I have observed and participated in the NAIC and written frequently about its role in insurance public policy for nearly 50 years. To say that the NAIC is vital to the system and success of state insurance regulation is an understatement, and today more than ever it must be tightly woven into the fabric of state regulation and not be a self-controlled, subordinated appendage as it is now.
From time to time over the years, the behavior and conduct of the NAIC as an organization has been called into question by its members, state legislators, insurers and others. Most recently, one of its members has called into question its governance practices. To fix such recurring issues and distractions, I believe the organizing principles for the NAIC must be set forth in state law. Most importantly, such a change will allow state regulation to survive and overcome the powerful forces at work nationally and internationally seeking to move regulation of the insurance industry to Washington, D.C.
Over the last 25 years or so, the resources, activities and functions of the NAIC have substantially changed. Its staff has grown from about 25 to well over 400. The scope of its activities has gone from national to international. It views itself as a standard-setting organization and not just a developer of model regulations. Many of its pronouncements have the force of law in most — if not all — states. Through the accreditation program, it has obtained substantial leverage to enforce its desires on the states. It exerts substantial influence over the resolution of insurers encountering financial or marketplace problems.
All of this has occurred without state legislative direction or input. Without a doubt these substantial changes would not have occurred without the financial resources the organization derives through provisions of state law. Today, the NAIC has a surplus of about $100 million as compared with the 1960s and 1970s when the NAIC broke even on an annual basis. In our American system, an organization with such importance and influence over private activities demands control and oversight set by law.
I propose that the NAIC become an interstate instrumentality of state government through an interstate compact or state law. This will give the NAIC a firm and statutorily-based foundation, and will enumerate its duties, authority and behavior. The ultimate goal would be to strengthen the NAIC’s position in the system of state regulation. Such a designation would identify the NAIC as serving a public purpose, working at the behest of the sovereign states but not designating it as a government agency of any state.
Let me further discuss the reasons why I believe such a statute is necessary at this time. The rationale will begin to describe what the contents of the model law might include. Its provisions would not only strengthen the organization at this critical time, but also resolve the recurring issue as to “the role of the NAIC,” “what the NAIC is” and similar questions that seem to be increasing as the NAIC has grown and changed. Ideally, this model law or compact would be developed with the National Conference of Insurance Legislators (NCOIL) and the support of other organizations of state officials. The following proposal should receive their support since its objective is to preserve the primacy of state regulation and related revenue:
- The designation of the NAIC as an interstate instrumentality of state government would strengthen its stature in various national and international quarters. Standing and acceptance is derived not only from what an organization says but the authority it has to say it. This recognition will be important as the NAIC and state insurance regulation confront the challenges that exist today, as well as those that lie ahead. The legislation I envision will transform the NAIC from simply being an association of state insurance commissioners to an organization that has the authority to represent the states with whatever power and authority the states are willing to grant. The NAIC has requested that the Financial Stability Board (FSB) give state regulators a nonmember seat at the FSB table. Whether this is likely is open to question. However, if the NAIC was an instrumentality of the states, and the state law establishing that status set forth that a qualified and experienced person would serve in that seat, the request would likely have a better chance of being approved. Further, state insurance regulation is not a relic. Relics are in museums or stored elsewhere because they have been superseded by a better product. For well over 150 years, the regulation of the business of insurance has been executed by the states with a high degree of success, demonstrating the best aspects of American Federalism. In fact, the success of state regulation has been unmatched by any federal regulatory agency over other financial services segments of our economy. Without doubt, the success of state regulation results from its inherent diversity assisted by the organizational resources of the NAIC and the collective wisdom and experience of its members.
- From time to time, most recently by Rep. Royce of California, many have properly asked, “What is the NAIC?” The unfortunate response has been that it is a “trade association made up of regulators.” Does this designation accurately and completely describe what the NAIC is and must be in today’s environment? I think not. The NAIC’s role in the system of state regulation and state government through its individual members and the services it provides has far transcended that unfortunate label. Of late, the NAIC has been referring to itself as a “standard setting” organization. That self determined status has raised such unanswered questions as — who asked them to perform such a role, and are they behaving in a way expected of that type of organization?
- For decades prior to the late 1980s, the NAIC was legally known and identified as an instrumentality of state government. The IRS had historically determined the NAIC to be such for the purpose of federal tax exemptions. Based on research I did in the mid 1990s, I determined that in the late 1980s the NAIC changed its bylaws to state that it was a 501(c) (3) organization so that data base sales would not be taxed. Perplexing letters from the IRS agreed that data base sales would not be taxed or would not alter the NAIC’s tax exempt status. These letters referred to the NAIC’s 501(c) (6) designation even though this designation had been withdrawn by the IRS years earlier when it called the NAIC “an instrumentality wholly owned by the states.” A review of the NAIC’s activities and operation shows it clearly does not operate like a business league or trade association. The states should officially acknowledge that the NAIC is an instrumentality of the states, a quasi-governmental entity helping the states to fulfill statutory obligations of insurance regulators.
- Behavior of the NAIC as an organization with respect to due process, governance, accountability, transparency and other elements of corporate discipline called for by its functions should be set by state law and not left to chance and hope. The rules of an institution like the NAIC should not differ from the rules its members are required to observe as state government officials. Periodically, the NAIC has departed from accepted governmental practices expected of an association of government officials. In 1995, I led an effort to have the NAIC become more transparent and accountable. I prepared a lengthy paper urging the organization to change its ways. This resulted in the NAIC having a public budgetary process, providing more information on its finances and funding and establishing an open meeting policy. The law would codify these and other behavior requirements for the NAIC so that these rules are known.
- The NAIC officers at one time were considered as primarily ceremonial roles and not positions possessing power and authority. Power only existed with the members which they exercised when in plenary session. Over time, this limitation seems to have slipped away. State law should set forth how these positions are filled and their duties and responsibilities.
- Only a few states require its insurance commissioner to participate in the NAIC. Given the importance of the NAIC, all insurance commissioners should be required to actively participate in the organization. On rare occasion in the past, commissioners have withdrawn from the organization based on personal disagreements with other members and not based on direction from their state legislature. The proposed law would require the participation of all insurance commissioners in the NAIC.
- State legislatures exercise control and oversight over the state insurance commissioner of their state. This control is exercised through the insurance laws that are enacted and appropriations to operate their office and enforce these laws. Yet, state legislators have not been involved with commissioner activities at the NAIC and the exponential expansion of the NAIC’s operations. Many of these activities, such as commissioner and staff travel, are paid for by the NAIC bypassing state appropriation processes. The law envisioned would bring state legislatures into authorizing the scope of the NAIC’s activities and its processes.
- The role and activities the NAIC undertakes are self defined. Some commentators and observers have stated that the NAIC has gone far beyond its legal authority despite the fact that the NAIC’s authority is not defined other than the NAIC’s bylaws or as the organization determines. Periodically, some NAIC activity has caused friction between the legislative bodies of some states and others. One example is the financial standards and accreditation program. I created this program to encourage states to adopt common sense and generally accepted tools and approaches to financial regulation. The program has gone well beyond that objective. Nowadays requirements are added before they are proven as effective by use. In the early 2000s, the NAIC proposed the establishment of a national commission to mandate insurance regulation standards which would preempt existing state statutes. The latter suggestion was never enacted into law, but did raise the question as to why the NAIC, founded on the principle of maintaining state regulation, would seek to undo it.
- State legislative bodies do not oversee the scope of the activities and operations being conducted by the NAIC, yet the NAIC relies on state law to create revenue. One of the largest sources of NAIC revenue is a fee paid by insurers to file annual statements with the NAIC. Filing of these statements with the NAIC is required by state law, yet it is only the NAIC that determines how these funds are spent. The model law envisioned would require an annual report to the legislature of each state, as well as a budget for each year so some level of control and oversight could be exercised.
- Certain of the NAIC’s revenue sources are not as secure as they should be. This could be fixed by the model law. For example, fees charged for filing annual statement data are voluntarily paid by many insurers since several state laws, while mandating filing by the NAIC, do not require payment of the fee. State assessments, while a small revenue item, are similarly contingent on a state’s willingness to pay.
- It should never be open to question that the NAIC and its staff, infrastructure and funds belong to the member states. As mentioned previously, this was clearly the position of the IRS when it found the NAIC to be an instrumentality of the states and wholly owned by the states. Because of the frequent changes in NAIC membership many of whom do not have insurance industry or regulatory experience, let alone an understanding of the NAIC, and coupled with the resources now available to the NAIC, it is even more critical that the organizing principles underlying the NAIC be set forth in statute.
- As stated earlier, actions of the NAIC have the force of law. For example, state law requires insurers to report their financial affairs on a form prescribed by the NAIC and to follow the accounting rules adopted by the NAIC. The practical impact of such requirements is that it allows the NAIC to effectively legislate through changes in these pronouncements. While such an arrangement is good from the standpoint of creating uniformity, it bypasses the state’s legislative process. Therefore, it is incumbent on the NAIC to employ proper due process and transparency when considering changes. Financial reporting is but one illustration, and there are many other areas of regulation that raise similar concerns. Because of the growing number and breadth of such pronouncements, it can no longer be left to chance that the NAIC will always allow due process and provide transparency when it proposes enhancements or new requirements.
The preceding list could be continued but is ample justification for the dramatic action recommended here. The NAIC needs to be strengthened to face the present realities. One needs to look no further than the recent report of the Federal Insurance Office to see the threat to state regulation that exists. It is clear the U.S. Treasury Department and some non-U.S. government agencies and organizations feel the best way to improve and modernize regulation is to move the financial regulation of significant insurers to Washington, DC.