Free Market Strategies for Insurance Reform

The provision of property and casualty insurance has long been the largest and most important sphere of economic activity regulated entirely at the state level. Since shortly after the Civil War, however, many insurance reform proposals have included partial or total federal regulation of insurance. In recent years, proposals for federal regulation have centered around ideas for optional or largely optional federal chartering that would allow most insurers to pick between federal and state regulation. In recent months, two major proposals to regulate insurance federally have appeared.

The first, the National Insurance Consumer Protection Act (NICPA, H.R. 1880), would establish a federal regulator for insurance. Under the proposed law, known as NICPA, a new federal bureau would regulate insurers’ rates, forms, and solvency. However, insurers would still have to pay state taxes, participate in state-run residual markets and state guarantee funds (as well as a newly created federal one), conduct most litigation in state courts, and follow all general-purpose state business laws. Homeowners’, automobile, commercial, and life—but not health—insurance would all fall under the sway of the new federal bureau.

Under NICPA, insurers would still have to charge rates high enough to maintain the capital needed to pay their likely claims, but would not have to file rates or justify how high rates would go. However, they would have to document rate decisions to government inspectors upon request. Proponents of the law argue that it would allow insurers to market the same products throughout the country—something that current law makes nearly impossible because each state requires a separate filing for each product. They also argue that it would encourage risk-based rates and product innovation. Groups like the National Association of Insurance Commissioners (NAIC) and the Coalition Opposed to a Federal Insurance Regulator have opposed the bill claiming that it fails to protect consumers from excessive insurance rates and grabs power for the federal government.

The second proposal stems from the Obama administration. Under Secretary of the Treasury Timothy Geithner’s proposals—yet to be released in the form of specific legislation—the federal government would assume responsibility for overseeing a new system for regulating against yet-to-be-defined systemic risks. Most other affairs, including most or all existing powers over rates, forms, and solvency of most companies would remain with state regulators.

Given the recent turmoil in financial markets, a revision of the federal role in insurance regulation appears very likely. Of all the proposals that have been put forth, a full-scale optional or largely optional federal regulator would go the farthest toward creating a more open national insurance market. This would benefit consumers through increased choice and insurers through the opening up of new business opportunities. However, given the political difficulty of major reform, and the political likelihood of greater federal regulatory involvement over certain aspects of insurance, aspects of other, more piecemeal proposals may be worth considering.

This paper explores six proposals that are less comprehensive than NICPA, but are still designed to free the nation’s insurance markets while improving the quality of regulation and oversight. Thus, the six proposals represent a potential “middle ground” from which a better system for regulating insurance might possibly emerge. The options are:

• An Office of Insurance Information (OII) that would serve as a repository of insurance-related knowledge in the federal government but have no regulatory powers.
• An interstate property and casualty compact (or law) that allowed states to delegate certain insurance-related functions to a federal regulator. • A phased implementation of NICPA.
• A “life only” federal charter that would give life insurers the option of subjecting their life insurance operations to a federal charter but leave other lines out.
• A “three pack” optional federal charter that would largely follow the outlines of current federal chartering legislation but leave the regulation of insurance for homes and other non-commercial real property at the state level.
• A “federal charter-lite” that would allow interstate insurers to subject themselves to federal regulation of rates and solvency requirements while otherwise remaining under state oversight. (This proposal appears consistent with Secretary Geithner’s stated goals for regulation and could be considered a version of the Obama administration’s proposal.)

This paper describes each of these options and outlines their advantages and disadvantages from a free-market perspective.