After nearly two years of delays, the U.S. Department of the Treasury’s Federal Insurance Office (FIO) today released its report on how to modernize and improve the system of insurance regulation in the United States.

In its report, the FIO has concluded that in some circumstances, policy goals of uniformity, efficiency, and consumer protection make continued federal involvement necessary to improve insurance regulation. However, insurance regulation in the United States is best left to a hybrid model, where both state and federal regulatory bodies play complementary roles, according to the report.

“For over a century, the debate over reform of insurance regulation in the United States has focused largely on the practical and legal limitations of the state-based insurance regulatory system,” the report says. “The absence of uniformity in the U.S. insurance regulatory system creates inefficiencies and burdens for consumers, insurers, and the international community.”

The need for uniformity and the realities of globally active, diversified financial firms mean that federal involvement of some kind in insurance regulation is necessary and regulation at the federal level would improve uniformity, efficiency, and consistency, according to the report.

However, the report also says that limitations in a state-based regulatory system do not imply that the ideal solution would be for the federal government to displace state regulation completely.

“The business of insurance involves offering many products that are tailored for and delivered at a local level. For the most part, effective delivery of the product will require local knowledge and relationships, and local regulation. Moreover, establishing a new federal agency to regulate all or part of the $7.3 trillion insurance sector would be a significant undertaking,” the report says.

For those reasons and others the FIO concludes that, in the short term, the U.S. system of insurance regulation should be modernized and improved through a combination of steps taken by states and certain actions by the federal government.

The report makes recommendations in the areas of insurance sector solvency and marketplace regulation. The recommendations outline near-term reforms that states should undertake. In addition, the report outlines areas for federal involvement in insurance regulation.

“The report reflects an extensive study of the insurance sector and benefits from the collective expertise and experience of state, federal and international supervisors,” said Michael McRaith, Director of the Federal Insurance Office. “It also recommends a hybrid approach to insurance regulation that provides a practical, fact-based roadmap to modernize and improve the U.S. system of insurance regulation. Importantly, this report reflects the dynamic nature of the regulatory system for insurers and provides an explicit path for state and federal regulatory entities to calibrate involvement going forward. We look forward to continuing our work with all stakeholders as the United States moves forward with modernizing insurance regulation.”

Some of the recommendations from the report for states and the federal government are:

Areas of Near-Term Reform for the States

Capital Adequacy and Safety/Soundness

1) For material solvency oversight decisions of a discretionary nature, states should develop and implement a process that obligates the appropriate state regulator to first obtain the consent of regulators from other states in which the subject insurer operates.

2) To improve consistency of solvency oversight, states should establish an independent, third-party review mechanism for the National Association of Insurance Commissioners Financial Regulation Standards Accreditation Program.

3) States should develop a uniform and transparent solvency oversight regime for the transfer of risk to reinsurance captives.

4) State-based solvency oversight and capital adequacy regimes should converge toward best practices and uniform standards.

5) States should move forward cautiously with the implementation of principles-based reserving and condition it upon: (1) the establishment of consistent, binding guidelines to govern regulatory practices that determine whether a domestic insurer complies with accounting and solvency requirements; and (2) attracting and retaining supervisory resources and developing uniform guidelines to monitor supervisory review of principles-based reserving.

6) States should develop corporate governance principles that impose character and fitness expectations on directors and officers appropriate to the size and complexity of the insurer.

7) In the absence of direct federal authority over an insurance group holding company, states should continue to develop approaches to group supervision and address the shortcomings of solo entity supervision.

8) State regulators should build toward effective group supervision by continued attention to supervisory colleges.

Reform of Insurer Resolution Practices

9) States should: (1) adopt a uniform approach to address the closing out and netting of qualified contracts with counterparties; and (2) develop requirements for transparent financial reporting regarding the administration of a receivership estate.

10) States should adopt and implement uniform policyholder recovery rules so that policyholders, irrespective of where they reside, receive the same maximum benefits from guaranty funds.

Marketplace Regulation

11) States should assess whether or in what manner marital status is an appropriate underwriting or rating consideration.

12) State-based insurance product approval processes should be improved by securing the participation of every state in the Interstate Insurance Product Regulation Commission (IIPRC) and by expanding the products subject to approval by the IIPRC. State regulators should pursue the development of nationally standardized forms and terms, or an interstate compact, to further streamline and improve the regulation of commercial lines.

13) In order to fairly protect consumers in all parts of the United States, every state should adopt and enforce the National Association of Insurance Commissioners Suitability in Annuities Transactions Model Regulation.

14) States should reform market conduct examination and oversight practices and: (1) require state regulators to perform market conduct examinations consistent with the National Association of Insurance Commissioners Market Regulation Handbook; (2) seek information from other regulators before issuing a request to an insurer; (3) develop standards and protocols for contract market conduct examiners; and (4) develop a list of approved contract examiners based on objective qualification standards.

15) States should monitor the impact of different rate regulation
regimes on various markets in order to identify rate-related regulatory practices that best foster competitive markets for personal lines insurance consumers.

16) States should develop standards for the appropriate use of data for the pricing of personal lines insurance.

17) States should extend regulatory oversight to vendors that provide insurance score products to insurers.

18) States should identify, adopt, and implement best practices to mitigate losses from natural catastrophes.

Areas for Direct Federal Involvement in Regulation

1) Federal standards and oversight for mortgage insurers should be developed and implemented.

2) To afford nationally uniform treatment of reinsurers, FIO recommends that Treasury and the United States Trade Representative pursue a covered agreement for reinsurance collateral requirements based on the National Association of Insurance Commissioners Credit for Reinsurance Model Law and Regulation.

3) FIO should engage in supervisory colleges to monitor financial stability and identify issues or gaps in the regulation of large national and internationally active insurers.

4) The National Association of Registered Agents and Brokers Reform Act of 2013 should be adopted and its implementation monitored by FIO.

5) FIO will convene and work with federal agencies, state regulators, and other interested parties to develop personal auto insurance policies for U.S. military personnel enforceable across state lines.

6) FIO will work with state regulators to establish pilot programs for rate regulation that seek to maximize the number of insurers offering personal lines products.

7) FIO will study and report on the manner in which personal information is used for insurance pricing and coverage purposes.

8) FIO will consult with Tribal leaders to identify alternatives to improve the accessibility and affordability of insurance on sovereign Native American and Tribal lands.

9) FIO will continue to monitor state progress on implementation of Subtitle B of Title V of the Dodd-Frank Act, which requires states to simplify the collection of surplus lines taxes, and determine whether federal action may be warranted in the near term.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, which created the FIO, had specified that the study must be submitted to Congress not later than 18 months after the date of the Dodd-Frank Act’s enactment. The Dodd-Frank Act was enacted on July 21, 2010, which made the FIO report officially due on Jan. 21, 2012.

Section 313(p) of Title 31 of the United States Code, as codified by the Dodd-Frank Wall Street Reform and Consumer Protection Act, required the FIO to conduct a study on how to modernize and improve the system of insurance regulation in the United States.

The FIO monitors all aspects of the insurance industry, including identifying issues contributing to systemic risk. The office also monitors the availability and affordability of insurance to traditionally underserved populations; advises the Treasury Secretary on major domestic insurance policy issues; and develops and coordinates federal policy on international insurance regulatory matters.

While preparing the report, FIO engaged in an extensive consultation process, including with consumer advocates, market participants, and state officials and regulators.

In October 2011, the Treasury Department solicited public comment regarding the modernization of the insurance regulatory system in advance of writing the report Following that, FIO hosted a conference on regulatory modernization with participants representing consumers, insurers and reinsurers, agents and brokers, and academics. This report reflects continued engagement with a variety of stakeholders throughout 2012 and 2013.

In completing the study and report, the Dodd-Frank Act requires FIO to consider several factors, including systemic risk regulation with respect to insurance, capital standards, consolidated supervision, consumer protection and affordability, the degree of uniformity of state insurance regulation, and international coordination.

Among other things, the Dodd-Frank Act also expressly requires a consideration of the costs and benefits of federal regulation across various lines of insurance and issues relating to regulatory arbitrage and competitiveness. The report examines all elements of the insurance industry, with the exception of health insurance.

The report is organized into five sections. The first section, an introduction, discusses the background to the report and the recommendations. The second section describes the history of insurance regulation in the United States, highlighting significant events in its development and the debate over the need for uniformity in regulation across state jurisdictions. The third and fourth sections include discussions of the specific recommendations regarding solvency regulation and market conduct regulation, respectively. Section five assesses the report’s recommendations and the Dodd-Frank Act from the point of view of criteria set forth in the statute for measuring the effectiveness of a regulatory system for insurance. Section six summarizes the report’s conclusion.

The full report can be read below: