Can interstate compacts solve the insurance regulation debate?
Interstate compacts, compacts formed to address problems that transcend state boundaries, could enhance state insurance regulation. Interstate compacts, unlike regulation by the federal government, can be adapted to the suit the particular needs of individual states. Although interstate compacts would improve state regulation, they would not eliminate federal monitoring of insurance regulation. Interstate compacts could also help to standardize and organize laws.

Insurance industry (Laws, regulations and rules)
Interstate agreements (Analysis)
Myers, Robert H. Jr.
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Name: Risk Management Publisher: Risk Management Society Publishing, Inc. Audience: Trade Format: Magazine/Journal Subject: Business; Human resources and labor relations; Insurance Copyright: COPYRIGHT 1993 Risk Management Society Publishing, Inc. ISSN: 0035-5593
Date: August, 1993 Source Volume: v40 Source Issue: n8
Product Code: 9108664 Insurance Regulation; 9218664 Insurance Regulation ex Auto-State NAICS Code: 92615 Regulation, Licensing, and Inspection of Miscellaneous Commercial Sectors
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The debate over insurance regulation reform is, predictably, following this model. The proponents of federal insurance regulation are asserting that only the federal government can provide adequate solvency regulation. The advocates of state regulation are countering by contending that state solvency regulation is not only adequate, but is also being enhanced through the efforts of the National Association of Insurance Commissioners' (NAIC) accreditation program.

There are several unstated, but relatively apparent, considerations that make this debate so interesting. The first is that the debate, although characterized as one regarding solvency, is really about who should regulate. Both Chairman of the House Energy and Commerce Committee John Dingell (through his proposal - H.R. 1290) and the NAIC (through its accreditation program) address issues that go far beyond the scope of solvency regulation.

A second consideration is that the federal effort has become the vehicle for various segments of the insurance industry to propose a federal solution to specific problems that they are presently facing under the state regulatory regime. For example, "highly capitalized insurers" would benefit from a "carve-out" from state regulation, "market withdrawal" would be permitted even over the objection of state regulators, "professional reinsurers" would benefit from the preemption of all state regulation, and so forth.

Despite the often conflicting and inconsistent aims and desires of the parties concerned, there is one conclusion that can be agreed upon by everyone: "dual" federal and state regulation would be onerous and destructive to the insurance industry. This is probably the only matter upon which the proponents and opponents of federal regulation can agree.

The regulation of insurance, unlike the regulation of banking and securities, has remained for the most part where it began - at the state level. While the debate is ostensibly over the merits of state versus federal regulation, the underlying issue that makes the problem so thorny is how could the transition from state to federal regulation occur without unbearable costs being loisted upon the industry and consumers by dual regulation, litigation, fraud and uncertainty.

Therefore, as the debate rages on and "gridlock" continues, it would be useful to consider a third alternative to either state or federal insurance regulation. That alternative is the enhancement of state regulation by way of interstate agreements known as "compacts"- binding contracts between two or more states. This effort, which could occur over the course of the next several years, perhaps would put an end to the federal versus state debate because if the compacts do enhance state regulation sufficiently, federal intervention will not be necessary. C@n the other hand, if they fail, federal intervention may be required.

What Is a Compact? Generally, compacts are created to address problems that transcend state boundaries. Examples would include land and water resources, corrections, juvenile delinquency, taxation, vehicle safety, nuclear energy, parks and recreation, regional planning and development, disaster assistance, mass transit, flood control and economic growth research. In the past 50 years, the number and coverage of interstate compacts has grown dramatically: today, almost every state participates in interstate compacts.

Although insurance regulation is not yet the subject of an interstate compact, a number of compacts address issues that are similarly complicated and that require comprehensive national attention. Many compacts establish for administrative purposes a commission or authority that may be empowered to promulgate rules and regulations. And many compacts have established formal procedures for rule-making and decision-making, similar in numerous instances to those procedures that would be adopted by a state government. A compact can also establish the jurisdiction of courts for purposes of enforcing or contesting the terms of the compact.

The Washington Metropolitan Transit Regulation Compact is a good example of a compact that establishes an agency with substantial administrative and procedural authority. The Washington Metropolitan Area Transit Authority created by this compact is charged with the responsibility of planning, developing, financing and operating improved transit facilities and coordinating the operation of publicly and privately owned transit facilities in Maryland, Virginia and the District of Columbia. This is a complicated task that requires fact finding, the utilization of experts, the application of expertise to complicated issues, the balancing of competing interests, determining and upholding the public interest, and the exercise of good judgment on the basis of experience and expertise. These are the same kinds of qualities that would be necessary for the purpose of developing and operating an insurance regulation compact.

Despite their numbers, compacts often are not readily identifiable as such. For example, the Port Authority of New York and New Jersey, which recently was the focus of public attention due to the bombing of the World Trade Center in New York, affects the lives of millions who do not realize that it is the result of an interstate compact. The Port Authority was established in 1921 to develop and construct comprehensive transportation, terminal and other facilities, and to promote commerce and trade. It also regulates and promotes transportation into and out of New York. Even though the Port Authority is an agency established by a compact between only two states, it acts with remarkable independence. The Port Authority is governed by 12 commissioners (six appointed by each state) and has over 8,200 employees, with its subsidiary, the Port Authority Trans Hudson (which operates the interstate PATH train system), employing an additional 1,100 workers.

In some ways, the NAIC presently acts as if it were an interstate compact. It operates the Securities Valuation Office in New York and the Insurance Regulatory Information Service (IRIS); it establishes IRIS ratios and adopts and amends the instructions for the preparation of insurer financial statements that will be operative in all 50 states. However, the NAIC is a voluntary organization without enforcement authority, a fact that is repeatedly alluded to by Chairman Dingell and the proponents of federal regulation. No matter how efficient the NAIC should become, the proponents of federal intervention will always be able to employ this criticism.

Immediate Attention

However, the adoption of an interstate compact or compacts to address various issues could strengthen insurance regulation and thus dilute this criticism and further ward off the prospects of federal regulation. Certain aspects of state regulation are immediately suitable for interstate compacts. Among them are agent licensing, accreditation, advisory committees, rulemaking, liquidation and rehabilitation, solvency and regulation of alien companies.

Insurance agents and brokers have often complained about the expense of becoming licensed in more than one state. H.R. 1290 offers to these disenchanted agents the establishment of a national regulatory body - the National Association of Registered Agents and Brokers to facilitate their ability to operate in all 50 states. Interstate compacts for the purpose of regulating the activities of agents and brokers and facilitating their licensing would address this problem. Such a compact could impose uniformity among state laws and their enforcement and minimize the administrative burden of applying for licenses in a large number of states. While the NAIC accreditation program has made great progress, it continues to be criticized by Chairman Dingell and others as being inadequate because the NAIC has no institutional ability to enforce it. At present, the NAIC accreditation program contemplates enforcement by accredited states not being required to accept the solvency examinations of companies domiciled in non-accredited states. An interstate compact among the states for the purpose of supporting accreditation would put legal teeth into the program and enable it to achieve its intended purpose.

At its spring 1993 meeting in Nashville, Tennessee, the NAIC decided to eliminate formal industry advisory committees, although industry expertise will still be utilized via less formal and more sporadic communications. The NAIC is restricted in its ability to utilize advisory committees because it is a voluntary organization. The NAIC would not be so constrained, however, if, by way of an interstate compact, it were to establish the authority for utilizing advisory committees and the rules under which they would operate.

It is ironic that the proponents of federal regulation should criticize the NAIC's utilization of advisory committees because, in fact, advisory committees are commonly used by federal regulators. According to the General Services Administration, there were 1,141 federal advisory committees in 1992. These committees were active in the areas of agriculture, commerce, energy, health, science, labor, interior affairs and transportation.


Advisory committees have traditionally been an integral part of the NAIC rule-making process, which, of course, produces the model acts and regulations that are then adopted by the various states. The NAIC terminated formal industry advisory committees at least partially in response to criticism that advisory committees are not sensitive to consumer interests and operate for the benefit of the insurance industry without appropriate regulatory controls.

Interstate compacts could respond to this criticism by adopting the type of regulatory structure imposed by the Federal Advisory Committee Act. The act establishes procedures for advisory committees relating to notice of matters to be considered, the nature of meetings, reporting requirements, open meeting requirements and the designation of a governmental official to attend each advisory committee meeting. In other words, the act establishes the rules under which an advisory committee can operate, and establishes a body of law that can be relied upon to require that the committees are operating subject to public scrutiny and with due process.

The same considerations can be applied to the operation of the committees and task forces of the NAIC. An interstate compact would permit the establishment of an administrative agency that would have the authority to adopt rules of practice and procedure, similar to those that are contained in the various state administrative procedure acts, to govern the rule-making process.

The NAIC rule-making process has been the subject of some dissatisfaction precisely because it is not subject to the kinds of notice, rules of evidence, and decision-making criteria that are generally addressed by state administrative procedure laws. Moreover, to the extent that an interested party may wish to contest a decision, there is no mechanism for appeal, other than appealing to the NAIC plenary session or lobbying against an NAIC model act or regulation when it is introduced in the various states.

An interstate compact on procedural matters could address these concerns and also provide recourse to courts of law. Numerous existing interstate compacts provide this kind of regulatory structure. This would benefit not only regulators, who would be protected from criticism by reliance upon the rules, but also insurers and consumer advocates, who would now be regulated by rules known to all and permitted to contest those decisions that they consider inadequate.

Aliens and Insalvencies

The current system of liquidation and rehabilitation has been the source of substantial criticism by the proponents of federal regulation. Even though state laws are generally based upon model laws and regulations, the interpretations of different state courts and different state regulatory environments have resulted in a system that is criticized as being unpredictable, occasionally unfair, and unnecessarily expensive due to high administrative costs. An interstate compact among some or all states could help to impose uniformity of law and its application.

At the recent NAIC Summer National Meeting held in Chicago, the insurance commissioners of the Midwestern Zone voted to develop a compact for the purpose of guaranty fund administration. This marks the first time that a powerful segment of the NAIC has embraced the concept that an interstate compact can be utilized for the purpose of enhancing the states' regulatory capabilities. The initial draft of the proposed compact should be available in the fall.

Regarding insurer solvency, the NAIC already provides oversight of this through the NAIC data base and IRIS. An interstate compact among the states for solvency enhancement could result in increased uniformity among the states in the application of solvency oversight.

But the source of much of the most dramatic criticism of state regulation concerns the regulation of alien insurance companies. Even the NAIC has indicated its willingness to have the Congress delegate authority to the NAIC to act as a "gatekeeper" regarding alien companies.

How would an interstate compact work here? It should be noted that an interstate compact need not necessarily be limited to the states of the United States, but can also include foreign states. The "compact clause" of the U.S. Constitution specifically makes reference to a compact between a state and a "foreign power." In this case, an interstate compact could allow the states to develop the funding and the administrative facilities necessary to regulate alien companies operating in the United States. It could also create the intelligence-gathering ability that is necessary for this purpose. Moreover, it could create regulatory and enforcement authority, the lack of which is so frequently criticized by Chairman Dingell and others.

Why Not Try a Compact?

The state versus federal debate continues to generate a great deal of heat but only a small amount of light. But in trying to answer the question of insurance regulation, the solution should not be perceived as a choice between state and federal regulation, but rather as an inquiry into how, within the parameters of the system of federalism created by the U.S. Constitution, the insurance industry can best be regulated. There are several hundred compacts that are presently enhancing the ability of the states to perform their governmental functions. That should serve as some guidance to a more imaginative approach to break the impasse in the state versus federal debate.

Utilization of the interstate compact for purposes of enhancing state insurance regulation offers a variety of benefits. First, it would provide a vehicle to enhance state regulation without the destructive effect of "dual regulation"- preempting state regulation through federal intervention will diminish the ability of the states to perform their regulatory functions.

Second, interstate compacts can take a variety of forms and address numerous issues. This will allow the states to perform their role as "laboratories of change" by experimenting with different solutions to different problems. A compact need not be adopted by all states to be effective. In fact, a variety of different compacts could be adopted expressly for the purpose of determining which solutions were the best.

This is a principal advantage of compacts over regulation by the federal government. The bail-out of the savings and loan industry, which will cost the taxpayers billions of dollars, is a model of federal regulatory ineptirude that needs to be avoided. Experimenting with a variety of interstate insurance regulatory compacts could arguably avoid the possibility that a single regulatory error could affect the entire nation.

Third, the adoption of interstate compacts would not eliminate the federal oversight of insurance regulation. Congressional probing and examination of insurance regulation has been a great motivator for state regulators. Chairman Dingell and his colleagues have played an important role in stimulating state regulators to higher levels of achievement.

Finally, an interstate compact adopted for the purpose of establishing and formalizing administrative procedure would provide the ability to enhance uniformity and provide a mechanism for the adoption of industry standards, laws and regulations in a more open and organized manner. This would benefit both the regulators and the regulated,

While interstate compacts have been criticized as being potentially cumbersome and time consuming to adopt, there are hundreds of examples of compacts currently in effect that can be reviewed to determine their efficacy. On the other hand, there are predictably a multitude of problems with a transition from state to federal regulation and no model to follow that would minimize the potential expense and danger to both consumers and the insurance industry.

Why not spend a couple of years experimenting with interstate compacts? At the end of the experiment, at least all parties will know where they stand.
Gale Copyright:
Copyright 1993 Gale, Cengage Learning. All rights reserved.