Federal regulation of life insurance and annuities is one step closer with the release of a report recommending that Washington seize some of the states’ authority.

The Dodd-Frank Act mandated that the Federal Insurance Office (FIO) deliver a study to Congress on the state insurance regulatory regime and recommend to legislators whether federal intrusion into insurance regulation is warranted.

A Report to the Federal Insurance Office, released earlier this month, offers detailed recommendations on all six of the mandatory areas that the FIO’s report must cover and considers another seven optional items. Indiana State University’s Networks Financial Institute (NFI) released the paper well in advance of the FIO report’s January 31, 2012 due date, giving the FIO to subsume the paper’s recommendations.

Essentially, the FIO is being asked to define its own bailiwick, and the report recommends that the FIO “focus squarely on the insurance industry and not become unnecessarily burdened” with the financial services industry as a whole.

Justifying its recommendation that the feds focus only on particular insurance lines, including life, the paper asserts that “[t]he efficiency gains from a federal regulator, or preemption of market conduct rules, are greater, according to some large insurers, than the gains from providing such arrangements for small property and casualty insurers.” The report also concludes that federal regulation may be more efficient than state regulation in other insurance sectors, including monoline bond and annuities carriers.

Despite its advocacy of federal involvement in insurance, the NFI does not recommend unrestrained federal regulation. Instead, it endorses a federal strategy that would support the insurance industry rather than weighing it down. To that end, it suggests that the FIO “take the lead in developing solvency standards and liquidity requirements” for the industry. 

The NFI report does not recommend that the states and the National Association of Insurance Commissioners (NAIC) be removed from the regulatory equation in favor of the federal government. It does, however, recommend that the FIO director take on the role of expert voice on insurance at the federal level.

That has been the NAIC’s role to this point, but according to the report, ” it lacks the support of federal authorities as well as the unanimous support and following of its state members, so it is limited in its ability to negotiate on behalf of the federal or the state governments.”

Although the FIO probably won’t adopt the NFI’s recommendations wholesale, we’re likely to see at least a handful of its proposals make their way into the official FIO report. The next couple years will undoubtedly be a formative time for the life insurance industry.

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See also The Law Professor’s blog at AdvisorFYI.