ance business. "[S]olvency requires (a) that premiums are sufficient to meet expected claims and expenses and (b) that assets are adequate to meet known liabilities, with an appropriate safety margin. Temporarily, large assets may balance out inadequate premiums, but long run solvency requires both adequate premiums and a contingency reserve or surplus to meet unexpected fluctuations." Protection of the insurance consuming public against insolvency is a primary concern and responsibility of the state insurance regulator. The means used to meet these objectives have been developed through years of experience and are continuing to evolve and become more sophisticated. Primary among the insurance regulators tools to assure solvency are capital and surplus, premium to surplus requirements, investment restrictions, filing requirements for a broad scope of financial data, periodic examinations, conservative statutory accounting methods, asset valuation, reserve requirements, early warning tests, and rate regulation. A brief summary of some of these requirements and regulatory technique is instructive. (a) Capital and Surplus The purpose of requiring substantial initial capital and surplus is to provide an initial basis for financial viability so as to protect policyholders. If capital is impaired, the insurer is not allowed to continue operating. Paid-in surplus provides a working fund to pay expenses during the initial phase of activity of an insurer and to provide a cushion for unforeseen losses and expenses. (b) NAIC Annual Statements One of the most useful tools for monitoring company solvency is through the data provided on the uniform NAIC blank required by law and prescribed for all major segments of the industry. From this data submitted to the state authorities, the NAIC has implemented an early warning system to help state personnel promptly identify companies requiring close surveillance and determine the form such surveillance should take. In addition to the annual statement, many states require quarterly or semi-annual statements from companies believed to be experiencing financial difficulties. (0) Valuation Procedures Influenced by experience during the depression years and recently reinforced by the 1974 stock market decline, the NAIC has maintained procedures to "stabilize" the insurer's financial statement. Stocks and bonds held by insurers are valued in each company's annual statement according to rules established by the Valuation of Securities Subcommittee of the NAIC. High quality bonds are carried at amortized values rather than market reflecting the long term nature of insurance obligations. Lower quality bonds and equities are carried at market values. However, the NAIC has, in periods of economic emergency such as the depression, used its valuation procedures to assure the continued solvency of insurers by authorizing the use of valuations at certain specified dates other than current market value. Without such stabilization procedures, excessive drain on company surpluses could have resulted from the temporarily depressed current market values. As long as insurance obligations can be met, wide transistory stock and bond market fluctuations should not per set force liquidation of securities at inopportune times. It might be noted in this context, that at the time during the great depression when banks were folding right and left and President Roosevelt was compelled to close the banks, the insurance industry was able to continue to function because of appropriate adjustments in the valuation rules by the NAIC. (d) Monitoring Competition Despite the general rule that insurers may use amortized values for high quality bonds, it is possible that in times of distress some insurers may be forced to liquidate such securities, resulting in heavy losses. For this reason, the NAIC has recently moved to enhance the regulatory monitoring of liquidity by adding to the financial reporting requirements a schedule of bond maturities and a cash flow statement. It is expected that these added disclosure requirements wil materially assist the regulator in assuring that insurance companies maintain a proper, balanced mix of short, intermediate, and long term bonds, thereby enabling the insurance industry to better withstand the pressures of various economic climates. Allen Meyerson, Ensuring the Solvency of Property and Liability Insurance Companies; Insurance, Government and Social Policy (1969) at 147. (e) Early Warning System The NAIC early warning system has been in operation for six years and has proved effective in flagging companies in financial difficulty. This system involves running a series of computerized financial tests on each company. Further efforts to improve the early warning system and promote its widespread, effective use are continuing. Regulatory scrutiny and the need for early examinations are suggested by the early warning system for particular insurers. (f) Examinations Every insurance company is subject to periodic examinations by the state insurance regulator. The ultimate purpose of surveillance is to protect against insolvencies and ensure fair treatment of policyholders and claimants. Examinations, either separately or in combination with other states, review both financial condition and market conduct. In 1976, the NAIC adopted a new modernized comprehensive handbook for examiners. This regulatory tool is subject to continuing review and improvement by a subcommittee of the NAIC. Major attention is now being focused upon improved training, upgrading and retaining competent examination personnel. The NAIC has adopted the concept of providing educational training for examiners and is currently working on the development, organization, and content of the program. Through these activities, the examination system has been undergoing a continuing review and strengthening process. (g) Reserves Reserve requirements are established by statutory state valuation standards for life insurers and by formula or percentage requirements for property-casualty companies by way of schedules in the annual statement blank. The NAIC con-stantly reviews these standards and schedules and updates them periodically to keep pace with current conditions. (h) Investment requirements The states, of course, control insurance company investments by statutory standards aimed at better assuring diversity, safety and liquidity and the ability of insurers to pay claims when due. In contrast to specific statutory or regulatory detail involved in state regulation for these solvency tools, S. 1710 presents a bare bone skeleton of alternative federal insurance regulatory authority that may be adequate, overbearing, weak, and/or unworkable. Unfortunately, we are left to guess at the details. Capital and surplus as well as reserve requirements are left to the Federal Commission to prescribe by regulation (secs. 202, 203 and 107). Examination and reporting requirements are similarly left to the commission to fill in. Rate regulation would be eliminated except for the judicial intervention of the antitrust division or the FTC. In short, S. 1710 suggests that the bulk of existing solvency controls be transferred to the discretion of a super powerful central regulatory bureaucracy that doesn't even currently exist. In other words, S. 1710 is being sold as an alternative to state regulation, which is alleged to be inadequate, but the alternative apparently remains some kind of secret locked within the imagination of a nonexistent federal bureaucracy. We scarcely view S. 1710 as a responsible alternative to existing solvency controls in the states. In this light, S. 1710 can't even be intelligently discussed on the merits. But we can say, as demonstrated by this brief summary of state financial requirements and techniques, that state insurance regulation comprehensively and effectively addresses the problem of insurance industry solidity leaving no regulatory vacuum for federal redress. 4. Guaranty fund protection Although insurance companies and the insurance regulators can minimize the risk of insolvency, the risk can never be entirely eliminated in the absence of regulatory burdens so onerous that the insurance mechanism could neither efficiently nor effectively function. It is very doubtful that a regulatory system which guarantees the continued solvency of every insurance company would contribute much other than higher tax or policy costs to the insurance consuming public. However, once an insurer reaches a point of severe financial difficulty due to adverse risk experience, bad management or other causes, it is essential that the insurance regulator have adequate authority to minimize the adverse consequences to the insurance consuming public. Consequently, in addition to regulating for solvency, the states are highly active in minimizing the adverse impact of insolvencies when they do occur. Recent years have witnessed great strides in this area of enhancing public protection through the development of guaranty fund legislation. A major premise of Senator Brooke's proposal, S. 1710, is apparently the perceived weakness of state insolvency proceedings and guaranty funds. It is our intention to correct this perception and highlight the firm resolve of the states to collectively address remaining interstate insolvency problems. Upon introduction of S.1710, Senator Brooke noted that "obligations of insurance companies are protected by a system of state insurance guaranty funds," but he concluded that "most observers question their ability"" to deliver the needed protections in the event of a major insolvency. We strongly disagree with this conclusion. Since the late 1960's, the vast majority of states have moved to implement guaranty funds that, in effect, provide an insurance back up system for the benefit of consumers. Today, all but two states have guaranty fund laws for the property-casualty insurance business. At least 22 states have guaranty funds for the far less troublesome life and health insurance lines. Several factors such as the long term nature of life contracts, predictable mortality risks, reinsurance and statutory reserves-minimize solvency problems in the life insurance business. Nevertheless, the NAIC has pushed for life and health guaranty fund laws for several years and adopted a model bill for this purposes in 1970. As noted earlier, the financial condition of the industry is adequate to bear the weight of insolvencies of the type that have occurred in recent years. During the period 1971-1976, property-casualty insurers had net operating income of more than $12 billion, while insolvency assessments through the guaranty funds for insurers becoming insolvent over a somewhat longer period (November 1969-December 1976) were approximately $121 million, or roughly one percent of net income. Related to premiums, the industry had aggregate earned premiums of $255.6 billion during the period and the insolvency assessments represent .05 of 1% of premiums. The fact that the state guaranty funds are financially viable is evident. Nevertheless, we recognize that the state system has not yet reached perfection. As part of current state efforts, the NAIC is moving toward a modernized model rehabilitation and liquidation law. It is expected that this model law will be finalized by December 1977. The model utilizes a three tiered approach to insurer financial problems. The first tier is supervision, which contemplates limited insurance department actions and the appointment of a supervisor when the state insurance department believes that an insurer's difficulties are readily correctable. Due process is assured to the insurer, and the state has access to the courts for necessary enforcement procedures. The second tier provides rehabilitation procedures in several situations including financial impairment of the insurer. Judicial action is necessary for rehabilitation. Finally, the model law provides for liquidation with judicial action again necessary. The model provides a definition of insolvency and provides the grounds under which the commissioner may petition for liquidation or rehabilitation. Adjudication of the financial condition of course guarantees due process to the insurer. The drafting task force of the NAIC has paid particular attention to assuring smooth interaction between the rehabilitator or liquidator and the various state guaranty funds. The already existing property-casualty guaranty fund system is patterned after model legislation adopted by the NAIC in 1969. Under this legislation, the states require assessments against all admitted insurers writing the types of coverage written by the insolvent insurer based on a uniform percentage of net premium writings. Typically, the fund is administered through a statutorily created guaranty fund association of insurance companies under the direct supervision of the state insurance department. These funds guarantee the repayment of unearned premiums and payment of claims subject to deductibles and recovery limits. The NAIC model post assessment guaranty fund law provides a guaranty fund deductible of $100 and a $300,000 maximum recovery. These limitations provide substantial financial protection yet minimize the costs of providing the guarantees which, of course, are paid for by policyholders in any event. 123 Congressional Record S10038. 10 Arizona. Connecticut, Idaho, Kansas, Maryland, Minnesota, Montana, Nebraska, Nevada, New Hampshire, New Mexico, New York. North Carolina, Oregon, Puerto Rico. South Carolina, Texas, Vermont, Virginia, Washington, West Virginia and Wisconsin. 99-073 078 - 11 Significant revisions to these guaranty fund laws have been made by a number of states in order to assure "early access" and "priority." In order to cut down on the assessments needed by the guaranty funds, at least 18 states now have "early access" provisions allowing the guaranty fund immediate access to any assets still held by the insolvent insurer for the purpose of paying claims assumed by the guaranty fund. In other words, upon an insolvency, assets of the defunct insurer can be used immediately to pay claims. When an insolvency occurs, only the deficit need be assessed to carriers participating in the guaranty fund. This substantially reduces the assessments and burden of the guaranty fund system. Without this provision, assets of the insolvent insurer are held in abeyance pending liquidation. "Early access" is provided by the new draft model liquidation law and is also expected to be acknowledged in an amendment to the model NAIC guaranty fund law. A number of knowledgeable experts have suggested that early access will improve the guaranty fund to the point where even jumbo or numerous smaller company insolvencies can be handled by the existing system without serious strain. Another significant revision is the assurance of priority for guaranty fund claims in the insolvency or liquidation proceedings. The guaranty funds in this sense represent the consumer-claimants and policyholders-who should be entitled to priority over other general creditors. At least 16 states have already added such priority provisions to their guaranty funds laws, and this change is soon expected to be incorporated into the NAIC model bill. Beyond these current changes to the existing guaranty fund system, the NAIC also has under review other suggestions which may or may not improve the method of guaranty fund operations such as a shift to a preassessment basis in which insurers would be required to set aside a specially earmarked guaranty fund reserve account, improved mechanisms for rescue of troubled companies in appropriate situations, etc. It is clear that the states are continuing to improve and are prepared, where determined appropriate, to revise the procedures and mechanisms used to provide public protections in the event of insolvencies. State guaranty funds have already added an important dimension to the protection of financial security through insurance. Guaranty funds are in place and they work. Alternative measures and improvements are now being considered or implemented and this record of progress will continue. Historically as the insurance business has evolved, the states have responded with progressive regulatory development. This entire area of insolvency protections is no exception. Coming on the heels of responsible state action in the 1970's in establishing the guaranty system, we view S. 1710 as an unnecessarily duplicative suggestion that would not operate in the public's best interest. State reforms are soundly based on real world experience gained from our day to day routine of regulating the insurance business. We respectfully suggest that the federal government's interest in regulating the insurance business be set aside until such time as it is demonstrated that the states have not and cannot provide responsible regulation and public protections. Most agree that 1974-1975 was one of the most difficult financial periods in recent history for insurers. The state insolvency system has proved its viability during this period despite speculative claims that it is now and has been unable to function adequately. We make no apologies and feel no embarassment in standing before you on our existing record of regulation for solvency and providing insolvency protections. B. NO NEED IS DEMONSTRATED BY THE IMPROPER ANALOGY TO THE BANK Although federally chartered corporations are not unknown in the U.S.-e.g. banks the addition of a new major industry to such federal regulatory control should be skeptically scrutinized. In his introductory remarks to S. 1710, Senator Brooke stated that the bill "Would seek to improve the quality of insurance company regulation by providing for an alternative system of federal regulation similar to the federal regulatory alternative presently available to banks and savings and loan associations." " Although our response to the quality of regulation point will be detailed later, I would like to comment now on the analogy drawn with the banking system. We 11 123 Congressional Record S10039. emphatically disagree with the analogy insurance to banking and with the suggestion that dual regulation of banks in any way justifies or even parallels dual regulation of insurance. The existence of continuing federal charter authority for banks did not come into being until 1863 after a "dismal record of state-chartered banks" in the early 1800's, poor and discontinued experience with the first two banks of the United States (1791-1811 and 1816-1836), and the pressures caused by the Civil War. The Civil War evidenced how unsuited the preexisting system was for financing of a major war effort. The operation of the banking system is closely entwined with the the national power to create currency and regulate its value. Without such demonstrated and compelling need for federal chartering and regulatory control, it is difficult to comprehend persuasive or reasonable motives for moving toward federal regulation of another major industry. It would certainly be a significant blow to the self-renewing vitality of federalism. There is mention from time to time in some political cricles of establishing a national chartering system for all industries-presumably to further centralize national economic control. Absent a showing of need, it is this anti-federalism motive which seems to stand out as a residual matter in S. 1710. 1. Perspective on banking analogy It is a superficially attractive notion that regulation by the federal government would be more effective, less expensive, less burdensome, or more uniform. On the basis of experience, each of these propositions is of doubtful validity and they are positively not self evident. As to effectiveness of solvency controls, there is no sound basis for proper analogy or comparative analysis with the banking system. Any statistical comparison of solvency data between insurers and banks or savings and loan institutions is empirically unsound. Historically, both the federal and state chartering authorities for banking institutions have contemplated the conferral of some degree of economic protection from competition-primarily to protect the security of deposits. "New entry into commercial banking is restricted in order to minimize the likelihood of failures." 13 This philosophy plays little part in insurance regulation. Capital and surplus requirements for insurers and other financial controls are intended primarily to assure financial responsibility, not preclude entrance into the marketplace. Competition is largely absent from the "deposit" end of banking with which FDIC is concerned, while competition in the insurance business is expected to be vigorous. The regulatory problems associated with financial examination and solvency determinations are more complex in the insurance business than in other financial institutions. For example, specific liabilities of property/casualty insurers for claims are routinely determined through negotiation or court verdicts, not on the basis of fixed dollar deposits, controlled interest rates, and known loan values. Moreover, the federal record has not been demonstrably better than that of state insurance regulation in assuring the solvency of their financial institutions-e.g. banks, pensions-where the dual regulatory or predominantly federal systems flourish. 2. FDIC parallel We have no intent to impugn the FDIC or any related regulatory operations of the federal banking system. We believe that the record of state insurance regulation for solvency is very good, although not perfect. Similarly, the record of FDIC lacks perfection but evidences a sound contribution to stability in the banking business and maintaining public confidence. Senator Brooke, in proposing S. 1710, states that "the possibility of a major [insurance] company failure prompted me to consider what steps might be taken to insure protection for policyholders and to improve the quality of regulation for solvency." While we entirely disagree with the inference that an insurance company (or bank) failure necessarily means poor regulation, we do note that the 29 bank failures in the last two years exceed the 27 failures insurance experienced in the preceding five years. Furthermore, "the three largest failures in history occurred between 1971 and 1975." 16 15 Brown. "The Dual Banking System in the United States," pp. 8–13. 13 Brown at 5. 123 Congressional Record S10038. U.S. Comptroller General Highlights of a Study of Federal Supervision of State and National Banks, January 31, 1977 at 7. 10 10. at 5. |