The long-delayed U.S. Treasury's Federal Insurance Office (FIO) modernization report concludes that the debate at present is not whether insurance regulation should be state-based or federal, but whether there are areas in which federal involvement in regulation under the state-based system is necessary.

The report, released long after it was due to Congress in late January 2012, states that "the basic question with respect to reforming any aspect of insurance should be whether federal involvement is in fact warranted at this time—and if so, in what areas.

"The necessity for federal involvement should depend on assessment of questions such as whether states can take measures to regulate effectively and with uniformity the degree of the national or federal interest, and the nexus of the issues and the firms with the global marketplace."

The industry as it stands has a role for federal government, according to the Treasury. The report offers suggestions of how various authorities can work together to improve uniformity and address the new realities of a globally active and diversified insurance industry.

The FIO concludes that insurance regulation in the U.S. is best viewed in terms of a hybrid model, in which state and federal oversight play complementary roles defined in terms of the strengths and opportunities that each brings to improving solvency and market-conduct regulation.

The report recommends 18 areas for "short-term" insurance regulation improvement, centering around capital adequacy, reform of insurer resolution practices and marketplace regulation, and nine areas of direct federal involvement in regulation (see p. 16.).

The strongest areas of proposed federal intervention are in mortgage insurance, reinsurance collateral and the monitoring of National Association of Registered Agents and Brokers Reform Act.

Treasury officials have a keen interest in the consumer's access to insurance and in the financial stability of the marketplaces, with insurance as a key linchpin. Recent evidence of this includes recommendations for oversight of private mortgage insurance and mortgage insurance pools markets, as well as in personal lines like auto with respect to the practice of risk-profiling groups and individuals based on personal information.

The Treasury also makes no bones about its commitment to being a guiding hand in international insurance regulatory areas. It also made clear that it would stay very involved in international regulation as insurance is ever more global and as many insurers in the U.S. are owned by overseas companies.

The report also calls for federal mortgage insurance oversight for all aspects of the mortgage business. This is a recommendation that would have to be enabled by an act of Congress. The Federal Home Loan Finance Agency overseeing Fannie Mae and Freddie Mac already set capital standards for mortgage insurance companies that want to do business with Fannie and Freddie, which is de facto federal regulation.

The states would still retain licensing of producers and premium taxes under the Treasury proposal.

It endorses, as expected, a cautious proceeding on principles-based reserving.

Many of the state-based recommendations are efforts already being put into practice by the National Association of Insurance Commissioners, although FIO would like to see a third party review accreditation for states for the sake of actually abiding by uniform standards.

Additionally, the report makes clear that the FIO has authority to monitor the affordability and accessibility of non-health insurance products to traditionally underserved communities. The FIO will study the appropriate boundaries of use of personal information for insurance pricing and coverage purposes.

The report's areas for direct federal involvement in regulation:

1. Federal standards and oversight for mortgage insurers should be developed and implemented.

2. To afford nationally uniform treatment of reinsurers, FIO recommends that the Treasury and the U.S. Trade Representative pursue a covered agreement for reinsurance collateral requirements based on the NAIC Credit for Reinsurance Model Law and Regulation.

3. FIO should engage in supervisory colleges to monitor financial stability and identify issues or gaps in the regulation of large national and internationally active insurers.

4. The National Association of Registered Agents and Brokers Reform Act of 2013 should be adopted and its implementation monitored by FIO.

5. FIO will convene and work with federal agencies, state regulators and other interested parties to develop personal auto insurance policies for U.S. military personnel enforceable across state lines.

6. FIO will work with state regulators to establish pilot programs for rate regulation that seek to maximize the number of insurers offering personal lines products.

7. FIO will study and report on the manner in which personal information is used for insurance pricing and coverage purposes.

8. FIO will consult with Tribal leaders to identify alternatives to improve the accessibility and affordability of insurance on sovereign Native American and Tribal lands.

9. FIO will continue to monitor state progress on implementation of Subtitle B of Title V of the Dodd-Frank Act, which requires states to simplify the collection of surplus lines taxes, and determine whether federal action may be warranted in the near term.

The state-directed recommendations include:

1. For material solvency oversight decisions of a discretionary nature, states should develop and implement a process that obligates the appropriate state regulator to first obtain the consent of regulators from other states in which the subject insurer operates.

2. To improve consistency of solvency oversight, states should establish an independent, third-party review mechanism for the NAIC Financial Regulation Standards Accreditation Program.

3. States should develop a uniform and transparent solvency oversight regime for the transfer of risk to reinsurance captives.

4. State-based solvency oversight and capital adequacy regimes should converge toward best practices and uniform standards.

5. States should move forward cautiously with the implementation of principles-based reserving and condition it upon: (1) the establishment of consistent, binding guidelines to govern regulatory practices that determine whether a domestic insurer complies with accounting and solvency requirements; and (2) attracting and retaining supervisory resources and developing uniform guidelines to monitor supervisory review of principles-based reserving.

6. States should adopt and implement uniform policyholder recovery rules so that policyholders, irrespective of where they reside, receive the same maximum benefits from guaranty funds.

7. In order to fairly protect consumers in all parts of the U.S., every state should adopt and enforce the National Association of Insurance Commissioners Suitability in Annuities Transactions Model Regulation.