(This article was derived from a panel discussion at the 78th Annual AAMGA Meeting, which was held in May in Phoenix.)

UNDER pressure from the federal government, state insurance departments are moving toward a more uniform and streamlined approach to insurance regulation. The initial impetus was the passage of the federal Gramm-Leach-Bliley Financial Modernization Act of 1999. It contained a provision calling for the creation of a National Association of Registered Agents and Brokers (NARAB) if at least 29 states did not enact uniform or reciprocal licensing laws for nonresident producers by November 2002.

The law contained quite a "hammer." If the goal were not met, NARAB would come into existence, establishing uniform producer licensing laws nationwide, and preempting individual states' licensing procedures and qualifications. The threat proved enough to get just about every state to enact reciprocal licensing laws; i.e., laws that allow an agent licensed in one state to do business in another. A system of uniform producer licensing goals, however, is still far from a reality.

Uniformity in most, if not all, aspects of insurance regulation seems to be the cry since the passage of Gramm-Leach-Bliley. Some participants in the insurance industry, including many life insurance and annuities companies, are calling for a dual charter approach that would give insurers the option of being regulated by the states or the federal government.

U.S. Rep. Mike Oxley (R-Ohio) appears to have different ideas, however. Oxley is chairman of the U.S. House of Representatives' Financial Services Committee, which over the past three years has held 14 hearings and "roundtables" concerning insurance regulatory reform and has now started the process of drafting legislation. Oxley is on record as being opposed to an optional federal charter, but has made it clear that he wants states to adopt uniform regulations where it makes sense to do so.

Seeing the writing on the wall, the National Association of Insurance Commissioners has been working on reform for the past three years, hoping it can come up with a plan that persuades Congress that it doesn't need to create one of its own. In March 2000, it approved a "statement of intent" concerning the future of insurance regulation. That was followed in September 2003 with a modernization action plan. In March, Oxley appeared at an NAIC meeting, where he commended the NAIC for its work to date. Citing NARAB as an example, Oxley also said he believes "federal tools"-i.e., federal legislation-are needed to prompt the states to act where they have been unable to find the will to do so in the past.

Regulatory reform is a multifaceted chore; and as individual tasks are tackled, the states have been far from in agreement about what needs to be done. For instance, there has been movement, but no stampede, in state legislatures to enact legislation to join the NAIC's proposed Interstate Insurance Product Regulation Compact. The compact would enable insurers to file life, annuity, disability income, and long-term care products with a single multistate commission, rather than the individual states. The compact would become operational when 26 states representing 40% of the premium volume for the aforementioned lines decide to sign up. So far, eight states have approved legislation and 12 more are considering it. Meanwhile, commissioners in three large states-California, Texas and Florida-separately enacted their own memorandum of understanding to enable insurers to make a single filing for new annuity or life insurance products and then immediately start marketing them in those states.

At the annual convention of the American Association of Managing General Agents, which was held in May in Scottsdale, Ariz., a panel of regulators discussed where things might go from here and also touched on the implications of regulatory reform for the surplus-lines industry. Taking part were Kevin M. McCarty, director of the Florida Office of Insurance Regulation, J. Robert Wooley, commissioner of the Louisiana Department of Insurance, Paula Davis, deputy commissioner of the Louisiana Department of Insurance, and Charles R. Cohen, who until last November was the Arizona director of insurance. He is now a lawyer in private practice. The panel's moderator was Andrew Frazier, CPCU, president of Western World Insurance Group. What follows are edited excerpts from the panel's comments.

Andrew Frazier: I think the discussion we're having today is very timely because of what is going on right now in Washington. The House Financial Services Committee is within weeks of introducing a bill that would set mandatory and uniform standards among the states in the regulation of insurance. We don't yet know the contents of this bill, but we have a pretty good idea that there are a number of areas likely to be addressed, starting with the interstate licensing of producers, licensing of companies, the taxation of multistate surplus-lines risks and, possibly, most important, the potential deregulation of rates and forms for admitted companies. All of these issues have important implications for everyone in this room. Our panelists will start off with opening comments about these regulatory reform issues.

Kevin McCarty: I'm a big proponent of state regulation; but if you look back, we can think of many examples where it has been an abysmal failure. I was at a conference once, where an insurance company executive told me about a routine filing he made in a certain state. He said he received a deficiency letter from the insurance department, stating that the filing did not pass the state readability test. The company reviewed the contract and found that the reason it did not pass was because of its inclusion of state-mandated language. That is probably an extreme example of some of the failures of state-based regulation.

I know that since the passage of Gramm-Leach-Bliley, there has been a major push by the leadership of NAIC to get the commissioners and directors across the states serious about the threat of federal regulation. But more important than the threat of federal regulation is the threat of a system that does not make sense. It just does not make sense that regulators cannot do more to promote efficiency and eliminate burdensome requirements-particularly since we have a difficult time showing any relationship between those burdens and the protection of the consumers.

I think the time for us to demonstrate that we can be successful in reforming the state regulation of insurance is fairly short. I think the opportunity is great and the chance for failure is equally great. I'm proud of the work of the NAIC but, having said that, I think we have a long way to go.

It is interesting that the NAIC is being utilized as a change agent. I mean, if you have had dealings with the NAIC, that is probably not how you would describe it. Some insurance executives refer to the NAIC as No Action Immediately Contemplated. When you are working on an action plan for modernization that takes three years to get consensus, the term "action plan" becomes a misnomer. I do believe, though, that the leaders of the NAIC understand the importance of having us reinvent ourselves and changing the way we do business.

Robert Wooley: I agree with a lot of what Kevin says. I know if I were an insurance company executive, it would drive me crazy to have to deal with 51 jurisdictions with 51 different sets of rules, and to have it sometimes take years to get forms and rates approved. It just doesn't make a lot of sense, especially in today's marketplace, where you have highly competitive areas in the insurance industry. We have hung on to a system of regulation that punishes the entire industry in the hopes of catching a few bad guys, and it's not working. It needs to be improved, and how we get there, I guess, is what the debate is about.

Competition is one of the best ways to find out who the bad guys are. Insurance companies are so competitive they'll turn each other in. Competition can work to help protect consumers and give them more choices.

In Louisiana, we're doing our best to encourage competition and bring more insurers to the state. We have maybe 25 companies writing homeowners statewide. Of those only about 12 will write south of Interstate 10. We had to do something, so we are starting to undo our prior-approval system for rates and forms. And by the time I'm finished, we will be Illinois without snow. (Congressman Oxley has praised Illinois' long-standing open-competition rating system.) We are going to do this responsibly, because if we immediately went from a totally prior-approval system to a totally use-and-file system, there would be chaos in the marketplace.

We have to help the insurance department's staff understand the change. Sometimes that's difficult, because a lot of those people have been there 25 years, and ask, "Without prior approval, how are we going to protect the consumers?" Others simply say, "This is the way we've always done it."

On the insurance industry side, they have their security blankets, too. When I tried to push for self-certification of forms, I got a scream from some insurers. "Wait a minute," they said. "We like to have the Department of Insurance put a 'good housekeeping' seal of approval on our forms. Then, when we find ourselves in court, we can say, 'But judge, that's approved by the department.'"

If we are going to have true competition, everybody is going to have to put their security blankets in the corner and walk away from them. So we're working with the industry and trying to allay their fears. Like I said, we're doing this in a very responsible manner. But before I leave as commissioner, we will be a use-and-file state for almost everything.

And I think that's where Congress is headed. Chairman Oxley and Chairman Baker [U.S. Rep. Richard Baker (R-La.), chairman of the House Financial Services Committee's Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises] have told me that's what they're looking for. They're looking for competition to operate in the marketplace. And if they have to bring it about with a cattle prod-by which I mean the federal tools, which have been called "NARAB on steroids"-I think we'll get it that way.

We're going to try to be on the front end of the curve in Louisiana and move toward the things Congress is going to push for. In that regard, I applaud Florida, Texas and California for their memorandum of understanding, creating a central point for filing new life and annuity products in those three states. We instructed our people to learn more about it, because it looks like a good system. It's simple; the industry likes it. The problem is that the staff at NAIC isn't in love with it. But looking at such ideas should be part of what we're doing.

Paula Davis: In Louisiana over the past three years, we have been aggressive in reforming the way we do business at the Department of Insurance. We've been educating our legislators, letting them know why competition works and that competition will benefit their constituents. We've been talking with insurance companies and agents, as well.

Last year, the legislature approved a 10% "flex-band" ratings system for all lines of insurance. (Insurers can file actuarially justified rate changes that are no more than 10% above or below existing rates on a 30-day, file-and-use basis.) It went into effect in January, and since then we've have 167 filings under the flex-band system. We have a commercial-lines deregulation bill that is currently before the state legislature. The bill has a $10,000 minimum written premium.

Use-and-file rates would apply to any risk larger than that. In regard to forms, we have enacted a self-certification process for certain lines. In spite of their initial protests, companies are using it and are encouraging us to add lines as we go, which we're doing.

Charles Cohen: I think what we have now is an insurance regulatory system that is anachronistic. The world around it has evolved, and the system has not changed enough to keep pace with it.

Today, we have local, national and international markets in the insurance industry. If we are to be pragmatic, I believe we must have a regulatory system that also has local, national and international elements that can mesh efficiently and effectively. Believe me, I'm a big supporter of the states doing the part of insurance regulation that is local in nature. But the way the world is now, you need some kind of effective system of national regulation.

I think what we need for a good national system are two basic elements. You need national standards, and you need a sensible and effective mechanism to ensure they are implemented. The inevitable and obvious conclusion is that some kind of national uniformity is going to have to come down from Congress in some way. I think the more elusive issue-and one that seems to me to not get enough attention-is, what's the national regulatory mechanism? If you are going to have uniform national standards, how are you going to put this system into effect? This is where the wheels always come off on these kinds of reforms. I personally favor some sort of hybrid, multilayered system of insurance regulation, a strategic alliance of local, national and even international components that is not just a code of regulations but is actually a working system.

Andrew Frazier: I'm hearing optimism in the individual states with regard to regulatory reform, but pessimism about coordination with the other states. Can the states really get together and develop true uniform regulation and hold off federal regulation, or am I hearing that many commissioners view the possibility of federal standards as a good thing to accomplish what in aggregate the states have been unable to do?

Kevin McCarty: I think it really depends on your perspective. And what does "accomplish" mean? The people who are questioning the value of state regulation-particularly the life companies-are big proponents of not just the federal tools but also a dual charter. There is another group of people who say, "Well, we met the standards of Gramm-Leach-Bliley by having (at least) 29 states participate in the agents licensing." Unfortunately, it did not include any of the large states. The same thing is true with the NAIC's Interstate Insurance Product Regulation Compact. So far, only low-population states like Utah, West Virginia and Hawaii have joined it. The six largest states, representing 56% of the premiums in the affected lines, have not.

We support the Interstate Compact (at the NAIC Web site, Florida is listed as one of 10 states that plans to introduce enabling legislation in 2005), but one of the reasons we also adopted the memorandum of understanding is to get the large states comfortable with what we think is inevitable: shared state responsibility for the review of forms and rates. Unless we get that comfort level, you will have another situation like NARAB, where we get the required 26 states to join the Interstate Compact, but they do not include the largest states. I hardly think the industry would consider that successful.

Robert Wooley: I think Kevin is right. I've seen regulatory reform as a debate between the small states and the big states-and even the big states against each other. That's why I was encouraged to see the announcement about the memorandum of understanding. A lot of people thought it was just a power play, or a matter of some big states leaving the reservation, but I thought the memorandum of understanding was very significant. A lot of small states are gravitating to it, too, because it's something that works well. So I think it might be a good mechanism to spur everybody's interest in the ideas behind the compact.

Part of the problem is that some states have had nasty experiences with other interstate compacts governing things like nuclear waste. So just calling something a compact makes it a little more difficult to discuss with state legislators than something called a memorandum of understanding, which doesn't give away the entire farm as far as state autonomy is concerned. But then you also have legislatures that simply say: "We don't want to give up the right to legislate for our citizens. We're not going to do anything to get along with anybody." That's why I think you're going to have to have some type of federal intervention, either by imposing some really tough penalties if you don't get in compliance, like NARAB, or simply by passing minimal national uniform standards.

Andrew Frazier: I'm gathering from the panel that, as we've seen with NARAB and now with the Interstate Compact, the states will be unable to agree on their own to a system of uniform regulation and, therefore, that a federal "hammer" or a federal standard is going to be required. If that's the case, we're talking about the nose of the camel under the tent in regard to federal regulation of insurance. Should this happen, what's the worst-case scenario?

Charles Cohen: I think the worst-case scenario is the obliteration of the state regulatory system and its replacement with some kind of wholly federal system. But that's not the answer, either, as I indicated earlier. I think you need a multi-layered system that has all the components needed to deal with a multi-layered market.

Completely replacing the state regulatory system would be very destructive. There are large parts of the insurance market that are most appropriately overseen by the state regulatory system. The state system also is the treasure trove of insurance regulatory knowledge and experience. To see that thrown away would put us back in the Stone Age of insurance regulation. Looking at it from the perspective of the specialty markets and the excess markets, this would cause a great disruption of your marketplace. There would still be a need for excess capacity and specialty lines, but you'd be throwing your cards in the air; you'd have a totally different system for delivering those products in that new environment.

Paula Davis: We all know Congress moves at a snail's pace. Some insurers may complain that state regulators don't move fast enough, but I can't imagine what they would think if we had a federal regulator.

Robert Wooley: I don't think turning over all insurance regulation to the federal government is the solution at all. There has to be something in between that and the current system, because those on the federal side have already shown in this debate an astounding lack of insurance knowledge.

During the last session of our legislature, some enterprising paralegal created a huge problem for us by uncovering a law that had been on our books for 60 years, requiring surplus-lines companies to post bond every time they got sued, with the court determining the amount. You can imagine our difficulty in trying to explain why this was a problem to legislators. Try explaining what a surplus-lines insurance company is. First off, it sounds like you don't need it.

We had to explain that if they thought people were screaming at them now about the price of their insurance, wait until they start calling to say they can't even get it at any price. If we keep this law on the books, we explained to the legislators, surplus-lines companies would simply leave the state. Lawyers would use the bond requirement as leverage against the insurers to keep them from using legitimate defenses. They would just ratchet up the cost of defending a claim until it became more palatable to settle it.

Try to explain something like that to Congress and see whether you don't get blank stares, because they don't have any concept of insurance regulation. At least in the state legislatures, you do have some basic knowledge about the issue. We could tell our legislators, to continue my previous example, that if the surplus-lines companies go, your constituents are going to be calling you-including the shipping, petrochemical, and oil and gas industries, which are some of the largest users of surplus-lines insurance. Those are all big players in your state, and they are going to be without any mechanism to get the insurance they need.

Andrew Frazier: Both AAMGA and NAPSLO have adopted regulatory principles that can be distilled down to the following points as they relate to federal standards for state regulations:

First, do no harm:

?Surplus-lines transactions are free from rate and form regulations in all 50 states. It hasn't always been that way, and the system is constantly under attack. From our perspective, if there are to be federal standards, then freedom from rate and form regulation for the surplus-lines market is a critical one.
?Almost as critical, if certain sectors of the market are to be deregulated under federal standards, then transactions in those sectors should automatically qualify for export to the surplus-lines market without requiring agents and brokers to make a diligent search for coverage in the admitted markets. This provides the insured with the greatest competitive choices for coverage and protects the vital surplus-lines mechanism from unnecessary market barriers.

Second, do some good:

?Uniform and reciprocal state licensing of producers would be an improvement over what exists today.
?A single point of payment for surplus-lines taxes on multistate risks would be a vast improvement over the conflicting regulations that exist today.

I ask the panel to comment on these regulatory principles and their prospects for implementation in any changed regulatory system.

Charles Cohen: I am in agreement with those statements of principle. Certainly, freedom of rate and form regulation is the underpinning of surplus-lines insurance. And I agree with automatic export of deregulated products. There's no reason I can think of to give the admitted carriers a competitive advantage over nonadmitted carriers with respect to deregulated business. In Arizona, where we enacted a commercial-lines deregulation law, it included automatic export for insurance obtained for exempt commercial policyholders. Enhancing competition, as automatic export does, should be one of the goals of deregulation.

Robert Wooley: I'm very fortunate to have a strong surplus-lines market, and we have fought to keep it that way. If it weren't for surplus-lines companies, we would be in a real fix. The reason these lines aren't regulated is to give surplus-lines carriers the flexibility to offer coverage for something admitted carriers would never even look at. We need to maintain that.

A single point of payment for surplus-lines taxes is going to be problematic, however, because the states depend on these taxes to a large degree-especially with the budget shortfalls many states have. The problem is, if you give up all our part of that income over a single-point-of-payment plan, how do you fill the hole? In our state, it would create a $180 million hole every year.

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