Accepting The Challenge: Redefining State Regulation Now


Accepting The Challenge: Redefining State Regulation Now

SECTION II
THE REGULATORY PRACTICES TO REDEFINE

The NAMIC survey identified eight regulatory practices that respondents viewed as priorities for redefinition. A ninth practice - market conduct examinations - was added due to the pending release of a market conduct study being done on behalf of NCOIL, and the interest of NAMIC member companies therein.

Table B summarizes the specific recommendations that NAMIC is advocating for each practice. 

Table B
SUMMARY OF RECOMMENDATIONS FOR REGULATORY PRACTICES IDENTIFIED IN NAMIC SURVEY

Regulatory Practice

NAMIC Recommendations

Producer Licensing

Supports NAIC producer licensing model, and ultimately prefers it to reciprocity approach for satisfying NARAB.
Outstanding "process" issues must be resolved, so that a strategy for uniform national standards can be implemented.

Company Licensing

Supports NAIC Accelerated Licensure Evaluation and Review Techniques (ALERT) uniform application process and urges its adoption in every state.
Supports specific timeline for adoption for review of applications.

Rate and Form Requirements

States should re-examine existing rating standards to see if reforms are politically possible.
More competitive rating standards should be promoted in each state.
Uniform national standards should be developed for specific filing procedures (i.e., transmittal forms).

Commercial Rate Deregulation

States should be encouraged to enact commercial deregulation laws that include competitive rating for all lines and buyers.

Market Conduct Examinations

Market conduct exams should focus on correcting systematic problems in insurer practices, rather than penalizing minor, inadvertent mistakes.
Debate needs to be refocused and stress "targeted" exams over routine exams and allow for self or third party audits for insurers.
Regulators should make better use of existing regulatory tools and develop more coordination among each other in scheduling and conducting exams.

Electronic Commerce Requirements

Supports more consumer education and information about electronic commerce, coupled with greater consumer responsibility for protecting their own interests.
Supports industry self-regulation and certification.

Desk Audits

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

Financial Examinations

Regulators should consider relying more heavily on annual independent audits of insurers for data verification and a more risk-based approach to financial examinations for solvency.

Annual Statement Filings

More streamlined electronic filing of underlying data elements should be encouraged for financial reporting.
Different financial reporting requirements for single-state insurers should be examined.

In explaining the justification for these recommendations, it is probably useful to categorize each practice as either representing an "existing" or "emerging" issue.

An "existing" issue is one where certain uniformity initiatives already are underway, while discussions among regulators and the industry have not really taken place yet with an "emerging" issue.

EXISTING ISSUES
PRODUCER LICENSING

NAMIC, while fully supporting the new NAIC Producer Licensing Model Act, understands why the insurance commissioners chose the reciprocity option to minimally satisfy NARAB. It requires states to follow a prescribed administrative procedure for licensing non-resident producers that includes accepting the producer's home state continuing education requirements and not imposing additional requirements on them.

A reciprocity strategy is understandable given the tight timeframe imposed by NARAB. However, until the new model is adopted and all the attending procedural issues are resolved, NAMIC believes that producer licensing uniformity in the public interest will not become a reality.

Successfully implementing the reciprocity option without a commitment to appropriate uniformity will be perceived by proponents of federal regulation as yet another example of the insurance industry's lack of dedication to making the changes needed to warrant continued sovereign state regulation.

The NAIC already has made some significant progress with different aspects of the producer licensing process.  At least 32 states and the District of Columbia, for example, have adopted the uniform application developed by the NAIC Uniform Producer Licensing Initiatives Working Group (formerly known as the Producer Information Network Working Group). Twenty-six states use the Producer Database, which links participating departments into a common system establishing a repository of producer information. 

Fifteen states can file reports with the Producer Information Network (PIN), that uploads licensing records into a centralized repository, where other regulators, insurers and producers can check on licensed producers. The database can handle routine functions such as letters of clearance, information on any producer administrative actions, and letters of appointment, although this is an optional requirement in the new model.

Producer licensing needs to be given the highest priority this year. Any outstanding process issues, such as further simplifying the uniform application or encouraging more states to use the centralized database, must be resolved. At the same time, regulators need to recognize that even if they compromise on some state-specific requirement, they are not relinquishing their ultimate authority to deny a license or revoke it if the producer fails to meet the uniform standards.

The regulators and industry also need to begin working together on a legislative strategy that not only satisfies NARAB, but also promotes the adoption of uniform national standards in each state. These standards will protect consumers as well as benefit them by easing entry barriers, increasing competition, access, and quality of service and lowering costs.

COMPANY LICENSING

NAMIC fully supports the work of the NAIC Accelerated Licensure Evaluation and Review Techniques (ALERT) Working Group in developing a Uniform Certificate of Authority Application (UCAA) process that allows insurers to use a simplified form in their state of domicile and a uniform expansion application in other states.

While each state still performs its own, independent review of each application, the need to file different applications, in different formats, has been eliminated. So far, 21 states and the District of Columbia accept the uniform application.

Uniform applications, however, are only part of the process. To achieve needed efficiencies, state insurance regulators also should adopt a standardized timeline for reviewing applications. The ALERT Working Group has recommended 90 days. This is a reasonable timeline. It allows for a thorough review of insurer licensing applications, while preventing unnecessary delays and costs that impede the entry of insurers to serve consumer needs.

RATE AND FORM REQUIREMENTS

NAMIC believes that any discussion of rate and form filing regulations should focus on three elements:

  • The standards or requirements for rates and forms (i.e., what constitutes "excessive" or "unfair");
  • The filing and approval requirements (i.e., prior approval, file and use, etc.); and,
  • Specific filing procedures (i.e., transmittal forms, required information and format, etc.).

In many states, legislatures over the years have enacted standards that reflect individual state preferences or circumstances, such as compulsory insurance requirements or mandated benefits. 

NAMIC recognizes that while it may not be politically feasible to standardize some of these requirements, the states should take a hard look to see where reforms could be made and would be supported politically. Because these requirements ultimately restrict consumer choice, such restrictions should be confined to areas where there is a public interest or where consumers are vulnerable to purchasing inadequate insurance. Special interests should not be allowed to dictate certain terms of insurance contracts that are not in the best interest of consumers and the general public.

As for the filing and regulatory approval process, the need for state differences is not obvious. If competitive rating works in many states for personal and commercial lines, it should work in all states. The prior approval systems still retained by some states are an outmoded legacy of a time when insurers were required to adhere to uniform rates filed by a rating bureau.

The situation has changed dramatically with intense price and product competition among insurers. Economists who have examined property/casualty insurance markets have concluded that they are structurally competitive and that there are no apparent benefits to prior approval rate regulation, although there is the potential for significant harm from politically pressured rate suppression. 

This view was reaffirmed by the NAIC 25 years ago when it published its landmark study advocating competitive rating.

It is important to note that a competitive rating system does not preclude an insurance commissioner from taking action if competition fails for some reason in a particular market. States can reallocate resources away from unnecessary prior review of all rates to competition monitoring and market analysis. 

Prior approval of personal lines policy forms may be justified, but prior approval is not needed for commercial lines policy forms. Business Owners Policies (BOP) might be the only arguable exception as these are typically purchased by small businesses.

Other commercial insurance buyers are sufficiently knowledgeable, particularly with the assistance of agents and brokers, to discern policies that meet their risk management needs and any statutory requirements. The varying circumstances of commercial buyers also warrants a more flexible approach in tailoring insurance contracts to meet their needs.

Finally, the need for different state filing procedures for a similar approval/filing system is the least obvious. These state differences have evolved over time mainly as a matter of the personal preferences of the regulatory personnel that fashioned them and do not provide any measurable benefits to consumers, but significantly increase the cost and time delays of rate and form filings, which ultimately hurt consumers. 

Surely, market regulators, if motivated to do so, can develop reasonable uniform filing and review procedures for the regulatory systems that remain in place.

Specific filing procedures can be made more uniform. For example, a uniform national standard should be implemented for transmittal forms. Such uniformity can enhance the System for Electronic Rate and Form Filings (SERFF) initiative.

COMMERCIAL RATE DEREGULATION

NAMIC supports the notion that certain commercial buyers should be exempt from rate and form filing requirements. 

Since 1998, at least 17 states have enacted exemptions for certain commercial lines policyholders. 

The rationale for this effort generally has fallen into three broad categories:

  • Commercial policyholders are sophisticated consumers who should be able to purchase insurance products that fit their particular business needs with little or no regulatory oversight;
  • Competitive underwriting and rating will allow domestic carriers to more fairly compete with off-shore entities who have captured some large commercial accounts in recent years because they are not subject to the same regulatory scrutiny; and,
  • Deregulation will create greater efficiencies for regulators and allow them to focus their limited resources on solvency and market regulation issues.

NAMIC encourages other states to consider deregulating their laws for commercial buyers.

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.