Who Will Be The Hammer?

There's an old adage in Washington which says the two biggest mythsin American politics are that Republicans believe in limitedgovernment and Democrats are compassionate.

Reps. Mike Oxley, R-Ohio, and Richard Baker, R-La., are doingtheir best to counter at least half of that sentiment by proposingfederally mandated standards for insurance regulation withoutcreating a federal bureaucracy.

While details of the regulatory scheme were not revealed duringa House Financial Services Committee hearing on regulatory reformlast week (see story on page 7), there is already a lot of talkabout whether they can pull this off.

As outlined by Rep. Oxley during a recent speech before theNational Association of Insurance Commissioners, the system he andRep. Baker seem to have in mind is unprecedented. I am not aware ofany existing model of federal mandates that is not backed up by afederal bureaucracy of some size.

Let me note that this is very early in the process. No onereally expects regulatory reform legislation to be enacted thisyear. Scores of questions will arise during the course of thedebate over how the Oxley-Baker system will function. I suspectthat whatever they propose this year will be adjusted many times asproblems are identified.

But there are two major issues that stand out:

o The first is how will Reps. Oxley and Baker compel states tocomply with the minimum standards.

o The second is what type of mechanism will be established toresolve disputes over the variations in interpretations that willcertainly occur.

It will take some very imaginative thinking to address theseissues in a way that does not create a federal regulator.

Looking first at compliance (which we inside-the-Beltway typeslike to call the “hammer”), the model everyone looks at is theNational Association of Registered Agents and Brokers. Under NARAB,the “hammer” was the possibility that a federally-chartered,self-regulatory organization would come into existence if thestates did not take sufficient steps to harmonize their producerlicensing laws and regulations by a specified timetable.

In other words, the states risked losing some control over agentlicensing unless they took the appropriate steps themselves.Possibly, some variation of NARAB could be adapted to force statesto create uniformity in product approval, rating, market conductand similar concerns.

But there is a problem. The constitutionality of NARAB wasalways subject to question, even though it was never tested. It wasnever entirely clear who in the federal government would overseeNARAB, should it come into existence.

Some government agency must oversee SROs, because it isunconstitutional for Congress to delegate power to an entity thatis not answerable to the nation's elected representatives.

The National Association of Securities Dealers is a primeexample of how an SRO works. NASD can issue rules, but it issubject to oversight by the Securities and Exchange Commission,which is itself subject to oversight by Congress.

Thus, if the “hammer” is the threat to create a NARAB type oforganization, there will have to be some type of bureaucracycreated to meet the constitutional requirements, should theorganization come into existence.

Another possibility is withholding some federal funding tostates that are not in compliance. This is also tricky. Which fundswill be withheld? Highway safety funds? Is that really a good ideawhen we want to reduce accidents on the nation's roadways?

In any case, someone in the federal government will have to makea formal determination of whether the states are in compliancebefore the funds are withheld. That person will be, for lack of abetter term, a regulator, unless Reps. Oxley and Baker can come upwith an alternative that no one has yet envisioned.

Similarly, the dispute resolution mechanism is a troublingissue. Someone will have to decide whether a particular state'sinterpretation and enforcement of a given standard are valid,because inevitably, variations in interpretation will occur.

Who will decide? Reps. Oxley and Baker suggest there could be afederal-state advisory panel that will make recommendations oninterpretations, and one personlet me repeat that, ONE personhousedsomewhere in the government who would simply stamp yes or no on thepanel's recommendations.

But it is not clear that this system would be legal. Federal lawand administrative case law require the governmentincluding the ONEperson noted aboveto follow certain procedures when issuing rulingsand determinations.

It is not sufficient to simply rubber stamp the recommendationsof an advisory panel. The person responsible for making thedetermination must engage in an evidence-based review. That personmust create a record to demonstrate that the determination is notarbitrary and capricious. And, of course, the determination will besubject to court challenge.

This person, one suspects, will need some type of staffing inorder to meet the responsibilities of the office. Another term forthat staffing is “bureaucracy.”

There may be ways around all this. I don't want to suggest itcannot be done. But it will take a lot of creative thinking toavoid a fairly sizable federal bureaucracy responsible forinsurance regulation under the Oxley-Baker approach. Maybe they cando it, but right now, I'm not placing any bets.

Reproduced from National Underwriter Edition, April 2, 2004.Copyright 2004 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.