professor Zimmerman. All compacts until 1930 were written by commissioners appointed by the respective governors. He said that, since that time, organizations such as the NAIC have drafted compacts on their own and transmitted them through state legislatures. When you go to state legislatures, many of the issues that were raised in the drafting of the compact are raised again. Professor Zimmerman said that enactment by two or more legislatures does not mean that the compact would go into effect immediately because a compact may be a self-executing compact but also could be non-self executing where it requires a state official to execute. Professor Zimmerman reiterated that only a political compact requires that consent of Congress. The U.S. Steel Corporation challenged the Multi-state Tax Commission on the grounds that it was an illegal body because it lacked congressional consent. The U.S. Supreme Court upheld the constitutionality of the compact in 1978 despite the lack of congressional consent, he said. Up until 1920, he said, all compacts except one were boundary compacts. The compact device started to realize its potential and revealed that it can be used for a wide variety of purposes starting with the Port Authority of New York and New Jersey, he said. Some compact drafters have decided to submit compact to Congress even though they were not political. Professor Zimmerman said that he had been quoted out of context in the Prentiss Cox report regarding uncertainties related to congressional consent. What Professor Zimmerman meant, he said, was that the drafters of the Port Authority compact, clearly a non-political compact, decided to submit it to Congress because they were creating an unusual entity and they wanted to reassure investors who would buy their bonds. Other non-political compacts also have been submitted to Congress while others do not. Professor Zimmerman said that many compacts have a sunset clause. They do a lot of business on a certain date. He said that there are two types of congressional consent: permissive consent, which is granted prior to the enactment of the compact, and ratifying consent, which is given subsequent to enactment. Consent in advance has occurred, but ratification by Congress is more common after the compact has been drafted and presented to them. Professor Zimmerman said that Congress is free to add conditions to the compact and two compacts actually limit the power of the federal government. Once a compact receives congressional consent, all member states and Congress must approve amendments, he said. Professor Zimmerman said that the Prentiss Cox report raised a question about 11th Amendment immunity. Although he said that he did not want to go into the matter, he did want to say that Cox's two citations are correct, but Mr. Cox did not give the full explanation. It is safe to conclude that the interstate insurance compact would not involve the 11th Amendment. Professor Zimmerman said that there is limited experience with regulatory compacts that make it difficult to reach conclusions. The one that most closely resembles the insurance compact in terms of economic regulation is the Northeast Diary Compact, he said. It created a legal cartel that was sanctioned by Congress for three years and then extended for two years before it expired in 2001 when it was not extended. The compact that achieved its objective most rapidly and continues to be highly effective is the Waterfront Commission of New York, he said. This most unusual two-state compact, which consists of commissioners from New York and New Jersey, is the only compact with the power to levy a tax. Professor Zimmerman said that it cleaned up the corruption on the waterfront, he said. Professor Zimmerman said that the Ohio River Valley Sanitation Committee is an eight-state compact that effectively took one of the most polluted rivers in the country and made it one of the cleanest rivers. Although it has enforcement powers, it has never used them and, instead, has operated on the basis of persuasion. Professor Zimmerman said that the opt-out provision in the insurance compact may encourage states to join the compact. The danger of the opt-out provision is that, if too many states exercise the opt-out, then you have a non-harmonious situation. Many people believe that, since the Republicans took control of Congress in 1995, many people believe that it is more state friendly, he said. When talking about congressional unfunded mandates on states, there has been a sharp reduction. However, he said, if talking about congressional preemption of state regulatory authority, it is a different situation. Professor Zimmerman noted that President Ronald Reagan actually signed more state preemption legislation than any other U.S. President. The rate of federal preemption legislation has not declined since 1995. Forty-two preemption bills have been signed since then covering a variety of important areas, he said. Technological changes and increased mobility of individuals and firms will continue to generate pressure for preemption to bring about some type of uniform system of regulation. Senator Hannon thanked Professor Zimmerman and said that he brought a dimension to the compact discussion that he did not think many had appreciate before. He also asked NCSL staff to provide copies of his written statement to the task force. Senator Hannon said that task force members may have received a letter from four attorneys general who had jointly signed a letter. This report, which also is referred to the Prentiss Cox report, is not a report from the national association that represents attorneys general. Senator Hannon then called on Gayle Yeomans with New York Life Insurance Company. Ms. Yeomans said that she spoke to the task force as the chair of the ACLI Task Force on Product Regulation, a position that she had held for only a week. However, she was able to study the work of her predecessor, Bill Fisher of Mass Mutual, who was in the room, she said. Ms. Yeomans said that she had been in and out of government over her career -- working for both the New York Assembly and Senate -- and, therefore, has a good idea of state legislative concerns. Ms. Yeomans said that, unlike many issues that come before state government, the interstate compact is not a solution looking for a problem. There is a very real problem, she said. Insurance commissioners, their staff, people in the industry, and consumer groups have put an immense amount of time into this issue. Ms. Yeoman said that products sold by life insurers must be customized and approved separately in each state. There are some areas where there is greater uniformity, but a great amount of customization continues. She said that some may say, "So what?" The "so what" is that the financial and retirement securities products sold by their competitors, such as banks (CDs) and securities (mutual funds) require only one regulatory approval or none at all. Therefore, the current system affects companies' ability to do business and, ultimately, the price at which products can be presented to the public. It also affects state government, where the state by state review demands additional staff time and resources that could be used elsewhere, she said. Ms. Yeomans said that someone could say that this was okay if consumers were better off, but they are not necessarily. One ACLI member gave the example of their effort to have a new annuity product in all 50 states as quickly as possible, she said. Seven months later, approval was pending in five states, four of which were major markets. In the other states, even though they receive approval, they had to comply with specific state requirements. In the end, the company created 35 different product contracts and one state required two versions. The company estimated an annual on-going expense of $500,000 for additional staff and compliance systems. It is not purely a matter of product filing; every time there is a different product in a different state, you have the potential to complicate your administrative systems and to cause problems down the road. The mere fact of having different state standards does not result in better products for consumers, she said. Ms. Yeomans said that there are many potential benefits of the interstate compact. At this time of scarce resources, a centralized system will allow states to reallocate staff and resources to other areas that are of equal -- if not greater -- importance, such as market conduct, fraud and consumer complaints. Regulators and individuals within the states still would be able to participate in the creation of the uniform standards, and state would be able to opt out of the standards if they do not like the result, she said. In these days of mobile populations, products purchased in another state with different standards when an individual moves to another state challenge state regulation. The compact would address this, she said. The industry also believes that the compact would permit them to bring products to market more quickly and less expensively while lessening the burden of maintaining different products for every state that are tailor to unique requirements. Ms. Yeomans also said that consumers would find it easier to participate in the development of standards, which is not always possible in the state by state system. The ACLI is working to further the compact in different way, she said. ACLI members worked with the NAIC in drafting of the compact. Ms. Yeoman also said that the ACLI actively will support the compact in states where the commissioner seeks adoption of the compact. Finally, the ACLI is urging and supporting the NAIC's current effort to develop national product standards. Ms. Yeomans said that her final point is that, while working in the health insurance world before coming back to the life insurance world, we thought that the entire world revolved around the health insurance world. Now, she said that she is reminded that the life insurance world also is a very complicated arena at the NAIC meeting in Atlanta when she sat in with an NAIC group that was beginning to formulate national product standards. One thing that was handed out was a matrix of various products that underscored the immense volume of products that must be reviewed by regulators, she said. There are variations on variations. Ms. Yeomans said that, if there is one thing that legislators can take away from this process, is an appreciation of the huge task that regulators have and the time that is necessary to review the products. It underscores the need for uniformity, she said. Senator Hannon called on Peter Gallanis with the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA). Mr. Gallanis said that NOLHGA is the national organization for the life and health insurance guarantee funds in the 50 states, the District of Columbia and Puerto Rico. NOLHGA coordinates the activities of these consumer protection mechanisms on a national level. State legislatures have done an excellent job in devising a system that protects consumers against the risks of insurer insolvency, and there is a consensus that -- even if a federal insurance regulator was enacted -- the state guarantee fund system could continue to serve consumers effectively, he said. Mr. Gallanis said that he is not before the task force on the behalf of NOLHGA, that the comments that he will make do not represent NOLHGA and, in fact, NOLHGA does not have a position on the interstate compact or optional federal chartering. He said that he was asked to participate in the panel because of other experiences that he has had, including those with the Illinois Insurance Department and as a former teacher of insurance law. Those efforts brought him in contact with insurance compacts. These experiences include the theoretical -- by writing and teaching on the subject -- and the practical -- by being involved with the interstate insurance receivership compact. He said that he served as Illinois' commission on the receivership for the last four years that he worked for the Illinois department. Mr. Gallanis said that his comments fall into a few different areas. The first area is a few observations about state regulation. The things that state insurance regulation does well, he said, it does very well. What has been demonstrated over the last several years is that state regulation can improve, and it can do so quickly. The great example is solvency regulation, which Congress identified 10 to 12 years ago as an area of great concern where the states were not doing a good job. The states acted collectively -- and very quickly -- to set a whole package of standards to improve solvency oversight that led to the NAIC's accreditation program of the early 1990s. However, accreditation is a label while the reality is that states began working more effectively both individually and collectively to supervise the solvency of insurance companies, and the results have been impressive, he said. In the history of state insurance regulation, since its inception in 1851, there has been a great deal of interstate cooperation, he said. A great deal of regulation that could be handled through an interstate compact mechanism, like the one being discussed, already is handled de facto by assignment of substantial decision-making to interstate cooperative efforts that are sponsored by the NAIC. Mr. Gallanis said that a good example of this is the valuing of securities that has been consolidated in the NAIC's Securities Evaluation Office in New York City. Mr. Gallanis said that this similar style of interstate cooperation could be lent to the product approval process. The difficulty that life insurers face to compete in a cost-effective way against their competitors in the financial marketplace is acerbated greatly by the inefficiencies that are built into the need to get their products approved through different state standards, different procedures and ultimately the development of different products necessary to get those approvals, he said. From an economic standpoint, it is something that serves as a regulatory drag on the companies that operate in the marketplace but also on the companies who cannot operate in the marketplace because they lack the economies of scale that allow them to meet the regulatory costs. Mr. Gallanis said that the big companies may be able to continue to play, but they will face costs that are not faced by their competitors in the other financial sectors. Some may see this as fine and others who are aligned with other financial entities may look at this situation as a zero sum game because the retirement money that does not go to insurance companies will go to banks and securities firms. He said that he, however, believes that this is not a good result. First, he said, it would lead to a depredation of consumer choice because products will be kept out of the marketplace by the continuation of the current system or by companies that will not be able to offer products due to the high regulatory costs. Second, he said that products that would be approved by the compact offer valuable choices to consumers that are not offered by bank or securities products. It may not be the right product for a particular consumer, but he said that he believes that it is better to have more choice rather than less choice. Therefore, the efficient regulation of products at the front end that is intended to be brought about by the compact is good for consumers, he said. Mr. Gallanis said that a couple of other criticisms that have been made about the compact deal with theoretical or technical shortcomings. One thing he said that he noticed about them is that none offer a significant suggestion of an alternative approach to solve the problem of getting products efficiently and quickly to market. If there is a problem -- and there is a real problem -- he said that the question then becomes, how do you go about solving it? Although he said that is not difficult to come up with theoretical or technical shortcomings to the compact -- and he offered to discuss these, upon request -- the question that he returns to is, if not this, what? Mr. Gallanis said, based on this approach, there are only three directions that states can take. The first is to do nothing, which he said believes is negative for consumers. The second is federal preemption of product regulation. He said that, if lawmakers do not know already, he has sat in the offices of Congressman Baker and other people who are prepared to move on this sooner rather than later if they do not see efforts that will address the problem at the state level. The third alternative is effective, real state reform that develops a working single point of filing that will bring efficiency to the system of product approval in a way that serves consumers and the companies that need to be offering the products that they need, he said. Senator Hannon thanked the panel for the wide breadth of their remarks. He asked members of the task force if they had questions. Professor Zimmerman said that, although they were discussing an interstate compact, the aims that they were looking to address also could be addressed through an interstate administrative agreement. He also said that he has a flyer for his new book titled Interstate Cooperation: Compacts and Administrative Agreements. Assemblyman Grannis said that he had two sets of questions. First, he asked if there had been an analysis that compares the products in the different markets and describes how the products differ. Is this just a time question or are the products just so different that it really justifies a different system, he asked. Senator Hannon said that a major catalyst for the task force was when Congress passed Gramm-Leach-Bliley and took down the walls so that competitors to the life industry have greater advantages than they did before, including not having anything near the comparable regulatory scheme that insurance does. Assembly Grannis said that he has heard industry complaints before, but he knows that the New York Department has done speed to market reforms that have made a huge different. Therefore, he asked whether it was just speed to market or whether it was substantial deviations actually hinder their ability to use the same product in different states with a little tinkering. Commissioner Vaughan said that, as Senator Hannon said, this is a new problem that comes with financial services integration. Also, she said that the problem is both a timing issue and a standards issue. Insurance companies wants to market products nationally like their competitors do with a single product and a national advertising campaign. It does take extra time to get it approved, and that is a problem, she said, but also the resources associated with compliance is another problem in itself. When the NAIC did CARFRA, they took the three simplest products and still found many deviations, she said. The deviations fall into two categories, she said. First are the minor technical deviations, such as font type requirements, exact wording of the fraud notices and grace periods of 30 days versus 31 days. There also are substantive deviations, such as the structure of the non-forfeiture benefits in the policy. Assemblyman Grannis asked, with a compact that is national in scope, how does the compact work. Is there a critical mass of states that must participate to make it work, and what if states opt out, he asked? Does this need all states to work and what if half the states decide against it? Commissioner Vaughan said that the compact requires 26 states or states representing 40 percent of premium volume to enacted the model before it goes into operation. Professor Zimmerman said that it was possible that there could be more than one compact, with different provisions, that serve the same function. Ms. Yeomans said that the NAIC has established an ad hoc working group to look at potential uniform standards to give states who are looking at the compact a better idea of what they are or are not enacting. One value is that there will be states participating in the development of standards that may not join the compact in the end. Superintendent Serio said that, when the NAIC went through the CARFRA process, they found that the big states -- especially Texas, California and New York -- were the ones with the most deviations. However, they also seemed to be the most in agreement with one another, he said. The big six states now have taken the work product from the CARFRA initiative and are creating a full matrix of the standards in the states. The New York department is going through its standards to see if they come from state statutes, regulations or the so-called "desk-drawer" rules. Three of the six big states have done this already, and the rest are now working on it, he said. The big six states represent about 45 percent of the market, said Superintendent Serio. They now plan to see where they stand and to see if they can create a standard from within those deviations. He said that the big states think that they can create a standard that retains consumer safeguards that currently exist in the big states so they do not have to go to their legislatures and ask for a dilution of their state rules. They instead want to identify the points of commonality among them and bridge the small differences that do not create a substantive change in the statutes, he said. For the NAIC funded consumer advocates, there has been a concern about the dumbing-down of standards, but the big six states actually are trying to see that the opposite happens, he said. Having such a large portion of the market say that it is going to one standard should help propel the discussion on the compact issue. Superintendent Serio also said that the companies need to show more effort to work with the states on the interstate compact without the shotgun to the head approach that is federal insurance regulation. They cannot bank on that happening. In New York, speed to market efforts have been achieve part and parcel with the industry, he said. By the last count, half of New York filings were filed on a speed to market basis, but the life industry nationwide is not reflective of the New York life insurance industry. There has not been an expression that the carriers are willing to follow the reforms to the degree that the New York companies have. Property and casualty still can not muster more than five percent of filings on a monthly in the New York department on a speed to market basis, he said. This is probably the same in both property and casualty and life in some states with some carriers. Therefore, unless there is a commitment by the industry that they are willing to work with us at the state level in discussing the interstate compact, it is difficult to go to the legislature that regulators and industry are moving in the same direction. Speed to market came right out of the NAIC statement of intent from early 2000, and there already has been great success and participation in New York, said Superintendent Serio. However, he said that he does not have great confidence that the buy in is complete, especially in other states and with the property and casualty industry, who show a dramatic disinclination to use the reforms. Yet, the industry raises suspicion among regulators in New York and elsewhere when it runs to Washington to ask for relief from speed to market because it does not want to sign certifications, he said. Senator Hannon said that the big six state efforts raise the valid point of what the standards will be, how they will be developed and who will be notified as they go along. He asked Superintendent Serio if their goal was to create a foundation for the states and promote their standards once the compact's process begins to move forward. Superintendent Serio said yes. He said that they do not intend to say that the big states have come up with something that all the other states must do, but rather to give everyone a sense of whether the deviations are minor or substantive and to show that the big six states amongst themselves can find a common standard. It also allows the states to tell Congress, which always asks about what the big markets states are doing, that 45 percent of the marketplace is going to one set of priorities. The experience of CARFRA cannot be dismissed, he said. It was a great learning experience, which included the annotation of all the New York standards, which then served as the foundation of speed to market. He also said that some of the smaller states have said that they would be willing to do whatever the big states do, which could serve as the foundation of uniform standards. Senator Hannon asked Commissioner Vaughan about the NAIC process to create standards. Commissioner Vaughan said that, when the NAIC adopted the compact in December, they knew that there were many states that would not be interested in adopting the compact unless they had a better understanding of how it would work in practice-and not just on paper. They have created a precursor to the compact that is functioning as the compact would, she said. They have created a management committee as it is in the compact with members from the six large states, four members from medium states and four members from small states by zone. Now they are beginning to create standards as they would if the compact was in existence, which should provide some guidance to what they standards are likely to look like, she said. Representative Hubbard said that the compact legislation has been introduced in Alabama. He asked Ms. Yeomans what the industry would do if enough states adopted the compact. Ms. Yeomans said that the industry is not an inanimate and unified thing. The concerns that she discussed are very real, she said, and there are some who believe that state reform is the way to go and there are others who believe the federal route is the way to go. She said that the approach they have chosen is not to set one approach against the other but to explore all options. Representative Hubbard asked if there is agreement in the industry to make the compact work. Ms. Yeomans said that there is strong interest in doing so. Representative Googins said that the bottom line for NCSL is to retain state control. She then asked Professor Zimmerman whether the interstate administrative agreement process is easier and if it was a valid option. Professor Zimmerman said that the interstate administrative agreement process is a valid approach and that it is possible to have interstate administrative agreements supplement the compact agreement. Senator Hannon asked if the courts have overturned a compact totally or partially. Professor Zimmerman said that none had. He added that they are rarely challenged in court, with few exceptions. Senator Robinson said that he understood that the problem is that there are a myriad of filings that need to be approved and that he heard Commissioner Vaughan say that she only had one person working on filings in Iowa. He asked if part of the problem is that the products are too complex for individuals in each state to learn. Commissioner Vaughan said that she always could use more staff. However, she added that, if they problem was just timing, it would be possible to solve with more staff, but that does not mean that it would be the best use of resources. It also would not solve the problem of deviations, she said. Superintendent Serio said that the process could not be discussed in a vacuum. The states need to get their departments to a level of efficiency through technology and by making the plain language of the law to work for us, he said. In New York, he said they have taken people off the filing system by not accepting filings that do not meet the minimum standards of the law and by holding companies to those standards. Once a state achieves base efficiency, then we can say where we need to go with the compact or any other reform. Legislatures need to check with their departments, one, to make sure that they are pursuing these goals and, two, to make sure that there is a base buy -- in on the part of the industry, which brings things together so that you can move forward from the same starting point. Peter Molinaro with the New York Insurance Department said that the NAIC also has created an ad hoc group to examine the interpretation of standards to resolve different understandings of standards as well as ethical and education issues. This is being done, among other things, to resolve legislative questions about the people who will comprise the compact staff and who actually do the work. Representative Hubbard asked if anyone could provide an estimate of the economic impact if the compact does not go through and the potential cost of federal mandates and preemption. Senator Hannon said that there were three potential economic impacts that he could name. First, federal regulation threatens $11.8 billion a year in state insurance revenues from premium taxes and other sources. Two, there are potential costs of regulatory efficiency. Third, there is a potential effect on state guarantee funds. Senator Hannon said that Mr. Gallanis may want to address this issue, which he had not heard discussed. Superintendent Serio added that a fourth revenue stream that could be affected is the fees and assessments that are levied on insurers to fund state insurance departments. He said that, if carriers were no longer filing products with the department, he would expect them to ask for relief from the assessments, which pay for far more than the product regulation system. Senator Hannon said that state insurance revenues were included in the meeting book as Attachment A of the task force's October 2002 report to the NCSL Executive Committee. He also mentioned the model of the federal banking regulator, the OCC, which has sought actively to encourage state banks to flip charters and become national banks. It has been trigger happy to exercise preemption authority as an advantage of a national charter, he said. Senator Hannon said that Mr. Gallanis had mentioned that he would be willing to share with the task force some of his concerns with the compact. He asked if Mr. Gallanis would do this. Mr. Gallanis said that he has had some conversations with people at the table about the process that produced the interstate receivership compact, which he believes accomplished some good things. The goal of that compact was to develop within a short period of time a new model to conduct insurance receiverships and liquidations. He said that the scope of the project was significant and to have achieve it with a short period of time was impressive. Nonetheless, in the end, only six states ever passed legislation and only three states currently are members. Its true significance is as a model, said Mr. Gallanis. The debates that occurred when states in the NAIC Midwest zone considered the compact raised some of the very issues that have been raised in the current debate over the product regulation compact. Some of those debates resulted in changes that made it into law, and some did not. However, the criticisms in many instances mirror those raised in the Prentiss Cox report and by others, he said. One criticism, said Mr. Gallanis, is that the compact does not have much specificity built into it, for example, as to the availability of records and public participation in administrative rulemaking. It does not have any specificity on products that would be approved. If the discussion occurred in a vacuum, he said, those criticisms would be valid. In comparing the product approval compact to the receivership compact, he said that the receivership compact as a result with discussion with state legislatures has greater specificity with regard to open records, open meetings and boundaries of rulemaking authority. Even as time goes by, the NAIC has taken to heart some of these critiques, and it is beginning to respond to them, he said. The ad hoc committee working to develop illustrative examples of how the compact would deal with development of standards, notice issues, and public records. This process should allow legislatures to develop a clearer example of the legislation that they are considering that make it less of a black box or a pagan of hope than would otherwise be the case, he said. Mr. Gallanis said that some of the other criticisms do not go to substantive issues and miss the point of what compact do. For instance, he said, some wrote that the compact amounts to the regulation of insurance by a private corporation. When you examine the comment, it ends up being unfounded when the compact would amount to collective regulation by insurance commissioners, who are fully accountable to the legislatures and executive branches of the states that they serve, he said. Some of these criticisms fall away when you examine them in the context of the other protective measures that are included in the compact, said Mr. Gallanis. These include, first of all, the fact that a state's entry into the compact if voluntary. If a state does not chose to enter the compact, it is of little significance to the citizens of that state. Mr. Gallanis said that the decision whether to enter the compact is made much more intelligently because of the work of the ad hoc committee, the work of the big six states and the work on uniform product standards by all of the state together. The opt out provisions also provide valid protections to the state. The authority of a state to exit the compact provide a valid protection to the citizens of a state. Finally, the most effective protection is that the decisions rendered by the compact will be reached through a process that is in the open. He said that the openness will help product standards be developed through consensus based on the standards that already have been developed by states for a variety of valid reasons. The compact will not be pulling the standards out of a hat, but they will be applying what they have learned over a 150 years of state insurance regulation, he said. Senator Hannon said that, in the middle of the uniform standard adoption process, is a requirement that the commission "give written notice to the relevant state legislative committees in each compacting state responsible for insurance issues of its intention to adopt." The point of that was to ensure openness and notice and to allow consumers in all 50 states to have notice through 99 state legislative committees, he said. Senator Larkin said that many in Congress see insurance as a big barrel of pork that would allow them to get hold of nearly $12 billion in revenue and almost a $1 billion from New York. Federal regulation would limit the authority of state regulators to regulate the industry and perform market conduct studies, he said. States must start to focus on how to act, and further delay increases the likelihood that Congress will act. He said that Congress is unprepared to handle consumer issues and complaints. They are prepared to take the insurance revenues but not for the responsibilities. They thought that Gramm-Leach-Bliley was the savior, but it was not, he said. Now they got the issue in front of him, but they do not know what to do with it. PUBLIC COMMENTS ON THE INTERSTATE INSURANCE COMPACTSenator Hannon called on Birny Birmbaum with the Center for Economic Justice. Mr. Birnbaum said that his comments would focus on three questions. First, what are the strengths of state insurance regulation? Two, what are the competitive advantages of state insurance regulation compared to federal insurance regulation? Third, does the proposed compact build on these competitive advantages? Mr. Birnbaum said that he is one of a dozen NAIC funded consumer representatives, who have their expenses reimbursed to participate in NAIC meetings. The dozen or so organizations represent a cross-section of various interests and activities. He said that some consumer representatives oppose the concept of the compact because they believe that standards created by the compact will move to the lowest common denominator, and the higher standards won in some states, like the long-term care insurance law in California, will be lost. Others, including him, support the concept of the compact because they believe that it has the potential to improve consumer protections in all states. However, all of the representatives aggressively oppose the current compact model, he said. Mr. Birnbaum said that the compact has the potential to improve the quality of reviews of product filings in the vast majority of states and to reduce redundancy. The model does not accomplish what it should because it ignores the competitive advantage of state insurance regulation and instead puts in place a process that will ensure mediocrity of standards and consumer protections. The principal advantage of state regulation is not efficiency. The federal government always is more efficient, he said. The goal is effectiveness of consumer protection, and this is where state insurance regulation has -- or should have -- an insurmountable competitive advantage. The reasons for the advantage is closeness of state legislators and regulators to the market, the ability of states to respond quickly to market issues, the accountability of regulators and legislators to the public, openness of process, and the opportunity for the states to be laboratories of innovation and to try different things that could be the answer to problems, he said. The compact has the opportunity to built on these strengths while overcoming some of the inefficiencies and ineffectiveness, said Mr. Birnbaum, but it fails to make the case for state insurance regulation. Instead, it focuses on the efficiency issue. He said that the compact's greatest failure is that it takes away the ability of the states to create and institute new consumer protections to effectively respond to an evolving marketplace. There is no incentive for state legislatures to do so because the protections would have no effect on the standards that the compact would use. He said that legislatures and not representatives from the 51 jurisdictions should drive the standards. Therefore, he proposed a compact provision that would require the compact commission to adopt a consumer protection once it was adopted by a certain number of states. He proposed a threshold of three states with a 20 percent market share or six states of any size. This provision would address the major failing of the compact by providing states with an incentive to pursue innovation and consumer protections. Mr. Birnbaum said that another major failing of the compact model is that it lacks statutory standards for public accountability. The response to all of the consumer groups' objections during the drafting is that they should wait until they see what the results of the ad hoc working group. He said that another way of putting this is that, rather than placing the critical public accountability features into statutory language, consumers should wait for the compact commission to respond to concerns through the bylaws and operational procedures. Although we are supportive of the work of Superintendent Serio and the other big states, it is unacceptable to include the features into the model. There are no guarantees that what the big states do will make it into the compact model, and there is no guarantee that it would continue into the future because the make of the compact today is not what it will be then, he said. Mr. Birnbaum said that the compact needs a mechanism for formal consumer involvement to ensure that consumers will be able to participate. It is reasonable to include a consumer participation mechanism as part of a new national system that will affect consumers in all states. The public also should be allowed to review and comment on individual filings as well as proposed uniform standards, he said. The argument against this is that product review is fairly mechanical once the product filing has been established and that consumer involvement would slow down the efficiency of the commission's activity. He said that he disagreed with both points. First, he said that product standards are discretionary and mistakes are made. Therefore, consumer input can add value to the system and enhances the fairness of the system by allowing reviews to receive input from perspectives other than the insurer who makes the filing. Second, he said that public review of filings does not need to bog down the process if there are deadlines and safeguards against that happening. In conclusion, Mr. Birnbaum encouraged the task force to adopt a compact that is different than the one approved by the NAIC and to create one that would maximize the strengths of state regulation. This also would provide the opportunity to enlist the support of consumer organizations that have been involved in this process when, at this moment, there are none, he said. In returning to something said by Superintendent Serio, Mr. Birnbaum said that the lack of speed to market in the current system is not merely a reflection of the way in which state regulators review filings. In fact, regulators have documented the poor quality of products filed by many insurers where they submit a generic product to all states, and they rely on department staff to review their filing and to tell them what to do. Therefore, he said that he wanted to emphasize Superintendent Serio's point that insurers must step up to their responsibilities to make speed to market work. Senator Saland asked why some consumer advocates would prefer a federal insurance regulator when state legislators give much greater individual attention to consumer issues. Mr. Birnbaum said that all the consumer representatives that he knows support the state system. At the NAIC, the consumers who are most opposed to the compact are the most ardent supports of continued state regulation. Representative Mautino asked in his group has a formal position on federal regulation. Mr. Birnbaum said that is not what his group does but that many other groups do. Senator Robinson asked if Mr. Birnbaum if he had prepared any specific language that he would like to see adopted. Mr. Birnbaum said that he could provide information to the group. Senator Hannon asked, besides the California long-term care law, what are standards out there that people are interested in having adopted that currently have not been consider in existing models. Mr. Birnbaum said that these include the ability for consumers to obtain copies of filings before they are approved and to offer comments. He said that it is a public accountability issue. Senator Hannon asked if there are any others, like California's. He noted that the initial opt out of long-term care insurance was included to take account of the California law. Mr. Birnbaum said that he wants a compact that encourages participation and does not encourage states to opt out. He said he would like to see a compact that, when a higher standard like California's is adopted, that the compact would adopt that standard. Senator Hannon said that the political model allows for that to happen. A state still could innovate and then attempt to the other states the merit of its model, he said. Mr. Birnbaum said that the mechanism permits a certain group of states to prevent a certain standard from being adopted but can not push through consumer protections. Representative Googins said that the creditability of the NCSL and everyone involved are important. Therefore, she encouraged Mr. Birnbaum to provide specific language and recommendations to the task force for its consideration as soon as possible. Mr. Birnbaum called attention to the two-third-majority requirement. He said that it encourages consensus and allows any member on the management committee to prevent the adoption of strong standards. Senator Hannon said that it is intended to encourage consensus. Many provisions in the compact -- including the notice requirement, the opt-out provision, the two-third-majority requirements, and the possibility that a state may withdrawal -- all encourage consensus. Commissioner Poolman said that he did not see Mr. Birnbaum's argument that there would be a race to the bottom. He said that, as a commissioner, he could not envision going to his legislature to opt-out of a uniform standard because the consumer protections were too high. He added that state legislatures have oversight authority, and he is accountable to them for his actions. The compact is about making regulation more responsive to the current market and not about rolling back standards, he said. Senator Larkin said that, in New York, they already have an insurance consumer advocate, the attorney general, and special consumer committees in both chambers of the legislature who already focus on consumer protection. Legislators are the people who represent and deal with consumers every single day. He said additional safeguards were not needed. Superintendent Serio said that there have been few consumer victories other than cleaning up bad industry filings, which is a task that he admits must be done. However, he said that the bulk of what is happening to protect consumers takes place outside the product regulation process. Reality demands that the department give greater attention to market conduct and the actual practices of insurance companies in the marketplace. He provided an example of a health insurer that had a provision that was great for consumers included in its filing but did not include it in the policies that it sold. He said this is against the law, but there is nothing in the product regulation process that guard against that type of abuse. No one is saying that states should go to file and use for life insurance and annuity products, but the states need to find a way that will allow them to transition more of their resources to market conduct, he said. Senator Saland said that, when legislators see a two-third-majority requirement, it means that there must be consensus for things to happen, and there is a comfort level for them to know that the representatives at the compact will need to compromise and balance various concerns. It would be very difficult to accept a three state and 20 percent of market volume threshold, which will allow a few states to preempt all other states. He said that states have a problem with preemption regardless of whether it is the federal government or three to six states. Commissioner Vaughan said that compact permits deviation, but everyone knows that, if too much deviation occurs, it will fall apart. Therefore, there is incentive built into the compact to go to higher standards to prevent deviation and states from opting out. Senator Hannon called on Bill Fisher with Mass Mutual who previously had chaired the ACLI Task Force on Product Regulation. Mr. Fisher said that he does not like the term "speed to market" because it connotes only one element of the problem. If the term is going to be used, it must mean three things. First, the ability of carriers to bring responsible products to market subject to appropriate regulation. Second, it means the ability to bring those products to market subject to uniform standards. Finally, it means the ability to bring products to market in a timely and efficient manner. Speaking exclusively for Mass Mutual, the competitive market for the life insurance industry has changed considerably in the last 15 years, he said. Insurers are competing head to head with banks and securities firms, which have a different regulatory structure that does not require 50-state approvals. Their ability to bring products to market from the perspective time can run between a couple weeks if they do not need approval to three months if they are going before the SEC, he said. In contrast, the typical time that it takes to receive approval nationally for a life insurance product is from six to 18 months -- the upper end being what it really takes to get all 50 states' approvals. For example, said Mr. Fisher, Mass Mutual has a fairly typical universal life insurance product, which is approved in all 52 jurisdictions. The standard version is good in 11 states while 41 jurisdictions require state-specific deviations, which means they have a total of 42 variations of the same basic product, he said. More recently, they have been introducing their latest edition of a new variable annuity product. It was first filed in October 2001; it has been approved by 49 jurisdictions and is outstanding in three states. They have had to create 30 different versions of the same product, which is an improvement over the 42 but somewhat marginally. Mass Mutual went to its business lines and asked what it cost the company in terns if lost sales because it cannot bring its products to market within a reasonable time. The company estimated that it lost approximately $80 million in lost sales in 2000 to life insurance and other competitors, he said. Mr. Fisher said that consumers would benefit from the compact because they ultimately bare the cost of inefficiencies in the system. Consumers also are harmed by an inefficient system because they either are denied products that could be of benefit to them or their access is delayed. It is important to note that, in the life insurance industry, the new products tend to be more price efficient from the consumers' standpoint and they typically contain more favorable features than the older products, he said. It is difficult to understand why, in 2003, a consumer must have access only to the 2001 product model. The compact before the task force offers the greatest promise of modernizing state product regulation in several ways, said Mr. Fisher. It provides the single point of filing. It provides for the chance to have uniform standards, and he said that his company also believes that it will provide timeliness. Turning to some of the criticisms of the compact, he said that it is a carefully thought out document that provides critical protections to consumers and ample opportunity for input for the companies themselves, legislators, and consumer groups. He said that the best way to think of the compact as putting in one central place the process that currently is occurring in any given state in terms of the product approval process. Regulations are adopted pursuant to the Model State Administrative Procedures Act with ample input of all parties. It does not place any given group in the regulatory role of reviewing products. He said that his company views that function a governmental activity not to be shared with non-governmental personnel. Assemblyman Grannis asked what was the most common deviation with their variable annuity product. Mr. Fisher said that he would have to go back to his people to find out. Assemblyman Grannis asked if they had an analysis of the different state requirements. Mr. Fisher said that his company maintains that information because when they file a product they attempt to anticipate what the deviations will be. On the life insurance side, the manual just to assemble a product is three inches think and it can take from three to six weeks to put a 50-state filing together. Some deviations are substantive but some are just smaller differences. Senator Hannon asked if NCSL could obtain a list of the deviations. Assembly Grannis asked, when they examined lost business opportunities, what portion was attributable to other life insurers as opposed to other financial services sectors. Mr. Fisher said that he did not think that there was a breakout. He also said that CARFRA produced a document that detailed deviations for the original 10 states. Since that time, CARFRA has expanded to many more states, he said. Commissioner Vaughan said that CARFRA did produce such a document, but -- to place it in perspective -- it was only for three products, which happened to be the three simplest products that related to life insurance, annuities and health insurance. They are now tackling more difficult products, she said. Senator Hannon announced a break for lunch. PROPERTY AND CASUALTY INSURANCE ISSUES PRESENTATIONRepresentative Mautino opened the afternoon session by thanking the task force members, panelists and interested parties for the discussion in the morning and said that they would return to the issue at the end of the meeting to discuss future plans for the compact. He said that the afternoon session focused on property and casualty insurance (P/C) issues. He said that, following a decade of favorable experience, the P/C market in recent years hit a perfect storm, which has caused difficulties for insurers and higher premiums for consumers. Representative Mautino introduced Philip O'Connor with PROactive Strategies, Inc. and the former director of the Illinois Insurance Department to provide a economic analysis of P/C rate regulation. Dr. O'Connor said that his focus is the relationship between P/C rate regulation and the supply of property and casualty insurance. Earlier, Dr. O'Connor said that Mr. Birnbaum said something that was very valuable, which was that merely looking at efficiency does not reveal much about consumer protections. It is not the mission of state insurance regulation to bring about efficiency but to bring about consumer protection, and Dr. O'Connor said that he could not agree more with that. A corollary notion is that economic efficiency to be consistent with fairness and economic justice and that we should not consider inefficiency an inherent feature of efforts to protect consumers. Some of these concerns should come into play when policymakers concern P/C regulation, particularly auto insurance, homeowners insurance and workers' compensation, said Dr. O'Connor. He said that there has been a false promise of P/C rate regulation, not at its inception but over time it has developed such that, whatever one might advocate as being the outcome of P/C rate regulation, it tends not to develop. The advocates of strict P/C rate regulation by the states would never set as their goals the actual outcomes of such regulation in many states over the past thirty years. Dr. O'Connor said that rate regulation has proven to be a disappointing exercise that often produces unintended adverse consequences that harm consumers and creates politically difficult conditions. A couple years ago, American Enterprise Institute and the Brookings Institute held a joint-conference on insurance regulation, which did an excellent job of bringing together 30 years of P/C rate and form regulation. The many papers that were presented confirmed that rate regulation was not delivering benefits and actually may be worse than that. There are several findings that result from that research, including that:
Dr. O'Connor said that prior approval laws were enacted in most states after Congress enacted the McCarran-Ferguson Act in 1945, but current market conditions now are radically different. Technology has improved pricing techniques significantly and made "cartel" pricing obsolete. Globalization has made capital no longer captive to a particular state. Consumers also have access to increased information via the Internet and other sources and much greater power thanks to a small group of informed consumers -- or "pathfinders" -- who protect and guide other customers, he said. The question that has been before legislators now for about 20 years is why to keep prior approval when states do not see benefits and competitive pricing works better, Dr. O'Connor asked. Dr. O'Connor said that strict rate regulation, on its face, would tend to impede supply and demand. Those dynamics are at the heart of insurance just as they are at most other parts of the economy. Insurance availability and -- to a lesser extent, affordability -- is a function of the supply of capital that insurers are prepared to allocate to markets. The markets are a combination of coverage, such as auto, home or whatever, and the state where they are willing to commit their surplus or investment as well as built up the infrastructure of a company. Dr. O'Connor said that what rate regulation does is create additional risks that inhibit capital commitments, he said. However, the effect varies from state-to-state as jurisdictions with similar laws may administer them differently. He said that it is well know that there is a normal insurance cycle, which involve periodic shortages in coverage and price increases. The question of rate regulation is whether states want to institute permanent solutions to temporary problems. Hard markets tend to last relatively short periods of time, and the research suggests that they last shorter periods of time under competitive systems and that last longer when rate regulation artificially suppresses prices. Competitive pricing allows a states' "hard" markets to self-correct more quickly, he said. Dr. O'Connor said that insurance is unique in one way, which is that a major cost factor -- losses -- are not known at the time the product is priced and sold. In the mid-1940s, during the period when states enacted prior laws, there were real questions about how to get the large numbers that allow companies to price. Companies tended at that time to be more local. This was before there tended to be the big national and independent companies that exist today. In response, pricing cartels emerged to collect and analyze loss data and to enforce adherence to standardized rates in order to assure company solvency. The McCarran-Ferguson Act was directed at restoring the status quo ante prior to the decision in the U.S. v. South-Eastern Underwriters Association case, which threatened to destabilize the way the market worked. However, since the mid-1960s, new actuarial and financial regulatory techniques have supplanted rate regulation as a loss data analysis, pricing and solvency tool. He said that rate regulation today is only a modest contributor to solvency concerns. Therefore, most than enough has changed that it is no longer necessary to look to strict rate regulation to address this unique feature of insurance. In light of these changes, Dr. O'Connor said that Illinois provides a valuable model for policymakers. He said that he calls it a model rather than an experiment because it has been in place now for over 30 years. It was originally an accident. In 1969, Illinois enacted an experiment of a competitive rating law based on the premise that the market was competition and the state only would get involved in rate regulation when there were competitive problems. After two years, in 1971, the General Assembly could not come to an agreement on how to modify the experimental law, and the law sunset. However, it took people until that fall before they realized that the state had no law whatsoever to regulate property and casualty rates because the new law expired and the old law -- while still on the books -- was inactive. Dr. O'Connor said that the state now has operated for over three decades with the reverse preemption in effect. Illinois lawmakers in every subsequent legislative session have opted for an anti-trust model in which the state has no law to regulate P/C rates. He said that he is not here to advocate that everyone adopt the Illinois model -- although, he said he would like to see a few other states try it -- but instead to show the task force what happens when a state has no P/C rating law whatsoever. The roof did not fall in, he said, and the state has not had over the last 30 years a situation that has encouraged the General Assembly to reenact a rating law. The state does have informational disclosure where insurance companies file the rates that they charge and examples. The department also oversees whether there is unfair discrimination but stays away from proscribing rating territories, with one specific exception about bodily injury coverage in Chicago. In fact, the experience has been so good that Illinois became the first state to move to competition in workers' compensation rates, he said. If anything, Dr. O'Connor said that the system has worked very well. He said that the results include the following benefits:
Dr. O'Connor then shared two slides that compare what happens in a handful of states with strict rate regulation to the supply of insurance. The first showed the percent of U.S. auto insurance companies that operate in each of six states: California, Illinois, Massachusetts, New Jersey, South Carolina and Texas. The second slide showed the same information for homeowners insurers. What the slides show, Dr. O'Connor said, is that the supply of insurance in Illinois far exceeds the supply in other states, especially those with intensive rate regulation. Where the percent of U.S. companies that operate in Illinois is 27 percent to 28 percent, only five percent to 15 percent of companies do business in Massachusetts, New Jersey and South Carolina, he said. Dr. O'Connor said that Massachusetts relies on state prescribed rates, underwriting rules and rating territories while New Jersey's auto market has been a political and economic disaster for decades, getting worse with each round of reform that avoids competition. In 1997, after half the auto market migrated to the state's residual auto insurance plan, South Carolina reformed its rate regulation and promptly experienced significant turnaround. South Carolina took this action with the clear view of doing what they should to attract more insurers to the state, he said. Senator Robinson asked if South Carolina went to a file and use system. Dr. O'Connor said that they actually went to a flexible rating system. They liberalized ratemaking -- although not to the extent of Illinois -- and reformed the state's residual market. It also sent a signal to insurers that a new day had dawned and that it was worth spending capital in the state. Dr. O'Connor said that a number of prior approval states, such as Ohio and Nebraska, operate in a competitive manner and have had few problems. However, he said that Texas is an interesting contrasting example. The state has had an accidental two-track market both with auto and homeowners insurers that are rate regulated and those that are not. Ninety-percent the state's homeowners market migrated to the unregulated "Lloyd's" market and a majority of the auto market set up county mutual companies, which allowed them to avoid rate regulation. The companies mostly are "small cap" affiliates of larger national companies. The crisis that the state faces with mold and "slab" results from state promulgated policy forms. What is interesting, as the charts show, is that there has been a flight of capital from the state, he said, and the companies -- especially the small caps -- are not writing new business. The only way the market will improve is if the parent companies decide to invest greater capital in the Texas. Despite this, legislation is pending to regulate all homeowner rates rather than to deregulate all prices and forms. He said that he does not think the situation will improve unless they face up to the issue of how to attract capital. Dr. O'Connor predicted that states with systems that allow a genuine opportunity for insurers to earn their cost of capital through competition would have better supply and price dynamics. However, states without competitive cultures tend to discourage capital commitments and thus reduce supply and inadvertently drive prices up, he said. State like Texas, New Jersey and Massachusetts are not facing up to the question of how to attract capital into their markets. State legislatures should revisit a budget allocation decision made over 50 years ago to determine if there are better uses for scarce regulatory assets, Dr. O'Connor said. He suggested that the funds would be used more effectively to provide better solvency oversight and technology, to better manage consumer complaints, to support fraud prevention and prosecution, to achieve technological parity for regulators with the industry, and to leverage the Internet for personal lines consumers. Illinois' reforms have allowed the department to devote its resources to things that he said he believes to have higher value. He added that public confidence in regulation would improve when prices were set competitively as consumers see the benefits it provides. Representative Mautino said that, with significant increases in recent years, there has been a great deal of legislation in Illinois to institute a political solution. There have been five or six rate regulation bills this year. Although he was glad that none of the bills cleared committee, there will be increased cries for it as the situation continues. Dr. O'Connor said that that has been the practice over the years that there are a number of bills introduced that do not pass and, by the time the next session comes around, the market corrects itself. If legislators have patience and rely on the market, they are likely to receive a more durable solution than if they try to impose rate regulation. This also was the case in the early 1980s when they addressed redlining. He said that Illinois was able to address that issue more quickly than the rest of the country through market-based solutions. Senator Robinson asked how states that are close to Illinois with more similar characteristics but with different systems of regulation would fare by the same analysis. Dr. O'Connor said that there are a variety of laws in the mid-west but there is a culture of competition. Ohio has a competitive rating law that is administered as if it were prior approval, but there is a great reliance on rapid approval and little political decision-making. Therefore, while different on paper than Illinois, Ohio tends to operate pretty much the same way, he said. Wisconsin was one of the earliest competitive rating states; Indiana is file and use. Senator Robinson asked if the attraction to capital stays the same as in Illinois. Dr. O'Connor said that Illinois perennially has the highest percentage of both auto and homeowners insurance but the mid-west generally has high participation rates when you account for the size of the state. Assemblyman Grannis said that, even with the favorable environment, Illinois still is losing insurers, which does seem to suggest that its entirely favorable. Dr. O'Connor said that the smaller percentage in Illinois is true for all states. Illinois continues to have the highest participation of any state but every time a new single insurer is set up -- like a Lloyd's affiliate in Texas or when State Farm sets up a company to business only in New Jersey -- it changes the percentages for all states. Assemblyman Grannis asked what happened when Illinois first made this change in 1971. Dr. O'Connor said that nothing happen -- actually, it was not noticed until the fall. Senator Robinson said that some people think that legislatures would be better off if they did not pass any laws. Dr. O'Connor said that anti-trust laws govern Illinois' market. The state accepted the reverse preemption of McCarran-Ferguson, which says that federal anti-trust laws apply to insurance to the extent that the industry is not regulated by the states. Senator Hannon asked what the effect of the anti-trust laws. Dr. O'Connor said that, just like other businesses, insurers in Illinois fight over market share. Senator Hannon asked if the exemption in other states allow insurers to collude to keep prices high. Dr. O'Connor said that he did not think so. McCarran-Ferguson wanted to require insurers to adhere to a set of proscribed cartel-set rates that were blessed by the states. Since the 1970s, however, the big national independent companies, like State Farm, Nationwide, Allstate and Progressive, there is a disinclination to adhere to a set of prices. Senator Hannon asked Dr. O'Connor if he had facts to back up his points, which Senator Hannon said challenged conventional wisdom. Dr. O'Connor said that it depends of whose conventional wisdom and that many insurance commissioners know what he said to be true. Senator Hannon said that he meant the average politician. Dr. O'Connor said that there is much to support he arguments, particularly Scott Harrington's study, Insurance Deregulation and the Public Interest. He said that he believed Debra Wozniak with State Farm to have copies of the study that she could give to task force members. He also suggested the work of the AEI-Brookings Joint Center for Regulatory Studies. Donald Bryan with the New Jersey Division of Insurance said that one of the things that rate regulation does provide is some degree of stability or predictability for the purchasers of insurance. This is perceived as a benefit to the consumer as it serves to mitigate the effects of the insurance cycle. In states such as New Jersey and New York, where the cost of insurance is high, fluctuations can be rather significant without some way of mitigating the swings. He said that this is one of the things that has affected commercial lines in recent years, namely medical malpractice. He asked Dr. O'Connor if he thought so and if he had any suggestions about to mitigate the business cycle without intrusive rate regulation. Dr. O'Connor said that they would be benefits if they existed, but he did not believe that there was an ounce of empirical evidence that suggested that rate regulation smoothed the insurance cycle or gives policyholders greater predictability. After 30 years of research, he said that he is waiting for any evidence that it does. Senator Hannon said that it is understood commonly that insurers tend to operate with a herd mentality. They do not raise rates because of various factors for an extended period and then, every ten years or so, they run into problems and they all raise their rates at once more sharply than if they had done so over time. If it is best to wait 12 months and the situation will take care of itself, Senator Hannon said that legislators are not in the business of waiting, especially in the post-Enron, post-WorldCom environment. Dr. O'Connor said that he understood the political motivation. Nonetheless, he suggested that there are economic consequences of political actions done with the best of intentions. The reality is that all the best things that strict adherents to rate regulation suggest should happen tend not to be achieved when it is put in practice and that the desired results are more likely to result from competition. The herd mentality comes from the fact that most insurers are subject to the same market forces at the same time, which leads to the insurance market cycle. It is possible to try to alter the market somehow to keep earnings up and contributions to surplus up so that there would not be the dramatic hard markets that there are. They also can derive from dramatically falling interest rates, which is one thing that is happening currently, he said. Dr. O'Connor said that the insurance market cycle would persist; the question is whether policymakers let market mechanisms address it or they try to impose a governmental solution. COMMENTS FROM INTERESTED PARTIES ON P/C ISSUESRepresentative Mautino thanked Dr. O'Connor and asked if there were any comments from interested parties on the issues that Dr. O'Connor raised. Mr. Birnbaum said that he had some comments to make. Mr. Birnbaum read a couple comments that were issued by the Texas insurance commissioner on the preceding Friday. "Several insurance companies who together write over 50 percent of the Texas homeowners insurance market are not currently writing new homeowners insurance policies. The largest writer of homeowners insurance in Texas with over 30 percent of the market has not been writing new homeowners policies for over a year. Another large writer of the homeowners insurance market with approximately 20 percent of the homeowners market in force is also not writing homeowners policies. Many other insurers have continued to maintain restrictions or limitation in writing homeowners insurance and some insurers have withdrawn from the market. In addition, according to statistics obtained from the surplus lines staffing office, in the last year there has been a 184 percent increase in homeowners insurance premiums written by surplus lines insurers, which indicate a significant increase in the writings of homeowners policies by surplus lines insurers. The increase is a clear indication that consumers are having difficulty obtaining or finding it impossible to obtain homeowners insurance through the voluntary market." Considering the current situation of the Texas insurance market and what Dr. O'Connor just told the task force, Mr. Birnbaum said that one should conclude that Texas is one of the most heavily regulation insurance markets in the country. In fact, he said that it one of the most deregulated homeowners insurance markets in the country. Therefore, the notion that deregulation is the answer to the problems in Texas is laughable he said. Legislators there are talking about what type of regulation to do and how severe is it going to be. He said that Texas refutes many of the notions that Dr. O'Connor puts forward, but -- instead of accepting the facts -- there is an attempt to explain away the anomalies. California has a prior approval system of regulation and has had very good experience over the last several years following Proposition 103. He said that its experience also contracts Dr. O'Connor argument. However, there is a notion that, when the facts contract the deregulation theory, there must be some other explanation to why those facts are like they are, he said. Mr. Birnbaum said that the facts in Illinois support deregulation but the facts in Texas and California do not. However, he said that there are other ways of looking at the situation to determine whether insurance markets are competitive. He said that he was not a big fan of prior approval systems and was not speaking to the task force in its defense. Instead, he said that he believed the debate over rate regulation to be beside the point. The most important issues are related to underwriting and risk classification, he said. Texas homeowners have received huge increases but the people who have received the largest increases are not because of rate regulation but because there has been no regulatory oversight of things like credit scoring. This allows a company to introduce a new factor that gives some people a 300 or 400 percent increase. Even if overall rate levels are at five percent, if some get a 300 percent increase, there will be dislocations in the market. Mr. Birnbaum said that much of the academic support for rate deregulation is based on methodologically flawed analysis, such as grouping states into prior approval versus file and use. However, what is said statutorily does not reflect necessarily what is done in practice. However, he urged the task force not to focus on deregulation or competition but to take a more comprehensive approach to regulatory oversight to include underwriting guidelines and risk classification, which are not examined in many states at all. It also is useful to take a further step back to look at how the product is delivered in the marketplace and ways to deliver that product more efficiently, he said. One example is paying for auto insurance part through vehicle registration and a surcharge on the price of gas, which ensures a basic level of universal coverage and resolves the problem of uninsured motorists. He said that the deregulation argument assumes the current method delivery and that policymakers do themselves a disservice if they do not try to think outside the box. Senator Hannon asked Mr. Birnbaum if he had a recommended model. Mr. Birnbaum said that he thought that California has a fairly extensive prior approval system and other features that have proven favorable. He does not draw the conclusion that California's should be the only feature that is available just like he does not look at the Illinois experiment as the definitive basis to conclude that all states should deregulate. He said that the thing about insurance is that distributive issues are just as important as aggregate issues. A low average statewide premium is little consolation to people in that state who pay considerably more. Senator Hannon asked if he was advocating for community pricing for personal insurance lines. Mr. Birnbaum said he was not, but that he wanted states to look at the distributive issues. He said that some issues may be related to higher risk but others may not be, and policymakers should examine these things. Mona Carter with NCCI said that, under the Illinois system -- despite having no law -- the state reviews underwriting guidelines and risk classifications. Dr. O'Connor said that Illinois performs market conduct exams of companies where they look at whether companies adhere to their own underwriting and risk classification guidelines and whether individual companies guidelines conform to state standards. Debra Wozniak with State Farm said that her company was committed to streamlined and simplified system of auto insurance regulation. There are a number of complexities to the regulatory environment, including policy forms, market conduct, fraud, and insolvency. Product regulation is on areas where states can move to improve efficiency and recommended improvements there would go a long way to accomplishing the goals of the task force. She said that she was pleased that Dr. O'Connor was able to share with the task force with underlying reasons for State Farm's position on product regulation and that she looks forward to continuing to work the task force on these issues. ROUNDTABLE DISCUSSION AND TASK FORCE TIMETABLERepresentative Mautino said that task force is charged with making recommendations to the NCSL Executive Committee. He said that it was important to lay out a timetable to reach those recommendations no later than the meeting of the task force at the NCSL 2003 Annual Meeting in San Francisco on July 21. Representative Mautino ask Commissioner Vaughan about the number of states that support the compact. Commissioner Vaughan said that 37 states voted for the compact in December. Representative Mautino asked the task force about their level of support for the task force. He said he was behind it and was interested in moving its adoption in Illinois. Assemblyman Grannis said that it remained new to him. Coming from a state with a heavy regulatory overlay, he said that he wanted to look at it more closely. Despite what was said at the meeting, he was stilled concerned with the perception that the compact could be a rush to dumb down the system. He said that he also is concerned about the opt out, which in New York could take years. Representative Hubbard said that the compact has been introduced in Alabama and that his commissioner is solidly behind it. Senator Saland suggested that the a presentation be made on the compact to the NCSL Executive Committee at its meeting in Quebec City in early May. He did not think that it would be the time to ask them to vote, but it would useful to update the members on where the task force is on the subject and to let them know that they may be voting on the compact at the Annual Meeting. Representative Hubbard asked how many states had introduced the compact. Mr. Calvo said that Alabama, Indiana and Iowa have. Mr. Calvo suggested that the task force consider how to tackle the issues before the Annual Meeting. He said that the task force will meet in Boston on Thursday, April 24 in conjunction with the NCSL 2003 Spring Forum and that a number of members who were unable to attend the New York City meeting have indicated that they plan to attend the Boston meeting. He suggested that this meeting was more conceptual while the Boston meeting may be an opportunity to examine the compact in greater detail. There also had been discussion about possible amendments, including some items raised by Commissioner Vaughan and the NAIC. Mr. Calvo said that the task force may want to consider proposed amendments and to consider them within the overall framework of the document. Representative Mautino, Senator Hannon and Senator Saland discussed the framework for the task force to make a presentation to the Executive Committee at its meeting in early May and then to possibly forward a recommendation to them at Annual Meeting. It was agreed that the task force should aim to have a recommendation to the Executive Committee in San Francisco. Mr. Calvo said that a time and space has been reserved for the task force to meet on July 21 in San Francisco prior to the Executive Committee meeting on July 22. He said that the task force also could schedule a meeting between Boston and San Francisco or could meet by conference call. However, he noted that restraints on legislative travel make additional meetings increasingly difficult. Representative Mautino said that it would be helpful to have a sense of the task force on the compact so that they could give the Executive Committee an accurate picture. Senator Hannon said that he has not heard any decent. People have raised questions about how to deal with consumer notice. He said that Mr. Birnbaum raised the issue of how to encourage a higher standard but he said that he does not see any steps necessary to get there. He said that there is the report by the four attorneys general and some other decent by someone from one of the western states who was saying that this was a loss of power. Representative Mautino said that the U.S. House Financial Services Committee is beginning to move and that their representative told the task force in December that they do not believe that the states can accomplish anything. He said it is easier for states to tinker with something down the road than it is to have the Congress undo something that it has done. Assemblyman Grannis said that he did not hear that Superintendent Serio said that he and the other big state commissioners supported the compact. Senator Hannon said that Superintendent Serio supports it but there is one big state commissioner that would like for the big states to create their own compact of just the six big states. Senator Hannon said that he was not sure if that would work but Superintendent Serio is supportive. He said that Superintendent Serio was not there at first but became supportive as the NAIC process progressed. Senator Hannon said that it would be helpful to take the attorneys general report and do an analysis of the issues they raised. Although he said he did not agree with many of them, he said the issues could be confusing and things such as the first article of the U.S. Constitution could be misled if they do not understand the context and the case law. Representative Stone asked if they were plans to transcribe the meeting and send them to members of the task force. She said that just reading the morning presentation would be extremely helpful. Mr. Calvo said that there are plans to do so quickly. Mr. Tucker said that NCOIL has videotaped an expanded session, which includes the individuals who participated at this meeting, and planned to mail CDs of the session to legislators, regulators and others within the next couple weeks. He said that, as the education process continues and it becomes clear what the compact is and is not, many of the concerns are allayed. Senator Robinson said that Oklahoma Attorney General Drew Edmondson, one of the four attorneys general who signed the Prentiss Cox report, was constituent of his Senate district and that he knows him well. Senator Robinson said that he would like to discuss the issue with Mr. Edmondson and possibly could invite him to a meeting. Senator Hannon said that the task force in general would benefit from listening to the concerns of attorneys general. He said that the full history of their involvement was that they got involve with the compact late in the NAIC process and most attorneys general signed a letter to the NAIC in December asking them to delay their adoption. Following that, these four attorneys general signed the report, which offers their particular concerns and point of view. Senator Hannon said that, to the extent that Senator Robinson and other members of the task force are able to discuss these issues with these four attorneys general and others who may be interested, the process is well served. Senator Robinson said that the "no" side is always easier to sell. Senator Hannon said that, in December, the task force heard directly from congressional staff that they are done with their informational gathering stage and are now in the action stage. He said that the "no" argument always would raise the question of what are the alternatives -- getting preempted or offering something better than the compact. Senator Hannon said that, before the Boston meeting, there will be produced a draft statement of principles for property and casualty issues for the task force to consider. He also said that he would like the NAIC to present on the electronic filing system. Commissioner Poolman asked if he wanted to see the system or to see its results. Senator Hannon said if wanted to see whatever would be appropriate but that he is curious as to how it operates. Commissioner Vaughan asked if they wanted the NAIC to provide language for some possible amendments prior to the Boston meeting. Senator Hannon said that, if there are possible changes, that it was best to examine the language. Commissioner Vaughan said that there were some points raised by Prentiss Cox, who drafted the report by the four attorneys general, that it may be appropriate to address. For instance, she said that he raised the issue of the compact being a private entity, which it is not but instead, a body of governmental officials. However, she said that the language in the document could be changed to make that fact clear. There are a few minor technical things that may be helpful. Senator Hannon said that there was another issue raised in San Diego about the preservation of market regulation authority. Commissioner Vaughan said there was. She said another one was related to the State Administrative Procedures Act. When they wrote it, they thought it included adequate open meetings safeguards but have since realized that additional language on this point also may be appropriate. Senator Hannon said that those are exactly the types of things that need to be addressed. Commissioner Vaughan said that the model has been introduced in Iowa and other states but that she assumed that, if NCSL made any changes, they could make amendments to the laws in those states in subsequent years. The task force adjourned at 3:22pm.
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