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Accepting The Challenge: Redefining State Regulation Now

SECTION II
THE REGULATORY PRACTICES TO REDEFINE

ELECTRONIC COMMERCE REGULATION

As more insurance products are sold over the Internet, it is inevitable that complaints will begin to arise about possible sales misrepresentation and other abuses and this, in turn, is likely to generate debate about creating more regulations to control this type of activity.

While NAMIC believes a certain amount of caution is warranted, significant problems can be avoided if regulators and industry begin working together now to understand the full potential of the Internet and avoid unnecessary impediments. Regulatory approaches must evolve to accommodate an electronic marketplace and innovative methods developed to take advantage of its efficiencies while preventing abuses where it is feasible to do so.

Last December, the NAIC Electronic Commerce and Regulation Working Group completed a paper that looked at electronic regulation and e-commerce issues. Among its findings, the Working Group concluded that there was a need to develop a common standard for electronic fund transfers (EFT) as states begin accepting electronic producer applications and policy form filings.

As for electronic commerce, the Working Group made the following recommendations:

  • Eliminate written signature or authentication requirements where consumer protections are not compromised;
  • Eliminate countersignature requirements;
  • Recognize electronic notification as a valid way to notify a policyholder;
  • Modify existing laws dealing with formatting issues to allow for electronic transmission of documents;
  • Develop a policy for satisfying proof of coverage requirements electronically;
  • Eliminate prohibitions or restrictions against electronic payments;
  • Allow flexibility in retaining records with whatever technology is used;
  • Allow disclosure statements by electronic means;
  • Consider eliminating prior approval standards for advertising materials; and,
  • Refrain from imposing any regulatory oversight over a Web site maintained by an insurer, who is not otherwise licensed to conduct business in that state.

At the same time, the Working Group endorsed a resolution supporting the Uniform Electronic Transaction Act (UETA), which recognizes that electronic signatures and records should have the same legal status as paper transactions. So far, at least a half dozen states have adopted the UETA model.

These examples underscore the great strides the Working Group already has made in addressing some of the electronic regulation and e-commerce issues before it. 

As this debate evolves, regulators and the industry should promote two initiatives that respond to the realities of digital insurance commerce:

  • Greater consumer education and information, coupled with greater consumer responsibility for protecting their own interests; and 
  • Greater reliance on industry self-regulation and certification enforced through admission requirements for electronic marketplaces.

EMERGING ISSUES
MARKET CONDUCT EXAMINATIONS

NAMIC believes the current market conduct examination process needs a regulatory overhaul due to the inconsistencies that exist with the present process.

The market conduct exam process today is too "localized," meaning that over time each state independently has addressed this issue with little regard about how other states perform the same function.

As a result, 32 states have created their own dedicated market conduct units with full-time market conduct examiners. Some of these states supplement their staffs with contracted examiners, and in three states, only contracted examiners are used. States without a separate market conduct unit perform this function by making it a part of the triennial financial examination process.

Funding of market conduct units vary. While most market conduct units are funded as part of an insurance department's overall budget, in some cases, the market conduct unit is self-sustaining, in that it exists through the revenues it generates by performing market conduct exams.

In February, PricewaterhouseCoopers (PWC) released the preliminary findings of an extensive study on market conduct examinations that it conducted for the Insurance Legislators Foundation, the non-profit research affiliate of NCOIL.

From interviews with chief examiners (CEs), examiners-in-charge (EICs) and insurance company representatives, the PWC researchers came to a number of preliminary findings, including:

  • Eighteen percent of the CEs and 15 percent of the EICs disagreed with the NAIC Market Conduct Examiner's Handbook statement that stresses that an insurer's general practices should be examined as opposed to looking for and correcting inadvertent errors in insurers' transactions; and
  • Forty-three percent and 38 percent of CEs and EICs respectively said they never use the NAIC Examination Tracking System.

These findings point to some serious "disconnects" among the regulators about the general philosophical nature of market conduct exams and about working together in tracking exams. These issues will need to be addressed and resolved before any discussions about greater uniformity can be undertaken.

A second issue is the current "structure" of market conduct exams. The Handbook lists seven areas of investigation and within those areas, there are 71 separate standards that could be examined. An analysis of these standards shows that several of them are "routine" in nature (i.e., an insurer should have a disaster recovery plan) and are not likely to change drastically over time.

A system of state deference could be developed for some of these routine standards. The state of domicile, for example, could certify that an insurance company meets the standard for having a disaster recovery plan. This certification could be performed during a triennial financial examination and the results could be forwarded to the NAIC Exam Tracking System. In this way, any state contemplating a market conduct exam of a particular insurer would have a record of when some "routine" standards were last certified.

Other "routine" standards are more time sensitive, such as an insurer's complaint log, and could be handled in different ways. One approach would be for regulators to develop a process where the insurer provides a printout of the complaint log that could be compared to the department's own records. Other approaches might be to either allow the insurer to sign a form certifying the accuracy of its complaint log or to have a third-party compliance expert sign an attestation to that effect.

The point of these different approaches is to either reduce or eliminate the more "routine" standards in the Handbook. This could help regulators to focus on the more critical aspects of a market conduct exam, namely, whether an insurer exhibits any discriminatory practices in its underwriting policies or it does not pay claims in a timely fashion.

Adopting new procedures has the eventual effect of shifting the emphasis of market conduct exams from more routine examinations to more attention on targeted exams that focus on the most egregious market practices.

We recognize that some differences in state market conduct laws and standards may remain even with significant movement towards uniformity. However, we believe that an insurer's compliance with the laws of various states can still be determined in a coordinated examination involving those states. It is not necessary and very wasteful to subject an insurer to multiple, duplicative exams that review the same files.

DESK AUDIT FEES

Several respondents questioned how some states impose fees on insurers for desk audits they perform and the audit results are never shared with insurers.

State funding of solvency monitoring activities should be made more systematic so that any company assessments are based on some reasonable formula that partially or fully funds monitoring activities, but does not exceed monitoring costs.

FINANCIAL EXAMINATIONS

The NAIC Financial Standards and Accreditation Program has been successful in significantly improving the financial oversight of insurers and because of that success, NAMIC believes it is time for reassessment and asks if there are ways the current process can be made more efficient.

Financial examinations serve three basic purposes: 1) ensuring that a company is prudently managed; 2) verifying that the financial statement of the company is accurate; and 3) identifying companies that are encountering financial difficulty or are assuming excessive risk. Routine regulatory examinations, conducted every three to five years, have focused on the second objective.

We think that there may be more efficient mechanisms to serve the data verification objective, allowing regulators to concentrate their attention and resources on the first and third objectives. Since most insurers are subject to annual independent audit requirements, one suggestion is to rely on this audit for data verification and reserve regulatory examinations for targeted and risk-based analyses. The annual independent audit could serve the purpose of verifying financial reporting and obviate the need for routine regulatory exams. Insurance regulators and independent auditors may need to work together to reconcile their information needs and procedures so that the independent audit may satisfy regulatory data verification needs.

If regulators came to rely on these independent audits for data verification, they could focus their resources on a risk-based financial analysis and examinations that are targeted at insurers who appear to be at financial risk.

Plans to modify the financial examination process should proceed cautiously, but developing a more risk-based approach is where the regulatory role is most clear and adds the most value.

ANNUAL STATEMENT FILINGS

The current annual statement filing process is still rooted in the pre-computer age when paper documents were the only means of conveying financial information. The continued expansion of the annual statement blank with numerous specialized exhibits that manipulate the same data in different ways appears to be increasingly less efficient and should be reconsidered in light of developing information technology.  If the current approach continues, special equipment will be needed to lift and move annual statements to the regulators who will be expected to review them.

The notion of more streamlined electronic filing of underlying source data on assets, liabilities, transactions and cash flows has been broached several times in the last 30 years, but bureaucratic inertia and the desires of financial regulators who still prefer to see a paper financial report seem to have thwarted any significant reengineering of the financial reporting process. 

This needs to be revisited with a stronger commitment of NAIC leaders and commissioners as the current direction is out of synch with modern information systems.

A re-examination of annual state filing requirements is needed for single-state insurers operating under special charters and underwriting limited risks, e.g., county mutuals. Several survey respondents openly questioned why companies operating in a single state should have to complete the entire NAIC annual statement filing when much of the information required is irrelevant or non-material. Still other single-state respondents wondered why their states required quarterly financial statements, or imposed certain restrictions on their investment portfolios.

Any changes should strike a balance between the need for some modicum of regulatory oversight, and the need to relieve the administrative burdens currently placed on single-state insurers.

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