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Mr. KINDER. I think we are talking about two potentialities, one is the potential of any loss, and the other is the loss that would exceed the amount of funds available to the State guarantee fund.

Senator BROOKE. I quite agree. But I am saying the same reasoning could be applied here.

Mr. KINDER. Well, if it is only a difference in degree, I would submit it is a rather significant degree.

Senator BROOKE. An article by Jack H. Blaine, appearing in the spring 1977 edition of Forum, said that State guarantee plans seem to be plagued by constitutional and other legal problems.

Would these serious and continuing legal difficulties compromise the effectiveness of State guarantee funds!

Mr. KINDER. Here again, Senator, we have not had an opportunity to complete our research into that area. There have been certain challenges, and I believe in at least one State the guarantee act that had initially been enacted was found to be unconstitutional.

I don't believe that it does offer a promise of serious and continuing legal difficulties, but it is something that should be reviewed and we will give you a complete review.

Senator BROOKE. You are making that review?
Mr. KINDER. Yes, sir.
Senator BROOKE. Will you submit your findings?
Mr. KINDER. We shall.

Senator BROOKE. Now you state if the Federal antitrust laws were applied, insurers continued ability to pool information would be thrown into doubt, and you cite the Container case.

But if this is true, could the antitrust law not be amended by the Congress to permit such legimate pooling?

Mr. KINDER. I would think it could be, yes.

Senator BROOKE. You state that the prime movers for the adoption of open competition laws are certain insurers who want more freedom to increase prices. Is that right?

Mr. KINDER. I believe that that is correct. I think that is where the strong pressure for open competition lies.

Senator BROOKE. Isn't that unfair to the proponents of open competition?

Mr. KINDER. I would characterize myself as a proponent of open competition, Senator. It seems obvious that if under a prior approval system that is administered stringently, if the rates there are fully adequate, that there would not be a pressure for open competition.

Senator BROOKE. How has open competition worked in California?

Mr. KINDER. I think it has worked rather well. We have had open competition on all property and liability lines since 1947. We have not made a review within the last several years on a comparative basis; but, earlier we had done this kind of review on several occasions, and we found a condition to exist which is roughly that on lines of business that were losing lines of business, countrywide, the margin of loss in California was less than it was in the average of other States. And that on those lines of business that were profitable countrywide, the margin of profit in California was less.

We interpreted this to suggest that the open competition law allowed the insurers to adjust their prices as the evidence emerged to suggest

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that they were pricing it either too high or too low, and it therefore avoided the extremes.

Senator BROOKE. According to the Justice Department, open competition has served consumers in your State of California very well. You seem to agree

with that. Mr. KINDER. Yes, sir; I believe it has.

Senator BROOKE. Mr. Chairman, I know we have another panel. I will defer the rest of the questions and will submit them to the Commissioners for the record.

[The following was received for the record :)

JAMES M. STONE, MASSACHUSETTS COMMISSION OF INSURANCE, RESPONSE TO

QUESTION OF SENATOR BROOKE Mr. Stone, many insurance companies and even some of our witnesses at these hearings complain about the increasing number of different insurance policy forms prescribed in the various States and the burden this places on companies doing business in many States.

Do you think the Federal Insurance Commission might play a role in promoting standardized forms.

Response. There is, as you suggest, a proliferation of policy forms. In general, they are spawned by insurers who continally wish to develop and market new products. Seldom are they the creations of the state governments. The regulators' job, in most cases, is simply to examine and judge those forms presented to them for approval.

The complaints we sometimes hear concern state legal requirements as to language and content of forms for consumer protection purposes. It is a problem for companies to meet the varying content and readability standards of all states simultaneously. These problems can be expected to increase as more states adopt an active posture in this area. Although Massachusetts presently has no comprehensive statute which provides standards for the organization and language of policies, we are hopeful that one will be enacted this session.

I personally believe that a Federal Insurance Commission could be helpful in promulgating minimum standards for the content, organization and language of insurance policies throughout the country. Federal standards would ease the industry's problems with conflicting jurisdictions and, at the same, would lighten the burden on state Indurance Departments which must now duplicate policy review many times over. If the standards were well drafted, consumers would certainly gain. Now standardization of rules from state to state is currently the principal obstacle to the development of clear and readable policy forms.

THE COMMONWEALTH OF MASSACHUSETTS,

DIVISION OF INSURANCE,

Boston, Mass., September 19, 1977. Mr. JEREMIAH BUCKLEY, Minority Staff Director, Committee on Banking, Housing and Urban Affairs,

U.S. Senate, Dirksen Senate Building, Washington, D.C. DEAR MR. BUCKLEY: Following the hearing on September 13, 1977, on Senate 1710, you asked me to elaborate on my evaluation of State Insurance Department examination capabilities in light of S.E.C. Commissioner Williams testimony about their uneven quality. Specifically, you asked me, “As a CPA, do you have confidence in the triennial examination process and the N.A.I.C. Convention statements which are not subject to independent audits?"

As you are aware, all insurers prepare an annual unaudited financial statement for filing with each State. These statements are periodically audited by State Insurance Departments. I am not aware of any State which audits more frequently than every three years, and certain States (including New York) perform them every five years or less frequently.

Prior to assuming my responsibilities for audits as Deputy Commissioner in 1975, I was an audit manager for a larger CPA firm and specialized in insurance companies. In addition, I was responsible for several State audits where the firm was hired by other New England States to be their examining arm.

Based on my experience, the timing of audits is too infrequent. The constantly changing complexity of the insurance industry and the speed with which the financial impacts of new situations are reflected require at least annual financial audits.

It was this urgent need for annual audits that prompted Massachusetts to require all insurers doing business here to have an annual audit by an independent certified public accountant. This Rule was effective for 1976.

The best argument in support of this requirement was the successful rehabilitation of the Loyal Protective Life Insurance Company this summer. Loyal, a domestic Massachusetts Company, did not have independent auditors prior to this Rule. Ernst & Ernst, hired to comply with this Rule, discovered very early in 1977 that Loyal's December 31, 1976, reserves were seriously understated. As a direct result, we were able to prevent the insolvency of this company.

The problem of frequency of State examinations (3-5 years) is compounded by the length of time required to prepare and issue the audit report. Equity Funding's December 31, 1968, audit was not complete until April 30, 1970. Even then, it did not identify the company's problems. The last State audit of All-Star Insurance Co., referred to at the hearing, was for December 31, 1972, and was not complete until September 27, 1974.

A random sample of 25 reports in our files indicate that nearly two years (21 months) elapses between audit date and completion of the report. One insurer in the sample, Drake Insurance Company, required 54 months (12/31/717/15/76).

Finally, since the quality of State Insurance Examiners is uneven, it is not possible to fully rely on an examination report unless the auditors responsible are known to our Division.

I hope this is responsive to your question. I would be pleased to assist you further. Very truly yours,

KEITH R. RODNEY, C.P.A.,

Deputy Commissioner of Insurance. The CHAIRMAN. Senator Schmitt.

Senator SCHMITT. I would be happy to yield my time to the Senator from Massachusetts so he may proceed.

Senator BROOKE. No, I appreciate that from my esteemed colleague, but I will submit any further questions. I think the panel has been very helpful, an excellent panel. I think that you, Mr. Chairman, and Senator Schmitt both, have indicated that it is very helpful that we had this meeting with you to get your views on what is needed. I am very grateful to you.

The CHAIRMAN. Thank you very much, gentlemen, for your fine testimony. We very much appreciate it.

Our next witnesses are T. Lawrence Jones, president, American Insurance Association; Andre Maisonpierre, vice president, Alliance of American Insurers, and Arthur C. Mertz, president, National Association of Independent Insurers.

Gentlemen, we are happy to have you. You have some substantial statements here. We would appreciate it if all of you gentlemen could abbreviate your remarks as much as possible, in 10 minutes, if you can, so we will have time for questions. Your entire statements will be printed in full in the record.

Mr. Jones. Thank you, Mr. Chairman. Could I have Mr. Vinyard sit here with me?

The CHAIRMAN. By all means, Mr. Vinyard, won't you come up. If any of you other gentlemen would like to have someone with you, that is fine.

Mr. MERTZ. Mr. Chairman, in case you get too deep, I might want to call on my colleague sitting in the back.

The CHAIRMAN. All right, any way you want to handle it. Mr. Jones.

STATEMENT OF T. LAWRENCE JONES, PRESIDENT, AMERICAN

INSURANCE ASSOCIATION, ACCOMPANIED BY WALTER D. VINYARD, JR., COUNSEL

Mr. JoNEs. My name is T. Lawrence Jones and I am president of the American Insurance Association, an organization of 145 insurance companies writing property and casualty insurance throughout this country. We are pleased to appear before this committee to present our views on S. 1710, introduced by Senator Brooke.

Title I of the bill creates a Federal insurance guaranty program similar to the Federal deposit insurance system available to banks. Title II provides a Federal chartering alternative which is similar conceptually to the alternative to banks and savings and loan associations.

TITLE - FEDERAL INSURANCE GUARANTY The Federal guaranty provisions of title I are not unfamiliar areas to the American Insurance Association. On November 19, 1969, we testified in favor of S. 2236, introduced in the first session of the 91st Congress by Senator Magnuson. That bill would have created a Federal Insurance Guaranty Corporation for the purpose of protecting the public against insurance company insolvencies. Applicable to all property-casualty insurers engaged in interstate commerce, the bill gained few supporters in the industry aside from American Insurance Association. It was vigorously opposed by most segments of the insurance business and the National Association of Insurance Commissioners. The active consideration of S. 2235 back in 1969, and conceivably AIA's support of the measure, led to the enactment of a model State post-insolvency assessment insurance guaranty law in many States.

Prior to the introduction of S. 2236, three States—Maryland, New Jersey, and New York—had prefunded insolvency laws. The workers' compensation laws of eight States had similar type security funds. In 1970, 19 States enacted the model postinsolvency assessment law, followed by 20 additional States in 1971. Currently, only Alabama and Oklahoma do not have some form of insolvency guaranty law.

All State laws and the District of Columbia law are now of the postinsolvency assessment variety with the exception of the New York law, which remains on a preinsolvency assessment basis.

Without denigrating the performance of State postinsolvency assessment laws, we agree with Senator Brooke's remarks on introducing S. 1710. It is true that these laws have yet to face the collapse of a major insurer with widespread interstate obligations. Such an unfortunate eventuality could place tremendous pressure on the present State-by-State system. Securing policyholders and claimants from losses resulting from an insurer insolvency through postinsolvency assessments has obvious weaknesses. Insurers cannot anticipate the cost of insolvencies and they can be exposed to assessment at time when all

or most insurers are suffering substantial losses. As an example, if GEICO had not been revived, assessments would have been imposed on insurers at one of the most critical periods for property-casualty insurers in recent years.

A glaring inequity of a postinsolvency assessment system is that only the healthy and well-managed companies contribute. Those that collapse through mismanagement or even fraud may never have contributed a penny to meet insolvency losses. A State preinsolvency assessment fund may be theoretically preferable, but again as Senator Brooke has pointed out, State security funds are subject to the whims of the legislature. Recently, the New York security fund was rendered illiquid just, in the words of Senator Brooke, “when it was most likely to be called upon to deal with an insurance company insolvency." Twice, moneys from the old New Jersey automobile preinsolvency assessment security fund were diverted into the New Jersey Unsatisfied Claims and Judgment Fund (chapter 241, laws of 1967 and chapter 322, laws of 1968).

American Insurance Association still supports the concept of a Federal insurance guaranty system. We believe a Federal system is the proper answer to possible insurance company insolvencies. Some form of Federal supervision would be a necessary adjunct to a Federal guarantee system but the supervision should be limited to what is essential to assure that the participating companies are financially sound and competently managed. In this respect S. 1710 grants broad regulatory power to the proposed Federal Insurance Commission, which in some areas is not clearly defined. Such pervasive, and to some extent uncertain, power bestowed upon the Federal regulatory body by S. 1710 is sure to feed fears that this bill is the beginning of the end of State regulation. Companies and State regulators will not be placated by the fact that not only is a Federal chapter optional but no company is required to seek a Federal guaranty certificate. Many believe that the choice is more apparent than real.

If most major insurers become part of the Federal guarantee system, the State postinsolvency assessment laws may no longer be viable, with the result that all insurers would be forced to apply for Federal guarantee certificates. With that "election" comes the distinct possibility that its financial operations, including its investment policy, will come under Federal control.

American Insurance Association continues to support the concept of a Federal insurance guarantee system, but we are concerned with the extensive Federal regulation contained in S. 1710. We believe a Federal guarantee system can be achieved without establishing a large Federal supervisory body and without providing a very broad and comprehensive pattern of control covering all aspects of financial management.

TITLE II—FEDERAL CHARTERING OF INSURANCE COMPANIES

The unusual, and unique for the insurance industry, part of the bill is title II, providing a Federal chartering alternative. Many segments of the business will be opposed to title II for a variety of reasons, but it may have an attraction for some companies. It will appeal to some

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